Brandywine Realty Trust Q2 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to the Brandywine Realty Trust Second Quarter 2020 Earnings Conference Call. At this time, all participants’ lines are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Mr. Jerry Sweeney, President and CEO. Sir, you may begin.

Crystal, I appreciate it. Good morning, everyone, and thank you for joining our second quarter 2020 earnings call. Along with me today are George Johnstone, our Executive Vice President of Operations; Dan Palazzo, our Vice President and Chief Accounting Officer; and Tom Wirth, our Executive Vice President and Chief Financial Officer. Before we start, I want to mention that some information shared during this call may include forward-looking statements as defined under federal securities law. While we believe that the estimates provided in these statements are based on reasonable assumptions, we cannot guarantee that the expected results will be realized. For more details on factors that could affect our outcomes, please refer to our press release and our most recent annual and quarterly reports filed with the SEC. To begin, all of us at Brandywine hope that you and your families are staying safe and healthy during this challenging time. The pandemic continues to affect our lives and has changed the landscape for businesses everywhere. It is becoming increasingly uncertain how long this crisis will last. During our earnings call on April 23, we expected a return to normal workplace conditions by mid-summer; however, recent developments have pushed that timeline back. We are constantly evaluating COVID-19's impact on all facets of our business. Based on our comprehensive review, we remain optimistic about our ability to execute every aspect of our 2020 business plan. More information on how we are addressing this crisis can be found in our COVID-19 insert on Pages 1 to 5 of our supplemental package. During our prepared remarks, we will discuss second quarter results and provide updates on our 2020 business plan. We will also cover the recently announced joint venture involving our One and Two Commerce Square properties in Philadelphia's Central Business District. Tom will share insights into our financial outlook and update you on our strong liquidity status. After that, Dan, Tom, George, and I will be available to answer your questions. Looking at the second quarter, we continued to execute our 2020 business plan effectively. For speculative revenue, we are almost at our goal, with only a small amount remaining to reach our target for the year. We experienced solid leasing activity in the second quarter, with 400,000 square feet in both new and renewal leases, leading to strong rental rate increases. However, the delayed reopening of Philadelphia has caused a $2 million decline in net operating income from our parking operations for the remainder of the year. This decline in parking revenue has affected our same-store cash and GAAP ranges. Office operations are progressing as planned, with excellent cash collection rates—over 99% of our second quarter billings have been collected, and July's collection rate shows a similar trend. Our capital costs are at the lower end of expectations, and we've adjusted our estimated full-year capital ratio down to 11% to 12%. We experienced a retention rate of 37%, significantly impacted by SHI's move-out in our Austin portfolio, although we have found replacements for most of that space. We anticipate occupancy levels will return to our target range of 92% to 93% by the end of this year. Our funds from operations were $0.34, aligning with consensus expectations. This crisis presents both challenges and opportunities for our company. We are prioritizing risk assessment and implementing strategies to mitigate adverse effects while focusing on opportunities for enhancing our business plan. Concerning COVID-19, we are maintaining an open and operational stance for our buildings according to health guidelines. Current occupancy levels are estimated to be around 5% to 10% in Philadelphia's Central Business District and 10% in Austin, among other locations. Collecting rent and managing deferrals remain critical priorities, and we are actively communicating with all our tenants, especially those with lease expirations in the next two years. On the construction front, our markets are allowing activities to continue with minimal delay. We are witnessing a potential decrease in construction costs as the pipeline for future projects continues to dwindle. Our leasing pipeline stands at 1.5 million square feet, and we've seen progress in that pipeline over the past quarter. Notably, many deals previously on hold due to COVID-19 are now moving forward. We are also excited to announce a joint venture involving our One and Two Commerce Square buildings in Philadelphia with a reputable global institutional investor, who is making their first office investment in the city. This partnership highlights the appeal of the Philadelphia market and Brandywine’s capability to create value. The venture includes a $115 million preferred equity investment, which represents 30% of the total capitalization of $600 million. Following deductions for rents and closing costs, Brandywine will receive more than $100 million in net proceeds, enhancing our strong liquidity position. We are looking to refinance the existing mortgage as the leasing process unfolds, which will also boost liquidity for both parties involved. Turning to our liquidity, we expect to have $500 million available by year-end 2020, which could increase to $580 million if we refinance an upcoming mortgage. Our financial health remains robust, with manageable debt obligations. We anticipate $55 million in free cash flow after servicing debt and dividend payments for the latter half of 2020, and our dividend payout ratio is well covered. Now regarding our development pipeline, all our projects are fully approved and ready to proceed once we identify pre-leasing opportunities. We expect no major advancements until the crisis subsides. Current development projects remain on track, and the Bulletin Building is close to full occupancy. In summary, we continue our active discussions with institutional investors and private equity firms about potential joint ventures to enhance our capital returns and provide growth opportunities. Due to the uncertain environment, we will not issue 2021 earnings guidance during our third quarter call but aim to provide that information by the fourth quarter. I will now hand it over to Tom for a look at our financial results.

Thank you, Jerry. Our second quarter net income totaled $3.9 million or $0.02 per diluted share, and FFO totaled $57.7 million or $0.34 per diluted share. Some general observations regarding the second quarter results. Operating results were generally in line with our first quarter guidance with a couple of items to highlight on our portfolio operating income, we estimated $8 million – $80 million in portfolio NOI, and we were $1.1 million higher than that. While we did have parking being about $1 million below our anticipated reduced parking level, primarily due to the transit and monthly parking. We did have lower physical occupancy, and therefore sequential operating expenses were lower, and we experienced higher operating margins in 2Q 2020, offsetting the lower parking income. Interest expense improved by $0.8 million, primarily due to lower interest rates than forecast. Our second quarter fixed charge and interest coverage ratios were 3.4 and 3.7 times respectively. Both metrics were similar to the second quarter of 2019. As expected, our second quarter annualized net debt to EBITDA increase. The increase to 7.0 times was primarily due to the lower anticipated sequential EBITDA outlined in the prior quarter. Adjusting for the Commerce Square transaction on a pro forma basis for the second quarter, that 7.0 would decrease to 6.7. Two reporting items to highlight for the second quarter cash collections, as reported, overall collection rate for the second quarter was a very strong 99.6%, based on actual quarterly billings. However, if we did include the second quarter deferred billings, our core portfolio collections rate would still have been a very strong 97%. In addition, cash same-store, as outlined on Page 1 of our supplemental, we have included $2.3 million of rent deferrals in our second quarter results. While not billed during the quarter, we feel this presentation is more accurately representing our current same-store metrics with normalized ongoing forward results not inflated by the subsequent deferred cash receipts. Looking then to third quarter guidance. Looking forward, we have portfolio operating income will total approximately $74 million and will be sequentially lower by $7.1 million. This decrease is primarily due to the Commerce Square JV. The joint venture will result in deconsolidation of the property and that will lower the NOI by $7.5 million. One good pickup on the other side is there’s $1.2 million of incremental income for the Bulletin Building, which has been placed into service in June and the building is now 94% occupied. FFO contribution from our unconsolidated joint ventures will total $6.5 million for the third quarter, which is up $4.1 million from the second quarter, and that’s primarily due to the Commerce Square joint venture, which has been deconsolidated effective with our earnings yesterday. For the full year 2020, the FFO contribution is estimated to be $19 million. G&A for the third quarter will total $7.3 million and will be sequentially $1 million lower than the second quarter. This is primarily due to lower compensation award amortization, and it’s pretty consistent with prior years. Full year G&A expense will approximate $31 million. Interest expense will be $1.5 million sequentially compared to the second quarter and will total $18 million for the third quarter, with 94.5% of our balance sheet debt being fixed rate at the end of the second quarter. The reduction in interest expense is primarily due to the $100 million of net proceeds received from the Commerce Square joint venture, paying off our line of credit at Commerce Square mortgage debt and then also the Commerce Square mortgage debt will now be deconsolidated. Capitalized interest will approximate $1 million for the third quarter and full year interest expense will approximately $76 million. We plan to extend our Two Logan mortgage beyond the August 1 maturity date, and we are looking to either pay that off or have it extended and we’ll be working on that during this quarter. Termination and other fee income, we anticipate terminations and other income totaling $2.2 million for the second – for the third quarter and $10.5 million for the year. Net management leasing and development fees will be $4 million and will approximate $10 million for the year. We have no plan land sales and tax provisions of any significance, no anticipated ATM or additional share buyback activity. In our guidance for investments, we have only one property in Radnor, Pennsylvania that we will acquire for $20 million, and that is scheduled for redevelopment. So we know generating of earnings of any kind in 2020. Looking at our capital plan, as we outlined, we have two development projects in our 2020 capital plan with no additional developments plan for the balance of the year. Based on that, our CAD range will remain at 71% to 78%. And uses for this year will total $285 million, $67 million of development, $65 million of common dividends, retained – revenue creating will be $25 million, revenue maintain will be $27 million, mortgage amortization of $1 million. We are including the $80 million payoff of the mortgage at Two Logan and the acquisition of 250 King of Prussia Road. Sources for all those uses are cash flow from – after interest payments, $115 million, $100 million of net proceeds from Commerce Square joint venture, we’re going to use the line of credit for $39 million, cash on hand of $21 and land sales of $10 million. Based on the capital plan outlined, we’re in excellent position on our line of credit and liquidity. We also project that our net debt will range between 6.3 and 6.5. It will likely be at the low end of that range as a result of the Commerce Square joint venture, which has reduced our leverage in the second quarter. In addition, our net debt – our debt to GAV will approximate 38%, which is down from 43%, primarily again due to the joint venture improvement in that metric. In addition, we anticipate our fixed charge ratio will continue to approximately 3.7 on an interest coverage basis and 4.1 – 3.7 on a debt service coverage and interest coverage will be 4.1. I’ll now turn the call back over to Jerry.

Great, Tom. Thank you very much. Thanks. With that wrapping up, we’re delighted to open up the floor for questions.

Thank you. Our first question comes from Steve Sakwa from Evercore ISI. Your line is open. Please ensure that your line is muted.

Sorry. The Commerce Square JV, I know you provided a bunch of detail there, but obviously, the preferred structure is a little bit different than what we've seen on kind of straight-up joint ventures. So I'm just kind of wondering how the discussions went when you went to bring this asset to market and sort of the pros and cons of doing it this way with maybe a bigger upside promote versus maybe protecting kind of the investor on their return. It seems like they wanted a little bit more downside protection.

Yes. Hey, Steve. Great question. I think, certainly, the macro environment played into the overall structuring of the deal. I think from our perspective, Commerce Square is a wonderful trophy-quality asset. We have a lot of churn, as everyone on this call knows, over the next several years. We knew that would have a call on capital as well as an earnings impact over the next couple of years, and we knew that was creating a bit of an overhang in terms of a catalyst for moving our stock price. So we were certainly motivated to try and find a co-investment partner who would help us, number one, recognize attractive point-of-entry pricing; two, create an opportunity for us to both through the creation of the venture as well as from the leverage aspect of it, create a capital capacity increase for us overall as a company. And I think as the discussions progressed, our investor, who again, when they announce will be a well recognizable and incredibly well-regarded name, their focus, given the rollover of the portfolio coming up, was to have some level of liquidation preference that would provide them some downside protection. And from our perspective, given the point-of-entry pricing we were able to achieve, the low cap rate going in, the amount of liquidity this would generate for our company, the capacity to delever and then also provide some liquidity for other uses for the organization, we thought that was a fair trade, particularly given our ability to create a significant promote structure that we think will deliver significant returns to our shareholder base once we’re able to execute on re-leasing that space, as we know that we would. And I think when we looked at the overall cost of this equity being in the very low double digits, we thought that was very effectively priced compared to a number of other options that we see out in the marketplace.

Okay, thanks for that color. And I guess, maybe just circling back. Obviously, there's a number of leasing issues that you need to deal with. You've been pretty transparent on laying those out. Can you maybe just walk through some of the kind of major timelines? And you've sort of talked about new leasing kind of being on hold until there's a lot more clarity on the pandemic. So how much longer do you think or how further out do these leasing assignments take? And just trying to sort of think about 2021 and sort of the risk to earnings at that point. If these things aren't going to get leased this year, sort of makes maybe the 2021 numbers a bit challenged.

It's too early to rule anything out because the situation is very fluid, and no one can predict the pace of recovery accurately. From my discussions with both tenants and brokers representing them, there is a strong expectation for increased demand in a short timeframe due to nearly two quarters of postponed activity. This does not change the fundamental needs these companies have for office space. That's one reason we're being proactive in engaging with our current tenants and maintaining open dialogues with potential clients, as those decision-making moments are approaching. They may not have happened by July, but could happen by September, and we want to be ready to act quickly. The statistic we shared about the percentage of deals transitioning from deferred due to COVID-19 to being in process, albeit with uncertain timing, indicates a positive trend for the office market. Many tenants are considering their upcoming lease situations, which we view as encouraging. When we look at our larger leasing commitments, particularly excluding Commerce Square, for which we won't retain full ownership, we're about 80% through with SHI, most of which will be occupied. We've also managed a significant lease renewal in Conshohocken for next year, and that's largely settled. George, do you want to add more details?

Yes, in the Macquarie space, now in a joint venture, we have successfully re-let 35% of their 150,000 square foot rollover at favorable terms. We believe this space is of high quality. Northrop Grumman is a significant tenant in Dulles Corner, with their lease expiring on December 31, 2020. We are considering all options for that building, including renovation, a potential joint venture, or an outright sale. We have observed an increase in interest in that building in the Northern Virginia market, as some large requirements are starting to emerge, although their timing remains uncertain. Additionally, we have a good pipeline for the remaining 35,000 square feet of SHI space. The 80% we've leased there will commence in the fourth quarter, which will increase occupancy at that time. We have also had many discussions with tenants whose leases expire in 2021, and even some looking ahead to 2022, many of whom are contemplating their next steps, whether that's delaying decisions for 12 to 24 months or planning for longer-term solutions.

Great. Thanks a lot.

Thanks, Steve.

Thank you. Our next question comes from Jamie Feldman from Bank of America. You line is open.

Thank you. Good morning.

Hi, Jamie.

So I guess, you had $100 million of net proceeds from the JV. A big conversation has been raising capital for development at Schuylkill Yards and Broadmoor, bringing in JV partners. I mean, how do you think about that $100 million? And where does it get you in terms of your ability to finance more than maybe you previously expected on your own balance sheet for these developments? And then also, can you expand the JV to raise more capital? And do you think we'll see more like this in the future to help?

Yes, Jamie, I have a couple of thoughts. We believe that raising liquidity through one of our existing assets, which has turned into a valuable opportunity, was the right move for us at this time. It has allowed us to increase our cash reserves and create capacity, particularly on a property where we had a significant embedded gain. Additionally, the pricing is favorable given the current market cap rates. We are optimistic about the possibility of collaborating further with this partner. As I mentioned earlier, we are engaged in various discussions with potential partners for Broadmoor and Schuylkill Yards. The life science aspect of Schuylkill Yards has notably attracted a broader range of potential investors, and it remains an opportunity zone fund. While some of these deals have taken time to develop, they are starting to pick up pace as investors consider the changing tax environment over the next couple of years. We are encouraged by the interest from private equity and institutional partnerships. We believe that completing the Commerce Square transaction will demonstrate to our shareholders that we have significantly strengthened our liquidity position. In challenging times like these, having robust liquidity expands our opportunities, whether that means increasing our stake in development projects or pursuing other options at Schuylkill Yards or Broadmoor. This is valuable when engaging with investors who prioritize the economic commitment of the sponsor to the project. We think that having additional liquidity will enhance our ability to achieve better overall economic returns in these ventures because it enables us to commit more resources. It also grants us the flexibility to explore other growth possibilities, including deploying these production assets, which we have always aimed to keep wholly owned, or exploring other avenues in the current market environment.

Thank you for the information regarding lease discussions for the upcoming year. I have two questions on that topic. First, as tenants have reached out to confirm their space requirements, are you observing any changes in how they utilize their spaces, such as redesigns influenced by increased remote work or different long-term layouts? Has this resulted in tenants either downsizing or expanding their space? Secondly, you're reporting a 13% likelihood of about 100,000 square feet vacating. How does this figure compare to a typical year at this point?

Okay. Great question. George, why don't we tag. I'll start off and…

Sure. A couple of months ago, as part of our outreach and survey to tenants, we asked them about their space configuration. Based on the feedback we received, we launched an initiative to offer free space planning services to any tenants who request it. While some of our larger tenants have their own infrastructure, many of our tenants, with an average space of around 8,000 square feet, are seeking guidance. We're hearing that tenants want to create more distancing in their spaces, whether that involves adjusting their workstations or increasing the size of their workstations from 6 by 6 to 8 by 10, along with higher walls. We're spending considerable time working with tenants to establish partitions that can be installed within their spaces. Many tenants are looking to reconfigure their areas. Although it's still early to determine if this will lead to new space requirements, we believe it may result in a reallocation of common area spaces to create more workstations or private offices. We expect to gain more insights on this in the next 60 to 90 days as we begin receiving definitive feedback from our tenants.

Yes, I think it's important to elaborate on that. Currently, only eight tenants have confirmed that they plan to leave. Three of them have moved to other leased spaces with longer lease terms compared to their agreements with Brandywine. Two were already subletting their spaces, making renewal impossible. We're now focusing our discussions on the subtenants to negotiate directly with them. Two tenants have indicated a shift to a work-from-home model, and one has already vacated but is still financially obligated under the lease. If it weren't for COVID, we would likely have a larger sample size than just eight tenants at this point. This is why we see 65 prospects and nearly 600,000 square feet; it's still too early to commit. They need time to determine when and how to bring their employees back and what adjustments they'll need to make once they do transition from remote work.

Okay. I appreciate the color. Thank you.

Thanks, Jamie.

Thank you. Our next question comes from Craig Mailman from KeyBanc Capital Markets. Your line is open.

Good morning. Jerry, I know you can't disclose all of the details of the JV, but when is the first kind of remeasurement period for the promote?

The remeasurement period…

When would you guys be in the promote? When is the first opportunity to get a promoted interest? I know you kind of said once you get some leasing done. Or is it solely on the sale of the asset?

It's primarily upon a sale or recapitalization of the assets, Craig.

Okay. So as you guys for the new financing on there at that point, you could be in the promote?

It's possible. One of the interesting developments we've established is that while the debt markets have significantly improved, especially for office properties with long-term leases, they aren't fully back in terms of returns on value-add transactions. Therefore, my partner and I decided to proceed with the venture using the existing debt, which is below 40% loan-to-value. We have secured new capital commitments of $20 million each from both Brandywine and our partner to reposition the asset. Given the pipeline mentioned by George, we are optimistic about our ability to refinance within the next 12 to 24 months.

Okay. And then I know we've talked a lot about Broadmoor and Schuylkill and maybe putting JV financing on those assets. But in the past, you've also talked a lot about Cira and some other kind of stabilized assets. I mean, depending on when the debt market kind of settles out and where it settles out, I mean, are there talks about doing more of these types of JVs to finance the developments and maybe not give up as much as you might otherwise give up in pre-construction kind of joint ventures?

Yes. Look, I think as we've talked before, I think we're in an environment where every option is on the table. I mean, we have an excellent portfolio, great management, operating team and leasing team. So just as we did something on an asset like Commerce Square, we're starting to look at that, creating some other capital-raising opportunities out of other pieces of our portfolio, similar to what we did with Rockpoint last year and Commerce this year. And we're very mindful of not creating any real complications in terms of our balance sheet. We also recognize that in today's environment, some of that capital is really looking for great partnerships, good sponsorship and the ability to grow. So we are having some discussions with groups on creating growth vehicles for certain submarkets and certain product types. And to the extent we were able to raise some additional liquidity for that, then I think, certainly, as I mentioned to the other question, having that additional liquidity broadens our perspective on what we can and cannot do with some of these development transactions. That's certainly a big driving focus we have within the organization.

Lastly, regarding the conversion of Cira for life science, do you have the necessary systems to facilitate an easy conversion, or will it require a significant update to the HVAC and other systems? Are there additional buildings you are considering to take advantage of the life science demand in Philadelphia to expand your offerings?

Yes. At Cira Centre, the building's infrastructure is suitable for life science use. The conversion primarily involves upgrading the HVAC and some mechanical systems, as well as possibly increasing power loads, which makes it a relatively straightforward process. Similarly, 3000 Market is a building where the infrastructure supports such changes, so we can definitely undertake that. We are also exploring other properties in our portfolio, particularly in the suburban counties around Philadelphia, where there is an increasing presence of pharmaceutical and life science companies. This could present additional opportunities for us to repurpose some of our existing assets for that purpose.

Okay. And I think you said in the past that you guys have looked at Schuylkill, some tenants don't want to mingle with life science. Is that an issue at all? Do you have some legacy kind of office sense in these buildings? Or as you look to put a life science tenant in a predominantly kind of just traditional office setting? Are there any issues with the tenants mixing?

I believe this concern is specific to individual tenants. Previously, we engaged with one tenant that was particularly focused on avoiding an environment with life science or lab space. However, we've found that to be more of an exception rather than a common rule. During our discussions with various tenants, whether they are life science tenants at Cira Centre, in Schuylkill Yards, or other locations, we have not encountered resistance to being in a mixed-use building that includes traditional office space, incubator office space, or dry lab office space.

Okay. Great, thank you.

Thank you.

Thank you. Our next question comes from Manny Korchman from Citi. Your line is open.

Hey, good morning everyone. Jerry, when we look at the Commerce JV, can you just give us some color on the timing of those conversations and maybe how they changed over time?

Sure. They really commenced, Manny, sometime in the March time frame. And as the macro climate changed, I think we've both pivoted to reaching a structure that work for both of us.

And was there any part in those conversations to have the same partner look at Schuylkill? I see similar flavors, right? It's an asset in Philly. There's lease-up risk, if you will. There's development dollars being put out, obviously, at a different scale. But was Schuylkill part of the conversations with this partner?

Schuylkill was not involved in any negotiations, just part of the conversation.

We discussed the occupancy and noted it negatively affected us in the second quarter. However, we do not expect this to impact us moving forward, even though we are currently facing challenges due to the ongoing situation with Macquarie, which will resolve by the end of July. This situation was a negative factor for our same-store metrics. Looking ahead, we anticipate better occupancy rates next year compared to this year for our same-store properties. We adjusted our same-store range by about 100 basis points primarily because of parking issues, including some at Commerce Square. However, the impact on this year's overall performance was not significant whether we included that parking or not. The decline in our same-store metrics largely stemmed from these parking concerns. For next year, we expect a positive shift in the same-store performance as we account for the absence of move-outs, including Reliance, which will vacate by the end of December 2020, freeing up roughly 140,000 square feet starting January 1 of next year. This will certainly provide us with a favorable momentum for our same-store metrics next year.

I'm somewhat unclear about why Commerce, considering the size of the building and its contribution to your overall net operating income, wouldn't have had a positive impact on the guidance you provided for same-store metrics.

Well, I'll let George elaborate on the guidance. Essentially, our guidance is focused on the percentage change from year to year. When we compare the weighted average occupancy for Commerce in 2020 with what it is expected to be next year, there is likely going to be a negative impact. If we analyze the contribution to the same-store pool between 2020 and 2021, it will certainly decrease due to the lack of move-outs with Macquarie and Reliance, even though some backfill is anticipated to start in 2021.

Yes. Commerce's same-store performance in 2020 was positive during the first half of the year due to some leasing we had completed on vacant space in 2019. However, that same-store metric turned negative in the second half of the year following the known move out of Macquarie. As a result, the two-building combination performed relatively flat as a same-store asset in 2020 compared to 2019. Additionally, as Tom mentioned, same-store performance in 2021 would have been significantly worse than in 2020 due to the additional move out of Reliance in McCormick and Taylor, even though some backfill is expected to start in 2021.

Thanks, guys.

Thank you.

Thank you. Our next question comes from Michael Lewis from SunTrust. Your line is open.

Great, thank you. On Commerce Square, you explained the structure of the lease expiration schedule and how that impacts the cap rate and the pricing. At $315 per square foot, does this sale tell us anything about the value of the rest of your Philly CBD portfolio? Or do you think this is kind of unique and doesn’t give us that much information?

Yes. Look, I think the pricing of the $600 million and the $315 per square foot, I think given the near-term rollover in the property, I think, says very good things about the stabilized returns that we’re realizing off of our other Philadelphia-based assets. I think we’re, frankly, very happy with the pricing. It’s not too far off what we thought was very good pricing on the Mellon Bank Center deal at 1735. That was a completely stabilized asset with no rollover at all. And that was $20 or $25 a square foot higher than ours. So we thought it was very good pricing, quite frankly. And certainly, the cap rate, I thought, spoke very well of the quality institutions, and certainly, our partner is a top-quality one, kind of viewed the growth potential within the city of Philadelphia. So I think from our perspective, the point-of-entry pricing where we’re in that level with that kind of rollover exposure, certainly, from an investment-based standpoint, as I touched on, we’re generating about a $270 million gain or about $140 a foot. And even on a gross basis, based on acquisition of all capital put in, it’s $100 a square foot gain. We thought that was very good, Michael. So we thought that we think it’s a great read through, to tell you the truth, on the strength of the market because the point-of-entry pricing is solid. But more importantly, if you take a look at the climate we’re in today, to have the focus going forward of generating a great value opportunity – value-creating opportunity we thought was very strong.

Yes. I think everybody is wondering about value, so it’s good to have a data point. And then my second question is about leasing, kind of a short-term and long-term look. In the short-term, I think last time we spoke, Dechert and Blank Rome have been close to signing renewals. I’m wondering if that’s still the case. And then kind of broader, George mentioned two tenants that are moving to work from home. Are you seeing signals in the portfolio that this is really a sea change moment in your business where there may be a wave of this coming? Any signals of that?

A couple of parts to that question. We’ll take – George and I will take it separately. The – I think on Blank Rome and Dechert, we continue to have great dialogue. So no real change on that other than the passage of time and summer vacation schedules for folks. So I think we continue being very positive on how those discussions will wind up. Michael, on your broader question, I honestly think it’s too early to tell. I mean, we’re hearing very conflicting data points. And I think we have in the supplemental package kind of a pie chart that talks about how tenants see the impact of the virus on their business, and most folks are fairly positive or neutral. We are hearing generally from all of our tenants that they can’t wait to get back to the workplace, that while working from home seems to be an adequate way of triaging business maintenance, the level of productivity that comes from working in a dynamic, collaborative environment far exceeds what I think people are realizing right now. So it’s kind of incredibly incremental progress that companies are making right now. And I think – certainly, as I talk to a lot of our major tenants, they can’t wait to get back in. I think that the phenomena of work from home had already been there, but it was at a lower pace. So I think it’s opened the eyes of a lot of companies that they can probably provide more flexibility to their workforce and not have the productivity decline that they might have feared before; that they can maintain a level of productivity by having work from home being part of their kind of standard personnel protocols. I think as we’re talking to tenants today, obviously, the macro situation is of concern. But I don’t think issues of mass transportation and schools seem to be the most often discussed topic that are governing when tenants view themselves returning to the workplace on mass. So in the Philadelphia Metropolitan area, we’ve got about 10% of the regional workforce that uses mass transportation. We’re certainly not as impacted as in New York City or San Francisco or some other major metro hubs. But that reintroduction of mass transit is going to be, I think, a governor of when people return to the workplace. But generally, and George, you’re talking to a lot of tenants as well, the ones I talk to are very anxious get back to work. So they’ve been very positive on all the steps that Brandywine has taken to ensure a safe return to the workplace. Even – as I mentioned earlier with one of the questions on being very proactive from a space planning standpoint. I mean, to the extent we can reconfigure space quickly, I think that brings people back even faster. But George?

Yes. I think to that point, I mean, I think a lot of tenants are really just thinking about how they can reposition their existing space, turning radiuses within workstation configurations. And the context of the two tenants out of the 673 that we conducted outreach to, two said that they were kind of ready to make that permanent shift. So I do think it’s extremely early in the cycle, and I’m not sure that those two are necessarily a barometer for the rest.

Got it. Thank you.

Thank you. Our next question comes from Tayo Okusanya from Mizuho. Your line is now open.

Hi, yes, good morning. Just following up on that line of questioning. The leases signed, again, average duration of 24 months ago, which is pretty short. Can you just talk a little bit about that decision process of signing these short leases? What exactly your tenants are kind of saying to you in regards to the short duration of the leases on a near-term basis?

Yes. Great question. And I think the general tone of those conversations and the fact that they averaged 24 months, I mean, some simply were 12 months, some were able to do kind of 36, 48. But in the – for most of them, it was they’ve got something to think about relatively quickly because they’ve got a first quarter 2021 expiration and not knowing necessarily when they will be fully returning and understand everything about their own business. This was just a means to kind of move that decision down the line. And as a result, we ended up with a lot of them just averaging that 24-month duration. And it softens the exploration curve for us, gives them a little bit more time to understand how they ultimately need to renew on a long-term basis. And I think thematically, it’s not that much different than a lot of companies like ours experienced during the great financial crisis, where you had a number of tenants who were keeping an eye on kind of the macro uncertainty, who just kind of did shorter-term extensions. For us, it’s a win-win. It preserves our revenue stream with a little more certainty. As George touched on it, it smooths out our rollover exposure. And frankly, gives our leasing teams and our property management teams another 12 to 24 to 36 months to keep working with that tenant to make sure they understand that Brandywine is their workplace solution. So I don’t think – we’re looking at the size of those tenants and kind of the composition, I don’t think there’s any read-through on that from the standpoint that tenants are only willing to do short-term extension. I think these were tenancies that had – within 12 or 18-month expiration. And given the pace of their business, they just didn’t want to deal with thinking about what they want to do in their office space. So we actually thought it was a positive sign that, that many tenants renewed even for a short period of time, but kept all their square footage in place. So I think looking at it from – through the other window, the fact that none of these tenants were coming back saying, "Hey, I’ll renew, but I’m in 10,000, I only want 1,080 square feet." We thought that was a good harbinger of the thought process that we know a lot of our tenants will go through as they start to think about their long-term space planning requirements.

Great. And just one quick follow-up. The cap rate on Commerce Square, the 5.1 cap, that is last 12 months NOI before the move out? Did I hear that correctly?

Yes, that’s based on where it is now, right?

That’s correct.

Okay, great. Thank you.

Thank you.

Thank you. Our next question comes from Bill Crow from Raymond James. Your line is open.

Thanks. Good morning.

Hey Bill.

Hey Jerry, I appreciate the statistic on the 10% mass transit Houston, Philadelphia. What is that rate for your CBD tenants?

Yes. The rate for our CBD tenants is – I could – I might be off here by a little bit, but it’s somewhere around 50%.

50%, 5-0?

Yes. 5-0, yes.

Okay, great. Have you all seen a pickup in tours of suburban assets from current CBD tenants that might be looking for either to move out to the burbs or maybe a satellite office closer to their homes?

No. We – I’ve read a lot about that trend, Bill. And honestly, whether it’s in Philly or D.C. or Austin, we haven’t seen that. I mean there’s only one example that I could give you where a tenant who’s a CBD tenant did a short-term sublease for several thousand square feet of suburbs just to get people back in to an office environment because their workflow really requires people to work together. And they just – they were meeting some resistance from their tenant base about using mass transit coming down to town. An interesting anecdote data point is when we did survey our tenants, after health and safety issues, which were obviously paramount, the next most asked question we got from tenants was could we provide short-term parking for them as they opened up their offices downtown. And that was one of the reasons why we were thinking that even with the anticipated opening of the city kind of in the early part of the summer, those parking numbers we had last quarter were good because the feedback we were getting from tenants was, hey, if they come back, they don’t want to park, drive in versus take the train. With the delay of opening up the city, I think that kind of – creates the result we have. But look, I do think there’ll be a transition here. Our regional rail authority is doing a great job trying to get out a message of it’s safe to return. Activity is picking up within the mass transit system. But until people get a lot more comfort with health issues, I think it’s going to be a slow adoption rate than you might expect for people to take mass transit. We’re fortunate where we have a lot of parking capacity. So to the extent that our tenants need to use parking, we can do that. We run, as you know, several shuttle services within the city. So we can actually bring people into kind of University City, the park and shuttle them downtown if we need to. So we’ll look at a number of different options to create mobility for our tenants other than just traditional mass transit to help them think through how they get their workforce back to our CBD locations.

Great. And if I can just ask one more, Jerry. We’ve seen a lot of headlines, especially in some of the Pacific Northwest markets, San Francisco, New York, Chicago, the governments, maybe out of necessity, having to become less business-friendly, heavier taxation. Can you just kind of – I know you’re buddies with the folks down in city hall, but just give us an assessment of where Philadelphia is on that spectrum?

Well, look, I think every city is facing some significant near-term financial issues, and I think almost every city is hoping that some level of federal and potentially state support could augment that. I think Philadelphia, in particular, given our tax structure, where only about 20% of revenues come in from real estate taxes, balancing from business and wage taxes, is particularly susceptible to revenue variability. So if you think about the folks who are traditionally working downtown, who live out in the suburbs, they pay wage tax for the time they work in the city. To the extent they are not in the city and they’re working from home, they’re not paying wage tax. So I think cities like Philadelphia that have kind of a, I’ll call it, an inverted tax structure compared to most cities will probably face some more short-term budget issues. Philadelphia did have a rainy day fund going into the crisis. That did pass a stopgap budget that did include raising marginally, at least short-term, a couple of elements of taxation. But I think that’s a bigger question every city will face in terms of how quickly the revenue base comes back and how they want to deal with that from a structural standpoint, particularly given some of the social equity and economic equity issues that are arising on a nationwide basis. So we’re staying in as close touch as we can with city leadership, certainly very much focused on articulating a point of view that the best pathway to economic growth is a job and ensuring that Philadelphia has a reasonable platform for job creation. But that’s a much broader discussion of which I’m not even sure what all the issues are, Bill. So – but we’re saying in close touch with it. And Philadelphia had been on a very good economic growth plan with job creation, employment growth, and we’re certainly hoping that once we get past these hurdles presented by the virus that we can get back on that.

Thanks for the time, Jerry. Appreciate it.

Thank you.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. You may all disconnect. Everyone, have a wonderful day.