Brandywine Realty Trust Q4 FY2020 Earnings Call

Company Representatives: Jerry Sweeney - President and Chief Executive Officer; George Johnstone - Executive Vice President of Operations; Dan Palazzo - Vice President and Chief Accounting Officer; Tom Wirth - Executive Vice President and Chief Financial Officer.

Ladies and gentlemen, thank you for standing by and welcome to the Brandywine Realty Trust, Fourth Quarter 2020 Earnings Call. At this time all participant 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 may be 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, thank you very much. Good morning, everyone, and thank you for participating in our fourth quarter 2020 earnings call. On today's call with me, as usual, 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. Prior to beginning today’s call, certain information discussed during the call may constitute forward-looking statements within the meaning of the Federal Securities Law. Although we believe estimates reflected in these statements are based on reasonable assumptions, we cannot give assurance that the anticipated results will be achieved. For further information on the factors that could impact our anticipated results, please reference our press release as well as our most recent annual and quarterly reports that we file with the SEC. First and foremost, all of us at Brandywine sincerely hope that you and yours continue to be safe, healthy, and engaged. And while we remain optimistic about the accelerating vaccine deployment and the path to recovery, the pandemic still continues to disrupt all of our lives and every business, and unfortunately the duration of the recovery cycle still remains a bit unclear. Our portfolio remains about 15% to 20% unoccupied, which is comparable to our occupancy levels as of our October call. And as noted in the supplemental package, most of the jurisdictions where we have properties still have significant return-to-work restrictions in place. Additional details on our COVID-19 approach are outlined on pages one to five of our supplemental package. During our comments today, we'll briefly review fourth quarter results, discuss our 2021 business plan, and provide color on our recent transactions and developments. Tom will then provide a brief review of 2020, discuss our 2021 guidance, and update you on our strong liquidity position. After that, Tom, Dan, George, and I are available for any questions. We closed 2020 on a very strong note; many of our revised 2020 business plan objectives were achieved despite the protracted nature of the recovery. We exceeded our speculative revenue target by $400,000, executed lease volumes increased quarter-over-quarter, and our pipeline increased by 229,000 square feet. For the fourth quarter, we posted a strong mark-to-market on rental rates of almost 19% on a GAAP basis and 11% on a cash basis. For the full year 2020, our mark-to-market was a very strong 17.5% on a GAAP basis and 9.3% on a cash basis. In addition, we had 59,000 square feet of positive absorption during the quarter, which included 33,000 square feet of tenant expansions with no tenant contractions. Our full year 2020 same-store number did come in below our revised business plan, primarily due to the joint venture sales activity that we’ll discuss, several COVID-related occupancy delays, and parking revenues that were well below our original forecast due to the slower return to the workplace. Our tenant cash collection efforts continued to be among the best in the sector, and we have collected over 98% of fourth quarter billings, and our January collection rate continues to track very well with 98.5% of office rents collected as of yesterday. Our capital costs for 2020 were better than our targeted range due to very good success in generating short-term lease expansions with minimal capital outlay. Tenant retention came in at 52%, slightly above our full-year forecast, and our core occupancy and lease targets were below our ranges simply due to the pandemic-related delays and targeted move-ins and lease executions and negotiations sliding into early 2021. We did post FFO of $0.36 a share, which was in line with most consensus estimates. A general update on COVID-19 impact is, first, consistent with all applicable state and local CDC guidelines, we do remain in a doors-open, lights-on condition in all of our buildings. As we noted in the supplemental package, most large employers have yet to return to the workplace for a variety of factors, primarily public policy mandates, employer liability concerns, mass transit, virtual schooling, and safety concerns. However, we are seeing more small and mid-sized companies beginning to return more employees to their various workspaces. Portfolio stability remains top of mind, and our progress on several key factors can be found on pages one to three of the supplemental package. We do continue to stay in touch with our tenants to understand their concerns and their transition plans. A key priority of ours has been to work with those tenants whose spaces roll in the next two years. Those efforts have resulted in 79 active tenant renewal discussions, totaling about 750,000 square feet and to date have resulted in 62 tenants, aggregating 500,000 square feet, actually executing leases. These leases had an average term of 30 months with a roughly 4% cash mark-to-market and a 4% capital ratio. An important point to note is that this early renewal activity, when we excluded the large known rollouts at 2340 Dulles and the retirement of 905 Broadmoor, we've reduced our remaining 2021 rollover to just 4.2%. So, looking at 2021, we are providing 2021 earnings guidance. Frankly, not an easy call given the overall economic and pandemic picture; however, our early renewal efforts, expense control programs, near-term visibility into our forward pipeline and the recently executed transactions we think have established a solid operating plan with a clear pathway to execution. That plan is based on a gradual return-to-work environment beginning in the second quarter through the balance of the year. So, our approach was to be conservative but as transparent as possible. We framed a defined operating plan with all key metrics quantified, and present the 2021 earnings guidance ranges as a platform to build from. And with the 2021 plan set, we do remain focused on revenue and earnings growth whether that be through accelerated leasing, margin improvement, cost controls, or working with institutional partners to seek investments in capital structures where we can create value. The 2021 plan is really headlined by two key operating metrics that we think demonstrate excellent growth potential. Our cash mark-to-market range is between 8% and 10%, and our GAAP mark-to-market range is between 14% and 16%. For 2021 we do expect all of our regions will post positive mark-to-market results on both a cash and GAAP basis. We do have several larger blocks of space to fill, particularly at Barton Skyway in Austin, 1676 International in Tyson's and several others. But looking forward, achieving our leasing objectives on those spaces can be significant revenue boosters, and our 2021 plan only has about $1 million of revenue coming in from those larger spaces. Our GAAP same-store NOI growth of 0% to 2% and our cash same-store of 3% to 5% is primarily driven by Austin up about 8%, Pennsylvania suburbs close to a 5% increase, and Philadelphia around 2%. Metro DC region will continue to be negative while 1676 International Drive continues through its reabsorption phase. With that renovation now complete, our overall leasing activity has really accelerated, and our pipeline is up significantly to about 600,000 square feet this quarter versus around 370,000 square feet last quarter. As we noted in the press release, our same-store forecast does not include 2340 Dulles, which is fully vacant and being placed into redevelopment, very similar to our 3000 Market Street renovation, and also we will be retiring 905 Broadmoor permanently as part of our Broadmoor master plan development. Other key operating highlights: speculative revenue will range between $18 million and $22 million. We have $14.7 million achieved, or 74% achieved at this point. This is the first time we're providing a speculative revenue range versus a dollar target, but given the lack of real forward visibility on the acceleration of leasing, we felt that it was warranted. Occupancy levels we think will be between 91% and 93% at year-end and with leasing percentages being between 92% and 94%. Capital will run about 11% of revenues, which is below our 2020 target range, and we are forecasting net debt to EBITDA being between 6.3 times and 6.5 times and Tom will certainly talk about that. Our leasing pipeline has picked up and stands at 1.3 million square feet, including about 88,000 square feet in advanced stages of negotiations. As I mentioned before, that pipeline is up about 230,000 square feet. Interestingly too, knowing that physical tours have yet to fully return for a variety of pandemic-related reasons, we have launched a virtual tour platform for all of our availabilities and to date we're generating close to 300 tours per month with over 500,000 square feet being inspected. So we think that’s an early harbinger of tenants looking at their office space requirements going forward. From a liquidity standpoint we’re in great shape. We anticipate having $562 million on our line of credit available at year-end. We have no unsecured bond maturities until 2023 and with the recent secured mortgage payoffs, we have a fully unencumbered wholly owned asset base. The dividend remains extremely well covered with a 53% FFO and 68% cash payout ratio. Now looking at our investment and development opportunities, during the fourth quarter we completed several investment transactions. We executed a joint venture with an institutional partner on 12 properties totaling 1.1 million square feet. These properties are located in suburban Philadelphia and Rockville, Maryland. The portfolio was valued at $193 million. We retained a 20% ownership stake. In addition to the $121 million first mortgage financing we put in place, we also elected to provide subordinated financing in the form of a $20 million preferred equity position that had a 9% current pay. As a result of that, we did receive about $156 million of net cash proceeds, and as with all of our ventures, we will generate an attractive fee stream by retaining property and asset management, as well as leasing and construction management services. On our previous calls we had highlighted that we had about $250 million of remaining non-core assets in our wholly owned pool. This portfolio had been our primary target and leaves us with very few assets that are not considered core holdings. This partnership, similar to others we have done, did create a different capital structure that more than doubles our return on invested equity from a mid-single-digit return to a mid-teen return on our remaining invested capital and also avoids a $20 million of direct capital investment by Brandywine. With this transaction we now have over 80% of our revenue stream coming in from sub-markets at around A-plus or A-double-plus quality as referenced in recent office market snapshots. We also made a preferred investment in a 90% leased two-building portfolio totaling 550,000 square feet in Austin near the airport. That preferred investment totaled $50 million, also had a 9% current pay, excellent cash coverage and a several-year term, similar to the type of transaction we did a number of years ago at Commerce Square here in Philadelphia. This investment increases our revenue contribution from Austin toward our 25% goal, and really enabled us to take advantage of the market knowledge and position we have to create a structured, well-covered financial instrument. Also, as we announced early this morning, we are delighted that we have entered into a joint venture arrangement with a global institutional investor that commenced our Schuylkill Yards West project, which is a combination of life science, office and residential tower. Our partner will have a 45% preferred interest in the joint venture with Brandywine holding the remaining 55% equity interest. The project will deliver a blended yield of about 7% and will consist of 326 apartment units, 100,000 square feet of life science and 100,000 square feet of innovative office, along with underground parking and 9,000 square feet of street-level retail. We do have an active pipeline totaling over 300,000 square feet for the life science and office space component of this project, and based on this level of interest, we plan a construction start in March of 2021. We are currently sourcing construction loan financing and plan to have the loan in place in the next 90 days at a targeted 55% to 60% loan-to-cost. And given the front loading of the equity commitment of about $150 million, assuming a 60% loan-to-cost construction financing, the first funding of the construction loan wouldn’t occur until April of 2022. Our share of the equity will be about $63 million, of which about $35 million is already invested. In looking at our production assets, they all remain ready to go subject to pre-leasing. They’re renewed every quarter. Each of these projects can be completed within four to six quarters and costs between $40 million to $70 million. The pipeline on those production assets is around 415,000 square feet and we are continuing our marketing efforts to hopefully get some pre-leasing done there as the market recovers. In looking at the two existing development projects, 405 Colorado is on track for a Q1 2021 completion. We have a pipeline that is built since our last call that approaches 360,000 square feet, including 53,000 square feet in advanced discussions. To be conservative, given the pace of the recovery in the market, we have extended stabilization until Q1 2022. We’ve increased our cost by approximately $6 million, primarily due to additional TI and leasing commissions, and a bit longer absorption schedule which has resulted in our target yield being reduced to 8%. 3000 Market construction is underway on this building, which will be fully occupied by Q4. The building is fully leased for 12 years. It will deliver a developed yield of 9.6%. The commencement date did slide one quarter due to October-related construction delay, but we have increased our yield in the project by 110 basis points due to some design scope modifications and success on the buyout. A couple of other quick comments on Schuylkill Yards and Broadmoor. We do continue our strong life science push at Schuylkill Yards. The overall master plan is about 3 million square feet of life science space, so we can really build on the work we've done at 3000 Market, the Bulletin Building and now Schuylkill Yards West. Plans for 3151, which is our 500,000-square-foot life science dedicated building, are well underway. We do have a leasing pipeline of over 500,000 square feet for that project and the goal would be to start that later this year assuming a pre-lease and market conditions permit. We have started constructing to convert several floors within Cira Center to life science use and that program is moving along per our plan. At Broadmoor, we are advancing Blocks A and F, which is a total of 350,000 square feet of office and 870 apartments. Block A has $164 million for the 350,000-square-foot office as part of that phase, along with 341 multifamily units at a cost of $160 million. We are heavily engaged in the joint venture partnership selection process. That process is going very well with discussions well underway with several parties and we hope to be able to start the residential component of Block A by the third quarter of 2021. Tom will now provide an overview of our financial results.

Thank you, Jerry. Our fourth quarter net income totaled $18.9 million or $0.11 per diluted share and our FFO totaled $61.4 million or $0.36 per diluted share. Some general observations regarding the fourth quarter results: they were generally in line with a couple of exceptions. Portfolio operating income totaled about $75.5 million and exceeded our $74 million previous estimate, primarily due to lower operating cost benefited by lower tenant physical occupancy. Termination and other income totaled $1.6 million or $3 million below our fourth quarter guidance. The results were negatively impacted by several one-time transactions that we anticipated occurring in the fourth quarter that are now anticipated and closed in the first half of 2021. FFO contribution from unconsolidated joint ventures totaled $6.3 million or $1.2 million below our fourth quarter guidance number, primarily due to some co-working tenant write-offs and that was slightly offset by the JV announced at the end of the year. Our cash and GAAP same-store results came in 100 basis points lower, again due to lower parking revenue and some tenant leasing slides, all of which have commenced. Our fourth quarter fixed charge and interest coverage ratios were 3.8 and 4.1 respectively; both metrics improved as compared to the third quarter. Our fourth quarter annualized net debt to EBITDA decreased to 6.3 at the lower end of our 6.3 to 6.5 range. The ratio benefited from improved operating income and higher-than-expected year-end cash balances due to our recent fourth quarter transactions. Two additional points: on cash collections, our overall collection rate continues to be very strong, above 98%. Additionally, our fourth quarter deferred billings were less than $100,000, so our core collection rate will essentially remain unchanged for those deferrals and our write-offs in the fourth quarter on the wholly owned portfolio were minimal. For cash same-store, as outlined on page 1 of our supplemental, we have included $4.1 million of rent deferrals in our year-to-date results. While not final, we feel this presentation more accurately represents our current same-store metrics and subsequently we have collected roughly 30% of those deferrals. Looking at 2021 guidance, at the midpoint net income will be $0.37 per diluted share, and FFO will be $1.37 per diluted share, and that includes roughly $0.04 of dilution related to the fourth quarter transactions we announced. Our 2021 range was built with the following general assumptions: portfolio operating income – operating level GAAP income will be roughly $285 million, or a decrease of about $30 million compared to 2020 due to the following items: 2340 Dulles Corner and the retirement of 905 Broadmoor will generate about a $10 million reduction from 2020 to 2021. The mid-Atlantic portfolio JV results in another $17 million decrease. The full-year effective Commerce Square results in a $19 million increase. Those are partially offset by the full-year effect of 1 Drexel Park in Dallas, the building being about $4 million. The 2021 completions are 405 Colorado and 3000 Market for about $3 million each and about a $3 million increase in our same-store portfolio GAAP NOI. FFO contribution from our unconsolidated joint ventures will total $20 million to $25 million. That increase is primarily due to the full-year effect of Commerce Square, as well as the transaction with the mid-Atlantic portfolio. G&A will be between $31 million and $32 million. Investments: there is no new property acquisition or sales activity in our guidance. Interest expense will decrease to approximately $67 million to $68 million. That’s primarily due to the payoff of our two remaining mortgages at higher interest rates. Capitalized interest will approximate $4 million as we complete the 405 Colorado building, but also commence Schuylkill Yards West. Investment income will increase to $6.5 million, primarily due to the new structured finance investment in Austin, Texas. Land sales and tax provision will net to about $2 million as we anticipate selling some non-core land parcels. Termination and other income totaling $7.5 million, which is above 2020 now, is primarily due to one-time items being moved from the fourth quarter of 2020 into the first half of 2021. Net management, leasing and development fees will be $16 million, which is just above our 2020 actuals due to the full-year effect of Commerce Square and the JV for the mid-Atlantic properties. In addition, we anticipate that we will get some development fees from Schuylkill Yards West once we commence operations there with the development. Then I anticipate ATM or share buyback activity. Looking closely at the first quarter, we anticipate portfolio property NOI totaling about $70 million and we’ll be sequentially about $5.5 million lower, primarily due to 2340 Dulles, as well as the mid-Atlantic JV. FFO contribution from our unconsolidated joint ventures will be $6.5 million. G&A for the first quarter will increase from $6.3 million to $8 million. Our sequential increase is consistent with prior years and primarily timing of compensation expense recognition. Interest expense will be approximately $16 million. Capitalized interest will be roughly $1.5 million. Termination and other income, we continue to anticipate that to be $4 million with some of those transactions moving to 2021. Net management fee and development fee income will be $4.5 million with investment income being $1.6 million. We expect some land gain potentially in the first quarter of about $0.5 million. Our capital plan is straightforward and totals $350 million. Our 2021 CAD ratio is between 75% and 81%. The main contributors to the lower coverage ratio are the property NOI reductions, as well as anticipated lease-up in the upcoming rollovers. Using that as our guide, our usage in 2021 will be $145 million of development and redevelopment. That does include the additional cash that's going to be necessary to complete our equity contribution into Schuylkill Yards West. $130 million of common dividends, $35 million of revenue-maintaining CapEx and $40 million of revenue-creating CapEx. The primary sources will be $185 million of cash flow after interest payments, $99 million use of the line, $46 million use of cash-on-hand and roughly $20 million in proceeds from land and other sales. Based on the capital plan outlined, a line of credit balance will be roughly $500 million. We project that our net debt to EBITDA range is 6.3 to 6.5, with the main variable being timing and scope of our development activities. In addition our net debt to GAV will approximate 40%. We anticipate our fixed charge ratio to be 3.7 and our interest coverage ratio to be 3.9. I will now turn the call back over to Jerry.

Thank you, Tom. So a couple of key takeaways: Our portfolio and operations are really in solid shape. We have excellent visibility into our tenant base; all signs at this point are evidenced by the numbers that we presented — our markets seem to be holding up fairly well. Our leasing pipeline continues to increase as tenants think about their workplace return. Safety and health, both in design and execution, are rapidly becoming tenants’ top priorities and we do believe that new development and/or trophy-class stock, as well as these extensive capital maintenance programs we have in place, will really benefit from that trend. The private equity and debt markets are extremely competitive and strong operating platforms like Brandywine are gaining significant traction for project-level investments as evidenced by our recent activity. I think our recent investment activity further improved our liquidity and created additional frameworks for growth for our shareholders. Our partnership on Schuylkill Yards West reinforces the increasing attractiveness of the emerging life science sector in Philadelphia, and I think it creates an excellent catalyst to accelerate the overall pace of the Schuylkill Yards development. We’ll end where we started, which is that we wish that you are all doing well and your families are safe. With that, Crystal, we're delighted to open up the floor for questions. We do ask in the interest of time that you limit yourself to one question and a follow-up.

Thank you. And our first question comes from Craig Mailman from KeyBanc Capital Markets; your line is open.

Good morning, guys. Just Jerry, on the joint venture, I'm wondering — and I apologize if I missed this — but could you give us a sense of maybe where you were able to price the JV versus construction costs or maybe on the stabilized yield base? Just trying to get a sense of the pricing you were able to achieve, and pre-leasing on a project like that.

Sure Craig. We're targeting a 7% blended return on cost from that property. I say blended because it's residential, life science, and office. We have a number of offers in from construction lenders. We think that debt will be priced somewhere off a LIBOR floor of roughly 300 to 350 basis points, so we think it'll be very effectively priced debt. In terms of the overall pricing, these things are always a challenge to think your way through, but we started with the premise that these projects can generate significant profits to our shareholders. We also recognized the reality of our ability to raise public equity. So the preferred structure enables us to retain a larger percentage of the direct ownership, which was one of our goals, and it did lower overall cost of capital compared to a traditional pari passu deal. We're also able to retain a disproportionate share of the upside, and we think this transaction will pencil out very well to over a 2x equity multiple with a very high-teens internal rate of return. So we’re very happy with the structure; we are delighted with our partner and their status in the real estate investment marketplace and their acumen, and their belief in our ability to execute a successful transaction at Schuylkill Yards.

Okay, that’s helpful. And just, I know you talked about 300,000 square feet of kind of active demand. Does that include anything from Drexel and their kind of rates that they have with us?

Great question, Craig. That pipeline at Schuylkill Yards West does not include anything from Drexel.

Have they indicated anything on that side? I saw the commentary from them in the press release.

Yeah, no — I think they are very excited about us moving forward in this joint effort as well, but I don't think their near-term requirements would be a receiver for Schuylkill Yards West.

Okay, and then just one quick one for Tom. I think you said $17 million of revenue coming from the JV. So was that closer to like a 9, 10 cap?

No, I think it was mid-single-digit cap rate, sorry, mid-8s cap rate on that.

Okay, and I know I'm over my question, but can you just walk through how you get to the $0.04 net dilution starting at the $8.5 million cap, with the kind of preferred returns?

Yes, so the way that works Craig is that if you take that $17 million NOI, we get 80% of that NOI coming to us, so that’s 80% of the $17 million. We’re also going to pick up debt though, because we put on a piece of debt. We’ll pick up $1.8 million, which is a 9% yield on the $20 million, and we pick up $4 million or $5 million, which is the 9% on the $50 million. So when you add those all up, it rounds to a $0.04 number.

Got you. So there’s no redeployment on any of the other proceeds?

No, we just put that in and put cash on the balance sheet, paid down a little bit of the line, although that doesn’t account for any redeployment that would be into other assets going forward. That's just those three transactions together.

Perfect! Thank you.

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

Hey, thanks. Good morning everyone. Maybe we can switch to Austin for a minute. What drove the preferred investment in a couple of assets there?

I’m sorry Manny, you cut out for a second.

I said, what drove the preferred investment in Austin?

I think we certainly have an objective to continue to grow our revenue contribution from Austin. Cap rate compression due to investor demand has made direct acquisitions a bit pricey, so we spent a lot of time understanding the market at a granular level with our local team. An opportunity presented itself that enabled us to help an existing owner recapitalize their partnership on a project that was extremely well leased with excellent cash flow coverage. From our perspective it enabled us to deploy capital into Austin, which is clearly one of our target markets, with a good covered secured coupon in an asset located close to the airport.

And then staying in Austin, 405 Colorado, I think you said you have a 360,000-square-foot pipeline there if I heard correctly. If we look at the pipeline and leases that may come from that versus initial underwriting on the building, has there been much change?

The primary change Manny has been really on the TI side. There’s certainly programming because we think there's good opportunity for us to keep our base rates in the mid-40s range, but the market is softening with some of the sublease space. We thought it was conservative and pragmatic to include some additional TI costs. We are seeing an uptick in activity in the last 30 days and we have about 50,000 square feet in active negotiations. The project being delivered with the curtain wall up, the lobby and sky lobby finished is showing better and we’re getting a lot more traction.

So the confidence in the revised 8% yield would be high, Jerry, taking all that into account?

Yes, it would be very high.

Thank you. Our next question comes from Steve Sakwa from Evercore ISI. Your line is open.

Thanks, good morning. Jerry, could you share a little more on the underwriting for the new joint venture? I know you talked about a blended 7% yield, but you mentioned luxury residential. What kind of rents are you looking for for both life science and residential, and how do those compare to current market rents today?

On the residential side, rent levels we’re projecting are very comparable to what we’re achieving today at our AKA development at FMC Tower. The unit mix is different, but the amenity package is strong — 29,000 square feet of amenity that will be available to residents as well as office and life science users. On the commercial side, the project is planned to be about 200,000 square feet, equally distributed between life science and innovative office, and we’re looking for rental rates in the mid-50s. We feel very good about that rent level given the conversations we’re having with existing tenants and other transactions in the marketplace.

And as you’re having discussions with tenants on renewals or new leases, how are tenants programming space? How are they thinking about space per person with work-from-home and hot desking trends? What trends are you seeing?

We’re seeing tenants trying to think through what they want to do, and the trends vary by company size. We offered free space planning services to tenants to help them post-COVID-ize their spaces. What’s generally coming out of that is more square feet per employee — larger, higher-profile workstations, more partitioning, more but smaller conference rooms, and a trend toward lower density, reversing prior densification. Some companies are talking about putting 10%–15% of employees on a work-from-home schedule. Whether those employees will hot desk or keep assigned desks when they come in is still being determined. A common denominator is a real focus on ventilation, touchless environments, and landlords who can demonstrate multiyear programs of capital investment in HVAC and building operations. George, I’ll hand it over to you for additional operational color.

I think the biggest trend we’re seeing is how people plan to spread out and navigate through workspace — considerations about ingress and egress flows, how kitchen and conference areas are configured. Large conference rooms may be less common; expect more smaller rooms for fewer people spaced differently. Workstations will get a bit bigger, and Plexiglas and height-adjustable desks are likely to remain. Overall, it’s about thoughtful circulation and distancing within the workspace.

Great, thanks very much.

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

Thank you. Good morning and congrats on the capital raises. I just want a little more color on the Schuylkill Yards JV. You said it’s a preferred JV. Can you talk about what the cash flow waterfalls are to the partner and why it was structured that way?

It is a preferred structure and our partner will receive first call on capital to their return on a current basis and then first call on recovering their capital as well. Fundamentally, given our conviction that this will be a successful project, we felt this structure fit our profit target best. We’re very happy with the structure.

Okay. You did the Mid-Atlantic JV sale and now Schuylkill Yards JV. How should we think about capital needs to get both Broadmoor and Schuylkill Yards done over the year going forward? Has anything changed in how much you want to raise, need, or think your ownership percentage could be based on what you’ve accomplished?

There are ample sources of private capital, and many investors are looking for strong operating partners. We view these JVs as relationship-building transitional capital. We don’t currently have the ability to fully self-equitize all opportunities we prefer to pursue, so we focus on structures with the best cost of capital. At Schuylkill Yards West we’re retaining a 55% stake with significant upside. Our remaining equity to put into that project is about $28 million and we’ll have discussions in Austin too. Our objective is to hold onto as much of the notional upside as we can because these initial phases are the first moves of significantly large developments. Executing the first phases well can signal significant profitability to shareholders and potentially allow future phases to be more fully owned.

To add, we've seen the debt markets open up in the last six months which helps. For Schuylkill Yards construction financing, we’re targeting 55%–60% loan-to-cost. Pricing we expect to get in the next couple months is better than what we would have expected a few months ago, which helps both pricing and loan-to-cost.

Is there any earn-out on the JV, promotes, or can you increase your stake over time?

They will have significant promotes. You could increase your effective economic participation by performing above the promote level, so the economic return would be disproportionate to our ownership stake, but our ownership stake as currently contemplated won't change.

Thank you. Our next question comes from Michael Lewis from Truist; your line is open.

Great, thank you. My first question is about the suburban JV and I guess it’s — why did you decide to sell these assets at this cap rate, mid-8s you said, versus other options? And assuming the answer has something to do with capital needs and crop profile, why not just sell all of it? Why keep capital deployed here when you have needs elsewhere?

We identified this pool of assets a number of years ago as part of our repositioning plan. When we put these portfolios on the market we’re always looking for either a sale or a JV. Many large institutional investors prefer operators to stay involved because it de-risks the deal for them, increases pricing metrics, and allows us to create a promote structure. From our perspective, this approach moves an asset from a mid-single-digit cash flow return to a high-teens overall return on our invested capital, and gives us options over time — including the potential to sell the portfolio with our partner in a terminal event or to adjust ownership through negotiated mechanisms as market conditions present themselves. We evaluated the partner, the structure, and the returns and felt this was the right outcome.

My second question — now that your guidance is out for next year, it's been many years that core FFO is between roughly $1.30 and $1.42. Could you talk about capital recycling and allocation and how you think about the growth profile and how to achieve it?

The joint venture strategy is a key part of our capital recycling. We've repositioned the portfolio over the last several years and created a forward development pipeline — Schuylkill Yards and Broadmoor are mixed-use opportunities where office, life science and residential can generate higher rates of return. The path to growth will come down to executing on existing vacant space and targeted vacancies; leasing those up would generate significant FFO growth. Our 2021 rollover is down to 4.2% on a net basis, and we’re working ahead of 2022 expirations. We’re frustrated our FFO target for this year is below consensus, but given significant rollouts and retirements we managed to keep FFO relatively stable. We aim to treat this year’s guidance as a springboard and execute on leasing and development to return to growth as the economy recovers.

Thank you. Our next question comes from Tayo Okusanya from Mizuho; your line is open.

Hi, good morning everyone and congrats on the JV. Regarding Schuylkill, the 45% preferred interest your JV partner has — is there a minimum return they get first before you start to participate in cash flows, is that the way it works?

Yes, that’s the standard preferred structure.

Can you tell us what that hurdle is?

No, I can’t disclose the exact hurdle. It’s a very effectively priced coupon that creates significant profit opportunity for the company, but we’re not at liberty to disclose the full details.

And does the JV partner have rights or options to participate in other pieces of Schuylkill or is it just for Schuylkill West right now?

We view these ventures as relationship-building. The partner has a high interest in participating in future phases at their election, and as we identify other phases, we may consider them as a renewable capital source if it makes sense for both parties.

Thank you. Our next question comes from Anthony Paolone from J.P. Morgan; your line is open.

Okay, thank you. My first question is, can you give us an update on a couple of law firms with near-term lease expirations?

Sure, Anthony. The largest near-term matter is Dechert at Cira Centre. We are getting some of their space back during 2021. Part of that will become part of the life science incubator on the fourth floor. We are still in active dialogue with them on a long-term extension on the upper bank floors, roughly 110,000 square feet. Another law firm at Cira has announced they will relocate to 1735 Market Street; they were in the mid-rise section and have an opportunity to relocate into the upper stack at 1735. One of the lower bank floors could also be part of the life science retrofit for Cira Centre, and floors 10, 11 and 12 at 1735 lay out contiguously for an approximately 80,000 square foot tenancy. We've already had initial inquiries on that space since the announcement.

So with the BakerHostetler space, that won’t impact 2021 numbers, that’s a 2022 item, correct?

That’s correct. Their lease expires on 12/31/2021, so that's a 2022 event.

And then thinking about dividend coverage and your sources and uses, what’s in the revenue-producing CapEx that wouldn’t be development or redevelopment?

On the revenue-producing CapEx, it’s a combination of smaller redevelopment projects that don’t fall into the redevelopment bucket and project-specific work for space that’s been down for quite a while and is being relet. So there is revenue TI in that number as well. It’s essentially smaller scope projects and tenant-related re-leasing work for spaces down over 12 months.

Okay, thank you.

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

Great, thank you. I wanted to follow up on the leasing pipeline. You mentioned 1.3 million square feet, up 230,000 quarter-over-quarter. Can you talk about the composition of that 1.3 million square feet?

A good portion of that is in Metro DC with 1676, and then we’ve got quite a bit of activity in CBD Philadelphia as well. Regionally, it’s about 30% DC, 35% Philadelphia, and the balance in the PA suburbs and Austin. The pipeline never includes development; it's the core portfolio. The breakdown of new versus renewal is about 65% new and 35% renewal.

Okay, great. And taking a step back on Austin, with subleases growing downtown but corporate announcements and positive job growth, what’s your big-picture view on how that market plays out in the next 12 to 18 months, downtown and up by the Domain or Broadmoor? What’s your expectation?

We’re increasingly optimistic on Austin having an accelerated recovery. Our supplemental package has Austin stats; we’re seeing diversified demand with 21 life science tenants, 39 software companies, seven semiconductor requirements, and defense-related requirements emerging. With announcements like Digital Realty locating to Austin, more companies are focused on the quality of life and business environment there. Our pipeline in Austin has increased over the last 30 days and we’re getting a lot of inquiries about forward demand for large office users. For Broadmoor, Block A includes 350,000 square feet of office and 341 apartments and we’re actively marketing the office component; larger users are engaging. We’re also working on transit access and expect infrastructure announcements to distinguish Broadmoor. We’re cautiously optimistic, and until some of these inquiries translate into real deals we’ll remain cautious, but the long-term trend for Austin looks positive.

Would you do build-to-suit there, like straight with a tenant or single-tenant structure?

Yes, we would consider build-to-suit or joint ventures with users. We’ve done that in the past and we’re keeping all options on the table as we enter these discussions.

Thank you. Our next question comes from Daniel Ismail from Green Street Advisors; your line is open.

Great, thank you. On 2340 Dulles, last quarter you mentioned looking to market that property. How has the market reception been to that marketing, and what is the overall desire for a value-add office product these days?

We have been talking to a number of potential investors for that project. We’re moving on a parallel path with our renovation program and plan to begin execution of the renovation. There are a number of larger tenants moving in that market and given 2340’s size, quality, location and visibility it could be an attractive receiver site. We decided to proceed with renovation, where every dollar we put in would be productive whether we sell or lease it up ourselves. The building has a higher-than-normal parking ratio and efficient floor plates. We’ve talked to potential buyers and partners; pricing varied based on underwriting assumptions. We’ll continue to market the building while executing the renovation, and the market should be stronger later in the year giving us better options.

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

Yeah, thanks. Good morning. I get the whole de-densification or reversal, but have you actually seen tenants take more space to make up for that?

I think there’s a bifurcation between larger and smaller tenants. Small and mid-sized companies (10 to 50 employees) are getting back to the workplace and are at the leading edge of space planning. Larger companies are debating how to structure hybrid schedules. We did have expansions during the quarter; George can add specifics.

For the quarter we had just a little north of 33,000 square feet of expansions and 191,000 for calendar year 2020. Most expansion activity is among small and mid-sized tenancies where an 8,000 square foot initial plan ends up growing to 11,000 or 10,000. We haven’t seen many large contiguous expansions yet, but if the return-to-work equation settles, larger expansions could follow.

Additionally, we see an accelerating trend toward quality — Class A trophy properties will likely pick up demand from tenants who want to communicate a high-quality, well-ventilated, and well-maintained workplace to employees. That's a green shoot for high-quality office landlords.

I guess the concern is that in pursuing many different product types and JVs you might be complicating the story such that the public market doesn’t award the underlying asset values. Is that a risk you consider?

We do consider that complexity, which is why we lay out details in our supplemental materials. I believe mixed-use, master-planned communities like Schuylkill Yards and Broadmoor increase value per site because residential, life science, office and retail together create more durable demand and higher asset value than an isolated office project. While the market may be cautious today, executing these phases well should benefit shareholders and potentially translate to re-rating over time.

Okay, thank you.

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

Hey, it’s Michael Bilerman here with Manny. Good morning. Jerry, you talked a little about disappointment in the FFO trajectory. How do you match that up with preferred investments you're making at 9% yield and retained preferred in the JV? Are you on a treadmill where when that capital returns you’ll have to find reinvestments, and the likelihood of finding something at a similar return may be limited?

When we look at those structured investments, they have to make sense. In Austin, cap rates are sub-5% and direct acquisition is expensive; the preferred investment enabled us to deploy capital into Austin at an attractive coupon with strong cash coverage. When the 9% coupon terminates, we'll redeploy where appropriate. At the same time, our larger blocks of vacancy and targeted leasing execution can generate core FFO growth, improving public market pricing and giving us capacity to continue pursuing development. These preferred investments are interim deployments of capital that produce strong current yields while we position the portfolio for growth.

On the suburban sale, why not exit completely? If financial investors want operators to stay in, why not sell 100% and focus capital elsewhere?

We considered sale alternatives. Institutional investors often prefer operator continuity to de-risk deals, which increases value and allows us to retain upside through a promote. These JV structures have in past cycles delivered significant returns for shareholders. That said, we also sell properties outright when that’s the best outcome, and we evaluate each opportunity on a case-by-case basis to maximize long-term shareholder returns.

Last question: on the terms of the two preferreds, are they cash-pay or accruing, and what’s the per-square-foot basis? Can you discuss Austin and the retained preferred in the suburban asset sale?

The Schuylkill Yards West preferred accrues and is structured by cash flow and distributions per the JV. The preferred in Austin is current pay. Our Austin investment basis is roughly $260 per square foot and we have over 2x cash flow coverage based on existing leases. The mid-Atlantic portfolio preferred is also current pay at approximately 9% with strong cash-flow coverage.

Thank you. That concludes our question-and-answer session. I will now turn the call back over to Jerry Sweeney for any closing remarks.

Great, thank you everyone for joining us for the fourth quarter 2020 call and we look forward to updating you on our first quarter 2021 call. In the meantime, everyone please stay safe and sound. Thank you.

Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation and you may now disconnect. Everyone have a wonderful day!