Brandywine Realty Trust Q4 FY2023 Earnings Call

Good day and thank you for standing by. Welcome to the Brandywine Realty Trust Fourth Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Jerry Sweeney, President and CEO. Please go ahead.

Michelle, thank you very much. Good morning, everyone, and thank you for participating in our fourth quarter 2023 earnings call. On today's call with me are George Johnstone, our Executive Vice President of Operations; Dan Palazzo, our Senior Vice President and Chief Accounting Officer; and Tom Wirth, our Executive Vice President and Chief Financial Officer. Prior to beginning, certain information that will be discussed during our 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 factors that could impact our anticipated results, please reference our press release, as well as our most recent annual and quarterly reports that we filed with the SEC. First and foremost, we hope that you and yours are well and are looking forward to a successful and ever-improving 2024. During our prepared comments, we'll briefly review our fourth quarter results and then spend time outlining the key assumptions of our 2024 business plan. After that, Dan, Tom, George, and I will be available to answer any questions. Looking at 2023, we posted fourth quarter FFO of $0.27 per share and full-year FFO of $1.15 per share. Our combined leasing activity for the quarter totaled 550,000 square feet. During the quarter, we exited 240,000 square feet of leases, including 66,000 square feet of new leases in our wholly-owned portfolio. In our joint venture portfolios, we achieved 312,000 square feet of lease executions, including 140,000 square feet of new leasing activity. Our quarterly rental rate mark-to-market was 13.4% on a GAAP basis and 7.5% on a cash basis. Our full-year mark-to-market was 13.5% on a GAAP basis, which outperformed our business plan, and our full-year cash mark-to-market was at 4.8% within our range. We ended the quarter 88% occupied and 89.6% leased, which is 100 basis points below our previously announced targets. That occupancy and lease percentage was lower due to two things: we anticipated December move-ins that slid until January, accounting for about 50 basis points of that change, and the anticipated portfolio sale that we had under agreement did not come to fruition, impacting our occupancy also by 50 basis points. In contrast, occupancy in our core markets of Philadelphia, CBD, University City, Pennsylvania suburbs, and Austin, which comprised 93% of our NOI, was 89% occupied and 91% leased. In looking just at our PA urban and suburban operations, we are 93% leased. As we highlighted in our supplemental package on page 4, eight of our wholly-owned properties comprise over 50% of our overall vacancy, impacting our occupancy numbers by almost 500 basis points. Plans are well underway to address each of these projects, ranging from accelerated leasing and capital investment programs as well as continuing to explore sale and conversion opportunities. Our 2023 spec revenue was $17.1 million, at the bottom end of our range, due solely to lower leasing volumes in our Austin Texas operation. The operating portfolio does remain in solid shape. Our forward rollover exposure through 2024 is now an average of 6.4% and through 2026, an average of 6.2%. Several points to amplify in terms of green shoots. The increase in physical tours has been very encouraging. Fourth quarter physical tours exceeded the third quarter by 54%, exceeding our trailing fourth quarter average by 55% or over 200,000 square feet per quarter. Our tour activity remains above pre-pandemic levels by 42%. On a wholly-owned basis, 55% of our new leasing activity was a result of a flight to quality. Tenant expansions continue to outweigh tenant contractions, and our total leasing pipeline is up for the third consecutive quarter and stands at 4.2 million square feet. That pipeline is broken down between two million square feet in our wholly-owned portfolio, which is up 300,000 square feet from last quarter, and 2.2 million square feet on our development projects, which is up 150,000 square feet from last quarter. The two million square feet in our existing portfolio pipeline includes approximately 250,000 square feet in advanced stages of lease negotiations, and about 41% of our operating portfolio and new deal pipeline are prospects looking to move up the quality curve. While the timeline for lease execution remains longer than we would like, tour velocity and the composition of those tours, which, as you know, is the starting point for the leasing cycle, continues to improve. Turning to the balance sheet. Our year-end net debt-to-EBITDA was 7.5 times, which is up by 0.1 point from the third quarter, primarily due to our delay in anticipated reduction in debt attribution from our unconsolidated joint ventures, asset sales being below our 2023 target, and a slight increase in our development and redevelopment spend. As a counterbalance to that, our core EBITDA metric, which excludes joint venture debt attribution and development and redevelopment spend, ended the year at 6.3 times within our targeted range. Looking at liquidity, controlled capital spending and our refinancing efforts have enabled us to maintain excellent liquidity as we closed out 2023 and look forward to 2024. For 2023, we achieved our goal of having full availability on our $600 million unsecured line of credit. We also closed the year with approximately $58 million of unrestricted cash on hand. More importantly, as noted on page 13 of our SIP, based on our 2024 business plan, we expect to have full availability on our line of credit at year-end 2024. During the quarter, we also bought back $10 million of our 2024 unsecured bonds at a slight discount. We did complete $25 million of sales during the quarter, ending the year with about $78 million of sales, which was below our business plan range. While we received good investor interest, the lack of attractive lender financing resulted in pricing levels below our expectations. Given our strong liquidity position, we decided to postpone several sales until market conditions improve. As Tom will touch on, our consolidated debt is 96% fixed at a 5.1% rate. We continue to assess our options to refinance our 2024 bond maturities, evaluating secured mortgage financing on several properties or an unsecured offering. We expect to finalize that plan in the next 90 days. Our 2024 business plan assumes this refinancing occurs by 6/30/2024, at a mid-8% interest rate. As noted on page 38 of our SIP, we have four operating joint ventures with loan maturities during the first half of 2024. Our ownership stake in those ventures ranges between 15% to 50%. All of these loans are secured solely by the real estate and are non-recourse with no obligation for either our partner or Brandywine to fund any additional money. That being said, we believe these ventures present a valuable opportunity as the debt and real estate markets recover. Along with our partners, we are engaged in productive conversations with each lender. While these discussions are progressing slower than we originally anticipated, we expect the full resolution on each of these ventures within the next 90 to 120 days. We still anticipate our overall joint venture debt attribution will be reduced by over $100 million. Looking at our dividend, we closed out 2023 with full year FFO and CAD payout ratios well covered at 63% and 80% respectively. As noted in our supplemental package, we recorded impairment charges totaling $151 million during the fourth quarter, which is based on several assets located in our D.C. operation, representing shorter-hold periods, with evidence of our intention to sell those assets as soon as permitted by market conditions. Given the unresolved loan renegotiation status on several of our unconsolidated operating joint ventures, we recognized impairment on several of those ventures on assets located in Virginia, Maryland, and suburban Pennsylvania. Looking at our 2024 business plan, we are providing guidance with an FFO range of $0.90 to $1 per share, with a midpoint of $0.95 per share. The primary drivers of this guidance include additional interest expense equal to $0.15 per share, representing the full impact of refinancing done in 2023 both on our consolidated and our joint ventures, and the anticipated refinancing of our $350 million 2024 bonds. Two of our residential projects are entering the lease-up phase, and we will recognize charges against earnings of $0.05 a share during 2024, since we've ceased capitalization at this point and will be recognizing operating carry losses during the lease-up.

Thank you, Jerry, and good morning. Our fourth quarter net loss was $157 million, or $0.91 a share, and our results were impacted by several non-cash impairment charges totaling about $153 million or $0.89 a share. Our fourth quarter FFO totaled $47.2 million or $0.27 per diluted share, and our full year FFO totaled $198.3 million or $1.15 per share and was within our guidance range of $1.15 to $1.17. Some general observations regarding the fourth quarter include several moving pieces and variances. The contribution from our joint ventures was $2.2 million, below our forecast, primarily due to increased costs to commence the lease-up of our multifamily project at Schuylkill Yards, and a one-time charge at one of our joint venture properties that was nonrecurring. Interest expense was $600,000 below what we forecasted, primarily due to some higher capitalized interest. We also forecasted two vacant land parcel sales to generate $1 million of earnings; one of those land parcels has been delayed to 2024 close. On impairments, as Jerry mentioned, we recorded impairments on both our wholly-owned properties and joint ventures. The wholly-owned impairments were based on short anticipated hold periods in the DC Metro area, while the joint venture impairments were based on the uncertain outcome related to the recapitalization of those partnerships. We still believe in the ultimate success and recoverability of those investments. Our fourth quarter debt service and interest coverage ratios were 2.5 and 2.6 respectively, and net debt to GAV was 43.4%. Our fourth quarter annualized core net EBITDA was 6.3 times and was within our range. Combined net debt to EBITDA was 7.5 times, above our 7.1 to 7.3 high end of our range. Our leverage was within our targeted range and we did not achieve that due to 2023 business plan sales targets, the debt attribution we had anticipated being reduced, due to some of the recapitalization events that we hope to take place in the first half of 2024 and continued capital spend on the development projects. During the quarter, 2340 Dulles was stabilized and added to our core portfolio. On the financing side, we remain focused on the 2024 bonds and continue to evaluate funding on both a secured and unsecured financing market, with an objective of completing the financing in the first half of the year. We're exploring some property-level secured financing options, including another wholly-owned CMBS transaction. We anticipate our ongoing sales and joint venture liquidation strategy will also generate additional capacity. As we've discussed in the past, we prefer to remain an unsecured borrower and we'll continue to monitor the unsecured market as well. Given the above, we have seen improved pricing for both secured and unsecured financings since our first call. We will continue to seek the most efficient capital source, with a bias towards the unsecured market. Regarding the upcoming joint venture maturities, as Jerry mentioned, we are working with our partners on the 2024 maturities to potentially extend those current maturity dates with our existing lenders and commence marketing efforts with some new lenders on certain properties for sale to help lower JV leverage. Going to 2024 guidance, at the midpoint, our net loss is projected at $0.31 per diluted share and FFO will be $0.95 per diluted share. Based on our 2024 guidance range, this reflects a decrease of $0.20 per share, primarily driven by our interest expense going up on both the wholly owned and JV side. Our 2024 range is built on some general assumptions. Overall, portfolio operations remain very stable, with property-level GAAP NOI totaling roughly $305 million, an increase of around $5 million compared to the prior year. The full-year impact of 2340 Dulles and 405 Colorado will provide us about $6 million in benefits. We continue to see the lease-up of 250 King of Prussia generating several million dollars. 155 King of Prussia will commence operations in the fourth quarter and generate about $1 million. Offset this with about $4 million of reductions due to the 2023 sales activity, including losing the state of Texas. That $4 million is income that was in 2023 but will not be in 2024. There will also be a modest increase in the same-store portfolio. The FFO contribution from joint ventures will total a negative $8 million to $10 million, primarily driven by our multifamily lease-up stabilization, which will total about $9 million. Higher interest costs on the operating portfolio are also anticipated to occur in 2024. G&A expense will be between $35.5 million and $36.5 million. Total interest expense, including $4.5 million of deferred financing costs, will approximate $122.5 million due to the refinancing of the bonds, which Jerry outlined will increase quarterly interest expense by roughly $4 million. Forecasted higher use of our line of credit to fund development until our speculative second-half asset sales take place, along with higher interest rates compared to 2023 are also included. Capitalized interest will decrease by about $6 million to $10 million as current development and redevelopment projects are completed and become operational. Land sales and tax provisions are estimated between $4 million and $6 million, as we anticipate further progress on selling non-core asset parcels. Termination and other fee income will be between $10 million and $12 million, slightly below our 2023 levels due to some one-time activities in the 2023 results. Net management, leasing, and development fees will be between $11 million and $12 million, a slight decrease due to lower forecasted third-party fees. Expected property sales of $80 million to $100 million are set to occur primarily in the second half of the year without material dilution anticipated. We expect no property acquisitions or use of the ATM or buyback activity, and we believe our share count will be roughly 174 million shares. Looking at first quarter guidance, property-level operating income will total approximately $74 million, which will be below the fourth quarter operating number by $2 million, primarily due to some of the fourth quarter asset sales and higher operating costs in some of our portfolios. FFO contribution from our joint ventures will total a negative $1 million for the first quarter, again primarily due to the ramp-up of leasing at our multifamily project at Schuylkill Yards. G&A expense for the first quarter will total about $10 million, and that sequential increase is consistent with prior years, primarily due to the timing of deferred compensation expense recognition. Total interest expense will approximate $26 million. Capitalized interest will be about $3 million. Termination fees and other income will total about $2.5 million. Net management fee and development fees will be about $1.5 million. We have no material land gain sales projected for the first quarter.

So, the key takeaways are that our operating portfolio is in solid shape. Again, we have very manageable rollover exposure through 2026. We will continue to have a relatively strong mark-to-market, along with good control of our capital spend. We're pleased with the level of leasing activity through the pipeline that we are experiencing. I want to reiterate that we are executing a baseline business plan that will continue to improve our liquidity, keeping our operating portfolio in solid footing, with a clear focus on leasing up our development projects to generate forward earnings growth. As usual, we end where we started, wishing you and your families well. Michelle, with that, we are delighted to open the floor for questions.

Thank you. Our first question comes from Anthony Paolone with JPMorgan. Your line is open.

Great. Thanks. I guess maybe for Tom. I think you quantified the drag from the apartments being about a nickel. I'm wondering if you can give us a sense of when those are fully stabilized, does that nickel drag become a few pennies positive? What sort of the bounce off of what seems like maybe the '24 is perhaps the worst impact of bringing those things online?

Tony, I do think it will turn into a positive a couple of cents once it's stabilized. There are two sets of timing. We will have some of those hits for Schuylkill Yards taking place in the first and second quarter since they opened up at the end of the third quarter. So, we'll begin to see positive NOI as we look at Schuylkill Yards in the second half of the year. We expect to be fully open on the project One Uptown, and again by the third quarter, you'll see some charges starting to hit there while it leases up. Towards the end of the year and going into next year, we see a couple of cents of positive momentum moving into 2025.

Okay. So, we should think about almost like, I don't know, $0.07 of swing from '24 into '25 from those? Is that the order of magnitude?

Yes, I think that's the order of magnitude. The NOI that's coming online is being offset by our preferred equity and interest expense. Until that NOI increases, we won't fully offset it, but yes, I think it's probably around a $0.07 swing as you go into '25.

Okay. And then just second one, maybe for Jerry, the 4.2 million square foot leasing pipeline that you talked about, can you provide a little more color on the nature of the tenants driving that, their industries, and type of space they're looking for?

Yes. Tony. George and I will tag team it, but we haven't seen any perceptible change in the composition of the tenancies quarter over quarter. Our primary pipeline here in Philadelphia remains life science institutional requirements, as well as law firms, accounting firms, and engineering firms, etc. In Austin, the pipeline there is actually less tech reliant and more service-related, including financial service firms and insurance companies. We've seen a large drop-off in larger tech requirements in Austin. Given the dearth of new tech requirements and the number of available sublease spaces controlled by tech tenants, we've shifted our focus to smaller-sized tenants that are service-based.

Yes, you hit the nail on the head. Professional services seem to be the predominant industry drivers, whether that's financial services, law firms, or life sciences.

Additionally, traditional service firms are looking for better corporate homes, which solidifies our quality thesis. We believe the quality of the space we're presenting, as well as the relative stability of our company from a financial standpoint compared to many private firms, narrows the competitive set. This is a key reason why we're seeing the pipeline build rapidly. However, we do face challenges in converting that pipeline into executed leases.

Okay, great. Thank you.

Thank you.

Thank you. Our next question comes from Michael Griffin with Citi. Your line is open.

Great. Thanks. Jerry, in your opening remarks you talked about how tour activity is notably above recent quarters. How quickly could we see that actually translate into demand and leasing for space?

Not quick enough for me, Michael. We're putting in a major effort as we respond to a lot of RFPs and RFIs where the level of tour activity has picked up. Even in Austin, Texas, the number of tours we've seen so far this year already equals about two-thirds of what we saw last year. We are beginning to see several, what I'm calling green shoots, and are just working to get them across the finish line. Our spec revenue target this year is well above the previous target, and as of now, we are close to 80% done on that target. This gives us a solid basis for generating additional leasing revenue in the second half of the year.

But tenants are still taking a while to make decisions, right? They haven't shortened their timeframe in terms of leasing decisions? You're just seeing more inbounds, is that correct?

It's anecdotal, as we have some companies that make decisions very quickly, while others, particularly the larger ones, are more over-deliberative. George, do you have any color on that?

Yes. The cycle times remain relatively unchanged. Larger tenants tend to take longer as they analyze combining several locations into one and going through their demographic studies of commuting times, although we're encouraged by our proposal conversion rates.

Got you. That's helpful. And then maybe just one on the debt stuff for Tom. For the JV debt coming due, you talked about conversations you're having with your lenders right now. Does it make sense to put additional financing on it, or would you be better off handing back the fees on some of those properties?

I think we would prefer not to put additional financing on those properties. However, if the opportunity arises to put in capital that we would recover ahead of the debt, that may be something we consider. In most cases, we prefer not to increase indebtedness.

All right. That's it for me. Thank you, Tom.

Okay. Thank you.

Thank you. Our next question comes from Dylan Burzinski with Green Street. Your line is open.

Hi guys. Thanks for taking my question. I wanted to go back to some of the occupancy comments you made in your prepared remarks. You came in 150 basis points below your targets; 100 basis points was due to anticipated move-ins sliding into January, and 50 basis points from a portfolio sale that didn't happen. What was the other 50 basis point drag you thought you had when you provided guidance last quarter?

Yes, Dylan. The third component was just not getting pipeline conversions on a number of new deals that we thought would be executed and added to the leased number.

On the portfolio sale, can you talk about the reasons it didn't go through? Was it simply that they couldn't get debt?

Certainly. It was an under-leased portfolio, remaining in our wholly-owned stack. It was to a non-institutional-grade buyer who was thinly capitalized and looking for third-party financing. When that didn't pan out, they proposed significant seller financing, which we were willing to consider, but the terms were such that we felt it was better to hold the portfolio, obtain near-term lease renewals, and wait for better capital markets. It did impact our year-end numbers; however, we believe it was the right decision not to proceed with that sale.

All right. Thanks, guys.

Thanks, Dylan.

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

Yeah. Thanks. Good morning. Following up on Dylan's question, Jerry, can you help us gauge your confidence level in the 88% to 89% leased and occupied numbers for this year, given the slower time to finalize deals?

We have a high degree of confidence in the numbers we've provided. This confidence is demonstrated by the high percentage of execution we already have in place, as well as a thorough review of our entire pipeline. If we look at sensitivity, we have revenue coming in from our Austin operation, and while that is precious given the slow velocity, the uptick in activity could offset any potential slowness. We expect a balanced performance across our other markets as well.

In terms of square footage, the open plan currently stands at roughly 340,000 square feet with 100,000 of that being renewals we feel confident about and about 240,000 square feet of new leasing. Our projections about the achievability of revenue and performance remain strong due to the metrics we've already achieved.

I think if we did the math right, the leasing on the residential in Schuylkill was pretty slow in the fourth quarter, maybe 20 leases done from the last reporting. Is that correct, and why was the leasing so low?

Yes, Steve, your math is correct. We were delighted to get that level of activity as many amenity spaces were not completed until much later in the year. The holidays factored in too, leading to a reduced leasing count in November and December. We anticipate a ramp-up as we approach peak leasing season with expectations of 12 to 13 new leases per month thereafter.

Are the rents you're achieving and concession levels consistent with your budget, better or worse?

We had a level of concessions that were in line with our pro forma to facilitate opening occupancy levels. The average rent is currently around $3,200 a month, aligning with our performance, which we hope will improve as we enter the leasing season.

Great. Thanks.

Thank you, Steve.

Thank you. Our next question comes from Upal Rana with KeyBanc. Your line is open.

Hi. Good morning. Could you talk about some of the sequential changes in the development pipeline? I saw some adjustments with ownership increases and delays. Any color on that would be great.

The increase in ownership is primarily due to the obligations of our joint venture partners to fund up to their investment level. We've also reassessed the timeframe for completing various projects, reflecting an understanding of time needed to build out and deliver spaces, accounting for regulatory delays. We're aggressively addressing this by planning interior construction ahead of time to mitigate those delays.

The reasons for changes that require us to contribute more capital relate mostly to evolving interest expenses tied to the projects. As interest rates increased faster than expected, we chose to fund these increases.

Okay. Thank you. And as a follow-up, could you discuss updates on your vacancy reduction plan, particularly regarding planned leasing, sales, or conversions of assets?

We are aggressively leasing several properties, focusing on higher-quality projects like Cira Centre and 401 Plymouth Road with accelerated marketing outreach. At 101 West Elm, we have begun a significant lobby renovation and common area upgrades. Additionally, we are evaluating the feasibility of conversion opportunities for some assets to residential as we make strategic capital investments to improve our facilities.

Great. Thank you.

Thank you.

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

Hey, good morning. First question is when you look at the competitive leasing landscape in the Philly and Austin markets, do you feel your competitors are getting more desperate or urgent in their leasing?

I think we are in a great position given the quality of our products and our ability to execute. Many of our private market competitors face tighter financing constraints, limiting their ability to fund leasing incentives, leading to delays in executions. These conditions create a competitive advantage for us, allowing us to attract prospects looking for high certainty in the execution of their leases. While the market reflects a general uncertainty, we are observing growing leasing activity, particularly for high-quality spaces.

I appreciate that. I do have a follow-up for Tom. If I go back to Tony's question about the trajectory of recovery in development, do you believe that earnings hit bottom late this year? Or will that $0.07 swing be enough to keep you flat or positive in 2025?

If you look at our yields once the multifamily projects stabilize, they're expected to generate over $0.09 of NOI. In 2024, they're projected to achieve under $0.03. The NOI as it grows from $0.02 to $0.03 represents a significant swing, so once stabilized, we should see that projected increase starting in the first half of 2025.

So, 2025 should see positive growth overall?

Yes. We expect NOI growth overall, as both projects will be stabilized and begin generating positive returns.

Thank you. Our last question comes from Omotayo Okusanya with Deutsche Bank. Your line is open.

Yes. Good morning everyone. I wanted to return to the interest expense forecast for the year. Regarding the debt refinancing planned for the 4Q, will it be refinanced earlier leading to a bigger impact on interest expense? Additionally, what's the SOFR forecast being used for your variable debt and how is that impacting your forecast?

Regarding the bonds, we prefer doing that deal sooner rather than later. Since our last call, we've seen rates come in pretty significantly by about 150 basis points. Thus, we would prefer to execute a bond deal earlier rather than later. If we can finalize that in the second quarter, we expect about $4-plus million in additional interest expense due to early refinancing of that bond, adding about $8 million over those two quarters to the bond deal by mid-October. Regarding SOFR, we expect to utilize the line more this year than last, with floating rate debt at the JV level.

That's all. Thank you.

Thank you.

Thank you. There are no further questions. I'd like to turn the call over to Jerry Sweeney for closing remarks.

Great. Well, Michelle, thank you for your help, and thank you all for participating in our call. I wish you a good day, and we look forward to updating you on our business plan on our next quarterly earnings conference call. Thank you.

Thank you for your participation. This does conclude the program, and you may now disconnect. Everyone have a great day.