Earnings Call Transcript - BDN Q4 2022

Operator, Operator

Good day. And thank you for standing by. Welcome to the Brandywine Realty Trust Fourth Quarter 2022 Earnings Call. 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. You may begin.

Jerry Sweeney, President & CEO

Catherine, thank you very much. Good morning, everyone and thank you for participating in our fourth quarter 2022 earnings call. On today's call with me 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, certain information discussed during our call may constitute forward-looking statements within the meaning of the federal securities law. Although we believe the 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 annual and quarterly reports filed with the SEC. First and foremost, we hope that you and your family had a wonderful holiday season and are looking forward to a successful 2023. During our prepared remarks this morning, we'll briefly review fourth quarter results, provide color on recent transactions, and outline our 2023 business plan. Tom will then review our 2022 results and frame out the key assumptions driving our 2023 guidance. After that, certainly Dan, George, Tom, and I are available to answer any questions. Quickly reviewing our 2022 results, we posted fourth quarter FFO of $0.32 per share in line with consensus and full year FFO of $1.38 per share, which exceeded consensus estimates by $0.01 per share. During the fourth quarter of 2022, we executed 226,000 square feet of leases, including 142,000 square feet of new leasing activity. For 2022, we leased 1.8 million square feet of space, which compares favorably to both our volumes in 2021 and 2022. More specifically, looking at 2022, our new leases executed during the year exceeded our 2021 new leasing activity by 11%, and it was equal to the pre-pandemic levels that we experienced back in the fourth quarter of 2019. We also posted a rental rate mark-to-market of 21% on a GAAP basis, and 12.5% on a cash basis. Our full year mark-to-market was just shy of 19% on a GAAP basis and just shy of 10% on a cash basis. Absorption for the quarter was negative by 123,000 square feet. Half of this negative absorption was the result of a tenant default in Austin, while the other half were known tenant move-outs, which resulted in a quarterly retention rate below our annual run rate. For the year, we did post retention above our business plan guidance at 64%. We ended the quarter at 89.8% occupied and 91% leased, which were below our targets. The previously mentioned tenant default accounted for about 50 basis points on each of those metrics, and occupancy was generally a little bit lower due to anticipated December move-ins split into January and the sale of our forward Tower Bridge property. From an occupancy and leasing standpoint, our DC portfolio continues to underperform. It's worth noting that our Philadelphia, Pennsylvania suburbs and Austin portfolios, which comprise about 93% of our NOI are 91.7% occupied and 92.7% leased, while spec revenue of $35.7 million exceeded the midpoint of our $34 million to $36 million range. As we look at it, the portfolio is solid with a stable outlook. As noted in the supplemental package, we've reduced our forward rollover exposure through 2024 to an average of 6.2% and through 2026 to an average of 7%. Physical tour volume has also been encouraging. Fourth quarter physical tours exceeded third quarter tours by 50% and were also ahead of our fourth quarter 2021 tour by 12%. For the full year 2022, our tour volume was over 1.2 million square feet. We experienced tenants taking advantage of opportunities to move up the quality curve. During 2022, over 600,000 square feet of leasing activity resulted from this flight to quality. In addition, tenant expansions continue to outweigh tenant contractions; in 2022, expansions totaled 325,000 square feet while contractions totaled 132,000 square feet, which is almost a 2.5 to 1 ratio of expansions over contractions. Our leasing pipeline of 3 million square feet consists of about 1.2 million in our operating portfolio and 1.8 million in our development projects. Our operating portfolio includes approximately 184,000 square feet in advanced stages of lease negotiations. Notably, 41% of that pipeline consists of prospects looking to move up the quality curve, and during the fourth quarter, 58% of the new leases executed were flight to quality tenants. Considering some financial metrics based on increased 2022 leasing activity and higher EBITDA, our fourth quarter net debt to EBITDA ratio decreased to 7.0x from the 7.2 in the third quarter. As discussed, this ratio was temporarily higher due to our development spend and the debt attribution from our joint venture activity. A more meaningful metric we track is our core net debt to EBITDA, which ended the year at the midpoint of our range of 6.2x. In times of rate volatility and economic uncertainty, leasing and liquidity are our two key benchmarks. Since our last call, we've made significant progress on both the financing and capital recycling fronts by raising over $745 million in proceeds. As previously announced in December, we completed a five-year $350 million unsecured bond offering at a 7.5% coupon, essentially used to retire our February bond maturity. In January, we completed a five-year $245 million secured financing with an 8.75% coupon, collateralized by seven wholly owned properties. The note has flexible release and prepayment provisions and has about two years until maturity. It's important to note that we took the secured route solely due to pricing differences between the secured and unsecured debt markets, as we plan to remain an investment-grade unsecured borrower. Additionally, during the fourth quarter, we recorded two sales generating $130 million in proceeds, with the cap rates on those two sales being below 6%. The team also swapped our $250 million unsecured term loan towards its June 2027 maturity date at roughly 5%. The results of all these combined transactions significantly improved our liquidity. Our consolidated debt is 96% fixed at essentially a 5% rate, and we have no consolidated debt maturing until our $350 million bond in October 2024. We now have full availability on our $600 million unsecured line of credit and approximately $30 million in unrestricted cash. As noted in our SIP, based on our full development spending projections, our 2023 business plan execution after fully funding our remaining development spend, all TI leasing, and capital costs, we expect to have about $590 million of available capacity at year end 2023. Based on our business plan, there will only be $10 million of net usage during the year, indicating a very strong liquidity position. Quickly turning to 2023, we are providing guidance for 2023 earnings and an FFO range of $1.12 to $1.20 per share for a midpoint of $1.16 per share. At the midpoint, the 2023 FFO projection is $0.23 per share below our 2022 FFO. The primary drivers are as follows: our 2023 NOI will exceed 2022 levels by $20 million, or about $0.10 a share. Those improved operating results include contributions from 405 Colorado, 250 King of Prussia Road, and 2340 Dulles, as well as higher same-store results. This NOI growth is offset by $33 million, or $0.19 per share, due to increased interest expense on the recently completed financings. We also anticipate about a $0.08 per share decrease in our contribution from joint ventures, primarily due to higher interest rates and projected losses from several development projects coming online and not stabilized until after 2023. We expect about a $0.04 per share decline in other income and a $0.02 per share decrease in projected land gains compared to 2022 levels. Tom can certainly amplify those points in more detail. Our 2023 plan is headlined by two key operating metrics: our cash mark-to-market range is between 4% and 6%, while GAAP mark-to-market is between 11% and 13%. Although these ranges are lower than our 2022 levels, they certainly remain strong, primarily driven by the composition of our projected 2023 leasing activity. For example, during 2022, much higher leasing revenue came from CBD, University City, and the Pennsylvania suburbs. In 2023, higher leasing volumes have shifted to Austin, Texas, given the high level of occupancy in our core Pennsylvania and Philadelphia markets. Our mark-to-market in CBD and University City will perform above our business plan ranges, while Austin, given current market conditions and demand drivers, is anticipated to perform below those ranges. Spec revenue will be between $17 million and $19 million, with $10 million or 56% done at the midpoint. Occupancy levels will be between 90% and 91%, leasing levels between 91% and 92%, and retention rates will be between 49% and 51%. We anticipate same-store NOI growth will range from 0% to 2% on a GAAP basis and between 2.5% and 3.5% on a cash basis. Capital will run about 12% of revenues, which is lower than the 2022 results. Based on increased 2023 leasing activity and continued development and redevelopment spend, we project our net debt to EBITDA to be in the range of 7.0% to 7.3%, with our core leverage between 6.2% and 6.5%. At the guidance midpoint, our current dividend of $0.76 per share represents a 66% FFO payout ratio and 100% CAD payout ratio. Our business plan, as I'll talk about in a few moments, projects between $100 million and $125 million of sales activity that could generate additional gains. Importantly, with liquidity needs substantially addressed, this targeted sale activity provides conservative underpinnings to our coverage ratios, allowing us to maintain the dividend at current levels. As the business plan progresses and we gain more clarity on the economic outlook, the board will, as they always do, continue to monitor both our coverages and dividend payout levels. In addition to the financing activities we've already completed, we are actively engaged in plans to enter into a construction loan on our 155 King of Prussia Road project, which is fully leased, and our 3151 Market Street project here at Schuylkill Yards during the first half of the year. During 2023, we also have two joint ventures with non-recourse loans maturing. We are already well underway with refinancing discussions for these loans as well. The first is a $20 million loan on our Commerce Square joint venture, which is a very low-levered financing with a significant current debt yield. We're currently in the market to refinance that mortgage, with over 15 lenders reviewing this financing opportunity. The second maturity is in August 2023, and refinancing efforts with our partners are underway there as well. As I mentioned during the year, we are providing a range in our business plan of between $100 million and $125 million in dispositions, which we anticipate occurring in the second half of the year. We plan to generate those proceeds from between $200 million and $300 million of properties in the market for price discovery. In terms of development, we currently have $1.2 billion under active development, of which $302 million is our wholly owned development, and it is 30% Life Science and 70% office. This portfolio is 83% leased with remaining funding requirements outlined in the SIP totaling $91 million. Regarding joint venture development, our pipeline approximates $930 million, with Brandywine's share being $500 million. At full cost, this pipeline is 31% residential, 41% Life Science, and 28% office. Brandywine’s remaining funding obligation in this pipeline is $4 million, with $68 million of equity remaining to be funded by our joint venture partners. I mentioned in the last call that, other than fully leased build-to-suit opportunities, our future development starts are on hold pending additional leasing on the existing joint venture pipeline and more clarity on the cost of debt, capital, and cap rates. Looking ahead, we do plan to develop about 3 million square feet of life science space. Upon completion of the existing properties, we will have approximately 800,000 square feet of life science space in operation, representing about 8% of our portfolio. Our objective is to grow our life science platform to 21% of our square footage. As outlined in the SIP, our redevelopment project at 2340 is now 92% leased, with $45 million of remaining funding and a mid-year coming online at that lease for those leases. 250 King of Prussia Road in our Radnor market remains 53% leased, with a strong pipeline of over 200,000 square feet. You will note in the SIP that we had increased our costs on this project, as our original pro forma assumed a 50:50 office and life science split. The pipeline is now 100% life science, which, while requiring more capital, is also generating longer-term leases at a higher return on cost. As we projected further on the pipeline of several key life science prospects, we have also split the stabilization to Q1 of 2024. 3025 JFK, our life science residential tower, is on time and on budget for delivery in the second half of the year. We currently have an active pipeline totaling 472,000 square feet, which is up about 75,000 square feet from last quarter. This project continues to see more activity as construction progresses, and the superstructure is now complete, with the window wall systems halfway up the building. We've conducted over 120 hard hat tours. We also expect to start delivery of the first block of residential units in the second half of this year, all remaining on schedule. 3151 Market, our 440,000 square foot dedicated life science building, is also on schedule and on budget. We have a leasing pipeline totaling over 400,000 square feet, which is again up from Q3. Assuming we enter into a construction loan on this project in the second half of 2023. Uptown ATX Block A, construction in Austin is also on time and on budget. Regarding the office component, our leasing pipeline there is 500,000 square feet. That pipeline has decreased from last quarter, primarily due to two larger users putting their requirements on hold. Our focus up to this point has really been on full building users. We're now shifting to a multi-tenant marketing program, so we expect that pipeline to build as the quarter progresses. To summarize our commentary on the development pipeline, the key phrase for our forward pipeline is timing flexibility. We have a low land basis and product diversity; of the 13 million square feet that we can build, only about 25% is required for office. We can construct 3 to 4 million square feet of life science space and over 4,000 apartments. Our overlay approvals give us flexibility to adjust our projects to meet market demands. Our 2023 business plan includes the $100 million to $120 million in property dispositions that we expect to occur in the second half of the year. While we are not including many in our plan for 2023, we do anticipate continuing to sell non-core land parcels and looking at our joint ventures; $458 million of our debt levels or about 19% of our total debt is coming from our joint ventures, with about $416 million from our operating JVs. Our 2023 plan expects to recapitalize several of those JVs, anticipating to reduce attributed debt from operating JVs by about $100 million or 24% by the end of the year. Certainly, every dollar generated from these activities will be used to improve our existing strong liquidity, fund our remaining development pipeline, reduce leverage, and redeploy into higher growth opportunities, including, as liquidity permits, stock and debt buybacks on a leverage-neutral basis. Tom will now provide an overview of our financial results.

Tom Wirth, CFO

Thank you, Jerry. Our fourth quarter net income totaled $29.5 million, or $0.17 per diluted share, and FFO totaled $55.7 million, or $0.32 per diluted share, in line with consensus estimates. Some general observations regarding the fourth quarter: while our fourth quarter results were in line with consensus, we had several moving pieces and variances compared to our third quarter call guidance. Our portfolio income was up by $900,000 above our third quarter guidance call, primarily due to overall portfolio performance being better throughout. Termination and other income totaled $2.7 million, which was $800,000 below our third quarter forecast primarily due to budgeted income items that will occur in 2023. Interest expense totaled $20.5 million, or $2 million below our third quarter guidance, primarily due to higher capitalized interest and slower capital spend. The line of credit balance at year-end was below where we anticipated it would be due to the bond deals transaction. G&A expense totaled $9.1 million or $1.1 million above our third quarter guidance. This increase was due to a $1.8 million one-time charge for the write-off of acquisition pursuit costs, partially offset by lower personnel costs. We anticipated that termination would generate $800,000 in gains in the quarter, which did not occur. We now anticipate that transaction to happen in the first quarter. Our fourth quarter debt service and interest coverage ratios were 3.3 and 3.5, respectively, and net debt to GAV was slightly below 40%. Our fourth quarter annualized net debt to EBITDA was 7.0 and 1/10 of a turn above the high end of our guidance, which was 6 to 6.9. As far as the portfolio changes for this year, we expect to have four or five stabilize and become part of our core portfolio during 2023. On the financing activities Jerry outlined, since our last call, we have made significant progress on our financing and capital recycling fronts. In December 2022, we completed the five-year $350 million unsecured bond offering at a 7.55% coupon, and in January we completed a five-year $245 million secured financing at a 5.875% coupon, collateralized by seven wholly owned properties. These two financings raised $595 million at a blended rate of 6.7%. Prior to the secured financing, our wholly owned portfolio was completely unencumbered and we anticipate that it will remain an unsecured borrower on future financings. We swapped our $250 million unsecured term loan through its June 2027 maturity date, and our consolidated debt is now 96% fixed at just above 5%. Only our floating line of credit and trust-preferred securities are floating rate on the balance sheet. Regarding joint venture debt, we are currently working on the 2023 maturities, including active marketing of our Commerce Square property. We are also already working with our 2024 maturities with our partners to possibly extend the current maturity dates with existing lenders. We are considering some asset sales to lower leverage. For 2023 guidance, at the midpoint, our net loss is $0.08 per share on a loss basis, and FFO will be $1.16 per diluted share. Based on the midpoint, FFO has decreased by $0.22 per share, driven by GAAP and NOI being up. We expect a slight increase in management fees but other income is expected to be lower, with interest income also being lower as a result of the sale of 1919 Market Street in Philadelphia and our joint ventures. Interest expense is going to be up $23 million; our land gains are down $5 million, and the JV FFO is down 16.8%, which is primarily due to interest expense resulting from higher rates. We anticipate initial losses primarily on the opening of our residential project at Schuylkill Yards West. Our 2023 range was built on the following assumptions: GAAP NOI will increase by $20 million. Most of that is due to 2340 and 405 Colorado driving incremental NOI as we progress through the year, with continued leasing of our life science development at 250 King of Prussia at about $5 million. We expect about a $3 million net increase in the improvement on the same-store portfolio. Our FFO contribution from joint ventures will total $8 million to $10 million, primarily due to lower income from higher interest expense. G&A expense will be between $34 million and $35 million, consistent with 2022. Interest expense will total about $105 million, and we foresee some use of a line of credit throughout the year. However, as asset sales are realized in the second half of the year, we expect that balance to decline, but there will be incremental interest expense during that time. Capitalized interest will increase to $12 million as we continue our development and redevelopment projects. We project $2 million to $4 million in land sales this year, anticipating further progress on selling non-core land parcels. Termination income is expected between $5 million and $6 million, which is below 2022 due to several anticipated one-time items. Net management fees will fall between $15 million and $16 million. Our property sales are anticipated to occur in the second half of the year, between $100 million to $125 million, with no property acquisitions or share buyback activity included in our model. We anticipate a construction loan on 155 King of Prussia Road, with approximately 174 million shares expected. For the first quarter, we anticipate about $73 million of property NOI, with a $5.5 million FFO contribution from our joint ventures. G&A will increase to $9.5 million, which is normal for the first half of the year. Total interest expense will be $24.5 million, with a termination fee around $2 million and expected land gains of about $1.5 million. From a capital plan perspective, our plan encompasses about $465 million. Our CAD ratio, as Jerry noted, is between 95% and 105%, with the main contributor to the higher range being lower earnings, partially offset by reduced leasing costs. Those first-degree expenses are going to be $105 million for development and redevelopment, primarily for 405 Colorado, 250 King of Prussia Road, and 2340 Dulles. We had $54 million to retire the balance of our bonds in January. Our primary sources will be cash flow from operations of $175 million, the secured term loan closing, which generated $236 million in proceeds, $80 million in cash on hand, and about $120 million from expected land sales and the property sales between $100 and $125 million. Based on our capital plan, we expect our line of credit balance to decrease by approximately $84 million by year-end, leaving almost full availability. We project our net debt to EBITDA to range between 7.0 and 7.3, with the incremental spend on development projects having minimal income by year-end. Our net debt to joint ventures will be in the 40% to 42% range, while our additional metric of core net debt to EBITDA should be 6.2 to 6.5 by the end of the year, excluding our joint ventures and development projects. We believe these ratios are elevated due to the growing development pipeline. We believe that as these developments stabilize, our leverage will decrease back towards our core metrics. We anticipate our fixed charge interest coverage ratios will approximate 2.7x, representing a sequential decrease primarily due to capital spend and higher interest rates. I will now turn the call back over to Jerry.

Jerry Sweeney, President & CEO

Tom, thank you very much. So key takeaways: we believe the portfolio is in solid shape from an operational standpoint. Our average annual rollover exposure through 2026 is only 7%, with strong mark-to-market, manageable capital spends, and stable and accelerating leasing velocity. Since last quarter, we have fully covered our wholly near-term liquidity needs; we finance our 2023 bonds, as Tom mentioned, while reducing our line of credit to zero, and presenting a baseline business plan that continues to improve all liquidity while fully covering our dividend and keeping our operating portfolio in very solid footing with strong forward growth prospects. As usual, I’d like to end where we started by wishing you and your families well. With that, we’d be delighted to open up the floor for questions. We do ask that in the interest of time you limit yourself to one question and a follow-up.

Operator, Operator

Our first question comes from Steve Sakwa from Evercore ISI.

Steve Sakwa, Analyst

Yes, thanks. Good morning, Jerry and Tom. I guess I just wanted to start on the operating portfolio and some of the outlooks for lease and core occupancy. I know those numbers came in at the end of the year, kind of below your original forecasts, and some of those numbers are expected to be flat or even down in 2022, but you've got a lower retention ratio. So just trying to sort of square up your confidence level in the new leasing pipeline to hit your leasing and occupancy numbers that seem to fall short last year.

Jerry Sweeney, President & CEO

Sure, Steve, George, why don’t you take that one?

George Johnstone, Executive Vice President of Operations

Yes, sure. Glad to, and good morning. Look, on fourth quarter occupancy, we did come up short; the tenant default in Austin was 51 basis points. We also had another 42,000 square feet or about 330 basis points of occupancy that did occur in January, but substantial completion and the actual moving process did not happen until December. We thought we might be closer to 90.7%, which would have been about 34,000 square feet off of our 91%. The outlook for 2022 is probably again close to a 90% average occupancy, which is driven twofold: in Pennsylvania and CBD Philadelphia, we're anticipating about 93% occupancy levels for the year, but in Austin and DC, only 82%. As Jerry mentioned in his commentary, that's really part of the dynamic that's occurring with CBD at 96% occupied for the year; however, contribution levels that we will require and anticipate out of Austin have risen. They were roughly 16% of our square footage contribution in 2022 and are projected to be about 32% in 2023. The pipeline is consistent with what we've seen in the past. In terms of Austin, we've seen good levels of tour activity, and we currently have a lease out for about 12,000 square feet of that space that was defaulted and given back in December. Activity levels are already starting to emerge in that building, so we remain positive. We still believe in the growth characteristics of Austin, and many of our suburban properties are somewhat insulated from the big tech companies, as we see a lot more financial services and professional service prospects in our pipeline.

Steve Sakwa, Analyst

Okay, and then maybe just quickly. I just wanted to touch on, Jerry, the 1.8 square feet on the development pipeline. I know you've kind of walked through 3025 and 3051, and it sounded like Austin maybe was a bit slower. But can you give us a little more color on the tenants that you're talking to—timelines? How many of these are new to Philadelphia for the life science assets? And are the Austin tenants new to Austin or expanding tenants in Austin? The mark is feeling some pressure with the tech slowdown you mentioned, so just any flavor on kind of in-house tenants or in-market tenants versus new to the market?

Jerry Sweeney, President & CEO

Sure, happy to. Looking at the Schuylkill Yards development, Steve, the 3025 project will come online later this year, while 3151 is about a year behind. As I mentioned, the pipeline is up quarter-over-quarter, and the majority of the prospects are significant growth of in-market companies. We have several who are new to the Philadelphia region, and the larger square footage tenants are consolidations from other areas around the city, coupled with some significant expansion capabilities. These seem to drive the life science tenant base we're discussing at Schuylkill Yards. From the office standpoint, they're primarily in-region companies, looking to move to higher quality, well-amenitized projects. It's important to note that while there is a lot of dissonance in the office sector, we're still very pleased with the level of new prospect activity we’re seeing from tenants moving from older buildings to upgraded options. This is a trend line we've seen for the last two years. We have a good high-quality existing portfolio and very good new developments; we’re pleasantly surprised by the velocity of new deals coming into our pipeline from market companies. Economics aside, these tenants are still willing to pay higher rents for premium spaces. We monitor this dynamic closely through our CRM software, outreach programs, and pipeline tracking on a weekly basis. Regarding Austin, we've been mainly focused on finding full building users; there were several major ones in the market engaged in tours and negotiations. However, some of those have been stalled—not dead but on hold. We're shifting our strategy to seek mid-sized prospects and consider a multi-tenant approach, which we believe will be effective. Although Austin is slower to return to the workplace compared to other markets, trends are improving.

Michael Lewis, Analyst

Thank you. You mentioned the JV that matures this year, including Commerce Square. It sounds like there's a lot of interested lenders, even though financing can be difficult to obtain for office properties. Can you speak to the financing environment? If you're able to share anything regarding what you might be expecting for proceeds or pricing on those loans?

Jerry Sweeney, President & CEO

Sure, Tom, you want to take that?

Tom Wirth, CFO

Sure, Mike, hi, it’s Tom. We are talking to a number of lending sources, and on the traditional lender side—mainly banks—we have seen some pullback in their appetite for new loans and newer originations. We are looking at other opportunities, like maybe securitized types of loans or debt funds. So there are alternative sources besides traditional banks, although we do have a couple looking at it. If banks are to participate, it might be as a group rather than a single institution due to the project size. Pricing is still to be determined. I would expect it to be higher than the current debt, and we are working on that over the next month or so for more clarity.

Michael Lewis, Analyst

Okay, great, thanks. I recently read an article arguing that the Philadelphia suburban office market might be in trouble because the flight to quality is bringing tenants into the Center City. You've talked about flight to quality a little, but there’s a broader theory that people are going into cities less, so perhaps offices in the suburbs are more easily commutable and better positioned post-COVID. Are you seeing anything in terms of demand in the suburbs vs. the city, indicating a shift that favors one strategy over the other? I know you're involved in both.

Jerry Sweeney, President & CEO

Hey, Michael, great question. We really haven't seen a discernible trendline, to tell you the truth. We expected to see people either moving into the city or out to the suburbs, but we haven’t seen that. We have only noticed a couple of tenants from the CBD moving out to the city. We’ve conversely seen a few tenants move from outside the city into the city. So, no real discernible trend by tenant type or size. We do continue to see tenants focused on quality in both places. Our Radnor portfolio, and the build-to-suit we did, announced on Arkema in Radnor, is a great example of a high-quality company with great credit who wants to enhance their amenity space for their employees. They appreciate the location of Radnor, served by two train lines and access to Interstate highways. Essentially, the quality and location predicates are both operational, whether they’re in the city or the suburbs. The percentage of those returning to the office has been higher in the suburbs than in the City. Even though foot traffic is back to pre-pandemic levels during the workday, mass transportation is on a positive trend line. Occupancy and daily levels in the suburbs are around 70% to 75%, while in the city, it's closer to 50%, although a number of large employers have been slow to transition back with hybrid plans.

Michael Griffin, Analyst

Great, thanks. Maybe we can talk about life science demand for a bit, specifically at 250 King of Prussia. You noted the stabilization was pushed back a quarter. This is a suburban asset, a bit further out from the core life science cluster in CBD Philly. Just how confident are you that demand is there for a product like this? Any additional commentary would be great.

Jerry Sweeney, President & CEO

Yes, I'm sorry, Michael, are you asking about demand at 250? I think we're very confident. We were marketing that project as a hybrid life science office. This was the basis behind our leasing assumptions and the capital costs. As I mentioned, we did raise our capital cost by about $20 million this quarter, while increasing the yield to 8.2% as we've been marketing it. The building, now in showcase condition, recently delivered, has tenants in place and has become a magnet for life science companies. We've invested significantly in the building’s infrastructure, making it an integral part of our Radnor Life Science Center, which comprises several buildings. The demand drivers have remained strong; however, they’ve been frustratingly slow in decision-making. As observed across the board, potential users take longer due to technical requirements and space planning. The existing pipeline shows continued solid demand, particularly in University City and suburban areas like Radnor, King of Prussia, and further north towards Springhouse, which have seen good leasing activity. In the city, demand has largely centered on University City with established firms down by Navy Yard and other prominent areas.

Michael Griffin, Analyst

Got you. That's helpful. And then, regarding the tenant default in Austin, can you expand on that a bit? Are there any other tenants in your portfolio that might find themselves in a similar situation?

George Johnstone, Executive Vice President of Operations

Sure, yes, I'd be glad to. This was a 65,000 square foot tenant at our Martin Skyway project in the Southwest Corridor. We had a kind of ongoing dispute with them during 2022. They were one of our fully reserved tenants, so they didn't impact the 2022 business plan due to the reserve. We reached a stalemate, leading to a default and eviction, and we've now started re-marketing the space. We have developed a pipeline and are currently negotiating a lease for about 12,000 square feet.

Michael Griffin, Analyst

Are there any other tenants that you might be concerned could default?

George Johnstone, Executive Vice President of Operations

Not at this time. We continually assess our tenants' credit and ongoing utilization, and we currently don't see any significant risks projecting.

Tom Wirth, CFO

We have been fortunate to not have many defaults, particularly in the office sector. Most of the relief we provided was in retail rather than office space. We actively monitor tenants' credit on a monthly basis, so we’re maintaining a good handle on risks, and this tenant accounted for by far the largest issue we've been following. We don’t foresee storm clouds impacting tenant collections currently.

Tayo Okusanya, Analyst

Hi, good morning, everyone. I wanted to talk a little bit about just about the dividend. Given the guidance you’re forecasting a dividend coverage on an FID basis of anywhere between 95 to 105, it's really tight. Just curious how you think about it forward, especially given your kind of source of the uses of capital in 2023?

Jerry Sweeney, President & CEO

Yes, provide context; the payout ratio for 2023 will be tight, higher than in previous years. When thinking about the dividend, we've established a strong, conservative baseline cash flow in our 2023 plan. We’ll monitor this closely, but we believe it’s prudent to maintain the current dividend levels, evaluating closely during the year especially given our projections for asset sales which could provide additional liquidity.

Tayo Okusanya, Analyst

That's very helpful. And just a follow-up on the JV debt side: can you give us a general sense of where you think you could raise debt for upcoming maturities, and would you consider putting any swaps on some of the outstanding variable rate debt?

Tom Wirth, CFO

Sure, Tayo, this is Tom. I wanted to follow up on Jerry's comments on the dividend. This year, because of the gains we realized on sales, we had full utilization of the dividend sourced from operating income and those gains. Our ongoing goal is to maintain stability in the dividend rather than issuing one-time special dividends. We closely monitor the asset sales that will yield gains, determining future dividend levels accordingly. We'll make decisions on the JV debt while considering interest rate movements along the curve, potentially hedging some variable rate debt, pursuing extensions with lenders on performing assets, and looking further out with a view to future refinancing.

Camille Bonnel, Analyst

Hi, good morning. This morning, you mentioned the quantum of disposition targets this year. Can you talk about the asset types or geographies you're looking to sell? More broadly, what are your expectations for when we might start to see pricing stability for office properties?

Jerry Sweeney, President & CEO

Yes. Great question. Good morning. As we work on our sales program for 2023, we've identified properties across our three markets, including Philadelphia and its suburbs, and several properties we’re targeting for sale in Washington, D.C., along with potential opportunities in the suburban areas of Austin. Currently, we have a number of properties in the market; as for pricing, there is a lot of price discovery happening where sellers are determining pricing while buyers are evaluating debt yields. We’re pleased with the volume of confidentiality agreements signed and the number of due diligence tours. For example, one property marketed in January already has over 56 confidentiality agreements signed. The pricing outlook remains uncertain; however, we believe that the debt markets are improving compared to the fourth quarter of last year, as we’ve seen positive lender interest in financing. While it's uncertain how this translates to the deals we’re pushing forward, we're targeting cap rates generally in the very high 6s to low 9s depending on asset quality. As we track offers, we'll also adjust our marketing timelines based on the external landscape and lenders' feedback on refinancings.

Unidentified Analyst, Analyst

Good morning, everyone. Thanks for taking the question. Just curious if you can comment on expectations for net effective rent growth across the portfolio.

George Johnstone, Executive Vice President of Operations

Sure, absolutely, and good morning. The net effective rent growth differs by market, but in Philadelphia and Pennsylvania suburbs, there are the best opportunities. Our CBD portfolio averages around 5% below the market right now, so as leases rollover, we can capitalize on these opportunities. Near-term rental rate growth is outperforming the construction cost increases, along with requests for free rent. Thus, we feel optimistic for these areas concerning net effective rent growth. In Austin, the trends might be flat to slightly down considering the current market dynamics and rental pricing.

Jerry Sweeney, President & CEO

Adding, we have been pleased with the mark-to-markets received, particularly from University City, CBD Philadelphia, and Pennsylvania suburbs. Monitoring capital ratios for projected 2023 leasing activity shows our ratios are lower than they were in 2022 even with varied leasing activity. We're excited about the potential to drive effective rent growth in core markets including University City, CBD, and Pennsylvania suburbs.

Unidentified Analyst, Analyst

I recall you mentioned Conshohocken trading at a sub-6% cap rate. Is anything driving that cap rate lower than the high 6s to low 9s mentioned previously?

Jerry Sweeney, President & CEO

The properties that are well-located like 4 Tower Bridge and others typically command lower cap rates. D.C. properties have not seen effective rent growth. However, we continue to see good demand for premier assets with long lease terms backed by quality tenants and minimal deferred capital. This reflects somewhat favorable demand for such assets; however, how this translates to pricing remains to be seen over the course of the year.

Bill Crow, Analyst

Hey, good morning, Jerry. As you speak with your joint venture partners, is there an increased sentiment regarding selling assets instead of financing at current rates? Is there pressure, and what does that imply for future joint venture agreements?

Jerry Sweeney, President & CEO

Good question, Bill. Our joint ventures serve as transitional strategies for our finances. We have executed many in the past and exited many as some of our current partnerships approach their target lifecycle. Discussions with our partners often revolve around whether it’s the right time to sell, recapitalize, or adjust our approach. While we could have engaged more on the JV side in Q4 if capital markets were friendlier, discussions today are leaning toward optimizing returns for both parties by considering sales of assets and refinancing strategies. We foresee robust progress in the first half of 2023 as we determine how to optimize our positions within our operating joint ventures. Thank you all for participating in our call today. We look forward to updating you on our 2023 business plan progress during our first-quarter call later this year.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.