Earnings Call Transcript - CMCT Q3 2022

Stephen Altebrando, Portfolio Oversight

Good morning, everyone, and thank you for joining us. My name is Steve Altebrando, the portfolio oversight for CMCT. Also on today is David Thompson, our Chief Executive Officer; Shaul Kuba, CIM Co-Founder and CMCT Board member; and Barry Berlin, our Chief Financial Officer. This call is being webcast, and will be temporarily archived on the Investor Relations section of our website, where you can also find our earnings release and latest investor presentation. Our earnings release also includes reconciliations of non-GAAP financial measures discussed during today's call. During the course of this call, we will make forward-looking statements. These forward-looking statements are based on the beliefs of, assumptions made by and information currently available to us. Our actual results will be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control or ability to predict. Although we believe that our assumptions are reasonable, they are not guarantees of future performance, and some will prove to be incorrect. Therefore, our actual future results can be expected to differ from our expectations, and those differences may be material. For a more detailed description of potential risks, please refer to our SEC filings, which can be found in the Investor Relations section of our website. With that, I'll turn the call over to David Thompson.

David Thompson, CEO

Thanks, Steve, and thank you, everyone, for joining our call today. Yesterday, we announced our third quarter 2022 earnings. Some highlights from the quarter: First, we had continued strong leasing activity, which is positioning us well for next year; second, we made significant progress on our value-add and development pipeline; third, we took steps to improve our liquidity and balance sheet, and this is extremely important in the current rising interest rate environment where we expect future acquisition opportunities; and fourth, we accretively deployed capital through both common and preferred share repurchases. Our core FFO per share was negative $0.07 in the third quarter. While we completed a significant amount of new leases this year, and have a strong lease pipeline, we will not see the full benefit until next year. Most notably, this includes our lease signed in August with the Rolls-Royce dealership at our Beverly Hills property, which will start generating revenue in 2023. Trends at our One Hotel continued to improve on a year-over-year basis, and the outlook for 2023 looks strong based on the pickup in group bookings. The third quarter is typically a seasonally slower quarter for the hotel. And in our lending business, we had a slowdown in originations in the quarter due to, among other things, the reduced volume of commercial real estate transactions market-wide. We also had some one-time costs in our JV property in Echo Park, in addition to some nonrecurring items in our G&A. Finally, the amount of our preferred dividend payment is increasing as a result of the significant amount of preferred stock we raised in the third quarter. Our third quarter FFO picks up dividends we declared in the fourth quarter, even though we did not have the benefit of the capital for the full quarter, and Barry will provide some more detail on these items. As we've discussed on previous calls, we are committed to balancing our portfolio between both creative office and multifamily assets. Right now, we're focused on growing the multifamily side of our portfolio in order to achieve that balance. We have a significant pipeline of multifamily development opportunities on land we already own. As we have previously mentioned, for value-add and development assets, we'll look to co-invest to increase our diversification and supplement returns by generating fee income or advantageous. We have a lot of work to do in front of us, but we believe we have an opportunity to create significant value for our shareholders by using our resources and access to capital. I would now like to turn the call over to Shaul Kuba.

Shaul Kuba, CIM Co-Founder and CMCT Board Member

Thank you. I wanted to highlight two significant updates in the quarter. First, we leased approximately 59,000 square feet in the third quarter. This was an increase from about 39,000 square feet in the second quarter. Our most notable lease being at our Beverly Hills building, 9460 Wilshire Boulevard. We signed a 20-year lease with Rolls-Royce dealership for approximately 18,000 square feet of the remaining retail. We expect to start to recognize revenue on this lease in 2023. Second, we did an extensive review of the portfolio to evaluate where we can create additional value. Based on this review, we believe we can develop over 1,500 multifamily units based on land we already own. This is an exciting update for CMCT and each shareholder. In Austin, we are evaluating adding one or more multifamily buildings to our 16-acre Penn Field Creative office campus. In June, the City Council approved zoning changes that allow us to add more density on this property, which is located just south of the CBD. We are excited about this potential opportunity at this tremendous campus, which was transformative to this section of Austin. In East Austin, we are working towards multifamily development on two adjacent properties at 1007 and 1021 East Seventh Street. We submitted our entitlement application in this third quarter. Those properties are very well located with numerous dining and entertainment options within walking distance and within close proximity to Austin CBD, Central Business District. We are also working on predevelopment work for potential multifamily development in Oakland and Sacramento. We recently submitted a request to entitle our Oakland development asset for multifamily as it is currently entitled for office. We believe entitling this asset will create incremental value for the land in the near term. And in Sacramento, we are evaluating a built-to-rent multifamily development over a large parking garage we already own. Those exciting opportunities are the result of the extensive review of this portfolio. Now for a quick update on some of the value-add and development opportunities we have been working on. At 4750 Wilshire in Los Angeles, we expect to start construction on the conversion of the unleased portion of the building into luxury multifamily rentals in early 2023. We anticipate a construction timeline of about 18 months. The total cost of the conversion is expected to be approximately $33 million. We are in active discussions with several institutional co-investors and seek to close transactions over the next several months. Since we are expecting to bring in co-investors and take a construction loan, we expect CMCT to generate meaningful proceeds from this transaction. CMCT will also earn a management fee on committed equity and have an opportunity to earn a promote. As we discussed on our last call, we expect to break ground in 2023 on our 36-unit multifamily property in the Echo Park neighborhood of Los Angeles at 1910 West Sunset Boulevard, which we acquired with a joint venture partner earlier this year. The asset is located in the middle of a trendy submarket and part of a walkable area that also has a dozen dining and entertainment options. In the Jefferson Park section of Los Angeles, we have made progress on the development of our two multifamily properties there, where we plan to develop about 150 units across both sites. We are working towards receiving the necessary approval and still expect to break ground on the first site in 2023 and the second site in 2024. We are excited about those developments as they are strategically located in the path of growth in close proximity to Culver City and just 1.5 miles from the University of Southern California. Right now, we are working hard to go vertical on those projects by getting all the necessary approvals as well as completing the design work. Obviously, we will continue to monitor construction costs as we move forward. Given increased borrowing costs, the lower availability of credit, and widening cap rates, we expect that overall development will slow. As a result, development costs may potentially come down. With that, I will turn the call over to Steve for more detail on the portfolio and recent capital market activity.

Stephen Altebrando, Portfolio Oversight

Thanks, Shaul. Starting off with the portfolio, our stabilized portfolio was 86.5% leased at the end of the third quarter. As Shaul mentioned, we leased approximately 59,000 square feet in the third quarter and at least about 120,000 square feet year-to-date. And as David touched on, we will begin to generate revenue on several of these leases and the leases in our pipeline starting next year. Our cash lease spreads for all recurring leases decreased slightly to negative 1.2% through the first nine months of 2022. This lease spread excludes our recent retail lease at our Beverly Hills property since the space was vacant for more than 12 months. We continue to have a strong pipeline of leasing activity. We have about 50,000 square feet of leases that are either signed in Q4 in LOI or legal, or represent in-place tenants that we expect to renew. We entered this year with nearly 15% of our leases expiring in 2022, which was about 151,000 square feet of expirations. In total, our leases executed in LOI or legal or expected to renew now exceed this amount. Our lease expirations will decline to just 11.9% in 2023, and to 6.6% in 2024. Turning to our capital markets activity. We announced a $10 million common share repurchase program in the second quarter of 2022. We have repurchased $4.7 million of common stock, including $4.4 million in the third quarter at an average price of $7.10 per share. Also, in the third quarter, we repurchased approximately $67 million of Series L preferred stock at a 3.4% discount to stated value. We believe these two transactions are highly accretive for our common shareholders. With that, I'll turn it over to Barry.

Barry Berlin, CFO

Thanks, Steve. First, I'd like to take a moment to thank Nate DeBacker for guiding us the past few years as our CFO and for assisting me through the transition to be your CFO. Nate and I worked closely together, and I will continue to work closely with Nate upon CMCT. Moving on to financial highlights. Our high-level third quarter results are as follows. During the third quarter, our core FFO reduced to a negative $0.07 per diluted share compared to a positive $0.08 in the prior year comparable period. This change was primarily driven by a reduction in segment NOI and the distributions for our preferred stock issuances. Our segment operations NOI was reduced to $10.1 million compared to $13.3 million in the prior year comparable period. This quarter-over-quarter change is broken out as a $3.7 million reduction in our lending segment NOI, a $1 million reduction in our office segment NOI, being partially offset by the positive trend in our hotel segment NOI by $1.5 million. Drilling deeper into our business segments. First, our lending division NOI decreased by around $3.7 million to a more normalized $1.2 million in Q3 2022. It's important to note that in 2021, we had a significant bump in loan originations and loan sales which had significant market premiums. This was due to COVID-driven additional government support of our SBA 7(a) loan product that drove NOI up to $4.9 million last year for the three months ended September 30, 2021. That increased government support did end in 2021. Second, our office segment NOI decreased to $6.5 million from $7.5 million in the prior year period. While the NOI in our same-store office properties remained relatively constant at $6.7 million compared to $6.8 million in the prior year quarterly period, the NOI attributable to our non-same-store properties had a reduction of around $900,000. Also of note is that the office segment reduction included a loss from our JV investment acquired in February this year of around $200,000 for the third quarter of 2022. The JV loss did include a one-time upfront cost related to the JV's mortgage debt origination. Our office segment continues to see improved activity, and we signed approximately 59,000 square feet of leases during the quarter. Third, our hotel segment NOI increased to $2.4 million from around $900,000 in the prior year comparable period. This was driven by improved occupancy, which went up to 74% from 67%, and we saw improved ADR, which increased to around $164 from $137. For our overhead, the largest impact is the reduction in asset management fees, which were reduced to below $900,000 from $2.3 million in the prior year comparable period due to the fee waiver that went into effect January 1, 2022. As a result, our net loss income for the company before preferred equity activity was a loss of $45,000 in Q3 of '22 versus a profit of $2.570 million in Q3 of 2021. Below the company net loss income line, we record our preferred stock activity. In September 2022, we repurchased a portion of our L shares and had $4.8 million in deemed dividends impacting our bottom line due to the expensing of upfront costs from when we issued those securities. We also had declared or accumulated preferred stock dividends of approximately $6.6 million in the quarter compared to $4.7 million in the prior year comparable period. This increase is related to the new issuances of Series A and Series A1 preferred securities. This includes the impact of forward dividends declared for the fourth quarter of around $1.3 million relating to our preferred issuance during the third quarter of 2022. As David noted, our preferred cash dividends paid were approximately $5.3 million, also about $1.3 million less than what runs through our net income available for our common shareholders. Turning to our liquidity. We had approximately $85 million drawn on our revolver at the end of the quarter with an estimated $120 million of availability as of September 30. Our credit facility matures in late 2023. We expect to close on a recast of the facility shortly, which should extend the facility another three years, plus we'll have the option for two one-year extension options. Finally, we generated around $57 million of cash proceeds from preferred stock issued in the third quarter, which is the largest quarterly amount since the Series A preferred have been offered, with momentum continuing into the fourth quarter with proceeds of $38 million in October, giving us additional financial flexibility. With that, I will now turn the call over to David for some closing remarks.

David Thompson, CEO

Thanks, Barry. In closing, I'd like to reiterate our key strategic goals. First, continue to make tangible progress on our stabilized and value-add assets as well as our development pipeline. We believe our asset-light approach will enable us to generate strong returns on invested capital. Second, we are focused on creating greater financial flexibility. As Barry mentioned, we are working to recast our credit facility, which matures in late 2023, and expect to close a new facility in the fourth quarter. We raised approximately $46.5 million in net proceeds from our Series A1 preferred stock so far in the fourth quarter, further enhancing our flexibility. This allows us to take advantage of potential acquisition opportunities or opportunities in the capital markets like we have seen of late. Third, we're working to keep our cost structure in check, including the continued benefits of our reduced management fee announced earlier this year. That reduction amounts to approximately $0.21 per share in annual cost savings. We are also focused on keeping our recurring G&A expenses down. Fourth, we're shifting the balance of the portfolio more towards multifamily and creative office over time. Taken together, we believe these priorities combined into a compelling business model for CMCT, which will provide strong returns on capital and a model where CIM Group's distribution and development capabilities provide a significant competitive advantage. CIM has more than 180 global institutional investors. It has developed over $11 billion of assets across the United States and has more than 100 professionals in our development group with expertise in urban planning, construction, design, architecture, engineering, and project management. To wrap up, we have great assets in highly desirable submarkets such as Beverly Hills, Culver City, Hollywood, and Austin. We are encouraged by the pickup in our leasing activity and declines in expirations as we head into 2023 and 2024. We have a very attractive growth pipeline where we are making tangible progress in development and construction activities. We look forward to sharing more updates on future calls. For value-add and development assets, we will seek co-investors to increase our diversification and supplement returns by generating fee income. And finally, we have significantly reduced our cost structure. Operator, you may now open the call to questions.

Operator, Operator

Today's first question comes from Gaurav Mehta with EF Hunton.

Gaurav Mehta, Analyst

I wanted to ask you about your development pipeline and your comments on the capital expanding for multifamily. Can you maybe help us understand how you're viewing acquisition opportunities given that CapEx are expanding? And how does that compare to the yields that you're getting on your development pipeline?

Stephen Altebrando, Portfolio Oversight

Yes, sure. This is Steve. Regarding the development pipeline and the yields we aim to achieve, the recent changes in cap rates have certainly raised our hurdle rate. However, we are also observing ongoing rent growth in the market and anticipate a decrease in development costs. Generally, for multifamily projects, we are aiming for about a 6% return on cost, and despite the rise in market cap rates, this still provides a substantial spread that allows us to create significant value through development. At the same time, we are actively seeking not only developmental opportunities but also stabilized and value-add multifamily deals, which were challenging to find a year ago due to the cap rate environment. We believe there will be more opportunities emerging in the stabilized sector.

Gaurav Mehta, Analyst

Okay. On your preferred stock capital raising, can you maybe talk about the uses of the cash that you're generating in 4Q? I think as earnings release, you guys said $46 million of preferred stock raise in 4Q. How do you plan to use that? Do you plan to carry that cash on the balance sheet or deploy that towards acquisitions?

David Thompson, CEO

Yes, I can discuss that briefly. We currently have some outstanding amounts under our revolving credit facility, which means we can immediately use our cash to pay it down. As mentioned, we have our Series L preferred stock that can be redeemed late in the fourth quarter, totaling approximately $80 million if we choose to use cash for that purpose. Given the current trading of our shares, redeeming in shares seems highly unlikely. Therefore, we plan to use some of the cash to help pay down the revolver and potentially for the redemption of the Series L preferred stock later this quarter. We have also identified several other opportunities to generate cash and improve our liquidity. We anticipate strong preferred volume continuing into the fourth quarter. Additionally, we are renegotiating our credit facility and expect the new terms to be finalized this quarter. The co-investment that Shaul mentioned will also assist us in positioning for growth opportunities in our pipeline and exploring other possibilities.

Operator, Operator

The next question comes from Eric Speron with First Foundation.

Eric Speron, Analyst

Guys, can you hear me?

David Thompson, CEO

Yes.

Eric Speron, Analyst

Great. My question is about multifamily, specifically in Oakland. You submitted some filings that are quite exciting, including a 46-story building with 600 units, which represents a significant portion of your multifamily opportunity at about 40%. Can you provide more details on this? I notice it's located near some opportunity zones, though I'm unsure if it's within one. Could you also discuss the appropriate amount of capital you plan to contribute and what your targets are for bringing in outside investment? Please address the Oakland multifamily situation.

Shaul Kuba, CIM Co-Founder and CMCT Board Member

Yes. Let me answer. This is Shaul. The land that we own in Oakland is prime for entitlement for multifamily. The office market in Oakland is pretty, I would say, at the moment, saturated with vacancy. So we decided to take advantage of the existing entitlement that we have converting them to multifamily. We're probably going to be done with that process in about 18 months to 24 months. And at that point, we're going to evaluate how much co-invest to raise for that project. We own the land free and clear, so we don't have any debt. Our overall debt load is very low, and the intent is to raise co-invest for it when we're ready to present it.

Eric Speron, Analyst

And just quick clarification. Is it in the opportunity zone there? Or is it a fallout side? It's hard to see on the maps.

Shaul Kuba, CIM Co-Founder and CMCT Board Member

I don't think it's an opportunity zone. But I don't know for a fact. Maybe, Steve, you know? I don't know.

Stephen Altebrando, Portfolio Oversight

Yes, I don't believe it's in, but either way, would not have much of a benefit for us.

Operator, Operator

This concludes our question-and-answer session as well as our conference. Thank you for attending today's presentation. You may now disconnect.