Highwoods Properties, Inc. Q4 FY2021 Earnings Call

Good morning, and welcome to the Highwoods Properties Earnings Call. During the presentation, all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. As a reminder, this conference is being recorded, Wednesday, February 9th, 2022. It is now my pleasure to turn the conference over to Hannah True. Please go ahead, Ms. True.

Thank you, Operator, and good morning, everyone. My name is Hannah True, and I work with Brendan on the Finance and Investor Relations team here at Highwoods. Participating on the call this morning are Ted Klinck, our Chief Executive Officer; Brian Leary, our Chief Operating Officer; and Brendan Maiorana, our Chief Financial Officer. For your convenience, today's prepared remarks have been posted on the web. If you have not received yesterday's earnings release or supplemental, they're both available on the Investors section of our website at highwoods.com. On today's call, our review will include non-GAAP measures, such as FFO, NOI, and EBITDAre. The release and supplemental include a reconciliation of these non-GAAP measures to the most directly comparable GAAP financial measures. Forward-looking statements made during today's call are subject to risks and uncertainties, including the ongoing adverse effect of the COVID-19 pandemic on our financial condition and operating results. These risks and uncertainties are discussed at length in our press releases as well as our SEC filings. As you know, actual events and results can differ materially from these forward-looking statements, and the Company does not undertake a duty to update any forward-looking statements. With that, I'll now turn the call over to Ted.

Thanks, Hannah, and good morning, everyone. I'd like to start off by welcoming Hannah to our call today. It's great to have you with us. Our fourth quarter was representative of our execution throughout all of 2021, as we delivered strong financial results, solid leasing metrics, and strengthening cash flows, all while improving the quality and resiliency of our portfolio, protecting our fortress balance sheet and laying the groundwork for additional long-term growth. Our simple and straightforward investment strategy is to generate attractive and sustainable returns over the long term by developing, acquiring, and owning a portfolio of high-quality, differentiated office buildings in the Best Business Districts, which we call BBDs. A core component of this strategy is to continuously strengthen the financial and operational performance, resiliency, and long-term growth prospects of our portfolio, and recycle out of properties that no longer meet our criteria. To this end, in 2021, we acquired $800 million of high-quality office buildings in Raleigh and Charlotte, completed $356 million of 92% leased office development, acquired approximately $100 million of land for future development in three BBDs, and sold $385 million of non-core properties. In addition, since our last call, we've announced $174 million of development that is a combined 36% pre-leased, even before putting the first shovel in the ground. Since the beginning of 2019, we have acquired 3.1 million square feet of best-in-class office assets for a total investment of $1.3 billion, delivered 1.4 million square feet of highly leased office development for a total investment of nearly $600 million, and sold 6.7 million square feet of non-core properties for $1 billion. Because of these continuous and meaningful improvements, our portfolio is even more resilient and better poised for long-term growth. Plus, our cash flows have continued to strengthen as evidenced by 15% higher average in-place office rents and a meaningful reduction in our CapEx spend over these three years. During this same period, we've grown core FFO 9% and our dividend 8% while maintaining a strong balance sheet and investing in the building blocks for additional long-term growth. Turning to our results, we delivered FFO of $1.06 per share in the fourth quarter, which includes $0.09 of land sale gains. Even when we exclude these land sale gains, our full-year FFO was $3.77 per share, $0.01 above the high end of our revised outlook in October, and $0.19 above the midpoint of our original outlook last February. In addition to FFO, our operations were also healthy. Same property cash NOI growth was solid at plus 3.2% for the quarter and plus 5.5% for the year. We leased 884,000 square feet of second generation space, including 284,000 square feet of new leases and 47,000 square feet of net expansions. Rent spreads were a positive 3.2% on a cash basis and plus 11.6% on a GAAP basis. We also signed 158,000 square feet of first-generation leases since our last call. Solid leasing activity helped drive year-end occupancy up to 91.2%. Similar to last quarter, utilization across our portfolio hovers around 40%. We anticipate more customers returning to the office later in the first quarter and during the spring months. Utilization tends to be higher in our suburban buildings and among smaller customers. Despite overall utilization continuing to be significantly below pre-pandemic levels, we are encouraged by the strong customer and prospect interest we're seeing across our portfolio, which translated into healthy leasing in the fourth quarter. Turning to investments, in the quarter we sold 1 million square feet of non-core assets for $191 million that were a combined 77.5% occupied. These sales helped bring our debt-to-EBITDA ratio down to 5.4x. We have sold over $350 million of non-core properties since the middle of last year, with another $150 million to $200 million to go to return our balance sheet to pre-PAC acquisition metrics. On the acquisition front, competition for high-quality properties in our markets' BBDs has continued to increase since the beginning of the pandemic. Institutional investors, both foreign and domestic, recognize the excellent long-term value of assets located in the best submarkets across our footprint. We will continue to be disciplined with our capital allocation as we seek to acquire office assets that would further strengthen our performance, resiliency, and long-term growth prospects. Our $283 million development pipeline is 51% pre-leased. Leasing was healthy for our completed but not yet stabilized developments. As you may remember, we started both Virginia Springs II and Midtown West fully spec in 2019. At our Virginia Springs II project in Nashville's Brentwood BBD, we're now 90% leased and have healthy interest in the balance of the space. At Midtown West in Tampa, our 150,000 square foot, $71 million property is 65% leased, and we have solid interest from additional prospects. During the quarter, we announced the 218,000 square foot, $95 million GlenLake III office and amenity retail project in Raleigh that is currently 15% pre-leased. We have just broken ground on this property, which will be LEED and Fitwel certified. We have 732,000 square feet of in-service product in GlenLake that are a combined 97% occupied. GlenLake III, which is scheduled to be completed in late 2023 and stabilize in early 2026, will provide growth opportunities for existing customers and new users. After year-end, we announced the 135,000 square foot 2827 Peachtree office development in a joint venture with Brand Properties. This $79 million boutique office development has a healthy mix of on-site and nearby amenities, which have helped drive strong activity. The development is already 62% pre-leased and talks with prospects continue. Our land bank has never been more attractive; it can support $2.3 billion of future office and another almost $2 billion of adjacent mixed-use development via new apartments, shops, restaurants, and hotels. Now to our 2022 FFO outlook of $3.76 to $3.92 per share. We assume utilization of our portfolio will gradually increase throughout the rest of the year. At the midpoint of our per share outlook, we project same property operating expenses will be $0.10 higher than last year, while parking revenues will improve by only $0.01. As we have long foreshadowed, as usage increases, operating expenses will recover faster than parking revenues. And this is incorporated into our 0% to 2% same property cash NOI growth outlook for 2022. As previously stated, we plan to sell $150 million to $200 million of non-core assets to return our balance sheet metrics to pre-PAC acquisition levels. We currently project the dilutive impact of these dispositions to be $0.04 to $0.08 per share. In addition, our outlook includes up to an additional $200 million of potential dispositions, the effect of which is not assumed in our 2022 FFO outlook. We have included a placeholder for acquisitions of $0 million to $200 million. We also continue to have conversations with build-to-suit and anchor customers for additional developments and project $100 million to $250 million of development announcements, inclusive of the $79 million 2827 Peachtree development. Before I turn the call over to Brian, I would like to briefly recap 2021. During the year, we generated 5% growth in core FFO; increased our dividend 4%; delivered 5.5% same property cash NOI growth; signed 194 new second-generation leases, the most in any single year since 2006, totaling 1.1 million square feet; acquired $800 million of high-quality office assets in Raleigh and Charlotte; completed $356 million of 92% leased office development; acquired $100 million of development land; and maintained a strong balance sheet with year-end leverage of 39% and a debt-to-EBITDA ratio of 5.4x. While we're pleased with our 2021 results, we're even more confident that we continue to have the building blocks in place to drive sustainable growth over the long term. In conclusion, while our high-quality BBDs and buildings are beneficiaries of a flight to quality, it is our humble, hardworking, talented teammates leasing, operating, and maintaining our portfolio as a single team wearing the same Highwoods jersey that are our true trophy assets. I would like to take time to thank the entire Highwoods team for their continued hard work and commitment throughout 2021. This type of dedication has put our company in a great position for years to come.

Thank you, Ted, and good morning everyone. The positive metrics we've posted for the quarter and throughout the global pandemic are a testament to the simple strategy we execute every day. This strategy has positioned Highwoods to be the beneficiary of a great migration to our markets, a great acceleration to our BBDs, and a flight to quality buildings, all of which are both urban and suburban in nature. Most customers have plans to return to the office, are expanding more than they are contracting, and now see the workplace as a vital part of their ability to retain and recruit, but specifically return, talent to their organization. Companies that create value through collaboration and culture have come to the clear conclusion that they are, simply, better together. We believe a workplace that attracts people and allows them to achieve together what they cannot apart will be full and command attractive economics. We're seeing this now throughout our portfolio and is evidenced in the results our team is producing. Occupancy increased 80 basis points from last quarter, ending the year at 91.2%. We expect occupancy to dip modestly in the first half of the year before increasing in the latter half. While utilization currently remains below pre-pandemic levels, we project it will increase steadily throughout the year. We continue to see healthy tour and RFP activity which is evident in the 884,000 square feet and 123 deals signed in the quarter, the highest quarterly deal count since 2016. Of these 123 deals, 54 were new, totaling 284,000 square feet. Emblematic of our balanced portfolio, no one market disproportionately carried the load as five of our markets garnered eight or more new deals. In addition, we signed 158,000 square feet of first-generation leases in the quarter for our developments in Nashville, Tampa, Raleigh, and Atlanta. Our markets are benefitting from what some have termed the "great migration." It has accelerated since the onset of the pandemic, is generating economic prosperity, and has started a flywheel of corporate expansions and relocations. These moves will have generational impacts as these talented individuals and organizations plant roots in our markets. As a result of this momentum, we continue to see strong fundamentals throughout our footprint. Atlanta, Raleigh, Nashville, and Charlotte all posted positive net absorption for the quarter. Unemployment rates are returning to near-record lows and multiple markets have grown their office-using jobs since the start of the pandemic. Raleigh has been a clear winner coming out of the pandemic, where tens of thousands of tech and life science jobs have been announced and where we signed 220,000 square feet of leases for the quarter, ending the year 92.8% occupied. Witnessing this demand firsthand and recognizing we had little room for growth at our 732,000 square foot and 97% occupied GlenLake mixed-use development, we started construction in November on a new 218,000 square foot office building and a curated collection of shops and restaurants. This will complete GlenLake's live-work-play master plan and serve as the latest product of our work-placemaking efforts. This $94.6 million investment is 15% pre-leased, will achieve LEED and Fitwel certifications upon completion, and will be home to McKim & Creed, a national engineering and surveying firm. While our friends in Tampa may have sent the "Title Town" banner up I-75 to Hotlanta, where the Braves and Dawgs delivered a double-dose of euphoria, Tampa has won Zillow's number one spot as the nation's top housing market for 2022, where the market's office rents increased 7% and our team signed 219,000 square feet of leases for the quarter. Our Midtown West development, above a REI and adjacent to a new Whole Foods, is now 64.5% leased and is busy with tours and inbound interest. Speaking of Atlanta, the unemployment rate has dropped there below 2.5%, and Cushman Wakefield has noted rents are at an all-time high and our team signed 136,000 square feet of second-generation leases in the quarter. Further, our $79 million 50:50 joint venture with Atlanta-based Brand Properties to develop 2827 Peachtree in Buckhead is 62% leased to multiple customers. This project will be completed in the third quarter of 2023 and is projected to stabilize in the first quarter of 2025. Wrapping up in Nashville where we ended the year 94.8% occupied, we made great progress on our Virginia Springs II development, which is now 90% leased, up from 59% last quarter. The most significant addition to our land inventory in 2021 was the acquisition of the remaining 77 acres of Ovation, a 145-acre mixed-use development already home to the Highwoods developed Mars PetCare North American headquarters and which is currently entitled for an additional 1.2 million square feet of office, 480,000 square feet of shops and restaurants, 950 residential units, and 450 hotel rooms. The opportunity inherent in Ovation is a perfect example of our work-placemaking efforts. Where appropriate, we'll utilize our mixed-use land bank to induce those vertical uses complementary to creating the best possible addresses to conduct business. In conclusion, thank you to the amazing women and men of Highwoods Properties who have put their customers first and allowed us to achieve great things together.

Thanks, Brian. In the fourth quarter, we delivered net income of $124.9 million, or $1.19 per share, and FFO of $113.5 million, or $1.06 per share. As Ted mentioned, the only significant unusual item in the fourth quarter were land sale gains of $0.09. Excluding the fourth quarter land sale gains, our 2021 FFO per share was $3.77, a penny above the high end of our revised outlook of $3.73 to $3.76. The better than expected FFO in the fourth quarter, which was primarily driven by higher occupancy and lower operating expenses, was consistent with the rest of the year as our FFO of $3.77 per share was $0.19 higher than the original mid-point of the outlook we provided last February. The upside for the full year was driven by: $0.08 from operations due to lower than anticipated OpEx, recovering parking revenues, and higher occupancy; $0.05 from higher than anticipated NOI from development, the majority of which was from the early delivery of Asurion's headquarters; and $0.06 from the net impact of the PAC acquisition partially offset by the acceleration of $353 million of non-core dispositions. Our balance sheet is in excellent shape. We ended the year with debt-to-EBITDAre 5.4x, down from 5.6x at the end of the third quarter. Last April when we announced the acquisition from PAC, we stated our plan was to return our balance sheet to pre-acquisition metrics by mid-year 2022. We're on pace to meet this target with a plan to sell another $150 million to $200 million of non-core properties in the first half of this year. We sold $353 million of non-core properties since the announcement of the PAC acquisition. These sales had average in-place occupancy of 80% and had a projected cap rate of less than 6% on a GAAP basis and in the low 5s on a cash basis. The remaining $150 to $200 million of dispositions are likely to have higher average cap rates, most likely in the low 7s on a GAAP and cash basis. During the fourth quarter, we issued a modest amount of shares on our ATM program at an average price of $46.75 per share for net proceeds of $7.2 million, consistent with our ATM activity in the second and third quarters. ATM issuances remain one of the tools we believe are an efficient and measured way to fund incremental investments, particularly our development pipeline, on a leverage-neutral basis. As Ted mentioned, our FFO for 2022 is $3.76 to $3.92 a share. As disclosed in last night’s release, this includes $0.04 to $0.08 of dilution from planned dispositions and the anticipated headwind of $0.08 to $0.12 of higher OpEx net of anticipated recoveries. The higher projected OpEx has also reduced our outlook for same property cash NOI growth by 200 to 300 basis points. Excluding this impact, we would be in line with our long-term average. Some of the major drivers of the year-to-year changes in our FFO growth outlook at the mid-point of the range are: $0.10 of lower FFO due to higher OpEx, net of recoveries; $0.10 of higher revenue on the in-service portfolio; $0.06 of lower FFO due to first half 2022 planned dispositions; $0.04 of higher FFO due to the net impact of a full-year of the PAC acquisition, partially offset by a full-year impact from 2021 dispositions; and $0.09 of higher FFO due to the full-year impact of the $285 million Asurion build-to-suit. These items add up to $0.07 per share of year-over-year growth, which equates to the mid-point of our 2022 FFO outlook. I'd like to take a moment to recap the financial impact from the PAC acquisition and accelerated non-core dispositions. We stated we expected our plan to be approximately FFO neutral upon completion with growth over the long run. We now expect it will be modestly accretive to our pre-announcement FFO run rate. Our 2021 FFO benefitted by a net $0.06 from the $683 million PAC acquisition and $353 million of dispositions, and we project this investment activity will add an additional $0.04 to our 2022 FFO, for a total of $0.10 of accretion. Offsetting this will be the estimated $0.06 dilutive impact at the mid-point from our planned $150 million to $200 million of dispositions in 2022. All-in, on an annualized basis, we now expect the PAC acquisition and the corresponding non-core dispositions to be about $0.02 to $0.03 accretive to our pre-announcement FFO run rate with no change to the aforementioned improvement in our long-term growth rate. Finally, as Ted mentioned, over the past three years, we have been very active on the capital recycling front, having sold $1 billion of non-core properties, acquiring $1.3 billion of high-quality, resilient properties with healthy long-term growth prospects, delivering $600 million of highly leased office developments, and adding over $100 million of development land. Over this same time frame, we've increased average in-place office rents 15%, averaged 3.5% annual same property cash NOI growth, increased FFO 9%, and our dividend 8%, all while maintaining a fortress balance sheet. Plus, as we have long highlighted, our cash flows continue to strengthen, increasing more than 30% over the last three years, resulting in higher dividend coverage on our growing distributions. Our growth may not always be linear quarter-to-quarter or year-to-year, but regardless of the short-term impact, we will follow our investment strategy as we believe it will continue to improve the quality, resiliency, and growth outlook of our portfolio over the long run. Operator, we are now ready for questions.

Thank you. That first question comes from Blaine Heck of Wells Fargo. Please go ahead.

Great, thanks. Good morning, everyone and thanks for all that detail. Brendan, can you talk a little bit about the operating expense guidance and what's driving that increase this year? And maybe also remind us of the proportion of leases outstanding that are in a net lease structure versus some variation of gross leases, in which you're not getting fully reimbursed for those expenses?

Yes, good morning, Blaine. Thanks for the question. So just first the easy answer on the triple net versus full-service. So we've got about 25% of the portfolio that has triple net leases; the remainder is full-service gross leases. And the full-service gross is where there's movement in terms of operating expenses. So I'm going to try to be as concise on this sort of complicated and complex answer as I can. So first, what we expect in terms of operating expenses is really to be in a pretty now let's call it "normalized OpEx" environment for most of 2022. I think OpEx will probably be a little bit lower in the first quarter than normal. And then we'll be back to normal in the second, third, and fourth quarters with the thought being, we expect the vast majority of customers to be back in their space by the second quarter. And while that may not be their full teams, it's difficult to heat and cool half a suite. So we think we'll be incurring a full load of OpEx for the vast majority of the portfolio over the majority of the year. And operating expenses were low in 2020 and 2021, as utilization was low across the portfolio, and that benefited us. And so for a number of our leases, our operating expenses that were incurred were below the base year expense stop. And so that accrued to our benefit. As expenses return back to normal and increase, we don't receive recoveries until we get back to that base year expense stop. And so, as expenses increase in 2022, we think the vast majority of our leases will be at or above those expense stops. But we won't receive the recoveries until we get to those levels. So we think that it will be an impact in terms of 2022 because expenses will increase, and we won't receive recovery on all of those leases where we're below the base stop in 2021. But as we get in beyond 2022, we don't think this is likely to be a major issue going forward. So I think if expenses continue to increase in 2023, we ought to be protected there. And so, it does hamper FFO growth for this year, as we disclosed in last night's outlook by $0.08 to $0.12. And does, as I think I mentioned in the prepared remarks impact, same property growth as well by probably around 200 to 300 basis points is our projection for this year. But I would say outside of that all the other major trends, I think, feel normal to us. And from a revenue standpoint, I think this year is pretty normal in terms of same property. So we do have a little bit of average occupancy growth that we expect in same property. So outside of absorbing higher OpEx in 2022, I think our same property growth would be right in line with that long-term average of call it between 3% and 3.5%.

Okay, that's very helpful. And just to be clear, I guess, we're talking about you should be able to kind of phase out the debt in OpEx burden. As leases expire, this shouldn't be a kind of multi-year headwind for you all. It should kind of normalize next year as you explained, is that correct?

Yes, that's right. I would say as leases expire so what I would pay attention to, to just determine whether or not there's any issue with respect to OpEx increases over time is probably looking at rent spreads. So when we calculate and provide rent spreads, which I think, we're what plus 3.2% this quarter. What we do is we take the operating expenses, and if we're getting $2 of recovery, let's call it in a lease. We add that to the expiring rent. So the expiring rent on the base rent is $35. And we're getting $2 of recovery; we would say that the expiring rent is $37. And then we would compare the new rent to that. So if we were absorbing anything in terms of higher OpEx, you would see that show up in the rent spreads. And as you can see our rent spreads have held up reasonably well. So it hasn't been an issue thus far. To the extent going forward, I think I would pay attention to those rent spreads to make sure that they're holding up in line with historical norms.

Yes, that's very helpful. Second question for you and then I'll turn it back over. Can you give us any color on your expectations for AFFO or FAD during the year in 2022? Is there any reason we should expect growth in AFFO or FAD should be materially different from FFO growth that you're expecting?

So I mean, cash flow is always more volatile than FFO. So I would say that, I mean, there always tends to be a little bit more variability from year to year. But in general, sort of the major movers between what's going to move cash flow versus what's going to move FFO are probably two main line items. So there's the level of non-cash rent, and we disclose that amount. And that ought to be relatively consistent, I think, between 2021 and 2022. And then there's the amount of CapEx, both leasing and building CapEx. In 2021, we probably had leasing CapEx that was a little bit lower than what it otherwise would be. And some of that there tends to be a lag. So I think we reported $79 million of leasing CapEx that we spent during 2021. And we committed $91 million of CapEx during the year. I would say the amount of commitments in terms of that leasing CapEx is probably a better gauge of what we are likely to spend on a go-forward basis. So that means that maybe there's a little bit more leasing CapEx that we would incur. I'd say on a normalized basis, but it is hard to tell kind of year to year. But regardless of that, as Ted mentioned, our cash flow is up over 30% over the past few years. So even with a $10 million or $12 million increase in leasing CapEx, it still means that cash flow would be very healthy. And I think, because of that strong cash flow, that was part of the reason why we increase the dividend a couple of quarters ago by over 4%.

The next question comes from Jamie Feldman, Bank of America. Please go ahead.

Great. Thanks, and good morning. Just a quick follow-up on the last question. So you talked about the $91 million committed in 2021? I mean, do you think there's a catch-up also, that you'll have to spend in 2022 that would take it above the $91 million?

Yes, that's a good question, Jamie. It's difficult to predict. I wouldn't say it's particularly likely, but it certainly could happen. There's usually some backlog of leases that are committed to, with the spending coming later. We believe the backlog is quite stable. If we continue to commit leasing capital in the range of about $20 million per quarter, then that number should remain stable. However, it's challenging to predict on a quarter-to-quarter or year-to-year basis. I don't anticipate any major factors that would lead to spending being significantly higher than the commitment levels.

Okay, thank you. And then I know you gave core guidance, but then you also talked about potential dispositions, potential acquisitions. If you hit those ranges, how should we think about what that could do to the earnings? And then I know you would, during the call, you guys talked about how your guidance has gone up from kind of initial guidance over the years. What are the upside and downside drivers to guidance here?

Yes, I'll address that and then perhaps Ted or Brian can provide further insights. Regarding the acquisitions, we estimated that the dispositions for the first half of 2022 will be between $150 million and $200 million. We did not factor the impact of the remaining acquisitions or dispositions into our guidance. For the first half disposition, we've indicated a range of $0.04 to $0.08. If we reach $200 million in dispositions early in the first half of the year, that would likely lead to a dilution closer to $0.08. Conversely, if we have $150 million in dispositions later in the second quarter, we would probably see a dilution around $0.04. For the remaining transactions, it’s difficult to predict since it depends on various factors such as the cap rates at which we sell, our acquisition choices, and timing. Ted, you may want to add some details about our considerations.

As Brendan mentioned, we have set aside a range of $0 million to $200 million for additional dispositions beyond the remaining $150 million to $200 million, as well as another $0 million to $200 million for acquisitions. It's really a matter of what opportunities arise; we are currently evaluating several acquisitions in the market. However, it’s uncertain whether or not we will be successful. If we do succeed in an acquisition, we will likely balance that with a disposition. At this point, it's difficult to predict the timing and success of these efforts.

Okay, thank you. And then, Brian had mentioned a pretty competitive acquisition market. Can you maybe talk about asset values in your markets and cap rates and maybe some movement to just kind of how they move, just to give us a better sense of what the investment market looks like?

Sure. Anything high-quality asset with long weighted average lease term, high credit, and certainly the new buildings, the cap rates are pre or below pandemic levels for sub in that in that five range. We said, we've had several trades in our markets in the 4s as well for some single tenant buildings. So incredibly competitive both from domestic capital sources and international capital as well in our markets. So anything of high quality is going to be changed very hard. On the value-add side, I think the pool is not quite as deep. But it's still there. It's still deep enough to make a market. I think we've seen that on our own dispositions, as well as value-add transactions worth chasing in the market. I do think buyers are becoming more comfortable with the underlying fundamentals in market. So they're able to underwrite vacancy, maybe a little bit more aggressive. So it's just competitive all the way around out there right now, Jamie.

Okay, thanks. And then last for me. Can you just talk about your thoughts on retention? I know you said that occupancy is going to be dipping early in the year and then recover. How are you thinking about the expiration schedule and retention ratio?

Sure. I can start and either Brian or Brendan can jump in. I think from our expiration schedule, I do think our retention might be a little bit lower this year than historically. But the nice thing is we don't have a lot of large expirations this year. I think I've talked about on prior calls really nothing above 100,000 square feet expiring this year. Our largest is 62,000 feet in December; then we've got 50,000 square feet in May, and both are known vacates. But we've got a strong prospect to backfill both of those with not a lot of downtime. Then after that, it's a 44,000 square foot expiration in Pittsburgh that we know the vacate that don't have strong prospects at this point. So in general, just lower expiration schedule, I think our retention ratio is a little bit lower, but to not weigh off historical levels.

And Jamie, the only thing I would just add to that is, I mean normally, we typically have a seasonal dip with respect to occupancy in the first quarter just because we have a lot of leases that expire at the end of the year, and invariably some of those are not going to renew. So we have a normal seasonal dip of typically 40 to 50 basis points in the first quarter or first half of the year, and then tend to build back up in the back half of the year. That is going to work. Our 2022 plan is consistent with that seasonal pattern or normal pattern. And we do expect occupancy by the end of 2022 to be a little bit higher than where we ended 2021. So we think all those trends are positive for us in terms of what's happening from a leasing perspective throughout the portfolio.

Jamie, Brian here. Just to follow-on to both what Ted and Brendan just said we're highly focused and inarguably aggressive on retention looking into the future. So you may have noticed in the past quarters, term was a little shorter; we're actually talking to a number of customers that are renewing years in advance now it's only maybe a three-year extension, so we're getting them thinking out of them in 2023/2024, and they're pushing out three or four years. And so that is falling down that term, but we're being direct with them. A lot of them are excited about coming back into the space and want to reposition their space, want to upgrade their space as they bring people back, and they're seeing the space as an opportunity to recruit folks and return them. So that's also another kind of nuance that's coming out of some of our focus on renewals.

That's a good point. So did that show up in your 4Q leasing volume?

It does primarily relate to the shorter term that you’re seeing being partially driven by that. It accounted for about 20% of that strategy. However, we're going to keep pursuing it. We have experienced some good success with it, and we will continue to engage in those conversations with our customers going forward. We won’t shy away from extending someone's lease years ahead to keep them in the space. It’s somewhat of a running joke with the leasing team. During our leasing calls, I often mention that I feel much more assured about renewing someone who is already in the portfolio than someone who isn't. So, we're taking that approach.

That is in September this year.

Thank you. The next question comes from Rob Stevenson of Janney. Please go ahead.

Good morning, guys. Can you talk to where parking revenues were in fourth quarter of 2021 versus 2019 and then also, how much additional expenses are there as that ramps back up? In other words, for each million dollars of incremental parking revenues that come in the door, how much incremental expenses do you have associated with that?

Hey, Rob, it's Brendan. So yes, I would say parking revenues, we're kind of running probably about a million a quarter below where we thought we would be at the onset of the pandemic on a same property basis. So it's certainly gotten better. We've improved from the depths of 2020 but not all the way back there. So there's probably another $4 million or so to go, and I think the vast majority of that revenue line is going to fall to the NOI line. So there's not a lot of incremental costs associated with additional revenue.

Okay. So you're basically down about $0.04 a share, given your shares outstanding in rough numbers in terms of parking revenue, still on an annual basis?

Yes, that's right.

Okay. And then how significant is the amount of your space that existing tenants are currently looking to sublease at this point?

Hey, Rob, Brian. I accidentally pressed the mute button. A couple of things to note broadly: sublet space is down across our markets. We have one user in Tampa, a medical university, that has shifted to remote work in the short term, which has had a significant impact on our numbers, though the trend is still downward. Overall, I would estimate we're down about 4% across our total markets. Within Highwoods, there is a slight uptick. Brendan, what would you say the percentage is on that? It's still a very small portion of the portfolio and remaining stable, with some positive movement. Atlanta is seeing declines, and most areas are following suit. However, Tampa is the only location where we've seen an increase.

Okay. So you wouldn't say that there's a significant issue with your current leasing vacancy at this point.

No, we're not.

Yes, Rob. We're looking at probably around 5%, maybe slightly less, in terms of the overall space that could be available for sublet. It's a very small portion of the portfolio.

And Rob, let me just jump in. A lot of the subleased space has pretty short-term on it. So it's just not necessarily competitive. With a lot of our leave or vacant space, it's just hard for owners once you get below two years to sublease their space. So we do have some that's have some longer-term on it, but would be competitive. And we've lost a couple deals over the last couple of years, probably less than a handful. But most of the sublease space just isn't competitive or vacant space.

The last thing on that is typically you might have to write a check as kind of the lessor for sublease in a deal. And so a lot of the folks who were putting space on the market don't want to necessarily write a check to move someone in there either. So that's kind of one of the things we're seeing in the sublet market.

Okay. And then, how much of the $150 million to $200 million of first half dispositions, you guys already either have under contract or letter of intent at this point? I mean, what's the likelihood that that is sort of more first quarter weighted than second-quarter weighted in terms of the $0.04 to $0.08 of dilution?

Yes, we currently do not have any contracts in place, but we have some assets available in the market and are in discussions with potential buyers. Although nothing is finalized, we are confident that we will reach the target of $150 million to $200 million by mid-year. We expect to have most of our offerings in the market within the next few weeks and we still believe that a significant portion will materialize toward the latter half of the second quarter.

And just remember, Rob, we thought what we said for 2021 was $250 million to $300 million of dispositions that we expected there; we ended up doing $353 million. So we were at the mid-point $75 million, $80 million ahead of our 2021 plan. So the 2022 plan was probably to have a fair portion of that $75 million to $80 million kind of occur in the middle or the early part of the first quarter; we accelerated that into 2021. And so the 2022 stuff is naturally just going to hit a little bit later in the first half of the year.

Okay. And then one quick one, are there any incremental mark retirement costs in 2022, was that all taken in 2021?

No, zero.

Thank you. The next question is from Emmanuel Korchman of Citi. Please go ahead.

Hey, good morning, everyone. Brian, maybe just a follow-up to your earlier comment, just as we think about the differentiation of quality and the different demands from tenants for that difference in quality. How does that get defined in your markets? Is it location, is it age of asset, is it amenity? I assume you'll say all of that. So help us figure out like as we think about quality, how your tenants think about it. And second to that, what happens to the non-prime product in these markets? Is it just more capital pumped in to make it prime product? Or is a conversion of use to more likely happen?

That's a great question, and I appreciate you bringing it up. From a quality perspective, it's really about convenience and amenities right now. Based on our conversations with customers, there is a clear desire for a return to the office, albeit at varying times depending on the size and geographical reach of the company. Larger firms tend to be more cautious about their return due to the broader impact their decisions can have, while small to medium-sized companies are already making their way back. For those who value physical space, it is seen as a competitive edge in attracting talent. As I mentioned earlier, we see value in both urban and suburban locations. Our suburban offices, as noted, are following the trend of high-rises in central business districts because of the convenience they offer, along with access to natural light, parks, and similar features. It’s a mix of various factors. The quality of our buildings reflects health and wellness standards, LEED certifications, and our ongoing development efforts. Food and beverage options are key, as is ensuring easy access to outdoor spaces. Additionally, we're focused on incorporating flexibility into our buildings, parks, or portfolios. We've previously discussed our spec suite and co-working programs, and we're noticing an increased interest from users who want the ability to adapt their spaces for larger events and gatherings. Ted, did I miss anything crucial on this topic?

Yes. I want to emphasize that we're observing a shift towards quality long-term owners who are willing to reinvest in their assets. It's not just about the newest or most impressive buildings; it's also about properties in prime locations. This trend towards quality is evident in our portfolio. Last quarter, I noted that in 2021, we signed 194 new leases, the most we’ve achieved since 2006. Additionally, we signed 18 leases related to our development projects, resulting in a total of 212 new customers who want to join Highwoods. We are clearly benefiting from this flight to quality.

And then I'll remind you on the second part of the question is what happens to the non-quality assets? Whether it be the ones that are vacated, or the ones that have been vacant?

Yes, look, I think it's going to be a conversion. In some cases, I think you've probably seen there's been a few big buildings that have sold and being converted to, they're going to be converted to industrial. I think you're going to see some multi-family conversions, maybe some hotel conversions over time as well. So I think it all depends on where the lower quality product is located and what the highest and best use is going forward.

One last thing, Manny, is that we are observing an increased densification and a mix of uses around some of these assets. In many instances, they are well-located but may be older or configured differently than newer constructions. We are witnessing surface parking lots being transformed into structured parking with multi-family units being added, along with retail spaces, which emphasizes the focus on enhancing locations. The importance of place remains significant.

Thank you. The next question comes from Dave Rodgers of Baird. Please go ahead.

Good morning, everybody. Ted and Brian, I think early on in the prepared comments, you said 40% utilization driven by smaller and suburban tenants. I was curious, two questions, one on the vacancy leasing. Is that also being driven by CBD or suburban? Is there a clear distinction kind of between where the new leasing is happening or is it following really the utilization? And I guess the second question is on RFP and tour activity that you mentioned is up. How does that compare to pre-pandemic levels, Brian?

Great question. First, regarding urban and suburban leasing, a significant portion of our leasing activity has actually been in suburban areas. This is where we have more opportunities for leasing. Additionally, urban locations have experienced higher occupancy, which provides some stability. Therefore, we have managed to achieve a good amount of leasing in suburban areas. That’s part of the picture. Ted, do you want to add anything to that?

No, I think that's it. We can only lease the space that is vacant. In the past, we have been heavily focused on the suburban side. As a company, we do not have many large vacancies. This past year, we mainly served smaller customers, which relates to the majority of our activity being with smaller clients, but I think that pretty much covers it.

All right, that's fair. And then the RFP and tour activity, maybe versus pre-pandemic levels on a like-for-like basis so how does that compare?

Sure, thanks for the reminder. I remember there was a second part to that. Let’s think back to the first week of March 2020 when the economy seemed to be thriving. We had a good amount of activity then, but I feel that currently, the request for proposals and tours are similar for a few reasons. Many customers are now considering their workplace as a crucial tool that contributes to their competitive edge, not just for retaining and recruiting talent but also for bringing that talent back. They have decided to enhance their workplace strategy and infrastructure. This is reflected in the inquiries we are receiving from customers who are looking to create their own workspace rather than just leasing space in someone else's building. It’s worth noting that constructing a new building today is costly due to factors like inflation and other expenses. Customers are therefore issuing RFPs and engaging in discussions, understanding the price visibility and rent premiums necessary for achieving an effective workplace. While I know this might sound repetitive, we are seeing positive outcomes from this trend. Customers are realizing the significance of their real estate costs, which can greatly influence their biggest expense—people—and help foster collaboration and company culture. Although we don’t have any specific announcements yet, companies appear willing to pay the premium for quality workspace. I feel we are currently on track with this trend, and it resembles past patterns. It will be interesting to see how this plays out by the end of the year and which of these initiatives come to fruition.

Thanks for that color, Brian. I really appreciate it. And then Ted, maybe just last for you on the disposition. It's been asked a couple of times, but I guess I wanted to get better color. Are you moving forward with the dispositions regardless? Or is it the acquisitions and the development that'll drive the dispositions? I guess I heard it two different ways in the call and I just kind of curious on kind of what comes first in the order of magnitude for your investment strategy right now for the additional sales?

Yes. So obviously, we're definitely moving forward with the $150 million to $200 million. So that'll get done, just to finish up the vortex transaction to match fund that. The remaining, $0 million to $200 million, look, I think that'll likely be dependent on if we find investment opportunities, whether it be development or acquisitions.

Thank you. The next question comes from Ronald Kamdem of Morgan Stanley. Please go ahead.

I want to follow up on the question about expenses, perhaps asking it in a different way. Can you provide more details on the specific line items that are contributing to these expenses? Are they related to cleaning utilities or similar items? Additionally, is the impact spread across the entire portfolio, or are there particular markets that account for the majority of these expenses? That information would be helpful. Thank you.

Yes, good morning, Ron. I would categorize our observations into two main areas. First, there are the taxes, which are increasing in several of our municipalities. Secondly, we are seeing a rise in building operating expenses as our customers return to the facilities, which is helping us return to normal operations. Additionally, we are experiencing some inflation, which is higher than it has been in recent years, contributing to these costs. However, most of the increase we anticipate absorbing without recovery is mainly due to restoring our operating expenses to normalized levels.

Thank you. Our final question comes from Daniel Ismail of Green Street. Please go ahead.

Great. Thank you. Ted, I think you stated previously that the net effect of rents across your markets are probably down around 5% to 10% from pre-COVID highs. I'm curious; your outlook for net effective rent growth is in 2022. Are you anticipating a recovery to pre-COVID levels? Or is that still a 2023 timeframe?

Sure, Danny, you're right. I think we've said, 5% to 10%, I think it's probably right at the maybe the lower end of that now, right. Mid-single digits down. Look, I do think it's going to come back. But it's going to take time; it's going to vary by market. The market's competitive still, right, and there's still pressure on TIs both from a competitive standpoint, but then it just costs more on top of that, and then free rent as well. So I think it's going to come back, maybe differently, or different cadence by market. Certainly, we're seeing already rent increases occurring in Nashville that does come with the corresponding increases in TIs. But I would hope we've hit the bottom and we're going to be starting our way back to get to pre-pandemic levels. But look, we're not there yet. And there's, see now, again, there's increased pressure on costs.

Great. And then can you remind us what international rent bumps are today in the portfolio? And then maybe, what are you guys negotiating for contractual bumps for today's leases?

Yes, Danny. We are currently seeing mid-twos across the portfolio, which has remained stable throughout the pandemic. It didn't decline significantly. In fact, this quarter our numbers were even higher, reaching 2.7%. We've managed to slightly increase those annual bumps. This has been beneficial in maintaining consistent annual rent increases across nearly all of our leases.

And then, Brendan, maybe, since I have you on. I appreciate all the details on the operating expense side, maybe just going back to the split between triple net and full-service gross leases. Is there any interest in pivoting more towards triple net leases? Or is this hold into market conventions that you guys are responding through?

Yes, I mean it depends. I mean, I think we do often push for triple net leases and do get those often. The one thing I'd like to just mention is full-service leases have actually been beneficial to us over time, because over time, we have typically been able to control expenses and often reduce expenses. And those reduced expense levels accrue to our benefit. So it's only been we, and I think we received a lot of benefit from lower operating expenses in 2020 and 2021, as OpEx was low and building utilization was low. And that helped offset a lot of the decline in parking revenue in both 2020 and 2021. Now, as expenses kind of come back up, then we are absorbing that increase. But keep in mind, we got the benefit. So we're really just getting back to kind of normal. So over time, full-service leases have actually worked well for us because we've enjoyed the benefit of our control on OpEx. And I think if you look at our same property growth over time, typically, we have had same property NOI growth that has outpaced our same property revenue growth because we've been able to control those expenses. So we often, I mean, we will push for triple net leases where we feel like we can get them, but full-service leases for us typically are not problematic. And we are protected on increased expenses, as long as those expenses are above the base year expense.

Thank you. I'll turn the call back over for any closing remarks.

I just want to thank everybody for being on the call with us this morning. And thank you for your interest in Highwoods. If you have any follow-up questions, please feel free to reach out. Thank you.

Thank you. This does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Thank you and have a good day.