Good morning, everyone. Welcome to the Highwoods Properties Q2 2023 Earnings Call. My name is Juc Pietr, and I will be your moderator for today. All lines will be muted during the presentation, and there will be a chance for questions at the end. I would now like to hand the conference over to your host, Hannah True, Manager of Finance and Corporate Strategy. Hannah, please proceed.

Thank you, operator, and good morning, everyone. Joining me 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 are 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. 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 turn the call over to Ted.

Thanks, Hannah, and good morning, everyone. During the second quarter, we once again had strong financial and operational results. We further improved our portfolio quality and balance sheet by selling $51 million of non-core assets. Leasing activity was healthy. We demonstrated resiliency with our FFO results in the face of higher interest rates, and we posted solid cash flows. Our markets continue to attract talent as seen by the outsized population and job growth compared to other major U.S. cities. CNBC recently published its annual ranking of top states for business; every core market in which we operate had its state ranked number eight or higher. North Carolina, our home state, which garners the largest share of our total revenues and where we generate 35% of our NOI, was ranked number one for the second straight year. It's no secret that the state's two biggest metros, Raleigh and Charlotte, generate the majority of the economic growth for North Carolina. Virginia, Tennessee and Georgia followed right behind at two, three and four, while Texas was number six and Florida number eight. We've long highlighted the benefits of the Southeastern U.S. with its strong demographic trends, business-friendly environments, low cost of living, and high quality of life. In fact, according to Bloomberg, the Southeast has accounted for two thirds of all job growth across the country since early 2020, almost double its pre-pandemic share. The main question, however, is how do these demographics and national trends translate into results for Highwoods? Let's take a step back and look at our performance. We've generated positive same-property cash NOI growth for ten consecutive years. Our total NOI over the last four quarters is 16% higher than full year 2019. Our net effective rents on leases signed over the last four quarters is 8.5% higher than our 2019 average. At the midpoint of our 2023 outlook, our FFO per share implies 7% growth over 2019 despite the headwind of higher interest rates. While availability rates are at cyclical highs, according to JLL, construction starts are down 75% over the past 12 months compared to the prior five-year annual average, and lower quality office is being taken out of stock at an unprecedented pace. These governors on supply should lead to a reduced amount of available office space, particularly after sublease space continues to get absorbed. This plays directly to our strengths, and users strongly prefer high-quality office space in BBD locations with well-capitalized landlords. Population and job growth continue to be strong across our footprint, demonstrated by 12 leases signed this quarter from users new to the market. Most of these are small- to medium-sized leases, which is our sweet spot. Our customers continue to bring their talent back to the office, and they are increasingly determining their long-term space needs. As an example, we signed six sizable renewals this quarter far in advance of the lease expirations, and they maintained or increased their leased space. At quarter-end, occupancy was 89%, leasing volume was strong with 918,000 square feet of second gen space, including 222,000 square feet of new leases. Our leasing count was robust with 110 total signed leases, including 39 new leases. Leasing economics were healthy. Rent spreads were plus 14.7% on a GAAP basis and plus 0.5% on a cash basis, and net effective rents were almost 6% higher than our trailing four-quarter average and 12% higher than our pre-pandemic average in 2019. Average rental rates in our portfolio were 3% higher on a cash basis compared to one year ago. Turning to our results. We delivered FFO of $0.94 per share in the second quarter. As expected, same-property cash NOI growth was minus 1.1% as we absorbed higher OpEx and lower occupancy driven by the temporary downtime on the former Tivity space. As a reminder, we do not take vacant buildings out of our same property pool. On the investment front, we sold three non-core office buildings for total proceeds of $51.3 million at a combined 7% GAAP cap rate. These sales were in Raleigh and Tampa, in non-BBD locations. Given the current capital markets environment, we are lowering our 2023 disposition outlook to a total of $200 million, including assets sold to date. Our $518 million development pipeline continues to progress well with all projects on time and on budget. We're 23% pre-leased with at least two years until projected stabilization across all of our spec projects. We have $300 million left to fund, and we project annualized NOI of $40 million upon stabilization. We're seeing good prospect activity across our development projects. At Glenlake III in Raleigh, we signed an 18,000 square foot user and are seeing increased interest as this project nears completion. We have strong demand at 23 springs in Uptown Dallas, and we expect 2827 Peachtree in Atlanta to stabilize by year-end. Following lease-up of Midtown West and Tampa to 100% earlier this year, we are seeing early interest in Midtown East, which has only just broken ground. Midtown East is the only office development under construction in the entire Tampa market and doesn't deliver until the first quarter of 2025. Turning to our 2023 outlook. We now project full-year FFO of $3.69 to $3.81 per share, flat at the midpoint from our outlook in April despite a meaningful interest rate headwind in the past 90 days. Before I turn the call over to Brian, I do want to acknowledge the challenges currently facing the office sector, including hybrid work, higher interest rates, and the difficulty of obtaining financing for office buildings today. In addition, despite the resilient jobs market, office owners are impacted by the cyclical demand headwinds when heading into a recession or a low-growth environment. As businesses become more cautious about their own growth prospects, they typically become more cautious about their space needs. This will likely pressure occupancy and net effective rents until the office market regains its footing. However, we remain confident over the long term because our Sun Belt portfolio is in a region of the country with the strongest demographics and job growth. We have a high-quality office portfolio in BBD locations that we believe will continue to outperform the market. Our purposeful diversification, whether it be by market, by industry, by customer or by lease size, should enable us to deliver resilient operational performance, which has been among the strongest in the office sector over the past several years. Our $518 million development pipeline will generate meaningful NOI as it delivers and stabilizes, and our balance sheet is strong with ample liquidity to fund the remainder of our development spending and all debt maturities until 2026.

Thank you, Ted, and good morning, everyone. As Ted highlighted, our performance in the second quarter showcases the robust and enduring demand for premium office space in the Sun Belt's best business districts and where our team signed 918,000 square feet for the quarter, 20% above our five-quarter average. This includes 222,000 square feet of new leasing over 39 deals, which is in line with our average quarterly new deal count for years 2018 and 2019. Our leasing activity was diverse among industries, with law and engineering firms leading activity for the quarter. We continue to see healthy interest from our small to medium-sized businesses, our core customers, which continued to maintain the highest levels of physical occupancy throughout our footprint. Echoing this trend, JLL recently reported that year-to-date, companies have enacted new attendance policies for 1.5 million office workers, with another 1 million expected to face similar requirements in the second half of 2023. Delivering across five markets, our 1.6 million square foot development pipeline is on time, on budget, generating significant inbound activity and is generally delivering into voids in our markets and BBDs regarding new and competitive inventory. Starting with North Carolina, CNBC's number one state for business for the second year in a row. The Raleigh market saw 139,000 square feet of positive net absorption for the quarter, according to CBRE. Office-using employment growth remained above the national average, and Apple filed plans to begin work on its previously announced 281-acre campus. Our team signed 276,000 square feet of second-generation leases with GAAP rent spreads of 16.4%. Moving to our Glenlake III development, where we remain on schedule for completion in the third quarter. Our team signed over 18,000 square feet, bringing the lease percentage to 23%. In Charlotte, as noted by CBRE, our BBDs experienced positive net absorption, and quarter-over-quarter leasing activity for the overall market was up 46%. During the quarter, we signed 104,000 square feet in our 2 million square foot portfolio, which is 94.6% occupied. Heading west to Music City, CBRE highlighted the market's positive quarterly net absorption of 744,000 square feet. Amazon occupied their HQ2 in downtown Nashville, and California mainstay, In-N-Out Burger announced they would be building their 100,000 square foot Eastern territory office in Franklin. Our team leased 89,000 square feet in the quarter with positive GAAP rent spreads of 17%. We are completing the Highwoodtizing of our Cool Springs buildings, and we saw the greatest Brentwood tour activity since the start of the pandemic. I should also note that Nashville's teammates to the south in Orlando have been hard at work filling up their portfolio, which is now 90.7% occupied and has over 200 basis points of additional momentum in the leasing pipeline. In conclusion, while we aren't immune to the global economic headwinds, the prevalence of sublease space, or a hybrid future of work, we're off to a good start for the third quarter. Our leasing pipeline is healthy, and we are benefiting from the flight to quality and capital occurring in the marketplace. We believe our people are our trophy assets, and it is because of their commitment and ability to deliver the greatest commute-worthy experiences we continue to deliver the positive results we have.

Thanks, Brian. In the second quarter, we delivered net income of $42.3 million or $0.40 per share and FFO of $101 million or $0.94 per share. Results were in line with our expectations with no significant unusual items. Rolling forward from last quarter, FFO decreased $0.04 due to lower NOI, which reduced FFO by $0.05, driven by lower top line revenue from reduced average occupancy due primarily to the Tivity move-out and higher operating expenses. This reduced NOI was in line with our forecast. Higher interest expense driven by an increase in SOFR reduced FFO by $0.02 for a total reduction of $0.07. This was partially offset by lower G&A, which added $0.03. The combination of these items net to the $0.04 reduction in sequential FFO from the first quarter to the second quarter. As Ted and Brian mentioned, our quarterly leasing stats were solid, with net effective rents showing continued resilience. And it's not just our leasing stats. Cash flows remain healthy despite the significant headwind from higher interest rates. We believe the resiliency of our cash flows is largely attributable to the active asset recycling we've completed over the past several years. Since 2019, we've sold $1.2 billion of capital-intensive non-core buildings and recycled into $2.2 billion of newer properties that are less CapEx-intensive and have a higher long-term growth rate. While we're pleased with the progress we've made, portfolio improvement is a continuous process, and therefore, we expect to sell additional assets over time. This may result in some uneven quarters from an earnings perspective, but we believe the long-term result will be similar to what has occurred over the past several years, strengthening cash NOI with a more resilient portfolio of high-quality buildings, all while maintaining a flexible balance sheet with ample liquidity. Turning to our balance sheet. We ended the quarter with net debt-to-EBITDAre of 6 times, nearly flat from Q1, even though we continue to fund our development pipeline and had lower EBITDA attributable to the NOI headwinds I just mentioned. Further, we improved our liquidity by selling $51 million of non-core properties, and we received a net $40 million from the repayment of our preferred equity investment in the McKinney & Olive joint venture. We did provide $10 million of seller financing for a 6-month term at 50% LTV on our sale of Indi Park 1. We expect this loan to be repaid in the fourth quarter. We now have nearly $750 million of total existing liquidity, more than enough to fund all of our current capital commitments, including development spending and debt maturities, which totaled roughly $500 million through the expiration of our revolving credit facility in March 2026. We do expect disposition proceeds in future quarters, and we may be opportunistic and potentially raise additional debt capital later this year or next, but our strong liquidity position allows us to be patient. As Ted mentioned, we've updated our outlook with no changes to the midpoint of our FFO range, which is now $3.69 to $3.81 per share. We've lowered the year-end occupancy range to 88.5% to 90%. This is always a challenging metric to forecast, given it's a point estimate on the last day of the year. Part of the reason for the reduction is certain customers where we previously projected their leases would commence before year-end, but now expect their leases not to officially commence until early 2024. This change in timing has impacted our projected straight-line outlook for 2023. Otherwise, there were no major changes to our FFO outlook. A couple of items to keep in mind going forward. First, our operating margin in Q1 and Q2 was higher than originally anticipated, which was largely attributable to lower OpEx. We expect lower operating margins in the second half of the year. Some of this is normal seasonality, while we also expect some increased repairs and maintenance spending in the second half. Other items that could cause a notable change to our FFO outlook include whether we pursue additional capital raising or other capital recycling initiatives. We did reduce our disposition outlook to up to $200 million for the full year, which includes the $51 million closed to date. As a reminder, any future dispositions are not included in our FFO outlook. Any disposition proceeds would bolster our liquidity and further improve our balance sheet metrics. In summary, we're pleased with our financial and operating performance in the first half of the year, and we're encouraged by the resilience our portfolio has exhibited over the past few years. Further, the lack of new development and capital challenges facing many of the office landlords we compete against, positions us for continued strong performance. We believe our strategy of owning high-quality properties in BBD locations in the Sun Belt while maintaining a flexible balance sheet with ample liquidity is why we've been able to consistently grow earnings year after year while simultaneously upgrading our portfolio quality, improving our long-term growth rate, and increasing our resiliency. Operator, we are now ready for questions.

Absolutely. The first question comes from Camille Bonnel with Bank of America. You may proceed.

Hello. So Atlanta has been a key market in your portfolio where occupancy has never really gone above 90%. Do you see where occupancy has been trending at the stabilized level for this market? Or do you expect you can achieve higher levels here?

I think we can get to Atlanta is very similar to that. Like Buckhead has had its challenges in the last couple of years. We've had some large rollover and some move-outs. But I think in a good market, I would fully expect it to meet what we think we can do with the portfolio, which is 92% to 93%.

Okay. And great. In the past, you've talked about net expansion activity. Can we just get an update for this quarter?

We experienced more expansions than contractions, approximately two to one this quarter, although we did see a slight negative impact on square footage, amounting to about 40,000 to 50,000 square feet. There were a few downsizes that you might notice, particularly in Pittsburgh, which contributed to the occupancy decline. Overall, our occupancy remained largely stable quarter-over-quarter, except for Pittsburgh. During this quarter, we renewed and downsized two customers in Pittsburgh. The first was a long-term, strong credit customer who renewed early, resulting in us taking back around 45,000 square feet. The second customer led to the retrieval of about 75,000 square feet. This was an anticipated vacancy, as they had been subleasing their space for the past six or seven years. In total, we took back five floors in Pittsburgh, which is prime space in the 1 PPG tower. We've already secured a lease for one of the floors and are seeing good interest in a few others. This explains why contracted square footage exceeded our expansions this quarter.

Thank you for the color. And a final question. Can you talk about the latest discussions you're having on the space where you have large tenant leases expiring in 2024? I believe Novelis moved out last year and the space is being sublet and EQT is subleasing some of its space. So how has leasing activity been there? And are there any updates on Bass Berry's plans?

Sure, I can address each of those points. Regarding Novelis, they vacated 168,000 square feet at the end of September and have since moved across the street, subleasing about 43,000 square feet. The remaining space is currently vacant. We are still in talks with the customer who is subleasing and hope to engage with them directly, but there are no new updates since last quarter. For EQT, their lease expires in October 2024, and we are anticipating they will leave, so we expect to reclaim that space, but again, no new updates there. As for Bass Berry, they are set to move out in February 2025. We are actively planning significant amenity upgrades in that building, which offers us the ability to provide competitive rates, although it's still a bit early to share more details since we are about two months away from their expiration.

Thank you for taking my questions.

Thank you.

Thank you. The next question comes from the line of Blaine Heck with Wells Fargo. You may proceed.

Great. Thanks. Good morning. So I was hoping to touch a little bit more on the change in occupancy guidance. I guess how far into 2024 are you expecting those leases to commence? And maybe just touch on why the move-in was delayed and whether the size of those move-ins has changed at all?

Hey, Blaine, it's Brendan. I'll start. So yes, there is a combination of things that probably impacted that year-end occupancy outlook that we have. As I mentioned in the prepared remarks, that's always a difficult metric to guide because it's just a point metric on one day of the year. So really, what it was probably the vast maturity of the change was attributable to a few different leases that we had projected to kind of be in occupancy before year-end, where we now project them in early 2024. And then we had the proactive downsize that we took in Pittsburgh that was a mid-2024 expiration. We proactively took that space back early to do a long-term extension with that customer. So a combination of those two things really kind of make up the majority of the decline in the year-end occupancy target that we talked about. We felt like the timing issue is just from a timing perspective, but not really a big issue there. And then we felt like the Pittsburgh proactive take-back was a good decision for us given that it locked up a long-term user, a long-term good credit user in that building for a long term.

Okay. And just to be clear, excluding that Pittsburgh situation, the size of those leases that are moving in has not changed?

That is correct.

Okay. Great. Just another one on guidance. Can you just talk about some of the potential positive offsets that allowed you guys to keep the guidance midpoint unchanged despite incorporating the lower occupancy along with lower straight-line rent, the dispositions you guys completed, and then higher interest rates?

Yeah. So I would say that, from just a high level, interest rates probably kind of if you look at the SOFR curve, which is generally how we project interest. That hurt us by probably, let's call it $0.02 to $0.03 compared to where we were in April. And then if we look at the change in occupancy, really with respect to kind of where straight-line rent is, that was probably a penny or two. So we're talking in the neighborhood of kind of $0.03 to $0.04 of sort of headwinds now versus where we were three months ago. Offsetting that, we probably have there's probably, let's call it, a penny or two that helps same-store, but not something that we felt like was enough to kind of move that range. So we still kept the range from down 50 basis points to up 1%. And then we've probably got another penny, let's call it, of NOI that is not within the same-store pool, that's also positive versus kind of where we were in April. And then you got another, call it, penny or so of kind of other income items that are outside of the NOI line. So those kind of things all canceled each other out. And really, so we felt comfortable kind of keeping the midpoint of the FFO outlook the same, even if there are a couple of movements within the P&L on some of the line items. And not really much impact. I would say there's a little bit of headwind, but nothing noteworthy with respect to kind of where the disposition cap rates were versus the incremental cost of paying off debt with the proceeds from those.

Okay. Great. That's really helpful. Thanks, Brendan. And then lastly, Ted, in your prepared remarks, you mentioned that lower quality office buildings are being taken out of stock at an unprecedented pace. Can you just expand on that? Is that space all being converted? And if so, what's it being converted to? I guess alternatively, are you seeing demolition of space? And then are there any markets in which you're seeing this happen at a faster pace than others?

Recently, JLL released some research indicating that this is a global trend. We're observing this in our local markets right now, but I believe it's going to pick up speed. There are several lower-quality office buildings that have been vacant for a while, and it appears that some may be converted into townhomes or redeveloped into townhomes or apartments. While we haven't seen many conversions yet, we're here to discuss a few happening in our markets. It feels like this is just the beginning of the conversion activity in our areas.

Okay. Great. Thank you, guys.

Thank you. The next question comes from the line of Michael Griffin with Citi. You may proceed.

Thanks. Ted, in your prepared remarks, you talked about kind of pressure you're expecting on occupancy and net effective rents. Do you have a sense of where net effective rents are in the portfolio and maybe expectations for the back half of this year and then heading into 2024?

I believe our net effective rents have remained stable. We had a strong quarter, but it can vary each quarter based on the leases signed and the specifics of each building and market. It's difficult to predict future trends. During COVID, our rents dropped mid-single digits. Historically, in economic downturns for office spaces, there tends to be pressure on net effective rents. Tenant improvement costs are higher now, and concessions have increased slightly. However, we have managed to maintain, and even grow, face rents in certain markets. While there is pressure due to a more tenant-friendly market, overall, we've performed reasonably well, although it can fluctuate from quarter to quarter.

Great. Thanks. Next one, I noticed that AFFO came in a bit below consensus in this quarter. I know there's some lumpier components related to that, particularly on the second-gen tenant improvements. But just how are you thinking about some of those line items from a run-rate perspective? And are there any worries around dividend coverage being elevated or thoughts you can add on that would be helpful.

Hey, Michael, it's Brendan. So I would say a couple of things on that. So if you look at the amount of capital that we spent in terms of leasing, which, as you noted, can be lumpy, right? In this quarter, we spent $31 million. That's $6 million higher than what the prior five-quarter average was. So that number was higher. And that number is going to bounce around. So I would expect that in a more normalized quarter, that number is going to be a little bit lower. So that has a benefit as we think about that in a normalized quarter versus where we were this quarter. And then similarly, you can see from the straight-line guidance in terms of kind of the amount of straight-line rent that we have incurred thus far in the first half of the year compared to kind of what the full year guidance is that it's likely that our straight line is going to go down as well. So as you think about that, that's more cash flow that's coming in. So I think for the combination of all of those things that makes us feel pretty constructive in terms of the cash flow outlook. And I would say that, that's in context of still covering having good cash flow this quarter even with higher TI and leasing commission spending and a higher straight-line amount this quarter compared to kind of what we think in future quarters.

Great. That's it for me. Thanks for the time.

Thank you. The next question comes from the line of Georgi Dinkov with Mizuho. You may proceed.

Hi, thank you for taking my question. I was just wondering if you could provide some examples of how tenant assessments are positively impacting paid needs, especially with the moderation in remote work. Also, could you comment on the recent utilization trends in your portfolio?

Sure. As we've mentioned, our expansions over the last several quarters have exceeded our contractions from a numerical standpoint. We have many growing customers, and while they are not taking additional floors or multiple floors, they are leasing 3,000 to 10,000 square feet. For instance, an engineering firm recently took an extra 10,000 square feet. This trend is seen across various sectors, including several law firms that are currently expanding their office space. Overall, it's a broad-based trend, but it's worth noting that these expansions are generally in smaller increments.

Georgi, it's Brian. I might add on to that, is that you think about on the sublease side, we've seen within our markets and within the portfolio, some large customers who we're contemplating putting large chunks on the sublease market or had and have now pulled that back off because they're returning their people to occupy the space. In one case, one that's been widely reported in Atlanta, AT&T vacated a number of buildings. And in fact, in the last couple of weeks came back and leased up a whole other building. So we do see that as positive for sure.

And just on the utilization trends in your portfolio, if you can give some color in the recent months, has that picked up?

Regarding utilization, we have seen an increase. This trend is evident not only in our portfolio but also reflects national momentum post Labor Day. Many policies have become quite public, as noted by JLL, stating that 1.5 million employees have had to adjust to new return-to-work or attendance policies, with another 1 million announcements expected from the end of summer to the end of the year.

Okay. Great. And just last one for me. Given what you know until today, no move outs and move-ins. I guess what is the low point in occupancy and same-store NOI growth over the next two quarters?

Hey, Georgi, it's Brendan. I would expect that occupancy is likely to be around or below expectations for 2023, but we'll see how the third quarter turns out. Similarly, regarding same-property NOI growth, we had anticipated that the second quarter of '23 would be challenging for us due to the comparison with last year. However, looking at expenses in the second half of last year versus where they are now, the comparisons become much easier. So, we do expect some improvement in same property performance as we move into the latter half of the year.

Thank you. The next question comes from the line of Rob Stevenson with Janney. You may proceed.

Good morning, guys. Ted, the two sizable renewals that did their renewals for in advance of the expirations you talked about in your comments, are they doing anything different with that space going forward, reconfiguring it in any material way? Curious when the larger space users renew, and that far in advance, what's driving that decision?

I believe that's precisely what you're observing, Rob. Both of them had long-term expirations and approached us expressing their desire to bring employees back to the office. To facilitate this, they needed to rearrange their workspace and requested some tenant improvements. Our discussions centered around this. The spaces are becoming more collaborative. One organization is opting for slightly more offices, while the other is reducing the number of offices. Ultimately, it varies based on the specific layout. However, the overall trend indicates a shift towards more collaborative areas, including more huddle rooms and spaces for team meetings when employees return to the office.

Okay. That's helpful. And then I guess a follow-up on that one. Are you seeing any more upward pressure today in terms of the TI dollars on a per square foot basis than you have over the last couple of years? Or anything changing there?

I think over the last couple of years, we have not seen an increase in the last three to six months, but certainly in the past couple of years, it has shifted to a customer or tenant market. It varies by market and submarket, but generally, there is upward pressure on tenant improvements due to the competitive environment and rising construction costs. This is one reason we have managed to maintain face rates, largely because of the overall cost structure. We have observed increasing pressure over the last couple of years.

But nothing materially different in 2023 versus the back half of '22?

No, I don't think so.

Yes, Rob. I believe it's reasonable to say that if any additional closures happen, they are most likely to occur in the fourth quarter. This will depend on timing and pricing factors, which could lead to a minimal impact on FFO or potentially something more significant based on those details.

What would you do today with the $150 million from the sale proceeds? What is the top priority in terms of paying down debt or funding development? What is the first item on the agenda for that money?

We had $100 million outstanding on the credit facility at the end of the quarter, along with $550 million of term loans that can be prepaid without penalty. Therefore, the proceeds would likely be used for a mix of those two options. We are also investing in our development pipeline, utilizing the credit facility for our share of those costs. The decision on whether to repay part of the next due term loan or reduce the credit facility will depend on the amount and timing.

Okay. Thanks, guys. Appreciate it.

Thank you. The next question comes from the line of Nick Thillman with Baird. You may proceed.

Good morning, everyone. It looks like there has been a significant increase in renewal activities. I wanted to get an update on how early you are starting renewal discussions. Additionally, in those discussions, have tenants shown any preference regarding the free rent component or the tenant improvements? Some of the larger tenants seemed to want a refresh of their space, but I'm curious if there have been any changes in that regard.

Hi Nick, it's Ted. I can start, and if Brian has anything to add. Generally, renewals depend on the tenant. We make an effort to reach out, but it really hinges on their timing, return-to-work plans, and their perspective. Generally, larger customers begin renewal discussions earlier. I don't think there's been a change in that regard. Regarding tenant improvements versus free rent, it's very specific to each tenant. It depends on the condition of their space and whether they need significant upgrades or if they're looking to cut costs by opting for free rent instead. I don't think we're observing a trend; it really depends on the customer's needs.

Nick, I don't know if it will add much more color, but we're not looking to self-inflict any pain on early renewals in a tenant's market from someone who started maybe in a landlord market. However, we have a captive audience in our portfolio that is fairly unique in our BBDs in our markets. We have a hungry brokerage community who is looking to be helpful with their clients, maybe looking upstream. And so to Ted's point, it's varied for sure. We're not necessarily knocking on the door of everyone and saying, 'Hey, you want to renegotiate by any stretch?' But sometimes they're coming to us and saying, 'Hey, we really need to up the amenity of our office space. We believe in it. We want to invest in it.' We're committed to this space. And what we talked about in Pittsburgh, that happened in Charlotte to a great firm. I didn't want to take any of the space. They're happy with their space. They just want to push out additional term and upgrade some things. So it's been a bit of a mix, but we see that embedded occupancy we have right now, is a captive audience to secure future commitments with.

That's helpful. Regarding the new leasing, it seems the new leases signed are approximately 5,000 square feet, compared to a total lease volume of around 8,000 square feet. Concerning the larger tenants in the market, you mentioned a slight increase, although it's from a very low baseline. Have you observed any changes in their behavior? As we approach some significant expirations in 2024, do you anticipate it will remain a small tenant market, or do you believe they will eventually return in the next 18 months?

Sure. Our focus has primarily been on small and medium-sized prospects, which has been our main area of business for quite some time. However, we are beginning to observe some potential opportunities in the 30,000 to 50,000 square foot range. Additionally, our development pipeline includes prospects that exceed 100,000 square feet. While larger prospects are taking more time in the decision-making process, we are beginning to see some movement in that segment as well.

That's helpful. And then maybe last one for me for Brendan. Your comments on additional debt capital, is that more a function of expected more muted disposition activity in the next 18 months? Or is there like some pressure from, say, banks when it comes to the amount they'll lend on the line? Just looking for some comments there.

No, I think it's just a matter of whether we want to take advantage of opportunities as they arise. We feel confident about our current position with the bank group and are satisfied with our standing among fixed income investors. We have good access to capital and want to maintain that. If we believe there's a valid reason to be proactive and an opportunity presents itself, we will consider it. However, as I mentioned in the prepared remarks, we do not see a need to enter the market at this time. It would purely be based on whether it makes sense and if there is a good opportunity.

That's it for me. Thanks guys.

Thank you. The next question comes from the line of Dylan Burzinski with Green Street. You may proceed.

Hi, guys. Thanks for taking the question. Appreciate your comments on construction starts slowing but just looking at what's under construction today and what's said to deliver over, call it, the next two to three years, do you guys view this as sort of a risk to further improvement in property fundamentals?

I think the answer is generally yes. In several of our markets, there isn't anything under construction. In Tampa, apart from the building we're developing, there's nothing else. The same goes for Orlando and Richmond. We do have deliveries coming up in Raleigh, Atlanta, and Nashville, but that remains a risk. However, I believe the necessary rental rates are at the top of the market, which tends to lift all segments, as we've seen in various cycles. While this is a risk, I think it's something we manage in all our markets, and I don't view it as significant.

Dylan, Brian here clipping on to that. The amount of stock that's under construction is from a competitive side, it's about 1.1%. So just from a macro standpoint, we don't think that is probably going to be that big of a headwind, but single individual buildings, sure. But you think about even Charlotte, which has just a few buildings under construction for the first time in over a decade, nothing started. So we are absolutely seeing that slowdown. And we do believe when our development pipeline is delivering us delivering into voids of competition.

That's helpful. And then just going back to some of the comments you made around outsized population and job growth across your markets, are you guys seeing any slowdown at all associated with any inbound or new-to-market tenants coming from some of the coastal markets? Or are you guys start seeing those trends continue relative to what we saw over the last several years?

The migration to the South has been happening for many years, and it picked up speed during the pandemic. However, I believe it has slowed down recently due to the state of the economy over the past six to nine months. We engage with the economic development teams in our markets, and while they remain very active, there are fewer office inquiries now compared to a year or two ago. That doesn't mean the activity has completely halted; they are still making progress, just at a reduced volume. Most of the current economic activity is concentrated in the industrial and manufacturing sectors rather than office spaces. Nevertheless, we signed 39 new leases this quarter, 12 of which were for new offices opened by companies in our markets across five different locations. So, while the in-migration has slowed, it remains a positive trend.

Dylan, just Brian here, one little footnote. When we have good anecdotal evidence to within the portfolio where we have, for instance, in Charlotte, the law firm opens their shop in from New York and Charlotte for the first time. They take one of our spec suites. We kind of nurture that occupancy and then they move next door to take a full floor. And to your first point on population, I think actually the population migration has actually ramped up even more so over this last quarter as we start to see how many hundreds of people are moving to these different markets every day. So to Ted's point, the economic developers are busy, and we do see that converting; like you think about Apple's announcement and what they're doing here in Raleigh, the 281-acre campus that they've committed to hire 3,000 people there, the average salary of $187,000 a year. We believe that's a pretty strong mover that will have a ripple effect.

Great. Appreciate the details, guys. Thank you.

Thank you. The next question comes from the line of Ronald Kamdem with Morgan Stanley. You may proceed.

Hey, good morning, guys. Just sticking to the occupancy numbers. It seems like most of the decline in occupancy was just driven by Pittsburgh and Richmond. Just as we look out into the future, are there any other expirations in those markets we should be mindful about understanding if EQT next year, but just anything else beyond that?

Specifically in those two markets, Ron, not really, as I'm looking at our expirations in 2000. We've got a couple of other things in Richmond that I think later this year or what have you. But looking into 2024, other than EQT, which is October 2024, I don't think we have any large expirations really similar in Richmond beyond getting through the rest of this year. And I certainly think we will ramp up in Richmond in terms of the new deal flow we're starting to see there. So no, not in those two markets.

There’s no update on Granite Park Six or Glenlake III. However, we saw some positive activity at 650 South Trion in Charlotte, Midtown West in Tampa, and Virginia Springs II in Nashville. These are the main projects outside of the non-same-store pool where things have improved in 2023. Regarding development projects like Glenlake III and Granite Park Six, there might be potential in 2024 as we consider the pace of lease-up versus the costs associated with these projects. If we can lease up faster, it could positively influence our 2024 numbers for these two projects. Conversely, if the lease-up process is slower, it’s unlikely to significantly impact us negatively, but if we manage to lease them out and generate some NOI, it would likely benefit us in 2024 compared to where we stand in the 2023 outlook.

Great. And then just last one. You guys talked about potentially raising debt back half of the year. Would that be secured or unsecured? And just give us a sense of how you would think about that trade-off there?

I believe we have a mostly unsecured balance sheet with no immediate expirations and significant liquidity. This positions us to be opportunistic and flexible. We have options available to us, and while there’s no immediate need to enter the market, if a favorable opportunity arises, we may consider increasing our liquidity. Whether we decide to pursue this will depend on the circumstances, but we are definitely monitoring the situation. We could explore both secured and unsecured financing, given the current state of our balance sheet.

Got it. Thank you, guys.

Thank you. The next question comes from the line of Peter Abramowitz with Jefferies. You may proceed.

Thank you. Yes, I just wanted to ask about kind of tenant behavior, tenant psychology. Certainly, it's being reflected in the equity markets that soft landing is potentially becoming the baseline narrative here. Is that having any impact on tenant behavior in terms of are they feeling better about things? And is that bringing anyone back to the market?

Our tour activity is still strong, even though it's mid-summer, a time when we usually experience a slowdown. Our market leaders are confirming that we're quite busy. The key trend we're observing is an increasing number of people returning to the office, with reports coming in weekly from market leaders, leasing agents, and property managers about more companies coming back. For instance, a large customer with over 100,000 square feet recently took their space off the sublease market and decided to keep it because they are bringing their employees back. Additionally, AT&T, which has been in the news, ended up leasing another 120,000 square feet after previously overcontracting. Overall, we are witnessing a continued return to the office, leading to more populated buildings. This trend is also reflected in our parking revenues, and our restaurants at the base of the buildings are performing well, indicating that the tenant behavior is largely a return to work.

There is a noticeable change in the return to work sentiment we are observing. Initially, the approach seemed very positive, but now it feels like there is a bit more pressure. Larger customers are beginning to bring their employees back to the spaces they already occupy, and they are not ignoring the need to provide incentives for their staff to remain. Consequently, we are engaging in discussions about enhancing the workplace experience, which includes improvements in programming, food and beverage options, and other elements that set us apart in the services we offer.

Got you. Thanks. And then one other one. I know the focus for excess proceeds right now is probably more on debt reduction. But just as things come across your desk, assets that you're underwriting, are things opening up? Are seller expectations adjusting? Are there things out there that if you had a little bit more capital freed up would be attractive at the prices that sellers are looking at today?

There's definitely a bid-ask spread today, and we are still in the process of price discovery. While we're pleased with the three transactions we've completed, there remains a significant gap in expectations between buyers and sellers. We're examining all options but intend to remain disciplined and patient. Many buyers seem to be waiting to see the Fed's next move regarding interest rates, and once that clarity is provided, we may see increased activity. Additionally, as lending conditions improve, we believe there will be further opportunities. Therefore, we're committed to being patient and disciplined in our approach.

Got it. Thank you.

Thank you. There are no additional questions waiting at this time. So I would now like to turn the call back over to the management team for any additional questions.

Well, thanks, everybody, for being on the call this morning. If you have any additional questions, please feel free to follow up with any of us. Thank you, and we'll talk to you next quarter.

That concludes today's conference call. Thank you for your participation. You may now disconnect your lines.