Earnings Call Transcript - PKST Q2 2023

Operator, Operator

Greetings, and welcome to the Peakstone Realty Trust Second Quarter 2023 Earnings Call. As a reminder, this conference is being recorded. I will now hand it over to Investor Relations to start.

Unknown Executive, Investor Relations

Thank you. Good morning, everyone, and welcome to Peakstone Realty Trust Second Quarter 2023 Earnings Call and Webcast. Earlier today, we posted an earnings release, supplemental and updated investor presentation to the Investors page on our website at www.pkst.com. Please note the use of forward-looking statements by the company on this webcast. Statements made on this call may include statements which are not historical facts and are considered forward-looking. The company intends for all these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and are making these statements for purposes of complying with those safe harbor provisions. Furthermore, the forward-looking statements reflect our current views about future events and are subject to numerous known and unknown risks, uncertainties, assumptions and changes in circumstances that may cause actual results to differ significantly from those expressed in any forward-looking statements and will be affected by a variety of risks and factors that are beyond the company's control, including, without limitation, those contained in our most recent annual report on Form 10-K or quarterly report on Form 10-Q filed with the SEC. We disclaim any obligation to publicly update or revise forward-looking statements to reflect changes in underlying assumptions or factors of new information, data or methods, future events or other changes after the date of this call, except as required by applicable law. Additionally, on this call, the company may refer to certain non-GAAP financial measures such as funds from operations, adjusted funds from operations, EBITDA, EBITDAre, and adjusted EBITDAre. You can find a tabular reconciliation of these non-GAAP financial measures to the most currently comparable GAAP numbers in the company's filings with the SEC. On the call today are Michael Escalante, Chief Executive Officer; and Javier Bitar, Chief Financial Officer. With that, I'll hand the call over to Mike.

Michael Escalante, CEO

Thank you, and welcome to Peakstone Realty Trust Second Quarter 2023 Earnings Call and Webcast. I'll begin by providing an overview of our key achievements during and subsequent to the second quarter. Javier will then follow with a review of our financial results and our balance sheet. And finally, I'll return with closing comments as we look to the future. We had a very active quarter. We listed our shares on the NYSE and redeemed our preferred shares and made meaningful progress in executing our disposition and deleveraging strategy. However, our financial results for the quarter were impacted by noncash charges, primarily related to office asset impairments and nonrecurring expenses related to the listing. Overall, our high-quality, newer-vintage industrial and office portfolio continues to deliver consistent REIT performance. At the end of the quarter, our wholly-owned portfolio consisted of 73 properties, totaling approximately 18.2 million square feet with annualized base rents or ABR of approximately $202 million. 63% of our tenants, their guarantors or non-guarantor or parent entities as applicable, have an investment-grade rating. The portfolio had a weighted average lease term of 6.5 years and was 96% leased, up from 95.3% last quarter. During the quarter, we strengthened our balance sheet by continuing to successfully execute our business plan. As previously disclosed, we used cash on hand to redeem our $125 million Series A Preferred Shares at par. These shares were issued to and held by a third-party international investor. The redemption generates annual savings of approximately $10 million in preferred distributions. We sold 5 office properties for gross proceeds totaling $131 million, bringing the year-to-date gross disposition proceeds to approximately $300 million at an average cash cap rate of 7.6% for the stabilized assets. Following the redemption and the property sales this quarter, leverage for our consolidated portfolio improved to 6.6x, improving by 1.5 turns during the quarter. The cash we're holding as a result of these dispositions affords us maximum flexibility to prudently allocate capital for uses aligned with our go-forward strategy. Since the start of the year, we have reduced our office concentration and improved our leverage by over 1 turn from 7.7x to 6.6x, and we are moving closer to our near-term target of 6x for our net debt to EBITDA. Turning to our segments. In our Industrial segment, which consists of 19 properties totaling approximately 9 million square feet. We ended the quarter with 100% economic occupancy and a WALT of 6.6 years. We continue to see sound fundamentals in our industrial markets. As an example, approximately 49% of our segment ABR is generated by property proximate to top U.S. ports. Many of these port markets in which we own properties are exhibiting robust economic activity and the ports are realizing growth in container volumes, notably in the East Coast ports of Savannah, Norfolk, New York and New Jersey and Charleston. Container volume growth is an important demand driver for industrial space in these markets, and we believe our properties will continue to benefit from strong fundamentals stemming from this activity. Our nearest expiration in this segment is the Samsonite lease in Jacksonville, which expires in the fourth quarter of 2024. This asset accounts for 8% of our Industrial segment ABR, and we continue to have an active dialogue with a tenant regarding a potential lease renewal. It's worth noting that the Jacksonville market has experienced meaningful leasing activity of late. Our team is actively evaluating industrial investment opportunities, and when appropriate, we intend to acquire additional, high-quality industrial assets to further enhance our portfolio composition. Now turning to our Office segment, which consists of 35 properties totaling approximately 5.7 million square feet. We ended the second quarter with 97% economic occupancy and a WALT of 7.9 years. This segment continues to provide stability with limited near-term rollover exposure. We have no remaining lease expirations in 2023. Leases expiring in 2024 account for less than 1% of Office segment ABR and leases expiring in 2025 only account for 2.9%. Economic occupancy in the Office segment declined by 1.2% from the prior quarter due to the expiration of a 60,000 square foot lease at our Terraces at Copley Point property in San Diego. This Class A building contains modern specifications and is prominently located at a key highway intersection with excellent visibility. We like the fundamentals and demand prospects in this market. And currently, we are optimistic about our re-leasing prospects. Across our office markets, we're starting to see some positive signs on the demand side with increases in tour activity and RFPs. We're also encouraged by continued upticks in daily physical occupancy as tenants prioritize in-office work. Largely due to the following attributes, we believe our differentiated office assets are well positioned to provide ongoing stability moving forward. Our average office building age is 11 years, and many of our properties offer market-leading specifications and amenities, which offer a competitive advantage. Over 81% of our Office segment ABR is generated from coastal or Sunbelt markets, which are generally experiencing strong net migration and superior leasing fundamentals. And finally, over 55% of our buildings contain essential functions such as corporate headquarters, critical R&D, labs or data center demand center operations, which are difficult and costly to replicate. Turning to our Other segment. We own 19 properties totaling approximately 3.6 million square feet. 14 of these properties are encumbered by nonrecourse loans that provide downside protection. We continue to evaluate the remaining 5 properties on a case-by-case basis to determine the best way to maximize value, whether to invest additional capital or sell them as is. To that point, we disposed of 2 vacant properties in the segment during the quarter. Finally, in addition to the 3 segments, we also own a 49% interest in a joint venture which contains 46 office properties or 59 buildings. It's worth mentioning that subsequent to the quarter end, the Board of Trustees approved a $200 million at-the-market program to provide additional flexibility to manage our balance sheet, diversify our capital sourcing options and offer a more efficient mechanism to access capital in the future. With that, let me turn the call over to Javier to review our financial results. Javier?

Javier Bitar, CFO

Thanks, Mike. In the second quarter, total revenue was $62.5 million, and total NOI was $49.6 million. The change compared to the same quarter in the prior year was primarily due to the disposition of 48 properties in 2022, and 8 properties in the first half of 2023. Net loss attributable to common shareholders was approximately $416.5 million or $11.59 per share, primarily attributable to the following: noncash real estate impairments of $397.4 million resulting from changes related to anticipated hold periods, estimated selling prices and potential vacancies that impacted the recoverability of 8 Other segment assets and 8 office segment assets. We had nonrecurring expenses of $28.3 million, consisting of $21.3 million for transaction expenses related to the listing of the company's shares on the New York Stock Exchange, approximately $5 million in a noncash charge to write off deferred costs from the initial issuance of our now redeemed preferred shares and $2 million relating to employee severance. And we also had a $17.5 million loss from investment in our joint venture, primarily due to interest expense, depreciation and amortization. We anticipate the JV will continue to have similar quarterly net losses for the remainder of the year. FFO was negative approximately $10.7 million or a negative $0.27 per share on a fully diluted basis. Please note that excluding the $28.3 million of nonrecurring expenses, FFO for the second quarter would have been approximately $17.6 million or $0.45 per basic and diluted share. AFFO was approximately $28.7 million or $0.73 per share on a fully diluted basis and same-store cash NOI was approximately $48 million, which represents a 2.5% increase on an annual basis after excluding a one-time termination fee received in the same quarter of the prior year. Moving on to our balance sheet. As of June 30, 2023, we had approximately $361 million in cash on hand and $34 million of available capacity on our revolving credit facility for total liquidity of approximately $395 million. We also have unencumbered assets that we could add to the facility to increase our available capacity or liquidity by more than $100 million. In regard to our consolidated debt, total consolidated debt was approximately $1.47 billion, $950 million on our credit facility and the balance consisting of secured debt. We are holding the $361 million in cash as it provides us maximum flexibility going forward and a significant portion of our cash is in money market accounts earning interest in the range of 5%. Net debt inclusive of cash was approximately $1.1 billion. Weighted average term to maturity was 3.1 years, assuming all available extensions are exercised. Approximately 86% of our total outstanding consolidated debt has fixed rates, inclusive of the effect of our interest rate swaps, limiting our near-term exposure to interest rate volatility. The interest rate swaps have a maturity date of July 2025. Including the effect of interest rate swaps with a notional amount of $750 million, the weighted average interest rate was 4.16% for our fixed and variable rate debt combined. And net debt plus preferred to normalized EBITDAre for our consolidated portfolio was 6.6x, improving from 7.1x as of quarter end 2023 and from 7.7x as of year-end 2022. The improvement in the current quarter resulted from sales proceeds offset by the redemption of our preferred resulting in a small change in cash and a reduction of $125 million on our total debt plus preferred balances. For the remainder of 2023, we have one small $17.4 million secured property loan in our Industrial segment, which matures in September. We have the ability to pay off the loan at maturity with available cash on hand or proceeds from our revolving credit facility. Beyond that, we have no material debt maturing until the end of 2025, including our $400 million facility term loan and our AIG II mortgage loan, which is in our Other segment and will have a balance of approximately $115 million at maturity. Finally, for the second quarter, we paid a distribution in the amount of $0.225 per common share on July 17, 2023, to shareholders of record as of June 30, 2023. While the company expects to pay dividends on a quarterly basis going forward, all dividend decisions, including amount and frequency, will be made by the Board of Trustees.

Michael Escalante, CEO

Thanks, Javier. Our cycle-tested team's experience and the quality of our assets continue to be positive differentiators as we continue to operate our portfolio, execute on property sales and reduce our leverage. Looking forward, we will continue to focus on strengthening our balance sheet with the goal to achieve an investment-grade rating and a more favorable cost of capital as soon as we can. We are close to achieving the upper end of our deleveraging goal, and we are optimistic about the pace at which we will hit that target. We continue to have a positive outlook on the industrial market. As I mentioned previously, our team continues to assess investment opportunities in the industrial sector. We remain committed to a disciplined capital allocation strategy and when appropriate, we intend to accretively deploy capital to lean into industrial and further shift our portfolio composition over time. Despite some varying degrees of volatility in the capital markets and macroeconomic environment, we believe our stable, high-quality portfolio is resilient and positions us well to execute on our strategy to maximize value for our shareholders. Please reach out to our Investor Relations team at ir@pkst.com with any questions or visit the Investors section of our website at pkst.com. We'll now turn it over to the operator to take a few questions from analysts.

Operator, Operator

Our first question comes from Joshua Dennerlein with Bank of America.

Joshua Dennerlein, Analyst

I'm interested in the asset sales. What other assets are you currently marketing? Also, what is the general demand like for office spaces? When we last spoke, your focus was primarily on office properties.

Michael Escalante, CEO

Yes, Josh, thank you for being here. We are currently active in the marketplace, but we are not providing guidance at this stage because we are still early in our lifecycle. Due to the uncertainty in timing and sales volume, we plan to offer guidance later. However, we did achieve $131 million in sales last quarter, totaling around $300 million overall. We've been pleasantly surprised by our ability to access the market at favorable pricing that helps clear it. One challenging aspect out there is buyer financing, specifically related to debt. We are careful to understand how debt financing will impact transactions as we engage with our buyers. Many of them have strong local connections with community and regional banks, which has benefited us. It requires a lot of diligence and support on our end, but we've managed to maintain a good pace in executing these transactions.

Joshua Dennerlein, Analyst

Okay. Appreciate that color. And then just thinking about the portfolio, so you have 12% of the leases expiring next year. Just or 12% of the portfolio expiring next year. Just kind of curious how those conversations are going with tenants, any known move-outs at this point?

Michael Escalante, CEO

Yes, as we mentioned earlier, you may have missed it, but we analyze it on a segment-by-segment basis. A key point we discussed was the Samsonite transaction, which represents 8.5% of our Industrial segment exposure through 2024. We are actively in discussions with that tenant and are excited about the Jacksonville industrial market overall. Regarding the office segment, we have only 3.8%, or just under 4%, expiring through 2025, and the leasing pipeline for office properties has been improving. We've noted some positive signs and are encouraged by that. The exposure you referred to is in our Other segment, and we have good transparency regarding that rollover, which will be detailed in our supplemental materials. We are engaged in discussions with several of those tenants. While there are no guarantees, we are actively exploring options in that area.

Operator, Operator

And our final question comes from the line of Anthony Hau with Truist Securities.

Anthony Hau, Analyst

Just want to follow up on Josh's question about the leasing pipeline for the Other segment, particularly the KBR building in Huntsville and Westgate II. It would be great if you can provide some color on those 2 pieces?

Michael Escalante, CEO

We're generally not providing specific property guidance. We did do it for Samsonite just because of the size and the percentage of the ABR there. I'll just say that we're actively engaged in as many places as we possibly can be. And we just really don't go into that level of detail on every property in our portfolio. So sorry, Anthony, on that one.

Anthony Hau, Analyst

No worries. How is the workspace JV portfolio performing? And also when does that reach for financing cost burn off?

Javier Bitar, CFO

Yes, regarding the joint venture, we experienced a loss primarily due to financing amortization and depreciation. Specifically, there was about $21.8 million in amortization this quarter, which is expected to continue until year-end. As mentioned in our quarterly report, there is a one-quarter lag in reporting for the joint venture. The initial financing to acquire that portfolio was secured in September of last year, leading to upfront costs. Consequently, the amortization will be recognized over the next 12 months, from September to September, impacting our fourth quarter. Therefore, as stated in our prepared remarks, you can expect to see a similar amount of amortization through the end of the year.

Anthony Hau, Analyst

Okay. And how does the portfolio like performing like in terms of like occupancy or like lease spreads or like NOI growth.

Michael Escalante, CEO

I think the only thing that I would just tell you is that we're continuing to produce positive cash flow out of that portfolio along the lines of what we anticipated. The positive cash flow, of course, does not flow through to us because contractually, we agreed with the lender that we would continue to add to reserves as a result of that cash flow. I don't know if there's anything else you wanted to add on that?

Javier Bitar, CFO

Yes. No, I think that's all we can provide.

Anthony Hau, Analyst

Okay. And my last question is, can you talk a little bit more about the assets sold in the quarter, like maybe in terms of pricing or maybe overall interest in those assets. I noticed that the ones from the office portfolio were all 100% leased and all had maybe 9 to 10 years lease term, whereas the ones you sold in the Other segment are vacant.

Michael Escalante, CEO

Yes. So you're looking for a little bit more information on the property sales and sales.

Anthony Hau, Analyst

Yes. Yes.

Michael Escalante, CEO

Unfortunately, our communication is somewhat unclear on this end. In relation to the second quarter, we've mainly provided information on a broader scale. You pointed out correctly that the office assets generally had a longer-term weighted average lease term. In the other two cases concerning the Other portfolio, those assets were vacant. That's probably the best I can provide at this time. We have more specific details forthcoming.

Javier Bitar, CFO

Yes, you'll note in the queue, there's a table that gives you asset by asset information on the sales proceeds for each one of those. We've added that to note 3 of the Q.

Michael Escalante, CEO

Does that answer your question, Anthony?

Anthony Hau, Analyst

Yes, it does. I didn't really to see, but thanks for pointing that out.

Michael Escalante, CEO

Yes.

Operator, Operator

This concludes the question-and-answer session. I'd like to turn the call back to Mr. Escalante for closing remarks.

Michael Escalante, CEO

Thank you, operator. I appreciate everyone joining us today and for your time. And we will look forward to updating you on our progress to achieving our goals during our next quarterly webcast, roughly 3 months from now. So again, thank you for your time. Appreciate it. And...

Javier Bitar, CFO

Thank you.

Michael Escalante, CEO

Bye-bye.

Operator, Operator

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.