HIGHWOODS-PROPERTIES Earningcall Transcript Of Q2 of 2024
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. Page 1 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. Theodore J. Klinck -- President, Chief Executive Officer, and Director Thanks, Hannah, and good morning, everyone. We delivered excellent operating and financial performance in the second quarter. First, we reported FFO of $0.98 per share, representing 4% year-over-year growth, and we raised our full year FFO outlook. Since the beginning of the year, we've increased the midpoint of our FFO outlook by $0.03, even with selling $80 million of noncore properties and absorbing the impact of higher-than-expected interest rates, neither of which were included in our original outlook. Further, our disciplined and ongoing efforts to further improve our high-quality BBD portfolio continue to pay off in the form of resilient cash flows. Second, we signed 909,000 square feet of second-gen leases, including over 350,000 square feet of new leases. This is the third consecutive quarter of strong new leasing volume. This is a testament to our Sunbelt markets, our BBD locations, our high-quality asset base and our talented team. Our leasing pipeline continues to be robust, which makes us optimistic will sustain strong leasing volumes for the remainder of the year. Third, we signed seven first-gen leases encompassing 61,000 square feet across our development pipeline. Upon stabilization, we expect these projects will provide approximately $40 million of incremental NOI and be a significant growth driver for our cash flows. Finally, our balance sheet is in excellent shape with debt-to-EBITDA of 5.8 times at quarter-end. Page 2 Being a long-term landlord with a strong balance sheet is a clear differentiator in today's market as we are able to fund leasing capex and reinvest in our best-in-class properties. Our occupancy, which was steady at 88.5%, doesn't yet fully reflect the strong leasing over the past few quarters. We have a meaningful amount of space that has been leased but where occupancy hasn't yet commenced, primarily in Atlanta, Nashville, Richmond and Tampa, and will start to contribute NOI later this year and in 2025. I want to provide an update on the former Tivity building in Nashville. As we mentioned at the beginning of this year, we modified a lease with a backfill customer for 110,000 square feet that currently leases 50,000 square feet in another Highwoods building. Since then, this customer has further reevaluated their long-term space needs. We are currently in discussions with our customer about what makes the most sense going forward for both Highwoods and for them. It's possible that we may agree to cancel their lease in exchange for recouping our investment. Regardless of what happens, we have healthy prospect interest for this space and, in fact, have already signed 66,000 square feet of new leases in this building. We do not expect any potential lease cancellation to have a meaningful impact to our near or long-term financial outlook. Turning to development. Our $506 million pipeline is now 45% leased. Activity is solid at GlenLake Three, our $94 million, 218,000 square foot development in Raleigh. We're now 34% leased and have healthy interest from additional prospects. At our $200 million 422,000 square foot Granite Park Six development in Dallas that we are developing with our 50-50 joint venture partner, Granite Properties, we signed a full floor user for 27,000 square feet to bring the lease rate to 26%. We still have seven quarters to go before pro forma stabilization at both GlenLake Three and Granite Park Six and remain confident in the long-term outlook for both Page 3 developments. Staying in Dallas, activity is study at our 642,000 square foot, $460 million 23 Springs project in Uptown that we're also developing in a 50-50 joint venture with Granite. The property is currently 56% leased and we have an LOI for another full floor user, with healthy interest from additional prospects. As a reminder, this project is scheduled for completion in the first quarter of 2025 and stabilization in the first quarter of 2028. Midtown East in Tampa, our 143,000 square foot, $83 million project we're developing in a 50-50 joint venture with Bromley in the Westshore BBD, continued to generate strong interest. Midtown East is the only office project currently under construction in the entire market. We're 16% pre-leased two years before scheduled stabilization and have a pipeline of additional prospects. As mentioned earlier this year, we don't expect to announce any new development projects during the remainder of the year. New starts are very difficult for any developer to pencil given the current environment, which is benefiting our existing portfolio as large requirements are seeing dwindling options of quality space available across our footprint. As we previously disclosed, we sold a little over $60 million of noncore assets early in the quarter to bring our year-to-date total to $80 million. We're prepping additional properties to bring to market, have included up to an additional $150 million of noncore dispositions in our outlook. While we don't have any acquisitions included in our outlook, we are having conversations with owners and lenders of wish list properties in our markets. While we're comfortable being patient, we do believe compelling investment opportunities will arise. To be clear, our criteria for capital deployment is highly selective. Target acquisition opportunities must be well located in a solid BBD, have good bones, and be well-positioned to generate attractive Page 4 risk-adjusted returns over the long term. In conclusion, we're confident about the long-term outlook for Highwoods. First, demand for our Sunbelt BBD portfolio continues to be strong. which positions us to drive meaningful growth in occupancy and NOI following our long telegraphed trough in early 2025. Second, our $500 million development pipeline will come online over the next few years and significantly bolster our cash flow and earnings. Third, we've been successful monetizing noncore assets and believe we can continue to create additional dry powder, which will also further improve our portfolio and cash flow. Fourth, our balance sheet is in excellent shape and will enable us to capitalize on acquisition opportunities. Fifth, even with higher interest rates, our underlying cash flows remain strong. This supports our attractive dividend and allows us to continue reinvesting in our portfolio. And finally, I want to thank my 350 Highwoods teammates who deliver for our customers and shareholders every day. It is their effort that has positioned us for success for many years to come. Brian? Brian M. Leary -- Executive Vice President, Chief Operating Officer Thank you, Ted, and good morning, all. The leasing momentum we had at the start of the year continues. Our leasing teams are busy, and in the second quarter signed 106 deals for 909,000 square feet, including 352,000 square feet of new deals. We are resolute in prioritizing occupancy and we'll continue to lean on our strengths as a long-term owner while strengthening our long-term cash flows. This is evidenced by our portfolio's occupancy outperformance in comparison to our BBDs, by Page 5 almost 800 basis points. We're seeing solid demand at various price points across our portfolio. As demonstrated by the leasing volume in our development pipeline, the top of the market is doing well, but we continue to see the most demand for our well-located second-generation assets. This is because a large segment of customers and prospects prioritized a premier office experience with a well-capitalized landlord at rents that are more affordable than new construction. To this end, over 70% of our leasing activity for the quarter was in suburban BBDs. Our belief continues to be that the talent within a building is the real trophy and the commute-worthy experience we're delivering is providing the lifestyle our customers prioritize to recruit, retain and return their talent to the office. Before we walk through the markets, it's worth noting that Virginia, North Carolina, Texas, Georgia and Florida, five of our core six states, came in one through five in CNBC's recent annual rankings of the best states for business. Our sixth day Tennessee was closed by in eighth. While Elon Musk may dominate the headlines with his announced headquarter relocations to Texas, there are hundreds of others finding these aforementioned states as welcoming environments for their most valuable resource, talent. This is further highlighted by JLL, who noted Dallas' ascension to the third largest office using job market in the nation, recently surpassing Chicago, while Dallas' population is projected to pass the Windy City five years from now. Moving to our markets where Nashville, Raleigh, Atlanta and Richmond made up almost 80% of this quarter's total leasing volume. In Richmond, our team signed 112,000 square feet in the quarter, including 57,000 square feet of new deals, including a new corporate headquarters location for a Fortune 500 company. We're seeing increasing interest from prospects in our Innsbrook BBD where our market-leading assets and sponsorship are clear differentiators. Nashville signed the most volume in the quarter with 271,000 square feet, including 157,000 square feet of new leases, the largest share of new Page 6 leasing across our portfolio for the quarter. Our Nashville new leasing volume was bolstered by a large new-to-market customer. Cushman & Wakefield highlighted that the natural market posted positive net absorption for the fifth consecutive quarter. 68% of all leasing activity in the market was either expansions or new leases, and new to market requirements increased with 18 tenants looking for more than 850,000 square feet in the aggregate. Further, the most active Nashville submarkets in the quarter were Brentwood and Cool Springs, where our combined leasing volumes were up over 100% year over year. As a reminder, these two submarkets encompass 60% of our 5.1 million square foot Nashville portfolio. In Raleigh, our leasing team signed 176,000 square feet of second-gen leases in the quarter, plus 20,000 square feet of first-gen space at our GlenLake Three mixed-use development. JLL reported aggregate space requirements in the market increased 70% year over year, and the number of prospects greater than 10,000 square feet increased by 23%. In conclusion, our leasing pipeline is healthy, and our high-quality portfolio is proving its resilience. The flight to quality includes a flight to quality buildings, a flight to quality experiences, and a flight to well-capitalized owners who are willing and able to invest in their portfolios. While facing the same headwinds as all office owners, we're benefiting from the long-term attractiveness of our Sunbelt BBDs and the elevation of a new commute-worthy bar of workplace experience, providing us across a variety of price points gives us a unique value proposition. Brendan? Brendan Maiorana -- Executive Vice President, Chief Financial Officer Thanks, Brian. In the second quarter, we delivered net income of $62.9 million or $0.59 per share, Page 7 and FFO of $105.9 million or $0.98 per share. During the quarter, the State of Tennessee modified the methodology for calculating franchise taxes, which lowers our annual franchise tax obligations and was applied retrospectively. As a result, we received $5.8 million of tax refunds related to prior years. This nonrecurring refund is included in other income in our 2Q results and was partially offset by a $1 million nonrecurring charge recorded as a reduction to rental and other revenues that also relate to prior years. The net impact is a $4.8 million benefit from these nonrecurring items, $2.5 million of which were anticipated in our prior outlook. In other words, these nonrecurring items resulted in a net $0.02 of upside compared to our outlook from April. Our balance sheet remains in excellent shape. At June 30, we had $27 million of available cash and nothing drawn on our $750 million revolving credit facility. Subsequent to quarter-end, our unconsolidated McKinney & Olive JV paid off at maturity a $134 million secured loan with an effective interest rate of 5.3%. This property is now unencumbered. Also, subsequent to quarter-end, our unconsolidated Granite Park Six JV paid down the $71 million balance on the construction loan with an interest rate of SOFR plus 394 basis points. In connection with these paydowns, we and Granite each contributed $103 million to the respective joint ventures. These loan repayments will increase our near-term cash flow from operations and also likely be a future source of capital as we plan to obtain long-term financing for both properties at some point in the future when conditions in the secured market are more favorable. As Ted and Brian mentioned, we had a strong leasing quarter, especially new leasing volume. Our lease rate, which includes current occupied spaces plus leases signed but not yet commenced on vacant spaces is 280 basis points higher than our actual occupancy of 88.5%. Page 8 And this current lease rate assumes we end up canceling the 110,000 square foot signed but not yet commenced leased at the former Tivity building in Nashville that Ted mentioned. Typically, our lease rate ranges between 100 to 200 basis points above our actual occupancy rate. This current spread illustrates the strong demand we're capturing across our portfolio, which makes us optimistic for a future occupancy recovery. As we stated last quarter, if we continue to post strong leasing volumes, we believe our trough occupancy level early next year will be higher than our original expectations and our recovery will be faster. Our strong second quarter leasing volume certainly supports this trend. As Ted mentioned, we've updated our 2024 FFO outlook to $3.54 to $3.62 per share, which implies a $0.045 increase at the midpoint compared to our prior outlook. As I mentioned, $0.02 of this increase is attributable to the additional unexpected upside from the nonrecurring items we recorded in 2Q, with the remaining $0.025 of upside, mostly attributable to better NOI. There are still several variables in our outlook, including projected property tax savings, which aren't assured yet. Same-property cash NOI, which does not include the $5.8 million of prior tax refunds that were booked in other income, does include the $1 million nonrecurring charge that relates to prior years. Even with this previously unexpected charge, we still maintained our outlook for growth in same-property cash NOI of positive 0.5% to 2%. Our updated outlook, combined with the strong first half of the year results, implies lower quarterly FFO for the second half of the year. A few items to note. First, we don't expect any significant nonrecurring items in the second half of the year. Second, the third quarter is typically our lowest from an operating margin perspective as utility costs tend to be highest over the summer months. Given the heat wave we've encountered so far this summer, we certainly expect lower margins in 3Q compared to the full year. Third, because GlenLake Three and Page 9 Granite Park Six developments were completed in the third quarter last year, GAAP requires us to seize interest and expense capitalization on those projects in the third quarter of this year. While this will be a temporary headwind to earnings, rising revenues from those projects will fall to the bottom line as occupancy grows. Finally, we have some long telegraphed known move-outs late in the third quarter and early in the fourth quarter, and therefore, we expect average occupancy will be lower in the second half. As mentioned earlier, we expect occupancy to trough in early 2025 and recover thereafter. To wrap up, we're very encouraged about the future for Highwoods. The leasing activity across our Sunbelt BBD portfolio has been solid, which should drive future NOI growth. Plus, we have strong embedded growth potential within our development pipeline as those projects deliver and stabilize. Our balance sheet is in excellent shape, which will allow us to capitalize on future acquisition opportunities, and our cash flows continue to be resilient. Operator, we are now ready for questions. Questions & Answers: |
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