Brandywine Realty Trust (BDN) Earnings Call Transcript & Summary

Welcome to the 8:10 a.m. session at Citi's 2020 Global Property CEO Conference. For those who don't know, I'm Manny Korchman with Citi Research. And we're pleased to have with us Brandywine and CEO, Jerry Sweeney. This session is for investing clients only. And if media or other individuals are on the line, please disconnect now. Disclosures are available here and on the webcast. For those in the room or the webcast, please use liveqa.com, with code CITI2020, submit any questions you have or you can just raise your hand. Jerry, I'll turn it over to you to introduce your company and management team, and provide the audience with 3 reasons why investors should buy your stock today.

Great. Good morning, everybody. With me is Tom Wirth, our Executive Vice President and CFO. I think I'll walk through some more detail. But I think, clearly, the 3 areas where we think we have an opportunity to drive shareholder value is within, number one, our existing portfolio. We are posting very strong cash and mark-to-market growth rates, 8% to 10% on a cash basis as part of our 2020 business plan. GAAP, 17% to 20%. But more importantly, even with those strong growth rates, we're really controlling capital. So we're keeping our capital costs between 14% to 15% of targeted revenues, which puts us in a very good position to grow net effective rents, which is really what it's really all about. So I think the ability to execute on the portfolio. We have some near-term rollover, and I'm happy to answer any questions on that. But each of those rollovers, we're making significant progress on and posting very strong, again, cash and GAAP mark-to-market rents with very strong control of the capital. I think the second area where we can really drive value significantly is through our land and development pipeline. I mean right now, the company has a land inventory that represents about 3.3% of our asset base. The bulk of that is approved and ready to go. That land bank can double the size of our company. We have 2 large multi-phase mixed use developments, one in Philadelphia, University City and the second one in the northwest quadrant of Austin, Texas. We think the ability to move those products into development will generate significant growth going forward. And again, happy to answer any detailed questions, but, essentially, the major parts of our development pipeline in both those 2 major developments as well as several other scattered sites, they're designed, they're priced, they're in marketing and they're ready to go. And we think that will be a huge driver of value for our company over the next several years. I think the third area that is -- that will drive growth for us really comes out of our development pipeline. Out of all that square feet that we can build, only about half of it is office. So we have an amazing opportunity to pivot the development pipeline of the company to incorporate a significant component of life science, which is an emerging market in Philadelphia, and we've captured some very good tenancies thus far. Our lead anchor tenant at Schuylkill Yards is a company called Spark Therapeutics. That was just recently purchased by Roche Pharmaceuticals. They have been a pioneer in cell therapies. There's over 30 companies in Philadelphia University City that are specializing in cell and gene therapy. In fact, another one of our tenants, just on Friday, had a very successful IPO, where they doubled the size of their equity proceeds. I think -- so I think the ability for the company to pivot our development pipeline on land that we own and create large mixed-use neighborhoods will really drive long-term and intermediate-term value. So they are the 3 items: very strong portfolio dynamics, large development pipeline and the ability within land we own to pivot to other product types.

Thanks, Jerry. The other question that we want to make sure to ask everyone is ESG is of increasing importance for all company stakeholders. What's one thing your company is doing to improve your overall ESG score over the next 12 months?

We have a number of initiatives underway, including a top executive, who joined us over a year ago, whose primary focus is on ESG. But we have a good platform that we're building off of. We have a low-rank score from ISS and have had that for a number of years in terms of corporate governance, transparency. Have a very active Board refreshment program underway for a number of years. We scored 100 out of 100 on the GRESB social score. We buy all of our energy in -- from renewable sources. And I think as we look forward to 2020, really 2 things that we're focused on. One is on our social engagement program. We received a number of significant positive feedback on our neighborhood engagement initiative, which encompasses everything from providing low-cost financing to nascent stage minority and women-owned businesses. We sponsored an apprenticeship training program, where we have, as of last count, 48 previously underemployed individuals working in the construction business. We formed a coalition with 5 neighborhood organizations to plan out a funding plan for creating low interest rate mortgages, affordable housing, neighborhood redevelopment and training programs. So that NEI, or Neighborhood Engagement Initiative, I think, is really a core part of the S in our ESG. And then from an environmental standpoint, we do plan on rolling out, later this year, our corporate sustainability report, which will lay out some very specific targets, which, again, we're doing very well in terms of energy management, waste management, recycling. All those basic things, we're going to ramp that up to another degree to focus on specific targets in terms of reducing our carbon footprint through our energy consumption.

Any questions from the room before I get into mine? So Jerry, you talk about developing, and so let's talk about those 2 markets specifically. Maybe we can start with Austin. If you could give us an update as to what's going on there, especially since the last earnings call, if you've had any movement on whether the funding side or just kicking off development.

Sure. Look, Austin continues to do very well. Obviously, statistically, they continue to outperform. In fact, if you look at the investor brochure, we have a little spotlight there on some key indicators on Austin. I think stepping back from just Austin, because now we'll pivot to Philadelphia as well, as we look at it, Brandywine has 2 projects in Austin that, again, are designed, priced and ready to go, one in the southwest, one in the northwest. And in addition to that, we have our Broadmoor development. And in addition to that, we're bringing onboard our 405 downtown project, 405 Colorado Avenue. On our production assets, which we define as the 2 projects in Austin, Garza and Four Points; and then 2 projects in the Pennsylvania -- I'm sorry, Philadelphia. They're about 500,000 square feet. Our current pipeline of deals in process, right -- prospects is about 1.5 million square feet. So our 2020 business plan contemplates 2 development starts this year. We're anticipating 1 start in Q2 out of that production asset category and targeting 1 start in Q3 as well based on the pipeline that we're seeing. But in our Austin portfolio, just to give you an example of the dynamic and the velocity through that market, those who follow us understand that we moved the tenant out of 180,000 square feet in one of our buildings into a new build-to-suit that we're just completing. That space will be vacant as of March of this year, 185,000 square feet. We've already leased 80% of that or 150,000 square feet. And our mark-to-market on a cash basis was 19%, on a GAAP basis almost 26%, and our capital ratio was just shy of 15%. So we've been able to do that in a number of cases where we faced a rollover within our Austin portfolio. So the demand drivers, Manny, are very, very strong, and we're very encouraged with the pipeline that we have on both Garza and Four Points.

And on the funding side, funding JV partners to sort of do the bigger Broadmoor development. Any updates there?

Yes. We're in the process right now of -- Broadmoor, for example, and it's outlined in the brochure, is a large multiphase development. All the approvals are done. We're in active discussions with CapMetro, the regional transit authority. And we'd expect to have a transaction with them done by mid-year to enable us to proceed with the creation of a train station along with Silver Line, which they will then commit to make a certain amount of dollar investment in improving the line. Marketing there, our Phase 1 project is 340,000 square feet of office, 340 apartment units, 1,500 parking garage and a lot of retail. We are in active discussions with a number of institutional joint venture partners, who would venture that product with us. So if you look at the company, stepping back, the -- we have tremendous value we think we can create out of our development pipeline. We also have a dislocated public currency value. So I think from our perspective, we're looking at 2 sources of funding for some of the developments. On the larger scale developments, like Broadmoor and like Schuylkill Yards, for where we are now, we're looking at lining up institutional partners for the first phase of those multiphase developments to create a catalyst to start going vertical in those developments. Hopefully, the market will respond well to that. And for subsequent phases, we may be in a position where we can fund those purely on balance sheet. So joint ventures, given where our stock is, is a key driver of how we can optimize both return on incremental capital, but also drive the forward-growth model for the company. And then we also have a number of other asset sales that we've -- that we're working on that could range between $50 million and $100 million. And they would certainly go towards our goal of getting some of these projects moving into development while keeping our balance sheet metrics within our 6.1 to 6.3 EBITDA target.

Is 405 Colorado a long-term hold? Or do you think you could eventually sell that to fund some of this larger scale development?

Well, we're planning right now on completing it on schedule, getting it fully leased up. We have a good pipeline on that. And then we're building that to north of an 8% return. As you know, the market -- the cap rate market in Austin is somewhere in the low 5s to high 5s. So we think we've got tremendous amount of embedded value. I think what we'll do, Manny, is take a look at where 405 lays into the overall fabric of where the company is in '21 and '22.

I guess the broader question there is, is there a benefit of owning a downtown asset when sort of your largest concentration of properties in those markets are not in downtown?

Well, the market is very integrated. And I think we've seen a lot of shifting of tenants between the northwest, the southwest and downtown. So I think the strategy that we like, from a real estate standpoint, is having opportunities in each of those submarkets. And that gives us the ability to reply to tenant request for proposals across all 3 markets. So I think from a real estate standpoint, it makes sense to be in all 3 of those markets. I think as we start to think through the capital planning for the company, we'll figure out how a 405 or a Broadmoor joint venture, any other assets layer into our overall strategic target in that market. Right now, we're about 18% of revenues coming from Austin. Our decided goal is to raise that to about 25%, and we think we're on a clear path to do that.

Any other awesome questions in the room or the webcast? Let's switch to Philly, which is the bigger piece of the puzzle. Give us an update of what's going on at Schuylkill.

Well, Schuylkill Yards, we continue to make great progress. As you know, late last year, we got all of our approvals in place for the full development, which was several years ahead of schedule. We have worked with city and state agencies to craft a public funding platform that will reinvigorate some of the regional rail train stations right in the 30th Street area, so that improves kind of the infrastructure. From a real estate standpoint, Tom, I and the rest of the team are in substantive discussions with one institutional partner in particular, that would -- if the transaction proceeds as we contemplate, would wind up being a 2/3 equity partner in the first phase of Schuylkill Yards, which consists of 2 buildings: Schuylkill Yards West, which is a couple of hundred thousand square feet of office and 300-plus units of apartments and some retail and parking; and then Schuylkill Yards East, which is about an 800,000 square foot life science and office tower. Major focus right now is on Schuylkill Yards West. We continue to pursue an anchor tenancy for Schuylkill Yards East. But if events continue to progress at the pace they are, we could be in a position to start Schuylkill Yards West around midyear. We're also discussing with our members of our banking syndicate, construction and mini perm financing. And I think as we outlined to our shareholder base on a quarterly earnings call, our objective there is to announce the equity structure and have that very much in place, and, at the same time, announce the debt component on the construction financing and then roll forward with construction. At a leasing level, we're very pleased. The site benefits from being a federal Qualified Opportunity Zone. So both companies and some of our investors, frankly, were very interested in those benefits. It is also a state and city tax zone, which provides an abatement of Commonwealth of Pennsylvania state and city taxes for qualifying companies. So the -- we have a whole pipeline of tenants ranging north of 1.5 million square feet, ranging from several hundred thousand square feet to, frankly, down to 25,000 to 30,000 square feet. So great visibility. We continue to work on the retail component of Schuylkill Yards and hope to have an announcement on the retail sometime in the second half of this year.

This 2/3 partner that you're well on the way on, are they an opportunity zone investor? Or did you choose to go with someone that wasn't focused on that?

At the current time, it looks like they're going to be targeting some money that's focused on the opportunity zone. They have the ability to do either, but I think -- right now, I think they're working through the tax implications of making this an opportunity zone investment.

And then Jerry, looking at the West Tower, which does include those 326 apartment units, why do those sort of in a JV or on balance sheet or however you want to think about why have Brandywine participated there at all rather than just selling that piece to someone else, doing the rest of the tower on your own and sort of still getting to that half-half ownership of the building?

Well, I think the Schuylkill Yards West is about a $275 million project. And I think from our perspective, since it's an integrated building, the value drivers for us will come much more from owning that or owning a piece of that building in its entirety versus creating a condominium interest because we're also operating on the long-term prepaid groundly. So I think when I look at kind of the reversionary value we can create, we do know and we always factor into underwriting the fact that there's a ground lease. There's a little bit of a discount to the cap rate. So frankly, we want to compound that by creating a condominium interest as well. And I also think, honestly, as we go back to 1 of the 3 points for growth for the company, Brandywine has been involved in a number of 9 office developments over the past several years. Whether it's with CalSTRS, LCOR, Toll Brothers, we've made a lot of money. And I think that really comes from owning the land at a very good basis. So as we look, Manny, at the buildout of Schuylkill Yards, we think there's going to be increasing opportunities for us to not only continue to generate value on the office side, but also actively engage on the residential side. And then as we touched on, Philadelphia is seeing a tremendous upsurge on the life science front. It's really quite startling. I mean our NIH funding is up almost 30% from several years ago. We ranked only behind Boston and New York in terms of NIH funding. With the emergence of the life science biotech business in Philadelphia, Philadelphia, now for the first time, is retaining more college students than Boston. There's, as I mentioned, over 30 companies, who are focused on cell and gene therapy, who are residing in University City. So as a result of that, as I mentioned on the last quarterly call, we have plans underway to develop a 400,000 dedicated life science building. As that will track its way through, we could be in a position to start that by early '21. In addition to the major drivers we're seeing from these emerging companies, like a Passage Bio, for example, who's one of our tenants, they did a very successful IPO on Friday, where they raised more than 50% of their targeted proceeds. And there's a handful of other companies of the near-term queue that either through cell or gene therapy are really looking at breakthrough technologies to cure hepatitis, pediatric blindness, leukemia. I mean what we're seeing is actually really exciting -- forget the real estate side, just from a cultural company evolution standpoint, is pretty amazing. And I think Brandywine is really well positioned to do that. That's why we're moving down the path of the life science tower. And then we also announced in our last quarterly call, we're taking a small building. It's a future development site that sits at a preeminent corner within Schuylkill Yards and have started the process of converting that to life science. We are already 3x oversubscribed for that building at rental rates just shy of $50 triple net. So the demand drivers are there. We're looking at converting some of our existing office space in University City because we plan some of these buildings to accommodate both office and life science. So I've seen an acceleration in that sector that has been, frankly, quite surprising to a lot of folks in the last 12 to 18 months. And given our drive to get everything approved, the land we control, the relationships we have with Drexel, Penn, Children's Hospital, the Wistar Institute, the existing biotech companies we deal with, we think we've got a build-in pipeline to rapidly grow that business line. So we're very excited about the potential for Schuylkill Yards to become an incredibly integrated mixed-use development, with a very high component of both lab space and office space for biotech and cell therapy companies.

So other owners of life science and the REIT space that we interact with have built out teams to sort of underwrite the -- not only the tenants, but the science behind sort of what's happening in the box to get comfortable, especially with pre-IPO companies or companies on high-growth trajectories. What have you guys done to get comfortable with bringing that type of customer that doesn't have large cap or the proven track record or whatever else it might be into your portfolio?

Yes, great question, Manny. I'll tell you exactly what we're doing. I mean number one, we've created amazingly deep relationships with a lot of the scientists and administrators of those major universities and health care systems. So most of our meetings on these companies involve represent us from those organizations. Secondarily, but just as importantly, we've had an ongoing outreach effort to folks like the Biotechnology Council of Pennsylvania, the DCED and the Commonwealth, who are focused on how to grow underwriting finance emerging companies. So our expectation is that within the next couple of quarters, we'll be forming a formal advisory panel to help us vet through some of these emerging companies. We're also talking to a number of very high quality and well-regarded incubators to help run some of the spaces that we'll create that will be meant to kind of seed some of these companies moving forward. And the final point of that is we also have a number of very strong relationships with venture capital firms that specialize in this. And the fact that Brandywine can work with them to -- where Brandywine provides the physical platform and the physical spaces for those companies to incubate is a very valuable tool in how they want to start creating a cluster in Philadelphia.

Okay. Any questions in the room? So let's go back to sort of your opening comments. You mentioned some move-outs that are coming and sort of the backfill prospects for those. Any updates you can share?

Sure. I'll just walk you through. We have -- again, I think the underpinning is the strong pipeline that we're building through the company for leasing projects on existing inventory and the very strong cash and mark-to-market. I mentioned SHI, which is a big rollover we have in Austin and that we're 80% pre-leased on that. Another large rollover we're facing in Philadelphia midyear '20 is Macquarie, who's rolling out of about 150,000 square feet of space in our -- one of our Commerce Square towers. When we factor in the deals we have under letter of intent moving towards lease negotiations, where we've leased about 66,000 square feet or about 40% of that, the cash mark-to-market is 17%, and the GAAP mark-to-market is around 30% with a capital ratio in the high teens. So we're very pleased with that. But when you take a look at the company overall, 2020, our rollover, including those large ones I talked about, is about 7% of our portfolio. So we want to keep everything in context. And then for '21, it's around 11%, where we have 2 large rollovers taking place. One is Reliance Insurance, again, in Philadelphia for about 140,000 square feet. It's a little too early to have a definable pipeline on that, but the prospects that we're talking to indicate a GAAP mark-to-market of around 15% and a cash mark-to-market of around 12%. Our largest rollout next year is Northrop Grumman, who's moving out of a building in our Dallas corner development, 250,000 square feet. We already have discussions underway to either sell or joint venture that asset. We think that there's a great opportunity to reposition that property or to, because it's a large block of space in a very strong submarket, maximize value and sell that asset. The mark-to-market there, obviously, is much different than I just talked about with Austin and Philadelphia because that's pretty much a flat rollover risk. So when we look at it as an on balance sheet renovation, the returns are a bit below our mid-teen threshold. So we'll either look to optimize that by selling it or creating an incentive structure where a lot of the capital goes into that is not ours. Very unlike what we saw down at the 1676 building in Tysons Corner. We had a major rollover there last year. We felt that the ability to move our rents from the mid-30s to the mid-40s was definable and executable. So we've moved forward on that plan. And as of right now, we're about 40% pre-leased on that with about a 22% cash mark-to-market. So 2340, where Northrop Grumman is moving out just doesn't meet that threshold for rent velocity and justifying the return on the incremental capital we need, particularly given the demands we have on the core development side. So they're really the major players, Manny. I mean the good thing about our company, it's pretty definable. You can kind of just hone in right away on what the issues are. And I think given where we are with those major rollovers for '20, we're feeling very, very good about our ability to execute the balance of that as part of our '20 business plan. We're already 75% done on the revenue component of our 2020 business plan.

And I know it's hard, but forcing you to look out into 2022, is there anyone in there that's chunky and sort of that right now you're calling them a 50-50 chance or worse of them staying?

We have IBM, which is expiring, and we're in negotiations for them for an extension at this point.

Okay. Any questions in the room? So I've got one here on the liveqa. Why does BDN need to exist as an independent REIT? Aren't their large REITs or investors interested in Philly and Austin portfolios?

It's a very fair question. And I think the REIT space probably has too many $5 billion companies. The -- our corporate governance is solid. We have a very good open independent Board. Any time we chat with folks, whether it's individual investors, institutions, other companies, public or private, I think our perspective has always been we're here to generate value for our shareholders. If there is an opportunity to harvest that and accelerate that return earlier, we've always been open to it. In the meantime, I think we have an excellent platform. I think we can drive tremendous growth going forward. And frankly, what keeps the Board and the management team very focused is the fact that we do believe we have near-term execution opportunities to drive value, and that we have all the tools we need within our existing arenas to drive and create that level of value. But we've always, always been open to other strategic transactions, be they public, private, be they sell or merger. I mean that's what we're in here to do. The name of the game for us is to generate an A on the report card and generate great shareholder value, as evidenced by a good stock price. So the fact that our stock continues to languish in the 20% discount rate, frankly, like a lot of other office companies, is a source of great frustration. But we're -- we focused on keeping our balance sheet strong, generating a near-term executable development pipeline, positioning the portfolio incredibly well over the last several years, where we're generating those kind of mark-to-markets, and balance the portfolio well between the Philadelphia and Austin, Texas. So I'd advise that the person who asked that question is we're completely open to the best way to drive value.

And then maybe last one before the bell rings. How should investors think about the long-term growth here for Brandywine looking forward?

I think we're -- we spent the last half dozen years creating a springboard, a platform to grow. I mean I think the fact that we have a development pipeline that can double the size of the company on land that's at a very, very attractive basis versus market, I think, gives us really significant runway to grow earnings, grow cash flow and certainly grow our dividend payout.

Any last questions in the room before we wrap? All right. We've got our fun rapid-fire questions here. Will the office sector have more or fewer public companies a year from now?

I think fewer.

What will same-store NOI growth be for the office sector overall in 2021?

We think about 2.5%.

What will the 10-year treasury yield be 1 year from today?

Well, I was dead wrong last year. I guess we'll hedge on...

Everyone was wrong last year.

We'll say 1.25%, but we'll see where it goes.

That's 2 in a row 1.25%. In what year will the U.S. enter a recession?

'22.

Thank you. You must have listened to Marshall's question -- answers before you came in.

No. Were they the same? Let me see?

1.25% in '22.

Everything works until it doesn't. Remember that.

Thanks, Jerry.

Thank you very much.