Brandywine Realty Trust (BDN) Earnings Call Transcript & Summary

Great. Good morning. Thank you all for starting your day with Brandywine Realty Trust. I have with me today, Jerry Sweeney, President and CEO, Board Chair of Brandywine Realty Trust; as well as Tom Wirth, CFO. As usual, I think it's a good idea to have Jerry or Tom provide a brief overview of Brandywine Realty Trust, who they are, what they're doing. And then I will ask a series of questions. And if anybody else wants to ask a series of questions, you can do so via the operator chat process within the Wall Street Webcasting. So with that, I'll turn it over to Jerry Sweeney.

Great, John. Thank you very much, and thank you all for joining us for our fireside chat with John. Brandywine is a Philadelphia, Pennsylvania-based office company. Assets are approximately $5 billion. We're really a 3-market company. Philadelphia, which generates the bulk of our revenue, we have active submarkets, the Central Business District, University City and the Pennsylvania suburbs. In Washington, D.C., which is our second market, we're primarily in Northern Virginia and Suburban Maryland, with a couple of development parcels within the district itself. And then our third market, which generates about 18% of our revenues, is Austin, Texas. The company has always been a full service, fully integrated real estate operating company, obviously, organized as a REIT. We do our own asset management, leasing, building maintenance, building engineering related services. We have a full-service construction and development operation. The company, including our joint venture activities, aggregates about 28 million square feet. Our development pipeline, which is on land that we own or control, can do about 15 million square feet, and it's primarily centered around 2 large mixed-use developments: One in Philadelphia's University City section, adjoining Amtrak's 30th Street Train Station, which can accommodate about 5.5 million square feet of mixed-use product; and our Broadmoor development in Austin, Texas, which is about the same size as located in Northwest Quadrant of Austin, And we have plans underway there to make that Austin's first mass transit serve development. The company in its full-service capacity is also very much engaged in community activities and has a very active neighborhood engagement initiative; has scored very well on the ESG metrics, including 100% grab score for community engagement; and the company has been in existence for about 25 years. And John, I don't want to take up too much time from questions, but certainly happy to provide an overview if you think appropriate.

Okay. By the way, Jerry, just so you know, we have known each other for 31 years. So we have known each other for longer than Brandywine has been in existence. So just want to point that out. That is...

And I always marvel at how young we look. I always marvel.

I am not going to ask about collections. That drives me crazy. This is about a 3- to 5-year business plan and what you plan on doing with the company over the next 3 to 5 years with your assets in your markets. But before I get into the strategy aspect, we do need to ask about sort of the topic of the day, which is potential secular changes in office demand. And as we all know, it's not as simple as work from home means less office demand. This is very, very multidimensional. It has a lot of economic issues. It's got collaboration productivity, workspace functionality issues. Can you talk a little bit -- peel back the onion a little beyond just the work from home means less demand headline?

Yes, certainly. And it's a great question to start off with, John. Look, I think from our perspective, we have really believed the office business has been in a state of evolution for the last decade with the deployment of additional technology that has really expanded the level of mobility of our workforce. That's had an influence on our designs of our buildings over the last 10 years. The assets we own, so we've completely repositioned our portfolio to be higher grade inventory that's attractive to large and small corporate users. And I think the pandemic certainly accelerated the thought that a lot of employers have relative to their need for office space and how they configure it. We have about 850 companies that are tenants in our buildings. We've had an extensive outreach program talking to every one of them through our leasing agents, property managers. And I think what we've realized or confirmed is that a lot of people who have been working from home have viewed that as a fairly effective triage to maintain their existing business. But relative to growing their business, generating new relationships, increasing their market penetration, it falls far short of meeting all those attributes. As a consequence, the lion's share of the feedback we're getting from our tenants really revolve around 2 central themes, all of which are supported of the safety in the workplace, so that's a different aspect. One is looking at the way their existing space is reconfigured. There's been a real push towards densification of space over the last decade, where people have been driving down from what used to be 250 square feet per employee end as well as 100 to 125. We see that trend reversing. We also see the trend reversing away from a lot of condensed bench seating and low profile 6x6 workstations to much more of the blend of office, partition walls, and higher circulation corridors. We got so much feedback on that from our tenants that is part of our customized deck for each office building we own. We're also offering the services of our space planning teams and outside architectural firms to help our existing tenant base rethink their office footprint. Relative to work from home, a lot of our tenants were already utilizing that really as a function of the digital deployment capabilities that exist today versus 10 years ago. But also as a function of the tight labor market, attracting people required employers to be a lot more flexible on how they engage with their employees. So that was always part of the theme. And I think that theme, as it evolved over the last 10 years, did reinforce the fact that the need for collaboration, in-person meetings, driving new business development through getting out and meeting with people still remain very much a key predicate. I guess as we look at it thematically, it will be interesting to see what impact, if any, this forced work from home program has on office demand. And whether or not that will be more than offset by the requirements of tenants for more broader space planning and more dispersion among the people who work for them. We're looking forward to that. We think our inventory is very high quality, great HVAC systems, great flexible floor plates. So we're -- we've opened up all of our buildings really in Austin last week and Philadelphia and Washington this week and welcoming back all of our employees. I think, John, to go to the core of your question, I think that will take several quarters to evolve. But one of the interesting data points is that since our earnings call, we've already signed 340,000 square feet of leases. And we have proposals outstanding for about another 600,000 square feet. And during those discussions, there has been scant conversation relative to taking less space because of COVID. In fact, it's been quite the opposite where we've had to retool a lot of our previously done space plans to reflect tenants now concerns on social distancing within the workplace.

That's an interesting segue. A few minutes ago, we had started talking and you had -- I had mentioned my thought that it would be a slow summer, and you disagreed with that completely. Can you talk a little bit about essentially the real estate world screeched to a halt, March, April and May? And how quickly you think it's going to gear back up?

Yes. Look, the rubric used to be, as we were chatting on larger lease transactions, if you don't have them done by Memorial Day, they really weren't going to be done until Labor Day because of vacation scheduled with top executives at the client firms. Given the fact there has been really very little activity in the second quarter, either from an investment transactional standpoint or from a leasing standpoint, we're seeing a tremendous increase in velocity driven by, number one, that tenants needs to make a decision; number two, driven by the brokerage community who have had really no sources of revenue because no transactions have been done by them driving forward a lot of these transactions; three, the -- with the work from home, a lot of the executives that our executive team and our lease agents talk to is they're ready for a much busier summer given the dearth of new business development they did during the second quarter. So we're actually expecting a fairly healthy summer from a demand standpoint. To wit on that, our pipeline of potential lease transactions has increased from 1.3 million square feet, at the time of our earnings call, to just shy of 1.8 million square feet as of last week.

Great. Okay. Good segue. Talk a little bit -- we started to talk about this, and then we decided we'd wait to hear what you had to say. A lot of conversation about public transportation, who uses it, why, will it continue to be used, how is it going to change. Philadelphia, a lot of people don't know, but the heavy use of public transportation, particularly the CBD. Can you elaborate a little bit on how you see the world of public transportation evolving?

Yes. Look, I certainly think that -- and a lot of our portfolio, for full disclosure, is multimodal. It's served by mass transit and automobiles or in all of our CBD and university locations by bike as well. So we built our portfolio to have multiple means of access. I certainly think after our tenant surveys, the second -- the first most important issue to -- really the safety of the buildings that they were returning to. The second biggest issue from our CBD and University City tenants was how they would get there. So I do think the ramp-up time for public transit systems around the country will be slower than the actual opening of the offices. And I think that will really be a function by market. For example, in Philadelphia, where we -- certainly, a number of folks use mass transit. So in Philadelphia, almost 900,000 employees who commute in the city use mass transit. But that only really represents about 9% of the regional workforce. So I certainly think some of our -- some of the ramp-up of occupancy in our CBD buildings will be directly related to the capacity that the regional rail system has to ramp up and convey safety and security and healthy commutes to the commuting population. We have been working very closely with the regional rail authority to make sure they're in good shape on that. Brandywine is also a fairly large owner of parking in the city of Philadelphia. So we are able to offer a number of our tenants short-term parking spaces to facilitate their smooth transition. But John, I really do believe that I think the commuting by mass transit and how that's handled by a lot of these cities will determine the rate of ramp-up. Now certainly, there's been a lot of CARES funds allocated to mass transit. I mean, New York, for example, is getting $5.4 billion, Philadelphia is getting close to $1 billion. So I think that will be very, very helpful. But certainly, as we look at our core markets, Washington has about 13% of folks commuting by mass trans; I mentioned Philadelphia, 9%; Austin really has an emerging mass trans system, so it's less than 1%. So we think we're well positioned to have the -- to continue accelerating bringing people back to the buildings even with some of the slight pause on the Philadelphia side. But certainly will not be as heavily impacted as New York or San Francisco or some other markets where 20% to 30% of the workforce commutes by public transportation.

Good segue. Why don't you elaborate, talk a little bit more about both Schuylkill Yards and Broadmoor, 2 master plan developments which you control, which have a lot of square footage and also evolving and emerging public transportation nodes? Maybe University city or Schuylkill Yards first.

Sure, John. Schuylkill Yards is a 14-acre site that Brandywine controls through a master development agreement with Drexel University. That deal represents a continuation of the relationships we've had with the University of Pennsylvania, University of Pennsylvania Health Care System, Children's Hospital. So very much enmeshed into the institutional fabric of the University City. That Schuylkill Yards is programmed for anywhere between 5 million and 7 million square feet. We have approvals in place for more, but we think that's a good target of density. Approximately half of the space will be residential, hospitality, obviously some ground level retail. The balance will be a combination of academic, life science and office space. We're into -- we're ready to launch our first phase, which consists of a multifamily and life science/office component, and that would be about 326 apartment units and about 200,000 square feet of life science and office space. We have another large office life science building design that we're marketing. And we've also launched a design development for a 500,000 square-foot dedicated life science building that we'll be launching in early 2021. We've had great success thus far. The first building that we did, it's been fully leased by a life science company, a subsidiary of Roche Pharmaceuticals. Our second building, as we announced on our first quarter call, has also been leased by that same company, Roche Pharmaceuticals subsidiary. Our pipeline of activity within Schuylkill Yards really is very heavily skewed towards life science and institutional uses out of the major health care systems and academic institutions. So we're very, very excited about the ability of Schuylkill Yards to really create a life science and residential ecosystem right next to the 30th Street Train Station. As I mentioned earlier, that is the third busiest train station in the country. It is also the nexus for mass transit on the regional rail system and has a very, very high walkability scores and biking scores within the city of Philadelphia. So we think we're very well positioned there to really create a very vibrant neighborhood consisting of a blend of uses. And from Brandywine's standpoint, it really gives us the ability to pivot from pure office development into residential and life science in a marketplace where we're the largest landlord, have significant dollars invested and have a tremendous personnel and economic infrastructure to facilitate those successful developments. Pivoting down to Austin, Texas. Broadmoor is a 60-acre site that can again do around 6-plus million square feet. That again is programmed to be heavy residential, along with about half being office. Right now, we're in the -- we received final approvals from the city of Austin several months ago. We'll receive final approvals for our first phase, which will consist of 350,000 square feet of a newly designed office space and about 900 residential units broken down into 3 blocks that we'll sequence in as the previous block is completed. One of the exciting differentiating factors with Broadmoor is we have spent extensive time with the city of Austin and the regional rail authority, which is called CapMetro, to form a public-private partnership to create a train station at Broadmoor, which would enable that development to be Austin's first transit-oriented development. Our hope is to start that train station construction in the third or fourth quarter this year. It will be done within a year. And we think it will be a major source of differentiation for us in the Austin, Texas market. Despite the distance we just talked about with the current state of mass transit in the country. But we're very excited about both. We're being very pragmatic in terms of how we allocate capital, certainly given the constraints within the public marketplace. We have very, very deep institutional investor contacts, and we're engaged in a series of discussions with high-quality institutional investors about becoming our partner in the first phase of Schuylkill Yards and Broadmoor to facilitate some vertical development take place couple of quarters in both of those developments.

Great. Great summary. Let's give you a little bit of time to breathe. Tom, why don't you talk a little bit about the balance sheet, sources and uses? And how much capital you're prepared to put in along with joint venture partners into University City and/or Broadmoor?

Sure. Looking at our liquidity and balance sheet and our funding sources. So we do have a business plan, we've pared back some of our capital spend for this year. But we do expect to end the year with over $400 million of liquidity for this year. When it look -- when you look at how we would deploy that liquidity, looking at Schuylkill Yards, we have spent a lot of time and money on the development of that project already. We are looking for a partner in the roughly 65% equity position where we would retain a 35% equity position. And for us, we've put in most of -- or all of the equity that will be necessary to start that project, with us having no additional equity funding requirements. So we're looking at allocations. We've already spent the money that would go into the first building, Schuylkill Yards West, where our money has already been put in. At the same time, we're also looking for financing. So we're looking to construct that project with construction financing with leverage in the mid-60s. So that project would be -- and I think we feel the same way about Schuylkill Yards East when it's ready to go, that we have put in most of our equity already through the infrastructure work through design development that there would be no additional funding required for us on that project either.

In both cases, my recollection is you, Tom or Jerry, have a very low land basis. Now some of that will get eaten up by the increased infrastructure cost. But can you talk through -- if you take your land basis, how you're looking at it and what sort of capital you need to put in for infrastructure? What the overall basis will be? And whether that's attractive in the overall development costs to make the numbers work?

Sure. Great question, John. I'll start South and move North. On Broadmoor, we're very fortunate with the transaction structure when we acquired that ground and the density we're able to achieve through the approval process. Our land basis is around $2 a square per buildable square foot, which is staggeringly low. When we take our full infrastructure budget, John, including our contribution to build the train station, that will add about another $28 a square foot to do the full road system, all the sewer laterals, the utility lines, everything, storm water management. So that would give us a fully approved, improved land basis of about $30 per buildable square foot. And this is within a submarket where land is going for -- last rates were close to $60 per buildable foot. So we think that as we start to look at forming these joint ventures, our imputed land value will be a significant portion of our contributed equity to a venture formation. So we think that gives us a tremendous amount of financial and economic flexibility in structuring these overall joint venture transactions. When we look at the Schuylkill Yards, we don't have the same level of off-site infrastructure requirements because that's obviously within the middle of the city with all the utilities and streets, et cetera, in place. Our land basis there is about $35 per buildable foot. We typically see in Philadelphia that, again, ranging on comparable sales between $50 and $60 per buildable square foot. In some cases, higher, but a dedicated residential as we've seen higher values there. So we think we have some good economic scrape there as well. And to give you an example, we did a joint venture transaction a few years ago on a student housing project we did within University City. And we did that initial transaction, the vast majority of our imputed equity -- I'm sorry, the vast majority of our equity accounts came from our imputed land value. So as Tom frames this out in terms of the sources and uses, with all the existing capital we have invested in Schuylkill Yards as well as, we think, an attractive land basis with some economic value there, we think that can more than compensate for any required further equity. So fortunately, on both of those projects, we think we're in extremely good shape in terms of having a below-market land basis, which again, gives the benefit from a venture financing or even doing a sale, creating a profit opportunity. But it also gives us, particularly in the case of Broadmoor, durability without distressing our balance sheet through excessive land carry. And just the final point I would mention is that at Schuylkill Yards, under the provisions of our master development agreement with Drexel University, we have actually, with extensions, the ability to extend land takedowns for almost 30 years. So we have very little carry on any of that land control until we opt to take the parcel down. So on that life science project I mentioned, John, that we're planning on starting next year, we'll take that site down when we're ready to start construction. So there's no land carry on that. There's none of those other things that might create a strain in our liquidity, particularly at a time where we're very focused on how we're deploying capital.

Okay. All right. Interesting. Interesting. Question, this is a kind of question I'm always curious about, when you're building residential in Schuylkill Yards versus building residential in Broadmoor, concrete steel versus stick-built in these particular locations?

Yes, great question. In -- at Schuylkill Yards, the residential will be concrete, very similar what we did at the student housing project Evo as well as 1919 Market Street and our FMC Tower residential component. At Broadmoor, it will be a mix. There -- the first phase of residential will be -- the higher elements will be concrete superstructure. It will be ringed by some stick-built podium product. And the second 2 phases will be podium, stick-built construction.

Great. Great. Okay. Unfortunately, my Wall Street Webcasting is not showing -- it doesn't seem to be functioning. So if there are questions in the queue, I'm not seeing them. So I apologize for that. But the good news, I get to ask things I'm interested in. So you guys exited D.C., I think you kept a couple of full positions and full buildings, and you've kept a 15% interest in a portfolio. Can you remind us exactly what your Washington, D.C. metro position is? And then also talk about how you're thinking about D.C. overall as an office market in this day and age?

Happy to. Yes, we wound up selling off via joint venture the significant portion of our Northern Virginia portfolio. We did that with an institutional investor. We retained a 15% stake. And the major reason for that was simply relative capital returns. The D.C. market has not had any real significant growth in net effective rents over the last several years. So our capital ratios and our net effective rents that we're getting out of our Northern Virginia portfolio were among the lowest in the company. So as we look forward, and we're certainly looking to grow our footprint in Austin, Texas, given the stock price being below net asset value, we were forced to really think about an effective way to recycle money. So we formed a joint venture in Northern Virginia, used the several hundred million dollars we generated from that to buy out a joint venture interest in Austin and thus, generated a significantly higher revenue growth model, higher net effective rents and lower capital ratios. The venture structure we did in D.C. is very effective. We took properties that were generating about a 5% cash return for the company after capital costs and moved that into a higher levered model, which provides a return on invested capital on Brandywine to the low double digits, including our fees. So when we have these assets where it's very hard to move net effective rents, we're very keen on either selling those or venturing those off. As they keep us as a proxy in the marketplaces, marketplaces change. We own outright in Northern Virginia 3 buildings in Tyson Corner and 1 building out in Herndon. And then we have several buildings in Suburban Maryland. We owned the 1 land site in the riverfront section of the district that can do a 250,000 square foot office building right next to the Nationals baseball stadium, which right now is not being used, as we know. And we're marketing that. And then we have a joint venture interest where we own 70% on 2 parcels of ground in NOMA. We like D.C. as a long-term market for us. Given the compression in cap rates, the low cap rate it's always had, along with the low net effective rent growth and high capital costs, we have targeted that market to be more of a co-investment market for us versus on balance sheet. Simply a better returns out of Philadelphia and Austin, Texas.

Excellent. Excellent. You brought up a question that I had not thought about until just now. When do you see or how do you see the leasing markets, investment sale markets, debt markets thawing? And when they do, do you think you'll see, let's say, in the leasing markets, will net effective rents look the same in the fourth quarter of 2020 as they did in the fourth quarter 2019? How do you feel about -- what's your crystal ball tell you about the debt markets? What's your crystal ball tell you about the investment sale markets?

Yes. I think on the leasing front, John, and the evidence to have right now is anecdotal and based on feedback from our frontline leasing people, is they're not hearing of any COVID discount on rental rates. So that may emerge, but we're in the midst of a number of large-scale leasing transactions, and that really has not come up. The good news is all the markets we're in, particularly in the Philadelphia and Austin region, we're pretty tight going into this. So it's not like there was a massive oversupply of space. So we think that net effective rents will trend as they have been. To the extent we think there's going to be any diminution of notional rents, I think there's going to be a softening in the construction markets, at least for a period of time, which may give Brandywine, given the substantial buying power we have in our core markets, the ability to drive down our TI costs, which, as you know, has a direct impact on net effective rents. So that's our prognostication on the leasing side. Look, on the investment side, I think, certainly, I think a lot of the tremendous opportunities that the private equity firms thought they might see 3 months ago have not really materialized. So there is still a gap between buyers and sellers. I think the rationale for a lot of the opportunities they thought they might see were really driven by the complete dislocation of the debt markets. And Tom, weigh in, please. But I mean, we've seen a great recovery of the investment-grade market, including some recent issuances this week and a further tightening of spreads. The high-yield market has started to perform very well. The institutional lending market seems to be tightening. A lot of lenders are now focused on new business versus just managing their own portfolio. But Tom, maybe you can pick up from there.

Yes. I think we have seen that the banks were spending quite a bit of time on the lending side, looking at their current portfolios and also looking at the processing of PPP loans. I think they've done a lot of that work, and they are starting to turn towards new business. I think it's going to be relationship driven, and I think spreads have increased, although they've started to come in. It seems like every few weeks we speak with our banks, but they're probably still 50 to 150 basis points wide in terms of pricing. But they certainly are starting to look at that business a little more, spending a lot more time on it.

Good. Good. Okay. Unfortunately, as I mentioned, I don't see any questions coming in mainly because the webcasting doesn't seem to be working. But -- so a question for you. Anything else you'd like to talk about, anything that we think we've missed? Otherwise, we'll wrap this up, and everybody will get back to their day jobs.

Yes. I think, John, the only point I would -- I think a very good question, I think a great conversation. The only point I'd like to amplify because we are amplifying it more and more with our investor base is I think the real potential for Philadelphia to accelerate its rate of growth in the cell and gene therapy business. As I said to a lot of our investors, when we first developed the master plan for Schuylkill Yards, we really -- and that was done 4 years ago. We really felt that it was going to be a -- life science would be a minor component. We have completely pivoted. And as evidenced by the transactions we've done thus far, we really think that that's going to be a major distinguishing factor in Philadelphia's growth rate going forward. Philadelphia as an employment base regionally is heavily weighted towards academic and health care institutions. About 1/3 of the region's workforce is employed in those segments, which has always provided a high level of stability to Philadelphia in any period of recession. Now it's had an impact on a slower growth rate for us as well, and we've been slower to come out of a recession, but we've been one of the last major metropolitan areas to go into a recession. We think a distinguishing factor this time is this upsurge in life science, particularly in the cell and gene therapy arrangements and the manufacturing thereof, a significant growth in the employment base within the city of Philadelphia. So we'd like our investors to keep that green shoot in mind as they look at Brandywine, our current portfolio.

Great. Okay. Well, gentlemen, thank you very much. A wonderful job, and maybe we'll do this in person next year.

That would be wonderful, John. Thank you for including us, and thanks for moderating the discussion.

All right, bye for now. Thanks a lot.

Bye.