Brandywine Realty Trust (BDN) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to Citi's 2021 Virtual Global Property CEO Conference. I'm Manny Korchman with Citi Research. We're pleased to have with us Brandywine and CEO, Jerry Sweeney. This session is for Citi clients only. If media or other individuals are on line, please disconnect now. Disclosures are available on the webcast. For all of you on the lines today, just if you have any questions you'd like to ask management, throw them into the box on your screen. Those will come to me and Michael anonymously, and we will try to weave those into the conversation. With that, Jerry, why don't you introduce the company and management on the screen here with you, and then we'll go to Q&A?

That sounds great. Thank you, Manny. Thank you, Michael. Good morning, everybody. On the meeting with me today is Tom Wirth, who's our Executive Vice President and Chief Financial Officer. And I think just as a brief intro for the company, most of you know it fairly well, but for those that don't, about 5 years ago, when we had a major investor meeting, we've really laid out a couple of key goals for the company. One was to fully reposition our inventory. And with the last transaction we announced at the end of 2020, we did complete that and have all the noncore holdings out of our wholly owned inventory. So including in that was perfecting all the approvals on our 2 large master plan developments, Schuylkill Yards and Broadmoor. So as of last year, all of those approvals, including final planning, final overlay zoning is all in place. We also set a goal to grow our CAD or cash available for distribution. And we're happy to report that over the last 5 years, we've been a top quartile CAD grower. We've grown our CAD at about an 8% annual rate compared to our peer group of less than 4%. And then we also identified growing our dividend as a priority. And we've grown our dividend about 5% annually the last 5 years compared to our peer group of about half that level. So we're pleased to have that phase of our evolution behind us. And now we're really focused on growing FFO and our net asset value. And I think we're really in a good position to do that. We did come out with '21 guidance. We do believe that set the baseline and an inflection point for future growth. We have several paths to get there. One of those paths, we have several projects, development and renovation projects coming online late '21 and into '22, and that's our 405 Colorado project in Austin, Texas; and our 3000 Market Street project in Schuylkill Yards in Philadelphia. We also, as those of you know, have a number of key vacancies that we are planning to fill up over the next 12 to 24 months. They're dispersed through our markets. We have a large vacancy in a newly renovated project in Tysons Corner at our 1676 International Drive project. The last pieces of our SHI vacancy down in Austin, Texas, and several parcels of vacancy in CBD Philadelphia. But we really do think as the market recovers and we lease those vacancies up, they'll be done at a positive mark-to-market on both the GAAP and cash basis. Our capital ratios, at least the visibility we have now, are holding very true, and they can be very additive to our top line FFO growth story. And given the tenure of the leases we expect to do there will also be a contributor to our CAD growth over the next several years. And then certainly, we think one of our major avenues for growth is looking ahead to late '22/'23 and beyond the delivery of the first real vertical construction that we anticipate taking place at both Schuylkill Yards and Broadmoor. We did announce the first vertical construction of Schuylkill Yards earlier this year, that project is underway and will be delivered in about 30 months. That's a mixed use of residential, life science and office project. We are on track and going through final partner selection for our first phase at Broadmoor. So we'd expect to select a partner in the next 30 days, move through the documentation, the debt financing cycles in the second quarter with the expectation of starting our first vertical development at Broadmoor sometime in the third quarter this year, and that will most likely be about 340 residential units as well as the potential for 350,000 square foot building, depending upon if we're able to achieve a prelease there. And we certainly think with those first 2 moves at Schuylkill Yards and Broadmoor, we can follow on that with some additional development as market conditions continue to improve. We have a 500,000 square foot dedicated life science building that's fully priced and ready to go and in the marketing phase right now. Again, assuming we get a prelease there, that could actually start by the end of 2021. And then as some of you know, we also have 4 or 5 production level developments and renovations underway that we think between Radnor, Pennsylvania, King of Prussia; 2 developments in Austin, Texas; a renovated project down the Toll Road Corridor. We think all of those -- the successful execution of those initiatives we think will really create both an accelerated growth rate in NAV and certainly get us back on a track record of developing a top line FFO growth. So I think with that, Manny, that's a good synopsis, but certainly happy to add any color to any points you have questions on.

Right. So Jerry, we've been opening with the same question. So I appreciate that you've covered some of this in that opening remarks. But coming out of this pandemic, if an investor were to own 1 real estate stock, what are the 3 reasons of that list that you just gave that, that stock should be Brandywine?

Yes. I think the 3 key reasons very simply are we have 2 fully approved mixed-use master plan sites that can double our existing inventory and diversify our revenue stream and drive earnings growth going forward. So that's certainly number 1. Number 2, which is kind of an adjunct to the first is our planned 3 million square feet of life science space at Schuylkill Yards, we think, will both accelerate the development time line for that master plan community, also create value and really accelerate the creation of the scalable life science community within University City in the Philadelphia region. So we think that's another key compelling reason. The third, I think, is we -- as I mentioned, we had very good CAD growth over the last 5 years. So we have a very attractive and well-covered dividend that we believe as we drive top line earnings growth, particularly through development and redevelopment projects coming online, that cash flow growth that we've had over the last 5 years will continue to accelerate.

Perfect. Maybe we'll start with what sounds like the newest piece of news within that, the partner selection within next 30 days at Broadmoor. I don't think that we've discussed that in the past, at least publicly. Can we talk about sort of what that partnership might look like?

Sure. And we've had a very tightly controlled auction process going on that for the last couple of months. We've identified a range of really blue-chip level both domestic and international investors. They're looking at participating in Broadmoor with us. We are looking at 2 different routes there. The Brandywine targeted hold is somewhere around the 50% range. And our objective is to both assess pari-passu capital structures as well as looking at some preferreds with the objective, as we did with Schuylkill Yards, the overall objective being to reduce our overall cost of third-party equity and to create a very clean governance structure. I think, Manny, as we've talked in the past, I mean, certainly, we view these joint venture structures as transitional capital programs that help us bridge the divide between what we see as really current real estate market opportunities that are demand driven versus where our public currency value is. So one of the things we're looking at particularly with Schuylkill Yards and Broadmoor as well, these are multi-phase 5- to 10-year build-outs. So one of our hopes is that by selecting the right partner and the right structure for the first couple of phases, maybe only the first phase than was happening in the public side, that we actually create the momentum for the vertical development. So we're very keen on looking at what the investment time line is of our partners because certainly one of our overriding objectives is to not only create value, but also to hopefully have all that value accrued to the Brandywine's shareholder benefit as our capital market conditions improve.

Would the idea, Jerry, be that, that partner would only have a commitment for a first phase, but then have a right to future phases? Or how would that -- how would something like that work?

Yes. And Michael, great question. I think what we're able to achieve at Schuylkill Yards and is also the plan for Broadmoor is we are very keen on reserving the rights to do all future phases on book for ourselves. So what we wound up doing is -- at Schuylkill Yards is we've given our investor the first right to negotiate with us on the next phase to the extent that we seek third-party equity, to the extent that we do not, we have -- we're completely unencumbered to do that for our own account. So certainly, as we look forward at both developments, we think there's an interesting opportunity for us to see if we can internally generate some additional capital to try and increase our ownership stake, if not wholly own those next phases. And then that's actually been fairly well received. We'd originally looked at maybe a master partner. But as we start to parse through the numbers, we just think there's so much value here that can be created that we didn't want to make a long-term commitment based upon a short-term price point on our stock. So that's the operating predicate, and I think we'll be very successful in achieving the same result at Broadmoor that we did at Schuylkill Yards.

And then as you think about that Broadmoor venture, I guess, is there going to be value creation in terms of your existing basis for what they're buying into for Phase 1? Is it -- would there be a spread? Or you just -- you view this more as a financing than necessarily value-creating immediate event?

No. A great point as well. Our land basis at Broadmoor is very, very low. So part of Brandywine's equity contribution to the venture will be a mark of that land to market. And also, similar to what we did at Schuylkill Yards, a full recovery of all of our predevelopment expenses. So...

Right. And that would be -- is it like 125 of cost? Or what sort of levels should we think about in terms of that land contribution for your equity?

Yes. I mean I think the market value for the land is in the $60 per FAR foot, $50 to $60. Our basis is somewhere south of $5 a foot. So we think that the approval process we went through, plus frankly, Michael, all the predevelopment work we've done to really master plan the community, I think every investor has recognized that value. So again, similar to what we did at Schuylkill Yards, we were able to kind of write the land to market and get value for the approval and the predevelopment spend that we put into the project.

A couple of questions coming out of that, Jerry. One, when you were selling the most recent batch of properties in the Mid-Atlantic, and you provided some preferred capital into that deal, how did you think about that preferred capital investment versus the fact that now you had to go and find a partner elsewhere, couldn't you have just sort of retained that cash, rolled it into whether it be the first or second or whatever phase of Broadmoor or Schuylkill it would have been and then not had to partner up and you still would have had the optionality partner in future phases, but you would have been in a much stronger equity capital position walking into it?

Yes. Thanks, Manny. And I think, look, one of the backdrops to that -- to answering that question is, if you recall, we had targeted about a 30% to 35% ownership stake in the first project at Schuylkill Yards. By actually generating the liquidity out of that sale we're able to increase that or stay from 35 to 55. And by doing that, we're able to drive more competitive terms on the cost of the third-party equity. You have to keep in mind that the first phase of Schuylkill Yards is $300 million. The first phase of Broadmoor is $300 million. These are large projects for a company our size. And it's not only just the -- increasing the ownership or the -- or equity stake in those projects, but they're also 24- to 36-month build-outs. So we're really trapping a tremendous amount of liquidity in those projects. And as we looked at it, we felt that it was -- from a return on investment capital perspective, we're able to drive much higher returns on our, for example, 55% position at Schuylkill Yards than if we did on a wholly owned basis. And there's a pre prescribed exit strategy in that deal that we feel very comfortable will create a lot of value for us. So as we kind of look at the entire capital allocation landscape, we have these larger assets that are 24- to 36-month deliveries that are a $300 million to $400 million, that's a big capital commitment for a company our size in this kind of marketplace. We also, though, Manny, really believe that given what we're hearing from tenants and the push by them to higher-quality state of the art space, we do think that there's a good opportunity for us to get some of our production level developments moving forward. So Garza, Four Points, 155 Radnor, the King of Prussia project, 250 King of Prussia Road, these are all projects that are kind of between $50 million and $75 million. We can deliver those within 12 to 14 months. And what we wanted to really do is be very mindful of not trapping so much of our liquidity and capital capacity in any -- in either of these first big project moves at Broadmoor so to give us some additional capacity to allocate into those production level developments. And certainly, one of our team's objectives to keep our balance sheet in fairly good shape and to kind of minimize the leverage creep as we go through these development cycles.

And Jerry, why was it so important for you to retain the multifamily component, whether it be Broadmoor or Schuylkill rather than sell off that component and again have more -- a larger stake or larger control and more equity within the office component?

Yes. Well, we -- it's hard to kind of bifurcate these prices, like in the case of Schuylkill Yards, it's 1 vertical neighborhood like we did here at FMC. And the first phase of the residential at Broadmoor is integrated with the garage and the office ones. So very integrated, complicated sites, number 1. Number 2, we did bring on Gotham Residential out of New York as our kind of incentive fee developer to provide some guidance on the technical side for residential here. We have Trammell Crow Residential as our technical adviser down -- and developer down in Austin, Texas. And I think, fundamentally, what we looked at was, these are both integrated master planned communities. So we're -- at least at this phase, we're looking at kind of a level of integrated ownership that provides -- and that level of integrated ownership what we think will drive the maximum level of value. I think the fourth point we looked at having really assessed the residential market in both Philadelphia and Austin, we're building these projects to a mid-6 return and comparable sales are in the 4 cap rate range, we just felt by trading off that potential development profit was not a good move for our shareholders. But does it mean, Manny, when they're done, we don't liquidate the position like we've done with a number of other residential joint ventures? But it just -- it was too much money for us to really leave on the table given the fact that as Tom and I work through the capital plan, we thought we could accommodate getting that done and effectively preserving as much of that value creation for our shareholder base.

Jerry, I remember that Investor Day in Philly 5 years ago, actually very well. Can't believe -- it feels like yesterday. That is 5 years already.

It feels like 10 years, right?

Yes, that is true. And I remember I asked you whether you would expand into other markets, and you were like, no, we're not going to do it, and you didn't, right? And you executed against this plan. And the attractiveness of Schuylkill and Broadmoor, which I think you talked about, right, just they're big projects, but they're too big for where your cost of equity is and the size of the company to do wholly owned, even though I would imagine if you had your druthers, you'd want to do it all yourself and not give up any of the upside, right? So is there an element of -- is that an accurate statement? If you were a larger company, let's say, you were 2x the size and your equity was still trading at the same price, would that alter your thinking? So how much of it is size of the company in terms of exposure and taking on too much relative to the size? And how much of it's a cost of financing? And then how much of it's just like public versus private? If you're a private company, would you just lever this thing up and do it yourself?

Yes. Great question, Michael. I will answer the best I can. Look, if we are 2x our size, I've got to assume we will have 2x the amount of opportunities to kind of allocate capital. So it's probably a linear increase, right? But look, I think we've always operated from the predicate. And is it -- we're not going to issue cheap equity to drive a near-term development opportunity. It's something -- some folks have asked us about it, but the reality is that we're really driven to kind of continue to create NAV growth. And look, I mean, being in the public marketplace does give you capital optionality to kind of look at the public-private arbitrage. We -- as a rated company, Tom and his team were able to do a very effective job on the debt side. So we closed out 2020 completely unencumbered on our wholly owned portfolio, which gives us maximum operating flexibility. So we have no secured debt in our company. But look, certainly, it's something we struggle with in terms of how we can effectively allocate capital and try and keep that in the mix. Look, if -- as a private company, they certainly utilize a higher degree of leverage. I mean Schuylkill Yards' capital stack is a good example, Michael. There, we bought in third-party equity. We have a wonderful promote back end residual structure, a very clean governance structure. And we'll find 65% -- or 60% or 65% very effectively priced construction capital. So we'll drive our return on invested capital close to the very high teens, low 20s. So that's a very good investment for our shareholders. I know as a public company, it complicates the analytical landscape, but I think we're always of the mindset if we keep executing our plan, hope springs eternal. Hopefully, we get back to an NAV priced stock. I mean some of the numbers that your firm put out a call were pretty stark in terms of -- if you take a look at the last 10 years, low-barrier office companies traded above NAV 10% of the time. High-barrier companies was like 15% of the time. So 10 -- basically 10 days out of every year, you're trying to figure out when you can issue equity. So it is a challenging landscape, but I think that's the optionality that we receive as a public company in terms of both debt and equity financing gives us a range of options to evaluate as we think about our next -- our forward business plan. And I think in terms of new markets, I think, look, we always believe that the opportunities we had, Michael, within Austin and within Philly, and those 2 markets are...

Probably different.

Very differently, right? But we do think that there's too much opportunity in markets we know so well and are tied into the civic and the political and the business community, that it doesn't make sense for us to jump into another market and take on inventory market or any other kind of risk. I think we're really critically focused on trying to execute these developments. And certainly, one of the things that's evolved with Schuylkill Yards since we got the original master planning pulled together was this acceleration cell and gene therapy. I mean, there's been a massive amount of venture capital on life science coming to Philly. We've seen the whole incubation of the Spark Therapeutics story being bought by Roche. Penn is incubating 20-plus companies. They've spun a few out. So I really do believe, and we're starting to get independent validation by a lot of life science investors looking at Philadelphia for the first time, that there's really a tremendous opportunity for growth here. And as we look at the landscape here in Philly, know it's competitive, but we think we're oceanfront property here. I mean we have the access to the train station. We're on the Schuylkill River. We're close to downtown. We're tied in with a number of nexuses with the University of Pennsylvania Health Care system, Children's Hospital, Drexel. So we think there's an opportunity here given our market positioning in Philly to really start to outperform what has been historically Philadelphia's growth rate. And we juxtaposed that with what we know will be a very successful development at Broadmoor, where we hope to announce the final deal on the train station later this year. We have the opportunity, as both you and Manny know from visiting the sites, we can draft off our next door neighbors infrastructure as we're creating our own next door. And as a master planned community, we have the ability to do residential hospitality, a lot of office. There's, I think, 21 life science companies looking at Austin, Texas, today. So we think that there's certainly an opportunity to kind of incorporate that as Broadmoor. There's some large companies looking for massive office campus space requirements. We have a 66-acre site that we think is going to be a prime uptown. We think we have the ability in conjunction with the work at the domain to really create a new uptown in Austin, particularly with that -- the train line being serviced to that location.

Jerry, if one of those large companies came to you and asked you to sell them that land or help them develop on that land and they would own it, is that something you would entertain?

Yes. I mean, certainly, we have to dovetail that against what we view as the long-term profit opportunity. But we have done that in the past. We did build the suites held for Subaru. We've done it for a couple of other companies over the years. And what we're trying to do is take a look at the net present value of what we could create as part of the equation and try and tie that into point-of-sale pricing.

So let me get through the questions in the queue here. Tom, for you, can you just walk through sources and uses over the next couple of years?

Sure. For the sources and uses just for this year, which we have outlined, we knew that we were going to have 2 development starts. We -- 1 of them being Schuylkill Yards. We have another one in the queue in terms of our capital plan. But at the end of the year, spending the capital that we have, we'll have $500 million of availability on our line of credit when we get to the end of the year. We -- in terms of financing, later this year, we may redo the line of credit, which is coming due mid '22 as well as a term loan and both would price similar to where they are now, so not expecting any changes there. We have no bonds till '23. Obviously, with what's been going on with the interest rate market and credit spreads, we're taking a harder look at whether something we may consider sooner rather than later going into those bonds. So I think those are 2 of the larger areas. We also have targeted this year, maybe you'll see more of them as some land sales. So we're looking to get some liquidity from land sales. And then going out over the next couple of years, we may look at a couple of our joint ventures that we have today, and those may be candidates to sell as we begin more development. So we'll look at some sales potentially down the road that may help fund some of the development, depending on what -- as we talked about earlier, what ownership we may keep.

The next one here is any update on Schuylkill Yards leasing?

Yes. I'll take that. We have a very good pipeline on the life science dedicated when we have a pipeline already north of 400,000 square feet and several hundred thousand square foot pipeline on Schuylkill Yards West between office and life science companies. So I think we're generally seeing across our pipeline company-wide is it's larger -- much larger than it was at the end of the year. So we're starting to see more and more companies start to unfreeze and come back into the marketplace a little bit. And as I alluded to earlier, Manny, I think we think we're in a really good position as I think some of our public company peers rather have really good inventory. There's clearly a movement towards higher-quality stock. As I phrase it, we used to get these 40-page RFPs in from these big corporate users. And all the technical specs were on like Page 39. Those technical specs are upfront now because I think every C-level executive we're talking to is looking for space. They're very keen on messaging the right thing to their employee base that it's safe, healthy buildings to return to. And we think our portfolio, and a lot of our -- I mean, our development pipeline is increasing significantly as well. And we -- during the pandemic, we've really pivoted some of our leasing and marketing materials to really key in on the advantages of indoor/outdoor air quality, air flow changes, some of our development buildings we're having larger elevators, faster elevators. We've changed the configuration of some of our bathrooms, widened stairwells. I mean all those things that, at least in the short term, should be a marketing catalyst. I have no idea of the durability of those things. I mean -- I think we're all hoping that next year when we're back in Florida at the Citigroup Conference, it's -- these things are well in the rearview mirror to us. But for right now that seems to be a major point of emphasis by a lot of the C-level executives we're talking to at both large and small companies. I think every company is very much focused on safe return to work, make sure the place we're going back to is effectively managed, well capitalized workplace, and I think we'll continue to see the pipeline build. We -- our business plan for '21, which we laid out on the earnings call, we really don't expect a lot of leasing executions to occur until late third, fourth quarter. So while the pipeline is building, I think the rate of decision-making will still, I think, be tied to the rate of vaccinations, the relaxation of public policy, some of these large companies getting comfortable with employer liability issues. So I think we're in interesting couple of quarters. And I think we're using that time frame to really get out there and effectively market. We have a great on the ground leasing people, and I think we're starting to generate some real good activity increases.

Last one I'm going to pull from a queue here, and then we got to get to ours. Prospectively, Broadmoor and Schuylkill are built out, noncore assets are sold, what's the geographic mix of the portfolio at that point? And when is that? Is that 7 years, 10 years?

Yes. I think we're looking at kind of a 7- to 10-year horizon. I like it to be 5, but we'll see how every things play out. But look, I think when we look at the mix, we are very focused on continuing to grow our concentration in Austin. So we bought that up from the mid-teens to right now, we're about 20%. We're very focused on growing that to 25%. But I also think one of the interesting things as you look at our company is given the targeted life science and the residential uses, we have the ability to have 20% to 25% of our revenues coming from life science companies through the build-out of just Schuylkill Yards and assuming no real life science at Broadmoor, about 20% residential. And we think we're going to fuel that growth by continuing to reduce our revenue contribution from the Greater Philadelphia region programmatically over time.

What are your top 3 priorities to improve your ESG score in this upcoming year?

Oh, yes, I think -- look, I think on the E side, I think we're going to continue to drive towards higher level certification. I mean, right now, we have about 7 million square feet that's Fitwel certified. We have 1 million square feet that's WELL certified, about 1 million square feet that's UL-certified. So one of our big thrust is to continue to get more buildings certified as well as kind of continue on the path of kind of -- we said 15% reduction targets on energy, water and greenhouse gas emissions, and we think we've got the programs in place to do that. I think on the F, we've -- it's really driven by expanding our neighborhood engagement initiative, which is a $17 million program we launched here as part of our Schuylkill Yards overlay zoning. So we're running our next apprenticeship class, even though it's being done virtually. We've already put 50-some young people into the construction trades. Our grow Philadelphia Capital Fund, which we've done in conjunction with the nonprofit, we made $600,000 of low interest loans to 16 minority-owned real estate-related businesses to see them through the pandemic, and we have them into our vendor program now. And we also created a lot of capacity for community development corporations. And as part of the residential programs, both at Broadmoor and Schuylkill Yards, are effectively evaluating some affordable housing options, which ties very much into a local public policy. So expansion of that neighborhood engagement initiative, I think, is a key part of our program. And on the G side, we already have a very high score. We're 1, but we will continue our annual board refreshment plan. With this next proxy, we'll bring in a new Board member. And so in each of the last 3 years, we bought a new Board member on board, that will continue. And then we've also ramped up our officer -- senior officer level engagement, where every one of our senior executives needs to be on the Board of at least 1 and the high you're in the origination 2 nonprofit organizations. So we maintained very good connections with the communities in which we do business.

Right. We're going to go with our rapid fires. When we're sitting physically together in Florida a year from now, what will be the 1 thing that will surprise people about your business in the proceeding 12 months?

I think the biggest surprise people will see is as we start to move forward with Broadmoor and Schuylkill Yards will be the rate of acceleration of the execution of that development program and the ability for Brandywine to diversify our revenue stream between life science and residential. I think we will have started to really prove the thesis of Philadelphia being a potential Silicon Valley and being able to be on a pathway to create a large ecosystem in life science. And I think, hopefully, we'll be in a position where we can generate sustained earnings and cash flow growth.

All right. What do you think your corporate travel budget will be in 2022 as a rough percentage of what you spent in 2019?

Yes. I think we're going to wind up being probably in that 75% range, and we don't have an extensive travel budget anyway. It's -- it was a lot of trips to Austin, Texas, which we -- have been put on hold. And then the Acela [ car ] between New York and Washington. So -- but I think as we look forward, it's probably about 75% of what we did this past year in '19.

All right. What will same-store NOI growth be for the office sector overall in 2022?

Yes, we think it's going to be in the range of about 3.5%. We think it's going to be -- there are going to be some good occupancy gains and I think at least Brandywine, a lot of our peers always factor in annual escalations in those. So I think as the market recovers, you're going to see these office companies start to move into a positive same-store growth territory.

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

I think we're going to go with 2%. Tom and I were debating it, and we heard range size 2.25, but I think we're going to circle in around 2.

Okay. Thank you very much, guys. Thanks for joining us. Enjoy the rest of the conference.

Great. Thanks, everybody. Manny, Michael, great to see you. Thanks, everyone, for joining.

Thanks.

Bye-bye.