Highwoods Properties, Inc. (HIW) Earnings Call Transcript & Summary

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Good morning, everyone.

I want to welcome everyone to our session with Highwoods here at June NAREIT. My name is Jamie Feldman. I'm the office REIT analyst at Bank of America Securities. Very happy you could join us today to talk about this Sun Belt office REIT with a lot of good things to discuss. Joining us today, we've got Ted Klinck, who's the President, CEO and a director of the company. We have Mark Mulhern, Executive Vice President and Chief Financial Officer; and Brendan Maiorana, Executive Vice President of Finance. So I think what we're going to do is turn the call over to the Highwoods team. But if you do have questions, please let us know through the -- you can ask a question in the app, and I am tracking it, so I'll be sure to insert your question into the discussion. So the Highwoods team is going to give a brief overview of the company, some latest thoughts, and then we'll get into Q&A. Ted?

Right. Thank you, Jamie. Let me first start by saying that I hope you all are well and your families are safe and sound. Obviously, this has been an incredibly challenging time for our country and our economy, but we're certainly grateful for all the efforts of all Americans, especially our first responders. What I want to start off just by doing is briefly reviewing our At-A-Glance before moving to Q&A. And a copy of At-A-Glance is also available on our website at highwoods.com. Just starting out on Page 1. We can -- we have an existing business continuity plan that went into effect for dealing with all COVID-19 issues. Our results so far, our buildings have remained open during the pandemic. We've developed return-to-work guidelines that are consistent with CDC protocols to prioritize the health and wellbeing of our employees, our customers and our guests in our buildings. Moving to Page 2. Our rent collections remain strong as we announced earlier this week, 99% for both April and May. In terms of the operations and financials on Page 3, historically, our rents have been increasing steadily throughout the portfolio. We've had an average 3.8% compound annual growth rate since 2013, and our GAAP rent spreads have been in the high teens for the past several years. But we do pay closest attention to net effective rents on the bottom right, and these have increased significantly over the past several years as well. So our operations and financials have been strong. On Page 4, the future large expirations that we frequently talk about, we substantially reduced and are manageable today. We only have a few expirations greater than 100,000 square feet in 2020, and we feel very confident on 2 of the 3. T-Mobile is the one that will be moving out. And we really have no large expirations in greater than 100,000 square feet in 2021 or 2022. And then our cumulative 3-year and 4-year expiration schedule on the right, at the bottom of the page, it's below our long-term average and it's really the lowest in probably over 20 years. We feel very good about our expiration schedule in the next few years. Page 5, in terms of the rent collections and then our strong -- we're diversified by customer and industry across our portfolio. There's no industry that's greater than 25% of our revenues and no customer other than the federal government who is greater than 4% of our revenues. Coworking is only about 1.3% of revenues, and our restaurants and retail combine for roughly 1.5% of revenues. In terms of the rent collections and deferrals, we have signed rent deferral agreements, not abatements, that represent 1.2% of our annual revenue. And in some cases, we've also had rent -- free rent, but only if we can do a rent relief that extends the term on the back end of the term. So the majority of our rent reliefs have been deferments, not abatements. The abatements have just been a little bit of free rent if we can get some term on the lease on the back end. Page 6, our updated FFO outlook of $3.55 to $3.68 per share is down about 1% from our original forecast. And despite this modest drop in the FFO outlook, the changes to our outlook do translate into increased expected cash flow. We do have a strong track record of consistent earnings and FFO growth. And we've increased our dividend 4 years in a row. Going to Page 7, our balance sheet. Really, our balance sheet remains in great shape. We've returned our debt-to-EBITDA to sub-5x with the completion of Phase 1 of our market rotation plan. We have over $600 million of liquidity today, more than enough liquidity to fund our development spending and our debt maturities through the year-end 2021. We have a well-laddered debt maturity schedule, with nothing due until 2021 as well. Moving on to Page 8. Over many cycles, we've been a consistent recycler of capital, with over $2 billion of acquisitions and dispositions completed since 2010, plus we've announced and done a $1.5 billion or so of new development announcements. Asset recycling continues to be and will continue to be a core part of our business. Page 9. Our development pipeline stands at $500 million today, it's 77% pre-leased. We have about $239 million or so left to fund at the end of the first quarter on the development pipeline. And that will be done over the next, call it, 18 months or so. And then we have a land bank on the top right that can support roughly $2.2 billion of future development. The majority of our core land is situated in Nashville, Raleigh and Tampa. Now on Page 10, going to the market rotation plan. We completed Phase 1 on March 31 of this year. We acquired Bank of America Tower last fall for $436 million. And then we sold, as part of Phase 1, $428 million of assets in Memphis and Greensboro. So we've accomplished the goal that we announced -- when we announced the Bank of America acquisition back in August. Phase 1 ended up being FFO neutral and cash flow accretive. It was also leverage neutral. The market rotation plan improves our portfolio quality, and it increases our future growth rate. Phase 2 of the market rotation plan, which consists of selling the remaining assets in Memphis and Greensboro, we feel good about, but there's no preset timetable to complete these sales. We do have a lot of assets that are going to be very attractive to buyers. We have medical office buildings in both markets, both Greensboro and Memphis. We have office along Poplar corridor, which is the best business district in Memphis, and then we have also some well-located Greensboro office buildings. Moving to Page 11. Obviously, we're very Sun Belt-focused. 80% of our revenues come from the Urban Land Institute's Emerging Trends in Real Estate, it's their top-rated markets for 2020, represent, again, 80% of our revenues. And then finally, on Page 12, in terms of sustainability. We remain highly committed to ESG initiatives. And we show our sustainability goals here so you can track the progress, which we continue to make year-over-year. I'm going to stop there and now turn it back to Jamie. Jamie? Jamie?

I think Jamie might be frozen for a second here. Jamie, are you back?

Jamie, do you want to move to Q&A now? All right.

I think we lost -- go ahead.

Well, why don't we spend some time just sort of going through some of the questions Jamie was going to go -- Brendan, I don't know if you have those?

I have it -- I have some. Yes. So I see Jamie's picture has popped up there. Just to double-check. Jamie, are you hearing us? Probably not. Okay. So Jamie, are you back? It looks like you're -- maybe not. All right. I'll ask the first one. This is like -- this is -- one team -- this is like an intramural scrimmage game here or something like that. But we're going to -- I'll ask the first question. So I think one of the ones I had on Jamie's list is, and this is probably for Ted, what do you think the long-term impact from COVID-19 is likely to be on the business?

Sure. Look, I think it's too early to tell what the impact is going to be on the office sector. Certainly, there's a lot of talk and speculation about the topic virtually almost every day, it seems like. But I don't think we really know yet. It's going to take some time. It reminds me of the whole densification trend that started probably 10 or 15 years ago, and everyone thought there was going to be a significant change in the office demand as a result of all the companies going from, call it, 250 square feet per employee, down to 150 or 175. But it took many, many years to play out. And I do think the potential work-from-home or just workforce mobility, I think, is going to take a long time to play out. I think near term, I think companies, less -- they're more focused on getting their employees back to the office in a safe way versus changing their layouts right now and given the uncertainty of the business environment. So I think companies right now are less focused on changing the way they operate than they are just bringing their employees back. But over the long term, look, I do think there's going to be some portion of companies that are going to allow some of their employees to work from home for some of the time. But I do think 100% work-from-home is not going to be successful over the long term for many companies. Again, some industries, maybe it will, but for the vast majority of companies, I think it's just very difficult to maintain a great culture when everyone is working remotely. So it's been tried by many companies. A lot of companies brought their workforce back from the home experiment several years ago. But obviously, everyone is forced to do it today. And there are going to be some companies that are going to do it. But I think there's a good chance that there's going to be de-densification, and that could offset the work-from-home. I do think, the other thing, hoteling has been a big trend in the last few years, where there isn't assigned seatings. I think that might go away as well. I think employees are going to want their own seat to feel comfortable to sit in when they're at the office. So lots of still moving parts and pieces to this, but I think it's going to take some time to play out.

I apologize for that. I froze up and had to jump off. I'm back.

Well, Jamie, when I was an analyst, I was always aspiring to get to your level, and so I got to play you there for a minute and asked a question, so -- I did ask the -- I just asked the COVID-19 long-term impact question to Ted, but otherwise, the floor is yours.

Okay. Great. We do have a couple of other questions coming in. Maybe if you could talk about market expansion. Are there any other markets -- and this question is asking about Latin America, maybe Brazil, but I guess even more -- so you can answer that question, but also just across the U.S., are there other markets that are interesting to your team?

Sure, Jamie. Look, we're going to stay a domestic company. So look, we're a Sun Belt company, so we constantly look at other markets that are in our footprint, that are in the high-growth Sun Belt markets. Obviously, Charlotte was the most recent entry last year. So we've looked at other markets, whether it be an Austin or Dallas and other markets, high-growth markets like that. It's -- those continue to be target markets for us. We watch the transactions. We spend time in those markets, just looking for the right asset, the right opportunity and the right risk-adjusted returns to enter it. So again, looking at different markets to expand is definitely on our -- part of our playbook and just finding the right opportunity at the right time and priced right.

Okay. So along those lines, how has your investment outlook changed since the pandemic began? Where do you think you can deploy capital, I guess, in acquisitions? Have you seen any change in pricing or the opportunity set?

No, there -- the investment sales market has largely been shut down for the last couple of months. It was fairly active the first 2.5 months of this year. But once COVID hit, virtually every transaction that was -- that we know about, that we were interested in looking at, at least, whether we were going to aggressively pursue it or not, but at least we were looking at, virtually, every one of those was pulled from the market. So right now, there's not a lot of data points on pricing, not a lot of price discovery out there. So I think right now, from a capital allocation standpoint, we'll continue to look at some development transactions, largely build-to-suit or heavily pre-leased. We're not going to be starting any heavy-spec component buildings anytime soon. But we do pursue those. And those, pre-COVID, we had probably a handful, if not a little bit more than a handful, of transactions we were looking at on the development side. Every one of those -- and then we had one come in post-COVID that has since been put on hold. So I think development is going to take some time. I think most of those transactions have been put on hold. Hopefully, they will restart at some point, but I wouldn't say there's any near-term urgency by any of those customers to make those decisions. So capital allocation, I think, is just going to take some time. We don't see really any distress near-term as well. That's going to take some time to play out, depending on how long and how deep the recession is. So we're really hunkered down right now, focused on operations, getting our customers back in the buildings, focused on those customers that need rent relief, have legitimate rent relief needs. So really, we're focused on the operations side right now.

In terms of lease discussions, though, would you say they're starting to open up at all, whether it's for vacant spaces in your pipeline, in your development pipeline, or even across the portfolio? Or even tenants are still so focused on the immediate near-term, I assume they're loosening up a little bit.

That's exactly right, Jamie. Things are loosening up a little bit. It's coming off a pretty low base back in early April and all that when it really completely shut down. But it's nowhere near the robust deal flow that we had in the first 2.5 months of the year. But clearly, things are opening up. Obviously, the deals that we were working on pre-COVID, I would say a large majority of those continued even once the COVID started in early April and all that. Those continue to move forward. Some of the new deals we were working and chasing, they just died. But there's constant lease expirations that we got to deal with. So I do think there's getting to be more discussions that are going on now that we've been hunkered down for a couple of months now.

Okay. And to take a step back here. I mean I know for our team and even for our firm, there's such a massive discussion about going to markets outside of the Northeast to either -- or from -- if you're on the West Coast in a more expensive market, going to the Sun Belt. Could you maybe just provide more color on the kinds of discussions you were having even before the pandemic? Companies that do really want to move to your region that aren't there now, we hear about reshoring as potential growth in the Sun Belt. Just even more color, I think, as people are so thematically focused right now on what the long-term trends are that really could help you and even how we might see them accelerate coming out of the crisis.

Yes. Sure. Look, it's -- we've talked about it for years, Jamie, as you know, that we believe the Sun Belt, there's a great migration to the Sun Belt. You just look at the historical population and office using job growth that have been in our markets is well in excess of most other markets. So it's the whole -- we call it the "smile" population. It starts in Mid-Atlantic and goes down through the South and West through Texas and just been getting a disproportionate share of the job growth over the last several years. And we think it's for a lot of reasons. Obviously, it's the low cost of doing business, low cost of living, high quality of life, access to highly talented pools of labor. A lot of the millennials come to school here from the Northeast, and they want to stay here when they graduate. So we think we're just well-positioned. Obviously, we don't have the mass transportation issues or the density issues that the Northeast and the other gateway markets have. So we do think maybe it's going to accelerate. I think we're pretty early to see that. But some of the discussions we've had prior to COVID have been -- obviously, it's been a lot of migration from the Northeast, primarily in our markets. We saw a lot of smaller companies from West Coast, but those haven't been on the development side. It's more been technology companies in San Francisco, Silicon Valley coming to our markets just because it's cheaper labor, and they can find talented workers to work. So smaller companies though, so really been across the board. On the development build-to-suits, several -- we've done over the last several years have been relocations from the Northeast, whether it be MetLife consolidating several offices from the Northeast into Raleigh; Bridgestone doing the same, more from the Midwest than anything else, but there are several examples like that. And we just -- we think it could continue, but it's pretty early in terms of those discussions.

Okay. And I apologize if I missed it. Have you talked about what your build-to-suit pipeline looks like now? I don't know if that's when I got booted.

No -- yes, real quick. I mean again, pre-COVID, we had a handful of discussions going on. Then post-COVID, we had one that came up that we responded to. And virtually all of those have been put on hold. What we've been told by the brokers, and we're hopeful they're -- it's -- they're going to get restarted, that they're just on hold. But really no -- it's been just slow in the last couple of months.

Okay. That's helpful. So Highwoods is just -- is in the process of a pretty large market rotation plan, probably towards the tail end of the markets to exit and just entered Charlotte in a big way. Can you talk about how that process went in terms of the execution of the sales and even the acquisition versus your original expectations?

Sure. First, on the sale. I think that we feel very fortunate to be done with Phase 1 and getting that done before the crisis hit. We finished it on March 31. And I think from a sale perspective, we did a little bit better than we had hoped. I think we are initially -- and Brendan, check my paper here, but I think we're a low-7 initial hope on the GAAP cap rate for the Phase 1 assets. We end up being in the high-6s on a GAAP basis. So we exceeded our internal expectations a little bit from that standpoint. And we also beat a little bit on time. We were hoping by the second quarter, and we were able to get it done by the first quarter. So I feel very good about getting those out the door. And then the acquisition itself as well has slightly over-performed as well, not materially, but slightly. So right now, we just feel like we're getting in Charlotte, a higher-growth market, has been a very good transaction for us thus far. Brendan, anything to add there?

Yes. No, that's exactly right. So I would say we're modestly ahead of expectations, feel really good about it.

And then how do you plan to grow in Charlotte?

Yes. Look, I think we're going to -- we've been pursuing -- we are a development company, as you know, Jamie, by background. So we certainly hope to grow it via both development and then potentially some add-on acquisitions if we can find the right transaction. So we're spending a lot of time, our -- Brian Leary, our Chief Operating Officer, moved up to Raleigh last year from Charlotte, so he was pretty entrenched in that market. So we're actively pursuing both sites as well as on the acquisition side.

Okay. We did have another question come in, just asking about employment. And are you -- have you shrunk your workforce at all during the downturn? Do you think you'll be expanding going forward? How should we think about headcount?

For Highwoods, really, we have and we kept our team in place. Again, as I mentioned, we've kept our -- all of our buildings are open. We've assembled, over the year, just a fantastic team, as most evident on -- I'll mention just briefly. The teamwork and dedication and the Highwoods I saw last weekend was phenomenal. We had -- Raleigh had some damage to our buildings down in downtown Raleigh. We had demonstrations that got a little bit out of hand, both Saturday night and Sunday night. I got down there about 8:00 Sunday morning, and I was probably the 15th person down there working on the cleanup already, boarding up broken windows and all that. Then I get down there about 6:30, decided to move it up a little bit or -- then go down there about 6:30 Monday morning. Same group of guys that were down there working on it at 6:30 that morning from the damage the night before. And that's just one example of what goes across our portfolio. So we're incredibly proud of our team. We want to keep the team intact. And so we haven't really had any workforce changes at all.

Okay. And then do you see any more large-scale moves, maybe thinking about Phase 2, what you still need to accomplish?

Yes. Again, that's going to -- we'll see over time, right? And again, we have no preset timetable on Phase 2. We're going to make sure we're -- we're not in any hurry to get rid of those assets. If we can hit our pricing, then it will be sooner. But if not, it may take a year to 2 years, 18, call it, 12 to 24 months to move those assets. So really, nothing significant.

Yes. And Jamie, we have closed the offices in both those markets. So we've gotten the G&A savings that we set out to achieve or that will come, obviously, as we go forward here. So we've gotten through that process as well.

Okay. Great. So we have about 5 minutes left. So if anyone still has questions, be sure to send them to the question chat here. Maybe just turning to the balance sheet. Can you just talk about your goals for the rest of the year and what your liquidity looks like for both -- to run the business, but also if you were to find some opportunistic buying, acquisitions?

Sure. So we're very fortunate, obviously. As Ted mentioned, we finished the market rotation and got the last deal, and that allowed us to be completely paid out of our revolver. So we have $600 million of dry powder on the revolver undrawn, another $30 million or so on the balance sheet today. So really good position from a liquidity perspective. As Ted mentioned, we're obviously prepared from a recession perspective. We've gone through our stress-testing on debt covenants and those types of things, and we review them with the Board. And so we're very comfortable liquidity-wise. Debt-to-EBITDA, we're under 5x. So all those metrics are good. The maturities, we don't have anything until June of next year. And as Ted mentioned, we have $239 million or so to fund the development pipeline over the next 2 years. So we believe we're in really good shape from a liquidity perspective. And we think we frankly have a lot of flexibility around the debt-to-EBITDA range that we've kind of articulated. It's been 4.5x to 5.5x. And as I said, we're about 4.9x right now. So I think we've got some flexibility if there were opportunities that came around in terms of being able to use some additional leverage if we needed to do that. So we feel like we've got a lot of flexibility around both riding through the recession and also capitalizing on opportunities if they arise.

Okay. Great. And then how should people think about the rent movements in your markets? Have you seen any -- I know you've had pretty strong rent growth this cycle. Have you seen any changes or expect any changes in negotiations on your leases?

So far, Jamie, we haven't seen really any change at all. But again, there's not a lot of data points. So with any potential recession and all that, there's -- in theory, there's going to be downward pressure on rates. But we just -- we haven't seen it yet. I think we're monitoring it, every lease that gets signed. We're monitoring our metrics and all that, but just haven't seen evidence of it yet. But again, we're prepared if -- in the event that there is downward pressure as a result of the recession.

Okay. Great. And then maybe just to get a little bit more granular on the rent deferral activity you've seen. As some of the markets have been -- have opened up sooner than a lot of the other parts of the country, just how would just say the tone has changed and the conversations on rent deferrals have changed, even as recently in the last few weeks?

Brendan, do you want to get that one?

Yes. I'll take that. So Jamie, so on the slide, and one of the slides here on the rent collection and relief, I think we disclosed that we have deferral agreements for 1 point [Audio Gap] annual rent and for customers that represent about 10% of our overall revenue base. We reported -- so that was as of through the end of May. When we reported our first quarter results, we gave an update through the end of April. And at that time, we had rent deferral agreements that were about 1% of annualized revenue, so -- and also customers who were asking that were around 10%. So you can see really the month of May didn't see a large increase. We saw most of the requests come in during the latter part of March and April. And then it's really slowed down since then. So we have a task force that used to meet daily to evaluate all of the rent requests that came in. And we were doing that daily for probably a little over 2 months, so kind of started in the middle of March through the end of May. And the requests have just kind of now trickled in. So we now just meet as needed, which is probably maybe a couple of times a week as opposed to what it was, 5x a week. So it's definitely slowed down.

Okay. Great. So we only have about a minute or 2 left. Any kind of last thoughts or anything we didn't cover that you want to get across to the group?

I think when we talked about -- I probably touched on it in a few different places, but I think our company is well-positioned. We're highly focused today on -- hunkered down from an operations standpoint, making sure we're focused on both our employees as well as our customers as well, making sure our balance sheet is in great shape as we talked about today. We're extremely excited about our low expirations that we've had the lowest in our 20 -- in at least the last 20 years. So we look at our other leverage metrics, and just the balance sheet is in great shape. So I think we're well-prepared in the event there's a downturn. And we're also prepared if there's going to be opportunities that arise during this downturn.

Okay. All right. Mark, Ted, Brendan, I want to thank you all very much for your time. And thanks, everyone, for listening in.

Thank you.

Thank you.

Thanks, Jamie.

Thanks, everybody.