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

Good morning, and welcome to the Highwoods Properties presentation. Thank you for joining us. Before we begin, I hope everyone is happy and healthy. My name is Daniel Ismail. I'm a senior analyst at Green Street covering the office sector. I'm pleased to introduce the Highwoods' team. With me are Ted Klinck, President and CEO; Mark Mulhern, EVP and CFO; and Brendan Maiorana, EVP of Finance. For those in the audience who wish to ask a question, there is a chat app, a widget in this panel, that's you're able to submit questions to the audience or me to Highwoods, which we see will get to you at the end of their presentation. So Ted, let's start with an overview of Highwoods and its underlying business.

Great. Thank you, Danny, and good morning, everyone, and thank you for your interest in Highwoods. I'm going to briefly review our At a Glance, which is up on the screen here, which will give you an overview of some of the key aspects of the company, then we'll move into Q&A. A copy of the At a Glance is available on our website as well. So really just starting at Page 1. We've had an existing business continent facility plan that went into effect for dealing with COVID-19. It's really served us well over the 8 plus months that we've been in this situation. Really, during this time, all of our buildings have remained open throughout the pandemic. We've developed return to word guidelines consistent with CDC guidelines and protocols that prioritize the health and well-being of employees, customers and our guests, and our buildings. The physical occupancy of our buildings has been relatively low in the last 6 months. We have seen a bit of an uptick since Labor Day. But in most markets, our buildings are, on average, call it, 25% or so physically utilized and occupied today. Moving on to Page 2. Rents have increased. This is a little historical perspective, rents have steadily increased in our portfolio, roughly a 4% compound annual growth rate since 2013. In the bottom left is our GAAP rent spreads. They've been in the high teens in the past several years. This year, it's really been in the low teens year-to-date. We pay closest attention to net effective rents, you can see on the bottom right side of the page. And our net effective rents have increased significantly over the past several years. We are starting to see some pressure on net effective rents for new leases. As concessions increase, but it really hasn't impacted overall net effective rents yet. Page 3. In terms of future expirations, really, we've substantially reduced them over the next few years and they're manageable today. We reviewed the FAA in the third quarter. There's about 100,000 square feet. And now we have no remaining expirations greater than 100,000 square feet until 2023. Then in the bottom right, our cumulative 2.5 and 3.5-year expiration schedule is well below our long-term average. And really, it's the lowest in highwoods in over 20 years. So we feel pretty good about our expirations over the next few years. Page 4. In terms of our rent collections, we've collected 99.7% of our third quarter rents as well as 99.7% of October rents, and November is tracking in that same range as well. We're also starting to get paid back on our rent deferrals that we granted earlier this year. Thus far, we've been repaid 25% of the deferred rent that's been paid as agreed and on schedule. We expect to be largely repaid by year-end 2021. Moving on to Page 5. Just in terms of our portfolio, we have strong customer and industry diversification across the portfolio. No industry is growing at a more than 25% of our revenues and no customer other than the federal government, is greater than 4% of revenues. Coworking comprises about 1.2% of our revenues and restaurant and retail combined for roughly 1.5%. Again, on the red deferrals, the red deferrals agreements. They're not -- they're deferrals, not abatements. They represent roughly 1.2% of our annual revenue. And as I mentioned, 25% of the rent deferrals have already been repaid. We have provided some free rent in certain cases where we've been able to get a rent and a lease extension as part of the rent -- the free rent we've given. Page 6 now. Our updated FFO outlook of $3.59 to $3.61 per share is down less than 2% from our original forecast back in February. The slight reduction from our original forecast is attributable to nonoperational items, a debt charge and dispositions that weren't in our original guidance. Despite the modest drop in our FFO outlook, the changes to our outlook translate to an increased expected cash flow, and you can see that on the top right side of the page, our cash flow is expected to increase in 2000. Now at the bottom of the page, you can see our strong track record of consistent FFO growth, and we've also increased our dividend 4 years in a row. Moving on to Page 7, our balance sheet. Our balance sheet remains in great shape. Our debt to EBITDA is roughly 5x. In August, we issued $400 million of 10.5-year bonds at an interest rate of 2.65%. We use the proceeds to repay roughly $150 million of bonds that were due in mid-2021 to fund development spending and then the remaining -- I'm sorry, roughly $150 million of bonds that were due in mid-2021. We also repaid $100 million term loan due in 2022, and then the remainder is cash on hand. Today, we have roughly $700 million of liquidity, and it's more than enough to fund our development pipeline and the remaining 2021 debt maturity. Then on the bottom left, you can see -- or top left, you can see we have a well-laddered debt maturity as well. Moving on to Page 8. Throughout the cycles, we've been a consistent recycler of capital, with over $2 billion of acquisitions and dispositions completed since 2010. Plus, we've also announced roughly $1.5 billion of development over that same period of time. Asset recycling continues to be a core part of our business. Moving on to Page 9. In terms of our development pipeline, it stands today about $530 million -- $503 million and 79% pre-leased. The pipeline is going to generate roughly $40 million of NOI upon completion and stabilization of each of the projects. All of our projects remain on schedule and on budget. We have roughly $138 million left to fund at the end of the second -- at the end of the third quarter. In our land bank in the top right of the page, it can support roughly $2.2 billion in future development. Majority of our land is in Nashville, Raleigh and Tampa. Now moving on to Page 10, the market rotation plan. We've completed Phase 1 at the end of the first quarter of this year. We accomplished the goal, as you can see on the page. Phase 2 is currently in process, which is Phase 2 just consists of spending the remainder of the assets in both Memphis and Greensboro. And we've made significant progress throughout 2020. We've closed $151 million year-to-date, including 2 separate transactions that just closed in the past couple of weeks. We have one additional small transaction under contract. And assuming that closes, we'll be left with 5 buildings, 1 in Memphis, and 4 small office buildings in Greensboro. We hope to complete those -- we're going to take our time, there's no real-time line, but we hope to complete those as soon as they're stabilized and we can maximize the value of each of those assets. Page 11. Just our geographic mix, we are largely Sun Belt focused, and we're geographically diversified. Over 75% of our revenues come from ULI's recently released emerging trends, the top real estate markets for 2021. So again, we feel like we're in the Sun Belt, we're in the right markets to capture the continued migration to the southeast. And then finally, finishing it up on Page 12. We remain highly committed to ESG initiatives. This is sort of our report card, and you can show how our sustainability goals and the progress so far. I'll stop there and turn it back to Danny for questions.

All right. Thank you Ted for that overview of Highwoods. I think the first question that pops the mind of many office investors and people looking at the office sector these days is, what are the post-COVID impacts going to be towards the office sector? Most of us are sitting at home and not the office these days. So what is Highwoods' current thoughts on remote working and the potential impacts to the office sector?

Sure. I think what we're hearing from our customers, again, we're -- we believe real estate is [indiscernible] we have local...

I think we're having some audio issues. I can't hear Ted on my end. I don't know if Mark or Brendan, if you're able to.

No, He's cut out on our end, too. They're going to try to fix them.

Yes. Do you want to take that one, Mark, or -- oh, no. He is back.

Can you hear me. I'm back.

Yes. Great example of some of the issues of remote work.

What I was saying is so the vast majority of our customers that we're talking to, they're anxious to get back in the office, and they're anxious to get their coworkers back to the office. But at the same time, obviously, they want to prioritize the health and safety of their employees, so they're not going to rush it. Obviously, the news with a vaccine the last week or so, I think that is fantastic, great news from a confidence level and a certainty level as well. So I think from an office standpoint, I think it's still hard to estimate. Still too early to know. But in general, we do believe there's likely going to be more flexibility with employers. We're going to let some of their coworkers let some of their functions may work from home some of the time. So I do think there's going to be some increased work from home but how that translates into long term demand, I think it's still too early. Meaning, if you're still going to come into the office, 3 of the 5 days, you're going to need a desk. So how are you going to do that? How are you going to be able to save space and it can dense your space if everyone still need the desk? Our company is going to want to do the hoteling model or the hot desking model. And our employee or coworker is going to feel comfortable working and sharing the desk. I think that's still too early to tell. And I think it's going to play out differently for different industries and different companies and maybe even some geographies. And then what else there is going to be from de-densification, you're going to create more collaborative spaces, more open spaces, is that going to offset what could be lower space as a result of more increased work from home. So I think today, there's still as many questions as they were 3 months ago, 6 months ago, 8 months ago. And I don't think we're going to see how it plays out until people get back in the office and they start seeing the success of the vaccine and how people are going to work going forward. So still a lot of unknowns in my mind.

Okay. I guess...

Dan, we still think culture and assimilating new employees and career development, so we're still hearing -- I mean, obviously, there's a lot of chatter about work from home and the efficiency of it and some of the productivity things, but we still think culture and to be able to attract and retain the best people and again, build the culture of the company is important. So we do see people return to the office again with some degree of confidence in the vaccine.

And perhaps another secular trends or a trend that we noticed accelerated post-COVID is the migration of companies and businesses from the coast down to the Sun Belt. I'm curious if you think that trend accelerates post COVID. And then in addition to that, do you think we'll see a bifurcation in your markets between urban versus suburban property types?

Sure. In terms of the migration, I think you alluded to it, is we've seen -- that's been really a trend that's been going on for several years now. And I think we're just now seeing some of the benefits. Again, the Sun Belt, in our view, has got a lot of advantages. Obviously, the low cost, low taxes, pro-business environment, high quality of life, proximity to the universities, but we're also seeing the mass transportation, some of the struggles in a lot of the northeastern large dense urban markets are experiencing right now in terms of trying to get some of their folks back to work on mass transportation. Most of our markets in the South doesn't have that or don't have that. So we do think the trend is going to continue. I think it's too early to see if it's can accelerate or not. But certainly, we think it's going to be a trend that is going to continue in the future. We're starting to see in the last 60 days more activity; and some of that is inbound from markets in the Northeast, actually, Midwest and West Coast. So we think it's a trend that's been in place and is going to continue in the foreseeable future. In terms of the urban versus suburban, I mean, our business plan and our belief has always been to be in the best business districts, whether that is a suburban submarket or an urban submarket. And I don't think anything's changed from our perspective on that. I think we call those the best business districts. And again, it doesn't necessarily have to be just urban or just suburban, it can be a mix. The activity we've seen in the last 60 days where it's increased, it's probably tilted a little bit more on suburban, closer to where people live, the whole hub-and-spoke type model. But I don't know if that's definitely going to be -- if it's just a short-term trend or a long-term trend. We just want to be in the best employment areas that have got walkable amenities, strong demographics and close to where people want to live, work and play.

I guess you alluded to it at the tail end of your response, but I'm curious maybe to get more granular. Do you think there'll be a bifurcation between higher quality Class A office buildings and Class B or Class C office buildings in your markets?

I think, Danny may, if you go through back through cycles, I do think, historically, there's been a fight to quality. If you see economics adjust in some of the B -- historically B customers might now be able to afford A space or what have you. But in our belief, it's not a one size fits all by any stretch. And I think over the long term, it's more location, submarket, quality of your buildings, quality buildings and suburbs as well. They may not be the trophy quality in some of the urban markets but high-quality buildings with high-quality owners, great locations, they're going to just as well over cycles over the long term.

And as a reminder, there is a chat function, whereby you can ask questions to the Highwoods team. I'm not currently seeing any questions in the queue. So I'll continue asking questions to the team. And I'm curious, how has this experience changed underwriting for Highwoods with respect to new acquisitions or developments, if it has at any?

Sure. I mean, obviously, we look at -- and I'll hit the acquisition piece first. For core acquisitions, there will be a long-term credit and long-term duration on the leases, I think what we're seeing from a pricing standpoint, there's been very little price change at all. So the underwriting, I'm not sure has changed there. Maybe our return requirements have gone up a little bit, but it's going to be hard to compete given the low interest rates and the wall of capital. That continues to chase core pricing. Where it's changed a little bit for us is on the value-add transactions, I mean as we look at underwriting those value-add transactions where I'm trying to underwrite, and we define value-add as buildings that may have existing vacancy or near-term rollover. I think we've been very, very concerned on our underwriting or very focused on our underwriting on what is the vacancy that's coming up? What are the market rents going to be? How long is it going to take the lease-up some of the existing vacancy? And I think where are the market rents going to be? So I think that's one of the advantages of Highwoods is being vertically integrated, have on the ground teams in place that are in the market doing leases every day. It helps us underwrite and quantify the risk of either existing vacancy or upcoming vacancy in the market as well as just market knowledge of what are the customers that are existing in the building, what are they going to do, what are we hearing about that? So I think it's we have increased focus on how long is lease-up going to take? What's the retention ratio going to be on our value-add acquisitions as well? So I think we've just had more of a focus on on the fundamentals and how we factor them in their overall pricing.