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

[Audio Gap] continued in the first quarter of this year. And then bottom right, net effective rents are generally holding up. I will say there's pressure. There's pressure on net effective rents, but we've generally been able to hold those up, face rents have either held up or even increased a little bit, but there's pressure on TIs and then certainly on concessions on free rent. Page 17, our FFO outlook, it's $3.68 to $3.82 per share with a midpoint of $3.75. That's up $0.01 at the midpoint from our February outlook. Same-property NOI growth is negative 0.5% to 1%. Positive one, which is up 25 basis points at the midpoint. And our cash flow continues to strengthen as we expect, again, once the delivery of the development pipeline comes through. We have planned dispositions that would set us up to $400 million, although at this point, it's going to be tough just given the transaction market to hit the high end. We've recently closed about $40 million of that and we expect additional dispositions every time, but hitting that upper end is going to be unlikely at this point in the year. Page 18, our balance sheet continues to be in extremely strong shape. As I mentioned, we're focusing getting some dispositions in the door to replenish our dry powder to take advantage of what we think are going to be some opportunities. At the end of the first quarter, we had debt-to-EBITDA about 5.9%, which was steady from year-end. Even with -- during that time, we had meaningful development spend on our development pipeline. 80% of our NOI is unemcumbered, which I think is important. And then the rating agencies, we met with them both recently and were reaffirmed with a stable outlook. We're one of only 2 office REITs who received a stable outlook from S&P recently. Page 19 just shows our well-laddered maturity ladder. We have no consolidated debt maturities until the fourth quarter of 2025. We have no debt maturities until the fourth quarter 2025, which I think positions us very well. We can also fund all of our development spending and with the debt maturities and with the availability under our line of credit until first quarter of 2026. So no funding needs until 2026, assuming the extensions. We have $766 million, you can see at the bottom of Page 19, available existing liquidity and only $329 million of known commitments by the fourth quarter of '25. So really, the takeaway here is just the balance sheet, it's very low risk, low leverage than many of our peers. Page 21, actually, let me hit Page 20, you can see the picture of a couple of buildings on the left, year-to-date dispositions. Let me just hit this. It's -- these were combined, you can see the pictures are not -- they're a lower-quality asset. We just sold both of these assets, both of them are net lease deals just shy of a 7 cap rate. So we feel the pricing on these 2 assets. They both had term and single tenant, which is exactly what buyers are planning for today. So -- but we feel very good about the pricing we received on the two dispositions. Page 21, really, this just shows additional sources of proceeds for us. We've been an active capital recycler, you'll see in the next page or so. But then we have some noncore land that we're in process of selling. I think we monetized about $30 million of land in the last few years that was sort of non-office.And we have approximately another $150 million of this noncore land that will be monetized in time. And a lot of this non-office land and actually can help lower existing assets, right? So we were selling land that might be -- we may be -- we've owned a pad for 10 or 15 years. We haven't been able to build a building on it. So we're selling to a multifamily or a retail use that's only going to make the assets that we own adjacent to it that much better. Two examples are on the top right here. This is a multifamily project that we just got completed. It's adjacent to one of our buildings that there's shared parking and shared amenities with that. And then on the bottom left is a land parcel we sold 22 acres, sold it last year, and we retained the office entitlements to this mixed-use project as well as we own several buildings right around it. So again, we're monetizing that noncore land over time. And then the bottom right is our largest piece of land, it's our Ovation development in Franklin, Tennessee. We're in process of getting entitled a large mixed-use project. We're going to be the office owner that's going to be immediately adjacent to a large multifamily and retail project. Going on to Page 23, again, active recycling. Heavy recyclers as part of our DNA. And I think we've resulted in a higher quality portfolio today. Next couple of pages just show acquisitions we've made. Importantly, on Page 24, it's really 3 of these buildings we bought coming out of the GFC. So it's patience, we bought them from lenders, Mezzanine debt providers as well. So we've been able to take advantage when the time is right and be able to acquire some high-quality assets. On the development side, you can see our development. This is a pretty representative of developments that we've historically done. Again, it's not all urban 0.5 million square foot high-rises. There's plenty of those between Bridgestone, you see [indiscernible] about 558,000 in the bottom right. But we're also in the burbs and the infill high-growth suburbs, you can see Virginia Springs II. It's a 4-story building. We did an analyst tour last year in Nashville, and we had some people ask us, "Why don't you build 8 stories here? It's a great location. Well, we would have loved to, but you can only build 4 stories in Brentwood. So we maxed out the density, but again, it's 4 stories. These 4 stories are probably our most supply-constrained submarket in all of our portfolio. 26. Again, we've also exited 3 markets the last several years. Kansas City, Greensboro and Memphis. So we've taken that capital, recycled out a slower growth, higher CapEx assets and markets into higher growth being Charlotte, which we entered in 2019 and then Dallas, which we entered in 2021 -- yes, 2022, actually. Page 27 just shows our consistent FFO growth. Again, 12 consecutive years, growing at 3.3% annual CAGR. This year, the headwinds our interest rates are a little bit of a headwind this year. If not for that, I think we would have had a higher FFO again this year, but interest rates have definitely been the headwind this year. But again, strong growth over many, many cycles and years. At the same time, our cash flows are strengthening 7% CAGR since 2010. So quality -- higher-quality portfolio is also improving our cash flows on Page 28. Quickly on 29 is just our ESG. We've made some great progress on sustainability goals, and we're highly committed to continuing this. And then finishing up with our development, this is our growth in process development is $518 million. We have a $329 million left to fund. That's going to generate over $40 million of NOI. And currently, it's about 22% pre-leased. And you can see the pictures inside are sort of the profiles of the buildings ranging from high-rise office to a little 2-story, build-to-suit and 4 Morecroft. We're building that in a parking lot. We're building we acquired a few years. So there's 0 basis in the land. It's doing a long-term lease with the bank. And we've got another pad that could be just like that. So again, both mix of low-rise and high-rise developments and then our raw material for growth, it's land. And I think our land position here, you can see we're going to build about $2.3 billion of office, other use is about $1.4 billion. Again, much of that will be sold and that's a total of $3.7 billion, and our land position has never been better than it is today. So with that, I'll open it up for questions.

All right, great. That's a very helpful overview, and then I'll open it up for Q&A in a second, but I wanted to get a couple of questions in here for myself. I think, Ted, your focus on the Sunbelt market certainly has been a differentiating factor. Can you just talk about how conditions in your markets held up during the pandemic and touch on some of the factors you think might have been kind of competitive advantages for you guys and relative to other markets in the country?

Well, look, yes, I think the biggest competitive advantages is our markets, right? The in-migration -- the whole in-migration story has been going on for 20, 25 years by most of my career, it accelerated actually during the pandemic. People are moving out of the high-cost urban cities down to more business-friendly, so jobs followed talent and talent wants to be in the Southeast. And so the jobs have been growing. So having the high-quality portfolio in the right markets and specifically the right submarkets or BBDs has really enabled us to continue. Again, we grew throughout the pandemic. It's continued us to be able to keep our portfolio full and provide growth opportunities for the company.

Have you seen any change in the pace of that in-migration as we've come out of the pandemic?

I do think it slowed down in the last year or so. I mean it was -- we were waiving people in during the pandemic and just capturing a significant share of demand. I think it slowed down a little bit. Again, whether it's the economy. Now having said that, the economic guys we talked to were very close to all of our markets, they're really busy. I don't think it's slowed down a whole lot for them. Now that's not all the economic development guys are also chasing manufacturing and everything else, right? So it's not all office jobs, but we've gotten 4 or 5 RFPs and lately talking to our leasing folks that it might be picking back up a little bit. But again, I temper that with both summer slowdown that typically comes and then just the economic headwinds we've got as well. So it wouldn't surprise me that it's going to be a little bit slower.

Okay. And are you seeing any particularly strong leasing trends in any of your markets relative to the others in your portfolio or relative to nationwide statistics that you want to point out for us?

I've been talking about it for the last few quarters. It's really the small customers. I'd say, under 15,000 feet, call it, whether it be 2,000 or 5,000, 7,500. They are the ones in our portfolio that are growing. So they're the most active. Last fall, the larger customers really put a lot of that in pause even before that with COVID. But the smaller customer, our average size customer in our portfolio is about 13,500, and they're growing. And they're renewing their leases. We're seeing, obviously, flight to quality there. So that's 1 trend. I think, suburbs, we've seen more activity in the suburbs than we have in our CBDs. So I think that may have commute worthiness where people want to live in the suburbs closer to home. So I think we've seen more there. And then Spec Suite program, we started Spec Suite program, we just build out suites, we design them. We put a couple of offices, maybe a conference center and room for a bunch of cubes. We aggressively went into that in 2017, '18, and it's just accelerated and people want, they want to do plug-and-play. They want to be able to get in space, not take 6 months to build out a 2,500 square foot space. They want to get in quicker. So we've aggressively gone after the Spec Suite program, it's been a huge success. I think that's been another trend. And then look, just from a market perspective, Nashville just continues to be on fire for us. It's a great market. It's pretty diversified, obviously, healthcare being the largest segment, but Nashville has been a great market for us.

On that topic, are there any markets out there that you're not in currently that you would like to have a presence in going forward?

Yes, like I mentioned earlier, again, we weren't in Charlotte, even though it's in our backyard. We weren't in Charlotte until 2019. So Charlotte, we've been able to grow from 0% to about 10% of our NOI in less than 4 years. In Dallas, we entered last year, Dallas sales of Pittsburgh for market rotation, we're going to be exiting Pittsburgh. We entered Dallas, we initially with 2 development transactions. And then late last year, we bought what we considered the best office building in Dallas called McKinney & Olive. We did all 3 of those with a local sharpshooter called Granite Properties. So we're thrilled to be in Dallas, again, highest growth market in the country and happy to be in Charlotte. So we've got other like markets on our market wishlist that we spend time. That's just part of our business plan. We go to different markets, spend time in markets and so it's others with those type of characteristics that maybe 1 day we'll go into.

All right. Great. Let's stop there and see if anyone in the audience has questions.

I have 2 questions. First one on your Slide 17, the same property NOI [indiscernible] flat this year. So can you explain why that is because we got obviously very [indiscernible]?

Yes. So I would say that part of the reason for Ted alluded to it in his prepared remarks, but part of the reason for the lower NOI last year and then some of that this year is due to higher operating expenses. So what happened to us during the pandemic is operating expenses went down, and that benefit generally accrued to us. We have expense stops in our leases. So when expenses get above a certain threshold, we get those recoveries from our customers. But when expenses -- we absorb the higher expenses as you get back to those expense stop levels. So we were going from very low expenses kind of back to those expense stop levels, and we absorbed that. So we had higher than average kind of NOI in prior years and then we absorbed that a little bit. And then also this year, as Ted mentioned, the 260,000 square foot user that vacated in March has been backfilled, but that new user doesn't come in until January '24. Yes. Those are the 2 main reasons.

And then on the development. [indiscernible] I'm sure you've canceled some developments out in 2021 or in 2022 [indiscernible] higher. How do you think about your pro forma [indiscernible]?

So for our largest development, the question is on the development is, we've [indiscernible] out some developments in '21 and '22, interest costs have moved significantly. How has that affected your pro forma? So if you go back to our development on Page 31, we've caps on the top 2 on the left, 2 largest developments. We've got interest rate caps with the lender. So we're insulated until those expire, which again we've got a few years on that. So those -- the other ones, we actually have funded off a balance sheet really be funding these off our lines. And we -- Midtown East was a recent one. We just started in -- so we had actually been able to bake in on Midtown East, 2027, interest costs are a little bit higher. Thankfully, our buildings have stabilized 2 years before we thought it was going to stabilize. So we've been able to make it up on 2027 deliveries in August or September. That's the bottom left. It's 88% pre-leased. I think it will be mid-90s before delivery. And we weren't anticipating that to deliver until 2026. So that's been a very big success for us. 4 Morecroft, again, it's a small little bit in GlenLake. We're about done there. So our interest costs in GlenLake are a little bit higher. That's really the one that had a little bit of an impact.

The other I'll just mention also, so when spot rates were very low, we didn't put in spot rates plus our spread as the expected borrowing rate on these development projects. We always bake in a much more conservative outlook when rates were low. And that accrued our benefit when rates stayed low for an extended period of time. Now rates are higher, we maybe didn't bake in SOFR being quite as high as where it is now, but certainly baked in a fair amount of cushion. So it's a little bit higher, but I would say not something that's going to materially change our return outlook.

Can you tell us a little bit more about your Pennsylvania investment. Pittsburgh, I know you talked about [indiscernible] what is there and what's the growth?

So last year, we announced we're actually exiting Pittsburgh, where we've announced the exit, but transaction market, it's tough right now to get out of those. So it's really 2 assets, 7 buildings. One is the most iconic project in Pittsburgh called PPG Place. We've got 1 million square foot asset, and it's got some buildings around it. So that's one and the 1 is called EQT Plaza, it's about 600,000 square feet. So we have a little over 2 million square feet. We'll be exiting those markets over time, right? Again, anything big is really hard to finance today. So we have a balance sheet that we don't have to rush it. We've been patient. It's been a good performer from an NOI perspective for us. So we're going to be patient on it. Yes, sir.

Are you able to track actual occupancy through the scans in the buildings? And if so, what are they? And then secondly, on Dallas, did you see a pricing opportunity there? Or what made you go strong into the Dallas market?

So first question, first question do we track scans and sort of what's the occupancy. We can do that in some of our buildings, but not all. We do it the old-fashioned way. We get our maintenance techs and our property managers to walk in, we're doing utilization. I was going to report everyone. We were getting to report every Friday afternoon on what's the weekly utilization. That's our folks are walking and counting, butts in seats, counting parking counts and all that. So we actually quit doing that 3 months ago, maybe 3 or 4 months ago. And we see people coming back every day, right? So our utilization, I don't know if it's 55% or 60%, and I'm not sure where that compares to, what was a pre-COVID was 70% or 75%. But we're definitely not back to pre-COVID, but we're getting there. Again, I do think we're seeing more people come back, virtually on a weekly basis. Our parking decks are full, our parking revenues were up kind of single mid or something like that. Yes. So our parking revenues come back. Our restaurants are doing better than they were in 2019. So things are really coming back. And second question is Dallas. What made you -- again, Dallas, if you look at any in-migration, any growth statistic, Dallas is near the top of it. So we saw the opportunity instead of going in and buying a 5-cap asset to get in with a local sharpshooter that's been in that market for 30 years, been a developer for 30 years and just do a 50-50 deal. So we like the local sharpshooter, we're a lot like minded. We've known them for a really long time. They're very much like Highwoods, but a private Highwoods. They're owned by high net worth family. And so we're like-minded. They're in the right BBDs. They're in 2 of the 3 BBDs we wanted to be into, and we can get a development-oriented deal versus an acquisition yield there. Then we added to our portfolio McKinney & Olive. Look when that deal came out last summer, we didn't get the OEM on it. We got -- heard the pricing guidance, and we said, "No, thanks. We got a call back from Granite 45 days later and said, "Look, things are slowing down. They're not getting the number. Let's go 50-50 on this as well if we can get it at the price we're happy with." So we're thrilled, again, we think McKinney & Olive is the best building in Dallas. The growth profile is significant in that rents were 35% to 45% below market and with some roll over the next few years in a phenomenal location. So we're very pleased with how that's going as well. Does that answer your question?

Yes, sir. When you -- how do you decide between investing on building for disposing? And how do you go on the investment from cash from operations and [indiscernible]?

Yes. Look, I mean we -- Brendan and his finance team did a great job and he can jump right in here. But we look at what the future growth, right, and as well as what are the capital needs and what's the net cash flow profile of the asset. And if we think we can invest in a better asset with a better growth profile. We're going to dispose the lower growth profile and invest in a higher growth profile and how we fund it.

Yes. So at the -- typically, as we would fund it kind of for the immediacy of any investment, whether it's an acquisition or investment in the development pipeline, that's going to be through our line of credit. But then what we're going to look to do is put more long-term financing on that. And our 3 main areas of longer-term financing would be asset sales. So we're doing $40 million that we got in the door last week. We would look to put longer-term debt. So typically, for us, that's going to the bond market, doing a bond issuance or equity issuance, which we haven't done a lot of equity issuance over the past few years as we haven't liked where our equity is trading relative to where our assets are. But those would be the 3 longer-term sources of capital. And we try to fund our business on a leverage-neutral basis. So we've invested $2 billion over the past 5, 6 years in terms of acquisitions. We have generally sold a comparable amount of assets and funded the business on a leverage-neutral basis. So we've been able to grow earnings, been able to grow cash flow, improve portfolio quality without jeopardizing kind of our balance sheet strength. And so that's generally the way that we think about kind of funding the business.

All right. So I think that takes us to time. I want to thank everyone for coming, and thank the team for presenting.

Thank you all.