KORE US REIT (CMOU.SI) Earnings Call Transcript & Summary

Vijay, there's a few reasons for the lower cash-adjusted NPI quarter-on-quarter. The first one will probably be the divestment of the 2 Atlanta assets. So for example, Powers Ferry was divested on 28 -- sorry. Northridge was divested on 28 July, so it contributed 1 month's worth of NPI in Q3 compared to 0 in Q4. Then Powers Ferry was divested in -- on 22 December, so the impact is not so significant, but there's about nearly half a month of lower contribution from Powers Ferry in Q4 compared to Q3. Then additionally, in terms of expenses, we have higher expenses for Q4 compared to Q3. And that was because no certain repair and maintenance expenses where the works are -- were still in progress, all right, were completed in Q4. So -- and certain expenses was pushed to the right, into -- in Q4 compared to Q3, so you can see that in terms of expenses there has also been increase in Q4.

So the next question here from Vijay. Leasing momentum has also slowed in fourth quarter. What's the outlook? So there definitely is a little bit of a slowdown in fourth quarter versus the rest of the year, about 2.2% versus our total for the year of 13.7%. I think, in terms of what we were seeing in the fourth quarter and what we're expecting, probably first and second quarter is a bit of a continued slowdown. We do have some leases under negotiation that are fairly substantial, which could mean for positive in the first quarter at this point, but given the economic uncertainty, we're definitely seeing a little bit of a slowdown in terms of tenants taking up additional space. We go to the third question. Can you discuss a bit on the demand in the market by new expansion versus relocation demand in your markets? If we look at that, it's an interesting question. The other thing is complete vacates would be the other thing to think about here, but in terms of 2022's leasing, we had 91 tenants signing leases. We had 7 tenants, for about 80,000 square feet, that had expansions. We had -- renewals with expansions are a subset of that, which was 5, but we also had 48 tenants that renewed, with 9 of them downsizing for about 37,000 square feet. I think the 2 key takeaways there are really the expansion total is 80,000 square feet and the downsize total was 37,000 square feet, but we did have nonrenewal in total for about 209,000 square feet, so as we look at that, it's pretty consistent with what we've been telling folks for the last couple of quarters. We have experienced in our portfolio more expansions than downsizes, but that needs to be taken in consideration with the fact that there are tenants that are nonrenewing. Some of those, a minority it seems for our portfolio, are going to work from home. Some others have downsized for other reasons, if a company is purchased, other things like that; as well as a few that have elected to go most specifically to less-expensive buildings. So there's a number of reasons within there, but we are encouraged by the fact that we've got a number of tenants that have expanded, in fact, more than have downsized within the space. Next question, are there more assets which you could potentially divest? Are you seeing attractive distressed opportunities which could -- you could potentially acquire? In terms of divests and acquisitions, there is really nothing in the stabilized marketplace in the U.S. right now. So in terms of the second half of the question, on an acquisition front, there is not much out there. And if you consider where our unit price is, issuing units at a significant discount is probably not ideal, so on the acquisition front, I don't think, for both reasons, that's something we're going to see a lot of this year. In terms of potentially divesting, that comes back to things that we've talked about for some time. We sold the 2 Atlanta assets, closed on both of those and actually had a small gain versus the valuations that we had in place, which we felt quite good about, being able to actually close those in a market where there weren't many folks that were able to close either purchases or sales. From there -- and a lot of that -- we made the decision, in large part, because they were too small and inefficient as we've grown, so if you think about where next that might make sense, that would take you to Sacramento which is another of the smaller side, less efficient for us. It takes about as much of our asset management time to manage a smaller building as it does a much larger one, so that is certainly one that we will consider over time. And we've also mentioned in the past that 1800 West Loop, at some point, is something we might consider selling once we get that to a fully stabilized level. We've been quite pleased with our leasing for the last couple of years and some of the work that we've done there. So those are a couple that we certainly would consider maybe more near-term possibilities than others. The next question was outlook on rent reversions and occupancy. "Can you also give some comments on tenant incentives in the market?" So we tend to have higher rental reversions in Bellevue, Redmond, at the buildings there. The rent growth has been quite strong. That has continued this quarter. That's why we were higher in fourth quarter than we have been for most of the year. We've got lower rental reversions in places like Houston, where we've seen slightly negative reversions that are offsetting that. Most of our other markets are relatively flat to a few others that are up a bit, so in terms of outlook, I think we're looking at rental reversions that stay in that low single-digit range where we've been for the course of 2022. In terms of occupancy, we mentioned we've got a little over 13% of the portfolio -- depending on whether you're looking at NLA or CRI, it's still a little over 13% expiring in 2023. We leased about 13.7% in 2022, but as was pointed out in an earlier question of Vijay's and -- things slowed a little bit in the fourth quarter. We expect first quarter to be a little bit slower. We're hoping, as the Fed, hopefully, is reducing the increases and potentially ending them as things start to turn around a bit; and as companies continue to feel more ability to tell employees they need to come back to the office, that we will start to see more demand as we get out in the second quarter and through the rest of the year. So occupancy is -- it will fluctuate through the year. If we're looking all the way out to the end of 2023, we could be a little up. We could be a little down. We could be flat, but I don't expect major swings in occupancy, which is probably where the question was intended to take us to. Have any major tenants -- whoops. I think I'm -- just missed -- what was the second part of that, where he talked about the -- oh, tenant incentives. "Can you give some comments on tenant incentives in the market?" It's all good news really in our markets. There was a brief period during the pandemic where we had increased the free rent that we were providing in the Seattle - Bellevue/Redmond area from about a half month to maybe up to a full month. That had gotten back to a normal half month per year of lease term and that's what we've seen consistently through this year. Our other markets have historically been one month per year of free rent. And that actually has remained consistent throughout the pandemic and throughout 2022, so we're not seeing major changes in terms of what those tenant incentives look like. TIs have been up a bit. That has been due to inflation, not due to needing to provide higher tenant incentives in the form of TIs to bring people into the space, so it's not -- neither of those statements is true for some of the gateways or most of the gateways in the U.S., but that has held true throughout our portfolio. So we felt pretty good about that during 2022. The next question. What's the impact from tech sector slowdown, in particular to your Seattle assets? Has any major tenant indicated that they want to exit, or have they defaulted? So I'll answer the second part first. The answer is no. We have not had defaults on our major tenants. We do have large tech firms -- and I think where the question is coming from is we have large tech firms that have announced layoffs. That is not a significant percentage of our portfolio tenants. That sort of a thing is -- it would be in the gateway cities. We are in the east side of Seattle, so Bellevue, Redmond. And Amazon, Meta, Google, Microsoft have been major drivers in those markets, albeit they have had some layoffs. When you look at the layoffs for these companies in Bellevue and Redmond and compare that to what their hiring has been over the last several years, you will find that it has been just a fraction of what their hiring has been. So these are very, very minor corrections that have been made rather than major corrections that have been made. So if you think about Amazon specifically, 840,000 employees in March of 2020. In September 2022, Amazon had 1.54 million employees. Following the layoffs, they'll still have 82% more employees than 3 years ago. If you look at Meta or Facebook, they have a workforce reduction of 11,000. In December 2019, Meta had 45,000 employees. In November '22, prior to the announcement, they had grown to 87,000 employees, so following the layoffs, they'll still have 69% more employees than 3 years ago. Microsoft announced the workforce reduction of 10,000 jobs. 878 of those are in Washington state, so virtually nothing, but Microsoft added 40,000 jobs in the most recent fiscal year, so again as we look at this for our portfolio, it's not a huge concern. Obviously I've mentioned before, as odd as it sounds, we view these hiring freezes and very minor layoffs to be somewhat positive in terms of being able to get employees back to offices. And so overall for us in that market, we think that will be a plus. That has actually been, I believe, our slowest market to get our actual physical occupancy back to where it used to be. So we feel good about the east side. If we were on the west side in Seattle with some of the vacancies and expirations and things like that, it would be a different story. I think that brings us to the next question -- or set of questions. From what I can see on the screen, I can only see one at a time. So Rachel from DBS. Thank you, Rachel, for your questions -- has at least one. There may be multiple here, so we'll start with we have some color on the sentiment and leasing demand -- do we have some color on the sentiment and leasing demand on the ground? I think I've answered that with Vijay's question, but Rachel, feel free to come back if you feel like you want to ask some more specifics. Are there any improvements or any bright spots? I would say really the bright spots have been leasing. Up in Bellevue and Redmond has been quite strong. The rental reversions there have been very strong. The majority of our assets have been relatively flat in terms of occupancy, which in this market and with what we're seeing across the U.S., that is definitely a bright spot for us. And we do have some potential leases under negotiation that may or may not close that make us feel pretty good about at least our prospects going into 2023 here as we start the year. The next question we've got. Any guidance on average cost of debt in 2023? And Andy is going to go ahead and take that one.

Yes. So let's say a point in time. I said 31st December based on the -- our borrowing and hedging position as at 31st December of 2022. And assuming a floating rate as at 31st December of around 4.05%, what you can see, that for 2023 the average all-in cost of debt will be around, I will say, 3.7%, 3.8%, excluding the upfront -- amortization of upfront fee, yes.

Let's see. Our next question: Can we have some guidance on cap rate assumptions and discount rate assumptions for the asset valuations? So in terms of our appraisals that came in this year, there is no clear consistent answer to this question. We had some markets where we saw those rates remained consistent. We saw a number of others where we saw a gap out in either one or both of those rates, and I think that's really to be expected. If you were looking at the gateway markets, you would see gaps out in probably both of those metrics across the board. That's why we've certainly been hearing and seeing a lot of valuations that are coming down 10% below where they had been, which is maybe the market expectation. Our markets have always had much wider spreads to the risk-free rate. And it appears to us that our hope that there has been a bit of a secular change in terms of the way our markets are priced has actually occurred. And that's why we did not see major changes in cap and discount rates for most of our properties. Those that did, the majority of those were more of the 25 to 50 basis point changes rather than really significant changes in those rates. Could we get some color on the leases expiring in 2023? Any major leases? And are they mostly expiring in first half '23 or second half '23? I think, as we look at that, there's a couple of buildings where we're going to have some fairly large footprints that are expiring during the course of 2023. Maitland in Florida has several. Iron Point has one. In Maitland, it -- out of those several, at least a couple are known vacates at this point, space that we are hoping to backfill. At Iron Point, there is one significant and it is a known vacate at this point. We're exploring some other options for potential tenants there. That one probably likely takes more time to try to backfill space, in the Folsom market, today. And then there's some regular churn at Westpark and some expirations amounting to about 3% from plaza, but those are -- it's not a significant -- one tenant making that up at plaza. In terms of Westpark and plaza, though, these are the buildings that we're happy to see our smaller tenants having lease expirations. Stay or go, we've had very good success, especially at Westpark, finding new tenants for those that outgrow our space, replacing them and having very good rental reversions. And at plaza, there's a bit less demand than there is at Westpark where we don't have a lot of concerns currently about demand for people taking space, but it is vacated. But we are still continuing to see quite positive rental reversions [ a plausibility ]. So those, we look at as positives. Maitland and Iron Point, which are softer markets without those significant positive rental reversions, are where our concerns are. And if we're looking at this for our portfolio, those are our 2 real focus buildings at the moment, Maitland and Iron Point. We've got some plans in the works for some additional AEI-type investments that we're making at those buildings because of upcoming potential vacancies, actual vacancy for sure at one, but again the majority of that hits later on in the year, so it doesn't have a big impact into the first half. The next question. "Are there any increases in shadow space in your portfolio?" So I guess I'll try to answer that. I'm not sure if that means -- and no. If I read the next question that's the follow-up: "Any submarkets within your portfolio seeing increasing shadow space, with the layoffs, that might be a cause for concern?" So now it's both questions. I was going to say I wasn't sure which one it was. And I'd take a guess as to, but since both are there, we'll answer both questions. In our portfolio itself, we are not -- we have not seen a significant increase in the shadow space in our tenancy within our buildings, which is the first question that's there now that I understand it. And it's not to say that we don't have it. We do have tenants that are dark in their spaces that continue to pay rent. But we haven't seen an uptick in that during the last quarter. And in terms of looking at our submarkets, are we seeing increasing shadow space? There's probably a small increase. We're not seeing it happen yet. So I understand that the point of the question -- I think we may see a bit more shadow space in a few of our markets as we move a little farther into 2023 as some tenants in various buildings within the markets start to use less space, start to put some of it back onto the market, things like that. We'll see what sort of an impact that has over time, but for right now we're not seeing that have an impact on us. And for our submarkets, the physical occupancy in most of our submarkets tracks pretty closely to what our average has been in those. The average for us for the portfolio is 60% at this point. Some are doing a little better than others, but we're not seeing anything that would indicate to us that there's a big difference between our buildings and the rest of the submarket in terms of physical occupancy. I think that brings us to Derek from DBS and a few more questions here. So what is the cap rate expansion on average we saw for the portfolio valuation movement? I think we've sort of answered that, although we didn't give an average for the whole portfolio, but we haven't calculated that either. And it's not particularly meaningful this time because there are some pluses and minuses in terms of improvements to expectations for rent growth and other things that offset in many cases changes in cap rates and things like that, so I don't think it's really particularly meaningful at this point. "Are you still seeing tenants returning space? Can you give us an update and thoughts around the top 10 tenants? Any potential return of space?" So we definitely continue to see a mixture of tenants that are vacating, downsizing and expanding, as we've talked about in an earlier question. I'm not sure we're really seeing an increase in much of that, other than we know we have a few known vacates of larger sizes than we're used to between Maitland and Iron Point that will be happening during 2023, but I don't know that we're going to see a significant change in terms of the volume of number of tenants that are giving back that space. We do continue to see for downsizes that tenants tend to be going in the 20% to 50% downsize levels, which is what we've been seeing. We're -- word of mouth, that seems to continue to be the case around the U.S. for finance, insurance, consulting firms, all those sorts of tenancies, law firms, that deal with this sort of a thing. So top 10 tenants, as we get to those specifically, we don't have a whole lot going on in the top 10. 1 of those in the top 10, we're actually hoping to see an expansion from. We've been in negotiations about an expansion from 1 in the top 10. We are at -- in negotiations, from 1 other of our top 10, for a reduction in space as well but not an enormous reduction in space. So an potential there for 1 of the top 10, but that would only be done in conjunction with the extension of existing lease at an early term or some other things that we could negotiate or discuss with them. But that is not one where we have a particular concern at this point. We move to the next question. "What are reinvestment cap rates that you can see?" I would tell you I can't see any at this point. In terms of reinvestment, there's just -- there are no potential transactions for us in the marketplace. And we're looking at one at the moment without any real visibility at the moment into what the cap rate might be, but it's not anything that would be likely that we would proceed with, to be quite clear, actually. I think that answers all of Derek's questions, so next, we've got Paul Chew from Phillip's. Thank you, Paul. "Has the impact from resizing office space due to work from home largely been completed by your tenants?" So that's a good question. And the answer is no, but they're a good way down the road because we've had tenants that have been doing this for over a year at this point with the shorter length of typical leases for us than the competitive set. I think we've worked through maybe more of this than some, but in the U.S. tenants can't just downsize their space unless they get to a place where they have a termination option or a lease expiration. And so we've worked through a good portion of our tenancy, but we're going to have the next several years, probably another 2.5 years to 3 years, of tenants hitting expirations. And as they do, we'll be having those discussions about what they want to do with their space, whether they want to downsize or not. So I think we're going to continue to see that, hopefully, mostly 20% to 50% reductions by some of our tenants. That would by no means be all of our tenants. As we've seen this year, we had far more tenants that kept their space. And we even had more tenants that expanded than reduced their footprints. The specifics of that are going to change over time. We might see more that are downsizing, but I don't expect the downsize piece to be a massive piece of what we experience within our portfolio. But for other office landlords who typically sign much longer leases, 7-, 10-, 12-year leases, of which some of our direct competitors here do, and a lot of competitors in the U.S., they'll be having those discussions for a long, long time as all of those leases hit their first expiration post the COVID and 2022 world. How is Iron Point coping with the huge relocation underway from California? What's the outlook for occupancy for Iron Point? Well, that is a good question. The interesting part of that question is we're not experiencing at Iron Point a relocation away from California. That has not been our experience. The tenant that left that brought us significantly down from -- I believe we were a bit over [ 90 ] -- was a mortgage company, Sierra Pacific; and they didn't leave California. They decided on a significant move and downsized locally because of the state of the mortgage market in the United States right now for home mortgages. And so they were impacted more by what's going on with the Fed than by anything else. We have a tenant, PRO Unlimited. I mentioned that we have one tenant that is a known vacate in 2023. In the third quarter, they will be vacating their space, again not moving to another state. Those move-outs from California have been significantly from the Bay Area, so San Francisco, Silicon Valley, San Jose, that whole spread; and from Los Angeles, where all the costs are significantly higher than in Sacramento. Sacramento has been the beneficiary actually of companies of all stripes and now even starting to see biotech-type companies moving from the Bay Area. If they don't want to leave California entirely and they want to go to a place where their employees can still be in California -- have been moving to Sacramento; and the surrounding submarkets, including Folsom, Roseville and some others. So I actually received an e-mail today from the appraiser we used on our Sacramento building that highlighted some of that movement out of Bay Area and the expectations in 2023 that we will see more movement out of Bay Area, into Sacramento, resulting in a positive outlook in his view and his firm's view for overall occupancy. That kind of goes against the grain for California, but it's the reason that we're in that Sacramento market because it doesn't look like the main markets in California or the gateways. I think we've got, it looks like, a follow-up from Vijay or maybe more than one. All I can see, so far, is one. Despite lower occupancy and weaker outlook for California, what drove small valuation -- what drove the small valuation increase for Iron Point? I will tell you it's assumptions made by the appraiser in terms of where occupancy will get back to. If you were to look at our property currently and where we would be after the PRO Unlimited expected vacate later on in the year, we will be well below the vacancy for our submarket. The vacancy in our submarket -- I'm going to try to dig this up real quick as I look for the right piece of paper that would tell me. Overall submarket vacancy in Folsom is only 8.5%. So I believe that he looked at that, looked at what the positive rental reversions have been. And frankly, for the last couple of years, we've had some quite positive rental reversions in Sacramento. So he's looking at the overall vacancies, looking at what rents have done; and did his valuation. And it came up a little bit higher, negligibly higher, than what it was previously. I see -- is any question popping up? Okay, we have one more question, a follow-up from Rachel from DBS. Which assets saw cap rate expansion? "Which are some of the submarkets within your portfolio that may see more shadow space going into 2023?" That's a good couple of questions there. So in terms of cap rate expansions, I don't have it directly in front of me here. We'll try to pull some of this up. So we saw cap rate expansion; places like Westmoor Center, Bellaire Park in Houston, One Twenty Five, Maitland, Bridge Crossing. Some of those make sense to us. Some of those don't necessarily make sense to us, but in terms of if you were going by a direct cap method, that's where you saw things that were more than a 25 basis point or a 0 change. We did have 1, 2, 3, 4, 5 buildings that had no change whatsoever; and then several with much smaller changes. So that was actually quite good in our view in terms of what we saw there. In terms of the submarkets that may see more shadow space, Maitland could be one of those. It tends to have quite a few large tenancies there that have historically done a lot of back office. We've had some of that in terms of [ Allstate ], Spectrum and some others, where they have fairly large footprints where -- some of them in other buildings. I don't believe we have -- I'm not aware of it at our buildings at the moment, where you may see some of that within the marketplace and within our specific buildings. Hard to stay where we might see more of that. I mean Houston is one of those markets where -- regardless of the fact that it continues to see companies moving to Houston from California; people moving; employment growth; GDP growth just because of where the energy companies have been, although some of them are doing incredibly well right now. That's one where that continues to be an issue, but when you look at our Bellevue, Redmond, we're not seeing that in the Redmond market, but in Bellevue there could be some more of that, that goes on. Microsoft has already announced they're giving back some space in a building in downtown Bellevue. That was not unexpected because Microsoft has been and is currently in the process of redoing a number of buildings on their campus and expanding it. And so the expectation has always been those people will be moving back to Microsoft, but there might be some expansion in that marketplace as well. We're not really seeing it in some of our other larger markets like Denver. I can't speak to downtown, but our submarkets in Denver were not seeing much of that. And to try to think through it, I don't think we're really seeing it too many other places yet, but we're not in a place yet where I think it will start to happen, so if we do see more shadow space, I think that, more like second quarter, third quarter, we might be able to better answer that. But hopefully, by then, we'll start to see a lot more tenants back in the marketplace because they'll know with that they have their employees back for, call it, the 3 days to 4 days a week and more comfortable leasing space and rightsizing space. So hopefully, we don't see a significant increase there. With that -- that's the last question that we have, so I'm going to give a few seconds to see if somebody has another question that they wanted to pop up, but otherwise, we will go ahead and close the call. We certainly appreciate all the questions that we had from everyone. Thank you for spending the time with us. And I think, with that, we can go ahead and close it. Have a great evening, everybody.