Manulife US Real Estate Investment Trust (BTOU) Earnings Call Transcript & Summary

A very good morning, everyone. Welcome to Manulife US REIT's Full Year Results Briefing. My name is Wylyn, and I'm with the IR team. This morning, we released our full year results, and you can find the related materials on SGXNet or our corporate website. Today's session, we have our analysts and media joining us in person, and we also have a lot of visitors -- sorry, investors dialing in to the live audio webcast. So thank you for your time. Before we begin, just [ reminding you ] that this session is being recorded. So appreciate if everyone here has their phone on silent, and the audio recording will be made available on our website after the event. So let me first introduce the management team here. So first, we have Mr. Tripp Gantt, our CEO. We have Caroline Fong, our Deputy CEO.

Good morning.

Mr. Robert Wong, our CFO.

Hi.

Choong Chia Yee, our Head of Finance, and joining us live from the U.S. is Mr. Patrick Browne, our CIO.

Good morning, everyone.

So Tripp will start by bringing through -- bringing us through the presentation slides, and thereafter, we will open for the Q&A session. So Tripp, please?

Yes, and good morning, everybody. First, thanks for coming and being here in person for those of you that are here. It's good to see you. And for everybody on the line, thanks for dialing in. We'll go ahead and jump into the slides here. The first one is really just the snapshot of the headlines here. Our distributable income of $87.9 million is up 2.7% year-over-year. Looking at our DPU of $0.0475, though, it is down 10.9% year-over-year, which -- and it does reflect a 91% payout of the DPU ratio this year. So we'll talk about that in the later slides. As I think everybody knows from our announcement in December, due to the 10.9% valuation decline in our portfolio, our gearing is at 48.8%. We were able to sign 378,000 square feet of leases in 2022, including 123,000 square feet of leasing in the fourth quarter. This has kept our occupancy stable at 88%, and our portfolio WALE remains pretty long at 4.7 years. And our financial highlights, looking at the right-hand side of this chart, you can see that our gross revenues, our NPI and our distributable income were all up on the year. And this was largely due to the contribution of the 3 assets that we bought at the end of 2021. However, our DPU before the retention is going to be down to $0.0497, which is down 6.8% year-over-year, largely as a result of the denominator, the issues -- or the units that were issued to -- in the private placement in December to pay for those assets. Now, as I mentioned, we're electing to do a 91% payout ratio for the second half, which will bring the 2022 DPU to $0.0475 and this will be down 10.9% over 2021. The next slide just really shows the -- how the 3 properties that we bought at the end of 2021 contributed to that increase in NPI. And then the DPU for the second half after the retention will be $0.0214, and we'll be distributing this out in March of 2023. Now, taking a look at our debt maturity profile, you'll notice that we have one remaining property level loan in our portfolio. It's on our fifth property in Atlanta. That $105 million loan matures in June of this year. And we do have a loan facility obtained in order to replace that debt. And so that will be off of our list here in 2023. The remaining $39.7 million that you see at the bottom there is actually a draw that we made on our revolving credit facility in December to do some CapEx funding. And that actually will -- since it's a revolving line of credit, will actually roll into 2024. Our weighted average interest rate of 3.74% is almost 100 bps higher than it was in December of last year. And our -- as I mentioned, our gearing is at 48.8% right now. Our ICR is at 3.1x, I'm sorry, at 12/31. Now, we've continued to have a relatively long WALE of 4.7 years. We've been thankful for that stability through a lot of the term loan that's been going on recently. You'll notice in the chart that our lease expirations are still pretty well spread out over time. We don't have any really lumpy years there. As I mentioned, we did 123,000 square feet of leasing in the fourth quarter. And one of the bright spots and something we wanted to point out that we were really pleased about, more than 2/3 of the leases that we signed in the fourth quarter were new leases, new tenants. We've mentioned before that renewals are important to maintain your occupancy, but you really need to be signing new tenants and new leases to make up for lost occupancy. And so, 2/3 of the leases signed in the fourth quarter were with new tenants and that's something that we think is kind of a bright spot for us. The next chart is talking about the valuations. This is similar to the chart that we put in our announcement in December. We reordered the properties in a slightly different manner from the percentage change from top to bottom. That's how we sorted it. What you can notice is that, of the 10.9% decline that we had in the portfolio, it was really driven by 3 submarkets, 5 properties in 3 different submarkets: Downtown Los Angeles, Northern New Jersey and the Washington, D.C. area. These 5 properties in these 3 submarkets accounted for 80% of the overall portfolio decline. Those 5 assets were down an average of 17.9%. If you take the remainder of the properties that we have, those averaged about 4.5% down. And it really just highlights the concentration, and the next slide kind of shows them as well, how this concentration was really even at one asset. Our Figueroa building in Los Angeles, the valuation declined by 33% year-over-year. And this made up 44% of the overall decline in our portfolio in this one single asset. Excluding Figueroa, even if you were just taking Figueroa out, the rest of our portfolio would have declined 7.1% year-over-year, which is much more in line with what we're seeing across the U.S. in the office market. The NCREIF index in the fourth quarter was down 7.4% year-over-year. And so, what we have in most of our portfolio, except in Figueroa, is more in line with that. A lot of the valuation -- a lot of what impacted the valuation were higher discount rates and higher terminal cap rates the appraisers were using in their assumptions, as well as just a weak forecast for demand in some of our submarkets. The concessions that we're having to pay the tenants to bring them in, and some of these weaker submarkets really had an impact on the forecast that valuers used for income going forward. Another important point to just kind of highlight here, I think everybody has heard about how office sales transactions have also kind of really fallen off in the second half of 2022. In the fourth quarter, the transaction volume fell off 69%. It's one of the lowest transaction volumes we've seen since the global financial crisis. And so, there really weren't very many sales comparables for a lot of the appraisers to use on these appraisals. But in the case of Figueroa, unfortunately, there was a sales comparable from 2022, that was really at a depressed price. And so, it just really kind of reinforced that valuation decline at Figueroa. So the next charts are charts that we've kind of shown you over the past few quarters, different things that we're tracking in our submarkets. This is put together for us by JLL and specifically for our submarkets. This is not national data. You can see in the top left chart that the leasing volume has faced a lot of headwinds in the fourth quarter again. And you can see that's been kind of a consistent trend downward through 2022. And actually, we're at a point now where we're even below -- the leasing volumes are even below where they were at the worst part of COVID. And so, there's really a lot of challenges in terms of leasing demand in our submarkets and just the leases that are being signed, it's a tough time out there trying to get leases done. And then that chart on the bottom left kind of shows some of the results of this. We've been talking again about how the concessions that you have to get to tenants to bring them into some of these buildings continue to creep up. The free rents has bumped up again in the fourth quarter. But really, it's that red line, the TI allowances that have an impact that we were tracking pretty closely through 2021 and 2022. We saw a really steep incline through the middle of 2022. And then we saw a leveling off in the third quarter, which we were kind of encouraged by. We have seen an uptick, it starts to tick up again, but the rate of increase is much more in line with the inflation now, and it really probably reflects just the ongoing inflation of construction costs, labor costs, things like that and not necessarily the tenants are getting more and more TIs allowed. And then in that chart on the top right kind of shows the relationship between these 2 things. The base rents, it's the delta between base rents and net effective rents, which essentially takes into account those concessions that you're having to offer tenants. Earlier in 2022, we saw those 2 numbers kind of moving apart from each other. In the third quarter, we saw them kind of be coming back in line, and now we're beginning to see them both kind of trend upward at the same pace. And then lastly, at the bottom right, looking at sublease, which I can tell you about the health of the leasing market. This chart shows the increase in sublease space. So there continue to be a slight increase in the fourth quarter, but the pace of that increase has moderated since the third quarter. The next slide just shows our -- the stability of our top 10 tenants. It's really blue chip companies and high credit tenants, headquarters, government agencies. And we continue to have the bulk of our tenants in the traditional finance industry -- finance and insurance and legal industries. Even though over time, we are still targeting to diversify our tenant mix even more. Some ESG highlights. 92% of our portfolio now has some kind of -- some sort of green certification. That's something that we're continuing to work on and that we're really proud of. In terms of our team and our people, part of the bright spot of opening up for 2022 was the chance for us to get back out in the community. We had 2 community service events with our team and the picture here shows a Batik painting session that we did with a senior activity center with Methodist Welfare Services, actually my Batik painting is sitting in my office right now on my desk. But another thing that I'm really proud of our team on this year was our investor engagement. It's been a tough year and it's been a year that we've had to deliver a lot of bad news in some ways. But we've continued to stay out in front of people and really invest and engage our investors. And the next slide kind of gives some highlights of what we did in the year. We held our first physical Investor Day since the pandemic in November. We had about 180 retail investors who joined. We had the auditorium at the National Gallery. And it was a great chance just to be able to look people in the eye, shake their hands, listen to their concerns, and we're going to continue doing that as we move forward. It's really important for us to continue staying in front of people and remain accountable for our shareholders. We also did an exciting event where we're reaching out to a younger generation. We held a competition with university students, and they were given a list of topics that were facing SREITs today, and their ideas were very creative and pretty smart. Who knows, I might actually use some. But just a really bright group of young people. So looking ahead, I mean, we've all kind of heard that there are dark clouds over the U.S. economy. But honestly, when you look closer, there's a lot of resilience in the U.S. economy as well. The economic indicators, we saw the modest GDP growth in the fourth quarter. I think some people were expecting us to maybe dip into a slight recession in the part of 2023. But unemployment remains really low and inflation is beginning to ease. And hopefully, the rate hikes that the Fed is putting in place will begin to taper as well. And the impacts that that has on our business, obviously, it has an impact on our tenants and their decisions about what kind of workspace they need. I think that we all see that hybrid work really is the new normal. And so, this new normal compared with -- I mean, combined with just what we're calling that kind of evolving space requirements of our tenants, people are still trying to figure out how much space they need. And it's a combination of both their economic outlook plus the kind of office space that they want and need for their organizations. And as we mentioned, the transaction market, the sales transaction market for office is still really, really challenged. It's largely related to the availability of debt. A lot of buyers are just having a really hard time that banks are not lending. And I think that the stabilization of interest rates is really going to be what brings the banks back in, and then we'll begin to see things loosen up. A couple of things that are coming in pretty clear into view for us right now, that flight to quality is real. The highest quality offices are seeing the strongest demand, and it really kind of reaffirms our focus on the assets where we think that we can make a difference and get a competitive advantage by spending capital in places where we'll be able to see an uptick in rents and values. And lastly, I think that the tapering of the rate hikes is really what we're looking for in terms of getting clarity in the market. I think that once that's said and begins to settle, we'll begin to see things kind of unsticking and begin to move again. In the third quarter, we talked about our reposition and recycle, rejuvenate, and we're really sticking to that same thing. In the short-term, we're looking at really focusing on our asset management, taking a look at which assets we -- again, we can really make an impact at once that we think can be long-term winners and focusing our efforts and our capital on those assets. The other assets that we're targeting for disposition, we're going to continue to look at the optimal time to sell those assets. We began the disposition process and testing the market for dispositions as early as the second quarter of last year. We were in advanced negotiations with 2 different buyers, both buyers because of debt issues and inability to get debt or the rising interest rates, made both of those buyers end up walking away from transactions. But we have tested the market, and we're going to continue to monitor for the right time to dispose of assets. And then just in terms of our longer-term rejuvenation, if you will, obviously, our gearing gives us very little debt headroom to work with at the moment. So in the short-term, I think to borrow on Rachel's terms actually every penny counts, right? And so, in the short-term, that's the reason that we're retaining 9% of our distributable income to use for working capital. We're also in negotiations with our sponsor right now on a potential transaction, which could make a difference for us and help to provide more liquidity. And that's something that we're working really hard on behind the scenes right now. As I mentioned, dispositions are still our preferred method of recapitalizing and raising funds right now. Like I said, we're going to continue to stay in the market, test the market and see what the opportune time to sell those assets is, and that's our first -- it's going to be our first choice. But we do have other tools in the tool belt. We have a DRP, which could provide us with some capital. We do have a mandate for equity fundraising still, that is still an option for us. And as we begin to look at our strategic review, and we're beginning to have different discussions with other partners, looking at equity injections in the platform is something that we're discussing. And on that strategic review, as you know, we announced that the strategic working group of our Board and our management team, we hired Citi back in late November. And we kicked off the outreach process at the beginning of January. We have been encouraged by the response that we've been getting. There has been a really healthy response from a really wide range of parties of all kinds of from different regions and approaching this at different angles. So we've been really encouraged by the traction that we're getting. The plan right now is for Citi in March to gather these proposals, put them together and present them to our strategic working group. And then through the second quarter for us to evaluate those proposals alongside Citi and really just determine which ones could be in the best interest of our unitholders. And so, the next 6 to 8 weeks are going to be really crucial and important for us here, and we're really looking forward to having updates to share with you as things develop.

Thank you, Tripp. We can now start our Q&A session. [Operator Instructions] Rachel, do you want to go first?

Yes, just a few update questions from me. I think firstly, on the Figueroa, I think you said occupancy dropped to 7%. Is it purely just Quinn or is there more vacants in Figueroa?

Yes. I'll let Pat answer that question. Yes.

Yes. So the question is, what's the outlook on occupancy or vacancy for Figueroa?

Or what was -- what attributed to the occupancy there? Was it just Quinn Emmanuel's downsize?

Yes. That's the vast, vast majority of it, which declined -- they cut their space in half and that declined to the current occupancy of 77%. So that's the vast majority. There have been some other moving parts there. We've signed some small renewals that have stabilized things, but there's also been 1 or 2 small tenants that have also vacated, but it's immaterial relative to Quinn Emmanuel.

If I were to put in TCW inside what would the occupancy be?

51%. If no new leasing or anything are signed, that would be the number.

Yes. Just second question, I think you mentioned there were quite a number of new tenants signed in the fourth quarter. Could you give us some color? Is it -- I think, from another building moving to your buildings? Or is it moving from another submarket and then shifting to yours?

Yes. For the most part, it was tenants from within the market moving into our buildings, which is a good thing. So we had a big law tenant that took a full floor at our property of 400 Capitol. We had an architectural and engineering tenant take new space at Michelson. I think we've already announced the semiconductor company that we signed at Diablo. So it's a number of factors that led to these new tenants, but mostly, I think we were fortunate that some existing tenants in the market saw value in our offerings and the quality of our buildings and decided to locate there. So we're encouraged by that. And I would like to highlight that, in the fourth quarter, we've had, what I would say is, great success. And I think we also have continued momentum as we head into 2023 there where we signed 92,000 square feet of leasing, which is a mix of new and renewals at 400 Capitol.

Just maybe one last question before I pass on the line to others. You mentioned about DRP, and I understand that the sponsor currently holds 9.8%. So if you've already rollout DRP, can the sponsor participate to support that and can they increase their percentage?

Well, sorry, DRP will be proportionate to their ownership. So that participation will be like around the 9% mark, DRP. We're talking about -- yes, reinvestment plan. So every unitholders can participate based on their stakeholding.

Yes, but there will be shareholders who won't participate then it really could...

Percentage.

I mean, it's a good question. So I think what is good about this is, we have the ability to balance it at the end of it, I think that the units come through so we can actually make sure that we will not called it 9.8% still for the sponsor side.

Yes. It's a calculation we'll have to make depending on how many people would take that up. And then we'd have to adjust the sponsors take them according to how many people take it up.

Still the sponsor trying to increase [indiscernible].

That's right, yes.

Anyone else? [ Jovi ]?

So [ I have ] 2 questions. So in your [indiscernible] just more important ICR or aggregate leverage because I believe the client valuation is not to [ the reach ] right now. So what is the management's view on this? And also based on the rental outlook and physical occupancy, what is the outlook like for ICR specifically in this year?

Yes. Well, obviously, ICR is important because if it drops below 2.5, our leverage limit drops to 45%. So I think both of them are pretty important metrics for us to be looking at in real time. But at the moment, I think that we're really focused on getting leverage down as much as possible and doing what we need to do to maintain operational liquidity and pay CapEx to preserve values and get the leasing done at the property. So I think that's our primary focus. In terms of the ICR, the impact of -- what exactly was your question [indiscernible] was?

So what's the outlook like for ICR this year?

Yes. Look, like what Tripp says, both ICR and gearing metrics are important to us. So we need to first address the current elevated gearing. As for ICR, it's quite dynamic. It depends on what kind of capital infusion exercise that we're going to do. I mean, Tripp highlighted that the sponsor support coming and there is dispositions that we're looking at and potentially even capital raising. So with those proceeds, we can pay down debt meaningfully, reducing gearing. And in some way, we'll exit that as a counterbalance to ICR. And also, concurrently, we're working on leasing and Tripp has mentioned that we encourage 2/3 of our leases signed in the fourth quarter last year with new leases. So we hope that those rentals will carry through for this year, and this is a brand-new year. So if we can get new leases coming in, we get the top line up, it will provide better support for ICR going forward. But if any of those, say, stats is compromised, it's not technically a bridge according to [indiscernible] because the [ cost ] of it is -- our gearing is elevated because of devaluations, right?

All right. So the question, I think you mentioned the 2 [indiscernible] working REIT. So which property is for consideration? I think we did the 3 distressed that market to highlight with.

So we were -- again, we were encouraged that we got to the point of negotiations in these properties. I can't divulge which properties because we may still want to look at those options. And I wouldn't want to give anybody -- I wouldn't want to give up our competitive position on negotiations. But what I will say again is that, it's very clear to us that it is the debt markets that are really hampering buyers at the moment, and that's what's holding up the transactions. We have seen some light at the end of the tunnel, even just with the recent tapering of just a 25 bp rate increase by the Fed. We're already beginning to hear some runways that some banks are looking to get back in the lending market in the U.S. And so, hopefully, there's light at the end of the tunnel here. And I think that as soon as we feel like we can transact -- the transaction risk is lower for us because that does come with costs. But I think that when we feel the transaction risk is lower and we can get a price that makes sense on these assets, we'll pull that trigger.

There's just one last question based on what you just said. So what is the overall physical occupancy? And also, I think you mentioned the moderation of TI and various inflation construction costs, right? So will these turn along with the peak rates or will the construction cost remains the key for this year? So what are the outlook for TI throughout 2023, maybe for 2024 as well?

Yes. Pat, do you want to try taking that one?

Yes. I think -- well, the physical occupancy, we've been pretty static, ebbs and flows, but we're -- we ended the year right around 30%. And on the TI front, I do think that there is a dynamic of the higher interest rates go, the more downward pressure it may put on construction costs. But there's a push-pull factor, right? The other factor is inflation needs to come down along with those interest rate hikes. So we'll see how it plays out. But I would say this chart gives us a little bit of optimism that it has begun to stabilize. So I think we're hopeful that we won't see any meaningful uptick in 2023 in construction costs or at least tenant improvement allowances that tenants were asking.

[indiscernible].

I was just checking on the TI graph, right? You said that for every about 5 years [indiscernible] that means that we will [indiscernible] rent on average.

Yes. If you take a look at these 2 charts, that's kind of how it works out. Yes.

Certainly, regarding the cap rate drag. So one on the asset stock cap rate expansion, as well at 3 assets [indiscernible] what is the reason for compression?

Yes. Pat, can you comment on the assets that had the cap rate compression?

Yes. Well, I just think it's important to remember that the way U.S. valuations work is more -- it's more of a discounted cash flow model approach than a direct cap rate, you cap your year 1 projected NPI and arrive at a value. So there's a lot of different levers that are pulled in evaluation. So I think that's important context. But in terms of the 3 assets there, it's Phipps, Diablo and Park Place. And what I would say about Phipps is that, it sort of checks the boxes of what the post-COVID world looks like in terms of office demand, and that's a modern building with a nice clean floor plate at a good size in a sunbelt market. So there could be an element there of the value we felt that, that was worthy of cap rate compression because that's what other sort of high-class modern buildings with a lot of tenant demand are seeing is more demand from the investment community and therefore, a little bit of valuation compression possibly. And then the other 2, Diablo, Park Place, like these are in Phoenix, and Phoenix is just a massive growth market, huge population inflows and job growth and all the things that we touted when we made these acquisitions. And I would attribute the cap rate compression there to the market catching on to those growth wins. There has been increased investor demand to buy assets in Phoenix. And it's -- that's probably attributed to sort of the growth factors that the market is now getting credit for.

And last question about this carpark income in the most recent [indiscernible]?

Wong?

We don't quite have the stats on the gross rental income, but it's improved quite significantly. I mean, half-on-half has increased by 14.9% to $6.5 million in the second half. Full year basis has risen by 36% to about $4.6 million. It hasn't quite gone back to pre-COVID level yet. I think pre-COVID is around $16 million a year. So this is about still a bit shy of that $4.6 million. So at least the carpark income is improving quite meaningfully.

Su Tye?

Can I check all the new leases signed in [indiscernible], what kind of returns are we getting in terms like rents and also the lease? Are they getting shorter period leases?

Yes. Again, I'll let Pat answer that question. We did actually have a much longer WALE on the leases that were signed in the fourth quarter. But Pat, can you touch a little bit more on the other metrics about concessions and things?

Yes. No, I would say that, as Tripp noted, we had a long way, I think it was 8.3 years. We had a number of fairly large tenants, some of which I've highlighted already, a large law firm that took a full floor at 400 Capitol and the tech -- or the semiconductor company at Diablo and a few other tenants across the portfolio that signed long-term leases. And when you sign long-term leases, you typically are giving market concessions. It's not like a 2-year lease where you might not have to offer any concession. So, we gave market tenant improvement packages and achieve market rents, and we got long-term leases out of them. So, I don't know if you're looking for more specific stats, but I would say that each of these that we did were market deals.

How should we look at your rental reversion this year? I think you're expecting -- I think [indiscernible] mentioned about as, single-digit.

Low single digits.

Low single digits, still low-single-digit that's because of the in-place rent against the market rate?

Yes. Pat, can you also talk about our current in-place rents versus market?

Yes. I would say that I expect continued low- to mid-single-digit rent reversion and it's because of the dynamic of our expiring rents are typically at or modestly below or modestly above market, depending on the building. So I think what we've delivered the last couple of years has been in that low- to mid-single-digit range. I think if you look over 2022, we've had different quarters where it was 2%. And I think in the second or the third quarter, we were basically at 0%, and we ended the year at 0.7%. And hopefully, we'll outperform that this year. But I wouldn't expect to do -- I wouldn't expect 10%, but I also don't expect a massively negative rental reversion in 2023. So I think we'll be pretty consistent as we head into the new year.

Okay. Then for the physical occupancy, you mentioned about like 30%. How does it compare to the industry in the U.S. on average? I think it would be lower [indiscernible].

It's a bit lower. And again, I think that what you do, if you look at the -- it's really, again, about submarkets. Los Angeles, Washington, D.C., New York, New Jersey are still lower than the national averages. Sunbelt cities along through Texas, Arizona, Atlanta, those physical occupancies are higher. So I think it has more to do with actually the -- again, our submarkets about where we are.

So how should we see this number this year? Are we still expecting like 30% [indiscernible]?

I'll have my crystal ball and take a look, right? Yes. I don't -- Pat, do you have any views on where you think the physical occupancy will end up this year?

My hope is a lot higher, but it's as Tripp said, we don't have a crystal ball. And the headlines in the U.S. that we see are, I think, inching towards more and more demands of employers to bring their employees back. There's definitely still some that are offering flexibility, but a lot of the banks in New York are requiring all of their employees to be in very consistently and more you speak to people anecdotally, it's everyone says, oh, I'm in 3 days or there's a policy 2 or 3 days a week, which wasn't the case 12 months ago. So I do think that there's upside here. I don't think it will get worse, and I'm hoping that there's upside.

Maybe if I can just add on to Su Tye's question, right? So Caroline here. But I think if you look at the entire 12 assets, our occupancy still ranges about 5%, all the way to 18%. So the rental properties, we do have very high physical occupancy. And if you look at the U.S. in general, including Google, you will see that whatever said, they always come out is from this [ catalogue ] system. So just bear in mind that this -- what we are seeing on online is actually a system that the newer Trophy Class A buildings are using with excess [ task ], so with the excess task, they will actually measure what the fiscal occupancy. And then it's actually not a representation of the entire U.S., but it is like the most, I would say, talk about because if you Google that's what you see. So that is not it's usually closer to like 40%, 45% or even higher. So that said, I mean, just like what is interesting, just like even this month, last month, some of the tenants that have actually downsized are now coming back to us and say maybe we need more space. So I think what we are seeing, I think same for all the market office, right? I mean, like we could have given that space and it's too much, and they realize, everyone wants to come back. So hopefully, I mean, it's a sign that there are more people coming back and then they realize like, okay, maybe the downsizing was a little bit too enthusiastic. So, I mean, those are some of the things that we are seeing, and we hope that it's like a sign of like, oh, okay, maybe people were kind of like figured out. And then which is why I think with physical occupancy should only get better if you ask us.

There's one more point that I'd like to add too. A lot of folks are beginning to move away from physical occupancy as a direct gauge of what future demand is going to be. What we're seeing in certain cases is that, an office space that might have had 100 people in it in 10,000 square feet. Going forward, they may only have 50 or 60 people in that office, but they're going to keep that same amount of space because the amount of space they need per employee may increase because they need more collaboration space, they need more meeting space. And just the way the space is utilized is different. So a lot of people are kind of moving away from the metric and the focus on physical occupancy as a measure -- as a proxy for that demand. It doesn't mean that there's no correlation. There is, of course, it's important, the more people come back, the more office demand than it will be. But it's not a direct indicator of how that future demand is going to be for space.

Okay. And also my last question is on the [ GM ] impact. So I think it's still quite challenging in the U.S. to sell any property. So, obviously, more higher likelihood of rights issue this year. How do you see...

Yes, I can take that, it's a great question. I think that's the question on everyone's mind. I think if you look at what we have done since 30th of December. So thanks for those who -- during your holiday tuned into our briefing, Christmas Eve present to everyone. I think since our gearing kind of announcement on the 30th, we [ are at the rights issue ] to look at all the levers that we can use in our 2 bonds. So I mean, there's only a couple of -- I wouldn't say a couple. There's like a few options -- I mean, just because Rachel is sitting beside me, that she has listed in her report on options to reduce gearing. So it's not something that is going to be very different, right? I mean, there is a distribution payout that we have done. And I think what is important is, within a span of 1 month plus, we've managed to sell something, right? Or we are trying to sell something? I think that is important. We have not stopped giving up selling something since 2Q last year, but we continue to do it. And currently, I think as Tripp has shared, we are currently in negotiations with the sponsor to see what they can do. So fingers crossed. And I think once that comes through, it will give us a little bit more planning ahead on what we might expect for the portfolio for 2023 because also we have some property that we think could be clear with us, and there could be some that we may not want to pick, right, because the world has changed. So looking at the entire toolbox and all the tools, I mean, on the last slide, we also have parallel running Citi's strategic review with our financials like -- as our financial advisor. We don't know. I mean, it is a [ capital ] injection from a new partner. I mean, so there's a lot of possibilities in, I think, in general and what we can activate. So any equity fundraising will be always one of the last option just because it's not the first that we will look at. So just -- I mean, that's just what -- I mean, basically what we are doing now to make sure where we can look at our funding needs and our requirements and what we should do. So hopefully, we give you a bit more color.

I'm just checking if anyone else has questions here. Jovi?

[ So I find that ] Peachtree acquisition in the first half of this year at a cost of $18 million over the 2 years, right? So [ give ] a bit on this? And I think also if you tell taxable space option in the third quarter last year. So did that help to improve the valuation anyway, would there be further expansion of this key to other assets? Or as mentioned, this disposition the primary right now?

Yes. So I'll touch on Peachtree first, and then I'll let Pat step into. We are going to be moving forward with the hotelization project at Peachtree. We've allocated that in our 2023 budget. So that will be moving forward. Our asset managers that are actually really excited about it and the architects and everybody are beginning to work. So we're really excited about that project. It's something that we really think is going to be a bright spot in our portfolio. So yes, that will launch this year. In terms of the valuation impact of the Flex -- JLL Flex at Plaza, Pat, can you talk about that, the valuation impact of that?

Yes. I think that it's early days there, right? We're trying to get up and running operationally. It's all moving according to plan. I think we're a few months behind schedule on it, but nothing material, and it's just mostly due to dealing with local jurisdictions. But the point of me saying that it's early days there and that we're just getting up and running is that, that we believe that this is a really compelling offering and that as we prove out success here in the coming quarters that it has the potential to, a, deliver higher cash flows than a traditional market rent. And therefore, that could flow through to valuation impact. And also, we think that this is sort of the new norm of the type of thing that you're going to need in certain office buildings. And if we do prove out our success, which I'm confident we will, I think that it also will add or hopefully derisk a little bit because the investment markets will want it and we'll realize that this is sort of the future of office, so to speak. So, no guarantees, but that's -- this is a huge part of the business plan, right, is that we hope that this is accretive to the value of the property. So hopefully, there's upside to our valuation if we're successful in executing in the coming quarters.

Just one question. So what other actions have the strategic working group under taken apart from appointing Citi? So in the release of the last quarter's results you mentioned plans for the asset classes in the U.S. have some -- gone through a multifamily asset. So there's management advancing lease plans or will the Citi's recommendation stay precedent?

They're tied together very closely, Jovi. I think that our ultimate objective is to find a partner who will help us achieve the strategic things that we've been talking about for a while now, pivoting to higher-growth markets, higher-growth type of tenants and asset classes potentially. And so, really, it's taking our vision of where we want to go and finding a way to bring that together with a partner who can help us do that. And that's really been the focus of the strategic review and the different parties that we've been reaching out to our folks who can either provide a pipeline of assets, asset management expertise, the capital needed, all those kind of things. So I'd say that they're actually very closely tied together. We're not really -- we're pretty confident that we have a strategy that will work going forward. It's just a matter of finding partners who can help us execute it. I do think that if -- during the strategic review and the process that we're going through with other parties, if somebody else has a potential idea that could be complementary to what we're doing now that would fit well with our structure and would end up being in the best interest of our unitholders, we're open to that. But our primary focus is really finding somebody that will help us execute our long-term vision.

Bringing the partner, [ can ] the pipeline be diluted?

It's hard to say. Yes. Again, our focus -- our overarching goal in all of this is to find out what's going to be best for the long-term interest of the unitholders. And that's really the driving force behind all of this. Yes.

Any further -- any questions?

Just wondered about can you reach on this --. I mean, I'm thinking more from a development standpoint. So you have this square foot of [indiscernible], right, for your overall portfolio. What's the replacement cost in the U.S. for that range, right?

Yes. Pat, do you know the replacement costs?

It's going to vary market by market, for sure. What I could say is that -- and I didn't really hear the question. It was a little bit muffled over my headphone, but what I could say pretty confidently is that, all of our buildings are valued significantly below replacement costs.

Okay. The next question is that to say this West Coast in the [indiscernible] asset, right, [indiscernible] it has the steepest decline. So how much more do you have to bring it down to make an all-cash buyer, right, comes with cash and buys this asset? How much more to be discounted in that portfolio?

That's a very difficult question to answer. It's a very -- and I'm not sure that that's a -- it's a tough question to answer, and I'm not sure that that's what we feel is the best decision. Of course, if we really just said, let's liquidate this at all cost, we could do it. But that's -- I'm not -- at some point, it creates value -- an attractive value proposition, right? So that's a tough question to answer in honest. Tripp, I don't know if you have a view or if you want to try to cover it better than me?

There's a couple of different things wrapped up in that question, I think. I do think that there are buyers out there who could be all cash buyers for an asset like this at its current value. There are people out there who have that kind of -- there are unleveraged buyers who can write that kind of check right now. They're not very active in the market and what they're looking for assets that, again, are winners. And Figueroa is probably not going to be on their target list. I think that the other -- maybe the other thing that's kind of embedded in your question is, asking at what price would Figueroa actually move, like what price could you sell it at? And I just say that it's really uncertain right now. Again, we're in this period of what we're calling price discovery between buyers and sellers. And so, I can't venture a guess on that at the moment. There's just so much uncertainties going on.

Taking [indiscernible] the standpoint, right? So you come with the rights issue, right? You sell an asset below book that also be diluting. So which is sort of better position to take. So...

That's a helpful context. And that's an equation that we have to do. Obviously, one of the downsides about selling an asset at a steep discount is that, you crystallize that loss. That is a loss that you cannot get back. And so, I think that we want to try to avoid that if we can. Rights issues do have an impact on share price, but it gives you an ability to stabilize our balance sheet and potentially have a unit price increase in the future. And so, I think that, that's something you can recover from, whereas if you sell an asset at a deep, deep discount at a distressed price, it's almost something you can't ever recover back. So which is in the best long-term interest of the unitholders. And that's really -- it's a balancing act here.

Maybe just to echo on the question you asked question about, I think if you look at the plot, we will be at 12%. If we're going to sell anything in 4Q, you would have done. So the reason I think we didn't and all the bids that came in does not make sense. I mean, it's going to be like people who want to buy your land, that have a [indiscernible] for free, if I may say it in that aspect, right, in 4Q. But as I think the market stabilizes and I think like the rates are going to have a bit more color like maybe not so much rate high. But every day, it's a bit different in the U.S. I think that will give actually buyers a bit more color. I think once the bank starts to kind of like loosen up and lend money, we could also see that come through. So to the point which property we want to sell, and I think we don't have to take Figueroa. I mean, ideally, you may say that we know that makes sense, but then we have to balance it and you're currently expecting, which is more, I would say, I would think makes more sense at this point. And I think the thing is, we have options that we can explore and then decide what's best. So we just have to make sure that there is a balancing act, I would say, yes. Rachel?

Following on that question. In the market, are you seeing any distressed sales assets coming out already?

I'll take a first crack, and then Pat, I'll let you give some more color. We are not seeing a lot of distressed sales at the moment, largely because there aren't any transactions happening. Again, even if you're in a distressed position, the buyers can't get debt. And so, you may want to sell your assets at almost any price and you can't. So we're just not seeing those sales happen yet. I do think that once the lenders come back into the market, then what you'll see is the most distressed sales beginning to happen pretty quickly. And so, I -- this is my forecast, my personal view. I'm looking forward to 2023 in the first quarter and second quarter, you may see some of that activity. But we haven't seen a lot of it yet. I will say that the sales comp that we had for Figueroa in Downtown Los Angeles was -- I'm not sure if it was a distressed price, but it was definitely a depressed price as to what we would have expected. But again, it's just the market has seized up at the moment, and we're just really seeing no transactions, except for the very, very highest quality stuff, like the really fully leased, super grade A, best located. Those are still moving. But anything below that is just not moving. Pat?

No, for sure. It's super quiet. I think on the distressed front, time will tell. And I think that anybody that's got sort of impending debt maturity that levered themselves up like 70%, 80%, 90% leverage over the last couple of years and some value-add development-type strategy, like if that stuff starts coming due and they can't refinance, then yes, you could start to see some distress, but nothing has really come in a way of any sort in terms of distressed office sales. There's a couple here or there, like Tripp said, where it is depressed pricing. I think the one he's referencing in Downtown L.A. was actually the -- a building that was -- it was the last asset in the fund. And I think that they just had to close out their fund and so they moved on. And so, that's -- there was some element of distress there. But not a widespread distressed market yet. I think everyone's sort of in wait and see what's happening with the Fed, what's happened with debt availability. And I think it will start to fall over 2023 and we'll figure out, is it distressed or is it sort of just a new normal operating paradigm.

Okay. I'm very much leading to the next question could be a bit difficult. I think we got negotiations with the sponsor of potential asset disposition. I'm just wondering, distressed assets we put out in the market, would that put that pressure on the asset prices that you might potentially sell to your sponsor. And how would that go? And also when you are considering selling the assets to your sponsor, would you work up an arrangement, say, maybe a joint venture [ second half ] buy back later? Or what sort of -- or is it a straightforward asset disposition that you're considering?

Yes. Well, there are -- first of all, what I'll say is, we're more engaged with our sponsor right now than we ever have been. They are really in the trenches with us at the moment. The sponsor has a few limitations, obviously, both the interested party transaction thresholds that would require unitholder approval in an AGM. The 5% rule. So we're somewhat limited in the size of the transaction that we can do on a very, very quick basis without an AGM. And so, there aren't many assets in our portfolio that are of a price that's low enough to transact at. So we could be looking at a partial interest sale in order to stay under that AGM threshold. I think that the other -- we're also bound by the property funds appendix that we cannot sell to the sponsor at a price that's lower than our book. So we would have to get 2 appraisals. The price can be the average of those 2 appraisals, but it can't be below the lowest appraised value. And so, that keeps us in any transaction that we're doing with the sponsor has to be based upon that book value. So we would not be able -- unless the stuck in appraisal came in significantly below the first, but we've just had an appraisal 30 days ago, I don't anticipate that that's the case. So that's -- I hope that answers your question.

Okay. Maybe following up on the interest cost question, the 3.74% in the full year fourth quarter average cost of debt, has that taken into account of $105 million refinancing?

No. The $105 million is currently still more fixed interest loan. It's actually tracking much lower than the prevailing rate at the moment. So that's why after we sign up the facility agreement we haven't drawn down on that yet because that type of piece of loan is not due in June, right? The primary cost of the increase is obviously that unhedged position, the additional borrowings, the [indiscernible] generally is not hedged because it's meant to be refi or repay depending on the next capital events. Yes.

Okay. So looking at including this new rate for the $105 million, what average cost of debt?

Tough to say, it depends on the capital events, right? So we can't hold at this current rate. If nothing move, naturally, the average interest rate will go up, right, because we are in an elevated interest rate environment. But that's not going to be the case because we're looking at ways to pay down debt, and that will help to ease off the interest cost, overall interest cost and apply further hedges were appropriate. At the moment, the short rate is more expensive than a long rate, right? But we don't exactly have long-term loans for us to hedge overlay. So clearly, yes, we'll look to improve that position.

Okay. All right. Just one more on sublease in your portfolio. Any changes in the markets on the [indiscernible]?

Yes. Pat?

No. We've been well insulated. There has been no meaningful change in our sublease activity in our portfolio. I think in the market, it's still -- it's -- there's a slide says it all. It's inched up. I don't know what slide it is, but the one that has the JLL stats on it, it inched up very ever so slightly in the fourth quarter of 2022. So we're not seeing a ton of it in our market. It doesn't mean it's not happening in other markets, but we've been pretty well insulated from it thus far.

Okay. One last question. I look for your [indiscernible] in Exchange Jersey City. I know that this is coming out in 2025, but any guidance with layoffs?

Pat?

Not yet. No. I mean, hopefully, no, not yet. And 2025 is in some ways an eternity away, and we could -- we'll be operating in a totally different paradigm, hopefully, a better one at that point in time. But they spent money on their space within the last 12 months, and they had sort of new business units working out of that space. So we feel pretty encouraged by some of the rumblings that we've seen from Amazon there, but you never know. But nothing sinister that I can report to you. That's for sure.

So it's 10:45 now. I just want to check if there are any last questions, we probably just take one more. No? Okay, great. There were questions received from the online chat. I think some of them -- I looked through them and some of them have been addressed with the questions here. So if there's anything else that you still want answers to, please feel free to reach out to the IR team. With that, I'd just like to conclude this briefing. Thank you very much for joining us. Thank you, and goodbye.

Thank you.

Thanks, everybody. Thank you. Thanks, everyone.