Orion Office REIT Q3 2024 Earnings Report

Orion Office REIT EPS Results

• Actual EPS: -$0.18
• Consensus EPS: N/A
• Beat/Miss: N/A
• One Year Ago EPS: N/A

Orion Office REIT Revenue Results

• Actual Revenue: $39.18 million
• Expected Revenue: N/A
• Beat/Miss: N/A
• YoY Revenue Growth: N/A

Orion Office REIT Announcement Details

• Quarter: Q3 2024
• Date: 11/7/2024
• Time: After Market Closes
• Conference Call Date: Friday, November 8, 2024
• Conference Call Time: 10:00AM ET

Orion Office REIT (NYSE:ONL) is a publicly traded real estate investment trust that acquires, owns and manages a diversified portfolio of Class A office properties across high-growth U.S. markets. The company focuses on suburban and infill locations, targeting properties with strong tenant credit profiles and long-term lease structures. Its business strategy emphasizes active asset management, capital recycling and selective development to enhance income stability and potential total return for shareholders.

Orion Office REIT debuted on the New York Stock Exchange under the ticker ONL following a spin-off from Government Properties Income Trust in June 2021, though many of its core assets trace back to acquisitions made as early as 2013. The portfolio spans key Sun Belt and Southeast markets, including Texas, Florida and North Carolina, as well as select West Coast submarkets. By concentrating on high-barrier office campuses and multi-tenant buildings, Orion aims to capitalize on demand from corporate, professional and healthcare occupiers seeking Class A space outside of downtown cores.

The company is led by Kenneth C. Stainsby, President and Chief Executive Officer, who brings more than two decades of commercial real estate investment and capital markets experience. Orion’s management team combines expertise in acquisitions, development, leasing and finance, enabling a disciplined approach to underwriting and portfolio optimization. With a board composed of real estate and finance professionals, Orion Office REIT seeks to deliver durable cash flows and long-term value through targeted asset selection and proactive leasing and capital strategies.

Orion Office REIT Q3 2024 Earnings Call Transcript

Key Takeaways

• Leasing momentum: Q3 saw 4 lease renewals totaling 254,000 sq ft at an 8.9-year average term, boosting the portfolio’s weighted average lease term to 5.0 years and pushing year-to-date leasing to over 830,000 sq ft with a 3.2% positive rent spread.
• Portfolio transformation accelerated with sales of 18 non-core properties (1.9 M sq ft) generating $63.8 M in gross proceeds, significantly reducing carry costs and sharpening the focus on high-growth markets.
• Strategic acquisition of a fully leased 97,000 sq ft Bay Area agricultural R&D lab on a 15-year net lease to Sumitomo at a 7.4% going-in cap rate, financed at sub-6% debt, is expected to be cash-flow accretive.
• Q3 revenue declined to $39.2 M (from $49.1 M) and core FFO halved to $0.21 per share due to lease expirations and dispositions, and management expects 2025 core FFO to be $20–24 M lower than 2024.
• Liquidity remains strong with $237.3 M of total availability and net debt to adjusted EBITDA at 5.6× as the company balances debt reduction with funding for capex and leasing initiatives.

Presentation

[Operator]

Greetings. Welcome to Orion Office REIT third quarter 2024 earnings conference call. As a reminder, this conference is being recorded. I would now like to turn the call over to Paul Hughes, General Counsel for Orion Office REIT. Thank you. You may begin.

[Paul Hughes, General Counsel at Orion Office REIT]

Thank you and good morning, everyone. Yesterday, Orion released its financial results for the quarter ended September 30th, 2024, filed as Form 10-Q with the Securities and Exchange Commission, and posted its earnings supplement to its website at onlreit.com. Certain statements made during this call today are not strictly historical information and constitute forward-looking statements. These statements include the company's guidance estimates for calendar year 2024 and are based on management's current expectations and are subject to certain risks that could cause actual results to differ materially from our estimates. The risks are discussed in our earnings release as well as in our Form 10-Q and other SEC filings. Orion undertakes no duty to update any forward-looking statements made during this call. Today on the call, we will be discussing non-GAAP financial measures such as Funds From Operations or FFO and Core Funds From Operations or Core FFO.

[Paul Hughes, General Counsel at Orion Office REIT]

Orion's earnings release and supplement include a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measure. Our presentation of this information is not a substitute for the financial information presented in accordance with GAAP. Hosting the call today are Orion's Chief Executive Officer Paul McDowell and Chief Financial Officer Gavin Brandon. Our Chief Operating Officer Chris Day will join us for the Q&A session. With that, I am now going to turn the call over to Paul McDowell.

[Paul McDowell, CEO at Orion Office REIT]

Thank you, Paul. Good morning, everyone, and thank you for joining us on Orion Office REIT third quarter 2024 earnings call. Today, I will provide an update on our business and discuss our third quarter performance and operations. Following my remarks, Gavin will review our financial results and provide our outlook for the rest of the year. With the completion of the third quarter, we have made strong progress against our key initiatives of extending existing leases and pushing out weighted average lease terms. During the quarter, we signed four leases comprising 254,000 sq ft, including a 10-year renewal for 152,000 sq ft at our Longmont, Colorado property. The other three leases were also renewals, and all four lease renewals combined represent a weighted average lease term of 8.9 years. Our year-to-date leasing efforts have been successful, as we see our well-located properties benefiting from both new and renewal leases.

[Paul McDowell, CEO at Orion Office REIT]

Through last week, we have completed over 830,000 sq ft of leasing so far this year, more than 3x our full year 2023 total. Overall, portfolio WALT now stands at five years, up from 3.9 years at the same time one year ago. Rent spreads on leasing activity have also been positive so far this year at 3.2%. Tenant leasing sentiment continues to improve, which is another positive aspect of the third quarter. We are seeing increased traffic at our vacant properties as prospective tenants have become more active throughout 2024, and we are responding to more inquiries from both these prospects and our in-place tenants. Additionally, our forward leasing pipeline continues to be strong. At quarter end, the pipeline stood at over 1 million sq ft in various stages of discussion, negotiation, and documentation.

[Paul McDowell, CEO at Orion Office REIT]

Our recent leasing successes, while specific to Orion, do seem to be part of a slowly emerging broader trend. To that point, for the overall industry, net office absorption turned positive in the second quarter for the first time in two years. Interestingly, while new office deliveries are falling and are expected to settle at negligible levels soon, the amount of space available in the newest and highest quality buildings continues to decline rapidly and is now below pre-pandemic levels. As super Class A space is rapidly absorbed, Orion and owners like us should start to see a positive benefit in our portfolios as tenants, by necessity, begin to search for available space more widely. These fundamental industry dynamics are further strengthened by corporate management sentiment shifting dramatically, with 79% of CEOs polled in September expecting full-time return to work over the next three years, up dramatically from 34% in April.

[Paul McDowell, CEO at Orion Office REIT]

Even with the macro positives and our own recent leasing progress, we still anticipate Orion's leasing activity will fluctuate and be quite lumpy between quarters. We also expect to continue carrying substantial vacancy for the foreseeable future, as the overall office market recovery will still be measured in years, not months. We also made further progress during the third quarter transforming the portfolio through the sale of vacant assets and properties that we believe do not align with our focus on owning properties in select growth markets around the country. Through the third quarter of 2024, we have sold over 15% of our portfolio, or 18 properties, representing about 1.9 million sq ft, and at quarter end, we owned 70 operating properties and six unconsolidated joint venture properties comprising 8.3 million rentable sq ft that were 74.6% occupied.

[Paul McDowell, CEO at Orion Office REIT]

Adjusted for three operating properties that are currently under agreements to be sold or have been sold, our occupied rate was 76.9% at quarter end. During November, we sold one 68,000 sq ft vacant property located in Dublin, Ohio, for a gross sales price of $3.2 million, or approximately $47 per sq ft, bringing our total properties sold since the spin to 19. We also have an ongoing sales pipeline and expect to close on additional dispositions by year-end or in early 2025. Regarding our vacant properties, we decided to step away from the pending contract to sell our sixth building, former Walgreens campus, located in Deerfield, Illinois. As we have been communicating the past few quarters, after almost two years under contract and some significant progress on a proposed redevelopment plan, there remained questions around when, whether, and at what price the buyer would close.

[Paul McDowell, CEO at Orion Office REIT]

Given the persistent uncertainty with this buyer, we were unwilling to further extend their due diligence period without the buyer putting additional deposit funds at risk, which they declined, and the contract was terminated. We have already begun to remarket the property for sale and are talking with some potential interested parties. I want to again emphasize how important our disposition efforts have been for the long-term health of this company. We inherited a portfolio of assets that contained a relatively large number of less-than-ideal generic office buildings in often tough markets, made all the worse by the historic collapse of the office market in the past two years. Our sales have generated $63.8 million in gross proceeds, but far more important, these sales resulted in a very material reduction of carry costs and forward expected CapEx.

[Paul McDowell, CEO at Orion Office REIT]

The sold properties will no longer weigh us down and have allowed us to focus on those assets where we believe we can achieve long-term leasing success in a recovering market. In short, our overall portfolio, while smaller, is far more attractive now, and although our disposition activities will continue, we believe one year from now our revenues and earnings will flatten and then rise significantly in the out years as we retenant the vacant properties we decided to hold. Since going public, we have devoted excess cash from operations and proceeds from asset sales to debt reduction to maintain maximum financial flexibility. We have consistently said that we intend to recycle some of that capital should the right opportunity arise. Such an opportunity came in September when we purchased a 97,000 sq ft mission-critical agricultural research and development lab located within the San Francisco Bay Area.

[Paul McDowell, CEO at Orion Office REIT]

The property is 100% leased to Valent U.S.A., a wholly owned subsidiary of Sumitomo Chemical Company, for a 15-year remaining net lease term through August 2039. The tenant's parent company, Sumitomo Chemical, has an A+ credit rating in Japan. This location is strategic for Valent due to its proximity to graduate research talent throughout the Bay Area, particularly UC Davis, which has the largest agricultural technology program in the U.S. Furthermore, Valent has invested over $25 million, or approximately $260 per sq ft, into the property since 2019. This includes various premium lab upgrades, supplemental HVAC, and various other renovations that support Valent's laboratory operations. We acquired the property at below-market rents and at a significant discount to replacement cost. The going-in cap rate is 7.4%, with an average cap rate of 9.2% over the term.

[Paul McDowell, CEO at Orion Office REIT]

We will finance the property with a low-leverage seven-year non-recourse mortgage at a rate below 6%, making it cash flow accretive. We believe that being selective and adding a property like this through capital recycling is a smart way to focus on complementing our ongoing asset sales and portfolio repositioning efforts by adding a very high-quality, long-lease duration assets. While we intend to redeploy capital to strengthen our portfolio over time with very selective acquisitions like we did in September with this California property, our first priority continues to be leasing our current properties, followed closely by asset sales of those properties that have poor future leasing prospects. As we have consistently discussed on previous calls, we are investing capital and adapting properties we want to keep in the portfolio, specifically those that are well located in our target growth markets.

[Paul McDowell, CEO at Orion Office REIT]

This strategy is the reason we have remained highly disciplined at maintaining a low-leverage balance sheet over the past two years so that we can appropriately fund capital expenditures, which will significantly enhance the long-term competitiveness of our assets. Additionally, we are realizing the benefits of some of our past investments as they have resulted in increased showings and leasings. That work continues, and we expect the pace of our CapEx spending will increase over the next couple of years, along with our leverage, as we lease vacant space and build long-term revenues. We are increasingly confident that our recent leasing momentum will continue and that the stabilization of our portfolio and earnings are in sight.

[Paul McDowell, CEO at Orion Office REIT]

That said, as we enter the final quarter of the year and look ahead to 2025, we want to point out that the combination of the rise in interest rates, the significant number of properties we have sold, and the vacancy we continue to carry that has resulted from the tremendous lease rollover of the last few years has had a cumulative negative impact and will be particularly pronounced in our 2025 results. We have been consistently communicating these dynamics over the past few years, and they are not a surprise. However, we continue to want to be as transparent to the markets as we can be, and while we are not issuing formal guidance for 2025, we expect that these cumulative impacts on Core FFO could be as much as $20 million-$24 million versus 2024.

[Paul McDowell, CEO at Orion Office REIT]

Given our initial portfolio and the highly challenged office market conditions of the past few years, while we are disappointed we could not overcome the earnings impact, we believe this lower expected earnings level in 2025 should be at the bottom for the business. We expect that level to stabilize and then start to grow as newly leased space comes online and associated vacancy costs recede. This space should give us a solid platform from which we can start to grow meaningfully and potentially give us additional options from a strategic standpoint. As we continue to execute and build on our substantial progress made to date repositioning the portfolio, I want to emphasize that the company remains profitable on an FFO and Core FFO basis, and we expect that to continue. With that, I will now turn the call over to Gavin.

[Gavin Brandon, CFO at Orion Office REIT]

Thanks, Paul.

[Gavin Brandon, CFO at Orion Office REIT]

I will start by reviewing our third quarter financial results and provide an update on our outlook for the remainder of the year. Orion's 2024 third quarter financial results compared to the third quarter of 2023 are as follows: Revenues of $39.2 million compared to $49.1 million. Net loss attributable to common stockholders of $10.2 million, or $0.18 per share, compared to $16.5 million, or $0.29 per share. Core Funds From Operations of $12 million, or $0.21 per share, compared to $24.1 million, or $0.43 per share. Adjusted EBITDA of $19.1 million compared to $30 million. As Paul mentioned and as we have previously communicated, lease expirations and dispositions of non-core assets to right-size our portfolio have negatively impacted the company's financial results quarter-over-quarter. Quarterly G&A was $4.5 million compared to $4.4 million in the third quarter of 2023.

[Gavin Brandon, CFO at Orion Office REIT]

CapEx was $6.1 million compared to $8.4 million in the third quarter of 2023. CapEx timing is dependent on when leases are signed and when property and tenant improvements are completed. The timing of CapEx for tenant improvements is controlled by our tenants, and therefore there is uncertainty when it will be spent. However, we expect that CapEx will begin to accelerate as we move into next year. As of the end of the quarter, $512.1 million of debt was outstanding, comprised of $355 million of a non-recourse fixed-rate CMBS loan that matures in February of 2027, $130 million of floating-rate debt on the revolving credit facility that matures in May of 2026, and $27.1 million representing our portion of the Arch Street Joint Venture debt, which is scheduled to mature on November 27th, 2024.

[Gavin Brandon, CFO at Orion Office REIT]

At quarter end, net debt to annualized year-to-date adjusted EBITDA was 5.6x, and total liquidity was $237.3 million. Total liquidity is comprised of $17.3 million of cash and cash equivalents, including the company's pro-rata share of cash from the Arch Street Joint Venture, and $220 million of available capacity on the company's $350 million revolving credit facility. As we have communicated, we intend to maintain significant liquidity on the balance sheet for the foreseeable future to provide the financial flexibility required to execute on our business plan over the next several years, including the funding of expected capital commitments to support our continuing leasing efforts. As it relates to the Arch Street Joint Venture debt, the joint venture has two successive one-year options to extend the non-recourse loan's maturity date until November 27th, 2026, subject to satisfaction of certain financial and operating covenants and other conditions.

[Gavin Brandon, CFO at Orion Office REIT]

In connection with a recent amendment of a loan agreement, the joint venture exercised the first extension option and is working with the lenders to satisfy all conditions to extend the maturity until November 27th, 2025. We expect the joint venture will satisfy the conditions for the first extension. Turning to our dividend, Orion's board of directors declared a quarterly cash dividend of $0.10 per share for the fourth quarter of 2024, payable January 15th, 2025, to stockholders of record as of December 31st, 2024. As it relates to our outlook for the remainder of 2024, we are narrowing the range of our 2024 guidance expectations for Core FFO and reaffirming our expectations for net debt to adjusted EBITDA and G&A. Core FFO is now anticipated to range from $0.99-$1.01 per diluted share, increasing the low end of the range by $0.02 from $0.97.

[Gavin Brandon, CFO at Orion Office REIT]

Our net debt to adjusted EBITDA range is unchanged and is anticipated to be 6.2x to 6.6x. Our G&A range of $19.5 million-$20.5 million is unchanged. With that, we will open the line for questions. Operator?

[Operator]

Thank you. At this time, we'll be conducting a question-and-answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question comes from Mitch Germain with JMP Securities. Please proceed with your question.

[Mitch Germain, Managing Director at JMP Securities]

Hey, good morning.

[Mitch Germain, Managing Director at JMP Securities]

Can a new buyer leverage the work done from a previous buyer for the Walgreens property, or do you think that now the whole process gets reset?

[Paul McDowell, CEO at Orion Office REIT]

Good morning, Mitch. No, the answer is a new buyer, we believe, can leverage the work that's been done from the previous buyer. That buyer had done quite a bit of work for the redevelopment of the property, and we are the owner of all of those files. The buyer also got put in place a tax increment financing district with the city of Deerfield, which is now owned by us. So there's a significant amount of work that has been done, which would undoubtedly work to the benefit of a new buyer, assuming they wanted to pursue a similar development plan.

[Mitch Germain, Managing Director at JMP Securities]

Okay, that's super helpful.

[Mitch Germain, Managing Director at JMP Securities]

Just shifting over to the acquisition that you did in the quarter, was there anything unique about the seller? Was there some distress, or was there some impending debt? Was there anything that was unique on that deal? And I might have missed a yield, though you talked about the debt, so obviously it's above that. But if any color you can provide there, I'd be appreciative.

[Paul McDowell, CEO at Orion Office REIT]

Sure. I don't think the sale was. I don't think the seller was under any particular distress. I will say that the market has been pretty thin. So our ability to purchase the property for an all-cash transaction was attractive, which we think gave us some additional pricing power when we negotiated the transaction with the seller.

[Paul McDowell, CEO at Orion Office REIT]

We're very, very pleased with not only the cap rate that we were able to obtain, but we bought the property at way below replacement cost, and the rents the tenants are paying are significantly below market. So we feel very, very comfortable there. We are financing the asset with, as I mentioned in my prepared remarks, with long-term debt at a rate below 6%, a seven-year loan, and a relatively low LTV loan of, call it, between 50% and 55%, which will, the combined rate will make the transaction for us very cash flow accretive.

[Mitch Germain, Managing Director at JMP Securities]

And the yield's north of 7%? Is that the way you think about it?

[Paul McDowell, CEO at Orion Office REIT]

Could you repeat that?

[Mitch Germain, Managing Director at JMP Securities]

The cap rate, going cap rate? If I missed it, I apologize. Is that north of 7%? Is that the way to think about the yield?

[Paul McDowell, CEO at Orion Office REIT]

Yes.

[Paul McDowell, CEO at Orion Office REIT]

The going cap rate is 7.24%, and the average cap rate is 9.2%.

[Mitch Germain, Managing Director at JMP Securities]

Oh, you know what? I did read that. I apologize. Great. Last one from me. Looking out, I think you and also Gavin referenced, obviously, increasing debt levels, increasing CapEx spend. So how do you start to balance these unique investment opportunities against the potential requirement for cash related to CapEx, whether it be building improvements or leasing related? How do you start navigating that as you continue forward?

[Paul McDowell, CEO at Orion Office REIT]

That's a terrific question, Mitch, and one we debate internally pretty much all of the time here. I think the best way to describe it is our first and foremost focus is on the assets we own already on the balance sheet. So our best use of capital, for the most part, is to put into the assets we already own.

[Paul McDowell, CEO at Orion Office REIT]

When I say put capital into assets we already own, I mean by that, generally, it makes sense for us to lease up the vacancy, and the capital we use to lease up that vacancy is the most accretive way that we can use that capital to generate returns rather than just using capital to try to fix up a building to attract investors. We are doing that, but when we look at a vacant building, we look at what's the capital we would have to invest without a guaranteed return versus investing that capital in an acquisition opportunity. That's where we try to make what we think is the best judgment. If we don't think it makes sense to invest capital in the building, we've been selling them. Utilizing that capital we might otherwise have invested to potentially buy new assets.

[Paul McDowell, CEO at Orion Office REIT]

But going forward from here, I think it's fair to say, and you should expect, and investors should expect, that we will focus most of our capital expenditures in the coming years on our existing portfolio.

[Mitch Germain, Managing Director at JMP Securities]

Great. Thank you.

[Paul McDowell, CEO at Orion Office REIT]

Thank you, Mitch.

[Operator]

As a reminder, if you'd like to ask a question, please press star one on your telephone keypad. One moment, please, while we poll for questions. There are no further questions at this time. At this point, I'd like to turn the call back over to Mr. McDowell for closing comments.

[Paul McDowell, CEO at Orion Office REIT]

Thank you all for joining us on our third quarter call, and we look forward to updating you further in the new year with our fourth quarter results.

[Operator]

Thank you. This concludes today's conference call. You may disconnect your lines at this time, and we thank you for your participation.

Participants

Executives

• Gavin Brandon, CFO
• Paul McDowell, CEO
• Paul Hughes, General Counsel

Analysts

• Mitch Germain, Managing Director at JMP Securities