Office Properties Income Trust (OPI): Navigating Challenging Office Market Conditions with Strategic Initiatives

Published on September 24, 2024 | Ticker: OPI

Office Properties Income Trust (OPI), a real estate investment trust focused on owning and operating office properties, has reported its financial results for the first quarter of 2024. Despite the ongoing challenges in the office sector, the company has demonstrated resilience through strategic initiatives aimed at addressing its debt maturities, identifying assets for disposition, and actively managing its leasing activities.

Financials

For the full year 2023, OPI reported annual net income of -$69,737,000, annual revenue of $533,553,000, annual operating cash flow of $141,726,000, and annual free cash flow of -$87,278,000. In the first quarter of 2024, the company reported normalized funds from operations (FFO) of $38.3 million, or $0.79 per share, which was in line with its guidance range. This compares to normalized FFO of $45.9 million, or $0.95 per share, in the fourth quarter of 2023.

The decrease in normalized FFO on a sequential quarter basis was primarily driven by higher interest expense and lower net operating income (NOI) as a result of tenant vacancies. Same-property cash basis NOI decreased 12% compared to the first quarter of 2023, which came in better than the company's guidance range of a 14% to 15% decline. The year-over-year decrease was mainly attributed to elevated free rent concessions, vacancies, and higher operating expenses.

OPI generated cash available for distribution (CAD) of $0.46 per share during the first quarter, which included $10.5 million, or $0.22 per share, of early termination revenue related to the sale of a property in Chicago. On a rolling 4-quarter basis, the company's CAD was $1.32 per share.

Looking ahead, OPI provided guidance for the second quarter of 2024, expecting normalized FFO to be between $0.62 and $0.64 per share, a decrease from the first quarter primarily driven by lower rental income. The company also expects same-property cash basis NOI to decline 15% to 17% compared to the second quarter of 2023, due to elevated free rent and tenant vacancies.

Business Overview

OPI's portfolio consists of 151 properties totaling 20 million square feet, with a weighted average remaining lease term of nearly 7 years. The company's properties are diversified by industry and geography, with more than 60% of its revenues coming from investment-grade tenants or their subsidiaries.

Despite the significant operational headwinds impacting the office sector, OPI executed 488,000 square feet of new and renewal leasing during the first quarter. This activity resulted in an average lease term of 9.3 years and a roll-up in rent of 10.2%, reflecting the company's highest leasing spreads since 2022. Leasing concessions and capital commitments continued to decline, reaching $2.42 per square foot per lease year, less than half of OPI's quarterly average in 2023.

The United States government is OPI's largest tenant, representing 20% of annualized revenues across 43 leases for over 3.5 million square feet. The company estimates that 12% of its annualized revenues are from leases at specialized building facilities that serve mission-critical needs for government agencies, providing stable and predictable cash flows. However, the remaining 8% of government exposure is from leases for back-office uses, which are subject to the same remote work threats as the company's private sector tenants.

Liquidity

Addressing Debt Maturities and Liquidity

OPI has been proactive in addressing its debt maturities and enhancing its liquidity position. During the first quarter, the company recast its revolving credit facility with a new $425 million secured credit agreement and issued $300 million of 9% senior secured notes. The proceeds from the note offering and borrowings under the credit facility were used to redeem all of the company's $350 million of 4.25% unsecured notes due in May 2024.

Furthermore, OPI recently commenced debt exchange offers, pursuant to which the company may issue up to $610 million of new 9% senior secured notes in exchange for certain of its outstanding unsecured senior notes. This strategic move is aimed at addressing the company's $650 million of senior notes due in February 2025.

As of the end of the first quarter, OPI had $2.6 billion of outstanding debt with a weighted average interest rate of 5.4% and a weighted average maturity of 4.9 years. The company had $159 million of total liquidity, including $135 million of availability under its credit facility.

Asset Disposition and Development Activities

OPI has been actively managing its portfolio, focusing on selling vacant or soon-to-be-vacant assets. During the first quarter, the company closed on the sale of a property in Chicago for $38.5 million, and it received an additional $10.5 million in lease termination fees from the former tenant. The company is currently in various stages of marketing more than 2 million square feet of properties for sale across its nationwide footprint, most of which were previously leased to single-tenant users.

On the development front, OPI reached a significant milestone with the substantial completion of its 300,000 square foot life science and office redevelopment project in Seattle, Washington, known as Unison LiSA. The property is currently 28% leased, and the company continues to aggressively market the project, including offering four move-in-ready spec labs.

Risks and Challenges

OPI faces several risks and challenges in the current market environment. The company has a significant amount of lease expirations over the next several years, with nearly 30% of total annualized rental income expiring through 2026. The company estimates that approximately 2.2 million square feet, representing $65.5 million of annualized rental income, will not renew, which will negatively impact its results in the coming quarters.

Furthermore, the ongoing impact of remote work and uncertain macroeconomic conditions continue to negatively affect demand for office space, making tenant retention a significant challenge for OPI. The company's re-leasing efforts are further impacted by a limited pool of tenants in the market to absorb large blocks of space, which can take upwards of two years and significant capital to stabilize vacant properties.

Conclusion

Despite the challenging conditions in the office sector, OPI has demonstrated its resilience through strategic initiatives aimed at addressing its debt maturities, identifying assets for disposition, and actively managing its leasing activities. The company's diversified portfolio, with a significant presence of investment-grade tenants and mission-critical government agencies, provides a degree of stability amidst the broader market headwinds.

As OPI navigates the upcoming lease expirations and works to offset the pressure from the decline in non-specialized government revenues, its focus on asset sales and proactive tenant engagement will be crucial. The company's ability to successfully execute its strategic plan and adapt to the evolving office market dynamics will be key to its long-term performance.

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