Brandywine Realty Trust Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
October 23, 2024

There are 11 speakers on the call.

Operator

Good day and thank you for standing by. Welcome to Brandywine Realty Trust Third Quarter 20 24 Earnings Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer session. Instructions will be given at that time.

Operator

Please be advised, today's conference is being recorded. I would now like to hand the conference over to your speaker today, Jerry Sweeney, President and CEO. Please go ahead.

Speaker 1

Michelle, thank you very much. Good morning, everyone, and thank you all for participating in our Q3 2024 earnings call. On today's call with me as usual are George Johnson, our Executive Vice President of Operations Dan Palazzo, our Senior Vice President and Chief Accounting Officer and Tom Wirth, our Executive Vice President and Chief Financial Officer. Prior to beginning, certain information discussed on the call today may constitute forward looking statements within the meaning of federal securities law. Although we believe estimates reflected in these statements are based on reasonable assumptions, we cannot give assurance that the anticipated results will be achieved.

Speaker 1

For further information on factors that could impact our anticipated results, please reference our press release as well as our most recent annual and quarterly reports that we filed with the SEC. Well, 1st and foremost, we hope that you and yours are well. And with summer now behind us, we are looking forward to an ever improving end of 2024. During our prepared comments today, we'll briefly review Q3 results in our 2024 business plan. Tom will then briefly review our financial results for the quarter and frame out the key assumptions driving our Q4 2024 guidance.

Speaker 1

After that, Dan, George, Tom and I are available for any questions. Well, similar to last quarter, I want to start off by addressing the key themes that guide our business plan. Our focus remains on 3 key areas liquidity, development lease up and portfolio stability. 1st on liquidity, look we're really in excellent shape with no unsecured bond maturities for over 3 years. We anticipate maintaining minimal balances in our line of credit over the next several years to ensure that ample liquidity continues.

Speaker 1

And our forecast liquidity does include proceeds from our asset sale program. During the quarter, as you noted in our SIP, we did sell a Class B portfolio located in the Pennsylvania suburbs for a little more than $65,000,000 We have several other transactions in progress. And as such, we did raise our 24 sales target to a midpoint of $150,000,000 I'll review some detail on that in a few moments. The majority of our operating joint ventures, which we spoke about earlier in the year, have been restructured. We have no operating joint venture debt maturities for quite some time as well.

Speaker 1

And this combined activity has reduced our operating JV debt attribution by $159,000,000 since the beginning of the year and I'll touch on that in a few moments as well. 2nd on development lease up, which remains a top priority for the organization. The pipeline on each project continues to build. Tour volume and issued proposals increased during the quarter. At Schuylkill Yards, we remain in advanced stage of negotiation with over 200,000 square feet of prospects with continued advancement in the ever building strong pipeline.

Speaker 1

The residential component continues to perform on pro form a in terms of absorption and rents. The office component at our Uptown ATX pipeline numbers now stand at over 600,000 square feet with tenant sizes ranging between 600,000 square feet. The Scoupledge residential project, which we call the Vera has met our year end target of being over 80% leased. We're obviously hope to make more progress in the ensuing 2 months. At Uptown Residential, we opened in September and we'll be delivering finished units through December and we're already about 15% leased.

Speaker 1

As I noted in the past that these projects remain top of market, they're attractive to a broad range of our customer targets and we remain confident of hitting our pro form a returns. We certainly recognize both the earnings drag and balance sheet impact of carrying this non revenue producing capital and continue our aggressive marketing efforts on each project. To the upside, upon stabilization, these projects will generate about a 15.5% increase to our existing income stream. So they do remain a key growth driver for the company. We do anticipate and Tom will touch on that with interest capitalization periods expiring on 2 of these office projects, the interest treatment on residential deliveries and the expensing of our preferred returns in those development joint ventures, there will be increased expenses attributed to this pipeline before stabilization.

Speaker 1

And the final third leg of the Tripod is portfolio stability, which again remains a top priority. The strong operating metrics we posted again this quarter reflect the underlying stability of that core portfolio. Austin continues to face near term challenges, but intermediate term growth prospects or dynamics of that market remain strong. Activity levels have picked up and our product is quality and will be a strong participant in that market's eventual recovery. Philadelphia, which has one of the lowest vacancy rates among large cities in the country continues to perform very well for us.

Speaker 1

And our wholly owned portfolio leasing level and occupancy levels are about 94% and that reinforces the strength of our product in Philadelphia. Looking ahead, we have only a 5% annual rollover through 2026, again, one of the lowest in the office sector. Our 2024 revenue plan has finished ahead of schedule. We have increased our spec revenue range to $26,300,000 and also raised our annual retention range. Our 24 spec revenue target is up $1,800,000 or 7.4 percent over our original 24 business plan.

Speaker 1

Our mark to market capital ratios and same store numbers all performed at strong levels as they have done for the last several quarters. With that said, the momentum we think we have built has led to overall to our operating results to perform in line with or above our 2024 original business plan. Just a few quarterly highlights. We did post 2nd quarter FFO of $0.23 per share. As I mentioned, our original spec revenue target of $26,300,000 is up from $25,000,000 to $26,000,000 last quarter and is 100% executed.

Speaker 1

Our combined leasing activity for the quarter totaled 558,000 square feet. During the quarter, we executed 298,000 square feet of leases, including 125,000 square feet of new leases within our wholly owned portfolio. Total leasing activity, wholly owned leasing and new leasing all exceeded 2nd quarter levels, so good signs of continued recovery in our various markets. Based on our efforts, as I touched on a moment ago, during the 1st 9 months of the year, we've eliminated $159,000,000 of debt attribution from our joint ventures, so that significantly exceeded our targeted $100,000,000 target for 2024. Consolidated debt is 94% fixed at 6.2% rate.

Speaker 1

Our quarterly rate mark to market was 14.9% on a GAAP basis and 8.9% on a cash basis. Our new leasing mark to market was a strong 18% and 2.9% on a GAAP and cash basis respectively. We ended the quarter right in line with our 2024 business plan expectations. So the business plan remains in very for existing portfolio remains in very solid shape. Forward rollover through 2025 has been further reduced to about 4.6% and the 26% average through about 5.2%.

Speaker 1

More importantly, we do not have any tenant lease expiration greater than 1% of revenue through 2026. So we're in very good shape from that standpoint. And along those lines to give you a little bit more color on the market, we do continue to see encouraging signs on the leasing front, certainly evidenced by the stats I just mentioned, but also by these metrics. The increase in physical tours has been very positive. 3rd quarter physical tours exceeded 2nd quarter tours by 7%, which also exceeded our trailing 4 quarter average by 22%.

Speaker 1

Also tour activity remains above pre pandemic levels by 36%. On a wholly owned basis during the Q3, 62% of all leases, all new leases were results of this flight to quality. For 2024, flight to quality deals represented 60% of our new leasing activity. Executed renewal and expansion activity has enabled us to again raise our retention target by 300 basis points, so up from our original 51% to 53% range to now 62% to 63%. Total leasing pipeline through the company remains strong.

Speaker 1

The operating portfolio leasing pipeline stands at 2,000,000 square feet and that includes about the 218,000 square feet in advanced states of negotiations. Development project pipeline again remains strong and 32% of our operating portfolio new deal pipeline are prospects looking to move up the quality curve. In terms of looking at some of our leverage metrics, our 3rd quarter net debt to EBITDA ratio decreased to 7.5 times, which benefited Tom Latushka from our 3rd quarter operating results and sales activity, partially offset by increased investment in our development projects. Our core EBITDA metric, which we monitor very closely ended the quarter at 6.6 times within our targeted range. Based on our operating results for the 1st 3 quarters of the year, we are adjusting and narrowing our $0.24 FFO guidance to $0.89 to $0.92 per share.

Speaker 1

The change in our FFO guidance is based on a change in our guidance for 2024 land sales, which we did anticipate to be about $0.03 a share for 0 point 24 dollars Based upon a couple of deals not coming to fruition, we now anticipate no further land gains in 2024. And looking at our liquidity and sales activity, our initial business plan projected $80,000,000 to $100,000,000 of sales activity occurring in Q4 with minimal dilution. During the quarter, we did sell a non core Class B portfolio in the Pennsylvania suburbs for about a little more than $65,000,000 To facilitate that sale, we did take back about $15,500,000 of seller financing at initial rate of 8.25 percent with subsequent rate increases over its term. In addition to that sale, we have a number of other sales that we believe will close during the Q4. Therefore, as we noted in our supplemental package, we have increased our sales target to a midpoint of $150,000,000 None of the additional contemplated sales will require any seller financing.

Speaker 1

In addition, if these transactions close as currently contractually anticipated, we expect the $150,000,000 to occur at a blended 8% cap rate. Properties in the sale pool are in the Pennsylvania and Austin suburbs. And looking at our developments, as I noted, our development pipeline remains strong. We are very focused on getting some of the leases in negotiation across the finish line. Tour velocity continues to pick up particularly at Uptown, ATX and 3025 JFK.

Speaker 1

Looking at our developments, we have about $1,000,000,000 under active development. Of that, our wholly owned development in Radnor, which is about $80,000,000 in cost is 100 percent leased, fully funded and the tenant is in the process of taking occupancy during the Q4. Looking ahead, given the mixed use nature of our master plan communities, we are expected for development pipeline product mix is about 27% life science, 42% residential, 22% office and 9% support retail entertainment and hospitality. Of course, any further development starts are conditioned purely upon us leasing up the existing pipeline as well as overall marketing market and capital market conditions. Specifically looking at some of the projects, 3025, our residential office, residential tower is fully delivered.

Speaker 1

On the commercial component, we're currently 23% leased with an active pipeline of well over 200,000 square feet, including leases and negotiation. We continue to see steady traffic and leasing activity for our Veera or residential component. We currently have 2 78 leases executed for about 80% of the project, which is up from 2 37 leases or 73% leased on our last call just about 3 months ago. We're also seeing very good renewal rates for some of our existing tenants, where we're in excess of a 60% renewal rate at an average increase in the high double digits. We have already met on Avera our year end lease target of being between 80% and 85%, but we're certainly continuing to push for more leasing activity in the ensuing months.

Speaker 1

For Uptown Block A Residential, which we've called Solaris House, we did have some last minute permitting delays. So we did not open up units for occupancy until late September. That being said, we currently have 52 leases executed. Or 15.3% for the other project, which is up from about 6% on the last call. We are still projecting even with the delayed opening that the residential component will be between 20% 25% leased by the end of this year.

Speaker 1

3,151 Market, our life science project is scheduled for delivery in this quarter. We have a leasing pipeline there including some leases under negotiation, which we are working to get across the finish line. Uptown ATX has a leasing pipeline that remains approximately more than double the space we have available. That does include a mix of prospects ranging from a low of 6,000 square feet to a high of about 200,000 square feet. We did recently complete a floor spec suites and are in the process of leasing those suites up.

Speaker 1

Our next phase of BLAS expansion in the 8th floor here at Sierra Center is nearly complete and we're in the final stages of negotiations with several tenants for these graduate lab opportunities. So with that, let me turn the floor over to Tom to review our financial results.

Speaker 2

Thank you, Jerry, and good morning. Our Q3 net loss totaled $165,500,000 or $0.96 per share and Q3 FFO totaled $39,800,000 or $0.23 per diluted share. Our 3rd quarter net income results were impacted by several impairment charges totaling $161,400,000 or $0.93 per share. Our 3rd quarter FFO results were $0.01 per share below consensus estimates and some general observations for the Q3. G and A totaled $12,600,000 $3,600,000 above our 2nd quarter re forecast, primarily due to higher non cash equity compensation amortization.

Speaker 2

The increase is due to higher than forecasted vesting and we expect this amount to decrease in the 4th quarter. Interest expense was $1,200,000 below our re forecast, primarily due to higher capitalized interest, primarily due to the delay in commencing our multifamily development in Austin, partially offset by higher projected borrowings on our unsecured line of credit. FFO contribution from our unconsolidated joint ventures was projected to be negative $2,000,000 and ended up being basically breakeven. The improvement was due to the timing on commencing operations for our multifamily project in Austin and some delay and some improvement in the operating portfolio. Our 3rd quarter debt service and interest coverage ratios were 2.4 times slightly above projection with net debt to GAV of 47.3%.

Speaker 2

Our 3rd quarter annualized core net debt to EBITDA was 6.6 times and this is within our 2024 range and our annualized combined net debt to EBITDA was 7.5 times also within our guidance range. Our leverage ratios were basically improved based on a higher cash EBITDA. Portfolio and joint venture changes. Our wholly owned core portfolio was reduced in the 3rd quarter by the sale of our campus in the PA suburbs. Our joint venture portfolio now includes $4,100,000 preferred investment for the recapitalization of our DK joint venture.

Speaker 2

We anticipate adding 155 King of Prussia Road to our core portfolio in the Q4 as we anticipate the tenant will take occupancy during the quarter and the property is 100% leased. Financing to activity as Jerry highlighted earlier, we've eliminated any material near term maturity risk with no unsecured bonds maturing until November 2027. Our wholly owned debt is now 93.9% fixed with a weighted average maturity of 3.9 years. Looking closer more closely at 4th quarter FFO guidance components, our operating portfolio, portfolio level operating income will total approximately $72,500,000 and will be roughly $1,300,000 below our Q3, primarily due to reduced NOI related to our asset sales in the 3rd quarter and projected sales in the 4th quarter. The FFO contribution from our unconsolidated joint ventures will total a negative $2,500,000 The increased loss is primarily due to 3025 JFK office being operational for more than 12 months, ending capitalization and commencing operations of our multifamily project in Austin, Texas.

Speaker 2

G and A, our 4th quarter G and A will approximate $9,000,000 due to lower equity compensation amortization. Total interest expense will increase to $33,500,000 due to primarily due to lower capitalized interest totaling about $3,200,000 The lower capitalized interest is partially due to joint venture and wholly owned development projects becoming operational. Termination fee and other income will total roughly $6,000,000 for the 4th quarter, which includes some incremental transaction income. Net management and leasing and development fees should be about $3,000,000 Land gains, which were going to be $5,000,000 for the year is now projected to be 0. Interest and investment income will be $800,000 and our share count should approximate 176.5 1,000,000 diluted shares.

Speaker 2

As Jerry outlined previously, we have lowered the midpoint of our guidance by $0.03 primarily due to the anticipated land gains totaling $5,000,000 that will no longer be included in our business plan. While we plan to continue to monetize our non core cash holdings, non core land holdings, none will close in 2024. For run rate guidance, as our development projects transition to operating properties, we will lose the ability to capitalize certain costs that will now be included in future earnings. While we will provide further guidance with our 2025 business plan, we anticipate that certain 4th quarter run rates will continue into 2025. Interest expense with the development projects becoming operation, our capitalized interest will decrease and future interest expense will be consistent with our projected 4th quarter run rate.

Speaker 2

FFO contribution from our joint ventures with certain developments becoming operational and others increasing NOI through lease up, our JV joint venture contribution on a quarterly basis will be consistent with our projected 4th quarter level. On our capital plan, which totals $109,000,000 for the 1st 9 months, our 2024 CAD payout ratio was 95.5 and our full year range remains 90 to 95. Uses for our capital for the 2024 Q4, dollars 35,000,000 of development, dollars 26,000,000 of common dividends, dollars 14,000,000 of revenue maintained, dollars 9,000,000 of revenue create and $25,000,000 contribution to our joint ventures, primarily related to Commerce Square. The primary sources are $28,000,000 of cash flow after interest payments, dollars 85,000,000 of land and other sales and $12,000,000 of construction loan proceeds. Based on the capital plan outlined above, cash on hand should increase $16,000,000 and our line of credit is expected to be undrawn at the end of the year.

Speaker 2

Our projected cash balances at the end of the year have been positively impacted by the incremental lease increased sales activity, partially offset by our seller financing and planned additional contribution to Commerce Square. We also project our net debt to EBITDA ratio will range between 7.5% and 7.8% and our net debt to GAV approximately 47%. Our additional metric of core net debt to EBITDA will range between 6.5% and 6.8 percent, which will now which does exclude primarily just our joint ventures as our active development projects will be complete. We believe that our core leverage metric better reflects the leverage of our core portfolio and eliminates our more highly levered joint ventures and our unstabilized development and redevelopment projects. During 2025, our core net debt to EBITDA should begin to equal our consolidated net debt to EBITDA as our wholly owned development projects reach stabilization.

Speaker 2

We anticipate our fixed charge and interest coverage ratios will approximately 2.2 by the end of the year, which is slightly below our Q3 results. I'll now turn the call back over to Jerry.

Speaker 1

Great. Thank you, Tom. So I think the key takeaways really are that the overall market dynamics in our sector continue to improve with a clear bifurcation of Class A versus Class B properties. Our portfolio remains operating portfolio remains in solid shape. I mean, we think we've got a very solid foundation for continued improvement over the next several years, evidenced by the average annual rollover, which is only 5.2% through to 2026, the strong mark to markets, very manageable capital spend to get new leases executed, so being able to grow net effective rents.

Speaker 1

And we think stable and hopefully continued acceleration of overall leasing activity. We're executing a baseline business plan that continues to improve both liquidity, improve our market position, keeps that operating portfolio on very solid footing with a major focus in the company on obviously leasing up our development projects. So we're in a great position to generate forward earnings growth. So as usual and where we started, which is that we wish you and your families well. And with that, we're delighted to open up the floor for questions.

Speaker 1

We do ask that in the interest of time, you limit yourself to one question to follow-up. Michelle?

Operator

Thank Our first question comes from Steve Sakwa with Evercore ISI. Your line is open.

Speaker 3

Thanks. Good morning, Jerry. I was just wondering if you could comment a little bit more on the demand in particular in Austin. And I'm just curious, the 600,000 feet that you've got kind of in the pipeline, are those kind of tenants that are already kind of in the Austin market that are expanding, are these new requirements? Just trying to get a feel for kind of the likelihood of them executing.

Speaker 3

And we've heard in other sectors there's some hesitancy to kind of commit to new deals. And so trying to figure out are these relocations or new commitments and are they in the market or coming into the market?

Speaker 1

Yes, it's Steve. Good morning. George, I can tag things. I guess as we're looking at the pipeline, the majority of the deals we're working through at 1 uptown are deals that are in the market.

Speaker 4

They are

Speaker 1

some significant expansions where one uptown can accommodate the expansion requirements. The overall market has been improving, albeit slowly. I mean there's about 90 tenants or about 3,000,000 square feet of prospects in the market. Opportunity Austin still represents they're reporting about 275 hot active prospects looking at Austin for new in for new in migration, about 22% of that is Austin. So that's up a bit quarter over quarter.

Speaker 1

But the pipeline primarily remains kind of Austin based at this point. But George, any other color you want to share? Yes. I mean,

Speaker 4

I think in the overall Austin market pipeline, there probably are some out of city companies in that pipeline. But specific, and as Jerry mentioned, our upcount portfolio was really in market with a predominance of expanding and growing in market tenants. So we're extremely pleased with the level of activity. And as we said, our building can accommodate the future growth needs that these tenants have.

Speaker 1

Yes. I mean, Steve, I mean, in our pipeline we have on a regular basis brokers and site selectors coming through looking for large requirements. And we certainly get them mature. We follow-up with them. But their gestation cycle tends to be a lot longer with no real definitive occupancy date.

Speaker 1

So we really we make our focus very crisply on tenants that we know have leases that are expiring. We know they need expansion. Stay put maybe an option, but there's an opportunity for us to kind of convince them to move up the quality curve. So the primary focus in that pipeline today is on definable requirements that are currently within the City of Austin.

Speaker 3

Great, thanks. Good color. Maybe just as a quick follow-up for you or Tom, just on all the dispositions, I guess that were done and are planned, can you provide kind of a gap in cash cap rate on kind of what you expect those deals to be done at? I don't think I saw anything as it relates to cap rates in the press release.

Speaker 1

Yes. I think, Steve, if we achieve the new sales target, which we're obviously confident on because we put it out there, we think the blended cashing GAAP cap rate is going to be right around 8%.

Speaker 3

Great. Thank you. That's it.

Speaker 1

You're welcome. Thank you.

Operator

Thank you. Our next question comes from Anthony Paolone with JPMorgan. Your line is open.

Speaker 5

Yes, thanks. Good morning. Just if we can get back to Uptown ATX, you said the pipeline there ranges from 6,000 square feet to 200, and there's been all the discussion out there around NVIDIA looking for over 300,000 square feet. Would something like that be considered in your pipeline or is that not?

Speaker 1

No. Look, I think any tenant who's in I think it's safe to say Tony and good morning, that any tenant who has a whisper of meeting office space in Austin, we're all over them. So I don't want to get into specifics of any one deal versus another deal, but we have a very, very good talented team of in house leasing folks on there augmented by a strong external team. So we track every single potential transaction in that market, whether looking at the Southwest, the Northwest, CBD. So we've been very pleased with the level of tour activity uptown.

Speaker 1

We clearly know we need to get at least. But now with the road improvements done, the residential component open, amenity floor done, The project really does show incredibly well. So as soon as we know any prospect is looking at space, even if they even if we're not on their initial tour because we're looking at a different submarket, we're on top of them, we're getting them marketing materials, videos, we're visiting them. So again, I won't name any specific tenant because there's a number of larger users kicking around the marketplace. But I think it's a safe assumption on your part to assume that we are talking to every tenant in the marketplace.

Speaker 5

Okay, got it. And then just my only other one was on Sierra Center. It seems like you're going up another floor on the lab space there. Can you just remind us like how much of the building now is lab and where sort of the limitation is there? I thought you guys had already hit that, but I guess there's still a bit more room.

Speaker 4

Yes, Tony, it's George. We delivered a full floor of graduate labs on the 9th floor. So the building in total is 27 floors. The lower bank 9 floors are what have been targeted for life science. 9th floor delivered fully leased and occupied.

Speaker 4

The 8th floor, 99% done in terms of build out with 4 different prospects with leases currently being negotiated. That would leave us really just with the 7th floor and a portion of the 6th floor left as potential either office expansion for those life science tenants or given the pipeline needs the opportunity for additional graduate lab expansion.

Speaker 5

Okay, great. Thank you.

Speaker 1

Thank you, Tony.

Operator

Thank you. Our next question comes from Michael Griffin with Citi. Your line is open.

Speaker 6

Great, thanks. Just want to circle back to kind of the development pipeline leasing for a sec. Do you think that you might have to really ratchet up concessions in order to entice tenants to sign leases and then maybe just on the concessionary environment broadly. Have you started to see concessions paper off or is it fair to say they're pretty elevated still?

Speaker 1

I think it varies a bit by the different marks. I think in the Philadelphia area on the development projects, we really haven't seen concessions kick up. I think where we've seen increased requests for TI for tenant improvement dollars, We're able to amortize that as part of the rental income stream. So haven't really seen any material change there at all. Austin is a competitive market.

Speaker 1

So I think there we're seeing us as well as our competitors keeping face rates, annual bumps, lease terms around the same, where we're probably and not a real huge increase in free rent either, Michael. We're seeing a little bit of pressures on the increased TI side. I think most tenants, they want a higher level of tenant improvement allowance. In many cases, we're able to get longer lease terms. But in terms of upfront load, we're definitely seeing a little more of upward pressure, particularly in Austin on the TI side.

Speaker 6

Thanks, Jerry. Appreciate the color there. And then just on the disposition pipeline, is it fair to assume the properties in there are similar to the portfolio that you sold them from this meeting? And I know that you mentioned probably there's no there's not going to be any seller financing with the subsequent transaction. But for the Plymouth Meeting deal, was there a need for that seller financing due to a lack of debt capital available for the transaction?

Speaker 1

Yes, great question. I guess stepping back for just a second if I might. I mean a couple of key points I think when we do get investor inquiries on our sale program. I mean, look, we're as I mentioned, we're in a very strong liquidity position. And really as a result, we're only really marketing properties for sale that we really view as non core due to either change in submarket conditions, their position in those submarkets, assets, physical, superstructure, infrastructure limitations, etcetera.

Speaker 1

And we also recognize that valuations are in a state of flux due to both uncertainty on some demand drivers for some of the B inventory and certainly as you touched on the state of the financing markets. So as such, we're really focused on using kind of this time period to improve our overall competitive position for the company on our best assets of which we have many. And then really calling the portfolio of properties even at a bit of a discount to improve our overall competitive position for the organization, reduce forward capital spend and then generate some incremental liquidity. So I think the when I looked at a deal like we did in the Pennsylvania suburbs, we're at a time in the market where you really do need to recognize reality, even if it's something you don't particularly like. And I think when we did help us think through that reality, we take a look at what the net present value of us holding any single asset is in terms of downtime, sunk expense costs, base building, TI capital required, etcetera.

Speaker 1

And we come up with a range we think the net present value of that asset hold period is. And if we go to the marketplace and the marketplace gets within that strike zone, we typically will sell. Even if we don't necessarily like where the price was versus our previous expectations, it's the right financial decision for the company. In some cases, based upon the profile of the property and this property sold was one of them, given the forward rollover, given the overall state of the financing markets, given the capital requirements to get that transaction closed, we needed to augment that with some seller financing. Good quality buyer, very good capital plan from their standpoint.

Speaker 1

We think the position is very secure. It's a great coupon rate for us that ramps up over time. So to facilitate us achieving our larger picture, which is to better improve our competitive position overall with our inventory, selling an asset like that made a lot of sense for us.

Speaker 6

Great. That's it for me. Thanks for the time.

Speaker 1

Thank you, Michael.

Operator

Thank you. Our next question comes from Michael Lewis with Truist Securities. Your line is open.

Speaker 7

Great. Thank you. So I cover Apartment and Office REITs and I get questions from investors in both sectors about residential conversions. Your 2 largest building vacancies on Page 4 of your supplemental say that you're evaluating the feasibility of a residential conversion. I think this is the 5th quarter in a row that those have said that.

Speaker 7

So I thought maybe you could just give a little color into what the process is and the timetable and the evaluation metrics that you're looking at. And if you think those will ultimately be conversions, just some comments on the process that we might be able apply to Brandywine and to kind of the broader question of whether we'll see a lot of these?

Speaker 1

Yes, Michael, great question. I think, I mean, the 2 properties really are the property we have in Wilmington, Delaware as well as a complex we have up in Northwest Austin. They're both a little bit of a different circumstance. Let me share with you the current rate thing. Number 1, we think they both are going to pass the muster for residential conversion.

Speaker 1

They do require a lot of upfront architectural design, a lot of work on the mechanical side to make sure that number 1, it's feasible to do. And then number 2, that what we could deliver is a marketable product that will achieve the rents that we're targeting. So we're reaching the conclusion part of that process on both of those projects. Both projects require some level of approval from the local authorities. To obtain those approvals also requires a level of community engagement.

Speaker 1

So that community engagement efforts underway on both of those properties to make sure that we feel comfortable from an approval standpoint, we get those approvals perfected and move forward with both projects. I will tell you, we have looked at a number of other opportunities where we don't think the conversions are feasible. And I know from a national standpoint, there's a number of initiatives underway in the public sector. There's a bill pending in the Ways and Means Committee of Congress now that provide accelerated tax credits for office to residential conversions. There is discussions underway here in the Commonwealth of Pennsylvania do the same thing.

Speaker 1

So my guess would be to get some of these to get the volume of office to residential conversions accomplished will require some level of public subsidy and that public subsidy will probably be conditioned upon having some element of affordability in the delivered units. So I know on those two properties, they've been on there for a number of quarters, but we did want to highlight to our investor base that we don't view these properties as necessarily viable office properties for us going forward. And we're going down the path to see if we can achieve a residential conversion there.

Speaker 7

Okay, got it. And then my second question, I'm going to make this up on the fly, but the stock is down about 7% this morning. The only change I think in the guidance, you can correct me if I'm wrong, is the land sale gains. I don't remember those called out before. But even with those, the consensus is at the high end of your revised guidance range.

Speaker 7

Maybe people expected some Austin leasing, maybe the seller financing concerns people. You just said you won't do any more of that. So I don't know, maybe just an opportunity here to talk about whether you think things are improving, have gotten better over the last quarter, whether we're not out of the woods yet, just kind of a general sense of where we are, when do you think occupancy is troughing, just anything to kind of I think is improving or not?

Speaker 1

Yes. Look, thanks for that question and we welcome the opportunity. Look, I think at a macro level, look, the overall landscape is definitely improving. The quality thesis has real traction. I mean, just look at the percentage of our deals that were moved up the quality curve.

Speaker 1

You look nationally statistically, roughly the 100,000,000 square feet of positive absorption has really been less than 10% of the office stock, which is really driven, which reinforces that quality thesis. The occupancy spread between A and B quality product is close to historic high at almost 800 basis points. And you have very, very limited supply growth going forward. So even with demand remaining somewhat muted, although I think it will pick up, the really good assets will see their competitive positions improve over time and I think lead to a formula of significant upward rent pressure on both a notional and effective rent base. I think from a Brandywine standpoint, look, we certainly think our occupancy is pretty well trough.

Speaker 1

With the delivery now of these development projects and the pipeline we have, we are very keenly focused on getting some additional leasing done. So I do think probably some investors might have been expecting more leasing. Now the residential properties are performing in But the But the operating portfolio is in very good shape. We did actually talk about the potential for a deferred land gains last quarter, but probably didn't highlight it to the extent that we probably should have. But I think the landscape for Brandywine given the positive macro overtones, but also the strength of our market positioning, augment it by the foundation we have in the operating portfolio is really very strong going forward.

Speaker 8

Great. Thank you.

Speaker 1

Thank you.

Operator

Thank you. Our next question comes from Upal Lanna with KeyBanc Capital Markets. Your line is open.

Speaker 9

Hi. This is Gabby on for Upal. Could you talk about your plans for the DC market and maybe any expectations on how you plan to reduce exposure down the line there?

Speaker 1

Happy to do that, yes. I mean, D. C. Has not really been a growth market for us for a number of years. We did a number of we did several joint ventures of our existing portfolio in D.

Speaker 1

C. A number of years ago. Those joint venture kind of reaching their natural conclusion point. I think we'll be exiting a number of those properties. At this point, our wholly owned portfolio is really down to 3 buildings, 2 in Tyson I'm sorry, 4 buildings, 3 buildings in Virginia, 1 in Maryland.

Speaker 1

So we have 2 buildings in Tyson at 1676 and 8,260, which are performing well. There's some vacancy there and we're trying to figure out if there's a formula there for us continue investing money to bring that occupancy level back up. We have one remaining wholly owned building out in on the toll road out by in Herndon and Dulles Corner that just is going through the process of major tenant moving in there now. And then one building that's fully leased over in Maryland. We'll continue to manage and operate those properties to our high standards, waiting for the investment market to improve.

Speaker 1

And as that market improves, I think our plan will be to sell those assets over the next couple

Speaker 8

of years.

Speaker 9

Thank you. That's helpful. And then as a follow-up, are you able to provide color on your few known move outs looking ahead and any conversations you're having with tenants about renewals or other options? And then maybe any idea on when you could anticipate net absorption turning positive?

Speaker 8

George, do you want

Speaker 2

to take that?

Speaker 4

Sure. Yes. I mean, as Jerry has outlined, I mean, our forward rollover exposure is extremely low. When we look at our 2025 expirations, we have one tenancy, 40,000 square feet here in the city of Philadelphia that the space was being utilized for construction swing space. That lease will end in the Q3 of 2025.

Speaker 4

Outside of that, we don't have any other large expirations. The next largest on the list is a 20,000 square footer in Austin. So we do think occupancy has troughed. I think during this Q3, we had 141,000 square feet of move outs, 100,000 square feet of that was a tenant here in Philadelphia that we've already backfilled 40% of that space. So we do think that the work that our leasing teams have done to reduce the forward rollover curve and the prospects that we have in the market to replace those that we do in fact lose bodes well for occupancy gains.

Speaker 1

Thank you.

Operator

Thank you. Our next question comes from Ohed Bregman with Deutsche Bank. Your line is open.

Speaker 8

Yes, good morning. This is actually Tayo from DB. Thanks for taking the time. The first question I had is on the joint ventures, any additional work that still has to be done in that regard or are we kind of at the point where they've all been recapitalized, repositioned, restructured?

Speaker 1

We're really closing in the getting across the finish line. I mean, most of those have been resolved. We have 2 more that are in kind of transition that we expected to be resolved by the end of the year in discussion with partners and lenders. We would expect to have those 2 ventures fully behind us by the time 2024 ends.

Speaker 7

So as I mentioned earlier

Speaker 2

I'm sorry?

Speaker 8

I'm sorry, Jerry, which 2 are those and is it just the debt that needs to be refinanced or what has to happen there?

Speaker 1

Yes, I think on one is a one small portfolio down in DC and that's in discussions with the lender at this point. And whether that portfolio is sold or restructured is in process right now. And then one other property where we're involved with our partner on a potential sale of our interest.

Speaker 8

Got you. Okay. Then if you could just indulge me and pardon me if I missed it earlier, but could you talk a little bit about the retention rate in the quarter? Again, it was kind of lower than kind of what you've guided to for the year. And then you actually increased guidance on retention for the year as well.

Speaker 8

So wondering again about the confidence in 4Q to kind of get the overall retention for the year higher than you initially expecting?

Speaker 4

Sure. This is George. I'll take that one. So the Q3 retention was negatively impacted by that 100,000 square foot move out here in the city of Philadelphia. That move out was known.

Speaker 4

That move out was in our full guidance range for the year. We are confident in meeting that new provided increased retention rate because the balance of the leasing plan for 2024 is 100% complete at this point. So we know the tenants that are leaving in the Q4 and we know the ones that have already signed their renewals. So the reason we were able to substantially increase it over the course of the year for the fact that we got some additional tenant expansions done. And then we had a number of tenants who in our original business plan we thought would not stay ultimately opted to stay.

Speaker 8

Thank you.

Speaker 1

You're welcome. Thank you.

Operator

Thank you. Our next question comes from Dylan Brzezinski with Green Street. Your line is open.

Speaker 10

Good morning, guys. Thanks for taking the question. Just sort of touching on the disposition guidance, I mean, just sort of trying to figure out, as you guys have gone through the marketing process throughout the year and gotten into contracts to sell the portfolios and assets that you guys referenced, I mean, how has that pricing shaken out relative to your initial expectations?

Speaker 1

It's actually our initial expectations when we launched the marketing process for those assets, we have stayed very much on track. I think we've got surprise to the upside on 1. The others were very much within the range of both we and the listing broker thought they could achieve. So no material change at all from what the launch pricing expectations were.

Speaker 10

And then maybe just touching on the Commerce Square transaction, you guys took up your ownership there. I mean, is there any as we look at as we think about the future of the company and the JVs that you guys have in the development pipeline as well as Future Commerce Square. I mean any desire to continue growing your ownership in the development projects or Commerce Square?

Speaker 1

Well, I think looking at Commerce Square, Bill, and I think, I mean, you may recall several years ago, we bought an investor in that project in a preferred position. And at that time, based on the reporting requirements, we wrote the value of the asset up about 2 $70,000,000 I think as we start to think through sources and uses of cash, given our liquidity position and frankly the cost of that preferred, we bought back a piece of that a few months ago. And when we did that, we were required to do an as is appraisal. Take a look at what the appraisal, the appraised value was. That's what kind of resulted in the write down based on the as is that I know we think the as is value based on the appraiser is much different than the stabilized value when we lease up the project.

Speaker 1

So it's really the commerce is driven by the cost of preferred, the strength of our liquidity position, what we believe is a fairly low and attractive investment base. So we thought that was a good transaction. In terms of your broader question, look, I think one of the opportunities we have as a company is to on these larger joint venture developments be that at Schuylkill Yards or at Austin, an opportunity to bring those assets on balance sheet. We structured those deals on a preferred basis where Brandywine is entitled to 88% to 90% of the upside of those properties. So as those properties approach stabilization, we certainly think that presents a very good opportunity for us to bring those assets on balance sheet.

Speaker 1

Did that answer your question?

Speaker 8

Yes, that's very helpful. Thanks, Jerry. Really appreciate it.

Speaker 1

Thanks, Dylan.

Operator

Thank you. Our next question is a follow-up from Steve Sakwa with Evercore ISI. Your line is open.

Speaker 3

Yes, thanks. Jerry, I just wanted to circle back on the apartments, I mean, in particular, I guess, Philly, because that one's been open much longer than Austin. And you went from 73% to 80%. And I know that seemingly was in your kind of bull's eye of where you wanted to be. But that 7% only equates to about 23 units, if I'm doing my math right, about 8 per month, which typically just seems like a low slow pace of leasing.

Speaker 3

So is there something kind of going on in Philly that you're intentionally holding back units? Is that a price point issue? Just 8 per month would strike me as low for a lease up asset.

Speaker 1

Yes. I'm looking for my notes here. I thought it was closer to 13 or 14 per month because we were at trying to find my page here, excuse me. While I'm looking, the answer is August was slower than we would have hoped, but we had and it's only really been Steve, it's been less than 3 months since our last call. So it's late July, we're now in October.

Speaker 1

So I think we are we were really focused on getting to that target by the end of the year. And I think we've met that target. Let me just see here. You guys have that page there? So I actually I thought it was about 14, 13, 14 units a month.

Speaker 1

We went from we're at 2.78, I thought we were in the $2.35 range. Anyway, we'll get back to that. But I think to answer your question, we're not holding back anything. I mean, we're clearly on a full court press to get all of our units leased. Same thing down at Solaris House where we had a little bit of a permitting delay to open those units up.

Speaker 1

So those units actually didn't open up until mid September. So yes, I got we have it here, Steve, sorry. So we were 278 leases, we're 237 last, so 41 over 3 months, we're 14 units per month.

Speaker 3

Okay. I'll go back and double check my math.

Speaker 1

I guess We would like to be there.

Speaker 2

Right. I'm sure you would.

Speaker 1

Pretty good in the summer. Yes.

Speaker 3

Okay. I guess to go back to Michael Lewis' question about the stock being down. I guess there were some comments by Tom maybe just about some dilution and you mentioned 8% cap rate, the dilution on the developments coming online. I know you're not giving 25 guidance, but at this point, is it fair to assume that it's going to be very challenging to have FFO growth next year and most likely FFO growth might dip down and be negative in 2025 before bouncing back in 2026 as the development stabilized given that you haven't done any office leasing of size in Austin and those leases would take time to kick in and 3,151 is nearing completion and unless you get a lease soon, may also contribute to some earnings dilution next year before stabilizing in 2026 and beyond?

Speaker 1

Yes. Look, I think as we bring these properties on, particularly with the residential properties where that interest capitalization ends, as Tom and I both touched on, there's going to be some run rate similar to what we'll have in the Q4 of 2024 impacting earnings growth for next year. Now certainly the expectation is given the pipeline we have, we'll be able to announce some definitive leasing activity that provides a clear runway to FFO growth. As I mentioned, when these properties come online, there'll be a huge boost to our FFO base to the tune of almost $50,000,000 a year from a cash standpoint. So we do anticipate that that trend line will be very, very positive, albeit with a transition period we'll be recognizing not capitalizing interest and the preferred the cost of preferreds.

Speaker 3

Great, thanks. That's it for me.

Speaker 1

Thank you, Steve.

Operator

Thank you. Next question is a follow-up from Tayo Okusanya with Deutsche Bank. Your line is open.

Speaker 8

Yes. Just a quick one along Dylan's line of questioning. Again, you guys did increase the guidance for dispositions. But at the same time, too, you kind of got cautious on the outlook for land sales. So I guess I'm just a little bit curious in regards to why is it that for kind of fee simple asset sales, you've gotten maybe a little bit more constructive, but for just like land, it actually feels like it's a little bit more difficult to sell?

Speaker 1

Yes. I think short answer is in this kind of marketplace, land is a challenge to sell. There's really not a lot of financing source that will provide debt financing on that. There with cap rate uncertainty, whether it's in the multifamily class or the office sector or industrial sector, folks aren't really sure what the underwrite, the required development yields. And one of the first things that gets squeezed there in terms of valuation is land.

Speaker 1

So you have a combination of kind of residual cap rate uncertainty, obviously what the development yields need to be and the challenged financing market. So we when we developed the business plan for 2024, we did expect to have a couple of land sales closed based upon where they were in the contract in the contractual and approval process. And at the recent date, those deals fell apart because of lack of financing.

Speaker 8

Sounds good. Thank you.

Speaker 1

Thank you.

Operator

Thank you. I'm showing no further questions at this time. I'd like to turn the call back over to Jerry Sweeney for closing remarks.

Speaker 1

Great, Michelle. Thank you and thank you all for participating in this earnings call. We look forward to updating you on our Q4 and 2025 business plan after the 1st year. So thank you very much and have a wonderful day.

Operator

Thank you for participating. You may now disconnect. Good day.

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Earnings Conference Call
Brandywine Realty Trust Q3 2024
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