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Text: We appreciate you joining us today for Piedmont's fourth quarter 2021 earnings conference call.
At this time, our president and chief executive officer, Brent Smith, will provide some opening comments and discuss our fourth quarter and annual results and accomplishments.
On the line with me is Eddie Guilbert, our executive vice president of finance and treasurer; George Wells, our chief operating officer; and Bobby Bowers, our chief financial officer; as well as other members of the senior management team.
Their tireless dedication continues to garner industry honors for operational excellence and sustainability, including our recognition as the 2021 ENERGY STAR partner of the year and achieving LEED status now on roughly half of the portfolio.
Today, I'm going to cover Piedmont's operational success and leasing momentum along with an update on capital allocation activities across our markets.
Focusing on the fourth quarter of 2021, our FFO per share was $0.51, in line with market consensus.
Portfolio operating metrics were solid with same-store NOI on a cash basis increasing 5.8%.
We leased approximately 400,000 square feet, generated a 3% increase in second-generation cash rents and executed an average lease term of six and a half years, illustrating the longer-term view taken by most of our customers.
Most notably, about half of the fourth quarter's leasing was related to new tenants, making this the second consecutive quarter Piedmont has achieved pre-pandemic levels of new leasing.
Overall, leasing activity remained robust and well dispersed across the portfolio with over 40 leases and amendments executed during the fourth quarter.
And while the omicron variant had a modestly negative impact on building utilization during December and January, the leasing pipeline has not dissipated and we expect the momentum from the second half of 2021 to continue.
Today, our leasing pipeline stands at over 500,000 square feet of negotiations.
And we're trading LOIs on an additional 1 million square feet, which positions Piedmont for space absorption in 2022 and with only about 1 million square feet of existing leases expiring or about 6% of the portfolio.
Boston, Dallas and Atlanta remain our most active leasing markets, albeit for different reasons.
The Boston market continues to exhibit strong fundamentals led by business migration to the suburbs and reduced competitive Class A office stock as the insatiable demand from life science users continues to drive office to lab conversions.
For example, during the past year in our Burlington submarket, three competitive Class A buildings comprising over 400,000 square feet have been repurposed to labs, helping to push net effective rents for office space to pre-pandemic levels.
And in Dallas and Atlanta, our two largest markets, we continue to see an increasing number of corporate relocations, resulting in meaningful job growth.
As an example, during the fourth quarter, we signed a 55,000 square foot lease at our Connection Drive property in Dallas to serve as the new corporate headquarters of an undisclosed Fortune 500 company.
And in that same market during the second quarter, we signed a 44,000 square foot lease to serve as the corporate headquarters for a large national beverage distributor.
In both these markets, rents at our properties are now above pre-pandemic levels.
However, net effective rents are approximately 2% to 5% lower.
I would note a customer flight to quality is well underway, which is driving wider rent disparities between place-making versus commodity office product.
For example, JLL Research noted that 84% of Atlanta leasing activity in the fourth quarter was in Class A or trophy product.
Orlando also continues to perform well with leasing and tour activity across all five of our downtown properties at pre-pandemic levels.
The downtown submarket continues to experience population inflows particularly for the millennial and Gen Z cohorts driven by a highly walkable environment with expanding retail, food and beverage options, along with entertainment amenities surrounding the University of Central Florida's Creative Village campus, Amway Center Arena and Camping World Stadium, along with a uniquely urban Lake Eola.
In Orlando, net effective rents are still trailing pre-pandemic levels by about 5% as a result of increased concessions.
Finally, Minneapolis, the districts in Washington, D.C. and New York City, all experiencing increasing tour activity.
However, leasing velocity and tenant demand still lag our Sunbelt markets.
I would add, we are fortunate to have limited vacancy and near-term lease expirations at our 60 Broad Street property in Lower Manhattan and virtually no expirations at our Washington, D.C. properties for more than two years.
Leasing across all our core markets contributed to the fourth quarter's totals.
And our customer CEO and HR dialogue continues to show our portfolio is positioned to gain market share.
Users of office space are undertaking a flight to quality that focuses on new or newly renovated office buildings with unique environments and a vast set of amenities, owned and operated by responsive, sustainability-minded service-oriented landlords.
And because of these demand drivers, Piedmont's portfolio is well positioned, supported by a concentration of newly renovated, well amenitized buildings located near housing communities and highly regarded education systems with easy accessibility to major highway thoroughfares and airports.
But today's tenants are not only focused solely on location and neighboring amenities.
The physical attributes of a building have never been more important.
The building's indoor air and light, HVAC, fresh air intake, elevator capacity and outdoor collaboration space are all critical.
In addition to high-quality building in a vibrant environment, customers are demanding a higher-quality landlord as well.
And by that, we mean an attentive operator that focuses on sustainability initiatives and which has the capital base and scale to provide tenant offerings and engagement.
Office space is no longer just a real estate product.
Taking a look back at the operational highlights for the 2021 fiscal year.
Piedmont leased almost 2.3 million square feet, which was in line with our average pre-COVID annual leasing levels.
In addition, the increase in second-generation cash rents was seven and a half percent, which helped increase same-store cash NOI for the year by almost 7%.
And finally, our tenant retention ratio was in line with prior years at approximately 70%.
Recovery in leasing activity bolsters our optimism for the rebound of the office sector, and particularly for landlords such as ourselves who offer high-quality, modernized sustainability-focused amenity-rich environments.
Looking ahead, approximately 750,000 square feet of tenant leasing has yet to commence as of this year-end or is in some form of abatement.
This backlog creates organic growth opportunities going into 2022 associated with approximately $26 million in future annualized cash rents.
In addition, approximately 60% of the portfolio's vacancy and 85% of 2022's lease expirations resided in our Sunbelt properties, where we are experiencing the greatest level of leasing velocity.
A schedule of the larger upcoming lease commencements and abatements is included in our supplemental financial information, which was filed last night.
Pivoting now to capital allocation activities.
Despite the disruption from the pandemic and more recently, the omicron variant, the office investment sales market has continued to unthaw.
We are currently in discussions on a pipeline of over $1 billion of high-quality assets primarily for properties in our Sunbelt markets.
Furthermore, we are encouraged to hear of several targeted buildings that will be coming to market in the first half of 2022.
Our principal and broker dialogue suggests insurance companies, pension funds and other private market participants are planning to reduce their office sector exposure in the near term in currently well-leased Sunbelt office with more than seven years of weighted average lease term is among the most liquid type of property in the asset class.
The increase in transactional activity is encouraging, given Piedmont's strategy to recycle capital strategically as an additional driver for our earnings growth.
And finally, I would note that cap rates remain steady for high-quality assets with limited lease rollover and particularly those that are highly amenitized and that can compete with new construction.
While the investment sales market has improved, construction starts have slowed dramatically due to the uncertainty created by the pandemic, a positive for the continued office market recovery.
With supply chain constraints, the construction of new product will now take two and a half to three years to be delivered.
In addition, new construction costs have escalated by 15% to 20% versus pre-pandemic pricing driven by an increase in both raw materials and labor.
In this capital environment, Piedmont continues to focus on our redevelopment opportunities where costs and time lines can be more easily managed.
In 2021, we completed over $50 million of incremental investment in our properties, upgrading assets to remain best-in-class within their respective submarkets.
That said, we continue to have dialogue with a number of clients regarding pre-leasing for ground-up development.
Focusing on Piedmont's investment activities.
During the quarter, we expanded our Atlanta market footprint with the acquisition of 999 Peachtree Street.
And subsequent to quarter end, I'm pleased that we closed on the disposition of a Raytheon asset as well as accelerated our plan to exit from the Chicago market.
As you all know, the 999 acquisition marks our entry into Midtown Atlanta submarket.
The iconic Class A LEED-Platinum 28-story building, a 622,000 square feet with 77% leased at acquisition.
We purchased it for $360 a square foot, which we estimate is over 40% below replacement cost.
We're working with Gensler, a tenant at the building to complete the redesign of 999s arrival experience in public spaces, including a modernized and expanded lobby, energized outdoor space and other enhanced amenities, which will complete over the next 12 to 18 months, and we'll revitalize this asset in a fraction of the time and cost of new construction.
With a 10-foot glass window line across 70% of the facade this asset will effectively compete against new construction at a fraction of the cost with an expected all-in basis in the low $400 per square foot versus new product costing in excess of $650 per square foot, creating substantial pricing leverage for our building when compared to that new development.
The $224 million acquisition of 999 is being funded through multiple dispositions.
Immediately after quarter end, the disposition of 225 and 235 presidential Way in Boston closed in a reverse 1031 exchange for $129 million or a mid-5s cap rate.
Also subsequent to quarter end, we negotiated an agreement to sell and have closed on Two Pierce Place, our last remaining asset in the Chicago area, and we'd anticipate more non-core asset proceeds in the first half of 2022.
The acquisition of 999 Peachtree Street during the fourth quarter as well as the completion of two non-core dispositions just after the quarter end, now makes Atlanta our largest market based on annualized lease revenue.
Adjusting our lease percentage for the disposition transactions our pro forma lease percentage as of December 31 would have been 87%.
Additionally, approximately 63% of our annualized lease revenue is now generated from our Sunbelt properties and our goal is to have 70% to 75% of our ARR generated by our Sunbelt markets before the end of 2023.
We believe a goal that's attainable given the investment in sales market activity we see today.
Myself and the team were extremely grateful to be able to share some of our most recent redevelopment projects.
Looking back on 2021, core FFO for the year was $1.97 per diluted share, a 4% increase over 2020 and in excess of the upper end of our original guidance range for the year.
This growth in core FFO overcame an approximately 1% reduction in our overall lease percentage on a year-over-year basis.
The decrease in occupancy was driven by several factors: Reduced leasing activity during 2020 in the first half of 2021 as a result of the pandemic, a number of sizable lease expirations at recently acquired properties in Atlanta and Dallas that were underwritten as part of their respective acquisitions and the purchase of the 77% leased 999 Peachtree Street property.
After incorporating the just completed disposition activity in January of 2022, our pro forma lease percentage as of December 31 would have been 87%.
We reported $0.51 per diluted share of core FFO for the quarter.
That's an 11% increase over the fourth quarter of 2020.
This increase is primarily due to accretive recycling activity and rising rental rates.
Our core FFO achievement during the fourth quarter also reflects the repurchase of approximately 1 million shares of our common stock at an average price of $17.76 per share during the quarter, leaving approximately $150 million in board authorized capacity under our share repurchase program.
Now, core FFO, as you know, excludes gains, losses, impairments on real estate as well as excluding depreciation and amortization.
And I do want to discuss this real estate activity during the fourth quarter of 2021.
While we had originally intended to lease up Two Pierce Place before disposition, we received an unsolicited offer to purchase the asset during the fourth quarter.
Given the fact that we have no other Chicago holdings, we made the decision to accept the offer if the purchase could be negotiated and closed quickly thereafter.
As is often the case, gap typically just dictates early recognition of potential losses and the decision to shorten the hold period for this asset did result in the recognition of a $41 million impairment charge that is included in our fourth quarter results of operations.
On the flip side, the sale of 225, 235 presidential Way will result in the recognition of an estimated $50 million gain during the first quarter of 2022 when the sell closed.
AFFO generated during the fourth quarter was approximately $39 million, which is well above our current $26 million quarterly dividend level.
Our board has indicated that given our cash NOI growth over the last few years, the fact that we're approaching the conclusion of the large construction restacking project for the State of New York at 60 Broad, and the time since our last dividend increase, they will be reviewing our dividend payout amount during 2022.
Turning to the balance sheet.
I expect more attention will be focused now on corporate financial positions given the rising interest rate environment, including the amount of floating rate debt, upcoming maturities and overall leverage.
Our annual debt -- net debt to core EBITDA ratio as of the end of the fourth quarter of 2021 was 5.7 times and we reported $210 million of unused capacity on our line of credit.
Taking into consideration the completed disposition activity occurring right after year-end, with the net sales proceeds received in January, our current available capacity on our $500 million line of credit is approximately $320 million, with an approximate $120 million more expected later this quarter from the payoff of a note receivable.
Adjusting for the application of proceeds from the two closed January sales, our pro forma debt to gross asset ratio at year-end would have been approximately 35%.
We have no secured debt currently on our books and we have no scheduled debt maturities in 2022 other than our revolver, which we currently intend to renew long term later this year rather than exercise the line's short-term extension options.
Finally, we're introducing 2022 annual financial guidance for core FFO in the range of $1.97 to $2.07 per diluted share.
This guidance assumes a gradual increase in physical utilization of our buildings by our tenants over the course of the year, to a level near pre-COVID utilization by the end of the calendar year.
It also assumes a neutral amount of asset recycling during the year with about $350 million to $450 million each of acquisitions and additional dispositions.
This net neutral activity excludes the recently completed sales of the presidential Way assets and Two Pierce Place property that were used to fund the 999 Peachtree Street acquisition.
We will provide revised guidance as each significant acquisition or disposition is completed this year.
The guidance assumes general and administrative expenses in the range of $29 million to $31 million for the year.
Our same-store cash NOI growth is expected to be flat for the year with a number of abatements occurring during 2022 due to the lease renewals and newly commencing leases such as 160,000 square foot renewal at 1155 Perimeter Center West in Atlanta, and a 56,000 square foot lease at 400 Virginia in Washington, D.C. As well as downtimes between leases associated with new tenant build-outs, such as a 67,000 square-foot lease at 5 and 15 Wayside in Boston and a 44,000 square foot lease at One Lincoln in Dallas.
Accrual-based store NOI is expected to grow from 1% to 3% during the year.
I will remind you that these estimates will ultimately be dependent upon the transactional activity achieved during the year since such properties will be excluded at year-end, from the same-store two-year comparisons.
Likewise, our lease percentage is expected to grow to approximately 88%.
But again, this estimate is subject to the lease percentages of the properties involved was $350 million to $450 million of potential recycling transactions completed during the year.
Our forecast also assumes there will be three to four interest rate hikes during 2022 that will impact interest expense negatively versus recent prior years.
And finally, we are assuming a dividend adjustment around midyear, and it is not expected to impact our overall financial results.
With that, I'll now ask our conference call operator to provide our listeners with instructions on how they can submit their questions.

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reported core funds from operations (core ffo) per share of $0.51 for quarter.
introducing 2022 financial guidance of $1.97 to $2.07 per diluted share of core ffo.

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