Highwoods Properties Inc

NYSE:HIW

Earnings Call Transcript 2023-Q1

[Operator]

Good morning, and welcome to the Highwoods Properties earnings call. During the presentation all participants are in a listen-only mode. Afterword’s we will conduct a question and answer session. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, April 26, 2023.

I would now like to turn the conference over to Hannah True. Please go ahead, Ms. True.

[Hannah True, Financial Analyst]

Thank you, operator, and good morning, everyone. Joining me on the call this morning are Ted Klinck, our Chief Executive Officer; Brian Leary, our Chief Operating Officer; and Brendan Maiorana, our Chief Financial Officer.

For your convenience, today's prepared remarks have been posted on the web. If you have not received yesterday's earnings release or supplemental, they're both available on the Investors section of our website at highwoods.com. On today's call, our review will include non-GAAP measures such as FFO, NOI and EBITDA. The release and supplemental include a reconciliation of these non-GAAP measures to the most directly comparable GAAP financial measures.

Forward-looking statements made during today's call are subject to risks and uncertainties. These risks and uncertainties are discussed at length in our press releases as well as our SEC filings. As you know, actual events and results can differ materially from these forward-looking statements, and the company does not undertake a duty to update any forward-looking statements.

With that, I'll turn the call over to Ted.

[Ted Klinck, President, CEO and Director]

Thanks, Hannah, and good morning, everyone. During the first quarter, we once, again, had strong financial and operational results. Leasing activity was solid; same-property cash NOI growth was positive; FFO per share was healthy, with a sequential increase from the fourth quarter; our cash flows continue to strengthen; and we reinforced our already fortress balance sheet by bolstering our near-term liquidity.

Our well-diversified, high-quality portfolio continues to outperform versus our markets and compared to other major metro areas throughout the U.S. As we stated last quarter, we believe that to be resilient, we must be diversified, which is a core component of our long-stated simple and straightforward goal of generating attractive and sustainable returns over the long term.

With nearly 2,000 customers, our portfolio is located in eight core Sunbelt markets, with a sharpshooter focus on best business districts, which are both urban and suburban. Our largest market is Raleigh, with just over 20% of our total NOI. Our largest customer, Bank of America, is less than 4% of total revenues. Our largest industry, financial services, is less than 20% of our revenues. Our average lease size is under 15,000 square feet, and our median lease size is 5,000 square feet.

Further, we believe there is a clear preference for quality when choosing office space, not just the high-quality buildings, but also high-quality locations and of increasing importance, high-quality, financially stable landlords.

Our portfolio is outperforming our submarkets by an average of 590 basis points on occupancy, and this outperformance increases to 750 basis points when compared to the U.S. average. We believe we are well positioned to increase this outperformance as customers and prospects focus even more intently on the quality of the building and the financial health of the property and its owner.

That being said, our portfolio is not immune to the cyclical headwinds that all office landlords face during an economic downturn. While tour activity remains encouraging, we do expect demand will be negatively impacted as customers and prospects become more cautious about their own businesses in the near term. We do believe that high-quality rewards with high-quality portfolios will, more often than not, visit on the flight to quality.

From a usage perspective, we can continue to be encouraged that our customers are increasingly retreating to the emphasis. While the overall office utilization hasn't returned to pre-pandemic levels, customers in our markets from all industries are realizing the difficulties of replicating the culture, creativity and productivity of their teams who went away from the office. Our goal is to provide our customers an environment where their teams want to come into the office to be with their colleagues or said another way, provide workplaces that are commute worthy.

Turning to the quarter. We delivered FFO of $0.98 per share. Same-property cash NOI was solid at plus 0.8%, despite the headwinds of lower occupancy due to a large known customer move-out in Nashville, which has already been backfilled, but whose lease doesn't commence until early next year. At quarter end, occupancy was 89.6%.

While overall leasing square footage volume declined modestly with 520,000 square feet of second-gen space, including 220,000 square feet of new leases, the number of leases signed remained stable at around 100 for the quarter. Each year, first quarter volume is typically lighter than subsequent quarters given the rush of getting deals done before December 31.

Of note, we signed net expansions of over 50,000 square feet, which follows a strong fourth quarter. And the number of expansions outpaced contractions by a ratio of 5:1. Rent spreads were positive 15.9% on a GAAP basis and positive 2% on a cash basis. Average rental rates are 3% higher on a cash basis compared to 1 year ago.

While it was a quiet quarter on the investment front, we're actively assembling the building blocks to further strengthen the resiliency and long-term growth of our portfolio. We've been busy prepping potential dispositions and have a variety of non-core buildings and non-core land in the market for possible disposition. Our disposition outlook remains up to $400 million for the year, though the upper half of the range seems unlikely given the current capital markets environment.

Over time, we're confident in our ability to recycle out of non-core assets, which will help replenish our dry powder for future investment opportunities. Our $518 million development pipeline continues to progress well, with all projects on time and on budget. We're 22% preleased, with at least 2 years until projected stabilization across all of our spec projects. We have about $320 million left to fund, and we project NOI of approximately $40 million upon stabilization.

Our next development delivery, 2827 Peachtree in Atlanta, is scheduled for completion in the third quarter, with a projected stabilization in 1Q '25 and is already 88% preleased with strong interest from additional prospects.

Turning to our 2023 outlook. We now project full year FFO of $3.68 to $3.82 per share, up $0.01 at the midpoint since our initial outlook in February. Same-property cash NOI is projected to be minus 0.5% to positive 1.0%, up 25 basis points at the midpoint. All other line items are unchanged.

Before I turn the call over to Brian, I would like to briefly reiterate our performance and outlook. Our diversified portfolio across the best urban and suburban baby days in the Sun Belt continue to perform very well. We're prudently investing in our portfolio through our spec suite program and Highwoodtizing projects that will drive additional portfolio outperformance.

Our $518 million development pipeline will generate meaningful cash flow as it delivers and stabilizes. Our full year 2023 outlook for same-property cash NOI and FFO per share are higher at the respective midpoints than originally forecasted. And our balance sheet is strong with a debt-to-EBITDA ratio of 5.9 times, with ample existing liquidity to fund the remainder of our development spending and all debt maturities until 2026.

Brian?

[Brian Leary, Executive VP and COO]

Thanks, Ted, and good morning, everyone. Echoing Ted's thoughts, we are pleased with the performance of the portfolio this quarter and appreciate the hard work our teammates have put in to support our customers as they recruit, retain and return their very best to the office. We believe the Highwoods portfolio is tailor-made to capitalize on the flight to commute worthy experiences in our open for business and growing Sun Belt markets.

As Ted mentioned, we believe there are reasons to take a cautious approach around demand growth in the office space as we approach the rest of the year. Yet, our team continues to see healthy interest from small to medium-sized organizations and a clear preference towards quality, which includes locations, buildings and owners. This dynamic plays directly to our strengths as our high-quality BBDs, workplaces and sponsorship is resulting in strong outperformance for our buildings.

While our portfolio has historically operated at higher occupancy levels than our competition, this outperformance has increased by 490 basis points since the onset of the pandemic and is now nearly 6% higher than the markets where we operate. We believe this spread can continue to increase as customers and prospects focus even more on quality.

While some larger customers are holding off on real estate decisions or using this opportunity to streamline operations, our core customers, small- to medium-sized businesses, continue to grow and have consistently generated the highest office utilization in our portfolio.

Further, we continue to see customers of all sizes increasing their average number of days in the office. To illustrate this point, our same-property parking revenues were up 19% in the first quarter compared to last year and up 9% sequentially from the fourth quarter.

In the fourth quarter, we added 80,000 square feet of net expansions. And in this quarter, we added an additional 50,000 square feet. We see our small to medium-sized average customer as a strength within our portfolio, and they serve as a general proxy for the diversified Sun Belt economy.

Turning to market activity for the quarter. CBRE reports that in Tampa, there are 2.3 million square feet of tenant requirements in the market, and it posted positive net absorption for the quarter. Our team there led the quarter for leasing volume with 112,000 square feet of leases signed. In addition, we're already seeing steady interest in our recently announced 143,000 square foot Midtown East development, slated for completion in 2025. This project is the only new construction underway in the West Shore or downtown BBDs. With its neighboring project, Midtown West, now over 97% leased, we have benefited from Midtown becoming the premier Westshore address to live, work and play.

Atlanta proved to be our second most active market in terms of leasing activity during the quarter with 81,000 square feet of leases signed. It should be noted, however, that this number does not include leases signed at our joint venture development, 2827 Peachtree, which is now 88% pre-leased, up from 75% at year-end and on schedule to be completed in the third quarter. Consistent with our own portfolio and experience, JLL noted that the great majority of activity in Atlanta was by tenants less than 10,000 square feet.

Moving to North Carolina, which was, again, named Business Facilities most recent Best State for Business and where we have approximately 35% of our NOI in the Raleigh and Charlotte markets. We've seen strong activity at 650 South Triumph, our 367,000 square feet asset in Charlotte, which has leased up to 88%, up from 79% when we acquired the building last August. We have also begun construction on our boutique build-to-suit for United Bank in Charlotte South Park BBD.

In Raleigh, our team signed leases for 75,000 square feet, and we ended the quarter with occupancy of 90.4% across our 6.3 million square foot portfolio. Our Glenlake 3 mixed-use development is on track to be delivered on time and within budget by the third quarter of this year.

The work place-making experience we are delivering to our customers is competitive currency as they recruit, retain and return talent to the office. They are telling us this in word and in action based on our sustained results throughout the pandemic and now into 2023.

We believe our ability to deliver the highest quality workplace experience has Highwoods well positioned for the long term. These experiences are delivered personally by our exceptional Highwoods teammates who manage, lease and maintain our buildings themselves, and we so very much appreciate their hard work.

Brendan?

[Brendan Maiorana, Executive VP and CFO]

Thanks, Brian. In the first quarter, we delivered net income of $43.8 million or $0.42 per share and FFO of $105.7 million or $0.98 per share. There were no significant unusual items in the quarter. We had a small term fee and an even smaller land sale gain, both of which were anticipated in our original 2023 outlook that we published in early February.

Rolling forward from last quarter's FFO, we posted an increase of $0.02 per share. Higher NOI contributed $0.05, driven by higher rental revenue, improving parking income and higher operating margins. Higher unconsolidated JV income contributed $0.02, primarily driven by the full quarter contribution of McKinney and Olive and also included the deconsolidation of our 50% interest in the Markel JV enrichment.

Other income and miscellaneous items added $0.01, for a total of $0.08 of upside, which was partially offset by $0.03 of higher G&A, mostly due to the accounting impact of our annual long-term equity incentive grants, which are customarily made in the first quarter each year and $0.03 of higher interest expense. The combination of these items net to the $0.02 increase in core FFO from the fourth quarter of '22 to the first quarter of 2023.

Turning to our balance sheet, where we ended the quarter with net debt-to-EBITDAre of 5.9 times, flat from year-end, even though we continue to fund our development pipeline and had no meaningful disposition proceeds. We further strengthened our liquidity by obtaining a $200 million 5-year interest-only mortgage with a 5.69% fixed rate secured by Bank of America Tower in Charlotte,

This execution highlights the benefit of our low levered largely unsecured balance sheet, combined with our high-quality portfolio. We were able to pivot to the mortgage market where pricing is currently more efficient and attractive than the unsecured market, yet still maintain a largely unencumbered asset pool and maintained strong credit metrics for our bondholders and banking partners.

At quarter end, we had $685 million of existing liquidity, and this amount increased to $725 million following the redemption of our preferred equity investment in the McKinney & Olive JV. We have only $329 million remaining to fund on our development pipeline and no consolidated debt maturities until the fourth quarter of 2025. We have ample liquidity to fund all of our capital needs, including development spending and debt maturities through the expiration of our line of credit in March 2026 without the need to raise any additional capital or receive any disposition proceeds.

To be clear, we do expect disposition proceeds as we move throughout this year. And we plan to be opportunistic about raising additional debt capital later this year or next, but our liquidity position affords us the ability to be patient. In addition, our investment-grade credit ratings were recently affirmed by both of our rating agencies with stable outlooks.

As Ted mentioned, we've updated our outlook with an increase to the midpoint of same-property cash NOI and FFO. Our revised FFO range is $3.68 to $3.82 per share, up $0.01 at the midpoint. The major changes from our prior outlook at the midpoint of the range are a $0.02 increase from higher anticipated NOI attributable to stronger leasing, better parking revenues and lower OpEx, partially offset by a $0.01 reduction from the net impact of the $40 million redemption of our MNO preferred equity investment.

As mentioned earlier, we started with a strong first quarter. A couple of items to keep in mind going forward. First, our operating margin in Q1 was higher than originally anticipated, which was largely attributable to lower OpEx. Some of the reduced expense items are expected to be incurred later in the year, and therefore, we project operating margins will be 100 basis points to 150 basis points lower for the full year compared to Q1.

Second, we will incur the full quarter impact of two large customer move-outs in Q1, most of which has been backfilled but won't commence until next year. Finally, with the redemption of the preferred equity investment in the M&O JV that had been previously paying us monthly distributions at a rate of SOFR plus 350 basis points, other income will be lower.

We have included up to $400 million of potential dispositions in our outlook. While the upper half of the range may be challenging to reach this year given the current state of the investment sales market, we are seeing good interest in smaller buildings and some of our land parcels that are better suited to non-office development. We expect any disposition proceeds would bolster our liquidity and further improve our balance sheet metrics.

Finally, as we've mentioned many times during the past several years, our cash flows continue to strengthen. This quarter is an excellent example as our cash available after distribution was $20 million even after absorbing a full quarter's impact from higher interest rates. The ability to recycle capital back into the business, whether into development, acquisitions or Highwoodtizing projects, is a major reason why we've been able to consistently grow earnings year after year on a leverage-neutral basis, while simultaneously upgrading our portfolio quality, improving our long-term growth rate and increasing our resiliency.

Operator, we are now ready for questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Blaine Heck, Wells Fargo.

[Blaine Heck, Wells Fargo]

Can you talk a little bit more about potential sales this year? It seems like you've pivoted from targeting the large sales in Pittsburgh or elsewhere to focusing more on smaller kind of bite-sized assets. Can you just give us some color around the timing and size of those potential sales?

And just in general, I guess, what are the characteristics in an office property? And what's the return profile that prospective investors are looking for in an office transaction these days?

[Ted Klinck, President, CEO and Director]

So in terms of the dispose, you're right, we have shifted to smaller deals. That's sort of what the investor pool out there is looking for right now. There's plenty of buyers to make a market, we think in that $20 million asset range. So we've got -- in terms of what's in the market, that we've actually picked buyers on all three of the buildings that we've got out in the market. Then, we've got a couple of land transactions as well.

But the buildings, two of the 3 are single tenant, single customer, good credit, pretty good waltz as well. And then we've got one multi-customer building, buyers, one is institutional, two them are private. So it's sort of a cross-section there.

But the bidding pool, when we took these out, I'll tell you is sort of surprising. And it was great to see. It wasn't as deep as it was couple of years ago, but we have plenty of -- again, plenty of buyers to make a market. So I think that was encouraging from our standpoint.

So they're all in the due diligence process in terms of the buildings. We're running through that. And I'm optimistic we'll get something over the goal line and be prepared to talk about pricing maybe at the earnings call in July.

And the same thing on the land. We've got a few land parcels out there. Buyers are going through due diligence, working on our closing conditions. So I'm hopeful we'll get a land transaction or two, maybe just one by the next call. So overall, we're feeling pretty good about getting some dispo proceeds in the door.

[Blaine Heck, Wells Fargo]

Second question, can you just talk about leasing activity on the development pipeline and whether you've seen much of a change in demand for those projects recently, especially for those that are delivering in the near term like Granite Park 6 and Glen 3?

[Ted Klinck, President, CEO and Director]

Yes, if you don't mind, maybe I'll take -- hit all of them just real quick. We mentioned in the prepared remarks 2827 Peachtree, so that one did move, I think, from 75% to -- we're just shy of 88%. I think 87.5% maybe this quarter, and we got good prospects to get us in the 90s. So that building, we deliver it, again, in the third quarter and it's come along very nicely. So we feel great about that one. The building looks great.

The next one, also in the third quarter, just a month or 2 behind 2827 is Glenlake 3 here in Raleigh. That one is about 213,000 square feet, which includes a little bit of retail we're adding to the overall Glenlake Park. So that one, we put a lot of proposals out, and it's -- the activity has increased in the last 90 days. Several tours. Larry has been on a couple. I've been on a couple with our Raleigh team. But it's -- I wouldn't say we have any strong prospects at this time, but we're encouraged by the increased activity there.

Grantite Park 6 up in Plano in Dallas, that delivers in the fourth quarter of this year. Tour activities picking up there, too. So far this year, in 2023, we've had 585,000 square feet of proposals. We've put out there 60,000 just in the last 30 days.

So decision-making for all the big prospects is just slow. So it's -- we've got activity out there and proposals submitted, but the decision-making has been slow. 23 Springs, that delivers in the first quarter '25. And the tour activity, I'd say, has been very, very good there. 560,000 square feet of proposals so far this year, 160,000 just in the last 30 days. And I'd say a couple of those are pretty strong prospects. It seem to be moving along a little quicker in decision-making. So no update yet, but we're making progress on that.

And then the last one is just Midtown East and Tampa. We just started construction in the first quarter of that building. We've fences up and we're starting to put in the pilings, but we've already seen some pretty good early interest. I think two or three inquiries already that we'll be making proposals on.

So -- and that again, that don't doesn't deliver for another 2 full years. So all in all, I'd love to have a little more activity maybe in Raleigh on the development, but activity seems to be picking up.

[Blaine Heck, Wells Fargo]

So it sounds like the activity is a little better at 23 Springs and Granite Park 6. What's the difference there?

[Ted Klinck, President, CEO and Director]

So it's about the same number of proposals there. It's just the 23 Springs, the decision makers are in a position to make those decisions. The leasing decisions has just been a little slower up at Granite Park. So I don't think it's anything -- Uptown is a great -- obviously, a great submarket, but it's just the specific prospects we're chasing. Maybe you've got a shorter time line to make decisions or what have you.

[Operator]

Next question from the line of Rob Stevenson with Janney.

[Rob Stevenson, Janney]

Brian, I think you spoke about it a little bit in your prepared comments. But can you expand on the renewals in the first quarter and what you have under discussion currently for the remainder of '23? Specifically, you're trying to figure out the relative breakdown of the amount of tenants pursuing expansions versus those looking to contract and those that are more or less seeking to maintain their same footprint these days. It seems like the market narrative is still that employers are going to give up 10% to 20% of their office space on renewals. I'm curious as to what you're seeing within your portfolio.

[Brian Leary, Executive VP and COO]

Thanks, Rob, for the question. Yes, as you mentioned and as I said in the prepared remarks, for this past quarter, most of the activity for folks kind of leaning in our small and medium-sized bread and butter customers. They expanded versus contracted, 5:1 for the quarter.

Just to give a little color into what we're seeing already for this quarter, we're off to a good start. We're feeling very enthusiastic about how this quarter is going to come in based on everything that's gone, either to lease or have agreed to terms. So my guide is we're going to be fairly consistent and -- from first to second quarter on that expansion contraction with more volume for the quarter.

The bigger users, as we've kind of mentioned, they're either delaying or streamlining and rightsizing their space. And it's -- I really do think it's maybe less from a work-from-home headwind from a -- this is how we're going to use space going forward. And again, as a little bit of talk in our book is that they're all telling us that it matters. The workplace matters and that they're leaning in to make it a differentiating factor with regard to their talent.

[Rob Stevenson, Janney]

And Ted, how are you and the Board thinking about unlocking value now given your comments that dispositions at the upper end of the range weren't likely given the current environment? I'm thinking of this in the context of your stock price, which is recently dip below $20 for the first time since the global financial crisis, which seems to totally contradict how your business did in your '23 guidance?

[Ted Klinck, President, CEO and Director]

Yes. Look, obviously, we talk about that a lot. And I think it's -- all office REITs are sort of being tagged with the same issue. So look, I think our view is we're going to keep our head down. We're going to continue to operate. We can't control what our stock price is doing right now in times like this.

Obviously, we're in a -- the office business is in a tough spot perception is, and the perception may not necessarily be what we're seeing on the ground. But any recession or economic slowdown you tend to see increasing vacancy, sublease space increases, quite the quality and so forth.

So we're experiencing today the same thing we experienced in 2000, 2008, and so forth. So we're intently focused on just going out and execute. We think, over the long term, there's going to be great opportunities over time. And as I think coming out of GFC, that's where we end up buying a lot of great office buildings. Some of the best buildings in our portfolio were just coming out of the GFC.

So I think there's going to be similar type opportunities this time around. We got to be patient. And while we're being patient, we need to execute as best we can, both on the leasing side, on the disposition side, while creating some dry powder to go take advantage of these opportunities. So it's really the same little stuff, but it's our playbook.

[Rob Stevenson, Janney]

And then lastly, not to leave Brendan out. Brendan, is second quarter going to be the low FFO per share quarter in '23, given all you know at this point?

[Brendan Maiorana, Executive VP and CFO]

Well, with the caveat that you put on the last part of that question, probably with all we know, I think that, that's probably likely. It depends a little bit on -- I would say, second and third quarters are probably the low for what we are expecting.

So occupancy is probably likely to kind of bounce around where we are currently for the next couple of quarters, and then we expect it to rebound in the fourth quarter. So given we had activity that moved out in the beginning of March, we had the CDC that moved out kind of mid-January, those contributed in the first quarter, they will not contribute in the second and third quarters because those backfill users won't be back in that space. And then we do expect that operating margins will be lower in the remainder of the year.

So with all that, yes, that probably means second, third quarter would likely be below.

[Operator]

Next question from the line of Camille Bonnel with Bank of America.

[Camille Bonnel]

I know your opening remarks noted that the first quarter is typically lighter from a leasing perspective. But looking a bit further into the activity this quarter compared to historic averages, the majority of the slowdown seems to be related to renewals. So can you comment on how the slowdown compared to your expectations for retention? And any color on what tenants are saying as the reason to not renew for their lease? It would be much appreciated.

[Brendan Maiorana, Executive VP and CFO]

Camille, it's Brendan. I'll start, and then maybe pass that along to Brian and Ted for additional color. But I would say the low level of whether renewals or retention in the quarter was largely expected given we had the activity move-out that we talked about for a long time. So that's 263,000 square feet. So that was a nonrenewal in the quarter.

We had the CDC, which was 116,000 square feet. So combined, those two are 380,000 square feet of kind of known non-renewals. And then recall that we also proactively took back 77,000 square feet with a user in Raleigh to extend their remaining square footage over a long lease. And with that, we have substantially backfilled the 77,000 square feet that we took back. So all of those things combined reduced the amount of renewal leasing that we did. But that was all known. So it was very much in line with expectations.

[Ted Klinck, President, CEO and Director]

So the only thing I would add is in any -- again, any downturn, you see companies contract their space. You see companies consolidate operations if they have more than one office in a submarket. We've got companies going out of business. Obviously, flight to quality.

And flight to quality, we talk about it a lot now, but any downturn, people are looking for a deal and they may want to upgrade their space. So we're losing our retention ratios being impacted just by the overall economic environment and some of the -- just what's going on with the customers, whether, again, consolidation of offices, closing regional offices and so forth. So not too dissimilar to any other downturn. I guess, with the caveat that certainly hybrid work is one of the additional headwinds.

[Camille Bonnel]

And just to follow up on that point. I think you mentioned excluding those first quarter move-outs, you're expecting retention for the rest of the year to remain around that 50%. So is there any change to this assumption for the back half of this year?

[Brendan Maiorana, Executive VP and CFO]

No, I think that's very much in line with kind of our expectations. So you had no change to the outlook for the year. And I think you can see that generally in the outlook that we provided. We still expect year-end occupancy to be between 89% and 91%. I'd say we're feeling maybe a little bit better about the business overall, given we did nudge up our same property NOI growth outlook.

So all those things are very much in line with expectations. I'd say, net-net, we probably feel a little bit better sitting here in late April compared to when we provided that outlook in the beginning of February.

[Camille Bonnel]

And finally, I know you've commented on having the flexibility around timing to execute on the Pittsburgh disposal and the fact that the market could look very different when you do. Historically, you've also had a very good track record in exiting markets while growing FFO. So just stepping back, how do you think about Highwood's ability to continue to deliver FFO growth in this tough market environment and the potential dilution from this sale?

[Ted Klinck, President, CEO and Director]

Yes. Look, I think, as you said, we had 12 consecutive years of FFO growth, which has been -- very few companies have done that. I do think it's a tougher environment, right? There's no question. We recognize it, and it's going to be tougher to do that.

So we're going to obviously wait for Pittsburgh. We're in no huge hurry to sell Pittsburgh. But certainly, when we do, just given capital market environment, we got the headwinds there. So there will be some FFO dilution. I do think, at the same time, our development pipeline is going to deliver over the next couple of years. And that's helped us in the past. And I think it's over $40 million of NOI when we stabilize that. So that's going to help on the growth standpoint.

I think that's one of the benefits of Highwoods is having that development value creation platform that can deliver some solid NOI growth with the development deliveries.

[Operator]

Our next question is from the line of Michael Griffin with Citi.

[Michael Griffin, Citi]

As much as I love the office and actually was down in Atlanta this week, so we'll have to stop by 2827 in Glenlake at some point. But on that day, my question was about State of Georgia. I noticed, I think there was a footnote in the looks like you're going to be taking about 60% less space on that $290,000 and 1,800 century. Just curious how you're thinking about backfilling that? Other tenant needs? Maybe it's not -- I think it's a little bit of past bucket, but anything you'd add there would be great.

[Ted Klinck, President, CEO and Director]

Sure. On specifically on the department of revenue -- as you know, we put the note in the 10-Q. That asset is a noncore asset for us. So when we got the RFP less than 2 weeks ago, just given our conservatism and transparency, we wanted to add that because it is. It's a -- they've been in that building for a long time, over 20 years. And up until, again, a couple of weeks ago, we thought it is a good chance for renewal.

So we're looking at it right now. There's a chance that we can keep them in that same building. There are other options in our portfolio that they may be interested in as well. So it's early days on that, but it will be a significant downside if we keep them. Again, there's an RFP out there, and we're going to be competing for it.

So I'm hopeful, but we'll see. It's a good -- it's definitely going to be competitive. It's a big, big requirement. So I'm sure a lot of folks will be chasing it. But -- so anyway, that's that one.

And then the other big ones, [Indiscernible] is the other big 1 in one in Atlanta. Michael, and that's, as you know, it's 169,000 square feet expires in September of '24. They moved out late last year across the street to Fips Plaza. So we now have a space vacant. They're still paying rent on it.

So -- but we're showing it. We had two large tours just in the last 30 or 45 days. And as we've mentioned in the past, they have subleased about 43,000 square feet. And who knows if we can keep those guys or not. It's another competitive opportunity just given the size. But -- so it's great space, great building, great location. So it's -- I think over time, we're going to -- we'll be able to lease that up to a great customer going forward.

[Michael Griffin, Citi]

And then my second question is just on Tampa, circling back on the developments and the presence there. Obviously, it's a growing market. But I'm curious what makes it as attractive as it is?

I mean I was reading somewhere recently. I think Tampa has around the same population growth over the last decade as Little Rock, Arkansas. I'm not saying a little rock bad per se, but like you've got Midtown West, you majority leased to Tampa Gas Electric, I think, starting the county. So maybe talk about why that's such a beneficial market, if you could.

[Ted Klinck, President, CEO and Director]

Well, we've been in Tampa since I think the '90s. And I think has been a good long-term performer for us. If you look at our assets there, they're largely in Westshore and the CBD, are the 2 best business districts there.

And then when you drill down specifically on these assets, Midtown East, that is in part of a 22-acre Midtown Tampa mixed-use development. There's really a unique type project for Tampa and the success we had at Midtown West. If you remember, right before the pandemic, I think as maybe summer or fall in 2019, we started a 150,000 square foot office building, 100% spec.

And during the pandemic, we completed it on time, on schedule. And we leased it up on time and better than our pro forma from a rental rate standpoint. So just the demand that we saw that is looking for a mixed-use, integrated mixed-use project in Tampa was -- gave us the conviction to go in Midtown East.

And as you're not Midtown East, it is larger build, it's about 438,000 or 40,000 square foot building that Tampa Electric, TCO, is going to be buying a condominium interest in that building. So we've only got about 140,000 square feet of office to lease up.

But we just think it's a unique mixed-use environment that's very vibrant. It's again it's going to help companies recruit and retain their employees.

[Brian Leary, Executive VP and COO]

Michael, it's Brian. I might just add on. If we think of all of our different markets having different ages in their life, many of them are further along in their development and evolution. And Tampa has fundamentally kind of changed its perception. Maybe years ago, sort of known this back-office kind of location, some defense connectivity with CENTCOM headquarter there.

What's happened really over the last few years and accelerated by the pandemic and the outward flow of companies from maybe the gateways, I think we've mentioned this before, Tampa is the one relocation destination for companies out of the Northeast into Florida. It's not South Florida, it's Tampa. So that's a great story.

In terms of the little rock growth rate, we're definitely looking to that. But we've seen the quality of the customers that are leasing space, as Ted mentioned, in Midtown. And now our Midtown West is north of 97% leased. The combination of the diversified economy in Tampa, they're spending billions dollars of expanding the airport.

You're seeing new investment with folks from around the country in Downtown through the Water Street development in Midtown, what we're doing with our partners there. It feels like Tampa is kind of taking its next seat at the table with the likes of Raleigh and Nashville and Austin and Charlotte. It feels like that.

[Operator]

Our next question is from the line of Ronald Kamdem with Morgan Stanley.

[Ronald Kamdem, Morgan Stanley]

A couple of quick ones. Back on the leasing, is there a way to sort of quantify what the pipeline, what the activity is? And then maybe just some qualitative comments on sort of tech and some of the life science hubs that were in some of your markets. Just curious what you're seeing from them.

[Brian Leary, Executive VP and COO]

Ron, Brian here. I'll take the first shot and let Ted and Brendan grade my paper. Couple of things. We have low exposure to tech in general. I think you probably know that. Not that we're down on tech, it's just as a fact.

As you look into the crystal ball of what we're seeing in second quarter already, a few weeks in, Nashville, Raleigh are going to be stuff we talk about next quarter, we feel pretty good about. Even Richmond is going to have something to talk about. Tampa was our leader this quarter, the 112,000 square feet. The momentum continues there following on kind of Michael's question.

So in general, those markets, we like the economics that are coming in, As Ted kind of mention, is something that people ask. Is it more expensive to do deals? What are the fundamental economics around the leasing that's going on?

Yes, it's competitive. We haven't seen costs come down per se in the build-out of spaces. Has it leveled out, we believe so. And we're optimistic that as other projects are slow down that maybe we have a chance to pick up some things there.

For those deals that will give us term and have the credit, we're inclined to win those deals. I have kind of a bad joke with our entire leasing team. That I'm more optimistic about renewing someone who's in the portfolio than is not. And we have the ability within our own portfolio to look ahead 2 years, 3 years with renewals and maybe do deals, work with customers in a way that the private side singularly financed building that we compete with might not be able to.

[Ronald Kamdem, Morgan Stanley]

The other one is I had that same question on 1800 Century Boulevard in the 10-Q. If I could ask it a different way. Obviously, it's not core, as you mentioned at the top. But if I could ask it a different way, is there -- is this idiosyncratic? Is there -- was there something unique about how they were using the buildings that you sort of looked at this and say, "Okay, that sort of made sense?" Were there any sort of clues just looking at their usage versus other tenants, maybe that kind of shown this was coming?

[Ted Klinck, President, CEO and Director]

Yes, Ron. Well, certainly, they were slower. Like most government users, they're slower on the return to work over the last couple of years. But really the ability have been in there forever. So space is tired. It does need to get redone. So I think it's probably a hybrid work combined with just needing to reconfigure their space like we're seeing in others.

Obviously, there -- they're in a building that's built in 1975. So it's an older building, right? So there's CapEx not only to retenant it, there's the BI, the TI associated with their lease, but they're just building capital that will need to be invested in that asset on a sort of an irregular floor plate. So it's just really -- they've been there a long time, and they are reevaluating their space like a lot of folks are.

[Ronald Kamdem, Morgan Stanley]

And the last one, if I may. Just the license insurance deal you did in the quarter at a pretty good rate. Obviously, Brendan went through sort of the funding plans. And you're well funded. I'm just curious, are you getting more calls from life insurance companies in terms of other assets where there's interest, there's opportunity down the road?

[Brendan Maiorana, Executive VP and CFO]

Yes, Ron, it's Brendan. Thanks. We were pleased with the execution on the mortgage at BofA Tower. I would say, I mean, in general, we are predominantly an unsecured borrower. So mortgages are not something that we're looking to do a lot of.

However, the benefit of us having a largely unsecured asset pool with a high-quality portfolio of assets is there are those options that are out there, should we choose to pursue some mortgages. So I think it's an option that's open to us. and we'll evaluate whether or not it makes sense. But we do want to balance the unsecured pool that we have out there with others.

And just as a reminder, I mean, we're in great shape from a liquidity standpoint. So I mean we can fund all of the development pipeline and all of our debt maturities through the expiration of the line, which is in March of 2026, without the need to raise any additional capital. So it's not something that we actively need to go out and raise capital, it's just an option should we choose to do so.

[Operator]

Next question is from the line of Dylan Burzinski with Green Street.

[Dylan Burzinski, Green Street]

Just curious if you can kind of provide your thoughts or expectations for net effective rents throughout the remainder of 2023? I know leasing costs have probably continued to remain elevated. And something that surprised us over the last several years is that base rents have held up surprisingly well. So I guess could 2023 be the year that we start to see pressure on base rents?

[Ted Klinck, President, CEO and Director]

Dylan, it's Ted. Look, I think -- look, I think so, right? I mean, again, it's an economic slowdown, just like any other slowdown in the office business. Right now we've got vacancy rates increasing. We got the sublease space increasing. So you got those headwinds.

And they've got cost pressures, right? We keep thinking or maybe hoping that costs are going to come back in line and as development start to fall off, you may see some contractors that are getting a little bit more aggressive. But up to this point, the TIs, it's still -- there's still cost pressures that continue to increase. Free rent is increasing.

Again, making blanket statement. There are pockets in submarkets that they're all different. But in general, there's upward pressure on TIs, upward pressure on free rent. Now the nice thing is since COVID, we've been able to maintain, if not increase, face rents. So when you throw all that into the mix, we've done a good job on net effectives, but just entering the slowdown we're entering, it wouldn't surprise me to see some downward pressure on net effective rents.

[Brendan Maiorana, Executive VP and CFO]

Dylan, it's Brendan. Just to -- just one thing I would add. We did do a lot of spec suite deals during the quarter. You saw that the average kind of sized lease that we did during the quarter was around 5,000 square feet. Those spec suite deals initially tend to carry a pretty low net effective because we spend a lot of capital upfront.

As we relet those, then the net effectives are very high. So if we adjust for the spec suite deals in the quarter, the net effective looks a lot more comparable to previous quarters. So I think it had a negative drag by around $0.65 a square foot on our overall net effective.

So I think we will do more of that during this year because we've been very successful and seen a lot of leasing traction there, but that will probably, from a headline perspective caused the initial net effectives as we sign those spec suites to be lower than they otherwise would be.

[Brian Leary, Executive VP and COO]

Dylan. Brian. Just to add on, on this kind of counterintuitive face rates. As the new development is delivered and leases up, market face rates will actually drop because that higher-end top of the market face rate is no longer in the pool to "face rates."

So we're actually seeing -- we're you have seen the market face rates drop is because some of the top stuff is leased up. And we're seeing -- to Ted's point, we've done a pretty good job of folks who see space as a differentiating factor. That face rate is a smaller part of their equation when they're talking about bringing their talent back.

[Dylan Burzinski, Green Street]

Just one more quick one, if I may. Were you guys able to share sort of the underwritten LTV at Bank of America Tower in Charlotte?

[Brendan Maiorana, Executive VP and CFO]

Well, it depends on who you ask for the V, I guess. But it's probably -- I mean, I think the lender had a probably a more conservative outlook of value than we think it would garner if you were to market that asset for sale. But let's call it, probably in round numbers, 50% is probably a pretty good benchmark in terms of with the LTV.

[Operator]

Next question from the line of Nick Hillman with Baird.

[Daniel Leben, Baird]

This is Daniel Leben on with Nick. I had a question. I know you were mentioning the mortgage. But given any potential slowdown in the market in the transaction market and your deals, would you look to equity then as a potential way of delevering those?

[Brendan Maiorana, Executive VP and CFO]

Daniel, it's Brendan. I'm not sure I totally understand the question. But I mean, I guess, if would we consider a JV partner for assets, if that's maybe the question, probably not the profile of kind of -- Okay. Got it.

Yes, I would say probably for the type of assets that Ted talked about, kind of those smaller buildings that we have out in the market, I would say that that's not really kind of something that we're contemplating on the assets that we have out in the market for potential sale.

[Operator]

[Operator Instructions] Next question from the line of Peter Abramowitz with Jefferies.

[Peter Abramowitz, Jefferies]

Ted mentioned possibly some opportunities on the acquisition side. I know there's nothing in your guidance, and maybe it's kind of looking a little bit further out. Could you just quantify how we should think about what you're targeting in terms of your returns on those?

I know there's not a ton of deal activity in the market today on the financing side. So cost of capital isn't totally clear. But just wondering if you can kind of quantify your return hurdles if you do start to get active.

[Ted Klinck, President, CEO and Director]

Yes. I think you said we're really not looking at anything right now. We're being patient, trying to replenish our dry powder, get some dispose over the goal line. So I think we're going to be patient and the bar has definitely been raised whether it be obviously development or acquisitions.

So I don't think we've had the cost of capital discussion because we don't have our pencils are sorted down on the acquisition side right now. And there are a whole lot of assets that are out there right now.

And we're -- what we've got is our well-developed wish list that we're tracking are -- actually I said there are a couple of assets that are out there we're tracking that would be good proxy for pricing if and when they trade. But right now, we're sort of sitting back and waiting. We think there may be better opportunities a little bit down the road versus today. So I really don't have an answer for you on the cost of capital question.

[Operator]

And we have no further questions on the phone line.

[Ted Klinck, President, CEO and Director]

Well, I want to thank you, everybody, for being on your -- on the line today. Thanks for your interest in Highwoods. And we look forward to seeing many of you at NAREIT in June. Thanks so much.

[Operator]

And that concludes today's call. We thank you for your participation and ask you to please disconnect your lines.