Peakstone Realty Trust

NYSE:PKST

Earnings Call Transcript 2024-Q2

[Operator]

Greetings, and welcome to Peakstone Realty Trust Second Quarter 2024 Earnings and Webcast Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Mikayla Lynch, Senior Vice President, Corporate Finance and Strategy. Thank you, Ms. Lynch, you may begin.

[Mikayla Lynch, executive]

Thank you. Good afternoon, and thank you for joining us for Peakstone Realty Trust's Second Quarter 2024 Earnings Call and Webcast. Earlier today, we posted an earnings release, supplemental and updated investor presentation to the Investors page on our website at www.pkst.com. Please reach out to our Investor Relations team at [e-mail] with any questions. Please note the use of forward-looking statements by the company on this webcast. Statements made on this call may include statements which are not historical facts and are considered forward-looking. The company intends for all forward-looking statements to be covered by the applicable safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Exchange Act of 1934 as amended and is making these statements for purposes of complying with those safe harbor provisions. Furthermore, the forward-looking statements reflect our current views about future events and are subject to numerous known and unknown risks, uncertainties, assumptions and changes in circumstances that may cause actual results to differ significantly than those expressed in any forward-looking statement and could be affected by a variety of risks and factors that are beyond the company's control, including, without limitation, those contained in our most recent annual report on Form 10-K and any subsequent quarterly reports on Form 10-Q filed with the SEC. We disclaim any obligation to publicly update or revise any forward-looking statements to reflect changes in underlying assumptions or factors, new information, data or methods, future events or other changes after the date of this call, except as required by applicable law. Additionally, on this call, the company may refer to certain non-GAAP financial measures such as funds from operations, adjusted funds from operations, EBITDAre and normalized EBITDAre. You can find a tabular reconciliation of these non-GAAP financial measures to the most currently comparable GAAP numbers in the company's filings with the SEC. On the call today are Mike Escalante, CEO and President; and Javier Bitar, CFO. With that, I'll hand the call over to Mike.

[Michael Escalante, executive]

Good afternoon, and thank you for joining our call today. Over the past several quarters, we have executed on our strategic plan by strengthening our balance sheet and optimizing our portfolio composition, while accumulating a substantial cash balance to provide optionality. As a testament to these operational successes in our well-leased diversified portfolio, we are pleased to have successfully amended and extended our unsecured credit facility. This amendment is a key milestone that provides us with a solid foundation for growth and increased flexibility to make industrial investments, which we believe will build long-term shareholder value over time. At a high level, this amendment reflects the bank group's endorsement of our business plan and does several important things for us. It pushes our revolver and 2025 term loan maturity out 4 years from closing to 2028. It lowers our borrowing costs, and it provides us with increased flexibility to grow. Javier will provide additional details on the amendment along with proforma balance sheet metrics in his later remarks. Turning to our portfolio. Our high-quality industrial and office segments continue to provide stability with a combined wealth of 7 years, 99.5% economic occupancy, minimal near-term rollover in the next 3 years, representing 7.5% of the ABR for these 2 segments, significant credit tenancy and newer buildings with minimal capital requirements. Disposition of our other segment assets continued this quarter with the sale of one property located in Mechanicsburg, Pennsylvania, totaling approximately 57,000 square feet for $8.7 million. Importantly, for the first half of the year, other segment sales totaled approximately $58.2 million. In addition, we significantly advanced the sales of several other segment properties, and we will continue to progress dispositions in this segment for the balance of the year. This quarter, we continued to demonstrate our ability to achieve positive leasing activity and strong re-leasing spreads.

In our Industrial segment, we finalized the fair market rental rate increase and annual escalations for a 5-year 818,000 square foot extension we executed and announced in the fourth quarter of '23 at our Samsonite property in Jacksonville, Florida. This extension takes effect December 1, 2024, and includes 3.75% annual rent escalations, resulting in a 28% GAAP and 7% cash re-leasing spread. Given the fair market rent was not finalized when this lease extension was executed, we previously recorded base rent for the extension period equal to the expiring rent, which was the floor value per the lease. Clearly, this is a solid no-cost lease transaction that will generate further strong internal growth. In the Office segment, a previously executed 7.7-year 83,000-square-foot new lease with Spectrum commenced June 1 at our property in Largo, Florida. In the Other segment, we executed a 305,000 square foot 1-year lease extension at an industrial property in Columbus, Ohio, at a 40% GAAP and 63% cash re-leasing spread, which will enhance the value of this asset. With that, I will turn the call over to Javier to review our financial results. Javier?

[Javier Bitar, executive]

Thanks, Mike. I'd like to begin by sharing a few highlights of our financial results for the quarter. Total revenue was approximately $56 million, and NOI was approximately $45.4 million. Net loss attributable to common shareholders was approximately $3.8 million or $0.11 per share, inclusive of a $6.5 million noncash impairment related to a pending other segment sale. Same-store cash NOI was approximately $44.2 million, a 1.7% increase compared to the same quarter of last year. But for rent abatement in the 11th year of a preexisting lease in our Industrial segment, same-store cash NOI would have grown by 4.2%. The abatement period for this lease continues through November 2024. FFO, as defined by NAREIT, was approximately $25.6 million or $0.65 per share on a fully diluted basis, and AFFO was approximately $27.6 million or $0.70 per share on a fully diluted basis. Moving on to our balance sheet. As Mike mentioned, at quarter end, we were in a great position to execute on our credit facility extension given our strong balance sheet and high-quality portfolio. Subsequent to quarter end, we used a portion of our cash to pay down the credit facility and simultaneously completed this amendment and extension, which leaves us with ample liquidity and flexibility to support our industrial growth initiatives. Key terms of the amended facility are as follows: we now have a total facility of $907 million comprised of a $547 million revolver, a $210 million term loan and a $150 million term loan. The maturity dates of the revolver and the $210 million term loan were extended 4 years from closing to July 2028. The maturity date of the $150 million term loan remains April 2026. The weighted average term to maturity for the credit facility is now 3.6 years. The rates are SOFR-based with applicable spreads ranging from 125 to 165 basis points. Given our $750 million of interest rate swaps at a weighted average rate of 1.97%, 100% of our current outstanding debt is now fixed through July 1, 2025. Based on our current consolidated leverage ratio, our weighted average effective interest rate for the entire facility is 3.67%, inclusive of our current swaps. Subsequent to quarter end, we purchased $550 million of 4-year forward interest rate swaps effective July 1, 2025, when our current swaps expire through July 1, 2029, at a weighted average rate of 3.58%. We are pleased that we were able to swap $550 million of our variable rate debt for an additional 4-year period at 3.58%. When we purchased these forward swaps, the current 1-month term SOFR was approximately 5.33%. The amended facility also provides an improved valuation for our industrial assets included in the borrowing base calculation. These assets are now valued at a 6% cap rate rather than 7% previously. I would now like to discuss certain financial impacts as a result of closing the extension. As of 6/30, prior to the extension, we have cash of $447 million, with the majority of our cash earning interest in the 5% range for approximately $4.6 million of interest income in the second quarter. Accordingly, at quarter end, our net debt to normalized EBITDAre ratio was 5.9x. In connection with the closing of the extension, we used $200 million to pay down the unhedged portion of the credit facility and incurred $13 million of one-time transaction costs. The $213 million of cash generated approximately $2.7 million of interest income in the second quarter. It's important to note that in the near term, the prospective interest expense savings more than offset the interest income earned previously on this cash. With that said, our proforma metrics reflecting the closing of the amended facility are as follows: cash of approximately $234 million, available revolver capacity of approximately $157 million, total liquidity of approximately $391 million, consolidated net debt balance of approximately $980 million, consolidated weighted average interest rate for all debt secured and unsecured of 3.96% and proforma net debt to normalized EBITDAre ratio of 6.4x, reflecting the $213 million cash utilization and associated reduction of interest income. For the second quarter, we paid a dividend of $0.225 per common share in July. And the Board of Trustees approved a third quarter dividend of $0.225 per share, payable on October 17 to holders of record on September 30. While the company expects to continue paying dividends on a quarterly basis, all future dividend decisions will continue to be made by the Board of Trustees. With that, I will pass the call back to Mike.

[Michael Escalante, executive]

Thank you, Javier. We are excited about our growth opportunities as we seek to build on the momentum achieved with our amended credit facility. Overall, we will continue to execute on the plan that we've laid out, strengthening the balance sheet, evolving the portfolio towards industrial, eliminating our other segment and providing the company with the financial flexibility to grow. The amended credit facility is a key aspect for growth and reflects our relentless pursuit to maximize shareholder value. We will now turn the call over to the operator to take a few questions from analysts. Operator?

[Operator]

[Operator Instructions] The first question comes from the line of Josh Dennerlein with Bank of America.

[Farrell Granath, analyst]

This is Farrell Granath on behalf of Josh. I just had a few questions. And I guess to start off, can you remind me what your target leverage is? And how does the new financing kind of play into your targeting or looking forward into how you're thinking about leverage?

[Michael Escalante, executive]

Javier?

[Javier Bitar, executive]

Farrell, yes, on a long term -- over the long term, we've mentioned we're targeting a 6x debt-to-EBITDA on a proforma basis, as I mentioned in our remarks. We're up a bit on that to 6.4x as a result of the lost interest income with the utilization of the cash paydown. We'll continue to execute on our sales program with respect to the other segment. So we'll continue to focus on our strong balance sheet, and over the long term, reaching a debt-to-EBITDA ratio that makes sense.

[Farrell Granath, analyst]

Great. And also, when thinking about the extensions or the re-leasing in the different segments, I noticed that there was also the re-leasing in the other segment. I was wondering if you could comment on, I guess, either the strategy when thinking about lease expirations coming up and how you consider to bucket the Other segment versus the Industrial and Office?

[Michael Escalante, executive]

The good news is we have very little rollover in both of our core segments, right, both on the Industrial and the Office side. And specifically, office only has, I think, 5% rollover in the next 3 years. So there's not a lot of activity there. As you might expect, the way we set it up was that other -- our other segment was going to be -- had the most exposure, and we identified that we were hopeful that we would be able to effectuate some renewals, which happily, we've been able to do. And all of that, we believe, is going to translate into a higher recovery for the other segment and facilitate on a much more rapid basis, the sale of those assets.

[Farrell Granath, analyst]

Great. And then one last one for me. When you mentioned about the sale of the one property. Was that a vacant asset? And also, could you either, if it wasn't update what you're seeing in terms of cap rates? I guess, I believe last quarter, you mentioned that you guys keep track of it on a rolling basis.

[Michael Escalante, executive]

So -- I'm sorry, you said we only sold one asset in the quarter.

[Farrell Granath, analyst]

Sorry, the -- or the property.

[Javier Bitar, executive]

Yes, we did have one sale during the quarter in April of this year. And correct, it was an asset that had a near-term expiration in others.

[Operator]

The final question comes from the line of Anthony Hau with Truist Securities.

[Anthony Hau, analyst]

Just curious, what was the reason behind reducing the maximum commitment amount on the revolver? Was it the change in capitalization rate? Or -- and did they use like last 12 months NOI or four 12 months NOI to calculate the portfolio on days?

[Javier Bitar, executive]

Hi, Anthony. Yes, we used -- in the facility, we use prior quarter annualized, and it did result from a change in the capitalization rate. We improved our cap rate on the valuations for Industrial, which will serve us well on a go-forward basis as we transition toward Industrial.

And on the Office side, we went from a 7% cap rate to an 8% cap rate. Also, as you'll note in the 8-K that was filed, the leverage percentage for the office side was at 50%, and we have a leverage capacity on the Industrial side at 60%. We do have the ability to accordion up -- back up to the $1.3 billion, and we'll utilize the accordion as we execute on our strategic growth plan. At this point, it didn't make sense to continue to pay a non-utilization fee for excess capacity.

[Anthony Hau, analyst]

Got you. And for the accordion, like can you just exercise the option and just upsize the facility anytime you want? Or are there certain conditions that you have to meet to exercise that option?

[Javier Bitar, executive]

Well, obviously, we have to be in compliance, and then, the member banks would have to approve.

[Anthony Hau, analyst]

And Mike, maybe this is for you. Can you provide some -- any color on the investment-grade tenancy for the portfolio? I saw that drop meaningfully this quarter, just curious which tenants caused that.

[Michael Escalante, executive]

Yes. I don't know what you mean by meaningfully, but I think part of that is happening as a result of some of the sales on the other side of the segment. We do tend to fluctuate a little bit back and forth relative to certain tenants inside the core portfolio depending on their ratings around -- some are on the cusp of BBB-, as an example.

[Anthony Hau, analyst]

Yes. So I was referring to the fact that like I think it went from -- say, for Industrial, right, it went from 74% to 59% this quarter, and...

[Michael Escalante, executive]

Yes. So that could be related to -- I think that could be related to restoration hardware coming and going. I think this is the first time that it happened actually at a quarter end, but they tend to move in and out within the quarter depending on what's going on in the marketplace.

[Anthony Hau, analyst]

Okay. And how does your like tenant watch list compare today versus like a year ago?

[Michael Escalante, executive]

Well, again, we spend an awful lot of time looking and managing and monitoring our credit tenancy. And I think, as you know, we've had 100% collections for quite some time. So we don't really call it a watch list. We just call it as part of our policies and procedures. We look at every single tenant all the time, making sure that we understand what's going on there. And I -- our receivables are quite small, almost de minimis, I think, at this point, so...

[Anthony Hau, analyst]

And just last question...

[Michael Escalante, executive]

I also -- I don't want to go so far as to jinx either by saying anything. I believe that putting words in the universe is not a good thing.

[Anthony Hau, analyst]

I believe that, too. Just last question for me. What are you guys seeing on the ground today in terms of like buyer's appetite for the single-tenant office assets? Last time we spoke, you mentioned that you're seeing more -- the [ dark pool ] increase a bit compared to like 6 months ago. Is that still the same? Has that changed at all?

[Michael Escalante, executive]

Yes. You sort of -- you've -- the way you described the question is interesting. I guess I would say that my statement was a broader statement, was that I believe that there is a significant amount of interest for properties in the marketplace generally, not necessarily net leased assets. And I think that's just across the board. I think what I said the last time was that we had, had very few buyers showing up and that our bid lists were burgeoning out, if you will, getting larger. And I still believe that they're on the larger side, certainly relative to the last couple of years.

[Javier Bitar, executive]

Let me make one correction back to Farrell. On the asset that we did sell, that was a longer-term asset, 7-plus years of term. We did have one held-for-sale asset that was a shorter term. So I just wanted to clarify that.

[Operator]

Ladies and gentlemen, we have reached the end of question-and-answer session. I would now like to turn the floor over to the management for closing comments.

[Michael Escalante, executive]

Thank you, everyone, for joining this quarter. Again, very happy with what we've been able to achieve. Very excited about the achievement, specifically on the credit side, and looking forward to moving the portfolio forward as we've been suggesting just over the last year since we listed the company in April, so stay tuned. And we think we have good news in our future. Thank you for your time.

[Operator]

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.