Office Properties me Trust(US:OPI)2021-02-19 18:09Part I Business Office Properties Income Trust (OPI) is a REIT focused on owning, operating, and leasing properties primarily to single tenants and those with high credit quality, with the U.S. government as its largest tenant, managing a 24.9 million square foot portfolio through capital recycling and external management Our Company and COVID-19 Pandemic OPI's 2020 portfolio comprised 181 properties totaling 24.9 million square feet, with the U.S. government as its largest tenant, and the company provided $2.5 million in temporary rent assistance due to COVID-19 while maintaining strong liquidity Portfolio Overview as of December 31, 2020 | Metric | Value | | :--- | :--- | | Wholly Owned Properties | 181 | | Rentable Square Feet | 24.9 million | | Undepreciated Carrying Value | $3.5 billion | | Number of Tenants | 349 | | Weighted Average Remaining Lease Term | 5.1 years | | Largest Tenant (U.S. Government) | 25.2% of annualized rental income | - In response to the COVID-19 pandemic, OPI granted temporary rent assistance of $2.5 million to 19 tenants, representing 3.3% of annualized rental income, with 78.5% of these deferrals collected as of February 16, 202131 - As of February 18, 2021, the company had $750.0 million available under its revolving credit facility and no significant debt maturities until 2022, providing substantial liquidity35 Business and Growth Strategy OPI's strategy focuses on acquiring and managing single-tenant and high-credit-quality properties, employing a capital recycling program to enhance portfolio quality and pursuing growth through strategic acquisitions - The company's business plan focuses on owning properties leased to single tenants and tenants with high credit quality, such as government entities41 - OPI employs a capital recycling program, selectively selling properties to reinvest proceeds into new acquisitions that aim to reduce the average property age, lengthen the weighted average lease term, and lower ongoing capital requirements4345 - Acquisition targets are primarily U.S. office properties in strong economic markets, focusing on single-tenant properties strategic to the tenant and properties leased to government agencies with high security needs49 Financing Policies and Other Information OPI funds operations and growth through capital recycling, a $750 million credit facility, and debt/equity issuances, aiming for investment-grade ratings, while being externally managed by The RMR Group LLC and emphasizing sustainability - OPI's financing strategy involves using proceeds from its capital recycling program, its $750.0 million revolving credit facility, and debt/equity issuances to fund operations, acquisitions, and distributions, while aiming to maintain investment-grade ratings606263 - The company has no employees; all personnel and services are provided by its external manager, The RMR Group LLC (RMR LLC)6566 - As of December 31, 2020, 28 properties (18.2% of total rentable square feet) were LEED® designated, and as of February 16, 2021, 31 properties had been awarded ENERGY STAR certification6869 Material United States Federal Income Tax Considerations This section outlines the complex U.S. federal income tax rules for OPI as a REIT and its shareholders, detailing the stringent tests for REIT qualification and the tax implications of distributions - OPI has elected to be taxed as a REIT and believes it has operated in compliance with REIT qualification rules since its 2009 taxable year, generally not being subject to federal income tax on income distributed to shareholders8485 - To maintain REIT status, OPI must annually satisfy two gross income tests (75% and 95% from real estate-related sources) and several asset tests at the end of each quarter105115 - OPI is required to distribute at least 90% of its annual REIT taxable income (excluding net capital gains) to shareholders to maintain its REIT qualification60120 - Distributions to non-corporate U.S. shareholders are generally not eligible for the preferential tax rates on qualified dividends but may be eligible for a deduction under Section 199A of the IRC for taxable years before 202685135 Risk Factors The company faces significant business risks from the COVID-19 pandemic, tenant issues, and government budgetary pressures, alongside management and relationship risks due to its external manager, and financial and tax risks related to debt and REIT status - Business Risks: The COVID-19 pandemic may adversely affect tenants' ability to pay rent and reduce demand for office space; the company faces risks of non-renewal of leases, tenant bankruptcies, and dependence on single tenants; government budgetary pressures and a property concentration in the Washington, D.C. market also pose significant risks179185188189191 - Management and Relationship Risks: OPI is dependent on its external manager, RMR LLC, for all operations, creating potential conflicts of interest due to cross-ownership and management of other companies, with management agreements not negotiated at arm's length and containing substantial termination fees that could discourage a change of control222224228229 - Financial and Tax Risks: REIT distribution requirements may limit the company's ability to retain cash for operations and growth; the company has significant debt, and failure to comply with covenants could trigger defaults; failure to maintain REIT tax status would have severe adverse consequences, including corporate-level taxation196202245 - Organizational and Securities Risks: Ownership limitations (9.8%) and provisions in governing documents may deter a change in control; the value of the company's securities is subject to market conditions, including interest rate changes, and future issuances of debt or equity could dilute existing shareholders234257258 Properties As of December 31, 2020, OPI's portfolio included 181 wholly-owned properties across 34 states, totaling 24.9 million square feet with a $3.6 billion carrying value, plus interests in three joint venture properties, with some properties encumbered by mortgages Wholly Owned Properties by State (Top 5 by Annualized Rental Income) as of Dec 31, 2020 | State | Number of Properties | Undepreciated Carrying Value ($ thousands) | Annualized Rental Income ($ thousands) | | :--- | :--- | :--- | :--- | | Virginia | 26 | $498,308 | $71,088 | | California | 24 | $483,503 | $70,978 | | District of Columbia | 7 | $548,385 | $62,997 | | Texas | 16 | $260,241 | $48,206 | | Maryland | 14 | $255,011 | $37,847 | | Grand Total (All States) | 181 | $3,577,232 | $578,018 | - In addition to its wholly-owned portfolio, OPI has noncontrolling ownership interests (51% and 50%) in three properties through two unconsolidated joint ventures269 - As of year-end 2020, seven properties were encumbered by mortgages totaling $170.8 million272 Part II Management's Discussion and Analysis of Financial Condition and Results of Operations This section analyzes OPI's 2020 financial performance, covering property operations, capital recycling activities, a decline in rental income and net income due to dispositions, and strong liquidity, along with non-GAAP reconciliations and critical accounting estimates Property Operations As of December 31, 2020, OPI's portfolio occupancy was 91.2%, with 1.97 million square feet leased at a 6.9% rent increase, and $93.1 million in capital expenditures, while the U.S. Government remained the largest tenant Occupancy Data Comparison | Metric | Dec 31, 2020 | Dec 31, 2019 | | :--- | :--- | :--- | | All Properties Percent Leased | 91.2% | 92.4% | | Comparable Properties Percent Leased | 92.1% | 93.3% | 2020 Leasing Activity | Metric | Value | | :--- | :--- | | Total Square Feet Leased | 1,965,000 | | Change in Rent vs. Prior Leases | +6.9% | | Weighted Average Lease Term | 7.3 years | | Total Leasing Costs & Concessions ($ millions) | $43.4 | 2020 Capital Expenditures ($ thousands) | Category | Amount | | :--- | :--- | | Lease related costs | $34,972 | | Building improvements | $41,280 | | Development, redevelopment and other | $16,858 | | Total Capital Expenditures | $93,110 | - As of December 31, 2020, leases representing 16.1% of leased square feet and 12.1% of annualized rental income are scheduled to expire in 2021297 Acquisition, Disposition, and Financing Activities In 2020, OPI acquired two properties for $46.6 million and sold ten for $110.5 million, while issuing $412 million in new senior notes and repaying $552 million in existing debt - During 2020, OPI acquired two properties for an aggregate purchase price of $46.6 million307 - The company sold 10 properties for an aggregate sales price of $110.5 million during 2020310 - Key financing activities in 2020 included issuing $412 million in new senior unsecured notes and redeeming or repaying $552 million in existing senior and mortgage notes313314315316317318319 Results of Operations OPI's net income significantly decreased in 2020 to $6.7 million ($0.14 per share) from $30.3 million ($0.63 per share) in 2019, primarily due to a $90.5 million decline in rental income from property dispositions and lower gains on real estate sales Consolidated Results of Operations (Year Ended Dec 31, $ in thousands) | Metric | 2020 | 2019 | | :--- | :--- | :--- | | Rental Income | $587,919 | $678,404 | | Total Operating Expenses | $195,968 | $228,962 | | Net Operating Income (NOI) | $391,951 | $449,442 | | Gain on sale of real estate | $10,855 | $105,131 | | Interest Expense | ($108,303) | ($134,880) | | Net Income | $6,678 | $30,335 | | Net Income per Share | $0.14 | $0.63 | - The $90.5 million (13.3%) decrease in consolidated rental income was primarily due to property dispositions323325 - Total operating expenses decreased by $33.0 million (14.4%), also mainly due to property sales, with utility expenses for comparable properties declining due to cost savings initiatives implemented during the COVID-19 pandemic323327328 Non-GAAP Financial Measures OPI's 2020 NOI decreased to $392.0 million, FFO to $255.1 million ($5.30 per share), and Normalized FFO to $259.2 million ($5.39 per share), reflecting property dispositions Reconciliation of Net Income to NOI ($ in thousands) | Line Item | 2020 | 2019 | | :--- | :--- | :--- | | Net income | $6,678 | $30,335 | | Adjustments (Depreciation, G&A, Interest, etc.) | $385,273 | $419,107 | | NOI | $391,951 | $449,442 | FFO and Normalized FFO Reconciliation ($ in thousands, except per share) | Metric | 2020 | 2019 | | :--- | :--- | :--- | | Net Income | $6,678 | $30,335 | | Depreciation & Amortization | $256,369 | $295,788 | | Loss on Impairment | $2,954 | $22,255 | | (Gain) on Sale of Real Estate | ($10,855) | ($105,131) | | Loss on Equity Securities, net | $0 | $44,007 | | FFO | $255,146 | $287,254 | | FFO per share | $5.30 | $5.98 | | Adjustments | $4,071 | $1,451 | | Normalized FFO | $259,217 | $288,705 | | Normalized FFO per share | $5.39 | $6.01 | Liquidity and Capital Resources OPI maintains strong liquidity through operating cash flow, property sales, and a fully available $750 million revolving credit facility, with net cash from operations increasing to $233.6 million in 2020 and no significant debt maturities until 2022 - Primary sources of liquidity are operating cash flows, property sales, and a $750 million revolving credit facility, which was fully available as of February 18, 2021347348 Summary of Cash Flows ($ in thousands) | Activity | 2020 | 2019 | | :--- | :--- | :--- | | Net Cash from Operating Activities | $233,628 | $215,329 | | Net Cash (Used in) Provided by Investing Activities | ($22,987) | $877,819 | | Net Cash Used in Financing Activities | ($254,482) | ($1,031,395) | - The company has no significant debt maturities until 2022, with $625.5 million due that year348364 - As of December 31, 2020, the company was in compliance with all debt covenants under its credit agreement and senior note indentures371 Quantitative and Qualitative Disclosures About Market Risk OPI's primary market risk is interest rate exposure, with $2.24 billion in fixed-rate debt as of December 31, 2020, and a floating-rate $750 million revolving credit facility, while monitoring the LIBOR phase-out Fixed Rate Debt Summary as of December 31, 2020 | Debt Type | Principal Balance ($ thousands) | Weighted Avg. Interest Rate | | :--- | :--- | :--- | | Senior unsecured notes | $2,072,000 | 4.78% | | Mortgage notes | $170,842 | 3.99% | | Total | $2,242,842 | 4.72% | - A hypothetical 1% increase in interest rates would decrease the fair value of the company's fixed-rate debt by approximately $110.5 million386 - The company had no floating-rate debt outstanding at year-end, but its $750 million revolving credit facility is exposed to LIBOR fluctuations, and the company is monitoring the planned phase-out of LIBOR390395 Controls and Procedures As of December 31, 2020, management concluded that OPI's disclosure controls and procedures and internal control over financial reporting were effective, with no material changes during the fourth quarter - Management concluded that the company's disclosure controls and procedures were effective as of December 31, 2020398 - Management's assessment, based on the COSO 2013 framework, concluded that the company's internal control over financial reporting was effective as of December 31, 2020401 Part III Directors, Executive Officers, Compensation, and Corporate Governance Information for Items 10-14, covering directors, executive officers, compensation, and corporate governance, is incorporated by reference from the 2021 Proxy Statement, with 1,094,909 common shares available under the 2009 Incentive Share Award Plan as of year-end 2020 - Most information for Part III (Items 10, 11, 12, 13, and 14) is incorporated by reference from the company's definitive Proxy Statement for the 2021 Annual Meeting of Shareholders407408411412413 Equity Compensation Plan Information as of Dec 31, 2020 | Plan Category | Securities to be issued upon exercise of outstanding options, warrants and rights | Weighted average exercise price | Securities remaining available for future issuance | | :--- | :--- | :--- | :--- | | Equity compensation plans approved by securityholders | None | None | 1,094,909 | Part IV Exhibits and Financial Statement Schedules This section includes OPI's audited consolidated financial statements for 2020, with detailed notes on accounting policies, transactions, and related parties, along with an unqualified audit opinion from Deloitte & Touche LLP on both financial statements and internal controls Financial Statements and Notes The audited financial statements for 2020 show total assets of $3.95 billion, total liabilities of $2.34 billion, and net income of $6.7 million, with detailed notes on debt, management agreements, and capital structure Consolidated Balance Sheet Summary (as of Dec 31, $ in thousands) | Account | 2020 | 2019 | | :--- | :--- | :--- | | Total Real Estate Properties, net | $3,070,229 | $3,105,575 | | Total Assets | $3,946,436 | $4,193,136 | | Total Debt, net | $2,202,971 | $2,327,325 | | Total Liabilities | $2,337,044 | $2,487,382 | | Total Shareholders' Equity | $1,609,392 | $1,705,754 | Consolidated Income Statement Summary (Year Ended Dec 31, $ in thousands) | Account | 2020 | 2019 | | :--- | :--- | :--- | | Rental Income | $587,919 | $678,404 | | Total Expenses | $479,163 | $574,512 | | Net Income | $6,678 | $30,335 | - The independent auditor, Deloitte & Touche LLP, issued an unqualified opinion on the 2020 financial statements and the effectiveness of internal control over financial reporting426437 - The critical audit matter identified was the impairment of real estate properties, due to the significant management estimates and assumptions required to evaluate recoverability431433