Summary: Office Properties Income Trust (OPI) recently announced a distressed debt exchange whereby OPI would issue USD 610m of new 9% secured notes due in September 2029 for a total of USD 899m of existing notes. The new notes would be secured with first-priority liens on 19 properties and second-priority liens on 19 properties that secure the credit facility. This exchange was not well received by the 2025 noteholders who only exchanged USD 81m (12.5%) of their notes by the early exchange deadline. Debtwire reported that noteholder dissatisfaction from an ad hoc group of creditors led by Lazard and Milbank was due to “less-than-expected collateral” and “too low a consideration” since the 2025 notes were nine months from maturity. Of all noteholders eligible for the exchange, only USD 399m of notes out of USD 1.7bn (23% of total) exchanged their notes. This led OPI to amend the offer twice in the span of three days. Included in the discussions with the company, Debtwire reported that an ad hoc group of longer-dated OPI bonds were working with PJT as financial advisor and Paul Weiss as legal counsel.

This exchange came on the heels of weak 1Q24 results, with concern about upcoming lease maturities in a challenging commercial real estate market. The fact that OPI did not take any analyst/investor questions on its 1Q24 call only heightened anxiety.

Going into FY24, OPI had almost three million of leased square footage expiring during the year representing 16.7% of total square footage and 15.5% of total annualized rental income. During 1Q24, OPI had strong renewal leasing activity, but despite this, at the end of 1Q24, the company still had 2.3 million of leased square feet expiring during the remainder of 2024 representing 13.1% of total square footage, and 13% of annualized rent income. On its earnings call, management stated that 2.25 million of square footage, representing USD 65.5m of annualized rental income, will not be renewed by current tenants as they are asking for lower rents and less space. Approximately 2.0 million square feet (89% of leases expect to not be renewed) are unencumbered properties.

Lease expirations over the next 12 months total 2.5 million square feet or 15% of OPI’s annualized rental income. The company is focusing on selling vacant, or soon-to-be vacant properties, and are at various stages of marketing these assets.

Due to the challenges OPI has concerning its capital structure, it engaged Moelis & Company LLC as its financial advisor to assist in evaluating options to address its upcoming debt maturities. The new credit facility and recently announced distressed debt exchange are two of the options that it looks like Moelis spearheaded.

Our next twelve months estimated (NTME) operational liquidity table assumes that the current distressed exchange is successful and that OPI repays its remaining 2025 notes with proceeds from asset sales. In this scenario, we estimate that liquidity will decline by USD 44.7m to USD 113.8m on 31 March 2025.

For our valuation scenario, using FY25E FFO of USD 85m, and including a 5% restructuring fee, we find that at our midpoint valuation, secured debt is 95% covered and unsecured debt has no recovery, while using EBITDAre, we find that all debt is covered with an equity price of USD 1.84.  We believe that under the management of The RMR Group, OPI will find creative ways to avoid bankruptcy and just kick the can down the road in hopes of a commercial real estate recovery.

Additional Details

OPI ended 1Q24 with 151 properties that were 85.6% leased compared to 152 properties on 31 December 2023 that were 86.9% leased, and 157 properties on 31 March 2023 with 90.5% leased. On a same-store basis, OPI had 145 properties that were 88.2% leased compared to 31 March 2023 when 94.2% were leased.

As of 31 March, OPI had 108 unencumbered properties, representing 13.2 million square feet that were 78.6% occupied having a gross book value of USD 3.25bn. The 78.6% occupancy level contrasts to occupancy of 98.8% for the 43 properties used as collateral for the secured debt. Thus, future debt will be secured with lower quality assets.

During 1Q24, OPI executed 488,000 square feet of new and renewal leasing, with an average lease term of 9.3 years and a 10.2% roll-up in rent rates. About 90% of the leasing activity was renewals driven by the US government and state tenants.

Approximately 62% of annualized rental income was from investment grade tenants, 33% from non-rated firms, and 5% from non-investment grade tenants. By industry, the US government represented 20.2% of annualized rental income, with real estate & financials representing 16.2%, technology & communications 15.5%, and legal and other professional services 13.7%. It is worth noting that approximately 12% of the US government’s annualized revenues are from leases at specialized building facilities, while 8% of annualized revenues are from non-specialized functions that will likely be consolidated in the future forcing OPI to re-lease or dispose of these properties.

As of 31 March, as shown in the table below, OPI had 20 tenants that each contributed more than 1% of total annualized rental income.

OPI has 51% and 50% interests in two unconsolidated joint ventures (JVs) which own three properties that are encumbered by an aggregate USD 82m of mortgage debt that is non-recourse to OPI. In March, one of the JVs (50%-owned with a USD 32m mortgage), did not have sufficient cash flow to pay its monthly debt service resulting in an event of default. OPI expects the non-recourse mortgage lender to the JV to take full possession of the property during 2Q24. OPI wrote off its full investment in the JV during 4Q23.

On 13 May, Moody’s downgraded OPI’s CFR and senior unsecured debt ratings to Caa2 from Caa1 due to the company’s high financial leverage (net leverage over 9x), operating risks (material leases expiring), and weak liquidity.

On 2 May, Standard & Poor’s (S&P) lowered its issuer credit rating and senior unsecured notes rating to CC from CCC (where the ratings had been lowered to in February 2024). S&P affirmed its B- rating for the senior secured notes, and CCC for the unsecured notes that are not part of the exchange. S&P noted that the recently announced exchange offer will be at below par, which is tantamount to a default.

Debt and Liquidity

On 31 March 2024, OPI had USD 2.63bn in total consolidated debt, up from USD 2.59bn on 31 December 2023. Debt was comprised of USD 590m of secured debt, USD 1.9bn in unsecured notes, and USD 177m of mortgage debt.

The net leverage ratio on 31 March 2024, according to OPI, was 8.4x compared to 8.2x on 31 December 2023 and USD 7.7x on 31 March 2023 using adjusted EBITDA re on a rolling four quarter basis. We calculated total leverage at 9.2x. The company had USD 190m drawn on its USD 325m secured revolver leaving USD 135m available to borrow.

In January 2024, OPI entered into an amended and restated secured credit agreement for a new three-year USD 325m secured revolver and USD 100m secured term loan at a rate of SOFR plus 350 basis points (bps). The credit agreement is secured by 19 properties that have 98.5% occupancy with a gross carrying value of USD 942m (45% loan to value (LTV)). The company has a one-year extension option available on the revolver. OPI immediately borrowed USD 132m on the revolver and used proceeds from this transaction to repay its unsecured revolver.

In February, OPI issued USD 300m 9% secured notes due March 2029 at an OID of 93.5 (10.67% YTM) with net proceeds of USD 271m. The notes are secured by first-priority liens on 17 properties in Atlanta, Provo, Silicon Valley, Sacramento, and Boise that have 98.5% occupancy with a gross carrying value of USD 574m (52.3% LTV) and a pledge of equity interests in subsidiary guarantors. With this issuance, and borrowings under its revolver, the company issued an early redemption notice for its USD 350m 4.25% unsecured notes due May 2024.

OPI’s unencumbered asset test requires it to maintain unencumbered assets of at least 1.5x the amount of unsecured debt. On 31 March, the ratio was 1.78x, implying approximately USD 3.3bn of unencumbered assets. The ratio on 31 December was 2.06x.

The Debt Exchange

On 1 May, OPI announced a private exchange offer for its unsecured notes due in 2025, 2026, 2027, and 2031 for up to USD 610m of new 9% senior secured notes due September 2029. The new notes will be secured by first-priority liens on 19 properties with an adjusted total assets value of approximately USD 722m (estimated market value of USD 716m), and second-priority liens on 19 additional properties that secure OPI’s credit facility with an adjusted total asset value of USD 1bn (estimated market value of USD 952m). The original exchange had an early exchange date of 14 May, and a late exchange date of 30 May. The exchange was conditional upon receiving at least USD 97.5m of the existing 2025 notes, and at least USD 488m in aggregate principal amount of new notes are issued.

As of 17 May, OPI received from eligible holders the following amounts for exchange (USD 399.1m total existing notes for USD 270m new notes):

• 2025 Notes – USD 81.048m (USD 76m of new notes)
• 2026 Notes – USD 87.767m USD 63.2m of new notes)
• 2027 Notes – USD 128.040m (USD 78.1m of new notes)
• 2031 Notes – USD 102.256m (UD 52.7m of new notes)

On 20 May, after an underwhelming participation rate from existing noteholders, especially the 2025 noteholders, OPI amended the exchange to include priority amounts for each series but kept the exchange consideration the same as the early consideration from the original exchange. The priority shifted to the 2031 notes which would allow for increased de-leveraging. If any series exchanged is less than the priority amount, the undersubscribed new notes amount will be allocated to holder of other series of existing notes as shown in the waterfall table. OPI also waived conditions that at least USD 97.5m of 2025 notes had to be tendered and at least USD 488m in aggregate principal amount of new notes had to be issued. The expiration date was extended until 4 June from 14 May.

On 23 May, the exchange offer was further amended to provide for updated priority levels and amounts, as well as to extend the expiration date for the offer. This amendment changed the priority back to the 2025 notes but capped the amount of 2029 notes to be issued for this issue to USD 200m. The expiration date was further extended to 5:00pm, New York City time on 10 June 2024 from 4 June 2024.

If the exchange offer is completed without any undersubscribed amounts, OPI will issue USD 610m of New Notes for a total of USD 899m of existing notes.

On 31 March, OPI had USD 158.5m of liquidity compared to USD 205.3m on 31 December 2023. Liquidity was comprised of USD 23.5m in cash and USD 135m available on its revolver. OPI also has USD 20.6m of restricted cash that is escrowed for real estate taxes, insurance, leasing costs, capex, and debt service.

During 1Q24, sold one property in Chicago, IL consisting of approximately 248,000 rentable square feet for a sales price of USD 38.5m, excluding closing costs. In April, the company entered into an agreement to sell one property in Malden, MA consisting of approximately USD 126,000 square feet for a sales price of USD 7.8m, excluding closing costs.

During 1Q24, OPI cut its quarterly distribution on its common shares of USD 1 cents per share that will save the company USD 47m annually based on the previous dividend amount.

Valuation

Before we delve into valuation scenarios, we provide a table from the recent offering memorandum that provides various metrics for the various secured debt tranches and how that compares to the USD 610m of new notes that OPI is offering for exchange. While the first lien collateral for the new notes is arguably not as valuable as that for the other secured debt issues, especially the loan to value (85.2% compared to 44.7% for credit facility, and 52.2% for secured notes), with the second lien collateral from the credit facility the loan-to-value falls to 49.1%. We also note that future secured debt might be collateralized by unencumbered properties that are of a lower quality with shorter average lease terms, higher vacancy rates, and greater percentage of lease expirations. While the pool’s 89 properties generate an LTM NOI of almost USD 138m, based on the declining metrics, it would appear that most of OPI’s declining NOI will be due to these unencumbered properties.

For our valuation scenario, we use a range of FY25E FFO from USD 65m-USD 105m and multiples of EV/FFO of 14x-16x. At the 15x midpoint, we find that secured debt is 95% covered with no recovery for unsecured (which includes a 5% restructuring fee). As shown in the table above, despite the weakening metrics in the unencumbered asset pool, we believe there is value for unsecured debt.

We also use a range of EBITDAre from USD 230m-USD 290m and multiples of EV/EBITDAre of 6.25x-8.25x. At the 7.25x midpoint, we find that all debt is covered with an equity price of USD 1.84.

The Details

For 1Q24, OPI’s rental income rose 5.3% YoY, or USD 7m, to USD 139.4m, primarily due to USD 10.5m of lease termination fees from Tyson Foods, a former tenant. Excluding these fees, 1Q24 rental income would have declined 4.1% YoY. Sequentially, rental income rose 4.2%, but again, excluding lease termination fees, rental income would have fallen 3.9%. On a same-store basis (145 properties), rental income fell 5.4% to USD 120.7m.

On the expense side, real estate taxes increased to USD 15.7m from USD 15.3m. Utility expenses rose 12.3% YoY to USD 8.2m, while other expenses increased 4.6% to USD 27.3m.

For 1Q24, NOI rose 5.3% YoY to USD 88.2m from USD 83.8m, while NOI on a cash basis dropped 13.9% YoY to USD 68.3m. Same property cash basis NOI decreased 12% YoY, better than guidance of a 14%-16% decline. The YoY decline was driven by elevated free rent concessions, vacancies, and higher operating expenses.

OPI reported USD 48.2m of funds from operations (FFO) and USD 38.3m of normalized FFO for 1Q24, which was lower by 2.7% YoY and 27.4% YoY, respectively. Normalized FFO was USD 45.9m for 4Q23. The sequential decline in normalized FFO was due to higher interest expense, and lower NOI due to vacancies.

Adjusted EBITDAre fell 6% YoY to USD 73.8m (52.9% margin) compared to USD 78.5m (59.3% margin) for 1Q23, continuing the trend of declining EBITDAre. For the LTM period, adjusted EBITDAre was USD 309.9m (57.3% margin) compared to FY23 adjusted EBITDAre of USD 314.6m (59% margin).

Business Description: Office Properties Income Trust is a real estate investment trust, or REIT, with 151 wholly owned office properties as of 31 March 2023 containing approximately 20.3 million rentable square feet, and two unconsolidated joint ventures with 51% and 50% ownership interests that own three properties. The REIT focuses on owning and leasing office and mixed-use properties in 30 US states and Washington, DC.

The RMR Group, an alternative asset management company focused on commercial real estate, is OPI’s manager and conducts day-to-day operations, as well as originating and presenting investment and divestment opportunities to OPI. OPI has no employees with all services performed by RMR.