Welcome to Washington Real Estate Investment Trust Third Quarter 2020 Earnings Conference Call. As a reminder, today's call is being recorded. Before turning the call over to the company's President and Chief Executive Officer, Paul McDermott, Amy Hopkins, Vice President of Investor Relations, will provide some introductory information. Amy, please go ahead.

Thank you. Good morning, and welcome to WashREIT's third quarter earnings conference call. Before we begin, please note that forward-looking statements may be made during this discussion. Such statements involve known and unknown risks and uncertainties, including those related to the effects of the ongoing COVID-19 pandemic, which may cause actual results to differ materially, and we undertake no duty to update them as actual events unfold. We refer to these risks in our SEC filings. Reconciliations of the GAAP and non-GAAP financial measures discussed on the call are available on our most recent earnings press release and financial supplement, which were distributed yesterday and can be found on the Investor Relations page of our website. Participating in today's call with me will be Paul McDermott, President and Chief Executive Officer; Steve Riffee, Executive Vice President and Chief Financial Officer; Taryn Fielder, Senior Vice President and General Counsel; Drew Hammond, Vice President, Chief Accounting Officer and Treasurer; and Grant Montgomery, Vice President and Head of Research. Now I'd like to turn the call over to Paul.

Thank you, Amy, and good morning, everyone. I hope everyone is safe and healthy, and we appreciate you being with us today. We're joining you from our corporate headquarters in Washington, D.C., where I've been working alongside many others from our team with social distancing and other safety protocols in place. We are all very happy to be back together on a voluntary basis. And while our technology has been incredibly effective and has helped us be successful while working remotely, there is no substitute for in-person collaboration. Last evening, we released our earnings for the third quarter of 2020. Our results were largely in line with our expectations, and our portfolio continues to demonstrate strong stable credit performance as we absorb the near-term impact of the pandemic. While uncertainty remains regarding how protracted this economic downturn will be, we remain well positioned to bolster our long-term strategic growth plans once the operating environment improves. Ahead of the downturn, we reshaped our portfolio with a long-term vision, and this focus has proven to be prudent from a capital allocation perspective. Our multifamily collections are consistently above national averages, and our suburban expansion through the Assembly portfolio acquisition is performing well. While our operating environment has changed drastically over the past 7 months, we swiftly adjusted to the demands of today's market. We have fully prepared our commercial properties for reentry by upgrading ventilation filters, implemented enhanced cleaning protocols and installing contactless opening technology and protective shields in addition to many other safety enhancements. We've worked diligently with tenants who have been financially impacted by COVID-19 to arrange deferral agreements that support their financial position and cash flow needs. Fortunately, these deferral arrangements have not been material and represent a cumulative impact of less than $0.01 per share through 2021. While…

Thank you, Paul, and good morning, everyone. I'll start off by discussing our cash collection performance before reviewing our third quarter results and outlook for the remainder of 2020 as well as recap our most recent steps to further strengthen our balance sheet. Our multifamily collections continue to be excellent, which as Paul outlined, is a testament to our strong portfolio credit and the resilience of the Washington Metro economy. We collected 99% of cash and contractual rents during the third quarter, and our rent collections through the first 3 weeks of October are in line with our quarterly trend. We have offered deferred payment programs to residents who have been financially impacted by the pandemic, and only $58,000 of deferred multifamily rent remains outstanding year-to-date. Our monthly multifamily collection performance continues to track above national averages. As Paul highlighted, we attribute our outperformance in part to our high exposure to industries that have outperformed during this crisis and low relative exposure to underperforming industries. We track the industries our residents are employed in, and our exposure is most heavily weighted to the most resilient economic sectors, and likewise, less weighted to the industries that have been most impacted, which has resulted in very high collection rates and stable cash flows. The impact of COVID-19 on the Washington Metro market has been contained primarily to the leisure and hospitality, education and health and retail sectors, which represent over 75% of Washington Metro job losses, but only 55% of total job losses nationally through August. These 3 sectors comprise approximately 20% of our resident exposure and only 8% of our office tenant exposure. Thus, we are experiencing high collection rates and cash flows despite this crisis. Turning to commercial. Our office and retail collections improved during the third quarter compared to…

Thanks, Steve. In closing, while we are operating in a challenging environment, we remain confident in our ability to effectively manage through this period of uncertainty while preserving the embedded growth of our assets. While we, like others, are dealing with an unprecedented pandemic, we have kept our eye on executing, diligently strengthening the balance sheet, maintaining value as well as preserving long-term growth opportunities. At our current stock price, we believe that we offer a compelling value proposition for investors, with a 7% dividend yield on a dividend that we are covering, a strong liquidity position, a development and renovation pipeline that can and will be reactivated once conditions approved and a solid long-term growth story. Now we would like to open the call to answer your questions.

[Operator Instructions] Our first question is from Blaine Heck with Wells Fargo.

So Paul, I think last quarter or maybe the quarter before when I asked about the investment sales market, you talked about how the transaction side of things is still relatively slow. Are you seeing any signs of an increase in transactional volume? And if so, is there enough to kind of figure out what the effect on pricing has been both in multifamily and office?

Well, let's start with multifamily, Blaine. I would bifurcate the market between obviously urban and suburban, and I'll start with D.C. proper. Occupancy, obviously, there's been some deceleration downtown, but the big challenge really has been TOPA. It's still hurting downtown investment sales, and it's really probably -- for those who wanted to close by year-end, it's probably really become the Achilles' heel to that execution. I would say in the suburban markets and multifamily, that seems to be the hottest product right now, particularly in Northern Virginia. I would say our observation, and let's go back to the end of the fourth quarter of 2019 where we thought it was a very hot market, we definitely saw tremendous activity and some cap rate compression probably in January and February of this year. And then obviously, in March, there was a static period. But I would say that it is back with a vengeance right now, thanks to agency lending. We have seen some cap rate compression. I think the cap rate now, I don't like to put all my eggs in the cap rate basket just because -- are they based on actual occupancy, actual collections, tax adjusted? Are you T12-ing, T3-ing, T1-ing? But we've definitely seen underwriting. I'd say probably since Labor Day, probably become more aggressive, and I'm really looking at that kind of year 2 growth assumption in the multifamily space, where I think, when we talked in the second quarter, some folks still probably had 0 to negative growth, and that growth rate now has translated to probably between -- just in the underwriting feedback we've got between 1% and 3%. Just in terms of capital, I think as we talked about the Odyssey Index, the core funds are kind of gone. But we're definitely…

That's great commentary, very helpful. Maybe just a couple of follow-ups there and focusing on the multifamily side. Are you seeing more core deals on the market? Or are there also value-add deals? And if so, I guess, what's the pricing differential between the two? And then assuming you guys are looking at deals, are you mostly focused on Northern Virginia? Or are you looking at properties in D.C. proper and Maryland as well?

Let me start with the last, and I'll work my way backwards, Blaine. The district right now, the district is really only 13% of our NOI stream. I don't think we're seeing any transactions in the district, like I said in my earlier comments, because of TOPA. And if you're looking for certainty of execution on closing, D.C.'s pushed out their restrictions to year end. There's nothing to say that, that won't become more protracted once we get to December 31. And given some of the occupancy and concessionary issues that are dealing with in the district right now, I think that you're probably having a little bit wider-than-normal bid-ask. Have -- if I go back into suburbs right now, I think Northern Virginia, just because of the resiliency of the job market with check and the government contracting, that is definitely seeing more deals and more value-add deals. And I think you're -- I remember talking to you last year at this time, I believe, when we were signed and sealed and executed on the Assembly portfolio and people were asking about suburban garden-style walk-ups. I mean that is one of the hottest products that's out there right now, and it's being priced well above replacement cost. And that is clearly value-add capital that it's not if, it's when they're going to grow rents. And I think they've brought that rent growth curve inward more than some folks that have been operating out there for some time. Like I said, I mean, they're growing rents probably to win these deals at the beginning of year 2. So have not seen, Blaine, a lot of core capital sniffing around those deals right now.

Okay. That's great. And the last one on the transaction side. At this point, would you guys be comfortable taking on more development risk through the acquisition of land or maybe an asset that's still under construction?

Let's look at our development pipeline right now. I mean we have 767 units shovel-ready in a market we know very well. And we've got -- our litmus test has been the excellent renovation work that we've done. That is probably what we look at, first and foremost. As you know, we have covered land plays that we don't have to go out and seek already embedded in our portfolio as well as some multifamily assets that have additional FAR. As far as broken construction deals right now, that's probably just too broad. That would be submarket by submarket. There are markets, as you know, we really still try to play and draft off of our affordability gaps. And so I haven't seen any broken construction deals right now in Northern Virginia that we would look at, but I think the -- we'd be in line with a number of other hungry capital potential participants.

Okay. That's great color. Last one for me, maybe sticking with you, Paul, or maybe even for Grant And I think Paul, you mentioned this a little bit in your prepared remarks, but I'm thinking back 4 years ago when we were looking at a pretty subdued office environment in D.C., and I think the hope was that alignment of the White House and Congress would spur more bills being passed and thus drive demand for office. But for, I think, a bunch of different reasons, that didn't really pan out like it has in past elections. Now who knows what happens in this election. But if we do see alignment of the White House and Congress, do you think there's an argument that we actually could see a surge in office demand this time around? And if so, I guess, what's the difference between now and 4 years ago?

Sure. Happy to answer that, Blaine. I think you sort of zeroed in on the point of that in that this -- the last 4 years have been different for a variety of reasons in terms of prior trends. And so our thought is that if we do reach alignment, that there is the opportunity for more of a typical relationship between the branches of government in terms of legislative and executive within the party that really hasn't existed over the last 4 years and a more cooperative stance. If there is alignment, may allow that to revert back more to the historical pattern, which we point out, typically, does relate to a higher number of legislative bills that are passed and then increased lobbying and legal precedents in D.C. that results in higher absorption.

Our next question is from Anthony Paolone with JPMorgan.

When I think about your markets, you've got, on the office side, the law firms and government and some companies as the big space users. And then you have the smaller folks like foundations and lobbyists and consultants and stuff. Just wondering if you have a sense as to the smaller tenants, any initial thoughts as to whether you see them trying to give up space or work in a more remote world going forward or just what you're seeing in terms of their thought process right now.

Yes, Tony, it's Paul. I would just use our portfolio -- our own experience and our own portfolio as kind of the litmus test. Smaller tenants are the ones that are back in the office right now. And that makes sense to me because for a 12- to 15-person firm, everyone is essential, number one. And they -- a lot of them don't necessarily have the technology infrastructure to support working from home. I mean if you look at our portfolio, I think we average roughly in the 5,500-square-foot range on that smaller tenant scale. And there -- some of them, yes, we've worked with, but I think a lot of them are very focused on making it work in the footprint that they have. The larger tenants for either liability purposes or other reasons are the ones we're not seeing back in the spaces actively. And -- but the larger ones are also folks that, at least in our discussions, are folks that are actively trying to put together a workforce strategy. And we're starting to see some folks. I wouldn't say it's a trend, but we're definitely seeing some folks looking at longer-term deals because they're taking advantage of current market conditions and realize that they can probably capitalize on free rent clauses, parking clauses, et cetera. And so I would consider them. I wouldn't call them visionaries, but definitely opportunistically looking at their workforce strategy with probably a longer vision than some of the smaller tenants that we're dealing with.

Got it. And what's happening in your Space+ space and with the leasing or just utilization there?

I think we've had good traction. I think like everybody else, other office folks you've probably discussed with, we have experienced a lot of folks looking for shorter duration leases with flexibility. And that does kind of neatly fit into the Space+ box, which is roughly 3% of our NOI right now. I think that we're going to continue to see -- as more decision-makers come back, we will continue to see our Space+ inquiries grow. Our first deal, literally, Tony, that we did during the pandemic were folks moving out of WeWork and co-working, where they could come into Space+ and kind of get their own identity and more importantly, control the safety protocols within their own environment. So we think that, that's still going to get traction throughout the balance of 2020 and going into 2021, and looking forward to reporting on that further as we progress through this.

Okay. And then just last question for me. You talked a lot about and gave a lot of color on the transaction environment. Anything specific to you all on the disposition side that could make sense or that you're contemplating now that could be used to fund capital to redeploy elsewhere?

Tony, we're always -- I'm not trying to dodge your question, but I think as you know, we're always trying to be opportunistic in how we allocate capital. And so if we see an opportunity to monetize an asset, we will probably take advantage of it. But we're always looking at recycling. I think we've tried to be good stewards of our investors' capital, and we're on top of the market. We see what's being bought and what's being sold. I still think we're dealing with a bifurcation between multifamily and office, obviously. And office, a lot of that sales market is being driven by the lending community. So it would -- we have to have kind of the glass slipper, but of course, we would look at it if it opportunistically made sense for us.

Our next question is from Chris Lucas with Capital One Securities.

Sort of a follow-up to Tony's question, Paul, which is just -- and it's counterintuitive, but you do have a couple of really nice infill retail properties, we've heard. While there's not a lot of retail that's traded, the stuff that has traded at a hot bed of -- considered high-quality infill in major markets is really trading at sort of pre-COVID cap rates or even lower, particularly if you adjust for NOI risk. And just curious as to whether or not a couple of the assets that you have Takoma Park, Spring Valley, in particular, would be something you'd look to monetize in this environment?

Well, just -- I mean not at the risk of repeating myself, Chris. I mean we're always open for business as any real estate investors should be. But I look at a couple of those assets and one that you mentioned, Takoma, I mean, that's directly on the purple line. We have some, what I would consider, good cash flow and covered land plays. But if somebody thinks that they are worth more fully developed as a mixed-use asset, of course, we would take a look at it. Spring Valley, as you know, we did an addition on that and wanted to make sure that, that leasing was complete. We're doing well there on a relative basis. We have not tested the market, Chris, just in terms of pre-pandemic cap rates. I mean we were, as you know, pretty comfortable with the high 6% cap rate that we achieved on our portfolio, the 75% of our retail portfolio NOI last year. But we haven't really tested the waters. But I'm not saying that if someone didn't come in with a compelling offer, that we wouldn't take a hard look at it.

Okay. Great. And then, Steve, just on the guidance, the sort of implied fourth quarter guidance sort of declines from third quarter, and your NOI guides were sort of generally at the midpoint, down a few percent. Just kind of curious as to what is embedded in guidance. And if there's something specific that I'm either not missing or that you're aware of that we should be aware of that is driving that.

Yes. I saw your note, Chris, and thanks for the question. I'm glad you asked. I think when you were looking at total NOI guidance and trying to find all the pieces, there's something you're probably missing because we did not update guidance on JMII because we sold it mid-year, but it had contributed about $1.3 million to NOI before the sale. And when I think you were looking at total numbers, that if you put that in there...

No, we took that out.

Okay. You got that.

No, we took that out. Yes, yes.

Okay. It looks like you may have missed that. In terms of our own thoughts about the fourth quarter, if you look at -- obviously, this is the first time that we have given guidance in the COVID world. When we look at the office sector, I would say probably the 2 things that imply a little lower in, say, commercial or office is anticipating less recoveries of operating expenses in the quarter than what we just experienced. And we're probably being a little conservative. We're a little nervous about projecting bad debt, so we're a little heavier on our bad debt projections, probably for commercial and multifamily, honestly, than what we've experienced so far. On the multifamily side, our trade-outs and our rents really haven't -- I mean we started to feel some slippage in September relative to the rest of the quarter. But when we look at what's happening in other gateway markets, I mean, a blended down of gross rents of 1.7% or even effective rents at negative 3% isn't bad as we're looking at all the data in all the gateway markets. But we are going into the winter months, so we're being a little bit conservative going through there. We're really happy that we've managed our lease maturity ladder so that it's really heavily weighted to the spring and summer months. So we're just being maybe a little bit conservative in that front. And obviously -- and maybe just for some perspective for a second, too. In terms of our original guidance to -- we finally reestablished it. If you recall, we talked about a lot of things that we're going to be building up throughout 2020 sequentially so that we would end very strong in 2020 and have a lot of momentum going into…

[Operator Instructions] Okay. With no questions coming into queue, I would like to turn it back over to Paul for closing comments.

Thank you. Again, I'd like to thank everyone for taking the time to join us today. We appreciate your continued support, and we look forward to talking with you at NAREIT and over the coming weeks and months. So thank you. Please stay healthy and positive, and have a good day.

Thank you. This does conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.