Douglas Emmett, Inc. (DEI) Earnings Call Transcript & Summary

Great. Good afternoon, everyone. I'm Michael Bilerman I'm here with Manny Korchman from Citi Research. We're extraordinarily pleased to have with us Douglas Emmett; and CEO, Jordan Kaplan. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available up on the webcast. And for those that are joining us on the live webcast, to ask management any question, simply type them into the box and they're going to directly to both Manny and me and we'll do our best to weave those into the conversation. So Jordan, I am going to turn it over to you just to introduce the company and the management team that's with you at your office today. And then we'll have -- we have a bunch of questions to go through.

Okay. Thanks, Michael and Manny, for putting this together. On the call with me are Peter Seymour, our Chief Financial Officer; Kevin Crummy, our Chief Investment Officer; and Stuart McElhinney, our Vice President of Investor Relations. We're actually at the tail end of all of our calls. So this is going to be our tell-all, right? The company itself, we're an office and residential company primarily located in Los Angeles and Honolulu, mostly in Los Angeles, the high-end markets. We have a little over 18 million square feet, a little over 4,000 apartment units. And this is actually my 14th year at your conference. I -- more but I suspect people know it, and I want to make sure we answer all the questions.

Right. Well, I think you actually came, I think, before you were even public.

I did, 1 year before. 1 year I got invited before and I had a very well-known REIT CEO say to me that you should dress up, you need to wear a suit and tie all the time. That was the 1 thing I got from that conference.

All right. Well, Jordan, we start on each of these sessions asking the CEO, "Coming out of the pandemic, if an investor were to choose only 1 real estate stock to own, what are the 3 reasons why they should invest in Douglas Emmett?

I think we're in one of the best markets, that's number one. So if you look at the supply/demand characteristics of our markets, we have really no new supply that comes on. And our demand is generated by a number of super strong industries. All of which are growth industries, whether it be tech and/or entertainment, which I know everyone calls out, but also our university system, our health care system and health care research and tourism and foreign trade and all the financial services that face Asia, all of that is growth stuff, and it's all happening in our markets against the backdrop of limited supply. I think we have, in terms of a management group that's a best-in-class management, but not to pat ourselves, we've tuned and designed through all types of methods, which I can get into more later, our management platform to properly meet the opportunities and challenges of the markets that we're in, we're pretty narrowly focused. And we're dominant in these markets with roughly 40% market shares in 1 of the 5 big gateway markets. And then I would say we have some of the strongest growth prospects, not only around fundamentals, which I think our fundamentals are very good going forward. But -- and that's a sort of internal growth, but external growth through product. We own a lot of property, that's -- where we can put new development. We have a lot of redevelopment opportunity. We have a lot of communities where we're such large owners that we can add amenities to a community and have it primarily impact our properties and be a valuable move for us. And then we still are making acquisitions. So I think we have a good growth prospects. So that would -- the same 3 things you look at, at any company to say, "What do I think, growth prospects and how they're going to operate?" I go, "We would be a good bet."

Right. Maybe we can tee off of the growth prospects. On the earnings call about a month ago, you did have a lot of enthusiasm about putting capital out and buying. And so can you update sort of where you stand today in terms of opportunities coming to market? And what is -- what you're looking at?

Well, I would say this, I believe we -- I believe, for a company our size, we should be targeting $200 million to $400 million of fresh capital going out in order to keep, like, an external growth activity meaningful. And as you know us in earlier years, a lot of that came from new acquisitions. And in the last 5, 6 years, because of our market penetration, because of the institutional ownership in our markets and the number of deals that were coming out, we've been redesigning things and focusing more on our construction and redevelopment. I think at this point, we are in -- I think we can rely on foreseeable future being able to put out close to $200 million a year of new capital in ground-up construction, redevelopment, things like that. To get to that really great number of getting up to $400 million out of very productive, high-return money, we need to make additional acquisitions in our markets. And we are pushing that. We're certainly a dominant buyer in these markets. We get more than our fair share, but we're at a time now when I think -- I don't think sellers are under a lot of pressure. They're not under pressure. They might be unhappy with what's going on with moratoriums and whatnot. But you don't see a lot of debt-driven pressure on any of the types of buildings that we own. And also, there's plenty of liquidity in the market and buyers. So I don't think you're seeing any distressed sales. And I think that people are just waiting to feel like the operating fundamentals are clear so that they don't feel like they'd have to take a discount to do a trade.

Jordan, have you widened your net of whether it be geography, quality or something else?

I would say, in geography, we've always had a little wider net than was exhibited. It's just been hard getting deals in some of those markets. I mean you know the one I've obsessed on was West Hollywood. I've always wanted to be there, but that's been dominated by one group. Not Hollywood, West Hollywood, which is a separate city and has supply constraints and all things we look for. I would also say, because we've seen such great returns out of the development side of our platform that we're more amenable to a development component to an acquisition, but we're still not just buying development land. But that would be what I would call almost a product widening.

But not targeting outside of LA going to a new market?

Well, we're looking at the markets up and down the coast. But I would also say that my test for moving into a new market, which has risk and a whole bunch of different things, is always what kind of returns can I get? And can I put out money at returns I like in the markets we're in? And so far, I still feel like we can do that. And so as long as I feel that way -- I don't feel we have the obligation to provide some level -- like, if you invest in Douglas Emmett, I'm providing you some level of diversity across anything. I mean I more feel like we take what we do really well with it be markets, products, whatever. And as long as I can continue to do that and reasonably grow the company and do it very well, then that's just what I'm going to keep doing. And if you need diversification into Boston, New York or whatever, then we all know the companies you can name that you should buy some of that, too. So I don't feel like a diversification obligation. I'm just going to where I think we can place our money to do the best where our skill set is.

When you're talking about the sellers didn't want to sell in terms of waiting for the operating fundamentals to shift, or to get more clarity in terms of the operating picture. If you're using your stock as a currency and just doing a trade, aren't they effectively going to get that upside if it turns out to be true? So I would have to wait.

Yes. But they did not talk me to doing that, which I would not be willing to do. So giving -- where you base this operating partnership units, or it's a very tax effective way for a guy to sell us a building. But of course, I think for almost any REIT, we would always prefer to buy for cash than giving OP units, right, because we take on tax and all kinds of complication. So when we give OP units, we need to get something. Now one thing I'm really not going to do is buy a building, we're out on the building next door, and I look at where our stock is trading and I look at what I'm paying for that building, I'm not going to trade in that, like, uneven -- with that kind of uneven discount. So we're going to -- that type of deal at a time like this, particularly, would have to have a floor on the value of the OP units and maybe I would be collared. But we wouldn't -- I mean I wouldn't -- that would be crazy for me, right? Because it's like I'm selling part of my buildings at a really cheap price in there. We would get a lot of takers if we were willing to do that.

Right. Well, I'm thinking maybe you can price the OP units higher. That's always a strategy...

Well, that's right. That's what happens. So what you do is you put a floor on the value, you say, "Look, if I'm paying this for your building, then regardless of whether we're trading at $20, we're going to put in a floor of $40, okay? And then if it goes above that, you'll get less units, but if it hits that and goes below, you -- I'll still be able to give you the amount of units of the $40." That's the structure of deals that we worked on.

Right. Well, maybe shifting to the operating fundamentals, what are you seeing on the ground? Have things opened up more where you are seeing a better pace of leasing and tenants returning?

Yes. And certainly, you guys heard it on our last call, we had our fourth quarter, which we announced, had 200 lease deals, which is incredible, and 1 of our largest amount of new deals. So that's great. Now it was smaller deals. And I think that can be attributed to 2 things, actually. One is yes, I think people -- even though it was one of the most locked-down quarters, I think with vaccination and rolling out in winter, people are seeing visibility into the world opening and they're preparing, right? So that's creating some of the activity. Some of the activity was generated. A good part of the activity was generated because I think it was the first full quarter where we rolled out our new leasing platform that is extremely accommodating to small tenants. So I mean in the prop tech world, it is all designed for small tenants in the same way you might run an apartment to come on our website, go through our filter, find space with, A, that helps you in the market that you want, see virtual tours the whole deal, be able to choose space, make a call, go online, do a little bit of space planning if that's needed, sign a letter of intent online, submit your credit stuff online and sign your lease online. Okay. That process, you go. That -- we started working on it when we went into the pandemic saying, like, without this, we're dead in the water. We got it up. You saw us go from 125 -- 125 leases, 175 leases. Fourth quarter, 200 leases, right? And that -- and believe me, fourth quarter, this place was really shut down in terms of the way the world was working. And so we know that system is now working. But we know it's designed to work with smaller tenants. The other way we know that is that in our -- if you would ask me in 2019, which we already have pretty good direct outreach to tenants, how many of your leases do the tenants use an outside broker? I will say, well, we do about 40% of our deals direct, okay? Now you got like brokers are home, everybody's home, right? So there's nothing gating our ability to just actually to finish the last technology mile of going direct to the tenants. That system is in place now. We look at fourth quarter, and we say, wow, we did a multiple of that 40% in terms of tenants that didn't use a broker and still did, by the way, 200 deals. So that tells us a lot of people are coming through that channel now. Now we'll see, as the world opens up, how robust that channel stays. But it's certainly -- I'm optimistic, I'm hoping for something a lot more deal flow out of that. That's not something you can do unless you own a big chunk of the market and you have the ability to spend the money. It's expensive to set up that backbone and drive that volume because the back office of that is meaningful. But for someone like us, it's so concentrated and has so much deal flow, it seems to be working out extremely well. And I think we saw our first good look at those results in the fourth quarter.

Sorry, I was playing with that while you're talking. I went to take a look.

Did you take a virtual tour?

I'll be honest, it's pretty cool. Now the only question I have is why do you limit it at that 100,000 square feet?

Well, we don't actually -- I don't think we have any space over 100,000 square feet.

You can't even type in a number of greater than 100,000 square feet?

Yes. Guess what, if 100,000 square foot tenant was going to go online and just lease some space, okay, you should assume that like fireworks would shoot off 1299 Ocean of where our headquarters is. I'd go, "We finally hit nirvana." Those guys are always one of the most painful new deal, renewal deals that exist is those large tenants.

If we think about the typical industries or users within your space, there's been some perceived stress in law firms and accountants and people that maybe don't need to be in office to be successful in what they do. Are you seeing that at all?

No. And not only are we not seeing it? What we are seeing, and we've been asked that kind of general occupancy question a number of times. And you know for the last few quarters we've said, we feel like -- other than the first quarter, we feel like 30% to 40% of our office space is being used on a regular basis. I would add to that, though, that on an irregular basis, since the beginning when we were able to close down -- so we had huge expense savings. I mean we closed down floor or sections, apartment garages, elevators, I mean we save a lot of money, right, in all those. Now we are seeing everything being used. Now -- and it may not be tenants coming in and saying, "Oh, my employees are showing up at 9 and leaving at 6." But all elevators need to be. All floors are being used. People are showing up at all different times of the day. People are showing up on the weekend. So we know that space is being used and people are kind of sneaking their way in. Now we're not going to be able to -- I think what you're seeing is small tenants are willing to come in and use our space. We -- when you got to kind of be cognizant of is, we're all subject to a stay-at-home order right now vis-à-vis office. So briefly, you're not allowed to come into the office. Now if you're someone with 5,000, 4,000 feet and 15 employees sitting around and say, "I don't care, let's go in, let's all just go work." Because almost all our space is built out well over 200-feet per person. So from a 6 feet and all that, all fine. But if you're a larger tenant and you say, "Hey, start coming in." I'm going to be very frank. There's a high likelihood that 1 of your employees is going to report you. And the cities are aggressive. I mean we have been multiple times reported, and we're an essential business. We're allowed to be in. And not only that, but we get surprise inspections, they walk through. I mean do you think if your mask isn't like over the nose, when you get a write-up for -- if you're in your office with no one else, you're allowed to not have a mask. If you're in a -- like Carmen in a cubical, you have to have mask over nose. You have to have mask over nose anywhere walking, bathroom, corridors, kitchen, any of the rest of it. And they don't -- I mean they are truly surprised inspections. I mean they show up, boom, they're walking all 3 of our floors, doing the writing. And so -- and we just had 1 last Friday, and we passed it. That was good because I don't think we passed the one before that. But I mean they're aggressive about it. So you're not going to see large tenants come back until the stay-at-home orders are off because the cities are aggressive about the reports and inspections and all the rest of it.

Right. Maybe if we just spend some more time talking about the office of the future. Your space maybe without that densification at an average of 200 square feet, maybe that was never the office of the future. And so does it change at all as people come back in any meaningful way?

So if I can hypothesize. But for our markets, I believe our 18 million feet or whatever is built out now to around 225 feet per person, which, by the way, if you work it out, generally means you already have a 6-foot separation and probably a little more, okay? If you -- from our conversations with large architectural firms and others that are building out now for larger tenants, which we aren't really doing much of, what I'm hearing is most of those large full floor play tech tenants and other tenants who take large amounts of space, they're moving from a typical 180 to 225 to 235. They are going to, on full floors. They're going to communities on the floor, where you have groups that work together. They're in the community, and then you have a big Zoom screen somewhere where everyone could turn to look at it and that will connect that community to another community. I know that's happening. I don't know how much of it's happening. But when we went to question, like, what are these big guys doing? How are they getting people back in? We're hearing about those sorts of build-out, and that kind of square footage change. But you have guys that are probably currently building out space in New York and San Francisco that could tell you more on that.

There's been a lot of focus and analysis done on sort of out migration from San Francisco comparing ZIP codes and mail holds and mail holds moves and stuff like that. Have you seen similar stuff for L.A.? Or do you have a sense of what's going on, if that is a similar story in L.A.?

We have not seen that. We have seen San Francisco people coming here, and I certainly saw my niece move here and now living with us. But the -- we have not seen people -- I saw the stuff on the post office box as saying, they aren't actually leaving the area. They're just going to like 1 town over. Yes, we're not seeing that here. A matter of fact, I'll go one more. We're seeing housing prices up and we're seeing occupancy in our apartments, as you can see from our numbers, 98-plus. I mean a lot of attention around occupancy. But remember, I live in a small world here of West L.A., just along Ventura Boulevard there's the very high end areas. But our residential that we have here in Santa Monica, Brentwood. And the same goes for what we have over in Honolulu, we're seeing very strong occupancy.

Peter, maybe we'll jump to you. If you're successful in Jordan's goal of buying $400 million or investing $400 million, you have, call it, $170 million of cash at year-end. That's going to mean getting other cash from somewhere else. What would that funding plan look like?

Well, it's a combination of things, but we'll just start with the fact that 41% of the portfolio is currently unencumbered, right? So we have additional buildings that we can borrow against to generate cash. Credit line is strong. We can use that for a substantial amount. So I think we're in pretty good shape for anything that Jordan is looking to do.

Although I got to say, if I get my, like, nirvana dream of everything you're saying, I doubt it would be debt financed. We would do -- I think we would use our sovereign platform. That's what they're for. They certainly want to invest. That's where we would get our equity combined with us taking as meaningful positions they allow. They are starved for product. And that's our outlet valve for getting up to those numbers. I mean, still, you got to -- we have to have a meaningful investment, which usually is what ends up being the battle.

You talk -- you've opened up by talking about the redevelopment sort of ability and new development. You want to update us on Bishop's Gate (sic) [ Bishop Place ] in Brentwood and what else is now on the table in terms of future starts?

So Bishop Place, which is in Honolulu, that one, we are -- we converted 4 floors, lobby. We already leased the 4 floors. We converted 3 floors. We're well through leasing those. We're going to -- we're starting to -- we're finishing some stuff with the city, where we're going to deal with the city to redo public-private partnership on something called Union Mall. And that's moving along. Now we're getting to the point where it's not so easy to get tenants out anymore because we're -- early on that market had a lot of vacancy. And so if you said, "I'll lay out your lease commit." "Not a problem. There's is plenty of space." Now they don't have a lot of places to go. So people aren't so anxious to move and plus rents are much higher, no one's in place okay? So that's Honolulu. Now if you come out here, we're right on schedule, on time, on everything, and I expect, as we've told you to be leasing units first quarter of next year in the high-rise that we're building, the 34-story high-rise, and we'll nail those numbers. I'm very optimistic about that. And then if you say repositioning projects, we stalled the repositioning projects. We told you when we went in that during -- at the end of this -- on our call after the first quarter, we said we're stalling our repositioning, hold on our cash. Okay. We restarted that fourth quarter. So we feel we have the visibility in terms of our cash flow, in terms of the economy, of the market, et cetera. So we've restarted a bunch of those projects. So we're back going on that again.

Do you feel like once you reposition in Honolulu, that would be a sale candidate? Or you feel like that's the continued hold for you?

I've always said that our core market, which we described as being kind of that strip on Ventura in West L.A., that's core market. And then you had -- we had 2 markets that were riskier and opportunity for better returns, right? Warner Center and Hawaii. I think Hawaii is seeing a very strong recovery right now. The office, the residential was always good there, and our residential is always doing well there. I think there's a lot more that we could do. But also, it's a -- I want to manage the weighting of the capital, the equity we have in all those markets. So we're always looking at that. But if you said, "Do I want to get out of Hawaii? "Absolutely not." Actually, I love what's going on in Hawaii.

So you'd rather go deeper rather than sell-out?

I want to manage the amount of capital I have there compared to my core markets, but I also want to be able to keep working and doing stuff.

Manny, I'll flip it back to you.

Just to finish that thought. When would -- I mean to Michael's question, I assume you'd have to be done with the conversion, you wouldn't go sort of halfway. So what kind of timing would you look at to be fully done with that conversion?

Well, so here's what happened there. We announced that we were converting that building. That was a little bit of a shock to that market. And it sort of flushed out the fact that the Hawaii Electric Company, which goes by HECO, or Hawaii Electric Company, came out and said, "Hey, by the way, we actually had plans to consolidate all of HECO downtown." So they had a lot of downtown, but they had a lot not downtown. So very quickly after that announcement, they leased another Class A office building, the entire building, even though it had tenants in it and they said, "As those tenants roll out, we're now putting our whole headquarters in this building." Because I think they felt that their hand will be caught, right? So we ended up in a market where the tenants in our building and the tenants in the southern building all found out within a few months that their landlord is not going to be renewing them. So that changes dynamics of that market. And you had a lot of office tenants that we're going, "Hmm, well, I want to be downtown." So that market tightened up a lot, and we saw rents move a lot. So now when you ask me the pace, like, we still have over 200,000 feet of tenants in Bishop Place that we now need to, either way for their lease to roll or find to way to move them into our portfolio, which I don't think we have that much excess space. I mean we have about 100,000 feet for maybe like 225,000 feet of tenants. So early on, we were able to knock out these 7 floors and do a bunch of this work. Now it's going to be -- it can't be as fast. I think we'll collect rent on the whole building, but we're going to have floors that we're going to have to manage getting the floor back in order to convert it. And then those tenants, maybe it's not too easy or obvious for them in terms of finding space that works for them and certainly, in terms of the cost of that space.

So Jordan, running through that, and thank you for that color, if you were to do it again, knowing that HECO is going to come in and take over this building and sort of essentially do what your goal was to do in the first place, which is eliminate some supply, would you have gone through with the conversion, was that still the right move to make? Or should you have just kept it office and HECO would have taken that building and those tenants would have come to you and you still would have been full?

First of all, HECO was not a 250,000 add to the downtown market. HECO was a -- it might have been a 50,000 or 75,000, I mean they were already downtown to a great extent, including in our buildings. Right? So I still would have done what we did. They were sort of a boost to what happened when they went ahead and did that deal. There was -- what I'm telling you, there's no secret about it. I mean, like, they came right out and said, "We planned it also to consolidated downtown and the buildings. Where are we going to consolidate?" I mean this is a big thing that happened down there. I think what we've done and what they have done is going to, overall, just be very healthy for that downtown area in terms of amenities. People are now reconsidering additional housing in that downtown area to move it more towards that 24-hour. I told you that we're working on -- we own the center square of Downtown Honolulu, which is Bishop Square. That's also in a public-private partnership, certainly the public uses it. But it's clear, safe, policed, managed by us. We're working with the city on doing something similar around 1132. So they're like broadening the area, that they're improving the amenity base on the -- in terms of walking, eating lunch outside, all the rest of it. So all of these are positive developments, not to mention that now you're hearing hotel deal being made downtown, residential, other residential downtown being worked on. So turning that into a 24-hour cycle, adding the amenities that -- I mean even office tenants go, this is a good move. We need this for our downtown.

Right. Switching over to ESG. What are your top 3 priorities to improve your ESG score next year?

Well, I would say, number one, we're focused on increasing our Board diversity. And by the way, that's being mandated by the state of California. I don't know where that will exactly end up, but we're doing it anyway. I'd say the thing that we have been dogmatic about and focused on for decades is our carbon footprint through reduction of electrical use. And we will continue to make strides and gains in that, not as compared to 2020 when the buildings weren't very well occupied but as compared to 2019. We just want to keep seeing that number go down in terms of our electrical use per foot. And we do a lot of stuff around that issue in energy management and all of the rest of it. And the last thing is we shouldn't have to focus on this, but we're watching it. We want our employee base, the diversity of our employee base to be very similar and reflect the diversity of the communities we're in. So if we're doing a great job of hiring and training and promoting and all that. You should be able to look at, like, the ethnicity of the markets we're in and go, "What does your employee base look like?" And it should look similar. And we've actually now started -- we're publishing those stats for you guys on our website now. And because we've said, look, that's something we're 100% in favor of. We want that to happen, and it's a great measure to see if we're doing a great job on that front. And so it's -- you can -- I don't remember what page it's on, but it's -- where is it, Stuart?

The tail end of the investor overview in the Investor portion of our website. Page 19.

Page 19. I would just like to say, I'm pointing that page out also because I worked a lot on it with Stuart and publishing it over the last month. So there it is. I hope everybody looks at it.

With that, we'll go to our rapid-fire closing questions. When we're all sitting together in Florida a year from now, what's the one thing that will have surprised people the most about your business over the prior 12 months?

They shouldn't be surprised by this, but all of these -- the preponderance and the projections about work from home, I think we're going to be sitting and sitting and go, "Well, that was interesting." I mean I don't buy it at all. I don't buy it at all, like, that amount. I think that when you look at the tech companies that only a year ago we're building some of the largest headquarters to be ever built in the history of humanity and saying everyone needs to be together because collaboration is the name of the game and culture. And in a matter of 9 months fully figured out that nobody needed to be in the office and they could all be home by themselves sitting at their kitchen table. That is laughable. And I would just like to say for people my age, which I'm turning 60 on April 3, that used to be called leadership and training, the people in your company, that was the old version of collaboration, and I don't know how you provide leadership and training to people that are all sitting at home. I don't know how that happens. So I really think you hear from now that people are going to be laughing about that.

What do you think your corporate travel budget will be in 2022 as a rough percentage of what you spent in 2019?

We are domestically down. And in international, we have a lot of trips we need to make to our overseas investors that have taken a 1-year hiatus, and we got to get out there. So I'm really using the royal we here because I'm talking about Kevin and Stuart. I mean, those 15-hour flights kill me. But they're going to be on the road -- when this thing is open, they got to get out to everybody, and they got to get out a couple of times. Domestically, I mean, you probably can get away with most of it, to be honest. But I'm also -- I'm going to be in Florida with you guys.

We'll be in Florida for sure.

Yes. But I used to make trip to New York to talk to our lenders. I mean I can do some of that via Zoom and not kill myself.

Well, you can do that on Zoom, and all the companies can work remotely a few days a week, too. Doesn't that contradict your first point?

So I'll tell them, stay at home, I'll Zoom from my office, you stay in your kitchen and work remotely and...

I want to be in person. I want to be -- listen, I want to come out and see you in L.A. and hang out, but I was just trying to juxtapose those 2 comments that everyone has to be in the office, but you don't need to come to New York because you're going to do it Zoom.

Well, I didn't say I needed to be in your office. I said you needed to be in your office. So -- but we will come to New York. I just may not as many times.

What will same-store NOI growth be for the office sector overall in 2022?

I mean in '22. So it should be pretty good. I don't know, '21 is going to be a mixed kind of a recovery year. We ought to be hitting our stride by '22. So I mean they ought to be able to get up into the 4%, 5%, 6%, somewhere in that range.

And what will the 10-year Treasury yield be 1 year from today?

So it's like 1.5% now, right?

Yes.

2.5 -- 2%, 2.5%, somewhere in there.

Perfect.

Awesome. Thank you so much.

Thank you all very much. Stuart pack your bags, you got a lot of traveling ahead of you.

I already packed.

All right. Well, thanks for the good stuff, you guys.

Thank you. Take care. All right.

All right. See you soon. Bye-bye.