Hudson Pacific Properties, Inc. (HPP) Earnings Call Transcript & Summary

Hello. This is Jamie Feldman, the Senior Officer and Industrial REIT analyst on BofA U.S. REIT team. I'm joined by Elvis Rodriguez and our team, and we want to welcome you to this BofA Global Real Estate Conference, virtual roundtable discussion with the senior management team from Hudson Pacific Properties. Hudson Pacific is a West Coast, U.S. office landlord and developer, and we'll have a lot to talk about with them today. Joining us today from Hudson Pacific are Victor Coleman, Chairman and CEO; Mark Lammas, President; Harout Diramerian, Chief Financial Officer; Art Suazo, Executive Vice President of Leasing; and Laura Campbell, Senior President, Investor Relations and Marketing. We have a large global audience joining us today, so management will spend the first 5 to 10 minutes of our discussion, providing an introduction to the company and update on operating conditions. We'll then move on to Q&A. We hope to make this an interactive session, so please add your questions on the Veracast platform, so we can weave them into the discussion. I'll now turn the conversation over to Victor to get us started.

Thanks, Jamie, and welcome, and Hello Elvis, thank you so much for hosting this great conference. I'm going to just start off with some just high level, and I'll get some participation from the rest of the team here. We're sitting in our offices in Los Angeles. So we're currently occupied in our regional offices. The Hudson team is occupied 100%. In our regional offices, we're between 35% and 50% as of September 9, and we expect to continue to grow to that number to over 50% in the near term. Obviously, living through what we've experienced in the last 6 months, I think the most important attributes are going to be talking about some of the markets that we're in, some of the collections and then -- and also just some of the leasing activity and then obviously, sitting here, I'm sure some questions are going to want to be discussed around some of the political aspects of California, Washington and the likes of that. So we'll try to cover all of it. And as Jamie said, we'll be as interactive as possible. I think the first highlight we should just sort of point out is since March 16, we have been retooling our business plan to accommodate the safety and protocol and infrastructure of our tenants, our staff and all of our service providers. I think in normal course of business, we would have said our performance has been relatively good in -- relative to what we've seen in the last 6 months, I think the course of business, we would say it would have been excellent. I think overall, our numbers are fairly solid. We've collected 95% rent across the board of all 3 of our property types, which is office, studio and retail, retail being the least productive, the majority of retail for everybody's knowledge and information for this recollection is 3% approximately of our portfolio is amenitized office, retail. We have a few large retail tenants that are not paying, the likes of Nordstrom, likes of Zach, the likes of Landmark Theater and Sur La Table who filed bankruptcy. We're hopeful that we're going to retain some of those tenants other than Sur La Table, and we are working on right now still rent deferred but I think people recognize that in terms of retail, deferment is going to be challenging when we're moving on to 6, 7 months in this process. And so we've reflected that sort of in our growth prospects going forward as more of an abatement. But that being said, our studio businesses are virtually 100% collected, and our offices are around 96% or 97% collected. And that's been consistent every single month since this has really started from April 1's collection. So we're very pleased on that aspect of the company and now we are working through our integration, which is maintaining the internal culture of the company, integrating our tenants in the safety protocol with PPE and working through what we initially -- were a lot more of a challenged environment to as a familiarity and a custom and education and communication is becoming a lot more easily advanced in terms of the operations on day-to-day of tenants moving into our buildings. That being said, I think overall, the numbers started to think about it is just that we've had a series of drive runs for months and months and months now of anticipating occupancy of tenants moving into our portfolios. And with the exception of our single-tenant buildings, which some have been occupied since day 1, 24/7, the likes of Riot Games, or KTLA or NFL Network and the likes of that have been virtually 100% occupied. But for the most part, our portfolio is around 15% occupied, physical occupancy day in and day out. That number has gone up from 5% to 10% to 15%. And we're seeing that number now move and we're hopeful to get towards that 25% number by the end of this month and then higher. As a mandate in California, right now, we are seeing that the governor is choosing counties to be open to the next level versus the state-wide opening. And so for instance, if you're in Napa Valley County or you're in Orange County, you are in a much more of an open-work environment, the work-from-home is less. And as a result, you're seeing retail opening up, up to 30% in restaurants. We're hopeful that, that's going to be the case here in Los Angeles County, in San Francisco County and in San Jose as well and throughout Silicon Valley. But to date, that is not the case. Clearly, we're all sitting in the same seat. There is a lot of anxiousness around people wanting to come back to work. The vision is, from our standpoint, a little cloudy in that tenants, specifically some of the big name tech tenants have said, you don't have to come back to work until summer of '21, and we're a little surprised that they made those comments so early on. Some tenants have said that and now they're backing away and encouraging people to come back earlier. I think overall, the feeling from Hudson's standpoint and what we've had interaction with our tenants, has been candidly, this is a young person's movement. Young people want to come back to work, people are anxious to come back to work and they're starting to -- and that's why we anticipate seeing the numbers. And as a result, that's why we see the collections being where they are today. Shifting over to activity, I would say that -- and Art will get into details on some questions on this. I would say our activity is limited. We have had leasing activity. We are in the process of signing some very large leases at numbers that were pre-COVID-related numbers. We've had very few pushbacks on rent to date and that is only because we have a very small amount of rolling space in '21. And so we feel that, that's going to get more impactful as the time goes by. But our mark-to-market, in the overall portfolio, was in the mid-20s. Now when we've reset the mark-to-market across the board, for the next 2 years, it's probably somewhere in the 17%. So we have some -- clearly, some tailwinds still on the mark-to-market before we have to actually make transactional businesses that are going to impair or our current value of the portfolio are. That being said, Hudson's protocol is very simple. We are a company that will make deals to retain tenants. And currently, as I said, we've had the luxury since we don't have a lot of retention, less than 4% rolling this year that we have to deal with. And next year, there is really only 2 big tenants that we're dealing with and both are in conversations for the most part, we're in pretty good shape to '21. Lastly, I'll just comment on it, and then I'll just turn the floor over to any of my coworkers here. Everybody knows that we announced a closing of our transaction with Blackstone for our studio portfolio for 49%. It -- henceforth, it brings up our liquidity in our balance sheet, which is as strong as it's been in a very long time, given where we sit with COVID, even our metrics are in a very good place. It's another partnership we've done with Blackstone. I think to take Hudson's almost right around $7 billion with them and it's a great growth model for us to use that capital for future acquisitions. And growing that platform, which we're very intently focused on in markets like New York, Toronto, Vancouver and London, inclusive of here in Los Angeles, and we're actively on that. We are also looking at some unique opportunities around office, but the office transactional business today is much more aligned with triple-net leased or yield -- higher-yielding lease assets versus value-add and because right now, value-add assets just start selling in a sort of volatile marketplace. And lastly, we are buying back our stock, and we will continue to do so. So those are the 3 avenues. Would that help? Ask Mark, Harout and Art, do you guys want to jump in on anything that I may have missed or you want to add?

Well, pretty comprehensive to me.

Same here. Likewise.

Okay. Jamie, is that okay for you?

Perfect. Thank you. I guess just to clarify the last statement you made. So you said -- you mentioned a couple of markets where the Blackstone JV is looking at potential bias. But did you also say that JV would be looking at office? Or no, the office would be on your own balance sheet?

No, the office is on our own balance sheet, Jamie.

Okay. All right. So I guess, let's dig into the Bay Area specifically, which has probably seen the most surprising headlines. And then I thought your comments were interesting that you thought for them to say, end of summer or summer 2021 seems a little far out. Can you just talk through what's really happening on the ground in terms of your conversations with tenants? And I think a lot of people are just wondering, will we see a redistribution of jobs at all from CBD San Francisco across other Bay areas, submarkets? Just any read on that -- how that seems to be playing out? And then thinking about the hub-and-spoke model? Does that sound like something that we'll see more of going forward?

Yes. Sure. I'll jump in, and the guys can sort of pick up on the tenant fee aspects as well. But -- so listen, San Francisco is San Francisco right now, everybody knows where the numbers are, right? The sublease space is approaching 6 million square feet. The vacancy has gone from somewhere around 5% to around 15%, very quickly. And right now, as we sit, we're very well protected, but let's not talk about Hudson specifically right now. Let's just sort of talk about the market dynamics. I'll follow on to the point that you reiterated that I made. I am still bewildered that the Twitters and Facebooks and Googles of the world have said, "Hey, we don't have to come back until June of '21. I think what they are telling you is something that they haven't really thought through in a practically looking method. And that is, these companies all set their businesses and created billions of dollars in worth for themselves and their shareholders and customers and everybody else on their culture. I mean Google was the as a founder of the office facility where it's co-working internally and in amenitized office space. And now they're basically saying, culture is secondary to us just being running our business. And so you can stay home and work from home. They're not like Netflix who said, you've got to get back as soon as possible or some of the financial institutions like Jamie Dimon said that or Disney or some of the other companies have said, "Hey, as soon as we can get back, we want to get back because we're not being productive. So I think what you're going to find is other companies are going to be coming to markets like San Francisco or they're there, and they're going to be poaching the individuals who are high-quality, high-paying job individuals because they're not going to be working from -- in some facilities, they're working from home. And so I'm optimistic that San Francisco will make a rebound. And on the ground, our tenants are telling us right now, we are about to sign a lease with a household name tenants in San Francisco at rates that were pre-COVID, like we may have signed, right? But we're -- but Artis motion that we're almost signed. With 0 pushback on this exact very aspect of what I'm talking about. They have negotiated nothing on that because they want the space. I think overall, what you're going to find is as these tenants start opening, they're going to realize that the hot desk thought process is not going to work. People are not going to want to have other people sitting in their space. So as a result, you're going to see more space for less people. And the numbers are pretty simple. I mean we got down to maybe 150 to 165 feet per person on our -- on the last sort of wave of office space. And I think we're going to go back to the 250 to 300 feet per person. And so a lot of the tenants that we are talking to are saying, we're reconfiguring our space to accommodate everybody we have or even less, and we need more space.

Yes, to that point, Jamie, it's uncertainty around utilization that really made the velocity, deal velocity drop off, not economics. So if you think about San Francisco, since we're focused on San Francisco, active tenants in the market dropped probably 50% to 60%. So it was somewhere at a 6 million square foot level of active deals in the market. Now it's just under 3 million square feet. And those deals are still moving slowly. And if you think about the 40% to 50% of deals that are on the sideline, I'm not suggesting they're all going to come back immediately or even all stick but there is some percentage of those deals that are going to stick once this uncertainty around utilization and reintegration and all that takes hold. And so I am encouraged by that, that there is in any normal downturn, there's nothing on the sidelines. It's -- you've got to try to manufacture deals, but I think that there's still some level of deals out there that call it, I'm not going to call, whether it's 6 months, 12 months or 18 months, they are going to start to kind of reemerge and be back in the market.

So from deals you've actually seen get signed, have you seen any change in space design, space from ploy? Like, has anyone actually made the concrete plan to do something different? We're hearing in a lot of...

It's a mixed bag, yes.

Yes. Jamie, I think it's a mixed bag. I think people are in process because they're trying to figure out what really makes a lot of sense. And so a lot of it is more temporary movable partitions or converting conference rooms or converting common areas to accommodate more people. And I think as you're -- as we're talking now, people are designing and building new space in our portfolio, but it's too early for us to see the absolute results. Honestly, when we're talking to the -- if you just want to focus on the fan tenants and we've talked to them all, they all have a different approach. They all have a different approach on whether -- and by the way, I can't answer the question, hey, are you going to move from a -- in some cases, 150 square feet per person to 300 square feet per person? Too early to tell. I mean we literally don't know what that's going to look like. And the people, by the way, that we're talking to are all working from home. So it's an interesting dynamic.

Yes. But I -- listen, what you saw with Facebook, what you're seeing with Google, what you're seeing with Netflix, what you're seeing with Amazon is they are looking for a long-term plan. This is a 5-, 10-, 15-year plan. So they're looking to lock up space in the markets they want to be in over a long period of time. And that's what I think they're focused on right now. Art is right? I think the initial decision is going to be short term, and they're going to accommodate and deal with it as they get educated. But right now, I think they're all figuring this is going to take a long sort of vision. And I look at these kind of tenants, and I can them to the mentality of universities. This is not a 5-year lease. This is a 50-year lease in their mind. So if they're going to be in Seattle, they're going to be in Seattle forever. That's what they're thinking. And this is what they're going to do. If they're going to be in Silicon Valley, they're going to be there forever, and this is what they're going to do.

Okay. And then what about other Bay Area submarkets? Have you seen any either short-term or long-term focus on those submarkets where maybe people weren't thinking about them before? Specific companies people weren't thinking about them before.

Yes. So -- listen, from our personal perspective, because we don't have a lot of expirations, those that are expiring in '21 have asked for much shorter renewals, right? 2, 3 years versus 5, 7 years. And that's not uncommon when you're dealing with uncertainty and aspects of uncertainty with employees and growth and the likes of that. I think the thought process when we started here was, oh, these tenants that are expiring in '21 or early '22 are going to be in the catbird seat because they're going to say, "Hey, you want to take. " No this is the deal we want. The reality is they don't know what they want. And so -- and they don't know what they're going to need. And so they're actually captive. So they're just trying to kick the can down the road. I think that's more of an appropriate phrase as to what they're looking at versus people that are expiring in '23, '24, '25, they're going to have time to figure out what their needs are and where the world is and then make those decisions.

Okay. Makes sense. And -- I'm sorry.

And Jamie, just lastly, because I think it's important from our standpoint. Remember, we're referring to the tenant mix that we have, which is much larger-sized tenant. The smaller tenants, it's a whole different ballgame, right? The smaller tenants are saying, I'm maybe out of business, I may not be out of business. I've laid off 4 people, and we only had 15. That's a different game. That's more hand-to-hand combat.

But if you look at the -- I mean, your non-San Francisco portfolio has -- does have smaller spaces and spaces to lease up. Are you -- have you seen any kind of uptick in demand for people who do want to be closer to their homes? Or why there is more flexibility?

In the valley?

Yes. In the valley.

No, I haven't seen movement.

Okay. So the whole like people want -- like hub-and-spoke, it just doesn't sound like it's getting any traction or a small...

Yes. And San Francisco is, -- right. And you just nailed it, which is the commute. Remember, if you're looking at our portfolio, think about Seattle, Silicon Valley and L.A., those are all drivable markets. So right now, people are driving to it from work, still the same. San Francisco is different. Public transportation is yet to be addressed. And because you're -- as I told you, we're dealing with 15% of the employees are coming and going, you're not seeing mass public transit yet. So that's going to be impactful, and that's why the city is going to be impacted differently than the other markets.

Okay. All right. Interesting. And so in terms of net effective rent moves, can you talk about what you've seen? I think you -- I want to make sure I have heard you right. You said San Francisco vacancy up to 15% with all the new sublease space? I mean what does that mean for rents?

Yes. That sounds right. Well, first of all, we don't -- we're not really exposed in '21. I think we've got 60,000 feet expiring. I think we're going to handle on most of that. But I think we've seen our renewal TI costs go down recently because tenants are renewing for a shorter term. But the net -- on a net-effective basis, we haven't started on those negotiations. I couldn't tell you what it's going to be. But right now, it's holding pretty flat. But it will be impactful, obviously, for new space or big space it's coming online, for sure.

But do you have sense of whether others are just staying in the market or what...

There really hasn't been any major deals done that are of consequence. In other markets we're in there have been and some other landlords have taken some haircuts. You're -- My guess is -- just pure speculation. We're talking 10% to 15% reduction in rent. That's probably where we're talking about.

Sure. And Jamie, don't get me wrong, I'm not sugar-coating it. I'm telling what we've seen right now in the deals that have -- I don't think there's been a deal over 40,000 feet in San Francisco since COVID started. We're on the verge of closing one, it's 30,000 feet. It's been in negotiations for several months. And as Victor mentioned before, it's right, it's literally right on top of our underwriting to -- on everything like that. So as we report, the deals that are actually happening, there's been no fall off. I'm not suggesting that there's going to be no fall off going forward.

Okay. Yes. And maybe shifting gears to L.A. it's a smaller piece of your business now, but clearly, the media seems to be driving or a reopening of media in the last couple of weeks seems to be coming back. Can you just talk about your media business, the studio business and occupancy there? And just the broader L.A. market, what kind of recovery you're seeing?

Yes. So I mean, listen, the media business is going to be exactly what we've always said is in this recovery. It's -- it was shut, now it's opened. It will be opened in full force probably by the end of October. I mean right now, it's probably 70% opened and you're going to have it 100% open by the end of October in terms of filming. Filming will have a massive burst in content. Every stage we have is leased. All of our space is leased. So the variability, which is the ancillary revenue is coming back. We really believe in earnest that the average of 3-day-a-week filming will go to 5 day a week. The on-location will go to on-set. And so you're going to be much more engaged filming on location -- not on location shoots but on set shoots because they're controllable. That seems to be the wave right now. Clearly, the pent-up demand by all the content players is showing its signs. Virtually, everybody is looking for additional stage space for filming in March, April and May. So we've got a backlog. It's going to be a pretty nice run. That's going to boost the recovery in other ancillary office space, I think, here in Los Angeles. We don't have a tremendous amount of vacancy in Los Angeles or new products coming online. And so it's going to be -- it should be a softer landing here when we see everybody opening up. But still, again, because we're not open for business yet. It's to be determined where rents are going to be effective. As I said, a smaller tenant have optionality so they can leave and go to somewhere else or they can leave and go home and come back somewhere else later on, and they've got that ability. There has been a couple of larger leases done at some good discounts. And unfortunately, the landlords that have to take those discounts were in a position where they had to negotiate given the fact that these tenants were coming due in '20 and early '21, and they didn't have an option as a landlord as the tenants were aggressive. I do think if your exposure is later on, you're going to be at much better position to see the effectiveness of you can transact and what you can get out of the tenants and what's mutually going to be determined to be the best deal for both versus just a good deal for one.

Okay. And then we've seen -- Bellevue specifically seen a nice uptick in demand and Amazon announcing 10,000 jobs. What are you guys thinking on Seattle now and where you can either put capital to work or lease-up some space?

Well, Seattle is going to announce 2 trades that are coming down on transactions that were well-leased credit buildings that are pre -- basically pre-COVID cap rate level stuff. That's what I was mentioning. So those 2 deals are going to be announced in the next 30 days, and they were both bid on transactions. I think Seattle -- it clearly has some political headwinds. But still, the growth of Seattle is going to continue because the demand is still there. Amazon is still there and as is everybody else in the same business that is looking at Seattle and the REI headquarters being bought by Facebook and other transactional companies that are there growing like Apple and Google. Yes, Seattle, we still think is going to be a marketplace that we are going to spend a lot of energy and effort in trying to continue to build our portfolio. Bellevue clearly is going the way we thought it was going to go 2 years ago. So I don't think this is any different. I do think this is somewhat of a mix statement, Jamie, which is Amazon saying, "Hey, some of the political headwinds in Seattle were going to Bellevue. " But the reality is there was no place for them to go in Seattle for those jobs, and they've already committed to Bellevue, and they committed to taking down a bunch of space there prior to this. So they're just fulfilling their obligations that they were talking about 2 years ago.

But didn't they just give back space in Seattle? I mean couldn't they have just occupy that building?

The building that you're talking about was right run set. And that building was something that they have been talking about for a long time. I think what our guys are telling us in Seattle is, is that some of the existing stuff that they currently have, they're going to be renewing and continuing to move. They've got a massive footprint in Seattle. They're not leaving Seattle for Bellevue because Bellevue can't handle all the demand that Amazon has.