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

Good afternoon, everyone. It's Michael Bilerman here with Manny Korchman, Citi Research. Welcome to Citi's 2021 Virtual Global Property CEO Conference. Very happy to have with us Victor Coleman, CEO of Hudson Pacific Properties and the entire management team with them from their office. This session is for Citi clients only, if media or other individuals are on the line, please disconnect now. Disclosures are up on the webcast. For those joining us on the live webcast to ask management any questions, simply type them into the box, and those are going to come directly to both Manny and myself. And we'll do our best to integrate them into the conversation. So Victor, I'm going to turn it over to you just to introduce Hudson Pacific, and the members of your management team that are around the table with you. And then we'll -- we have some Q&A to get the session going.

Great. Well, across me, if you could see. So we're in our offices. And thank you for having us. Michael and Manny, and we're getting to any questions you want. Across from me, to my left and back is our EVP of IR and PR, Laura Campbell; across from me directly is Art Suazo, our EVP of Leasing. Diagonally to me here in the same conference room is Mark Lammas, our President and COO; and just in front of me here is our CFO, Harout Diramerian. So thank you for having us. We're here actually back in call to discuss any of our markets, any of our assets and any updates you want us to talk about real-time, since there's a lot of moving things that are going on with Hudson and our markets.

Great. Well, we've kicked off each of these sessions by asking every CEO the following. 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 HPP?

Okay. So Hudson Pacific Properties, Hudson Pacific Properties, Hudson Pacific Properties. Content, content, content. So I mean in a world that for 10 years of being a public company, we've had a studio component that's been very magical for people to get our arms around, but nobody really gave us any validation on cap rate, compression or values of where we bought the stuff at. And we were -- we accomplished a massive transaction in the eye of the pandemic early summer with Blackstone, validating our price. But on top of that, the content proliferation in the last 12 months is going to set a precedent for our platform, our company and our portfolio going forward for years to come. This is not a moment in time. This is an obvious realization. And so when some of our peers have Class A assets or product types and markets, or talking about life sciences and great categories like that, we're the only ones in this category, and we're the only ones we can take advantage of it in the public market. So that's number one. I think our ability to retain, attract and build out functional space in our markets that is going to be adaptable for post pandemic is obviously been our success tree prior to the pandemic, with tenants like Google and Riot Games and Netflix and Amazon and the likes of that. We've already built out this model. Our company over the last 12 months has enhanced that model. Our company has turned around, and I think, taken a much bigger step in terms of securing the safety and the values of our portfolio around our tenant integration. And most importantly, our employees to come back into the space and the employees of our tenants to come back in the space in a comforting, very secure environment. So I think we've accomplished that in more ways than not. I think lastly, I would say that the third aspect is we've been pushing very hard on our AFFO growth, our numbers quarter-over-quarter keep going up. Our cash flow has been part of cash flow model that Mark Lammas has created for years now. And it's proven out year-over-year how strong our cash flow, how strong our NOI growth and how strong our markets have been in a mark-to-market basis. Albeit we've seen a setback, we still have positive market growth. But most importantly, I mean, we've had 40% AFFO growth despite hits on -- onetime hits throughout, and that light is fairly bright. And it's going to be very much, I think, a differentiator between the massive gap of public market valuations and private market valuations. And so we hope to strive to be a part of that gap shrinkage.

Great. Maybe if we hit on some of those opening comments. On the content side, it's probably hard for you, right? Because you have to sell something, even though you got the value, but that also reduced your exposure to something that you're really, really excited about, right? So you get the value benefit, but then you lose the NOI and the NOI growth from it. So how do you think about redeploying and growing that platform after selling down a chunk of it?

So yes, listen, we have 2 sort of earmarked -- I guess Michael, we have 3 earmark business lines to deploy that capital. The most active right now, and we're hopefully going to make some announcements in the coming months on studios that we are going to be building that are purpose-built facilities in conjunction with some pre-leasing component and some non pre-leasing component in the markets we've talked about, London, New York, Vancouver and Los Angeles. And so we've got some great projects that we're going to deploy capital with Blackstone, and grow that platform in a very methodical, long-term growth prospect on quality real estate that, as I said, is going to be purpose-built. The second this is we -- because of the Blackstone exposure, and they are clearly what people see them do, people try to emulate. That's opened a lot of opportunity to their relationships on existing deals that are in those core markets and other markets as well. But mostly those core markets we're dealing with that are going to come to market, and we're going to be bidding on and we should be active players on that to deploy capital that way. So expect that to also come through that process. Lastly, in combination with our platform that we have in play, and some of the opportunities that we've missed in the past, we are very active on growing the operating business platform. So that ancillary businesses that would enhance cash flow growth albeit it would be, in some instances, taxable, it falls into our nontaxable REIT status. And we believe that, that will be a massive differentiator from just a property owner and a REIT strategy player to us actually growing income for our shareholders in other avenues that we'll get multiples on and multiple valuations on. So it may be more challenging for you and Manny to evaluate us on a company valuation, but it will actually be very much of a positive bottom line number and very accretive to the company. So those 3 factors are what we're going to take our capital line with and grow the platform with.

How should investors think about the difference between a purpose-built development return, especially where it sounds like pre-leasing is going to be part of it. I don't know if that's 25, 50 or 75 in terms of where your levels are comfortable. But what sort of that initial yield and growth is versus an acquisition of an existing studio?

That's a great question. I think -- listen, first of all, the quality of a pre-lease purpose-built is much different than a conversion, short-term gap of an industrial make shift, right? Which a lot of people are saying, can we just take my land or my industrial property and convert it over? Listen, with the value of industrial property today, why would you even want to change that model? But some people are considering that. That's not us. So that's not part of what we're looking at. I think we're looking to build somewhere in the mid-7s on the low end of the scale through 8.5, 9 on a purpose-built. So I mean, it could be up to those levels, depending where the content growth is. And I think we're going to see a massive bubble of capital that is pent-up right now for additional content. If you think about most of '20, those numbers weren't spent. And so they got to spend -- the $15 billion that Netflix wanted to spend for content in '20, they're going to spend in '21, '22 and '23, let's just say, equally across the board. They're $15 billion, now it's $20 billion for the next 3 years. So the demand is going to be very high, and that's one of many players on that. Existing facilities, I think we -- you all know what we did with Blackstone, and we were very transparent. It was somewhere in the high 5s. And my guess is we're talking somewhere in the 5 range to buy something existing, maybe give or take a basis point either way. But that sort of seems to where the growth prospects are. So then you're going to ask me, why would you just not build all the time, if the spreads are so big? But you need a balance both, and that's what we would do. But building on a pre-lease basis is now an opportunity that wasn't the case several years ago because it was too expensive.

Right. And then how should we think about the timing of just the construction, getting the entitlements, constructing and when the income hits, right? Because I think that 7.5 to 8 is very attractive. But it sounds like this may take time to, a, announce the deal, build, have it delivered, pre-lease, just that...

A couple of the deals we're working on right now are entitled, and so that should be a much shorter time line, 24-month range on that basis versus positioning more like a 36-month time frame.

And when should we expect announcements like today and talk about the deals that are...

I wish I was prepared, but I didn't know we were actually sitting down together today.

Okay. Manny, just on the...

I would say you're going to hear some positive stuff from us by the end of the second quarter or early third quarter. Yes. All good stuff.

I was just impressed with Michael's magically disappearing water bottle.

Yes. How did you do that? Wow.

Amazing.

Blue screen.

The little things we don't have to think about. Green screen with a green bottle. I was going to wear green striped shirt, but I thought that might be too much. Victor, you talked about the valuation gap between private and public. And I think that you're one of, if not the only, deeply discounted REIT that's put significant capital to work during the pandemic, and you actually went and bought. And so how do we sort of reconcile that gap of -- saying, "Okay, we're discounted, but we're still willing to grow with a discounted cost of capital." And so it's sort of a confusing topic because you're saying, "Okay, I agree with where the private market is. And I'm going to play in that and pay those values, but look at me on mispriced." So how do we connect those 2?

Well, first of all, I wouldn't say look at maybe were mispriced. I would say, we're mispriced. And I think it's been validated. And I don't know -- and I'll answer your question. I think the mispricing has been validated by countless companies, investment companies, experts and massively successful capital allocators multiple times over. But for some reason, people don't seem to want to put any weight on that. And so it's still relatively confusing to me. And I think there's only 1 way to go, which is public companies have to go up. Valuations have to go up. Just 2 days ago when Kilroy announced their deal, it's another indicative situation where it was not a one-off deal. So the answer to your question is simply put, we have always been very transparent in our business plan, which is, to say, we will buy back stock and we will buy assets and grow our portfolio, and they are not mutually exclusive. And we have been consistent to the point where we bought back millions of dollars of stock in the last -- over 12 months at great valuations that have been very accretive to our shareholders and the company in general. But in turn, we bought a fantastically priced deal. And to thank John Kilroy and his team for helping validate their pricing, it makes our deal even look a lot better with a AAA+ credit deal for 13 years, annual increases with Amazon with great debt markets and accessibility that we put on that asset, and a fantastic capital joint venture partner in CPP. Our yield's out of the box are going to be a stabilized 8. And that just shows you that there is a mispricing in the marketplace for what private valuations are in public. Now we got that deal, and we're very happy on our pricing and the quality of the real estate and the tenant mix. But we got that deal because of proof of ability to execute on an expedited time line. I mean we got -- we said we're going to get this deal done by year-end, and we closed on Christmas Day. So -- or the 24th. Maybe it was Christmas Day, I'm not sure. Anyways -- so it was 24th. And so -- and that's what we did. And you know what? We stand firm on the commitment on doing that going forward. Now that being said, Manny, I do think that we're all a little surprised at the lack of value-add assets that are coming to the marketplace today. We thought we would see more, all of us. We thought we would see more at some discounted values. So it does show you that the amount of capital in the market is obviously weighted to that and pushing pricing at levels that I don't think any of us would have thought. And so maybe the valuations are fair because of access to debt and equity, but maybe the valuations are inflated slightly because people feel that they have to get money out. I'm not really sure, yet. Time will tell.

So when we opened up, you talked about validating the value of the studio business by forming this JV, essentially selling those assets and proving out value.

Yes.

So we expect the same on the office side then that you would start selling more to either bring in that capital, then you can redeploy into whether it be Seattle office or Vancouver studios? Or is it, we did that on studios because we wanted to get this partnership, et cetera, et cetera, it's a completely different story?

No. Listen, we've talked about calling our portfolio. I think we've done a very good job to date. We've hit some great marks and we've expedited, I think, our plan on that. We do have a few assets that we would consider doing, continue to do that and then redeploying that capital either into the company or into other assets in our core markets. I'm not discounting that at all right now.

And has the recent move in the stock changed your view on buybacks at all?

I don't know if it's changed the view. I think, opportunistically, we will always look to buy back stock at certain levels. But we bought back stock in the low 20s consistently, and I think we're trading today somewhere in like $27 a share. So it's been a fairly 30-some-odd percent return on our investment.

Right. Art, maybe we can spotlight you and you can run through some of the markets and what you're seeing out there from tenants?

Sure. I appreciate the spotlight. Let me have my makeup on. So listen, we've said on the call, as you know, the markets, the activity in the market, it was off 50%, 60%, just about across the board in terms of activity. Deal velocity was down even more than that. And in some cases, closer to 80%. I think the encouraging piece is that we're starting to see an uptick in interest, in the front end of the pipeline, in all the markets, right? If you think about some of that 50% to 60% drop-off in activity, some of it was pent-up. We always say, hey, yes, not all of it's going to stick, but there's a lot of people just kind of waiting to see what's going to happen as we get into the vaccine, as we get into schools reopening. I think a lot of tenants are starting to look beyond that, come out and kick the tires again. Now again, interest is not deal velocity. That has to happen, and I think it -- but it is encouraging to see some of that come back now. And is it -- equates to our particular pipeline. We were down to about 700,000 square feet of active deals in negotiation. Towards the end of the year, into January, we popped back up to about 1.2 million. So we're feeling it, too, again, on the front end. And if you look at our pipeline, it is -- I would say 80% of it is new negotiations, new proposals, right? So we've got to clearly move that through. And in some cases, there'll be very competitive situations. But I think in the markets where you've seen the most erosion on net effective rents, for example, San Francisco, where the Class A trophy, net effective rates have dropped 5% to 7%. But the commodity space and beyond has dropped 15% to 20%, we don't have much exposure. We're 2% vacant. We've got 50,000 square feet expiring there. So through '21, we're pretty well set. But I am -- again, I keep saying that I am encouraged about the new level of activity that's starting to percolate within the markets.

And then in terms of sublease, any changes there?

In terms of -- just goes specifically, I mean, I know that's been the focal point of the amount of sublease. I think everywhere, you can say, with the exception of 1 market, I think sublease spaces started to decelerate. The amount of sublease of the market decelerate on the Peninsula -- excuse me, in Silicon Valley. We actually had absorption of sublease. So that's moving in the right direction. I think anywhere -- well, in particular, San Francisco and Seattle because those are the markets that we have the highest mark. You're starting to see a lot of tenants who perhaps have been in 4, 5 years beyond test the waters opportunistically on the sublease. Because they're such high marks, they figure, well, we're not back yet. We don't know when we're going to come back. If there is a 50%, 60% mark, in some cases, let's see what we can do. And so you're going to see maybe a 20% kind of pullback of sublease. That's a number that I'm hearing and I'm seeing. And I don't have hard data, but I think it's somewhere in that -- be conservative, be 10% to 15%. That's still a lot of that's a lot of space off the market if you consider that.

Also, you know that nobody's planning on doing spec development for at least a little -- a moment in time. And that's going to help with the sublease space in the marketplace. You've got to sort of stoppage in development, that's going to be only a positive indicator to get some of that space back in the marketplace.

Right. And if you're talking specifically about our subspace on the market in our assets, Uber is the largest. Obviously, they're out in '25. The mark there is -- pre-COVID mark was close to 100%. The mark now might be 80%. So we're hoping that they can find someone because we'd love to do a deal, direct and capitalize on that mark before '25.

Can we spend -- there was a question that came in here through investor on Veracast. How many days a week do you think people work from home in the future? And what are the plans for your own company?

So we are now -- outside of the corporate office, we're 5 days a week. So the entire -- all of our offices outside the corporate office, 5 days a week. We're running at 35% right now. Planning on moving April 15, the latest date, May 1, to 50-plus percent. So an extra day. 2 days a week now, going to 3. We still have a lot of people who have been here every day. Our intent is to have everybody back in 5 days a week at September 1. That's our goal. Maybe earlier, but that seems to be a realistic time line. I personally think that the work-from-home theory in that is a theory will burn off relatively quickly once people get used to coming back and are comfortable with the environments they're working in. People want to be back, we all know that. I'm speaking to everybody who knows the same concept. People want to be back. Those who don't want to be back, if it's not a medical issue, or they don't feel comfortable, won't have jobs in time. It's just a matter of people being -- versus laziness versus activeness. I just think at the end of the day, we're finding our tenants, for the most part, are saying, they're all coming back. Now the voices that are saying, you don't have to come back, you can work from home forever, those are loud, but they're few. And those loud voices have been very loud because candidly, the louder -- the majority of voices that are saying, you got to get back in the office, can't say that right now. It's not politically correct. We don't have enough vaccinations. We do not have the mentality. We know that some places have not put in facilities to be protected. So why say it until you're prepared to say? But when they do, I think the voice is going to be much louder and many, many more populous going that route.

Victor, can I add to that?

Yes.

I think there's also a disconnect between what you're reading -- what we're all reading, and what we are seeing. And Victor mentioned it about things that are not politically correct or things like that. But many have been named -- there's a handful of named tech tenants who have said, hey, we're not coming back until pick the date in the future, right, somewhere on the horizon. However, what's happening is they're already scheduling people to come back, people wanting to come back. So they're actually scheduling the return to the office imminently, well before this date out on the horizon. So that gives you a little bit of indication that some of the workforce, some of the people are wanting to come back.

Right. Right. Is there anything changing in the design of spaces as they want to bring people back?

So Michael, our largest tenant, as you probably all know is Google. And we've done -- during the COVID time frame, we did 2 big deals with them. We just announced 1, and we did another deal at Rincon in San Francisco, which was an expansion, not just an extension like we did in Silicon Valley. And we're building them out right now at One Westside. So they are the template. And One Westside, we designed that space 1.5 years ago, and it has not changed. What we're finding is, and they we are looking at increasing the square footage per head right now from what was maybe as low as 175 feet per person to maybe closer to 250. And so the thought process is I think that will follow suit. I personally have been fairly vocal on my opinion on hot desking. I'm not so sure that works. And I think it's going to be maybe a stock gap. But right now what we are finding in our portfolio, specifically, we have very few downsizing tenants. Tenants are either going to leave or they're going to extend, but very few are downsizing. We have 1 main tenant in our portfolio of size that has come to us and said, "We are downsizing. And it is not based on COVID, but it's based upon a company-wide decision."

If we flip to ESG, what are your top 3 priorities to improve your ESG score this upcoming year?

Yes. Listen, I think we've been very active on ESG as a company, as you well know. And I do believe that our focus on the S side is going to be equally as sincere and absolute as we earmarked it. We have put a tremendous amount of effort during COVID on DEI, DEI training. And it's been a great time for us to get everybody on the same page on that. So we can all do better on the S side. I think on the G side, we -- during COVID, it was always our plan. It was a State of California mandate. We increased our Board quota for an additional woman on the Board, which we announced at the beginning of this year. So that has been part of our goal process. Obviously, on the E side, we came out in our carbon neutrality plan, which you know, the entire company achieved our goal 4 years earlier than expected. And we did it with some offsets, as people know, with us buying wind. But 100% of the portfolio now is carbon neutral. That's a start. It's not the end. I think as a company and the markets we're in, with the tenants and investors that we have, we are leading the pack. And I'm very proud to say that we're leading the pack, but that doesn't mean anything at the end of the day, and we need continue on this. And it's not part and parcel of checking a box from a Hudson-specific standpoint, it's part and parcel of growing our business.

So Victor, if we go back to the comments on space usage and return to the office once this is over. In some of these other meetings, we've talked about businesses that have looked at this as the opportunity for reset. And a way to look at there, whether it be the operating expenses, whether it be the revenue streams, whether it be the core way they do business. But what we've heard across a lot of the office meetings is no, everyone's going to come back 5 days a week because that's what we're used to. There's 2 days of a weekend, and those a Saturday, Sunday. There might be a little bit more expansion of space, but that's only because we over densified in the interim. It sounds like, we've been using offices for 35 years, and this is how the last 15 of that, they've had -- we've had computers on the desks. The prior 20, we didn't. And that's been the most innovation. And maybe we have a little bit more wee space, but that doesn't change either. That strikes me as a little bit surprising. And you're not the only one saying that. Is that really how people are thinking about this, that this was a big experiment, and experiment's now over and we're not going to think about the takeaways from that experiment for another 5 years?

Well, it's funny. I'll comment this way. If you hear some of the louder voices that have come out and say, "You don't need to get right away." They said, "Don't need to come back for a year." Or -- and everybody is like, "Oh, my God, a year." And then they said, "Oh, it's 1.5 years. You don't have to come back until June of '21," right, or maybe September of '21. These are the same companies that built their entire enterprise on quality of employees, collaboration, 3 meals a day, working out facilities, amenity-based, this -- your work is your life. And then you throw all that culture away. I'm not saying, Manny, that this is going to shift back to, "Hey, all this was done for naught." I actually believe all this was done purposely, but it now needs to be honed in a little bit. Because, one, we have a society who are younger than you and I, and the people in this room who have already been trained only one way. They've been onboarded based on a culture and a collaboration and input of inclusiveness, which is how the world is going to go forward. If you want, like we do at Hudson to include people in your decision-making tree and get input and growth, you need them to be together. I've made this comment on these type of scenario calls. And if we were seeing in your little conference room in Florida right now with the rectangular table and I'm at one end and you're at the other, I promise you one thing. You and myself would not do one thing, which is we wouldn't pick up my phone or you wouldn't look at your computer because it would be disrespectful in front of each other. I never would have done that. And right now, people on this call are doing that right now through -- uniformly throughout this entire country and this world. And yet you're not focused 100% on what I'm saying and what you're saying. So how could we be productive under that environment? And how could you actually look at yourself and say, "I'm paying something full-time for this, and they're productive." You're fooling yourselves. So yes, I think there's got to be a moderate change, but it's got to be based on 1 factor: productivity. And for companies to come out and say, "Oh, we're just as productive doing this new world that we're moving into." I say, you're not being honest. And at the end of the day, do you want those people who are not going to be producing what you want them to produce in your environment? The answer is no. Eventually, you got to say no. And so I think the model that we've changed -- that we've come from will be moderated. I don't think COVID attacks everybody on a Friday. I find it hard to believe that every single Friday, people are getting close to getting COVID so they have to work from their homes. Can't be that way. If we want to say we're going to a 4-day work week and everybody gets a 3-day weekend, well, let's just be honest and say that, okay? That's what we should do. But I just, right now, believe that there are enough voices that are permeating to the top that are going to prove me a little bit more accurate than, hey, let's not be at home. Now before you go to the next point, I also feel there are clearly businesses and departments that don't need to interact. We know that, okay? I mean I'm in the real estate business. I buy and sell real estate, and I manage and operate real estate. When I have a contract, I used to, years ago, go to my lawyer's office and sign closing documents. I haven't been at my layers office in, I don't know, 15 years, okay? Why did my lawyer's office need to have a massive conference room that Victor Coleman goes to? They don't. So okay, there's an example. So that, I think, is sort of a changing of the guard that was coming anyways, but maybe this expedited it.

You have to worry about all those tech workers that are now working at multiple companies from home.

Yes. Get paid by 2 or 3 places.

Yes, and taking the Friday off at all the companies.

There's so many people smarter than I am out there.

Yes, clearly. Manny, should we go to rapid fire or do you have something else?

Rapid fire? What are you rapid firing this year?

Okay. So when we're sitting physically together in Florida a year from today, what will be the one thing that will have surprised people the most about your business over the preceding 12 months?

Well, obviously, I mentioned the proliferation of content. But listen, I just think that our business is going to change. Hudson's business, the real estate business in general, but more importantly, the commercial office businesses and the amenities around it has to change with technology. And so the VTSs of the world and other companies that are coming out with access to information, I think that will be the biggest surprise that we knew was sort of on the horizon, but will be expediting the process. So technology related.

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

I'm going to say this, and this is not for my competitors, this is for my peers. If my peers are getting a plane and going to visit my tenants and going to visit my investors and going to visit people who have deals, I'm going to go twice as much. I'm not sitting around, waiting for somebody else to go visit you and say, "I don't need to visit you. I'll get in a Zoom call." I think that's complete bulls***. I say it's 120% of what we said, maybe more in...

Right. Well, especially if you're going to go to London and Vancouver and New York.

Yes. Wherever. I mean we -- I believe deals are done based on face-to-face and reputation, not based on presumption and assertion.

Same-store NOI growth for the office property sector overall in 2022.

I think we're in line with Green Street on that. I mean I think it's 3%.

Who?

Green Street. They're -- the small company. I think we're aligned with them. We gave them some of the data that we shared with you guys. But I think 3%. If we needed your number, we'd say maybe we're in line with you.

10-year treasury a year from today. So 1.55 right now.

Less. 1.25. Yes. I think we're going the other way again. Lots of capital out there.

Well, great. Thank you so much for the time and the thoughts, and have a great rest of the conference.

Yes.

Well, thanks, guys.

Thanks, all.

See you later.