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

All right. Good afternoon, everyone. Welcome to the 4:15 p.m. session at Citi's 2022 Global Property CEO Conference. I'm Manny Korchman with Citi Research. Parker [indiscernible] is up at the table there on my team. We're pleased to have with us Hudson Pacific Properties' CEO, Victor Coleman. This session is for Citi clients-only. If media or other individuals are online, please disconnect now. Disclosures are available on the webcast and at the AV desk. For those joining us in-person, you can use the mics for anyone. Who's listening or in person, you can use the live QA. I'll get them, I'll ask them. You guys are getting tired here as the day goes by, but put in some questions. With that, Victor, I'll turn it over to you to introduce the company and the guys sitting up there on stage with you, and then we'll go to Q&A.

Thank you, Manny. So before I begin, I appreciate giving us the time and everybody here. We'll try to be expeditious and get to everybody's questions. To my right is our Executive Vice President of Leasing, Art Suazo; to my immediate left, is our President, Mark Lammas; and beside him, my far-left is Harout Diramerian, our CFO. So really briefly, for those of you who probably know about us, we're a West Coast based studio, media, office REIT with assets from Vancouver, Seattle, San Francisco, the Bay Area and Los Angeles, about to be in the U.K. as well in our newest acquisition. We are a 50-50 partner with Blackstone in our studio business. Obviously, we're revolving around the content, proliferation of content and growth in our portfolio and others. We also have acquired and we'll continually to acquire vertically integrated business lines to support our studio space, and we can talk a little bit about that as well. We own approximately 20 million square feet of Class A exceptionally located assets with about 20 of those assets to running through the portfolio, which are single-tenant assets of high-quality tech and media tenants for durations of 5, 7, 10-plus years. We have some multi-tenant assets in the portfolio. Currently today, our leasing -- leased assets overall for the 20 million square feet is about 92% to 93% leased. And we are actively engaged in some of our lease-up metrics in our markets, which we can talk about at the same time. And some of the activity in our vacancies there that are currently coming due in '22 and '23. We have an active company standard around our ESG platform as well as our DEI engagement. We are Developer of the Year recipients in 2021 and we are GRESB 5 Star graded as well. Almost all of our assets have been upgraded during the COVID timeline without safety protocols, MERV HVAC systems and the likes of that. So I will stop, Manny, because I know you have a whole host of questions we could probably get into instead of me delivering more information, we can sort of jump into it. Okay?

If you proceed my question and I ask them, it gets all awkward. So I'd rather ask them first. So what are the top three reasons as investor should buy your stock today instead of any other listed property companies?

So let's -- thank you for that. So listen, I think the first reason is that we have embedded NOI that is signed, sealed and delivered. You know of some of the assets. But between our newest acquisitions and our developments that are leased and coming online, and additions of our new vertical integration, I mean, you're talking about somewhere between $75 million and $100 million of new capital that will enhance the value of the stock as we sit right now directly to the bottom line. Secondarily, our company's assets are positioned in the best-in-class markets with the best-in-class tenants. Our track record of leasing, redevelopment and repositioning, I think, is second to none. We've taken unique assets that people had different visions of and created massive value and we continue to do that. So I think our track record is such that it would support that. I think thirdly, not the least important, most important, but when you start talking about metrics and you start talking about peers and start talking about quality of assets, our multiple is way different than our peers and our NAV differential is way different than our peers, but yet our asset quality is in line with our peers. And so there is an upside to our portfolio that I think has not been realized to markets are starting to show that realization with the recent increase in our stock and future increase in our stock.

So as you sit around and say, the funnels us, it doesn't make sense. Why are we getting beat up with the same or better quality, but the metrics don't line up, what answers do you come up with?

I don't have a straight answer for that because it really isn't one. I mean, if you look at the assets I mentioned I think if you look at our 18 assets in our portfolio today that are single-tenant assets with the tenancy, the likes of Google and Amazon and Netflix and the quality like that. The value of those assets in the private market sector would almost equate to the entire value of our current market cap of our portfolio. So effectively, you're getting everything else for free. So it doesn't make any sense. There's been banter around conversations that say, well, private market valuations and public market valuations are different. Yes, we've seen those spreads. I've been doing this for 22 years. So I've seen the differentiator in the spreads, but not to the extent it is today. And the aspects of proving those valuations out have been proven multiple times over by multiple comps, by private investors as well as public investors. So I don't have a clear answer for you, Manny, on that.

I guess, you guys took advantage of it a week ago or two weeks ago, I lost track at this point -- two weeks ago with the buyback -- the accelerated buyback.

Two weeks ago.

And I know that, that was something Harout and I spoke for quite a bit about how that was sort of a different structure of buyback than what we're typically seeing in the REIT space and typically seeing in your stock. So I don't know if you want to talk about that or Harout or Mark do, but can you explain to the room what made that different?

So listen, I'll get into just the top level. We have been talking about various different buybacks. We've been active in the marketplace and ATM. And I think that for slightly less than $200 million over the last -- or really since just pre-pandemic, there's about $175 million of buyback [indiscernible] yes, on the 10b-18. We've been looking for an ability to take a much bigger chunk. And there are two methods that we did in a tender. The method here was a cleaner, cheaper, more efficient method. It is unique to the REIT world, but as Mark will tell you, it's definitely not unique to public company.

Yes. So we want to -- as opposed to what we have been doing, which for accessing the market under 10b-18, which we've done very successfully. We bought $170 million of stock over the last few years. We wanted to commit to a larger share repurchase. And you really have two alternatives that are regularly used. One is a tender and the other one is an ASR. It's not commonly used in the REIT space, but if you look at a survey of major share repurchase programs outside of the REIT space, what you'd find is ASRs are far more relied upon than tenders. And you know that the drawback of a tender, you can do a quick execution on the tender, but the drawback is you have no certain of execution, right? So it's not uncommon to see a tender go out and only a small fraction of the amount that is being tendered for actually gets repurchased. And oftentimes, if the entirety of the target not gets repurchased, it's sometimes because you misprice the shares. In any of that, this gives us complete certainty that we are repurchasing $200 million of the stock. All but the last 7.5% of the $200 million is pulled out of the flow essentially immediately. It takes 9 days for the portion of the transaction to clear. But so you're committed on the $200 million. We're hedged on half that trade. So we have pricing -- at least pricing certainty on half of the trade. And so anyway, that -- when we weighed the advantages and dissipates, just felt that it was the better way to go.

And how did you come up with the $200 million?

With all the other potential uses of capital, it's -- and looking at ideal sizing for an ASR, we were at the outer boundary for a company of our size on an ASR. So a $200 million tender would be small and a $200 million ASR skews to the high end. Candidly, if we thought we could do it, we would have pushed it a bit higher, but it stretches out your time frame for the period that the program has to be in place, so we selected the $200 million because we felt like a workable time frame. And depending on how it goes, we might continue to look at further share repurchases.

What would that be, Mark, just on the last point, what would that be contingent on? Is that on execution and pricing of the sales you talked about? Is it price volatility? Is it a combination of the two?

Yes. I mean I think we just -- we've had a pretty steady track record of depending on what other opportunities are to deploy capital into, when our stock seems especially on cheap. We've taken advantage of those windows time under 10B18 and we did likewise with this. And I think we'll continue to monitor other opportunities on what the share price looks like at any point in time, and if it seems like the right way to deploy capital, that's what we'll do.

I think about those other opportunities, you guys have been actually somewhat, I don't want to call it aggressive because that has a bad connotation, but you've bought throughout the time and over the pandemic. And I guess as you sit here today and think about what those opportunities might be, you've now taken up $200 million of capital into the buyback. Obviously, you measure what the return on that was versus some of these other things. But help us figure out what your mind is? Because it's like, oh, we want to be growing and you're growing, then you do buyback, you're like, okay, maybe they don't need to be growing, then be selling noncore assets, so that's maybe they're going to get a little bit. Is this growth? Is it shrink? Is it like from a company size for site that's maybe to you or Victor, I don't mean to point at you, but what's sort of the -- what's the direction of the company?

I think the direction has been consistent since day 1, Manny, and we continue to do so. We're a growth-oriented company that we said we're not mutually exclusive just growing. But the opportunity for us to buy back stock is in place. We will do that, but it's not mutually exclusive. Does developing and/or acquiring other assets? So at the same timeline as announcing this, we just closed on a transaction in Seattle, not 30 days prior too. We're about to announce another transaction on the development side. in the studio portfolio and probably two as well as evaluating a couple of other acquisitions. So it's consistent. We're also breaking ground on almost 1 million square feet within -- between now and hopefully at the end of the year on two projects. So I think it's been consistent. So it shouldn't be confusing because I think our story has been very much aligned.

I've got a couple of questions here in the live Q&A queue. Victor, can you expand on the $75 million to $100 million new capital to the bottom line comment that was from earlier in our conversation? Is that $75 million to $100 million in NOI or is the NOI based on a yield on an investment of $75 million to $100 million?

So about $45 million of it is going to be NOI for our One Westside, which has stabilized, and that's about $45 million of it. About $35 million of it is EBITDA just on our existing acquisition of our two vertically integrated assets in the studio business. We've got an additional new asset that we just brought online, which is Fifth Wall in Seattle. So that would take it actually to more than that number I'd just give you sort of a snapshot of it.

And in the office portfolio, can you talk about your largest tenants plan for home and the impact on potential reduced demand for space? And second to that is, what is -- HPPs as just for your company itself, what's your work-from-home policy?

Okay. So the...

Well, the first is about your tenants, your largest tenants, and what they are doing?

Yes. Yes. I got you. So HPP, we've been in the office 4 days a week since June of 2020. And so we've not moved off of that. We actually took over the holidays and the first two weeks, we were worked from home the entire time only because of Omicron. So we've been consistent throughout we are work-from-home one half day a week, which is a Friday. Our tenants in almost concert are either on their way back, have indicated that they are back and have not, for the most part, if we did a -- if we turned around and did a survey of tenants in '19 that were expiring, whether they downsize or not, it would be consistent with our portfolio right now. So we've had a few tenants that have downsized or left, but we've also had a lot of tenants expanding and continue to grow. Our largest tenants, in no particular order, the biggest ones are Amazon, Apple, Netflix, they're all -- and Microsoft, they're all returning to work and have announced their return dates, which is in the next few weeks to the beginning of April.

Right. Maybe we'll go to Art. Does Art want to go market-by-market or Mark, or who wants to go market-by-market here?

Yes, we can do that. We can start in Vancouver, if you'd like.

Yes.

Well, first of all, just to kind of level-set, all the markets over the last 3 quarters are really -- the fundamentals have been coming back, starting with tenant demand as covenants has been growing, we've been talking about it over the last 3 quarters, how demand has been growing and certainly, you're starting to see it everywhere. Even in San Francisco, by the way, there's some highlights. But in Vancouver, which never really fell off too much been very consistent. The tenant -- the tendency there, the large tenants are still in the market. The small tenants are still in the market. We don't have a lot of exposure there, and we started to see the rates, really the asking rates over the last two quarters start to tick-up slightly in Vancouver. In Seattle. I think the story just as important as demand is really that sublease. The sublease availability that it had ticked way up has come down, really, I think over the last, just over the last second half of the year, 750,000 square feet or so of sublease availability came off the market, and it was all quality space, right? So it was very competitive to us. It's -- it's coming off the market. I think there's still about 350,000, 400,000 square feet to go. Rates have started -- last 2 quarters really started -- we started to flatten out and starting to tick up. The last quarter was up about 1.5%. And it's -- the demand for us on existing vacancy. I think we've got about 45% coverage on existing vacancy, once again, driven by the larger tenants in the market and the expirations, the expirations for this year, we've got about a 50% coverage on those. And the mark-to-market in Seattle, by the way, is close to 50%. In San Francisco, the two things that stand out to me, a lot of people think it have mentioned it was falling into the ocean. The thing that jumps out to me really is the sublease space. $1.2 million was absorbed over the last, call it, half of the year. We're down about 8.5 million square feet. That's a good sign. Gross leasing, everyone kind of forgets about gross leasing was just under 7 million square feet, right? And even if you go back to pre-pandemic gross leasing numbers, not off very far. So that's very promising. We don't have a lot of exposure there right now, Manny. In San Francisco, we're kind of 95% -- close to 95% leased, and the spaces we have are just really kind of smaller spaces and some of that is retail. Moving down into the Valley. I would say that the Valley has responded the best out of all of the markets. Combined, there was 6.5 million square feet of activity last quarter. There was 3.5 million square feet of gross leasing. Again, most of that driven by large tenants that are out there. But we're seeing the kind of the renewed confidence in the smaller tenants in that market and they're drafting off the large tenants. One example is the Peninsula, Redwood Shores, right? Most of that is a smaller tenant base for us. We're pretty close to 92%. I mean, we've been getting comments over the last year or so that have been languishing. We're very close to 92%. That's because of the small tenant activity that's driving that market. And rates in the Valley and the Peninsula throughout the pandemic have remained very, very stable, ticking up slightly over the last quarter or two. Down in L.A., really L.A. is driven by West L.A., the West L.A. market. Again, larger tenant activity, techtainment, driven really 350,000 square feet of positive absorption just in the West L.A. market, which drove the activity in Greater L.A. And we don't have -- we're about to finalize a lease for Harlow which will bring that to 100% leased in our whole portfolio, then they will probably be 98% leased. The big exploration on the horizon, which is NFL, which you all are aware of. It's 170,000 square feet comes up at the end of the year. We're on the NFL space, we are very, very close to the goal line on signing a lease pardon the pun. And at about 26% mark-to-market. So we feel really good about our L.A. portfolio. And again, this just speaks to the momentum that's been happening across all of the markets over the last 3 quarters. We've been tracking it very, very closely. And again, I think, Manny, I think it starts with the confidence that people are having -- tenants are having coming back. And that runs it out.

Thank you for taking us through all of those. Maybe on that point on confidence, we've had sort of mixed responses on how much occupancy of the actual physical space matters to leasing decisions. You're pretty close to this and you're speaking to tenants. How much are they thinking about how many people are in the office right now versus what they need or want longer term?

Listen, I don't think anybody knows right now other than the fact they want all the space that they currently have. And I think what they're realizing is they need more space for less people, which would equate to more space for that at the end of the day. And I think that's a pretty consistent theme. So people aren't making decisions for right now. I think they are making decisions, whether they're saying, we're going to start at 3 days a week. It doesn't matter how much space 3 days a week, 4 days a week, 5 days a week, 7 days a week, it's going to be the same amount of space. They're -- like anything else, these companies are looking for their growth prospects over the next year or 2, 3, 4, and that's what they should be doing. They're not looking for a moment in time. And so I think getting away from the equation of 1, 2, 3 days a week versus just occupying space. The only difference for us as real estate owners and landlords is the ancillary revenue around that, right? Parking after our was HVAC, the security costs, et cetera, on expenses and revenue. And so that will stabilize as we get closer to the stabilization of people coming back.

Victor, in that response, though, I guess, the pushback that I get when I talk about the same topic is what are they willing to or how much can they stomach the rent to do that? So if you're in days a week. Are you willing to pay 5 days a week versus 5 days a week of rent, or do they come to you and say, "Hey, look, we're happy to stay in the space? We want more space, but the rent doesn't align with the use we're getting out of it"?

Manny, I can't think of a tenant in our portfolio that has come to us and said, "We want to alter rent for occupancy or for timeline." I don't think there's been one. Am I wrong?

No.

No, not at all. In fact, 3 day -- like he said, 3 days a week, 4 days or whatever it is, tenants are going to -- they're not going to want to overlap, they're going to want some people in and stagger their occupancy in there. They're going to need the space, period.

Art, I've got a follow-up here on the live Q&A. On the NFL space, when that lease gets signed, knock on wood, what type of TI dollars will you have to spend? And so that 26% is a, I guess, a cash mark-to-market or is that space mark-to-market?

26% is cash mark-to-market.

But that's not base rent?

Sure. On the start rent, yes.

And so how much other sort of math needs to go into that?

Market guys. Yes. It's $100 TI.

And rents are in the what ballpark?

I'm sorry?

Rents.

Just the rental rates, what ballpark are they in for that space?

They're -- monthly, they are $350.

Okay. Okay. And then Victor, this one is for you in the question queue here. The common perception of HPP is that you have a tougher near-term rollover schedule versus peers. What do you think?

It's funny. One meeting we had today brought that up. And I think this is consistently our role has been fairly stable in that it's been a larger number, 12%, 13%, 14%, 9%. And year-over-year, we have achieved our role in excess of rent and exploration and achieved higher mark-to-market on -- for the last 10 years. So I don't think our track record should speak for itself. I don't think that the numbers should speak for themselves in that it's expiring. It's normal business for us. We're not fearful of it. I mean, Art just told you, we got a tenant expiring in December. And so you're effectively talking 9 months from now. We've got a lease that's going out at 26%. That's standard. We've got tenants that are expiring in '23 that were negotiating terms at the same time. I think moment in time expiration is a very, very volatile way of evaluating the value of a portfolio.

Maybe we'll get off of office in a few minutes we have left here and talk about studios. It sounds like you've got some exciting stuff going on there. Just maybe to start, what does the operating environment there look like? And how are your couple of recent acquisitions then?

Yes. I mean, listen, let's first of all, talk about the environment, right? It's gone from a 2007 acquisition and a timeline that was -- content was probably $10 billion or $15 billion a year, and now it's gone to $175 billion a year in content, growing to $250 billion by 2025. So the environment is such that this is not going away. I think everybody understands it. We're going to see consolidation for sure. we're going to see technology evolve around virtual production and other avenues by which you're going to see gaming companies and other production companies get involved in this. Our portfolio consistently performs to the highest level. It has since the very beginning. I made a comment on this, which is a shockingly surprising fact, but we've never had a default on a sound stage in our, I guess, it's been 15 years of running the sound stage business. So it just shows you the stickiness of the industry and the business. The comments around, well, how do you feel about Netflix losing market share or eyeballs or whatever the case might be? Listen, the quarter that they lose, the next quarter, somebody else picks up. we're not picking and choosing content. We're picking and choosing an industry by which it's going to continually grow and has been growing for 100 years for the likes of Disney and Warner Brothers. So we're very excited about our recent opportunities. We're building our newest development opportunity Sunset Glen Elks. We've got a very, very strong indication from a handful of very, very recognized tenants to lease the whole thing. That's followed on by our Sunset Waltham Cross, which is going to be a $1 billion project in London, and it's going to be a best-in-class as well. We've got tremendous interest on that asset from multiple tenants for a large percentage of it. I think at the end of the day, what you've seen is the investment community is recognize this is an asset class and a business and is looking to get their share. We still have a great platform. I think it's the most recognized name platform and Sunset Studios under the Hudson umbrella. And our opportunities in Vancouver, New York and Los Angeles in the U.K. and some other markets are going to come to fruition, I believe, in the next 3 to 6 months with some new deals.

In those markets you just named, if we had to guess?

If you had to guess, you wouldn't. Listen, we're going to grow in London for sure. We're going to grow in New York for sure. We're going to continue to grow in Los Angeles and Vancouver for sure. And then there's a couple of other markets that we're looking at right now.

But I guess, just on the 3 to 6 months that you sort of baited us with a couple of times, that -- those are New York?

Those are New York, Vancouver and L.A., all three. Yes.

All right. Art, before I forget, somebody wanted a clarification. On the NFL space, the $350 monthly, that's net or a gross?

$350 is a modified number.

Okay. Back to Studios. And then these video operating businesses, Victor how those performing versus what you expected?

So we're very excited about that existing platform and the other ones. We've tied up another operating vehicle. We are looking right now at a fourth operating vehicle, and we'll continue to grow that business. Currently, the two vehicles that we have purchased last summer, we've rolled them into the consolidation of the enterprise under the Sunset Studio brand. I think we projected a low 30s EBITDA. I believe these guys have got us sort of at mid- to high 30s EBITDA for '22, and we're on track for that. And that's -- I think the investment is -- the multiple on that is a very attractive investment. The business is going to be vertically integrated, as I said, based upon the fact that we've got a captive volumes. So it's not just on our facilities, but the facilities that we control, all goods and services flowing through that our facilities, we're going to be charging for. Currently, it's all under the TRS. But at the end of the day, if we cap out on the TRS in terms of size, we'll continue to acquire businesses, and we have the unfortunate situation we're very prepared to pay the tax.

And -- sorry, I completely spaced. The -- you mentioned two more operating -- potential operating businesses. Would those be done fully on balance sheet or would those be done in the partnership?

Everything we're doing in Sunset Studio is going to be the partnership.

Including the operating businesses?

Yes.

Because I thought -- correct me if I'm wrong, but Zio's Star Waggons was not done in the partnership, correct?

It will be.

Okay. But right now, they're not?

Correct. But we're rolling it...

You confused me. You thought -- I thought I was wrong.

No, it's not a confusing question. No, it will all go into the same end, and our partner in Blackstone is going to be financing that enterprise.

So they've decided to go into the -- all the operating you're going to be doing under Sunset?

Yes. So they decided some time ago, right?

Yes. Yes. They -- candidly, we had exposed it to them, and they're -- it's not exactly an easy fit for their cores fund. Obviously, it's an operating business. and we needed to move as quickly as we could. And so we bought it -- we took it down and now they're underwriting it now.

I think at the time, Mark had indicated that we wouldn't be surprised if they wanted to come back in to align the businesses and all the revenues. And so they're doing exactly that.

Okay. Any questions in the room there?

I see no hands.

I actually can see the room, believe it or not. Cameras everywhere, be careful. I don't think we've touched this one yet. And if we have, pardon me, but what's your #1 ESG priority?

So we've achieved carbon neutrality with offsets, as you well know, 5 years ahead of our plan. I think we're thinking that will be between 2025 and 2030, 100% carbon neutral. So I think that's our biggest and brightest. We've recycled concrete and rebar steel for our new development repurchased recycled goods. We've got window treatment companies that we've invested in. We've got solar companies that we've invested in. We are a founding investor in Fifth Wall's Climate Fund. We're a founding investor in Fifth Wall's other funds, and we continue to invest in that. So we've set our targets. And so we're looking for emissions we're looking for embody carbon for our development, as I said. And I think that's the direction that we feel comfortable with and very confident we're going to get that achieved.

Well, with that, let's go to our rapid fire questions. What will same-store NOI growth be for the office sector overall in 2023?

4%.

What will the 10-year treasury yield be a year from today?

2.13%.

It sounds like you did a lot of thinking about that on apply that.

I'd say 2%, but I like to be -- it's beneficial for me to keep saying lower numbers from that. So yes, 2.13%.

And where -- will the office sector have more or fewer public companies a year from now?

Fewer.

Thank you all.

Thanks, guys. Bye, guys.

Thank you.