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

This is kicking off day 2, our roundtable sessions, and we appreciate everyone joining today Hudson Pacific Properties. I'm going to introduce Victor Coleman, Chairman and CEO. He'll introduce the team. This is webcast, so we're going to try to get the questions into the mics as well. I want to make this as interactive as possible and address all the -- any key questions you have. But first, I'm going to turn it to Victor to talk about Hudson Pacific for the first 5 or 10 minutes. Some in the room may not be as familiar with the story, but it does look like a lot of familiar faces. So -- and then we'll go into Q&A.

Great. Jeff, and congratulations. So to my left is Laura Campbell, our EVP of IR and Marketing. And beside Laura is Harout Diramerian, he is our CFO; and beside me, to my left, is Mark Lammas, our President; and to my right, our EVP of Leasing is Art Suazo. So welcome, everybody. We are Hudson Pacific. We're a West Coast office REIT that is focused on media and tech primarily from marketplaces in Vancouver, Seattle, the Bay Area and Los Angeles, with also a development and a new office in London on our media side. For those of you who don't know us, just real quick, we -- about 20 million square feet in those marketplaces. The mix is about 85% is office and 15% studio facilities. We also have opco that we can get into a little bit, which is our operating businesses for our studio business that is in our TRS. And overall, we'll get into some market conversations from West Coast, from Vancouver all the way down. We'll talk about leasing, and we'll talk a little bit about our portfolio in general. We are also developers of assets. We've developed several million square feet in all those marketplaces. Currently, today, we have 2 active developments, one in Seattle called Washington 1000, which is almost 0.5 million square feet, which we broke ground on, which is a Class A office building and one is in Los Angeles called Sunset Glenoaks, which is a 7-stage fully utilizable [indiscernible] facility with office and ancillary businesses around the office as well. Our last development opportunity that had quite a lot of notoriety is our partnership with Blackstone in London, which is called Waltham Cross, which is a $1 billion asset that we're building [indiscernible] and 500,000 -- 400,000 square feet of office and production space. So I think it gives you a snapshot of who we are, and I'm sure we want to talk a little bit about the markets and stock price and all aspects of the company.

Not the stock price. We don't have to talk about that. But we can talk about whatever anybody wants to talk about. So Jeff, do you want to start or if you want us to just go to the floor?

No, let's make it interactive. Let's focus on the fundamentals and strategy, recent acquisition, more into studios. But maybe let's start with leasing, right? That's the #1 question and people looking into visibility. I hosted a few of your New York City peers yesterday, and it sounds like at least in New York City with a little bit more pickup with return-to-work leasing has picked up, including -- I appreciate one of the comments was on kind of the small-to-medium businesses. So I guess, I think the best place to start would be just leasing, right? What are you actively seeing as of today? Maybe we could go by market.

Sure. Let me start to talk in general. First half of the year, we did about 1.2 million square feet of leases, which was a very solid number from our standpoint that I believe it was at 6% GAAP and 15% cash spreads to our rolling rents. We currently have today some outstanding large leases that are coming due that have been notified, so we'll walk through those, giving the status of those. Our utilization has changed dramatically in the last 10 days in the portfolio. So we're about 50% occupied right now coming from a low early pandemic to the worst part of the pandemic, 5% to 10%. So 50% just in perspective, and I don't know what other office landlords talk about their portfolio, but from our standpoint, that's about 20% of off peaks. So when people think it's 100%, it's never 100%, it's always closer to like 70%, especially the tenants that we have they were occupying space 3, 4, 5 days a week, in some instances, depending if they're FIRE or tech or media. And so we're getting close to those numbers. We've seen traffic patterns increase both on public transport and then obviously on the freeways and systems in Los Angeles. So it's encouraging with the Googles and Apples and some of the other big tech companies going back to 3 days a week plus, it really has made a shift, and we've seen that in the [indiscernible] and the swipes and the parking cards alike. So yes, let's talk a little bit about our markets and we'll get. Yes...

[indiscernible]

That's 50% the average for the whole portfolio. Tuesday, Thursday are the 2 peak days right now. It's like 70-some-odd percent, maybe even higher. So yes, though -- it's back in those markets on Tuesdays and Thursdays. Mostly Tuesday, Thursday, Wednesday is the off-day, but they've all shifted now. They're not all taking Mondays and Fridays off or just Fridays off. So -- but yes, Tuesdays and Thursdays, it's like 70%.

I don't want to interrupt the conversation on the leasing, but just because it keeps coming up, Tuesday, Wednesday, Thursday versus the Monday and Friday, from your standpoint as an office landlord, does it really matter as long as people are coming in or required to come in 2, 3 days a week? And I know again, companies are trying to figure out the space needs, but like BofA, for example, we're asked to be majority of the time, which is typically 3 days a week, and we're keeping our space, of course, to accommodate those needs in that...

So I like the percentage, majority is 3 days a week. 3 out of 7 to me is not a majority. That's actually...

Majority 40%. So...

That's not maturity. But yes, I think as a landlord, do we care? No, there seems to be banter around -- listen, they pay rent 7 days a week, but nobody is in 7 days a week. They've always paid rent 7 days a week. So I see the trend going from 3 to 4 and then from 4 to 5, probably in some businesses. In some businesses, we know that they can work from home or other places. And we'll give you some examples of that because we just had a meeting with the Head of Real Estate at Google last Thursday in our offices, and we just talked all about this aspect. But let's go through the markets, and we'll come back to it a little bit. So the first market I'll walk through very briefly is Vancouver. Vancouver has been the best-performing market in our portfolio by far throughout all of COVID. It's in the mid-90% occupancy range. Our activity in that market, even on the sublease space, is extremely high. Rental rates we're seeing at all-time high levels. And it's just a very solid market. There's very little product on the marketplace. A couple of large leases were just signed. One, a distinct one from Microsoft, and that marketplace has really flourished throughout all of COVID and we see no downturn. And our vacancy activity there is very, very strong, mostly middle-sized tenants. In Seattle, I think Seattle is an interesting story right now. It's a very good performing marketplace for us and our assets there, we have 2 sort of main areas of focus on leasing: One in Pioneer Square. Our assets are only in Pioneer Square and South Lake Union, but in Pioneer Square where we had a Dell EMC move out 3 years ago. They gave notification. They moved out, and we're backfilling that space. And I think we have -- how much square footage in negotiations there?

Very close to 300,000 feet in negotiations right now, chiefly in Pioneer Square.

And what emptied out, how much emptied out?

Dell was 145 and then we got another 43 at the end of '23, which we -- is part of the activity we have in Pioneer Square.

So we have solid activity there at marks that are much higher. That's a portfolio we bought in '12, I think?

'13.

'13. And these tenants have been there since we bought it. So that mark is pretty impressive. But I will talk a little bit about marks because I think at the end of the day, some of the space we have, the marks are irrelevant. We're looking to maintain occupancy with tenants, and we're prepared to do what it takes to get those tenants in. But that mark is like close to 40%. So we have a lot of room there. We have 1 asset in that marketplace that is occupied by Amazon. Amazon is our largest tenant in Seattle but they have an asset that will -- people will be looking at. They come because now their forecast is no longer 12 months out, it's much longer, but they come due for 140,000 feet at the end of 2023, and we're in conversations to renew them. And that looks solid. They came to us. So we're confident that there is some activity around us making a move there. So we'll shift down to the Bay Area where I know a lot of conversations, we've talked about San Francisco. So before I get there, I think the easier story is for us to talk about the Valley. In our portfolio, the best performing leases and the most activity we have in the portfolio has been in the Valley and the Bay Area in general, with the exception of San Francisco. And we are seeing exactly what Jeff commented on other landlords have made that messaging. Somewhere between that 10,000 and 25,000 square foot activity FIRE related. We have a very strong focus in that marketplace on law firms have come to us. And so we've got the most square footage in activity that we are in negotiations. It's about 1 million square feet?

Close to.

1Close to million square feet of transactional business. So very optimistic about that marketplace. We have a known move out last month, which was Qualcomm for approximately 400,000 square feet in 2 buildings in San Jose. Those buildings need to be repositioned. We have one tenant who is interested in either occupying or purchasing one of the 2 buildings. So half of that plus -- half of that in the portfolio. Other than that, we have no activity at all. I would say, on a realistic basis, we would love to get that one tenant in and buy the building or lease it and buy it. And then we're going to have to deal with the other one. They're identical assets. The repositioning of that is mostly amenity driven. We budgeted that for starting the end of this year, early next. And that probably would be classified as, in terms of the activity, probably the weakest that we have of our 4 major spaces that we -- that I'll walk through, this being the second. The third marketplace in San Francisco. So I was in San Francisco a week ago -- a little over a week ago. And I was very surprised to see the street activity there because the last time I was there, it did not have that same flow. So we are seeing a pickup in activity. We're seeing a pickup in the Class 8 asset interest. Fortuitously for us, we do not have any major vacancy in that area. Where we have our vacancy is on Market Street at 1455, which I'll talk about in a second, but our assets like the Ferry Building or Rincon, our south of market assets are full and the activity on 1 of the assets is a sublease activity that is a second-tier sublease activity that's occupied, but it's from Salesforce to Twilio. And then now Twilio is looking to sublease that space. And we actually have activity on that sublease space for the entire thing. But from our standpoint, I think that lease goes till '27 or '28. So we're not that concerned about that. We do have some serious concerns on Market Street, that is an asset that got a lot of conversation and banter when Square decided to announce they were not going to renew, their lease expires in August of 2023. They occupy almost 470,000 feet. We sublet -- they sublet 120, approximately in thousand square feet. We're in conversations to retain those tenants for that sublease for 120,000 square feet. That asset, and when I talk about marks, this is one of those assets, that asset with that space is also a 35% to 45% mark-to-market, but that asset will have to have unique users. And so we're prepared to literally cover what we're getting on that space right now, if it's a plug and play. That being said, we have one tenant who is new to the marketplace, who is not a move around for 250,000 square feet that we're in proposals with. And I say just candidly, if we can make that deal, that would be absolutely fantastic. So team is working hard on the 120 to extend on the sublease and the 250 new. I should also say just the tenant that I mentioned who is looking to buy in at Qualcomm is also new to the market. It's not a move around, which is distinctively different than we've seen in the past, a lot of tenants are moving around. So it's a positive sign. But we're concerned about that asset because it's a lot of square footage. And that marketplace is a lot weaker than any market that we're in specifically up there. And I think all of you will get a feel for San Francisco, exactly what I have mentioned, to sort of 2 distinct feelings as to when you all go to NAREIT in 1.5 months and see the city up where the conference is and then you go down to the financial district or you go down to some of the more populated areas, you'll see the difference. So that's the Bay Area. And just as a side and it doesn't change the perspective, but I think it changes the tone of investors at Hudson. We only own half of that asset. So we don't own 100%. So our exposure is shared, I would say, even though it's all of our exposure, it's shared. Lastly, have 1 asset in Los Angeles, and I'll just talk about the Los Angeles market really briefly. The activity in L.A. has been very limited. There's not a lot of new square footage. There's not a lot of new product in that marketplace. And there's not a lot of availability on the Class A stuff that's comparable to us. And so we do have 1 asset, which is the asset we own in Culver City for about 150,000 square feet that is occupied by NFL. NFL moved out last year to go to the new SoFi Stadium. So we've known they've been gone for 1.5 years. Their lease expires the end of this year. We have 2 tenants looking at that space. One is in leases. Also, both those tenants are new to the marketplace, that's new requirements. The second interested tenant is a named media company that is, I think the difference in the rent and the difference in the terms is quite dramatic. And so we're focused on the first. I would say after that, and therefore the 100%, both of those are for 100% of the property. After that, if we don't get 1 of those 2 deals done, we would have to look to reposition the asset completely on a multi-tenant basis, which is possible, but it's not the preferred route. I do say that in Los Angeles, specifically in Los Angeles as one of the markets that we're in, we have seen in the Class A space on the mid-level tenants, because there's not a lot of large tenants in that marketplace, leasing space at very high rental rates, highest that we've ever seen in markets like Santa Monica, Beverly Hills, Century City. Those markets have performed exceptionally well throughout the last 1.5 years to 2 years. And as I said, there's a lot of transactions that are going on for smaller tenants, and there's not a lot of space. So that gives a perspective on what we see in the marketplace. Any questions on any of that stuff?

A lot of detail. Thank you. I guess maybe just to take a step back and think about just as an example, we mentioned I think it was, again, the Qualcomm, your focus on the renewals. But the new tenant, like, I guess, can you describe like -- and I think that was the second new tenant you mentioned in Seattle, too. Like when you say new, like new to the market? What type of tenant are we talking about? And then -- what are the economics of a deal like this? What would it look like?

So on the Qualcomm space, the tenant is not tech-related and not business related. They're specific to an industry specific. So I don't really want to go in more detail than that. So -- and they are new. It is in a growth -- they're an existing tenant in the marketplace that has a growth need that's fairly voracious. The terms of that, I'm not going to talk about the actual terms, but I can talk a little bit about the concessions and the stability around that and where we're seeing because it's pretty much similar throughout the portfolio, which is we have not seen concessions go to a level that are beyond normality. So what's normal in terms of a concession package after you pay commissions. It's about a month a year free rent. And the TI packages for an asset like that are going to be well in excess of $100 a foot. And I believe that asset is going to be closer to $120, $125 because it's a complete gut and redo. And that's normal from what was 3 years ago, maybe $85 to $100. So pre-COVID numbers. So it just gives you a perspective of that.

Okay. And then on the NFL space, like what's the -- when is the timing on that go/no-go decision if the deals don't work versus the repositioning to multi-tenant, how does a decision like that work?

So that's an interesting asset in a marketplace that's very solid. We've had these 2 tenants looking at it for quite a while. I think it is a little bit symptomatic of the markets that unless there is some sense of urgency on their part, they don't have to be urgent. And so we're seeing -- that's taken, in our opinion, a lot longer of a time line than we would have liked and quite frankly, would have expected. But that being said, I think without sort of holding us to a specific date, if we can't execute on the current structured deals by year-end, my guess is we would make that decision and look to schematics around breaking the building up sometime first quarter of '23.

Any questions on markets on some of the vacancies or leases we've discussed so far? On utilization rate, I think back to the 50%, was that across markets as well?

Yes.

Okay. Any particular differences in the markets?

I think specifically, you're looking -- when you look at Vancouver, Seattle and Los Angeles, Vancouver and Seattle would be slightly higher than that. L.A. would be right at that number. I think the value would be slightly higher than that, but San Francisco is lower. So my guess is San Francisco is probably in the 35% range.

Okay. And let's say, where was that before the summer, the 50%? How has that progressed?

It's progressed significantly. I think it's probably gone up 15% to 20% -- 15, 20 points. So from like 30 to 35 up to 50.

And then, I guess, the [indiscernible] just again, tours or traffic, the leasing velocity, I guess, by market, how has that changed, let's say, just even in the last few weeks, has there been a change?

You want to jump in?

Leasing velocity certainly, everyone's tracking Labor Day, right? It's hard. Some people weren't even back last week. So I wouldn't say there was a noticeable uptick in any type of velocity last week. I think beginning this week and next, we'll start to see a difference, we anticipate a difference. Activity has been our activity, which means we have active deals in negotiation, having nothing to do with tours, is at a very healthy level at about 2 million feet. We've carried that even after leasing 1.2 million in the first half of the year, we still were able to kind of reload and have active deals in negotiation at that level. So we feel good about that. I think what Victor had already alluded to was getting those deals -- turning those deals into deal velocity, deals signed. And so it just take it a little bit longer, in some cases, much longer than we anticipated. But we feel good about where we are with activity, and we'll start to see an uptick as everyone has anticipated going forward. So...

What's the hesitancy on the tenants? I mean, again, I know it's a market-by-market answer, but is it that they're going to competing buildings or they decided not to enter the market or decided less space? I guess, can you provide any color on that.

Sure. I think the 3 common threads are we -- tenants still don't know how they're going to utilize their space. Just by and large, economic concerns that [indiscernible] in May, coupled with seasonality of the third quarter, I think, affected all the markets similarly. I do know that trying to assess how they're going to utilize space has really slowed down some of the deals that we have in process. It's not a matter of, gee, we're going to grind you down to a knob because -- we do we see that, of course, we see that in some very competitive markets. But I think it's -- we've got 4 user groups that are coming into this particular space, how do we plan for that and then how do we plan growth. Those are the major really delays in my opinion.

Let's say you do need to reposition the NFL asset, I guess the building in L.A., like I guess can you just talk about what that cost wise...

Capitalized cost on that? Yes. I mean I think it's probably 40 or 50 a foot, something like that.

Okay. I guess, Victor, from your seat as you think about strategy and investments over the next 3, 5 years, just based on the experience over the last few years, what's gone right? What's gone wrong? I know a lot of it's been out of your control, but how are you thinking about investment decisions, whether it's, again, office or studio? We can get into the new studio acquisition and then by market.

Yes. Listen, I think right now, we've been very successful in development. We're going to continue with our development pipeline. As I mentioned, we've got a couple right now. We do have other access of approved development opportunities that we can pull at the right time. I do think that what we've all seen is, there has been a massive -- when there is growth, there's been a massive flight to quality. So we feel very good about our existing portfolio and the quality of the portfolio. I don't think we've ever sort of looked to be an acquirer of B-level assets. We build to As, we like to acquire As or at least fix them up to be As. And so that would be the standard going forward. I think it's way early in -- given what we have on our plate for us to even look at assets in the marketplace, aside from obviously, capitalization because there are really no assets to buy in the office nor are there assets to buy that are of interest to us. So we're not looking in the acquisition mode on the office side. We clearly have a vehicle on the studio side, which we'll talk about where the yields are much more compelling and the asset quality is much more desirable than office. And so we obviously have some wood to chop in those 4 assets that I mentioned to get leases done. I think once those assets are leased or taken care of, it's a much different perspective because the remainder of our portfolio is a very nominalized roll over the next 4 to 5 years. So we don't have a lot of exposure in any one area or any one marketplace.

How do you balance the appetite to, let's say, develop or acquire studios versus the economic environment, we've heard a few times at the conference now on tightening capital markets. How do you balance all of that from your seat when you're taking that into consideration?

I think you have to always -- whether it's this time line or any other time line, I think you're always balanced. I think we've been very disciplined in buying at the right time and buying assets that make the right sense. And I think that's more of the process when you develop or you buy, you're buying something that's accretive, not just economically, but to your existing portfolio. And so we look at it that way. We're building the portfolio up in the studio business. There's no need to build the office building business. We have enough coming online over the next several years, and we have enough repositioning that we can do, and we think that the numbers will favor the growth of the company when the leasing is done. So the core right now is really internal growth on the office side as well as on the studio side with the exception of the opco and maybe some of the other aspects as well.

Before we talk more about the recent studio acquisition and studios, let's talk about -- there are needs here, right? You have development, maybe the repositioning, the studio acquisition. Let's talk about then funding because I get, I guess, just from my seat listening to folks at the conference, it does seem that, again, lending not -- we know that it's tightened, but it could get tighter over the next year, especially as the government sets -- continues to sit on QT. So how are you funding all of this?

So I mean we're extremely well capitalized. We've been very fortunate for some transactions that have occurred. We've put 4 assets out to sale. We've closed 2. We're in a contract on a third that goes -- hopefully goes hard on Friday. Yesterday was an interesting day, but hopefully, we'll continue to be supportive and they'll go hard on Friday. We have a fourth asset that was under contract, dropped. It now is the same buyer is back, they have financing. So we're hopeful that we can structure a deal with that. And then we have 2 other assets we've not announced yet that we're looking to put on the marketplace that we've had 7 reverse increase from it just happens to be some other seller was selling something right in the same area and decided not to sell because of partner issue, not because of price. And the group that was looking to buy it had 7 bidders -- sorry, the group who was brokering, had 7 bidders and they've come to us and we're now entertaining that. If the -- all of those go ahead, I think it's $550 million. It looks like it will be somewhere, if we don't do the last 2 and all 4 go, it's about $350 million, and we've already, as I said, with the deal that hopefully goes hard on Friday, more than half of that is already taken care of. Fortuitously, last week, we did a bond offering, our first green bond for $350 million, the economics on that were exceptional given yesterday's 5 year. We had a slot under the 5-year in our expiration. So that we chose that for a reason. We chose that because rates were increasing, we chose that because we had the opening in the marketplace, and we chose that because the demand was very high. So we had a 2-plus oversubscribed on that and we executed it in a day and we're happy we got that done. So that -- that transaction takes our $1 billion access on our line of credit down substantially. And I know there's been talk, which I can get on these guys to sort of talk about sort of increasing on our balance sheet. But our leverage levels now and the variability is that are on -- the variable level of our debt today is about 25%. If we take this acquisition, it's going to get down in the low 20s. And of that, it's all capped but the exception of about 9% of it, correct? So we have -- and those caps go for a long period of time. So we have sub-10% variable debt, and we don't have any major maturities other than one comes due in January of this year for $110 million. So other than that, we're very well positioned. In terms of our development and our growth that's currently in place today, not future, but currently in place today, we've got construction financing locked up for everything we're doing with the exception of our Washington 1000 asset. We've got JV partner in our -- in Blackstone in our studio business for 50% of all the acquisitions and development that we do there as well. So we're very well positioned for the current situation and even if it gets worse than it does today. So I think the last transaction that closed -- the one that's closing in the bond deal really solidified that for us.

Great. We're almost out of time. So let's talk about the new studio acquisition.

Yes. I'll run us through very quickly. So we did a deal -- 2 transactions a year ago for about $250 million. We did a deal last week -- sorry, last month for $360 million. These are operating companies. We now own about 75% of the market share of the operating companies. And we control the marketplace for [ Transpo ] and all the other aspects of that. So on the -- I'm going to be very, very quick here because I know we're running out of time. But these are super accretive assets. This acquisition is very accretive day 1 for the next 4 months, both on an FFO and an AFFO basis. And then for next year, all through '23 it's the same thing, taking into account how we structured the debt because we did a seller carryback for a short period of time until the end of '23. Effectively, this is how it's sort of for a real estate acumen. We bought these at about a 15% cap. It's about a 22% IRR assets, we'll have full year '23 about $80 million in EBITDA for these assets. So this adds about another $40 million. It's about double the size of what it was. So it's another $40 million in EBITDA that was not going to be accounted for when you start looking at our cash going in 2023. If you look at that and the multiples we bought this on, traded at both -- all 3 were roughly the same, right around mid-8s. And so if you look at the mid-8 multiple on the 80, next year, that's going to equate to somewhere around $1 billion of value, and we bought these for $600 million. So it makes a lot of sense. The assets are accretive and it puts us in a very strong negotiating position, not just for the studios that we own, now for all on-location shoots, they have to come through our opco.

Great. We have 1 more minute. Any other question?

[indiscernible]

No. I mean, listen, this is a marketed deal, investment banks, 5 bidders. They chose us, we went back and carved it up a little bit and said, hey, plus we're covering up the price. We said, we lowered the price and we said carryback 5% debt for 1.5 years, why not? And they said, fine.

5 Okay. Great. We're just asking 3 rapid fire questions at the end of each...

What was this last 25 minutes, it's not rapid fire?

It felt like rapid fire. A lot to talk about. Well, for those that want to hear more. We have our January West Coast to tour to L.A. [indiscernible] has been kind to participate. So we'll talk more then. So first question, which of the following is the greatest macro challenge facing U.S. public REITs today. A, risk of higher rates; b, risk of a recession; or c, the rise of private equity and MTRs on traded REITs.

I would say, A.

Which of the following is the greatest sector-specific risks, labor issues, supply or liquid capital markets.

Supply.

And last, are you seeing any signpost of weakening demand? Yes or no?

No.

Great. Thank you very much.

Thank you. Thanks, everyone.