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

Hi, everybody. I'm Victor Coleman. I'm CEO and Chairman of Hudson Pacific Properties. And with me today to my left is Harout Diramerian, our CFO. To my right, Mark Lammas, our President; and right of Mark is Laura Campbell, who is our Executive Vice President of IR and Marketing. I'd like to say thanks so much for coming today. I'm going to just do a quick introduction of the company, and then we can turn it directly over to Q&A. And as the sign say, I will have to repeat the questions because the microphones are only on our end. So bear with us through that process. For those of you who follow Hudson, we put investment update out yesterday morning at 6 a.m. Eastern Time on our website, which is the most up-to-date investment prospects of the company in the realm of a multifaceted -- throughout the whole businesses, which deal with our balance sheet, deal with the leasing parameters in the company today in all of our markets. It deals with our debt expiration schedule. It talks about the inflow of leasing activity directly and indirectly in markets and addresses some of the work-from-home aspects, which we can comment on in any Q&A. And then finally, it also addresses the status and current conditions of the actors and writers strike in Hollywood, which affects our media and entertainment portfolio. Briefly, we are a entertainment, media and tech office REIT that owns assets on the West Coast and in London and just announced a new deal that we are doing here in New York. We have assets currently under ownership in Vancouver, Seattle, the entire Bay Area and Los Angeles. We have a development opportunity that we have been working on in London and a new one here in New York. Those are 2 studio assets. We own office and studio assets, plus operating businesses around the studio component. And that's effectively our footprint, in that the company has been public since 2010. With that, I will open it up to questions to anybody who wants to start.

So I'll start first. Lots to dive into today in such a short time, but let's start big picture. There are a lot of imperfect data out there to track physical occupancy. And in your presentation, you put out -- it seems like you're tracking footfall in Transit Ridership closely, at least in your Seattle market. When you factor in the likeliness that we'll never return back to a 5-day work week, where do you think these trends will stabilize to? And how much longer before we get...

Well, never is a long time, never is an impossible phrase to say. You and I had this conversation 4 years ago and said "You're never going to have a pandemic". You would have said, "Yes, that's the case, too." So I would not sort of tone anything around never. I think 24 months ago, people were saying, "People are never coming back to work." And now, virtually every company and finally, CEOs in this country have stood up and said, "If you want to have a job in this company, you're going to have to come in the office." I think tracking the data is something that we do, but I also think it's somewhat irrelevant at the end of the day because whether it's a 3-day work week, a 4-day work week or a 5-day work week, it doesn't change the footprint of the companies. What we found and seen throughout this cycle is a couple of transitory aspects have taken hold and now have taken hold, I think, in dynamic way. One is companies have decided that hot desking and variable seats and things like that are not working. So people want their own space, people want their own environment, and they need to collaborate with their own teams. And so that has determined what we've tracked and what we're seeing currently today is the differentiator of square footage per person has now gone up in the last couple of years from 135 on the low end to now closer to 155 square feet per person. You've also seen, as I mentioned, the [ preponderance ] of companies have said, "If you want to work from home, you're probably not going to be working for us." I'm not going to get into the political aspects of arguments between companies and employees about whether or not you're better off working at home or you're better off working in the office and the levels of productivity. But I think clearly, the markets have spoken and companies have spoken that you're a lot more productive and you're going to move up the corporate ladder and get educated and coexist by working in the office with other people versus at home by yourself.

And could we dive a little bit more into your key subregions like Silicon Valley and Seattle? We've been hearing a lot of positive updates on the office market in Seattle. So just like to hear your thoughts on what's going on there.

Yes. I think, listen, the best market we're in is Vancouver. It's a 90-plus percent occupancy marketplace. It's got very little new development. It's almost back to a complete 5-day-a-week work week because it's Canada, it's not the U.S. The U.S. trails that for the rest of the world. If we move down the coast, and I'm just going to move down the coast versus talk about better markets versus not better markets, I'll just continue going down the coast, Seattle is absolutely much better off today than it was 18 months ago. And the big trigger effect in Seattle was Amazon coming back to work 3 to 4 days a week. That has translated from truly not just ridership and occupancy levels, but it's translated to additional revenue, decision-making in Amazon. We just leased building -- renewed a building that they had come to us exactly a year ago and said they were not -- they were going to leave, and they just renewed the entire building after they told us they were leaving just recently. So that's 150,000 square feet. Our parking revenue in Seattle is up, I believe, sits well...

For '23, over 20%.

20%.

Compared to our original projections.

Yes, over all original projections already for '23 in Seattle. So it's showing some really good signs. I would say, our tours have increased, our pipeline has increased, probably the second best in our portfolio in Seattle relative to everything else. In San Francisco, I see a lot of opportunity in certain assets. I think San Francisco is truly the flight to quality marketplace. You are seeing transactions in the city for high-quality assets. San Francisco also has signed a 0.25 million square feet in deals in AI recently. There's another 600-plus square feet coming. San Francisco is a smaller city, so these impacts of 800,000, 900,000 square feet is a positive trend. But you have assets in that portfolio, and you have markets -- sorry, in that city, you have [ margins ] in that city that are bad. And they're not -- they are, unfortunately, going to take a lot longer to come to fruition. Clearly, you do not have a supply issue in San Francisco of new supply. You have a supply of existing supply that's going to have to either get repurposed or take it out of the system because some of those assets just won't lease currently today. But we are seeing, as I said, some activity in San Francisco and much better than it was 6 months ago. You mentioned Silicon Valley. In the Valley, we have the most activity we have in our entire portfolio currently today. What we are seeing there on a positive side is pipeline is an all-time high, tours have picked up precipitously since last spring and signing of leases. Size of deals have changed, though, in Silicon Valley throughout. And from South San Francisco all the way down to San Jose, it's very consistent. There's very few large tenants. The largest tenants that we're looking at are 50,000, 60,000 square foot deals, which we were working on a few. But the preponderance of those deals are somewhere in the 10,000 to 20,000 foot range. And that, overall, has changed from -- earlier this year, our average [ deal ] in that marketplace was close to 7,000 square feet, and now it's closer to, I think, 11,000 or 12,000 feet. Los Angeles is an interesting marketplace because, again, it is a flight to quality. You look at the Century City, you look at parts of West Los Angeles or Beverly Hills and in Brentwood, and you're seeing today deals signed at the highest rent still year-over-year and great space flying off the marketplace. Well, a lot of that is because tenants are moving from second-tier markets to be associated with high-quality markets. But then we have a whole array of second-tier assets in that marketplace that are not performing at the same levels that I think people would anticipate. So it is truly a bifurcated market. From our standpoint, we only have one asset in Los Angeles that is a multi-tenant asset that's not leased because we just did some asset sales in that marketplace.

So I would like to pick up on some of those points you mentioned around the leasing pipeline. But first, can you provide some context on how you set the budget for your parking revenues? That 20% outperformance looks quite good and -- given everything we're hearing.

Sure. I mean, going into the year, we were taking cues from previous period physical occupancy. And on an asset-by-asset basis setting what our expectations were non must-take parking was likely to look like for the year. And we've been, I would say, pleasantly surprised to the upside in terms of just how much better the physical occupancy has been relative to those early expectations. So the announcement by Amazon for -- to return to work on May 1 and enforcement around that led to them being at max physical occupancy for the majority of the week. And that's -- while we were obviously optimistic that we were going to see improved occupancy, I don't know that -- we did not anticipate the level of occupancy, full capacity, if you will, for the majority of the week across that square footage. That's one of the key reasons why we beat our expectations.

And not sure how many people in the room have gone in a chance to look at your presentation, but you've provided some very helpful context around your historic leasing pipeline data. And while the pipeline looks to have picked up to about 2 million square feet now, the conversion ratio to leasing activity is nearly 60% activity when you -- the leasing [ unit ] pipeline was the same level before the pandemic. So how much of this pipeline represents proposals versus near-term leases?

I mean the pipeline is total of what we classify 2, 3s and 4s. So 4 is in leases, 3 is a lease negotiation, and then it goes all the way down to trading paper back and forth just on back and forth inquiries. I would say that the biggest differentiator is the number of tenants in this cycle versus the number of tenants in the '19 pre-pandemic cycle. As I mentioned earlier, I mean, just the number of large tenants that we would entertain as a company was a lot higher. And that, therefore, the numbers on a conversion basis was much higher because these larger tenant [ resigned ] deals. This is hand-to-hand combat today. I mean we're doing a lot of singles, a lot of renewals, and we're seeing just a pipeline, hopefully, will convert to occupancy levels. And we feel comfortable by '25, we're going to get up to a stabilized number that feels very comfortable with where we are pre-pandemic.

And how much of the new increase that you're seeing recently is being driven by tech versus media or other industries?

Well, I mean the majority of our space has always been sort of tech-, media-, entertainment-related tenants. And I would still say we are entertaining most -- what's the most -- 50-plus percent of the activity still revolves around that. Surprisingly, though, we have seen a big pickup in FIRE-related tenants and most directed to law firms and financial advisory firms, financial companies, VC firms, the likes of that. And so that seems to be where the big shift is for a differentiator of tenants.

And any change in interest from the larger tenants in the last few months leading on to September?

We have in Seattle, I think the activity would be better than it was a few months ago. I think I'm -- off of memory, about 4 or 5 large tenants that are looking at 100,000 square foot plus. In San Francisco, we've got 3 large tenants. Don't have any large tenants in the Valley or in Los Angeles that are looking at any large space.

And can you speak more to how long the signing cycle is for leasing activity today?

It's hard to quantify. I mean, listen, we've -- like our peers have talked about this, I think, in quite detail, a lot of detail, and the fact is that leases are taking longer to sign. And there is no rationale other than the fact that -- I guess you could say that prior to the current position we're in right now, where people are actually coming back to work in a much more of a regimented timeline, will mean that I think that should obviously equate to leases getting signed quicker. For the most part, what we are seeing on a positive side is our average lease term quarter-over-quarter from last quarter into this quarter has gone up quite a bit. I think it was in the mid-40s, [ 40 ] months, the lease term on average. And now, we're over 60. So that's a pretty good pickup. And then on the rental side of the rates, because I think you want to go there, too, I mean the rates have pretty much held firm across the board in all our markets, with the exception of San Francisco.

And I wanted to pick up on an earlier comment because it sounds like you've made progress addressing large lease expiry in 2023, about 150,000. And in your slides, you provide the breakdown of where your '23 expiry rents are versus market. Just to confirm, is that slide talking to net effective or gross rents?

Net effective.

And just given the fact that total availability remains high, one would think that there would be further downward pressure on market rents.

Yes. I mean there would be. I mean, listen, in '23, we have 1 tenant of size expiring now, which is this month, which is block/square. They've left our premises in our building in San Francisco 3 years ago. So it's 475,000 square feet. So it does skew the numbers a little bit. I mean '24, we have one tenant in the entire portfolio over 100,000 square feet expiring. And it's a known vacate because we did a [ blend ] and extend with them, which is Nutanix down in North San Jose. So it's changed dramatically from our exposure level. We're looking at -- our [ 1455 building ] is where Square is coming from. That's was, at one point, 100% leased, 1 million square foot asset. And now we have the largest exploration in the history of the company coming due with 1 tenant. So it will skew the way the numbers look. But even that lease, which was signed almost 7, 10 years ago -- sorry, 10 years ago, is 30% below market on that lease. So we do have some headroom, hopefully. And we have activity on that space, not to the entire 475,000 feet, but over 275,000 feet of it.

Just a follow-up to that. How confident are you that market rents will remain relatively stable over the next 12 months?

I think it's all quality of assets. Certain of the assets that we own, I'm super confident that they're going to outperform where leases are rolling. And other assets, we feel that we're going to have to give on rent in order to get occupancy in place. You can see one of the slides is there, talks about our asset quality and -- the current makeup of the existing portfolio, 85% is identified as Class A assets. I feel comfortable in the 85%. The 15% that [ fees ] that I think we're going to have a little bit more of a struggle.

[ Waiting ], if there are any more questions on the operations side. Otherwise, I think a big topic people would like to hear more is around the dividend announcement. I think timing around that came a little bit as a surprise to some. So can you just talk to the motivation behind this? And what thresholds would the business need to reach before we could see it reinstated?

Yes. I would like to know why it would be a surprise, given the fact that there's multiple points that I can bring up on that. One is we were getting paid from a stock valuation on the current dividend at $1 per share when we're trading at $4 a share. We did cut the dividend based upon the fact that market conditions have changed in our overall portfolio. And then we came out and said we're going to suspend a dividend, given the fact that there is a prolonged writer strike and actor strike, which affects us to the tune of somewhere around $100 million a year in lost revenue on an EBITDA basis on something that is a short-term impact that is completely out of our control. When it does restate, we will revisit the dividend. We visit the dividend every quarter. It's a quarter-to-quarter decision-making tree, and so we're coming off of a May 1 strike with a combination of a June collaborative strike with -- sorry, July 1 strike with a collaborative strike of the actors, which is a moment in time that has never been seen in the history of the entertainment industry. I think we sold a couple of assets. We're going to have some capital gains. We are very sort of laser-focused on identifying what that special dividend will look like. We will have a dividend. It will depend on -- or the depreciation lines are the asset sales and then the timeline of our year-end decision-making in December. In terms of what's going forward, it's not going to be any similar than what I just said right now. I mean, with the strike ended tomorrow, we had a line of sight as to where we're at, I think we will then consider the next phases of where that dividend would be. Lastly, I mean, it's -- we suspended a dividend for all the reasons that I just mentioned. But we also suspended coverage for all the reasons I mentioned, and that was suspended 2 quarters ago because of the strike. So it shouldn't be at the shock. And candidly, the majority of means I've had and the team has had and conversations we have has been resoundly positive about the decision-making of the suspension of the dividend under the current circumstances.

And so just to clarify, it was a combination of all these factors that were driving that decision, not the to view the writer strike is going to progress longer or...

I mean we don't know where the writer strike is going to end. We just know a moment in time, and it's -- we can control our controllables, and that's what we're doing.

And -- there's a question.

Yes. You gave an update on Washington 1000 that [indiscernible].

Washington 1000, yes. The question was update on Washington 1000, the leasing status of that, we top out on that. I believe it will be right around the beginning of the first quarter. We've had activity on that to date for a couple of tenants over 100,000 square feet, one of which is over 250, and then 2 tenants that are inquiring an early, early interest for the whole thing. The market has made a big change since May 1. And I think you could surmise that in my earlier comments that flight to quality will be the way to go. This will be the newest -- it will be one of the best buildings in Seattle. It will clearly be the [ best ] building in Seattle when it's done, de facto when it's completed. I think what we've seen and what we're hoping is that the trend of these large tech companies, going forward, is they want to control their environments. So I think the desire to lease multi-tenant buildings, going forward, is going to be not their first preference if they have space needs. So that's why we're hoping that we would get some traction around some of these single-tenant users. That being said, we'll have to make a decision whether it's a multi- or a single-tenant use, based on demand and timing. That decision will probably come down, in my opinion, somewhere in December, January because there's going to be additional capital if it's a multi-tenant building, clearly. And so we're going to monitor the situation, monitor the existing inflows and tours that we're getting. And as we get closer, then I think we're going to determine where we're going to go with that.

Just going back to the dividend and your point about building liquidity, could you discuss some of the potential avenues to generate more liquidity if you need? For example, based on your financials, it looks like you've retained debt from the [ Hollywood ] media portfolio. Curious, would you entertain the possibility of selling this retained CMBS debt in order to raise cash and...

Yes. I mean, listen, we have more options today than we did yesterday. And hopefully, we'll have more options tomorrow than we do today. But as we currently sit today, we're in the process of finalizing -- renewing an existing loan on our Bentall asset in Vancouver with Blackstone. We are in the process of evaluating, just as you said, our $209 million debt piece that we currently hold, that we don't have any [ encumbers ] on. So there's a market evaluation on that. On Washing 1000, it's currently being funded for cash, [ $350 million ] of cash. There's an avenue there. We have a $600 million investment in our operating businesses that is fully untapped. And all these -- all 3 of these that I just mentioned, do not have any correlation to any of our metrics around our line of credit and the likes of that. So they're fully untapped. And that's $600 million for operating businesses that throws off an EBITDA, when the strike is over, of $100 million. So there's -- and those are obviously, clearly not real estate lenders. Those are operating business lenders that have indicated interest. So we have avenues. We have unencumbered assets in the portfolio that we've been quoted on 50% LTVs. So there are a number of avenues. But just the 3 I mentioned, without even getting into asset levels, is over $1.1 billion of some form of liquidity that I think we've been very prudent waiting for the right opportunity on a [ need, need ] basis. And currently, today, as we have mentioned and as we clearly point out in our deck, and we've been doing for the last 1.5 years, I mean, we don't have anything coming due until '25. And so at the right time, we'll make the right decisions and then look to continue to do that. But the dividend helps, too.

And when it comes to conversations with your lenders today, what are they most focused on?

I mean I just think that it's market conditions. It's blocking and tackling around leasing. As I said earlier, it's what we can control. don't see -- I don't think any of our lenders have come to us and talked about the strike or attributes around that because they know it's a moment in time. But yes, it's a normal course of business. And as I said, if we were sitting here in May, it was a lot worse than it is in September. And hopefully, in January, it is going to be better than [ September ], and we'll have some leasing execution that would be surprising.

And just around the writer strike that's going on, are you hearing anything from your tenants on how the negotiations are going on?

No. Listen, we don't have a seat at the table. I do think that it is a forefront for not just Los Angeles because it is a forefront for the economic aspect. This is a billions of dollars of lost income revenue and an affiliate trickle-down process, right? It's not just production. It's not just the [ vaccines ] of production, which could be catering or it could be hair and makeup or affiliated businesses and law firms and everything else. I mean, it trickles all the way down and through the economy to housing, to restaurants and to how people are trying to survive. And so it is impactful. I do want to mention that I think what happens and how it happens, I don't know when we're going to have a resolution. But I think what happened last Friday with Warner Bros. writing off $0.5 billion because of the strike, surely correlated to that, was the forefront news line people saw. But maybe people didn't realize what they also said was they terminated all their show runners' contracts because they have a force majeure in those contracts. And what that means is show runners are the people who run all the production on every show. And these are the name people like Shonda Rhimes or J.J. Abrams that people know and do all these shows. And what that meant was J.J. Abrams happened to be a contract that they terminated. So now Monday, 2 days ago, he goes into his office and he has to start writing the checks for his employees. And he has to start paying the bills that studio has been paying since May 1 or all the way through because that was their contractual obligation. That impacts the decision-making tree as to is he going to lay people off and what's the perception of him laying people off and how that impacts the industry and where people go when you've made millions of dollars and now you're being impacted on a day-to-day basis. And that today -- I've been talking about that in meetings. And then today, as I was talking in one of our meetings, came across that now the show runners have requested a meeting with the Writers Union on [ Friday ]. So this could be a trigger point that I think is something that they either hold firm and they suffer more pain or we see the next step.

And so given that it's a very complicated situation, so people at the table right now, what do you see as some of the potential path forward?

It's a unique situation where you have really 4 parties here, right? You've got 2 unions, Screen Actors Guild and the writers. You've got 2 constituents on the other side, right? You have studios, which is your old line [ guard ] studios, who are affected every single day. And then you have your streamers, which if you're an Apple or an Amazon and a Google/Hulu, you're not affected because you have a [ lead ] businesses. So it's -- and then Netflix is sort of in between, right? Clearly, their subscription revenue has not changed yet, but it will if they don't have new content. So you've got a lot of push, pull here, and you don't really have anybody -- like in the old days when you had strikes like this, you had decision-makers like a [ Lou Roserman ] or Marvin Davis or even like a Michael Eisner, Disney, who will step in the room and lock the door and say, "Let's make a deal." You have too many constituents here. So I think it is a very complicated scenario that has been magnified, which I'm not so sure -- and I'm just telling you, from my opinion, I'm not so sure that the actors feel good about saying to the writers, "You guys go first" because the actors at least have one voice. In Fran Drescher, the writers are being negotiated by union representatives. And so the writers have more complicated issues to solve than the actors do. And it would have been easier if the actors had said, "We're done. Now writers, you go and you figure it out." But they said, "You go first, and you say it all." And there could be an infighting there next. So as you said, it's a complicated scenario. I do think that it is running its course. How long it goes? I have no idea.

But if one side were to reach an agreement before the other, do you think that would be enough to restart some of the activity or would both...

I think it would set the table for at least a light at the end of the tunnel. But that being said, I do think that, as I said at a moment in time, what we are comfortable and we will guide to is when it settles, there will be a downtime to get up and running. But at that point, it will be a hockey stick kind of reaction for 12 to 24 months of feverish activity like we saw in COVID, like we saw in 8, 9 -- the strike that was in '8 and ended in '9. So it should be exactly like that.

And we have time for a few more questions before our rapid fire. But definitely want to touch on [ PR-94 ], the new JV development. Can you just talk to the opportunity there? And if you see any further plans to expand that partnership?

I mean it's a unique opportunity. It's the first and only purpose-built facility in Manhattan. Our relationship with [ Ford ] and our partners in Blackstone, the partnership upon 3 of us -- I've been talking about this deal since -- it's almost 3 years that we've been working through it, through the [ EDC ] and getting the ground lease put in place. It will be a one-of-a-kind type studio asset. It's already attracted single-tenant users in the studio business who are interested in learning more about a single lease for the entire facility. So we have a couple of proposals that have already gone out. Very excited about it. We've invested our -- 1/3 of our equity already in the deal. We already have a loan in place. And so the project should hopefully break ground by January 1. Our true dollar or the whole project?

$300 million.

I think our equity is 39, and we've put in 13.

More broadly on the studio business, can you speak to your -- how you're thinking about it? Do you expect it to eventually spin off the business?

Listen, I think there will be lots of opportunities for us to look at that business as a freestanding entity or in the same vehicle it's at today. I do think more importantly that when the strike ends, there is going to be opportunities in the operating side to grow that business and in the studio side with people who have bought assets on yesterday's debt structures and variable debt structures. And maybe there will be opportunities for us to capitalize that Blackstone is fully ready to continue to grow that business.

Perfect. We'll go into rapid-fire questions now. We have three. So first, to start, on the Fed, do you believe they're done hiking? Yes or no.

Yes.

And do you expect the Fed to cut rates in '24, yes?

Yes.

That almost sounded like a no.

No, it's a yes.

Okay. Second, do you believe real estate transactions will meaningfully pick up by, a, fourth quarter of '23; b, first half '24; or C, second half of 2024?

First half of '24.

Is that more of a view of...

I just know that there aren't a lot of transactions today. So I'm just not going to correlate through the end of the year. And I saw the activity around the 2 assets that we just closed. We had a lot of activity around them. And I just think that there's enough capital in the marketplace and out there. People may think in certain areas and certain asset classes it could bottom out. And therefore, I think there's going to be more activity in the first quarter -- first half of the year, '24 than the second.

And finally, are you using AI today to help you run your business? Yes or No.

No. Well, no. We'd like to.

So you do plan on ramping up spending?

Yes. I don't know how much capital dollars because we haven't gotten to that point. But I mean, listen, we invested with VTS and other aspects of AI through [ prop tax ] we've invested with. And so I think it will continue to enhance our ability to work more efficiently.

Perfect. Well, thank you for your time.

Thank you. Appreciate it, everybody.