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

Welcome to the 11 a.m. session at Citi's 2024 Global Property CEO Conference. I'm Michael Griffin with Citi Research, and we're pleased to have with us Hudson Pacific and CEO, Victor Coleman. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. [Operator Instructions] Victor, we'll turn it over to you to introduce HPP and the team, provide any opening remarks, and then we'll get into Q&A.

Thanks for having us, Michael, and thank you for the conference. With me today is the HPP senior management team. To my immediate left is Mark Lammas, our President. To my immediate right is Harout Diramerian, our CFO. Executive Vice President in charge of Marketing and Investor Relations, to the right of Harout, is Laura Campbell; and Art Suazo, EVP of Leasing is to the left of Mark. I'll just start off by sort of giving a little bit of a landscape as to where we sit, being that we're a West Coast office REIT that combines office and then studio and our studio component portfolio extends beyond just the West Coast. It's obviously on the development side and operating businesses around our transpo. As we see a ramp-up in the studio business services post the strike, our development opportunities are going to drive some form of additional external growth in the portfolio. We're also going to see significant increase in stabilization as we enter the second half of this year and the production for the -- not just production but also from our ops businesses, and we're very confident that we're online for that. It was a slow start, given when the strike ended, and then it was finally settled and voted on and -- in December. But starting this year, right now, we're seeing month-over-month increase in holds, demands and activity in our entire portfolio. Given that we're on the West Coast and the office market is now seeing somewhat of a shift, and we're seeing some growth in tech, specifically around AI in San Francisco, but also normalized FIRE-related tenants are coming to the table and we're negotiating a whole host of opportunities around leasing. We can get into that conversation as well. But the Silicon Valley marketplace has been our strongest tenant absorption area followed by Seattle and then San Francisco. Our portfolio in Los Angeles currently is almost 100% leased. So we're not seeing a tremendous amount of activity. But the reality was the strike in the entertainment business affected all businesses in Los Angeles. And now we're seeing that hopefully turn to a positive demand and increase in entertainment and media-related businesses. Lastly, for those of you who've not noticed, we did some capital transactions last year to the tune of almost $1 billion-plus in sales. And we've now currently got over $1 billion of liquidity in the portfolio, and we ended up rightsizing our metrics around our leverage. And as a result, we just posted a deck today, which you can get online on -- and you'll see are all updated for this conference and going forward. So with that, Michael, I'll introduce -- I'll let you shoot off some questions, and the team and I will attempt to address.

Great. The first question we're asking in each of these roundtable sessions is what are the top reasons investors should buy HPP stock today?

Yes. So first and foremost, I think we're known office, we're known media and entertainment and studio-related. We're the only institutional studio ownership in the country. And as a result of that, we're also the only public company that's studio-related. When you come through a timeline like we've just done, which is really a once-in-a-lifetime strike that all things collided at the same time, as a result of that, your upside is massive. I think we're very conservative as to where we think our future growth is going to be in a stabilized basis on the studio. So the post-strike demand is something that we're laser-focused on. We own 70-plus percent of the market share in the transpo business. And as a result of that, production is something that we're very laser-focused on. Secondarily, with tech and AI sort of reverting back from its high levels to delivering now what I think has been more of the rightsizing from an employment standpoint and downsizing. In some instances, we're seeing positive growth around that. And as I mentioned in my prepared remarks, we're also seeing positive growth on the ancillary FIRE-related businesses or tech-related businesses. And to date, our pipeline is as high as it's ever been. On average, we have a pipeline of about 1.5 million square feet. We now have a pipeline of approximately 1.9 million square feet. And so we're seeing averages pre-pandemic. And lastly, I think quality of portfolio is such that has proven out if anybody looks at -- office has not been in anybody's radar in terms of something positive, but what we have seen consistently on the positive side is the quality of real estate prevails. In San Francisco, we own one of the nicest buildings in the city and we're getting the highest rents in the city in that asset. That doesn't come because the marketplace is delivering that, it's because of the quality of the assets. And it's the same in Seattle, it's the same in Vancouver, which is our highest occupancy, highest growth marketplace in our portfolio there and really has been consistently in the low 90% occupancy throughout the pandemic and throughout the most recent downturn as well from the work from home. So that being said, I think the upside potential in the company currently today, given where we're at and where our growth prospects are and our future aspects around cash flow, it's a great time to invest with Hudson.

Maybe we'll start with the studio platform first. You mentioned the Hollywood strikes being in the rearview mirror and production starting to ramp back up. How quickly do you expect the Quixote businesses to reach stabilization? And where could you see the platform growing over the next few years?

So right now, our portfolio in Quixote and Sunset, which is the OpCo, and then the bricks-and-mortar businesses currently have holds on almost all of our stabilized asset level-related cash flow businesses. And so what a hold is, is that they're waiting for green lighting on assets to the -- on production to be approved by the production companies. So we always said we'd see some form of a normalized production level second half of '24. The number of productions in Los Angeles right now is about 30% below where it was overall, but that is already garnered to be stabilized by May or June to be at where it was. Interestingly enough, because of the strike on both the actors' and the writers' standpoint, we were flexible in the ability for us to take our transpo and operating businesses and look at other live entertainment aspects. And so when we have a normalized stabilization of mid-50s to 60% of all of our equipment business, now we've enhanced that to include live shows. So we are running out for Coachella and Stagecoach this month. We're sending over 100 vehicles out for that. We're going to see that pick up on live production, on-site location shoots and the likes of that. So we're pretty comfortable with the second half of the year being normalized. It could happen sooner, but we're not projecting it. It's only a matter of a few months. And so we believe that the production will be up and running. Our largest tenants, which are the Netflix, the Disneys, the Amazons, the Apples of the world have maintained their budget for production for 2024 that they're going to produce content to where it was stabilized in '22. So as an example, I mean, Netflix has come out and said, "We're spending $17 billion this year." That's what they're going to spend. So it's going to permeate throughout the business, and we're going to be a benefactor of that.

And do you expect that to continue in the near and medium term, the streaming services committing spending capital on new TV shows and movies?

100%. I mean, the numbers are over $300 billion in production, and nobody's come off those numbers.

And can you remind us how the leasing for the studio business works? Is it a show-by-show basis or will these media companies typically sign longer-term contracts?

I mean, it's a case by case for each soundstage and each studio. On the Sunset portfolio that we have in Hollywood, on our Sunset Gower and Sunset Bronson Studios, we have long-term leases that go to 2031 effectively for those -- all of those stages. We have some long-term leasing on production companies at our Las Palmas Studios. We are seeing a demand on our new product, which is Sunset Glenoaks, which is our new 7-stage facility that is completed by April of this year for long-term leasing. On a show-by-show basis, that is where we see more of our Quixote soundstages, and the demand around that has been show by show. I think Mark can comment on the numbers, but I believe that it's -- we're making more money on a show by show, we always have, but then the comfort level of having a tenant in place long term versus the cash flow and then maybe the downtime. But on average, we're seeing a fundamental shift on smaller 1, 2-off, 3-off productions on a show by show. But on a captivity basis for the entire studio, we're seeing still the demand for quality, purpose-built facilities for long-term leases.

What does the competitive landscape for the studio, either real estate or operating business, what does that competitive landscape look like given you're the only player in the public space with a sizeable studio presence?

I mean, there are really very few players in the marketplace. Of size, there's really only one other than us. In terms of operating skills and expertise, there is only one other ownership in the landscape. There have been several one-off production facilities that are either converted or looking to be ground-up. I think a lot of those have been put on hold given where the cost of capital is and where the debt markets are. So it's still a predominantly secure marketplace for us to expand and grow and still be the leader or a leader in that marketplace. I think our comfort level with competition is not something that concerns us at this moment.

We just had a question come in from live QA. Has there ever been a consideration to spin out or sell the studio business and then use the net proceeds to delever or buy back stock?

Sure. There's always opportunities in conversations and strategy sessions around spinning out or rolling it into another entity and distributing it through stock or some sort of subclassification. And we'll always entertain that if it's the right decision.

And then just touching on development opportunities. You highlighted the recently announced one in New York. I believe you also have one over in the U.K. as well. Can you -- expanding -- by that, expanding your studio presence into other markets. Why did these developments make sense? And could we see Hudson expand into even more markets in the future?

Well, each case is different. So we currently have 3 development opportunities. One, as I said, is our Sunset Glenoaks 7 soundstages that is completed this quarter or next. And that will be a best-in-class first purpose-built facility since, I think, 1980 -- right around 1980 or -- sorry, 1989. And the demand for high-quality facilities is extremely popular right now. I mean we have a once -- a unique opportunity with Vornado and Blackstone and us building our Sunset Pier 94 Studios in Manhattan. It will be the only purpose-built facility in Manhattan. We're just in the process of that development opportunity, and already the demand and interest level from multiple tenants to lease it 100% is better than anything we've seen. Our London opportunity is within the 35-mile radius of production of London, and so that's effectively like their equivalent of the TMZ. It's a spectacular piece of property that is, as I said, close into the city. And the competitive landscape in London was a lot more prevalent prior to the downturn and then the strike. As a result of that, we're one of the only players that potentially can build there or have decided to evaluate building there. So overall, I think our asset quality on development is best in class. All 3 of those facilities are purpose-built. Are we looking at other aspects of development? I think we're looking at all aspects of expanding that portfolio. With our partner in Blackstone, the demand interest and level of our understanding of where we think that business is going to go will enable us to maintain us being not just interested, but a top player in that business and industry.

Maybe now switching over to the office portfolio. With the headwinds facing the office macro environment broadly, how is Hudson differentiated from the competition in terms of portfolio composition, tenant makeup or any other growth opportunities?

I think like it's no different than I was just talking about on the studio side. Best-in-class has proven out in the office, no matter where you are or what you have, to be higher and better producing content of demand for leasing. At the end of the day, as I mentioned in my first remarks, high-quality real estate is leasing. We own assets in Seattle, San Francisco, Vancouver and Los Angeles. And we have -- our high-quality assets are fully leased or almost fully leased across the board. When you start digging down and if you look at our portfolio catering to tech, entertainment, media-related businesses, 80% of our portfolio is Class A. Other 20%, that's where our work is. And that's where we are finding a lot of our energy is going to try to lease up space. As I mentioned earlier, the demand in our markets have picked up dramatically. The tours have picked up dramatically. It is taking longer to lease, but that doesn't mean that the quality of real estate doesn't prevail as you're entering into a different dynamic around office currently today. And yes, everybody is looking at office and saying, "When's it going to rebound?" The reality is there is no -- virtually no new product in the marketplace in office. New product is going to lease up quickly. But the second tier of that is going to be highest and best use. And we feel that our portfolio is conducive to attracting virtually any type of tenant in the markets we're in. And as a result of that, I think tenants are reevaluating how they're looking at space. And we're accommodating those thought processes to have a lot more open space, a lot more amenities. And for the most part, during the pandemic, we took our time and energy and repurposed our portfolio to accommodate the tenants' needs prior to this downturn. And so we don't have a lot of capital spend going out the door to make our portfolio conducive to what the tenant demands are today.

Do you have a sense of what utilization is in your portfolio kind of across markets broadly?

Yes. You're talking about physical occupancy, right?

Yes.

With I would say the sole exception of San Francisco CBD, which we still have Uber in that portfolio, so across the rest of our portfolio, it's in the high 80s to low 90s. It's either full-time occupants in the office or hybrid work schedules, so between 3 and 4 days in the office a week. And then in San Francisco, it's still in the 40-ish percent range, but that's largely a byproduct of the fact that we have a few large tenants who, during the pandemic, stopped utilizing their space and have since announced relocations.

And maybe just expanding on the leasing pipeline a bit. You noted in the investor presentation you've got about 40% activity on the 1.5 million of expirations this year, only one expiration of greater than 100,000 square feet. How are those conversations going on renewals? And what are you expecting to have to give up, whether it's free rent or tenant improvement dollars in order to get deals done?

We're not leaving anything on the table when it comes to negotiating. I mean we're 40% to 50% retention, seems reasonable for this year. And the conversations are fluid. We're not losing out to competition, and we're not losing out to rate. I think, as I said earlier, what we're losing out to is just time. It's just taking time for us to execute some of these transactions, and we're comfortable with the quality of real estate that we own, and the tenants' desires to stay with our assets is consistent. That being said, at the end of the day, there has been a downsizing almost uniformly with tech and that's sort of flattened out. And we believe that the next aspect of that will be growth. Tech companies have benefited greatly from downsizing. And as a result now, their productivity levels are at, I believe, at the comfort level that they think it's going to sort of be sustainable. From that point on, we'll see where the growth goes.

So I guess to that end, Victor, what do you think it's going to take for some of these larger space takers to reenter the market? Is it turning back on employment growth? Is it kind of other factors that come into play? When do we start seeing those larger entrants come back?

Michael, that's a good question. I think we're seeing less of the larger yesterday tech companies coming back to the marketplace anytime real soon with the exception of, I mean, Apple expanding in Seattle. We've seen several large tenants expanding in Seattle, not dissimilar to the new wave of today's tech tenants, which is AI in San Francisco. It's been a massive boost to the city to have 1 million square feet of new tenant demand in the city, and it's not stopping at that -- those levels. We're a little further behind because of the entertainment strike in Los Angeles for the media companies to grow. But hopefully, media and gaming companies will sort of come to the table on the same level in that marketplace. So it's differentiated by market, but we're getting close.

How real is the long-term demand that AI is bringing for office space needs in downtown San Fran? And do you think that can really help kind of reboost and revitalize that CBD?

100% it's real. How much more? I don't know. I think the quality and the capitalization of these companies are very high. And so that's where we sit today, and they're all backed by companies that already have existing space in other marketplaces. So we're seeing it come to fruition. It's in San Francisco because of the employment availability of some of the tech companies that have laid off a lot of these tech and engineering qualified individuals who now are available to have jobs in this next sector of growth.

We had a question come in from live QA. Can you speak to concessions being used across your portfolio? And is there any way to quantify it either in terms of percent of rent or months of free rent, et cetera?

Yes, I'll take this at top level and let Art jump in a little bit because that's what he is here for. But the reality is on the concessions, we've seen very little movement on free rent if at all in the most recent negotiations in the last 12-plus months. So we're not changing or seeing a change in that in terms of the demand by tenants. That doesn't mean we wouldn't because we don't want to let any deal go by, but right now, that's not been a push button. Conversely to that, we're actually seeing our capitalized and tenant improvement costs going down from where it was 24, 36 months ago in the last 12 months. Comment on that?

Yes. I mean it's a market-by-market specific convention, right, and Victor hit the nail on the head. I will say that if you look at -- I think what proves us out is if you look at our trailing 12 on spend relative to each deal. From trailing 12 months prior to pandemic beginning, we're down -- we're only down 5%, right? So we -- our rates have remained very, very consistent and the spend hasn't gone crazy.

And then maybe just sticking with you there, Art, just on the leasing environment. If tech leasing doesn't pick back up maybe as expected over the next couple of years, do you think demand from other industries can help backfill that space and then ease the supply pressure that some of your markets are facing?

Yes. Well, first of all, we've seen tech demand increase, right? Probably year-over-year, it's probably up about 5%, 7%. So that is happening. What we saw during the pandemic when there wasn't as much tech demand, we saw the FIRE sector really kind of dominating the landscape with mostly small to midsized tenants, and we've consistently seen that. Even in the Valley, we've seen some of the FIRE sector growing, and it's been carrying the day with our really smaller suites that are available.

And with the hybrid work model that a lot of employers have started implementing, do you think longer term this will make them look to take less space or rather will they look to reinvent their current real estate needs to keep more or less the same square footage?

I think consistently what we've seen is the square footage per person has gone up in the hybrid model. But that's because they've adapted certain space to be much more collaborative, open-end space with amenity based. And so we're not seeing it reduce and probably not going to see it increase. I think it's going to be stable. As everybody knows, it doesn't matter if you're working 3, 5, 7 days a week, you still need a space.

Maybe just switching over to kind of capital allocation opportunities. We've seen some distressed deals kind of across markets start to transact now. But curious if you're seeing any opportunities on the distressed side out in your markets? And if so, how best do you think you can capitalize on those?

I will say this on the distressed side. Currently, today, clearly, we're seeing distressed transactions available to anybody in the marketplace who wants to venture into those geographical regions and buy real estate on the commercial side. I think we're not at the quality of assets yet, and we're not at the time in the cycle where the activity is such that people are voraciously looking to acquire. I think you need to have your finger on the pulse. I think you need to be aware and underwrite assets because there will be certain opportunities, whether on a one-off basis or a portfolio when you could parse it out and sell. Those are going to be very, very accessible and evident for people like us to sort of be in the marketplace and try to capitalize on that at the right time. Interestingly enough, we're looking at our very first asset that we're seriously underwriting. It's not a large asset because it makes really good, sound economic sense in the long-term growth. But yet to date, we've not really seen a lot of that. I expect to see more. How long it's going to last in the marketplace? Who knows.

And maybe to that end, just kind of as we look forward over the next 12 months or so, is it fair to assume you would look to dispose of more assets in the portfolio? Or is this acquisition you're talking about underwriting, could that be a sign of things to come in terms of like growing the portfolio and acquiring more?

We've rightsized our balance sheet in the last several months, and we've got some long-term leverage targets, about 30% of our share of net debt to gross assets currently today, sort of a sub 7 on the net debt to EBITDA. We're positioned to take advantage of opportunities on a JV basis with current and new JV partners. And I think as a result, we're also positioned to take advantage of select asset sales. To date, the majority of our asset sales has been inbound -- based on one-off inbound buyers, not marketed. We have a couple of assets in the portfolio of the same ilk in that we've got inbounds from third parties who are interested in buying it. So we'll evaluate highest and best opportunity and repurposing of capital and rightsizing. I think we've done an exceptional job given the time and given some of the headwinds we've had. And so we feel comfortable that this decision-making process will continue going forward.

Victor, your occupancies have fallen from the end of '22 to the end of '23, call it, 800 basis points, and rents are off about $4 or $5. Do you think we're done, and we found the floor and things will recover from here?

Do I think what?

The rents and occupancies have now found a floor where we are now?

Well, so let me sort of take a high level first, [ John ], and then we can go from there. The large tenants in our portfolio -- first of all, 2024 is the lowest expiration we've had in 3 years. So we've had a series of headwinds from large tenants leaving the portfolio. We only have one more tenant that's leaving, which is February of '25, I think, which is a known move out, which is Uber of size. Everything other than that is less than 100,000 feet. So that is affected -- between asset sales and these large tenants, that's what's taking our occupancy level down at these levels. We feel very comfortable that, that swing is going the other way now given where the activity is in the growth. I definitely believe that we're seeing the floor in where rents are in our portfolio on our assets. Overall, in the market conditions, I mean, Art, there's very little movement on rents going the other way, right? They're going up.

They're absolutely going up.

And then, [ John ], lastly, I mean as I mentioned earlier, there are assets in San Francisco as an example, where we're getting the highest rents in that marketplace. You've seen that in every marketplace. High-quality assets are gaining great rents. Century City is getting top, top rents countrywide. And then you go 3 miles to Westwood and they're not even related in terms of rent. So it's quality real estate is what's proving out to be the support of rent.

And can you comment on where you think cap rates are or where you're seeing transactions for comparable assets to yours?

It's hard to quantify that. It is a general blanket clearly. I mean if you're talking about suburban quality Class A stuff, I mean, you're still -- look, we just sold a Class A asset at a 6 handle. So I mean that's what we sold it at. That asset 24 months ago, maybe right -- middle of the pandemic was a 5. So that's 100 basis points wide of a Class A asset. If you look at some of the suburban or lesser quality B+, A- to B assets, I mean, you're talking 7.5 to 8.5 maybe as much as that much of a diversity.

And is that on low current occupancy? So if occupancy is down...

Stabilized future, 12 months future. So...

We had another question coming from live QA. Can you please provide a breakdown of NOI or FFO growth and where it's coming from, be it the studio business, existing office business or development? And then also, what has the impact of interest rates been across your portfolio?

So we -- listen, I'm not going to go through our deck. We posted a deck, so take a look at the deck we posted this morning. It's got the breakdown. It's got a future growth and it's got a bridge, gets us from where we are today to where we'll be given some of the existing development assets coming online and leasing up. That being said, we've talked pretty openly around our studio portfolio and where our stabilized occupancy on a run rate would be year-end '24, and it's roughly around $75 million, right? So I mean, that's a good number to sort of hold your hat on in terms of some form of stabilization of the existing studio operating businesses with the exception of the Sunset portfolio, which is 100% leased. I'm sorry, what was the second part of the -- last part?

Just the impact of interest rates, and what it's been on your portfolio?

Yes. Yes. I mean listen, this team has done a phenomenal job resetting our debt in place today. We don't have anything coming due till 2025. 90% of our portfolio is fixed and the exposure on that, we've got very little coming due on an asset level with the exception of 2 assets. One is a single tenant Amazon lease that's got 7 years of WAL to go, and the other is a single-tenant Tencent credit. Both those assets have debt coming due in 2025. And both those assets are appreciably higher than the debt levels. So it shouldn't be very challenging for us to get those either extended or we can have other opportunities around those assets.

The regulatory environment in a lot of your markets remains a key topic of discussion. How have you been working with key public stakeholders in order to try to entice workers to feel better about coming to the office and improving the quality of life in your CBDs?

Yes. I mean, listen, we're actively working to improve the quality of life in our marketplaces, promoting safety, facility and return to work. Clearly, we're focused on the key elections that are coming up in some of our markets as early as tomorrow. In San Francisco, we're working with the current mayor, whether she is going to be in office or not, but we're working on the streetscape, we're working on the safety restrictions, civic programming, all the aspects of which you're getting people more comfortable with coming back to the city of San Francisco and working as a 5-day work week process. In L.A., the current mayor, I mean, has also a safe program that they've gotten over 17,000 people off the streets. We're focused head on with the DA race there, which is a challenge. Obviously, some of the council seats to ensure much more of a moderate city council going forward. Seattle has been probably the most aggressive and the most productive from our standpoint with relationships and a pro new mayor and new council. So focused on where we see the weakness in our portfolio there, which is Pioneer Square. Obviously, working with organizations for some storefront activation and some tenant signage and promoting the city in a lot of ways. So I mean we're not dissimilar to other office landlords. It's key that our cities are getting promoted from within, and so those relationships are invaluable. We've always had them. We're always going to continue to have them and we just hope that -- listen, our candidates win. If they don't, we're going to have to adapt and work with the other candidates.

Victor, it seems like you're pretty constructive on the outlook ahead for the next year and beyond. Is it fair to characterize that we've moved past the pain point in office? Or do you think there's still more issues to come?

I can say this. If we were sitting here 10 months ago, it was pretty painful, right? May of last year was pretty painful. I think March of last year was equally as painful, but nowhere near as to what it is today. But I classify May because we look at -- started with the strike. It went on 3 to 5 months longer than anybody thought. It was impactful by the tune of billions of dollars, which then perpetuated throughout our portfolio in the office side. I believe that those headwinds were magnified by a lot of negative press. And the reality on the street was a lot better than what we were seeing and hearing. And so as a result of that, I think we've definitely bottomed out in terms of people's interest levels of reverting to -- this work from home is going to be -- that's it. And so we all know that's not the case. A lot of people pontificate on the fact that work from home is here to stay. We're not believers in that. We're not seeing that in other companies, in other CEOs. If you want to advance in companies, we already know where that's going to be. That has now changed the rhetoric and the growth prospects, I think, are much better than they were, as I said, 10 months ago.

I've got my rapid-fire questions to end the session. What is the best real estate decision today: buy, sell, develop, redevelop or pause?

It's going to depend on the marketplace, but I think the reality is going to be looking at redeveloping something that's Class A or about to be Class A, highest and best use of dollars.

Quickly, what is your expectation for same-store growth for the office sector overall for 2025?

0% to 2%.

And lastly, will there be more, fewer or the same number of publicly traded office REITs a year from now?

Same.

Great. Thank you so much.