SL Green Realty Corp. (SLG) Earnings Call Transcript & Summary

[Audio Gap] Citi Research. We're very pleased to have with us SL Green, CEO, Marc Holliday; Matt DiLiberto, CFO. This session is for investing clients only. If media or other individuals are on the line, please disconnect now. Disclosures are up here and available on the webcast. For those in the room or on the webcast, you can sign in at liveqa.com and enter code 'citi2020' to ask questions or you can just raise your hand. Marc, let me turn it over to you to introduce your company and the management team that's with you here today and provide the audience 3 reasons why investors should buy your stock today, and then we'll turn it over. Sorry.

3 reasons?

3 reasons.

Okay. So first of all, good morning, everyone. Thank you for joining us here today. We appreciate everybody weathering all the elements and getting here to enjoy a great 2, 2.5 days here in -- at The Diplomat, courtesy of Citi. So thank you, guys. To my left is Matt DiLiberto, my CFO of many, many years, who help steward the ship and the balance sheet; and to my right, you all know Anastasia Verghis and her efforts on Investor Relations. So I'm going to give you 10 reasons, if that's okay, please. It's the only thing that's what I have prepared...

The fact that you came, that you're here, you have the right to give as many reasons as you'd like.

I haven't ranked them. I mean we are here, we are good, we are ready to roll. And I do have 10 great compelling reasons why to buy our stock in this little handout. And Michael has been courteous enough to give me 6 minutes and 30 seconds to read my response to you guys. So I will do that now. First of all, it's a pleasure to give you guys an update on the performance at the early part of this year. We're 2 months into it, and a lot has happened. So that's a good news. We're off to a very good start in 2020. And until about just 2 weeks ago, our stock price was starting to reflect the significant gains that we've been making by selling mature noncore assets and reinvesting in our deeply discounted stock. Obviously, the global markets have changed of recent, but that hasn't dampened the progress we've been making in our largely core portfolio and our truly extraordinary development portfolio. On Page 2 of this handout, you can see the 7 development projects that we profiled in our December investor conference. We went through each of them in great detail. And as of this morning, you can add an 8th one to that lineup, as we announced our latest project on Nassau Street in downtown Manhattan, which is already net leased by us to a user. So that's the way we like to do, simultaneous close and lease. The success of these development projects that you see here on Page 2 has a positive impact on the city that I think will be long-lasting and, in some cases, transformational and cement SL Green's position, not only as the leading owner/operator of commercial properties but also as one of the premier developers in New York. These development activities will disproportionately contribute to SLG's outsized NOI growth over the next 5 years. Page 3 illustrates a 9% CAGR between 2020 and 2024, with the majority of that growth coming from the premium incremental earnings derived from our development pipeline, all of which is now well underway. Page 4 highlights this high level of NOI growth can be achieved with very little in the way of incremental equity investment required by SL Green as core portfolio capital is funded out of excess cash flow, and development portfolio capital is funded with proceeds of project-level financings and a $450 million plus JV of 1 Madison, we hope to conclude in the next 90 days. One of the more compelling stories that will unfold by the end of 2024 is that our consolidated debt-to-EBITDA will be reduced by greater than 1 turn, notwithstanding the aggressive level of buybacks slated for 2020. On Page 5, we turn our attention to the Manhattan leasing market, and there are 4 key takeaways from these tables. First, Manhattan leasing continued at a near record volume in 2019, and 2020 is off to a very good start with many announced new deals. Midtown, you see, continues to represent the majority of this leasing activity, large block leases remained at healthy levels in line with the 3-year average, and the number of $100-plus per square foot leases recorded were the most since 2008 and 2007. The strength of the Manhattan leasing market can also be seen in our own portfolio as we've signed 240,000 square feet as of Friday of new Manhattan leases with a 12% mark-to-market over expiring fully escalated rent to get the apples-to-apples comparison. Page 6 gives us a breakdown of this early stage leasing activity, along with a look at our pipeline, which now stands at close to a healthy 1 million square feet of leases that are either pending or in active term sheet negotiations. That pipeline is 10% mark-to-market. So we are tracking well and actively attending to the less than 900,000 square feet left to roll this year. The New York City economy continues to post impressive growth numbers, notwithstanding public shareholders' suspicions concerning New York City's resiliency. The dashboard on Page 8 shows how the New York area workforce is benefiting from a 10-year economic expansion, with unemployment rates below 4% and wages that are increasing at higher than inflation rates. As a result of these tight economic conditions, office-using job growth numbers are again forecasted to exceed the 20,000 mark in 2020, representing approximately 4 million square feet of new demand, and that is shown on Page 9. Strong fundamentals can also be found in New York's office investment market where buyers are represented roughly equally between domestic and foreign capital. Page 10 summarizes some of the important themes driving the investment market in Manhattan, including the obviously -- the obvious driver of pricing, historic low interest rates, driving cap rates lower, record levels of private capital have increased the dry powder that sits on the sideline and poised for new investment and strong demand in the absence of the Chinese buyer. If you flip the page, you'll see 6 large transactions that were all recently put under contract, with SL Green having participated in 4 of those 6 deals, either as seller or lender. Since 2016, SL Green has been a steady seller into this market achieving high pricing for its assets and intentionally shrinking and simplifying the portfolio. We have now shred the bulk of our suburban and residential portfolios and significantly pared down our retail holdings. Page 12 illustrates the nearly $10 billion of assets we have sold at share, representing weighted average price per square foot of over $900. This activity has generated over $4.3 billion of net proceeds, which we have used to fund the stock buyback program that you see on Page 13. And as most of you know, we believe the stock buybacks to be, on average, our best investment opportunity in our space. And we've invested heavily with another $141 million year-to-date of buybacks as against our over $500 million plus for 2020 programmed purchases. So I'll just close here with a look at the NAV, which is on Page 14. This obviously underlies our conviction in the buyback program. We are constantly updating this, testing it, illuminating it with sales and making sure that we feel that we're right with our internal models. And then when you translate that into an implied cap rate model, here, you see that the implied cap rates at current price are well over 8%. It seems to touch on the high side for quality in Midtown assets. And it rates between 4.5% and 5%, it implies the value that you see on the right, and this is basically the data we showed you guys in December. At the end, you'll see our 2020 goals and objectives, which we're working hard to achieve and our mandate is clear for 2020 to progress the development, construction and leasing for a development pipeline, maintain virtual full occupancy for the core portfolio, actively sell mature noncore assets, aggressively invest in ourselves by repurchasing stock at a significant discount to underlying value and continue investing in our properties to sustain our sector-leading sustainability initiatives. So those are my reasons, Michael.

Thank you for that, Marc. And if I just pick up on your last comment about stock buyback, and it's been, I think, heroic in terms of what you've been able to execute in terms of sale volumes at NAV and repurchases at significant below and creating that value. A lot of the time over the last few years, your stock has been disconnected relative to the private market and certainly relative to office peers overall, right? There's been a negative sentiment on New York. The most recent downturn, which has taken down all REITs, including the New York centric REITs as well, is a little bit different, right, because you have this situation going on that could have a material effect on the economy. How do you think about executing stock buyback in this light, where the stock is, with what's going on around the world, which seems different from perhaps when you were doing it before, which was a more stable economy, but just a negative on New York basis?

Yes. Remember, and I've said it before, the -- our buyback program is not a call on the stock. It's an arbitrage that exists where we sell at a low cap rate and commit those funds to buy at a high cap rate period, and we're only buying to the extent of sole property. So there -- it is a pure arbitrage, the way I see it. You can always argue the stock may go low or higher, but we're not stock forecasters. That's not the foundation of this program. The foundation is, we sell an asset like 220 East at a 5.2% cap, and then we buy it at 8.5% cap. Done. And we've locked that profit, and regardless of where the stock goes. We sell an asset like the Olivia, mixed-use resi and commercial, for a 3.9% cap. We buy at an 8.6% cap. Locked and done. Where the stock goes, it goes. That's not really we -- we hope the stock is going up, not down, although the buyback program benefits from lower levels of prices, but it's about a paired trade, selling assets, buying stock and remaining leverage-neutral that drives this regardless of direction of stock price.

How have, either your asset sale program or what you're looking at on the buy, changed with the current sort of environment? Have people sort of put pencils down? Have things got on hold? Or you're still finding a pretty active transaction market?

Well, I mean, there is 6 deals, and that's into the latest episode of sort of global events. I mean those events have been maybe escalating or at least escalating in perception over the past couple of weeks. But so far, we don't see that affecting the appetite for property. I mean you can take the other side of the equation, say, with a treasury rate approaching 1%, 4.75% cap looks insanely high. And there could be pressure on lower cap rates as everybody is reaching for yield and safety in this type of market. I look at core Midtown, well-located, well-leased assets or brand-new development pipeline as the equivalent of U.S. treasuries in real estate Portland. So I think if there's a flight to quality, it will be a flight to the kind of assets we own and with a 1% 10-year, I think, a 6% to 7% real rate of return and a 4.5% to 5% cap rate looks to me high, but we'll have to see where that goes.

Your earnings call was a number of weeks ago, prior to, I think, a lot of the impact in the market that occurred to talk a little bit about the transaction market and the impact. Can you talk about whether the leasing market has seen any effect or caution on behalf of tenants in their leasing decisions? Are they waiting to see how things go? Or you've been still able to bring that leasing pipeline that you talked about to fruition?

Yes. I mean we're signing -- I guess it's been 10 weeks, and we've signed, how many leases was on that chart, 20 leases or so. We're signing -- in a typical year, we'll sign 2 to 3 leases a week, over 150 a year. The pipeline is full. As of last Wednesday is the only real data I can give you because we have our leasing meetings every -- once a week, and deals were getting done moving forward. I don't know that this situation is something -- and I don't mean the potential for the virus itself but the impact it's having on the economy, whether they will cause people to pull back or not. I mean if it does, I think it will be temporary. We've seen global shocks like this can cause a 3 to 6-month back up. The market seems to be sort of foreboding that, if you will. It doesn't mean it will necessarily happen. Russia debt crisis in the late '90s really didn't affect asset prices demand in any meaningful way. And I don't know that this will or won't, but I do know that our buildings are all well improved, not -- over 96% leased. We got a big pipeline. There's sort of a latent need for growth space for a lot of these companies. So it's going to take more than, I think, a stock correction to alter that. If it does, we'll be the first to see it. But as we sit here today, we don't see any impact on the pipeline.

As you think about the impact of COVID-19 and the spread of it, what are you doing, I guess, from a building protection standpoint -- well, coronavirus? They said we're not allowed to say coronavirus anymore. It has to be [indiscernible]. Like, Corona told us like, "Stop saying. It's negative." There are Coronas at lunch, though. So we have that. But what precautions are you taking to protect your buildings? Is there increased cost of that? And I guess, what emergency protections are in place?

Yes, the protection is being put out there by CDC and others. And we've got a security team that is out there looking for best practices, city, state and federal level. It's really sort of the obvious things. We're wiping down handles, elevator call buttons and any other common surface that gets touched. I mean -- and advising tenants to sort of take care hygienically to try to reduce the amount of times that there's a potential to spread. But beyond that, I'm not aware of any meaningful steps buildings are taking that would be consistent with those -- that kind of guidance that's coming out of Center of Disease Control. And when there is, we'll be first adopters as I'm sure my peers will be as well. But if you walked into our building today other than sort of an increased cleanliness staff and a little more precaution on common surfaces, you wouldn't really notice a change.

I assume, Ed is all over this. He's -- this is what he's living and breathing for.

This is what he built for. This is -- it's his moment. We have a Head of Director of Security, Ari, who is all over this. He had -- I got an e-mail last night, just doesn't sound that you mentioned that, he called an 8:00 a.m. emergency meeting this morning, simply to get the team together to rally them from a cohesive standpoint to get his whole operations team in there, bright and early, sending out a positive message, getting in front of tenants, letting them know we're taking some extra precaution and distributing the literature that we're getting from the various health agencies.

Right. I skipped over our first opening question, which was, ESG is of increasing importance for all company stakeholders. What is the one thing SL Green is doing to improve your overall ESG score over the next 12 months?

I'll take that one. I mean ESG has become a huge focus for our company, and we have a team, actually, that was started 10, 15 years ago, within Ed's group, looking at sustainability. So we've invested tens of millions of dollars a year into ESG and have gotten the scores and they reflected -- we put them out, not only in our Investor Day presentation but we have, I think, it's an award-winning sustainability report that's available on our website and Anastasia carries with her. We have the highest scores in the office sector across multiple scoring mechanisms. And whenever anyone say, "What's your ESG score?" I mean, I think every week, there's a new scoring method. We set goals this year to raise the bar even further. Our CDP score, we wanted to increase from B to A-, and so our team is focused on that. We have the highest score among all office REITs already in the S&P 500. We're just trying to make that higher. And then we're going to try and increase our GRESB score from 4 to 5 stars. What things are we doing? We could spend the next couple of hours trying to go through the litany of things that this team is focused on. But to get the scores even higher than where they are is in and of itself an achievement, since we are the highest, I think, on every 5 or 6 grades as you could look at most prevalently.

Yes. I would just add to that, that in terms of what are we doing, everything we're doing is largely using advanced technology to use less power to generate whatever it is to convert steam or electricity or drive fan units, whatever it is. There are ways that are out there, low-voltage solutions, which are relatively new. There's a big upfront capital cost to convert from these systems we have, which, in some cases, could be 10, 20, 25 years old to the new state-of-the-art technology, the payback periods for that will typically range anywhere from 3 to 7 years. So all -- anything higher than 7 years will probably -- it's not on the priority list. I'll put it to you that way. But there is still a benefit, notwithstanding a longer payback period because this all does help our overall low-carbon emission scores, which we voluntarily were complying with pre-Local Law '97. Now we're mandated in our compliance post-Local Law 97. And when 2024 rolls around, we expect no charge to the portfolio for compliance because we expect to already be there now or by then.

So we've got a couple of questions here on the LiveQA that we'll clear out and we'll keep going. The first one is just sold residential, the Olivia. Can you talk about the opportunity to or interest in selling core office in 2020?

Well, I'd have to go -- we have an interest in selling core office in 2020. If it's something that's core where we view there's good growth associated with it from our perspective that would generally drive us towards a joint venture. So clearly, 1 Madison is probably the best example of us selling a fairly significant 40-some-odd percentage risk in a core office asset. There 220 East 42nd, we owned, I think, for 15 years. So I call that a core asset, and we just sold that asset. It hasn't closed yet, but it's under contract scheduled to close this month. And there will be others. So there's an appetite to do that, either via 100% sale or JV. There will be more, other than 1 Madison this year in 2020 that is not yet in the market, but will be. And we're always looking for that arbitrage, which is enhanced at today's levels of stock price.

So Marc, if I go on your website and pull up the presentation that you gave at this conference a year ago, the themes are pretty similar to the flipbook that you opened your commentary up with. So do you feel better about where the New York City market and your company are today than you did a year ago? Are things kind of the same? Or is it worse?

Well, in part, you can look at it for the past 5 years. I mean we only do business in New York City. So a lot of these themes are replicable themes to us: value, investment, sales market, the leasing market, sustainability initiatives of recent 3-year stock buyback program, development. That is probably the extent of our development is magnified now, and that's an intentional shift to focus on an asset class where we can make higher returns than with straight acquisition. And we found global capital acceptance for those deals, much more liquid than some of the noncore stuff. So the themes, I think, will always be the same. It's a question of which strategies do we apply to the themes. Right now, we're net sellers of real estate. We're buyers of our stock, and we like the market we're dealing. I think your question was, do I think the -- is the company better today than it was a year ago? Monstrously, and the year before that and that and that because we're shedding the noncore and/or lower-growth assets. We're shrinking the company, getting more nimble and being able to impose more earnings growth on a smaller share base. I mean that's a big reason why we're projecting a midpoint of $7.30 FFO per share this year, coming up off of $6.90 -- well, a midpoint of $6.90 or so last year and maybe $7 of actual earnings. So good earnings velocity. It takes a lot to generate these earnings on a, whatever we are, say, $17 billion market cap. And we're doing it in one market. So the way we do it is by imposing a lot of value and value-add on a shrinking shareholder base that's less complex and I would say more nimble and of a higher average quality. If you had an average quality score and you applied it this year versus last year, you'd have a higher score this year. It's without question. If you looked at the leasing of our development properties, we're more advanced this year than we were last year because we've just leased more. So yes, I would say we're in a better position. And the market, I would say, at the moment, putting aside, again, last 2 weeks, which everybody is going to have to adjust for, I would have come in here saying, market is kind of on par with last year, which was a pretty good market.

Maybe let's switch to DPE book for just a second. Has the change in the 10-year changed any of the underlying drivers there? Is it going to lower your sort of ingoing yields on new investments or anything else?

Is -- the impact of the 10-year on our DPE production?

Right.

Yes. It's a good question. I think it's too early to answer that question. So I don't want to say something -- like, there's a decided view on this yet. I think, Andrew, David and I are kind of assessing what that impact will be. We closed predominantly floating rate loans and/or preferred equity positions into the DPE program. So it's not very treasury based. I think you'll see, again, what happened previously as treasury rates dip low to historic levels. Credit spreads will probably gap out a bit, such that the overall rate should be downward trending, but maybe not, basis point for basis point so that the actual net effect may be a little more modest than it appears. But clearly, directionally, I do think this is going to cause a demand for pickup in quality assets. I'll give you the example, the Nassau Street deal we just did, long-term lease to a credit user, we had one set of financing assumptions in our underwriting model. And I guarantee, we'll be using lower financing assumptions now. And whatever profit we had underwritten into that deal will be improved by this. And so we're going to want to do the next deal if we can get at the same pricing. So I think that it's to be seen how it affects volumes, but the DPE program itself is off to a very good start right now. We've got about close to $2 billion...

Yes, over $1.9 billion...

Over $1.9 billion.

At this point. So we're up $300 million from our year-end balance already. So that kind of takes out of the equation a little bit of the effect of the current market since we front-loaded our originations and got so much done in the first 2 months of the year.

But I would also add that we are a big believer in always trying to get as much as we can out of the opportunities we have fingerprints in. You saw on the first page, there's a picture. It's not the island of Manhattan. It's just that which we've invested in. It's 120 million square feet of real estate that we've invested in over 21 years. And some of that we've been in and out of 2, 3 times. And so a case where we're selling aggressively as we are right now, it's a great opportunity to concurrently originate new structured finance opportunities on those asset sales, which you've seen us do many times in the past, assume we're doing that now and into the future. And that's kind of almost our own proprietary pipeline, if you will, that comes out of the assets we're selling so that we're derisking by lowering our LTV point typically by 20% to 35% and getting a relatively high rate of return on collateral. We know better than we possibly know because we've owned it, and that's not really driven by the treasury.

Marc, there's a question that came here through the webcast, and I'm going to read it. It says, you are a young management team, so that's nice -- I'm just reading the question, with strong views on capital allocation. Your largest peer now trades at a 45% discount to their own disclosed NAV estimate. Is this a good time to seriously look at the potential for coming together to create a larger mono-market platform, eliminating duplicate G&A? I know you cannot answer that, but curious if the Board even thinks along those lines? Or is the focus simply on buying back your own shares and doing the other value-creating opportunities that you talked about?

I can't get past the young management. I'm still stuck. I didn't hear anything...

Someone's got to bugger you up, clearly.

It's so flattering to -- we've been doing this for 22 years at SL Green, and I'm like, yes, so it's nice to hear. So if the question is, are we interested in and/or evaluating or would consider like-to-like purchases or combinations? Is that...

Basically, I think that's an M&A question?

Sure. I mean we're not shy about that in any way, shape or form. It's a fairly limited pool of like-companies in our space, but obviously, there are several. And we've all know each other well and we compete, but we partner and we are after the same tenants. But then we come together on sort of issues affecting New York City and lobby together to try and keep this business-friendly environment as possible. So I think those opportunities are there. If the opportunity ever looked right for us, we're not married to any one approach. Those of you that know us for a long time know that we'll pivot on a dime if we think there's a great, in this case, great big opportunity where we can come in, add value, save overhead and have it be sort of accretive to shareholders in a way that's more meaningful than buyback or development. So yes, we think about it. We look at it. That's not commentary on point in time in the market. I'd say that's all times, all markets. And I think over time, it's natural. Some of that will happen. The question is, is time a year or 2, 3 to 5, 7 to 10, I don't know.

3 months.

Was that the question?

No, I don't know.

Yes, I don't know. Maybe. Not us.

There is another question in the queue here. Has the supply chain disruption in China, due to the shutdown, caused any delay or inflationary pressure in your materials for development?

Yes. Our artwork is held up in China right now for One Vanderbilt lobby, and we're upset about it. But nothing else at this moment.

Make sure you disinfect it when it gets here. Make sure you disinfect it when it gets here.

Yes, I will. It's a -- that's for sure. But that's actually true. But short of that, we have not seen any supply chain impact. We'll be bidding 1 Madison, I think, August -- second half of the year, we'll be bidding 1 Madison. If it's like anything, like, One Vanderbilt, the supply chain will be nondependent whatsoever on China, so I don't see that being an issue. We haven't seen any problem getting materials in quantities for the tenant build-outs. We're building out a lot of space right now across the portfolio, and I've not seen any impact to us. I'm sure there are a lot of businesses in the city that are severely impacted by it and are faced with having to make alternative arrangements right now. It's just not really an issue for us directly, but certainly derivatively in the tenant base, I'm sure.

One more in the queue here. We're going to try to get through all of them. Regarding your comment about providing financing to buyers of your assets via DPE, would you do first mortgages on these or just perf or mezz?

Well, we -- generally, we are not -- for the kinds of assets we're selling, we are generally not the most efficient provider of first mortgage. So generally, we're providing mezz or pref. That's not to say we haven't on certain transitional assets that we've sold provided mortgage. I can think of one case, in particular, was quite small, but up on Third Avenue, the old Grace's market, we sold to a buyer and took back mortgage and mezz. So that's one example. And there's probably more examples like that, but I'd say the vast majority of pref and mezz. But we would -- we have and would price mortgage if we were competitive.

Questions in the room? Yes.

Just, Matt, if you could give us a quick update on any other -- you discussed at your Investor Day, the large move-outs you had coming in sort of the redevelopment in some of those buildings. Anyone else that we should be mindful of as we look out over the next number of quarters?

No. CS is out, so we can now take that conversation, I think, off the table. We did say, we signed a deal with them late last year to leave early for payment of virtually all of the rent they were otherwise contractually obligated to pay us for the year. They did leave in January. So we are moving ahead now with the development of One Madison, and Marc said we're bidding that later this year. No other new developments on the expiration schedule. Because I'd say, as time passes, Steve Durels continues to have more active conversations on some of the larger spaces. Debevoise, which people have been focused on -- over on Third Avenue, did just sign another 6-month extension, though. So this is their second 6-month extension. As they plan to move, they are needing more time in their existing space to prepare for them. So they have now extended out for a full 12 months.

All right. Let's go to our quick rapid fire, picking up on the M&A question. Will the office sector have more or fewer public companies a year from now? Which way?

Fewer. And it's hard to imagine a more scenario.

Right. Exactly. What will same-store NOI growth be for the office sector overall, not SL Green specific, in 2021-2020 guidance? Manny is...

I have one more.

What do you think the office sector is...

Well, it's got to be an over/under question. So what's the -- Manny, you got to...

Manny is going to. So once Manny gets that 10-year treasury...

So right now, we're at 4.7% in CBD, 3.5% in suburban and 4.5% average.

4.5% average, 4.7% CBD. I'm going to take the under on average. I think that's -- it's a high number on average.

10-year treasury, a year from now, it's $1.07 right now?

$1 or less.

$1 or less. When -- what year will the U.S. enter a recession?

Enter.

Enter. No year.