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

Good morning. This is Jamie Feldman, the senior office and industrial analyst on BofA's U.S. REIT team. I'm joined today by Josh Dennerlein and Nicole Phang on our team, and we want to welcome you to this Bank of America Global Real Estate Conference Virtual Roundtable Discussion with the senior management team from SL Green. SL Green is a New York-focused office REIT that recently delivered -- that opened its flagship One Vanderbilt project yesterday, and I'm sure the team will be more than happy to discuss that. We congratulate them for doing so. Joining us today from SL Green are Andrew Mathias, President; Matthew DiLiberto, Chief Financial Officer; David Schonbraun, Chief Investment Officer; and Steve Durels, Executive Vice President and Director of Leasing and Real Property. We have a large global audience joining us today, so management will spend the first 5 to 10 minutes of our discussion providing an introduction to the company and update on operating conditions. We'll then move on to Q&A. We hope to make this an interactive session, so please add your questions on the Veracast platform so we can weave them into the discussion. I'd now like to turn the call over to Andrew to get us started.

Good morning, Jamie. Thanks for having us, and good morning, everybody. Yesterday, we hosted a transformational event in SL Green's history. We cut the ribbon on One Vanderbilt, our $3.1 billion development adjacent to and connected underground to Grand Central Terminal. We had about 350 people in attendance in 7 different-sanctioned 50-person events, and we hosted the mayor and a number of New York's politicians in celebrating the opening of the building and the public improvements that came with it. Many of our large tenants were in attendance, and the excitement for the ribbon-cutting and introduction to this building was overwhelming. So I think it was a real signal of the -- our belief in the strength of New York City, the recovery of the economy here and the underlying fundamentals that drove 9 years of growth following the Great Financial Crisis and the return of those fundamentals, which we believe will occur and bring this market back into a fully healthy state. I think there's no better evidence of the belief in this market around the world, in our own success in executing the $1 billion plan, which we introduced shortly after the pandemic hit, that was met with a lot of skepticism in terms of the ability to close asset sales, close sales of structured finance positions, close complicated financings, and we've executed that plan. We announced the completion of it, and we've continued to execute beyond it. So at this point, the $1 billion plan is something more than $1 billion, including our announcement this morning of the capitalization of our development of 126 Nassau, where we brought in a foreign investor and a lending source to fully capitalize this project. We are a 20% development partner, building this building for Pace on a long-term leasehold condominium interest. And we brought in a foreign investor led by Meritz Securities, who is anxious to partake in New York's recovery and believes in New York long term. And we're speaking to investors all around the globe, domestically and internationally, who all believe in New York long term, and I think we've seen signals of this confidence throughout each of the facets of the $1 billion plan as we execute. We returned from the Labor Day weekend to our offices, where we've been operating at full capacity since June, and welcomed back quite a number of additional tenants into our buildings. As tenants start to get their office plans reinvigorated, start to reoccupy their space, the level of people commuting into New York City and the level of business folks on The Street is definitely tangible since Labor Day. We were happy to celebrate that activity with -- at One Vanderbilt yesterday and continue to experience it this week. I know we've seen upticks in leasing inquiries on space, giving actual physical space tours, which is a welcome re-addition to our daily activities and continue to see great interest in the properties that we are marketing out there for sale and lease. So I think with that, Jamie, we'd love to hear the questions and happy to answer anything about investments, leasing, the balance sheet or, more generally, New York City from the audience.

Sure. One of the first questions that came in, can you talk about the utilization rates across the portfolio? Are there certain buildings that are coming back faster than others?

I think there are definitely buildings that are coming back faster than others, others are just depending on the tenancy. Where we have our financial tenants, we're starting to see more activity and more reoccupation of space. And I think some of the creative industries are lagging a bit more. Steve, I don't know if you have specific comments.

Yes. Yes. It's -- the buildings that are more heavily occupied are the buildings that have -- are more multi-tenant buildings as opposed to being dominated by just 1 or 2 tenants. So we've no surprise. So if there's 1 large tenant dominates the building and they've chosen not to occupy yet, then obviously, the utilization is down. The tenants that are trailing are the big banks and the law firms, but I'd say, other than that, we're seeing activity come back from all the other users in the portfolio. And we were at -- I'd say a month ago, we were kind of in the 8% occupancy than it -- before Labor Day, it popped up to 9% to 10%. The week after Labor Day, it was at 12%. We think this week, we could be very close to 20%. There was this -- as Andrew said, this week in particular, there's a palpable change down The Street, and just walking into our own lobby today, it almost felt like it was like back to normal, the number of people that were in front of the security desk.

And then what about proximity to transportation modes? Or transportation [ initiative ]?

Well that's -- it's an interesting question because from a leasing perspective, there is a growing conversation in the marketplace where tenants are -- you're hearing more frequently that tenants want to be as close to major transportation as possible in order to avoid a multi-leg commute. So in other words, being able to take Metro North into Grand Central and then walk to their office as opposed to come in to Grand Central and then have to jump in a subway or a bus. So I've heard that from both brokers and firsthand from tenants that are on tours that they're -- that some tenants are very focused on having that proximity for that reason. And certainly good news for us as so much of our portfolio is Grand Central-centric.

Can you talk about your current leasing pipeline and the composition?

Sure. I mean we're roughly 700,000 square feet in the pipeline today. Of that, half is -- are leases out, half are term sheets that I think have a good shot of converting over to leases. We've done about 700 -- we signed about 700,000 square feet of leases to date, so we're going to be -- we're on a path that if everything closes that we're working on right now, we should hit our 1.2 million or very close to the 1.2 million revised goal that we set on the last earnings call. Of the tenants that we're dealing with, it's both a combination of renewals and new tenants that are out there. We've seen certainly over the past, I would say, 6 weeks, a slow return to normalcy as far as deal flow, as far as tenants coming in to shop the space, do tours, proposals being received, leases that are now in negotiation. So in the early days, it was wrapping up deals that were in the pipeline when we all were sent home, then it would turn to more about almost exclusively renewal deals. And over the past 6 weeks, we're kind of back to seeing a lot more tenants in the market about -- willing to talk about relocations. And I'd say we're seeing it from all industries with the exception of media. Media, the advertising firms, media firms are the one very notable industry that's not in the market right now. But technology, law firms, financial service firms have all been through our door, and we're trading paper with tenants in those industries.

So when you take a step back and think about how the conversations have changed or maybe where the type of demand seems to have changed, what does that tell you about where New York may be in the next couple of years just in terms of the more important submarkets or streets or building types? Is there anything you can read through at this point?

Yes. Sure. Part of it is, like in every other -- when we've had a major disruption in the marketplace, you see a large number of tenants that go on the defensive, which means they do short-term deals, they put greater emphasis on concessions as opposed to face rents, so -- and we're experiencing that right now. We're seeing less erosion on our face rent and more tenant demand for TI and free rent to buy the short-term events. On the renewal side, tenants are doing -- are favoring shorter terms, so that could be anywhere from 1- to 5-year-type lease extensions. And ultimately, what that means is that there'll be pent-up demand in the near to medium term. So if you look down the road 2, 3, 4 years from now, there's going to be this natural pent-up demand from tenants that have chosen to kick the can down the road. We've seen it in prior market disruptions and not surprised at what we're seeing now. For us, we happen to be in a very favorable position with a 95% occupied portfolio. So doing net effective renewal deals, we're happy to do that business all day long.

So where would you place mark-to-market or leasing spreads on your -- on a net effective basis on both renewals and new leases, both in terms of what you've been able to get done and then where do you think the market is?

Well, I would say it's -- from a net -- I don't know the mark-to-market on a net effective basis, I will say. I will say to you that relative to our budget numbers that we had underwritten for the years, our net effectives are very strong because we're doing -- we've done a bunch of probably 45 or 50 renewal deals with very moderate concessions, face rents at or near what we had previously budgeted, and a lot of those deals were done without the participation of a broker, so we've saved that expense line. So net effective, they have been great deals on the renewal deals. And on the relocation or new tenant deals, I would say that our TIs and free rent are up. So if it was -- previously, if we were giving $100 in TI, we're probably giving $115- to $120-a-foot today. And if we were giving 12 months of free on a 10-year deal before, we're probably giving 14 or 15 months of free rent.

Okay. And then another question coming in. I mean we've seen a few financial firms announce a permanent change in office. What's your view of where New York City occupancy is heading next year? And they asked about net effective rents also, but I think you just addressed that.

In the first part of the question, have we seen financial firms announce what?

Just permanent changes and just how they're thinking about office space. Just, I guess maybe to take a step back, just what conversations have you had or what do you -- what's your latest view on how people may be using office differently coming out of this? What do you think that means for you?

Yes. I think it's very early and premature to extrapolate permanent changes out of 6 months of disruption and what may turn into 12, 18 months or 24 months or some relatively short period of time. So people ask these things as though the world will never be the same, and that's really -- that's not the view of our firm sitting here. It's not the view talking to our tenants. It seems to be the view of the media, but I don't think there's going to be a permanent change in workplace. And I think you've seen Reed Hastings and a lot of Jamie Dimon, a lot of other business leaders come out and say, work-from-home is not as effective as work-from-work, and their goals are to return to 100% work-from-work over the course of some reasonable period of time. So we're believers in that. We've exercised that with our own staff and our own company and have successfully returned to work. And we would anticipate the vast majority of our tenants returning to the way things have been for decades as this disruption clears up, whether it's by vaccine, herd immunity or something else.

It is interesting, though, like anecdotally, just talking to personal contacts or at small businesses, maybe law firms or just smaller firms, and a lot of them are saying that if they have -- they're comfortable giving up leases over the near term, just assuming that they'll be able to -- when they're ready to get back, they can -- they're not worried that they won't be able to find space. Are you seeing any evidence of that in your portfolio? Just your smaller businesses that maybe have shorter-term leases just waiting things out on the sidelines?

Not with any great amount. There's always the -- you get the random small guy that said, you know what, I can just work from home right now because I'm a 2-man shop or something like that, but none of the big corporate guys. I don't hear that. Just the opposite, quite frankly, we hear. To Andrew's point, the early days, it was -- I think a lot of people speculating about working from home or 50% of our people are going to work from home, and that conversation, I think, has shifted dramatically over the past couple of months. I hear a lot more conversation from tenants and their brokers that are -- have said, just the work-from-home is not working for them and they're going to come back to the office. I think what we're going to see is just more flexibility in the workplace. So you'll do some of your work at home, you'll do some of your work on the road, you'll do some of your work in the office and ultimately it just means you're just going to do more work.

Great. Wonderful. Glad to hear that.

Yes. Andrew perked up when I said that; so he's real happy.

Sounds great.

Exactly. So -- but have you seen, I guess on the space design side, when we've talked to some of the space designers like Gensler or others, they make the same comment you made which is maybe first meeting is a Zoom meeting at home, then you go into the city to avoid traffic and then you're there for most of the day. I mean are you seeing any changes in the actual layouts or how people are building out their spaces to reflect that?

No. More change in furniture configuration than true layouts, where you're seeing fewer people plan for the straight-on traditional benching-type layout and more going towards clusters of people grouped together. And I think you're seeing maybe programming in a greater number of small conference rooms in anticipation of doing smaller group meetings as opposed to large group meetings, so that you'll have -- and we see it in our own office, quite frankly, where if I may have hosted a weekly meeting with my group of 15 people in a room, now we'll put 6 or 7 in a room and the others will participate on a video screen even though they may be sitting at their desks. So I think you hear more about that kind of stuff, but I don't hear anything like we're going back to everybody getting a private office or something like that. I think it's just more furniture configurations.

And any change in space per employee?

Without a doubt. Without a doubt. Everybody is programming more square footage per employee because they're giving them more larger workspaces and they're spreading them out a little bit more, but that's an acceleration of what we had seen prepandemic, right? We've gone from a densified world. People, I think, were rapidly coming to the conclusion that they had over-densified. It was actually being counterproductive. And you'd started to see tenants begin to unwind that. And now with COVID, it just accelerated the -- let's go with a less-dense work environment, even though it may be heavily-open plan.

Okay. I guess just going back to One Vanderbilt, 72% -- or targeting 72% leased by year-end. Just how are leasing discussions going there? And then maybe to bring that into the discussion, how should we think about that building coming online? Let's say it does stay 70% leased, what is that -- what's the earnings impact of coming online at that level of occupancy, even if it's for an extended period of time?

From a leasing perspective, we're almost back to where we were pre-work-from-home as far as deal velocity goes, the number of leases that are in the pipeline or term sheets that are being negotiated. We'd signed 2 leases while we were working from home. We're currently negotiating 2 leases. I have high hopes that within a week or 2, we'll be -- we'll have a third lease with a handshake to go to a third tenant there for a full floor. We've got 4 or 5 proposals that are in active negotiation. We're doing multiple tours every week at this point, sometimes 2 or 3 a day. I'd say the one thing that's different than where we were previously is that there's -- and this is part of our strategy as well -- is we've opened the building up to smaller tenants, to multiple -- multi-tenants on per floor. So whereas previously, it was all full-floor deals, now we're seeing a lot of deal flow from the half floor or 2/3-floor-type tenants, 7,000 to 15,000-square feet in size. And that's the nature of what we have left to lease, which is the top 1/3 of the building, so those are smaller floors. They're -- by and large, 90% of the deals that we're working on are financial services, so we're seeing plenty of guys from the hedge fund, private equity world comes through the door right now.

And Jamie, to answer the other part of your question, we did delay -- construction was delayed by a couple of months, obviously, with the construction moratorium. So we had, in our initial guidance back in December, said we will have some earnings impact, some NOI coming on from a GAAP perspective later this year from One Vanderbilt, not from a cash perspective because tenants will be in free rent. That number is even smaller now, so we're expecting the earliest tenants, including SL Green, to be maybe November, likely December, as -- at the earliest. So there will be a little bit of earnings potentially from One Vanderbilt but not much, and then it will ramp through next year, but it pushed us a couple of months -- the construction moratorium did.

But as you think about -- I mean I know Matt, you and I have talked about this in the past, just capitalizing the project going forward. I think you're -- I don't remember what the latest date for the observatory to open would be, but just how should people be modeling over time the building kind of ramping up? And then whenever the observatory does open up, I mean is it still considered under construction over that whole period or is there some point where you actually have to start reducing your capitalization? Just how do people think about that in terms of the earnings that...

We generally view a property at -- not stabilized occupancy, but for accounting purposes, stopping capitalization, around 70% to 75%. So using where we are today or expected to be by the end of the year, at the point all of those tenants were in physical occupancy, you'd stop capitalization. Obviously, that will take some time because it takes the better part of a year for tenants to build out their space, 6 to 12 months, but that's generally just from an accounting perspective when we stop capitalization, 70%, 75%.

Okay. And do you have any updated plans for the observatory? Are you still thinking that's the end game?

Yes. That's -- I mean we -- the observatory, mercifully, is a 1-year forward-opening. We're not opening now. It's late, late 2021.

I think it's late 2021 opening and planning is coming along terrific and construction is underway, although not fully underway.

Okay. And then maybe shifting gears to One Madison. Obviously, we saw Facebook sign their big lease in the Penn District. What does the appetite look like for that building? And what are your thoughts over the next couple of years as that unfolds?

Well, we delivered it in October of '23. We've continued to do early days of marketing in the -- for the building, originally doing virtual presentations to brokers and tenants. And recently, we've started to see tenants come back to the door to do physical tours. We've got 2 large proposals that are on the table that are being -- or proposals are being exchanged with prospective tenants. Both of those are tenants that emerged post-pandemic, and they are large tenants that are looking past the current disruption and planning for occupancy 3 years down the road. So it's still the best building in the neighborhood. It's going to be, like One Vanderbilt, transformative to the neighborhood. It has the rare commodity of large floor plates in a popular part of town where there are very few buildings with large floor plates, and it's going to have all of the modern infrastructure of new construction. So it's going to hit the market, I think, actually at the perfect time because, as I was saying earlier, there will be pent-up demand as businesses took a pause on some of their leasing currently, and then they're going to look down the road in the not-too-distant future -- 2, 3 years down the road -- and say, it's the right product for us.

And these are tech tenants, I assume.

They are both technology and financial.