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

Great. We're here at the 9:00 a.m. session at Citi's 2022 Global Property CEO Conference. I'm Michael Bilerman. I'm here with Manny Korchman. We're pleased to have with us Marc Holliday from SL Green. This session is for investing clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available up here and on the webcast. For those joining us in person, you can ask a question just by scanning the QR code during the live QA and those online can simply type them in, but come directly to Manny or me. And anyone feel free just to step up to the microphone. Marc, I'll turn it over to you to introduce Matt and the company, and then we'll turn it over to Q&A. I know you have some opening remarks to make.

Okay. Thanks. Good morning, everyone. I'll keep the opening quick because I want to get into a couple of things. First of all, to my left, Matt DiLiberto, my trusted CFO of many, many years, who I'm sure is familiar to many of you. We are happy to be back and after a 1-year hiatus last year, credit to Michael, Manny for pulling off something that I'm sure was logistically not so easy, but something that I hope marks, among other things, a turnaround in getting back to normalcy. A lot of good things to be talking about this year. I've got a little slide presentation that's up on the web or maybe some of you have in front of you. I'm just going to reference off of it as I go through some things that are fundamental to where we see SL Green right now at this point in time. And in no particular order, I think one of the big things you'll see as part of this comeback is adapting to a changing workplace pattern. There's definitely a shift underway in how the workplace is designed, how it's viewed, how it's utilized, and how I think tenants and employees feel that it must be outfitted and built and designed in order to be competitive for this new environment. It used to be very heavy workplace centric, a little bit of amenity just to check the box, I'd say, over the past 5, 10, 15 years, then maybe from 2017 to 2019, the amenity really started to overlap and creep into that workplace in a minor but an important way. And now over the past 2 years, there is complete convergence of amenity workplace such you have buildings and tenant spaces that are really lifestyle-oriented from the moment you walk into the moment you walk out and hit on all the major categories and food groups of health and wellness, food and beverage, media spaces, social spaces, collaboration spaces. And people are testing, they're experimenting and they're seeing what works and what doesn't in order to create environments that I think are most conducive to not only bring people back to work but having people feel they're maximally productive that they want to be there, that there are things being offered in the workplace that can't be had remotely or elsewhere. And these things work. I mean we did it as I think, a good example of what can be done in our space is at One Vanderbilt, both in the building with Vandy Club and La Pavillon restaurant and in the space itself with cafes turning out all the workstation seating out to the window front, putting all the offices on the interior core things like that make an enormous difference in how people, I think, perceive the [ arc of a workday ] and I think people have responded well, not only to what we've done at One Vanderbilt, but also as we've carried that thesis out at 100 Park Avenue where we have Park House, 420 Lexington, [indiscernible] beautiful space at 420 Lex was served as our headquarters for many years, turned it into a new state-of-the-art conference center, I think now is among the best [ conference centers ] in New York City and things that we're doing at One Madison by bringing Chelsea Piers to do a 60,000-foot health and wellness and food and beverage program at One Madison on a long-term lease, only the second location in Manhattan for Chelsea piers. We also have a major focus on development and redevelopment. We have about $3.25 billion of development underway and yet we only have to fund about $125 million of equity left to complete those projects. Those projects will be able to best incorporate the things that I just spoke about in terms of convergence of amenity and workplace, like One Madison, like [ 7 ] Day, like the job we're doing for [ pace ] and like 760 Madison, we're doing a big job for Armani but also we're doing major redevelopments. There is 3 projects, happen to all be on Third Avenue. So we're Third Avenue is where we have not our only but are really one of our few pockets of vacancy. So we're taking 919 Third, 750 Third, 885 third, Lipstick, doing substantial repositionings of those projects at a sort of best-in-class level for today's -- for today's demand and not spending a ton of money because the buildings have already been repositioned. So this is kind of a secondary positioning for each, but this is really putting programming and amenitization and health and wellness into these buildings that I think will make them among the best buildings on Third Avenue. For those of you that were at December investor conference that we held back in I don't know, first week in December of 2021. You'll recall I mentioned a transition of our investment strategy to an asset management approach. I do see investment opportunities coming our way. We have not been a net acquirer over the past 3 to 4 years, like we were over the prior 15 to 18 years. But as a result of this movement in the market and low interest rate and increasing demand, we do see a couple of unique opportunities. I think you will see us, if not be a net acquirer, be a material acquirer in this market in 2022. But whereas in the past, we might have owned 50% to 100% of the equity in those projects. I think you'll see us more in the 20% to 25% range with a bigger focus on conservation of equity for stock buyback, debt pay down, development or redevelopment, and also we'll be increasing our marginal returns through fee enhancement even more so when you express it over 20% or 25% of the equity as opposed to 50% or more. We are also diversifying the platform going into this time period. I think some of the best examples of that is the incredible global success of Summit One Vanderbilt. For those of you that haven't yet seen it, I would urge you next time you're in New York City, go see it. It is an amazing, amazing experience that's only been open since October of last year and has already moved to sort of the top of the list of must see, must do attractions and experiences in New York City, not said by me, but by all the different opinion makers out there that talk about what to do when you come to New York City. Summit Vanderbilt has become sort of a bucket list must-do item. It has -- I was there -- well, I'm there almost every day. But I was there a couple of nights ago and you could hear every language being spoken and everybody gets dressed up to come there because it's very photographic and Instagramable. People who are doing wardrobe changes in the bathroom coming back out, laying on the floor, doing all these crazy kind of very unique photographic experiences and sound experience and people are coming back multiple times, 2, 3, 4 times is not uncommon.

I'm sorry that my kids were lying on the floor and jumping up and down.

That's all right. We're very embarrassed -- it didn't cause any damage. But it's -- whether from kids to teens to the Gen Xers all the way up to some of the adult audiences, everybody comes, everybody loves it, it is a good time. So Summit's doing great. We're also -- Le Pavillon has been kind of a runaway success with Daniel Boulud we figured out just a great secret. It was not a secret for him, it's just endemic to who he is and what he does as a level of -- high level of culinary excellence and service and great design. And as a result, the waitlist is 200 to 300 people on any given night. And that's -- and like not a lot of people are back in Midtown right now and yet we're achieving that kind of success. Everything we're doing, we've -- Matt, do you want to talk about quickly the ESG?

So our ESG focus actually began long before it was [ involved ] to do so in 2007. We continue to get a lot of recognition for our efforts in the slide deck that's available on our website. You'll see some of the accolades we've gotten even early part of this year from all of the major rating agencies. And we -- from a capital perspective, are able to save a lot of capital in this environment, people are focused on what you need to do to bring your portfolio to today's standards because we've been investing in the portfolio over that 15 years into the things that are most in focus and needed today. We don't have a lot of significant capital other than into our development and redevelopment projects to bring us to today's standards. So very proud of the efforts, the sustainability ESG team have done. And then just this morning, on the G side of ESG, we did add another independent director women, Carol Brown, very pleased to welcome her to the board. Should be a great addition.

So I know this morning is all about Q&A, which we'll get to. I just want to say for all those reasons and more, we are investing in ourselves substantially. I think we are rounding out a $3.5 billion stock repurchase program that has been value accretive, earnings accretive, and most importantly, I think the best investment opportunity we've had through most of the past 4 years or so that we've been doing it. We intend to continue doing it, and it's great to have that as one of our investment options, if you will, along with development, redevelopment, debt retirement and some new acquisitions along the way. Most of all, we're going to subscribe to Eric -- new Mayor Eric Adams theory of get stuff done. Get stuff done. GSD. We've got 18-or-so goals and objectives for the year. It's only 2 months into the year, but you saw with the leasing release this morning. We're well on our way to meeting some or more of those objectives, and we are optimistic about the balance of the year ahead of us. So with that, Michael, I'll turn it back to you.

Right. Well, thanks for that, Marc. [ We've been ] starting each of these sessions asking each CEO what would be the top 3 reasons an investor should buy your stock over any other listed REIT.

Stock buybacks, One Vanderbilt, Summit.

Okay. You talked about changing workplace patterns. And while our [indiscernible] spaces, how do you think about funding the cost of that? And how much of that is -- well, just as you redevelop these buildings and the changing workplace needs, a lot of that is redoing space. And so ultimately, it has to come from someone, either the tenants paying for it or you're going to pay for it. And do you think you can get that back in the rent when there's so much vacancy in the marketplace, how does that all sort of work. And while you have to make the improvements your buildings are at the top of the market, how do you ensure that the return on that incremental capital is creating that shareholder value.

Okay. So there's a couple of different things in there to unpack. I mean first, where is the money coming from? It's coming from an extensive asset sale program that we implemented back in 2017 or so, probably a little before than 2. But I think just in 2021, these are I'm looking at [indiscernible] 7 asset sales that were just office asset sales for SL Green, just in 2021, all which generated -- or most which generated sizable gains, sizable net equity into the company and all achieved at very low accretive cap rates such that our cost of equity, notwithstanding our equity multiple in the public markets, our cost of equity as it relates to harvesting monetizing mature non-core assets is very, very low, and it makes it very lucrative and profitable for us to be able to recycle that money, whether it's into the buildings, as you were talking about for either base building redevelopment where I think you get the best bang for your buck because on those redevelopment projects on Third Avenue that I was talking about, as big as those buildings are it is substantial as those programming is. We're talking $50 to $100 a foot on assets that are typically valued at $1,000 a foot or more, and we're only making that kind of investment every 10 to 15 years. And so you get to amortize these costs over a fairly long period of time. In general, we think the kinds of improvements we make are moving the needle on rents anywhere between $10 and $15 a square foot depending on kind of for the midpoint, a little less on our lower rent buildings in the 50s and 60s, a little more on our higher-priced buildings that are triple digit and above. But in the building that's $80, $90 a foot, I would say that $10, $15 foot is accurate. Then there's a lot of capital going to tenant concessions that is not quite as lucrative as the base building expenditures. But that we have to do to meet the market. And because you have this anomaly where whether you're doing $60 rents or $125 rents, the cost of the concession packages are reasonably close. It's not linear. We -- the strategy behind the paring down of these buildings is to move away from the lower rent buildings and into the triple digit and above buildings of which we have at least 6 or 8 that meet that profile now and more to come after redevelopment. And there, the return on those incremental invested [indiscernible] dollars sustains itself and meets our investment thresholds.

What's the current discussions you're having with corporates, you announced some leasing activity this morning and sort of compare where we were sort of in New York in late October, early November, we came off Delta. I felt like the city and certainly the offices were getting busier and then we went through this Omicron [ low ], do you feel like it's accelerating in terms of tenants coming back into their offices? And is that showing up too in the leasing discussions that you're having?

Yes. I would separate leasing and leasing discussions from the tenant back in the office. They -- for us, our experience has been that they are completely disassociated if you can imagine, that people who are making commitments of space now and planning for space now, 10, 15, 20-year commitments are not guided so much by what percent of the people are back in the office in February of 2022. I rarely see any connection there. There's -- from a longer-term viewpoint, many, many of these companies in the tech industry, finance industry, health-care-related industries, all the building support services are making lots of money. There is -- the economy in New York is very, very good. The big 5 banks are making record profits. The Wall Street profitability in 2021 was like the second best -- maybe the third best of the year with 2020 being the second best and I think 2000 and coming right off the great recession being the best. So 2 of the best years in the past 20 have come in '20 and '21 in that same point. Also technology firms have boomed over the past couple of years and proliferate in New York City where right now, they are -- make up almost as much of an incremental demand category as does finance and then life sciences, health care, et cetera. So that part of the market was very strong through us throughout 2020. I think we leased over 2 million square feet, if not. And we're projecting 2 million square feet or more, which, for us, on a smaller portfolio, I might add, than we've had in the past [ close ] of these divestitures is a lot of leasing for us. And our average rent has elevated through that leasing. In terms of physical occupancy back in the building, that peaked towards the end of last year, then it went way down in Jan-Feb as a result of winter and Omi. And then now it is coming back very strongly in February into March, and we expect to see most companies back to whatever their new normal level is by April, May of this year.

Well, and that new normal, I think, is a big sort of question mark. SL Green has been an in-office company, I think from the second week of the pandemic, 100%. And I recognize that your views are maybe a little bit contrary to corporate America, right? And I can remember in that April call, right? I mean none of us sort of knew things, what about your confidence of people returning. We're now sort of 2 years into this work-from-home hybrid environment. The employees seem to like it, right? I think if we were pre-pandemic, and I told my team, hey, you only have come in 3 days a week, they'd be like cheering, right? Oh, my god that's great. And now I tell my team, like, okay, you have to come in 3 days. It's like, we do you mean I got to come in 3 days. So it's changed pretty dramatically. What gives you the confidence that work from home, hybrid, less days in the office is not going to affect the office market overall. So let's just talk about, I guess, what we're seeing and what we're hearing, and I can give you a sense of how I think the effect of the.

Yes. I think I want to make one point since you targeted us specifically as being unconventional, bringing people back to the office. We actually just got our great place to work certification on Friday and handily beat the normal standard. We got 84% of our employees who have been 100% in the office 5 days a week, no exception. Since June of 2020, 84% of them said is a great place to work. The standard is 59%. That's what it is normally across other companies. So for those who said I want a little bit of flexibility, I mean we do provide flexibility, but we are 100% work from office company. For those who moved on to find flexibility somewhere else, it's been incredible to see the demand from employees who said, "I need to be back in an office, my employer for whatever reason, won't let me back in. I'm coming to work for you because you'll have me here. It's been astounding and picking up pace dramatically recently as we've been able to fill turnover in a matter of days.

I think that's an important point. I mean I think it was a very healthy routing out for us that we had more turnover probably in the past 24 months than we had in the past 22 years or 24 years because this is our 25th year. But it still only amounted to less than 10% of the company, and we were able to replace them, I mean, almost immediately with very talented people who are ambitious and want to be at work and want to learn and want to rise. New York is still a very -- it's still the best of the best in terms of, I think, the workforce and the diversity of the workforce and the ambition of that workforce. And I think there's a recognition amongst employees who may like the sound of a 3-day or 4-day work from office week, but also recognize that you are giving something up. I think people use the word balance today, balance is a big buzzword. That balance to me means making concession and giving something up on the work and for something on the personal life and -- which is fine, and that's a personal decision. It just, I think, will make those companies or people less competitive on the margins. I was on a panel 2 or 3 days ago with our biggest financial companies and our biggest tech user and there was me. And these are normally very collegial, but we sort of got into it over this issue of the merits, the pure merits of work from office, I know we couldn't achieve what we have done over the past 24 months if people were taking a day or 2 and mailing it in from home. I don't care what people say but I'm so much more effective when I'm working in my bedroom, et cetera. I just -- for the kind of work we do, you got to be on the job site. We open and service and secure 30 million square feet of office every day. I try to make it a mandate for all my managerial level people to take breakfast, lunches, dinners to create and foster new relationships. Le Pavillon has become like our extended work hub forget about 5 days a week from office, I want 5 nights a week from Le Pavillon. We're going to use that in the next company [ launch ] because a lot of business gets done in Le Pavillon stays so it's just everyone's got their own philosophy. I meet business leaders who subscribe to a strong work-from-office philosophy, other business leaders who I think, kind of rationalize well, we can do okay in a less than fulsome work from office environment, but I think the results will speak for themselves over the long term. And if a 4.5-day work week as a result of pandemic moves down to a 4.0 or 3.9 work from office work week. It won't impact the footprint in any material way. So that's the bottom line. I think to your question, Michael, is how is it going to effect? I think there's going to be 0 effect on a company's footprint. We've seen that in the 2 million square feet we leased last year and the $2 million we expect to lease this year, that -- whether it's 3, 3.5, 4, 4.5 days work from office, I don't think the footprint will just. And if anything, the footprints have gotten dramatically looser as a result of this, what I opened up with, the requirement to converge [ amenitization ] into the workspace in order to create a great environment.

Thanks for that, Marc. There's a bunch of questions in the live QA queue. We've only have a few minutes left, so we're going to try to fly through these. With the $1.5 billion CMBS Deutsche Bank headquarters deal being delayed due to potential market weakness. Have you encountered any financing pushback for similar reasons with any of your properties?

No. We -- spreads are out a little and the [ indices ] are still holding pretty steady. Spreads have gotten quite low that we were at historically low interest rates. I think those spreads are up a bit. But beyond that, in terms of the availability of that capital for some of our larger refinancings that we are currently involved with I think other than a 1-week or 2-week pause in and around the current global events in Russia and Ukraine, nothing to do with COVID, obviously, or work from office or work from home debate I still think there'll be plenty of availability of capital maybe 15, 20 wide, maybe not of historically low rates. And if there is any kind of pause that Deutsche or others are having, I don't think that pause is more than measured in days or weeks.

Maybe backing up a second, just can you tell us your views on the supply outlook in New York City more generally at this point?

I think supply is relatively balanced right now, certainly in terms of what's coming online in the next 3 to 4 years. There's always a new host of projects that are on the table for the future that I think will be more like 5 to 8 to even 10-year projects when you look at things like Penn Station or the project that Scott wants to build in Midtown East, which we welcome as any new state-of-the-art development Midtown East, I think, further serves to anchor what has become the best lease market submarket in New York right now. But there's a few projects topping out. I don't think there's going to be a lot of new spec development right now until the market vacancy and trims in and market absorption picks up so I would call it in the term that I look for the next 1 to 3 years, I think it's relatively balanced in terms of new addition to what -- to meet incremental demand. Over the next 5 to 10 years, there could be a lot of new projects slated, but you got to remember on an office inventory of 400 million feet. I have always thought if that market should grow by at least 1% a year, that's 4 million feet a year. So over 10 years, that's 40 million feet, and there's not 40 million feet programmed for that period of time, just probably half of that or less. So I don't think you're going to see a situation where the market is anyway oversupplied in the long term and in the short term, I think it's a nonissue.

And then just thinking about inflation for a second. You talked about repricing your leases every 10 years. We touched on construction costs, which are going up base rents haven't really moved up as much as inflation has and TIs have moved up meaningfully. So with all that tried to put that all in the pot, you end up with a soup that's inflationary. How do you combat that or what makes your portfolio better suited for that type of environment than others?

Yes. I mean, I think on the one hand, you've got face rents for, I'd say, the middle market and the commodity have not gone up. Face rents in new A-Class products have gone up dramatically. So I think that's where a lot of the action is. And so there's definitely a secular push into well-located Class A [ amenitize ] new or substantially redeveloped buildings. And for those buildings, there is rent increase, and I think we're showing that in our results. For everything that's not that, and I think the rents are a bit flat. But because our portfolio is so heavily weighted right now to new development and substantial redevelopment and great amenity programs, we've been holding our own as a net beneficiary there in terms of how we've seen that market play out. And I think that will only get better coming out of COVID as what I see and more importantly is what New York City projects as substantial incremental office using demand, new jobs being created in '22 and '23, create the need for more office and then expansions and then turn the clock back on vacancy rate getting back towards hopefully an equilibrium in the next couple of years.

Marc can you talk a little bit about -- you talked about this asset management platform, generating more fees and leveraging the scale of SL Green. Obviously, you've done a lot of joint ventures and you've bought from them, you've sold to them and then you've bought back. There's been a lot of activity and you're always constantly going. How do you think about -- are you thinking about selling more of your assets into a fund like structure? Or are these going to be individual joint ventures versus how much of it is going out and buying the next trophy building with a small amount of your equity leveraging OPM?

So just to finish out comment that Manny made I just want to point out, the market vacancy in New York City is around 17%, 18%, and we're 94%. So I think that in terms of the point about how is SL Green's portfolio differentiated, I think the numbers speak for themselves that if our vacancy is 1/3 of the overall market, then obviously, we have a portfolio that's been positioned in a way to warrant that. Putting my personal feelings aside, that's what the market is telling us, and we're pleased about that. In terms of the asset management platform, I think we're going to take very much a separate account kind of approach, not a fund approach to the way we would do it because there is one thing I think we've seen over the past 5 years as we've accelerated our private equity investment platform, which coincided with a stock price multiple and stock price itself that wouldn't allow for us to look at issuance of public equity as a viable source of capital for new acquisitions. It's very clear that -- this is all very custom-tailored activity as it relates to the types of investors who are looking for new versus old, high rents versus high yield, trophy versus non-trophy, redeveloped [indiscernible] and the market is very conducive. We talked earlier about rents and expanding TI concessions, but you got to finish that conversation with historically low interest rates and very low cap rates, which have -- can readily offset some of the underlying market metrics resulting in asset sales we're achieving at substantial profits in this market, notwithstanding the dislocation in the market over the past couple of years. So there is heavy, heavy global demand out there, I'd say, as much now as we've ever seen. We want to be able to deliver prime New York City assets into that demand base -- the fact that we don't have a stock price or multiple that will allow us to take advantage of those opportunities strictly for shareholders. That's -- it's an unfortunate reality, we hope reverses itself in the coming year. But until then, the private equity, global equity is our best source and in order to stretch our equity, the furthest rather than own 50%, 100% of assets like we have in the past, we're looking at 20% to 25%. It has pros and cons. I mean, mostly many pros, but when we make big returns on a building like One Vanderbilt, building that we built for under $3 billion worth over $5 billion now, I want as much of that as possible for our shareholders. And in that case, we have 70% of that asset. We have a great partner who came along and benefits from the other 30% of that gain but however, we don't want to miss opportunities right now at a time where we think there's going to be a couple of interesting buys out there. So we will go with its different formula and try and scale that business because now we have so many domestic and foreign relationships, looking to invest with us in these markets that we feel like we have to take advantage of it for them and for our shareholders.

Do you think -- I mean, in your sort of NAV, right, it's a $475 to $525 million cap. Stock is trading, I think, in the mid-6s. What would you go out and buy even it was with your equity, what's the right cap rate that the capital partner together with you is buying? I mean if it's not 5% at the midpoint, then isn't effectively market where they're buying?

Yes. We have a -- one of our more interesting slides in this deck is the implied net asset value slide, which has a 7.1% implies. I mean the sort of amazing, what we sit back and look at, I mean, again, these are how we strat these numbers, but we are slaves to NAV. We mark our portfolio to market almost like daily. I mean, we believe and we have our finger on the pulse of value of our underlying assets and 500-or-so $500 or so foot of implied asset value in a market that routinely is $800 to $1,200 a square foot as we illuminate time after time through our asset sale program through 2020, 2021 and now into 2022. But with that said, what's the right number? I mean everyone is total return driven. I know this audience tends to look a pretty insane focus on cap rate. The private equity world has an insane focus on total return. And I think that total return for good assets today can be anywhere between levered 6% to 9% for the right assets that have been fully repositioned.

Right. I know there's a lot more questions. So we're going to come to your office in person. We will invite everybody to go up to the top. I'm going to [ throw ] rapid fire here. One word answer. Same-store NOI growth for the office sector in 2023.

Yes. Same-store, 1% to 3%.

10-year treasury a year from now?

Sub 2.

Property sector office, have more or less public companies a year from now?

Property office. I don't know how it could be more. So I'm going to go less.

All right. Thank you very much.

If he didn't, I was going to answer.