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

All right. Good afternoon or good morning, everybody. Welcome to the SL Green Realty Corp. 2022 Nareit presentation. I'm Tom Catherwood, Senior REIT analyst at BTIG. And I'm excited to be here today with the team from SL Green. Up here with me is President, Andrew Mathias; CFO, Matt DiLiberto; and EVP, Director of Leasing and Real Property, Steve Durels. Gentlemen, thank you for being here.

Thanks, Tom.

So obviously, a lot to cover, a short period of time, so I want to jump right in. Andrew, if we had been here 3 years ago, the last time we had an in-person Nareit in New York, company was very different. You've done more than most, if not all other office REITs as far as adjusting the strategy, the portfolio and the platform to meet shifting needs of office tenants. So maybe to start, what's changed and where is SL Green right now?

Sure. I think we've completely retooled our strategy for the post-pandemic world, which we're in now in New York City. And I would say we're a smaller company. We're a more nimble company. Our company is a lot more concentrated in a smaller portfolio of properties. We've significantly reduced the size of our debt and preferred equity book, to raise a lot of liquidity, to take advantage of opportunities that may present themselves in the rising rate environment that we're currently in. And we've done an enormous amount of leasing in a credit to our leasing and -- run by Steve and our construction and operations team, which have been busy completely retooling the buildings we own. So we feel like we're a company that's very well positioned for the market environment we set in today. Our properties are generally highly improved, generally sit at the very -- most desirable submarket, which is Grand Central, and Midtown South is the core of our portfolio. That's where we've seen the most leasing activity in Manhattan coming out of the pandemic. It's where we would have expected to see the most activity. And in fact, it has been. And our properties are generally highly improved because we've gone ahead and amenitized many of our flagship properties in response to tenant demands and sort of retooled the company to meet the hospitality requirements of today's tenant, which is more intensive, more food and beverage, more fitness offerings, more sort of a holistic approach to the office than just rows of cubicles and sort of the densified office of the past. And we see tenants starting to enact that business -- that floor plan across our portfolio, and we've adjusted our business plan to meet those requirements.

So there's a lot I want to touch on there, especially when you mentioned kind of pivoting and changing. But maybe to start with, you mentioned the leasing activity that you had. And that's one of the dichotomies that we see, is that we hear the negative headlines, and we see some of the data of what's out there, and yet 2021 was an active year. First quarter was active and everything from your new developments One Vanderbilt [indiscernible] to your existing portfolio on Park Avenue and Sixth to even the redevelopments on Third. So I guess, with that in mind, what's driving that demand? And how does it look today in your portfolio?

I think really driving the demand is the fact that the statistics from Manhattan are across 400 million feet, but within our submarkets where our properties are occupied -- are located, occupancy is stronger than sort of the overall market statistics would imply. And what's really driving that demand is the fact that we've made significant improvements in our properties. We've sold the bulk of our noncore properties. Exciting announcement on 609 Fifth yesterday for us where that was a property -- we redeveloped the retail, leased it to [ PUMA ], sold that off at the beginning of the pandemic to the Reuben family. And then did a lease with WeWork for the upper floors of that building. It was one of our only WeWork leases. They did in at least -- they put significant capital investment into the building and then decided they weren't going to occupy. So we did an agreement with WeWork, where we took back possession of the space, got quite a bit of consideration from them per our contract with them, and we're able to sell it of $720 an office foot or about $1,000 a residential foot and that building will likely be converted to condominium. So I think the great part of Manhattan in sort of the life cycle of real estate is if there's not an office use, there's another use, a school steps up, a hospital steps up, a residential converter steps up. It's a very dynamic market, and you see sort of spaces go to their highest and best uses all the time. And 609 is a good example of that. So I think that's driving a lot of the demand is the capital that we've invested in the properties and where our properties are located specifically.

And you made this comment about the leasing demand in Grand Central. And I guess, again, bringing up dichotomies yet again, the message we hear time and again is everything has moved west and south. That's where demand has moved. That's where tenants have moved. Is that wrong? Or is it just -- are you seeing something different? Is that just big block space? What are those dynamic changes that are bringing demand back to Grand Central, I guess?

I think the financial firms are generally back in the office a little bit more than the creative industries, the medium technology firms. And they generally have been bigger consumers of space during COVID. And those financial firms, their primary location is the Grand Central submarket. They want to be close to Grand Central for their commuting population. And the Hudson Yards on the West Side was a great alternative for new construction at a severe discount to core Midtown, but that space is generally pretty much absorbed. And those that have the choice, if it's not a price issue, are generally going to choose to locate in Midtown East.

And obviously, we have the Grand Central access for LIRR coming up to near-term benefit?

Hopefully, very near term. End of '22, it's supposed to open Penn Station going directly into Grand Central. So that will bring another 100,000 commuters or so a day into the Grand Central network.

So obviously, leasing has been strong last year, it's been strong this year, but workspace patterns are changing, right? You kind of led into it that tenants have different demands for their space. You've improved many of your buildings, but are there risks within your portfolio for how some of those tenant demands are changing? And how do you address those if you haven't already?

Steve, do you want to?

Well, there's a couple of things to note there. One is we've got a big portfolio. So we've been able to work with tenants to move them around the portfolio if the space that they're in, the building they're in doesn't work for them today. Secondly, from a risk perspective, we're pretty -- we're very proactive about understanding exactly where our tenant needs are so that we try to get ahead of it 12 to 24 months in advance of a tenant making a decision. So at the depths of the pandemic, we were working with everybody with an [ expiration ] that was expiring 3 to 4 years out to either do short-term or medium-term extensions. And then as we've come out of the pandemic and tenants have started to realize exactly what their own requirements are because the reality is many businesses are still quite frankly, [indiscernible] is exactly how much space they will need as a result of a hybrid work environment or some level of work from home. But what they do know is that they want to be in buildings, as Andrew was saying, that are upgraded to be a healthy work environment that are amenitized. And they're certainly favoring convenient locations, which is the silver lining for us of COVID is it's brought a lot of emphasis back to the Grand Central submarket. So when you asked earlier about this belief that there was a shift towards the West Side, that was purely as a result of that's where the product was at that moment in time. And the best counter to that is to see the leasing success at One Vanderbilt, right? One Vanderbilt is kind of the poster child for what tenants want in today's world. It is efficient workspace. It's highly a healthy work environment. It's very conveniently located on top of Grand Central. It's highly amenitized with a 30,000 square foot amenity floor. So it checks all those boxes. And oh, by the way, did the majority of its leasing through the COVID period. I mean just think about that. So the headlines that you're reading, which is there's this big disruption in the leasing market, but for the right product, even through the depths of COVID, that's where we've had some of our greatest successive leasing provided that we have the right product for it. West Side enjoyed their moment today because that's where the product was. But now, it's more of a struggle in downtown. Forget about right now, because of the inconvenience of location. So if you can combine all of those attributes that I was talking about and put it in a Grand Central location, then it's the -- wins the day.

You mentioned it a couple of times, amenities, the offering, obviously, at One Vanderbilt you've rolled out. It's not just amenities, but it's a whole hospitality team. You're rolling out the same program at One Madison. But is that -- does that just fit in with new construction? Or does that fit in with the Graybars of the world, the 885 Thirds of the world? Is there a spot for that in the rest of your portfolio?

Yes. So I think there's this misnomer that the only leasing and the only thing that works today is new construction, which is not -- that's just simply the best example of it. But there are also plenty of examples of 40 and 45-year-old buildings that are being repositioned to meet the market. And provided that the bones of a building that you can create something special, and you have a forward-thinking owner with a vision for a property, then you can have equally strong leasing success. We're fortunate that we spent a lot of time over the past years, whittling down our portfolio to our -- really a portfolio of best quality products. And we are upgrading or have upgraded many of the properties to meet that demand. Good example is being even a Graybar building, which is a [ prewar ] building. Recently opened up an 18,000 square foot conference center, and that single opening is already paying off dividends with an uptick in our leasing pipeline for Graybar. And that's a lower price point building but sits on top of Grand Central terminal services small to medium-sized tenants. But then go to 750 Third Avenue or 885 Third Avenue [indiscernible] building or 919 Third Avenue, same story. Sometimes it's as small as lobbies, mechanical system upgrades and some level of amenitizations. And other times, it's a bigger project like a 750 Third Avenue where we're doing all the way to new windows and [indiscernible] and things like that, that are making a bigger statement in the market. But you can absolutely take an older stock building, bring it to current day demand, that's not going to be for tenants that want to pay $150 a foot, but within their place in the market, elevate that to the highest part of the market that we compete against and get leasing success.

I think there's a real trichotomy of pricing, as Steve points out, which was new development, which is amenitized and which is sort of -- you have real pricing power in older buildings that are amenitized where you actually have a little bit of pricing power because of the offering. And then the commodity space, which is -- we don't really own any of it in a portfolio, fortunately, but buildings are really struggling with large blocks of vacancy that the owners either don't have the means or they haven't yet come to the realization that they have to make that capital investment.

And I think that's the interesting difference between 3 years ago and, again, when we think the last in-person Nareit, right, is what you've done there back then, we would have been talking about taking advantage of the public market, private market arbitrage, selling assets, buying back stock, One Vanderbilt. As we sit here today, obviously, we're still talking about new construction One Vanderbilt. You're still taking advantage of the public-private dislocation, like with 609 Fifth, but you're doing more repositionings, you're rolling out the amenities to more buildings. And it seems like now you're even at the point in time where you get the inflection point where you can grow the portfolio given certain opportunities through acquisitions. What do you think as far as that opportunity set to now add to the portfolio, not just through new development?

Well, 450 Park, I think is a great example of the type of opportunity we're targeting. There was a point in time in the market where the debt markets were seizing up and a lot of the higher levered buyers shied away from the bidding process because they couldn't line up financing and time to go commit to a contract. It was an asset we've tried to acquire twice previously, both times got beat out in a bidding process and was available with a motivated seller. And it turned out to be a great sort of cornerstone start to our new focus on asset management. We're going to be a 25% equity partner in that building. We're going to put on 60% bank leverage, which our partners require. And it's a flagship asset on Park Avenue that has not -- the previous 2 trades were actually at higher prices than the price we purchased the asset at. So there are opportunities out there, we believe. And we think that, that environment may get even more target rich as we sort of leverage our contacts worldwide to raise equity capital partner with us and go out and grow the size and footprint of the portfolio again, without really growing the equity base of the company, which we've worked very hard to shrink down through the stock buyback program.

So and this ties into what you mentioned at the Investor Day last December was this pivot towards asset-light, more institutional partners, utilization of more JV structures. You have a lot of those relationships from the JVs that you have in place. What are the next steps to building out that institutional investment management platform? Are they underway today?

They're definitely underway, and I think you'll see us start to do debt deals through that asset management platform as well. We're getting a lot of inbound calls from people to recognize our special servicing program and know of our previous debt experience. And they want to fund us to go out and make new investments, fill some of the gaps that are out there in the market today. So we're actively evaluating the pipeline for that business. And as we close 450 in the coming weeks, we're going to turn our attention to new opportunities and new investments we see on the horizon as we continue to evaluate. So I think you will see us continue to lean into that program, both on the equity and the debt side. It's going to lead to higher ROEs for us. It's going to lead to a bigger, better footprint of high-quality assets. And at the end of the day, we think it's a more efficient way to run the business.

So you mentioned the opportunity to potentially add more assets in the near term. And I know it's lumpy and it can be opportunistic. But have you seen interest rate pressures and the dislocation in CMBS driving some assets into the market? And/or are you seeing it change either bidder pools or pricing and the kind of ultimate cap rates that people are achieving on their assets in Manhattan?

I think it's really still playing out sort of real time. I mean, the CMBS market is not functioning very well. There's not a lot of cash buyers for AAA bonds these days. So we're definitely happy to have the bank relationships we have and have the liquidity of a market like New York where we can turn to the banks when the CMBS market is not as efficient versus bank financing. The biggest question in every buyer's mind, every owner's mind is where the short end of the interest rate curve is going to go. The forward curve projects 3% for SOFR and LIBOR. In that environment, if you see 3% SOFR and LIBOR, you're going to see a lot of old capital structures come under pressure out there, and you're going to have the type of buying opportunities you're describing, I believe, because it's -- there's a lot of stress on those capital structures from rising rates. We don't see it so much today with 1% SOFR, LIBOR. But if it goes according to the curve, I think you could see some interesting distressed opportunities out there.

But it sounds like it's still too early to get a read on that volatility driving a change in asset pricing.

A little bit too early, I would agree.

So as you think about then 450 Parks, obviously, on the horizon, you -- 609 is now taken care of. How do you think about allocating incremental capital then to a variety of uses, whether it's acquisitions or redevelopment or share repurchases, what's the strategy now for that incremental dollar?

This is where I have to steal the mic. So look, you've heard us talk a lot about pivots -- leasing strategy pivots and business strategy to more asset management model. We're going to do a little bit of a capital pivot here, too, in terms of a priority shift in face of rising rates. Andrew talked about it. We gave guidance in December, we carry about 20% floating rate debt that's intended to tick up a little bit next year as we have some swaps that burn off. And LIBOR and SOFR are expected to be 200 basis points higher by the end of this year than they were expected to be back when we gave guidance in December. We need to manage the balance sheet. We've executed a $3.4 billion share buyback program, leverage neutral, very accretively, both from a value and earnings perspective. And that was, back in 2016, '17, a $500 million program intended to take advantage of what we viewed as short duration kind of arbitrage. It lasted 5 years, it's still attractive. But the incremental dollar towards debt repayment, particularly floating rate corporate debt repayment is our priority. Share repurchases are still a great opportunity, and we will still take advantage of the price when we can, but we're looking at debt maturities at the end of this year, particularly bond maturities. The bond market, as Andrew said, CMBS market and public bond market, not really constructive. We have $800 million maturing. I'd like to pay off $300 million to $500 million of those and issue somewhere between $300 million and $500 million. Do them short duration, use cash that we're getting in next year from our partners at One Madison to pay down that debt. And as we sell incremental assets or otherwise identify incremental capital, push that as a priority to floating rate corporate debt repayment.

So is the thought to line that up then with -- obviously, bond maturities are one, but the swap burn off when we're thinking of the actual timing of this? It sounds like it's more '23 or...

It's late '22 to the nearest term floating rate debt repayment that we otherwise would have expected to refinance in a floating rate fashion. Pay those bonds off and then as we get into next year, pay off more when we get proceeds from One Madison.

So when we think then strategically managing the balance sheet, Andrew, you mentioned on 450 Park taking 60% loan. Obviously, your stake in the overall project will be 25%. But is that then a pivot obviously more secured with -- especially within that investment management structure and less on the corporate side? Or is this just, again, matching floating rate and reducing that?

So this move is in direct response to rate movement. The balance sheet, as a company, we feel we're prudently levered overall. 50% LTV, which is the right measure of leverage in real estate is where we are comfortable, but as we go towards a more asset management model in a JV structure, the JV partners require higher leverage than is typical for a REIT. So we will have to balance out the higher levered JV structure with a corporate overall leverage that needs to be more balanced in a REIT structure.

Is the thought then to just add to that investment management platform through new acquisitions? Or is it also, over time, taking what are your wholly owned assets and potentially putting those into it, especially given if you have use of proceeds for that?

It's -- we've discussed both with prospective partners. Moving assets off the balance sheet. We did that with 220 [ East ] 42nd Street last year, I think, very effectively. And I think that's something we definitely look at in the future. It was a great alternative to selling that asset. We really wanted to own it. But cash flow was pretty flat and didn't have sort of the compound growth we look for in a wholly owned asset. So we were able to bring an equity partner and redo the financing on that asset in the last couple of years. That's a strategy we may definitely look at other assets on balance sheet. It will just depend on capital markets demands at the time.

So as we then think about use of proceeds, right? Obviously, acquisition, share repurchases will be opportunistic. It looks like the focus is more on the debt repayment side. But there continues to be redevelopment like 885 Third, 750 Third, there's obviously One Madison. With this growth in that capital spending, is the balance sheet positioned to support that growth? Or do you need to bring in more capital in order to make that happen near term?

We talk about a lot of projects, One Madison, the redevelopment projects. One Madison is fully funded through construction financing, right? It's actually a source of liquidity next year when our partners fund in their capital. And the other projects we're talking about are very small. So we have the capital earmarked for those and in the face of that are actually expecting to increase our liquidity by the end of '22 by $300 million more than we had projected back when we gave guidance in December. So our target is $1 billion of liquidity all times. We expected it to end around $1.1 billion. We now expect to end at $1.4 billion. So have the capital to complete the projects because it's fairly modest or already spoken for. And then increasing liquidity even further on top of that.

So One Madison, obviously, is a source of those funds.

Next year.

Next year. You've talked in the past as well about One Vanderbilt being a potential source, more of a stake there. Is with One Madison, I guess, being the near-term opportunity, what are the current thoughts on One Vanderbilt?

I think we're going to be very patient there. There's not an asset. We're happier to own 71% of One Vanderbilt and the success is there. And sort of -- we're still working on that sculpture. So there's some more amenities and features yet to open. There's a little bit more leasing to do. We actually think there -- we haven't reached the ceiling on that asset. We have tremendous observation deck at the top. We're really just ramping into full operations of the summit. We have a very successful restaurant at the base. So if we see the right offer, we definitely would part with a small incremental interest in that building, which we've indicated at Investor Day and at other times, but we're going to be very patient there. We're thrilled with the financing we put in place last July and 10-year fixed rate, 2.85%, it sort of locked away the capital structure of that asset. We have very patient equity partners in NPS and Hines, and we're going to sort of play that one based on what we see in market opportunity. That's not sort of a go-out-there-and-sell, a strategy like 609 was.

So you don't...

We may. We're not sure.

Totally fair. But you don't need that to execute the business plan that you have in front of you right now?

That's right.

Correct.

That's right.

Okay. Maybe to loop back on the leasing front because -- Steve, I just want to touch back on this. We obviously came into the year with incredibly robust pipeline. You executed a large portion of that in the first quarter. As we look forward to the balance of the year, how has that pipeline been backfilled? How is it looking as you think of kind of matching what's pretty robust full year leasing goal?

Well, we've done over 900,000 square feet of leases to date. And we have consistently maintained a pipeline between $800 million to $1.1 billion for the past 12 to 18 months. And as we sit here today, the pipeline's got about 850,000 square feet of either leases out or proposals that are being exchanged that we think have a high probability of going to lease. The good news is that as we've been signing leases, we've been successful in refilling the pipeline because there's been reasonably good velocity in the marketplace. And I think we're getting more than our fair share of deals out there because of the quality of the portfolio. In the industries that are driving the leasing have expanded a little bit with the introduction of law firms being more active today than they were a year ago. So clearly, there's 26 million or 27 million square feet of active tenants that are being tracked in the marketplace. 2/3 of that is made up of either financial services or technology businesses. But then sort of not the new kid, but the new sort of notable industry that's out there today is law firms. Whereas last year, they were very quiet. Today, there's a lot of big legal deals that are either in search or recently signing leases. So it's good to see a 1/3 [ leg ] there of industry.

We're coming up on our time here. It was really helpful, Steve. But maybe last quick one for Andrew. Given all these pivots, when we're here in person a year from now, what do you think is the biggest change?

Hopefully, people back in the office in droves. I think there's a lot of positive momentum in New York that's getting drowned out by some negative headlines. But we're excited about sort of the prospects for the return to the city. I mean, apartments are full, apartment rents are at all-time highs. The young workforce is still moving to the city in droves so employers want to be here. And as we see people, we hope, shift back to the office and the political environment shift a little bit with our new mayor. We think we're sort of set up to have a healthier environment here, keeping close eye on interest rates, as we know. But hopefully, in a year, we're talking about how we're fully through the pandemic and sort of the trend of people not commuting in and not going to offices has dissipated somewhat.

I think that's a great goal for next year. And with that, I think we'll wrap it up. Andrew. Matt, Steve, thank you all so much for being here today.

Thank you, Tom.