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

Welcome to the 8:35 Monday A.M. session of Citi's 2023 Global Property CEO Conference. I'm Michael Griffin with Citi Research, and we are pleased to have with us SL Green and CEO, Marc Holliday. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. For those in the room or on the webcast, you can sign on to liveqa.com and enter code Citi 2023 to submit any questions if you do not want to raise your hand. Marc, I'll turn it over to you to introduce SL Green and members of management, provide any opening remarks, and then we'll get into it.

Okay. Great. Thank you. And I'm going to go quick because I know time is short, a lot to cover, and we'll have some questions. So good to be back. I think 2-year high it is, if I'm not mistaken. Okay. It seems like we had at least a gap, but good to be back, and thank you for joining us this morning. I wanted to give a quick update. This has been 3 months since our investor conference when we do a bit of an in-depth market review. And these markets move quick and lots happened so I wanted to go through what's happening today. I've got a deck in front of me, and I think it's available online if anybody wants to pull it up all along, feel free. First, just starting out with New York City's economic recovery, which I think when you get past the leasing, the month-to-month leasing stats that affect our business, in particular, being office rental, the city itself, I think, is doing reasonably well and continuing its recovery and upward trajectory, measured by private sector jobs, which have recovered to about 90%, 91% of pre-pandemic. Office-using jobs are 115% of the level that they were at in 2019, which is something that doesn't -- deviates quite a bit from a 17% vacancy rate, but that's -- the reality is there are a lot of jobs out there in December and January, again, were growth months. I don't have the February numbers. We'll see, but both December and January were plus and plus on office jobs increases. And tourism ranged in at around 56 million domestic and foreign tourists last year. That's this year projected 61.5 million. So that's plus 5 million new visitors to New York City, most of those to Manhattan, both leisure and business, which puts it only about 7% down from peak in 2019. And it has a big similar effect on the New York economy. I'd also say you saw yesterday or 2 days ago, articles came out for February in terms of more advancements in crime reduction in New York City, which I think is very positive in terms of -- I think there's 7 major crime stats that they follow. They were down 6% year-over-year for February, which I think shows that the city is moving in the right direction, getting tougher on crime in the streets and subways feeling better. One of the important new developments to follow is the opening of the $11 billion East-side access program, otherwise known as the new Long Island Rail Road station into Grand Central. It's called Grand Central Madison. It opened about a month ago, I want to say. It started with service just between Grand Central and Jamaica, but now has been expanded throughout most of Long Island. Right now, about 30% or 35% of the LIRR's trains, which used to run 100% to Penn Station, 30%, 35% are now running through Grand Central Madison. And I think they expect to stabilize that number at about 45% once people and commuters get accustomed to the new commute pattern, which saves people anywhere between 40 and 50 minutes a day on their commute. It's a seismic moment for East Midtown. And for SL Green's portfolio, there are some phenomenal images of the city that's been built beneath the ground, which you can see online or go see it in person. And it affects so many of our buildings that are within a 5-minute walk of where the new Grand Central Madison Station is, we've diagrammed that in the online proposal, but it's about a dozen buildings or almost half the portfolio, a 5-minute walk from this new train station that will become one of the biggest and business commuter rails in the world from nothing, not counting subway, obviously. So we think that will have a significant uplifting effect on office in a market where commutability is probably the #1 on the checklist items for all business tenants. I'd also say office to resi conversion is a topic that's out there that people should keep their eye on has been talked about for years and years. People always said, well, it's too political, it's too complicated and not wrong, but there is so much momentum behind this effort to take secondary and tertiary office, expand the universe of what's eligible to be converted right up through buildings built to 1990, adding over 100 million square feet of potential convertible inventory, eliminating the 12 FAR cap that has constrained certain conversions and also putting in place tax incentives, meaningful tax incentives for conversion that the governor has included in 1 of her 2 bills related to this topic as part of her executive budget and for the upcoming fiscal year that begins in April. So it has nearly unanimous political support. It's really just a question in my mind of what the changes to the zoning will be and what the tax incentives will look like in the end in order to make sure there's enough incentive there to offset the cost of conversion so that estimated between 20,000 and 40,000 new residential units can be developed what I'll call fairly easily in our parlance through the conversion of office to resi. I'll end now with just a quick snapshot on our leasing progress since -- over the last 90 days, that being what we felt was a recent time period, we've done about 446,000 square feet of leasing deals that -- bigger deals that range anywhere between 20,000 and 185, 000 and 28 other transactions making up 145,000 feet for a total of 446,000. And with that done, we're obviously off to a good start for the year and meeting our leasing objective of about 1.7 million square feet for the year. We hope to end March at least somewhere around 0.5 million square feet. So 1.2 million square feet, let's call for the remainder of the 9 months. 400,000 a quarter, not a small task in this market, so I don't want to, in any way, make light of it because we'll have to really outperform and hustle and get leasing done, but at least in my mind, keeps us on track to meeting our objective for the year. Based on the pipeline that we have right now of about 700,000 square feet of either leases out, leases and negotiation or term sheets in substantial progress. So with that, open up for questions.

Outstanding. Well, thank you, Marc. I appreciate that overview. We're starting off each one of these sessions with the same question. What are the top 3 reasons investors should buy SL Green?

Well, I mean, one, stock price, I think the -- there's a lot of value, I think, that underlies the portfolio. And we've got a premier portfolio of assets. We've got great development pipeline. I think the price, as we've seen in the past 25 years of SL Green's existence tends to exaggerate on the high and exaggerate on the lows, and I think we're in one of those lows right now where in terms of our free cash flow, our dividend, our relative stability of the portfolio at around 91% occupancy with a goal to increase that by year-end to 92%. The East Side access kind of unlocking value and half the portfolio, our ability to deliver hospitality and amenity, I think, is kind of a market leader in New York City, which, like I said, top tenant checklist items that are commutability or portfolio sinks up nicely with that. Amenity and service, I think we're doing an excellent job there. Buildings are well leased in a good shape and almost all redeveloped at this point. And we've got what I think will be -- so those are, let's call it, 2 reasons, I don't know how you define that. But -- and then lastly, I think when the market settles, there will be a very big opportunity set for doing what I think we do best, which is coming into complicated situations of recapitalizations and bringing our platform and our special servicing and our market relationships to bear in order to capitalize on what will be, for sure, dislocation in the office market in '23 and '24.

I guess to expand on that a little bit, just given the headwinds the office sector is facing currently, you touched on it somewhat, but if you could expand a little bit what differentiates Green's business in terms of your portfolio composition, tenant makeup, any growth opportunities kind of relative to your competitive set?

Well, I think that locationally, East Midtown is our territory. And I think East Midtown is where you're seeing the most traction right now in terms of what leasing there is out there, a lot of it is really centered in this area, a lot of financial firms, even some tech firms are in the area. I think the whole Park Avenue spine from 100 Park on the south to, I don't know, 450 Park on the north where we have all these great buildings, we're seeing pretty good leasing demand for those products. And so I think on a relative basis, we have more of that in the sweet spot than a lot of our competitors. And I think that's only going to be aided by Grand Central Madison because you're taking -- I forget how many commuters a day, but it's over 200,000 commuters a day. That exclusively were commuting into Penn Station and now we'll have a choice between Penn Station and Grand Central. So I think on that basis, we're differentiated. Also, I think we have a kind of a unique skill set that we've been able to express in terms of the debt markets through our debt and preferred equity program. So where I think the only rated special servicer in that subset of peers that gets hired routinely today more than ever, to perform special servicing functions on SASB assets where we get a seat at the table to earn fees, workout recaps and in some cases, bring investment opportunities to our shareholders and our partners. I think that differentiates us because we're so deeply embedded in that market. And I think our focus on hospitality and service, I mean there's a lot of good owners out there that are focused in that area, but we are diversifying in ways that I think are not just areas that are trying to meet the tenant demand or meet public demand, but are really showing some thought leadership when it comes to great restaurants, like Le Pavillon and Joji were great immersive destination experiences like SUMMIT, which we project will do over $100 million of revenue this year and only a second year of existence and is frequently sold out very successful. And we've got plans there to expand SUMMIT, both within One Vanderbilt and then globally. So I think that's a bit of a differentiating factor. Our -- just our work ethic, I mean, everyone works hard, but we're 5 days a week in the office. Still unchanged doing -- working very, very hard to try and keep everything well leased, stabilized to finish out One Madison, big project, 1.4 million square feet, which right now is 6 weeks ahead of schedule and $60 million below budget.

We've had a couple of questions in for our -- coming in from our live QA feed. [Operator Instructions]. Are office tenants taking more or less space when their leases expire? And do you think -- where do you think long-term office utilization rates shake out at?

I think the trend right now and what we hope to try and see is to have tenants maintain their existing footprints. We have some expansion, for sure, that's occurred throughout the portfolio. But I would say it's offset more by tenant contraction. So the way we're going to maintain our occupancy and go forward is not necessarily by net absorption in the city because I don't think we're necessarily going to see net absorption in '23. February was obviously a tough month, but the first quarter is always a bit slow. And I think the real telling signs will be April on into July and then again from September to year-end. I mean that's when we do the bulk of our leasing. Our pipeline indicates it's pretty good. So how we're going to sort of meet this market is by bringing other tenants into our portfolio through consolidations, which may be consolidations that are at equal space or even if there are consolidations for less space, what we care about as they end up in an SL Green building so that our properties stay above 90% occupied. And at that level, we're in great shape regardless of the trend for some tenants towards downsizing space because of primarily remote work.

And then what percentage of your portfolio would you characterize as Class B in which you would need to put more CapEx in order to stay competitive?

We don't -- I don't have a Class A, Class B designator, so it's -- whoever asked that question, it's a tough question to answer. I mean we've got -- every year, we're a big seller of assets every year even through pandemic, we sold quite a bit of real estate always somewhere between, I want to say, 1 and $2 billion a year consistently. And that goal for us is true again this year, whether it's outright sale or joint venture. I would say that there are certain assets that we look to either sell entirely, which don't fit the business plan. It doesn't mean the Class B assets. It just means we don't see the risk reward for us in terms of investing more capital given the earnings growth potential, but that could be on Class A or Class B assets. Obviously, the portfolio size-wise, revenue-wise, is weighted now more than ever in our 25 years as a public company towards irreplaceable high-grade assets like One Vanderbilt, One Madison, 245 Park. I've got a whole presentation in here about what we're going to be undertaking starting in December of this year for basically a $200 million redevelopment of that asset to be what I think will be a world-class Park Avenue asset to line up with our other holdings like 450 Park and 280 Park and obviously, one Vanderbilt and 100 Park and other assets in and around that area. So we've got great assets like 1515 Broadway and 460, 150. So I don't know percentage-wise, but I could say it's -- here's what I can say with confidence. The portfolio today with One Madison is monstrously better than it's ever been in the past.

Maybe just on the transaction activity and the capital allocation plan for 2023. I think you highlighted during your Investor Day targeting about $2.5 billion of disposition proceeds. Is there any way you can take advantage of distressed deals you're seeing in the market as it relates to your disposition program? And then can you comment on any expectations around buyer interest, valuations, that sort of thing.

So I'm going to turn it over to Matt DiLiberto, who I'm joined here today for all of you in the room and not in the room. Our CFO for another 3 years per the 8-K this morning. Matt is not going anywhere. We're not letting him out just like we don't let tenants out.

I said it was in comments this morning until 8-K filed this morning.

So we filed about a minute before his talk and he can sort of go into detail on where we stand on the disposition plan for the year.

Yes. So as you noted, we put out an ambitious business plan back in December, $2 billion plus of dispositions, $2.5 billion of debt reduction and a $500 million mortgage maturity just to throw that in. And please report that's all going well, only 2 months and a week in. The $500 million mortgage financing, that's 919 Third Avenue. Everybody here knows well. The financing markets are tougher today than they have been in a long time. The conventional financing for this asset would have been a 10-year fixed rate CMBS or Lifeco execution. That's what's maturing. Those markets are very tough today. It's bank financing, and it's -- banks are more likely to say, no, these days than to execute. So it's all about sponsorship and property, and we are advantaged in both at 919, so feel good about getting that refinancing done at its existing proceeds, which is our target and knock on wood, hopefully, we can get that done even before maturity. The disposition program, the highlight of that was obviously a 50% to 75% JV interest in 245 Park. That is part of the deleveraging strategy as well. We took on 245, fantastic asset. We've had our eye on for many, many years. It's right in that sweet spot that Marc talked about, it's right on top of Grand Central Madison, but it's big and it's got a lot of leverage on it. So we have gone around the world looking at various partners, gotten good reception to the asset, particularly because of its size, quality and location and then us as the operator. So feeling good about that execution. That was towards the mid- to later part of the year. So still have a lot of wood to chop getting it done, but feel good. And 750 Third Avenue, another targeted sale. That's an asset that was in redevelopment, lower occupancy sets up well actually for residential conversion. So those are the people we've been talking to are likely residential converters of the tower in particular, and wholly owned unencumbered assets. So that's $300 million of proceeds, and that is going reasonably well. The beauty of not having our CIO here, is I can say whatever, and he can't stop me, but including Harrison, he is doing a good job in sourcing these transactions. And then when you say the opportunity set, that ambitious business plan along with debt reduction was a bolstering of liquidity. So we do see, as Marc said earlier, some opportunities likely later in '23 into '24 as owners that are not as well capitalized and structured as we are, we may find themselves in some distress. So we are setting ourselves up to be more optimistic once we execute this '23 business plan.

Maybe to that end, Matt, I think you also targeted, I believe it was 7 days, the apartment building in Lower Manhattan for sale, just given the probably more favorable fundamentals for residential real estate now compared to office, I mean you've talked about conversion opportunities. I mean it seems like a building you might want to keep in the portfolio. Why does this make sense to sell now?

Well, I mean, we're asset rotators. I mean we've -- in terms of what it makes sense, it's a function of what the price and the cap rate is and relative to how we can reinvest and try and make yields. There's going to be some opportunities with some pretty substantial yields, investment yields that I think we're going to see in the back half of this year and into 2024. And for the right situation, these are double-digit yields that might be plus 500 bps from -- 500 basis points from what they were previously for high-grade opportunities. And with that said, a fully rented residential building that we could try to attempt to sell it at an attractive cap rate and attractive price would make sense for us to sort of clip that gain and reinvest. So that's how we generally look at these things. I mean, you can always make a case to keep the asset, but we like to invest, add value, make marginally higher returns and move on. So that one has got some traction, and we hope to be able to consummate a deal on this year.

Maybe just -- sorry, we got a question from the audience. Just a quick question. What kind of ROIC do you expect on new investment opportunities going forward?

It depends where you are in the capital stack and how levered. I mean we're going to be very judicious in how we use our capital. So I would expect that you would see us taking relatively smaller positions in relatively bigger opportunities that may have a debt stack that's in the process of being worked out. So it's a leverage situation, but with not a lot of downside to whatever position we would be coming into to kind of help clean things up. And on that capital, it could be 15%, 20% for sure, is -- would sort of have to be. But again, that's -- that would be what I would call rescue capital at the bottom of the capital stack.

Just return on capital employed, just curious what specific number do you have in mind on today?

Is it [ 50 in '22 ] or is it -- I mean that was the number I get. That's a levered, yes. You're talking about an unlevered? I mean what asset were and then what kind of -- I mean some assets, I think you're going to sell if it's a multifamily asset that's relatively new and in good shape. You could be talking about 7% unlevered. And then if you have trickier situations, it could be closer to like 10% or higher. I mean so there's a range, but it's just too broad a universe of situations out there to pin it down any further than that, I would say.

I think we got another one down there.

[indiscernible].

Well, look, the city says it needs 500,000 new housing units. So if measured in that regard, this isn't -- the solution is going to have to be new development. It's not going to be conversion, you're not going to be able to convert and get 0.5 million units. But to me, that's not a reason not to do it. I mean there's a double benefit of conversion you don't get with new construction, which is you're winnowing the office inventory while you're adding new units more rapidly than you can achieve with new construction and without the displacement and all of the [ nimbies ] that accompanies that. People are relatively relaxed about a change of use, and it's just a matter of getting possession of the space and converting the building. So in that regard, I think there's enormous merit because of that double benefit. Like I said earlier, I think that could produce 20,000 to 40,000 units in Manhattan, which that's a lot of units. Like you tell me, we spent a lot of time building 7 days, which was just brought up was 250 units. So if there's a path to convert to adding 20,000 to 40,000 units, city should pursue it. And it's not a question in my mind is, well, is that going to solve the problem. That doesn't matter. It's good business. It should be done, and it will help the cities ratable because it will stabilize the office space by taking the marginal buildings out of play, and it will help the residential because it will be fastest to be delivered. In terms of the economics, when I look at it, I think there's a very good play for maintaining podiums and converting towers. I think then I don't know what you've underwritten. But I think that's kind of the sweet spot for a lot of these buildings is a mixed use in nature, which I think underwrites reasonably well because the tower is where you can get your better rents and floor plates typically line up and set up better for conversion of the tower and you push your tenants into the podium if you can or relocate them out of the portfolio. And it's -- I think it's a win-win in that regard, and we think the numbers work. And I think you will see more than just a couple of buildings downtown go that way with a tax incentive. Right now, what you're looking at and underwriting I assume is without the tax incentive. The governor has a plan out there in her budget for a 50% real estate tax abatement over 19 years with 20% set aside for affordable housing at around a blended average of 70 AMI or average median income, 70 percentile. We gave testimony. Rob Schiffer gave testimony at the City Council hearing that was last week on this particular issue. And we stated that we think the incentives should be and need to be much more and that there's a big upside for the city in doing so. And it's not this kind of perceived windfall to landless just isn't there, as you've shown, but it makes the deals economic. And if it happens, as we hope it will, and if the incentives are broadened out a bit, which I think there's an opportunity for, then I think you'll see buildings convert.

[indiscernible].

No, I think about it a couple of different ways. One, I think that as buildings converted just helps bolster the market generally, one. Two, there are certain buildings in the portfolio that we think couldn't take advantage of this, but it's -- it's not many. I mean that's not. And then three, we think we can bring to bear the expertise. We've converted buildings. We've built new. We've got a very good sort of boutique residential operating division right now that I think we can help others do, again, for not a lot of capital commitment on our part, that may not be the same that you're looking at when you're underwriting those deals, you might have to be committing large amounts of capital and you're not getting to your returns. But we would be sort of rolling up the sleeves, the sweat in the deal and committing equity because we always put our money where our mouth is, but it doesn't have to be the preponderance in these situations that are caught up in limbo right now where resi conversion is the highest and best use.

Marc, to those unlevered IRRs that you stated just a little bit ago, I guess how are cap rates not moving up proportionately just given the difficulty in assuming any NOI growth for the out years going forward?

I think there's a perception that rates are going to be coming back in once they stabilize, I think that's why you've got a 3.90% treasury against a 4.76% 2 year. And I think that when people are talking about cap rates, they're talking about long term, almost in perpetuity cap rates, a 3.90% 10-year, I think, is a manageable interest rate in order to capitalize a deal around. And if you think that rents are kind of at their lows right now because of all the hell we've been through in the past 2.5, 3 years, I think it's fair to think that as the rest of this country inflates, like on every measure that hard assets will catch up. And when it does, it's great inflation protector, depending on the asset class. And the cap rates are just not going to be in that range there. New York City is still considered the highest quality market to invest our capital dollars in. We are spending a ton of time right now with various forms of private equity investors in various parts of the country. Andrew and I have kind of divided the world and we're making those trips and the reception is very, very strong. There's a lot of equity out there that wants to invest, not just in the U.S. but in New York City, in Manhattan. The returns are, I think, within the realm of the kinds of numbers we've discussed this morning and what I talked about in December. And I think there's a real belief that this is a great way to play in economic recovery where rates will hopefully be falling in the next several years and rents will be rising. And that -- the combination of those 2 very powerful forces should keep cap rates relatively in check.

So it seems like you're in the Fed cutting rates camp at some point in 2023 versus the higher for longer.

I think that -- I think this rate environment, specifically, this 3.90% treasury environment in and of itself is an environment we can do a lot of business. And we've worked in 5% treasury, 6%, 7% treasuries and made money. So to me, it's -- I think that the increases -- the data seems to say that the increases are having its effect. Economy is starting to cool off a bit, should lessen the pace of the increases and the yield curve suggests that the rates will be coming down. I don't have any rate projections myself. I always look to the yield curve and they had 50 basis points for cushion. And so based on that, I would say the market expects some tightening, forget about what [indiscernible] expects. And therefore, I think investors are saying I can put some money to work in '23 and '24 and then in '25, '26 '27, have a better overall economic environment for that investment.

Real quick on the rapid fires to finish up. Best real estate decision today, buy, sell, develop, redevelop or pause? Buy, sell, develop, redevelop or pause?

Recapitalize.

Same-store growth for 2024 in office?

Same-store...

Well, the mic is still working, do you want to have.

Same-store growth -- what would be the figures before. Between 3% and 4%.

And then more, fewer or the same office REITs a year from now?

In New York City, the same.

Great. Thank you.