Hudson Pacific Properties - Earnings Call - Q2 2017

Transcript

Speaker 0

Greetings, and welcome to Hudson Pacific Properties Second Quarter twenty seventeen Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to turn the conference over to your host, to Kay Tidwell, Executive Vice President and General Counsel.

You may begin.

Speaker 1

Good morning, everyone, and welcome to Hudson Pacific Properties' second quarter twenty seventeen earnings conference call. With us today are the company's Chairman and Chief Executive Officer, Victor Coleman and Chief Operating Officer and Chief Financial Officer, Mark Lammitz. Before I hand the call over to them, please note that on this call, certain information presented contains forward looking statements. These statements are based on management's current expectations and are subject to risks, uncertainties and assumptions. Potential risks and uncertainties that could cause the company's business and financial results to differ materially from these forward looking statements are described in the company's periodic reports filed with the SEC from time to time.

All information discussed on this call is as of today, 08/03/2017, and Hudson Pacific does not intend and undertakes no duty to update future events or circumstances. In addition, certain of the financial information presented in this call represents non GAAP financial measures. The company's earnings release, which was released this morning and is available on the company's website, presents reconciliations to the appropriate GAAP measure and an explanation of why the company believes such non GAAP financial measures are useful to investors. And now I'd like to turn the call over to Victor Coleman, Chairman and Chief Executive Officer of Hudson Pacific. Victor?

Speaker 2

Thank you, Kay. Good morning, everyone, and welcome to our second quarter call. We've wrapped up yet another strong quarter. Other than the Sunset Las Palmas studio acquisition, which we announced last quarter and closed on May 1, the majority of the second quarter activity centered around robust leasing. So today, I'm going to focus my remarks on our leasing activity and market conditions.

And Mark, in addition to touching on the financial highlights, will dig into our lease percentage for our stabilized in service and lease up assets. Many of you likely noticed a small dip this quarter in our stabilized and in service lease percentages, Mark's comments will lay to rest any concerns that this is indicative of a slowdown or a longer term trend. Also, since we've just passed our two year anniversary of our EOP portfolio acquisition, we thought it would be worthwhile to discuss where we are on leasing and NOI growth on those assets, and Mark's going to review those numbers as well. As noted in our press release and filings, we completed over 580,000 square feet of deals in the second quarter, and that surpasses our Q1 numbers and gets us to 1,100,000 square feet year to date. We've now had six straight quarters of leasing activity in excess of 500,000 square feet.

We've averaged nearly 620,000 square feet per quarter since Q2 of twenty fifteen. Cash and GAAP rent spreads also ticked up quarter over quarter at forty eight percent and sixty seven percent, respectively. Our demand pipeline remains consistent, if not elevated. Right now, we have 1,500,000 square feet of real activity. That's deals in negotiations, LOIs or leases.

This is across our markets and proportionate to availability. Larger deals signed in the quarter demonstrate the tremendous mark to market we've been achieving on backfills and renewals. Our 95,000 square foot renewal of Bank of America at 1455 in San Francisco had a 300% mark. We signed another four deals over 30,000 square feet. Three of those, one in San Francisco, one in Seattle and one in Silicon Valley were backfills with an average of 32% mark to market.

The balance of new and renewal deals are smaller, less than 5,000 square feet on average, and nearly 80% were completed in our Silicon Valley assets. I'd like to start off with The Valley this quarter as we run through our markets. And there's no doubt that year to date, fear of a slowdown in The Valley has weighed on our stock. It's been two plus years since talk of TechRec began, and it's disappointing to see investors still waiting for the other shoe to drop. Those who bet against us in The Valley over the last two to three years have been, quite frankly, wrong.

Quarter after quarter, we've been posting fantastic numbers. And sadly, it seems fear of being on the wrong side of a supposedly inevitable tech meltdown has, in many instances, negated our stellar performance. Reality is there's an abundance of positive news and trends regarding The Valley. Companies driving growth in The Valley like tenants like Google and Nutanix, also Facebook and Apple are posting strong quarterly numbers. Day after day, we see reports of big names like Google, Adobe, Apple taking hundreds, if not thousands of square feet in our Valley markets to accommodate major growth.

Our properties in Milpitas, San Jose and Santa Clara now have greatly enhanced public transit access as a result of BART's 16 mile extension. And just last week, The Wall Street Journal ran two relevant articles, the first on record breaking fundraising. In the first half of this year alone, eight VC mega funds raised an aggregate of $9,300,000,000 from leading institutional investors. The second article highlighted that there's been no real dispersion of specialized fast growing tech occupations. In conclusion, San Jose and The Valley as the epicenter of the advanced industries poised for outside growth, AI, robotics, machine learning, virtual reality will remain the clear leaders for these types of employment opportunities for the foreseeable future.

A recent Silicon Valley Business Journal article also noted how autonomous car companies are flocking to the Peninsula, where they plan to grow significantly. They view the South Bay, which is talent based proximity to Stanford and inflows of VC funds as superior to San Francisco or the East Bay. Leasing activity along the Peninsula remains very strong. There are 56 active tenants in the market, representing just under 3,000,000 square feet of demand. Another quarter of positive net absorption brought year to date totals to 480,000 square feet, and vacancy was down 10 basis points in the quarter to 6.8%, and asking rates were flat at $69 per square foot.

Further south, new supply, specifically two projects delivered, one in Santa Clara, other in San Jose, contributed to just over 500,000 square feet of negative net absorption in the quarter. And market wide vacancy ticked up two twenty basis points to 9.7%, while lease rates stayed flat at $57 per square foot. Sublease space in our Peninsula And Valley markets increased by just over 2% in the quarter, driven almost exclusively by additional availabilities in Santa Clara. Again, the preponderance of the sublease space is larger blocks with eight of the 10 largest sublease availabilities in Santa Clara. Even so, demand is quite strong.

There are 153 active tenants in the market, and we expect to soon see a few large deals that will absorb some of these excess spaces, specifically in Santa Clara. North San Jose, where our airport place assets are located, did not have a top deal in terms of size signed in the quarter. It did, however, have the largest gross absorption with 63 of the three zero five leases, a testament to a robust demand for smaller spaces. Our lease up and other Valley assets are well positioned in the marketplace as we reach the end of the capital program to upgrade common areas and fully reposition select properties like Gateway. Taking a look at this playing out in terms of our leasing momentum, over the last one hundred and twenty days, we've executed 19 deals at Gateway totaling 76,000 square feet.

We have another 140,000 square feet of deals in the pipeline. That's in leases, negotiations or LOIs, plus another 100,000 square feet of inquiries and tours. Note that at the end of the second quarter, Gateway had just over 100,000 square feet of vacancy. While Gateway was a representative of our larger repositions in the region, common area improvements in the VSP program are driving momentum at our other assets. Aside from Gateway, we've executed another 25 leases totaling 94,000 square feet in North San Jose over the last one hundred and twenty days, and we have approximately 82,000 square feet of deals and leases, negotiations or LOIs and more than 185,000 square feet of increase in tours.

That's relative to about 155,000 square feet of availability to those assets as of the end of Q2. Suffice to say, we're very pleased with our team's efforts in that marketplace. What's happening in Downtown San Francisco, the robust demand for bigger blocks of space from high quality tenants seems to be more readily understood. We're seeing it play out in our portfolio again this quarter. BofA signed on the heels of Google, GluMogul signed for 57,000 square feet and DoorDash for 50,000 square feet.

Broader market statistics stayed relatively constant with Class A vacancy up just over 6% and asking rates stable at $76 per square foot. 5,500,000 square feet of tenant demand in San Francisco is the highest since the fourth quarter of twenty fourteen, and sublease availability fell to just under 2% in the quarter, which is the lowest since the third quarter of twenty fifteen. We expect to see upward pressure on rents in the 2017 and the blended mark to market in the remaining 458,000 square feet of our 2017 and 2018 expirations in San Francisco is just over 50%. In Los Angeles, media related markets are leading growth in activity. Hollywood had nearly 375,000 square feet of positive net absorption this year.

And in the quarter, vacancy dropped 100 basis points to 11.4%, while Class A rates held steady at $54 per square foot. As underscored by our recent deal with Netflix for another 48,000 square feet at Sunset Bronson, we're seeing significant demand for content creators for premier studio adjacent office space. And following our Sunset Las Vegas studio acquisition and the delivery of ICON and Q, we have approximately 1,200,000 square feet of development opportunities with studio access. We're in early conversations with multiple users that have requirements ranging from 125,000 to 300,000 square feet for our EPIC development, which we intend to break ground on this fall. And overall, we're seeing great activity throughout our L.

A. Portfolio. We're in leases or negotiations for almost 70,000 square feet at fourth and Traction, and we're in leases on a deal for the entirety of our 604 Arizona with a substantial mark to market rent increase. We expect to have further updates on both of those projects over the next quarter. Seattle seems to top another list every single day.

The city offers a lower cost of living without sacrificing career opportunities or lifestyle. A recent LinkedIn article cited more workers from core urban markets coming to Seattle than any other city, and the pace of hiring is up more than 10% from the 2016 to the beginning of twenty seventeen. In turn, Seattle companies are rapidly absorbing space. In the first six months of this year, Seattle had 1,400,000 square feet of positive net absorption, which is almost three times that amount for the same period last year. And under construction projects are currently 50% plus pre leased.

Pioneer Square, where the preponderance of our portfolio is located, is the tightest submarket. Total vacancy was down 50 basis points in the quarter to 5.1%, while Class A rents stayed flat at 35 per square foot. In addition to the 50,000 square foot deal that we signed with RealSelf at A3 King to backfill the Capital 1 space, we're in leases for the two remaining floors at Hill 7. Upon execution, that property will be 100% leased. We're also in leases with a single user for nearly all of 95 Jackson and a floor at 450 Alaska Way.

That deal totals over 46,000 square feet, and we'll expect to have more to report on those transactions next quarter as well. With that, I'm going to turn the call over to Mark, who's going to talk about our second quarter financial highlights. Thanks, Victor. Funds from operations, or FFO, excluding specified items, for the three months ended June 3037 totaled $75,300,000 or $0.48 per diluted share compared to FFO excluding specified items of 62,900,000.0 or $0.43 per share a year ago. There were no specified items for the second quarter of twenty seventeen, while specified items for the 2016 consisted of acquisition related expense of $100,000 or $0.00 per diluted share.

As of June 3037, our stabilized and in service office portfolio was 95.690.8% leased respectively. All but one region within the stabilized and lease up portfolio witnessed a steady or sequential improvement in lease percentage. Lease expirations at three of our Bay Area assets for a combined negative net absorption of approximately 77,000 square feet essentially account for the slight quarter over quarter roll down in the combined stabilized and in service lease percentages of 80 basis points and 40 basis points respectively. These include Carrot USA moving out of 33,000 square feet at 875 Howard, which we are very close to backfilling, Uber vacating approximately 20,000 square feet of short term space at Skyway Landing and a handful of small tenant move outs at Concourse, several of which have already been backfilled. I will provide further detail on the performance and projections for our Silicon Valley assets in a moment.

Net operating income with respect to our 34 same store office properties for the second quarter increased 8.5% on a cash basis and 8.5% on a GAAP basis. For the sake of clarity, the cash basis increase for the second quarter is not in any way bolstered by Cisco's early lease termination payment, all of which was recognized for cash purposes in the previous quarter. Moreover, the cash basis net operating income continues to be muted by the previously discussed September 2016 commencement of a lease amendment with Weil Gottschall Towers at Shore Centre. We estimate that second quarter same store office property cash net operating income would have increased approximately 14.4% ignoring the impact of Weil Gashall. The trailing twelve month lease percentage for our same store media and entertainment properties ended the second quarter at 89.9%, up four sixty basis points year over year.

The year over year increase is the result of increased demand for stages and production offices at both studios. Same store media and entertainment net operating income during the second quarter increased by 49% on a cash basis and 47.2% on a GAAP basis. This was due to higher occupancy and production, again, at both the Sunset Gower and Sunset Bronco. This quarter marks the two year anniversary of reporting on the former EOP Northern California portfolio, which inclusive of dispositions and acquisitions still comprises the bulk of our Silicon Valley Holdings. We thought it timely to provide everyone with a closer look at the progress we've made and the value we've unlocked thus far as a result of acquiring that portfolio.

From the 2015 to the second quarter of twenty seventeen, we have realized 21% cash net operating income growth on our '22 same store former EOP portfolio assets. We achieved such significant cash flow growth because of and in spite of the fact that 57% of the leased square footage at those assets expired during that same period. Even so, we managed to increase the lease percentage at those assets by nearly 130 basis points, bringing the lease percentage to 87% as of the end of the second quarter. We expect these 22 assets could be approximately 90% leased by the end of twenty seventeen. You may recall that when we began reporting on the 22 same store former EOP assets, 14 of those assets were not yet stabilized.

As of the quarter just ended, only eight of the 22 assets remain in lease up and even those assets have steadily contributed to cash flow growth. From the 2015 to the second quarter of twenty seventeen, we realized 17% cash net operating income growth, while 49% of the lease square footage at those assets expired during that same period. As with the entire same store former EOP portfolio, we still managed to increase the lease percentage at these eight assets by over 130 basis points, bringing the lease percentage to 79% as of the end of the second quarter. We anticipate these eight assets could be approximately 85% leased by the end of this year. It's also worth pointing out that even as we've improved rents and occupancy at our Bay Area assets, including those throughout Silicon Valley, the underlying composition of our entire portfolio, whether measured in square footage or revenue, continues to evolve.

From the 2015 to the second quarter of twenty seventeen, our Bay Area Holdings decreased from nearly 76% to 68% of annual base rents. Our Silicon Valley portfolio went from 58% to less than 52% of annual base rents. And our Los Angeles portfolio grew by from 20% to more than 26% of annual base rents. These numbers showcase our success in rebalancing our portfolio, which remains a key component of our longer term strategy. Since acquiring our Silicon Valley assets, we've been a net buyer in Seattle and Los Angeles and a net seller in the Bay Area.

Development projects coming online such as ICON and Q and shortly $4.5 Alaskan and Forth and Traction will also continue to be a major driver of this shift. Turning to guidance. We are narrowing our full year 2017 FFO guidance to a range of $1.93 to $2.01 per diluted share excluding specified items, maintaining the previous midpoint of $1.97 per diluted share excluding specified items. This guidance reflects transactional activity referenced on this call in our earnings release and prior announcements. It also includes Cisco's $10,400,000 early lease termination payment reduced for GAAP purposes by the write off of approximately $5,900,000 of non cash items, including straight line rent receivable and above and below market rent lease adjustments.

This is amortizing beginning in the second quarter at approximately $1,500,000 per quarter. As always, our full year 2017 FFO estimate reflects management's view of current and future market conditions, including assumptions with respect to rental rates, occupancy levels and the earnings impact of events referenced on this call in our earnings release and in prior announcements. It excludes the impact of future unannounced or speculative acquisitions, dispositions, debt financings or repayments, recapitalizations, capital market activity or similar matters. There can be no assurance that the actual results will not differ materially from this estimate. And with that, I'll turn the call back to Victor.

Thank you, Mark. Heading to the second half of twenty seventeen, conditions across our markets remain very favorable as does our positioning in each market. We can deliver big blocks of studio adjacent office space in Los Angeles. We're focused on smaller tenant deals in The Valley. We still have a significant embedded mark to market in San Francisco and have assembled a unique portfolio and a foothold in Downtown Seattle.

All these aspects reinforce our ability to continue to deliver positive results for our shareholders. Once again, I'd like to thank the entire Hudson Pacific team, particularly our terrific senior management group for their hard work for this quarter. And to all of you on this call, we appreciate your continued support for Hudson Pacific Properties and look forward to updating you next quarter. Operator, with that, let's open the call for questions.

Speaker 0

Thank you. At this time, we'll be conducting a question and answer session. Our first question comes from Alexander Goldfarb with Sandler O'Neill. Please proceed with your question.

Speaker 3

Good morning. Good morning out there. So two questions. The first, Mark, I think you said in the discussion about the 22 same store EOP assets in Northern California that currently they're like 87% and you're hoping to get them to 90% by year end. But just sort of curious, given all the demand and obviously the pretty healthy mark to market that you're achieving on this spread, why wouldn't that be you know, north of ninety percent two years after you closed on the transaction?

Speaker 2

They they might be. I mean, when we do our lease walk, we show somewhere north of, you know, call it, 600,000 of total new and renewal activity for the second half of the of the year. You know, after reviewing that with Art and the rest of the leasing team up there, our view was the 22 assets could get to 90, if not higher than 90. But remember, there's a decent amount of exploration over that same window. I think it's 314,000 feet expiring in the in that same period.

So, you know, it's like, as we've said from the outset when we first bought this portfolio, there was, you know, there's a fair amount of near there was always a fair amount of near term expiration in the overall portfolio. So as the the goal of reaching stabilization was always gonna require both a heavy amount of lifting on new on renewals and backfills as well as net absorption. So it just takes a little while to get it towards stabilization.

Speaker 3

Okay. And then, Victor, you know, your comments about sort of the frustration with you guys leasing and obviously achieving on performance in Northern California net for the past two years, it's sort of been a headwind from a stock market perspective. Clearly, in the past, you've sold a company. What about considering just taking advantage of the private market bid and selling a good chunk to reduce the exposure up there, capture the private market value and either redeploy the capital to Seattle or L. A.

Or maybe buy back stock?

Speaker 2

Well, listen, think, Alex, you're absolutely right in reading through my direct comments on the frustration. Clearly, this whole conversation came out two years ago, spring, that the tech market is going to blow up. And we've been given zero credit for the yeoman's work that our leasing and the management team have done through the entire Bay Area from San Francisco all the way down to San Jose. And I'm just sick and tired of hearing the fact that the whole world is coming to an end up there when you're seeing mark to market rents, you know, 30%, 40%, 50%, we've done in, you know, in March reference to the portfolio at the EOP portfolio. You know, we've rolled 57% of that portfolio in the last less than two years.

And still, you can sense that the frustration is there. I'm not prepared to directly answer your question on dumping the portfolio to private market bidders to redeploy the capital in other marketplaces. I think those assets are quality assets. I think what the misperception is because leasing may not be to the expectations of some third party analysts or reviewer who's not in that marketplace to look at what they believe is not real time, but what they believe it should be. I think the misnomer is the cash flow has been spectacular.

The growth on cash has been spectacular. And anybody who looks at it would say, Look, they love to have the yields that we're having on those assets. So I'm not prepared to do that. The team's not prepared to do that. The quality of real estate that we hold in all those markets, and I think we've been very clear from day one, there are a few assets and I mean a few assets, Alex, that we would sell, but we're not selling the portfolio up there.

Speaker 0

Our next question comes from Jamie Feldman with Bank of America. Please proceed with your question.

Speaker 4

Thank you. Sticking with the prior question from Alex. I mean, think part of the challenge here is it's a very large market, Peninsula and Silicon Valley and people maybe don't understand the details of each submarket. We're definitely seeing some large supply deliveries and there's talk of sublease backing those up. So can you just talk through maybe your largest exposure by submarket in those markets and maybe give a little bit more color just in terms of the fundamentals and why maybe you can't you will outperform those markets versus maybe just a broader market that seems to have relatively muted rent growth?

Speaker 2

No. I think, Jamie, that's an excellent point. If you look at as we commented on now, I think this should be our second maybe call, maybe it's our third on Santa Clara. The exposure in Santa Clara, which we have no exposure is, you know, is is on for the for the most part, is a huge amount of of of asset exposure with our tech BART asset there, but the seven or eight largest, sublease locations are in that marketplace. But if you go market by market, I mean, I think you you've got on the Peninsula Side, you've you've got, you know, Palo Alto that's doing well.

You've got you've got Redwood Shores that are doing well. You've got Foster City doing well. I mean, San Mateo is doing okay for us in a marketplace. North San Jose, you know, I specifically talked about our San Jose marketplaces. I mean, I think, you know, I I think you're talking about, the activity in that market has been as good as it's ever been.

We've got 800,000 square feet, of assets in the I mean, activity in the pipeline in the Peninsula, and over half of the activity in that right now are in leases or or in in LOIs. And I'm not referring to campus center. Would we take that out, Jamie, in terms of our numbers? You know, we've got, I think, a a million and a half feet in proposals back and forth and another 3,500,000 feet in prospects, and that's not inclusive of any of those numbers in our campus center. I think it's a total of 17 different tenants looking that marketplace.

So you take Santa Clara out, I do think that, if you look at what we've had at Metro, I think it's been slow. We've commented on both those, Techmark and Metro. I do think that those two assets have been pretty slow and maybe POP as well, which we're getting a lot more activity on right now. But they're select assets versus the global, say, Peninsula is really doing poorly. And, I think you've got a good handle on it.

Speaker 4

Okay. And then I you mentioned Campus Center. Can you just provide more detail on the leasing progress or activity progress?

Speaker 5

Yeah. Mean, listen. We haven't

Speaker 2

got the asset back. I mean, you're gonna hear me say this until until we can We're not gonna go on the whim like other people may or may not do and say we're in leases or we got a great activity, and then we're gonna wait two years, and we're gonna say the same thing. We're gonna tell you where the activity is, and we're gonna tell you what the prospects are. Right now, you know, we have three proposals, at various different phases from three different tenants totaling almost 1,400,000 feet.

Our marketing plan is complete. Our design interior is almost complete, exterior is complete. We're prepared to start construction on the exterior this fall. We get it back January 1. I think we've got another 3,500,000 feet of prospects in the marketplace, which are about somewhere in the range of 13 or 14 additional tenants.

But at this time, I'm not prepared to talk about rate. I'm not prepared to talk about timing, and we're and we're definitely not prepared to talk about any commitments. But but I'm pleased given the fact that we have don't even have it back yet, you know, that that we're on track for a pretty effective splash 01/01/2018 in terms of our marketing.

Speaker 4

Okay. And is it a sale, one of those three proposals? No. No. Is that still on the table, potential sale?

No. Okay. And then just finally for Mark. So you took your same store guidance up, but you maintained the midpoint of your earnings guidance. Can you just talk us through what was offsetting that better core outlook?

Speaker 2

Sure. So I think the first point to understand is the same store changed on account of getting back recapturing $6.00 4 and moving it to redevelopment because we're gonna do some repositioning there. And and so I think, you know, we walked everyone through when we made the press release following the recapture. So it muted a little bit the FFO. We maintained our midpoint, the $1.97 notwithstanding the fact that we lost the FFO on 06/2004 because there's other positive things going on in the rest of the portfolio that mitigated the impact of that.

Having said that, 06/2004 is no longer running through the cash on same store full year projection. Right? So the fact that we lost that in FFO isn't impacting negatively the full year, year over year cash NOI growth. Meanwhile so there is no negative impact coming from 06/2004 there. Meanwhile, other positive things help the cash same store growth.

And I mean, Haroop sitting next to me, we literally went through every single asset there. And I have to tell you, I mean, it's made up of a lot of small items here and there. But the main drivers sort of fall, I would say, within two categories. One is we have some favorable resolution on some recovery items. There was a decent sized one at $14.55 dollars on some utility expenses that we were kind of going back and forth with one of the main tenants on.

That worked out favorably and helped us on cash NOI. Another one was at Concourse, for example. Again, we had some property tax savings. We picked up some cash recoveries there. The other one was we're doing a bit better on upfront free rent on a fair amount of the leasing activity that we had projected.

That is to say, we're giving we're having to give less upfront free rent. And those, I would say, are the main contributors to the better than previously projected cash NOI, but which don't really they they help on the FFO front, but the again, six zero four muted that impact on FFO. Hopefully, you know, that gets you there, Jamie.

Speaker 4

Yeah. That's helpful. So just to be clear, so if you had not moved six zero four out, you still would have increased what what would have changed?

Speaker 2

Well, if we had well, if you said we didn't move it out, we would have lost about 1,300,000.0 about between 1.3 and $1,400,000 of FFO. Right? So that would have actually further muted the cash NOI growth, if you will. Right?

Speaker 4

I guess, ma'am, so you would have increased your same store?

Speaker 2

You The the year over year the year over year NOI growth is about $4,800,000. I mean, the difference between the the previous estimate and current estimate, you would have to ding that about 1,350,000.00. Right? So you I I you could run the math if you want, but that would be the net impact of of keeping six zero four in the same store, but not having the NOI associated with it. Jamie, are you referring to if six zero four didn't have a leasing issue and therefore contributed like the previous year, or are you asking if we just kept it in the same store But it had no tenancy.

That had no tenancy.

Speaker 4

I'm just saying if you if you just remove six zero four completely, would you have raised your same store and your FFO? Or would you have lowered

Speaker 2

We did remove it. That's why the same store went from 34 to 33 assets.

Speaker 4

Right. No. That's alright. I'll follow-up with you guys later. I get it.

Okay. Thank you.

Speaker 2

Okay. Alright.

Speaker 0

Our next question comes from Blaine Heck with Wells Fargo Securities. Please proceed with your question.

Speaker 6

Thanks. Hey, guys. I'll get away from the Silicon Valley for a second. Victor or Alex, can you guys just talk a little bit about the acquisition environment? Are you guys finding any opportunistic investments out there in general?

And then maybe are there any other opportunities to grow the media portfolio as you did with Hollywood Center?

Speaker 2

So on a global basis, we've got a couple of deals that are non marketed deals, not represented deals that we're sort of working on both in Los Angeles in or one is in Los Angeles and one is in Seattle. On the media side, we're looking at one opportunity right now that is also a non marketed opportunity. And as I think I mentioned in the past, with Sunset Las Palmas, it took us almost two years to pry that deal. I'm not saying this will take two years, but we're looking at an opportunity for sort of a unique one that Alex and his team have been working on. There's a few assets in the marketplace that we are actively bidding on with with other with other guys that that that are in our space.

In the majority of what we're looking at right now is, think, in Los Angeles relative to San Francisco or or the Bay Area, I mean, and and and Seattle. But the activity right now summertime is a little slower than normal. Alex, do you want to comment?

Speaker 7

Yes. Like always, we continue to try to find opportunities in our four main markets. As Victor highlighted, a lot of the activity right now seems to be in L. A. We do think there's gonna be a healthy pipeline coming to market in the fall and the latter part of this year.

That being said, as you know, most of our successes come from off market deals versus the marketed stuff. But we're working on a couple of transactions and they're a little chunkier in size, but hopefully we'll be able to get a couple of things done.

Speaker 6

All right. That's helpful. And kind of related to that, Mark, I guess when you look at the balance sheet, looks like you guys are pretty close to 6x on a debt to EBITDA basis now. But you have about $100,000,000 more spend on the current pipeline. You have spend on EPIC that will be ramping up soon.

You have continued CapEx spend on the lease up properties and then whatever you're going to spend on Campus Center. And then on top of that, possible acquisitions. So can you just talk about how you guys think about funding all of that? What capital sources are attractive to you at this point since kind of the stock price has moved away from you? And I guess how much capacity do you think you have before hitting kind of the top of your internal leverage range?

Speaker 2

So when we run the sort of high percent, both the capital spend, as you mentioned, which is maybe on an asset specific basis seems decent, but when you aggregate it, it really isn't that much. So take, for example, Camp Center, you know, our whole repositioning cost on that's like 11 and a half million. It really from a capital availability point of view, it barely moves the needle and sim similar for 06/2004, it's really next to nothing. And then the remaining spend on the active developments, if you look at the supplemental is, you know, quite small at this point. So when you flow all that through and then you run through some hypothetical acquisitions, even if we do some sizable amounts of acquisitions, hundreds of millions of acquisitions, 300, even 400, and you use leverage to finance that, what you find is on a leverage ratio basis, you get into the kind of the mid ish 30 range debt to net enterprise.

So leverage really doesn't become much of a governor on it. In terms of capital availability, we have line availability currently on $190,000,000 or so. We've got untapped availability on a line that's secured by our ICON Gower Bronson properties. We have $250,000,000 of availability under that. We have, you know, decent amount of cash on hand.

Yes. And then I you know, there's and as you know, and I won't I don't wanna get in ahead of anything, but we're we're always exploring possibility of strategic dispositions. And if we should get a disposition done over that time frame, that could potentially both delever to some extent and also offer net cash flow. So suffice to say, when we run it through all of those scenarios, leverage we have ample sources of capital and leverage stays in that mid-30s range.

Speaker 6

Okay. And then just on Epic, can you guys share how much you guys are expecting to spend there and whether that's going to be another kind of media and entertainment focused development? Or is it going to be more traditional office?

Speaker 2

Well, I mean, the the asset itself is an office building, and so it will be an office building. Whether it's a media entertainment focused tenant is probably the case, or tenants will probably be the case. I mean, that's the activity that we are seeing with the multiple tenants right now. In terms of the doll the dollar amount on the asset, I think it's just slightly under $200,000,000 is what our sort of number is going to be by the time we're into it. And that looks like we're going to break ground, as I said, in the next within the next month or two.

Speaker 6

Any early feel for the kind of yield you expect on that?

Speaker 2

I mean, listen, don't want to get specific, but it's got a seven handle in front of it.

Speaker 4

Okay. Thanks, guys.

Speaker 0

Our next question comes from Nick Yulico with UBS. Please proceed with your question.

Speaker 8

Thanks. Just sticking with Epic, I mean, it sounds like the demand in Hollywood is very strong right now. How long do you think it might take before you would be able to expect to announce some leasing on the project? I know you haven't even started yet, but

Speaker 2

I mean, listen, Nick, everybody knows we're coming out of the ground. I think it's the best project ever to be built in Hollywood going forward. So I think the activity has already shown itself. I don't want to put in that time frame. Listen, nobody seems to be stupid in the marketplace.

We have a tenant that's growing. They've indicated interest. We have lots of other tenants in the marketplace that have indicated interest, and we're the only project coming out of the ground in the near term. There will be other projects in time, but I do think that there are several tenants that have approached our CB Richard Ellis brokers, which are the same guys who did Icon and Q for 100,000 to 250,000 feet in the marketplace.

Speaker 8

Okay. That's helpful. And then, Mark, I want to make sure I heard this correctly. When you were talking about the eight EOP assets that are in that lease up category, which were 79% leased quarter end, did you say that you anticipate getting to about 85 leased by the end of the year?

Speaker 5

Yeah. Yeah. So I think that, by

Speaker 2

the way, in the earlier conversation when we were talking about the activity on the 22, obviously, the eight's a subset of that. And the I think, you know, sort of similar to the response on the 90%, I think 90% is definitely an achievable threshold for the '22, and it could be north of that. I think, likewise, 85 is definitely an achievable threshold, and it could even be a

Speaker 7

little bit north of that.

Speaker 8

Okay. If I mean, these eight assets were the least amount was flat this quarter versus last quarter. Looks like some of them, the numbers went down. I imagine there was, what, some expirations. I guess I'm just trying to understand how much expiration impact you had so far this year?

And then does that ease in the back half of the year so it kind of helps with your absorption?

Speaker 2

Yeah. It's a little bit it's a bit of an ease on expiration, but it's also a fair amount of just positive activity on for obviously leading the net absorption. You know, I do think to some extent there's perhaps not complete enough or good enough appreciation of what how little activity it takes to really move the needle on these assets because I think the percentage gets looked at. But if you actually run the numbers, you realize it doesn't take much to move the needle one direction or other. So let's just if I could illustrate that really quick.

If you look at three three three, I think one of the notes highlighted that is where there was a roll down from the previous quarter of 80.3 leased to 74.6% leased, which on a percentage basis looks like it might be material, but that is that's 10,000 square feet of negative net absorption. I mean right? I mean, it's next to nothing in the grand scheme of things, right? And likewise, Palo Alto Square was focused on because it rolled from 82.5 to 79.1, that's 11,000 feet of net negative absorption. I mean, we're not obviously, we want to continue to move this portfolio in a positive direction and get them all stabilized.

But I think on the heels of doing 580,000 feet of activity in the quarter to get focused on 10,000 feet of negative net absorption in in an asset is completely missing the what's really going on here. I and, again, I'm not trying to say don't focus on it, it's fine, but you gotta keep it in perspective.

Speaker 8

Yes. No, it would be helpful to see because I think when you look at the lease up numbers, we have those numbers. We don't have all the details about all the expirations associated with the specific segment. So it's a little hard you know, to figure out how much that is impacting leasing, but sounds like Yeah.

Speaker 2

Fair enough. I would say, Nick, and I I know you know this, but we do provide by region all lease expirations two years forward. Now in fairness, we do bucket them by region and not by specific asset. But, I mean, there is a considerable amount of detail in the supplemental about expirations for you know? And to underscore what you know, Nick, the the this is Art talking.

The the activity, again, it remains very strong. That was, you know, kinda 800,000 square feet of activity that we have in our active pipeline, you know, some of which is in Silicon Valley, probably, I would say, about 450,000 square feet, the rest is on The Peninsula. Looking at these smaller spaces to backfill, again, insignificant, but some of these some of these vacancies were tenants who actually downsize, right, where you keep the tenant and they downsize and they kind of accumulate to about 10,000 feet. So I think with what we have, we're very, very bullish on not just backfilling, but just filling the vacancies.

Speaker 8

Okay. Thanks, everyone.

Speaker 0

Our next question comes from Vikram Malhotra with Morgan Stanley. Please proceed with your question.

Speaker 9

Thank you. So just maybe taking a step back, maybe focusing on San Fran and LA just in terms of asset pricing. Some of the peers, I should say, focused on New York City have started saying there's a disconnect between certain buyers and sellers, certain, call it, maybe lower quality assets, they're starting to see downticks. Wondering what you're seeing kind of in your markets. Are there any disconnects emerging?

And just your expectations for asset pricing.

Speaker 2

Vikram, so I'll start off and then Alex can jump in. So both in the two instances that you mentioned, San Francisco and L. A, first of there are not a lot of transactions in the last quarter that have been done that you can cite. But the ones that have, there has really not been a disconnect. I mean the prices per foot in Los Angeles that have closed or that have been announced are the highest we've ever seen in Class A assets.

And there's going to be an announcement on a Class B asset that was recently awarded literally this week, a very large asset that will top its last sale by 50%. And so I think that's consistent throughout the L. A. Marketplace. There's not a huge cap rate differential between A and B class assets or leased up assets.

I think in San Francisco, clearly, what you're seeing with the leasing activity and what's happened there, there have been so few transactions even this year in San Francisco, but the ones that have been completed. I mean, you're talking $1,000 plus a foot. And even on the second tier stuff, it's $708,100 dollars a foot numbers that have been pretty consistent to the last twelve plus months. And there are lots of guys who want assets still in that marketplace that are still looking at few that are out there. You want to comment?

Yeah. So LA, obviously, is

Speaker 7

a huge market, and a lot of the attention that's been given recently is the the flurry of transactions that have occurred really from Beverly Hills to Santa Monica, which is going to command the highest pricing on a per square foot. I think if you go kind of submarket by submarket, if there was an asset to trade, let's say, in the San Fernando Valley, you're not going to achieve the same price per square foot you're going to achieve in Santa Monica. So the things that have been trading have really been kind of trophy core assets on the West Side Of Los Angeles, which is going to continue to garner the really high pricing. And I think in San Francisco, we've just seen a very limited pipeline this year just because of how much has traded over the last couple of years. So there haven't been a lot of comps.

But I think for the assets that have come to market, there has certainly been no slowdown depth of buyer pools for the Class A product in both markets.

Speaker 9

Okay. That's helpful. And then just, Mark, maybe for you, just from a trajectory standpoint on the same store NOI growth,

Speaker 0

which

Speaker 9

is given guidance, is it fair to say that the next two quarters, we see a decelerating trajectory? And then as we think about 2018, it's sort of the opposite where you start seeing some of the benefit of the recent leasing activity you've done towards the second half of twenty eighteen?

Speaker 2

If you're referring to sort of expectations for same store, like cash NOI growth, let's take, for example, where we finished off the second quarter, 8.5%, I don't think we have any reason to expect a deceleration of that into the next two quarters. No. I the the number we provided is an annual number, so it already factors in the the first two quarters. So to the extent the the projections have to match the annual number, so we think it'll be consistent. Yeah.

We haven't really looked at 2018 yet in in granular detail. So we haven't done the budget, and that's gonna be a sheet by sheet analysis. And so we're not prepared to talk about that yet.

Speaker 9

Okay, great. Thanks, guys.

Speaker 2

Thanks.

Speaker 0

Our next question comes from Craig Mailman with KeyBanc Capital Markets. Please proceed with your question.

Speaker 10

Hey guys. Just a follow-up on Epic. Just curious what the leasing strategy is going to be in terms of how quickly you'd prefer to put a tenant in there just to get the risk kind of off the table versus trying to find a tenant that may want studio space and pay a higher rate for having the office and the studio kind of packaged together?

Speaker 2

Well, Craig, if you look at where we are right now, we just launched our website last week, I believe, on Epic. So that just went live. We won't hold back on it on the tenant activity. I think, you know, it it's gonna be the marketing suite is is virtually complete. We we're adding something to that as well that will be sort of a virtual marketing suite as well.

And I think that the activity will be a combination of media and entertainment tenants and also because of the activity that Bill has had at the studios across the street, both of them, you know, there may be a Ground Floor studio ability for us to put a studio facility in there as well for the for the interest level of the tenants. But we're not gonna hold back. I think the rates we're talking about are well, they're they eclipse the rates that we're doing at ICON and Q, and so those are the highest rates in Hollywood right now. So there's no need for us to hold back when we're talking a seven plus yield on the asset.

Speaker 10

Got you. That's helpful. Then up in Seattle, can you just talk about the activity you guys are seeing for the rest of 450 Alaska?

Speaker 2

Yes. I mean, I mentioned, we are in leases for another full floor there. We're in leases for virtually all of 95 Jackson. And the activity for the remainder of 458 is really been pretty solid. I mean, Seattle is, as you know, Craig, is virtually on on fire right now.

I think that, you know, we've got, you know, I think a 100,000 square feet of of of current activity for the remaining of the property. You know, we're about to complete the building by year end. And as a result, I do think there's an instance where holding back you know, I think, as you know, we're we're sort of a victim of our own success in that asset and that we leased it to Saltchuk so early on at the highest rents at the time that were in Seattle. And now when the building's going be complete, I think you're going to find that I think we're going to achieve even better rates than we initially thought on that asset, given the fact that the asset's going be completed. It came out spectacularly, and it's gotta be one of the nicest assets in all of Pioneer Square, I'm sure, so at the end of the day.

And then the remainder of Seattle, you know, we're also in leases for the last two floors at at our Hill 7 project, which then will be a stabilized 100 occupancy asset as well at the underwriting that we projected it to be.

Speaker 10

That's helpful. And then assuming we go back to Silicon Valley for a second because, Mark, you were talking about putting numbers around things. I just kind of looked at your expiration schedule and looked at what you guys would need to get to 90% leased. It looks like about 190,000 square feet of absorption. And so just looking at what you guys have expiring over the next two quarters and kind of slap it on a normal retention rate there, it just seems like you guys need to do somewhere in the order of 550,000 to 600,000 square feet ish to get there, and you guys have 800,000 kind of demand.

Does that sound sort of round the

Speaker 2

ballpark? Yes. In fact, I more or less outlined that number, right? I said we had a little bit over 600,000 feet in our Q3, Q4 lease walk for the 22 assets. And so your math is hovering right around our number.

Speaker 10

Okay. Given all the concerns around the health of the Valley, you guys have given the strong pipeline. Any way you guys might give kind of what you guys have done quarter to

Speaker 4

date? No.

Speaker 0

Our next question comes from Zachary Silverberg with Mizuho Securities. Please proceed with your question.

Speaker 5

Rich Anderson here with Zach. Good morning out there. So this call yesterday, Jordan talked about down zoning in the LA area. I'm curious two questions on that. How much do you think the market has been impacted by that fact?

In other words, how much more expensive are existing assets because of the down zoning? And two, has it impacted your ability to develop? Would you have been able to develop bigger? Or has it not really impacted you from that standpoint?

Speaker 2

Well, I think listen, on the first part, Rich, it's absolutely impacted the value of the assets. I mean, at Santa Monica as a great example on the down zoning and the value of the assets in the most recent comps that have gone transpired in the last twelve months. So you've seen a precipitous increase. And so, yes, the answer is listen, down zoning is absolutely a factor and will increase the value of our portfolio and our peers' portfolios and their and and and and the real estate in general throughout all of West Los Angeles and inclusive of Beverly Hills and and Hollywood. I just think that the, you know, the the other the other aspect of trying to develop in LA is is a huge challenge.

Just getting entitlements, period, is a huge challenge. And so to answer your second part of your question, it's not the down zoning that that's impact us. It's the ability or lack thereof to develop given the political and and basically local constraints that are put in place. I mean, you know, when you have the ability to sequence suit an approved project just because you feel like it and it will slow the process, and then if you win, it's then gone to the project end end up then going to an appeal process, that's, you know, millions of dollars of legal fees and time that goes away that enables you to miss a marketplace. You know?

And we have lived that in our projects as is everybody else who tries to develop here. It's not easy. But as a result, it also makes the value of the current real estate worth more.

Speaker 5

Because I mean

Speaker 2

And more important oh, sorry, Rich. One more thing. And more importantly, and I've mentioned this before, entitled real estate is worth a lot more than people perceive it to be.

Speaker 5

Okay. I mean, so if some if a deal goes in for 1,100 a square foot, I mean, would you know, absent the down zoning, could it

Speaker 6

be 800? I mean,

Speaker 5

what is there any way to quantify how much it's impacted the value of your real estate of your portfolio?

Speaker 2

No. Listen, I think I think $1,100 a square foot is market. That's what market is. Market is telling you that's what the market is. I I don't think with the we're we're not going back from downselling, so you can't look back in a rearview mirror say because it's downloaded, it's worth less.

So it is market. And I think people just have to get used to that's what market is.

Speaker 5

Ladies

Speaker 0

and gentlemen, we've reached the end of the question and answer session. I'd like to turn the call back to Victor Coleman for closing comments.

Speaker 2

Thank you so much for the support and for participating in our second quarter conference call. We look forward to talking to you all at a later date.

Speaker 0

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.