Douglas Emmett, Inc. (NYSE:DEI) Q4 2022 Earnings Call Transcript

Douglas Emmett, Inc. (NYSE:DEI) Q4 2022 Earnings Call Transcript February 8, 2023

Operator: Ladies and gentlemen, thank you for standing by. Welcome to Douglas Emmett’s quarterly earnings call. Today’s call is being recorded. At this time, all participants are in a listen only mode. After management’s prepared remarks, you will receive instructions for participating in the question-and-answer session. I will now turn the conference over to Stuart McElhinney, Vice President of Investor Relations for Douglas Emmett.

Stuart McElhinney: Thank you. Joining us today on the call are Jordan Kaplan, our President and CEO; and Kevin Crummy, our CIO; and Peter Seymour, our CFO. This call is being webcast live from our website and will be available for replay during the next 90 days. You can also find our earnings package at the Investor Relations section of our Web site. You can find reconciliations of non-GAAP financial measures discussed during today’s call in the earnings package. During the course of this call, we will make forward-looking statements. These forward-looking statements are based on the beliefs of, assumptions made by and information currently available to us. Our actual results will be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control or ability to predict.

Although we believe that our assumptions are reasonable, they are not guarantees of future performance and some will prove to be incorrect. Therefore, our actual future results can be expected to differ from our expectations, and those differences maybe material. For a more detailed description of some potential risks, please refer to our SEC filings, which can be found in the Investor Relations section of our Web site. When we reach the question-and-answer portion, in consideration of others, please limit yourself to one question and one follow-up. I will now turn the call over to Jordan.

Jordan Kaplan: Good morning, everyone. Thank you for joining us. For Douglas Emmett, 2022 was a year of real accomplishments in the face of notable challenges. In our markets, during the first three quarters, the impacts of COVID dissipated, we leased 3 million square feet and office utilization rates rebounded to over 80%. During the fourth quarter, as economic concerns grew, we saw a slowdown in new and renewal demand from large tenants. Fortunately, we continue to see good activity from the small tenants who dominate our markets and leased 770,000 square feet during the quarter. Overall, our absorption was slightly negative for the year. Given the macroeconomic climate, we believe it is prudent for our guidance to assume no meaningful recovery in office occupancy during this year.

Photo by Alex Mihis on Unsplash

During 2022, the value of both our residential and commercial leases increased. Our straight line office rates were up 5.8% and our residential rents increased an average of 7.8%. In addition, our two multifamily development projects added 505 units to our portfolio. The current state of the national economy is challenging for all of us, but remote work, oversupply, the reliance on large tenants and concerns about reduced urban appeal seem to pose additional obstacles for some office CBDs. Fortunately, our markets, supply constraints, smaller tenants, short commutes and low reliance on public transit have supported relatively high leasing volume and utilization during the pandemic. This recent experience, combined with our industry diversification and strong operating platform, gives us confidence in the long term prospects for our markets.

With that, I’ll turn the call over to Kevin.

Kevin Crummy: Thanks, Jordan, and good morning, everyone. Our multifamily development projects continue to exceed pro forma. In April, we delivered Landmark, Los Angeles, a new 376 unit residential high-rise in Brentwood, and have already leased over 60% of the units. In addition, we have now delivered and leased over 350 of our eventual 493 units at Bishop Place in Honolulu, and we expect to substantially complete the conversion by year end. Asset sales in our markets have remained slow, but we continue to search for opportunities. Regarding our balance sheet. We have no outstanding debt maturing until December of 2024, and almost half of our office portfolio remains unencumbered. With that, I’ll turn the call over to Stuart.

Stuart McElhinney: Thanks, Kevin. Good morning, everyone. We did a substantial amount of leasing this quarter, primarily driven by the small tenants that support our markets. We signed 218 office leases, covering 772,000 square feet, consisting of 244,000 square feet of new leases and 528,000 square feet of renewal leases. For all of 2022, we signed 924 office leases, covering 3.7 million square feet, including 1.3 million square feet of new leases and 2.4 million square feet of renewals. Nonetheless, during 2022, our leased rate declined by 53 basis points to 87% and our occupied rate declined 83.7%, driven mostly by the slowdown in activity during the fourth quarter and recapturing space from nonpaying commercial tenants as local moratoriums expired.

Our leasing spreads during the fourth quarter were positive 1.8% for straight line and negative 9.9% for cash. As I’ve been saying in recent quarters, we remain focused on occupancy at this point in the cycle and expect rent spreads to remain choppy until our lease rate climbs back near 90%. Our leasing costs this quarter of $5.80 per square foot per year in line with our recent trends and well below average for other REITs in our benchmark group. Our multifamily portfolio remains essentially full at 99.4% leased. We saw continued strength in rent growth during Q4 with average rent roll up for new tenants over 5%. We assume that extraordinary 7.8% increase in multifamily rents during 2022 will moderate somewhat in 2023. We are pleased that the residential rent moratoriums in our markets are ending, although the payback periods have been extended into 2024 for some of our residential tenants.

With that, I’ll turn the call over to Peter to discuss our results.

Peter Seymour: Thanks, Stuart. Good morning, everyone. Turning to our results. Compared to the fourth quarter of 2021, revenues increased by 6.4%, FFO increased by 7.2% to $0.51 per share. AFFO decreased 11.1% to $81.2 million, reflecting more tenant improvement expenditures as a result of our robust leasing in Q2 and Q3. And same property cash NOI increased by 1.4%, primarily as a result of higher rental revenue and parking, partly offset by inflationary impacts on expenses and lower office occupancy. For all of 2022, FFO increased by 9.4% over the previous year. Our G&A remains very low relative to our benchmark group at only 4.4% of revenues. Turning to guidance. As Jordan said, our guidance assumes that office occupancy growth may not start in 2023.

We elected to allow interest on one loan to float when the related interest rate swap expired on January 1st. Our guidance also assumes we will do the same when two other swaps expire in March. Due to increasing interest rates, expiring swaps and the new residential acquisition loan, we expect interest expense in 2023 to be between $192 million and $196 million. Overall, we expect FFO to be between $1.87 and $1.93 per share with higher NOI more than offset by approximately $0.16 per share of additional interest expense in 2023. For information on assumptions underlying our guidance, please refer to the schedule in the earnings package. As usual, our guidance does not assume the impact of future acquisitions, dispositions or financings. I will now turn the call over to the operator so we can take your questions.

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Q&A Session

Operator: Our first question is from Blaine Heck with Wells Fargo.

Blaine Heck: Just starting with guidance, can you guys provide the assumptions for retention in 2023 and rent spreads on executed leases during the year, if possible?

Stuart McElhinney: Blaine, we have never given guidance on those particular items. I think for retention, our retention rates have historically stayed in a pretty tight band in kind of mid 60s. So I think you could assume that this year we’ll probably be like most years before it. And trying to predict rent spreads, it’s been impossible. We’ve tried that in the past we were not very good at predicting them ourselves, and it’s nothing we’ve ever provided guidance on. As I said, we’re focused on retaining occupancy and growing occupancy. So I think you should expect spreads to be kind of how they’ve been, but it’s hard for us to make predictions quarter-to-quarter on how they’re going to play out.

Blaine Heck: Second question, Jordan, I think you’ve been pretty focused on getting your development team working on some new projects now that Landmark is done and Bishop is wrapping up. Is there anything you can talk about on that side of your initiatives, have you identified the next project or projects? And does the increase in cost of capital make you any less likely to move forward with development projects at this point?

Jordan Kaplan: So the next big thing I think we’re going to be focused on is construction at Barrington Plaza, where some years ago, we had a fire, we’ve gone through a lot with the city, trying to get it worked. We have a lot we’re going through and have gone through with the city on insurance and — with insurance companies and with the city to get positioned to be able to start work there and do all the work that we need to do, including putting in fire sprinklers. And so that’s probably the next big step there. Although, I will say, this may not be the exact right time to do this, but some changes in state law have made it much easier for many of our sites, very good sites that we have in Wilshire — whether Wilshire, Beverly Hills and in the Valley, to made it more cost effective, less time consuming in terms of entitlements.

I mean it just fixed a lot of stuff. But those changes to make sure we really understand their impact. We’re waiting — we were waiting — we thought we were actually going to get some guidance like this month or next in terms of how it’s actually going to be executed, but then we heard we weren’t going to get any guidance until June or July, sort of waiting to hear that. But there’s no version of guidance isn’t going to come out pretty positive for us on some of those sites.

Operator: The next question is from Michael Griffin with Citi.

Michael Griffin: I wanted to ask on the Warner Bros Discovery leases expiring over here in ’23 and ’24. Just curious the demand that you’re tracking on that space. I know the lion’s share expires in 2024. Is there a sense that that’s weighted toward the first or the second half of ’24 for that? And any other color you can provide would be helpful.