Hudson Pacific Properties, Inc. (NYSE:HPP) Q3 2023 Earnings Call Transcript

Hudson Pacific Properties, Inc. (NYSE:HPP) Q3 2023 Earnings Call Transcript November 4, 2023

Operator: Good morning, and welcome to the Hudson Pacific Properties Third Quarter 2023 Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Laura Campbell, Executive Vice President, Investor Relations and Marketing. Please go ahead.

Laura Campbell : Good morning, everyone. Thanks for joining us. With me on the call today are Victor Coleman, CEO and Chairman; Mark Lammas, President; Harout Diramerian, CFO; and Art Suazo, EVP of Leasing. Yesterday, we filed our earnings release and supplemental on an 8-K with the SEC, and both are now available on our website. An audio webcast of this call will be available for replay on our website. Some of the information we’ll share on the call today is forward-looking in nature. Please reference our earnings release and supplemental for statements regarding forward-looking information as well as a reconciliation of non-GAAP financial measures used on this call. Today, Victor will discuss macro conditions in relation to our business. Mark will provide tail on our office and studio operations development, and Harout will review our financial results and 2023 outlook. Thereafter, we’ll be happy to take your questions. Victor?

Victor Coleman : Thank you, Laura. Good morning, everyone, and thanks for joining our call today. As we head into year-end, with our leasing activity accelerating, we’re in a position to begin benefiting next year from both the ongoing sentiment improvement in office and the pending completion of the writers and related actors strikes. Tech employers along the West Coast are finally enforcing in-office policies, mostly 3 to 4 days a week and growing. Foot traffic and public transit ridership is improving, and there’s a renewed public sector focus in our markets to address crime and safety and implement more pro-business policies. Close to 90% of our office space outside of the San Francisco CBD is already utilized on either a hybrid or full-time basis.

And portfolio-wide, our office-related parking revenue was up 13% year-to-date. [San Francisco’s] outlook is improving as well. In the third quarter, there were over 5 million square feet of requirements in the city, up 80% year-over-year and at fully 75% of pre-COVID levels. Over 40% of these requirements are tech related, and there are now 11 requirements over 100,000 square feet, with AI remaining as a key driver of this growing demand. This includes late-stage deals with [OpenAI] for 450,000 square feet of [Uber] sublease space in Mission Bay and [Anthoropic] for 230,000 square feet of slack sublease space in the South Financial District. We’re seeing similar strong tenant interest in our assets across markets in the form of increasing tours.

The number of tours at our assets, which were already in line with pre-COVID levels, increased 17% sequentially, while aggregate square feet of demand grew 20%. With the writers’ strike resolved as of September, we’re closely watching the progress of the SAG-AFTRA strike and discussions with AMPTP. Both sides appear motivated to get a deal done soon. We’ve seen a pickup in preproduction activity on our watch related to in-place leases as well as an increase in tours, especially for production offices used by writers. Once the actors reach an agreement, we expect to experience an increase in stage bookings positively impacting both occupancy and rental revenue as productions begin to prep. As filming resumes, we’ll start to see the ramp-up of our service-related revenue as well.

With the holidays approaching, the precise timeline remains difficult to predict. However, assuming that SAG strike resolves by mid-November, we expect some level of increased activity through year-end, with the recovery picking up through the first quarter and normalized production in the second quarter next year. We continue to build on our studio business. And in the third quarter, we closed on our joint venture with Vornado and Blackstone to develop Sunset Pier 94 as Manhattan’s first purpose-built studio. New York has been a high-priority marketplace for expansion for our Sunset Studios brand due to the established talent base, production infrastructure and recently extended and expanded tax credits. This represents only a $39 million capital commitment, with fee enhanced returns of approximately 9%.

Beyond just project-level NOI, we expect our new footprint in the city to drive further demand for and revenue from our existing New York [Quixote] businesses, building a full-service platform in the city akin to what we’ve done successfully in Los Angeles. Our vision is an end-to-end production solution, totally vertically integrated with top-notch facilities and exceptional service. We also remain focused on deleveraging and further fortifying our balance sheet. We have no material maturities until year-end ’24 when our loans secured by One Westside matures. And in the third quarter, we raised $72 million proceeds from the sales of 2 California office assets, which reflect excellent execution by our team in an obvious tough transaction environment.

Our dividend reductions have thus far, this year, yielded [$54 million] of savings. In terms of dispositions, we currently have 2 assets under contract to sell, with the possibility of adding a third, all with the potential to close by year-end. And additionally, I’ll note that we’ve once again earned top rankings in the GRESB Real Estate Assessment. This is the third consecutive year we’ve been named a Regional Sector Leader in the Office of Americas and our fifth consecutive year earning 5-star and Green Star ratings. We are very proud of our team for continuing to innovate and make our business more sustainable in ways that create values for our tenants and shareholders. With that, I’m going to turn it over to Mark.

Mark Lammas : Thanks, Victor. Our gross leasing activity accelerated again in the third quarter. We signed nearly 520,000 square feet of leases, including the renewal of our 140,000 square foot tenant at Met Park North in Seattle. Our cash rents increased nearly 9%, largely due to the strength of leases signed in the Seattle and Vancouver markets. These are positive results, thanks to the hard work of our team, but is still taking considerably longer to get leases signed versus pre-COVID. This is especially true for new deals. And as a result, approximately 80% of the leases we signed in the third quarter were renewals. Even with this relatively healthy level of activity, our lease percentage, as expected, dropped 390 basis points to 83%, with 330 basis points of that decline attributable to 1 tenant Block’s move out at 1455 Market, which we’ve discussed for more than a year.

The sales of 3401 Exposition and 604 Arizona also contributed. Occupancy within our portfolio has been impacted over the last 12 months by a similar large tenant [move-outs]. As we look to 2024, we only have 1 lease, over 100,000 square feet, expiring, specifically Nutanix for 117,000 square feet. This expiration is the result of a 216,000 square foot renewal and extension through 2030 we completed with that tenant in 2022. Thus, with our leasing pipeline steady at 2.1 million square feet, including 400,000 square feet of deals in leases or late-stage LOI, we’re optimistic we’ll begin to see occupancy in our portfolio stabilize and start to recover in the coming quarters. We currently have 62% coverage, including deals in discussion on our remaining 2023 expirations, which are approximately 5% below market.

We have about 37% coverage on our 2024 expirations over 50,000 square feet. Turning to the studios. The trailing 12-month lease percentage for stages at our in-service studios ended the quarter down 580 basis points at approximately 90% leased due to a single tenant opting not to renew on 6 stages at Sunset Las Palmas because of the strike. Underscoring the uniqueness of this situation, this is the lowest lease percentage we’ve had at that facility during our ownership since 2017. Having acquired Quixote in the third quarter of last year, this is the first quarter we’re disclosing the trailing 12-month results for those assets. Quixote stages were 41% leased on a trailing 12-month basis in the third quarter, which obviously includes the strike’s impact and is therefore not indicative of the asset’s long-term potential.

That said, historically, several of Quixote stages have been leased on a short-term, less than 1-year basis. So going forward, we could expect to see lower trended occupancy for those assets versus our predominantly long-term leased in-service portfolio, but also comparatively higher per square foot ABR. You’ll note, ABR per square foot for the Quixote Studios was $64 as opposed to $46 for our in-service studios. So there is a trade-off between occupancy and rate, which we would expect to benefit from as production activity ramps up post-strike. Our team has continued to do a exceptional job of leveraging our Quixote stages and services to maximize revenue derived from non-strike impacted productions, including short-form content like print ads, reality TV and large-scale events.

However, similar to occupancy, I’ll underscore our third quarter revenue from Quixote as well as our same-store studio assets is far from indicative of long-term potential performance. Year-to-date, the combined studio businesses generated approximately $10 million of cash NOI due to the impact of the strikes. By contrast, our same-store studios generated approximately $34 million of cash NOI in 2022, and we estimate that our Quixote stages and services have the potential to generate $80 million to $85 million of annual cash NOI once normalized production activity resumes. In short, our same-store studio historical performance and initial estimates for Quixote support the potential for as much as $120 million of annual cash NOI compared to just [$13 million], based on annualized year-to-date results.

Moving to development, we’re staying disciplined in our approach. Our in-process projects reflect highly differentiated product within our respective markets, and our remaining capital commitments are minimal. Nearly half of this in-process pipeline is studio related. Sunset Glenoaks Studios in Los Angeles is expected to deliver at the end of the year. And as Victor noted, we’ve started construction on Sunset Pier 94 Studios in New York, with delivery anticipated by end of 2025. Despite the strike, we’ve continued to tour potential tenants who recognize the exceptional quality and uniqueness of these properties and who have interest in both long-term and show-by-show leases. Clearly, the strike’s resolution will accelerate leasing activity for these assets.

With respect to our only other in-process development, Washington 1000 will deliver in the first quarter of next year. There are currently 2 million square feet of tenant requirements for Downtown Seattle. This will be the best product in that market, with no other product delivering in South Lake Union, Denny Triangle through year-end 2024. The surrounding neighborhood is vibrant due to the combination of return-to-office mandates and the recently completed convention center, which added hotel, residential and retail amenities. Our basis is only $640 per square foot, representing a 30% to 40% discount to comparable trades in recent years. And now I’ll turn the call over to Harout.

Harout Diramerian : Thanks, Mark. Our third quarter 2023 revenue was $231.4 million compared to $260.4 million in the third quarter of last year, primarily due to the sales of 6922 Hollywood, Skyway Landing and Northview Center, previously communicated tenant move-outs at Skyport Plaza and 10900 to 10950 Washington as well as a reduction in studio services and other revenue due to the related union strikes. Our third quarter FFO, excluding specified items, was $26.1 million or $0.18 per diluted share compared to $74.1 million or $0.52 per diluted share in the third quarter last year. There are no specified items for this quarter. Prior-year specified items totaled $0.07 per diluted share. The year-over-year change in FFO is attributable to the previously mentioned asset sales and tenant move-outs, higher operating expenses associated with Quixote acquisition and higher interest expense.

Our third quarter AFFO was $28.1 million or $0.20 per diluted share compared to $55.8 million or $0.39 per diluted share, with the change largely attributable to the previously mentioned items affecting FFO. Our same-store cash NOI grew $126.7 million, up slightly year-over-year, with the same-store office cash NOI up 3.5%, largely driven, once again, by significant lease commencements at One Westside and Harlow. The 40.9% decline in same-store studio cash NOI reflects, as Mark mentioned, a single tenant’s decision not to renew on 6 stages at Sunset Las Palmas due to the strike. During the third quarter, we repaid our $50 million Series E private placement notes with funds from our unsecured revolving credit facility. At the end quarter, we had $555 million of total liquidity, comprised of $75 million of unrestricted cash and cash equivalents and $480 million of undrawn capacity on our unsecured revolving credit facility.

There is additional capacity of $295 million under our One Westside, Sunset Glenoaks and Sunset Pier 94 construction loans. At the end of the quarter, our company share of net debt to company share of undepreciated book value was 38.6%, and 77.1% of our debt was fixed or capped. The reduced percentage of fixed or capped debt reflects the expiration of the hedge associated with our Bentall Centre loan until the refinancing is complete and a new hedge is put in place. On a pro forma basis, for the new hedge, our percentage of fixed and capped debt would be 79.7%. Regarding our upcoming maturities, as noted, we’re in the process of completing our refinancing on our Bentall Centre asset, of which our 20% ratable share is $90.4 million. Thereafter, our only remaining expiration through 2024 is our loan secured by One Westside and Westside Two, which matures in December 2024, and of which our 75% ratable share is $243.5 million.

Specific to our covenants, our percentage of unsecured indebtedness to unencumbered asset value increased in the third quarter to 57.7%, up from 53.7% in the second quarter. This increase was anticipated per our projections, and we expect to remain compliant. Turning to our outlook. While we remain positive about the strike’s near-term resolution, we still don’t have sufficient visibility around the nature and timing of the post-strike ramp-up in production. We continue to maintain our approach on our 2023 FFO outlook and studio-related assumptions, again, providing certain assumptions related to our office outlook. We’re reaffirming our office same-store cash NOI growth projection ranging from 1% to 2%. As always, this outlook excludes the impact of any potential dispositions, acquisitions, financings and/or capital markets activity.

Should the strike resolve by year-end, we would anticipate reinstating our full-year FFO outlook for 2024 when we report our fourth quarter 2023 results next year. Now, we’ll be happy to take your questions. Operator?

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Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions]. The first question today comes from Alexander Goldfarb from Piper Sandler.

Alexander Goldfarb : So two questions. I’ll be first just sticking with the Bentall asset. Your partner has been busy exiting a number of other office assets that they’ve owned. I assume that Blackstone is like studios to given that they just upped with the Hudson studio here in New York. Can you just give a sense of Bentall if this is an asset that they’re committed to and you guys will stay in? Or should we look for you guys to exit Vancouver?

Victor Coleman : Alex, thank you for the question. Yes, it’s — currently, we’ve had countless conversations with Blackstone on this asset. And I don’t want to speak for them as to how their portfolio has performed, but it’s our understanding that this is — could be their best office asset in their entire portfolio. And to date, they are fully engaged and prepared to continue the ownership and the plan to move and stay — sorry, to remain in Vancouver with this asset and look to extend this relationship on this asset and in Vancouver with us.

Alexander Goldfarb : Okay. And then the second question is, I think — I’m not sure if this was just about Quixote or Quixote, I always have trouble pronouncing it, or studios overall. But you guys mentioned that you’re only $13 million now versus $120 million potentially. So just want to get a better understanding, especially as we think about hopefully the strikes resolving and how the NOI buildup comes back. Simply put, where is NOI now and where could it go? And I’m asking the question again, based on — you mentioned that you’re sort of $13 million now, potential of $120 million with the studios.

Victor Coleman : Sure. So let me just start top level, and then Mark and Jeff can jump in. So as you know, this strike is now 6 months in, and we can talk about the status of it, if that’s what you have it. But just in terms of the numbers, I mean, we are looking at somewhere around loss of EBITDA for the company for the year at around $100 million, okay? And so if you look at — if we were to look to be stabilize and the strike is moving forward, it would be more like the 120 that was broken out in the comments that Mark has prepared — his prepared remarks, which is a combination of Quixote, our [South Lake] businesses and our ancillary revenues and cost savings that we’ve implemented throughout the last 9 months of this year.

Mark Lammas : Yes, Alex. I mean you can obviously see it’s broken out by segment, so you can see nicely where we are year-to-date in terms of NOI on the studio business itself. I mean — so that’s sort of what’s underpinning the annualized number that we shared in our prepared remarks. I think maybe more importantly, Alex, is what we’re trying to do is give you and others an idea of what the potential is, right? And so 2022 for our same-store assets is pretty — it’s a normal operating-type year. We had normal occupancy at the stages. We had — up until about the last month of that year, we had normalized production activity until it started to curtail in anticipation of the strike. So that’s a pretty good benchmark, right? And we’ve shared — along the way as we’ve done the acquisition, Zio, Star Waggons and eventually Quixote itself, we’ve shared what we view as the potential EBITDA on a normalized basis.

Jeff and his team have implemented somewhere in, we believe, synergy-type savings and top line improvements that we think will result in somewhere in the neighborhood of [$15 million]. You combine that with the $70 million of prior pre-synergy run rate NOI, that’s how you get to that $80 million to $85 million of normalized, annualized NOI. So that’s — those are the contributors, if you will, that get to that 120.

Operator: Our next question comes from John Kim at BMO Capital Markets.

John Kim : Just sticking to the NOI uplift in studios, looking at your presentation in September, you go from [120 to 159], including developments. And the U.K. Waltham Cross was not included in that NOI contribution. I was just wondering if there was an update on that project.

Victor Coleman : No. I mean, currently, we’re still in design phases and entitling, and we’ve not anticipated a start date in ’24 yet for Waltham Cross. We’re looking at some other alternatives and — around candidly sizing the deal on maybe 2 phases, and that’s going to come back on some pricing differential. But that’s why it’s not in the underlying cash flow, going forward, yes.

John Kim : Okay. And on the development yields that you’re expecting on the 2 current developments, does that include any additional revenue from Quixote?

Victor Coleman : No, no. That’s just a straight development deal. Remember, we — and it’s complicated and it’s a good — very good question. We balance this out. This is a Sunset asset. So it’s an asset under Sunset, both Pier 94 and Sunset Glenoaks. And then the Quixote is the operating business asset, and that is a different enhanced number on top of that. For all the service revenue that we’ll go through, we’ll go through Quixote on those Sunset-owned assets. But there’s separate ownership, so we have to keep it separate in terms of the returns.

John Kim : Okay. So that yield is just the studio rental yield. And you do expect Quixote to service the studio?

Victor Coleman : Yes. The 9 yields that was in the remarks was for Pier 94, and that’s just the Sunset yield on the studio for Hudson.

John Kim : My final question is on your dispositions. You mentioned 2 to 3 that may close this year. Any commentary that you could provide on the dollar amount in the yield?

Victor Coleman : No. We just don’t do that. I appreciate you asking. We have 3 assets, 2 are under contract. Hopefully, the third will be. And as we get closer to closing, we’ll share the numbers and the assets and the size.

Operator: Our next question comes from Michael Griffin at Citi.

Michael Griffin : Maybe just a question on leasing. You called out Seattle and Vancouver and the releases being — markets that you’re seeing relative strength in. Is there something about these markets that give you more confidence, I guess, relative to San Francisco and L.A.?

Victor Coleman : So let me start on just the general, and then Art’s sitting here. So Michael, he can jump in on that. So listen, Vancouver has been positioned throughout pre-pandemic, pandemic and currently today, right? The vacancy is very low. The rental rates have not moved considerably in either direction, and it’s been absolutely consistent and could be one of the best markets. But yes, as we’ve talked in the past, it’s very small. What we’ve seen in the shift in Seattle is generally that when the workforce has gone from 3-day a week going to 4 now in that area, some of the high-quality space in both Bellevue and Seattle is getting eaten up. And there are a few deals right now that are about to be announced in both those markets, but we’re seeing the quality space being eaten up in those markets, a lot more efficient than, I would say, specific to Los Angeles, we don’t have that kind of space available in Los Angeles for the same level and size of tenants.

Plus, I think what’s the underlying tone in Los Angeles, and Art’s going to talk about some of the demand numbers. But because we have a strike here and we are a media entertainment-related city in Los Angeles, where we’re sitting right now, things have slowed dramatically until we get back up and running. So it’s not just the studio business, it’s the overall industry itself for people growing in real estate.