Hudson Pacific Properties, Inc. Q3 FY2024 earnings call

Management Statement and Operational Highlights

• Industry Trends: Positive office-related indicators with more companies moving to in-office work, tech layoffs slowing, venture fundraising picking up. AI companies in the Bay Area are driving leasing, with 44% of AI companies in the Bay Area and 2024 on pace to be a strong year for AI funding there.
• Leasing Activity: Office leasing signed 539,000 square feet in Q3, with year-to-date total of 1.6 million square feet, 25% ahead of last year. Studio has contracts or interest in nearly 80% of film and TV stages.
• Capital Recycling: Actively selling non-core office assets, with three sales under contract and potential for $200-225 million gross proceeds. Discussing JV and secured financing for six office assets as a secured financing and joint venture opportunity.
• Development: Sunset Pier 94 studios in Manhattan is an active development project, with construction progressing on time and budget for an anticipated delivery by the end of 2025.

Segment Performance

• Office Segment: Third quarter 2024 revenue was $200.4 million. Occupancy was 79.1% sequentially, with a lease percentage of 80%. Year-to-date office leasing totaled 1.6 million square feet, which is 25% ahead of the previous year. West Coast tech-centric office markets saw significant tenant requirement increases, with positive net absorption in San Francisco, the Peninsula, the Valley, and Seattle. For example, downtown San Francisco had positive net absorption for Class A product for the first time in two years, and Seattle saw midsized demand returning with overall requirements up about 30% year-over-year.
• Studio Segment: Los Angeles show counts in the following three months were in the low 80s, with production nearing 90 shows in October. Studios had 76% leased in-service stages (excluding Sunset Glenoaks) sequentially, and Quixote stage lease percentage was 33.4% sequentially. Studio revenue was $5.6 million higher year-over-year but down sequentially due to lower production levels. Currently, there are contracts or interest in nearly 80% of the film and TV stage square footage.

Guidance

• Fourth quarter FFO per diluted share is expected to range from $0.09 to $0.13.
• NOI for the Quixote business is anticipated to moderately improve in the fourth quarter compared to the third quarter results due to improved production activity.
• Office occupancy is expected to stabilize by the middle of 2025, with potential for meaningful occupancy growth thereafter. The same-store property cash NOI range is updated to a negative 13% to 14% from a negative 12.5% to 13.5% due to the removal of Foothill Research Center from the same-store pool.

Risks

• Studio production in Los Angeles is still not back to normal, and there is a need for tax incentives in Los Angeles to boost demand.
• Potential delays in securing the proposed state tax credit legislation could affect studio demand.
• Office lease expirations and the early termination of a full building tenant at Met Park North impact occupancy projections.

Question and Answer

Q: Good afternoon. Just starting on the sales Victor, can you just talk about the drivers behind what looks like an accelerated effort on the asset sales side and the rationale behind looking at the additional six office asset securitization? Any expectations for cap rates you can provide there? And then lastly, just maybe how we should expect all of those moves to kind of affect your covenant.

A: Thanks, Blaine. Well, listen, I’m not going to comment on the actual sales indirect until we have them non-refundable, which to-date is not the case. As I said, we’ve got three under contract of which one is non-refundable. We got three more that were in negotiations that should go under contract and the combined total of those are between $200 million and $225 million. The assets, how you should look at those assets as being non-core, we always evaluate assets in the portfolio that may or may not fit into our long-term strategy with capital allocation and with excess work around leasing or capital improvements or the future growth of those assets. So that’s how we identify them. They’re not core to the portfolio and they’re not what we would call as our best and highest quality assets. I do think, you touch on the JV and in the CMBS structure we’ve allocated some time and energy around six assets that we’ve got a very, very great response from JV Partners and from our CMBS debt allocation for that portfolio. We’re exhausting our talents around that. We should have, I think, more definitive information by first quarter – early first quarter of the year, but so far it’s on track. Don’t want to get into cap rates at all, at this time. Suffice to say, our ownership interest in that is going to be equal to what’s been in our past JVs, which is roughly around 50%. So that’s the intent for that aspect. Lastly, in terms of covenants, there is not going to be any impact in covenants. We are working through that right now and we feel confident that this form of liquidity is another avenue for us to go on the offensive down the road.

Q: Good afternoon out there. Just going to two questions. First, I guess, Victor, continuing on Blaine’s question on the debt covenants. Looking at the 2025 and 2026 maturities, they’re certainly meaningful amounts. And as you sit here with your leasing that you have coming up and expected asset sales and NOI, how are you looking at that debt as far as – is all of that scheduled to be dollar for dollar refinanced, or do you think that some of this will be subject to negotiations?

A: I’m not sure what you mean by subject to negotiations. I mean, listen, we are intended on refinancing. We’re in conversations right now on a secured debt that’s coming due and in 2025 we’ve got a very good response on that. And I don’t think we are all concerned about the value of those assets and the equity that we have in place and those assets are coming due. I’m not going to comment, Alex, on where we see rate, but we’re looking at either floating or fixed and a term that could be 5% or 7%. And the market is very conducive to that right now. So we feel that they’re going to get executed and we have all the confidence that we’ll get it executed well before expiration at the end of 2025.

Q: Great. Thanks. Just wanted to go back to the studios for a second. And it seems like things are maybe getting better into the fourth quarter. So I know you didn’t specify around kind of the Quixote piece of the fourth quarter guide, but is it fair to assume we should see an increase in NOI there relative to the third quarter? And then maybe stepping back, you talked about the tax credit being beneficial obviously for the industry. But is there a worry that maybe similar to the worry about the Teamsters strike this year, production could be delayed until the tax credit gets enacted. And do you think there’s the political capital to go forward with the tax credit like this?

A: So let me address the latter part first, Michael. At the end of the day, listen, I think we’re all very confident, the industry is confident that this legislation is going to pass. The Governor would not have come out as strongly as he did with the amount of $750 billion, which is going to be the highest in place tax credit for the entertainment business. And as a result, I think the modifications could be minimal. We’ll see what happens in the coming months. But it’s all sort of earmarked for it to be voted on and in place by mid-year 2025. That’s the anticipation. The citywide mandates that are being put in place. There’s already a committee in place that is promoting back to Los Angeles production at its highest levels. There’s a city tax proposal out to enhance production in Los Angeles. There are multiple factors that I think are supporting it. And just to answer your question in specifics, it doesn’t mean they’re going to wait till everything’s in place. I think directionally that’s what we were waiting for is leadership and direction both on the state level and on the city level. And then overall, just in the production companies to see that this is a direction because it will take hold for two, three, four years. This is not a one and done process. And I think that’s how we’re looking at when people are looking for production. They’re going to look at multiple savings over multiple venues, over multiple productions over a short-to-medium timeframe. So, I wouldn’t envision this to say it’s going to be impacted day one when it’s voted on. A lot of it will have some tailwinds and get us to a point where you’re going to see upsourcing and production going forward immediately in the first second quarter of 2025.

Q: Hi, everyone. I think in the prepared remarks, you guys talked about how if you kept up this pace of leasing about 500,000 square feet per quarter, that could support occupancy stabilization in mid-2025. So I guess I was just wondering if you could talk a little bit about the kind of leasing cadence that you’re seeing, how confident you are that that can stay at that pace and maybe like any other details on the size and type of kind of leasing requirements that you’re seeing?

A: Yes, Caitlin, I’ll start off. Listen, I think we’re really very pleased with all three quarters of leasing, but the most recent quarter, it’s just indicative of as the prepared remarks were made, in 2023, we did 1.7 million square feet, and we’re right now in excess of 1.6 million square feet. And we’re only three quarters in. The pipeline is consistent as Mark said in his prepared remarks, we’re confident we’re going to execute on that. And that’s why we come across to say that in 2025 we should see some stabilization and continue to increase in occupancy to a stabilized level. I do think Art would like to probably comment on just what markets we’re seeing positive absorption in for the first time in some time.

Q: Thank you. Your G&A guidance went down about $1 million in your guidance, but it’s still expected to increase year-over-year. And when you look at it on a year-to-date basis versus your NOI, it’s at 22% versus 17% last year. I realize you expect a recovery in NOI and earnings going forward, but is there anything you could do on the overhead front to kind of reduce the cost and normalize it closer to earnings?

A: Sure. A good question, John. This is Harout. So first, we’re constantly looking for ways to reduce our G&A, as evidenced by our revised guidance. Secondly, the increase in the G&A is primarily related to incentive based shares that we added in 2024 that we didn’t have in 2023, they’re not cash G&A. It’s really going to be reflective of how the shares are performing.

Q: Thank you so much and good afternoon everybody. Maybe starting with Art, two-part question on Seattle for you. First, how is sublease availability impacting demand for Washington 1000 if at all? And then second over in Pioneer Square, you’ve made progress at 411 First this year. What are your expectations for 505 First to 95 Jackson over the near term?

A: Sure. I’ll start with sublease. The reduction of sublease supply is one of the positive fundamental shifts consistent across all our portfolio, not just in Seattle. And this quarter alone we see the most significant improvement in San Francisco and Seattle where the market has absorbed 400,000 square feet and 350,000 square feet respectively, much of which is high quality space allowing us to compete more effectively. The second question is, yes, 411. So we – yes, that was our VSP program at work. We’ve talked about it constantly. It’s the market demand is in smaller space is 5,000, certainly under 10,000 square feet. We lease 411 to 94% and it was just a great success story there at 505. Those are larger floor plates, about 45,000 square foot plates. As we’ve talked about we’re starting to see demand grow significantly. And in Seattle, we’re starting to see the 20 to – kind of 20,000 to 50,000 square foot tenants, which is right in our wheelhouse, increase out there, touring constantly. We feel that there’s one to three – one to three floor tenant out there that we’re going to make some real headway on very, very shortly.

Q: Yes. Good afternoon, guys. Thanks for taking the question. I think over the last several quarters you guys talked about being able to achieve or ending the year in terms of office occupancy flat versus end of last year’s figures. But it doesn’t seem like that’s the case any longer. So just trying, just curious, trying to figure out sort of what has changed in the last several months to where you guys no longer feel like you guys can reach, flat occupancy year-over-year. I realize some of that’s probably Amazon related, but maybe if you can just talk about sort of, why that’s kind of new news and being incorporated and occupancy now and then two, like has anything changed on the leasing front? It seems like if anything at all, like leasing momentum has picked up throughout the year. So just more thoughts on that would be helpful.

A: Yes, I mean, you singled out one of the two factors we would be, we’re confident we would have been flat if not slightly improved by year end, but for two changes. One, Amazon expense in the early termination, which increased our expirations by year end by 140,000 feet and then the held for sale for Foothill roughly at the 20 basis point impact on occupancy percentage. And best of those two new developments, we expected to finish the year at or above current occupancy levels.

Q: Hey, just two quick ones. Just looking at the NOI margin in the quarter, maybe was that seasonality or what sort of drove it down? And as you, I think you mentioned occupancy not really bottoming till the sort of the middle of next year, as that occupancy declines at the beginning of next year, is that, should we expect more margin pressure?

A: I’m sorry, are you referring to margin pressure on the studio properties? On the office properties?

Q: On the office properties.

A: Got it. I think the impact there is just basically leasing activity in the middle of the quarter. So we, like we said, we wrote off that one tenant and that drove down some of the margins. I Apologize.

Q: Okay, great. And then just my second question was just to follow up on Amazon. Obviously, you still have two leases with them. Just what are conversations are like any sort of update on their plans with those leases? Clearly a lot of term on those, but wondering if they’re how they’re utilizing that space. Thanks.

A: Ron, we’re in active conversations. Obviously we don’t get into the details, but suffice to say, Amazon is talking to us on existing assets and some future growth throughout our Pacific Northwest portfolio. So we’re confident in their ability to continually grow within our markets. And candidly in the Hudson portfolio, you know, the Met Park North asset was not something that we were surprised that they were going to turn around and give back. We just thought it would be probably beginning of the year versus the end. But remember, we did renew them for a very short timeframe for a reason and they were looking to expand their portfolio outside of that.