Hudson Pacific Properties Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
August 2, 2023

There are 11 speakers on the call.

Operator

Morning, and welcome to the Hudson Pacific Properties Second Quarter 2023 Conference Call. All participants will be in listen only mode. 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.

Speaker 1

Good morning, everyone. Thanks for joining us. With me on the call today are Victor Coleman, CEO and Chairman Mark Lamas, President Ruth Dearmerian, CFO and Art Swazo, EVP of Leasing. Yesterday, we filed our earnings release and supplemental on an 8 ks with the SEC and both are now available on our website. Our audio webcast of this call will be available for replay on our website.

Speaker 1

Some of the information we'll share on the call today is Today, Victor will discuss macro conditions in relation to our business, Mark will provide detail on our office of studio operations and development, and Harut will review our financial results and 2023 outlook. Thereafter, we'll be happy to take your questions. Victor?

Speaker 2

Thanks, Laura. Good morning, everybody, Thanks for joining our call. During the Q2, we worked diligently to position Hudson Pacific optimally as we continue to navigate The unprecedented confluence of an unfavorable macroeconomic environment, the lingering impacts of remote work and most recently, A historic and prolonged studio union strike. Office fundamentals across the West Coast markets remain challenged In the Q2, with gross leasing either flat or decelerating quarter over quarter, sublease activity either stable or rising And negative net absorption in all but Vancouver. As expected, studio production in Los Angeles slowed significantly with shoot days In the quarter, falling 60% to 70% year over year for TV comedies and dramas and 20% to 25% across film, Unscripted TV, commercials and photo shoots.

Speaker 2

Our focus in this environment remains on occupancy preservation and expense reductions, Both at the corporate level and within our office and studio portfolios, as well as proactively managing our balance sheet. Mark and Haru will be discussing our progress on all these fronts In detail. But beyond today's challenges are a variety of bright spots emerging that have the potential to shift the dynamics around our business And provide for significant upside and opportunities specific to Hudson Pacific as we move through 2023 and beyond. On the office front, according to a recent JLL study, the broader U. S.

Speaker 2

Office market is starting to show some signs of recovery. To date, the West Coast has lagged due to big tech rightsizing and tenants broadly staying as offensive. With mounting data pointing to historic declines in innovation, productivity and human capital development, Big Tech has taken notice. The 10 largest tech companies now have concrete hybrid attended policies impacting most of their workforce With the focus shifting into enforcement. These policy changes are starting to make positive contribution to Hudson Pacific's portfolio.

Speaker 2

As a sign of reintegration, year to date parking revenue was up in our portfolio 18% compared to last year, including 25% In San Francisco and 15% in Seattle, where Amazon returned to work May 1. More recently, Amazon asked employees To move closer to team hubs or apply for new jobs within the company or they will be considered to have voluntarily resigned. Furthermore, office demand increased quarter over quarter in both Seattle and in the Bay Area, increasing 18% in Seattle, 25% in San Francisco and 11% across the Peninsula and Silicon Valley. As we've communicated in the past, upon reintegration, tenants often realize that they don't have enough workspace or conference rooms to comfortably accommodate employees on peak days. And given the growth in tech's workforce through the pandemic for FAANG tenants, Even net of layoffs, we're conservatively estimating a 45% increase in headcount.

Speaker 2

Reintegration could begin Place expansionary pressures specific to our tenants and our markets. Couple this with the slowing of new office deliveries and accelerated conversions of older office space assets Non office space uses and we will see vacancy rates begin to turn as we approach year end. We continue to believe in our markets driven by tech and media, and we're going to provide a significant growth for long term. Although in its infancy, AI promises a wave of innovation and growth not seen since the advent of the Internet or the smartphone. Once again, the Bay Area, more specifically San Francisco, is the for this groundbreaking industry, and our portfolio is well located to benefit from its growth.

Speaker 2

VC funding to generate AI In the 1st 5 months of the year, grew 6 50% in the city, with companies there garnering 90% of the global AI related funding. This is translating into office demand and there are currently 9 requirements totaling 870,000 square feet in the city. We're optimistic AI and relative service industry growth will begin to alleviate the lack of large square footage requirements and serve as a catalyst For sustained positive net absorption, especially in the Bay Area. Now turning to our studios. While the directors reached a new contract in June, the actors joined the writers On strike in mid July, and this is the first time since the 1960s that both unions have been on strike simultaneously, and that strike lasted 22 weeks.

Speaker 2

We're hopeful all parties are going to reach a fair agreement soon, although it appears currently that they remain far apart on important issues like streaming residuals, AI and writer's rooms. The simultaneous strikes do mean that previously written production activity that still could be filmed is now on pause. However, we're 9 weeks into the strike relative to an average strike of 14 weeks, and we continue to expect a significant ramp In production post strike, like we experienced following COVID, but it's going to take time to fully reengage. And while studios have strategically spread out new releases, They could face significant shortfalls in 2024 if production isn't up and running before the fall. Netflix, as an example, recently affirmed its intent To maintain content spend through 2024 at levels in line with 2022, albeit with some lumpiness post strike similar Coming out of COVID, Comcast too noted a relative increase in content spend likely in 2024.

Speaker 2

And with subscriber growth and engagement across multiple broadband applications trending up, the underlying demand drivers for production remains strong. A strike of this magnitude, while impactful, is rare and has historically proven to be relatively short term in nature. Over the first half of the year, we've made significant enhancements to our studio cost structure. These equated to A $12,000,000 annual savings around labor and fixed operating expenses, as well as another $15,000,000 of savings attributable To deferred capital expenditures. While we'll continue to evaluate additional operating capital adjustments, we'll do so in a manner that weighs short term cost savings Against capitalizing on long term value creation.

Speaker 2

Not all industry players have the ability to make this trade off, which could present a compelling opportunity for us post strike. We'll also be able to fully capitalize on the economies of scale from our now fully integrated service acquisitions post strike, and we expect these synergies Result in approximately $15,000,000 of additional annual NOI in a normal operating environment. So despite these current challenges, We've thus far been able to navigate the ever changing landscape in a manner which speaks to the well located portfolio we've assembled, our diversified classes and the fortitude and experience of the entire Hudson Pacific team. And we understand this was going to take time to overcome, but we believe in our strategy And our long term positioning sets us up to generate even stronger results in the coming quarters. With that, I'm going to turn it over to Mark.

Speaker 3

Thanks, Victor. We signed approximately 50 office leases, roughly 50% new deals, totaling just over 400,000 square feet in the quarter. The average lease size was approximately 7,000 square feet and 50% of that activity was in the San Francisco Bay Area.

Speaker 4

Small and

Speaker 3

midsized tenants in tech and other industries continue to drive the preponderance of activity across our markets. GAAP and cash rents were approximately 4% 8% lower respectively on backfill and renewal leases with the change largely driven by a few mid sized leases, both new and renewal across the peninsula in Silicon Valley and in Vancouver. Our in service portfolio ended the quarter at 87% leased, Off about 170 basis points compared to Q1 due primarily to the move out of midsized tenants in those same markets. Our leasing economics improved across the board quarter over quarter with net effective rents up close to 9% to $44 per square foot, Tenant improvement and leasing commission costs improved close to 50%, down to $6 per square foot per annum and lease term increased by 6 months For 13% to 48 months. In terms of our 2 larger 2023 expirations, we're still negotiating a renewal of our 140,000 tenant in Seattle at Met Park North, whose lease expires in late November.

Speaker 3

We're in discussions with 2 requirements that could potentially Partially backfilled a 469,000 square foot block lease at 1455 Market in San Francisco, which expires at the end of September, 1 for approximately 25,000 square feet, the other for approximately 275,000 square feet with additional tenant interest behind these. In regard to our remaining 2023 expirations overall, which are about 5% below market, we have 50% coverage, that is deals and leases, LOIs are proposals with another 5% in discussions. Outside of the 2 large expirations I mentioned, The average expiring lease size is roughly 5,000 square feet. We're staying creative and flexible as we work to boost occupancy That even as the growing number of tenants commit to a 3 to 5 day in office schedule, thus far they continue to transact very slowly. Our current leasing pipeline totals 2,000,000 square feet, slightly above our last call even with continued leasing, and that Pipeline includes over 285,000 square feet of deals and leases.

Speaker 3

We also have close to 1,200,000 square feet of tours across our portfolio, roughly on par with this time last year, although down from last quarter. We did see an increase in both aggregate and average square footage of requirements for our assets across the peninsula and Silicon Valley. This coincides with the rise in early interest we obtained more broadly in the Bay Area and Seattle, even as the timeline for getting leases across the finish line remains Unpredictable. Turning to the studios, our in service studio stages remained well leased at 95.7% on a trailing 12 month basis And 94.1 percent on a trailing 3 month basis due to the preponderance of long term greater than 1 year leases. On a trailing 3 month basis, we actually experienced a 490 basis point increase in lease percentage at our Quixote Studios.

Speaker 3

This was largely due to the commencement of a handful of long term leases at our Central Valley and recently delivered North Valley facilities As well as a general influx of short term non strike impacted production such as commercials and photo shoots. This activity led to an additional $1,000,000 of rental and lighting and grid revenue quarter over quarter at our Quixote Studios. However, revenue from ProSupplies, transportation and other services was off by approximately $4,000,000 in aggregate, Even as we still had activity from non strike impacted productions such as music festivals and other large scale events. That said, we expect these service related categories are likely to be further impacted given seasonality and the expanded strike as long as it continues. Throughout our portfolio, we're continuing to limit capital improvements until we have certainty around demand.

Speaker 3

This includes staying conservative on new development. We do, however, have 2 in process developments close to completion. We're on track to deliver our state of the art Sunset Glen Oaks studio in Los Angeles By year end, as expected, pending receipt of Department of Water and Power Permits. We've continued to tour major production companies despite the strike. We anticipate leveraging a more traditional show by show sales model for at least a portion of the facility, which we will be able to Queued on to the fullest extent post delivery.

Speaker 3

There is no directly competitive supply for this project, Which has a delivery date potentially quite well timed to capture pent up demand post strike. In Seattle, Washington 1000 is also on track And should deliver in the Q1 of next year. While we expect even greater interest once the project is complete, we're already in early discussions with 3 tenants, Each with requirements over 100,000 square feet. As Victor mentioned, Amazon's push earlier this year to bring employees back at least 3 days a week And more recently, telling workers to return to its main hubs has accelerated return to work for many local businesses. Washington 1000 will be one of the nicest buildings in the city and is the only new product of its kind under development.

Speaker 3

Our all in basis is only $6.40 per square foot, representing as much as a 30% to 40% discount to comparable trade. And now I'll turn it over to Rick.

Speaker 2

Thanks, Mark. Our Q2 2023 revenue was $245,200,000 compared to $251,400,000 in the Q2 of last year, primarily due to Qualcomm and NSL vacating Skyport Plaza and 10,900 to 10,950 Washington respectively. The sales of office properties 6922 and Skyway Landing. Our Q3 FFO excluding specified items was $34,500,000 or $0.24 per diluted share compared to 74 point $6,000,000 or $0.51 per diluted share a year ago. Certified items in the 2nd quarter consisted of Transaction related income of $2,500,000 or $0.02 per diluted share, which includes lowering of accruals For future earn outs related to our Zayo Studio Services acquisition, prior period property tax reimbursement of $1,500,000 or $0.01 per diluted share, Deferred tax asset write off expense of $3,500,000 or $0.02 per diluted share and a gain on debt extinguishment Net of taxes of $7,200,000 or $0.05 per diluted share.

Speaker 2

Prior year 2nd quarter specified items consisted of Transaction related expenses of $1,100,000 or $0.01 per diluted share and prior period property tax expense of $500,000 or $0.00 per diluted share. The year over year decrease in FFO is attributable to the aforementioned office Tenant move outs and asset sales as well as higher studio production, higher studio operating expenses associated with Quixote acquisition And increased interest expense. Our 2nd quarter AFFO was $31,100,000 or $0.22 per diluted share Compared to $60,300,000 or $0.41 per diluted share, with a decrease largely attributable to the aforementioned items affecting FFO. Our same store cash NOI grew $127,600,000 up 4.7 percent from $121,900,000 With same store cash office NOI up 5.1 percent, largely driven by significant office lease commencement at Oneone side and Harlem. During the Q2, we repaid the Quoty note for $150,000,000 a $10,000,000 discount on the principal balance with funds From our unsecured revolving financing revolving credit facility.

Speaker 2

At the end of the quarter, We have $581,200,000 of total liquidity comprised of $109,200,000 of unrestricted cash and cash equivalents And $472,000,000 of undrawn capacity on our unsecured revolving credit facility. We have additional capacity of $122,400,000 under our One Westside and San Antonio construction loan. At the end of the second quarter, Our company's share of net debt to the company's share of undepreciated book value was 38.7% and 85.3% of our debt Was fixed or capped? We remain focused on delevering. This quarter, our Board reduced our quarterly common stock dividend to $0.125 per share, which resulted in an additional $17,900,000 of cash flow savings this quarter.

Speaker 2

We also continue to Collectively explore asset sales. We currently have 3 deals under contract, including 2 office assets and 1 land parcel, Which could collectively generate over $100,000,000 in gross proceeds within the next several months. We're also in negotiations to sell 2 more office assets, The pricing and timing of which are under discussion. Regarding our upcoming maturities, we only have one small maturity remaining in 2023, Our $50,000,000 private placement note due next month, which will repay with our line of credit. We have 2 maturities in 2024.

Speaker 2

Blackstone is leading discussions around the extension of our Bentall Fender loan, which matures in July 2024, of which our 20% ratable share is $100,500,000 We received indicative terms and are now formally commencing discussions around refinancing our One Westside Westside Q Loan, which matures in December 2024 and of which our 75% ratable share is $143,500,000

Speaker 5

As for

Speaker 2

2025, 96% of our indebtedness does not Until the final 2 months of the year. And 3 of our 4 2025 maturities comprising nearly 2 thirds of the maturing amount are secured by high quality assets, 1918 Almond, LA and Sussex Glen Oaks. The first two of which have High credit single tenant occupancy with the remaining lease terms into 2,030. South Lake Glen Oaks should be stabilized and fully operational, State of the art studio campus before its 2025 maturity. Our 4th and final 2025 maturity Consists of a $259,000,000 prior placement loan that matures in December 2025.

Speaker 2

While this is still nearly two and a half years out, Due to continued uncertainty around the duration of the studio union related strikes, we're continuing to withhold our 20 23 FFO outlook and studio related assumptions, while providing certain assumptions related to our office outlook, including reaffirming An office same store cash NOI growth projection range from 1% to 2%. This range includes the impact of the block lease Expiration in September 2023, but does not include any of the aforementioned potential dispositions, we continue to expect FFO to be negatively impacted as long as the strike persists. As always, our 2023 outlook excludes the impact of any opportunistic and not previously announced Acquisitions, dispositions, financings and capital market activity. Now we're happy to take your questions. Operator?

Operator

Thank you. We will now begin the question and answer session. Our first question today comes from the line of Alexander Goldfarb with Piper Sandler. Alexander, please go ahead. Your line is now open.

Speaker 6

Hey, good afternoon or good morning out there. And again, thanks for moving the call time to avoid the overlap. So two questions. First, it sounds like the sales so far Not contemplating One Westside, I don't know if One Westside is in the potential 2 additional for sale. But Haru, when you think about all the assets that you guys may sell, what is the NOI impact that we should think about?

Speaker 6

And then more to Victor's opening comment Corporate expense, if you're selling a bunch, what does this mean about the need to reduce the cost structure of the company overall?

Speaker 2

So let me answer the first question, which is we're not going to provide any NOI detail yet, primarily because the sales Are uncertain. And once we have confirmation of the sales and feel confident, we will share all the relevant details around them. So Doing that is not appropriate at this time. As far as the G and A goes, I think we've said before, we constantly look for ways to reduce Our costs and reevaluate them and depending on the sales and the impact, which will also Garner our ability to reevaluate G and A. So, they're always being evaluated and thought through.

Speaker 6

Okay. The second question is on Hollywood. Clearly, I mean, you guys benefit from owning independent studios, which is good. But when we think about some of the headlines we read, Disney and others who are talking about trouble with their full their screen productions or streaming services, How do you weigh like over investment in streaming or ways that Hollywood may retrench after some tough goes With the resurgent demand once the strike ends. Just trying to figure out, are we back to the races or is Hollywood reconsidering how much It puts into its production investments, just given some of the headlines we've read recently.

Speaker 2

So Alex, as I mentioned in my prepared remarks, I mean, it's so far what we found between the bigger Streaming entities to date, they are on budget at least as we know through 2024 to spend at or more Then their run rate has been in the past. And that's been Netflix's and Apple's and Amazon's and Disney's and Comcast's Tone to date, I think it's approximately a 2% increase year over year. So that I believe will probably be greater Given the fact that they're not spending the money currently today because they're on strike, so you're going to have a massive ramp up. After that, I believe we feel From what the industry is looking at that we've always mentioned that there will be some form of consolidation. Whatever that consolidation looks like, We don't know.

Speaker 2

I don't think it's going to impact the stage use and the production use because there is still very limited number of The demand in peak times are much higher than the stages that are available. Jeff, do you have any comment to that? No. The only thing I would add, Alex, is that What's clear with all of the streamers is that original production drives a lot of subscriber growth and it also mitigates their churn. So it's a key economic ingredient into their playbooks.

Speaker 2

Even if consolidation happens, they all know that they have to invest in original content production. And hopefully, obviously, we'll benefit from

Speaker 6

that. Okay. Thank you.

Operator

The next question comes from Blaine Heck with Wells Fargo. Blaine, please go ahead. Your line is open.

Speaker 7

Great. Thanks. Just to follow-up on the sales, Victor. You guys have talked openly about evaluating dispositions recently and that there are no sacred Cows within the portfolio. I mean, Harut's commentary was helpful, but just more generally, can you talk about what you've learned about the investment sales market throughout this process, Whether there is more interest in certain segments of the market and just as you've gone through the process, whether the composition And the bucket of assets up for disposition has changed based on what you've learned?

Speaker 2

Yes. I think, listen, we've The 3 assets that we have under contract right now are, as we mentioned, 2 individual assets and one parcel of land. The demand for those were relatively high on smaller user or owner user or family office type investors. The other couple of assets that we're working on right now, I think have a makeup of a more of a institutional play, change of use play. And I think that's the drive that we're looking at right now.

Speaker 2

Listen, as Haru said, we're not going to get into identifying the assets in the open marketplace. I believe that we have not explored true institutional ownership sales for large assets at this time. Not to say that that won't be something that we look at in the future, but that's not part of the game plan and the assets that we're talking about right now. And so I think The bottom line is the activity is relatively good. Clearly, financing around those assets is the hurdle.

Speaker 2

And so the size of the assets From our standpoint, and the type of buyer, is going to be identified based on the access to liquidity and capital.

Speaker 7

All right. Great. That's helpful color. And then just taking a little bit of a step back on the studios, Victor, can you just talk a little bit more about any insight you have into the negotiations going on related to the writers and actors strikes And just what your best guess is or maybe even what you're hearing from any insiders you're talking to on how long these strikes could last Kind of based on the current state of negotiation?

Speaker 2

Well, listen, I'll take the first part initially. I mean, listen, what we're hearing is there's As I mentioned in my prepared remarks, there are a few issues on the table that are hurdles that they're going to have to try to figure out, writers rooms, The issue obviously in AI, which is an undeterminable issue and a new issue for all parties, And then the residual issue are the big issues. I think the dollar issues and the issues around healthcare and all the perks around that are Pretty much agreed to. Couple of things. The fact that SAG is at the table, I believe helps The process because you've got now another constituent with thousands of people now involved, that are more than the 3,000 writers that were involved in the past.

Speaker 2

So hopefully that will set a precedent on some of this. Real time, we just heard last night, They're going back to the table Friday. The writers are they have not been at the table, I believe, for a month and a half or so. So that's a good sign. In terms of what we're hearing on the ground, we are, as I mentioned in the past, we don't have a seat in the table.

Speaker 2

We obviously have a lot of constituents around that are giving us information. It could start in a heated conversation to hopefully settle As early as September and maybe as late as year end. But I think as every day goes by, Blaine, We're all hugely aware of the shrapnel around just the industry in general And all the residual businesses that are getting affected, and it will start to feel fairly painful for these Residual companies and employees and individuals that work in the industry and it will be damaging and I think everybody is Very cognizant of that. And hopefully, we'll try to get to some resolution quicker than we all anticipate.

Speaker 7

Great. Thanks, Victor.

Speaker 8

Thanks, Blaine.

Operator

The next question comes from Nick Yulico with Scotiabank. Nick, please go ahead. Your line is now open.

Speaker 9

Thanks. I guess just going back to the asset sales, is there anything you can provide us in terms of a view of if you get a certain level of asset Sales done this year, what that's going to do to improve your debt to EBITDA metric, which is went up again this quarter?

Speaker 2

So addressing that is a little bit too outside The range of what we want to talk about right now, but ultimately it will improve it over the long term, which is kind of our main point, which is we're going to delever. And that's kind of the focus that we have. And we're using different tools to do so. So not only debt to EBITDA, but also the Covenant calculations, all those things, we have a very strong, eye on and we're projecting out. In fact, This quarter was in line with our projections and we're not in a risk of breaking any of them.

Speaker 2

But like we said earlier, the delevering is a high priority for the company. Yes. And Nick, just to add to that, the assets That were in escrow or under contract with, and the other 2 we're talking about and then the next sort of tiers that we're looking at, none of those assets currently have debt. So effectively, all that all the cash flow I'm sorry, all the proceeds from the sale will go to pay down current debt. So we're not replacing we're not getting rid of existing encumbered debt on assets in any asset at this stage.

Speaker 2

So it's all going to be very helpful. And just to touch upon the net debt to EBITDA.

Speaker 6

Okay. And

Speaker 2

then it is real quick, sorry, to address our EBITDA comment, It's being artificially reduced by the strike. And so it doesn't really reflect a normalized net debt to EBITDA As a result of the strike. And so it is being, like I said, artificially being reduced or increased, I guess.

Speaker 9

Right. I guess I just wasn't sure if there was any specific target you're trying to get to on that metric, Realizing that the EBITDA for the studio business, there's uncertainty about how long that could be under pressure. You also have Yes, some move outs still on the back half of the year that haven't been released. So I wasn't sure if you just there was a sort of plan in place where you have a target and you think that The dispositions can get you to that target.

Speaker 3

Yes, there's a plan in place. The plan is get it lower. And we're doing that Through these announced disposition goals, I'll add to the comments that Harud and Victor, I've already shared one of the asset sales is land. So that's 100% accretive to debt to EBITDA because there's no EBITDA associated with it and it goes all to debt reduction. So the plan is to get it lower.

Speaker 3

We have always said that we want to be below 7 times debt to EBITDA. We understand that there are tenants rolling, there's other areas Impacted like the studio and the strike things we don't control, but everything we can control, we are laser focused Following through with the goal of getting that metric, improving that metric.

Speaker 9

Okay, thanks. And then just one other question, if I could, on Silicon Valley and thinking about Your portfolio there. And I think historically, there was talk that the portfolio would benefit at times from Just ancillary services supporting the large tech community there. And I guess I'm just trying to Trying to understand better the dynamic right now where we all hear that large tech is more on hold With leasing, and I'm not sure if that's also impacting some of the kind of ancillary Companies that support tech, is that also sort of affecting that tenant base as well? Or is it more that Just large tech is slow in Silicon Valley.

Speaker 2

I think it's not affecting as much as I think we would have thought it would, Nick, be candid with you, because as you can see by our numbers, the majority of leases that we're doing in the Peninsula and in the Valley are smaller tenants. I mean, we've got a Handful of tenants in the 50,000 square foot range, but the majority of those tenants are 5 to 20. And so and as you can see by our numbers this quarter and the number of deals we've done, there's a lot of activity in the peninsula and the valley. The physical occupancy is in the valley and the peninsula has increased dramatically and that's converted to more people looking at space and touring and the likes of that. Art, you want to comment on that?

Speaker 2

Yes.

Speaker 8

The answer is we are as tenants are starting to Discover how they're going to utilize space, right? So return to office is really kind of on the forefront and they're enforcing these return to office mandates. They're discovering how much space they're going to need to rightsize. We're seeing those rightsizes go both cut both ways, but we are seeing Tenants coming back and looking for more space. That's going to affect both the large and the smaller users.

Speaker 8

So it's going to play all the way through.

Speaker 5

Okay. Thanks. That's helpful, everyone.

Speaker 2

Thanks, Nick.

Operator

The next question comes from Michael Griffin with Citi. Michael, please go ahead. Your line is now open.

Speaker 6

Great, thanks. I wondered if you could expand on what you mentioned in the release about extended times for decisions to be made on leases. Is this just a function of space takers more hesitant to take Base, is it supply? Any incremental commentary you could give there would be helpful.

Speaker 2

Yes. I mean, listen, it's so hard to pinpoint. Every case is a case by case. We've seen tenants come and negotiate feverishly and have leases out for signature and we've waited. I mean, We've got 2 fairly substantial leases that have been on the desks of the legal counsel fully negotiated For a matter of months, one overseas and one domestic.

Speaker 2

So Michael, I just think that It's just taking time. And maybe if you want to read into it a little deeper, I don't think it's about looking at the footprint or the competitive landscape. I just think It's a need, currently versus a need in the future. And maybe that's where the decision tree is right now. Obviously, things have changed expeditiously in terms of back to work and the number of Tenants that have come out and companies have come out with policies, the next phase of policy is enforcement and I think that level of enforcement goes to Execution of leases and I think that's exactly where we are right now.

Speaker 2

We're on that precipice of everybody's policies are in place. Now they're going to be enforced As you know, the example we gave with Amazon, which is a great example, now the enforcement comes into place. So now they recognize the need and then the executions are the next stage.

Speaker 8

Yes. But we've seen forward thinking on this relative to all the 10 basis across our portfolio. Why? Because over the first half of the year, we've seen a spike in tours early activity. And that early activity is going to translate into Actual transactions downstream.

Speaker 8

And so they've already been thinking about this and the return to work, I think, which has caused the spike in early interest.

Speaker 6

Great. Thanks. And then just going back to the riders' strike. I mean, obviously, I think it's anybody's So as to when this thing ends, but is there a worry if it gets protracted kind of into the latter part of this year that given you have a seasonal aspect of this business that production It could be slower to ramp up into 2024?

Speaker 2

Yes, it's a great question. Listen, I think we're very confident that when this Ends, the ramp up will be non seasonal and it will just go. And as I said, we just had an example of this with COVID 2 years ago And we saw the results and they were pretty spectacular. I think seasonality is out the window. I do caution, and I know Harut It's made it evident to everybody who he speaks with.

Speaker 2

We're not saying the next day things jump. I mean, this is A business and an industry that you're going to have scripts written, you're going to have sets designed, you're going to have actors hired and then you're going to have production in play and that does take time. I think they're getting prepared for it behind the scenes, but there will be some form of a ramp up. I don't know whether it's going to be. But when it's up and running, We're going to benefit from it and we think it's going to be fairly expeditious and furious.

Speaker 5

Great. That's it for me. Thanks for the time.

Speaker 2

Thanks, Michael.

Operator

Our next question comes from John Kim with BMO Capital Markets. John, please go ahead. Your line is open.

Speaker 5

Good morning. With the repayment of the Quixote note, you now have $528,000,000 outstanding on the line. And I was wondering how you plan to pay that down, whether it's disposition proceeds, I'm not sure if the 5 assets are enough to fully pay that down, Free cash flow or long term debt financing?

Speaker 3

Yes. I mean, I think the first two are the Sources along with the dividend cut. Expect to see cash flow on and our coverage on dividend continue to improve, especially when Studio operations return to normal, that Net cash flow, net of debt service and dividends will go towards either The payment of capital requirements that otherwise would have required the use of the line or reduction of the line, it will just depend on You know the period of time that we're talking about. So that'll do it. The asset sales also go to reduce that, the line balance.

Speaker 3

The use of it's possible if the capital markets are more available and the cost of Secured debt is attractive. Potentially, we would access the secured market to reduce it. But I think the Access cash flow and asset sales are really where we're going to get the debt reduction.

Speaker 5

Okay. Some of the multifamily companies this quarter talked about property tax relief in Seattle. I don't think we've heard you or other office companies talk about this, but I'm wondering if you see a similar trend either in Seattle or just property taxes in general Being alleviated?

Speaker 2

Yes. Listen, I think we are all over it in all of our markets. We are seeing a very good resetting of valuations and property tax Benefits to the company in all of our assets in California and in Washington at the same time. I think our team is way ahead of the curve on that and you'll see some impacts in the quarters to come. We have already gotten wins.

Speaker 2

I think the wins will then impact to the bottom line, expense reduction on taxes And potentially some rebates as well across the board.

Speaker 5

Okay. Victor, you talked about AI demand and the potential opportunity. I was wondering if you Had seen or are talking to any tenants currently in your portfolio either direct or sublease and if there's any way to quantify how much demand there is out there?

Speaker 2

Well, I can tell you like in my prepared remarks, as I said, San Francisco seems to be leading the On where the AI demand is, it's currently today at about almost 900,000 square feet. We've seen a couple of deals done. Hayden is an AI company. They did 42,000 square feet in the city. I also think that Another Hive, which is another AI company did I think about 60,000 square feet.

Speaker 2

There's another 800 plus 1000 square feet of activity right now. Some of it has been for sublease base and some of it is direct deals. So I think the numbers that we're quantifying at least that are real, it's about 600,000 square feet of net absorption. And then just like what was asked about the residual, then you're going to see the follow on on ancillary companies that are servicing these AI companies hopefully growing. And we're optimistic that it's going to make some kind of an impact, but it's real, it's now and we'll see where it goes in the next couple of quarters.

Speaker 2

We're looking at a couple of tenants that are very active in the marketplace and trading paper back and forth. So we're hopeful that we can execute on that.

Speaker 5

That's great color. Thank you. Thanks, John.

Operator

Our next question comes from Julian Bluhin with Goldman Sachs. Julian, please go ahead. Your line is open.

Speaker 4

Yes. Thank you for taking my question. Haroop, maybe for you. What is causing the increase in the interest guidance, is it just the forward curve going up and the impact on floating rate debt and I guess also the interest rate cap expirations you have Coming up this

Speaker 2

quarter. There's a few things, but you hit upon a couple of them. One is the forward Curve increase also while this doesn't help interest expense, it does Accretive to us, which is we paid off the Chiyoda loan and generated $10,000,000 savings. However, the cost of that loan versus The current curve is increasing interest expense.

Speaker 4

Got it. Okay. That makes sense. And we were I was encouraged to hear that the covenants came in line with your projections. Sounds like you don't really expect any issues there.

Speaker 4

I guess just could you sort of walk us through what The deterioration in the unsecured indebtedness to unencumbered asset value was? And I guess also when you say You don't expect any issues. Does that sort of assume sort of any length of strike? Or is there maybe a minimum level of leasing or tenant retention Through the end of 2024 that needs to happen?

Speaker 3

So, yes, The deterioration is really a combination of the increase in the unsecured debt balance stemming from the repayment of the Kyoto, which was a secured debt that went on that became unsecured upon repayment. And then there's almost 40 assets running through the unencumbered asset calculation and some of them increased In the quarter, some of them decreased. The net decrease was about $112,000,000 We stress test the metric, Including a protracted strike all the way through the end of 2024 and even in the most impacted quarter, we Still on that metric remain more than 300 basis points above the threshold. So, the studios, neither the studios, I should mention, runs through the unencumbered asset base or 1455, which I think some people May focus on due to the block expiration doesn't affect those valuations at all. There's an indirect effect due to the cash flow, right, because To the extent that we are generating more cash flow from the studios, it would be available to repay the debt, which will eventually Take hold.

Speaker 3

So that metric improves as we see the studios normalize. And yes, and we've factored in or sensitized that for, like I said, the protracted strike, all the known move outs, You know, everything we can project all the way through the end of 24.

Speaker 4

Got it. That's very helpful. Thank you.

Speaker 2

Thanks, Julien.

Operator

The next question comes from Camille Bonnell with Bank of America. Camille, please go ahead. Your line is open.

Speaker 10

Hello. I wanted to pick up on the comment about how market mark to market opportunities are around 5% for 2023 expirations. If we think about the negative cash rent spreads on the leases you've signed to date, has this been in line with your Given you're still seeing positive rent growth, net effective rent growth?

Speaker 3

Yes. And our mark The remaining 23 expirations remains positive 5%. A couple of deals really account for that 8% drag on the March market. The Rivian 60,000 feet extension through 28 within we had hit that Rivian deal at literally peak market rents at Palo Alto. And we're obviously glad we were able to get that significant extension, but it reflects current market.

Speaker 3

So it was a negative 18% mark. We also did a 3 month extension with Luminor. It also dragged that number down a bit. If you account for those two deals, You're essentially flat mark to market. So, yes, our numbers still show that the remaining expirations are 1, that was our expectation for the quarter.

Speaker 3

2, we expect to see something like 5% mark.

Speaker 8

Yes, more color. Both of those yields happen to be in the same exact same market where we hit peak rents and Now we're going to be adding market rent, which is also a very healthy rent, happens to be well below the mark.

Speaker 10

So just specifically within that market then, just given demand still remains below, I guess, where you need to B, to support stronger pricing power there, do you expect that these negative rent growth trends will continue over the next 18 months or Any thoughts if we're close to a bottom here?

Speaker 3

Well, I mean, our numbers, which reflect Refreshed MLA assumptions that get done every I mean, we're constantly refreshing our MLAs show a positive for the balance of 2023 and we're essentially flat On our expirations in 2024 and in 2025 there's a slight positive. Looking through the lens of our assets and assumptions associated with our assets, it suggests sort of a bottoming out.

Speaker 10

Thank you.

Speaker 8

Thanks, Camille.

Operator

Our next question comes from Dylan Bircinski with Green Street. Dylan, please go ahead. Your line is open.

Speaker 5

Thanks for taking the question. I guess just going back to Big Tech Leasing and I appreciate your comments so far, but one of your peers recently mentioned that they don't Like Big Tech Leasing to materialize or recover even through next year. So just curious, is that how you guys are sort of viewing this tenant cohort? And if what do you think ultimately brings them back to wanting to lease more space?

Speaker 2

Hey, listen, I don't know what other Landlords are saying what we're seeing is we're seeing activity in Big Tech in certain markets. We're seeing Already a decision tree that's made as to how space is going to look and now they're looking to find out where they're going to accommodate in the space. Obviously, we're seeing a flight to quality just still dealing like everybody else is. Our higher quality assets, the highest quality assets have the most activity And there's tech activity around that. I'm not going to venture into saying Big Tech is not coming back or They're not coming back anytime soon.

Speaker 2

I just know that what Art's team is seeing is that I believe that Our tours are higher than most, that we've seen in the past and we're seeing that activity. I do think that, in reference to Specific to Big Tech, I mean, just look at Amazon. I think their return to the hub messaging last week was Dramatic and absolute. And when there was pushback, they said, you know what, if you aren't going to be within an hour's Timeline of where your current office is, you can apply to another job. And if you don't, you're expected To be considered as unemployed going forward.

Speaker 8

Right. And it's not just big tech, right? We're seeing it from these comments from AT and T, Farmers, etcetera. It's starting to you're starting to see kind of the trickle down.

Speaker 2

Yes.

Speaker 5

Appreciate those comments. And I guess just in those discussions, any noticeable trends with regards to changing space layouts?

Speaker 2

Yes. I mean, listen, Dylan, we're getting a handle on this real time and we're seeing the same thing. As I mentioned in my prepared remarks, You're seeing a lot more conference room facilities, a lot more space per head. We've seen that number go up to like 165 You know, or more, maybe even to close to 200 feet per person when it was as low as like 120. And so that those numbers are consistent throughout, more space for less people.

Speaker 2

And I think that seems to be the trend. Obviously, amenity driven, that's the trend. And location and quality, Which we've talked about since the beginning of this downturn.

Speaker 5

Great. Appreciate those comments guys. Have a good one.

Speaker 2

You too, Dylan.

Operator

Our next question comes from Ronald Kamden with Morgan Stanley. Ronald, please go ahead. Your line is open.

Speaker 5

Hey, just going back on the leasing, really helpful color on the 23, too large exploration in the Amazon deal. But Any sort of updates on the remind us on the new to Nick space as well as the towers at short centers Coming to 2024, any sort of color or context there, how our conversation is going?

Speaker 8

Sure. This is Art. Nutanix, Nutanix is remember, it's a contractual giveback. We extended them for 215,000 square feet for an additional 7 years. So this was part of their contractual giveback.

Speaker 8

The piece that came back in the quarter, it was about 51,000 square feet. We're in leases for Half of that currently. Going forward, the next large piece in 2023, which is up in May, we're We're just currently marketing the space. We don't have a backfill user inside, but we are touring currently.

Speaker 5

Got it. And then Poshmark, sorry.

Speaker 8

Yes. Poshmark, we're in negotiations. If you think about it, they're a 3 floor tenant. We're in negotiations for Two floors at the current time, right? So we'll see as they assume what kind of footprint they're looking for.

Speaker 8

It might be all 3, but right now we're

Speaker 5

Got it. And then zooming out to the you talked about the 2,000,000 square feet In the pipeline, is there a way to thematically break that down a little bit? Like is there like AI, Financial Services, TAC, is there a way to sort of dive into that number a little bit more?

Speaker 8

Yes. I don't right now, I mean, I don't Dissect it in that fashion, but I will tell you the sense that I'm getting on that 2,000,000 feet. By the way, that 2,000,000 feet is up 100,000 square feet quarter over quarter After having at least 400,000 feet. So that's the early interest that I had been talking about. Repeat is real and it started to work its way into our pipeline, which Again, it bodes well.

Speaker 8

I would say that because of the markets that we're in, I would say probably 60% of that is 60%, 65% of that is tech. Now I can't break it down to AI versus hardware, software, but it's 65% squarely is tech.

Speaker 5

Got it. Helpful. Thank you so much.

Speaker 2

Thanks, Ron.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Victor Coleman, Chairman and CEO, for any closing remarks.

Speaker 2

Thank you so much for participating in this quarter's call. We'll speak to you all in the next quarter.

Operator

The conference has now concluded. You may now

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Earnings Conference Call
Hudson Pacific Properties Q2 2023
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