Earnings Call Transcript - DEI Q2 2022

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to Douglas Emmett's quarterly earnings call. Today's call is being recorded. I will now turn the conference over to Stuart McElhinney, Vice President of Investor Relations for Douglas Emmett.

Stuart McElhinney, Vice President of Investor Relations

Thank you. Joining us today on the call are Jordan Kaplan, our President and CEO; 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 website. 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 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 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 may be 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 website. I will now turn the call over to Jordan.

Jordan Kaplan, President and CEO

Good morning, everyone. Thank you for joining us. As pandemic concerns subsided, we saw strong tenant demand in our local office markets. During the second quarter, we leased over 1 million square feet, including 355,000 square feet of new deals. Based on parking income and feedback from our property managers, we estimate that our office utilization has meaningfully improved and now exceeds 80% of pre-pandemic levels. Despite leasing over 1 million square feet during the second quarter, our net absorption metric was slightly negative. With the expiration of commercial eviction moratoriums in our markets, we are finally able to replace non-paying tenants while still pursuing the collection of their outstanding balances. So during the second quarter, we recovered approximately 100,000 square feet from such tenants, and that turned our net absorption metric slightly negative. We still have about 100,000 square feet occupied by non-paying tenants, which we expect to address by year-end. Although these efforts impact our nominal occupancy, they will actually have a positive impact on our financial results as we have not been recognizing revenue from those tenants. Our growing residential portfolio is performing well. It remains fully leased, and rents on new leases are increasing at a very strong pace. We added 162 units to our apartment portfolio during the second quarter through the acquisition of 1221 Ocean Avenue and our ongoing conversion project at 1132 Bishop. Our portfolio now includes over 4,500 apartment units. While tenant demand remained strong in Q2, we're closely monitoring the macro environment for recessionary impacts, and we are already adapting to the impacts of inflation. With that, I'll turn the call over to Kevin.

Kevin Crummy, CIO

Thanks, Jordan, and good morning, everyone. During the second quarter, we acquired 1221 Ocean Avenue, an iconic 120-unit apartment property overlooking the ocean in Santa Monica. The property is essentially fully leased. We are upgrading the common area and the individual units as they roll, and we are achieving significantly higher rents in our upgraded units. Our development projects at 1132 Bishop and downtown Honolulu and The Landmark Los Angeles and Brentwood continue to progress nicely. With the recent spike in interest rates, we are fortunate that our program to refinance $1.3 billion last year extended our maturities and locked in a very favorable 2021 rate. We now have more than 2 years before any significant maturities. With that, I'll turn the call over to Stuart.

Stuart McElhinney, Vice President of Investor Relations

Thanks, Kevin. Good morning, everyone. We had an extremely successful leasing quarter, signing 261 leases covering over 1 million square feet, including 355,000 square feet of new leases. For the reasons described by Jordan, our nominal net absorption was slightly negative, bringing our lease rate down to 87.5%. As Jordan mentioned, our lease-to-occupied spread widened to 3.7% as a result of the large amount of new leasing we did during the quarter. That number was also impacted by the permitting delays and on-site inspection delays that we have been experiencing during the pandemic. Nearly half of our current occupancy backlog is scheduled to move in during Q3. As we've been saying these past several quarters, we expect rent spreads to be choppy as our primary focus remains on recovering paying occupancy at this point in the cycle. Our leasing spreads this quarter were positive 3.5% for straight line and negative 7.4% for cash. Our multifamily portfolio remains full at 99.6% leased, and we continue to achieve very strong rent roll-ups on new leases across our various residential submarkets. With that, I'll turn the call over to Peter to discuss our results.

Peter Seymour, CFO

Thanks, Stuart. Good morning, everyone. Turning to our results. Compared to the second quarter of 2021, revenues increased by 9.8%. Same-property cash NOI increased by 5.1%. FFO increased by 9% to $0.51 per share, driven by increases in both Office and Residential revenue, including improved office parking income, partly offset by higher expenses, primarily utilities. AFFO increased 15% to $89.6 million. Our G&A at only 4.7% of revenues remains very low relative to our benchmark group. Turning to guidance. We are narrowing the range of our full-year FFO guidance to now be between $2.03 and $2.07 per share. 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.

Operator, Operator

The first question comes from the line of Steve Sakwa with Evercore ISI.

Steve Sakwa, Analyst

Jordan, I was wondering if you could just provide a little bit more color on the leasing environment. I certainly can understand the desire to want to take back the space. But can you give us some sense as to what the pipeline looks like? I know you've got a lot of space coming due both in the second half and next year. And just trying to sort of figure out the cadence of occupancy improvement over the next 12 to 18 months?

Jordan Kaplan, President and CEO

Okay. Well, I think I focus more on leasing and occupancy because leasing is sort of the lead that tells you where you're going to end up with occupancy. Because as the market comes down, that spread just keeps shrinking and shrinking, so I'm always looking at leasing. But I can tell you, obviously, we had a great quarter last quarter. I know there was a slight loss in the occupancy number, but it really was driven by the fact that we've started moving people out, taking space back, or more turns over. And so it's really just impacting a stat; it didn't impact revenue. The great news is we did 350,000 feet of leasing. A lot of what I'm telling you is driven by the experience I saw. I mean, we've had a little bit of July, right, happen. And we're on track, but I'm definitely hearing a lot of the same things all of you are hearing about a potential slowdown in the economy. I can't say we're seeing that yet, obviously, but we're watching carefully for that to happen. So it's hard to make go-forward predictions other than to say, assuming we don't have a recession and assuming everything goes along good, I would look at the last quarter and actually the last few quarters, on the amount of leasing we've been doing, going, we're really starting to come back strong. And so strong, we have the confidence in getting people out and saying, okay, let's start putting people in. And if these people don't want to pay, we're going to sort of have it out with them but get them out of the space.

Steve Sakwa, Analyst

Okay. And as a follow-up, you sort of mentioned Bishop and The Landmark. Can you just kind of provide any more financial commentary around the pace of leasing at, say, The Landmark, where our rents are coming in versus pro forma and sort of where Bishop is in the kind of evolution of that lease-up?

Jordan Kaplan, President and CEO

Bishop is progressing well, and when completed, it will have just under 500 units, specifically 493. We have already completed around 300 of those units, and we are currently working on additional floors. Finishing these requires waiting for current tenants to vacate. The common areas have been completed, and the project looks great. I invite our investors to visit if they are in Hawaii. This project exemplifies a successful conversion from office to residential while still maintaining a healthy income from tenants who are currently renting. As tenants move out, we continue to convert the floors, which has been a significant engineering accomplishment. Regarding Landmark in Los Angeles, which we refer to as LMLA, it began accepting tenants in April, and leasing has been excellent. However, there's a slight delay in moving in new tenants due to limited elevator access, as we can only move a certain number of people at a time. We have successfully leased over 150 units out of the total 376. The rents exceed our initial projections for the project, to the point where we have essentially moved beyond our original financial estimates. Did that provide the information you were looking for, Steve?

Steve Sakwa, Analyst

Yes, I was wondering if you were still tracking around $9 a foot or if you had to adjust that figure.

Jordan Kaplan, President and CEO

Yes, yes. I mean, we hold on to the $9 number, which so far so good. That's an incredible result for that project. That's correct.

Operator, Operator

The next question comes from the line of Michael Griffin with Citi.

Michael Griffin, Analyst

Maybe to get back on the leasing. I noticed the lease terms, at least relative to last quarter, were up this quarter, both on new and renewals. Can you sort of comment on that and kind of what you're expecting lease terms for leases signed to be trending throughout the rest of the year?

Jordan Kaplan, President and CEO

I believe our lease terms have fluctuated somewhat. While I do appreciate seeing longer terms, especially in new agreements, I take that with a grain of caution. It really depends on some larger deals, which might have longer terms. So, yes, the lease terms appear longer, but I'm hesitant to read too much into that. The key figure I'm focusing on is the volume of activity, as that will help us assess the market demand and work towards our primary objective, which is to increase our lease rate back above 90%. We started at around 93%, and that's what we're concentrating on. The only potential obstacle to achieving this is a significant recession that could reduce the available volume for leasing. The volume figure this time is 1 million square feet, which is excellent, plus the additional 355,000 square feet is also impressive. This indicates strong market interest. As stated in our prepared remarks, it’s encouraging that we are now comfortably over 80% utilization, placing us in a positive position. All these indicators are encouraging, although I've noticed reports suggesting that other markets may be performing differently, which could make us seem like an outlier.

Michael Griffin, Analyst

Okay. No, that's helpful. Maybe for my second question, just touching on recession. I think we've seen some of your office peers come out and say potentially that a recession could be good for the office space. I think we've seen kind of how historically that may not necessarily be the case, but curious kind of to get your thoughts on what we could expect from an impact on the portfolio just given the central recessionary environment on the horizon?

Jordan Kaplan, President and CEO

Well, do you think the recession could be good for the office space or inflation could be good for the office space? Look, so the only way I would call recession to be good is if it comes with a level of unemployment that puts employers back in the driver seat and allows them to get all their employees back into the office. I don't think it's something our markets necessarily need, as you just heard, people are coming back in. Beyond that, recessions are a revenue-hitting activity. And if my tenants are feeling the impact of recession, then I can't imagine how I think that's good. Now you could take the position that inflation, because fixed assets rise in value during time and place. Inflation has a long-term effect that's very positive for real estate. It has a short-term effect of the costs of running the buildings and our interest costs going up, and we're an industry that's under some level of leverage, so the interest rates have an impact on us. I do think over the long haul, inflation has generally left real estate in better shape than when it arrived. But a recession, I could only imagine maybe the thought would be that unemployment would be up. And therefore, employers would be in the driver seat to bring people back in the office, which is where they want them. Rather than that, I would not be pleased to have us going into recession.

Operator, Operator

The next question comes from the line of Alexander Goldfarb with Piper Sandler.

Alexander Goldfarb, Analyst

Jordan, you must have been pretty excited to get that 100,000 square feet back, and I'm guessing the same will be when you get the remainder. Maybe a 2-part on that space. One, what are the steps that you need to go through to get back the remaining 100,000 square feet? And then, Stuart, if we just do simple math on the space, should we just take like $40 a foot times the 200,000 square feet and spread it out over 2 years and then assume that that's the income pickup over the next 2 years? Or is it something more to the math than that?

Jordan Kaplan, President and CEO

The process for reclaiming each space differs. You typically start with lease terminations and unpaid dues, which often resolves the matter. Then, you find yourself in a specific situation. We indicated that the income from these tenants wouldn’t be negative since we aren’t counting on any revenue from them. I’ve stated that we expect to recover significant amounts from tenants who owe us money, and we have indeed secured funds from those individuals. I’ve mentioned that we expect to maintain a default rate of no more than 2%, and this will hold true even when we collect from those tenants. Ultimately, once we decide to evict a tenant, various factors come into play, including their obligation for the entire lease term. However, we also need to take action to mitigate losses and re-rent the space to determine what they owe us, after which we typically negotiate a settlement. This is quite a complex situation, making predictions challenging. It’s difficult to apply a straightforward formula over the next couple of years, especially since some tenants have been reluctant to pay and we chose to evict them. We anticipate that they have the financial means to pay, so we will now undertake some mitigation efforts. We will aim to resolve matters with them, and the process will continue as it has in California for the past several decades.

Alexander Goldfarb, Analyst

Right. But Jordan, let me simplify things. We're talking about 200,000 square feet at $40 per foot, which totals around $8 million. Should we anticipate an $8 million increase in NOI over the next two years, with $4 million added next year and another $4 million the following year? I'm trying to consider how earnings might change. Should we expect earnings to rise by $8 million in 2024, or is it more complicated than that?

Jordan Kaplan, President and CEO

I believe that having an additional 100,000 to 200,000 square feet available for lease is valuable and can be quantified. However, we have noted for some time that we may see a pickup of around 600 basis points, or possibly around 500 basis points, as the economy improves, which would represent a significantly larger financial impact than what you mentioned. I would consider this space alongside our other assets.

Alexander Goldfarb, Analyst

Okay. And then moving to the balance sheet. You have some floating rate debt, approximately $550 million that recently had swaps expire. I believe it's due in 2027. Can you share your thoughts on floating rate debt in the current environment? Are you considering implementing some near-term swaps? What are your thoughts on this given that you haven't had any floating rate debt for a while? Now that you have it and with rising rates, I’m curious about your perspective.

Kevin Crummy, CIO

Well, Alex, it's Kevin. I'll answer that. Our program is to borrow for 7 years and swap for 5, which gives us a lot of flexibility with a 24-month runway to refinance. And that strategy provides flexibility, which is exactly what you need in the current market. As you're well aware, there's a lot of turmoil; rates have gone up and just as importantly, spreads have gapped out. So it's really not an ideal time to do anything until things calm down. And we're monitoring the market and we're going to take advantage of it when it makes sense. But right now, it's just not an ideal time to do anything.

Jordan Kaplan, President and CEO

We decided to let that go to floating because it’s not a good time to lock things in due to the current market turmoil.

Operator, Operator

The next question comes from the line of Nick Yulico with Scotiabank.

Nicholas Yulico, Analyst

The first question is regarding the difference between the occupied and lease numbers, specifically the 3.7% gap you mentioned. In the release, you noted that half of this relates to the current occupancy backlog expected to move in during the third quarter. Can you clarify if you're suggesting we should interpret the 3.7% as leading to an occupancy increase of just under 2% next quarter?

Jordan Kaplan, President and CEO

The change in occupancy is largely influenced by the ability to absorb some openings. While I believe we will see an increase, suggesting that half of the 3.7% will move in is just a way to illustrate the current pacing. In fact, we might reach that number again next quarter. If we engage in significant leasing this quarter, that figure could remain consistent. We aimed to provide insight into the dynamics behind that gap. Upon examining it, one might wonder why there’s such a delay in move-ins. That’s why we estimate that about half of those individuals will actually move in next quarter. It's important to note that we're actively leasing, particularly new leases, which is a key factor driving this number. Additionally, the pace of city inspections and plan approvals have both contributed to the slowdown. The overall environment has become more sluggish. Although we are skilled at accelerating processes during challenging periods, the current situation is slower. This delay, particularly concerning tenant improvements and final approvals, intensifies the gap since we are engaged in substantial leasing activities. It’s evident that delays are impacting us, as we have indicated that out of that 3.7%, half are set to move in this current quarter.

Nicholas Yulico, Analyst

Yes, that's helpful. I'm trying to understand how you arrive at your full-year occupancy guidance, which shows the midpoint is about 100 basis points higher than your current level. It seems you expect some occupancy improvement, but there are also expirations to manage in the latter half of the year. Can you provide any insights into these expirations? They account for roughly 6% of your square footage for the rest of the year. Has any of that been addressed? I'm curious about the potential benefits from renewing some of those expirations as well.

Jordan Kaplan, President and CEO

We have lighter expirations in the second half of the year compared to the first half, but there are several factors to consider. We analyze all those figures when providing guidance, and we believe we will remain within the previously stated range. It's important to note that we are only halfway through the year, so we will see how the remainder unfolds.

Nicholas Yulico, Analyst

Okay. I guess because you didn't change your occupancy guidance, I wasn't sure if you're now suggesting you're more likely to be at the lower end of the range because of the extra space you got back. Or if you still feel like the middle of the range is possible, which assumes some occupancy growth through the back half of the year. That was kind of the point of the question.

Jordan Kaplan, President and CEO

I think the changes are minimal. In the meeting I attended, we agreed that the range still seems valid and reflects the typical distribution. I'm not sure if we'll hit the exact middle, but I believe we'll be somewhere within that range.

Operator, Operator

The next question comes from the line of Jamie Feldman with Bank of America.

James Feldman, Analyst

Can you talk more about the 355,000 square feet of new leases? What kind of tenants are they? Are there certain buildings, certain submarkets? I'm just curious what the incremental demand is looking like. And then as you think about the pipeline, is it more of the same?

Stuart McElhinney, Vice President of Investor Relations

Yes, the positive aspect of our market is the variety of tenants driving it. We are still experiencing strong demand across various industries, with no single sector standing out as particularly influential. Some markets have seen lease rates increase while others have decreased, resulting in a mixed performance overall. There’s nothing specific in terms of submarkets or industries that indicates a notable trend worthy of mention. Demand remains robust overall, and the same applies to our pipeline; we haven't encountered any significant changes in the typical diverse demand we typically observe.

James Feldman, Analyst

And would you say the new or more tenants who didn't have space at all? Or you're winning deals from other buildings, other landlords?

Stuart McElhinney, Vice President of Investor Relations

It's always a mix of that. We have tenants moving from other buildings in the markets. We have new business creation, so it's always a combination of all those factors. I mean, like we had over 261 leases, so it's a various group.

James Feldman, Analyst

All right. So it sounds like no real perceivable trend or change in trend?

Jordan Kaplan, President and CEO

Yes, I think it's normal.

James Feldman, Analyst

Yes. Okay. And then shifting gears to 1221 Ocean. Can you talk about the expected yield on that or stabilized yield on that? I know it sounds like you're having great success with the upgraded units. And then, I guess, just bigger picture. I mean how big do you think you'd want apartments to be in terms of your total NOI stream?

Jordan Kaplan, President and CEO

I don’t really know how many projects we actually like, so I can't provide a specific calculation. Right now, it seems to be around 15%. If it were to increase to 20%, 25%, or 30%, that would be acceptable to me. The challenge lies in finding large, high-quality institutional apartment projects in our targeted markets; most of what we are acquiring now involves building them ourselves. Our focus is mainly on apartment construction rather than office buildings. From that angle, it’s possible for our apartment projects to increase. However, if the office market improves or if transactions start picking up again, the office sector could catch up, returning to the balance of 15% to 85%. Regarding your question about the remodeled units at 1221, we are indeed experiencing success with them.

James Feldman, Analyst

Oh, no. What's your targeted yield or expected yield on that project or that investment?

Jordan Kaplan, President and CEO

I think in general on that project, it's somewhat down the center line. A job well done would yield an all-cash IRR over 10 years of around 7%, maybe slightly under that, due to the high quality of the apartment project. The leverage is relatively low, and I believe the leverage number will be similar because we secured a good loan on that project and have a partner involved, likely around the 9th percentile.

James Feldman, Analyst

Okay.

Jordan Kaplan, President and CEO

Is that what you're asking?

James Feldman, Analyst

What are you assuming about the yield? I mean, just use the model.

Jordan Kaplan, President and CEO

You mean, what am I assuming in the cash flow, right?

James Feldman, Analyst

Correct. Your cash flow, your earnings yield.

Jordan Kaplan, President and CEO

Well, I just gave the IRRs. So you mean what's, like, what was the going in cap rate or?

James Feldman, Analyst

Sure, if you can give that.

Jordan Kaplan, President and CEO

I think going in, we're around a 3.

James Feldman, Analyst

A 3. Okay.

Jordan Kaplan, President and CEO

A little higher than a 3.

James Feldman, Analyst

So I guess for every additional dollar you have to invest, do you prefer apartments or office space? How do you approach that decision?

Jordan Kaplan, President and CEO

If there were two equally high-quality projects, I would be willing to pursue both. I've never faced the need to choose one over the other, as we've generally managed to maintain sufficient capital, avoiding such a situation. However, if the projects differ in quality, we always opt for the higher quality one. Therefore, if I had a limited amount of money in the same market, whether it pertained to an apartment or an office, I would choose the higher-quality option.

Operator, Operator

The next question comes from the line of Rich Anderson with SMBC.

Richard Anderson, Analyst

With an estimated utilization of over 80%, that's clearly a positive figure. It seems to compare favorably to the wider national industry. However, we certainly prefer higher utilization levels. Looking ahead to next year, there are almost 3 million square feet of space set to expire. How does utilization influence your ability to lease out vacated or expiring spaces? Is it merely an indicator of interest in your properties, or is there a more significant factor that you can leverage in the leasing process that I might be missing? Apologies if this seems like an obvious question.

Jordan Kaplan, President and CEO

No, that's not a silly question. What you're saying makes sense; having a space filled with activity and people is always more appealing. People are drawn to that environment. The utilization statistic is often more relevant than not, especially for predicting future activity and demand. When utilization was very low, we experienced low demand. Now that utilization is higher, we can look at several factors. We had substantial leasing activity last quarter, which is positive. The next thing to consider is what other analytics I can connect to forecast future trends. If utilization continues to rise, it indicates that more people are returning and may need more or different space after having let theirs go. Thus, rising utilization is a good sign. However, a negative factor is the increasing discussion about a recession, which can create hesitation among tenants. It may lead to a more cautious approach, as the outlook isn’t necessarily straightforward. Overall, utilization is a key statistic that aids in predicting our direction.

Richard Anderson, Analyst

Okay. Fair enough. And the second question is the 200,000 square feet, is that everything that you can get back? Or is there some amount that's out there that's particularly stingy and for one reason or another, politically or otherwise, you can't get to it in the short term?

Jordan Kaplan, President and CEO

I understand you are asking if we can reclaim some space. We are looking to make a deal to maximize our use of the space. To clarify, when you mention this, it implies that having someone there is not beneficial. We will explore all legal options to address the situation, either settle to remove them or take necessary actions to regain the space. We believe there is a certain amount of space remaining, possibly a bit less than we estimate. This is our current understanding of what we have left regarding people that fit this description.

Richard Anderson, Analyst

Okay. And is there anything about that space that's kind of particularly different than everything else that's expiring, maybe non-paying rent, get space that's a little bit more beaten up? Is it well located? I mean, how competitive is it relative to what you would normally see in the leasing process in terms of quality?

Jordan Kaplan, President and CEO

I think it's just like the stuff we've been leasing. I don't think there's any special thing about the space that is worse than the rest of the space in our portfolio.

Operator, Operator

The next question comes from the line of Dave Rodgers with Baird.

Dave Rodgers, Analyst

Yes. I wanted to ask about the uncollected rent balance. I know it's not in the favorite topic, but I guess, I'm curious about the 200,000 square feet of kind of the eviction tenants you're talking about this year. How much of that balance comes from them? And then maybe a second question just to kind of layer on top of that is the tenants that aren't being evicted, that still owe you money, how is that going to start coming in now that the eviction moratorium is over? Do we see that in the fourth quarter? Are you going to start kind of aggressively renegotiating leases with those guys early? But how does that work? So maybe those 2 questions separately, if I could, please.

Jordan Kaplan, President and CEO

So they are in a declining number, but they are also part of the outstanding figures that we have shared. Their amount will be difficult to determine now. If you haven't reached out to us yet, you owe us money for the past period. Once you are evicted from the space, you also owe the remainder of the lease. However, we are required to mitigate. We believe we can find someone else to take over the space, which would allow us to recover some funds, and then we can assess what you owe. It’s difficult to gauge whether these individuals will pay or expand, but previously I noted that amount was $130 million, and that figure is decreasing. The 200,000 square feet is not a large amount. All these figures are reducing to smaller totals. Collecting from most people is complicated, particularly because of our obligation to mitigate, and there may be legal processes involved. Predicting when that money will come in is tough. Nevertheless, in many cases, I believe they have the funds and will eventually pay; it's just that they have developed a habit of not paying in the past, making it a bigger challenge to recover the money.

Dave Rodgers, Analyst

On the flip side of that, the other part of that was the tenants that are still in; they didn't pay for a while they owe you another paying, so you're not evicting them, but they have some time to catch up. Can you talk about what percentage of that remaining balance that is and how that comes in?

Jordan Kaplan, President and CEO

Well, I don't know the split between the 2 groups of tenants. I could tell you that people are still in are paying some amount, probably paying current, probably paying current plus something, and it's slowly causing the balance of decline. And this group that we're talking about are the ones that were causing the balance to increase because they warrant.

Stuart McElhinney, Vice President of Investor Relations

Yes. James, the way you characterize it, now we can start aggressively pursuing is not right. We've been aggressively pursuing collection the entire pandemic. So the folks that are still in, most of them we've made bills with. They owe us some past due balance, and they're starting to pay that. They're paying current rent, and some of them are hanging out and paying according to what the moratorium allows. But we prefer to sign a new lease with them or extend out their lease and let them pay us back what they own over time, so we've been doing that for 2 years now. We haven't been waiting until now to start aggressively pursuing those balances.

Dave Rodgers, Analyst

Yes. Sorry for the mischaracterization, I think I was thinking about the eviction where you could pursue those now more aggressively. Last just for me, I wanted to clarify on the occupancy guidance, both your lease and your occupied number for the end of the year. Before or after these evictions, those numbers don't change. Is that correct? I mean, you've already taken them out of occupancy; they're not in the lease number, so there is no change regardless of whether they leave or not.

Jordan Kaplan, President and CEO

Occupancy leased and occupied statistics are currently affected by 100,000 square feet that is still counted while tenants are moving out. However, none of the accounting figures are influenced by this situation because we did not recognize any rent revenue from it, so it hasn't impacted our financials. The space is included in the stats because it was leased and occupied, meaning it's not available for other leases. The difference between leased and occupied arises when a lease is signed but the tenant has not yet moved in. We've also introduced a new metric called utilization, which emerged during the pandemic. This indicates that some tenants could be using the leased space, meaning it is both leased and occupied, yet they may not have paid rent, though it's possible that some have.

Operator, Operator

The next question comes from the line of John Kim with BMO Capital Markets.

John Kim, Analyst

I had a couple of questions on leasing activity. You did over 1 million square feet during the quarter; that was great. 440,000 square feet expiring in the second quarter, according to your last couple of months, and then you captured another 100,000 square feet. This remaining 500,000 square feet or so that I thought would have improved your leasing number and then said it went down during the quarter, so I was just wondering if there was some other unknown vacate or termination that offsets the leased rate?

Stuart McElhinney, Vice President of Investor Relations

Yes, John, it's Stuart. So if you just go back one quarter before this quarter and look at what we had expiring, it does not capture nearly the population of the expirations that we had in that quarter because, of course, nobody waits. Most folks wait till the last day of their lease to renew. So we're renewing tenants 1.5 years in advance of their expiration, a year in advance, 6 months all along the way, and that expiring number that we're telling you that we're putting the supplemental is what's left to address. Not working out, so if we've addressed it, if we renewed it, it comes out of the expirations. So you can't do the math the way that you laid it out, and you had to go back in the quarter and look at what you have expiring and then add the leasing you did and tie it out; you can't do it that way.

Jordan Kaplan, President and CEO

In fact, many tenants tend to renew their leases even after they expire. So when a lease technically expires and they are in holdover, you might still be negotiating a new deal. A few months later, they might say to reinstate their lease and request a refund for the holdover period, resulting in a new agreement with them. This is more common with smaller tenants as they are less concerned about the exact expiration date.

John Kim, Analyst

I see. So you have this additional 68,000 square feet of signed leases not commenced that's not in your exploration schedule? And that may be part of that.

Jordan Kaplan, President and CEO

It's in the exploration phase but not necessarily in the current quarter. If you have been following this for a while, you might have noticed that each year, especially leading up to the next year, the outlook for that next year starts to decline in terms of expirations because deals are being made. By the time we reach the actual year, what might have initially seemed like around 14% often ends up being less than 10%, usually 8% or 7%, due to the numerous deals we have completed.

Peter Seymour, CFO

But John, it's Peter. You were asking about the signed leases not commenced, the $680,000. What was the question about it? Those are leases where go ahead.

John Kim, Analyst

If we have a signed lease on that, are in our exploration.

Peter Seymour, CFO

Yes, there are essentially recent leases that we have done, which are considered leased but have not yet moved into occupancy. They will adhere to an expiration schedule; for instance, if it's a 5-year lease, it will expire in 5 years. These are newer leases. The signed leases that have not commenced account for 680,000 square feet. This contributes to the gap between what is leased and what is occupied.

John Kim, Analyst

Okay. I'll follow up offline. But my second question was on seasonality. So you see at 1 million square feet of leases signed this quarter and $900,000 last quarter. Is there typically any seasonality in leasing? Or can this be resolvable in the second year?

Jordan Kaplan, President and CEO

Yes, there's seasonality. Some are slow, some just tend to be slower.

John Kim, Analyst

What about the fourth quarter?

Jordan Kaplan, President and CEO

Yes, many leases expire on the last day of the fourth quarter. Consequently, the first quarter often becomes one of our most challenging periods due to these lease expirations coinciding with the end of the year. This can create the appearance that activity is happening at that time, even though the effects may extend into the following quarter. Regarding seasonality, I believe the environment for signing leases has changed, as some times are slower than others for various reasons. However, the pandemic has greatly altered our understanding of seasonality, aligning it more closely with public sentiment about the economy and fluctuations in COVID-19 cases. This shift has had a greater impact on leasing activity than traditional seasonal patterns we observed prior to 2019.

Operator, Operator

The next question comes from the line of John Nickodemus with BTIG.

John Nickodemus, Analyst

So I know this past quarter was robust for multifamily rent growth across the country. Obviously, your markets were no exception. You had an average rent roll-up over 8% across your portfolio during that time. I was just curious if you had any further detail about the rent roll-up, sort of that number that came from your market rate apartments? And how much of a drag there was from any sort of rent-controlled units you have?

Stuart McElhinney, Vice President of Investor Relations

Yes. The number we're giving you is on new leases, so there's no rent control component to that. That's on new leases signed, which when we get it back when it's vacant, that's not subject to rent control on the new lease side. We can sign a market rate deal. So we're giving you the stat unblemished by the rent control.

John Nickodemus, Analyst

Got it, Stuart. Very helpful, and we'll definitely keep that in mind going forward. Then my other question was just on the 1221 Ocean Ave. acquisition. I know with that, you now have an entire block of frontage between that property, 1299 Ocean and 100 Wilshire. With that entire block of frontage on Ocean Avenue, are there any opportunities you're looking at for operating synergies or any other revenue-enhancing upgrades across these contiguous sites?

Jordan Kaplan, President and CEO

Yes. It's a good question because the acquisition was special for us; 100 Wilshire and the other buildings were constructed by Lawrence Welk. 100 Wilshire and 1299 share a common parking garage, and when we acquired 100 Wilshire, I negotiated the agreement which was beneficial but not perfect for us. The garage is actually managed by 1299 Ocean. They had separate floors available, and there were several complexities involved. This acquisition has resolved many of those issues. Additionally, these buildings own significant parking resources, including another garage. In terms of parking management, this is making a substantial difference. We're in the process of renovating the buildings to create a more cohesive appearance, which will enhance their overall look. Once completed, I believe these will be recognized as premium properties in LA, with fewer competitors due to the improvements. We are striving for a stunning collection of properties that boast incredible views and prime locations, aiming for top quality all around.

Operator, Operator

Next is a follow-up question from the line of Michael Griffin with Citigroup.

Michael Bilerman, Analyst

It's Michael Bilerman here with Griff. Jordan, I wanted to come back and sort of look at stock price valuation and sort of firm valuation, and just how you're sort of thinking about where the shares are today. And I know you're not alone in the office world, trading where you are, but I suspect you're as frustrated as other office CEOs are. And I know you've been reluctant to want to do stock buybacks by taking off capacity, raising leverage and not having that for acquisition development. But you've done, obviously, personal purchases alongside other members of management. You've also been reluctant to sell assets to joint venture partners because I think you've always preferred going arm and arm on a new deal where you're both going in at the same basis. Does where the stock...

Jordan Kaplan, President and CEO

Everything you just said is exactly right.

Michael Bilerman, Analyst

I understand your question, and it's perfectly fine if you don't want to answer it. You're asking about the current mindset of the Board, especially after the addition of three new members last year. I'm curious if Shirley, Sugar Ray, and Doreen bring different perspectives, as well as the overall views from the Board, Tan, and Dan today. With the stock trading in the low 20s and an implied cap of 7%—almost a double-digit AFFO yield—it must be surprising. I'd like to know how this situation is viewed within the organization and whether there are any further steps you can take to enhance shareholder value.

Jordan Kaplan, President and CEO

That's a great question. I don't see the share price as a threat to the company. We've had extensive discussions about the opportunities arising from the current situation with Dan, and we've shared these views with the Board. It's a mixed bag of opportunities, but it could be something you might consider presenting as an opportunity. I've expressed my thoughts on stock buybacks before, and while I'm not dismissing that option—since we have repurchased our stock—it’s just one possibility. Another avenue could be acquiring properties, like the building at 1221, which I’ve wanted since the 90s. Are there other properties we can acquire in this climate, particularly in the office sector, where we remain optimistic? This challenging environment could allow us to enhance our office portfolio. When sentiment is negative, it's wise to explore those areas because it might present a genuine opportunity for us. Additionally, in terms of residential, there might be an upturn on the horizon, as we're still actively developing. However, many residential investments have become more dependent on low interest rates and accessible financing. This may lead to the elimination of some vital projects that we were interested in. Thus, there are opportunities available, but we need to carefully consider how to approach them. There are always risks associated with economic downturns, inflation, or whatever challenges we currently face, particularly concerning the office market. We are analyzing all these factors, aiming to find the right balance between seizing opportunities and maintaining the company's strength. The company boasts a robust balance sheet and is well-managed, generating significant cash flow annually, even amidst current challenges. We want to make the most of the opportunities that arise, as they don't appear very often, and this has been a prominent topic of discussion in our boardroom.

Michael Bilerman, Analyst

Has there been any change in the opportunity to sell existing assets, either outright or to your long-standing institutional partners? It's clear that your partners have interest, as shown by some of the deals made over the last 36 months. I understand that you have been hesitant to do this, but why not liquidate a few assets and reinvest that capital into the stock to create NAV value? You could continue to generate proceeds and reinvest in redevelopment, development activities, or future acquisitions where you could achieve a higher return.

Jordan Kaplan, President and CEO

I believe there is an opportunity to purchase properties like office and apartment buildings, which makes me hesitant to sell. If I see a chance to buy, I wouldn't want to be the seller at that time. There are two main ways to buy back stock: one is through selling assets, which might not be ideal if asset values have declined alongside stock prices. The other option is to borrow money for stock buybacks. Since I currently see buying opportunities, I'm not inclined to sell.

Michael Bilerman, Analyst

Right. But you still need to find the funds, and at $22, I feel there is little to no interest in issuing equity. Any of your private partners might consider taking units valued in the 30s, but then someone could argue they can purchase some at 23%. And despite my concerns about taxes, I would prefer the half discount. So, I’m unsure how to navigate this situation or if it's just a matter of time. I'm also wondering if having new Board members buy shares at the current stock price has shifted perspectives regarding these issues.

Jordan Kaplan, President and CEO

Well, I can't say having new Board members has changed the mindset around this. I think what's changed the mindset is saying this was, say, its own type of opportunity. Different from the opportunity that happened in 2008, different than other recessions when we were private that created opportunities. And we've got to look at this one and do this one right. But in the end, it means there's 2 real simple things. Number one, when the company is way off, it usually presents a supplement opportunity. And number two, make sure that you protect the company and don't put a risk, and those are the 2 primary things I'm looking at.

Michael Bilerman, Analyst

I appreciate the conversation, Jordan, on that. Just one follow-up just on occupancy and lease rates, just so were perfectly clear. So as you mentioned today, 87.5% leased, 83.8% occupied, that 370 basis point delta, call it about 680,000 square feet, it sounded like half of that takes occupancy potentially in the third or fourth quarter. And then the only question is what happens with the role which you have about 1.4 million in the back half, about 800 basis points? How should we just think about the retention on that to really understand how occupancy and lease rate move in the back half of the year? And then obviously, 2023 is a whole different area. I just want to understand that aspect of where these 2 numbers go in tandem over the back half?

Jordan Kaplan, President and CEO

Our goal is to improve in both areas. I believe these numbers are manageable for the third and fourth quarters. Beyond that, I'm not certain what else to add. You have our guidance regarding the figures and our expectations for where we will end up.

Michael Bilerman, Analyst

You have the guidance for office, of occupancy, 84%, 86%. Did you also give an office lease rate? Because I don't see that on Page 22; I see Residential.

Stuart McElhinney, Vice President of Investor Relations

We don't give guidance on lease.

Jordan Kaplan, President and CEO

Yes. We haven't been giving guidance on lease, other than we reported, obviously, every quarter.

Stuart McElhinney, Vice President of Investor Relations

And Michael, you asked about retention?

Michael Bilerman, Analyst

Right. So that's what I'm going with it, right.

Stuart McElhinney, Vice President of Investor Relations

Yes. So historically, our retention has been in the mid-high 60%. That's typically what we've retained. No reason to think that, that wouldn't continue to be the case going forward.

Michael Bilerman, Analyst

I’m trying to understand what you expect to happen in the second half of the year, given the 1.4 million square feet of expirations and the 700,000 square feet of signed but not occupied space. I want to know how these two factors will influence our situation, whether we anticipate ending the year with a similar spread but higher occupancy and lease rates, or if that spread will narrow while occupancy remains relatively flat, which represents the lower end of our guidance. I'm also trying to grasp the leased portion of the equation.

Stuart McElhinney, Vice President of Investor Relations

We've outlined all the components, but now we need to do the work. We have to see how the rest of the year unfolds. There is new leasing and retention to address, and we have many move-ins planned for Q3. However, there are still many uncertainties regarding the components we've discussed. We need to keep working on leasing and evaluate how retention develops for the remainder of the year.

Jordan Kaplan, President and CEO

So, as I mentioned in response to a previous question, I'm not certain that all those factors contribute to reducing the gap between occupancy and leased. That gap changes.

Michael Bilerman, Analyst

Right, because you're going to be in the next 6 months, you're leasing for '23 and '24 expirations of people coming to you, and you're getting ahead, and we believe that's part of the activity, yes.

Jordan Kaplan, President and CEO

Well, thank you all for joining us, and we look forward to speaking with you again next quarter.

Operator, Operator

That concludes the Douglas Emmett Q2 2022 Earnings Conference Call. Thank you for your participation. You may now disconnect your lines.