Hudson Pacific Properties, Inc. Q3 FY2020 Earnings Call

Greetings and welcome to the Hudson Pacific Properties, Inc. Third Quarter 2020 Earnings Conference Call. It is now my pleasure to introduce your host, Laura Campbell, Senior VP of Investor Relations and Marketing. Thank you. You may begin.

Thank you, operator. Good morning everyone and welcome to Hudson Pacific Properties third quarter 2020 earnings call. Yesterday, our press release and supplemental were filed on an 8-K with the SEC. Both are available on the Investors section of our website hudsonpacificproperties.com. An audio webcast of this call will also be available for replay by phone over the next week and on the Investors section of our website. During this call, we will discuss non-GAAP financial measures, which are reconciled to our GAAP financial results in our press release and supplemental. We will also be making forward-looking statements based on our current expectations. These statements are subject to risks and uncertainties discussed in our SEC filings, including various ongoing developments regarding the COVID-19 pandemic. Actual events could cause our results to differ materially from these forward-looking statements which we undertake no duty to update. Moreover, today, we’ve added certain disclosures, specifically in response to the SEC’s direction on special disclosure of changes in our business prompted by COVID-19. We do not expect to maintain this level of disclosure when normal business operations resume. With that, I’d like to welcome Victor Coleman, our Chairman and CEO; Mark Lammas, our President; Alex Vouvalides, our COO and CIO; and Harout Diramerian, our CFO. Note they will be joined by other senior management during the Q&A portion of our call. Victor?

Thank you, Laura. Hello, all. Welcome to our third quarter 2020 call. I hope you are all healthy and well. I’m pleased to report that we’ve had a very safe and very productive third quarter. Our outstanding Hudson Pacific team, which throughout the pandemic has brought tremendous talent and expertise to every aspect of our business, continues to successfully navigate this complex environment. As an essential business we’ve had 100% of our workforce back in the office since Labor Day on a routine schedule with all the necessary precautions and some fantastic speedy operations. There is no doubt that we, like others in our markets, have been impacted by the extended shutdowns in California and Washington which have tampered the recovery we’ve seen accelerate in other parts of the country. Regardless, our buildings are fully operational with industry-leading health and safety protocols in place. Our tenants are paying rent, our office and studio assets are well leased, our leasing activity is starting to accelerate and our rent spreads were made at pre-COVID levels. Our development pipeline is on time and on budget and we’ve got ample capital augmented by premier, well-aligned JV partners to operate and invest. The bottom line is we’re still poised to make visionary strategic moves that consistently reinforce our position as one of the most creative dynamic players in our industry. We are, however, starting to see some positive signs throughout our markets. Last week San Francisco allowed nonessential offices to open at 25% capacity. Los Angeles schools can now welcome back 25% of high-need students, which in turn helps working parents return to the office. And physical occupancy at our office properties across our markets has reached about 15%, which was slightly higher in Canada. We’re in constant dialogue with all of our tenants and clients. We know that despite bold statements regarding work from home and seemingly distant return to the office, particularly by tech companies, most are simply on hold to figure out how, not whether, to use their space. Should cities open sooner than anticipated, we wouldn’t be surprised to see CEOs accelerate at least a partial return to work. Further, the media has focused on permanent work from home shifts when the reality is many companies, most recently Microsoft, are simply making moves toward more flexible schedules. Our office tenant base is made up of the world’s most creative, innovative companies that build their businesses and competitive edge around culture, creativity, collaboration and our work environments that are exponentially better than working from home. There are types of work that you simply can’t do at home. Security infrastructure, for example, are major issues for tech companies. If you’ve ever visited our Element LA campus in West Los Angeles, it perfectly exemplifies all these aspects. This is the type of office space we provide throughout our entire portfolio. As for our studios, despite some delays getting content producers, guilds and unions on the same page regarding health protocols, production recommenced in late August on 10 of our stages and we’re expecting to have 34 out of 35 stages active by next month. Clients currently utilizing the stages include a roster of major media companies such as CBS, Fox, Netflix, Disney, ABC and HBO, and to date we’ve seen no further shutdowns. Given the pent-up content spending in production, particularly for non-feature film single camera episodic dramas for which all our stages are ideal, we anticipate demand to remain extremely robust. The bottom line is we believe tech and media will lead this recovery. Digital has accelerated during this pandemic, bringing significant venture capital investment into cyber security and the cloud, e-commerce, healthcare, business services, fintech and ed-tech. In the third quarter 2020, U.S. VC investment reached $38 billion, marking the third highest quarter in a decade, surpassed only by the second quarter 2020, also during the pandemic, and the fourth quarter of 2018. Software companies still dominate allocations. Money has flowed into pharma and biotech, but it’s a fraction of overall investment. 2020 is shaping up to be a good year also for first-time venture financing, and fundraising has already surpassed 2019 levels at $56 billion, making 2020 the second highest year ever. Additionally, in the third quarter, pent-up demand for unicorns led to near-record U.S. IPO activities in terms of valuation. These trends are expected to continue and are extremely positive for tech and the resiliency of office demand across all of our markets. We’ve also observed firsthand the incredible pent-up demand for streaming content. Netflix, Amazon, Apple+, Hulu, Disney+ and HBO Max have gained tens of millions of new subscriptions this year. Now, 80% of U.S. consumers subscribe to at least one streaming service, and nearly a quarter of them have streamed a first-run movie, with 90% likely to do so again. Nearly half have participated in some form of gaming activity, particularly pronounced among Gen Z and millennials. Even pre-COVID, these six streaming companies planned to spend approximately $35 billion on content for 2020, indicating huge demand for stages and support space in the near term. In the mid to long term, this bodes exceedingly well for Los Angeles studio and office space as production and gaming companies continue to grow. I’d like to highlight our Corporate Responsibility initiatives. In May, we launched our industry-leading ESG platform, Better Blueprint. The pandemic’s challenges have only underscored the value and importance of making bold moves across three focus areas: sustainability, health, and equity, and we’ve done just that. Following the rollout of our diversity, equity and inclusion programs, adopting Fitwel’s Viral Response Module, and directing significant charitable donations to the communities hardest hit by the current challenges, we’ve achieved 100% carbon-neutral operations, receiving recognition from the World Green Building Council as one of the first major real estate organizations to do so. While we initially anticipated reaching this milestone in 2025, we moved swiftly and creatively to achieve it now due to the heightened energy demands associated with COVID-19 health and safety measures. Our solutions eliminate all Scope 1 and 2 GHG emissions by leveraging our energy-efficient portfolio, utilizing on-site renewables, and employing a combination of renewable energy certificates and carbon offsets. However, we have much more to do. We are pursuing additional on-site renewables and innovative technological solutions to further reduce operational carbon while also working to decrease our Scope 3 GHG emissions from non-operational carbon, specifically from building materials. In closing, much more is forthcoming as we continue to lead the industry on this and related fronts. With that, I’m going to turn it over to Mark.

Thanks, Victor. As you noted, our tenants continued to pay rent. We collected 97% of total third-quarter rents comprising 98% of office rents, 100% of studio rents, and 52% of our retail rent. To date in October, we’ve collected 94% of total rent comprised of 96% of office rent, 98% of studio rent, and 51% of retail rent. These percentages exclude rents contractually deferred or abated in accordance with COVID-19 lease amendments. If we included those amounts, our third-quarter collections would have been 96% for total rent, 98% for office, 98% for studio, and 48% for retail. Our October collections would be 95% of total rent, 96% for office, 99% for studio, and 52% for retail. During the third quarter, we deferred approximately $3.1 million or 1.8% of total rent. An additional approximately $3.1 million or 1.9% remains under discussion for either payment or deferral. We abated only $1.1 million or approximately 0.7% of third-quarter rents in connection with COVID-19 relief. Our success with collections is a testament to our high-quality office tenants and studio clients, which include many of today’s most innovative and creative growth companies. Over 90% of our office ABR is attributable to publicly traded or mature privately held companies in business for 10 years or more. Only 3% of our office ABR is tied to companies in operation for fewer than five years, and each of these 53 companies contributes on average only 0.05% of our office ABR, ensuring any risk from younger companies is well diversified. Among our top 50 tenants, which collectively generate about 60% of our office ABR, nearly 75% of that ABR is derived from publicly traded companies, and nearly 55% is from large-cap and/or credit-rated companies. Beyond tenant quality, we believe other attributes make it unlikely our tenants will give back space in the near to mid-term. Smaller office and retail tenants have certainly struggled during the pandemic, but we’ve always focused on larger, creditworthy tenants and longer-term leases. Today, our average lease size is over 15,000 square feet with the remaining term averaging five years. We also specialize in creative, flexible workspaces, meaning our tenants traditionally operate at very high densities, typically around 150 to 180 square feet per person. Even if a company decides to keep a portion of its workforce working from home longer, we expect physical distancing and lower density requirements to range from 230 to 250 square feet per person to buoy demand and occupancy at our properties. Finally, we own and operate a premier portfolio. Through industry-leading development and redevelopment and strategic capital investments, we’ve always focused on providing the most modern, safest, and healthiest workspace in the market. Our portfolio is relatively young, with an average effective building age of 16 years. We own predominantly low- to mid-rise products, averaging eight stories, reducing the need for elevator access. Nearly 85% of our portfolio has functional outdoor space including patios, courtyards, and rooftop decks. Essentially all of our properties feature state-of-the-art HVAC systems, including MERV 13 air filters or higher. Before turning the call over to Alex, I’ll provide a brief update on various ballot measures this year that could impact our business. States and cities across the country are facing rising deficits resulting from the pandemic, and Washington and California are no exception. This election season brings several proposed tax increases. Prop 15, if passed, would be the largest property tax increase in California history, with major implications for both large and small businesses. We’ve taken an active leadership role in opposing Prop 15, and polling shows a dead heat at 46% to 46%. However, if passed, the measure won’t take effect until the 2022-2023 tax year, and as history has shown, implementation will be incredibly challenging and take years to complete. As a result, we believe any near- to mid-term impact on operating expenses will be nominal. Potential long-term impacts will depend on future asset revaluation. Given the recent reassessment of our California portfolio, we enjoy a comparative advantage relative to competing landlords looking to preserve operating margins. San Francisco specifically faces three new ballot measures intended to raise additional revenue at the city and county level. The business tax overhaul to increase gross receipt taxes or Prop F will minimally impact our San Francisco portfolio. While the proposed increase to the real estate transfer tax or Prop I is significant, it is only relevant upon the disposition of an asset, thus having limited applicability to our portfolio. Additionally, the impact is relatively insignificant when compared to the underlying value of our San Francisco asset. The business tax based on top executive compensation or Prop L does not directly impact our Company’s taxes, but would place an additional tax burden on certain San Francisco-based companies. Finally, in Seattle, the City Council passed the payroll tax expense, also known as the head tax, with a veto-proof majority vote. Even so, there is a concerted effort among the business community, including ourselves, to advocate for local and state solutions to maintain Seattle’s competitiveness as a business destination. And now I’ll turn the call over to Alex.

Thanks, Mark. We are fortunate that our markets entered the pandemic on very strong footing. Despite negative net absorption in almost every submarket in the third quarter, vacancy remains in the single digits, with some cases just over 10%. Thus far, we are seeing minimal deterioration in rent, both more broadly in the market and within our own portfolio. Sublease space is on the rise in several of our markets, but the data presents a complex picture, including the fact that some of the larger subleases were pre-COVID offerings. Our stabilized and in-service office portfolios remain well leased at 94.5% and 93.5% respectively. We had a notable sequential uptick in leasing activity quarter-over-quarter, signing nearly 185,000 square feet of new and renewal deals, despite many tenants being on pause and our very limited near-term expirations. This included a 42,000 square feet expansion lease with Google at Rincon Center in San Francisco, signaling a positive outlook on how companies view office space even while pursuing both in-person and remote work flexibility. We achieved a robust 41% GAAP and 29% cash rent spread. Only about 20% of our activity this quarter involved shorter-term extensions, which typically entail a rent premium. Even excluding those deals, our mark-to-market was still up pre-COVID levels, with a 38% increase on a GAAP basis and 25% on a cash basis. We’re seeing renewed tenant activity in our leasing pipeline, which increased 40% quarter-over-quarter to 960,000 square feet. This is fully in line with third quarter 2019 and now less than 10% of those deals are on hold. Our remaining expirations for 2020 equate to about 2% of our ABR, and we have coverage on about 45% of those deals. Our 2021 expirations, with about 40% coverage, equate to around 11% of our ABR. Our mark-to-market on in-place leases remains around 14%, providing us with some cushion even amid ongoing rent pressures. We have hit several major milestones within our development pipeline over the past four months. Harlow has received a certificate of occupancy, we topped off structural steel at One Westside, which remains on budget and is on track to deliver in the first quarter of 2022, and we received unanimous approval to build nearly 480,000 square feet at Sunset Gower. We, alongside our partner Blackstone, can now commence pre-leasing efforts. We intend to replicate our success at Sunset Bronson, revitalizing this historic lot when the time is right. More than 50% of our 2.7 million square foot pipeline of future development projects, encompassing some of the best sites in the country’s top office market, is fully entitled and ready to build as we emerge from the current crisis. Regarding new acquisitions, over the last quarter we’ve focused primarily on growing our studio platform with Blackstone in Los Angeles, New York, London, Toronto, and Vancouver. We are exploring both development and redevelopment opportunities. For traditional office deals, flow remains slow. We’re currently assessing nearly value-add or opportunistic deals with near-term lease-up risks; however, the bid-ask spread remains too wide, preventing market entry. We’re instead evaluating best-in-class properties with long-term credit tenants. Deal pricing sometimes matches or exceeds pre-COVID levels, but with our strong liquidity, we’re actively seeking to redeploy capital, scale our efforts, and generate attractive risk-adjusted returns. And now, I’ll turn the call over to Harout.

Thanks, Alex. In the third quarter, we generated FFO excluding specified items of $0.43 per diluted share compared to $0.51 per diluted share a year ago. The third-quarter specified items in 2020 consisted of transaction-related expenses of $0.2 million, or $0.00 per diluted share, and one-time debt extinguishment costs of $2.7 million, or $0.02 per diluted share, compared to prior-year transaction-related expenses of $0.3 million, also $0.00 per diluted share. The sale of a 49% stake in our Hollywood Media Portfolio, lower parking revenue due to COVID-19 impacted occupancy, reserves against uncollected rents, and lower service and other revenue from our studios largely offset gains from lease commencements at EPIC, Fourth & Traction, Foothill Research Center, and 1455 Market Drive, explaining the year-over-year decrease. Third-quarter 2020 FFO excluding specified items includes approximately $0.02 per diluted share of revenues against uncollected cash rents, along with approximately $0.02 per diluted share of charges to revenue related to reserves against straight-line rent receivables, collectively resulting in a negative impact of approximately $0.04 per diluted share, some or all of which may ultimately be collected. Third-quarter 2020 FFO also reflects approximately $0.03 per diluted share decrease in parking revenue, a portion of which will resume with tenant reintegration. Simultaneous with closing our JV with Blackstone, the partnership secured a $900 million mortgage loan against the portfolio with an initial two-year term and an annual interest rate of LIBOR plus 2.15%. We received $1.2 billion of gross proceeds, deploying approximately $849.5 million to fully repay our unsecured revolver, Met Park North loan, and term loans B and D. We also purchased $107.8 million of the loan secured by the Hollywood Media Portfolio, bearing a weighted average annual rate of LIBOR plus 3.31%. Additionally, we repurchased 1.2 million shares of common stock at an average price of $22.57 per share. To date, we have repurchased a total of 2.6 million shares of common stock at an average price of $23.89 per share under our $250 million share repurchase plan. We currently have $1.3 billion in liquidity, consisting of $365.3 million in cash and cash equivalents, $600 million in capacity on our unsecured revolver, and $339.5 million of capacity on our One Westside construction loan. We have no maturities until 2022 and a weighted average term of maturity of 6.1 years; therefore, we have ample capital to manage properties, complete development projects, and pursue new opportunities. Before turning to guidance, I’d like to highlight a very positive emerging trend in our AFFO. Despite a $12.7 million decline in FFO quarter-over-quarter due to the temporary impact of our Hollywood Media Portfolio JV, we generated a modest increase in AFFO during the same period. This reflects normalizing leasing costs coupled with the transition from non-cash revenue to cash rent commencements after the burn-off of free rent under significant leases, as evidenced by a $9.1 million drop compared to last quarter. Notably, the increase in year-to-date AFFO is over 45% higher than in the prior year. This increase occurred despite the temporary impact of our latest JV, primarily due to significantly lower leasing costs and the transition to cash rent commencements. It is an important milestone that we've often referenced in relation to prior-period leasing activity. On May 5th, we withdrew our previous 2020 earnings guidance due to uncertainties surrounding business disruptions tied to the COVID-19 pandemic. Given these uncertainties persist, we have not reinstated guidance for the rest of the year. However, we are providing helpful insights based on what we know today to assist in evaluating our potential earnings results for the fourth quarter of 2020. We anticipate operations in the fourth quarter 2020 to align closely with those in the third quarter 2020, with office NOI expected to increase approximately 1.5% and media NOI expected to increase approximately 5.5%. Note that third-quarter operating results include the impacts of the new Hollywood Media Portfolio JV for two months, whereas the fourth quarter will fully reflect this transaction. After adjusting for one-time debt extinguishment fees from the third quarter, we estimate interest expenses will be approximately 4% higher due to the full quarter impact of interest related to the new Hollywood Media Portfolio loan. We also expect an increase in FFO attributable to non-controlling interests of around 20% compared to the third quarter. And now, I’ll turn the call back to Victor.

Thanks, Harout, Mark, Alex, and Laura. I’ll conclude by stating that we do not take lightly any of the hurdles California is placing or proposing on its businesses and residents. In many ways, this is unfortunately nothing new. While we remain optimistic that Californians will thrive despite these challenges, as we have for many years, we plan to do everything in our power to ensure California remains a great place to do business, raise a family, and truly a great place to live. I also want to express my sincere appreciation to the entire Hudson Pacific team for their hard work and dedication. Thank you all for participating in today’s call. We appreciate your continued support. Stay healthy and safe, and we look forward to updating you next quarter. Operator, let’s open the line for any questions.

Thank you. Our first question has come from the line of Alexander Goldfarb with Piper Sandler. Please proceed with your question.

Hey. Good morning out there. Just been a long earnings week. So, two questions. First, if you could just give a little bit more color, the stock buyback, good thing. Obviously, the stock is incredibly depressed, but your stock is trading at an implied 8% and you guys bought a piece of the media loan that was at 3.3%. So if you could just walk through that, because it would seem like that capital would have been better used to buy back your stock at a higher yield. So just want to hear more about how you guys viewed the transaction.

Yes. Alex, hey, it’s Victor. Thanks for the question. So, Alex, you’ve personally asked this several times and the answer has been the same. First of all, it was a LIBOR plus 3.3%, and yes, it is a far cry from an implied 8%, even though today stocks are probably trading at a forward-looking implied 10.5%. The answer to your question is we will always buy back our stock at these levels. We couldn’t buy back our stock during that transaction because we were initially locked out, as we are right now. However, as of Wednesday, we will start buying back our stock at these levels and continue to do so. But as I’ve said previously, we’re not going to miss out on opportunities. We fortunately are in a very nice situation with accessible capital to invest in various aspects: stock being one and assets being another. Specific to this, we just recognized that the credit being Blackstone and our opportunity there was timely, so we could take it ourselves and have this as a parking opportunity for a period, given our need for capital to invest at that moment. That’s what we chose to do, and it was a small amount.

Yes. I would just add that the $900 million loan on the $1.650 billion is 55% leverage. The purchase of $107.8 million not only allowed us to deleverage to effectively 40%, which is closer to our target leverage, but we delevered purchased at LIBOR plus 3.31%, which is significantly better than other debt classes. Thus, if we decide to relever, we can do so at much cheaper rates. It makes a lot of sense.

Okay. And then the second question, Victor, and you’ll love it because I’m playing the typical sell-side analyst. On one side, I dislike something, on the other side I like something. There was a recent Silvercup trade here in New York that I think created sort of low-five, and it would seem like these transactions, these studios are a rare breed. They come up every now and then, like buying a Ferrari GTO from the 1960s. There are not many, and when they come up, they command big money. Low-fives have been still pretty cheap for an asset that is hard to replicate. Obviously, right now your cost of capital isn’t great. The Blackstone JV makes it better. But what are your views on where cap rates for studios are going, and why they shouldn’t continue to go lower, in which case the low-fives for Silvercup end up looking cheap? Just some color on your thoughts regarding these trades.

Yes, sure. I think cap rates are certainly going to compress in that area. There are many interested parties. Competition has noticeably increased. That asset is a fantastic asset. It’s one we considered acquiring, but we didn’t pursue aggressively due to our process with Blackstone. Timing was simply misaligned. Those assets will still be in demand. Hudson and Blackstone in our venture will continue to expand that platform. We’ve discussed this previously and are currently investigating several deals, and we plan to remain competitive in that area. I believe you are correct; those types of cap rates are attractive, and the market will likely tighten further since they are scarce.

Okay. Thank you, Victor.

Thank you. Our next question is coming from the line of Dave Rodgers with Baird. Please proceed with your question.

Yes. Good morning out there and good afternoon, everyone. I guess I heard in Alex’s comments that maybe you guys are really focused on core transactions today. I wanted to verify your thought process around that, and additionally, where you’re comfortable buying assets. Are you comfortable buying core assets in San Francisco proper today? What’s your thought process around that, Victor?

It’s an excellent question. Core assets providing long-term cash flow stability are certainly on our radar, and we evaluate tenant quality, geographic location, economies of scale, our cost of capital, and that of our JV partners when considering these opportunities. To directly answer your question about purchasing an asset today in San Francisco: my answer would probably be no. At current levels, we are not comfortable with that marketplace. As Alex indicated, we are not observing the spread for value-add assets in any of our markets that would justify acquisition. They are still priced at levels we believe are too high, especially given the slower leasing activity in our markets compared to 12 months ago. However, unique opportunities will always arise, and we will consider those synergies. We have historically taken advantage of various cycles and capitalized on them effectively.

I think you also made a comment—maybe it was Alex—that on the 40% coverage for the 2021 lease expirations, there’s a 14% mark to market on that. Is it more challenging to navigate those discussions today if you don’t have a first-half maturity? Do you have good visibility on the tenants that want to remain in place or those that might be leaving next year? I’m particularly interested in smaller tenants versus larger tenants; can you share any insights on that?

Sure. This is Harout. We have a fairly solid grip on the 2021 expirations. As you recall, two of those tenants account for 25% of the $1.5 million, and we are engaged in dialogues with them. Overall, we feel optimistic about this. The remaining tenants average around 40,000 square feet, and we are actively negotiating with a couple of them. So, yes, we feel confident about where we stand, and the mark-to-market is likely to remain strong.

Last, regarding co-working, you guys have addressed WeWork's leases in previous quarters. I know Regis has filed for bankruptcy, and there have been recent articles discussing you in San Francisco and elsewhere. Are you progressing regarding these transactions, and do you feel you’re adequately reserved at this point for the flexible negotiations you are navigating?

Yes, this is Mark. We are appropriately reserved. Every one of our co-working locations, except for Shack 15, which is a relatively small space, and one of five WeWork locations where we transitioned to a percentage rent arrangement, are current. We are working on adjustments with Regis regarding some of the footage in Seattle; they will effectively pay 100% of the rents on the 450 and return some of the area back to us at 95 Jackson. We view this as a genuine opportunity to fill those spaces, given the contiguous nature. Overall, the picture on the co-working front is healthy, with only minor adjustments required, as I just pointed out. We are fully reserved against all related matters.

I appreciate all the clarity from everyone. Thanks.

Thank you. Our next question comes from the line of Jamie Feldman with Bank of America Merrill Lynch. Please proceed with your question.

Great. Thank you. I want to get an update on your thoughts regarding the relative demand across the Bay Area submarkets. Are you observing any trends in Silicon Valley versus Peninsula versus CBD as your leasing pipeline begins to recover?

Certainly. It’s interesting—our pipeline has rebounded quarter-over-quarter, returning to levels similar to earlier in the year. There are some expansions in the pipeline; some tenants have taken their fingers off the pause button and are now re-engaging in discussions, with some returning as early as 2021. This increased pipeline is part of our optimism looking forward. Regarding the markets, I’d argue that the Peninsula and Silicon Valley are showing more strength compared to the city, where active requirements fell from about 6 million square feet to 2.8 million square feet. This suggests activity exists, but it has largely been sidelined. I’m encouraged going forward as tenants gain clarity regarding how and when they will utilize their space; I believe we will see some demand materialize.

Okay. In terms of possible shifts towards more suburban satellites or hub-and-spoke models—has that changed your assessment?

Well, it's not that we’re not noticing it; we simply don’t have the space in those areas that might be experiencing a significant shift. Our recent deal with Google reflects that. They are not necessarily migrating into the city or the valley; each market has varying requirements. I think it's typical that people claim the valley is suffering while the city performs well—demand appears stable across all markets. There’s no substantial migration away from one area to another; both the Valley and city continue to experience interest.

Jamie, it’s Alex. Just to add to what Victor said, the West Coast is somewhat different from what you might see in New York, where reliance on public transport is high. The idea of spreading out geographically was already one we were pursuing. If you consider our markets—from Seattle to Bellevue on the Eastside, or from the city to San Jose—tech companies have operated successfully across different areas, and this trend existed pre-pandemic. So we’re not observing any further shifts such as pulling back from one area and moving towards another excessively.

That makes sense. I thought the VC numbers you shared were impressive. Any thoughts on how that translates into demand and the market it might influence?

While we can’t precisely quantify that demand, the available capital indicates growth prospects for companies ranging from established firms looking to go public to new unicorns. Absorption of space is expected based on these companies' growth trajectories. Moreover, we observe many VC companies investing not just in technology but in ancillary businesses as well, which will play a significant role in demand, particularly in California. We anticipate more clarity regarding the growth and stability of companies post-election and into the new year.

Can you talk about leasing prospects at Harlow? I know you received your Certificate of Occupancy for the building.

Harlow is a fantastic project. Currently, tenant tours are still limited, and many tenants are not utilizing their existing space. As such, we see it as a prime growth opportunity. We are being patient, waiting for tenants to return, recognizing that many deals lately have been renewals favoring existing relationships rather than new deals and expansions.

Lastly, you mentioned an interesting AFFO spike in the third quarter compared to 2019. How are you considering the dividend and potential increases for that?

We’ve discussed that topic. Mark can elaborate, but this shows what’s ahead. Our collections rate has remained consistent since March at 95%, which will clearly influence dividends positively. We foresee dividend increases sometime in 2021, perhaps mid-year or earlier. Mark, would you like to add anything?

I appreciate the acknowledgment, Jamie. We’ve hinted at this for a while, and if we look ahead, we believe that the third-quarter results will be sustained. As Victor noted, we'll monitor the dividend and seek the next suitable opportunity to increase.

Thank you.

Thank you. Our next question is coming from the line of Manny Korchman with Citi. Please proceed with your question.

Hey. Good afternoon, everyone. Victor, you opened the call with a very positive note, yet fundamentals aren't necessarily portraying that. What observations do you have on the ground that might be more positive or negative, particularly regarding investor or analyst sentiment amidst stock fluctuations?

Manny, let’s cover the facts. This all began in March, and here we are on November 1st. We have consistently collected rents at 95% and experienced minimal occupancy drops of about 1%. People are observing what they believe to be the worst of times; however, our fundamentals remain stable. We haven’t encountered volatility in rent collections or occupancy rates. The keys are factors beyond our control, like the return of children to schools in Washington and California, akin to what we see in Vancouver. Increasing our occupancy from 15% back to normalized levels is imperative. The trend discussions are significant but we've remained vigilant about the quality of our holdings. We boast a high-quality portfolio with excellent tenants. Hence, the question remains: why are our values trading at 11 caps when private markets are consistently purchasing assets at much lower cap rates? This disconnect suggests that perceptions surrounding the future of office spaces are skewed. Changes will inevitably occur; work arrangements might blend, creating flexible solutions. However, people need their office spaces—especially young professionals—to foster collaboration and learning—elements that are essential to growth in their careers. Additionally, while some CEOs may be reticent to discuss this topic publicly, especially amid COVID uncertainties, it will likely shift back to normal in time.

Thanks for that, Victor. Harout, I appreciate the guidance moving forward. I was surprised to see that studio income isn't recovering as quickly as anticipated now that filming is back on track. Is the issue one of magnitude, such that people aren’t paying additional fees due to the scale of shoots not being there? Is there another layer to this?

Let me jump in before Mark provides additional insight. First and foremost, production resumed in late August, which means the reopening of the stages took time as protocols were established. Getting unions back on board proved slower than we expected; however, we’re currently operating at about 95% activation across our studio portfolio. You can anticipate a surge in ancillary revenue that we weren't receiving prior. Mark, please elaborate.

Yes, indeed. Compared to Q2 and Q3, ancillary revenue increased. Although it did not reach Q1 levels, we project that Q4 should nearly approach those Q1 levels due to the ramp-up that started in Q3 and is expected to continue into Q4. Further projections indicate that 2021 ancillary revenues may exceed even 2019 levels. While control rooms responsible for live audiences may introduce uncertainty, all other stages should be as busy as ever, marking a strong Q4.

Hey, Victor. It’s Michael Bilerman here alongside Manny. Just revisiting your statement about things reverting back to normal—it’s worth considering that the retail and mall sectors haven’t recovered as such, and many retailers claimed e-commerce wouldn't affect them. What sets your confidence apart from potential parallels with the mall business, in terms of permanence in office demand?

I can’t predict what will or won’t happen. I can only share our observations regarding our tenants and our internal discussions. The change has influenced young professionals primarily, who thrive in collaborative environments where they engage socially and learn to advance their careers. While some aspects of office work may become less essential, creating value and collaboration remains crucial—especially aided by the tech and media sectors' growth, which rely on interaction and in-person efforts. Unlike retail—which can be a choice—employment is essential for many households. Workers need to earn a living, and that reliance on office settings won’t disappear. I believe there are CEOs who politically may not voice these notions yet, but once the climate shifts later post-COVID, we’ll likely witness a transition back towards normalcy, irrespective of the specific schedule.

Absolutely, it's been a pleasure being back together as a team after several months apart. I completely agree with you.

Thank you.

Thank you. Our next question comes from Craig Mailman with KeyBanc Capital Markets. Please proceed with your question.

Hey, guys. Just curious here. It sounds like the mark-to-market values are holding. I’m wondering beyond base rents what your projections for net effects look like given the trends in concessions and CapEx?

Yes, Craig, this is Harout. I’d say the deals we’ve closed encompass a slower deal velocity overall, yet our concessions are stable. We’re not increasing free rent, nor are we expanding tenant improvement packages within our packages. As of now, our asking rents are flat. Many of these deals have been in the pipeline for a while, with ample opportunity for them to adjust; however, they have not. I’m referring to deals that have been executed in our portfolio. Overall, we feel positive about that.

That’s helpful. You discussed some sublease space available with Uber. Just out of curiosity, how does that sit and are you hearing about the demand for it? How might that affect competitive rents within your San Francisco portfolio?

Craig, the lease extends to 2025; it is not short term and has just over four years left. It comprises excellent space with open floor plans, ample space for employees. Remember that this was marketed pre-COVID. Decisions Uber must make about their new space will invariably impact what we do. I don’t believe our available space will influence market values significantly, as it falls below market levels compared to deals made previously, prior to COVID, as evident with our recent deal with Google.

Yes.

Lastly, you mentioned asset acquisitions—albeit recognizing it may not be the timing currently—should your stock price not reach appealing levels for a currency and considering debt remains exceptionally cheap while you have solid cash flow in the coming years, would you contemplate using more leverage in the near term with intent to deleverage over time?

That’s not our business model. However, certain instances of bringing in a little more leverage can make sense. Regardless, we’re committed to maintaining our disciplined balance sheet management rather than attempting to pursue temporary yield enhancements.

Thank you. Our final question comes from the line of Nick Yulico from Scotiabank. Please proceed with your question.

Thank you. On Page 15 of your supplemental material, there’s a statistic regarding the ending leased percentage in the same-store office pool that was down 280 basis points year-over-year. Could you explain the driving factors behind that and how much of this is tied to reduced leasing activity given existing vacancy versus any potential retention challenges with renewals?

Nick, I wish there was a single simple explanation, but I’ve noted down several contributors to this decline starting with retail exits. We’ve seen a considerable amount of retail tenants exit—Ferry, 6922, GSA at Rincon Center are examples. Thus, it’s a composite of various small tenants moving out coupled with those retail departures that have really driven that period-over-period percentage decline.

Okay. Based on the visibility you currently have regarding new leases in progress, those upcoming expirations where you can ascertain tenant renewals—will this number likely stay pressured due to lower new leasing activity amid COVID?

Yes. Nick, this is Harout. Your assessment is correct. Actual lease velocity across the board has slowed. We’ve consistently done an excellent job of backfilling and leasing up vacancy, so while we still have deals in progress, we are optimistic regarding the timing of those renewals. Our team is actively pursuing tenants to ensure we lease up our spaces before year-end, and we feel positively about our lease-ups moving into 2021.

Understood. Just to clarify about 40% coverage for next year’s expiration—is that figure based on actual leases secured now or just confidence of securing them in the near term? And is that statistic applicable for upcoming quarters? You have roughly 2% expiring every quarter in the upcoming quarters, does that represent 40% or could it reflect a higher percentage?

Yes. Nick, the 40% reflects leases that we currently have under negotiation with some that are complete already. It encompasses a totality of renewing existing leases and those currently being negotiated. Thus, we have a strong handle on the situation. Notably, many tenants average much smaller spaces, roughly 6,000 to 7,000 square feet. Additionally, the forthcoming renewal discussions that usually occurred 9 to 12 months in advance have now shortened their window to three to six months, showing how decision timelines have compressed.

Hi, yes, good afternoon, all. Given the discussion on filings around accelerated AFFO growth in the third quarter and referenced potential financings, could you help clarify what we might expect for 2021 including free rent burn-off or any other important factors to consider as we evaluate AFFO per share growth?

It’s a bit premature to delve into detailed projections for 2021, but in preparing our remarks, Harout and I analyzed the model to ensure that the growth we noticed sequentially, from Q2 to Q3, and looking ahead to Q4 and beyond, remains sustainable. This trend appears to be a turning point we've long anticipated. Although I can’t highlight any significant leases transitioning from free rent to cash rents in 2021, I believe we will benefit from the ongoing commitments and full-year cash payments as opposed to partial payments.

The free rent segment is falling into place. Naturally, any large deals signed may incur leasing costs, but based on our existing portfolio, we expect free rent to continue to diminish. There may be fluctuations from quarter to quarter depending on specific deals, but ultimately, we are on a positive trajectory.

Thanks. Just to clarify, regarding work-from-home dynamics: If a young candidate tells an employer they want to work from home four days a week while another equally qualified candidate states they prefer in-office work, how might that weigh on the outcome?

That’s an exciting perspective. I think you’re spot on. Younger professionals who prioritize social engagement and face-to-face interaction will continue gravitating to in-office roles, as that is crucial for career advancement—particularly in collaborative environments. While work-from-home dynamics certainly present options, I believe the urgency for quality interaction will drive people back into offices—making it vital. Thank you. I want to extend my gratitude to everyone for their participation. Please know how proud I am of the entire Hudson team for their efforts during these challenging times. We look forward to reconnecting for our next quarterly update. Take care, everyone.

Thank you. This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation. Have a great day.