Earnings Call Transcript - HPP Q4 2022

Operator, Operator

Good morning, and welcome to the Hudson Pacific Properties Fourth Quarter 2022 Conference Call. Please note that this event is being recorded. I will now hand the conference over to Laura Campbell, Executive Vice President of Investor Relations and Marketing. Please proceed.

Laura Campbell, Executive Vice President, Investor Relations and Marketing

Good morning, everyone. Thanks for joining us. With me today on the call are Victor Coleman, our CEO and Chairman; Mark Lammas, President; Harout Diramerian, CFO; and Art Suazo, EVP of Leasing. Yesterday, we filed our earnings release and supplemental on 8-K with the SEC, and both are now available on our website. An audio webcast of this call will be available for replay on our website. Some of the information we'll share on the call today is forward-looking in nature. Please reference our earnings release and supplemental for statements regarding forward-looking information as well as a reconciliation of non-GAAP financial measures used on this call. Today, Victor will discuss our 2022 accomplishments and 2023 priorities, along with macro trends across our markets. Mark will review our office leasing and development highlights and Harout will review our fourth quarter financial results and 2023 outlook. Thereafter, we'll be happy to take your questions. Victor?

Victor Coleman, CEO and Chairman

Thank you, Laura. Good morning, everyone, and thanks for joining us. Let me start by highlighting Hudson Pacific's 2022 accomplishments, which align with the five key objectives centered around leasing, capital recycling, development, balance sheet management, and ESG that I outlined on our call at this time last year. Let me start with leasing. We leased over 2.1 million square feet in 2022, just shy of our long-term average and up more than 300,000 square feet from 2021. We achieved positive GAAP and cash rent growth of 14% and 4%, respectively. We executed on all four of our planned nonstrategic asset sales, closing three last year for a combined $144 million of gross proceeds with our fourth Skyway Landing now closed for an additional $102 million of gross proceeds for total dispositions of $246 million. As part of our efforts to grow our portfolio, the world-class amenitized collaborative sustainable office and studio space, we purchased Quixote, a leading stage and production services provider, in an off-market transaction, and we made good progress on our two under-construction studio and office projects totaling 780,000 square feet, while securing entitlements for two future projects totaling 1.6 million square feet. We now have $1 billion of total liquidity and with a focus last year on using proceeds from asset sales and our successful $350 million green bond offering to pay down and refinance debt. We also reduced our interest rate exposure through caps and swaps to maintain our total fixed and cap debt at over 85%. We continue to return capital to our shareholders throughout the year, repurchasing approximately $240 million of our common stock and maintaining our dividend with a stable full year AFFO payout ratio of just over 60%. We also continue to achieve sustainability and ESG excellence, ranking number one among office companies in the Americas by GRESB and winning NAREIT's Leader in the Light Award during 2022. Most recently, we were recognized by Newsweek as one of America's most responsible companies and included in the 2023 Bloomberg Gender Equality Index further aligning our platform with stakeholders prioritizing sustainable and equitable workforces. I'm also very proud of the Hudson Pacific team and our ability to execute and work toward creating long-term value for our shareholders in this complex and highly dynamic environment. Our strategy places Hudson Pacific at the confluence of several macroeconomic trends that we believe are transitory. Therein lies the opportunity as we leverage our unique industry expertise and full-service platform to position our company and world-class portfolio optimally for the next cycle. We continue to see utilization across our portfolio and proved with multiple assets trending towards 50% to 75% peak occupancy. Utilization remains very tenant and thus asset specific, but we believe growing employer mandates and employee willingness to return, especially in light of the recent layoffs, will result in even higher utilization and reemphasize the need to be in the office to improve workforce productivity in the coming year. Looking at the five largest layoffs among North American tech companies over the last six months, only about 15% of those layoffs, based on loan notices, impacted our U.S. markets, accounting for about 1% of the company's total workforce. While hiring among tech and media companies has notably declined in recent months, we recall these industries had massive hiring gains throughout the pandemic with little or no augmentation of their office footprint. In our target U.S. markets, employment levels in tech and media-related sectors are still at or well above pre-pandemic levels, reflecting the inherent long-term secular strength in the case of Seattle and the Bay Area as much as 15% above. Software and IT job postings are still 20% to 25% above pre-pandemic levels according to Indeed. And we know as big tech rightsizes, talent will migrate and build the next high-growth companies, the next Google or the next Amazon. VC capital firms raised about $160 billion in 2022 and have record amounts of capital to invest in Series A and B rounds, and they're still very active. This will give rise to innovative small and medium-sized companies that will ultimately expand within our portfolio and beyond, just as they've done in past cycles. As of the fourth quarter, top studios, including Apple TV, Netflix, Disney, Amazon, and others, were still projecting to spend a total of $140 billion on content this year, up 11% from last year to a new high. Original content spend, which typically accounts for 20% to 50% of the total spend and is perhaps a better indicator of production was expected to increase by a more moderate 2%. However, we did see production activity moderate in the fourth quarter, particularly here in Los Angeles, which we attribute to several factors, including studios growing austerity measures, the Amazon MGM and Discovery WarnerMedia acquisitions, cautiousness ahead of the late spring studio union contract negotiations, as well as annual seasonality. We'll continue to monitor these trends but remain confident in the long-term fundamentals around content creation and the ability of our platform through a combination of long-term leases and an increasingly diverse geographic footprint and product offering to meet the current and new client priorities and preferences. At Hudson Pacific, we're building upon a strong track record of execution, be it our ability to uncover opportunities, deliver premier office and studio space, execute leases, and grow rents. And in so doing, we've set the bar when it came to creative, collaborative, high-quality, high-touch, sustainable work environments and related services to inspire the world's most innovative and creative companies and their employees. As these industries evolve and grow once again, we will be at the forefront of this next shift. We will leverage our full cycle team, which has been fully tested; our full service programs, vertically integrated platform, and our unique strategy and value of our relationships to continue to expeditiously optimize our portfolio in ways that we could create significant value for shareholders. Looking ahead to '23, our priorities are as follows: to continue to successfully address our 2023 office lease expirations with the goal of preserving rent and occupancy; to execute on our near-term value creation office and studio development opportunities, specifically Sunset Glenoaks and Washington 1000; to further strengthen our balance sheet by deleveraging through asset sales and reducing interest rate risk through hedges; and finally, to continue our ESG and sustainability leadership which has become a hallmark of our businesses and how we create long-term value for our shareholders. Now I'm going to turn the call over to Mark.

Mark Lammas, President

Thanks, Victor. Our leasing team continues to hustle. In the fourth quarter, we signed 517,000 square feet of new and renewal leases. This resulted in over 96,000 square feet of positive net absorption and drove our in-service office lease percentage up 40 basis points to 89.7%. This included a 100,000 square foot, 10-year lease with a large publicly traded software company at Metro Center in Foster City, which was not only the largest deal in our portfolio for the quarter, but also the largest along the entire San Francisco Peninsula and a win for the team. Our activity also included the full building 47,000 square foot backfill of Lockheed Martin with a 17-year lease with Stanford at 3176 Porter in Palo Alto, and a 40,000 square-foot 10-year renewal with SFMTA at 1455 Market in San Francisco. Both deals addressed two of our larger 2023 expirations. Our GAAP rents on fourth quarter deals were up 16%, while our cash rents were down 0.5%, driven primarily by Stanford's renewal at 3176 Porter. Adjusted for the Stanford lease, cash rents were close to 3% higher. Note that the NFL, which vacated 10900 and 10950 Washington on January 1 of this year, is still included in our fourth quarter lease percentage. Although we continue to negotiate with a single tenant for the entirety of that asset, we're actively exploring redevelopment of the property as residential to take advantage of its prime Culver City location and pending upzoning. This is a decision we expect to be able to make in the coming months as we review our options. Even as we continue to sign significant leases, we have 1.9 million square feet of opportunities in our leasing pipeline at multiple stages. We also currently have activity on both of our only two large block expirations in 2023. Specifically, we have 60% coverage on block space at 1455 Market in San Francisco, which expires in the third quarter of this year. We're negotiating with an existing 25,000-foot subtenant and a new tenant with a 250,000-foot requirement. If we can close on these, we'll have largely addressed our only material expiration in downtown San Francisco this year. We're also in discussions with Amazon to renew their fourth quarter 140,000 square foot expiration at Met Park North in Seattle and expect to have more visibility after their plans by the third quarter. We currently have 42% coverage on our 2023 expirations with an average tenant size of roughly 9,000 square feet. Approximately 50% of these are located in the Peninsula and Valley submarkets where we're seeing resilient demand from small to midsized tenants for our assets. According to CBRE, in the fourth quarter along the Peninsula, over 70% of leases signed were under 5,000 square feet. In the Valley, over 60% of deals were under 10,000 square feet. We're staying disciplined in our approach to new development as we monitor market conditions. Our under construction development pipeline consists of two attractive and unique projects. Our Burbank adjacent 7-state Sunset Glen Oaks studio, which will be the first purpose-built studio in Los Angeles in over 20 years is on track to deliver this year. We're in discussions with several tenants regarding multistage, multiyear commitments, including some single-tenant users for the entire lot, but we're also prepared to leverage a more traditional show-by-show lease model for some stages. Construction also continues at our Washington 1000 office tower, which will deliver next year and is well positioned as the best of the best product in Seattle's Denny Triangle submarket. Over the last decade, we've established a proven track record of excellence in development with our platform and projects winning numerous awards from the likes of GRESB, NAIOP, and ULI. Apart from our two under construction projects, we continue to progress entitlements and designs for the balance of our 3.6 million square foot pipeline of potential development opportunities, which contains unique projects like Burrard Exchange, which will be one of North America's tallest mass timber office towers and Sunset Waltham Cross, which will be one of the largest studio facilities in the U.K. We're taking this time to ready our pipeline to ensure we can commence construction and create value, but only when the timing is right. With that, I'll turn the call over to Harout.

Harout Diramerian, CFO

Thanks, Mark. Our fourth quarter 2022 revenue increased 12.2% to $269.9 million compared to fourth quarter 2021, primarily driven by income generated from our Quixote acquisition in August 2022 and the commencement of Google's lease at One Westside in December 2021, partially offset by Qualcomm's vacancy at Skyport Plaza in July 2022. Our fourth quarter same-store property cash NOI increased 2.7% to $126.9 million compared to fourth quarter 2021, primarily driven by increases in revenue at 1998, 11601 Wilshire, 45 Market, and Sunset Gower Studios, partially offset by Qualcomm's vacancy at Skyport Plaza in July 2022. Adjusted for Qualcomm, our same-store cash NOI would have increased to 6.7%. Fourth quarter FFO, excluding specified items, was $0.49 per diluted share compared to $0.52 per diluted share a year ago. Fourth quarter specified items consisted of transaction-related expenses of $3.6 million or $0.03 per diluted share compared to transactional expenses of $1.5 million or $0.01 per diluted share and a property tax reimbursement of $0.7 million or $0.00 per diluted share a year ago. Fourth quarter AFFO was $62.1 million or $0.43 per diluted share compared to $72.5 million or $0.47 per diluted share a year ago. Our payout ratios for the fourth quarter and year-to-date were 58% and 61.4%, respectively, underscoring that our dividend remains well covered. We continue to execute on financing and asset sales to fortify our balance sheet. At the end of the fourth quarter, we had $870.8 million in total liquidity comprised of $255.8 million in unrestricted cash and cash equivalents and $615 million of undrawn capacity under our unsecured revolving credit facility. We also had another $98 million and $59.3 million of undrawn capacity under construction loans secured by One Westside, 10850 Pico, and Sunset Glenoaks, respectively. Upon repaying our $110 million Series A notes in January 2023 and using $102 million of sales proceeds from Skyway Landing to pay down our unsecured revolving credit facility this February, we now have $1 billion in total liquidity. In January, we also entered into interest rate swaps on our $172.9 million pro-rata share of our 1918 loan and $351.2 million net pro-rata share of our Hollywood Media portfolio loan. Accounting for these debt repayments and interest rate swaps, the composition of our debt as of December 31, 2022, on a pro forma basis, results in fixed debt of approximately 82.8% and fixed and capped debt of approximately 86%. We currently have $210 million of debt maturing towards the end of 2023, which can be repaid from our line availability. This includes our $50 million Series E notes maturing in mid-September and $160 million note of Quixote secured debt maturing on December 31. Now I'll turn to our outlook for 2023. As always, our guidance excludes the impact of any acquisitions, dispositions, financings, and capital markets activity. We're providing an initial full year 2023 FFO guidance range of $1.77 to $1.87 per diluted share. There are no specified items in connection with this guidance. We expect same-store property cash NOI growth of 2.5% to 3.5%, which reflects the additions to the same-store property pool of One Westside, 5th and Bell, and Harlow and the removal of 10900/10950 Washington and Culver City, which we've designated for redevelopment to residential for guidance purposes. Our 2023 full year guidance reflects for the first time the full year benefit of our Quixote acquisition, which occurred in the third quarter of 2022. However, guidance does not reflect the potential disruption in studio production activity beyond the slowdown mentioned earlier, in the event ongoing studio union contract negotiations lead to a strike and halt on production, which could occur as of May 1 and/or June 30 of this year. Now we're happy to take your questions.

Operator, Operator

Our first question is from Michael Griffin with Citi.

Michael Griffin, Analyst

Maybe we can just start off on the guidance for '23. Victor, in your prepared remarks, you talked about preserving rent and occupancy for the year ahead. Should we read this as you expect the occupancy to be flat? And then as it relates to the same-store, it seems like it's more a function of just moving assets in and out of the same-store pool as opposed to more organic growth. Do you have a sense of what that number would be if the NFL building was included in the pool this year?

Victor Coleman, CEO and Chairman

Well, let me start, and I'll get the guys to jump in on your second part of your question first. We're not moving assets in and out. I think it's important to note that on the NFL asset, we have limited activity from single building users. When we recognized that the interest was not as high as we anticipated in a marketplace that we know is in high demand for residential, and the opportunity for the upzoning in Culver City, it's now being evaluated by our team for the highest and best use. The return on that asset would be obviously much higher in residential capacity, but we're going to evaluate it. We'll keep you posted on what we think the returns will be based on the construction costs and other factors. That being said, the asset, if we had kept it in on a same-store basis, that asset was well below market in terms of NFL numbers. I do think we're probably looking at a '24 occupancy, physical occupancy of that asset as the year went by in '22, and we saw where the activity was. Harout, do you want to comment on that?

Harout Diramerian, CFO

Sure. What we don’t want to do is really do what you’re trying to do right now, which is selectively add or remove certain assets that comply with our same-store policy. Regardless of these assets, they were supposed to come in as our policy states, which is Harlow, One Westside, and 5th and Bell, and that's all being removed is because of a change in use. You noticed that Skyport is in the same-store because there is no change in use in the asset. I don’t think selecting one asset versus another to see what the impact of same-store is beneficial to anyone. However, if we ignore both Skyport and One Westside and leave 10950/10900 out, our same-store cash NOI would go up by 5%. Cherry-picking certain assets doesn’t move any of us. This is our same-store pool, and this is what we've guided on.

Michael Griffin, Analyst

I understand that. But I guess my apology.

Mark Lammas, President

I was just going to address your question on occupancy. Last year, we began with 2 million square feet of expirations starting in 2022 and signed 2.1 million square feet, maintaining our lease percentage close to 90%. This year, we have less expiration at about 1.6 million square feet, though there are some significant expirations included in the NFL block as part of this. Our perspective is that we currently have around 2 million square feet of activity in the pipeline. I anticipate healthy leasing activity for the full year, but estimating the ending year lease percentage is challenging since it's linked to our success in backfilling certain spaces, which can notably impact the figures at any given moment. However, we believe we are positioned for a very successful year.

Michael Griffin, Analyst

Right. And again, I don't want to focus on moving assets in and out. It just seems to me that if there is potential office demand for NFL, one would think that, that should still be in the pool. But I understand you have your own metrics for quantifying which is in or not in the same-store pool. And one more, if I could, just quickly. Victor, you mentioned in your prepared remarks just a comment on transitory effects in the environment right now. I guess can you expand on that? Is the long-term assumption that we go back to what the office was like at a pre-COVID level? I just found that the use of the word transitory was sort of interesting, just given we're sort of in what I would interpret as more of a permanent remote hybrid work environment. If you could expand on that a bit, that would be great.

Victor Coleman, CEO and Chairman

Yes. I could describe what we're observing region by region. However, we are definitely in the later stages of post-COVID and are experiencing a return to some level of normalcy. Most of our tenants are in the office at least three days a week, with some working up to five days. Some of our tech tenants are back full-time, while others related to the fire sector are coming in three days a week on average. We're noticing this trend, and our overall occupancy rates have decreased from about 75% pre-COVID to an expected range of 60% to 70%. Presently, in our portfolio, Vancouver is at 75%, Seattle is also at 75%, the Peninsula ranges between 45% and 60%, and San Francisco is around 25%. The Ferry Building is at 75%, while in L.A., we have assets at 100%, and our multi-tenant properties are at 50%. Overall, the average occupancy is between 50% and 100%. I believe we are experiencing a significant change, which will continue to develop as companies establish their physical and social presence within their environments and cultures.

Operator, Operator

Our next question is from Dave Rodgers with Baird.

Dave Rodgers, Analyst

Yes. I guess first on the leasing, you talked about 42% coverage on the expirations for this year, and I think you said 60% of block. Does that include leases that you've already just signed? Or is this still leases that you're negotiating? I just wanted to try to get a sense in those two particular instances how much of that activity is already done?

Arthur Suazo, EVP of Leasing

Dave, it's Art. Do you mean of the 42%?

Victor Coleman, CEO and Chairman

How much of it?

Arthur Suazo, EVP of Leasing

Yes. Most of it is in negotiation. We signed, I think, three deals, and most of that is in LOI stages right now.

Dave Rodgers, Analyst

Okay. Victor, a second on the union negotiation. Can you give us a sense, I guess, across the studio business of how much of that business would that impact for you? Is that Star Waggons, Quixote like the whole services side as well as kind of the services you're providing or sourcing within the studios themselves? How much direct impact do you get on expenses, maybe, let's say versus just the occupancy hit shutting the studios down?

Victor Coleman, CEO and Chairman

Yes, I'll start, and I'm going to kick it over to Jeff Stotland because he's here also to sort of focus specifically on this. But yes, first and foremost, Dave, I mean, the unions negotiation between the three, between SAG, DDA, and the Writers Union right now, it’s an obvious hot button. The last time it was contentious was right around 8. When we first owned our studios, we saw a 100-day strike. It’s a little bit of a land grab right now to see who's going to go first. Our preference, like everybody else who is on the ownership and production side, would be DGA because they seem to have great leadership and a direction. If they can get ahead and make a deal, which is what we're all hopeful for it may set a precedent, but we don't know what's going to happen there. Specifically, we're looking at a timeline of May and June as some sort of emphatic timeline when the actual strikes would occur. We’re obviously not impacted by our sound stages that are on leases; we are much more impacted on our operating businesses, which will produce content up until the strike occurs, and I will let Jeff get into a little bit more detail on that.

Jeff Stotland, Studio Business Representative

Yes. If the strike happens, obviously, it impacts occupancy and utilization, and it's a high fixed cost business, right? Once those impacts happen, obviously, it ripples through and rolls down to our profitability. We have two different sides of the business, as you know, on the Sunset brand. Most of our business, 80%, 85% of it is under long-term lease. So really, there's much less of an economic impact on the Sunset side. On the Quixote side, which is our collection of the stages that are under lease as well as the service codes, that business is maybe 90% show by show, not sort of a short-term lease. All in, the entire portfolio is roughly 50-50. But the two different businesses are pretty different. The last thing I would say is we look at this as, obviously, it's not great, but it's fully out of our control, and it's a short-term impact. Our expectation is if and when a strike happens we expect to recapture a lot of demand, whether it's Q3, Q4, or '24; we expect to recapture most of it. That's kind of how we think about it.

Dave Rodgers, Analyst

Just to recap that, about 50% of that could be at risk if all three are striking and the studio is shut down?

Victor Coleman, CEO and Chairman

Yes, for the temporary period, yes.

Jeff Stotland, Studio Business Representative

Yes. Well, it's 50% of revenue. The impact to NOI would not necessarily be the exact same thing because of the cost nature of each business. But yes, about half of the revenue is under a short-term and about half is under long-term.

Dave Rodgers, Analyst

Okay. That's helpful. Last one for me. Just on disposition, appetite and desire to get assets into the market currently and get those closed, to continue to create liquidity for the business.

Victor Coleman, CEO and Chairman

Listen, we have a few more that we are looking at. Market conditions will obviously dictate timing and pricing on that. Nothing is imminent. We did take our Arts District assets off the market last year and have not looked to revisit to bring them back at this time. But we successfully executed on our most recent disposition, which was closed this quarter but executed last year. So I think you could sort of anticipate that we'll let you know when we bring assets to the marketplace because we're not going to do them on our own. We'll bring in third parties, and it will be public, just like it was at the Arts District.

Operator, Operator

Our next question is from Alexander Goldfarb with Piper Sandler.

Alexander Goldfarb, Analyst

Great. Continuing on the studio business, you have increased the mobile studio business, and I would like to know more about it. We are familiar with how the traditional downstage business operates throughout the year, but now that you have more mobile studios, I want to understand the seasonality of that. Additionally, I want to discuss the depreciation; more of it is not an add-back. Are there any adjustments we should consider to ensure we accurately account for the depreciation now that we have a full year of the mobile studio platform?

Harout Diramerian, CFO

Thanks, Alex. We provided that in the guidance section in the chart; we've illustrated what our range is for 2023 in terms of the non-add back of depreciation or real depreciation to be more precise, so that's in our guidance, and the Q4 number is probably the closest to our run rate you'll see just because it has a full quarter of Quixote and obviously, the formerly Star Waggons and Zio products. So that’s all in that number and the guidance is our best indication of that.

Victor Coleman, CEO and Chairman

In terms of your first part of the question, I mean, listen, when we first got into this industry and this business, we were really running show-by-show variability, and we converted over to long-term leasing. So it's exactly what it was. As each show goes in, the success of the show will be based upon the success of the pickup. The biggest difference though today than when it was some time ago, when we first bought these studios, is that now the shows that go in on a variable basis, which are for the small screen, the series episodic versus features, are almost always picked up for two years. Unlike before, it would be much more seasonal, filming would be starting sometime in early or late spring, early summer and carry through to March or April, and there would be a hiatus. Now filming is 24/7, 12 months a year. We do see seasonality around the mobile studio business, specifically in December. Usually, we see it again around August. There have been weaknesses in quarters at various different times, and we pointed that out. The stickiness is what's going to happen between the increase of location shoots and the amount of days there versus in our sound stations. What we've tried to message around this is we're capturing both. We're capturing production on location now at about almost 70% that’s filmed specifically in Los Angeles, and then we’re capturing location shoots in studios that are not just all of ours but also our competitors and friends studios because we control a substantial amount of that business.

Alexander Goldfarb, Analyst

The second question is about how Los Angeles has successfully diversified its economy over the years. While it remains focused on content, it now has a broader tenant base. Do you think Northern California and Seattle are overly concentrated? If so, are local business communities taking steps to diversify? Or do you believe that the benefits of technology outweigh its downturns when it comes to owning and investing in real estate?

Victor Coleman, CEO and Chairman

I would completely concur with your statement in Los Angeles. People do think of L.A. as the city of entertainment, but really, it is the most diversified of all the markets we're in. Whether it's entertainment, tech, small business, or fire-related businesses, the diversity of our tenants is much more apparent in Los Angeles. How that has trickled through our portfolio in the Peninsula, in San Francisco, and in Seattle, it is evolving by just what you're seeing statistically in our portfolio and the leasing that our team did. The makeup of our portfolio is about 40% tech. Most people know that. If you look back on '22, we completed about 300-plus leases. Of that, about 20% were tech, around 30% square footage. In the most recent quarter, we did about 76 leases, and if you look at that portfolio-wide, about 17% of those were tech and about 30% square footage. It’s consistent that you’re seeing the spread. Now what are communities doing? At the end of the day, I can't comment on the political environment and community interactions. But I can tell you there is still a welcoming atmosphere for small business growth, specifically in California, specifically in the Valley. The next Amazon or the next Google is coming out of the divisions of those companies with the way VC capital has always attracted those types of tenants that start small and hopefully grow big and become successful. They are not all tech, and they are not all entertainment. The diversity will be there; it just takes a little bit of time. The generation of capital is driven by the success of the companies, which in the history of Seattle, San Francisco, and the Peninsula, these companies have largely been tech-related because that's where the success has come from.

Operator, Operator

Our next question comes from Ronald Camden with Morgan Stanley.

Ronald Camden, Analyst

Just going back to sort of the same-store NOI question. Is there a way we could sort of break it out that growth? What's occupancy, what's bumps, what's free rent burning off? Just trying to get a sense of what's driving that 3% at the midpoint.

Harout Diramerian, CFO

I don’t know if we ever got that granular on our same-store disclosure. I think I illustrated earlier where if you back out the big movers, which are Qualcomm, Google, and I guess, NFL, we were still having a 5% increase in our same-store NOI, and that’s just a product of good leasing and/or ramp-ups and free rent burning off. Otherwise, I don't think we can get into that very granular detail, especially in our Northern California segment, which is about 5,000 square feet in average occupancy. So it's really hard to break that down. But that’s the big picture of it.

Ronald Camden, Analyst

I think that's helpful. Moving on to leasing, you mentioned the $1.9 million pipeline currently in focus. Can you share what the tenants are saying? You brought up the Amazon situation that has been in the news, so how are you all approaching that? How are those conversations progressing?

Victor Coleman, CEO and Chairman

Let me sort of start by giving accolades to the leasing team. Signing 2 million square feet in '22 was literally end-to-end combat. When I mentioned that we did over 300 leases, that was a lot of hard work; that's indicative of where we sit right now. We are still in a headwind position where tenants have choices. They’re looking at the availability of space, the likelihood of the landlord to be able to write a check for TIs, and the ability to execute at their timeline, not ours. Never before have we seen such a delay of tenants that are interested in leasing space but haven't committed because they don’t have to until the absolute last minute. If they're leading space to come to our space or others, their current landlords are extending and holding over when times in the past, they said, the holdover ratios are 150 or 200 percent over rent, and you have to pay that. Now they’re waiving that. It's an absolute flat, and you can take more time and make your decision. So with that as a backdrop, of our 1.9 million square feet in the pipeline, as Mark indicated, about 300,000 feet of that is two tenants at block. Those two tenants, one's 250,000 and the other a little over 25%. We are working hard on those two tenants. The next million feet, I can let Art sort of address that.

Arthur Suazo, EVP of Leasing

The 1.9 million square feet is a very healthy level, as Mark indicated earlier, especially since we just completed leasing over 500,000 square feet. Our team's ability to refresh the pipeline in this environment has been impressive. We expect demand to remain strong moving forward due to our past successes. The remaining square footage that Victor mentioned includes tenants around 6,000 to 7,000 square feet. These types of tenants have largely dominated most markets, except for Silicon Valley, which remains tech-driven. Other markets have experienced an increase over the last few quarters in the fire and professional service sectors. In fact, it was surprising to see those two sectors surpass tech in the Seattle market two quarters ago. Currently, these are the tenants we are focusing on. This demand generally benefits our portfolio because of our VSP program, which includes market-ready suites that have seen great success. We've been able to lease them at an 80% rate as we build them out. This is why we feel optimistic about the return of small tenants to the market.

Operator, Operator

Our next question is from Camila Bonnell with Bank of America.

Unidentified Analyst, Analyst

So there's been a number of big tech firms coming out recently stating that they're planning to cut back on their office footprints, Google being the latest. I know that your leases with Google are longer term, but I wanted to understand if you see any risks of subleasing or lease termination from them as they're your largest tenant in the portfolio.

Victor Coleman, CEO and Chairman

Yes. Well, listen, we're in constant contact with Google, and we have several leases with them. I think we have not seen any indication of subleasing in any of our assets with them to date. I think in one of our assets, we have an early term at the end of '24, which is Hillview, and I think that's about 200,000 square feet or so. They’ve had some discussions about keeping half and maybe terminating half, but that’s evolved since it involves three different departments. That’s the only conversation that I can recall to date. As I said, that’s at the end of 2024.

Unidentified Analyst, Analyst

Okay. And from any other tenants within the portfolio, any increased risk for subleasing there too?

Victor Coleman, CEO and Chairman

No. The only other one in the portfolio that everybody already knows about is Uber because they're at 1455 and they expire in '25. They've been trying to sublease their space, and one of the transactions that we're working on will include part of that, but that’s it.

Unidentified Analyst, Analyst

Got it. And can you spend a bit of time talking about the Skyway Landing sale you recently closed on the types of buyers that you were seeing and any color around how pricing came out versus your expectations?

Victor Coleman, CEO and Chairman

Yes. So, if you recall, we detenanted the building to approximately, I think, 30% occupancy over the last year on the ability for us to maybe convert this for life sciences for either ourselves or a particular buyer. The life science interest buyers were who was looking at this asset. I think we sold the asset effectively vacant for about 400-plus a foot. We’re pretty pleased with the number. And I think as a result, the execution was one that’s in today’s marketplace, we did not entertain where we asked to carry back financing. So I think it was clean. Mark, do you want to add to it?

Mark Lammas, President

Yes. I mean just in case you want it for your numbers, that’s less than a 1% GAAP and cash cap rate on Q4 annualized. So it makes effectively no difference to our operating results going forward. As Victor points out, we did north of $400 a foot on the sale, so good execution on that.

Operator, Operator

Our next question is from Nick Yulico with Scotiabank.

Nick Yulico, Analyst

Going back to the same-store NOI guidance for this year, I wanted to see if you could break down the impact between office and studio for the components?

Mark Lammas, President

Yes. We are providing guidance without that. Our competitors do not distinguish when reporting their numbers. It's important to note that office makes up the majority of the same-store net operating income. To reach the 3% midpoint, office would have to be very close to that figure initially, which gives you a clear idea of the makeup of the two numbers.

Nick Yulico, Analyst

Okay. Got it. And then, I guess, just following up on that. I know you talked earlier about it's hard to forecast where the lease rate might be for the portfolio at the end of the year, but maybe you could give us a sense for a same-store office occupancy type of number that's embedded, the change in same-store office occupancy embedded in your same-store cash NOI growth.

Mark Lammas, President

Look, Nick, I respect the tenacity. But look, if we were going to guide to it, we would have guided to it.

Nick Yulico, Analyst

Okay. All right. Just one last question is going back to 1455 market and the tenant, the prospective tenant you're talking about there. At this point, is it solely reliant on that one tenant? I think in a pithy might have said it's a government tenant. So I’m trying to figure out the likelihood of risk of actually that deal getting done.

Victor Coleman, CEO and Chairman

Listen, I can’t tell you if it can get done or not. We’re the only place that they're looking at, I'll say that. It either makes or it doesn't with us. I'm not going to put a number on what it is. We're hopeful that something comes out of it. If it doesn't, then we'll figure something else out. To answer your question directly, yes, that’s the only one tenant of size currently that we’re entertaining.

Nick Yulico, Analyst

Okay. And is it a government tenant?

Victor Coleman, CEO and Chairman

I can't say.

Operator, Operator

Our next question comes from John Kim with BMO.

John Kim, Analyst

I wanted to ask about your fourth quarter cash same-store growth, which in office was positive at 1.9%, but you also had occupancy drop 510 basis points year-over-year is a big, I think, headwind to overcome. Were there any one-time items in there, whether it's termination fee or free rent burn-off that really helps to this quarter's results?

Harout Diramerian, CFO

If there are any termination fees, there are probably de minimis. So I don't think there's anything in there. It's a combination of partial quarter increases in occupancy and rent bumps. So there wasn’t anything as I recall, one-time in those numbers that would drive it. It's just rental income, and maybe a collection of some rent stats basically rent burn-off.

John Kim, Analyst

Okay. And just to clarify, you don't include termination fees in your guidance. Correct?

Victor Coleman, CEO and Chairman

If we do, we call it out. In our guidance, no, we don't include termination fees?

Mark Lammas, President

We haven't had much material termination fees unlike many of our peers; they just haven't played much of a role in our numbers.

Harout Diramerian, CFO

The last time we had a big one, we were very clear on calling it out everywhere, so people understood the impact of them either in same-store or total even FFO.

John Kim, Analyst

Can you discuss the conversion opportunity at the NFL Culver space and whether you are considering other assets in your portfolio for residential or life science conversions?

Mark Lammas, President

Yes. A clarification around the conversion. What we're exploring at 10950 in Culver City is really a full redevelopment, not just converting that to residential. The upzoning that's currently underway in Culver City is to densify sites along transportation corridors. We think our site could support as many as, say, up to 470 units. There are comps within a mile radius of us that are good residential comps that are under development today that point to valuations for our site at that density level, possibly double our current GAAP basis, which is why we think it's a compelling opportunity to pursue. As for other conversions, it's happening in various markets, residential conversions, more on B or even C quality real estate. We don’t really have that within the portfolio. We are looking at what it entails to convert assets that may physically be well situated for conversion or may be nearby markets that have residential to understand what the conversion opportunity looks like, but I don’t think we think there's much of our existing portfolio that's a real candidate for conversion given the quality of the assets.

John Kim, Analyst

Okay. Just one more for me on your dividend and your decision to maintain it. I think it's refreshing you’re not going the herd necessarily, but how committed are you to maintaining the dividend for the year just given you're trading at a 9% yield and you might have some use of proceeds on retaining that capital?

Victor Coleman, CEO and Chairman

We are fully committed to keeping the dividend. Our AFFO ratio is currently one of the lowest we've experienced in a long time. Regardless of whether we are following trends or charting our own course, the reality is that our access to capital won't see significant changes if we chose to lower the dividend. We believe this reflects the strength of the company and aligns with our consistent approach moving forward. At one point last year, we even discussed the possibility of increasing our dividend based on the direction of our AFFO. Harout, would you like to share your thoughts?

Harout Diramerian, CFO

I just wanted to add and not to take away anything that Victor said. We always evaluate our dividend policy and coverage and factor in current economic conditions, leasing activity, interest rates, everything that we also put into our guidance. We’ve decided to maintain our dividend in the short term at least; whether or not we increase or decrease later on is something we evaluate on an ongoing basis.

Operator, Operator

Our next question comes from Young Ku with Wells Fargo.

Young Ku, Analyst

Just wanted to go back to the commentary on Google. I think you mentioned Hillview as a potential early termination. But other than that, are there any other chunks of lease that we should be aware of that's coming up by end of 2024 that could potentially move on?

Victor Coleman, CEO and Chairman

No, there's nothing to the end of '24. The next lease is probably Foothill in 2025 sometime maybe. But it's in our supplemental lease expirations.

Harout Diramerian, CFO

For Google, yes, it’s all laid out in our top 15 tenant listing and has all the breakdown of all the leases there.

Mark Lammas, President

All of our expirations are outlined for the next eight quarters in the supplemental.

Young Ku, Analyst

Okay. That’s helpful. And then, yes, just since you mentioned Google again: what kind of utilization are you seeing at the different spaces?

Victor Coleman, CEO and Chairman

I think at Hillview, they are nearly fully occupied due to two different groups. At Foothill, we have two buildings, and I'm fairly certain one is completely occupied. There was some vacancy in the other building, which I believe was around 20,000 square feet or less.

Mark Lammas, President

Yes, some of that effect.

Young Ku, Analyst

Got it. Okay. That’s helpful. And Harout, I think you mentioned this when you were talking about guidance. So you're not baking in any potential strike on the studio side that's in your guidance right now, right?

Harout Diramerian, CFO

That's correct.

Young Ku, Analyst

What kind of FFO impact would there be if, say, the strike took place and there was minimal growth in production for the back half of the year?

Harout Diramerian, CFO

I’m going to just let Jeff Stotland answer that at least relating to this question.

Jeff Stotland, Studio Business Representative

Yes, rather than trying to quantify this now if the strike occurs, since we're not completely certain it will happen, I believe it wouldn't officially begin until May 2 because the contract expires on May 1. Our next earnings call is likely on May 3, and by then, we should have a clearer understanding of the timing and impact, and we might be able to provide more information. But at this moment, it's too early to say.

Operator, Operator

Our next question comes from Dylan Burzinski with Green Street.

Dylan Burzinski, Analyst

Just curious on a capital allocation perspective, is there any desire to start some of the developments that you guys have laid out in your prepared remarks?

Mark Lammas, President

I think we indicated that we are not expecting any immediate starts on the office projects, specifically Burrard. We're keeping an eye on it and will ensure it's ready if market conditions improve or if we see significant pre-leasing. The studio developments are progressing differently. We are well along with Waltham Cross, a studio site we own in partnership with Blackstone, where we hold a 35% stake. That project could potentially start soon; we are monitoring the situation closely and market conditions are favorable. We are seeking construction financing, but we are still uncertain about how pricing will affect us. It's possible that this could begin this year. Aside from this, we do not have any imminent starts planned.

Dylan Burzinski, Analyst

Okay. That’s helpful. And then just curious, what's the overall mark-to-market on the portfolio today?

Mark Lammas, President

Yes. So the spot mark-to-market across the entire portfolio consolidated is about 2%. The 2023 mark on expirations is about 4%, both positive.

Operator, Operator

Our next question comes from Vikram Malhotra with Mizuho.

Vikram Malhotra, Analyst

I wanted to check in on two specific tenants to see if there are any updates. The first is Salesforce, in light of their recent news about restructuring or terminating leases. Do you have any updates regarding your Salesforce leases? The second is WeWork, which I believe returned 40 buildings last year. Can you provide any information on how the WeWork spaces are performing?

Mark Lammas, President

So, I mean, Salesforce, we still have a considerable amount of time on that lease. The earliest expiration of 83,000 feet is not occurring until the middle of 2025; then we have like two-year staggered expirations thereafter. It’s fully subleased to Twilio. So there’s really nothing immediate to update you on Salesforce.

Harout Diramerian, CFO

Let me just add to that. It’s not only is like Twilio subleasing, it’s somewhat an above-market rate. The idea of Salesforce returning that and giving up their upside profit would be strange.

Mark Lammas, President

Yes, I’ll clarify. Not necessarily above market but above the underlying directly. So we’re sharing in the profit of that. Salesforce is highly motivated to maintain that lease. On the WeWork front, we have four locations with them. They’ve approached us, and we’re in discussions. For now, three of those locations appear to be quite profitable, and they seem motivated to keep those locations. The fourth is at 1455 Market; although it has higher attendance, it’s not generating enough membership. So with that one, we will likely enter negotiations with them at some point.

Vikram Malhotra, Analyst

Okay. That’s helpful. So maybe I guess what you're saying is part of WeWork or one of the three could potentially be terminated or given back. But as of now, three of them are performing really well. Is that fair?

Mark Lammas, President

Yes. We’re looking at a number of financials, so they all appear to be profitable.

Vikram Malhotra, Analyst

Okay. And then just back to the occupancy; I respect that you can't give a specific number, but I'm just looking for like guardrails or ultimately just ranges. Assuming you do very little new leasing, we all know the known move-outs as well as the expirations that are there in the book today. I'm just wondering if you can clarify where spot occupancy was on January 1? And if you were to do no new leasing or no new backfilling, can you just give us sort of a range?

Victor Coleman, CEO and Chairman

I'm going to stop you now, okay, because we're not going to go here, okay? You're the fourth guy on this call who has asked the question; the answer still is the same, okay? It’s the same question if you say, give me the high end. What's the best-case scenario? We leased out 1.9 million square feet. We're not going to do that either. Let's go on, okay?

Vikram Malhotra, Analyst

Okay, fine. I mean, I guess, ultimately, for real estate, there's occupancy and rent, so it's just tough for us to sit here and say where it's going to be. But I guess it would be helpful if you could give us for midyear or a range.

Victor Coleman, CEO and Chairman

Go ahead.

Vikram Malhotra, Analyst

Maybe just last one on FAD. The comments were around this year; at least, you're committed to the dividend. If I just look at CapEx, assuming similar levels that you saw last year, is it safe to say like based on your FFO range, a FAD of around 130 to 140? Is that the equivalent to what you’ve guided to on FFO?

Harout Diramerian, CFO

We can run the numbers. If you’re backing into it that way, I'm sure those numbers work. First of all, I think when you say FAD, you mean AFFO, right? In my mind, it's different calculations.

Mark Lammas, President

But yes, I mean, look, you're sort of extrapolating which is fair. You’re looking at FFO year-over-year change on that and what that might imply in terms of AFFO. There are a lot of other adjustments that make the correlation between FFO and AFFO a little trickier to pin down. I would say maybe to give you a sense as we look at the model between Google and Company 3 cash rents commencing this year on those significantly mitigate the impact of vacancy like Qualcomm, NFL block and should help us maintain an AFFO level pretty close to 2022. We have to normalize TI and LC spend to get to that level, which is totally reasonable. I want to point out because I think it gets lost a little bit as people think about the trend on FFO and AFFO. Can you lose track of what's going on directionally in terms of TIs, LCs, and net effective rents because those have much more profound impact over the long term? If you look at what's going on directionally in terms of average lease term, our leases signed in '22 were 17% longer than they were in the prior year. We’re elongating our leases. They were 5.5 years in '22. In the most recent quarter, the TI costs were 36% below what they were in Q4 of '21 and 57% below on a per square foot basis than they were in '19. Those drivers of AFFO are significant, and I think that gives you some comfort in terms of how our coverage could trend.

Victor Coleman, CEO and Chairman

Operator, we're over our time limit. Thank you everybody for participating in the call, and I apologize that we're slightly over what our commitment was. Appreciate everybody taking interest in us, and we look forward to talking to everybody next quarter. Bye-bye.

Operator, Operator

The conference has concluded. You may now disconnect.