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spk04: Ladies and gentlemen, thank you for standing by. Welcome to Douglas Emmett's quarterly earnings call. Today's call is being recorded. At this time, all participants are in a listen-only mode. After management's prepared remarks, you will receive instructions for participating in the question and answer session. I will now turn the conference over to Stuart McElhenney, Vice President of Investor Relations for Douglas Emmett. Please go ahead.
spk11: Thank you. Joining us today on the call are Jordan Kaplan, our president and CEO, Kevin Crummey, our CIO, and Peter Seymour, our CFO. This call is being webcast live from our website and will be available for replay during the next 90 days. You can find our earnings package at the investor relations section of our website. You can find reconciliations of non-GAAP financial measures discussed during today's call in the earnings package. During the course of this call, we will make forward-looking statements. These forward-looking statements are based on the beliefs of assumptions made by, and information currently available to us. Our actual results will be affected by known and unknown risks, trends, uncertainties, and factors that are beyond our control or ability to predict. Although we believe that our assumptions are reasonable, they are not guarantees of future performance, and some will prove to be incorrect. Therefore, our actual future results can be expected to differ from our expectations, and those differences may be material. For a more detailed description of some potential risks, please refer to our SEC filings, which can be found in the investor relations section of our website. When we reach the question and answer portion in consideration of others, please limit yourself to one question and one follow-up.
spk10: Thank you. I will now turn the call over to Jordan. Good morning, everyone. Thank you for joining us. We had another strong leasing quarter with total leasing exceeding 1 million square feet and new leases of very healthy 365,000 square feet. Despite this accomplishment, I feel like we've been on a treadmill for the past several quarters, considering our efforts have only produced a modest increase in net absorption and occupancy. Of course, this is partly due to our program of replacing non-paying tenants with new paying tenants. As I mentioned last quarter, the expiration of commercial eviction moratoriums has finally allowed us to recapture space from non-paying tenants while still pursuing their outstanding balance. During the third quarter, we recovered about 50,000 square feet from non-paying tenants. We expect to address a similar amount of space in the fourth quarter. With respect to occupancy, our leased to occupied spread improved slightly, but remains more than twice our historical average. While we expected occupancy growth from a reduction in that spread, it has not happened yet. One reason is that an unusual number of tenants are expanding our portfolio or simply relocating, which increases occupancy lead times. While we are concerned about a future economic slowdown, we firmly believe in the long-term health of our markets. Our demand comes from numerous industries without any risk of material new supply. Having successfully managed through several prior cycles, Our strategy and platform are designed to withstand downturns while staying positioned to act opportunistically. Now, I'll turn the call over to Kevin. Thanks, Jordan, and good morning, everyone. Higher interest rates have begun to affect us, even though only 13% of our debt is currently subject to a floating interest rate. To provide us flexibility during challenging debt markets like these, We typically borrow for seven years and swap for five so that we can delay refinancing for up to two years without any penalty. With current loan spreads historically wide, we do not think this is the best time to refinance. We have no debt maturities until the very end of 2024. We do have additional swaps expiring in 2023. As a result, we expect our interest expense to increase next year. Turning to development, our residential projects continue to lease up at a very good pace. At Bishop Place in Honolulu, our office to residential conversion project, we have now delivered and leased about two-thirds of the eventual 493 units, and we will continue to convert more floors to residential as office leases expire. At the Landmark LA in Brentwood, we have now leased over 50% of our 376 new units. rents at both projects remain above our proforma levels. While sale transactions have remained very slow in our markets, higher operating expenses and a challenging refinancing market may encourage sellers to bring their properties to market. With that, I'll turn the call over to Stuart.
spk11: Thanks, Kevin. Good morning, everyone. As Jordan said, we had another very successful leasing quarter, signing 199 office leases covering over 1 million square feet, including 365,000 square feet of new leases. Larger tenant demand picked up during the third quarter, increasing our average deal size to over 5,000 square feet. We were also very pleased to see strong expansion activity from our existing tenants, with expansions outpacing contractions by over 50,000 square feet. Our office leasing spreads this quarter were positive 7.2% for straight line and negative 8% for cash. This means that new leases have a greater total value, even though the starting rent is less than the ending rent in the prior lease. Turning to multifamily, our portfolio remains full at 99.3% leased, and rent roll-up on new leases was a very healthy 8%. With that, I'll turn the call over to Peter to discuss our results.
spk09: Thanks, Stuart. Good morning, everyone. Turning to our results, compared to the third quarter of 2021, revenues increased by 6.5%. Same property cash NOI increased by 0.4%, with increases in both office and residential revenue largely offset by the effects of inflation, particularly in the cost of utilities, insurance, and third-party vendors. FFO increased by 6.7% to 51 cents per share, and AFFO increased 3.1% to $90.4 million. Our G&A at only 4.4% of revenues remains very low relative to our benchmark group. Turning to guidance, elevated least occupied spreads have restrained occupancy growth. In addition, residential revenue growth will be impacted as Barrington Plaza vacates in preparation for rebuilding. While insurance may cover some of that lost revenue, the collection of any insurance proceeds can be very slow. Finally, we also expect increased operating expenses as a result of higher office utilization and inflation. Taking these factors into account, we now expect our full year FFO to be between $2.03 per share and $2.05 per share. This reflects revised assumptions that average office occupancy will be between 84% and 85% for the year, and that same property cash NOI growth will be between 3.5 and 4.5 percent. For information on other assumptions underlying our guidance, please refer to the schedule in the earnings package. As usual, our guidance does not assume the impact of future acquisitions, dispositions, or financings. I will now turn the call over to the operator so we can take your questions.
spk04: Thank you. We will now begin our question and answer session. To ask a question, you may press star then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Again, in consideration of other participants, please limit your queries to one question and one follow-up. At this time, we will pause momentarily to assemble our roster. And the first question will come from Michael Griffin from Citi. Please go ahead.
spk06: Great. Thanks. Um, just on leasing, I'm curious if you're seeing, um, tenants, you know, if they're quicker to make decisions around their real estate and then on, on the new leases in the quarter, sort of where, what, what the industry is you seeing that from? Is that from one specific one or generally just seeing it from, from across the board?
spk10: Well, to take your second question first, uh, we're still seeing it across all the industries. So we have a big mix of industries. We're getting them from every direction. But when you say, are there leasing quicker, we did a lot of, we've done a lot of leasing the last few quarters. I would say this quarter, which a fourth quarter is typically a slow quarter, but even taking that into account, I think things are slowing down a little bit. So I certainly wouldn't say they're speeding up. And we're very concerned about what's coming vis-a-vis the economy.
spk06: Gotcha. And then maybe on the multifamily side of the business, I think we've heard and the apartment rents might be kind of slowing down after, you know, pretty sizable increases recently. Are there any concerns within your portfolio and maybe some additional color around expectations there would be great?
spk10: I don't, certainly there are not concerns. I wouldn't be surprised to see multifamily rents slow down. They, I mean, when, To have that move up at the pace, I think, what was it, 7% this quarter, 8% this quarter, that's a crazy pace. That's certainly unsustainable. The history in the markets that we're in is in the mid-fours. If you look at a CAGR going back a long way, 20-plus years, and I would expect it to zero back in on a number like that.
spk06: Okay. That's it for me. Thanks for the time. Thanks.
spk04: The next question is from Blaine Heck from Wells Fargo. Please go ahead.
spk02: Thanks. Good morning out there. Can you just talk about the remaining square footage in your portfolio that's occupied by nonpaying tenants? And I think last quarter you talked about working through the remainder of those tenants by year end. Is that timeframe still achievable?
spk10: Yeah, it's pretty achievable. I mean, we had about 100,000 feet left at the end of the last quarter. last call, and we did about 50,000 feet, and I suspect the rest will be, for the most part, dealt with. I mean, there might be stragglers in the first quarter, but nothing you'll notice.
spk02: Okay, great. Second question, can you just talk about your interest in acquisitions at this point? Are you guys actively pursuing investments? Are you seeing better opportunities in office or multifamily? And then it sounded like you're expecting to see distressed opportunities given the increase in rates. You know, is that happening yet? And if not, you know, when do you think those deals start coming to the market?
spk10: So, hey, Blanche, Kevin. Buyers and sellers are still kind of adjusting to the new environment, and so that's slowed things down a little bit. Although, you know, the changes when the sentiment changes, things should move pretty quickly. We are seeing opportunities that we're underwriting both on multifamily and on office, but a lot of it is not things that we would consider to be a target acquisition. But I'm hopeful that there will be some more opportunities coming next year.
spk02: Great. Thank you.
spk04: And the next question is from Nick Ulico with Scotiabank. Please go ahead.
spk05: Thanks. Hi, everyone. In terms of leasing, I wanted to see if you could give an update on how the fourth quarter is trending so far in terms of lease velocity versus the last quarter, if you've seen any slowdown.
spk10: So, as I said, historically, the fourth quarters are our slowest leasing quarter. But even taking that into account, I think we're seeing slowing, like beyond that. Obviously, that's only with a little bit. We only have one month of information on this quarter, but it feels like even compared to what you'd expect in a slowdown in the fourth quarter, it feels like it's slowed down a bit more.
spk05: Okay, thanks. And then just a second question is on the upcoming expirations, next several quarters. I don't know if there's any numbers you're able to share about
spk10: know how much of that square footage may have already been you know addressed or you think you have a good chance of um you know um releasing right now so what's in the supplemental which it did show what's been addressed because it says 14 which is for the year which is very very typical for us if you go backwards for this appointment cycle for what the upcoming year is and um as we've said A lot in the past, we typically have about a 70% renewal rate. So, I mean, that would give you as good a feel for what's coming in next year. Now, you know, presumably some of what will get done this quarter will change those numbers. So once we actually enter 2023, that will be a lower number, and we'll be working our way through that.
spk05: Right, yeah, I guess I just wasn't sure, like, you know, for your fourth quarter expirations, by way of example, you know, 3.8% square footage of the portfolio, if you had any, you know, activity on a specific amount of that space to, you know, talk about right now.
spk10: Well, we have a lot of activity. So every quarter we have a lot of activity. So when I say things feel like they're slowing down, I'm not saying we don't have a lot of activity. We just don't have – as much as I would typically expect in the fourth quarter. So certainly a lot will get done this quarter.
spk05: All right. Thanks, Jordan.
spk04: The next question is from Steve Sacqua with Evercore. Please go ahead.
spk01: Thanks. Good morning out there. Jordan, I think in the past you've talked about this, you know, $30 million number or so of rent that you're owed. I guess it probably relates to some of that square footage that you're taking back from the non-paying tenants. Just can you give us any sense for the, I guess, progress you're making on collecting that money in addition? I know it sounds like you're getting those tenants out and replaced, but what about the collection of sort of prior period rents?
spk09: Hey, Steve, it's Peter. We continue to make progress against that number. I mean, as we've said, it sort of jumps around a little bit at the beginning of the month, end of the month, but we're down to low 20s, almost $20 million as we work through that. And we'll continue to work through it. As the moratoriums officially end, it brings everybody to the table, and we're confident we're going to get through it.
spk01: Okay, and then maybe just on the financing markets, could you just give us a sense, if you guys were to come to market today to do something new, just, you know, where are financing rates for the types of deals that you guys would do?
spk10: Depending on whether it's residential or office, it looks to me like, at the moment at least, The spreads are, you know, for residential at the lower end, maybe closer to 200, and for office at the higher end, closer to 300. It's a very – everything's kind of blown up right now, so it's not a great time to go in and try and sort of level set the market and see where things are at. But that's the sense we've gotten.
spk01: Great. Thanks. Mm-hmm.
spk04: The next question is from Alexander Goldfarb from Piper Sandler.
spk08: Hey, good morning. Good morning out there. Just, you know, continuing on Steve's question, you guys have a bunch of swaps that are coming due next year. So my question is, you know, some of the other companies of your other peers who have engaged in swaps, you know, we've gotten some insight into swap pricing, obviously not really something that most Reland does apart from you guys. But it sounds like swaps are still available. They're whatever, five basis points. I have no idea if that's expensive or cheap. You guys are much more insightful on that. But what are your views on the swaps for next year? And is the market attractive that you would re-engage? Or because of where interest rates are overall, you really don't want to lock in these levels? Just trying to get a better sense of how we should think about that for next year.
spk10: There's In the debt markets, there's an abnormal amount of uncertainty and kind of risk-off fear. And so in that, separately from trying to say rates are high, low, and this and that, that's just not a good time to lock in things long-term. And so we usually sort of avoid this amount of tumult and wait for things to stabilize a little bit. I'm not saying we're right or wrong on calling the market, but I know that there's a lot of kind of risk premium built into spreads right now, which means if you want to go out and start doing swaps, you're going to have to take the spreads and live with them. We don't ever swap out speculatively. And so we're at least, I don't know where we'll be next year. Maybe next year will be a good time to do it, but right at the moment, it's probably not a very good time to lock things in for five or seven more years.
spk08: Okay. And the second question is, Kevin, on the JV side, you guys obviously do a lot of your acquisitions with, you know, especially overseas Gulf money. Are all of your joint venture institutional partners, are they all fully engaged that if you found a deal today, they'd be there signing up or have your traditional institutional partners, you know, are they also pulling back the way the public markets are pulling back?
spk10: So, We've been engaging with all of our partners because they have a lot of questions. And, you know, we talk about the same things that you guys ask us. What's the utilization rate? What's happening with expenses? You know, what are we seeing on the leasing side? And, you know, L.A. is a bright spot in our markets relative to a lot of other major markets in the country. And so we've gotten pretty positive feedback from people that if there are opportunities that we think are compelling – that they want to underwrite them with us. And so, you know, we're definitely planning on a going forward basis to, you know, show any deals that we're excited about to those guys, and hopefully they'll do it with us.
spk08: Okay. Thank you.
spk04: The next question is from Rich Anderson with SMBC. Please go ahead.
spk12: Thanks. Good morning. Most of my questions have been already asked. Fortunately, two more. On the $20 million remaining to collect, what's the cadence of that? Is it taking like another year, you think, to get at that money, that back rent number, or will it be longer or shorter than that based on what you've experienced so far?
spk10: Well, our goal is – to take the tenants that owe that money, they're in the portfolio, and say, let's renew and lengthen it out and we'll spread it out over that. So that would mean that the cadence of actual collection would be stretched out over time. If that isn't followed, then I don't remember what they have, something like another three or six months left to just pay it off over time and it just gets paid off.
spk12: And what if they don't? What if they just give you the Heisman?
spk10: Well, if they don't pay you, then they fall in the category that you guys have been hearing about, right? So we had about 200,000 feet of it. We did 100,000 second quarter. In the third quarter, we just said now we just 50, and we got about 50 of exactly what you're describing that are going to see the door this quarter.
spk12: Okay. I was actually referring to the people that are no longer tenants but still owe you back rent. Are we talking about the same thing?
spk10: Oh, that just goes through a legal process. And, I mean, their problem is, you know, unless they want to file bankruptcy, they've got to pay. They have nowhere else to cash.
spk12: Okay, fair enough. Second question, Stuart, you mentioned this quarter 7.2 up on the gap basis on your office leasing and down 8% on a cash basis and made the observation that the leases are more valuable even though your starting cash run is lower. Are you guys somehow getting bigger escalators? Is that the explanation there? How is that gap happening this quarter? And is it something that you see as sustainable?
spk11: Yeah, that's right, Rich. We are. We're pushing on our annual bumps. You know, it's something that's been a tool we've used for a long time. I think our escalators are probably higher than any other office company that you're looking at. And we have, in times like this, in inflationary times, we have definitely been pushing, trying to push rent bumps higher because we feel, you know, that That should be kind of a proxy for inflation.
spk12: Yeah, so what are you getting approximately, you know, over and above what may be considered normal?
spk11: I mean, I think each deal is different. I mean, some deals are still three, but you're seeing a lot of fours. You can even go four and a half a year on some deals, maybe even a five in there once in a while. But that's a, you know, it's a negotiating tool that we can use in the lease, and we definitely have the mindset to be pushing on those.
spk12: Okay. Good enough. Thanks very much.
spk04: And the next question is from Dave Rogers from Baird. Please go ahead.
spk00: Hey, Jordan. You guys are a pretty good leasing machine. So this lease-to-occupied gap, I wanted to dive into that a little bit more, why that's kind of so different today. When you talk about relocations, is that within the portfolio? Are you relocating more people from outside in, less business formation? If you could give a little more color on just kind of why that gap is so unique today for you guys, and then when do you anticipate that closing would be my follow-up to that.
spk10: Okay. I would have already thought it would have closed a little bit, to be quite frank. I mean, it's such a wide gap. Now, of course, the big driver of something like that is that we're doing a ton of new leasing. And when you do a lot of new leasing, then it gaps out. That's how you get that gap. Now, the other way you get that gap, which is why we thought it was worth mentioning, is that you might have people in our portfolio. We're pretty good at keeping people, but sometimes they want to move. In the last quarter, most of them wanted to move to larger space. So we had a really pretty meaningful amount of people that stayed in the portfolio but moved and expanded. Well, when that's going on, you're going to create, you know, you're going to have a space that's leased but they haven't moved into yet, right? And you're going to have a space that they're in. And when they make that move, you get left with the space that they have. So it's good for them to expand, but it does create a bigger gap That also creates a gap. And the third thing, which you can't understate, is that when you're building out all this new activity, the city's just slowed down. And even though we're ready to go at a much faster pace, just getting your inspections and getting your permits has just become a slower process, and that will also drive that gap. I mean, that gap is the difference between a signed lease and a guy in and paying. And the three things that, you know, The more transition there is of space widens the gap, both in moves within the portfolio, expansions within the portfolio, and new deals. And then the city just slowing us down is the other big one, and we're experiencing both, and it's caused a very wide gap. I mean, the good news is that's sort of built in. We're going to get that. And when the gap does shrink, hopefully it's not because we're not doing a lot of new leasing, right? Hopefully you keep doing a lot of new leasing and the city found a way to speed up, but we'll see what happens.
spk08: I appreciate it. Thanks.
spk04: The next question is from John Kim with BMO. Please go ahead.
spk07: Thanks. Good morning. Looking at your top tenant list, it looks like you have about 134,000 square feet expiring in 2023, which isn't a huge amount, but it's a higher rent. portfolio overall. Are there any known move-outs? Or maybe ask a different way. What's your handicap as far as the renewal rates on these leases?
spk10: Well, we don't talk about individual tenants to start with, but I'll also tell you our handicapping is super bad on these things. And so, you know, we've had some big tenants I guess we're moving. We're just not good at guessing at it. And large tenants are very cat and mouses, so we don't really know the answer until the deal's done. So I can't make a good guess on that. I can tell you, because we're much better at predicting flow, because we do so many deals, that we do tend to run in the like 60%, 90%, 70% renewal rate overall. And that includes large tenants, small tenants, and all the rest of them.
spk07: If one of those larger leases Is it difficult to cut it up into the smaller leases that you typically find?
spk10: Well, it's always cheaper to renew the guy in place. But when large tenants move out, I would say one of our expertises is to put in quarters, break up floors, and quickly lease the buildings. And actually, we've used that as a strategy when buying buildings. When a large tenant was leaving, our cost of converting that to multi-tenant space has always been much cheaper than everybody else's because we have a whole group that's very quick at doing that. So that's well within our comfort zone.
spk11: John, the other thing to keep in mind on our large tenants is if you look at the list, you'll notice that most of them have multiple leases. So a lot of them aren't large continuous blocks of space. They don't act like large tenants anyway. So a lot of these are smaller spaces that are spread around within the portfolio.
spk07: Yeah, that makes sense. I just want to follow up on the interest rate swap discussion. I know you don't want to, Jordan, you mentioned not wanting to lock in higher rates now, but is it cost effective or do you find it attractive to place caps to replace those swaps that expire?
spk10: Tight, meaningful caps are very expensive. You can go way out of the money caps. but I don't think you would care. But meaningful caps are expensive. Got it. Okay. Thank you.
spk04: And the next question is from Daniel Ismail with Green Street Advisors. Please go ahead.
spk03: Great. Thank you. Peter, you mentioned the impact of inflation on all effects. Can you unpack that a bit more on what line items you're seeing higher increases and how much of that can be passed on to tenants?
spk09: Yeah, so, I mean, look, we usually are able to mitigate it with tenant recoveries in the office space. The line items specifically, it's, you know, we mentioned utilities, insurance, but we're also seeing it across the board with our third-party vendors, you know, security and janitorial and so on. So, yeah, We hope to recover a good portion of it, but it's definitely affecting the numbers.
spk03: Any specific reason as to why that isn't a direct pass-through? Is it just slightly lower occupancy or timing?
spk09: It is a direct pass-through, but in the office space, obviously you have base years, so it's all – certain portion of the tenant base has base years in any given year. But yeah, I mean, we generally recover quite a bit of it.
spk03: Got it. And then maybe just last one for Jordan. You mentioned being on the treadmill and trying to keep up with those shorter duration leases. Does this make you want to go a bit longer in terms of your average lease length given the amount of volume you're putting out versus your expirations in the upcoming years?
spk10: Well, of course we like longer leases, but the nature of our markets is, first of all, our leases have very good security, and most of them are guaranteed by the principal. And so when you're a person guaranteeing your lease, a lot of times you don't like going longer than five years, just out of personal preservation and fear. And that's why we tend to really zone in on that five-year market. It's the overwhelming median number, even though our average... lease length is higher because larger leases tend to be longer. But that's just where someone, if you have a business and you have, you know, 2,000 to 6,000, 7,000 feet, and you've got a guaranteed lease, you're going to go, okay, I'm comfortable for the next five years. I'm not comfortable beyond that. And that's what you get.
spk03: Thanks, Alex. Thanks, Aaron. All right.
spk04: And again, as a reminder, if you would like to ask,
spk08: question please press star then one the next question is a follow-up question from alexander goldfarb from piper sandler please go ahead so uh thank you uh peter on barrington that you're emptying out uh can you give a timeline for that and then how much noi you know what sort of the ffo impact because i don't know if you're going to end up capitalizing that building where there's minimal ffo impact or not to maybe just walk through what we should expect for timing Is that fourth quarter? Is that next year?
spk10: So it's a... I'll answer because I'm in the middle of it. It's a long process that's starting next year. And frankly, the FFO impacts can have a lot to do with collections from insurance and when they pay on loss of rents and all that. That's the part that would go through FFO. It goes through like an other income section. But it's a very... This is going to be a long, complicated process. It's three buildings, putting in sprinklers, gutting floors. It's going to be very complicated, including that it will be complicated to figure out how it passes through FFO or AFFO or however you look at that, depending on the way the insurance company pays.
spk08: Okay, so when you give guidance, are you going to have your guidance number you know, with some element of impact? I mean, I'm just thinking, Stuart, should we be modeling some elements for Barrington or should we leave or should we not try?
spk10: I expect an impact, but that impact is going to vary depending on, first of all, how fast we empty the building because it's not easy to empty the buildings. Secondly, how fast we can get the work done. Thirdly, how and on what schedule the insurance companies pay i mean they're you know like if we empty the building super slow but they're not paying much you may not see an impact if we empty it fast and they pay you may not see an impact if we empty it fast and they don't they don't pay everybody's going to see an impact so i and by the way how they allocate their payments so it's just going to be complicated i mean we're going to make a guess at that you're correct so that's a You formed your question extremely well, but I haven't made that guess yet.
spk08: Okay. Thanks, Jordan. All righty.
spk04: Ladies and gentlemen, this concludes our question and answer session. I would like to turn the conference back over to Jordan Kaplan for any closing remarks.
spk10: Thank you all for joining us, and we will speak to you again next quarter. Bye-bye.
spk04: Thank you. Thank you, sir. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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