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spk07: Good morning and welcome to the Hudson Pacific Properties second quarter 2023 conference call. All participants will be in listen only mode. Should you need assistance please signal a conference specialist by pressing the star key followed by zero. To enter the question queue at any time please press the star key followed by one on your touchtone phone. If you are using a speakerphone note you will need to pick up your handset before pressing the keys. Please note this event is being recorded. I would now like to turn the conference over to Laura Campbell Executive Vice President, Investor Relations, and Marketing. Please go ahead.
spk01: Good morning, everyone. Thanks for joining us. With me on the call today are Victor Coleman, CEO and Chairman, Mark Lamas, President, Haruth Yarmirian, CFO, and Art Swago, EVP of Leasing. Yesterday, we filed our earnings release and supplemental on an 8K with the SEC, and both are now available on our website. Our audio webcast of this call will be available for replay on our website. 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 the reconciliation of non-GAAP financial measures used on this call. Today, Victor will discuss macro conditions in relation to our business. Mark will provide detail on our offices to do operations and development. And Harut will review our financial results and 2023 outlook. Thereafter, we'll be happy to take your questions. Victor?
spk14: Thanks, Laura. Good morning, everybody. and thanks for joining our call. During the second quarter, we worked diligently to position Hudson Pacific optimally as we continue to navigate the unprecedented confluence of an unfavorable macroeconomic environment, the lingering impacts of remote work, and most recently, a historic and prolonged studio union strike. Office fundamentals across the West Coast markets remain challenged in the second quarter, with gross leasing either flat or decelerating quarter over quarter, sublease activity either stable or rising, and negative net absorption in all but Vancouver. As expected, studio production in Los Angeles slowed significantly, with shoot days in the quarter falling 60% to 70% year-over-year for TV comedies and dramas, and 20% to 25% across film, unscripted TV, commercials, and photo shoots. Our focus in this environment remains on occupancy preservation and expense reductions, both at the corporate level and within our office and studio portfolios, as well as proactively managing our balance sheet. Mark and Haru will be discussing our progress on all these fronts in detail. But beyond today's challenges are a variety of bright spots emerging that have the potential to shift the dynamics around our business and provide for significant upside and opportunity specific to Hudson Pacific as we move to 2023 and beyond. On the office front, according to a recent JLL study, the broader U.S. office market is starting to show some signs of recovery. To date, the West Coast has lagged due to big tech right-sizing and tenants broadly staying defensive. But with mounting data pointing to historic declines in innovation, productivity, and human capital development, big tech has taken notice. The 10 largest tech companies now have concrete hybrid attended policies impacting most of the workforce with the focus shifting into enforcement. These policy changes are starting to make positive contributions to Hudson Pacific's portfolio. As a sign of reintegration, year-to-date parking revenue was up in our portfolio 18% compared to last year, including 25% in San Francisco and 15% in Seattle, where Amazon returned to work May 1st. More recently, Amazon asked employees to move closer to team hubs or apply for new jobs within the company, or they will be considered to have voluntarily resigned. Furthermore, office demand increased quarter over quarter in both Seattle and in the Bay Area, increasing 18% in Seattle, 25% in San Francisco, and 11% across the peninsula and Silicon Valley. As we've communicated in the past, upon reintegration, tenants often realize that they don't have enough workspace or conference rooms to comfortably accommodate employees on peak days. And given the growth in tech workforce through the pandemic for FANG tenants, Even net of layoffs were conservatively estimating a 45% increase in headcount. Reintegration could begin to place expansionary pressures specific to our tenants and our markets. Couple this with the slowing of new office deliveries and accelerated conversions of older office space assets to non-office space uses, and we will see vacancy rates begin to turn as we approach the year end. We continue to believe in our markets driven by tech and media. and we're going to provide a significant growth for long term. Although in its infancy, AI promises a wave of innovation and growth not seen since the advent of the internet or the smartphone. Once again, the Bay Area, more specifically San Francisco, is the cradle for this groundbreaking industry, and our portfolio is well located to benefit from its growth. VC funding to generate AI in the first five months of the year grew 650% in the city, with companies there garnering 90% of the global AI-related funding. This is translating to office demand, and there are currently nine requirements totaling 870,000 square feet in the city. More optimistic AI and relative service industry growth will begin to alleviate the lack of large square footage requirements and serve as a catalyst for sustained positive net absorption, especially in the Bay Area. Now turning to our studios. While the directors reached a new contract in June, the actors joined with the writers on strike in mid-July. And this is the first time since the 1960s that both unions have been on strike simultaneously, and that strike lasted 22 weeks. We're hopeful all parties are going to reach a fair agreement soon, although it appears currently that they remain far apart on important issues like streaming residuals, AI, and writers' rooms. The simultaneous strikes do mean that previously written production activity that still could be filmed is now on pause. However, we're nine weeks into the strike relative to an average strike of 14 weeks, and we continue to expect a significant ramp in production post-strike like we experienced following COVID, but it's going to take time to fully re-engage. And while studios have strategically spread out new releases, they could face significant shortfalls in 2024 if production isn't up and running before the fall. Netflix, as an example, recently affirmed its intent to maintain content spend through 24 at levels in line with 2022, albeit with some lumpiness post-strike similar to coming out of COVID. Comcast, too, noted a relative increase in content spend likely in 24. And with subscriber growth and engagement across multiple broadband applications trending up, the underlying demand drivers for production remains strong. A strike of this magnitude, while impactful, is rare and has historically proven to be relatively short-term in nature. Over the first half of the year, we've made significant enhancements to our studio cost structure. These equated to a $12 million annual savings around labor and fixed operating expenses, as well as another $15 million of savings attributable to deferred capital expenditures. While we'll continue to evaluate additional operating and capital adjustments, will do so in a manner that weighs short-term cost savings against capitalizing on long-term value creation. Not all industry players have the ability to make this trade-off, which could present a compelling opportunity for us post-strike. We'll also be able to fully capitalize on the economies of scale from our now fully integrated service acquisitions post-strike. And we expect these synergies to result in approximately $15 million of additional annual NOI in a normal operating environment. So despite these current challenges, We've thus far been able to navigate the ever-changing landscape in a manner which speaks to the well-located portfolio we've assembled, our diversified asset classes, and the fortitude and experience of the entire Hudson Pacific team. And we understand this was going to take time to overcome, but we believe in our strategy and our long-term positioning sets us up to generate even stronger results in the coming quarters. With that, I'm going to turn it over to Mark. Thanks, Victor.
spk04: We've signed approximately 50 office leases, roughly 50% new deals, totaling just over 400,000 square feet in the quarter. The average lease size was approximately 7,000 square feet, and 50% of that activity was in the San Francisco Bay Area. Small and mid-sized tenants in tech and other industries continue to drive the preponderance of activity across our market. GAAP and cash grants were approximately 4% and 8% lower, respectively, on backfill and renewal leases, with the change largely driven by a few mid-sized leases both new and renewal, across the peninsula and Silicon Valley and in Vancouver. Our in-service portfolio ended the quarter at 87% lease, off about 170 basis points compared to first quarter, due primarily to the move out of mid-sized tenants in those same markets. Our leasing economics improved across the board quarter over quarter, with net effective rents up close to 9% to $44 per square foot. Tenant improvement and leasing commission costs improved close to 50% down to $6 per square foot per annum and lease term increased by six months or 13% to 48 months. In terms of our two larger 2023 expirations, we're still negotiating a renewal of our 140,000 square foot tenant in Seattle at Met Park North whose lease expires in late November. We're in discussions with two requirements that could potentially partially backfill the 469,000 square foot block lease at 1455 Market in San Francisco, which expires at the end of September, one for approximately 25,000 square feet, the other for approximately 275,000 square feet, with additional tenant interest behind these. In regard to our remaining 2023 expirations overall, which are about 5% below market, we have 50% coverage, that is, deals and leases, LOIs or proposals, with another 5% in discussions. Outside of the two large expirations I mentioned, the average expiring lease size is roughly 5,000 square feet. We're staying creative and flexible as we work to boost occupancy, but even as the growing number of tenants commit to a three- to five-day in-office schedule, thus far they continue to transact very slowly. Our current leasing pipeline totals 2 million square feet, slightly above our last call, even with continued leasing. And that pipeline includes over 285,000 square feet of deals and leases. We also have close to 1.2 million square feet of tours across our portfolio, roughly on par with this time last year, although down from last quarter. We did see an increase in both aggregate and average square footage of requirements for our assets across the peninsula and Silicon Valley. This coincides with a rise in early interest we have seen more broadly in the Bay Area and Seattle, even as the timeline for getting leases across the finish line remains unpredictable. Turning to the studios, our in-service studio stages remained well-leased at 95.7% on a trailing 12-month basis and 94.1% on a trailing three-month basis due to the preponderance of long-term, greater-than-one-year leases. On a trillion-three-month basis, we actually experienced a 490 basis point increase in lease percentage at our Coyote studios. This was largely due to the commencement of a handful of long-term leases at our Central Valley and recently delivered North Valley facilities, as well as the general influx of short-term, non-strike-impacted production, such as commercials and photo shoots. This activity led to an additional $1 million of rental and lighting and grip revenue quarter over quarter at our COD studios. However, revenue from pro supplies, transportation, and other services was off by approximately $4 million in aggregate, even as we still had activity from non-strike impacted productions such as music festivals and other large-scale events. That said, we expect these service-related categories are likely to be further impacted given seasonality and the expanded strike as long as it continues. Throughout our portfolio, we're continuing to limit capital improvements until we have certainty around demand. This includes staying conservative on new development. We do, however, have two in-process developments close to completion. We're on track to deliver our state-of-the-art Sunset Glen Oak studio in Los Angeles by year-end, as expected, pending receipt of Department of Water and Power permits. We've continued to tour major production companies despite the strike. We anticipate leveraging a more traditional show-by-show sales model for at least a portion of the facility, which we will be able to execute on to the fullest extent post-delivery. There is no directly competitive supply for this project, which has a delivery date potentially quite well-timed to capture pent-up demand post-strike. In Seattle, Washington 1000 is also on track and should deliver in the first quarter of next year. While we expect even greater interest once the project is complete, we're already in early discussions with three tenants, each with requirements over 100,000 square feet. As Victor mentioned, Amazon's push earlier this year to bring employees back at least three days a week and more recently telling workers to return to its main hub has accelerated return to work for many local businesses. Washington 1000 will be one of the nicest buildings in the city and is the only new product of its kind under development. Our all-in basis is only $640 per square foot, representing as much as a 30% to 40% discount to comparable trades. And now I'll turn it over to Rick.
spk10: Thanks, Mark. Our second quarter 2023 revenue was $245.2 million compared to $251.4 million in the second quarter of last year. primarily due to Qualcomm and NSL vacating Skyport Plaza and 10900 to 10950 Washington, respectively. The sales of office properties 6922 and Skyway Landing. Our second quarter FFO excluding specified items was 34.5 million or 24 cents per diluted share compared to 74.6 million or 51 cents per diluted share a year ago. Specified items in the second quarter consisted of transaction-related income of $2.5 million, or $0.02 per diluted share, which includes lowering of accruals for future earnouts related to our ZioStudio services acquisition, prior period property tax reimbursement of $1.5 million, or $0.01 per diluted share, deferred tax asset write-off expense of $3.5 million, or $0.02 per diluted share, and a gain on debt extinguishment net of taxes of 7.2 million or five cents per diluted share. Prior year second quarter specified items consisted of transaction related expenses of 1.1 million or one cent per diluted share and prior period property tax expense of 500,000 or zero cents per diluted share. The year over year decrease in FFO is attributable to the aforementioned office tenant move outs and asset sales, as well as higher studio production higher studio operating expenses associated with QOD acquisition, and increased interest expense. Our second quarter AFFO was $31.1 million, or $0.22 per diluted share, compared to $60.3 million, or $0.41 per diluted share, with a decrease largely attributable to the aforementioned items affecting AFFO. Our same-store cash NOI grew $127.6 million, up 4.7%, from $121.9 million, with same-serve cash office NOI up 5.1%, largely driven by significant office lease commencement at 1 Wednesday and Harlow. During the second quarter, we repaid the QOD note for $150 million, a $10 million discount on the principal balance with funds from our unsecured revolving credit facilities. At the end of the quarter, We had $581.2 million of total liquidity comprised of $109.2 million of unrestricted cash and cash equivalents and $472 million of undrawn capacity on our unsecured revolving credit facilities. We have additional capacity of $122.4 million under our One Westside and Sunset Glen Oak construction loans. At the end of the second quarter, our company's share of net debt to the company's share of undepreciated book value was 38.7%, and 85.3% of our debt was fixed or capped. We remain focused on delivery. This quarter, our board reduced our quarterly common stock dividend to 1.25 cents per share, which resulted in an additional 17.9 million of cash flow savings this quarter. We also continue to selectively explore asset sales. We currently have three deals under contract, including two office assets and one land parcel which could collectively generate over $100 million in gross proceeds within the next several months. We're also in negotiations to sell two more office assets. The pricing and timing of which are under discussion. Regarding our upcoming maturities, we only have one small maturity remaining in 2023. Our $50 million private placement note due next month, which we'll repay with our line of credit. We have two maturities in 2024. Blackstone is leading discussions around the extension of our Bentall Fender Loan, which matures in July 2024, of which our 20% ratable share is $100.5 million. We've received indicative terms and are now formally commencing discussions around refinancing our One Westside slash Westside 2 loan, which matures in December 2024, and of which our 75% ratable share is $243.5 million. As for 2025, 96% of our indebtedness does not mature until the final two months of the year. And three of our four 2025 maturities, comprising nearly two-thirds of the maturing amount, are secured by high-quality assets, 1918 Almond LA and Sussex Glen Oaks, the first two of which have high credit single tenant occupancy for the remaining lease terms into 2030. Southside Glen Oaks should be stabilized and fully operational state of the art studio campus before its 2025 maturity. Our fourth and final 2025 maturity consists of a $259 million prior placement loan that matures in December 2025. While this is still nearly two and a half years out, we're focused on ensuring that we have capital available ahead of repayments. Turning to outlook. Due to continued uncertainty around the duration of the studio union-related strike, we're continuing to withhold our 2023 FFO outlook and studio-related assumptions, while providing certain assumptions related to our office outlook, including reaffirming an office same-store cash NOI growth projection range from 1% to 2%. This range includes the impact of a block lease expiration in September 2023, but does not include any of the aforementioned potential dispositions. We continue to expect FFO to be negatively impacted as long as the strike persists. As always, our 2023 outlook excludes the impact of any opportunistic and not previously announced acquisitions, dispositions, financings, and capital market activity. Now we're happy to take your questions. Operator?
spk07: Thank you. We will now begin the question and answer session. As a reminder, to ask a question, you may press star, then one on your touchtone phone. You are using a speakerphone. Please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. Our first question today comes from the line of Alexander Goldfarb with Piper Sandler. Alexander, please go ahead. Your line is now open.
spk08: Hey, good afternoon, or good morning out there. And again, thanks for moving the call time to avoid the overlap. So two questions. First, it sounds like the sales so far not contemplating one west side. I don't know if one west side is in the potential to additional for sale. But Haru, when you think about all the assets that you guys may sell, what is the NOI impact that we should think about? And then more to Victor's opening comment on corporate expense, if you're selling a bunch of What does this mean about the need to reduce the cost structure of the company overall?
spk10: So let me answer the first question, which is we're not going to provide any NOI detail yet, primarily because the sales are uncertain. And once we have confirmation of the sales and feel confident, we will share all the relevant details around them. So doing that is not appropriate at this time. As far as the G&A goes, I think we said before, we constantly look for ways to reduce our costs and reevaluate them, and depending on the sales and the impact, which will also garner our ability to reevaluate G&A. So they're always being evaluated and thought through.
spk08: Okay. The second question is on Hollywood. Clearly, I mean, you guys benefit from owning independent studios, which is good. But when we think about some of the headlines, we read Disney and others who are talking about trouble with their their screen productions or streaming services. How do you weigh overinvestment in streaming or ways that Hollywood may retrench after some tough goes with the resurge demand once the strike ends? Just trying to figure out, are we back to the races or is Hollywood reconsidering how much it puts into its production investments, just given some of the headlines we've read recently?
spk14: So, Alex, you know, as I mentioned in my prepared remarks, I mean, so far what we've found between the bigger streaming entities to date, they are on budget, at least as we know, through 24 to spend at or more than their run rate has been in the past. And that's been, you know, Netflix's and Apple's and Amazon's and Disney's and Comcast's tone to date. I think it's approximately a 2% increase year over year. So that I believe will probably be greater given the fact that they're not spending the money currently today because they're on strike. So you're going to have a massive ramp up. After that, I believe, you know, we feel from what the industry is looking at that we've always mentioned that there will be some form of consolidation. Whatever that consolidation looks like, we don't know. I don't think it's going to impact the stage use And the production use because there is still very limited number of stages in the demand in peak times are much higher than the stages that are available. Jeff, do you have any comment to that?
spk09: No, the only thing I would add, Alex, is that, you know, what's clear with all the streamers is that original production drives a lot of subscriber growth and it also mitigates their churn. So it's a key economic ingredient into their playbooks. Even if consolidation happens, they all know that they have to invest in original content production. And hopefully, obviously, we'll benefit from that.
spk08: OK, thank you.
spk07: The next question comes from Blaine Heck with Wells Fargo. Blaine, please go ahead. Your line is open.
spk11: Great, thanks. Just to follow up on the sales, Victor, you guys have talked openly about evaluating dispositions recently and that there are no sacred cows within the portfolio. I mean, Harut's commentary was helpful, but just more generally, can you talk about what you've learned about the investment sales market throughout this process? You know, whether there's more interest in certain segments of the market and, you know, just as you've gone through the process, whether the composition in the bucket of assets up for disposition is has changed based on what you've learned?
spk14: Yeah, I think, listen, the three assets that we have under contract right now are, as we mentioned, two individual assets and one parcel of land. The demand for those were relatively high on smaller user or owner user or family office type investors. The other couple of assets that we're working on right now, I think have a makeup of a more of a institutional play, change of use play. And I think that that's the drive that we're looking at right now. I, you know, listen, as Harut said, we're not going to get into identifying the assets in the open marketplace. I believe that, you know, we have not explored true institutional ownership sales for large assets at this time, not to say that that won't be something that we look at in the future, but that's not part of the game plan and the assets that we're talking about right now. And so, you know, I think the bottom line is the activity is relatively good. Clearly, financing around those assets is the hurdle. And so the size of the assets from our standpoint and the type of buyer is going to be identified based on the access to liquidity and capital.
spk11: All right, great. That's helpful, Keller. And then just taking a little bit of a step back on the studios. Victor, can you just talk a little bit more about any insight you have into the negotiations going on related to the writers and actors strikes and just what your best guess is, or maybe even what you're hearing from any insiders you're talking to on how long these strikes could last kind of based on the current state of negotiations?
spk14: Well, listen, I'll take the first part. Um, uh, initially, I mean, listen, what we're hearing is there's, as I mentioned, my prepared remarks, there are a few issues on the table that are, um, hurdles that they're going to have to try to figure out, uh, writer's rooms. Um, uh, the issue, obviously an AI, which is an undetermined issue and a new issue for all parties. Um, and, and, and then the residual issue are the big issues. I think that the dollar issues. and the issues around healthcare and all the perks around that are pretty much agreed to. Couple things. The fact that SAG is at the table, I believe helps the process because you've got now another constituent with thousands of people now involved that are more than the 3,000 writers that were involved in the past. So hopefully that will set a precedent on some of this. Real time, we just heard last night TAB, Mark McIntyre, they're going back to the table Friday, the writers are they have not been at the table, I believe, for a month and a half, or so, so that's that's a good sign. TAB, Mark McIntyre, In terms of you know what we're hearing on the ground, you know we we are, as I mentioned in the past, we don't we don't have a seat in the table, we obviously have a lot of constituents around that are giving us information. It could start in a heated conversation to hopefully settle something out as early as September and maybe as late as year end. But I think as every day goes by, Blaine, we're all hugely aware of the shrapnel around just the industry in general and all the residual businesses that are getting affected. And it will start to feel fairly painful for these residual companies and employees and individuals that work in the industry. And it will be damaging. And I think everybody's very cognizant of that. And hopefully, we'll try to get to some resolution quicker than we all anticipate.
spk12: Great. Thanks, Victor. Thanks, Blaine.
spk07: The next question comes from Nick Ulico with Scotiabank. Nick, please go ahead. Your line is now open.
spk13: Thanks. I guess just going back to the asset sales, is there anything you can provide us in terms of a view of if you get a certain level of asset sales done this year, what that's going to do to improve your debt to EBITDA metric, which went up again this quarter?
spk10: So addressing that is a little bit too outside the range of what we want to talk about right now. But ultimately, it will improve it over the long term, which is, you know, kind of our main point, which is we're going to deliver. And that's kind of the focus that we have. And when using different tools to do so. So not only debt to EBITDA, but also the covenant calculations, all those things, you know, we have a very strong eye on and we're projecting out. In fact, this quarter was in line with our projections and we're not in a risk of breaking any of them. But like we said earlier, the de-levering is a high priority for the company.
spk14: Yeah. And Nick, just to add to that, the assets that we're in escrow or under contract with and the other two we're talking about, and then the next sort of tiers that we're looking at, none of those assets currently have debt. So effectively all that, all the cash flow, I'm sorry, all the proceeds from the sale will go to pay down current debt. So we're not replacing, we're not getting rid of existing encumbered debt on assets in any asset at this stage. So it's all going to be very helpful.
spk10: And just to touch upon the net debt to EBITDA. Okay. Real quick, sorry, to address your EBITDA comment, it's being artificially reduced by the strike. And so it doesn't really reflect a normalized net debt to EBITDA as a result of the strike. And so it is being, like I said, artificially being reduced or increased, I guess.
spk13: Well, I guess I just wasn't sure if there was any specific target you're trying to get to on that metric, realizing that you know, the EBITDA for the studio business, there's uncertainty about how long that could be under pressure. You also have some, you know, some move outs still on the back half of the year that hadn't been released. So I wasn't sure if you just, it was a sort of plan in place where you have a target and you think that, you know, the dispositions can get you to that target.
spk04: Yeah, there's a plan in place. The plan is get it lower. And we're doing that through these announced disposition goals I'll add to the comments that Haroud and Victor have already shared. One of the asset sales is land, so that's 100% accretive to debt to EBITDA because there's no EBITDA associated with it, and it goes all to debt reduction. So the plan is to get it lower. We have always said that we want to be below seven times debt to EBITDA. We understand that there are, you know, tenants rolling, there's other, you know, areas, impacted like the studio and the strike things we don't control but everything we can control we are laser focused on on uh following through with in it with the goal of getting that metric um you know improving that metric okay thanks and and then just one other question if i could on you know silicon valley and you know thinking about your portfolio there and you know i think historically there was
spk13: Talk that you know the portfolio would benefit at times from you know just ancillary services supporting You know the large tech community there, and I guess I'm just trying to want you know trying to understand better the dynamic right now where we all hear that you know large tech is more on hold with leasing and I'm not sure if that's also impacting some of the kind of ancillary you know, companies that support tech. Is that also sort of affecting that tenant base as well, or is it more that, you know, just large tech is slowing in Silicon Valley?
spk14: I think it's not affecting it as much as I think we would have thought it would have, Nick, to be candid with you. Because as you can see by our numbers, the majority of leases that we're doing in the peninsula and the valley are smaller tenants. I mean, we've got a handful of tenants in the 50,000 square foot range, but the majority of those tenants are, you know, 5 to 20 tenants. As you can see by our numbers this quarter and the number of deals we've done, there's a lot of activity in the Peninsula and the Valley. Also, the physical occupancy is in the Valley and the Peninsula has increased dramatically, and that's converted to more people looking at space and touring and the likes of that. Art, you want to comment on that?
spk03: The answer is, as tenants are starting to discover how they're going to utilize space, Return to office is really kind of on the forefront, and they're enforcing these return to office mandates. They're discovering how much space they're going to need to right-size. We're seeing those right sizes cut both ways, but we are seeing tenants coming back and looking for more space. That's going to affect both the large and the smaller users, so it's going to play all the way through.
spk15: Okay, thanks. That's helpful, everyone.
spk12: Thanks, Nick.
spk07: The next question comes from Michael Griffin with Citi. Michael, please go ahead. Your line is now open.
spk05: Great, thanks. I wondered if you could expand on what you mentioned in the release about, you know, extended times for decisions to be made on leases. Is this just a function of space takers more hesitant to take space? Is it supply? You know, any incremental commentary you could give there would be helpful.
spk14: Yeah, I mean, listen, it's so hard to pinpoint. Every case is a case-by-case. You know, we've seen tenants come and negotiate feverishly and have leases out for signature, and we've waited. I mean, we've got two fairly substantial leases that have been on the desks of the legal counsel, fully negotiated for a matter of months, one overseas and one domestic. So, Michael, I just think that It's just taking time. And maybe if you want to read into it a little deeper, I don't think it's about looking at the footprint or the competitive landscape. I just think it's a need currently versus a need in the future. And maybe that's where the decision tree is right now. Obviously, things have changed expeditiously in terms of back to work and the number of tenants that have come out and companies have come out with policies The next phase of policy is enforcement, and I think that level of enforcement goes to execution of leases, and I think that's exactly where we are right now. We're on that precipice of everybody's policies are in place. Now they're going to be enforced, as the example we gave with Amazon, which is a great example. Now the enforcement comes into place, so now they recognize the need, and then the executions are the next stage. Art?
spk03: Yeah, but we've seen forward thinking on this relative to all the 10Bs across our portfolio. Why? Because over the first half of the year, we've seen a spike in TOR's early activity. And that early activity is going to translate into actual transactions downstream. And so they've already been thinking about this and the return to work, I think, which has caused this spike in early interest.
spk05: Great, thanks. And then just going back to the writer's strike, I mean, obviously I think it's anybody's guess as to when this thing ends, but is there a worry if it gets protracted kind of into the latter part of this year that given you have a seasonal aspect of this business that production could be slower to ramp up into 2024?
spk14: Yeah, it's a great question. Listen, I think we're very confident that when this ends, the ramp up will be non-seasonal, and it will just go. And as I said, we just had an example of this with COVID two years ago, and we saw the results, and they were pretty spectacular. I think seasonality is out the window. I do caution, and I know Harut has made it evident to everybody who he speaks with, we're not saying the next day things jump. This is a business and an industry that, you know, you're going to have scripts written, you're going to have sets designed, you're going to have actors hired, and then you're going to have production in play, and that does take time. I think they're getting prepared for it behind the scenes, but there will be some form of a ramp up. I don't know whether it's going to be, but when it's up and running, we're going to benefit from it, and we think it's going to be fairly, you know, expeditious and furious.
spk12: Great. That's it for me. Thanks for the time. Thanks, Michael.
spk07: Our next question comes from John Kim with BMO Capital Markets. John, please go ahead. Your line is open.
spk15: Good morning. With the repayment of the QOD note, you now have $520 million outstanding on the line. And I was wondering how you plan to pay that down, whether it's disposition proceeds. I'm not sure if the five assets are enough to fully pay that down. free cash flow or long-term debt refinancing?
spk04: Yeah. I mean, I think the first two are the sources along with the dividend cut. So, you know, expect to see cash flow and our coverage on dividend continue to improve, especially when studio operations return to normal. That net cash flow, net of debt service and dividends will go towards either the payment of capital requirements that otherwise would have required the use of the line or reduction of the line. It'll just depend on the, you know, the period of time that we're talking about. So that'll do it. The asset sales also go to reduce that, the line balance. The use of it's possible if the capital markets are, you know, more available and the cost of secured debt is attractive, potentially we would access the secured market to reduce it. But I think the excess cash flow and asset sales are really where we're going to get the debt reduction.
spk15: Okay. Some of the multifamily companies this quarter talked about property tax relief in Seattle. I don't think we've heard you or other office companies talk about this, but I'm wondering if you see a similar trend either in Seattle or just property taxes in general being alleviated.
spk14: Yeah, listen, I think we are all over it in all of our markets. We are seeing very good resetting evaluations and property tax benefits to the company in all of our assets in California and in Washington at the same time. I think our team is way ahead of the curve on that, and you'll see some impacts in the quarters to come. We have already gotten wins. I think the wins will then impact the bottom line expense reduction on taxes and potentially some rebates as well across the board.
spk15: Okay, Victor, you talked about AI demand and the potential opportunity. I was wondering if you had seen or are talking to any tenants currently in your portfolio, either direct or sublease, and if there's any way to quantify how much demand there is out there.
spk14: Well, I can tell you, like, you know, in my prepared remarks, you know, as I said, San Francisco seems to be leading the pack on where the AI demand is. You know, it's currently today at about almost 900,000 square feet. We've seen a couple of deals done. Hayden is an AI company. They did 42,000 square feet in the city. I also think that another Hive company, which is another AI company, did I think about 60,000 square feet. There's another 800 plus thousand square feet of activity right now. Some of it has been for sublease space and some of it is direct deals. So I think the numbers that we're quantifying, at least that are real, it's about 600,000 square feet of, you know, net absorption. And then just like what was asked about the residual, then you're going to see the follow-on on ancillary companies that are servicing these AI companies, hopefully growing. And, you know, we're optimistic that it's going to make some kind of an impact. But it's real. It's now. And we'll see where it goes in the next couple of quarters. But we're looking at a couple of – um tenants that are that that are very active in the marketplace and trading paper back and forth so we're hopeful that we can execute on that that's great color thank you thanks john our next question comes from julian bluin with goldman sachs julian please go ahead your line is open yeah thank you for taking my question um
spk06: Haru, maybe for you, what is causing the increase in the interest expense guidance? Is it just the forward curve going up and the impact on floating rate debt and I guess also the interest rate cap expirations you have coming up this quarter?
spk10: It's a few things, but you hit upon a couple of them. One is the forward curve increase. Also, while this doesn't help interest expense, it does accreted to us, which is we paid off the QIOTI loan and generated $10 million savings. However, the cost of that loan versus the current curve is increasing interest expense.
spk06: Got it. Okay. That makes sense. I was encouraged to hear that the covenants came in line with your projections. Sounds like you don't really expect any issues there. I guess just could you sort of walk us through what the deterioration in the unsecured indebtedness to unencumbered asset value was? And I guess also when you say you don't expect any issues, does that sort of assume sort of any length of strike or is there maybe a minimum level of leasing or tenant retention through the end of 24 that needs to happen?
spk04: So yeah, the deterioration is really a combination of the increase in the unsecured debt balance stemming from the repayment of the KEODI note, which was a secured debt that became unsecured upon repayment. And then there's almost 40 assets running through the unencumbered asset calculation. some of them increased in the quarter, some of them decreased. The net decrease was about 112 million. We've stress-test the metric, including a protracted strike, all the way through the end of 24. And even in the most impacted quarter, we still, on that metric, remain more than 300 basis points above the threshold. So the studios, neither the studios, I should mention, run through the unencumbered asset base or 1455, which I think some people may focus on due to the block expiration, doesn't affect those valuations at all. There's an indirect effect due to the cash flow, right? Because to the extent that we were generating more cash flow from the studios, it would be available to repay the debt, which will eventually take hold. So that metric improves as we see the studios normalize. And yeah, and we've factored in or sensitized that for, like I said, the protracted strike, all the known move outs, you know, everything we can project all the way through the end of 24.
spk06: Got it. That's very helpful. Thank you.
spk12: Thanks, Julian.
spk07: The next question comes from Camille Bonnell with Bank of America. Camille, please go ahead. Your line is open.
spk00: Hello. I wanted to pick up on the comment about how mark-to-market opportunities are around 5% for 2023 expirations. If we think about the negative cash rent spreads on the leases you've signed to date, has this been in line with your expectations given you're still seeing positive rent growth? that effective rent growth?
spk04: Yes, and our mark on the remaining 23 expirations remains a positive 5%. A couple of deals really account for that 8% drag on the marked market. The Rivian 60,000 feet extension through 28, we had hit that Rivian deal at literally peak market rents in Palo Alto. And we're obviously glad we were able to get that significant extension, but it reflects current market. So it was a negative 18% mark. We also did a three month extension with Luminor. It also dragged that number down a bit. If you account for those two deals, you're essentially flat mark to market. So, yeah, our numbers still show that the remaining expirations are, one, that was our expectation for the quarter. Two, we expect to see something like 5% mark.
spk03: Yeah, more color. Both of those yields happen to be in the exact same market where we hit peak rents, and now we're going to be adding market rent, which is also a very healthy rent, happens to be well below the mark.
spk00: So, just specifically within that market, then, just given demand still remains below, I guess, where you need to be to support stronger pricing power there. Do you expect that these negative rent growth trends will continue over the next 18 months or any thoughts if we're close to a bottom here?
spk04: Well, I mean, our numbers, which, you know, reflect refreshed MLA assumptions that get done every, you know, I mean, we're constantly refreshing our MLAs, show a positive for the balance of 23, and we're essentially flat on our expirations in 24. And in 25, there's a slight positive. So, you know, looking through the lens of our assets and assumptions associated with our assets, it suggests, you know, sort of a bottoming out
spk12: Thank you.
spk07: Thanks, Camille. Our next question comes from Dylan Bozinski with Green Street. Dylan, please go ahead. Your line is open.
spk15: Thanks for taking the question. I guess just going back to big tech leasing, and I appreciate your comments so far, but one of your peers recently mentioned that they don't expect big tech leasing to materialize or recover even through next year. So just curious, is that how you guys are sort of viewing this tenant cohort? And if so, what do you think ultimately brings them back to wanting to lease more space?
spk14: Hey, listen, I don't know, you know, what other landlords are saying. What we're seeing is we're seeing activity in big tech in certain markets. We're seeing already a decision tree that's made as to how space is going to look. And now they're looking to find out where they're going to accommodate the space. You know, obviously we're seeing a flight to quality just still, you know, dealing like everybody else is. Our higher quality assets, the highest quality assets have the most activity and there's tech activity around that. You know, I'm not going to, you know, venture into saying big tech's not coming back or they're not coming back anytime soon. You know, I just know that what our team is seeing is that, you know, I believe that our tours are higher than most. that we've seen in the past and we're seeing that activity. I do think that in reference to specific to big tech, I mean, just look at Amazon. I think their return to the hub messaging last week was dramatic and absolute. And when there was pushback, they said, you know what, if you aren't going to be within an hour's timeline of where your current office is, You can apply to another job, and if you don't, you know, you're expected to be considered as unemployed going forward.
spk03: Right. And it's not just big tech, right? We're seeing it from these comments from AT&T, farmers, et cetera. You know, it's starting to, you're starting to see, you know, kind of the trickle down. Yeah.
spk15: Appreciate those comments. And I guess just in those discussions, any noticeable trends with regards to changing space layouts?
spk14: Yeah. I mean, listen, Dylan, we're, we're getting a handle on this, you know, uh, real time and we're seeing the same thing is, is I mentioned in my prepare with March, you're seeing a lot more conference room facilities. You're a lot more space per head. You know, we we've seen that number go up to like 165, you know, uh, uh, or, or more, maybe even, you know, to, to close to 200 feet per person when it was as low as like one 20. And so that those numbers are, are, are consistent throughout, you know, more space for less people. And I think that seems to be the trend, obviously amenity driven. That's the trend. And, you know, location and quality, which we've talked about, you know, since the beginning of this downturn.
spk12: Great. Appreciate those comments, guys. Have a good one. You too, Dylan.
spk07: Our next question comes from Ronald Camden with Morgan Stanley. Ronald, please go ahead. Your line is open.
spk02: Hey, just going back on the leasing, really helpful color on the 23, too large expiration in the Amazon deal. But any sort of updates on the, remind us on the new to next space as well as the towers and short centers coming to in 2024, any sort of color or context there, how our conversation is going?
spk03: Sure, this is Art. Nutanix is a contractual give back. We extended them for 215,000 square feet for an additional seven years. And so this was part of their contractual give back. The piece that came back in the quarter, it's about 51,000 square feet. We're in leases for half of that currently. Going forward, the next large piece in 23, which is up in May, we're just currently marketing the space. We don't have a backfill user inside, but we are touring currently.
spk02: Got it. And then Poshmark? Sorry.
spk03: Yeah, Poshmark, we're in negotiations. If you think about it, they're a three-floor tenant. We're in negotiations for two floors at the current time, right? So we'll see, you know, as they...
spk02: assume what what kind of footprint they're looking for it might be all three but right now we're focused on two got it and then zooming out to the you talked about the two million square feet uh in the pipeline is there a way to thematically break that down a little bit like is there like AI financial services tech is there a way to sort of dive into that number a little bit more
spk03: yeah i don't right now i mean i don't dissect it in that fashion but i will tell you uh the sense that i'm getting on that two million feet by the way that two million feet is up a hundred thousand square feet quarter over quarter um after you know having at least four hundred thousand feet so that's that early interest that i had been talking about you know you know repeat is is real and it's starting to work its way into our pipeline which again uh abodes well i would say that because of the markets that we're in i would say you know probably sixty percent of that is 60%, 65% of that is tech. Now, I can't break it down to AI versus hardware, software, but it's 65% squarely is tech.
spk02: Got it. Helpful. Thank you so much. Thanks, Ron.
spk07: This concludes our question and answer session. I would like to turn the conference back over to Victor Coleman, Chairman and CEO, for any closing remarks.
spk14: Thank you so much for participating in this quarter's call. We'll speak to you all in the next quarter.
spk07: The conference has now concluded. You may now disconnect.
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