Paramount Group, Inc.

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Paramount Group third quarter 2024 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. Please note that this conference call is being recorded today, October 31, 2024. I'll now turn the call over to Tom Hennessy, Vice President of Business Development and Investor Relations. Thank you. You may begin.

Thank you, operator, and good morning, everyone. Before we begin, I would like to point everyone to our third quarter 2024 earnings release and supplemental information, which were released yesterday. Both can be found under the heading Financial Results in the Investors section of the Paramount Group website at .pgre.com. Some of our comments will be forward-looking statements within the meaning of the federal securities laws, forward-looking statements which are usually identified by the use of words such as will, expect, should, or other similar phrases are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. Therefore, you should exercise caution in interpreting and relying on them. We refer you to our SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial conditions. During the call, we will discuss our non-GAAP measures, which we believe can be useful in evaluating the company's operating performance. These measures should not be considered in isolation or as a substitute for our financial results prepared in accordance with GAAP. A reconciliation of these measures to the most directly comparable GAAP measure is available in our third quarter 2024 earnings release and our supplemental information. Hosting the call today, we have Mr. Albert Baylor, chairman, chief executive officer, and president of the company, Wilbur Paes, chief operating officer, chief financial officer, and treasurer, and Peter Brinley, executive vice president, head of real estate. Management will provide some opening remarks and we will then open the call to questions. With that, I will turn the call over to Albert. Good morning, everyone.

Thank you for joining our call today. Yesterday, we released our third quarter results reporting core FFO of 19 cents per share, a penny above consensus. In the third quarter, we leased 179,000 square feet, bringing our -to-date total to 655,000 square feet leased. We are now trending ahead of most of the goals that we had established at the beginning of the year. In New York, we leased 72,000 square feet in the third quarter. While our third quarter leasing in New York was trailing that of the previous two quarters, the pipeline, which Peter will cover in a few minutes, is robust. And most of the leasing we expect to complete in the fourth quarter will be in New York. We are seeing good interest from a wide array of tenants, especially financial services and law firms. This demand reaffirms our conviction of the long-term appeal of high quality, strategically located office spaces in New York's core sub-markets. The Paramount Club at 13016 Avenue, which we unveiled last quarter, has been receiving exceptional reviews from our tenants, prospective tenants and brokers alike. This bespoke amenity has quickly become a key differentiator, enhancing our ability to both retain existing tenants and attract new ones. The enthusiastic reception it has received validates our investment in creating unique tenant-focused spaces. I'm also happy to report on the tremendous success of Din Tai Pung, the Michelin-starred restaurant that opened in July beneath the iconic glass cube at 1633 Broadway. In addition to Din Tai Pung, we also welcomed the Italian bakery Rosetta and signed the lease on the last remaining retail space with La Pecora Bianca, a vibrant Italian restaurant at 1633 Broadway. These carefully curated amenities have generated significant buzz, adding a new dimension of energy and sophistication to our headquarters. All these unique offerings are elevating our portfolio, setting us apart in a highly competitive market. As businesses continue to gravitate towards the highest quality of office spaces, we are confident our properties are well positioned to meet this demand, driving occupancy improvement and leasing rates across our New York assets. Shifting to San Francisco. As you will recall from our last earnings call, we indicated that JP Morgan was unlikely to renew the majority of their space at one front street that was set to expire in 2025. In the third quarter, JP Morgan renewed approximately 10% of their 2025 expiry. While we are all disappointed with the outcome of their near-term expiration, JP Morgan will continue to have a significant presence at one front with about 125,000 square feet, post its 2025 expiry. One front street is a terrific asset at one of the finest locations in San Francisco's CBD. We are now in the early planning stages of repositioning the asset with a re-imagined ground floor experience and various added amenities, all in an effort to return one front to being among the top 15 office buildings in San Francisco. We look forward to sharing more details around our plans in the upcoming quarters. While the San Francisco leasing market remains challenging, we continue to make progress on our business plan. This quarter, we leased approximately 107,000 square feet, bringing our -to-date total to 287,000 square feet leased. Most of the leasing in San Francisco continues to be renewal-based and for shorter terms. That said, the flight to quality remains prevalent and San Francisco's position as a hub of tech innovation and its leadership in AI-focused venture capital funding underscore its potential for recovery. We are confident our portfolio is well-suited to capitalize on these trends. Turning to our balance sheet, it remains robust with approximately $412 million in cash and restricted cash. In an effort to maintain the utmost financial flexibility, our board suspended our regular quarterly dividend. This was a carefully considered decision, aimed at enhancing our financial resilience, retaining an excess of $30 million in cash on an annualized basis. The broader real estate transaction market, while still subdued, is showing signs of revival. We are seeing an uptick in potential deals, which could signal a more active market in the coming year. The persistent gap between buyer and seller expectations is beginning to narrow, potentially unlocking more opportunities. In this evolving landscape, we remain committed to our disciplined approach to capital allocation. Our strong financial position enables us to act swiftly on attractive opportunities, particularly those involving strategic partnerships where we can leverage our market expertise. With that, I'll hand over to Peter.

Thank you, Albert, and good morning. During the third quarter, we leased approximately 179,000 square feet, with approximately 72,000 square feet in New York and 107,000 square feet in San Francisco. The weighted average term for leases signed during the third quarter was 8.1 years. The third quarter's velocity was evenly split, roughly, between new leases, including expansions, and renewals in both New York and San Francisco. Looking ahead to the fourth quarter, we're encouraged by the tour activity we see across our portfolio, particularly in New York, where markedly improving market dynamics and the Paramount Club have been a significant tailwind. The ever-increasing interest from prospective tenants coupled with our -to-date leasing momentum positions us well to finish the year strong with accelerating leasing velocity and increased occupancy. In both New York and San Francisco, we continue to see tenants prioritizing premium, centrally located, amenity-rich buildings operated by well-capitalized reputable owners. This trend plays to our strengths, allowing us to leverage our market position and grow our leasing pipeline. Our focus remains on maintaining strong tenant relationships, securing renewals for upcoming explorations, and leasing our vacant space. Our pipeline is solid, with more than 230,000 square feet of leases out, 80% of which are with new tenants for vacant space or -to-be vacant space. At quarter end, our same store portfolio-wide lease occupancy rate at share was 84.7%, down 160 basis points quarter over quarter. This decline was primarily driven by several known move-outs, the largest of which was Lerig at 1301 Avenue of the Americas. The remaining lease expirations for the year are manageable, with approximately .3% expiring at share in the fourth quarter. Turning to our markets. Midtown's third quarter leasing activity outpaced the five-year quarterly average for the fourth consecutive quarter. Demand for high-quality assets in Midtown's core sub-markets continues to accelerate. Increased deal volume in select sub-markets throughout Midtown has resulted in increased competition for space, creating a greater sense of urgency among tenants. The knock-on effect has been an accelerated decision-making process for tenants and improved leverage for landlords. Throughout Manhattan, tenants' space demand has grown to more than 2018, 2019 levels, and is a driving force behind Midtown's improving leasing fundamentals. Our New York portfolio is currently 85% leased on a same-store basis at share, down 190 basis points quarter over quarter. Our lease expiration profile in New York remains manageable with approximately .2% expiring at share by year end. Shifting to San Francisco. Leasing activity in San Francisco is steadily improving, up approximately 45% as compared to the first nine months of 2023. While overall market conditions remain challenging given elevated supply, there has been a steady uptick in leasing inquiries and tour activity, which have increasingly led to proposals. San Francisco-based companies continue to attract significant venture capital funding, especially for AI-focused companies, raising approximately 20% of the global AI venture capital funding year to date. This significant inflow of capital has begun to translate into increased demand for office space. Of the more than 60 AI leases completed year to date, approximately 70% of these leases are new to market. This developing AI demand coupled with active requirements from more traditional tenants in San Francisco has buoyed San Francisco's Tenants in the Market pipeline to levels approaching pre-pandemic levels. Our high-quality portfolio in San Francisco is well-positioned as the market recovery progresses. As mentioned, we remain focused on de-risking future lease role and leasing vacant and -be-vacant space, most notably the backfill of Google space at One Market Plaza and the portion of J.P. Morgan space at One Front Street that expires in 2025. At quarter end, our San Francisco portfolio was .6% leased on a same store basis at share, down 60 basis points quarter over quarter. Overall, we're encouraged by our progress this quarter and look forward to building on this momentum in the months ahead. With that summary, I will turn the call over to Wilbur, who will discuss the financial results.

Thank you, Peter, and good morning, everyone. Yesterday, we reported core FFO of 19 cents per share, which was a penny higher than Wall Street consensus. Same store growth in the quarter, while down .9% on a cash basis and up .8% on a gap basis, came in better than expected due to a true up in expense billings in our San Francisco portfolio. During the third quarter, we executed 12 leases totaling 179,403 square feet at a weighted average starting rent of $84.55 per square foot and for a weighted average lease term of 8.1 years. Mark to markets on 96,320 square feet of second generation space were negative .4% on a cash basis and negative .2% on a gap basis. Based on our year to date results, as well as our outlook for the remainder of the year, we have updated our guidance and improved our same store cash and gap NOI growth outlook by 100 basis points and 50 basis points respectively. As such, we are raising our core FFO guidance by one cent at the midpoint to a new range of 78 to 80 cents per share. From an operational standpoint, we have increased our leasing guidance to a new range of 825,000 square feet to 925,000 square feet and have reduced our same store lease occupancy range by 50 basis points at the midpoint. Please refer to page six of our supplemental package for additional information regarding the changes and assumptions underlying our guidance. Turning to our balance sheet, our liquidity position remains strong at over 1.1 billion. We ended the quarter with over 412 million of cash and restricted cash at share and the full 750 million of undrawn capacity under our revolver. In August, the 500 million interest rate swap and the 360 million interest rate cap on 1301 Sixth Avenue expired. Upon expiration of the swap and cap, we entered into a new agreement for the entire 860 million to cap so far at three and a half percent through August, 2025. Our outstanding debt at quarter end was 3.61 billion at a weighted average interest rate of .53% and a weighted average maturity of 2.9 years. This of course includes the debt on the two non-core assets in San Francisco. Excluding the debt on the non-core assets, we have 3.25 billion of debt at a weighted average interest rate of .26% and a weighted average maturity of 3.1 years. 73% of this debt is fixed at a weighted average interest rate of .5% and the remaining 27% is floating at a weighted average interest rate of 6.29%. Excluding the debt on non-core assets, we have no debt maturities until 2026. Please refer to page 40 in our supplemental package for the impact of the non-core debt on our capital structure. With that operator, please open the lines for questions.

Great, thank you. At this time, we will be conducting a question and answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two to remove yourself from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. One moment please while we pull the questions. Our first question is from Blaine Heck from Wells Fargo, please go ahead.

Great, thanks, good morning. So first, I was hoping to get some color on Market Center. It was reported that the debt is being marketed for sale. Can you just talk about the reception from the market thus far and your thoughts on timing and potential pricing of the sale?

Sure, Blaine, as you point out, the debt is in the market to be sold. The lenders are out there to sell the asset. We think obviously given that it's in the market right now, we think that some type of resolution will occur in the not too distant future. We are not the ones running the process, so we cannot comment on the reception in the market. We are watching it just like you guys are. And when it gets resolved, we will have more to report. But clearly the fact that it's in the market, you'd expect resolution to happen sooner than later.

Okay, great, thanks Wilbur. And then can you just talk about what's driving the decreased lease rate guidance at the end of the year, given that the leasing volume guidance increased?

Sure, when you look at it, we increased the leasing volume guidance because effectively there were some leases that were pulled back. We read some of the analyst's notes whether it was driven by some unexpected move out. That was not the case. Essentially we sat together as a team, looked at the deals in the pipeline that Peter mentioned, and then thought about the probability of those deals getting executed within the next two months, and the probability of some of them getting pushed over into early 2025. And so we just tightened that, and that's what caused the reduction. I think the important thing to look here is we ended same-store lease occupancy at 84.7. To get to the revised midpoint, that implies 190 basis points of absorption in the fourth quarter. So when you look at the pipeline that Peter dimensioned and said, we have 230,000 square feet of leases out, most of which is on vacant space, that's what gives us the comfort to say, we think we're gonna have a really good fourth quarter. And to get to the volume, we need 220,000 square feet to get to the midpoint. So off the 220,000 square feet, most of that is on vacant space, and that's what's driving the 190 basis point uptake in occupancy as we close out the year.

Okay, great, that's really helpful. And then, I think we've gone through the upcoming expirations a lot on this call in past quarters, but I wanted to take a step back and ask, when you think you might see a trough in occupancy just based on the headwinds that you have, and kind of knowing any of the progress you might have made on working with the tenants to renew or backfill some of these spaces, I guess, is there any level of occupancy or timeframe that you'd be comfortable talking about now as a potential floor that we can kind of look forward

to? Well, that's a good question, Blaine. And I think you have to look at both markets a little differently. I think New York is much more vibrant, and you will see that our assets in New York will increase occupancy. You will hopefully see some of that very soon. Wilbert talked about it a little bit. San Francisco, the occupancy might go lower for the portfolio because the market is just significantly behind, I would say, a year. As we said in past earnings calls. But we are optimistic in general because there is a lot of momentum. People are coming back to the office. I mean, even the Wall Street Journal came up with an article that was positive about office yesterday. So we see it here in New York and San Francisco will follow.

Great, thanks, Albert.

Thank you. You're welcome. Our next question is from Steve Sagla from Evercore ISI. Please go ahead.

Yes, great, good morning. Albert, I just wanted to touch on your comment about transaction market, the company sort of looking for deals. I mean, how are you sort of thinking about your own current valuation and the ability to deploy capital? I guess, what kind of returns would it take for you to kind of pull the trigger? I know in the past you've looked at share buybacks as an option to deploy capital. So how do you sort of think about new acquisitions, higher leverage, buybacks, and has anything changed in your calculus as you look forward?

Yeah, with buybacks, we always said we wanna do it leverage neutral and that is still the policy. And with regard to the other question, we will, and our position hasn't changed. If we do an acquisition and we have, as I mentioned over other calls in previous calls, we have relationships that want to invest, believe it or not, and they are cautiously looking at that office investment. Our PGRE equity commitment would be very, very limited. And you would have to look at a combination of the fee income and the returns on our equity. And as we had, I think, shown you in the past, it should be a very good double digit return for Paramount. We have a terrific team, a terrific platform, and that's what's appreciated by some of the investors. But I can tell you that there will not be a lot of PGRE equity capital invested.

Okay, thanks for that color. And maybe one for Peter, just trying to think through all of the AI demand that has surfaced in San Francisco. How are you thinking about that activity, and I guess more importantly, like what are the tenants looking for, either what part of the city, what type of building, what type of space, does the Paramount portfolio in any way, shape or form play a role in what they're looking for, or is it, they want to be in different parts of the city and different types of buildings that don't necessarily mesh up with the types of assets you own today?

Yeah, Steve, that's a really good question and something that we're assessing real time. I do think AI demand continues to develop and will contribute north of million square feet towards leasing velocity in 2024. And interestingly, in terms of number of leases, 70% of those AI leases are new to market. So yes, they are the recipients of huge venture capital funding. They acknowledge the importance of the office and they're starting to transact. What we've seen a lot from these AI companies is that in many cases, they're pursuing some of these smaller sublet opportunities. That's why we've seen sublease availability stabilized in San Francisco, which we think is a good start. And more generally speaking, we believe that the North and South Financial District, as reflected in the figures, will be the first sub markets to return San Francisco to healthier leasing fundamentals. So we are in conversations with AI based companies. I don't know that you can say that there has been a trend that's heavily pronounced in terms of what their preferences are entirely, but we're in front of all of them. Many of them are names that are new to us. And we do think that some of our product mix in our buildings will appeal to these AI based companies that in many cases are looking for built space and they're looking to move quickly. So it's a very positive development for San Francisco. We continue to be heavily focused on it as these requirements come about very quickly. And we're expecting north of a million square feet of velocity attributable to AI based companies in this calendar year.

Great, that's it for me, thanks.

Thank you, Steve. As a reminder, if you would like to ask a question, it is star one. Our next question here is from Dylan Brzezinski from Green Street, please go ahead.

Hey guys, I guess just sort of continuing on that AI theme. As you guys are looking at sort of the credit of these AI tenants, how are you guys doing about that? I know obviously there's still a lot of uncertainty over whether or not this AI environment is sort of a bubble and in which companies are gonna survive on a long-term basis. So just sort of curious as you guys are sort of looking at these companies, a lot of them being new to you as you had alluded to Peter, just sort of how you guys have viewed it from a credit perspective.

Yeah, I would start by saying that the credit review process that we undertake with respect to any tenant is something that we take very seriously. So it's not limited to just AI, but yes, there is more risk with some of these newer companies and the way we evaluate that is by certainly limiting to the extent we can a capital outlay and then securing it with a letter of credit. That is how we do it in every instance, irrespective of the company. So I think that's a very important part of industry.

That's helpful and then I think you guys mentioned, appetite amongst your JV partners to look to invest capital in office today. Obviously still taking a more cautious approach than other property types probably. And I think on the Q1 call, you guys kind of alluded to your JV partners looking to achieve, call it a seven to 10% unlevered IRR. Expectations changed and are you sort of seeing an IRR premium required for those looking to put capital to work in San Francisco versus in New York?

I think both markets are very different from the investor point of view. And in San Francisco, there are very few transactions with regard to institutional assets. What has been bought is normally 100% cash. It's very difficult to get debt financing for those kinds of acquisitions. They haven't been trades that are of any significance. So the return requirement there is more in the double digits for San Francisco and New York, I would say has also increased a little bit, but it really depends on the asset. It depends on whether it's core or opportunistic or whether you have to really do, take leasing and market risk. We look at each asset totally different. And it depends on the appetite of the investor. We see core investors, but more investors that are interested in opportunistic.

Great,

thanks, period of time.

Thank you. This concludes the question and answer session. I'd like to, I'm sorry, I'd like to turn for about to Abba Bell for any closing comments.

Thank you all for joining us today. We look forward to giving you an update on our continued progress when we report the fourth quarter results of 2024. Goodbye.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you again for your participation.