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 McElhinney, Vice President of Investor Relations for Douglas Emmett. Please go ahead.
Thank you. Joining us today on the call are Jordan Kaplan, our President and CEO, Kevin Crummy, 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 also 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. I will now turn the call over to Jordan.
Good morning, everyone. Thank you for joining us. 2019 is off to a great start. Compared to first quarter of 2018, we grew our FFO by 7.4%. We increased our AFFO by 20% as we continue to replace non-cash with cash revenue and benefit from lower leasing costs. Driven by strong revenue growth, our same property cash NOI grew by 7.6%. Last quarter, I announced our plan to add approximately 500 new workforce apartments in downtown Honolulu by converting Bishop Place, a 25-story, 490,000 sq ft office tower. We expect to start construction this summer. Sustainability remains a major focus of our operating team. Since 2009, we reduced our energy consumption by 21% per sq ft across our entire portfolio. For new acquisitions, it is not uncommon for us to reduce energy consumption by 25% during the first two years.
Finally, I want to welcome Peter Seymour to his first earnings call. Peter is now our CFO, and Mona Gisler is continuing as our Chief Accounting Officer. With that, I'll turn the call over to Kevin.
Thanks, Jordan. Good morning, everyone. In Brentwood, the construction of our 376-unit high-rise apartment tower remains on budget and on schedule for a late 2021 completion. We are wrapping up our first group of office repositioning projects and are already seeing positive impact to rental rates. We plan to continue pursuing repositioning opportunities that we believe will provide a high return on our invested capital. For example, while repositioning a 650,000 sq ft Warner Center office property, we are converting a vacant gym into a 45,000 sq ft creative office building with 15-foot ceilings and spacious balconies. In March, we renewed our $400 million non-recourse revolving credit facility secured by six properties. In addition to extending the maturity date, we lowered the interest rate and reduced the unused facility fees. The extended credit line bears interest at LIBOR plus 1 15 and matures in August of 2023.
With our AFFO payout ratio under 61%, our cash flow remains healthy and our balance sheet is strong. Although the volume of trades in our markets has declined from the frenetic pace of recent years, we are seeing some good opportunities and expect to see more going forward. With that, I will now turn the call over to Stuart.
Thanks, Kevin. Good morning, everyone. In Q1, we signed 196 office leases covering 772,000 sq ft, including 280,000 sq ft of new leases. Leasing spreads for the quarter were 20.5% for straight-line rent rollout and 9.1% for cash rollout. These results reflect a high concentration of leases in the valley. The lease rate for our total office portfolio increased slightly to 91.8%, and occupancy remained 90.3%. For the first time in years, Honolulu is seeing increased tenant demand. This, combined with the relocation of tenants from Bishop Place to our other office buildings, has increased our Honolulu lease rate to 94.8%. On the multifamily side, our portfolio remained fully leased at quarter end. Our recently completed units at Moanalua continue to lease up at a good pace with rents well above our pro forma. I'll now turn the call over to Peter to discuss our results.
Thanks, Stuart. Good morning, everyone. We are pleased with our Q1 results. Compared to a year ago, in the first quarter of 2019, we increased revenues by 5.6%. We increased FFO 7.4% to $103.1 million, or $0.52 per share. We increased AFFO 19.9% to $85.1 million, and we increased our same property cash NOI by 7.6%. As you know, we now include certain internal leasing expenses in our G&A. Even with this change, our G&A is only 4.4% of revenues and remains well below that of our benchmark group. Turning to guidance. Based on the strength of our core operations and continued rent increases, we have increased our assumption for growth in same-property cash NOI to between 5.5% and 6.5%. As a result of this and other factors, we are raising our FFO guidance for 2019 by $0.02 to between $2.09 and $2.15 per share.
As usual, our guidance does not assume the impact of future acquisitions, dispositions, or financings. For more information on the assumptions underlying our guidance, please refer to the schedule in the earnings package. I will now turn the call over to the operator so we can take your questions.
We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you are 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. Thank you. At this time, we will pause momentarily to assemble our roster. The first question comes from Jason Green with Evercore. Please go ahead.
Good afternoon. Just a question on the rent spreads coming in at 9%, which is still strong, but does represent a deceleration quarter-over-quarter. Is there anything going on from a market rent growth perspective, or is that just a different mix of space?
Hey, Jason. Yeah, we had just a higher concentration of leases in the Valley this quarter. Still seeing really good roll-up, and that can be a choppy metric quarter to quarter, but still very happy with the roll we're seeing.
Got it. Just taking a look at your markets, Warner Center is still clearly the laggard in terms of % leased. Can you maybe go a little deeper into what the activity level is out there and what the long-term strategy is?
Yeah, we've made great progress there. We're up 300 basis points in lease % from a year ago, so we're generally pleased with the progress and still seeing good activity.
Got it. Thank you.
The next question comes from Craig Mailman with KeyBanc Capital Markets. Please go ahead.
Hey, guys. Just a follow-up on the rent spread. Just looking kind of next two-quarter lease expiration, you guys have a decent amount in kind of the Valley and Honolulu. Should we expect a little bit of that moderation to continue relative to kind of the 10+% you guys have had the previous few quarters?
We don't provide guidance on lease roll-ups just because it's so hard to predict quarter to quarter. Overall, the trends we're seeing are really good. It can be choppy depending on what gets signed in any individual quarter.
We said that those two markets that you just named don't have the steep roll-up as you do on the Westside, though. You're correct to presume that.
Yep. You said demand in Honolulu's picked up. Have you seen market rents move at all, or is it too early?
Yes, we've seen market rents move.
Just one other one. You guys have a few years until Time Warner and Burbank rolls again. Just with their big investment out there, what do you think happens to that space, and does that at all change your view of kind of holding that lone asset out there?
Hey, Craig, it's Kevin. First of all, we're super excited about their increased commitment to the market. It's not only Warner Bros. Disney's actually been absorbing some space out there, so it's tight as a drum. Our lease runs until 2024, so it's really tough to roll it forward five years and say what's going to happen. There's no indication that space is coming out of our building. As I said, that market is really tight. That's as much as we know.
Thank you.
The next question comes from Brendan Finn with Wells Fargo. Please go ahead.
Hey, guys. Good morning, everyone. In the presentation, you guys indicated that you'll spend about $70 million on office repositioning projects in 2019. I guess, can you guys talk about the level of returns you're seeing on that investment? Then, I guess maybe any initial expectations on how much you plan to spend on these types of projects next year?
Okay. We gave the spend on 2018. Have we given the spend on 2019?
Yeah, we said about $70 million.
We did?
Literally, we don't have a number for 2020, which is what you're asking. The returns on this year that we're in, I think, are going to be very similar to the expected returns on the other stuff. We're probably going to add four projects this year as we finish the other projects that we're doing, and they are all equivalently very high payback projects. All these numbers are so high that it's useless to try and say 20 IRR or 23 IRR, whatever, but they're high numbers.
Got you. Okay, thanks. That's helpful. Just on guidance, can you guys just comment on the drivers behind the 50-basis-point increase in cash same store? Is that driven more by office or multi-family, or is it a combination of the two? I guess since you guys didn't increase office occupancy guidance, is it more of a benefit on the expense side?
Yeah. This is Peter. You can see in the results that the big growth this quarter was in office. That's really driving the number. I think it's a combination of rent growth and expense control, and that's the main driver there.
Okay. Thanks guys.
The next question comes from Emmanuel Korchman with Citi. Please go ahead.
Hey, everyone. Just sticking to the repositioning for a second, do you anticipate any revenue loss from any of that? Do you have to move tenants around or get anyone out, or is it just focused on either more vacant buildings or more vacant space and sort of just upside?
When I think through what we're doing in the various locations, I'm not expecting substantial occupancy changes being driven by them. Until we really get in the work, we'll see whether some tenants can always be unhappy about stuff we do in a building even when we're improving it. I know that some of the work we're doing is in Hawaii to be fully prepared and accommodate tenants moving out of our other building. Of course, one of them is in the Valley, which you saw, which I think Stuart talked about in his section. We have two here on the West Side, and all of them are good candidates for very high returns without us taking much in the way of hits as a result of the work.
Thanks. On the acquisitions that you mentioned might pick up again, just if we were to think about structure, would they be similar to the JVs that you put in place the last few years?
I mean, Emmanuel, that's really dependent on the size of the property, because, keep in mind that a lot of our buildings in our markets don't require hundreds of millions of dollars of equity. For the smaller stuff that might come on balance sheet, maybe it drops into an existing venture. We kind of have to look at it opportunity by opportunity.
Thanks, guys.
The next question comes from James Feldman with Bank of America Merrill Lynch. Please go ahead.
Great, can you talk more about the pickup in demand in Honolulu, what's driving it? With the REIT legislation on the docket there, would that change at all your appetite to do your redevelopment plan or invest there?
The pickup downtown, I think is a result of two things. One is, large tenants moving into the area. A big university took 100,000 feet. Of course, you know that with 1132, we're moving tenants out of there, and that's just changing the whole kind of supply-demand equation in that area. We're working to accommodate that situation appropriately and with work we're doing there, not just to 1132, but to four other office buildings there. In terms of the REIT legislation, that still hasn't passed. It's still out there. We're not going to comment on that until we see where it goes.
Okay. You're saying on the demand side, there's actually a pickup in job growth and in demand downtown?
What I'm saying is that some large tenants, some that have settled and signed and others that we know are looking to work their way into the downtown area, are all creating additional demand on the demand side beyond the fact that you know we're moving tenants out of 1132, which is creating demand in the other buildings. Of course, 1132 coming out of the downtown as a viable candidate for multi-office and moving to multi-resi is reducing the supply on the office front.
Okay. Thank you. If you can provide an update maybe on the Century City blocks that you guys have available. It looks like you had a vacancy dip in Westwood and Brentwood, just if there's anything sizable there, or that was just more kind of ins and outs of the portfolio.
Yeah. Just, I think, normal ins and outs. We had several tenants, kind of our typical size, move out across a couple buildings in Brentwood, but we're seeing good activity there. We had a two-floor tenant move out of a building in Westwood. That's a good opportunity for us to break up some space there in a building that's going through a pretty major repositioning, and we're really excited about. It'll be done in the fall.
The Century City spaces?
Yeah. Century City, I think we're making good progress. I know there was focus on Century City and Santa Monica a couple of quarters ago, but those are two of our strongest sub-markets, and we're getting good activity on both of those.
Okay. All right. Great. Thank you.
The next question comes from John Kim with BMO Capital Markets. Please go ahead.
Thank you. Just to follow up on the office repositionings. It looks like a lot of these investments are mostly cosmetic changes, except for maybe adding some retail. Is that the case this time around, or are there investments to improve the energy efficiency, for instance, of some of your buildings?
We've been investing a lot of money in energy efficiency, we don't count that among this group of repositionings, because that's going on separately in many more buildings than just the ones that we mention to you that we say we're repositioning. I'm glad you asked because we put it in my section to mention what was going on there because we've made such great strides, which have ended up being particularly important because, as you know, rates are going up. We're rapidly working to lower our utilization. Of course, we're fighting against increasing rates, and that's creating a lot of noise in what otherwise would be tremendous gains when you look at the amount we're reducing our energy consumption.
It's been super helpful, the fact that we have all those programs when we buy a building, because it's one of our best pickups in terms of the cost of running the building compared to what's going on in the pro forma the seller provides us in terms of their energy costs.
Jordan, could you place a figure on the kind of returns you get on those kind of investments?
Well, I think most of them fall within three years in terms of payback. I think some of them even can almost look like two-year, when you look at the benefits that we get, in terms of credits back from the utilities and stuff like that. Obviously, they're very high return, and the return keeps moving up, unfortunately, as they keep increasing the rate at which they charge us.
On the additional opportunities that you're looking at, could you break that down between office and multifamily?
Yeah. Well, I can break it down to the extent to say we're looking at both. There's office and multifamily, and in Westside and the Valley.
I know on the last call you mentioned that you were, or it seemed like you were more bullish on multifamily than office, and I'm wondering if you're just pursuing more opportunities weighted towards multifamily or mixed use.
Well, we were always willing to pursue opportunities related to multifamily, but you have to have a good institutional deal come up, and then, it's not a secret that multifamily is a very valuable product, so when it does come up, they trade at very low cap rates. When you find a deal that you can buy that works, that's super good, and we turn none of those down. Now, at the same time, it's just a fact, more office deals come up, and that's why you see our ratio always leans to office. Not that we're not willing to buy an equal amount or more multifamily if it's available and priced in a way that we like.
Thank you.
The next question comes from John Guinee with Stifel. Please go ahead.
Great. A couple clean-up questions. First, is your Honolulu apartment expansion 100% stabilized and operating? That's one question. Then second, I have this recollection that you own 200,000 or 300,000 sq ft of retail in Sherman Oaks. If that's correct, what's the status of that asset?
The residential that we just completed, I think it's around two-thirds leased. As we've said in the past, we expect it to be fully leased before year-end. I think it'll easily be fully leased before year-end. That project has been really just tremendously successful for us. In terms of Sherman Oaks retail, without giving guidance on a particular building, I don't know that the retail we have is particularly well-fit to the office. We have a high density of office all around that corner. I know you're thinking of the Sherman Oaks Galleria, and I don't know of any particular issues around the retail that we have there that serves that office community.
Okay. Just to clarify, if I'm looking at your corporate data on page three, it has 10 multifamily unit properties, 3,600 units, 99.6 leased. That doesn't include the lease-up of the property in Honolulu.
That's right. I think if you look at the guidance section, it actually says that it doesn't include properties that are in lease-up.
Got you. Okay.
Brand new lease-up. Yeah.
last question, we talk about this all the time, but Proposition 13 on the 2020 ballot split between commercial and residential. What's your current thinking on that?
My current thinking continues to be that I think it is extremely unlikely. Proposition 13's very popular. What they're trying to do is actually more complicated than the simple thing that you just said. On top of all of that, my prediction is supported by the fact that it's not polling very well.
Great. Thank you.
Thanks.
The next question comes from Alexander Goldfarb with Sandler O'Neill. Please go ahead.
Hey, good morning out there. Just two questions from me. The first is, a few years ago, you guys had done some proactive leasing where you got tenants to cancel out and take back the space early to relet. Just given what's going on, are you aiming to do that as you undertake the office renovations that you're talking about, as you go through the portfolio trying to utilize space? Are you trying to seek to also get at some of the office space early from tenants?
In general, in terms of the market economics, absolutely. Now, in terms of the sophistication of tenants and the amount of opportunities that exist in that space, as people have seen rents rise all through the Westside, the opportunities just aren't as plentiful as they were a couple of years ago, when we were more successful in knocking more of those off.
Okay. The separate question is, Jordan, you guys obviously have been trying at the Brentwood Apartments for many years, so that wasn't a surprise. The Hawaii building rehab into residential, again, that theme had been out in Hawaii for a few years as far as the need for multifamily. You guys recently are stepping up your office game as far as improving your buildings and what have you, making them more productive. Is that just a function of now the economics work, that these were always plans that you guys had in mind, but now the economics in the market make sense to actually do it? Or are you finding that you're potentially losing tenants to other buildings because they don't have whatever the amenities that you are putting in, or some of the stuff?
I'm trying to understand how much of this was always on the drawing board and now you're implementing because the economics make sense, versus the environment's a lot more competitive and therefore, this is just what you have to do to stay at the A status that you guys are.
Okay. That's a great question, and I like being asked it. I'm going to take two seconds to really answer it. If you think about, generally, how we talk about the company, we always historically have talked first about the operating platform. In fact, of all the 30 years, the way the company has operated, for the most part, is the operating platform protects us in a recession. If you see when you go into a recession, rents flatten out across all markets. All tenants come at you from a price perspective. Our operating platform is so sophisticated in a recession, and if you look at our numbers, you'll see we dramatically outperform everybody else, and we keep our buildings filled that way and keep our revenue strong that way.
When you're in a strong market and a tight market, there becomes a lot of rent differentiation across markets and across buildings. In that situation, in order to push our revenue and our income, it does pay then to redo buildings, and then the capital that you're putting in is paid back at very high multiples because there's rent differentiation, and you can see that there'll be a difference in rent that you'll get from that capital that you spent. If we were to spend that kind of capital in a recession, we would only be buying occupancy. We wouldn't be buying return. Because the operating platform protects in a recession, doesn't cause us to have to lay out that kind of capital, the time to do it is when you see rent differentiation, when you can get paid for the capital.
That's why you see us undertaking so many of those projects now, because we start out studying the market and saying, "If we lay out this capital, will we change rental rates and income?" When that answer becomes yes, then we get into that program. You know all through these markets, they're very tight and good, and there is rent differentiation. That's why we know we're getting paid for laying out the capital.
Okay. Thank you.
Sorry, that was long. That was long, that's why that works that way.
It's been a quick call, thank you for the time.
Okay.
The next question comes from David Rodgers with Baird. Please go ahead.
Yeah, Jordan, I don't know if this dovetails into maybe the last question. Obviously in the most recent cycle, we've seen a lot of larger office transactions, leasing transactions. If you guys are able to aggregate more space together of the $1.6 million or so, I think that you've got available in office together. I don't know if that's possible, is there more demand for larger space in your markets, or are you finding it harder to find the smaller tenants as interested?
There's a lot of demand coming from large tenants. There's a lot of demand coming from small tenants. We lean the exact opposite direction. We lean towards trying to break space up, not going after large tenants, because, just speaking frankly, I think the returns we get from smaller tenants are higher than the returns you get from all the turnover costs and the cost of getting large tenants in the space. We would prefer always when we have a large space to take our medicine, break it up, and lease it to small tenants, because then going forward, that never represents, again, a large risk space. We lean more towards the breaking up than to aggregating and creating large blocks of space.
I will say there's super high demand on both areas, and it's obviously more rare when it's coming in the large tenant side, but there is a lot of demand on the large tenant side.
Great. Maybe just a follow-up to the Honolulu office conversion to resi. Do you have a good sense of the existing tenants and who's going to stay in your portfolio, who won't, and kind of how that's going to play out and any impact that that might have to your portfolio and financial metrics in the next year or two? Is there better clarity now?
Well, we're not giving guidance going forward. We have said already that we've cleared four floors. We expect to deliver 100 units next year. Obviously, we want to accommodate and work with our tenants and get them properly placed in their next space. We won't know those answers until as time progresses, we go through with each tenant what they want to do and where they want to go. In the end, the whole building's going to be residential.
Right. Okay, thanks.
Again, if you have a question, please press star then one. The next question comes from Mitch Germain with JMP Securities. Please go ahead.
Yes. What's the timeline on the creative office development that you guys are contemplating?
You mean the conversion of the gym that we're doing out in-
Yeah. Sorry about that. Exactly.
Yeah. It's a project that's going to start this year, and I suspect it'll be completed before the end of next year.
No real hold up with approvals or anything like that?
There's always hold up with approvals, but I think that's a reasonable timeline, the one I just gave you.
Thanks. Then on the multifamily rents, obviously the pace of rent growth slowing a bit. I know that the market itself, is there anything to read into there or?
No. I think we all got used to very high rent growth for a while. I don't think the fives and sixes and even sometimes higher, we should get used to. I don't necessarily think two or three is. I've always thought that number should be in the fours, and that's where it stabilizes.
Thank you.
This concludes our question and answer session. I would like to turn the conference back over to Jordan Kaplan for any closing remarks.
Thank you, everybody, for joining us, and we look forward to speaking with you again next quarter.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.