Property CEO conference. I'm Michael Griffin with Citi Research, and we're pleased to have with us Douglas Emmett and CEO Jordan Kaplan. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. For those in the room or the webcast, you can sign on to LiveQA.com and enter code Citi 2023 to submit any questions if you do not want to raise your hand. Jordan, I'll turn it over to you to introduce Douglas Emmett and members of management here with you today, provide any opening remarks, and then we'll get into Q and A.
Okay. Thank you, Michael. To my, I'm Jordan Kaplan, I'm the CEO. To my right is Peter Seymour, he's our CFO. To my left is Stuart McElhinney, and he's our vice president in charge of investor relations. I think most of you know this, but we're an office and residential company focused in Los Angeles and Honolulu. I don't know, maybe that's all that everybody needs to hear, and I'll let you go over to doing your questions.
Thank you, Jordan. We appreciate that. We're starting off each of these sessions with the same question. What are the top three reasons investors should buy Douglas Emmett stock today?
Well, okay. I'll tell you number one, just in general, if you think where is the most beaten up sector in our industry, in the REIT industry, you gotta say office, right? Therefore, where should you be looking? Office. Let's start out with that. I think everybody should be looking at office. I don't see the crowded room here, so obviously people are distracted by residential or industrial, but office is where they should be looking. Secondly, I think that when you think about the reasons why obviously people are looking elsewhere, it's because they're worried about whether it be oversupply or people not coming back to work and utilization or the amenities or safety or something revolving around these downtown markets that have a high density of office buildings.
Maybe just they think commuting patterns are changing and people aren't gonna be willing to commute anymore. They don't like the, they don't like the long train ride, they don't feel like the train ride's safe, et cetera.
Thank you for that.
I'm not done. Hold on. For starters, I don't even believe all those issues are gonna stop people from coming into the office eventually. I think the office buildings are gonna be filled again. tell all my colleagues, we're almost done. I wanna point out that the office markets we're in, and also large tenants are struggling more to bring people back. The office markets we're in do not have any of those ills. Okay? first of all, we're smaller tenants. Our utilization's been high. It was high during the pandemic. It's very high right now, almost essentially back at 100%. The commuting, we don't have. We just don't have transit. I mean, we don't have it. Everybody drives in, parks in their space, goes up, goes up there.
Our amenity base is robust and full all around our office buildings, whether it be not just the housing, but I'm talking about the restaurants and the walking around and all the rest of it. It's all there. It's all fine. I, you know, I mean, everywhere has safety concerns. We have the most minor of safety concerns compared to all the other markets that are large gateway markets. I'm not talking about downtown L.A., we're just in West L.A. and in, out in San Fernando Valley. Why Douglas Emmett? 'Cause I think we've performed in accordance with what I just said. If you look at our leasing, we came out of the pandemic in the fourth quarter of 2021, did 1 million ft of leasing. We did basically 1 million ft of leasing for four quarters.
Lot of leasing for a company our size. fourth quarter of 2022, we warned you that people were talking about the recession and things were slowing down. We at that time did 770,000 ft. Still a lot. I mean, a lot of leasing, 200 deals, right? I think that, you know, what I said has been proven out by the activity and the leasing in our markets. Now look, recessions are bad for real estate companies, and we're gonna suffer from the impacts of the recession, which is tenants becoming more conservative about doing deals. Of course, interest rates are up, so that's impacting us on our floating rate debt. We don't think, well, I don't think anybody's gonna have long-term effects from what I discussed earlier, but I don't even think we're having short-term effects.
We just need to get through the recession. That's the reason why I think Douglas Emmett's a good investment.
Appreciate it, Jordan. Maybe expanding on that, just with the headwinds facing the office sector currently, you know, why is Douglas Emmett differentiated from the competition just in terms of portfolio composition, tenant makeup, you know, other growth opportunities? You talked about the specificity of your market, so maybe expand on that a little bit.
Well, in terms of portfolio composition, I mean, as I just talked about our markets, we also have the nicest buildings in those markets. More even important than that, unlike some of our competitors, so if you're... These are great companies, SL Green, Boston Properties, whatever. They're very sophisticated operating platforms, but they operate in markets where other owners have very sophisticated operating platforms. We do not. We have a very sophisticated operating platform in a market where we don't have a second place, right? There's nobody else that I mean, we have a lot more brokers working directly for us, going direct to tenants than most of the brokerage offices for CB and the other guys. We're running a huge operation in-house ourself, in property management, in leasing, and all those other things.
That operating platform has historically, and this is mine and Ken's fourth recession. I've been doing it for 36 years. That operating platform has historically carried us through all the other recessions and given us the ability to do what you see happening now, have a lot of excess cash flow and to grow during the recession. What are our I mean, our growth opportunities are exactly the same set as everybody else that everyone here is meeting with, right? You can pay down debt, you can do development, you can buy buildings, or you can buy back your own stock. That's the entire list for capital in our business, right? We can talk about debt. Maybe you have a debt question later. Debt's not an issue for us.
We're in great shape on the debt front other than the floating rate debt that's costing us more at the moment. We have some development stuff that's going, but we just funded out of cash flow, and we have plenty of cash flow. That gets you down to our the same opportunities that everybody else has, which is buying buildings and buying back our stock. We think both of those are, you know, developing as good opportunities, and we're certainly focused on them.
Just on the smaller tenant base, relatively lower CapEx or TI needs, do you think this makes for a better strategy as we try to navigate the office landscape in a post-COVID world?
I think the smaller tenants. Okay. I'm gonna just keep repeating this. Long term, I think the post-COVID world goes to the pre-COVID world. I mean, just to be clear about that. Yes, all through this COVID and what's going on right now, small tenants have been fantastic. We went into the recession with people saying, you know, short Douglas Emmett because their credit is gonna be worse. In fact, I said to everybody, our default's gonna be less than 2%. People guarantee the leases. Our default really is less than 1%. I mean, it's basis points across all those years, right? We collecting our money. That issue's gone away. Small tenants kept coming into the office. Small tenants kept doing deals. Small tenants haven't had problems with the utilization issue.
They told everyone to come in, they're all in, right? I actually think going through this period of time, they've been very good. The reason long term, I like forget about the COVID thing. I like small tenants more is the cost of transitioning tenants in space, the cost of leasing is just substantially less. If you look at a office company and you're honest with yourself about the expenses of the company, the largest expense of the company is leasing costs, right? It's commissions and TIs and the downtime associated with moving people. As opposed to, if you were to compare it to an apartment deal, which they, what, $300 a unit or something, paying carpet, and it's a few days in a good market. The company is focused a lot on that number, that expense number, and reducing it as much as we can.
We have. We're half of our peers. We're not half of our peers 'cause we're smarter. We're not half of our peers 'cause we're better. We're half of our peers 'cause small tenants don't take a lot to turn them. 50% of our deals are direct. I mean, just going to the tenant and leasing to them, right? That's a great. That allows us to have substantially more cash flow, and you guys see it in our numbers. You see how much cash flow we have, even after our dividend all the, you know, all the time. That's why I like small tenants more.
You know, we're big and they're small, and therefore, you're able to sort of standardize the lease form and have a more fair set of economics that are not so tricky in the form.
Maybe just on leasing expectations, you know, are there anything tenants are looking for or asking for today that they might not have been, you know, six-12 months ago? Have you seen a noted uptick in tenant interest from any particular industry? I think y'all's bread and butter tenant is called that four to five person wealth management kind of office that drives in from Beverly Hills. Any updated thoughts there?
I think the mix of our tenant base has stayed relatively the same throughout this whole thing. Now I really can't say I've seen much of a difference. I did point out in the fourth quarter last year that the decline seemed to be mostly driven by larger tenants, which large for us is 20,000 ft-40,000 ft. The small guys are still going, and that's why we did 770,000 ft instead of 1 million.
Just you touched on your commentary, particularly around the office occupancy, just more on the conservative side. You talked about your worries around a recession, you're not baking in much of anything for occupancy growth expectations in 2023. Do you think anything could happen where we could see occupancies surprise to the upside?
Of course. I hope for that. Yeah. I mean, look, we're making the same predictions that the predictions that are relevant and matter is using the same information that you guys have access to about whether we're going into a recession, whether tenants are going to slow down, how long is the U.S. economy going to be risk off, which is what causes tenants to slow down in their decisions. Then around interest, our predictions around interest is just we're using the same curve you guys can look up for our variable rate debt, and we're going, "Yeah, that's that curve is what we put into our guidance.
That's why we got rid of the 10-year treasury yield question for the rapid fire. We had an interesting question come in from LiveQA, thank you for whoever put this in. The Water Garden asset in Santa Monica is now expected to sell at a lower per square footage valuation, I think, relative to where it was initially brought to market. I know this probably wouldn't particularly be in y'all's wheelhouse, any implications for, you know, your property's asset values and the transaction market in general?
Well, all transactions that close are implications for value for other buildings in the market. I mean, we're not, we're not a large tenant company. That's a large tenant building. Yeah, I'm sure they're. Yes, it has implications. I don't know if the deal will happen or not, but it has implications. Yeah.
Just expanding on this again, I know it's not in y'all's wheelhouse, the distress we've seen in office, particularly in downtown L.A. Could your portfolio be a beneficiary of this kind of distress in terms of tenants maybe looking at opportunities more on the Westside?
You know, the primary beneficiary of tenants leaving the downtown market for you know, for, you know, quality of life reasons, I guess, basically, has been Century City, and they're extremely well-leased. I mean, they've gotten a lot of big tenants out of downtown that have kinda come to the conclusion, even when there's a lot of time left on their lease, they've concluded, "I can't bring my people back unless I move to the Westside." They just abandon their lease and move to the Westside, and then they bring everyone back in the office. If you're kind of a natural kinda hunter downtown, you're gonna have a comfort zone at Century City if you wanna be at the Westside. We think some of those tenants could spill to Beverly Hills and to Westwood.
Beverly Hills because there are people that are living there that were driving to downtown, saying, "I might decide, forget it, I'm gonna shorten my commute to zero." Then Westwood because it does have those larger, more institutional buildings, and it's along the high-highway there. We haven't seen anything close to what they're seeing in Century City.
Maybe just on Century City, I know there was that big lease with Creative Arts, I think, signed recently for the one building yet to be built there. I know that's, again, not y'all's sort of general tenant that would look in your portfolio, but what does that say about the health of that sub-market?
Century City is very healthy. I think it's very healthy because of what's happening downtown. There's tenants that, I mean, like I just said, they're leaving. Law firms are walking around, away from five years left on their lease and saying, "If I wanna bring my associates and everyone back in, I gotta move." You know, historically, people be downtown. One of the reasons they were located, I mean, obviously for government and for being by the courts, but one of the other reasons is some senior peoples live in Pasadena, San Marino, et cetera. Now, that, even that has shifted to the Westside, and they're just moving the crew west.
Maybe just on external growth opportunities, we had a question come in. Just given where your cost of capital is already and, you know, you have significant sub-market share in the sub-markets we talked about, you know, how would adding new assets make a appreciable difference? You know, why would external growth, be it, you know, acquisitions or development opportunities, make sense today?
Well, they make great sense because the strength of the company has come from the fact that we have such dominant market share, and we're able to make all of our platform more efficient every time we gain share. We add buildings in these markets at substantively 25% less than the cost for someone else to buy a single building in that market. As we do that, it's been very, you know, good for us to control the market, and we can spend more on marketing that market, and we have more options to show tenants.
You know, if you believe in the markets and you believe in the long-term viability of the markets, which obviously we do in the markets we're in, then owning a more dominant share, especially with the synergies we get out of doing that, is super beneficial, and it builds the long-term strength of the company.
Just expanding on capital allocation priorities now. I mean, what might make the most sense at this juncture? You recently talked about, right, you right-sized your dividend, authorized the share buyback program. I mean, how should we think about that in the sense of what you're looking to target in 2023?
Well, I mean, we could buy back shares, and we could buy buildings, and we gotta look at those various options as they're presented to us and where the best place is for us to put our capital, and that's what we're doing.
I guess to expand on that, does one maybe look more attractive relative to the other now, or should we view it maybe in a greater context? Don't have to give me a specific number if you're gonna buyback.
They're, depending on what's offered in the buildings, and we watch the stock price, we watch all of that, and we will make decisions around all of that and all the other options we have for our capital. I mean, that's... You know, I've never even been in love with telling people that we bought a building until after we bought it, I don't have a lot more, like, announcements around that.
Just maybe getting back to the leasing and, you know, bigger expirations you might need to backfill. I think about one, kinda notable one being Warner Bros. Discovery, you know, in 2023 and 2024. I guess any updated thoughts on how this might transact in terms of backfilling or any other commentary there would be great.
That lease is, comes up at the end of 2024, and Discovery, Warner Discovery, whatever it is, and I mean, we don't know what they're going to do. I suspect that if you sat in their boardroom and were listening to their conversation, they don't know what they're gonna do. you know, it, right now the building's not, they're not, like, occupying it to any meaningful degree, you should make the assumption that they could be moving out. I don't know what's going to happen in the end. At the moment, that market is a large tenant market and therefore it's suffering from, like, the large tenant disease of bringing people back in and they're having trouble bringing people back in.
It's been one of the best markets in the whole, like, L.A. County for decades. Matter of fact, that building we bought in 1993, it's never had 1 ft of vacancy. Like 1 foot since 1993, right? It's a very good market. If they don't end up taking that space or take half of it or take zero of it, then we'll just re-lease it. It's a great market. It's a great building.
Maybe just touching on the regulatory environment for the bit. I think about the mansion tax upcoming in L.A. You know, how do you see this and the potential impact for demand for your business and product type? How important is it to work with key public stakeholders in order to give, you know, tenants confidence in returning to the office?
Is key public stakeholders another name for politicians?
We could call it that.
Yeah, we're spending a lot of time with politicians because I gotta tell you, I mean, I haven't been as vociferous as John, but I haven't been happy with what's going on. We've been spending a lot of time on it and been partnering with John and Victor and the people that have good positions in the in our markets. There is actually shifting happening. I mean, you know, it's, you know, Rick, he's not in the public markets. Guy named Rick Caruso. He ran for mayor, and that would've been great, okay. In fact, he made the conversation about cleaning up the streets, making them safer, getting homeless people off the streets to wherever they're needed properly end up. That then became the front-running discussion for Karen Bass.
It wasn't even, like, on a, you know, it was not. That is the conversation in the city right now about dealing with those issues and cleaning things up and making them safe again, which is what we needed to have happen. That has happened. Things have been going kind of in a much better direction. Not in love with the tax that you brought up. It's obviously being challenged in multiple ways. There's other legislation that's coming up that's going to even further challenge it. It might decertify it. You know, we're there is politics, which for the first 30 years of my career were like literally zero budget item has become a meaningful budget item. I mean, because they're having such a significant influence on the quality of life in our markets.
Are there worries about continued outmigration trends in California and how that could impact demand for your product, or just the fact that you've talked about your tenant base being, you know, the smaller kind of tenants that, you know, go to the office more, is there any worry around that kind of longer term trending to other markets away from California?
Look, I hate even saying this, but this isn't the first time for California. California is very good at kind of creative destruction, right? We built up. We had the oil industry. We had the aerospace industry. I mean, we had banking, and we sort of destroy them. We seem not to be that in favor of big companies that provide great middle class jobs. We are great at incubating. We're an incubator state. All new industries, we're great at it, and we'll give you tons of extra money and even let you waste it. When you get big enough to really employ middle income people, get out. We have been doing that for, you know, decades and decades and decades. You know, in my decades, I've seen it happen.
It's certainly we haven't been the easiest on large companies in the last 10 years. There's no doubt about it. Of course, we also are spending a lot of money in healthcare tech, and there's, like, people coming here for that. Yeah, I mean, it, I, I will say I'm much less worried about outmigration than I am about inmigration. We need more migrants, I'm not talking about, like, from Arizona. I'm talking about from out of the country. We need more migrants. We should be fully opening up, everybody that wants to come and work, bring them in. California really needs it. I mean, opening, we don't need to open the border to the north, but to the south, get more of those workers that are coming through and wanna come in and work.
That's creating a big problem for us. The other big problem that's being created for us is this ridiculousness over kids coming here, going to the universities, which we have great universities in California, and then after they lose their student visa, and they're, like, telling them to go home after we just educate them, which they would be the most productive people. It's an outmigration, I don't I'm not sure, even if you really look at the stats, there's some high profile people like Elon Musk that gave the finger and slammed the door. Really what we need is more inmigration. That's really where our issues are more surround. If you fix that, don't worry, the outmigration is not as much of an issue.
To quote the great show, Arrested Development, "I'd rather be dead in California than alive in Arizona." Seems like you're of that mind. maybe touching on multifamily for a little bit. You know, what is the growth opportunity set there? the portfolio is essentially fully leased. You know, are you seeing the ability to push rents, or is the expectation for relatively softer rent growth in 2023?
What do you mean? Softer during 2023 than 2022? Yeah. The 2022 is crazy. Of course, I mean, I assume it'll be softer. I don't know. It's still pretty strong. The opportunity for growth is we are still, I still think there could be some rent growth there, also we own... I mean, that's a part of the state. When I said Sac Go, like we're an incubator state, when we go in, like, a certain direction, we really go all in. There's many state laws that have been passed in Sacramento that override the city zoning. They really revolve around transit corridors and people that own land on, for transit corridors. When I say we're one of the largest, we're overwhelmingly one of the largest.
There's almost like a law passed for Douglas Emmett. If this rezoning thing really works, a lot of sites that I would have formerly said would take three, four, five, six years for me to get it rezoned to be able to build an apartment building, I go, by right, I can build one. We're waiting and watching that come out because we have so many sites. By the way, even without that, we have a lot of sites where you could potentially build. We just own a lot of land as an adjunct to a lot of the office buildings and full blocks that we own. We're following all that, and we're moving forward. The growth that you should expect out of that area of our company will come from development on land that we already own.
To that end, maybe on the acquisition front, are multifamily acquisitions maybe more attractive to office? Or if you see an office acquisition potentially come up, maybe that would make more sense. Any color around that would be helpful.
Office is way more attractive than multifamily. Like, you can't even touch it. Are you kidding? I mean, multifamily is still trading pretty tight. What, four cap? You know, it used to be trading more. Whereas office is like, gap down gargantuanly. If you believe in the market, of course, you're going to focus more on office.
Oh, we have a question down here. By the way, if you want to ask a question at the mic, you got to press the little button in front.
Got it. Got it. Thank you. Jordan, you've differentiated yourself from the other office companies, or at least in some ways, you're trying to make the case. If I ask other companies, you know, the traditional office companies, you know, if they could wave their wand, what would they change? I've gotten some interesting answers from them. How would you answer that question? If you could wave a wand and change one thing right now about the business or about the outlook or about finance, whatever is the most important characteristic, what is it that you would change right now?
Well, you mean separate from just having the recession end? I would love to see the economy settle and interest rates go... I think that's going to happen. I'd like to see it sooner than later on interest rates. I mean, we're generally in a leveraged industry, so, you know, all of us are being impacted by that eventually. Then I think the other thing for me would be I would like to move faster toward, like, the rule of law in all these coastal markets. I mean, wherever the country's gone on this craziness where you can steal $800 and all that, it's just destroying communities. I mean, it's just destroying them. I never knew that that would be something I'd even have to think that could even happen.
This thing, you know, even passing stuff, now you don't get a ticket for jaywalking, and now you know. I just think it's wrong. I think we have every way, hundreds of ways to win. All my peers do, too. We do, particularly in our markets and with what we're doing, as long as they just don't, you know, just cut loose and, like, hand it over to barbarians. I mean, they just need to, you know, like, start enforcing the law. We need to hire more police. That's why we're all spending so much money and time on this, like John is and Victor is, and I am, is like, supporting the police, bringing more police in the area, supporting hiring programs. We did a program where we went to the city of Santa Monica.
We said, "What do you need? We need more police." They said, "We want to restart our..." They had gotten their budget cut on the cadet program. It took me, like, one day. I called a bunch of owners around there. We all put in the money, we say, "Here's the money. Restart your cadet program." They develop into the police officers. All of that stuff is getting a ton of focus out of us. I mean, it's, I thought, like, you know, taxes are super bothersome, but that stuff's way more important. That's probably our biggest thing.
We're asking an ESG question in each of our roundtable discussions. Can you highlight important ESG initiatives that Douglas Emmett is undertaking?
I think I can't honestly say that we've, like, ESG never been a big thing, but energy has been a big thing for us. In the energy side, we've been reducing our energy use for decades and still are, and we're very focused on it. You know, I don't think on the social side, we're pretty well distributed in terms of all... You know, our company and our employees almost perfectly match the communities that we work in terms of all type of ethnicities and all the rest of it. I don't know that we have any governance issues either. Energy is always something that you can focus on and especially focusing on it where it's profitable.
We've done that consistency for consistently for years, and we continue to do it, not even with the focus or not focus on it. That's what we do. We expect to continue doing that and reducing our energy consumption.
Maybe we can talk about, the Hawaii part of the portfolio for a bit. You know, what opportunity sets are you seeing there and, you know, could you expand that part of the portfolio? I know you've got the one office-to-residential conversion you've got there, you know, other properties. Any, any color there would be helpful.
Hawaii is a great development opportunity for us. We own two big 30-acre sites that are way underdeveloped, and we've already built 500 units on one of them, and we have the ability to build another 700 units on that same site and even another third phase beyond that. We also have 12 acres. How many units are in Hawaii?
Thousands.
No. How many are there now?
I think, oh, $400.
Like 400 units, we can have 2,000 units there, or 475. We have huge growth we could do there. Kevin, literally over Covid on Zoom, got our entitlements increased for number of units and height right next to. It's right next to downtown. I mean, it's there. We have a lot of development capacity on land that we already own, which has been very profitable for us in that market. That's probably where you're gonna see our growth, and we're gonna continue doing development there.
Then just maybe one more on valuation and cost of capital. You know, how do you consider your share valuation and implied cap rate when considering an acquisition or development? I mean, even with higher cap rates, could you acquire or develop it in a creative level just given the current cost of capital?
Wow, that was long. Implicit in your question.
I didn't write it. It came from like-
Yeah.
I think you've heard it.
It's like another, like a fifth way of getting at, like when you look at the cap rate on the properties and your stock price, and then you look at buildings, how, you know, why aren't you deciding to buy your stock versus buying a building? 'Cause it's not a creative, more creative than. Look, I think it's good. The long-term health of the company is good to buy the buildings, as I explained already, and I think it kind of increases our dominance and control. You just can't ignore the stock price at this time. Very rarely do you guys hear me even mention the word of, like, buying back stock. Most of the time long term, I don't think companies do very well just tinkering with their stock, buying and selling. Like, they think it's high, they issue some.
They think it's low, they buy some. Historically, CEOs aren't that great at knowing when the stock's high and low, right? It's very, very low right now, so it has to be on our list. It has to be on our menu. That's the amount I'm going to say about it.
Just probably one last one on the balance sheet. I know we're running up on time here. Just any appetite to execute on additional swaps or caps for the floating rate portion of the debt, given, you know, some of them are expiring here over the near term?
Well, I still feel like if rates stay up or stay high longer, it's gonna be very destructive to the economy. I think the economy is. I know the 517,000 new people entering the workforce and whatnot, but I still think we see it, that everybody's shrinking back. I think the economy is gonna do a surprising about face. I think when they do, they'll drop rates. I'm not willing to swap right now and lock in the rates where they are today. I'm willing to. I think for the money it costs, which is not horrendous for a company our size, I'm playing out this portion that's floating and seeing where things go by the end of the year. That's just the decision we've made.
It's unfortunate 'cause I hate having to make calls about interest rates. We want to make decisions about, like, the right real estate and developing and the rest of it. We're being forced to make that call right now, and that's the call that we're making.
I have my three rapid-fire questions to end the session. First, what is the best real estate decision for Douglas Emmett today? Buy, sell, develop, redevelop, or pause?
buy and maybe a tiny bit of development, but mostly buy.
All right. We put that in the spreadsheet as buy. Same store growth expectations for 2024.
For, like, the whole industry?
The sector, yeah.
Oh, like, I don't know. 3%.
Thanks for some of these questions.
3%.
lastly, more, fewer or the same number of office REITs a year from now?
I think th ere'll be fewer.
Great. Thank you.
Thanks, you guys. Thank you.