Greetings and welcome to Hudson Pacific Properties' first quarter 2016 earnings conference call. At this time, all participants are in listen only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please push star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Kay Tidwell, Executive VP and General Counsel. Thank you. You may begin.
Good afternoon, everyone, and welcome to Hudson Pacific Properties' first quarter 2016 earnings conference call. With us today are the company's Chairman and Chief Executive Officer, Victor Coleman, and Chief Operating Officer and Chief Financial Officer, Mark Lammas. Before I hand the call over to them, please note that on this call, certain information presented contains forward-looking statements. These statements are based on management's current expectations and are subject to risks, uncertainties, and assumptions. Potential risks and uncertainties that could cause the company's business and financial results to differ materially from these forward-looking statements are described in the company's periodic reports filed with the SEC from time to time. All information discussed on this call is as of today, May 5th, 2016, and Hudson Pacific does not intend and undertakes no duty to update future events or circumstances.
In addition, certain of the financial information presented in this call represents non-GAAP financial measures. The company's earnings release, which was released this morning and is available on the company's website, presents reconciliations to the appropriate GAAP measure and an explanation of why the company believes such non-GAAP financial measures are useful to investors. Now I'd like to turn the call over to Victor Coleman, Chairman and Chief Executive Officer of Hudson Pacific. Victor?
Thanks, Kay. Good afternoon, everyone. Welcome to our first quarter call. We had a terrific first quarter across the board, but particularly in terms of our leasing results. We've also had notable activity on the disposition front in the first half of the year, which I'm going to get to in a moment. We're going to keep our prepared remarks relatively brief this afternoon. We'll have a bit more time for Q&A, and we'll be digging in a lot more at our upcoming Investor Day in Los Angeles on May 24th and 25th. If you'd like more information about this event, please reach out to our head of IR, Laura Campbell, whose contact details can be found on our website. In the first quarter of 2016 alone, we executed nearly 820,000 square feet of new and renewal leases across our markets.
Not only are leases on track with a pipeline of executed and in-lease deals that Mark discussed on our last quarter's call, but it's our best quarter ever in terms of leasing, both on an absolute and a pro rata basis. Even more impressively, and a testament to our ability to push rate and maintain velocity, we achieved phenomenal cash and GAAP rent spreads of 66% and 73%, respectively. In terms of earnings reported thus far this quarter, none of our office peers are posting these kind of results. We have pre-leased a significant proportion of our development and redevelopment pipeline. Netflix leased the balance of ICON. Saltchuk took 55% of 450 Alaska Way, and a deal with WeWork took 12655 Jefferson to 100% leased.
The activity along the Peninsula and the Valley this quarter has been robust. We're going to keep providing a deep dive at our upcoming Investor Day on these results. In the first quarter, we completed over 350,000 square feet of new and renewal leases in those markets at rent spreads on par with the larger portfolio. Noteworthy deals, both in Palo Alto, including a 22,000 square foot lease with Toyota Research Institute, Toyota's R&D division, focused on the autonomous cars, and Lockheed Martin's 43,000 square foot renewal for our entire 3176 Porter Drive asset. We also executed a 25,000 square foot renewal with Virtual Instruments, the world's leading IT analytics company, at Metro Plaza in North San Jose. We're making excellent progress with regard to our upcoming expirations, as we alluded to on our last call.
We've now executed a renewal lease with Qualcomm for 365,000 square feet at Skyport Plaza in North San Jose. While we're not going to discuss all of our second quarter activity today, this deal, a credit to our leasing team's proactive approach, addresses our 2017 expirations and brings our year-to-date total leasing activity to north of 1.2 million square feet. The terms of this renewal, executed nearly 16 months before the expiration, include a 44% mark to market on cash rent effective as of April 1 of this year and extend through expiration of July of 2022. Overall conditions across our markets remain positive. In Los Angeles, it has the right ingredients for strong to medium near-term performance, a high level of investor interest, modest new construction, stable employment growth, and reinvigorated media entertainment industry.
Our primary Los Angeles markets continue to perform well across all key metrics in the first quarter. We're currently in discussions with a pipeline of media-related tenants representing around 350,000 square feet of requirements for our 90,000 square foot CUE development to be delivered in mid 2017. We're also seeing a pickup in activity at all of our studio stages as a result of Netflix. Since our last call, we kicked off formal marketing efforts for our 120,000 square foot Fourth and Traction redevelopment. We're seeing growing interest from potential tenants, particularly as the sub-market continues to gain recognition. We now have demand for pipeline for both of our two Arts District projects for nearly 500,000 square feet. In Seattle, the market remains very strong. Sublease activity less than 1%. Fundamentals improving across the board.
50% of the projects currently under construction are pre-leased almost entirely by tenants expanding to the marketplace, new and renewed. While we're closely monitoring new supply for companies looking to locate in the rapidly transforming Pioneer Square, options for Class A space remain very limited. Specifically, our 450 Alaska Way development is set up part by already having a creditworthy anchor tenant, as well as adjacency to the progressing Seattle waterfront redevelopment. We're in active conversations with both tech and non-tech tenants, representing nearly 400,000 sq ft of demand for the remaining four floors. In the Bay Area, we're seeing some signs of moderation. Asking rates for the CBD, Peninsula, and Valley all increased slightly, with incremental increases in vacancy and in general, slowing absorption.
Sublease vacancy in the CBD ticked up. While we suspect this is a result of some of the tech companies rightsizing, demand for this type of space remains very strong. We're keeping a close eye on supply. Our portfolio is well-positioned as the market, which has experienced feverish growth in the recent quarters, inevitably cools. Leasing momentum at our properties remain very solid, and we're seeing nice activity at assets with some of the larger vacancies, like Metro Center. We'll be digging into your much more on our upcoming investor day. We've completed a number of non-strategic asset sales. Year-to-date, we've closed or put under contract nearly $315 million of deals. I'm going to walk you through those now.
Our previously announced dispositions of Bay Hill Office Center in San Bruno to YouTube and Patrick Henry Drive in Santa Clara to KT Urban, generated a combined $234 million of gross proceeds. Like our fourth quarter sale of Bay Park Plaza in Burlingame, these assets were all sold on an all-cash, off-market transactions at premiums to our original purchase prices. As I mentioned, we're working on a couple of other dispositions. We've recently placed 12655 Jefferson under contract to sell. After successfully pre-leasing the building and our only holding in Playa Vista, we received a reverse inquiry from a qualified buyer that highly valued the asset's location, redesign, and tenancy. The agreed-upon $80 million sale purchase price represents a 30% increase over our projected future basis. The buyer's good faith deposit is now non-refundable. A portion of it has been released to the company.
This deal is expected to close in the fourth quarter of 2016, after we complete all the tenant work. With that, I'm going to turn the call over to Mark, who's going to touch on our first quarter financial results, including how strong our performance has led us to raise our one-year full guidance, even though we have pending dispositions.
Thanks, Victor. Funds from operations, excluding specified items for the three months ended March 31, 2016, totaled $63.2 million or $0.43 per diluted share, compared to FFO, excluding specified items, of $18.5 million or $0.23 per share a year ago. There were no specified items for the first quarter of 2016. We had $6 million or $0.08 per diluted share of acquisition-related expense in the first quarter of last year. FFO, including the specified items for the three months ended March 31, 2015, totaled $12.4 million or $0.16 per diluted share. As of March 31, 2016, our stabilized and in-service office portfolio was 95.8% and 90.7% leased respectively, up from 95.3% and 90.1% as of the end of last year. The trailing 12-month occupancy for our media and entertainment properties increased to 81.6% from 71.6% for the same period a year ago.
Net operating income with respect to our 21 same-store office properties for the first quarter increased 8.5% on a cash basis and by 6.4% on a GAAP basis. Net operating income at our same-store media and entertainment properties increased by 47.9% on a cash basis and 36.3% on a GAAP basis. As many of you know, April 1st marked the one-year anniversary of our acquisition of the EOP Northern California portfolio. Beginning next quarter, our financial statements will reflect a more comparable portfolio for quarterly year-over-year comparison purposes. Consistent with our same-store reporting policy, the EOP Northern California portfolio assets owned as of January 1, 2017, will be added to our same-store office portfolio beginning with our 2017 reports. Before turning to guidance, we would like to walk you through our recent loan activity, which has improved our debt maturity schedule and our access to capital for future requirements.
On May 3rd, we drew all $175 million of five-year and $125 million of seven-year unsecured term loan credit facilities entered into in November of last year. We used the loan proceeds to repay floating rate indebtedness, including the $30 million loan secured by 901 Market Street, the $60 million outstanding balance under our revolving credit facility, $110 million of the outstanding balance under our loan secured by Sunset Tower and Sunset Bronson, and $100 million of our unhedged existing five-year term loan. The repayment of the loan secured by 901 Market Street addresses one of our only two loan maturities scheduled to occur this year. I will discuss the other maturity in a moment.
For the $110 million pay down of our Sunset Tower and Sunset Bronson loan, we arranged with the lender the right to reborrow these proceeds, thereby enabling us to reduce our current interest expense while providing yet another committed source of capital. The $100 million pay down of our existing five-year term loan effectively extends the maturity on $100 million of our term loan indebtedness by a weighted average of one and a quarter years. Finally, repayment of our credit facility provides us complete access to all $400 million of our revolving loan facility. Our only other 2016 loan maturity is at Pinnacle 2, where we have already selected a lender and begun documentation to fully refinance the existing $86 million loan on, or ideally before, the scheduled maturity in September.
We will provide more details as we get closer to finalizing this loan, but we anticipate 10-year financing at a rate as much as 125 to 150 basis points lower than the existing loan. As a result of our successful disposition and loan activity, our already conservative leverage levels continue to improve while providing the company with ample capital to fund all projected 2016 and 2017 leasing development and redevelopment expenditures. Even if we assume no future dispositions, we expect to have in excess of $250 million of capital available, net of operating set-asides, and after accounting for all 2016 and 2017 capital requirements. The successful completion of targeted dispositions, including the sale of 12655 Jefferson, could increase that projected availability to more than $380 million. In short, we are very well positioned to fund our future capital requirements while remaining highly liquid. Turning to guidance.
We are increasing our full-year 2016 FFO guidance from the previously announced range of $1.65 to $1.75 per diluted share, excluding specified items, to $1.68 to $1.76 per diluted share, excluding specified items. This reflects our first-year FFO of $0.43 per diluted share, excluding specified items, as well as the transactions mentioned on this call, including the sale of 12655 Jefferson. We have also assumed the sale of another asset, yet to be announced, for approximately $50 million later this second quarter, with proceeds going to repay a corresponding amount of our unhedged existing five-year term loan. This guidance also reflects the funding of the $175 million five-year and $125 million seven-year unsecured term loan credit facilities and the repayment of indebtedness I described earlier.
We have assumed the new $175 million unsecured five-year credit facility remains unhedged through this guidance period, while the $125 million unsecured seven-year term loan becomes fixed as of June 1st through an interest rate swap at a rate of 3.03% to 3.98% per annum, depending on leverage and before amortization and deferred financing costs. This guidance assumes full-year 2016 weighted average fully diluted common stock and units of 147,118,000. As always, the full-year 2016 FFO estimate reflects management's view of current and future market conditions, including assumptions with respect to rental rates, occupancy levels, and the earnings impact of events referenced in our press release and on this call, but otherwise excludes any impact from future unannouncements or speculative acquisitions, dispositions, debt financings or repayments, recapitalizations, capital market activity, or similar matters. I'll turn it back to Victor.
Thank you, Mark. Once again, I'd like to thank the entire Hudson Pacific team and our talented senior management for their fantastic work this quarter. To everyone on this call, we appreciate your continued support of Hudson Pacific Properties, and look forward to updating you next quarter. Operator, with that, let's open the call for any questions.
Thank you. Ladies and gentlemen, we will now be conducting our question and answer session. If you would like to ask a question, please push star one on your telephone keypad now. A confirmation tone will indicate your line is in the question queue. You may push star two if you would like to remove your question from the queue. For any participant using speaker equipment, it may be necessary to pick up your handset before pushing the star key. One moment while we pull for questions. Our first question comes from the line of Craig Mailman from KeyBank. Please go ahead.
Hey, guys. Victor, maybe just on your comments about San Francisco moderating, could you just clarify, is that just you're seeing growth moderate or you're starting to see cracks?
Craig, good to hear from you. Thanks for calling in. I think it's a couple things. First of all, we've had quarter-over-quarter, year-over-year tremendous growth. We're not seeing cracks by any means, and the activity is still fairly consistent. What I think we're starting to see a little bit is deals are just, specifically larger deals, are taking longer to get done. Now granted, we had a phenomenal quarter and executed a lot of stuff, but a lot of that stuff was being worked on in the fourth quarter, and we got done in the first quarter. I just believe that that's just a sign of brokers and tenants taking their time to get deals done, and that's what I'm inferring.
Okay, you're not seeing any weakness in rents or anything like that, maybe just a little bit more sublet space, but you're not seeing a huge impact from a moderating pace of VC funding yet?
No, absolutely not.
Okay. Moving on to the leasing. You guys are basically 75% of the way through the $1.6 million you laid out last quarter. Could you just give an update on what the pipeline looks like? Has it grown at all from that $1.6 in terms of backfilling it, and what you think a reasonable volume of leasing for the full year could end up being?
Yeah. Craig, this is Art. The pipeline remains, it vacillates around $1.2 million across the portfolio, even after doing the volume that we've done.
It still remains. We've gone out over the last 30 days, we've picked up some deals that weren't on the radar, still here we are at about $1.2 million in the pipeline. I feel very bullish in all markets.
Okay. You guys could top $2 million for the year?
Well, I don't want to give a number of what we can and can't top, but I think, right now, with the 820 and the Qualcomm deal, and we've got other deals that we've executed this quarter, we're well on our way to $1.5 million plus.
Okay, that's helpful. Just lastly, with Netflix being more active at the studios, how much do you think you can push rents and push revenues at the studios versus what you guys thought was a more historic kind of top-out level?
Well, I think, listen, this is indicative of this quarter. I mean, the numbers are as best as we've ever performed. A lot of it is the stickiness of having Netflix. I think we're also going to see some more stability in the sound stages around Netflix and tenants like them who are taking longer term, not just show to show or year to year. That's going to prove out to see some proven revenue over a multiple-year period. I'm comfortable with the numbers the way they are right now. I do see that our media team has seen a large pickup in desire for office space there. Virtually, we're full on office, which bodes well to our CUE development, and the kind of activity we're seeing around that. Even though it's a small number right now, we're pretty excited about the opportunity around the growth.
Great. Thanks, guys.
Thanks, Craig.
Thank you. Our next question comes from the line of Blaine Heck from Wells Fargo. Please go ahead.
Thanks. Just a couple for Mark here. It looks like your office operating margins have shown pretty vast improvement. You guys average margins of 58%-59% in 2013 and 2014. Over the last five quarters, that's been closer to 65%-66%. Do you think that's mostly attributable to the addition of the EOP portfolio? Is it fair to assume these margins can hold up for the rest of the year? Is there anything that might put pressure on either the revenue or the expense side?
Yeah, you're looking at the GAAP margins, right? I don't attribute that, and that's flowing through same store, right, which does not include Redwood. It's really indicative of the 21 office assets flowing through that number. I think what you're really seeing there is stabilized occupancy, kind of a leveling off of Well, not free rent because that's running through GAAP. I think what you're really just seeing is improved operating efficiencies in that 21 office portfolio and a leveling off towards what I think is a normalized operating margin, which it should be somewhere in kind of the low to mid-60s.
Okay. No kind of headwinds that you see that might-
No
be changing.
I think we ought to be able to maintain that margin in a stabilized portfolio.
Great. Okay. Just looking at earnings going forward, you guys will have a little FFO pressure from sales, Bay Hill was done early in the first quarter, and Patrick Henry and 12655 weren't really generating NOI. The biggest drag is going to come from $50 million coming later this quarter. Your guidance implies that each of the next three quarters averages about $0.43 a share, which is equal with the first quarter. That seems light to me. I'm just wondering if there's something else I'm missing that's going to keep FFO from.
No. You got it. There is going to be some dilution on NOI from that assumed sale. We've got a pickup, in no small part, from Qualcomm, right? We did an early blend and extend on that, effective as of April 1. That's offset the dilution from the sales more than offset the dilution.
Okay. How should we think about lumpiness as far as FFO kind of is trending throughout the rest of the year?
I don't think it's going to be very lumpy.
Okay.
Getting precise in terms of guiding on a quarterly basis obviously We don't do that. It won't be particularly lumpy.
Okay. Fair enough. Just one more from me. Maybe for Victor, can you talk about some of the largest vacancies in the lease-up portfolio, specifically Metro Center and Foster City and Shorebreeze and Redwood Shores?
Yeah. Listen, in the last few months, we've got a lot more interest in Metro, which is really our biggest gap, we've got a couple of full-floor tenants that we're looking at. Now we're looking at also subdividing one of the floors on a multi-tenant basis. The activity seems to be pretty stable. Redwood Shores, the same thing. There's virtually nothing in the portfolio on the peninsula of the large vacancies that we're not having at least some activity on at or better than our underwriting numbers. We're pretty comfortable with the flow in the pipeline as Art mentioned.
All right. Great. Thanks, guys.
Pleasure.
Thank you. Our next question comes from the line of Nick Jellicoe from UBS. Please go ahead.
Thanks. Can you guys just remind us where you think your in-place portfolio rents are in the overall San Francisco Bay Area versus market rents today?
Well, the markets are quite a bit different between CBD and, say, Peninsula and Silicon Valley. If you're focusing on the CBD, judging by deals that are getting done, we're probably over 50% below market. You saw our mark-to-market on the lease activity page of 66% cash and 70 GAAP. The deals that are driving that are things like Uber, which signed at $69 compared to, at least, on half of that space, a rolling out base rent of $13.51. That gives you some indication of just how significant the spread is in the CBD between market and in-place. It's 50%, probably could be much higher than that.
In the Peninsula and Silicon Valley, it's in the high 20s, maybe a 30% mark-to-market on rents, and that's also borne out by some of the bigger deals that are flowing through that leasing activity that are closer to that range.
Okay. Recognizing you guys don't give same-store guidance, can you talk a little bit about how you think the same-store trends might play out directionally for the rest of the year on a cash basis?
I think, the first quarter, Let me think about this. I think it'll probably stay around the levels that we posted in the first quarter, at 6.4 on growth rate on a year-over-year basis. We don't guide for it, so I didn't isolate that number for the balance of the year. I think that's probably a fair expectation.
Okay. Got it. That's helpful. Just one last one. Can you just remind us what's left on the capital spend for the EOP portfolio?
Yeah. I sure can. Because of the old number that we spoke of in the very early going of the acquisition, that $75 million or so, that's been adjusted in no small part because of asset sales. For that three-year period, that is the period ending by the end of 2017, the total spend has been adjusted to $63 million. Of that amount, we've already incurred about, let's call it $nine and a half million. That leaves, call it $53 million or so of spend for the balance of this year and into 2017. Of that, we've already committed about $36 million.
Okay, thanks, Mark.
Thank you. Our next question comes from the line of Sumit Sharma from Morgan Stanley. Please go ahead.
The 65 or 66% mark-to-market spreads, I guess I was wondering, how much of this was driven by the demographics of the leasing sort of tilted towards San Francisco? I guess as a follow-up to that, because we were expecting a lot of this to occur in 2017 based on a previous schedule, how much of this sort of moves 2017's numbers upfront into the run rate?
Well, this was anticipated. The only 2017 movement that it's inclusive, which we haven't posted on that number, is Qualcomm. No, this is all 2016-related mark-to-market.
Okay.
The leases are better performed than we thought. We knew where they were rolling at, but for the most part, we're just getting higher rental rates on average across the board for 2016. The numbers in 2017 are looking the exact same way. Mark just quoted them at 50%-plus mark-to-market. That's going forward for the remainder of this year and into next year, it could even be higher. We've got some pretty substantial roll below market in the city and in the Peninsula and here in Los Angeles. Then we start to roll in late 2017, 2018 in Seattle at well below market numbers. He's throwing a 50% number out there. Our estimates here, they're going to be higher than that, and specific instances, a lot higher in many specific instances.
Which was kind of in line with what we had originally forecast as well. I was just trying to see if there's an opportunity that some of the 2017 sort of staggered mark-to-market had moved forward. Thanks for clarifying that. I guess with regards to the large Qualcomm lease, was there anything you could add about the tenant improvements or leasing commissions that were sort of different, especially given what you're talking about in terms of the Bay Area moderation? Any changes in those statistics at all?
On the leasing commissions, they were in line with what we underwrote them at. Obviously, they were earlier because we didn't anticipate signing this until 2017, or closer to their expiration. In terms of TIs, they were well below our underwriting.
In that there was very little that we thought that was going to be in place for that relative where the market was for us to have it be replaced clearly.
Understood. Thank you so much for that. It sounds like it's basically in line with your expectations and possibly the market. I guess last question. Besides the $50 million asset that you mentioned in your guidance, is there anything else that you're looking to sort of dispose or cull from the EOP portfolio or actually, more interestingly outside the EOP portfolio now with Playa Vista?
I think there's nothing of material levels that we're looking to dispose of in the EOP portfolio now left. There may be a smaller asset or two in the existing portfolio, but we've not identified anything at this time.
Understood. I promise this was my last question, so I'll save it up for another time. Thank you.
Thank you.
Thank you. Our next question comes from the line of Richard Anderson from Mizuho Securities. Please go ahead.
Thanks, and good afternoon. To answer my first question, which was the $50 million out of EOP, but it sounds like it is not. The second question is, you mentioned sublease space trending up. Can you put some numbers around that, what you're seeing from a sublease space perspective in the Bay Area?
Yeah. Rich, let me clarify because I think you misunderstood. The asset that we're not going to tell any details on in the $50 million is an EOP asset.
Oh, excuse me. Okay.
Yeah, he was referring to any additional assets outside of that one.
Okay. Thank you.
Just to have that clarified. Let me give you sort of the statistics around sublease space. For the most part, the sublease space has been a dominant conversation around the CBD in San Francisco. If you look at the Valley, first and foremost, there's really been no material sublease changes at all. It's very minimal and not noteworthy at this time, which is good news. I think if you start at the beginning of the year, there was on average, a 77-million-square-foot portfolio in the city is what they're benchmarking it off of. There was 1.7 million sq ft or 2.2% of the market was available for sublease. That number today is about 3.1%, 2.4 million sq ft of sublease space. What's important to look at is of that 1.7 million sq ft, about 730,000 sq ft is actually vacant. About 1 million is available.
About 0.9% of the total market in the beginning of the year was vacant. That number has moved to about 820,000 sq ft vacant, a little bit more than 90,000 sq ft. It's immaterial, and it's about 1.1% of the total market. Those are the numbers that the people aren't focusing on. They're focusing on the total sublease space, which is still very small relative to the marketplace. What's sublet and what is now occupied of the sublease space with tenants other than the tenants that are on the lease is really minimal. What's shifted from January 1 basically till May 1 has only been a 90,000 sq ft increase.
Yeah. Okay. Thank you. Sort of a theoretical question. Would you have signed a lease with WeWork if you weren't selling Jefferson?
Well, we signed a lease with WeWork without selling Jefferson. I guess that answers your question. Listen, I can tell you, we spent a lot of time with WeWork. Specific to Playa Vista, the reason we sold that asset is because we realized that we couldn't get any more traction in buying any more assets in that marketplace at valuations, one. Two, the value of that asset relative to what we're into it for ended up being an exceptional deal. WeWork's business model in Playa Vista makes a lot of sense in that, Rich, Playa Vista's got a tremendous number of large tenants, and there is no small multi-floor creative space available for all the ancillary consultants and other administrative-related co-working space requirements in that area.
They're the only guys, the demand when they decided to look at the space, the demand that they've already had without even starting to market it, but the tenor of which the market understood they were going there has been incredible. It makes a lot of sense for a WeWork-type operation, a co-working operation to be in a marketplace like Playa Vista with no other competition. Tenants like Google and YouTube and Facebook and the likes of that are there and growing dramatically, there is a lot of need for them. To answer your question indirectly, we didn't get the yield and the terms until we signed that lease.
When we were approached by an off-market buyer, it was because of that lease and the renovation work that our team did and the other lease in the building that got the value of the building to the pricing that we thought was indicative enough for us to sell.
Okay, fair enough. Mark, to you. What is the rationale for leaving the $175 million floating? I know some of it will be paid down, but what's the thought process there?
That was it. We had $250 on hedge, we want to leave ourselves some financial flexibility on some of these relatively near-term facilities so that depending on how proceeds come through, let's say, on dispositions, we have some availability, if necessary, to apply it against indebtedness and avoid too much dilution. With the reduction of the existing five-year by the 100-
The introduction of the new $175, we incrementally ticked up on the unhedged piece of it. We have other activity which is going to potentially generate proceeds, depending on whether or not we utilize that or not, we wanted to leave ourselves additional floating rate exposure, low repayment cost debt to apply that against if necessary. If you look at the overall debt picture, the floating rate amount is relatively minimal compared to the overall indebtedness.
Okay. Do you have an interest expense number you have in mind for guidance?
Well, we obviously have an interest expense amount running through our guidance, but I don't think it makes sense to isolate it for this call.
Okay. Fair enough. All right. Thank you.
Thanks, Rich.
Thank you. Our next question comes from the line of Alexander Goldfarb from Sandler O'Neill. Please go ahead.
Good afternoon. First, thank you for releasing results before the open today. Made things a lot easier. Just a few questions here. Victor, on the tech, you mentioned the moderation in San Francisco and then taking longer to do deals, but said it really is not having an effect overall. Just sort of curious, is there no change in Seattle and Southern Cal? Just curious how the tech is different in those other two markets versus what you're experiencing in Northern California.
Alex, that's a good question. I think in Seattle, we are really seeing no change at all. I mean, the activity on a pre-lease basis for 450 Alaska Way and the activity there, as well as our other vacancies, we have a fairly strong pipeline of tech and non-tech related tenants. I think if you isolated to the tech side, you'd see no slowness relative to that marketplace. In L.A., specific to our markets and the assets we currently have, we have the exact same amount of momentum. I would actually say it's even increased with the correlation of media and media-related tech tenants. It is still very strong here, and we're still seeing, I think, a flow of activity that we're pretty excited about where the rent comps are moving to. I don't see the same correlation.
I want to make sure you understand that the slowness of large tenants is just natural in the progression of right now, I think tenants realize that they can take their time if there's space available. That being said, we have space coming to the market at 875 Howard, hopefully, and we have a tremendous amount of activity around that and mark-to-market rents that are greater than we even imagined. I think we are equally being as slow to sign to make sure we actually do the right deal. I think it's a mutual sort of process.
You mentioned, like where Mark mentioned about the 50% mark-to-market later this year into next year's roll. How on your degree of confidence about locking that in if this is the start of a trend and first it takes longer to do deals and then next people are backing out or downsizing, et cetera. How confident when you guys budget, I mean, are you budgeting the 50% marks or you're budgeting something less than and leaving that to the upside?
It's a good question. I think what we're doing is we're underwriting our assets on our budget year-over-year. We don't sit back and reflect back in the middle of the year and say, because rates are moving so dramatically, we're going to underwrite a different budget. Clearly, we're pushing for rate, term concessions, and TIs. Our deployment across the board is what we're going to be budgeting on. I think when Mark says 50%, he is using that as across the board. There are clear indicators of numbers that are well in excess of that
Yeah
that we're going to try to capture on an ongoing basis. That being said, you look at some of the renewals we've done early. We've done those renewals at some great mark-to-market spreads. If we had waited, would we have got a better number? Who knows? We were pretty comfortable with the execution, so we took it. Yeah, Alex, let me just underscore one thing. I was attempting to answer where the mark would be across the CBD portfolio, not with respect to near-term expirations per se, right? I was giving an indication which would include even a mark that would reflect deals that were even recently signed. You're going to see an elevated spread on near-term expirations because those will be more disproportionately made up of leases that were signed longer ago, right?
When you blend it out with those deals which are way below market and deals that were more recently signed, I think you're probably in that 50-plus percent range, but you're going to see elevated amounts in the near term.
Okay. Just final, Victor, did you say upfront in your opening comments, you talked about it almost sounded like the next Hollywood development site, but then you mentioned the Arts District. Were you mentioning two new developments, or you were just talking only about the Arts District?
Only about the Arts District. The activity around. What we did was on our Fourth and Traction and 405 Mateo projects, we said that respectively would come out in mid 2017, late 2017, early 2018 with the two. We've started marketing on the Fourth and Traction project now, so our materials are ready to go. Now we are just releasing the materials out to the marketplace. It's around that project I'm referring to.
Thank you very much.
Thanks.
Thank you. Ladies and gentlemen, as a reminder, if you would like to ask a question, please push star one on your telephone keypad now. Our next question comes from the line of Jamie Feldman from BofA. Please go ahead.
Thanks. Good afternoon.
Thank you.
I guess just starting out with Mark. Can you just walk us through the changes to the guidance in terms of, if you hadn't done the sales, how much your core NOI or your core FFO would've gone up? I'm trying to just
Yeah
separate the two pieces.
Yeah. On the office component, it probably would've been a pickup of something from last guidance of closer to $0.03, which is now being offset by that disposition assumption, which is maybe about $0.015. We've got some interest savings as a result of that debt activity I walked through, Jamie, and that's being partially offset by a little higher expectation on minority interest, which is the non-controlling piece. That's offsetting by $0.01. We have a little bit higher G&A just because we're trying to anticipate for the potential impact at year-end of our OPP. One other item on the interest expense, which should be more or less isolated Q1 if we put this in place. You'll notice in our income statement, we had $2.1 million of hedge ineffectiveness.
That's a non-cash, in effect, interest expense that stemmed from the unusual rate environment in the first quarter as we've actually seen interest rates go negative in certain countries. What that led to was, if you run a regression analysis against the $650 million of swap, there's actually now a mismatch in the swap and the underlying instrument, because the underlying debt has a zero LIBOR floor. There's an actual real value now in there's an ineffectiveness in effect from the possibility that LIBOR could go negative. Q1 reflects that non-cash interest expense of $2.1 million. That's mitigating our Q1 results. One, we don't think that that's likely to continue into Q2, indications are that we're also looking at putting a floors into our existing swap so we would remove that inefficiency or ineffectiveness going forward.
Okay. It sounds like you would've raised $0.03 except for the sales, the higher G&A, the changes in the interest expense?
Yeah. Maybe I would say potentially $0.04 if it weren't for the sale the higher interest expense.
Okay.
Going back to Victor's comment on the Bay Area, moderation. Can you talk about the Peninsula and Silicon Valley versus San Francisco, how things might be behaving differently across the two different parts of the region?
Well, Jamie, I don't think we're seeing material changes at all in the Peninsula. It's obviously evident by our numbers and the flow of activity and the leases we're signing and we're negotiating on now. I think the flow of leases going into the second and third quarter looks pretty strong. I don't think we're seeing anything on that basis. I know people jump on comments of any moderation and want to obviously assume that that's the end of the cycle. I'm clearly not saying that. I want to make sure. I'm glad you brought it up because now you're the third guy out of eight questions that have mentioned it. I'm clearly not saying that we're seeing a slowdown. We have virtually every space in the city and in the valley of material size, we have activity on.
That's clearly indicative of the fact that we've seen quarter-over-quarter, year-over-year, five-plus years now in a row, rental rate increases and growth. Those are all fairly aggressive signs as to what we're seeing in the activity I think that we're producing. Combined with the fact that rental rates are moving still in our favor on a positive basis, and we have a great amount of tailwind behind us on the basis of mark-to-market rents, that even at a standstill, are going to be very impressive numbers. I've seen the new deals that are being worked on, and they're consistent with the past. I don't see it in the valley, and by no means should it be interpreted that taking a little longer to make deals means that it's over in the city.
Okay. I guess as we've seen a, I don't want to say more restrictive, but I guess a slower funding environment from VC, has the behavior or leasing patterns changed in terms of the kind of space people are looking at?
I don't think.
types of buildings?
It's interesting, Jamie. A lot of focus on the VCs, and a lot of focus on what they're doing now in terms of funding that has sort of impacted some of the tenants aspects. Bill Gurley, one of the largest Benchmark VC guys out there, came out and said, "What we're looking at for supplying capital to
Our clients and the companies by which we're backing is for them to be much more cognizant of expense cutting, not of taking less space, much more cognizant of how they run their business. That being said, the flip side of that is $13 billion in capital was flowed into the D.C. market in the first three months of this year, which is the highest ever since 2000. I think there's some mixed messages there. Like anything else, because they have the capital, maybe they're just deploying it at different levels and different tempos by which. We're not seeing VC step in and telling decision-makers and companies to say, "Don't take space or take less space or pay less rent." We just haven't seen that intervention.
Okay. Last from me, the Toyota lease, I think it was kind of pretty interesting here, the driverless car. Can you just talk about maybe around that building, what the other opportunities are maybe in your portfolio for others in that sector? Maybe just more color on the leasing pipeline around there.
Yeah, absolutely. What we're seeing, I think you've heard our banter around that, we are seeing a definitive movement in the autonomous car from name companies and non-name companies. We're seeing the Toyotas of the world, the Teslas of the world, BMWs, Mercedes-Benz. Ford now is out in the marketplace looking for space. The name brand automobile guys for R&D and IP are looking for space in and around that area, and it seems to be a hot demand item. Volkswagen was in the marketplace for 200,000 feet. I believe they're going to be back in the market. They've obviously had a slowdown. That being said, what we're also seeing is we have tenants that are looking at expanding that are not name tenants that are the core brand names like Toyotas. We have a tenant in our portfolio, Zoox. They're a driverless company. They're German-backed.
They've grown from one floor to almost three floors in a matter of seven months. They're paying top-dollar rents, and they're backed by a capital company out of Germany, as I mentioned. This is a wave I think that's getting now some attention and some traction, and we're pretty excited about the fact that we have availability. We are looking at right now two of those companies that are name related, and I haven't even mentioned the 400,000 feet that Google's looking to take down and the 800,000 feet that Apple's looking to take down for their autonomous cars as well.
Okay. Those last two, could that be in your portfolio, or I know you don't have that much space, but like any-
We have the potential to attract one of those in one location in the portfolio on a build to suit, and we have the attraction to look at one of those, depending on what happens with one of our vacancies in 2019.
Okay. All right. Thank you.
Thank you.
Thank you. Ladies and gentlemen, there are no further questions in queue at this time. I would like to turn the floor back over to management for closing comments.
Thank you so much for participating in our first quarter call. We look forward to seeing all of you at our Investor Day, May 24th and 25th, right here in Los Angeles.
Thank you, ladies and gentlemen. This does conclude our teleconference for today. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.