Q4 2023 Douglas Emmett Inc Earnings Call

Participants

Stuart McElhinney; Investor Relations Officer; Douglas Emmett Inc

Jordan Kaplan; President, Chief Executive Officer, Director; Douglas Emmett Inc

Kevin Crummy; Chief Investment Officer; Douglas Emmett Inc

Peter Seymour; Chief Financial Officer; Douglas Emmett Inc

Blaine Heck; Analyst; Wells Fargo & Co

Michael Griffinx; Analyst; Citigroup Inc.

Jay Mirostaw; Analyst; Evercore Inc.

Dylan Burzinski; Analyst; Green Street Advisors, LLC

Paul Romano; Analyst; KeyBanc Capital Markets

Peter Welford; Analyst; Jefferies Group LLC

Camille Bonnel; Analyst; Bank of America

Bill Crow; Analyst; Raymond James Financial, Inc.

Presentation

Operator

So yes, ladies and gentlemen, thank you for standing by and welcome to Douglas Emmett's quarterly earnings call. Today's call is being recorded. (Operator Instruction's)
I will now turn the conference over to Stuart McElhinney, Vice President of Investor Relations for Douglas Emmett.

Stuart McElhinney

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.

Jordan Kaplan

Good morning, and thank you for joining us in 2023 higher interest rates fueled recession fears. As a result, tenants became more cautious office leasing slowed and our leasing gains immediately following the pandemic were reversed. Our office occupancy declined but large fixed rent increases, stable rental rates and low concessions in our markets mitigated the impact on revenue.
Interestingly, remote work does not seem to have meaningfully reduced demand from our tenants. In addition, due to our typical year lease terms, more than two thirds of our current leases were actually signed after the pandemic began. As Peter will tell you, our 2024 guidance anticipates lower FFO as a result of vacating the Barrington Plaza apartments the expiration of one large lease and higher interest costs. Our guidance does not take into account any significant recovery in leasing demand, even though we see the potential for that as tenant confidence increases. I am pleased that shortly after quarter end, one of our largest tenants signed in early renewal for 250,000 square feet.

Kevin Crummy

We continue to grow our residential portfolio. We have added almost 1,300 apartments over the last five years in our strongest markets despite removing bearing composite from the market, our residential portfolio now provides almost 20% of our rental revenue.

Jordan Kaplan

In addition, we have not experienced the residential building boom seen in other major markets, so our apartments remain fully leased.

Kevin Crummy

That said, the rapid rent growth during the pandemic seems to be normalizing. There are challenges and opportunities ahead. We are prepared for both as I am confident in the long-term prospects of our markets our supply demand dynamic is among the best in the US.

Jordan Kaplan

Our submarkets are vibrant and our office tenants have overwhelmingly returned to work.

Kevin Crummy

We have significant cash on hand, meaningful free cash flow, no corporate-level debt and almost half of our office properties remain unencumbered.
With that, I will turn the call over to Kevin.

Jordan Kaplan

Thanks, Jordan, and good morning, everyone. I would just like to take a moment to mention that we have completed the lease up of our 376 unit landmark LA property in Brentwood at our office to residential conversion in Honolulu, we finished the conversion of another office floor and as expected, the 22 new apartments at leasing quickly as the remaining two office floors vacate over the next few years, we will add the final 47 units to complete that project. Otherwise, our cash and strong JV relationships position us to take advantage of new opportunities in our markets, and we're focused on finding those opportunities in both residential and office. Stuart?

Kevin Crummy

Thanks, Kevin.

Stuart McElhinney

Good morning, everyone. For all of 2023, we signed 872 office leases totaling 3.2 million square feet for an average of 800,000 square feet per quarter. During the fourth quarter, we signed 202 office leases covering 710,000 square feet, including 243,000 square feet of new leases and 467,000 square feet of renewal leases. These results do not include the 250,000 square foot renewal in Beverly Hills signed after quarter end, extending the term for 10 years through 2037. The overall value of new leases we signed in the quarter increased by 4.3%.
Cash spreads were down 6.1%, reflecting the strong annual rent increases built into our leases at an average of only $5.86 per square foot per year. Our leasing cost during the fourth quarter remained well below the average for other office suites in our benchmark group. Our residential properties continued to perform well during the fourth quarter, ending the year at 98.5% leased.
With that, I'll turn the call over to Peter to discuss our results.

Peter Seymour

Thanks, Stuart, and good morning, everyone. Reviewing our results compared to the fourth quarter of 2022, revenue increased by 2%, partly from higher multifamily revenues and ground rent. During the fourth quarter, we prevailed in the ground rent reset arbitration on land that we own. The result was a one-time payment of accumulated back rent of approximately $5.5 million and going forward, there will be approximately $1 million of additional annual rent.
FFO decreased by 12% to $0.46 per share, primarily as a result of higher interest expense, AFFO decreased 8.1% to 74.6 million and same-property cash NOI decreased by 1.1%, driven by a comparison to a strong prior period that benefited from onetime tax refunds on our residential portfolio. Adjusting for those items, residential cash same-property NOI would have been positive 3.3% and overall cash NOI growth would have been negative 0.6%. Our G&A remains very low relative to our benchmark group at only 5.6% of revenue.
Turning to guidance for 2024, we expect FFO per share to be between $1.64 and $1.70, reflecting the expected move out of one large tenant in Burbank, the removal of Barrington Plaza from the rental market, higher interest costs and modest leasing assumptions. For information on assumptions underlying our guidance, please refer to the schedule in the earnings package. As usual, our guidance does not assume the impact of future acquisitions, dispositions or financings.
I will now turn the call over to the operator so we can take your questions.

Question and Answer Session

Operator

(Operator Instructions) Blaine Heck, Wells Fargo.

Kevin Crummy

Great, thanks. So Jordan, it seems like some of the rhetoric in the market has shifted back towards interest rates that could be higher for longer. I guess, how are you thinking about where rates go in the next year or two? And has anything changed around your thoughts on and then how to handle the upcoming swap and debt maturities in 24 and beyond.

Jordan Kaplan

So the reason they're swaps coming up is that we typically do a seven year loan and we swapped five years, and that gives us a two year window to then refinance alone. So most of the time when swaps are coming up, it means that we need to start to have a point of view toward refinancing. But more importantly, it means that it's probably not worthwhile to trying to swap two years or one year or whatever is left, which is which is to some degree what you see coming up. But as we refinance, those loans will focus on then on swapping them and they'll be fixed at whatever rate we're always and the market at that time and hopefully we have a good spread.

Blaine Heck

All right. Great. That's helpful. And then just second question with respect to Barrington Plaza, I guess, can you guys give any update on your expectation with respect to insurance proceeds, any update on with litigation from prior tenants? And then talk about kind of the mechanics of that project, especially how capitalized interests might impact numbers and just at a high level, how we should be thinking about and of the impact to earnings this year and beyond?

Kevin Crummy

Okay. So I'll answer the first part, and I'll let Peter answer the second part, but, in terms of the look, go ahead, you can answer your section. They come back and ask whatever you want to answer.

Peter Seymour

Yes. Okay. It's Peter. Yes. I mean, with respect to the impact of Barrington this year, we had about $0.045 of variance in 2023, and that will be reduced to about 0.5% in our in our numbers for 2024, mostly due to the remaining retail commercial on tenants that are in the property. And then our interest guidance assumes a certain level of capitalized interest. But obviously, that's going to depend on how quickly we move and how much we spend.
Okay. So then your questions then revolve around both the litigation and the insurance, right? You're beginning questions. And while we feel it's insured, I mean, we still have to get the insurers on board with that. So we're dealing with that. And then in terms of litigation coming from tenants, I mean, obviously, that has also ensured, but it's ongoing and all and all litigation is disruptive. So I mean that's it's a drag that it's going on, but we're dealing with them.

Blaine Heck

All right. We'll stay tuned for an update. Thanks.

Peter Seymour

Yes, all right.

Operator

Michael Griffin, Citi.

Michael Griffinx

Great bags of Jordan. I want to go back to your comment you made on the leasing front. You said that two thirds of your leases have already been signed during or after the pandemic. Is it fair to assume that leasing is going to materially pick up in the next couple of years? Or is this just kind of the new normal that we should Perfect.

Kevin Crummy

I fully believe that leasing will pick up over the next couple of years. And matter of fact, as as I tried to really make this point, a huge amount of times, which is that you saw our leasing pick up right after the COVID kind of got lifted. But what's happened now is the country and particularly a lot of people holding office space. I've gotten some sort of recessionary fears, shrinking cost cutting. I mean, you don't hear about many companies saying here's the units that we're expanding, right. Everybody's focused on cutting expenses. And we are just at we're just one of the results from that going on across across the country. And certainly here. So people aren't making big commitments to doing new things are small. Our smaller tenants are going forward.

Jordan Kaplan

Great. And you see it. You see we're doing a lot of leasing, but large ones or are very hesitant around commitments. And frankly, what I keep seeing and having nothing to do with COVID or return to work or any of it, I just see that they're showing telling analysts you guys what you want to hear, which is we're cutting costs by cutting staffing, and there's just one article another like that. So as soon as that lightens up I fully expect the market to return to where we were before. And by the way, most of our history, when we weren't in a process of buying or acquiring a lot of vacancy. We have been at a very high levels of occupancy with the portfolio ranging from 92 to 95 96. And you go well, what's the reason for that and why do we feel it's such a great market is what I said. We have the best supply demand dynamic of any market in the United States. We effectively have no new supply coming in. And we have a lot of industries that drive demand. And I know nobody wants to keep hearing about tech and and entertainment, but we have Madison we have universities, we have research. All of those are space takers, and you're seeing articles about it even even today. So I'm very optimistic about where our buildings will be headed as soon as what I think what you'll actually see is you'll see interest rates might lighten up and tenants kind of come back strong and in the market all around the same time zone. And you mean, but we all need to make predictions about that, and I don't think there are market specific for us.

Michael Griffinx

Got you. So appreciate the insights there. And then I was wondering if you could comment if you could give some additional color on the 20% acquisition in your JV fund. Was this more opportunistic given the existing relationship you have there or should we read into this as you're looking more proactively at that acquisition opportunities?

Kevin Crummy

So in general, when we're in these JVs, our recommendation is always you know, we think this is a good holder. We think we should all be selling at the same time. But then in specific when one of our JV partners wants to sell we work hard to make sure there's a market for that and they can get liquidity. And this is a this was a relatively small deal. I mean, it's not very material but we were certainly happy to provide that liquidity for that partner that wanted to get out and that's all it really happened there.

Michael Griffinx

Great. Well, that's it for me. Thanks for the time. And the next question comes from Nick Yulico with Scotiabank. Please go ahead.

Jordan Kaplan

Thanks, maybe first question is on acquisition opportunities and how you're thinking about of those. And particularly in relation to, you know, if you have a portfolio right now where you're already dealing with some.

Michael Griffinx

Yes, some unstabilized occupancy levels. I mean, are you still willing to go out and find investments if day if they pencil makes sense and put capital to work with a JV partner?

Jordan Kaplan

Absolutely. Absolutely. I mean, I think I mean, we're spending definitely spending time trying to find deals. And I think it's an amazing opportunity right now. And when I think back to the last time, I thought it was such an obvious and amazing opportunity which maybe the rest of world than thing. But it did turn out to be the case that you've got to go all way back to 1990, 91, 92 93 when Ken and I were just getting going with this company with Dan and Chris, and we looked at what was going on out there and we said, well, I mean the price you can buy these buildings for assuming some of this stuff comes up and we have a chance to get it or their Epic, their parent leader one, 30 years, and we've been I don't want to miss that opportunity at all.

Michael Griffinx

All right. Thanks. And then a second is just on the William Morris extension. You're able to give us any feel for how the rent spread worked on that? And I guess we'll learn next quarter when you put the new rent in the sub. But any preview you can give us on that along with how to think about the capital you have you had to extend to get the lease done? Yes.

Kevin Crummy

So the current lease expires in 27 this a 10-year extension. So now it's 2037 and they kept all their current space. There's not going to be any current impact on cash revenues because of the start for a while, but we're doing we're doing some building work. But I don't think that THLD. is going to look at the TI.s and say that was a big difference. I doubt they'll impact anything in terms of averages or any of that. And there will be very significant cash and straight-line rent roll-up.
Thanks for writing.

Operator

Jay Mirostaw, Evercore.

Jay Mirostaw

Hey, thanks for taking my question. And I was wondering, can you just provide a little bit of color on where you typically see renewal percentages at the start of the year, just thinking through and kind of how occupancy will trend throughout 24?

Jordan Kaplan

Hey, Jay. Yes, you know, our long-term average renewal rate for our office tenants is in the high 60s between 65% and 70% kind of over the long term. If you're looking at the supplemental on the roll over the next four quarters. Obviously, that renewal percentage goes down the closer you get because most of our tenants have renewed, you know, six months or a year before their term. And so if you want to talk about that offline, but a long-term average is in that high 60s range.

Jay Mirostaw

Okay, that's helpful. Thank you. And then just going back to the distress front, as well. I'm curious if you could provide anything on just where you expect to see that, whether it's on the office front, multifamily or maybe a combination of both?

Jordan Kaplan

No, I'll take that. Good morning. We're going to see it on a combination of both. I mean, when you look at the headlines of lenders are taking back both office and multifamily and I mean, candidly, I was just at something yesterday where they were showing upcoming maturities and the pending defaults and some of these very, very low cap rate, multifamily assets that were bought with floating rate debt. It's a pretty deep bench. So and I'm expecting that we're going to see more of both of those as the year progresses.

Jay Mirostaw

Great. Thanks. That's all for me.

Operator

Dylan Burzinski, Green Street.

Dylan Burzinski

Yes, thanks for taking the question. And I appreciate your comment sort of on longer-term leasing expectations but as we think about what's embedded in the current occupancy guidance, is your sense that causes a 700,000 square foot leasing volume per quarter is going to be more of the norm here as the economy works its way through a lot of the uncertainty, or do you think that the level seen earlier last year is more representative of what's embedded in guidance?

Jordan Kaplan

Yes. Well, I mean, actually, we averaged last year, I think 800 or a little over 800,000 square feet. I'm at I'm hopeful, but I'm not gutsy enough to say that we're willing to put in guidance some kind of big, big recovery. And that's why, as we said, we probably hopefully we in terms of the leasing and what we thought would happen. I mean that's in our guidance and you have it now, but I'm hopeful, but just like everybody's kind of watching overall economy, which which won't be any different for us. It will be for the rest of the country.

Dylan Burzinski

And then as you as you think about acquisition opportunities, you're saying that we may be in the early innings of things. But just curious, internally, as you guys think about deploying capital, is there some sort of yield on cost or IRR that would really get you guys excited and if so, can you kind of walk it's sort of how you guys are thinking about that?

Jordan Kaplan

I don't look at each opportunity is unique based on the rent roll. What the property is and the metric that gets us really excited right now is cost per square foot is going to be very attractive. And then it's a function of taking what we believe in the leasing and the debt market and figuring out what that IRR is going to be. But the opportunities are certainly going to be richer than they were a pre interest rate environment high.

Dylan Burzinski

Appreciate it differently.

Operator

(Operator Instructions) Paul Romano, KeyBanc Capital Markets.

Paul Romano

Great. Thank you. I'm just going back to the retention rate here. I know based on your occupancy guidance, your retention seems to imply about 62%, which is marginally below your historical, Randy mentioned from last year, new leases doesn't come online in 24 or if new leases slows, the required retention rate would would need to be increased. So I'm just wondering how curious and how confident you are on that and it's going to do that.

Jordan Kaplan

Yes. So of course, this year includes so the Warner discovery move out, which is, you know, 2.5% of our square footage so that that's built into the range we gave you. So that's going to skew the retention average for this year. Down lower than it normally would be in the high 60s retention rate.
That's our historical average. It's over a long period of time, but something that large will skew this year so that's certainly taken into account beyond that one known move out. As John mentioned, we're keeping our leasing assumptions pretty in line with what we've seen the last couple of quarters and we're not assuming kind of any ramp up from here.

Paul Romano

Okay. Got it. Thank you. That was helpful. And then just the I wanted to your thoughts on the future of UCLA in your portfolio, you they've made a pretty big purchase at Westside Pavilion mine. They do have a number of expirations coming up over the next couple of years. So want to get your thoughts on on what their future looks like with you guys?

Jordan Kaplan

Well, it's a lot of different leases. I cannot I know the mall deal is not all new so it's for me, it's a whole new program. The whole state is funding a new center for research and immunology. And then also there's a completely separate set of bankers that are fun funding a brand new research of one 500,000 feet that are 70,000 feet with brand-new whole research center for quantum computing.
And so that's not in any sense a drain of anything, even even from campus, I mean from anywhere in terms of just in general use Chili's plans and what they're doing. It's very hard to tell all those leases are either decisions about those leases are independently made by the people in those departments. And so it's hard to say one thing or another, madam.

Paul Romano

Okay, great. Thank you.

Operator

Peter Welford, Jefferies.

Peter Welford

Thank you. I just wonder if you could provide an update. Have you had any initial tenant conversations about potentially backfilling that space in Burbank. Is it more likely to be? Do you think you do it as one large lease or is it something you anticipate having a breakup in, it's a smaller midsize leases?

Jordan Kaplan

Well, I mean, of course, we're doing showings and there are certain lead tenants there. I think there's reticence to committing. But I mean, I think that will happen. So I'm not nervous about leasing up the building. And all I can say is I hope it's not one large lease again, because we've spent 30 years talking about that lease every 10 years when I can have, I'd rather have it be multiple leases and be done. We've done talking about, but I'm not sure how it will end up. There's there's obviously large tenants in that market.
Thanks. And then one other would be besides the move out of discovery there, any other kind of big components in the same-store NOI growth guidance to consider sort of what or what are sort of the other swing factors there aside from that move out, and I don't know again our same stores, but Tracey calculation. I couldn't make a good analysis of that for you here. You could give Peter, I guess later and trying to figure out if there there's some now I don't think there's anything unique and driving that not is driving that guidance.

Peter Welford

Got it. Thanks. And also it is studio Plaza is not included in the same-store.

Jordan Kaplan

Okay. So it's mainly the occupancy drag that that's kind of it's leading to the negative growth there, but other than discovery.

Peter Welford

That's great. Okay, thanks.

Operator

Camille Bonnel, Bank of America.

Camille Bonnel

Hi, everyone. Can we get your thoughts on the media sector and how its recovery is trending since the strikes have been resolved? Just based on the conversations you're having in the pipeline.

Kevin Crummy

I mean, I know I don't know that I have the greatest. I mean, I don't have a lot of thoughts.
I mean they're there and try and sometimes it can be I'd say this and we are getting the strikes resolved perhaps has to be a good thing on the margin. We do certainly have entertainment clients and tenants and so some of that stuff did slow down a little bit on the margin during the strike. So I think it's got to be a good thing for us going forward. But I don't know that it's a huge needle mover in the near term in others. There's still caution in the market as Doron has been describing, but I think happy that those are resolved. We need those tenants to grow.
And hopefully that will happen here when when the economy gets a little better, I think we had one large entertainment tenant. We know they're leaving. So I don't think they have any other big entertainment tenants that are big ones. But we do small.

Stuart McElhinney

We didn't handle tenants, small leases with writers groups and other small intent.

Kevin Crummy

Yes.

Blaine Heck

Yes.

Camille Bonnel

Just trying to get a sense of like the smaller guys are coming back to the table to have conversations looking to start new projects, just trying to get a sense if anything's changed since then. I mean, you just saw W. I mean, you just saw renewal the tenant in Beverly Hills that we renewed was an entertainment tenant Got it. And for my second question, I was just wondering if you're able to provide any additional color same-store NOI outlook for office versus multifamily?

Jordan Kaplan

Yes. We don't break that out between the two. I think that the recent trends that you've seen or would be helpful for you to think about going forward of residential has remained pretty strong and we're dealing with the occupancy drag that that's hurt us a little bit. So that will be the case for 2024 as well, I'd assume.

Camille Bonnel

Okay, thank you.

Operator

Bill Crow, Raymond James.

Bill Crow

Good afternoon. Just two quick questions. First of all, is there any real organic or non-organic, I guess demand in your markets in other words, is it just a market share game still? Are you seeing actual new base demand?

Jordan Kaplan

I think we I don't think from large tenants, we're seeing new space demands, but I think we're seeing kind of from the smaller ones. I think we're seeing a lot of business as usual. But larger ones for us are really like over 10 or 20,000 feet. So it's impactful when they when they don't grow or don't have or don't renew them.

Bill Crow

Okay. Second on downtown, and I know it's not your market, but but the flow out of downtown can be helpful. Have we reached bottom on this downward cycle or is it still is the market still declining?

Jordan Kaplan

Well, downtown, most of downtown went a Century City or a couple other deals, and it was probably pretty positive. It was pretty positive for Century City. I'm not sure of how this cycle downtown will play out. I mean, pure there, you'll maybe have a better better feel on IT. I mean, there's a lot of people are focused on getting that area recovered, but there's a lot of tenants that have said, you know, for better or worse, my next 10 years is going to be on the west side is not going to be in downtown. So I know that that that's certainly going to have an impact.

Stuart McElhinney

I don't know how that's going to play out to see you're still seeing and out-migration from Delta.

Kevin Crummy

I don't think we've been up. I mean our markets have been a beneficiary. I'm not sure that we've been a primary beneficiary. So what we're in particular saying, I cannot I cannot say that we're seeing anything meaningful from that.

Bill Crow

All right. Thanks for the time.

Operator

And this concludes our question-and-answer session. I would like to turn the conference back over to Jordan Kaplan for any closing remarks.

Jordan Kaplan

Yes. Well, thank you for joining us, and we look forward to speaking with you again in a quarter.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

Paul Romano

And yes, no, no, no, start. Yes, no, no, no, yes, yes. Good afternoon. Yes, yes, yes, yes, yes, yes, yes, yes, yes, yes, yes.

Jay Mirostaw

Yes. Yes.