Q1 2023 Douglas Emmett Inc Earnings Call

Ladies and gentlemen, thank you for standing by welcome to Douglas Emmett as quarterly earnings call. Today's call is being recorded at this time all participants are in listen only mode. After management's prepared remarks, you will receive instructions for participating in the question and answer session.

I will now turn the conference over to Stuart Stuart Mcelhinney, Vice President of Investor Relations for Douglas Emmett. Please go ahead.

Thank you joining us on the call today are Jordan Kaplan, our president and CEO , Kevin Crummy, our CIO and Mona Giesler our CFO .

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.

For a more detailed description of some potential risks please refer to our SEC filings, which can be found on 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 I'll turn the call over to Jordan.

Good morning, everyone. Thank you for joining us.

Our revenue during the first quarter is up compared to the first quarter of 2022, but the increase was offset by higher operating costs and interest expense.

The slowdown in the leasing pipeline that we mentioned on our last call resulted in a decline in our leased rate, even though we actually signed more leases in the quarter than usual.

We continue to have strong demand from tenants under 10000 square feet, who dominate our markets, but because larger tenants have become more conservative in response to recessionary concerns we leased less total square footage.

We have reduced our assumptions for average office occupancy and same property cash NOI.

The national economy is challenging for all of us, but for some office C. B DS remote work oversupply and overwhelming reliance on large tenants and concerns about reduced urban appeal seem to pose additional obstacles.

As I have said before our market supply constraints smaller tenants short commutes and lower reliance on public transit supported relatively high leasing volume and utilization during the pandemic.

As the pandemic east leasing and our markets was very strong until the fourth quarter of 2022 when larger tenants became more concerned about a recession.

While economic downturns are unpleasant they are not new to us we remain confident in the resilience of our portfolio and in our ability to navigate these challenges we've guided our company through four recessions and always found the silver lining we repurchased 6 million shares of our common stock and <unk>.

March and early April and we are well positioned to take advantage of other opportunities created by the current economy.

With that I will turn the call over to Kevin.

Thanks, Jordan and good morning, everyone.

Our balance sheet and cash flow after dividends are strong.

We have no outstanding debt maturing until December 'twenty, 'twenty, four and almost half of our office portfolio remains unencumbered.

We developed our debt strategy to protect our company during times like these.

Our debt is all non recourse secured by first trustee mortgages at the property level.

We have no corporate level debt and no corporate covenants.

We have a perfect 30 year debt repayment record and are confident we will maintain it during this downturn.

Our cash flow after dividends remains one of the best in our industry and we use less than half of our F O for dividends, leaving us with substantial liquidity.

Our multifamily projects continued to perform well and lease up at a good pace.

At Bishop place in Honolulu.

Our office to residential conversion project, we just delivered another floor of apartment units and expect to deliver three more floors by year end.

Only two unconverted, Florida will remain which are currently leased by office users for several years.

At the landmark L. A in Brentwood, we have now leased over 70% of the 376 new units that we began delivering in April last year.

With that I'll turn the call over to Stuart.

Thanks, Kevin and good morning, everyone smaller tenants continue to drive our leasing in Q1, we signed 235 office leases covering 625000 square feet, consisting of 168000 square feet of new leases and 457000 square feet of renewal leases.

Our leasing spreads during the first quarter were positive 6% for straight line and negative six 7% for cash.

Well this is somewhat better than recent quarters, we don't expect to achieve meaningful gains in office rental rates until our leased rate begins to recover.

Our leasing costs this quarter were $5 37 per square foot per year.

Which is a bit lower than recent quarters and well below average for other Reits and our benchmark group.

Turning to multifamily our portfolio was 99, 3% leased at quarter end and rents continue to roll up across our portfolio.

With that I'll turn the call over to Peter to discuss our results.

Thanks, Stuart good morning, everyone.

Turning to our results compared to the first quarter of 2022 revenue increased by five 7%.

Reflecting the addition of new units to our multifamily portfolio, which has increased by 617 units.

And higher in place office and multifamily rental rates.

<unk> decreased by 5% to <unk> 47 per share primarily as a result of higher interest expense on our floating rate debt.

<unk> decreased 13, 5% to $81.4 million, although our leasing costs per square foot remain low we paid the tenant improvement costs. This quarter to move in a large number of tenants with whom we executed leases last year.

Same property cash NOI decreased by 1.5% with higher rental revenue and parking revenue offset by continued inflationary pressure on utilities and wages.

Our G&A remains very low relative to our benchmark group at only four 3% of revenue.

During late March and early April we repurchased 6 million shares of our common stock at an average cost of $12 32 per share.

Turning to guidance as Jordan said, we are adjusting our assumption for average office occupancy, which we now expect to be between 81 and 83% for the year.

And for straight line revenue to be between one and $3 million.

These adjustments are offset by the benefit of our stock buyback. So our guidance range for full year F. O remains between $1 87, and $1 93 per share.

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.

Thank you we will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone if youre using a speakerphone. Please pick up your handset before pressing the keys if at any time. Your question has been addressed and you would like to withdraw your question. Please press Star then two.

And again in consideration of other participants please limit your queries to one question and one follow up.

At this time, we will pause momentarily to assemble our roster.

And the first question will be from Alexander Goldfarb from Piper Sandler. Please go ahead.

Hey, good morning.

Good morning out there.

I have.

Hey, how are Ya Jordan. So two questions first on the stock buybacks are I believe you have a floating rate debt, where the swaps burned off yeah. This year. So what are your thoughts on instead of the buybacks using that cash to pay down you know those floating rate loans to try and reduce the.

The impact of rising rates.

Well I.

I mean, we have I actually think the floating rate debt is that a good margin and its pretty good that the question is just when do we want to re swap. It I think there is going to be coming off telling you. We swap. It if you look a little longer out not including this year I think it swaps down at it back to a reasonable rate almost already.

So I'm not anxious to use cash for that I think theres better better uses for it and that's very good that with a lot of time left on it.

I like to imagine something.

A N a lead in.

Two that are called Stuart section, it said that Mona as our CFO , which actually Peters our CFO . So just some behind the scenes as that.

Stewart doesn't like to Rerecord his opening over and over again. So he said use my last one you didn't mean lose use my last one from the Dark ages. He actually just met use my last one from the last year. So they obviously pulled one from four years ago, but anyway, maybe nobody caught that except for us now.

What's your second question second question and so the second question is.

When we were out in Hawaii at the Investor event I, you were talking a lot about how downtown L. A tenants are moving to the west side are not enough space for all these tenants that are coming and yet you're also talking about are the large tenants being the weak spot in your portfolio. So small tenants very active large tender.

Not active and I'm just curious how we rationalize that if downtown L. A tenants are moving to the west side. Those yeah, I would think our larger tenants. So why wouldn't we see some increase in large tenant activity in your portfolio as well.

So most of that increase has been reflected in century city, they're actually a bit larger than even we can accommodate so now century city I think almost all the fall sports and the towers and some of those other buildings are gone. We don't have a lot of blocks as basic winter to us large tenant is 10 to 40000 feet.

And you know when you get over 20, that's a full floor already right and so 10 to 20 is more I mean, we don't have we have full floor tenants plenty of them, but but but nothing nothing close to the way century City operates now they moved in.

If I move to century, I think century city is very full right now and we're hoping that some will move in it like Beverly Hills and West what are the other places for those people tend to head and maybe there's a little bit of activity there, but in those markets. We have not had the blocks of space that would have accommodated someone that's looking for 50.

Thousands feet when we were just haven't had it.

Okay, but you would expect some spillover eventually.

Yeah well.

What I think is that.

More.

There, there's definitely tenants moving I mean, you kind of look at CBA report or some other reports that tenants aren't moving from downtown to the west side.

I don't know if it's small one you know smaller ones here I have a great reason to be there they probably live over in.

Pasadena or in that area and so it's a big deal for them to make the hop all the way across now they might probably like these larger ones are having trouble getting people to come into the office downtown So they're saying, we're moving I mean, the anecdotal stories that I've heard as law firms set them called everyone back in and they're saying I'll come back in but we don't Wanna be down.

Yeah. So they are literally imagining leases are still paying on that math and their leasing space.

In century city, and they're saying, Okay, now everybody back and so that.

Yeah, I think there will be some spillover.

Bank hope, whatever but I mean, they're definitely moving our way.

Okay. Thank you.

Thanks, Alex and the next question is from Camille Banal from Bank of America. Please go ahead.

Hi, Good morning can we focus a bit more on what you're seeing in the Olympic corridor and right what sub markets.

The reasons.

I'm kind of it's been shown cheer leasing teams when they move out.

Hey, Camille Yeah, I mean, our tenants as you know we've got almost 3000 tenants and the list of reasons. They move out as it was a long list of them you know they're growing they're shrinking there there you know partners retiring or they're breaking often into two different firms. It's a huge list of reasons.

It's kind of that same list of reasons that we've always seen so no noticeable shift in you know our trends to point to there.

Some submarkets are you mentioned, there's some specific submarkets I know we've had some movement around.

And some of the Submarkets, but our submarkets are so small that theyre sensitive to small changes. So we really internally you think it's more useful to focus on our kind of our major regions the west West L. A valley in Hawaii.

Because individual submarkets really can bounce around a pretty easily with small changes.

Yeah.

Okay and.

I guess as my follow up question.

The small tenants seem to be very active in your markets are you tracking enough demand to keep up their snap all of leasing momentum through 2023, and if you have any comments on <unk>.

Tenant watch list.

Okay.

The reason is that Smith S T E P.

Hey, Shannon.

Okay. So.

As we forge Shadow last quarter, we said, we saw the pipeline slowing down and it did slow down and you're seeing it. So this is if you're asking me if it's going to slow down more than Mezz. No. We are not saying that we're seeing this amount of activity, which is still a good amount of activity I'm in over 600000 feet, but not anything to.

What we're used to.

But we wanted to be closer to that 800 that we want to be around 800000 feet and we get four quarters of a million feet. So yeah. It is substantially off but I don't consider it I don't we don't view it as being able to go off a lot more.

What was your second your second question.

If theres been any changes to your credit tenant watch list.

You know their pet so 10 tenants are.

I guess, there's two versions of that so tenants are still chipping away and chipping away and paying that are kind of the hangover group from Covid and that number is down down down and I think the last time I saw that number it was $17 million.

And and.

And if you're asking if more tenants are going on our watch list.

Yeah, a little here and there, but not much not not no not noteworthy amount now.

And the credit of the 10 the credit attention is very good and I don't know if you would recall, but even in Covid went beyond.

10% of our tenants weren't paying because the state said you don't have to pay we kept saying that these people can all pay that's not going to be where we end up.

I think where we are actually going to end up over those but you know whatever that two or three years of COVID-19 as maybe like 20 basis points forget about 10% and it's gonna be almost nothing number.

And the reason for that is as we've said it's smaller tenants. They are very good credit and by the way they sign on the lease.

Personally so.

Yeah, not a lot of default are in our portfolio over the long haul and I wouldn't expect a lot right now.

Thank you for taking my question.

Alrighty.

And the next question is from Blaine Heck from Wells Fargo. Please go ahead.

Great. Thanks, Jordan several of your office REIT peers have expressed optimism this quarter around the return to office mandates that some of the tech companies that were really quick to go fully remote during the pandemic have now implemented.

You know I know you guys don't have much exposure to tech, but can you talk about whether you think this could be beneficial to the L. A market in general and your portfolio in particular or maybe not from those tenants are exactly but but other supporting kind of smaller tenants.

Yeah.

So.

I love seeing people come back to work.

And I love, saying those tenants, bringing people back yet.

And and I think it's gonna be it's very good for me in L. A economy in all economies, where large tenants that didn't really have people stay at home and whether it be San Francisco or New York or anywhere.

If you wanted more specifically talk about our portfolio.

I you know I would love to say, it's gonna be like a big deal and blah blah blah, but we've been over 80% for a long time, maybe we're going to go to 100 or 95, I don't think it's been getting in a way of leasing I don't think it's been getting into way if anything for it quite frankly.

Even our parking I know, we can't sounds to me a little analysis of visitor blah blah blah.

We were able to like more spot track. It. It's it's it's it's fast and I noticed that on the last one Ken sent me our visitor is back to full like back to the 100% level of that of that it was.

Pre pandemic so.

I don't I guess I I'd like to say that would be a good benefit to us, but I actually think the entire issue that we're facing is is Ah Ah Ah Ah.

I don't think I want to call it a recession or whatever the real estate recession that we're having or the conservative way that people are approaching expecting a real estate recession. That's caused a slowdown in leasing I don't think there's anything else I think it's not dissimilar from the last four recessions that we've.

Been in it since we've been running this kind of candidate I've been running this company.

And and we have to work our way through the recession and as we come out of it I'm sure will come out extremely well.

Okay. That's really helpful color switching gears real quickly to the investment front can you talk about any recent conversations you've had with your capital partners.

Or they're willing and interested in acquiring office or multifamily assets and maybe what sort of return requirements or return targets that they have in this kind of environment.

Sure.

Hey, Blaine, it's Kevin we've been having those conversations and having meetings with their capital partners because as we've said on previous calls.

We are super anxious to deploy some capital in this market and there are not a lot of people that feel the same way. Although there are some so it's gonna be lower competition.

And our office and multifamily in West L. A or are both okay.

With our partners and so.

You know, we've all adjusted our return expectations in accordance with interest rates and so it's it's not going to be as it was but we're looking forward to some opportunities coming out and deploying capital.

Great. Thank you guys.

And the next question is from Michael Griffin from Citi. Please go ahead.

Great. Thanks, maybe to piggyback on blames question there on capital allocation, you've talked about being kind of.

Ready to look at opportunities I think we've seen some stuff, it's mainly been in like Orange County, So not exactly your wheelhouse sort of trade at a discounted valuation anything youre seeing from the transaction market are you talking with your contacts out there you know I know you've got prop you in west L. A so that kind of helps the supply front and then Kevin just on you know you talked about off.

The multi being okay with your partners just one of these screen better as the other for potential investment opportunity. Thank you.

Sure so well I think that there's more certainty around the demand for multifamily in the near term and people are trying to figure out the demand for the office from a tenant perspective, and an underwriting perspective so.

You know I would expect that that multifamily is going to trade at a tighter price range then than office and you know so far we haven't seen.

Anything that really fits the profile of the assets that we're looking for and what we look for specifically our <unk>.

Assets with a smaller tenant base may be a problem in the rent roll or something that needs to be repositioned, where we can deploy our operating platform into the asset to maximize its potential and we just haven't really seen that come out yet, although our you know.

I'm optimistic that towards the latter half of this year, we're going to see some opportunities.

I I really feel like.

I won't be surprised to see opportunities in residential I'm, just say it that way I think it's still trading pretty tight.

I think we have a better chance of making some great deals in the office if you just.

You know because we have a lot of conviction around it and that's where you see the weakest conviction from like the broader capital markets, which means that I know, it's not fun to go against the tide, but that's where we excel.

Thanks This is Nick.

Nick Joseph here with Michael just a question on occupancy I think our guide is 82% average occupancy for the full year can you just talk through how you get there just because number one Q1 did.

Well you want to talk about it or you want me I mean, so we're so what happens is.

This quarter, we look at what happened in this quarter in terms of leasing and we can start projecting out pretty good because occupancy is a function of leasing.

And so when you got a well we didn't hit goals for leasing and therefore, we're gonna be Iraq them, our average arguments who's going to be lower I mean, it's actually just kind of calculating mouth out.

Yeah.

Great. Thanks.

And the next question is from Steve Sochua from Evercore ISI. Please go ahead.

Great Jordan, Thanks for clarifying about Peter I thought I missed an announcement this morning about his resignation.

Oh by the way motor stalwarts here too I mean.

So maybe she was also surprised to hear that because she actually asked to do this wage hike what.

But.

Anyway, Yeah that was weird.

Thank you so coming back to leasing you know Jordan I know you did a lot of renewal leasing, but you know clearly the linchpin and getting occupancy and lease rate up as is the new volume and you know based on your comments.

It sounds like it's less of an art T O problem of more of an economic outlook problem and then to the extent that that doesn't really clear off this year or does that sort of suggests that the leasing volume you did in this quarter on the new side is kind of the new.

Run rate, if you will until until the economies really on firmer footing.

So probably what you said.

I hope not but you certainly understand the situation, let me say it that way I hope that's not true I know, we just keep accelerating our push on the new deal and the leasing and we're doing you know, we're constantly adding and doing things.

I actually think that it was oddly low this quarter and that there'll be that we probably for the next three quarters, well I'm hopeful that we'll do a little better usually when we have a very low core like this we get some recovery I think this number is lower than our run rate that I would expect an IRA and I and it was lower office.

Just said a second ago caused us to adjust our occupancy.

So I'm not expecting well basically what we're expecting we gave in our new and our and in our adjustment to the assumptions.

Which would probably not be this run rate of this quarter all for the rest of it so.

I I I bet, you certainly understand it.

But I think we will get some recovery over the next four quarters three quarters, Okay, Great and then on the capital deployment side, you know I'm I'm sort of just wrestling with the the share buyback I sort of understand at the you know what the implied cap rate, where you are where you trade is probably high single digits, maybe on certain days pushing low double.

<unk>.

And you know how that would stack up against the new deal and I agree with your apartments, probably won't come cheaply, so you'd have to be looking at office.

And I guess you already know what you own. So I mean can you envision finding deals that are as good as what you already own to make them, even more accretive than buying back stock.

Well I can envision it I can envision a lot of things now I know some deals.

Ware.

The.

People in that building are anxious to have us come in and take over.

Okay. So so I think there might be some deals out there where people are saying you know.

Maybe I'm not getting top dollar for this but I'm not going to sell 100% of it at all so a big chunk to you, but we just don't want to run this anymore.

And that is that there might be opportunities there that are very good opportunities for us.

Very good and that's frankly, a lot of what kevin's focusing on and he's traveling and doing the whole deal around so.

So you know.

We you're right to say, we own a lot and we own a lot of what we own is the best of whatever market happens to be in.

But there are still deals out there deals we'd like to do and I think there's still there's a few groups out there that.

Our.

Kind of have an attitude that I just described and that's really the opportunity around office that I was talking about.

Yeah.

Great. Thanks for the time.

Thanks.

And the next question will be from Dillon Brzezinski from Green Street. Please go ahead.

Hi, guys. Most of my questions have been asked already but I guess, just curious given the news coming out of Hollywood and the strike seen there do you guys expect that had any impact in your guys portfolio.

Still in its pure.

Probably shouldn't have much impact where we we don't tend to have you know a lot. That's you know that's a factor we get a little bit of a temporary production space you know when it shows up and running and you know that that might go away, but it's it's it's pretty ancillary to our overall business.

And then you guys have any update on sort of the discussions that youre, having with Warner Bros. Given their exploration in the latter half of next year.

I don't think grab.

How much of an update I mean, I said are.

The expectation is that they move out although they haven't said, they're doing that and I think theyre going through a lot right now and so it's you know maybe they're not you know.

Their plans are changing fast now on the other side of the coin I also said we're marketing the buildings.

That's it.

Economy gonna be it until they come to us.

They're not under any pressure to say, we're moving out because they didn't have any.

So there.

There are you know they're going to play the end and see where they end up I know there you know.

At this moment the reason, we expect them to move out is because they are the.

Same announcements that you guys are able to read about how hard they're working to cut costs, but you know if a company just continuously cuts cost then they would go away. So at some point theyre going to change.

Change their.

Their view and say weird now we're rebuilding that.

For that and we don't know where that's going to end up.

Do you have a sense of the utilization of the space today.

I think the utilization is extremely low.

Barely any but I think that their utilization.

Like every office space, Yeah, I mean, I I E. If people start Cai you know they the studios have been very slow to bring people back into office space I would just say it that way.

Okay. Thanks, guys.

And the next question will come from Tayo Okusanya from Credit Suisse. Please go ahead.

Oh, yes.

Morning out there.

Just a quick question in regards to the swaps that are going to be dropping off I think the mindset before was we're just going to let the underlying variable rate debt notes is that.

Still kind of the idea given again some of the latest news from the fed around you know the policy.

Hey, does the fed do their announcement, yet or did they go Oh, yeah, okay great.

Plenty of closet.

Oh.

Well, that's new news to me I just heard it just now so I have to think about it.

I actually I think.

I D.

There might be some opportunities considering we have some very good debt in terms of the margins to to kind.

Kind of.

But this year play out but its forward swap maybe starting earlier next year that number is down and.

Three range, you know put our swaps more in the low fours, which is fine and we could swap out and start fixing some of those can start layering. It back in my I mean, our intention not to just put the whole company to floating that's of course.

But I also as I said in the past I don't like.

And then you know nobody flies a quite during the storm you know, even though you need to win to fly a kite set so I like to see.

Minimal time see how things settle a bit before we do something.

Sounds good thank you.

Hum.

Again, if you have a question. Please press Star then one.

The next question is a follow up from Michael Griffin from Citi. Please go ahead.

Hey, great. Thanks, So if you could touch on the Warner Brothers are at least a couple of questions ago. I'm curious I know you have the conversion in Hawaii, I think youre doing it yourself, you said of Atlanta Mark.

Is this a candidate for conversion I mean apartments might be you know pretty hard because of the floor plates, but like could it be converted to a movie studio like don't they felt like they felt Larry king around there and in that general area, just just a thought thanks.

Well.

Is that.

I mean, the floor plates actually this that building can be converted to apartment building, but I can't imagine a scenario in which we do that I mean that Burbank media district, while during the recession and what's going on it.

It seems to be shot showing some weakness and maybe because of the new construction that happened there, that's even showing more weakness, but I'm going to tell you that for.

Like 25 years, it's been the strongest office markets and O L. A county, I mean, it's been a very strong office market, maybe downtown Santa Monica.

And maybe just have Beverly hills, but but it's a really solid office market. So I can't imagine unless you have a building down there that's really like.

Almost dysfunctional I don't see a lot of the spread between office rents and.

And apartment rents being a wide enough gap to encourage anybody to do a convergent frankly, I think out there auctions are probably higher than apartment rents.

So I mean, just because we have a tenant moving out we're going to have some vacancy there that's it.

Miles from the idea of saying is the market where can we do better long term of the conversion and especially in the immediate dress shirts.

But maybe to that point like if it's a big single tenant user of that building I mean, they've got like 430000 square feet or whatever how hard is it to cut up the building.

Like the smaller kind of.

Bread and butter so to speak.

It did floor plates are very good for being broken up the building can be broken up quite easily theres larger tenants. There, though I mean, you know we could do a few for some smaller tenants. My guess is you're still dealing with tenants that are 50 to 200000 feet and that would be perfect. I mean did you.

Do you know three or four tenants, it's more what I'd like to go to so where NOLA. It I mean, the reality is there really are only large tenant oh, we have one other that's largish at that so.

WMA, but there right in the Nova Beverly Hills, which is like the heartland to small tenants. They just happen to have grown big in one of our buildings. That's it that's where the list stands.

Alright, that's it for me I appreciate the follow up.

Thanks Les.

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

Well. Thank you all for joining us and we look forward to speaking with you.

Again in a quarter.

Thank you Sir the conference has now concluded. Thank you for attending today's presentation you may now disconnect.

Yeah.

Okay.

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