Douglas Emmett, Inc. (NYSE:DEI) Q1 2024 Earnings Call Transcript

Douglas Emmett, Inc. (NYSE:DEI) Q1 2024 Earnings Call Transcript May 8, 2024

Douglas Emmett, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you for standing by. Welcome to Douglas Emmett’s Quarterly Earnings Call. Today’s call is being recorded. At this time, all participants are in a listen-only mode. After management’s prepared remarks, you will receive instructions for participating in the question-and-answer session. I will now turn the conference over to Stuart McElhinney, Vice President of Investor Relations for Douglas Emmett.

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. During the first quarter, we leased 1.2 million square feet of office space, which includes renewing a 250,000 square foot lease with WME through 2037. Even excluding that lease, we still did 950,000 square feet of leasing. New leasing was just over 200,000 square feet. Still not quite enough to drive positive absorption. As we said in February, we are not assuming a significant increase in new leasing demand this year. However, our strong renewal rate tells us that our existing tenants, especially the smaller tenants on which we have built our portfolio, are not reducing their space needs. Despite challenges in new large tenant debt demand,, our office leasing economics continue to perform well and leasing concessions remain low.

We are still signing leases that are more valuable than the prior lease for the same space with straight line rollup this quarter over 23%. While that number benefited from the WME lease, even excluding that lease, we achieved straight line roll up of over 11%. As we mentioned before, our average leasing costs since the pandemic have actually been lower than our prior long-term average and remain below that of other office REITs. We are well positioned to navigate this downturn and emerge stronger in the next growth cycle. I am confident in the long-term performance of our portfolio as our markets have excellent supply constraints and diversified demand from high growth industries. With that, I’ll turn the call over to Kevin.

Kevin Crummy: Thanks, Jordan, and good morning, everyone. Now that we have stabilized our landmark L.A. residential development and are waiting for the expiration of office leases to finish the final two floors at our office to residential conversion in Honolulu, we have shifted our focus to the fire life safety upgrades at Barrington Plaza. Office sale transactions remain slow in our markets. However, we are starting to see some sales in surrounding markets and hope that similar opportunities will soon come available in our markets. We remain ready to pursue acquisitions that fit into our strategy. With that, I will turn the call over to Stuart.

Stuart McElhinney : Thanks, Kevin. Good morning, everyone. During the first quarter, we signed 214 office leases covering 1.2 million square feet, including 202,000 square feet of new leases and 987,000 square feet of renewal leases. This was the second highest quarter of renewal activity in our history. As Jordan mentioned, office rental rates remains strong despite the challenges in new large tenant demand. This quarter, we achieved a 23.8% increase in the value of signed leases. Our in-place office rent per square foot is now the highest in our history. Our high fixed annual rent increases mathematically lower our cash leasing spreads. Though the WME lease signed this quarter lifted our average cash spread to a positive 1.9%.

Even excluding the impact of the WME lease, straight line spreads this quarter were positive 11.6%. Our total leasing cost during the first quarter averaged $6.11 per square foot per year, slightly above our recent average due to some larger renewals. Leasing costs on new leases were only $5.64 per square foot per year. Below even our recent trend and well below the average of other office REITs. Our residential portfolio remains essentially fully leased at 98.9% and is generating healthy rent roll-ups. With that, I’ll turn the call over to Peter to discuss our results.

Peter Seymour : Thanks, Stuart. Good morning, everyone. Reviewing our results. Compared to the first quarter of 2023, revenue decreased by 2.9% as increased revenue from new residential units, higher in-place office rents and increased parking revenue were more than offset by lower office occupancy, lower tenant recoveries, and the removal of Barrington Plaza Apartments from the rental market. FFO decreased by 8.7% to $0.45 per share, primarily as a result of higher interest expense and lower revenues, partially offset by lower operating expenses. AFFO decreased 8.2% to $74.7 million and same property cash NOI increased by 0.7% reflecting lower expenses including some property tax refunds. Our G&A remains very low relative to our benchmark group at only 4.7% of revenue.

Turning to guidance, first quarter FFO per share was above expectations due to lower operating expenses and we expect straight line revenue to be higher during the balance of the year. Nevertheless, we have left FFO guidance for the year unchanged because we expect the operating expense savings and higher straight line revenue to be offset by higher interest expense. As a result, guidance for full year FFO remains between $1. 64 and $1.70 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.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Steve Sakwa with Evercore.

Steve Sakwa : Jordan, I know given the small nature of the tendency, it’s hard to really discuss much of a pipeline because it’s a little bit more like apartment leasing. It happens pretty quickly. But can you maybe just talk about kind of what you’re seeing in the marketplace and what are some of the upcoming plans and tours looking like for retenanting the Warner Brothers known vacancy up in the third quarter? Thanks.

Jordan Kaplan : Sorry about the delay. We had trouble getting on the website, but yes, so in term, I’ll take them in reverse. In terms of Studio Plaza, they move out in two quarters and we’re going to probably do some work to the building. And we are having showings and we’re working on releasing it. And my hope is that we release it to a multitude of tenants and not a single tenant so that it’s no longer kind of hanging over us away. But it’s a great building and I’m confident we will lease it up. In terms of the leasing pipeline, I don’t know whether — that’s a tough one, because the small tenant leasing pipeline is better than strong. I mean, it’s great. We did nine — to just leave out the large lease that we did, 950,000 square feet is just a fantastic amount of leasing.

But it’s really being driven by our small guys who are doing a lot of renewing and even new deals. But because of some larger ones, we’re just not getting the one third of new, because when a large one moves out, we’re not getting the one third of new that we need to make gains. And that’s what’s happening. And in terms of taking temperatures, I can tell you large tenants are very cautious regardless of whether you believe we’re in a recession, going into a recession, or it’s simply because the cost of capital and new investment has become so high that they’re just improving earnings by shrinking their expenses as opposed to driving for new business or creating new revenue.

Steve Sakwa: And then maybe the follow-up question, I don’t know, Stuart or Peter, if you think about kind of where guidance is, and you look at what you did in the first quarter, it kind of implies something like a $0.41 plus or minus quarterly run rate moving forward. And I realize there’s a little bit of seasonality in expenses, but as you think about the cadence of FFO over the next couple quarters and really the exit rate, how do you think about sort of where we’ll be at the fourth quarter, moving into ‘25?

Peter Seymour: Yes, I mean, it’s Peter, Steve. So look, I mean, you’re asking for quarterly guidance. We don’t really give quarterly guidance, but that there are a number of factors that affect us in the tail end of the year. The studio plaza, we mentioned, so they move out, right? So that’s a negative in the last quarter. And then, of course, Barrington Plaza is the other factor. You see a couple of those. You also see — as you saw, we raised our interest expense guidance and that reflects expectations. That interest is going to be higher over the remainder of the year. So I think that can give you a sense of where we’re headed.

Operator: The next question comes from Anthony Paolone with JP Morgan.

Anthony Paolone : I know this maybe sounds like quarterly guidance, but just thinking about your occupancy, because you kept the range the same for the year, but you also talked about just the retention coming in stronger. Any thoughts on like, when that troughs or if there’s a part of that range that you feel a bit more comfortable with at this point? Or has anything changed there?

Jordan Kaplan : I think we’re pretty comfortable with the middle of the range, but that’s why we gave a range. I’ll tell you, I don’t want to say this because we’re in the middle of the year, but I had always thought this was the year to hit the trough. But I’m still — maybe probably because I was still a little surprised that inflation backed up, but then I was unsurprised that we had lower than expected new hiring that just came out. I don’t think we have — you probably even have better information than we have because I really do feel like we’re floating on the larger national economic trends. I mean everything that’s impacting us, and I said, important point, which is that we’re not really impacted by — we’re not getting hit with work from home.

We’re not getting hit with oversupply of buildings, and therefore, we’re just going to take a long time to absorb that new space and old space and all the rest of it. We just have one simple thing happening, which is, in this economy, large tenants are like scaling back. And they’re not signing lease. I can’t believe — they can’t stay that way. I mean I know they have to be in business and make money. So we’re just waiting for people to have confidence in the economy and the cost of putting out new capital will be good, and then you’ll — then I think you’ll say, all right, we’ve hit a bottom, we’re climbing out, because everything else about the company, we’re working like crazy to control expenses. We’re actually doing a lot of leasing. There is activity in our market.