Douglas Emmett, Inc. (NYSE:DEI) Q4 2023 Earnings Call Transcript

Douglas Emmett, Inc. (NYSE:DEI) Q4 2023 Earnings Call Transcript February 7, 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: Ladies and gentlemen, 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. [Operator Instructions] 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 five 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 an early renewal for 250,000 square feet. 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 Barrington Plaza from the market, our residential portfolio now provides almost 20% of our rental revenue. In addition, we have not experienced the residential building boom seen in other major markets, so our apartments remain fully leased. 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 U.S. Our submarkets are vibrant, and our office tenants have overwhelmingly returned to work. 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.

Kevin Crummy: 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 L.A. 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 are leasing quickly. As the remaining two office force 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?

Stuart McElhinney: Thanks, Kevin. 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 ten 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 costs during the fourth quarter remained well below the average for other office REITs 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. 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 a ground rent reset arbitration on land that we own. The result was a onetime 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%, $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 a 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.

Operator: We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Blaine Heck with Wells Fargo. Please go ahead.

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Q&A Session

Blaine Heck: 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 how to handle the upcoming swap and debt maturities in 2024 and beyond?

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

Blaine Heck: All right. Great. That’s helpful. Then just a 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 litigation from prior tenants and then talk about kind of the mechanics of that project, especially how capitalized interest might impact numbers and just at a high level, how we should be thinking about kind of the impact to earnings this year and beyond?

Jordan Kaplan: Okay. So I’ll answer the first part, and I’ll let Peter answer the second part. But in terms of the – well, go ahead, you can answer your section, then you can come back and ask me whatever you don’t answer. Go ahead.

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 Barrington in 2023. And that will be reduced to about $0.005 in our numbers for 2024, mostly due to the remaining retail commercial tenants who 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.

Jordan Kaplan: Okay. So then your questions then revolved around the litigation and the insurance, right. Your beginning questions. And well, 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 is also insured, but it’s ongoing and all litigation is disruptive. So I mean, that’s – it’s a drag that is going on, but we’re dealing with that.

Blaine Heck: All right. We’ll stay tuned for an update. Thanks guys.

Jordan Kaplan: All right.

Operator: The next question comes from Michael Griffin with Citi. Please go ahead.

Michael Griffin: Great. Thanks. 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 expect?

Jordan Kaplan: I fully believe that leasing will pick up over the next couple of years. As a matter of fact, that is as I tried to really make this point a huge amount of times, which is that you saw our leasing pickup right after the COVID kind of got lifted. But what’s happened now is the country, and particularly a lot of people that hold an office space have gotten some sort of recessionary fear, 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’re just one of the results from that going on across the country and certainly here. So people aren’t making big commitments to doing new things. Our smaller tenants are going forward great.

And you see it. You see we’re doing a lot of leasing, but large ones 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 the analysts, you guys, what you want to hear, which is we’re cutting costs by cutting staffing and there’s just one article or 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 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 entertainment, but we have medicine, we have universities, we have research. All of those are space takers. And you’re seeing articles about it 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 lighten up and tenants kind of come back strong into the market all around the same time. So I don’t know – but we all need to make predictions about that and I don’t think they’re market specific for us.

Michael Griffin: Got you. I appreciate the insights there. And then I was wondering 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 acquisition opportunities.

Jordan Kaplan: So in general, when we’re in these JVs, our recommendation is always, we think this is a good hold or we think we should all be selling at the same time. But then in the 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 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 that really happened there.

Michael Griffin: Great. Well, that’s it for me. Thanks for the time.

Jordan Kaplan: Okay. Thanks.

Operator: The next question comes from Nick Yulico with Scotia Bank. Please go ahead.

Nick Yulico: Thanks. Maybe first question is on acquisition opportunities and how you’re thinking about those and particularly in relation to if you have a portfolio right now where you’re already dealing with some unstabilized occupancy levels. I mean, are you still willing to go out and find investments if they pencil and make sense and put capital work with JB Partners?

Jordan Kaplan: Absolutely. Absolutely. I mean, I think, we’re spending a – 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 the world didn’t think, but it did turn out to be the case, you got to go all the way back to 1990, 1991, 1992, 1993, 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, wow. 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. They’re epic. Apparently, they’re 130 years and I don’t want to miss that opportunity at all.

Nick Yulico: All right, thanks. And then second is just on the William Morris extension. Are you able to give us any feel for how the rent spread worked on that? I mean, I guess, we’ll learn next quarter when you put the new rent in this up. But any preview you can give us on that along with how to think about the capital you had to extend to get the lease done.

Jordan Kaplan: Yes. So the current lease expires in 2027 this is a ten-year extension. So now it’s 2037. They kept all their current space. There’s not going to be any current impact on cash revenues, because it doesn’t start for a while. But we’re doing some building work. But I don’t think the TIs, I don’t think you’re going to look at the TIs 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.

Nick Yulico: Thanks.

Jordan Kaplan: All right.

Operator: The next question comes from Jay Poskitt with Evercore. Please go ahead.

Jay Poskitt: Hey, thanks for taking my question. I was wondering if you just provide a little bit of color on where you typically see renewal percentages at the start of the year. Just thinking through kind of how occupancy will trend throughout 2024.

Peter Seymour: Hey, Jay. Yes. 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 six months or a year before their term ends. So if you want to try to, like, map something more specifically near-term, you and I can talk about that offline. But the long-term average is in that high-60s range.