Ladies and gentlemen, thank you for standing by. Welcome to the Douglas Emmett’s quarterly earnings call. Today’s call is being recorded. At this time, all participants are in a listen-only mode. After managements’ prepared remarks, you will 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. Please go ahead..

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 Web site and will be available for replay during the next 90 days. You can find our earnings package at the Investor Relations section of our Web site.

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 maybe 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 Web site.

When we reach the question-and-answer portion, in consideration of others, please limit yourself to one question and one follow-up. Thank you. I will now turn the call over to Jordan..

Good morning, everyone. Thank you for joining us. We had another strong leasing quarter with total leasing exceeding 1 million square feet and new leases at very healthy 365,000 square feet.

Despite this accomplishment, I feel like we've been on a treadmill for the past several quarters, considering our efforts have only produced a modest increase in net absorption and occupancy. Of course, this is partly due to our program of replacing nonpaying tenants with new paying tenants.

As I mentioned last quarter, the expiration of commercial eviction moratoriums has finally allowed us to recapture space from nonpaying tenants, while still pursuing their outstanding balance. During the third quarter, we recovered about 50,000 square feet from nonpaying tenants. We expect to address a similar amount of space in the fourth quarter.

With respect to occupancy, our leased to occupied spread improved slightly but remains more than twice our historical average. While we expected occupancy growth from a reduction in that spread, it has not happened yet.

One reason is that an unusual number of tenants are expanding in our portfolio or simply relocating, which increases occupancy lead times. While we are concerned about a future economic slowdown, we firmly believe in the long term health of our markets. Our demand comes from numerous industries without any risk of material new supply.

Having successfully managed through several prior cycles, our strategy and platform are designed to withstand downturns while staying positioned to act opportunistically. Now I'll turn the call over to Kevin..

Thanks, Jordan, and good morning, everyone. Higher interest rates have begun to affect us, even though only 13% of our debt is currently subject to a floating interest rate.

To provide us flexibility during challenging debt markets like these, we typically borrow for seven years and swapped for five, so that we can delay refinancing for up to two years without any penalty. With current loan spreads historically wide, we do not think this is the best time to refinance. We have no debt maturities until the very end of 2024.

We do have additional swaps expiring in 2023. As a result, we expect our interest expense to increase next year. Turning to development. Our residential projects continue to lease up at a very good pace.

At Bishop Place in Honolulu, our office-to-residential conversion project, we have now delivered at least about two thirds of the eventual 493 units, and we will continue to convert more floors to residential as office leases expire. At the Landmark LA in Brentwood, we have now leased over 50% of our 376 new units.

Rents at both projects [Technical Difficulty] while sales transactions have remained very slow in our markets, higher operating expenses and a challenging refinancing market may encourage sellers to bring their properties to market. With that, I'll turn the call over to Stuart..

Thanks, Kevin. Good morning, everyone. As Jordan said, we had another very successful leasing quarter, signing 199 office leases covering over 1 million square feet, including 365,000 square feet of new leases. Larger tenant demand picked up during the third quarter, increasing our average deal size to over 5,000 square feet.

We were also very pleased to see strong expansion activity from our existing tenants with expansions outpacing contractions by over 50,000 square feet. Our office leasing spreads this quarter were positive 7.2% for straight line and negative 8% for cash.

This means that new leases have a greater total value, even though the starting rent is less than the ending rent in the prior lease. Turning to multifamily. Our portfolio remains full at 99.3% leased and rent roll up on new leases was a very healthy 8%. 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 third quarter of 2021, revenues increased by 6.5%, same property cash NOI increased by 0.4% with increases in both office and residential revenue, largely offset by the effects of inflation, particularly in the cost of utilities, insurance and third party vendors.

FFO increased by 6.7% to $0.51 per share and AFFO increased 3.1% to $90.4 million. Our G&A at only 4.4% of revenues remained very low relative to our benchmark group. Turning to guidance. Elevated lease to occupied spreads have restrained occupancy growth.

In addition, residential revenue growth will be impacted as Barrington Plaza vacates in preparation for rebuilding. While insurance may cover some of that lost revenue, the collection of any insurance proceeds can be very slow. Finally, we also expect increased operating expenses as a result of higher office utilization and inflation.

Taking these factors into account, we now expect our full year FFO to be between $2.03 per share and $2.05 per share. This reflects revised assumptions that average office occupancy will be between 84% and 85% for the year, and that same property cash NOI growth will be between 3.5% and 4.5%.

For information on other 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 our question-and-answer session [Operator Instructions]. And the first question will come from Michael Griffin from Citi..

Just on leasing.

I'm curious if you're seeing tenants quicker to make decisions around the real estate and then on the new leases in the quarter, sort of what the industries you've seen that from, is that from one specific one or generally just seeing it from across the board?.

Well, to take your second question first. We're still seeing it across all the industries. So we have a big mix of industries we're getting them from every direction.

But when you say are their leasing quicker, we did a lot of -- we've done a lot of leasing in the last few quarters, I would say this quarter, which fourth quarter is typically a slow quarter. But even taking that into account, I think things are slowing down a little bit.

So I certainly wouldn't say they're speeding up and we're very concerned about what's coming vis-a-vis the economy..

And then maybe on the multifamily side of the business, I think we've heard and the apartment rents might be kind of slowing down after pretty sizable increases recently. Are there any concerns within your portfolio and maybe some additional color around expectations there would be great..

Certainly there are not concerned. I wouldn't be surprised to see multifamily rents slowed down. I mean, it’s when they have that move up at the pace, I think what was it 7% this quarter -- 8% this quarter, that's a crazy pace, that's certainly unsustainable.

The history and the markets that we're in, is in the mid 4s, if you look at [Ks] are going back a long way 20 plus years, and I would expect it to be zero back in on a number like that..

The next question is from Blaine Heck from Wells Fargo..

Can you just talk about the remaining square footage in your portfolio that's occupied by nonpaying tenants? And I think last quarter you talked about working through the remainder of those tenants by year end.

Is that timeframe still achievable?.

Yes, it's pretty achievable. I mean, we had about 100,000 feet left at the end of the last quarter, last call, and we did about 50,000 feet, and I suspect the rest will be for the most part dealt with. I mean, there might be stragglers in the first quarter, but not that you'll notice..

Second question. Can you just talk about your interest in acquisitions at this point? Are you guys actively pursuing investments, are you seeing better opportunities in office or multifamily? And then it sounded like you're expecting to see distress opportunities, given the increase in rates.

Is that happening yet and if not, when do you think those deals start come into the market?.

Buyers and sellers are still kind of adjusting to the new environment and so that slowed things down a little bit. Although, the changes, when a sentiment changes, things should move pretty quickly.

We are seeing opportunities that we're underwriting both on multifamily and on office, but a lot of it is not things that we would consider to be a target acquisition, but I'm hopeful that there will be some more opportunities coming next year..

And the next question is from Nick Yulico with Scotiabank..

In terms of leasing, I wanted to see if you could give an update on how the fourth quarter is trending so far in terms of lease velocity versus the last quarter.

If you’ve seen any slowdown?.

So as I said, historically, the fourth quarters are our slowest leasing quarter. But even taking that into account, I think, we're seeing slowing like beyond that. That's with only -- obviously, that's only with a little bit -- we only have one month of information on this quarter.

But it feels like even compared to what you'd expect in a slowdown in the fourth quarter, it feels like it's slowed down a bit more..

And then just the second question is on the upcoming expirations next several quarters.

I don't know if there's any numbers you're able to share about how much of that square footage may have already been addressed or do you think you have a good chance of re-leasing right now?.

So what's in the supplemental, which did show it's been addressed because it says 14%, which is for the year, which is very, very typical for us if you go backwards for this point in the cycle for what the upcoming year is. And as we've said a lot in the past, we typically have about 70% renewal rate.

So I mean that give you as good a feel for what's coming next year. Now presumably, some of it will get done this quarter will change those numbers. So once we actually enter 2023 that will be a lower number, and we'll be working our way through that..

I guess I just wasn't sure like for your fourth quarter expirations, by way of example, 3.8% square footage of the portfolio, if you had any activity on a specific amount of that space to talk about right now..

Well, we have a lot of activity. So every quarter, we have a lot of activity. So when I say things feel like they're slowing down, I'm not saying we don't have a lot of activity, we just don't have as much as I would typically expect in the fourth quarter. So certainly, a lot will get done this quarter..

The next question is from Steve Sakwa with Evercore..

Jordan, I think in the past, you've talked about this $30 million number or so of rent that you're owed. I guess it probably relates to some of that square footage that you're taking back from the nonpaying tenants. Just can you give us any sense for the, I guess, progress you're making on collecting that money in addition.

I know it sounds like you're getting these tenants out of replace, but what about the collection of sort of prior period rents?.

We continue to make progress against that number. I mean, as we've said, it sort of jumps around a little bit at the beginning of the month, end of the month, but we're down to low 20s, almost $20 million as we work through that.

And we'll continue to work through it as the moratoriums officially end, it brings everybody to the table and we get -- we're confident we're going to get through it..

And then maybe just on the financing markets.

Could you just give us a sense, if you guys were to come to market today to do something new, just where are financing rates for the types of deals that you guys would do?.

Depending on whether it's residential or office, it looks to me like at the moment at least, the spreads are for residential at the lower end, maybe closer to 200 and for office at the higher end, closer to 300. It's a very -- everything's kind of blown up right now.

So it's not a great time to go in and try and sort of level set the market and see where things are at, but that's the sense we've gotten..

The next question is from Alexander Goldfarb from Piper Sandler..

Just continuing on Steve's question. You guys have a bunch of swaps that are coming due next year. So my question is, some of the other companies of your other peers who have engaged in swaps, we've gotten some insight into swap pricing, obviously, not really something that most [resembles] apart from you guys.

But sounds like swaps are still available, they're whatever 5 basis points, I have no idea, if that's expensive or cheap, you guys are much more insightful on that.

But what are your views on the swaps for next year? And is the market is attractive that you would reengage or because of where interest rates are overall, you really don't want to lock in these levels. Just trying to get a better sense of how we should think about that for next year..

In a debt market, there's a abnormal amount of uncertainty and kind of risk off here. And so in that separately from trying to say rates are high-low and this and that, that's just not a good time to lock in things long term.

And so we usually sort of avoid this amount of tumult and wait for things to stabilize a little bit, not saying we're right or wrong, I'm calling the market.

But I know that there's a lot of kind of risk premium built into spreads right now, which means if you want to go out and start doing swaps, you're going to have to take the spreads and live with them. We don't ever swap out speculatively. And so we're -- at least I don't know where we'll be next year, maybe next year will be a good time to do it.

But right at the moment, it's not -- probably not a very good time to lock things in for five or seven more years..

And the second question is, Kevin, on the JV side, you guys obviously do a lot of your acquisitions with especially overseas Gulf money.

Are all of your joint venture institutional partners, are they all fully engaged that if you found a deal today, they'd be there signing up or have your traditional institutional partners, are they also pulling back the way the public markets are pulling back?.

So we've been engaging with all of our partners, because they have a lot of questions. And we had talked about the same things that you guys ask us, what's the utilization rate, what's happening with expenses, what are we seeing on the leasing side? And LA is a bright spot in our markets relative to a lot of other major markets in the country.

And so we've gotten pretty positive feedback from people that if they're opportunities that we think are compelling, that they want to underwrite them with us. And so we're definitely planning on a going forward basis to show any deals so we're excited about to those guys and hopefully, they'll deal with us..

Next question is from Rich Anderson with SMBC..

Most of my questions have been already asked, I’ve got fortunately two more.

On the $20 million remaining to collect, what's the cadence of that? Is it taking like another year you think to get at that money that back rent number, or will be longer or shorter than that based on what you've experienced so far?.

Well, our goal is to take to tenants all that money that are in the portfolio and say, let's renew and lengthen it out and we'll spread it out over that. So that would mean that the cadence of actual collection would be stretched out over time.

If that isn't followed then I don't remember what they have something like another three or six months left to just pay it off over time and it just gets paid on..

And what if they don't, what if they just give you the Heisman?.

Well, if they don't pay you, then they fall in the category that you guys have been hearing about. So we had about 200,000 feet of it, we did 100,000 second quarter and the third quarter, we just said now we just 50 and we got about 50 of exactly what you're describing, that are going to see the door this quarter..

I was actually referring to the people that are no longer tenants but still owe you back rent.

Are we talking about the same thing?.

That's just goes through a legal process. And I mean, their problem is, unless they want to file bankruptcy, they go okay, they have nowhere else….

Second question, Stuart, you mentioned this quarter 7.2 up on a GAAP basis on your office leasing and down 8% on a cash basis, and made the observation that leases are more valuable, even though your starting cash rent is lower.

Are you guys somehow getting bigger escalators, is that the explanation there? How is that gap happening this quarter and is it something that you see as sustainable?.

We're pushing on our annual bumps, it's something that's been a tool we've used for a long time. I think our escalators are probably higher than any other office company that you're looking at.

And we have, in times like this, in inflationary times, we have definitely been pushing -- trying to push ramp ups higher, because we feel that that should be kind of a proxy for inflation..

So what are you getting approximately, over and above what maybe considered normal?.

I mean, I think each deal is different. I mean, some deals are still three, but you're seeing a lot of 4s, you can even go 4.5 a year on some deals, maybe even a 5 in there once in a while. But that's a -- it's a negotiating tool that we can use in the lease and we definitely have the mindset to be pushing on those..

And the next question is from Dave Rogers from Baird..

Jordan, you guys are pretty good leasing machine. So this lease to occupied gap, I wanted to dive into that a little bit more, why that's kind of so different today.

When you talk about relocations, is that within the portfolio, are you relocating more people from outside in, less business formation? If you could give a little more color on just kind of why that gap is so unique today for you guys, and then when do you anticipate that closing, would be my follow-up to that..

So I would have already thought it would have closed a little bit, to be quite frank. I mean, it's such a wide gap. Now, of course, the big driver of something like that is that we're doing a ton of new leasing. And when you do a lot of new leasing, then it gaps out, that's how you get that gap.

Now the other way you get that gap, which is why we thought it was worth mentioning, is that you might have people in -- in our portfolio, we're pretty good at keeping people, but sometimes they want to move. In the last quarter, most of them wanted to move to larger space.

So we had a really -- pretty meaningful amount of people that stayed in the portfolio but moved and expanded.

Well, when that's going on, you're going to create -- you're going to have a space that's leased, but they haven't moved into yet, right? And you're going to have a space that they're in and when they make that move, you get left with the space that they have. So it's good for them to expand, but it does create a bigger -- that also creates a gap.

And the third thing, which shouldn't -- you can't understate is that when you're building out all this new activity in cities just slowed down. And even though we're ready to go at a much faster pace, just getting your inspections and getting your permits, it's just become a slower process.

And that will also drive that gap, that mean that gap is the difference between a signed lease and the guy in and paying. And the three things -- the more transition there is of space widens the gap, both in moves within the portfolio, expansions within the portfolio and new deals.

And then the city just slowing us down as the other big one, and we're experiencing both and it's caused a very wide gap. I mean, the good news is that's sort of built in, we're going to get that. And when the gap does shrink, hopefully, it's not because we're not doing a lot of new leasing.

Hopefully, you keep doing a lot of new leasing and the cities found a way to speed up, but we'll see what happens..

The next question is from John Kim with BMO..

Looking at your top tenant list, it looks like you have about 134,000 square feet expiring in 2023, which isn't a huge amount, but at a higher rent portfolio overall.

Are there any known move-outs, or maybe asked a different way, what's your handicap as far as the renewal rates on these leases?.

Well, we don't talk about individual tenants to start with, but I'll also tell you, our handicapping is super bad on these things. And so we've had some big tenants, I guess, we're moving, they stay -- we're just not good at guessing at it. And they -- large tenants are very cat mouse, so we don't really know the answer until the deal is done.

So I can't make a good guess on that. I can tell you, because we're much better at predicting flow, because we do so many deals that we do tend to run in the like 69%, 70% renewal rate overall, and that includes large tenants, small tenants and all the rest of them..

If one of those larger leases had left, is it difficult to cut it up into the smaller leases that you typically sign?.

Well, it's always cheaper to renew with the guy in place. But when large tenants move out, I would say one of our expertise is to put in quarters, breakup floors and quickly lease a building. And actually, we've used that as a strategy when buying buildings.

When a large tenant was leaving, our cost of converting that to multi-tenant space has always been much cheaper than everybody else’s, because we have a whole group that's very quick at doing that. So that's well within our comfort zone..

John, the other thing to keep in mind on our large tenants is, if you look at the list, you'll notice that most of them have multiple leases. So these aren't large -- a lot of them aren’t large contingent blocks of space, they don't act like large tenants anyway. So a lot of these are smaller spaces that are spread around within the portfolio..

I just want to follow-up on the interest rate swap discussion. I know you don't want to -- Jordan, you mentioned not wanting to lock in higher rates now.

But is it cost effective or do you find it attractive to place caps to place those -- price those swaps that expire?.

Tight -- meaningful caps are very extensive. You can go way out of the money caps, but no, I think you would care, but meaningful caps are expensive..

And the next question is from Daniel Ismail with Green Street Advisors..

Peter, you mentioned the impact of inflation on OpEx.

Can you unpack that a bit more on what line items you're seeing higher increases, and how much of that can be passed on to tenants?.

So I mean, look, we usually are able to mitigate it with tenant recoveries in the office space. The line items specifically -- we mentioned utilities, insurance, but we're also seeing it across the board with our third party vendors, security and janitorial and so on.

So I mean we hope to recover a good portion of it, but it's definitely affecting the numbers..

Any specific reason as to why that isn't a direct pass through, is it just slightly lower occupancy or timing?.

No, it is a direct pass through. But in the office space, I mean, obviously, that base here, so it's all certain portion of the tenant base as base years in any given year. But yes, I mean we generally recover quite a bit of it..

And then maybe just last one for Jordan. You mentioned being on the treadmill, and trying to keep up with those shorter duration leases.

Does this make you want to have go a bit longer in terms of your average lease length given the amount of volume you're putting out versus your expirations in the upcoming years?.

Well, of course, we like longer leases. But the nature of our markets, first of all, our leases have very good security and most of them are guaranteed by the principal. And so when you're a person guaranteeing your lease, a lot of times you don't like going longer than five years, just out like personal preservation and fear.

And that's why we tend to really zone in on that five year market, see overwhelming median number, even though our average lease length is higher, because larger leases tend to be longer.

But that's just where someone -- if you have a business and you have 2,000 to 6,000, 7,000 feet and you got to guarantee the lease, you're going to go, okay, I'm comfortable for the next five years, I'm not comfortable beyond that. And that's what you get..

[Operator Instructions] Next question is a follow up question from Alexander Goldfarb from Piper Sandler..

Peter, on Barrington that you're emptying out. Can you give a timeline for that and then how much NOI, what sort of the FFO impact? Because I don't know if you're going to end up capitalizing that building where there's minimal FFO impact or not.

So maybe you just walk through what we should expect for timing, is that fourth quarter, is that next year?.

So it's a -- I'll answer, because I'm in the middle of it. It's a long process that's starting next year. And frankly, they have full impacts that have a lot to do with like collections from insurance and when they pay on lots of rents and all that, that's the price that would go through FFO, goes through it like other income section.

But it's a very -- this is going to be a long complicated process. It's three buildings putting in sprinklers, cutting floors. It's going to be very complicated. nd including that it will be complicated to figure out how it passes through FFO or AFFO or however you look at that thing on the way the insurance company pays..

So when you give guidance, are you going to have your guidance number with some element of impact? I mean, I'm just saying, should we be modeling some elements for Barrington or should we leave, or should we not try it?.

I expect an impact, but that impact is going to vary depending on, first of all, how we can into the building, because it's not easy to empty the buildings. Secondly, how fast we can get the work done. Thirdly, how and at what schedule the insurance companies pay.

I mean, there's -- like, if we empty the building super slow, but they're not paying much, you may not see an impact. If we empty it fast and they pay, you may not see an impact. If we empty it fast and they don't pay everybody is going to see an impact. And by the way, how they allocate their payments. So it's just going to be complicated.

I mean, we're going to make a guess at that, you're correct. So that's a -- you formed your question extremely well, but they haven't made that guess yet..

Ladies 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..

Thank you all for joining us and we will speak to you again next quarter. Bye, bye..

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