Jacques Cornet - ICR Albert Behler - Chairman, Chief Executive Officer and President Wilbur Paes - Executive Vice President, Chief Financial Officer and Treasurer Peter Brindley - Executive Vice President, Leasing.

Blaine Heck - Wells Fargo Kim Hong - Bank of America Merrill Lynch Vikram Malhotra - Morgan Stanley Steve Sakwa - Evercore ISI.

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Paramount Group Second Quarter 2018 Earnings Conference Call. [Operator Instructions] Please note that this conference call is being recorded today, August 2, 2018. I will now turn the call over to Jacques Cornet with ICR..

Thank you, operator, and good morning. By now, everyone should have access to our second quarter 2018 earnings release and the supplemental information. Both can be found under the heading Financial Information Quarterly Results in the Investors section of the Paramount website at www.paramount-group.com.

Some of our comments today will be forward-looking statements within the meaning of the federal securities laws.

Forward-looking statements, which are usually identified by the use of words, such as will, expect, should or other similar phrases, are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. Therefore, you should exercise caution in interpreting and relying on them.

We refer you to our SEC filings for a more detailed discussion of the risks that could impact our future operating results and financial condition. During the call, we will discuss our non-GAAP measures, which we believe can be useful in evaluating the company's operating performance.

These measures should not be considered in isolation or as a substitute for our financial results prepared in accordance with GAAP. A reconciliation of these measures to the most directly comparable GAAP measure is available in our second quarter 2018 earnings release and our supplemental information.

Hosting the call today, we have Albert Behler, Chairman, Chief Executive Officer and President of the company; Wilbur Paes, Executive Vice President, Chief Financial Officer and Treasurer; and Peter Brindley, Executive Vice President, Leasing. Management will provide some opening remarks, and we will then open the call to questions.

With that, I'll turn the call over to Albert..

Thank you, Jack, and good morning, everyone. Thank you for joining us today. We again delivered a quarter of strong operating performance. Our portfolio is 96.4% leased, up 240 basis points from the prior quarter and a milestone as it represents the highest leased percentage we have achieved as a public company, and we are far from done.

We had a very active second quarter, signing leases for almost 313,000 square feet of space. Leasing activity for the first half of the year reached nearly 598,000 square feet, just shy of the midpoint of our leasing goal for the full year.

While a substantial portion of this leasing activity resulted in increasing our leased occupancy by 290 basis points since year-end, a fair amount of it represents early renewals and derisking our future role, which has consistently been our focus and was something I mentioned on our prior earnings call.

Our second quarter leasing activity was highlighted by the previously announced 2 large deals in the New York portfolio. We signed a 136,000 square-foot 16-year lease with McGraw-Hill Education at 1325 Sixth Avenue and an 89,000 square-foot 12-year lease with a law firm, Pillsbury at 31 West 52nd Street.

In addition, we signed a 21,000 square-foot lease with the prominent financial services firm, which will be relocating to 31 West 52nd Street from 9 West 57 Street. 1325 and 31 West are now 95.9% and 95.8% leased, respectively. With the signing of these deals, we have completed backfilling substantially all the large block vacancy.

This leasing has translated into and will continue to translate into strong additional same-store growth. At the end of the quarter, the spread between our lease percentage and our occupied percentage was 290 basis points.

With a high volume of leasing over the past year plus a more moderate expiration schedule for the next couple of years, the narrowing of this spread is simply a function of time. And as the spread narrows, the recent growth inherent in our lease percentage will ultimately translate into cash-paying rent.

On guidance, we increased our core FFO expectations by $0.01 at the midpoint. Given our leasing success in the first half of the year and our outlook for the remainder of the year, we are increasing our leasing goal to be between 700,000 and 900,000 square feet, up from our prior range of 500,000 to 700,000 square feet.

In addition, given current leased occupancy levels, scheduled expirations and our outlook for the remainder of the year, we are increasing our guidance for the year-end same-store lease percentage to be between 96% and 97.5%, up from our prior range of 94% to 96%. Wilbur will provide further details on guidance.

Overall, the markets in which we operate continue to do well. And with Class A and trophy buildings in some of the best locations, we benefit from the underlying market strengths. Having great product is one factor, but having a great team that consistently executes is really what sets us apart.

Whether it is mining our existing portfolio or finding new opportunities by recycling capital, our focus has been to create long-term shareholder value. It has been almost four years since our historic IPO.

Looking back, our goal was simple, unlock the significant embedded growth in our portfolio by first re-leasing the large block availabilities in New York; second, increasing the occupancy in our D.C. portfolio; and third, remaining disciplined and opportunistic with respect to allocating capital.

First, leased occupancy in our New York portfolio is now 95.9%, up 740 basis points over the past five quarters. This despite all the buzz in the market about the Far West Side and [chether] that core Midtown was the thing of the past. The short 15 months later, our portfolio is stabilized, well ahead of what market pundits predicted.

Hence, we have done this by keeping capital spend in check and these very positive marks on re-leasing spreads. Second, our Washington, D.C. portfolio was 96.7% leased at quarter end. And I'm happy to report that subsequent to quarter end, we completed another lease at 2099 Pennsylvania Avenue, which Peter will discuss in more detail.

This new deal brings the buildings leased occupancy to 98.5% and the D.C. portfolio to 98.2%. That compares to a 68% leased occupancy at the time of the IPO for the same portfolio. Third, in addition to delivering on our promise to lease up the portfolio, we have been very selective in allocating capital.

As all of you are very well aware, we are highly focused and specialized in our approach at Paramount. We are disciplined and opportunistic, and since we have been public, have identified very select investment opportunities upon which we have acted. 2 of those opportunities where we increased our share of a joint venture interest by about 1/3.

And I'm referring to 31 West and 50 Beale. And the third opportunity was 1031 exchange where we sold Waterview, a fully stabilized asset outside of Washington CBD and reallocated that capital into San Francisco CBD at One Front Street.

We feel that our specialization and focus on Class A and trophy office assets in select CBD submarkets of our target markets allows us to identify and execute on opportunities that others may shy away from or find too complex.

For instance, at 31 West, you'll recall that buying our joint venture partner share allowed us to engage with the tenant who occupied the top 5 floors in the building with a lease that was way below market rent and rented through to 2026.

We found a way to provide the tenant with greater efficiency on 2 floors in the mid-rise of 1633 Broadway, addressing the vacancy in that building at the time with an even longer lease at a market rent. This also created a tremendous opportunity at 31 West that otherwise would not have been available until 2026.

Today, we have leased substantially all of that space with a starting rent in the mid-90s at roughly 35% mark, which unfortunately does not show up in our statistics, because that space was vacant for more than 12 months. At 50 Beale, we increased our stake at a value of well below replacement cost.

And in just 9 months since increasing of her ownership, we have driven leased occupancy to nearly 96% from 78% at the time of the transaction. This past quarter, we signed a long-term lease with Equinox, providing current and future tenants with a great amenity.

At One Front Street, since we acquired the asset about 1.5 years ago, we have executed leases of nearly 415,000 square feet of space or about 2/3 of the building and have been consistently achieving mark-to-market increases well ahead of our underwriting.

Our execution and results speak for themselves, and we remain focused on our objectives of creating long-term value for our shareholders. We will continue to very selectively target opportunities where we can leverage our operating expertise, tenant relationships and proactive approach to asset and property management.

Along the same topic, we have often been asked questions about our willingness to sell assets. And over recent months, the frequency of those questions have increased.

As we have said before, our approach is always to evaluate our portfolio and assess assets by comparing what we think we can achieve by continuing to own an asset versus what the market affords us on being able to capitalize on private market values.

If we were to transact at this point, the most likely scenario would be something in Washington, D.C., where in most cases the assets are fully leased and value has been created and the demand for our type of assets continues to be strong. With that, I will turn the call to Peter to give additional insights on our leasing..

Thank you, Albert, and good morning. We had a very successful quarter of leasing, signing leases totaling approximately 313,000 square feet. Through the first half of the year, we have leased approximately 598,000 square feet.

As a result, our portfolio was 96.4% leased at quarter-end, which as Albert mentioned, is the highest it has been since going public in 2014. Let's review the highlights by market. Our New York portfolio was 95.9% leased at quarter-end, up 320 basis points from last quarter.

During the second quarter, we leased approximately 260,000 square feet, bringing our year-to-date total to more than 405,000 square feet leased. The New York portfolio is now very well positioned with less than 3.5% expiring per annum through year-end 2020. Leasing activity in New York remained strong.

During the second quarter, Midtown realized its higher quarterly velocity total of three years, recording more than 5 million square feet of leasing activity, a figure that is 22% above the five-year quarterly average. This is the fifth consecutive quarter in which Midtown has experienced more than 4 million square feet of leasing activity.

Suffice it to say, we have realized our fair share of the activity with the most recent transactions at both 31 West 52nd Street and 1325 Avenue of the Americas. Now that we have completed our big block leasing in New York, we have turned much of our attention to future lease expirations and expect to build on our momentum.

As mentioned, we remain very well positioned going forward, given our high occupancy and minimal lease expirations. Shifting to Washington, D.C. We ended the quarter at 96.7% leased, up 20 basis points from last quarter. Subsequent to quarter-end, we signed a 14-year 14,477 square foot leased with Capital Group for our largest vacant space in D.C.

at 2099 Pennsylvania Avenue. Capital Group is an existing tenant at One Market Plaza in San Francisco, and we are pleased to report they have chosen to expand their footprint in Paramount's portfolio. With the Capital Group deal complete, the building is now 98.5% leased, up from the 91.6% at quarter-end. The D.C.

portfolio is now 98.2% leased, up from the 96.7% reported as of June 30. We remain very well-positioned in D.C., with only 3.1% expiring per annum through year-end 2020. In San Francisco, we ended the quarter at 98.2% leased, up 50 basis points from last quarter.

The office leasing fundamentals in San Francisco remain very strong, as tech tenants continue to grow and the majority of new supply continues to get leased. At One Market Plaza, we are currently 97.9% leased with a de minimis amount of lease roll in 2018.

One Market is an iconic asset that appeals to prospective tenants representing a diverse range of industry as evidenced by the existing tenant mix and by the current interest in the building's limited availabilities.

Similarly, One Front Street is currently 99.5% leased as a result of the almost 415,000 square feet of leasing we have accomplished since acquiring the property. During the second quarter, we continued to execute on our business plan at the property by extending another lease and further reducing 2018 lease roll.

At 50 Beale Street, we continue to make progress. As Albert mentioned, we have increased leased occupancy to 95.8%, up from 78% 9 months ago. In addition, we are in discussions with several prospective tenants for the last remaining office availability.

Our leasing progress at 50 Beale Street has benefited from the virtually column-free structure of the building, the large and efficient floor plates and the property's location in the heart of San Francisco's South Financial District.

During the second quarter, we completed a lease with Equinox for approximately 42,000 square feet, spanning a portion of the ground floor, the entire second floor and the partial third floor.

The Equinox lease, coupled with the recent lease up of the base floors to dynamic technology tenants, establishes the building as a premier property in the most active submarket in San Francisco. The new Transbay Terminal further solidifies the long-term appeal and convenience of this dynamic location.

These recent developments at both the property level and in the immediate neighborhood set the stage for future opportunities at 50 Beale Street. With that summary, I will turn the call over to Wilbur to discuss the financial results..

Thanks, Peter. We had another very strong quarter highlighted by solid financial and operating metrics. Our core FFO for the quarter was $0.24 per share, up 3.8% from the $0.23 per share in the prior year's second quarter.

It is important to note that the prior year's second quarter included an aggregate of $3.9 million or $0.02 in earnings from the acceleration of a below-market lease liability and lease termination income. Excluding this $3.9 million, core FFO is actually up 13.8% from the prior year's second quarter.

This increase was once again driven by strong same-store NOI growth of 5.9% cash and 6.1% GAAP. Portfolio leased occupancy increased 240 basis points from the prior quarter to 96.4%, with increases in each of our portfolios. As Peter mentioned, our New York portfolio is now 95.9% leased, up 320 basis points.

Washington is 96.7% leased, up 20 basis points before factoring the lease that was signed subsequent to quarter-end. And San Francisco is 98.2% leased, up 50 basis points. We leased approximately 313,000 square feet in the quarter, and mark-to-markets were 19.8% cash and 8.7% GAAP.

Leasing was concentrated in New York, where we leased almost 260,000 square feet, and mark-to-markets was 16.2% cash and 8.4% GAAP. The majority of the remaining leasing was in San Francisco, where we leased 51,000 square feet, and mark-to-markets were 55.6% cash and 10.3% GAAP.

Based on our results for the first half of the year as well as our outlook for the remainder of the year, we are raising our full year 2018 core FFO guidance to be between $0.93 and $0.97 per share, up $0.01 from our prior range of $0.92 to $0.96 per share.

In addition, we are increasing our same-store GAAP NOI assumption to be between 7% and 10%, up from our prior assumption of 6.5% to 9.5%, which now brings it in line with our same-store cash NOI assumption, which is also at 7% to 10%.

As Albert touched upon earlier, we have also revised our leasing guidance upward significantly, given the strong first half activity, and now expect our full year leasing volume to be between 700,000 and 900,000 square feet, up 33% at the midpoint from our prior range.

As a result, we have also increased our expectation for same-store leased percentage at year-end to be between 96% and 97.5%, up from the prior range of 94% to 96%. Turning to our balance sheet.

We ended the quarter with over 1.2 billion in liquidity, comprised of 238 million of cash and restricted cash and $1 million of availability under our revolving credit facility. Our outstanding debt at quarter end was 3.1 billion at a weighted average interest rate of 3.6% and a weighted average maturity of five years.

86% of our debt is fixed and has a weighted average interest rate of 3.6%. The remaining 14% is floating and has a weighted average interest rate of 3.8%. We have no debt maturing until the fourth quarter of 2021. And beyond that, our maturities are well laddered.

Lastly, we have updated our schedule of free rent burn-off in our investor deck, which now sits at 68.7 million. Our investor deck can be found on our website at www.paramount-group.com. With that, operator, please open the lines for questions..

[Operator Instructions] Our first question comes from the line of Blaine Heck with Wells Fargo. Please proceed with your question..

Albert, I wanted to get a little bit more color on your asset recycling plans. It's been reported you guys are in the market for an asset or two in D.C. and you alluded to it in your prepared remarks. So I wanted to get your thoughts on pricing in that market at this point and maybe any thoughts on the timing of the dispositions..

Well, as I had mentioned in the prepared remarks, we are consistently evaluating our portfolio. And we think D.C. is a good opportunity for us to harvest assets, and that's the only thing I can say at this point. We don't have anything to report on actual transactions yet..

So you guys took an impairment in this quarter, and I'm assuming that's related to contemplated sales.

Is that right? And does that suggest something happening in the near term?.

So we have taken an impairment blame in the quarter related to an asset in D.C. The accounting mode of our impairments are very arcane and it runs undiscounted cash flow model. But at a very high level, we have to step up a lot of the assets of the IPO to fair value.

And if you have an asset that you purchased for $100 and you had a below-market lease of $20, you would artificially gross up the asset side or the real estate to $120 such that your net assets are still $100. So you had something like that going on. And with the 10-year hold period, all these assets will recover above.

But as Albert touched upon, because we were evaluating certain assets in the D.C. market, it would be disingenuous to say that you're going to hold this for 10 years. So when you shorten the hold period, it traded an impairment, which we thought was the right thing to do and recognize in the current quarter..

And then when you think about the different options for redeployment, should you guys do the dispositions, you've got stock buybacks, any delevering options and then redeployment either on the balance sheet or through the funds.

So I guess, Albert, at this point, what's the most attractive use of funds if you guys generate those at this point?.

We are always, on a quarterly basis, discussing with our board the highest and best use of our capital. We are considering stock buybacks as well as potential opportunities to invest. We have been very, very cautious and disciplined over the last 3.5 years here and have invested limited capital.

So all the options are open anytime, and we are evaluating that carefully. So let's talk about it when we have that opportunity, maybe in a quarter or 2 quarters from now..

Last one from me. Peter, you guys have some good execution on the leasing front this quarter, but we noticed your concession ratio, the TIs and LCs per square foot as a percent of rent went up to 13.5%, which, I guess, is still little low relative to some peers, but I think is the highest you guys have reported as a public company.

So wanted to get your updated view on concessions and you can throw free rent in there and whether there was anything specific that drove up this quarter..

Blaine, the majority of our leasing were new deals, and we think our concessions were very much in line with market. The free rents was roughly a month per year of term. And TIs, given the term, were very much in line with what we had expected and very much in line with market.

So we were pleased with the economic result of the velocity that we've reported this quarter..

Blaine, just to add to Peter's comments, I mean, if you look back and if you look at the last quarter and the quarter before, last quarter, to Peter's point, we had a lot more renewal activity rather than new deals. So quarter-to-quarter, those metrics will fluctuate. I want to say, last quarter, it was sub-10%. This quarter, it's 13.5%.

But when you compare also to peer groups, you have to recognize that when we disclosed the metric, it includes tenant improvement and leasing commissions. Some of our peers just disclose that number as just tenant improvements only. And we've gone back all to 2017 and the concessions have been fairly stable and in line..

Our next question comes from the line of Jamie Feldman with Bank of America Merrill Lynch..

This is Kim Hong on for Jamie. Can you speak more about the lease economics for the lease to Capital Group in D.C. and the 21,000 square feet lease in New York? And it seems like the percentage lease dropped at 712 Fifth Avenue.

Can you speak more about the move-out here and what the prospects are to backfill the space?.

The 21,000 square-foot lease that we referred to at 31 West was a very strong deal. The economics were in the mid-90s. In fact, we started that deal at $96 per square foot, with roughly $105 in TI and what equated to about 10 months of free rent with 11-year term. D.C., the economics of that deal at 2099 were very strong.

The rent was approximately $80 per square foot gross. So we felt good about those economics as well. Then at 712, we did take back two floors. I will tell you at this point, Kim, we have very good activity on one of those two floors and we feel good about the economics that we're now discussing as part of that transaction as well..

And Kim, Albert touched upon in his prepared remarks that on the 31 West deal, the 21,000 square-foot deal, that was a roughly at 35% mark-to-market, notwithstanding that, that does not show up in our statistics..

And then what are your latest thoughts on the Barclays lease expiration in 2020? And do you know what options the tenant is currently considering?.

Kim, it's Peter. It's too soon to say, unclear at his point how that will ultimately play out. I can tell you that with the velocity occurring on the west side of Midtown, we really feel very good about a lot of what we're now realizing on Sixth Avenue. Availability is now below 10%.

It's one of only two of the nine submarkets in Midtown where availability is below 10%. So we see tenants looking for base floors. We see tenants seeking large floors, where they can densify.

So unclear at this point how that plays out, but we think we have a compelling opportunity in the base of the building in the event we were to get any of those floors back..

And the last one from me is, can you provide an update on the fund and any investments that you are considering or lift that and pass on during quarter?.

Kim, this is Albert Behler. We currently have two funds that are actively investing. One is our mezzanine fund #8 and one is the fund number nine, it's an equity fund. And the fund number eight has been actively investing in mezzanine opportunities in the quarter. We have missed about $175 million.

But the equity fund, we didn't have any activities in the quarter. We are very carefully exploring opportunities, because as I mentioned even last quarter, the market seemed to be quite expensive. We are looking for value-add opportunities and we are looking at opportunities, but we have not anything that we could talk about at this point..

Our next question comes from the line of Vikram Malhotra from Morgan Stanley..

You alluded to, obviously, selling some assets potentially in D.C. area. Can you just talk about maybe your appetite to explore other West Coast markets? You obviously have a nice group of assets in San Francisco.

But can you just give us a sense of what else you may be looking across the West Coast?.

Yes, sure, Vikram. We have been looking in these markets in the history of the previous for quite some time. Actually, we owned a couple of assets in Los Angeles downtown as well as Mid Wilshire. Currently, we are not really interested in any of these markets outside of San Francisco.

As I had mentioned numerous times, we -- real estate is a very local business. You have to have boots on the ground to be long-term successful. And we have that in San Francisco. We have that in D.C. And we have that in New York. So we're very comfortable with our position, and we're not exploring at this point any other opportunity..

And I know your lease expirations are low.

But can you just call out any sort of either known move-outs or any major tenants that you're working on over, say, the next 2 years?.

Well, we are always getting questions about Barclays. And Peter and his team are evaluating opportunities there that potential tenants knocking on Peter's door. Otherwise, there's really not that much happening over the next couple of years. We have expirations that are well below the average. So on a yearly basis, about 4%.

And you would assume that a portfolio of our structure, that means we have very long-term leases, on average maybe 10 years. So we have basically made this portfolio watertight and leased at a very high percentage rate. And I think we are expecting this to get better, as I mentioned in my prepared remarks.

And it's very typical for our quality portfolio. So we have long-term stable leases locked in, and that's a great position to be in..

So there's nothing -- no chunky lease or nothing sizeable of note in the expiration?.

No, there's none..

[Operator Instructions] Our next question comes from the line of Steve Sakwa with Evercore ISI..

I know you won't definitely comment on the D.C. asset sale.

But to the extent that you did pull one-off down there, are there any sort of tax implications or issues that would force a 1031 of that money? Or could you do something else with the cash?.

Yes, we are very capital and exploring this before we take any asset potentially into the market to sell. And we have done a very detailed report on the entire portfolio, and that's an important consideration. And Wilbur and his team are always exploring the situation on each assets.

So Wilbur, you want to comment on that?.

Yes, sure. I mean, largely, what Albert said, the only thing I'll add is as we go through the portfolio, Steve, we look for assets where we've created value and where we can be tax efficient. Obviously, be mindful of that, there's a sting tax associated also with some assets at the time of the IPO. So D.C.

portfolio seemed to be the place that made the most sense with respect to any asset that we would transact in D.C. We have the ability to shelter the proceeds, given where our taxable income is and given where our dividend payout is today.

Notwithstanding, we would still continue to look for opportunities should we be able to recycle that capital vis-à-vis 1031 exchange. So both options are available to us..

So it doesn't sound like you'd be forced to do a 1031, a share buyback could be a very use of capital?.

It could be..

Ladies and gentlemen, at this time, I would like to turn the call back to Albert Behler for closing comments..

Well, thank you, everyone, and we are looking forward to reporting and talking to you on our next quarter. Thank you very much. Bye-bye..

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation..