Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Paramount Group’s First Quarter 2019 Earnings Conference Call. [Operator Instructions] Please note that this conference call is being recorded today, May 2, 2019. I will now turn the call over to Rob Simone, Director of Business Development and Investor Relations. Please go ahead..
Thank you, operator, and good morning. By now, everyone should have access to our first quarter 2019 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 first quarter 2019 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, Rob, and good morning, everyone. We are off to a tremendous start to the year as financial and operating results are well ahead of our initial expectations. Core FFO for the quarter was $0.24 per share and same-store cash NOI grew by 11.3%.
We had the highest first quarter on record for leasing activity, which was over 353,000 square feet, and all that leasing was done at a record weighted average starting rent of over $97 per square foot. As a result of our strong start, we are increasing all of our 2019 guidance metrics.
Wilbur will cover our financial and operating results and our increased guidance in greater detail. As I mentioned a minute ago, first quarter leasing activity was robust at 353,000 square feet, and that activity was well balanced across both our New York and San Francisco portfolios.
Of the quarter’s leasing activity, 45% was in New York and 52% was in San Francisco. The leasing in New York was driven by a 2-floor, 108,000 square foot lease with New Mountain Capital at 1633 Broadway, which has brought the occupancy of the office portion in this enormous 2.5 million square foot asset to 100% leased.
The 184,000 square feet of leasing in San Francisco was driven by 3 leases at One Market Plaza at a weighted average starting rent of $109 per square foot, escalating at 3% per annum. This trophy asset continues to command some of the highest rents in San Francisco’s CBD.
We continued the strong leasing momentum in San Francisco, and subsequent to quarter end, we signed a 265,000 square foot lease with First Republic bank to expand their footprint at One Front Street. The expansion spans 16 floors as staggered explorations and have a weighted average lease term of approximately 10 years.
We are thrilled that First Republic now leases over 515,000 square feet or roughly 80% of this trophy office tower. As a result of this deal, the occupancy in the building, which was 92% at quarter end, is now at 100%.
Furthermore, we have proactively put to bed all of the lease roll that we had at the time we acquired this building about 2 years ago, which I must say exceeded all of our underwriting assumptions. Let me spend a minute on each of our markets. We remain very constructive on the New York office market. Underlying fundamentals are strong.
We continue to see the market benefiting from sustained office, using job growth and record-low unemployment. Our trophy office portfolio in New York is in Midtown, and the majority of our assets sit in some of Midtown’s best-performing submarkets.
The availability rate in Midtown remains healthy, and average asking rental rates are up quarter-over-quarter. All these dynamics bode well for us as we are now laser-focused on the 500,000 square foot Barclays lease at 1301 Sixth Avenue, which expires in about 20 months.
Based on recent discussions, we now expect that all of Barclays floors will come back to us when their lease expires in December of next year. As we have said in the past, we have been preparing for this eventuality and had ramped up our marketing efforts and have now listed the space.
We remain confident that given the quality and location of the building, the size of the block near the base of the building and the large and efficient floor plates, this space will remain very desirable in the market, and we already have significant interest.
As most of you already know by now, last week, New York City passed Bill 1253-C, which mandates, among other things, that office landlords reduce greenhouse gas emissions significantly over 2 compliance periods, the earliest being 2024.
While we certainly feel that the spirit of that bill is a huge step in the right direction to reduce the carbon footprint of our buildings, the bill needs a lot of work and it is very onerous to office landlords.
That said, we, at Paramount, have been a leader in proactively reducing greenhouse gas emissions, and we are the only REIT that boast a portfolio of 100% LEED Platinum- or Gold-certified buildings. You don’t get those accolades if you are not laser-focused on sustainability initiatives.
As a founding member of Greenprint, which is now part of ULI, we have been committed to being environmentally responsible from the beginning. And our own internal goals regarding reducing greenhouse gas emissions are perhaps, in some cases, even more aggressive than that of the New York City bill.
While it is still very early in the process and too soon to know the specifics, we are confident that we will continue to steadily improve the environmental performance of our buildings in working towards meeting the city’s mandates by the 2024 compliance period.
In San Francisco, the market continues to remain supply constrained as tenants continue to expand, availability continues to shrink and rental rates for Class A space in the CBD continue to increase in the low double digits.
Now that One Front is 100% leased, we look forward to unlocking value and proactively leasing the newly acquired 111 Sutter Street.
Much like One Front Street, this acquisition presents us with a tremendous opportunity to recycle a portion of the capital we received from selling 2 stabilized assets in Washington into a market with strong fundamentals.
As you can see in the supplemental, at just 70.6% leased, 111 Sutter offers significant upside from leasing vacant space as well as re-leasing pending roll over the next 3 years at much higher rates. Obviously, that means there is a lot of work to be done, but this is right in our sweet spot.
Just at One Front and 50 Beale, the roll along with the in-place rents at 111 Sutter offers us the opportunity to achieve double-digit mark-to-market and significantly grow the property’s NOI as we work through and lease the space.
As we discussed on our last call at the time of closing, we brought in a joint venture partner for 51% of the equity and completed a $138 million financing.
From our perspective, this was a modest equity investment, which provided us the opportunity to generate double-digit returns on net capital from leasing and re-leasing the space and earning fees by managing the asset, a very attractive proposition for our shareholders.
Over the coming years, we have a lot of leasing opportunities at both 50 Beale and 111 Sutter, which is why we see our San Francisco portfolio as very well positioned to contribute to earnings growth over the next few years. In Washington D.C., we remain in a very strong position.
Given the quality of our portfolio, our leasing success and limited lease roll over the next several years. Our disciplined approach to focus on the best assets in key locations within the CBD continues to be the right approach. We don’t have much available space, but whenever we do have availability, we are able to execute.
To summarize, the first quarter was a great beginning to 2019 for Paramount. Our portfolio is well positioned, offering a balance of stability and opportunity. We are 96% leased with very modest expirations over the next several years. We have opportunities to keep growing cash NOI throughout the portfolio.
Our confidence in both our strategy and its execution remains high as our results continue to demonstrate that we are on the right path. With that, I will turn the call to Peter to give additional insights on our leasing..
Thanks, Albert, and good morning. We are off to a strong start in 2019. During the first quarter, we leased approximately 353,000 square feet and expect to build on our sustained leasing momentum in the second quarter. At quarter end, we were 96% leased and remain encouraged by the current tenant demand in the properties where we have availabilities.
Let’s review the highlights by market. Beginning in New York, our portfolio was 96.6% leased at quarter end, up 60 basis points quarter-over-quarter and up 390 basis points year-over-year. During the first quarter, we leased 160,000 square feet with a weighted average term of approximately 14.5 years with initial rents of $91.75 per square foot.
This marks the second consecutive quarter we have recorded initial rents in excess of $90 per square foot in New York. Looking ahead, the New York portfolio remains very well positioned with approximately 4% expiring per annum through year-end 2020. Midtown’s leasing fundamentals remain healthy and current tenant demand remains strong.
We continue to capture more than our fair share of tenant demand as evidenced by our leasing results and remain heavily focused on the successful lease-up of our remaining availabilities, the largest of which is the Barclays block of space at 1301 Avenue of the Americas.
As a reminder, Barclays lease expires on December 31, 2020, and shows up in our lease expiration table in 2021. We have officially launched the marketing of this block of space with the expectation that Barclays will not extend the lease.
As Albert mentioned, we have a high level of early interest in the space given the size of the block, the quality of the building and its central location in one of Midtown’s best-performing submarkets.
These attributes, coupled with the building’s large and efficient floor space, provide a competitive advantage that will resonate with prospective tenants. In San Francisco, we ended the quarter at 94.4% leased. During the first quarter, we leased approximately 184,000 square feet and remain very well positioned relative to current tenant demand.
Leasing fundamentals in San Francisco continue to strengthen on every level. During the first quarter, there were 7 deals completed in excess of 100,000 square feet, which is noteworthy given that San Francisco set a record in 2018 with the signing of 21 deals in excess of 100,000 square feet.
Net absorption remains positive and average asking rents continued to increase, up 11.7% year-over-year for Class A products in the CBD. Vacancy for Class A products in the CBD continues to decline, down 400 basis points year-over-year to 5.7%.
It is our expectation that rents will increase further given the robust demand and limited supply, especially for large blocks of space in the CBD. At One Market Plaza, we are 99.2% leased.
During the first quarter, we executed 2 office leases with existing tenants totaling more than 172,000 square feet and added yet another retail amenity to One Market’s dynamic retail mix. One Market remains in high demand and continues to achieve among the highest rents in San Francisco. At One Front Street, we are currently 92% leased.
Subsequent to quarter end, we executed a significant lease expansion with First Republic Bank for 265,000 square feet. This transaction brings One Front to 100% leased. We are thrilled to not only accommodate First Republic’s growth at the building but also to solidify our partnership with an investment-grade tenant with this new long-term deal.
At 50 Beale Street, we are currently 99.7% leased. During the past year, we began the process of repositioning the building by commencing our lobby renovation, transacting with Equinox in the base of the building and securing the base floors with dynamic tech tenants.
Our focus has now shifted to the marketing of the 262,000 square feet block of space we will get back at the beginning of 2020 when Blue Shield vacates the property. This block of space, which is located on 50 Beale’s uppermost floors, is the largest block availability in San Francisco over the next 12 months.
Given 50 Beale’s attributes, which include virtually column-free floors and a highly desirable location in the heart of the South Financial District, it is not surprising that we are in advanced discussions with prospective tenants for the space.
We view the lease-up of this block of space as an opportunity to create significant value as the current in-place rent is roughly $55 per square foot, well below market.
Lastly, in San Francisco, we are excited by the opportunity we have at 111 Sutter Street, an asset that we view not only as complementary to our existing portfolio, but one where we can create tremendous value to the lease-up of the building.
The building is currently 70.6% leased with approximately half of the in-place leases scheduled to roll over the next 3 years. Similar to One Front and 50 Beale, we are well positioned to take advantage of the building’s current and upcoming availabilities. We look forward to updating you on our progress in the months ahead.
In Washington D.C., we ended the quarter at 94% leased and remain very well positioned with approximately 5.5% expiring per annum through year-end 2020. But despite the influx of new supply in the core submarkets of D.C., we continue to attract demand from premier tenants for our limited availabilities.
This is a testament not only to the location, but also to the quality of our properties in D.C. With that summary, I will turn the call over to Wilbur who will discuss the financial results..
last year’s first quarter was positively impacted by earnings from the 2 Washington D.C. assets that were not in this year’s first quarter; and this year’s first quarter was impacted by a change in accounting rules requiring us to expense internal leasing costs.
This earnings growth was once again driven by sector-leading same-store NOI growth of 11.3% cash and 6.9% GAAP. We ended the quarter with a same-store leased occupancy rate of 96.4%, in line with the leased occupancy at year-end. Here is the breakdown.
Our same-store portfolio in New York is 96.6% leased, up 60 basis points from year-end, notwithstanding the termination of the Henri Bendel lease at 712 Fifth Avenue, which brought the leased occupancy in that building down to 70.8%.
Interestingly enough, if we were to exclude 712 Fifth Avenue from our same-store statistics, which we have not, our New York portfolio sits at 97.6% leased, full by any measure.
Our same-store portfolio in San Francisco is 96.4% leased, down 160 basis points from year-end driven by the lease expirations at One Front Street, which have already been backfilled by the recently announced First Republic deal. Washington remains virtually full at 94%.
We leased over 353,000 square feet in the quarter and portfolio-wide mark-to-markets were solid at 5.6% cash and 13.2% GAAP. The quarterly mark-to-markets would have been even higher were it not influenced by a couple of unusual items worth highlighting.
The reported mark-to-markets in the New York portfolio were negative 6.7% cash and negative 3.9% GAAP. While we leased approximately 160,000 square feet in New York, less than 78,000 square feet or about 49% of this quarter’s leasing qualified as second-generation space for the purposes of mark-to-market calculations.
As Albert highlighted earlier, the New York leasing activity was driven by 2-floor 108,000 square foot lease. One of these floors had a roll-up in rents of over 15% on a cash basis and about 3.5% on a GAAP basis.
However, because this floor was vacant for over 12 months, it did not meet our definition of second-generation space and therefore, was excluded from the reported mark-to-market results.
Furthermore, the other floor that was included in the reported results was a victim of our prior success where we executed a short-term renewal with an existing tenant, and that rent was nearly $100 per square foot.
The combination of excluding the space that rolled up and including the space that rolled down essentially drove the reported negative mark-to-market results in New York. While these one-off above-market short-term renewals are a great outcome at the time, they do have an impact when you re-lease the space later even if that is at market rents.
Mark-to-markets in San Francisco were a robust 18.8% cash and 31.1% GAAP, and in Washington were a very respectable 5% cash and 6.9% GAAP. Given our strong first quarter results and our outlook for the remainder of the year, we are raising our guidance on all fronts.
Leasing volume is now projected to be between 800,000 and 1 million square feet, up 20% at the midpoint from our prior estimate. We anticipate same-store lease occupancy to now be between 96% and 97%, up 150 basis points at the midpoint from our prior estimate.
Same-store cash NOI is now projected to be between 7% and 9%, up 200 basis points at the midpoint from our prior estimate. Same-store GAAP NOI is projected to be between 3% and 5%, also up 200 basis points at the midpoint from our prior estimate.
And core FFO is expected to be between $0.90 and $0.94 per share, up $0.02 per share at the midpoint from our prior estimate. Turning to our balance sheet. We have over $1.3 billion of liquidity comprised of $338 million of cash and restricted cash and $1 billion of availability on our credit facility.
Our outstanding debt at quarter end was $3.2 billion at a weighted average interest rate of 3.7% and a weighted average maturity of just under 4.5 years. 85% of our debt is fixed and has a weighted average interest rate of 3.6%. The remaining 15% is floating and has a weighted average interest rate of 4.4%.
We have no debt maturing until the fourth quarter of 2021, and beyond that, our maturities are well laddered. Lastly, we have also updated our schedule of free rent and signed leases not yet commenced, which now sits at $53.3 million.
This can be found in our investor deck, which is posted 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 Jason Green with Evercore ISI..
Just a question on Barclays.
Now that you’re officially marketing this space, can you expand on the activity you’re seeing there, maybe types of tenants that are looking at the space and how many times you think it will take to fill the space?.
Sure, Jason. This is Peter. As you’ve now heard us say and as you pointed out, the space will be coming back to us. Not only that, Barclays has indicated that they could give up the space prior to their expiration of 12/31/2020 if we find another tenant.
So that gives us the flexibility to appeal to prospective tenants, for example, that may have immediate requirements. And it also allows us to communicate to the market with certainty that we will, in fact, get the space back.
There are really only a handful of competing opportunities greater than 300,000 square feet asking for rents in line with what we are asking. And we believe we have the most compelling offering given what we described previously, large floor place, location and building quality.
Whether it’s 1 tenant, 2 tenants, perhaps even 3 tenants remains to be seen, but I can tell you in the early going, we feel very good about our activity primarily from financial services tenants, and we look forward to updating you as we move forward.
I will say beyond the space itself, recall Sixth Avenue has been one of the strongest submarkets in Midtown. Last year, velocity outpaced the 5-year annual average by 13%, and we’re expecting good results by way of velocity in the year ahead..
Got it. And then just a question on buybacks. You bought back stock heading into the back half of 2018 and stock’s still trading at a discount.
Does that experience dissuade you from doing additional buybacks? Or do you still view it as a potential opportunity to invest in undervalued real estate?.
We still see this as an opportunity to invest either in real estate or buy back our stock. We want to keep all of our options open there. And we have been very active in the fourth quarter, most probably one of the most active public REITs. And we are watching the stock price very carefully.
And Wilbur and I are conferring about it consistently, and we are also discussing it with the Board on a quarterly basis..
Our next question comes from the line of Blaine Heck with Wells Fargo..
So you guys have quite a bit of cash on the balance sheet at this point. Can you talk about how you guys are thinking about possible deployment options between acquisitions, fund investments, repurchases and then just continuing to invest in your current properties? And on that last option, if I can add a question.
Can you also give us any color around the amount of renovation spending that might be required at 111 Sutter, 50 Beale where Blue Shield is moving out, the Henri Bendel space at 712 Fifth and possibly the Barclays space at 1301?.
Yes. Let me start with a capital improvement or capital investments on our assets. We have been, at Paramount, always very proactive in investing in our properties. So 111 Sutter is clearly something that needs some upgrading on elevators and repair on the facade. That’s in motion.
And we have about 30% to lease, so we think that can be successfully executed with not too much of capital to be spent. It will be in the single-digit million dollar range. So nothing out of range. On 50 Beale, we expect that normal tenant improvements will cover the necessary capital investment there, once we are talking to our tenants.
And Peter and his team have been in constant discussions, and we know we are very well positioned because of top floors of building. So we think normal tenant improvement expenses will cover that. On 1301 Sixth Avenue, the Barclays space, we’ve got large floors.
And there again, we think because of the uniqueness of the space and rents located in the asset, we don’t think that we have any kind of exceptional capital to be invested. You might remember that we have already spent capital to do a light renovation of the lobby about 2 years ago. So we think we’re in a very good position there as well.
And as you can see from the leasing of the asset, a very good March. We are pretty much fully leased other than the Barclays location. Henri Bendel is something that is very unique. It’s – it’s in a great location on 56th and Fifth, most probably one of the best retail locations in the world, but it really depends on who the tenant is going to be.
We are not sort of objecting to spend capital upfront in a major way. We are making plans on basically improving the space, but just the basic improvements. And then it really depends on the tenant for that space and the capital there to be invested.
When it comes to general investment balance sheet, capital investments, we – as I mentioned on the last question before, we are keeping our options open. We have sufficient capital to invest in new properties similar to what we had done at 111 Sutter in San Francisco. And it’s – at the same time, we bought back our stock in the fourth quarter of 2018.
So we will try to do the best to – for our shareholders at appropriate time..
That’s very helpful, Albert. And I’m not sure if you guys went over this, and I’m sorry if you did. But just to follow up on the Henri Bendel space, can you give a little bit of an update there and the situation with L Brands? I think maybe on the early interest that you guys have seen in that space..
Well, we had informed everyone that basically L Brands has moved out in the first quarter, and it’s too early to talk about what the outlook will be for new tenancy there..
Okay. Fair enough. Last one for me. Peter, looked like you guys had a move-out at 1899 Pennsylvania.
Can you just give some color on how you think that space is positioned and your prospects for backfilling that space?.
We have had, I would say, a healthy amount of tour activity on the space. We have a broker launch coming up in the next couple of weeks where we have 200 brokers attending. We think the space shows well.
And at this point, it’s too soon to say who ultimately may lease that space, but we feel good about the level of interest for that 1 floor that we have in the building..
Our next question comes from the line of Derek Johnston with Deutsche Bank..
Could you talk about how much of the guidance raise was related to the First Republic lease or what was driving it?.
Sure, Derek. This is Wilbur. If you look at our investor deck, we kind of pointed a $0.01 increase from the guidance relative to highest straight-line rent. So the First Republic lease is an expansion. It really will not contribute to the cash NOI bump in the guidance, but mostly on the GAAP side is what it contributed to..
Okay. And then just going to some of the opening questions on the green new deal building initiative.
Do you think that this initiative will negatively affect older in-place office building valuations and really create more of a divergence in value from some of the newly developed and redeveloped buildings versus the older in stock?.
I think it’s too early to say what the final result there, and this was just put into law recently. And we, as I have pointed out in my remarks, we feel with our properties has been very proactive on the environmental side. We think that we are well prepared for this.
It’s not necessarily just a matter of age of the building, it’s a matter of how you maintain your buildings. But it’s too early to really go into the details on that. I could imagine if some of the landlords are not investing in the buildings that might ultimately lead to a divergence in value.
And I think that bodes well for Class A and trophy properties..
Okay. And just lastly and I guess quickly, your lease rates are pretty full, I mean, especially after the First Republic lease in April. The own supply is pretty light. Now rent spreads have been robust.
But is there a possibility that you guys can be a little more aggressive on pricing especially since there aren’t many concerns with rolls through 2020?.
I think it’s always a good starting point to be pretty fully leased to negotiate and increase rents when you negotiate about new leases. I think the team has done this already as you can see from the increased rates. So I think that’s part of the strategy that we have already [indiscernible]..
Derek, I would add to that by saying we are pushing when and where we can. I think it turns out that our availabilities are located in buildings in submarkets where we do have some pricing power.
I think about our block of space, for example, at 50 Beale Street where we have in-place rents at roughly $55 per square foot, and it is our expectation that we will transact likely across that block for rents somewhere in the $90s.
So we are, I think, shrewd in terms of how we’re thinking about negotiating each and every one of our leases, and that is something that we are thinking about now..
[Operator Instructions] Our next question comes from the line of Vikram Malhotra with Morgan Stanley..
This is Adam on for Vikram.
Can you just talk about the level of demand you’re seeing in the New York City market by tenant subsector as far as tech tenants versus financial tenants?.
Sure. In the first quarter, financial service tenants represented 30% of the velocity, which is generally in line with what they represent in the broader Midtown market. On our spaces specifically, we are seeing some TAMI. We’re seeing even more financial services.
We’re seeing financial services looking for additional space beyond their current envelope of space. So that’s generally the 2, I think, drivers of demand that we are seeing in our properties currently..
Got it. And then just one more on New York City. Just as far as TIs, last year, people were sort of talking about how they were elevated but were starting to level off.
Can you just talk about what you’re sort of seeing in the marketplace as far as the trajectory of TIs for leasing this year?.
We’re seeing TIs stabilize..
Yes. And you can actually can see that in our reported results. As you can see, we published the TIs per square foot per annum as a percentage of initial rent, and you’ll see that over the last 18 months to 24 months, they’ve been pretty flat..
Ladies and gentlemen, this concludes our question-and-answer session. I’ll turn the floor back to Mr. Behler for any final comments..
Albert Behler:.
Thank you. This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation..