Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Paramount Group Second Quarter 2020 Earnings Conference Call. [Operator Instructions] Please note that this conference call is being recorded today, July 30, 2020. I would now like to turn the call over to Rob Simone, Director of Business Development and Investor Relations.

Thank you. You may begin..

Thank you, operator, and good morning. By now, everyone should have access to our second quarter 2020 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, including, without limitation, the negative impact of the coronavirus, COVID-19, on the U.S.

regional and global economies and our tenants' financial condition and results of operation. Therefore, you should exercise caution in interpreting and relying upon 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 conditions.

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 2020 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 thank you, everyone, for joining this morning. First and foremost, I'll start by saying that all of us at Paramount hope that you, your friends and your family remain safe and healthy during this unprecedented global health crisis. At Paramount, we continue to navigate this uncertain environment.

When we spoke last quarter, our focus, including that of our tenants, was on transferring to a remote working environment in an efficient manner. Now that we have seen the results from this, what I would refer to as a mandatory work-from-home experiment, let me share my observations.

The positive was that work got done and we did not miss any of our deadlines or delay any of our filings. The negatives, which are quite a few to speak of, seem too far outweigh the positives.

Based on the feedback from our own employees, the amount of time and effort in accomplishing their tasks was far more than it required while being in the office.

The inefficiencies resulting from poor WiFi connections, the need to schedule time for simple questions that could have been answered by simply walking over to their supervisors and various other distractions have contributed to the incremental time and effort.

In speaking to our tenants, and based on our own experiences, there seems to be no surrogate to in-person meetings and collaborations.

The only reason that this work-from-home experiments had some level of success for Paramount is because we are reaping the benefits of the years of training and development and trust that we have built with our employees.

You cannot cultivate a positive culture through team building and innovation, and furthermore, you cannot mentor the future leaders of our country without building a rapport in person in the office. All these intangible aspects are, in many ways, what represent hallmarks of successful companies.

That said, a by-product of this mandatory work-from-home experiment could be that employers provide their employees more flexibility rather than requiring them to be in their offices every day of the week, but in no way will that negate the need for traditional office space.

In fact, space utilization discovery is currently underway and will undoubtedly lead to de-densification. The pendulum has, in this cycle, swung too far with the rise of co-working. And now it will swing back. In fact, we have had tenants who have come to us and said they need more space as they evaluate how best to reconfigure their offices.

While de-densification considerations had started pre-pandemic, this planning has only accelerated as companies aim to create safe and productive space for their employees, all of which will likely require companies to add to their current real estate footprint.

As we continue to engage with our tenants during this pandemic, other than concerns surrounding the health and safety of their employees, their focus is on the reintegration of their workforce.

While the reintegration will likely occur gradually over phases extending into next year, we see our tenants starting to return, albeit slowly, to their offices. In New York, the process began in late June when the city entered Phase 2 of reopening and permitted tenants to begin to reoccupy office space, subject to certain restrictions.

In San Francisco, recent events have obviously paused this process, but the protocols we are adding and improvements we are making are in place across the portfolio as both cities reintegrate office employees over time.

Mindful of all local guidelines and working in conjunction with our tenants, we have established protocols to ensure all individuals who arrive to our buildings feel safe and secure in a healthy environment. Most visible, we have implemented a series of lobby protocols and substantially augmented cleaning standards.

Less visible, some of our buildings that did not have top-of-the-line air filtration devices to improve ventilation systems and sensors to measure indoor air quality have now been or are in the final stages of being retrofitted. In addition, building personnel have undergone special training focused on COVID-19-related issues.

We are taking these measures in an effort to ensure that we are holding ourselves, as the landlord, to the highest standards of workplace safety and comfort, in essence, being safest-in-class. Turning to our financial and operating results for the quarter.

Core FFO for the second quarter was $0.23 per share, in line with the second quarter last year and consensus among our analysts. Our results demonstrate the strength of our assets and their resiliency during this crisis.

We continue to benefit from having a high-quality portfolio of trophy assets with a roster of blue-chip tenants and very limited exposure to retail. Our collections have remained solid and consistent and have not materially changed from our pre-COVID collections.

To quantify, we have collected almost 98% of our contractual rents to office tenants and just under 60% from our retail and non-office tenants, bringing total portfolio-wide collections to over 96%.

Wilbur will cover both our financial results and our collections in greater detail, including the methodology of our reported figures as we have seen a diversity in practice in which these figures are being reported.

I'm happy to see that our efforts in building a high-quality office-centric portfolio with a blue-chip tenant roster and where retail serves as an amenity to office tenants is manifesting itself through our high collection rate.

From a leasing perspective, our leasing team had a productive quarter as we executed on more than 300,000 square feet at a weighted average starting rent in excess of $93 per square foot. As we expected, and as I highlighted on our last call, virtually all of the activity was renewal-based and addressed expirations in 2021 and beyond.

We ended the quarter nearly 96% leased on a same-store basis and for the remainder of the year have just 1% of annualized rent rolling. Longer term, we remain well positioned. Peter will provide more detail on our leasing activities, but I want to make a few observations about our markets.

Renewal leasing activity in Midtown post the onset of the pandemic has represented a higher-than-normal share of total leasing. This is consistent with what we are seeing in our leasing results, as I just mentioned a moment ago. Companies are taking a wait-and-see approach towards relocating or expanding.

As a result, tenants are focusing on shorter-term renewals. Most, if not all, activity has been exploration-driven, a trend we anticipate will continue until there is better clarity with the economy and the pandemic. Within our New York portfolio, the Barclays' space at 1301 Avenue of the Americas remains our primary focus.

As we discussed in our last call, in the current environment, we continue to view the lease-up of this space as a 2021 event. Nonetheless, over the long run, we continue to see Sixth Avenue as one of the most desirable submarkets in the city.

Space that is centrally located in that submarket in a high-quality building with large and efficient floor plates remains very attractive to prospective tenants over the long term. In San Francisco, the sentiment is not much different. Similar to New York, tenants are focusing more on renewal transactions, many of which are short term.

Tenants are taking a similar wait-and-see approach towards committing to new space until there is more clarity around the broader economic outlook and the reopening process. As in New York, we are in a strong position. Our portfolio in San Francisco is nearly 97% leased at quarter end with a very manageable expiration profile over the next 4 years.

During the quarter, we executed renewals on approximately 250,000 square feet at rents averaging nearly $100 per square foot. Turning to the transaction market. Much like in leasing, volumes have slowed considerably. From our perspective, this drop in transaction volume is not driven by a lack of liquidity.

In fact, the appetite for Class A product in gateway cities across the U.S. remains, including interest from foreign buyers. However, the market is on pause in a period of price discovery.

There are opportunistic buyers looking for bargains, but there are no sellers to provide those bargains, causing a considerable gap between the bid and ask between buyers and sellers.

In addition, the cost of debt capital is at historically low levels, and the debt market remained very liquid, which is resulting in sellers opting to refinance instead. How this plays out and for how long is unknown and will depend on how the global economy emerges from this current crisis.

It is that price discovery process as well as the debate around workplace flexibility and de-densification that leads to the continuing dislocation in our stock price as well as those of our peers in New York and San Francisco-focused CBD office suites.

While frustrating for shareholders and us alike, we have to remain disciplined and focused on the long-range objectives as the favorable long-term fundamentals supporting our markets are unchanged.

To ensure we remain in a position of strength to execute on our long-term strategy over the short term, we continue to maintain a defensive posture around liquidity and preservation of capital until there is better visibility on the economy as a whole.

During the quarter, as previously reported, amidst all the market volatility and severe dislocation of our stock price, we announced and closed on a 10% sale of 1633 Broadway, raising over $110 million in net proceeds. The transaction valued the property at $2.4 billion or $960 per square foot.

1633 is the largest asset in our portfolio both in terms of size and from a valuation perspective, and we think the transaction is indicative of the underlying long-term value of our real estate compared to the levels at which our stock is currently trading.

Also, as previously reported, we have entered into an agreement to sell 1899 Pennsylvania Avenue, our last remaining property in Washington, D.C. We remain on track and expect the transaction to close in the fourth quarter.

Overall, we continue to manage through the current uncertainty in a strong financial position with a stable portfolio of high-quality Class A buildings occupied by high-quality credit tenants.

We are focusing on reintegrating current tenants in a manner in which every single employee of every tenant feels they are entering a safe and healthy environment. We are focusing on extending lease expirations and continuing to engage with the markets where we have availability.

We are focusing on ensuring we maintain sufficient liquidity, which amounted to $1.35 billion at the end of the quarter, and remain well capitalized and positioned for the long term. With that, I will turn the call to Peter to provide additional insights on our leasing..

Thanks, Albert, and good morning, everyone. During the second quarter, we leased in excess of 300,000 square feet at a weighted average starting rent of $93.47 per square foot. All of this activity was renewal-based and primarily addressed expirations in 2021 and beyond.

At quarter end, we were 95.6% leased on a same-store basis, down 20 basis points quarter-over-quarter. For the remainder of the year, our New York and San Francisco portfolios have lease roll equating to 1% on a square footage basis and 1% on an annualized rent basis.

Needless to say, this is very manageable, particularly at a time of uncertainty, and is the result of our strategy to pre-lease space and derisk future roll. Moreover, through 2024, our New York and San Francisco portfolios' lease roll is 7.7% per annum, inclusive of the Barclays block expiring at the end of this year.

While in-person touring and leasing activity is expectedly down in both of our markets, it has become increasingly apparent that limited lease roll in the near term and the portfolio comprised of best-in-class credit tenants will serve us well as we work through these difficult times. Let's review our results by market, starting with New York.

The Midtown Manhattan office market saw new leasing activity declined significantly during the second quarter amidst the ongoing pandemic. However, approximately 1.2 million square feet of renewals were executed during the quarter, generally in line with the 5-year quarterly average.

As expected, renewals, which represented 48% of Midtown's total leasing velocity during the quarter, were generally shorter term in length relative to historical norms as tenants elected to buy time before reassessing their longer-term real estate requirements.

It is our expectation that renewals will comprise a disproportionately high percentage of Midtown's leasing velocity in the near term. With that being said, the number of new space inquiries and virtual tours has accelerated over the past several weeks.

In certain cases, these virtual tours have been the precursor to in-person tours, which has allowed us to remain productive during this period. On our last call, we mentioned that we were in late-stage negotiations with a 50000-square foot tenant.

In the second quarter, we signed this extension with ICBC at 1633 Broadway for approximately 5 years at a starting rent of $82 per square foot, resulting in the further reduction of our 2021 lease roll. Our New York same-store portfolio was 95.3% leased at quarter end, unchanged since year-end.

Looking ahead, the New York portfolio is very well positioned with approximately 7.9% of currently leased space expiring per annum through year-end 2024, which figure includes the lease expiration of Barclays' 500,000-square foot block, as reflected in our 2021 lease expiration schedule.

Excluding the Barclays' space, a modest 6.6% of currently leased space in New York is set to expire per annum through year-end 2024. As we have stated previously, 1301 Avenue of the Americas remains our primary focus as we market the Barclays' block of space. The Sixth Avenue submarket remains among Midtown's most well-positioned submarkets.

Our offering is even more compelling in today's environment given certain attributes such as walkability to major transit hubs and our ability to create a private welcome center that affords not only an enormous branding opportunity, but also a way for a large tenant to control the experience for its employees and its guests.

We have been actively presenting the building through virtual presentations to both tenants in the market and the brokerage community and remain confident that we are well positioned. We look forward to updating you on our progress. Turning now to San Francisco. 2 weeks ago, the city paused its phased reopening amidst an increase in COVID-19 cases.

The result of this will extend the slowdown of new leasing activity beyond the second quarter. Similar to what we are experiencing in New York, tenants have focused on renewal transactions, particularly short term in length, and have largely taken a wait-and-see approach toward relocations, expansions and longer-term space commitments.

Despite this pause in the market, we remain long-term believers in the resiliency of the San Francisco market.

Unlike prior cycles, the San Francisco market is anchored by mature, large-cap tech, financial services and the life sciences firms, all of which have continued to attract a disproportionately high percentage of venture capital funding through the first half of 2020.

Our same-store portfolio in San Francisco was 96.9% leased at quarter-end, down 50 basis points quarter-over-quarter. During the second quarter, we leased approximately 250,000 square feet at a weighted average term of almost 4 years with initial rents averaging just under $99 per square foot.

The San Francisco portfolio also has limited near-term roll with just 7.3% of currently leased space expiring per annum through year-end 2024. At One Market Plaza, we completed 2 significant renewal transactions during the quarter, the largest of which was an approximately 150,000 square foot extension with a law firm we previewed on our last call.

This deal was the largest transaction completed in San Francisco during the second quarter and will contribute to the further reduction of lease roll in our portfolio as this space was set to roll in 2021. In addition, we extended another law firm in the building for approximately 85,000 square feet.

The 2 renewals resulted in a cash mark-to-market of 37.2%, and both deals reinforce One Market's immense appeal to leading tenants. One Market Plaza's leased occupancy remains virtually full at 98.2%. With that summary, I will turn the call over to Wilbur, who will discuss the financial results..

Thanks, Peter. Let me briefly cover our financial and operating results for the quarter. Yesterday, we reported core FFO of $0.23 per share, which was in line with consensus and consistent with that of the prior year's second quarter.

That said, our second quarter was impacted by COVID-19, which resulted in us taking some noncash write-downs and reserves, which totaled $0.04 per share. As such, core FFO would have been $0.27 per share had it not been for the $0.04 write-off and reserves that we took.

Of the $0.04, $0.03 represented noncash write-offs related to straight-line rent balances and $0.01 represented reserves against accounts receivable.

All of the reserves that we took this quarter, whether it was against the straight-line rent or against accounts receivable, related to the retail tenants in our portfolio, which, by the way, account for only 3.5% of our annualized rents.

And that is not a modified or adjusted figure, that is the pre-COVID, pre-rent-relief and pre-rent-deferral figure.

As expected, our same-store results for the second quarter were also negatively impacted due to the pandemic and, more specifically, by our election not to utilize the relief provisions provided by GAAP as it relates to lease modifications.

What I mean by that is that we elected to not record any revenue from tenants whose rent we deferred or abated and will only record such revenue when it is paid.

While some of our peers avail themselves of the relief provisions provided by GAAP in response to the pandemic, we felt our approach was the more conservative one and better represents the true cash NOI generated by the business in the current period versus the alternative of overstating cash NOI by building up receivables that may ultimately have to be written off in the future.

This was the primary driver in our same-store cash NOI growth being negative 4.1%. As Albert highlighted earlier, our collections during the second quarter continued to remain solid, and office collections have only improved throughout the second quarter and into July.

During the second quarter, average collections from office tenants stood at 97.8%, a remarkable result. While office collections had been robust and improving, obviously, the same cannot be said about retail collections, which have steadily deteriorated to just under 58%.

This result is not surprising to us at all as the retail tenants in our portfolio are service-oriented and serve as an amenity to office buildings. And these tenants, be it restaurants or theaters, have been closed during the pandemic, with some of them resuming operations only in a limited capacity.

Notwithstanding the retail collections, overall portfolio collections averaged 96.4% for the second quarter, and this is because retail represents only a small portion of the overall pie and accounts for only 3.5% of our annualized rents.

Because not everyone may report collections on the same basis we do, I think it is important to note that these figures are based on pre-COVID contractual rents that do not take into account deferrals or abatements, which we believe is a more faithful representation of our business.

During the second quarter, we executed 14 leases covering over 300,000 square feet at robust positive mark-to-markets of 24.2% on a cash basis and 19.2% on a GAAP basis. Mark-to-markets in New York were 0.3% cash and 2.7% GAAP. Mark-to-markets in San Francisco continued to be stellar at 37.4% cash and 27% GAAP. Turning to our balance sheet.

We ended the quarter with over $1.35 billion in liquidity comprised of over $550 million of cash and restricted cash and $800 million of capacity under our revolving credit facility. Our cash balances increased by roughly $150 million since the last quarter, driven primarily by the proceeds generated from the sale of a 10% interest in 1633 Broadway.

Our outstanding debt at quarter end was $3.83 billion and includes $200 million that was borrowed under our revolver. Other than the borrowings under our revolver, all of our debt is secured and non-recourse. This debt has a weighted average interest rate of 3.1% and a weighted average maturity of 5.2 years.

83% of our debt is fixed and has a weighted average interest rate of 3.4%. The remaining 17% is floating and has a weighted average interest rate of 2%. We have no debt maturing until the fourth quarter of 2021. And beyond that, our maturities are well laddered. With that, operator, please open the line for questions..

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] The first question comes from Derek Johnston with Deutsche Bank. Please proceed with your question..

Of these renewal deals, is it the tenant's desire to lock in relatively favorable terms caused by the pandemic? Is it the expectation that they perhaps won't need additional space in the near to midterm given work-from-home success? Any additional trends emerging or data that you can share on these elevated renewals?.

Derek, I think we missed the first part of your question. Could you say that again? I think it's about the work-from-home situation, but maybe you can do it again. I think you came through wobbly..

Of course, Albert, and I'll paraphrase.

So just looking at what's driving the pull forward of renewal deals, and I didn't have a great sense as to whether or not it was tenants looking to lock in favorable terms caused by the pandemic or it's maybe because they don't think they're going to need additional space in the near to midterm given work-from-home success? Any additional trends emerging or data that you can share on these elevated renewals?.

Derek, I think we missed the first part of your question. Could you say that again? I think it's about the work-from-home situation, but maybe you can do it again. I think you came through wobbly..

Of course, Albert, and I'll paraphrase.

So just looking at what's driving the pull forward of renewal deals, and I didn't have a great sense as to whether or not it was tenants looking to lock in favorable terms caused by the pandemic or it's maybe because they don't think they're going to need additional space in the near to midterm given work-from-home success.

Any trends that you can share in addition to your prepared comments, I would be grateful..

Sure. Derek, the, this is pretty normal when, in this kind of business environment, similar to what happened after September 11 or after the Great Financial Crisis. Tenants don't, if they have to extend or make a decision, they focus on rather shorter term, and they don't want to make additional investments, major decisions.

So that's very, very typical. And I have to say there was no real pressure on pricing, to the second part of your question. I think the terms that Peter and his team were able to achieve were market and were pretty much as expected..

Okay.

How do you guys think about balancing capital allocation priorities, especially given 1633 Broadway? How do you look at further acquisitions, perhaps in San Fran or other markets, potentially redeveloping or repositioning assets or even possibly contemplating share repurchases at these low valuations? How do you kind of stack that up?.

Currently, in this kind of environment, the priority is keeping liquidity and capital preservation until you have a good visibility on the recovery. And I use the term of don't catch a falling knife. I think it's too early to really analyzing capital market's development with regard to property values.

And we are clearly not in acquisition mode in general. It's liquidity preservation. And you need to find a willing seller and a willing buyer. And currently, that has not been defined yet..

Yes. No, understood. And lastly, historically, we've kind of thought of Paramount as a remarket company. As you exit D.C., it looks like it's going to be San Fran and New York going forward. Is there any appetite or potentiality for perhaps Seattle or L.A.

or another market, even if it's several quarters down the line? Or is your footprint basically set?.

Yes. I wouldn't currently do anything entrepreneurial in a new market. It's, as I said before, it's way too early to do something like that. I think D.C., we invested at the right time. We harvested what we worked on. Most of the properties got leased in a pretty solid market. Currently, as we pointed out, we are in the process of selling our last asset.

We are still asset-managing in D.C. That's a market that might become attractive. I don't see it to become attractive for investments within the next year or so. But we still have a small operating management platform there for the assets that we are managing, for assets that are outside of Paramount Group.

We are not considering to going into another market like you were saying, Seattle or so, at this point..

Our next question comes from Blaine Heck with Wells Fargo..

Great. So clearly, the biggest question and focus for you guys continues to be the Barclays' backfill of 1301.

Can you just give a little more color on how much current activity you guys have there? How has the market changed since even just last quarter? And maybe just discuss your level of willingness to be flexible on rents or concessions in order to get a lease signed and a tenant in there..

Blaine, this is Peter. What I would say is that we continue to have productive conversations. They have slowed a bit as tenants recalibrate their own requirements and what their required space on a go-forward basis.

We have put together what I would say is a very effective presentation that we've been sharing with both tenants in the market and the brokerage community. And all of the attributes that we've talked about have been very well received, the private welcome center, the enormous branding opportunity, the outdoor space that we can create.

And so when we think about our offering relative to other opportunities, we do have a lot of conviction in our pricing. At this point, there is some price discovery taking place, but generally speaking, relative to other large blocks of space as well located as ours, there are not many at our price point.

So we think that, as tenants further define their requirements, we'll be well positioned to capitalize on that demand as things start to normalize..

Albert, I wanted to go back to one of your comments during the prepared remarks. You said you guys have been approached by tenants that are asking for more space to de-densify or maybe reconfigure their office environment to be healthier and safer.

Can you just expand on that a little bit? Is this something that was just a one-off request? Or is it more widespread throughout your portfolio? And I guess how much in the way of additional space requirements do you think this trend could create?.

Yes. I think it's still very early at this stage to have this kind of discussions. Tenants are focused more on the reentry to get their workforce back into the office space. And I think that's focused, for most of the tenants, more like early September.

But we had a couple of requests, and especially when there's an opportunity like there's a small vacancy next to an existing tenant's occupancy and they want to be early and, on their plans, and they have requested whether they could potentially take those, take that space.

So we think that this will accelerate post-crisis because, currently, people are focused on the day to day. And I think that's one of the trends that we focused on..

And then maybe one last one for Wilbur. We appreciate the conservative approach to same-store NOI.

But given that some of the peer group, as you mentioned, is reporting same-store using a calculation that does include that revenue that was deferred despite the fact that they're not actually collecting that cash during the quarter, if you were to do that, do you know what the result would have been for your cash same-store NOI?.

Blaine, I don't want to give you an exact figure. But needless to say, it would be higher. But look, we -- it's -- I don't want to comment about other people. Other people have a greater exposure to retail. We are office-centric. We are with large credit-quality tenants.

It's -- for us, retail, as Albert said, as I said in my prepared remarks, it's service-oriented retail. These are newsstands, restaurants at the base of office buildings, and they are all feeling a lot of pain.

So for us to sit here and prognosticate, it's 3 months, people will come back to the well to look for additional relief based on the reopening protocols.

We thought it would be prudent and the most conservative approach to take that number out and so we can present to our investors the true cash and the true same-store and the true operations of the business in this period..

Fair enough. Thanks..

Our next question comes from Steve Sakwa with Evercore. Please proceed with your question..

Thanks. Good morning. I know it's not a large number, but on the lease expiration schedule, there's about 135,000 feet, I guess, about 91,000 at your share that comes due basically in the back half of this year.

Can you just kind of provide us an update on kind of the status of those? And then also, could you maybe just talk about the TD space that comes back in the second half of 2021?.

Sure. And maybe I'll start with it and Peter and Albert can chime in. You're right, Steve. Basically, we have 91,000 square feet at share. And if you look at where occupancy is at 95.7% on the recurring -- the continuing portfolio, that would equate to bringing occupancy levels down about 1%.

We are -- based on the outlook we have and the discussions that are ongoing, we think that, that number doesn't go below possibly a 20 basis point or 25 basis point reduction. So we feel good about the expirations in the back half and the possibility of renewing a majority of them..

Steve, as it relates to the TD space, roughly 130,000 square feet expiring in April of '21. The building shows beautifully. The lobby has most recently been redone. It's one of the more highly regarded Class A products in Midtown. We've begun marketing those floors, which are highly efficient floors.

And we look forward as tour activity and activity in general start to come back at some point, hopefully in the near future. We look forward to providing an update on the progress we're making at 31 West 52nd..

Okay.

And I know this is a very difficult question to sort of try and triangulate or come up with, but do you have a sense of kind of where you think the whole portfolio stands on a mark-to-market basis? I realize there's a lot of questions about what market rents have done or have not done and discussions maybe about TIs, but could you just maybe give us where you think the mark-to-market is today? And then, maybe Peter, just talk about concessions in the marketplace and how you think they may change going forward..

Steve, like you said, it's a very difficult question. And I think it's too early to answer that. It's -- and it really depends also on property by property, and it's different from San Francisco to New York. I would rather answer that on the next earnings call when the market has played out a little better..

Yes. On concessions, Steve, I think CBRE quotes TI around 107 and free rent around 14 months for deals, 10 years or more in length. I think the reality is, in terms of new activity, there haven't been a lot of data points over the last quarter.

I do know in a few instances on a few select deals that were executed, there was another month or 2 given to finalize the deal during this turbulent period of time. But generally, it's really, I think, too hard to say what will ultimately happen by way of economics on deals going forward..

Okay. And then just last question.

I guess, Albert, on the debt book and just kind of mezz positions and kind of what you guys are seeing in the marketplace, any activity or anything that we should be thinking about as it relates to your funds? And any kind of future investments or anything that you see on the distressed side?.

Well, we, our Fund VIII is fully invested, as you know. And our acquisition team is analyzing opportunities. Actually, quite, we are seeing opportunities getting better over the next 12 to 24 months because I think liquidity is still pretty strong currently, and the bid/ask spread will narrow over time. So we're analyzing a lot of it.

We are also, as you know, raising a special-situation fund for opportunities that come up. This is something that we had already in the pipeline before the pandemic hit. Not that we know anything more than anybody else, but we had a special-situation fund in the Great Financial Crisis at the end, which was quite successful.

And we see opportunities there. This is a fund that can invest in equities as well as debt positions. And I think that's an area where we, first of all, we have a lot of investor interest and where we see opportunities over the next 12 to 24 months..

Our next question comes from Jamie Feldman with Bank of America..

There's a lot of talk about sublease space increasing in both New York and San Francisco. I'm just curious what your view is of how much higher you think it could go and what the impact is on the leasing market and potential economics..

Sure, Jamie. In New York, in Midtown specifically, sublease space is 21% of total availability. It's about 6.3 million square feet, which is very much in line with the 5-year quarterly average. So it is not elevated. There are rumors about some tenants potentially putting space on the market.

We haven't seen it yet above more normal levels like I just described. So we're paying close attention to that because, obviously, sublease space oftentimes puts downward pressure on direct average asking rents. In San Francisco, sublease space is elevated in excess of 4 million square feet.

If you look into CBD, specifically where we're located, of course, it's roughly 2.6 million square feet, which is less than 5% of total inventory. So it is elevated. Sublease space can be potentially difficult to deal with. You'd like to see some of that absorbed in the near term, of course, for all the obvious reasons.

But it is slightly elevated in San Francisco, and we are paying close attention to it as a factor..

Are you starting to see that space come up as competitive in your lease discussions?.

We haven't. No, we have not..

All right. And you had talked about at the outset of the call some of the retrofits you've done in terms of upgrading filters, and I think you said sensors.

Can you talk about anything else you've done as a result of COVID and just what the costs have been?.

Well, the cost is, Jamie, a factor that is really pretty much de minimis. And we have talked to our tenants, and the tenants know that this will be most probably part of the operating expense pool. And they see that this is a requirement, and they can deal with it.

I think the main focus of the tenant is to be in a safe environment, to make sure that the employees come to an office building that's run in a first-class fashion. And it's really not something that will be significant to the bottom line..

Do you think it's not significant because you can pass it through or just not significant overall?.

It's not significant overall, and it becomes even more insignificant when you can pass it through..

And are there any other projects you're contemplating that might be larger?.

No. Not required..

And as you think about potential distressed opportunities, given more of a focus on wellness standards going forward, are there certain qualifications of buildings that you would only look at? Is there anything that maybe you would have looked at pre-COVID and now you're not willing to, based on either age or air quality or any other kind of new things people are thinking about?.

That's a good question, Jamie. We have, because we really believe in quality assets, we have been pounding that for quite some time because the quality of assets is important to create a strong portfolio with long-term leases and credit tenants.

And I think our focus will be even more focused on these kind of assets that have some other issues, more on the financial side, where a seller needs help and is in a difficult situation on the financing side, where we could basically bridge the gap. But from an asset quality point of view, I think we are looking more for Class A now than ever..

And your capital partners, I know you guys are focused in San Francisco and New York, but is there any interest in, from them in maybe pursuing markets that they haven't in the past given maybe population movement trends or just any other things that they're thinking about that they didn't in the past?.

No, not at this point. I don't think that our investment partners are that fickle that they believe that this is a long-term trend. They very much believe in our strategy of CBD markets and believe that this is something that will be overcome within the next 12 to 24 months. So they see the opportunities.

They are, rather than running with everybody else, with the herd, they are doing what we do and try to be countercyclical..

And then I know you took some impairments or write-downs on credit tenant. I assume you reviewed the debt book as well.

Did you take any charges there? Or how do you think about the risk of that going forward?.

So the debt book that you're referring to, obviously, sits in our fund business, which is -- we represent a very small portion of it. And so we don't -- not our requirement to take any reserves on that. It would be, obviously, the owner of that asset who have to look at that.

That said, we haven't had real distressed signals in that book yet, but we're doing our best to monitor all the mezz positions we have vis-à-vis the fund..

Okay.

So you're saying none of those positions have been impaired even to the fund?.

No. So again, I don't want to comment on what people are doing with respect to the assets. I think the positions we have -- there is one investment that's been broadly talked about in the market where we had a position, but other than that, we are looking pretty good on that book..

And again, Jamie, the public company investment in those funds is de minimis. We have a $10 million investment in an $800 million fund, just to remind everyone..

Okay. All right. Thank you..

Our next question comes from Vikram Malhotra with Morgan Stanley. Please proceed with your question..

Thanks.

So I recognize it's probably early for this question or there may not be an update, but any incremental thoughts on timing or strategy around leasing up the Henri Bendel space?.

Vikram, you -- I mean you know how the retail market works. So it's really too early to tell you anything about that situation. You can imagine up and down on Fifth Avenue with -- in addition to the pandemic, having the demonstrations over the last couple of weeks, that hasn't improved the showings. So I really can't give you an update on that.

There are interested parties, believe it or not, but it's too early to say anything more than that..

Okay. Fair enough. Just the move -- the known move-outs, you talked a little bit about TD.

Can you just clarify, over the next, call it, 12 to 18 months, are there any other known kind of move-outs, call it, over 50,000 feet?.

No. I think you know Barclays, you know TD, and I don't think there's anything else..

That's it, Vikram. I mean there was a question earlier, when you look at what's happening in the second half of this year, which is about 90,000 square feet, if you look at what's happening in 2021, it's about 960,000 square feet.

And when you aggregate all that 1-million-plus square feet together, as Albert said, Barclays is 500,000, that's a known move-out. And TD, pre-pandemic, was intending to move out. So those are the 2 only spaces that are in the range coverage that you articulated that are known move-outs..

Okay. Fair enough. And then Wilbur, just -- I wanted to clarify the provisions you took in the straight-line write-offs related to the retail tenants. What you wrote off or reserved for, that is the total amount, right? There's no like a, you assessed a certain amount and said, "This is what may not get paid in the future, and this is could be.

You just took out, you just wrote down the entire chunk of it and not sort of picked what you thought may or may not occur in the future?.

That is correct. I mean we did not sit here and try to assess, hey, should we take a reserve against 20%, 30%? We thought the most prudent and conservative approach would be, let's reserve the entire amount. We're obviously going to retain our rights, and that in no way gives the tenant any relief from a legal perspective.

But from keeping our books and records clean, we reserved 100% of those tenants' balances, and we've effectively moved to a cash basis of accounting because, as I said before, you don't want to be in a situation where the initial deferral was for 2 months and 3 months and the lockdown continues and then you have to do this again next quarter for another 3 months and then reassess how much of that you should reserve against.

If they pay us, we will record that income when and if they pay it. And that's the approach we took. So that should not occur next quarter, absent another pool or another wave of any of the discussions. But everything we did was based on the discussions and amendments and executions we conducted in the quarter..

And just lastly, is there a talk or a discussion you've had with any of these tenants that are now cash-paying that you may decide to have some sort of percentage rent in there?.

Well, that's potentially, with retail tenants, that is, if you want to throw them a lifeline, that is helpful because, as we said before, some of these tenants are really an amenity to the office buildings. We like to work with them because you don't want to have an unused space in, for the next 24 to 36 months while the market recovers.

I think it's an amenity that provides the office tenants with services and so we are working with tenants there. And percentage renters is one of the features that we might use..

And Vikram, just to add to what Albert, and further clarify, those discussions percentage renters is not with an, not with the intent that you're going to take a lease agreement and move from a fixed-base rent concept to a percentage rent concept for the remainder of the term.

It's mainly used as a bridge such that those tenants can get back on their feet and then pay back over the remaining lease term. So I want to just make sure that that's clear..

Our next question comes from Tayo Okusanya with Mizuho..

In regards to your buildings and kind of retrofitting the buildings to get client, tenants much more comfortable with the health requirements that's on one of these buildings, have you had any challenges at this point in regards to retrofitting anything simply because of just the age of building, the way it was built? Or do you kind of feel that some of the older buildings can be effectively retrofitted such that all those issues or concerns are alleviated?.

Tayo, our buildings are Class A. They are state-of-the-art. We've maintained and we've kept up with the latest technology by way of infrastructure. We did make some tweaks, replaced some filters in order to improve air filtration. We think we've been highly effective in rolling that out across the portfolio.

We do perceive physical occupancy to be very important toward igniting new activity once again. And so it's in our interest to get tenants back. And we think, obviously, a big part of that is making them feel safe. We've been highly communicative with our tenants about what it is that we are doing operationally and otherwise.

And we think not only do the tenants appreciate it, but we think our buildings and our portfolio are extremely well positioned to accept the re-occupancy of our tenants. And that's a function of not only the infrastructure, but the protocols we put in place..

And let me add, this is Albert Behler. Let me add that the age of the building is not necessarily saying anything about the quality of the office space. We have assets in our portfolio that are a little older. As long as you have the floor-to-ceiling heights to build out the space properly, you are in a good position.

And we are, as Peter was saying, we are maintaining our properties in a first-class fashion since before we went public. That's part of the culture of the Company. And so we didn't have any issues with getting them through preparing for the reentry now..

And then just, I may have missed this earlier on, but any additional insights in regards to practicing in California at this point as we get closer to the election?.

No. I mean, it is our view that, that doesn't pass..

And that's based on, I'm curious on what the theory is based on..

No, it's just based on talking to people in the market, and that's it. We don't have any other greater insight than that..

Our next question is from Daniel Ismail with Green Street Advisors..

Can you update us on your plans and timing to settle the debt maturity at 1301, particularly in light of the Barclays expiration?.

It's still relatively early. We are talking about October next year, and it's something that we would consider, of course, early in 2021. If we have some activity, it is better to get the better terms if you have some leasing activity on the Barclays space that we have documentation on. And that's how we consider it.

It's debt that should not be problematic to refinance. Our team has been in the market for a couple of assets that we are managing in our asset management pool, so we are well aware how the market works. And we don't see any liquidity issues whatsoever..

So is your sense that underwriters haven't really changed how they viewed office properties with near-term rule or any gateway locations or anything like that post-COVID?.

That's correct. And actually, the liquidity is, in certain areas, better than before. In this low-interest environment, you have various different sources outside of the United States who want to put their money to work. And as you know, we are well connected in these parts..

And yes, I would say that the one thing that underwriters are probably focused on a little bit more than in the past, because it was a given, is rent collections. And if you can see from our portfolio where those figures stand.

So that's a question we do get to just -- as we're going through this, understanding the tenant, the credit of the tenant, whether they're paying rent currently, whether we've engaged into any deferrals. And based on our results, we've had no issues..

Okay.

And maybe following up on that, given where debt costs and hedging costs have trended, could we see cap rates towards stabilized Class A CBD office properties move lower once transactions and price discovery resumes?.

Yes. That's actually happening in other markets of the world where you -- that markets that have managed the pandemic a little better than the United States at this point, you see that the cap rates are holding up or even improving because of the low-interest rate environment and the expectations.

And in many countries, you have negative interest rates, as you better know than I do. And there's a tremendous demand for hard assets and to invest in those..

Great. Thank you..

Our next question is from Tom Catherwood with BTIG. Please proceed with your question..

Excellent. Thank you. Just a quick one for me, guys. Peter, you had mentioned, obviously, the low lease roll over the next few years.

But one thing you guys have been successful doing in the past is moving tenants around, creating contiguous blocks of space and kind of maximize the needs of growing tenants with those that want to shrink within your portfolio.

Do you view that as an opportunity given the dislocation in the market? And kind of what are you seeing from your tenants that you think you might be able to take advantage of in the near term?.

Well, we have really very close relationships with our tenants and we nurture those. I will tell you that some of the activity that I've referenced historically as it relates to 1301 are with tenants that have said, "We may need some additional space." So some of that composition, if you will, of prospective tenants comes from existing tenants.

But we're always thinking about ways as a REIT that we can structure deals that are accretive.

And the reality is we do have very strong tenants in our portfolio, and we do expect that as they reconfigure their space and bring their employees back to the office, that those are the types of conversations that we will have, perhaps even more so than we have in the past.

And so those are relationships that we manage and take very seriously and nurture, as I said..

Got it. Thanks guys.

Ladies and gentlemen, we reached the end of the question-and-answer session. At this time, I'd like to turn the call back over to Albert Behler for closing comments..

Thank you all for joining us today. We look forward to giving you an update on our continuous progress when we report our third quarter results during the fall. Stay safe. Goodbye..

This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation..