Douglas Emmett Inc (DEI) 2014 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Douglas Emmett's second-quarter 2014 earnings call. Today's call is being recorded.

(Operator Instructions)

I will now turn the conference over to Stuart McElhinney, Vice President of Investor Relations for Douglas Emmett.

Thank you. Joining us today on the call are Jordan Kaplan, our President and CEO, and Ted Guth, our CFO. This call is being webcast live from our website, and will be available for replay during the next 90 days. You can also find our earnings package at the investor relations section of our website.

During the course of this call, we will make forward-looking statements. These forward-looking statements are based on the beliefs, assumptions, made by, and information currently available to us. Our actual results will be affected by known and unknown risks, trends, uncertainties, and factors that are beyond our control or ability to predict.

Although we believe that our assumptions are reasonable, they are not guarantees of future performance, and some will prove to be incorrect. Therefore, our actual future results can be expected to differ from our expectations, and those differences may be material. For a more detailed description of some potential risks, please refer to our SEC filings, which can be found in the investor relations section of our website.

When we reach the question-and-answer portion, in consideration of others, please limit yourself to one question and one follow-up. I will now turn the call over to Jordan Kaplan, President and CEO of Douglas Emmett. Jordan?

Thanks, Stuart. Good morning, everyone, and thank you for joining us. We had our best quarter ever for office leasing, signing a total of more than 1 million square feet of leases. That included a record-breaking 375,000 square feet of new leases, which increased our leased percentage to 91.9%. Our leasing and tenant demand have been excellent, especially in Warner Center, and especially from tenants over 10,000 square feet.

Large tenants can take more time to move in, so the average time from lease execution to occupancy for new tenants more than doubled last quarter. Our leased to occupied spread widened to 240 basis points, our largest move in inventory in seven years. This pushed about 80,000 square feet of expected 2014 occupancy into 2015.

Focusing on the general health of our Los Angeles submarkets, they are 89% leased, and rents continued to rise in all of them except Warner Center. The average straight-line value of the office we signed was over 4% higher than that of our prior leases for the same space.

Performance of our multi-family portfolio also remains excellent, with average asking rents 8% higher than a year ago. We have been finalizing the plans for our 496-unit residential development in Honolulu, with construction expected to start at the end of 2014. In Brentwood, the long development process is still proceeding well, with ground-breaking projected for late 2015.

Finally, as we have previously announced, Kevin Crummy has joined us as our new Chief Investment Officer. We enjoyed a great working relationship with Kevin during the 20 years he was at Eastdil Secured. His tremendous knowledge of our markets, his experience, and judgment, will all be great assets for us as we continue to expand our portfolio. With that, I will now turn the call over to Ted.

Thanks, Jordan. Good morning, everyone. I will begin with our results, then address our office and multi family fundamentals, and finish with 2014 guidance. Compared to a year ago, in the second quarter of 2014, our revenues increased by 1.8%. Our FFO increased 4.5% to $70.8 million, or $0.40 per diluted share. Our AFFO increased 3% to $56.9 million, or $0.32 per diluted share, and our G&A decreased by 5% to $6.7 million, or only about 4.4% of total revenue.

Comparing the cash basis results for our same properties, in the second quarter of 2014 to the second quarter of 2013, revenues increased by 0.6%, with higher in-place office rents, higher parking and other income, and better multi-family revenues, partly offset by lower office occupancy. Expenses increased by 2.4%, primarily reflecting higher utility rates and hotter weather, only partly offset by the greater efficiency from our ongoing sustainability efforts.

And as a result, cash same-store NOI decreased by 0.3%. The ongoing decline of our non-cash FAS-141 income resulted in a reduction of our GAAP NOI in Q2 by 0.6%. As non-cash rent items continue to convert into cash rent, the percentage of our FFO to reconvert into AFFO continues to increase.

Now turning to office fundamentals for the quarter. As Jordan mentioned, we had a record leasing quarter, signing 213 office leases covering 1.043 million square feet, including 375,000 square feet of new office leases.

These are both high water marks for us. Tenant demand in our submarkets is strong across our diverse mix of industries, with technology and healthcare above trend during the second quarter.

About 40% of our leasing in the second quarter was in Warner Center, where we increased our leased percentage by 100 basis points. This is great news, but as Warner Center has somewhat higher TIs and longer lease terms, both those metrics were higher than usual for us in the second quarter.

Our strong leasing in Warner Center, and the tenants over 10,000 square feet throughout our portfolio, had another impact. 80,000 square feet of our 375,000 square feet of new leasing will start occupancy in 2015.

This delay has caused us to reduce 2014 year-end occupancy guidance by 50 basis points, even with good ongoing tenant demand. We continue to raise rents by an average of 5% to 10% annually in all our submarkets except Warner Center. As a result, the straight line value of our leases in Q2 averaged 4.1% greater than the expiring leases for the same space.

The spread between ending cash rent on our expiring leases and the starting cash rent on the new leases for the same space was negative 7.6%. While we would like to see this number improve each quarter, we recognize that leasing space in Warner Center and harder to lease spaces in our other markets can adversely affect this metric. On a mark-to-market basis, at June 30, our asking rents exceeded our in-place rents by 3.7%, up another 130 basis points in the quarter, even with the increase in our average in-place rents.

On the multi-family side, our 2,900 units were fully leased at quarter end, with both our in place and our asking rents again setting all-time highs. During the last 12 months, we raised our residential asking rents by an average of 8%.

The current asking rents for our multi-family portfolio exceeded in-place rents by average of 26%. While about half of this relates to our remaining pre-1999 units in Santa Monica, even leases for tenants who had moved in less than two years ago have an average mark-to-market of 9% as a result of our recent strong rent increases.

Now turning to our balance sheet. At the end of June, we had $12.8 million in cash in our balance sheet and $280 million of availability on our line of credit. We have no remaining debt maturities in 2015, and expect to refinance our only -- sorry. We have no debt maturities in 2014, and expect to refinance our only 2015 maturity during the third quarter this year.

At June 30, our net leverage was 39% of enterprise value, well within our target range. We still have ample liquidity for potential acquisitions and other working capital uses.

Now turning to guidance, we are narrowing our full year 2014 guidance to between $1.58 per share and $1.62 per share. As we discussed in previous quarters, our guidance currently assumes that we exercise our option to purchase a ground lease in Honolulu in the third quarter, which would accelerate between $8 million and $9 million in non-cash FAS-141.

We still have not made a final decision on the best timing for exercising that option. If we defer the exercise of our option, FFO for the third quarter and the full year of 2014 will be reduced by approximately $0.05 per share, although AFFO would not be affected. With that, I will now turn the call over to the Operator, so we can take your questions.

(Operator Instructions)

Your first question comes from the line of Jamie Feldman.

So I guess, could you provide a little bit more color on the change in occupancy outlook? I understand fundamentals are good, you pushed out some leases that are going to take occupancy into next year, but how does that work that you keep your same-store flat, you narrow range on your FFO? I would think if nothing else, maybe it takes your same-store to the lower end of the range, and takes your FFO to the lower end of the range. Can you just help us think all that through?

Sure. We had always said that, as happened in 2013 and 2012, that the gains in occupancy this year would be all happening in the fourth quarter, or largely happening in the fourth quarter. So what this did really was just push off that occupancy by a few months, and only reduce -- actually a fairly small impact of 80,000 square feet for a couple of months on same-store NOI, and we have more than made it up with a variety of other factors.

Okay. And so I guess talk about the other factors. Is it better rents? Better margins?

It's a whole lot of factors. Rent, expenses, all of those other things. None of them are of the significance. These are pretty small numbers here.

Okay. All right. Thank you.

Your next question comes from the line of Rich Anderson.

It took me a little second there. Thank you, thank you. When I look at this quarter, you have these building blocks of things really starting to come together, whether it's the mark-to-market or it's the occupancy starting to build, spread between leased and occupied, and so does it require a little vision into 2015, to think when does the break-out really start to happen? Because you will have better occupancy comps to deal with relative to 2014.

You will have this 80,000 taking occupancy as well. In the meantime you have all this build up in rent growth that's going on around you. So do you think that while you just maintain guidance right now, that the real story becomes 2015 for you?

Well, I would like to say I hope so. The truth is when you compare 2015 to 2014, and we haven't gotten that deep into that direction in terms of predicting, but I will say this. I feel like this is a very good year, because we are looking at our cash flow and more of the AFFO than anything. Our cash flow is building a lot of steam. I mean, it's really gotten going. We're cash flowing huge amounts.

The numbers that we think about when we are looking at the Company is the way the Company's cash flow, and how much excess cash we are generating. I look at the health of the buildings and if there is huge amounts of CapEx needed anywhere, or if it is all looking pretty good and up to date. Then at we look, in terms of leasing metrics, I say how fast are we leasing, and are we leasing at higher rents?

When you see this spread widen out where we're leasing, it's stunning that we leased 1 million feet in a quarter. I remember when people were asking me last quarter how I felt, which was in the beginning of May, the very beginning of May, and we felt bad about what had happened the previous quarter and we were saying, listen, we are telling you, this quarter is looking very strong. And it continued very strong as you have now seen in our reported numbers.

So when we look at, when will the good news be exposed to the world, I feel the good news is exposed to the world. We are cash flowing a huge amount, and we have very strong leasing going on right now. How that filters its through to certain numbers and metrics in 2015, we have to take a look at that, and I hope it comes through in as positive a way as we are seeing today.

You had this great quarter as you describe, and great year so far, and you popped up FFO guidance by 5%.You would not be down 0.5% today, you would be up 2 or 3. It's the market is fickle like that, I suppose. That's what I am waiting for, is to see FFO number and the AFFO number start to really grow and move away from some of these moving parts that maybe disguise the good stuff that's going on behind the scenes.

That all could be. We have been very, very bad at predicting how what we say will relate to how the stock moves. I mean, we have been horrible at it. So that may be the trick. I don't know.

Okay. Then just on Time Warner, Ted, you gave a little bit discussion about higher TIs, but I mean to what degree do you think you had to get the especially strong tenant demand there? Did you have to discount on the rent side? Is it mainly just TIs?

First of all, you said Time Warner, and Time Warner is not the same as Warner Center.

I meant Warner Center.

I don't think that we saw -- if you look it's not a question that for the larger tenants we had do more TIs than we usually do for larger tenants. It's just that there was a larger percentage of those tenants in this, and Warner Center is a market where there's a little more TIs. But I don't think for those markets or for those side tenants, it was out of line. It was more a skewing of the mix.

So again, in general, you look at it, for very small tenants, it's just paint and carpet. When you get to full floor tenants and above, then there is usually some TIs to be done.

So really there wasn't any major discounting on the rent side. It was just bigger tenants, more TIs, that kind of thing?

That's correct.

Okay. Great, thank you.

Your next question comes from the line of Alexander Goldfarb.

A few questions here. First, the addition of Kevin, and with your G&A being down, I am assuming that Kevin may help offset some of that reduction.

That was reason for the hire.

Kevin viewed us as 501c3 and just came for free.

Judging what Eastdil guys make in commissions, that may be. But you, you have never been a deal machine as far as like just buying stuff up -- buying a lot of stuff at once. But you have steadily bought one or two deals a year.

Certainly you have your own good relationships within your core market, so the addition of Kevin was what? Was that he was looking for a change and you said we could use someone like that? Or is there a shift in your thought process for potential deal flow, or how you want to orient the portfolio going forward?

Well as you know, Bill retired, right? So for starters we had an opening of needing a CIO. Kevin is an extremely good fit for that position in terms of -- We worked together for 20 years on almost all of our major capital projects that we have done, whether it raising private equity, or buying buildings, or financing and stuff. He knows the Company well.

He is one guy that I knew could come in here and would not have to lean as heavily, let's say, on my relationships with the other owners in the market, in terms of accessing new deals, and has many of his own, some which are better than mine. I was super pleased. It's a good fit, it's a very good fit for him too.

He was in a job where he did a tremendous amount of traveling. He has some younger kids. It all came together very well for us, and for sure it's my best acquisition of the year, I can tell you that. I'm real happy about it. I am hoping for great things, not to put too much pressure on him.

Okay. But we shouldn't expect a ramp-up in the acquisition activity? It should be about the same. It's just filling, replacing Bill?

I always hope for a ramp up in acquisition activity. That would be with or without Kevin, and I even more hope for it with Kevin. I don't know that -- we are not changing our metrics, or our discipline for what we are or aren't willing to buy. I guess you are asking that question. Maybe he is going to work super hard, and source even more stuff. I hope he is.

Okay. Then as far as the leasing activity this quarter versus last, what changed? Did you have -- was it tenants who just in the first quarter, they weren't making any decisions, and suddenly in the second quarter they decided, or did you get some new, is it spill over from people who were displaced because tech people were taking up offices where they were, and therefore they had to look for a new office and you are getting a benefit of growing tech as a collateral effect, if you will?

I don't think that it was the latter. I think the reality is, I don't think we really understood exactly. We actually thought, as you will recall, going to the first quarter that all of metrics were looking good and everything was going well, and all of a sudden, the leases didn't get signed.

I don't think we really understood that. I think this quarter probably benefited a little from that, but I think it just underlines, reflects a great tenant demand in the markets.

Yes. We have general very good tenant demand. When you slice a quarter break right on a day, we get caught sometimes too little in one too much in another, or the same thing is happening to us at the end of the year with occupancy. It happened to us between first quarter and second quarter.

But in general, as you guys always ask us on these calls, the pipeline is just very, very strong. There is a lot out there. I hope it all falls perfectly in the quarters and lays out right. It's out there, and it's moving and I am glad that the actual results of this quarter gave you a good look at it.

Go Ted.

It may be worth talking about a story we had in Century City where we had a tenant that was disbanding and gave us back a full floor, and we had a -- within days, we had a new tenant that came in and was willing to take that space on the day the old tenant moved out, and upped the rent and two days later, or a week later, we had a second tenant come in to argue over that space and we got it all back filled. There is good strong tenant demand out there, and that's what we saw in that quarter.

Bottom line is the first quarter was a bit of anomaly. For the balance of the year you may not do 1 million square feet, but you feel like third and fourth quarter should be pretty healthy positive net absorption quarters.

Leasing.

Okay, cool. Thank you.

Your next question comes from the line of Jordan Sadler.

So I guess I am curious about -- I feel like this question hasn't been asked yet, in terms of rent growth, and it ultimately translating, so I've got the obligatory question this quarter. In terms of at what point do we switch over, and start to see positive mark to market? It's not quite that simple, but are you seeing things that are pointing us in the right direction still?

It does seem that we're getting closer, you are still talking about rent growth. Are we still seeing the same sequential rent growth trajectory? That should continue to give us the same confidence we had last quarter?

I think the answer is yes, that the rent growth trajectory is the same as before. As I said in the prepared remarks, one of the things that is going to suppress that statistic a little bit is, we are not seeing rent growth at Warner Center, so to the extent, like this quarter when you have 40% of the new leasing in Warner Center, you are going to see that we don't have the boost off of the last rents coming from the current increases. So it's going to take -- when that happens, it's going to slow down that transition.

Just because one, we are getting over-weighted on one narrow submarket and therefore it is -- might skew what you think is happening across entire portfolio, because there's so much of the leasing, as we said, of the 40% leasing is going on in that one narrow submarket.

How do you think about that submarket and that exposure today, vis-a-vis the rest of the portfolio? You've got all this positive feeling and this confidence about what's going on in the markets more broadly. In your prepared remarks, you talked about every market has rent growth except for Warner Center, and it's this--.

I hated that phrase. We are super accurate in everything we say, and we always say except for Warner Center, because it's true. It's the truth. But I hate having to say that.

I feel very good about Warner Center, and we like the market a lot. I will tell you also, that we are not alone in that. You have a tremendous amount of capital going into that Warner Center market from Westfield, and the mall extension they're doing there, and in numerous apartment developers that are building additional units, and in terms of larger tenants that are making commitments there. You read last quarter about the Farmers thing.

They're actually selling their location out in Wilshire, and took a lot more square footage there. So in terms of being an office owner, you can't ask for better things to happen. You don't want people to build office, you do want more residential, you do want more amenities. Everybody is spending a huge amount of capital for all that stuff, all good stuff.

In terms of the office going back into the recession, there was construction as you know, at the project. It added 1.2 or 1.3 or 1.4 million feet. I can't remember. That's been a lot for us to absorb, but it's being absorbed.

While the metrics and we always have to say that, except for Warner Center, which I hate. While we always have to say that, it is not reflective of our feeling towards the market. We like the market a lot.

That market's overall occupancy actually has been moving up pretty steadily and pretty fast over the last six quarters. Our own rates got hit a little bit, with some of the move-outs in Q1. Other than that, they have been moving up pretty smartly as well.

Okay. I mean, any thoughts to reduce the exposure there, given the appetite?

No, I can't say there are. We owned essentially three good-sized projects there, and I think they're three of the best projects in that market. I like what we have there.

Okay. Thank you.

Your next question comes from the line of Vance Edelson.

Just going back to the topic of potential acquisitions, a few months ago you mentioned an investment pipeline, and that you might be able to get deals done this year. Could you give us an update on that? Were there deals you were looking at the time that were just deemed too expensive, which is perfectly understandable, and is there any pipeline to speak of right now?

Yes, there is a pipeline right now. There were some things that just, as you said, we felt like we missed on for one reason or another, one or two things, but actually the pipeline is pretty good now.

Okay. Great. Then as you mentioned a few minutes ago, in early May you were able to tell us one month into the quarter that things were off to a good start from a leasing perspective, and that clearly proved correct. Anything you can tell us about the trends you have seen in July, I guess it's August now, but the trends you saw last month relative to what you experienced during 2Q? Did it just remain robust, or did it actually get any better, for example?

Getting better than Q2 would be Olympian so I wouldn't want to say it got better but it is still very strong.

Then maybe just one more quick one if I can, the reference to the higher utility rates being somewhat offset by lower usage, is that electric or water or both, and should we consider the higher costs to be the new norm, a permanent cost of doing business, or is that really just an anomaly?

First of all it's almost what's happening is utilities keep raising rates, which makes it more cost-effective for us do even more energy-saving tactics. We do energy-saving moves, utilities raise rates, and we do our best to go flat to down, and they push their best to cause it to go up.

In Hawaii, it's horrific, and we are seeing it here too. Whether it be water rates, you know what's going on with California and water. Or electric rates, both of them.

We are definitely doing what we can, and have -- we literally have regular meetings on energy and utility conservation. Regularly scheduled meetings on the subject, scanning through our buildings, every building ranked how energy efficient is it, keep looking at the ones at the bottom, what can we pick up there, what can we do there, making sure the ones that are in the good zone stay in the good zone. It's an important line item for us, it gets a lot of attention.

Okay. Got it. Thank you.

Next question comes from the line of Brendan Maiorana.

I was a little bit confused on Warner Center. Ted, you mentioned it was 40% of the new leasing activity, which would suggest that it was call it 150,000 square feet of new leasing, but at the same time, net absorption was only about call it 30,000 square feet, it was 100 basis points on your overall portfolio there during the quarter. I didn't think there were big move-outs that were supposed to happen in Warner Center during the quarter, so why wasn't your net absorption higher in Warner Center during Q2?

Well first of all, it doesn't take big tenants moving out to have that be an issue. You can have a combination of a lot of smaller tenants. I think there were some tenants in the 20,000 to 50,000, which I don't think we would consider a big tenant, the type we talk about, that moved out, but it's also a lot of the smaller tenants.

Okay. But there were some move-outs in Warner Center that happened during the quarter?

That's the nature of our business. There are always move-outs in every submarket or almost every submarket, in every quarter, and the point is that, A, you try and keep the people. B, if you didn't, you have to back fill those spaces and that's our job.

So Jordan, I completely hear your comments about the great leasing volume you have done, best quarter ever from overall perspective, from new leasing perspective. I think maybe the disconnect from thinking about it from my end is, I think we look at you as a lease-up story.

There was great leasing volume that happened in the quarter, but at the same time your net absorption was plus 30 basis points, which I think if I dial back to the beginning of the year, that seemed about like a normalized quarterly run rate average that we would expect to get occupancy, where we thought it would be at the end of the year. Was it just -- do you think that the leasing volume stays high and the move-outs go down going forward, and that's going to get occupancy and net absorption to really pick up?

Yes exactly. We told you the way leases have fallen the last few years, and we try and get some forward view, whether someone is shrinking, moving out, expanding, whatever. A lot of that activity tends to fall in the fourth quarter, or a lot of the move-out type activity falls earlier, and as leasing velocity stays strong, when we get in the fourth quarter, we get great gains. That's what's been happening.

Our loss out of that equation has been front-loaded on the year. Our gain side of the equation has tended to be back-loaded on the year, which is same answer essentially to the other question we were asked, of how can you lose occupancy and not change your actual financial guidance? It's just because it happens at the end of the year anyway.

Yes. Okay. A last one as a follow up to that. If I just think about the year-end occupancy target, it's still up 190 basis points from where you ended Q2, and if I take off the 50 basis points that we know is going to hit in Q1, your leased spread on that adjusted number is about 190 basis points. How confident are you in hitting the revised occupancy target by the end of this year, given that it's pretty big ramp to get to the midpoint of your revised target.

The revised occupancy target?

Yes exactly.

Well I will tell you this. Translating from, especially as folks on Warner Center which has larger leases, translating from the leasing, which is the first step that we have to do, is trying to figure what the leasing is going to be throughout, into occupancy, is getting tougher and tougher, because these larger guys take longer to move in and especially when that you have cut off, and we thought a lot of what was happening at the end of the year, if they flip over to January or February, boom they're gone.

Not really a big money difference, but a difference in terms of that metric at the end of the year. So it's obviously -- it's proven to be a hard number for us to peg.

All right. Thanks.

Your next question comes from the line of Jed Reagan.

I guess I was following up on a lot of questions. The occupancy guidance change, Was it strictly an issue of the lease commencement timing, or were there any unexpected move-outs or terminations? I guess on the lease commencement timing issue, did your previous guidance anticipate any of that sliding out past 2014 or did it all come as a complete surprise?

So I think that whenever there is occupancy, there are lots of different factors, and it is not really possible to say it's only one thing. However, this was the thing that stood out for us, and that really explains the whole thing. But yes there are lots of ups and downs, people moving out, moving in, and so forth, so you play that out.

In terms of what happened here, in a funny way, we actually went back and looked at this. All of these leases that are now moving into next quarter were all ones that came in at the last day of May and in June. So this was again -- (multiple speakers) next year. Jordan said this is, because our tenants move in so fast, this is a looking forward and making estimates, and as Jordan said, it's not always easy.

Last year --

Last year, all of the leases that we signed in Q2 moved in by the end of 2013.

So they were included in the occupancy numbers which is the assumption we made. For the speed at which our tenants move in, usually you'd think, a guy you signed in Q2, you'd think they will be in occupancy. It's very odd for them to launch out beyond that date.

Okay. That's helpful. Then I guess a related question, if you were giving guidance for your percent leased per year end rather than occupancy, do you think that number would be changing? Then how about if you were thinking about your occupancy expectations for say mid to late 2015? Do you think you feel better or worse about that outlook versus, say, three months ago?

We haven't given guidance on any of those things. I am not sure we are in a place right now do that. Leased has its own problems when you pick a particular date, because then what you are really predicting is exactly what leases get signed in the last period of time during December. It has its own issues.

Again, we are in a model that's significantly different from a lot of other -- our peers, because we are moving in -- 60% of our tenants move in within that two to three month period after they sign their lease. So even leased though, again, you come down to it, if you end up with a quarter like the first quarter, which again, we had good tenant demand, we were feeling very good about it, and they decided not to sign their lease in March. If you have that in December you will see leased rates drop down a lot. Both numbers have a lot of play in them.

We are doing our best to predict these numbers for you, and obviously if we are doing a ton of leasing, of course we have a good view towards occupancy next year. But the hard information we give you, we give you. When you ask how is the pipeline, I can look right now at the pipeline, and go the pipeline's great. There is a huge amount going on there.

Now how many of those guys are going to sign this quarter, and how many are going to move into next quarter, I am guessing on that. They're pretty educated guesses. We do 2 million to 3 million square feet a year and we nail our occupancy within 100,000 feet, that's pretty good, right, at the end of the year.

Still, when we miss it, and I know people don't like it when we miss it. I certainly don't like when we miss it down. That's unpleasant, but it is not the same as starting the year if you do these huge leases where people sign two years in advance, you know everybody that's moving in, you should know your occupancy pretty well.

We have, as Ted was saying, we have 1 million plus feet that we don't even know the name of the tenant when we start the year, that's going to be part of our occupancy at the end of the year. It's hundreds of tenants that make that up. So we're feeling a little stung from having missed it, and so I think we're getting tentative about wanting to make very many predictions.

Okay. Thanks and just a last one, on some of the occupancy declines this quarter, Ted, I think you talked about some known move-outs in Warner Center. Were there any other locations that were impacted as far as move-outs? As you look forward, are there any bulkier expected move-outs we should be thinking about, for this year or next year?

Again there are always move-outs in any quarter and you can see it even just in what happens in -- for example, we had in Honolulu you had tick down in occupancy in Olympic Corridor. Both of those are ones where you had tenant move-out, and it takes us sometimes a quarter or two to backfill that space. So the answer is yes, there was about a 24,000 square foot tenant in Honolulu contracted its space, and because they lost a contract, and so we are back filling that now, and we are working at it.

Okay. Great. Thanks.

Your next question comes from the line of Ross Nussbaum.

I've got two questions for you. The first is, can you just give a little more color on the trend you are seeing in Santa Monica versus, say, in Brentwood? Are there any notable differences in terms of the velocity of the leasing and traffic you are seeing in those two districts?

So Santa Monica has obviously been one of the strongest markets, and is really strongly leased now, and the rents have been moving up nicely there. Brentwood, as we have said in the past, consists of two markets. One of them has been market on San Vicente, which has been not far off from Santa Monica in terms of it being full and being -- for a while now.

Then you have the space along Wilshire, which as you know, we had some issues where we were struggling a little bit with that, with the 405 being worked on, and which now has recovered very strongly in the last three or so quarters, I think it's been, that's been coming back. It's not -- again, that market is still not at the level that Santa Monica is.

Santa Monica might be the strongest market in LA. I mean you are really comparing it to the champ, for sure the downtown Santa Monica market, where we own all our buildings.

Okay. The second question is a follow up to I think to what Jed and Brendan were getting at. I think maybe the reason why you guys have a great quarter in terms of absolute leasing volume, and feel good about the numbers, yet the stock goes down today. I think it comes back to the I don't want to use the word game, right?

But game of having conservative guidance and beating it, and at least on the occupancy line, two quarters in a row, that has hasn't happened. Do you guys walk away from this saying maybe we need to -- whatever we thought the definition of conservative was before, we need to go revisit that?

You know what? What's funny is that I thought we were doing that last time, because we were sitting there at the beginning. I may get the numbers a little bit wrong, but I think we have done in just the month of April about 400,000 feet, which a normal whole quarter for us is like 700,000 feet. When someone asks like, hey how you looking in terms of the occupancy number you're predict, I thought great, I am feeling great.

You used the term quote extremely confident in early May of last year.

Yes.

That's the issue, right?

In my first month I had done more than half of what I would normally do in a quarter. But you know what? May, June, we get all these great I am glad to be leasing in Warner Center, but all of a sudden leases fall in January or even February, and I am like, God call them back, tell them you'll start in December, and get my number right. It's just a tiny miss, looks like a large miss in this.

I think also that from our point of view, while I think we understand being conservative is good, I don't know that we have been good at doing what's also known as sandbagging, and I think --

We try and give the real number. We try and sometimes put a range around it. We try and give you the real number, and particularly though, if there is anything we do that's -- let's say even more conservative, we will be quicker to adjust a number that looks like it's going the wrong way in a negative fashion, than we are to adjust a number that looks like it's going in the other, in the upside way.

That's probably where more of the conservativeness goes in. We try and give you where we think the world will end up, when we gave you numbers initially. The adjustments are made quicker in the down direction, though, that's true.

Thanks for the color.

Your next question comes from the line of Michael Bilerman.

I think sometimes everyone forgets that you do 800 or so leases a year averaging 3,500 square feet. So call it 60 a month. The leasing machine that you have, just the volume is a lot. That certainly plays a part, I think, in some of the dynamics, because you are not doing big 100,000, 200,000-foot leases where you can get that far-out clarity.

Yes. That's true. We all agree.

If we look at the back half of the year in terms of what's still rolling, you've got about 576,000 square feet and 35% of that is in Warner Center. I guess how should we think about the renewal percentage first, on that 576,000?

Well in general, our renewal percentage really fairly tightly surrounds 70%. Now with that said, it has a good range. When you look at it quarter-to-quarter, it has a pretty good range. It can pop up in the mid 80s, and it can pop down to 50.

Quarter-to-quarter, you can have a bigger lease that throws it off, if the guy moves out. I will let Ted talk a little bit on this. Usually, if you think we're zeroing in on 70%, that's an extremely safe assumption.

I think that's a fair assumption. I mean the problem on the renewal side is, again, our tenants tend to make the renewal decisions quite late in the process, because they can. So we have, I think that 70% that Jordan gave is a good assumption. We have a lease by lease analysis of it, but that changes -- literally can change on a day to day basis, as people are going through the negotiation process.

I think a misconception that people have about renewals I'll just mention, although it's not the question you are answering, is that percentage in a good market or bad market, it seems to be consistent. It's not like in a good market, the renewal percentage goes up.

Maybe you would think it would, but looking backwards for us, it doesn't. In a bad market, it doesn't necessarily go down either. It's a pretty consistent rate through both types of markets.

I guess I was hoping for a little bit more granular detail. I have to assume Jordan, that two quarters in a row to drop with all the caveats we have been talking about in terms of your business, but to drop your occupancy 100 BPs in terms of year end, I know it's only a moment in time, at this point, you sit around the table prior to having this call, saying we gotta make expletive word these numbers, at this point.

You know what? If you are right, that sitting around a table with Ted and Bill and the guys, and we all are together when we are working on the script and the release and I am going, God, please let us hit these numbers. You are right. We are pretty focused on it.

If you are saying am I going into operations, and this is a huge flow here. I can go into operations and go, guys, now all the rules are changed. Here is what I care about. I want people's occupancy to start this year.

You got to cut rate, do it, you got to change bumps, do it. This is a number I want. I do not do that. We push for the best economics out of the leases.

We look for the best mixture of credit and long-term value that we can get, and I deal with that hand as it is dealt. I go back and I do my best, as does Ted and Bill and the rest of us, to try and figure out how are these numbers going to play out. I don't bend operations backwards to meet the numbers.

Right.

Certainly I am not going to say I thought of doing it, but I realize that's out there. But I am not thinking of doing that.

There are two factors that you have. You have the tenants that are in place that you know are rolling, which is this 575,000 square feet. Right? Ideally, your renewal percentage has averaged the last eight quarters at 61.3% to be exact.

50, it's gone to 80, but that's somewhere in that ballpark. You know those guys are rolling with 35% of that in Warner Center. (multiple speakers) Think about your occupancy target that you have gone through that roll and saying okay, we are working with this guy, this guy is a 20,000-footer here. There is 10,000 here. We think that the likelihood at this point is, this amount percent is going to roll in the back half of the year. Next -- (multiple speakers)

We do that. We have a program that tracks every space in the portfolio that is rolling within the next 18 months, and every week, people go in and update both what they think the situation is, and then rate what they think whether that tenant will move-out or not.

So the only next step I could take because we see with these tenants. We are negotiating with them. We're trying to move around out, et cetera, et cetera, so I see a bit of an ask on all these guys unless they flat out said I'm moving, I'm going to Arizona or whatever.

I can go in and go, hey make your deal. I need that deal done. I want it done now. I want them in this year. I can go in and start saying make the deal, make the deal, make the deal. That's what we don't do.

Right.

We see all that. We know every single tenant where we're at, what they want, what we want. But if we go in to try and make these numbers work, and start saying I have committed to such and such occupancy at the end of the year, therefore go make this range of deals. We are going to be managing the numbers towards metrics that in truth don't really have a lot to do with financial health of the Company, and trading that for numbers that really matter to the Company, like what we get out of these leases and the economics that we get.

And particularly in a rising rent market, chasing occupancy now, as opposed to letting it come to you on a good basis is not a smart move.

I want our guys to stiffen up and negotiate hard and to move rates up now. We have a huge commitment to these markets.

So if we think about the 360,000 that's signed, you said 80,000 is going to be flowing into 50 and so I assume the balance starts this year.

Yes.

Then Ted you said typically call it a two to three month time frame from signing to taking occupancy.

That's the sort of median that's in that, yes.

So come the third quarter we will -- that will be it, right?

Generally -- no. When I said that's the median, we have tenants that literally will take occupancy within a week after signing their lease. We actually have a significant number that take occupancy within 30 days.

You know that signature suites on there? On our website? We have those suites ready to go? It's a lot of little deals that move very fast.

It would appear if you go through renewal percentage and what you need to do, it is a down shift in terms of volumes, relative to where you have been, if we're doing our math right. Your leasing velocity. Certainly you do not need to keep a 1.7 million square foot pace.

No. If we stay on this pace, we can all fire the fireworks off the roof of the building and go, hey, we're done. The whole portfolio is full.

As Jordan said, while we feel really good about what's happening, we're not prepared to continue to assume record velocity every quarter. You are right, were we to do that, life would be really good.

Then next year you'll go, how are you going to improve on this?

Last one. As we think back to that May call you talked about 70,000 square feet that moved from what you thought was going to be the first quarter. Therefore, you wanted to move down the occupancy target by 50 basis points. You do 1.043 million this quarter, and you talk about 80,000, and that's going to shift into 2015, that was done. Even if you net that 150,000 down, the number was still massive in the second quarter.

That's what, I guess, I think everyone is having a harder time getting around. Even if you take the excuse from last quarter that 70,000 flipped to the second quarter and you take the excuse that 80,000 is now going to take occupancy in 2015, and the spread between leased and occupancy is wider, it's actually 90 basis points than it's been over the last seven years, it still I guess, is not letting people sit with?

So I don't know that it's a good idea to try. It's hard to follow all the numbers that you are going through. Maybe Michael, we can set up a time to talk it through afterwards.

Remember also, that when we are looking at the change in these things, there are two sides to the equation. The first one is new leasing. Renewals in many ways -- some ways it is the renewal percentage, not the renewal number that matters.

Secondly, it's in the outflows. Again, as Jordan said earlier, and as we have said in prior calls, for whatever reason, it seems like the outflows in the last few years, have happened in the first half of the year.

The first half of the year were our tougher quarters. When we had a tough first quarter and it didn't get matched to a lot of leasing, that quarter looked bad. The second quarter was a strong quarter, but we didn't get the occupancy to move into this year as we would have wanted, but it definitely covered for the previous quarter, in terms of just lease percent.

Okay.

It was against two of our tougher outflow quarters.

Yes, understood. Thanks for the time.

Your next question comes from the line of John Guinee.

Michael, thank you for your one question, and a follow up. A little more mundane, I think your operating income, other income is about $4.6 million, other expense is about $1.7 million, $2.9 million this quarter. Refresh my memory.

How much of that is some insurance settlement? How much of that is a health club? Does that burn off, or does that continue for the rest of the year?

So as you can guess from the title, other income, other income is a grab bag of a whole bunch of things. As you mentioned, it includes insurance proceeds. It also includes fees from our funds.

It includes for the moment some interest on a $27 million loan we made in connection with the ground lease in Honolulu, and then it also includes the health club revenue, not health club expenses, but just the health club revenue. The expenses are down in other expense.

The insurance items I think will probably tail off as we move into the rest of the year. I think that the interest on the loan will end at the time when we exercise our option on the ground lease. The health club will continue as long as we continue to have that operated by a consolidated entity.

So, and the other unrelated income stuff is just going to go up and down as it goes up. So overall, if I were looking forward, I would think that going forward in future quarters, that you are probably more into a $2 million or $3 million run rate on here, probably closer to $3 million, I would guess, but it's a very variable number, because really this is where things that we don't have a better place for on the income statement go to die.

Okay. And then I think you have answered this before but I have to ask it again. On page 15, 421,000 square foot lease expiring in September of 2019, with an early termination September of 2016, I think that's Time Warner.

That's right.

When do they have to exercise that termination option?

In early 2015.

Do you have any clarity in terms of, are they occupying all 421,000 square feet? Are they sub leasing it? What's the status of their little bodies in the space?

They're definitely fully occupying the space. It's a large lease for us. They have indicated they would like to stay on the space, but it's a large lease, and you never really know what somebody's going to do. It's still pretty far out.

In that, we had some other questions, since you're mentioning that. In that footnote we also had a 45,000-foot lease that we had in the past associated with Time Warner, and Time Warner spun off Time, Inc. and now it's a lease with Time, Inc. so it's not in that footnote anymore, it's not that they moved out, which we got asked.

So they're all still there. We've got some time in the program. They are fully in the space.

That space, if you recall, is right at their studio, and in fact, if you go to Warner Brothers and you look on their website, our building is shown as the thing because it's where you start your tour for the Warner Brothers thing, you meet in the lobby there. It's been pretty integral to their --

They've incorporated it into their lot, to a great degree.

My perspective and correct me if I am wrong, is that the whole Warner Center is a B-minus submarket within the greater LA market, and the buildings are tired, and it's an ex corporate headquarters. Isn't possibly the answer is you are doing best you can with a tough product in a tough market?

Well I hate to call it a B-minus market and I don't think that, at least buildings we have, are that tired. I think what -- I know that we said this a lot of times, but what's going on is, that market increased something like 20% or 25% with the new construction that went on there through the recession. So it's the one market that has had a harder time, or slower time, if you will, in terms of recovering.

Prior to the recession, they got -- some of the highest rents were in Warner Center. So that means like the Encino, Sherman Oaks, moving all the way -- Glendale, Burbank Airport District, Pasadena. Highest rents? That Warner Center area. So what happened was just that great amount of supply coming on, at we'll call it, the exactly wrong time has caused us to be slower, in terms of recovering at the same pace as other markets around here.

The other thing that's happening there is, as so much more residential gets built and as so much more retail gets built, and as larger tenants, which this is the good news, but also bad news, is larger tenants start moving out for cheaper places, whether it be Arizona or Texas or whatever, the space is getting backfilled with smaller tenants that are less rent-sensitive but it's a process where you have vacancy and then you back up, you have vacancy and then you back up. We are going through that.

We have been going through that, which is an improvement in the area, as well as absorbing the new space that was brought on, but I got to say when you go throughout and you see what's going on, and as I said, we are not the only ones with this feeling. There is a lot of capital being spent in that area because it's a very nice area to live, in terms of the schools and housing, and all the rest of it. Even though the metrics, the numbers you guys are seeing, it's always except for Warner Center, when you go out there, it's a really good market.

Let me add two facts to underline what Jordan is saying. The first one is, I actually think contrary to what I think you are assuming, I think that the physical buildings that we own in Warner Center may be among the very best in our portfolio, in terms of new.

Yes, they're newer buildings.

Secondly, if you look at Warner Center, and taking out the fact that it had new construction in the 2004, 2005, 2006 range, then through 2008, for the last 15 years, since 2000, Warner Center has added more occupied office space, Class A office space, than any other of our submarkets. The problem has not been demand in Warner Center. Warner Center has added a lot of demand. The problem has been, up until now, has been the addition of all of the space back in that period right before the recession, and then continuing into it.

There is a shift now, and as I said, it's amenity construction. It's residential construction, all great stuff for that area.

Okay. Then just one last comment, you switched from having this call at 11:00 a.m. Pacific on a Wednesday to 11:00 a.m. Pacific on Friday. Maybe next quarter we just switch it to 3:00 p.m. Pacific.

(laughter) Well, we could do that. Actually the reason this switch happened is I was supposed to be out of town next week, which I didn't end up being, but we'd already set the date, so we moved it forward on ourselves. I wanted to move the call earlier, and all the people have to prepare the accounting numbers and the releases and the quarterly stuff freak out, because I ruin their time line.

So the compromise was to slam it to the end of this week, because I thought I was going to be out next week. I suspect we'll go back to the Wednesday and our normal schedule going forward.

3:00 p.m. Friday, a lot better, a lot easier.

I suspect we wouldn't have as many people calling in with questions, that's for sure.

Thanks.

Your next question comes from the line of Jamie Feldman.

So I guess -- can you just talk about how the current leasing pipeline compares to this time, last quarter?

I think it's a tiny bit less than it was at this point last quarter.

So in terms of square footage?

Square footage in the pipeline, yes. I mean last quarter when we were having this call, which was the first week in May, our April was like crazy. Is it 460,000 or something like that?

Come on, 460,000 feet in one month. That would be a stunner to have in any other months this year. It's going to be a little off from that, but still extremely strong.

Then how does it break out by the different submarkets? I am also trying to get a sense of, obviously you've talked about Warner Center, but what about some of the other parts of your portfolio?

It's pretty well spread, with certainly new coming in Warner Center, because that's where the space is.

Okay. All right. Thanks.

Thanks.

Your next question comes from the line of Rich Anderson.

I'm good. Have a good weekend.

Thanks Rich, you too.

Your next question comes from the line of Jed Reagan.

Just one more from me. I am just curious if the pricing environment out there makes you a little more keen to develop new buildings versus acquiring existing ones, and if so, are you actively looking at any new development opportunities, and maybe related to that, any updates on the Brentwood permitting process?

Well, in terms of being able to develop, there is just not a lot of development opportunities for office, so mostly we'd be talking about residential, which we are doing, that is where we are doing development. Brentwood, I mean, where it's at is we had our -- we had a good round of meetings with the community, the various community groups, and with the city council and all those people. We have submitted our initial environmental impact report, it's being reviewed.

We got -- there is a lot of sections, there is a very big document with a lot of sections that have been done right and have to have comment from the community in terms of everything they want in that report. We got that comment, we got the report done, we turned in.

We are now waiting for comment back from the City in terms of I want a little more on this, little less on this and whatever. We are also contemplating dialogue on it. So that's where that's at. Does that answer your question?

But feeling like you are still on track, relative to where you were last time?

For the Brentwood deal, yes. I mean as on track as you can be in a process that is absolutely unpredictable, in terms of whether you are going to get approvals, when you are going to get approvals, if there is community groups that want to negotiate this, that, or the other. It's a tough process, it's like asking a politician if he is on track to being elected. Yes, I guess so.

In terms of the project in Hawaii, I mean, we are real pleased with where that's going. We had an opportunity, there was a sliver of land which we had an opportunity to buy, which we did buy, and it has allowed us to reposition the buildings a little bit which is very positive what's going on there. We have 30 acres, there was this weird little piece.

I think we only paid $70,000? Yes, we paid $70,000 for it, but it allowed us to move --make a pretty big change that made the whole thing flow better, so we are making that change, and that stalled us a couple months.

Okay. Terrific. Thank you.

There are no further questions.

Well thank you everybody. Next time we won't make it so late in the day for those of you on the east coast. We look forward to speaking with you then. Goodbye.

This concludes today's conference call. You may now disconnect.