Douglas Emmett Inc (DEI) 2017 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Douglas Emmett's quarterly earnings call. Today's call is being recorded. (Operator Instructions)

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

Thank you. Joining us on the call today are Jordan Kaplan, our President and CEO; Kevin Crummy, our CIO; and Mona Gisler, 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. You can find reconciliations of non-GAAP financial measures discussed during today's call in the earnings package.

During the course of this call, we will make forward-looking statements. These forward-looking statements are based on the beliefs of, assumptions made by and information currently available to us. Our actual results will be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control or ability to predict. Although we believe that our assumptions are reasonable, they are not guarantees of future performance, and some will prove to be incorrect. Therefore, our actual future results can be expected to differ from our expectations, and those differences 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. (Operator Instructions)

I will now turn the call over to Jordan.

Good morning, everyone. Thank you for joining us. We had a busy and productive second quarter.

First, I'm happy to report that we have successfully paid down and consolidated our debt by completing the sale of the $350 million remaining in our ATM program. That replenished $350 million of equity that we invested in the 9 properties purchased during the last 18 months. It also allowed us to completely pay off a $347 million high interest rate loan while refinancing and extending to other loans.

In sum, we lowered our leverage to 35%, extended our average debt maturity by almost a year, reduced our average in-place interest rate to only 3.2% and stored capacity for future growth by completely unencumbering 8 additional properties.

Second, we set an all-time record this quarter for leases signed, and we are still taking advantage of rising rental rates by unlocking embedded rent growth through early space recapture. Overall, we have increased the average in-place cash rents across our portfolio by 6.2% in just the last 12 months. The total value of leases signed this quarter was 27% higher than those they replaced.

As we mentioned last quarter, the exceptional long-term benefits of early space recapture are partly offset by some additional downtime and TIs in the short term, but it is well worth it.

As Kevin will describe in a minute, we also acquired 2 properties in Santa Monica and another in Beverly Hills while making good progress on our development projects in Honolulu and Brentwood.

FFO per share for the second quarter was impacted by $0.01 as a result of $1.4 million in one-time debt consolidation fees and dilution from our ATM sales, which were not reflected in our prior guidance. Our FFO assumptions for Q3 and Q4 are unchanged as we expect the additional NOI from our recent acquisitions, lower interest expense and better operating results will offset the dilution from our recent stock sales.

Looking forward, I'm excited about our prospects. With lower leverage, no debt maturities before 2019, over $100 million of cash on hand and nothing drawn on our $400 million credit facility, we have ample liquidity for acquisitions, development and other future opportunities.

With that, I will turn the call over to Kevin.

Thanks, Jordan, and good morning, everyone. We had a very busy quarter.

First, we closed the purchase of 2 office buildings in Santa Monica: 1299 Ocean and 429 Santa Monica Boulevard. As discussed on our last call, both buildings were purchased by a consolidated joint venture managed by us, where we provided 20% of the equity. That same joint venture also recently purchased 9665 Wilshire, a 171,000 square-foot building in the Beverly Hills Triangle, for $177 million or $1,035 per square foot. The JV invested $100 million of equity and borrowed the remainder under its secured nonrecourse interest-only loan at LIBOR plus 1.55%. At 85% leased, this building provides us with another great lease-up opportunity as our other Beverly Hills buildings are 95% leased. We now own over 25% of the Beverly Hills submarket.

During the quarter, we also paid down and consolidated our debt. Most significantly, we paid off a $347 million loan, which was one of our highest interest rate loans and was our last loan scheduled to mature before 2019. In addition, we refinanced and extended 2 other loans. In May, we refinanced 4 of our L.A. multifamily assets with a secured nonrecourse $550 million interest-only loan that matures in June 2027. The loan bears interest at LIBOR plus 1.37%, which we have effectively fixed at 3.16% for 5 years. In June, we refinanced 6 office properties owned by one of our unconsolidated funds, with a secured nonrecourse $400 million interest-only loan maturing in July 2024. The loan bears interest at LIBOR plus 1.65%, which we have effectively fixed at 3.44% for 5 years through an interest rate swap.

Turning to the future, our 2 residential developments remain on schedule, and we also expect more acquisition opportunities in our markets this year.

With that, I will now turn the call over to Stuart.

Thanks, Kevin. Good morning, everyone. As Jordan mentioned, we had a banner quarter for leasing. We executed 238 leases, our most ever, for an all-time high of 1.2 million square feet.

Our leasing spreads for Q2 remained strong with 26.6% straight-line rent roll-up and 9.7% cash roll-up, reflecting good leasing activity in Honolulu and Warner Center. The lease rate for our total portfolio decreased 30 basis points to 91.4%. Virtually, all of this decline comes from the volatility expected from new acquisitions rather than our same-property portfolio.

Our ending same-property occupancy increased 10 basis points from last quarter to 90.3%. Rent growth in our west side submarkets is strong, Warner Center continues to make modest gains and Honolulu remains flat.

On the multifamily side, our 3,300 units were again fully leased at quarter-end. Our multifamily asking rents rose more than 6% year-over-year, with the annualized asking rents for our multifamily portfolio exceeding our in-place portfolio rents by $20 million per year.

I'll now turn the call over to Mona to discuss our results.

Thanks, Stuart. Good morning, everyone. Overall, compared to a year ago, in the second quarter of 2017, revenues increased by 6.6% despite headwinds from $3 million of lower noncash revenue, mostly due to straight line write-offs from early space recapture and having fully amortized the residential FAS 141 from our IPO.

FFO increased 3.8% to $84.9 million or $0.47 per share after a $0.01 impact of dilution from the shares we sold and the $1.4 million of one-time loan costs Jordan mentioned. AFFO increased 2.1% to $67.8 million.

Comparing our same-property cash results in the second quarter of 2017 to the second quarter of 2016, revenues increased by 4.1%, reflecting higher average in-place office rents.

Operating expenses increased by 3.9% because expenses in 2016 were offset by a $500,000 one-time excise tax refund and because some expenses in 2017 were carried over from the first quarter. Adjusting for the tax refund, operating expenses for the first 6 months increased by only 1.5%.

Overall, same-property cash NOI increased by 4.2%, and core same-property cash NOI rose by 4.4%. Excluding the one-time tax refund in 2016, our same-property cash NOI increased by 4.7%, and core same-property cash NOI increased by 4.9%. Our G&A for the second quarter was only 4.3% of revenues, well below our benchmark group.

On the capital side, during the second quarter, we sold approximately 9.1 million shares of our common stock for $350 million through our ATM, completing that program. Our cash at quarter-end does not reflect $69 million of the proceeds, which settled just after quarter-end. We plan to file a replacement ATM.

Finally, turning to guidance. We are adjusting our full year guidance for FFO to be between $1.89 per share and $1.93 per share. As Jordan mentioned, the $0.01 decline in the midpoint reflects the Q2 impact from $1.4 million in loan costs and dilution from our equity issuance.

Our FFO assumptions for the remainder of the year are unchanged as we expect the additional NOI from recent acquisitions, lower interest expense and better operating results will offset the dilution from our recent stock sales.

As usual, our guidance does not assume the impact of possible future acquisitions, dispositions or financings. For more information on the assumptions underlying our guidance, please refer to the schedule in the earnings package.

I will now turn the call over to the operator so we can take your questions.

(Operator Instructions) And our first question comes from James Feldman with Bank of America.

Kevin, I think you had mentioned a few resi developments on schedule and expect more acquisition opportunities. So can you talk to us about the kind of deals you guys are looking at? And do you think you would still use a partner going forward? And would it be the same partner?

Okay. There are a lot of properties in the market. And so it's, I guess, what we'd call, a target-rich environment. We're very busy underwriting a number of properties. As to whether or not we'll do it with partners, it's really going to depend on the size of the asset, what the asset is. We -- as we said on the last call, we've identified a number of properties for our partners that we have a moral commitment to pursue them with. Some of these assets are not in that group, and I think we're just going to have depend on the circumstances of the transaction to determine whether or not we'll do it with a partner. And as far as which partners, we've been doing it with the same partners on these EOP deals, we've got a number of different sources that we can go to. And I think you might be wondering about one particular partner, Qatar, and I'll just say that they performed -- they been a great partner. They performed on 9665, which was a voluntary acquisition, nothing they were obligated to do. And on a going-forward basis, we would expect that they would be one of the partners that we would go to.

Okay. I guess, just to take a step back, Jordan, when you started talking about buying EOP assets however long ago, we had discussions on these calls about how much you'd spend, where you're comfortable getting your leverage to. I guess, now that you've paid down the $350 million on the ATM, can you give us a new framework of how much of your own balance sheet you'd be willing to -- how much more equity you'd be willing to put into deals or just some framework around how much we think you may spend going forward?

Okay. So I -- we have -- basically, we have 4 programs that spend equity beyond in the certain normal course of operations. One, is what you just asked Kevin about, how's the pipeline look for new single building acquisitions? And it actually looks pretty good. It looks good in Hawaii, it looks good on the west side. There's even a good-looking deal on Ventura in the Valley. Another is kind of dramatic rehabs of buildings, which you'd go beyond rehab, you'd say repositioning, okay? We have 4 of those going on. That takes capital, right? We also have capital that we're putting in to do new construction, which is happening, you know 2 of those deals. And we have some other potentials, but we want to play out what we've got in the pipeline right now and get it built and get it operating. And the last, which I've mentioned before, and you've only seen one example of it, which is putting that park in, in the area where we have so many unit -- all those apartment units where we're building an apartment building, we also have all the units next door, which is -- which we look at as sort of community impact money, which you got to watch it very carefully because you want it to make sense for the company. But there does seem to be opportunities where we can spend some capital on community-level amenities and have it make a significant difference to us. So when we look out at what we have going on, we think to ourselves, we have a good chance to put very, very impactful equity out, more than a couple of hundred million dollars. Now all of this is offset by the fact we also generate a lot of cash flow, right? And so I feel like we still have a good opportunity going forward. When I brought that up about the EOP deal, and I said, "Look, I wouldn't be comfortable putting more than $400 million in," that was when we thought we were going to have to buy the whole EOP at once. It actually happened over a couple of years. And we -- and now it's just a very -- I don't care how good we think the deal is. That was just a super big check for us to write at one time for one acquisition or set of acquisitions. And that's why we went out, and we kind of set a limit on that. We went out and found partners to do it. But to further answer, I agree with Kevin that while we have a good amount of equity, we can use our equity to buy whole buildings. We've worked really hard. We have -- obviously, Qatar is a fantastic partner. But we have a bunch of other partners, too. And we've worked hard to create those relationships, have documents in place that work for them and work for us. And we want to keep it going. So we will look for opportunities to continue doing deals with them. Some deals don't work to put in a JV structure. Maybe someone wants OP units or something else, okay, then those aren't going that way. But we like the process of doing deals with them, having them as partners. They've been good partners. They've been -- the process has gotten better and better about funding and making their decisions and getting quick answers. And so we want to keep that kind of system live and operating.

So when you add up those 4 buckets, what -- like what is the total capital amount? And I know the first one is it depends on JV or no JV. But the last 3, what kind of...

As I said, I hope we can get over $200 million. It'd be a great day if we have $400 million of new capital coming out of Douglas Emmett for all that stuff, it doesn't tend to work that way, it kind of flows over time. And when you hope you got it this year, then it went to next year and next year then stretches out. But we're hoping there's numbers in that range that we can get out, still.

Our next question comes from Manny Korchman with Citigroup.

Jordan, just as you sat back and thought about refilling the capital drawer following all these deals, how did you get comfortable to equity when sort of a year ago, with the stock at a similar level, you made it sound like -- I think, your exact quote was "buying buildings with the stock where it is right now doesn't make sense."

So number one, I didn't get that comfortable. That was a very painful process for me. I don't like being diluted. I don't really like issuing equity. But there was a lot of things that came together, that convinced me that it was a good move. And some of it had to do with all the moves we could do with debt and have it all happen at once. The refis that we did, the payoff that we did. I mean, the stats in that sentence, at the end of my first paragraph, where I go like, look: We paid off a loan. We were able to store the money in unencumbered properties. That loan was at a high interest rate. At the same time, we restructured this other loan, and we stretched out our maturities. We lowered our average interest rate to 3%, 3.3%?

3.2%?

3.2%, okay. All very compelling and -- but I mean, it wasn't a big equity issuance. But you're right, I mean now is a real bad part of it. I didn't like that part of it.

And maybe following up then on Jamie's question. If you were to go and put out another, call it, $200 million or $400 million, whatever it is, of capital, would you think about doing the same way where you're going to go and buy what you can along the way and then think about sort of the equity component later? Or can we expect the ATM close to be a little bit more matched to the actual acquisition?

Well, I think that it did match that last group of acquisitions, but that was not the reason we did it. There were a lot of things involved. As I just said, in terms of the reason we did it, and I know that it's kind of compelling to go spend $350 million, issue $350 million. But there was a lot more going on there in terms of making that decision. So you know that we tend to be on the slower side in terms of issue equity and dilution. We take a long time to think about whether the right set of circumstances exist, and we look at what's going on in the future. We look at how we can use or store the money. We look at a number of factors. And you brought up one that we looked at it, that was a negative factor, right? I don't like the kind of relationship between the NAV and the stock price. But we put of them all together, and that's how we decided it. So I can't really call out going forward what exactly is going to be going on to be able to give you a lot of guidance on that.

Our next question comes from Craig Mailman with KeyBanc Capital Markets.

Maybe just one more follow-up here on the balance sheet. I understand kind of a lot of things came together to put money out and being able to refi some stuff. But internally, is there any different view on kind of where you guys want to run the company from a leverage perspective longer term?

It's hard -- not really. I think that we have a lot of opportunities to put equity out. The market is very strong. So it's an extremely rare time in the real estate business. I mean, I know a lot of you guys have heard me say this a bunch of times, but my partner here, Ken Panzer, used to say all the time, "Real estate's an odd business because you can get 1 good year out of 20," okay? And we happen to be in that year. Although, we've been in that year for like the last 2, 3, 4 years. I mean, we had some very good years. When you're in a year where you can actually put capital out there that really makes money like good purchases. And at the same time, fundamentals are going up and, at the same time, the cost of capital isn't abusive, that's very rare for real estate. So we're making hay while the sun's shining. I mean, we're working hard to make the most out of all of that, that we can. And that's why you see us doing what we're doing. I don't think our view, whether we thought 38% LTV was risky, 35% LTV is risky, 30%, I don't think any of them were risky. I don't think 40% is risky, right? But there are other things going on, and we want to have certain capital available. And we're certainly very comfortable with our leverage level. And when we brought all that together, that's where we ended up.

That's helpful. And maybe your point about how good things kind of leads to my next question. A lot of articles about subleased space. A lot of it's downtown. But maybe you guys are seeing more of it in West L.A. Just curious, are you guys seeing anything on the ground that kind of substantiates the articles? Or is it overblown at this point? Just kind of thoughts there.

We aren't seeing it in our portfolio. I know they were talking about there being subleased space downtown in that article. And it was a funny article because they said there's more subleased space, but there's less vacant subleased space. So I wasn't exactly sure what that sentence meant because I don't know why anyone cares whether someone has a direct lease or a sublease if the space is occupied, but we -- I mean, funny, I mean, we've been talking a lot about tenants potentially coming to us on subleases, and we've been -- as you know, we've looked at that as an opportunity. But we certainly aren't seeing, on larger spaces, which also I think is what that article is talking about, we're really not seeing it in larger spaces, although we're small, we work more around small spaces. And we tend to look at it -- been looking at it as an opportunity that we can take advantage of. But no, net-net, we are not seeing an uptick in our markets.

Our next question comes from Jed Reagan with Green Street Advisors.

One of your peers mentioned this earnings season that leasing velocity has moderated in the West L.A. market. And just curious if that's consistent with what you're seeing.

Yes. We saw that, too. I know that, that was something that, I guess, someone said. So we aren't seeing that at all. I think he was talking about relatively large tenants. And he might have even more information on that than we do. We don't operate a lot in that sphere. And in fact, the west side doesn't -- isn't particularly accommodating the large tenants to begin with. We -- I mean, you saw our numbers. We've never had -- in terms of leasing velocity, this is the largest quarter in the history of the company, all right? And so, okay, I've been doing it for 30 years. Dan's been doing it for over 40 years. But how can you come to a conclusion, any conclusion, beyond that leasing velocity is running at a torrid pace when we just put those numbers up? I mean, it's moving like lightening.

Okay. And how about sort of the pace of rent growth in the market? I think, in the past, you guys had talked about near double digits. Where would you say we're sitting today as far as what you guys are seeing?

I think that, depending on the market, you're above double-digit and below double-digit, which is why we keep ending up kind of just there or just under there. But it -- the market is -- I mean, rents -- look, rents are going to move up as vacancy declines and as space availability declines and as tenants start feeling the pressure of not getting their space or worrying about being able to stay in their space. And that is definitely going on. And that is adding a lot of pressure to rents. And rents have moved a lot lately. One of the things we were talking about a little while ago that was noticed by, I don't remember, Ted or Stuart or somebody, was that we're getting more rapid rent growth out of new deals than renewal deals. And it's because new guys have been out looking, and they're much quicker to want to make a deal at much higher rates because they're a little more educated. And when you go to renew someone, they have to -- you tell them the new rate, and they go into PTSD. I mean, they go into shock. And it takes them a while to kind of absorb and assimilate it. And at the same time, we, ourselves, you have tenants that have been in our buildings for decades in some cases, and we feel some loyalty to them. We don't like completely throwing them into a tizzy. So -- but it's all moving very fast. And I think people are kind of working to adjust to how quickly rents have moved up.

Okay, that's helpful. And then just maybe one more. As we think about funding sources in the next few years for the pipeline you guys laid out and just given your comments, Jordan, that you're not crazy about issuing equity, do you think dispositions might figure into the equation going forward?

I don't want to say I wouldn't do anything. I don't want to say I wouldn't issue equity. Obviously, we would issue equity. We just did. And I don't want to say I'm not selling anything. But I don't like selling properties. I think we have a great portfolio. But I think that, at least, in the environment we're looking at right now, I don't see a lot of sales on our horizon.

Our next question comes from Alexander Goldfarb with Sandler O'Neill + Partners.

So just 2 questions here. The first is on the spend and on the CapEx. You guys started a few projects. There was a lobby. I think there are a few lobby upgrades. And I think one, there's a possible reskinning. But just when you look at the look and appearance and feel of some of the new construction, do you feel that even though your existing stock is well located, that tenants may start to push back just by the age in the '80s, sort of early '90s vintage look of the buildings? Or is it just that with traffic so bad, even if it's an aged building, it's going to be just as competitive as new construction?

Are you accusing us of having ugly buildings?

Not at all.

All right. I was just checking. I mean that's -- I think, let me say -- first of all, no, okay? Our occupancy actually is -- even though we're such a huge percentage of the market, our occupancy outpaces the market in the exact same markets that we're in. So certainly, there's not a lot working against us in terms of attracting tenants. But said in a little different way, I will say this, we have definitely got buildings that we think we can do some major repositionings to and change the level of rent that we're receiving in that building by a meaningful number. And I know you've seen -- because you're bringing them up, I know we've shown you that 1801 Century Park East and some of the other buildings, some the changes we're making, and they look like new buildings when we're done and, certainly, big changes to lobbies and courtyards. And in the case where the skin's ugly, the skin, which I know you've looked at all of them, and we think that, that money is going to be very, very good return money. And now to go to the other side of what you're saying, to say competing with new buildings, there's not a lot of new buildings. As a matter of fact, when we're done with these, they will look like the newest buildings in the markets. I mean, to go look back and find an old build -- a new building, you're saying new, new is like very early '90s, right? There's not much since then. I mean, you can point out one here, one there, but not much. So that's not a very robust competitive set.

Okay. But do you think, Jordan, that increasingly, over the next few years, we'll see more of those rehabs coming up, where you're sprucing up lobbies or maybe some reskinning or you think it's more of a targeted case in the portfolio?

I think that you may see more of it because it's on our agenda, but I don't know how much super profitable, low-lying fruit we have, just like many of the things we do. We took on some residential, we're going to play it out. We're going to build it. We're going to see how it does. We're doing a couple of projects here. We want to see good returns out of the money we're spending. But if we do, we'll be a little more educated about the sensitivity to the market in terms of rates and all this stuff, and then we might continue taking steps. It's certainly something that we're taking a harder and harder look at.

Okay. The second question is, Jordan, on a number of the private equity-owned buildings that you guys have bought, it always seems that the occupancy is low. And just curious, is that just for the typical, like, private equity just wants to max out the last dollar so that way, they never fully lease the buildings? Or are there some specific issues with why that vacancy is there when you guys have been acquiring it?

Well, I mean, I think that, primarily, the reason the vacancy is there is sort of the operating strategy of the previous owner. I think if you're selling some buildings, certainly, the Blackstone buildings we were selling, I think Blackstone makes the calculation and basically said, "I think it's more impactful to the value we'll get if we can hold and push for rent than push for occupancy." So they push for rent, and they push very hard for it. And so you're not going to see as much occupancy. I think longer-term owners tend to like to have a pretty full building. Certainly, we're certainly in a market where if you want to have a full building, you can have it, right? So that is a much more of an operator decision than anything else. If you're intimating that was there something wrong with those buildings, and that's why the vacancies, well, a lot of those buildings, we already bought and leased up. I mean, it was very quick to move it up when we kind of opened the doors, met the market, got kind of our systems in place. Now still, I will say, it takes years for us to own a building till it's really running the way we like it to run. A lot of our leases in place, all the vendors have all settled in, everything is done right. So there's always noise in -- that continues well beyond the announcement that we bought the building, in new buildings that we bought that goes on for a couple of years but, in general, buying great buildings. And I expect them, as they settle into our portfolio, to perform extremely well. And they already are.

Our next question comes from Nick Yulico with UBS.

I'm just trying to reconcile a couple of things here. So you have a little over $170 million of cash on the balance sheet, talked about the $69 million of share proceeds that are still being settled, I guess, after the quarter-end. You had, it looks like about, $20 million of equity you're putting into the new Beverly Hills purchase. So you're still over $200 million of cash. But this is a harder cash balance than you've run it. I'm just wondering, did you raise more proceeds from the ATM to put some aside for more acquisitions? And -- or is this also being done in a way to fund some of the development pipeline?

Well, so what we did is to fund all 4 of the things that I named: it's the development pipeline; it's new acquisitions; it's redevelopment, redevelopment of the buildings that we mentioned; as well as some community stuff. But I think when you look at the $170 million, one thing you have to realize is -- and I remember someone called me about this before, that when we do -- when we buy a building into those joint ventures, and we know we have CapEx, lobby remodels, et cetera, et cetera, there's not really any draws after that. So they prefund all that they're going to do for those specific buildings. So there's some money that's for the buildings that we bought, that's there for the buildings that we bought. So that's a dedicated pool for -- in the various JVs. We have obviously cash that we can use for anything we want. We have cash that -- I mean, we have availability, both in our credit line, which is $400 million, as well as our -- as properties that are completely unencumbered. So if we want to directly buy a building or we want to buy a building with OP units or something like that and then put financing on it, we could sort of take a building and then take one of our unencumbered buildings and finance them as a pool. And boom, you've just sort of drawn equity back out and put it to work. So we have a lot of different ways, depending on what we're doing, to fund what we're doing. Does that answer your question or I don't know?

Yes, I was just trying to tie it all together. It seems like you raised some excess funds for acquisitions. What you're saying, I'm just trying to understand (inaudible).

Well, I don't know if it's -- I mean, I don't know if it's -- I hope it's not excess because I hope we have a lot of good things to put this money to work on. But if the strong pipeline that Kevin mentioned turns weak, if we don't go after a lot of the development stuff or additional stuff we're thinking about doing, if -- there's a number of things that could happen, and I go, "Oh, okay, maybe we over raised." I mean, I don't know that answer. We had an opportunity to do this, raise $350 million, pay off that loan, restructure the other debt, and so that was the amount we chose to do. But if it turns out that it's too much cash, I'd be a little bummed because I hope that a lot of the stuff that we have scheduled that we'd like to spend equity on comes to fruition.

Okay, got it. Last question is how much square footage have you taken? You talked about taking square footage back to take advantage of below-market rents. How much have you taken back in the second quarter year-to-date? Just trying to understand how much of the negative absorption you report is because of this factor.

I think -- I don't know that answer, let's start with that. I keep getting -- every time we prepare for the call, we talk about are we still doing that recapturing? And we go and check with leasing. And they give us a bunch of anecdotal stories of recaptured deals. And I'm telling you, those deals are like gold. I mean, they were really very, very profitable deals. They create noise in the quarter you do it, both on the vacancy front because, obviously, now you're putting a brand-new tenant in, so you got to put the new tenant in. So it's not leased, you got to get the other guy out. But they also create noise around costs and having to take into expenses, straight-line and some stuff like that. I think, the other thing, and because we looked at this, is that we really aren't having much -- the leasing in our same-store portfolio, if you will, is actually not contributing, maybe not at all, to the loss in lease rate. It's mostly coming out of the new stuff that's kind of still just getting a lot -- there's just still a lot of turmoil there of moving people in and out. And they're what's creating the upticks and downticks a little more aggressively in vacancy as those buildings settle in. That's where most of the action, like, when you buy something, you know some guys are moving out already because -- so they move out but all of a sudden now that's on our watch even though we knew they were leaving. Then we have some other deals, and we move it back in. That's going to take a little while for that noise to settle out. But those buildings are also very strong contributors to our kind of roll-up in rents and all the rest of that stuff. So I think they're probably stronger contributors to the -- a little bit of loss of lease rate that we got than the downtime that we suffer from the recapturing of subleased space.

Our next question comes from John Kim with BMO Capital Markets.

Another comment made this morning by one of your peers was that recent office transactions in West L.A. have been sold above replacement costs. So I was wondering if, a, if you agree with that assessment; and b, can you just comment on the [depths] of the market as far as who you're seeing when you're looking at buying assets?

Well, I'd say you have to start out by asking 2 questions. Number one, when you say replacement costs, can these assets be replaced? And I know this isn't -- for many of you and for you, John, this is repeating something you guys already know, but these markets were downzoned all the way back in 1986. Essentially, what that means is -- without boring you with Prop U and all the changes and everything that went into place is -- most buildings are larger than if you were to build a new building on that site that you could build, okay? So most of the buildings we're buying -- when I say most, I'd say pretty much all. So if we're buying a 200,000-foot building on a site in Beverly Hills and then we just wanted to go down to the dirt and say, "Now what can we build there?" It's likely that they would let us build like a 40,000-foot building, okay? It was a dramatic downzoning. A lot of places were zoned 8 to 1, 9 to 1, 10 to 1. And now for pretty much the whole place, it's 1.5 to 1, okay? So when you say replacement cost, I think intrinsic in that question is, is someone going to build a building cheaper near you as a competitor? No, they're not, okay? The second thing, when you ask about replacement cost is, well, replacement cost is a tough number because when rents are higher, land goes up and, therefore, replacement cost goes up. And when rents go down, land values go down and replacement cost goes down, only for the land component, right? So I don't think that you could replace any of these buildings. And then taking -- just replace them, flat out, I don't care how much money you want to spend. I don't think you can replace them, okay? And then, now go to the next step, which is, if you were to try and do some kind of a component analysis and say, "What are construction costs? And what does land cost?" Well, land is selling at a very high premium right now in the markets that we're buying it. Absurdly high, absurdly high, on an FAR basis. So I suspect, if you really were to say, "I know that Douglas Emmett just bought a 200,000-foot building on Ocean Boulevard in Santa Monica," I'm not going to go buy enough land to build 200,000 feet. I think when you were done, we'd probably come half the replacement costs because the land would be so absurdly expensive to get that much land. Now with that said, construction costs have also gone up, but they're not super meaningful to this equation. It's mostly the other things that I mentioned.

Can you just elaborate more on that land value as far as either percentage of the overall value per square foot or just the dollar amount?

Well, land compared to construction costs can get up to the point where it's equaling. I mean, the numbers -- we see small sites that will trade down there, like down in Santa Monica, near the beach, or in Beverly Hills around the Triangle, any of these places that we've been buying property. And it's almost ridiculous to calculate the costs per FAR foot. The numbers are gigantic. Like you almost go, what's the guy doing -- what's the guys going to do on the site because how could any rent justify it? It's just the incredible scarcity of land in any of these markets.

So you're talking north of $500 a square foot?

I think land sells for a lot more than $500. What do you think it's selling per FAR foot, if you want to buy a piece down here on Ocean Boulevard?

I -- there really haven't been any office land trades. So there's nothing really to compare it to.

There was a little site on Ocean that had just a [space] for a restaurant and that park in the back, I think it sold for, just the land foot, it sold for like $1,200 a land foot. And the thing only had like a 6,000-foot restaurant on it and a little parking behind it.

Our next question comes from John Guinee with Stifel.

Great. A few quick questions. First, it looks like you get about $0.09 a share in FFO from FAS 141 income. Is that going to stay fairly constant? Or is that burn-off? And if so, how quickly? And then the second...

Go ahead. Go ahead. You can ask them all at once.

Okay. And then second question, it looks like on your lease expiration schedule, and if you mentioned this, tell me so, it looks like the rest of '17 was about $35.50 a square foot. In '18 and '19, the rents that expire in the $40 to $41 range. And then in 2021, '22, you're in the mid-40s. Do you still have the same mark-to-market rental rate growth potential once your expiring leases get up over $40?

Okay. So let's take the first one. So the first one was asking about FAS. I don't think -- when you look at kind of the 2 big noncash items in our revenue, which is FAS and straight-line, we do look at this a lot of times and compare because we're trying to understand -- with numbers with other office companies. We know we're at the extremely low end, the extreme low end in terms of those noncash items being part of our revenue. In terms of the FAS being kind of a stable number going forward, I think just because of the nature of our portfolio, the nature of our markets, I don't think it will become -- I don't foresee in the future, it becoming a much more significant number. But you buy buildings, and you get some and then some also rolls off, so the number moves around, right? And something similar happens with straight-lining. Then, your second question was lease expirations and whether we can still get the roll-up. We have not enjoyed the process of predicting roll-up on quarter-to-quarter on what we're going to get out of the leases. The roll-up right now is extremely strong. It does move. I remember when it was rolled down, and we talked a lot about when it was going to go to 0 or go positive, we guessed that wrong pretty much every quarter, including when it did go up, we didn't think it was going to. So we're not -- we weren't going to guess on that. And now it's moving up, and it's up at very high territory. If you look at quarter-to-quarter, it jumps around, although all these numbers are very high. If you look across the year, I can't predict years out, but I think that we're looking, obviously, at having a very strong year this year. And I suspect we will have a very strong next year in terms of the metric of cash and straight-line roll-up. But getting any more precise than that, it's virtually impossible in terms of when people decide to move out, when they renew, when they -- new people move in, how long it takes to lease a space, which space actually comes up, whether there's a concentration in markets that are flatter or concentration in markets that have gone up real fast in terms of like where the leasing happens. All of those things defy prediction. But the numbers are very strong, and I think they'll probably be pretty strong next year.

Okay. So even though the lease expiration is $35, $36 in '17, but $40 rents in '18, '19, you think you could still have strong re-leasing spreads?

Yes, I do. I mean, look at what we're talking about here. We're talking about cash numbers -- like this quarter, what was -- cash is almost 10, 9-something. And we've been up in the high 20s, 30s, in terms of straight-line. I mean, there's a lot of room there. Rents don't have to move super-fast. You're only talking about moving up ending rent by, what, like 10% or something, right? So yes, I do.

Our next question comes from Steve Sakwa with Evercore ISI.

I guess, as it relates to Hawaii, I know that you spend some time trying to find an asset or 2 that you could take and do a conversion. I know there's at least one building in the marketplace that's being marketed. I'm just wondering if it's you that is successful in that building or, perhaps, a competitor of yours. Just how confident are you that the downtown Honolulu market could start to see some office space coming kind of off the market, if you will, over the next 12 to 18 months?

That's good local market knowledge that you have there in terms of downtown Honolulu. Well, I don't want to talk about any individual deals. So I'm not going to talk about any individual deals. I can tell you that when you look at the various -- we have -- you've watched us now for our entire time being public. We kind of choose things, we work on them and we keep working on them till we get there. I mean, God knows, we put in our time on getting that EOP portfolio. We are very focused on impacting that Honolulu market, both by adding some workforce housing downtown, improving the downtown in general -- the downtown experience, if you will, as well as improving the metrics in terms of leasing and occupancy and rental rates. And so we are putting a ton of time and work into that market. And I can't imagine that it will not yield some results. And so I'm going to be pretty positive and say that I expect that we'll be successful in the end. But how long does it take? I've asked Kevin to get it done by the end of the next quarter.

Okay. I guess, secondly, I know the portfolio is really mostly small tenants, but you do have a couple of large tenants. And you've got a page here in the supplemental devoted to it. Time Warner, I guess, has a large expiration in 2019. I realize it's a little far out, but it is 400,000 feet. I'm just curious, have you kind of started the discussion with them? And sort of what's the status?

Yes. I mean, I know that there are discussions going on there, but I don't know -- I mean, you never really know what they're going to do. It's too far out, and they're a sophisticated tenant, and they're not going to tip their cards on anything. And so we're sort of playing it through with them.

Okay. I mean, I guess, if there aren't that many spaces of that size, so somebody's got to sort of move early in order to get something and get moved at that kind of level. So...

We're listening. We're definitely listening and watching the market, listening for what's going on. I mean, I have no strong indications that we'll lose them, but they also haven't given us particularly strong indications that we'll keep them. I mean, it's just too far out. Nobody has any reason to really come and get something done yet.

Okay. And I guess, just lastly on the, I guess, the Brentwood, I guess, apartment development. Just, I think, you said that you were hopeful, I think it starts out by the end of the year, just kind of bring us up to speed maybe on that project.

Well, yesterday, day before yesterday, when did we get that e-mail?

Yesterday.

Yesterday, the last thing that had to be aired in a public hearing, which we were told would be on the consent calendar, actually was on the consent calendar. And it was consented to, which was our development agreement, so we have nothing left that even sees a public hearing. We already have plans in, going through a plan check. And we stick by what we said that we expect to start construction fourth quarter.

Okay. And just could you remind us, do you have an estimated yield on that project? Or you haven't talked about that at this point?

We've said we think we would get above a 7 going-in cap, and I feel pretty confident that, that's a good number to start with.

Our next question comes from Rich Anderson with Mizuho Securities.

So Jordan, you mentioned land prices. Is it possible that you can make a better deal for yourself if you were to do a leasehold deal as opposed to fee simple? Is that something that you're considering?

Better deal doing what? Building a building?

No. Willing to pay a ground lease.

You mean sell off the ground position and just own the building, subject to a ground lease?

That, or if you're buying a new asset, to break the 2 into 2 tranches, the building and the land.

Yes. So I've seen people do that for sure. I think that when it comes to ground leases, they get -- their impact is underappreciated in a very aggressive market, and it's -- and then the properties are over discounted in a weak market when they're subject to a ground lease. So they sort of add to the volatility. I know -- I mean, I'm going -- showing my age, but I remember when [Speaker] broke his properties into -- I mean, when (inaudible) broke his properties into the building and the ground leasing. He only sold the buildings to Speaker on 30-year ground leasing, and some of that stuff is still kind of circling around. That's very -- I mean, that's a calculation that at any moment in time, you can conclude one way or another, but it's not something that I think we'll do. First of all, we're in the business of running office buildings. And secondly, I don't really like owning buildings on ground leases. We always -- when we do, we always want to make sure we have a path to own the ground and eliminate the ground lease. We are willing to buy fee positions, subject to ground leases, but those are trading at an extremely dear price right now because the overall rates are low. So there's just not a lot of activity around that.

Okay. And then just the second question is, if it's -- was 18 months for you to kind of invest, now replenish and repeat, and thinking about how deep the market is for future investments, how many more kind of 18-month cycles do you think are in store for you? Do you think there's enough out there for one more round? Or do you think that this is kind of an in perpetuity type of story from you guys for the foreseeable future?

Well, okay, that is only one aspect of why we issued the equity. There was a chance to pay off the loan. There was a lot going on there. So I don't want to kind of narrow this down to we decided we needed money to buy stuff in the future because, really, we didn't. We had capacity before, we have capacity now. If I sort of just take the broader and just say, "How long do I think the run is where we can just put out equity in a profitable way and impact the portfolio?" I mean, in some sense, your guess is as good as mine. But it certainly looks like we have a couple of years in terms of not seeing too many stormy clouds in our markets. But all of this can be impacted by some type of strange downturn in a national economy or a war or some strange kind of steering the bus off the cliff type of maneuver. And that's something that when I look back, I mean, that's something I'm less confident in, whether I can see kind of going forward what's going to happen on the national economy front. When we look at times when we've been impacted, it is almost always been because of a downturn in the national economy or the global economy. It's never been something that happened in our market like some crazy amount of new supply or big tenants leaving the market or anything like that. It's always been some kind of downturn in the national economy that had a bad impact on us. And so certainly, that can bring an end to the music where everyone's jumping for a chair. But I don't see anything beyond that in the way of storm clouds for the markets that we're in.

Okay. And just quickly, in terms of the acquisition side of your investment dollars, how much would you say is value-add? How much would you say is stabilized?

There's a couple of deals that would be very good deals for us, but they're relatively full buildings. And there's a couple of deals that are not as full or they're rehab opportunity and then, obviously, working on the stuff in Hawaii that Steve already brought -- Steve brought up. So I don't know where -- how you would bucket those, and I don't know what mix of that stuff shows up in terms of actually coming to fruition.

Prefer value-add over stabilized, though, I guess, depending because you...

Well, we have historically preferred that. But sometimes, when there's a market with a very good building, even if it's full, as long as the price -- look, we miss deals. You saw even on the Blackstone thing, we didn't get everything because we can be pushed to a point where we're not willing to pay that. But if we think it's a great building, a great market, it's certainly a lot easier for us to win the bid when there's vacancy or something else that needs to happen. But I won't say we've never won a bid on a building that's been over 90%.

And Rich, it's Kevin here, I'd just like to add. I mean, a building might be full, but there are opportunities where you can work through the expenses, you can work through the rent roll, you can restructure a lease. There are ways to add...

You could redo the lobby and some other stuff. There's always something you can do.

So what you should look for out of us is we are most aggressive for buildings that have vacancy or value-add opportunities where we can apply the operating platform to it and optimize the cash flow on the building. If there's a property that's at market with one tenant where we can't really add any value, that's probably not the best use of our dollars. So you'll find us most aggressive on buildings where we think that we can quickly add value and increase the cash flow at the property.

And our next question comes from Bill Crow with Raymond James.

Most of my questions have been addressed. So let me turn back to Honolulu. Jordan, I think it was 2 quarters ago that you discussed the possibility or the potential of doing a joint venture on those assets, finding a partner in order to provide some capital. And I'm just curious whether the ATM usage and/or the changing landscape of international buyers has tweaked your thoughts on what you might do out there.

No, no. We're going forward trying to make one or more of those deals. That's what we're working on.

Okay. Do you have any idea? Can you communicate what the size of the joint venture might be?

We're working on 4 different things out there. And depending on how many of them we're successful on, that will determine the size. I mean, we're trying to have a real impact there.

Our next question is a follow-up from Jed Reagan with Green Street Advisors.

I'll keep this quick. Just back on the acquisition pipelines. Are there any residential deals in that pool you're looking at? And then how much is left in the Blackstone EOP portfolio at this point that you would still be interested in?

Jed, we do look at a lot of residential that comes out. We just have trouble making sense of it because it's trading at such -- residential's effectively at market, right? You're moving these leases every year. And when things are trading in the mid-3s and, call it, high 5s unlevered IRR, it's tough to get really excited about it, which is what's led us to taking some of the assets where we have additional density and do development. As far as EOP, there's not a lot left. I mean, to kind of recap, I think they put 12 -- they've sold 12 assets so far. We purchased 8 of them. One of them we didn't get a shot at because it went to a partner. And they've got a couple of more assets that they're going to be putting in the market that we'll definitely take a look at. And if they meet the criteria that we answered on the last question, that's something that we might have a shot at. If they're more stabilized, that's something somebody else might get more aggressive for.

Okay, I appreciate that. And then just on the Beverly Hills deal. What kind of starting cap rate and maybe stabilized yield are you targeting there? And is there any color on kind of the leasing profile as far as near-term roll or below-market rents you could talk about?

Well, like a lot of the properties that we bought, this property has a lot of vacancy on it. It's 85% leased. So initial cap rates aren't really relevant to the discussion. We anticipate that we'll be able to stabilize this somewhere in the mid-5s. The vacancy is all on the ground floor in this property. And so we're getting a lot of inbounds, both from office and retail tenants wanting to take a look at the space. It's very, very prominent space on Wilshire that has great visibility. And so...

Courtyard.

It actually comes with a lot of opportunity.

And rents below-market, fair to assume?

Well, being vacant, it's way below market.

The in-place, I meant.

Yes, yes, the in-place in the building. The building actually doesn't have as many -- I mean, it's got a lot of full-floor for tenants. There's almost an aggression to get into that building, up in the tower. I mean, honestly, it's hard to know why they didn't just go ahead and lease the ground. They have a lot of hits on the ground floor, I think they just wanted to sell it and be done. Now I know, turning it over to our group, they're going to do some -- they plan to do some work to the courtyard and the ground floor, and they will probably move relatively quickly and make one of the lease deals.

This concludes our question-and-answer session for today. I'd like to turn the conference back over to management for any closing remarks.

Thank you, everyone, for joining us, and we look forward to speaking with you again next quarter.

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