Hudson Pacific Properties Inc (HPP) 2016 Q4 法說會逐字稿

Greetings and welcome to the Hudson Pacific fourth-quarter 2016 earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded. I'd like to turn the conference over to your host, Ms. Kay Tidwell, Executive Vice President and General Counsel. Thank you, you may begin.

Good morning, everyone, and welcome to Hudson Pacific Properties fourth-quarter 2016 earnings conference call. With us today are the Company's Chairman and Chief Executive Officer, Victor Coleman, and Chief Operating Officer and Chief Financial Officer, Mark Lammas.

Before I hand the call over to them, please note that on this call certain information presented contains forward-looking statements. These statements are based on management's current expectations and are subject to risks, uncertainties, and assumptions. Potential risks and uncertainties that could cause the Company's business and financial results to differ materially from these forward-looking statements are described in the Company's periodic reports filed with the SEC from time to time.

All information discussed on this call is as of today, February 16, 2017, and Hudson Pacific does not intend and undertakes no duty to update future events or circumstances. In addition, certain of the financial information presented on this call represents non-GAAP financial measures. The Company's earnings release, which was released this morning and is available on the Company's website, presents reconciliation to the appropriate GAAP measure and an explanation of why the Company believes such non-GAAP financial measures are useful to investors.

Now I'd like to turn the call over to Victor Coleman, Chairman and Chief Executive Officer of Hudson Pacific. Victor?

Thanks, Kay. Good morning, everyone. Welcome to our fourth-quarter call. The last three months of 2016 capped off a terrific year for Hudson Pacific. I'd like to talk about some of the highlights.

We signed over 2.9 million square feet of leases in 2016, well exceeding the 2 million square foot benchmark we offered up on one of our calls earlier this year. The total activity for the year was also nearly double the number of deals we signed in 2015. And GAAP and cash rents for these transactions were 45% and 37%, respectively.

We increased leased percentage of our Q4 2015 lease-up assets by 240 basis points, up from 79.5% to 81.9%, and we did this despite nearly 18% of the footage at those assets rolling during the same time period. Sizable new deals like Qualus and major renewals like Nutanix and Qualcomm had a lot of velocity in the sub 10,000 square foot range really helped move the needle at those assets.

We did more than 600,000 square feet of pre-leasing in our development and redevelopment projects, which is almost 2 times our active unleased pipeline of such projects. We delivered 12655 Jefferson 100% pre-leased in the fourth quarter, and ICON was delivered 100% pre-leased in Q1 of 2017. Now, remember, both those projects are here in Los Angeles where pre-leasing is the exception not the rule.

Even with all this activity, our leasing pipeline remains very strong and consistent with prior quarters. We still have around 1.5 million square feet of deals throughout our portfolio where we're trading paper in leases or LOIs. We also completed more than $1 billion of capital recycling and very selective investments in our core markets in 2016. This included about $370 million of dispositions which resulted in us being a net seller in the Bay area for the year.

All dispositions were at nice premiums to our bases, like 12655, which we sold at 30% premium in the fourth quarter. We also completed about $640 million in acquisitions, and we were a net buyer in the Los Angeles and Seattle markets. This is very much in line with what we've been saying about our longer-term strategy to balance out our portfolio.

All of acquisitions were strategic in location and had some sort of value-add component like Page Mill Hill, a mark-to-market play in the Stanford Research Park, where we're already the largest office landlord; and Hill7, a lease-up play in South Lake Union near our Met Park property in Seattle. Both of these transactions closed in the fourth quarter of 2016.

Now let's just take a little closer look at the fourth-quarter leasing activities and conditions across our markets. Big picture as reported, we signed over 560,000 square feet of new owner renewal deals in the quarter. GAAP and cash rent spreads were a solid 15.5% and 9.5%, respectively. Mark's going to provide context around those numbers, but the delta between Q3 and Q4 numbers is entirely attributable to the extension we signed with the NFL in Culver City at in-place rents.

Our Los Angeles portfolio continues to be the center of what's driving our office demand in that marketplace. Specifically the influx of streaming media companies and the growth in original content production. Net absorption for the quarter exceeded 2 million square feet for the first time since 2005. That's the second strongest quarter for absorption ever since Q1 of 1998, and quarter-over-quarter vacancy fell 340 basis points in Hollywood to 11.7%, and 200 basis points in West Los Angeles to 8%. While rents were basically flat in the quarter in those two markets, we expect continued growth in 2017, particularly given the limited new supply.

Netflix is a perfect example of these broader market trends, which is part of why we received so much attention around this deal. They continue to expand their footprint with us to over 500,000 square feet in Q4. They pre-leased all of the 92,000 square feet of CUE on the heels of signing 100,000 square foot agreement for stages and production offices at Sunset Bronson.

With ICON and CUE spoken for, we're turning our attention now to EPIC. We're fully approved for 300,000 square foot project and about to kick off formal marketing for what is going to be the most forward-looking, highest design office project to hit the Los Angeles marketplace. There is already roughly 800,000 square feet of demand from creative tenants and content providers in the market right now. And with that number growing with companies like Apple, Amazon, and Hulu looking to build a significant business around original content, we only expect that number to get bigger.

I'm not going to spend too much time on the San Francisco CBD other than pointing out a few key points that highlight the strength of our position and the level of comfort with the activity. Our assets are 97.7% leased with in-place rents at about 55% below market. 2017 expirations are 97% below market and 2018 expirations are 77.3% below market, so we've got a lot of head room in the event the market softens.

Rents were basically flat but still very strong at $73 a foot, and vacancy dropped 60 basis points in the quarter to 6.3%. 2016 construction levels were 100% pre-leased and full absorption of 1.5 million square feet surpassed 2015 levels. Available sublease space even fell by about 15% in Q4.

The bottom line is tech tenants are continuing to expand. We're seeing that firsthand on both the AIG space at Rincon, where we're negotiating with multiple top-tier tenants. We also had great activity on that space, and we're reviewing several proposals for the former Heald College space at 875 Howard.

In the Peninsula at Silicon Valley, asking rents continue to rise in the fourth quarter, while vacancy ticked up slightly but remained very low between 7.5% and 8%. We're closely monitoring new supply in sublease space as both put some downward pressure on Q4 absorption levels. That said, we're still seeing very healthy levels of demand.

Along the Peninsula, high-profile, high-quality tenants like McKinsey & Company, Goodwin and Proctor, and the Zuckerberg Chan Foundation are signing deals that are permanently transforming the profile of those marketplaces. On the number of international and non-tech companies like car companies that now need a Silicon Valley outpost is driving a lot of demand further south.

Note that these outposts are typically smaller deals, and you're going to understand why I say that in a moment. But in short, we fully expect that these trends will continue throughout 2017 and will continue to benefit disproportionately given how we're positioned, and I'm going to expand on that comment momentarily. There are three aspects that distinguish our offering to tenants and help guard our portfolio from the threat of rising sublease space and new supply.

First, the preponderance of our availabilities in the Peninsula and the Silicon Valley are smaller sub 10,000 square foot spaces, where typical term is three to five years. For example, the average size of our 2017 expirations is about 6,400 feet. Activity in this segment remains particularly robust.

There were 900 or so deals of 10,000 square feet completed in 2016, relative to just 11 in the 50,000 square foot plus range. Most of the available sublease space is 100,000 plus square foot blocks and many are short terms. The same applies when you're looking at the size of new supply availabilities. Even if developers ultimately decide to carve up their projects, we're looking at 25,000 to 50,000 square foot blocks at a minimum.

Secondly, with the market for sub 10,000 square foot space rapidly growing, we are building upon our success on the vacant suite prep program, or VSP program. We're leveraging forward TI spend to transform outdated space into market-ready plug-and-play suites. As of the end of 2016, we signed over 150,000 square feet of deals in the VSP spaces.

We're currently marketing about 120,000 square feet, and we're in the process of reloading with another 235,000 square feet of spaces. For example, we quickly leased up the majority of the market-ready suites at Gateway. Our more significant repositioning in capital spend at that property also has paid off. We now have several multi-and full-floor tenant prospects who would not have considered Gateway pre-renovation.

In addition, both the size of our space and the forward TI spend has already allowed us to cast a wider net in terms of fast moving tenant demand while flattening out concessions, and even still, we've got nice embedded rent growth in our Peninsula and Silicon Valley portfolio should market conditions shift. 2017 expirations are about 23% below market, and 2018 are 25% below market.

The last point I'll make in this portfolio is that Redwood Shores, Palo Alto, North San Jose and the scale of those markets in concentration within our portfolio, the fact is that we can offer tenants a variety of sizes and price points in specific locations facilitates our ability to attract and retain tenants as they grow. New tenants in North San Jose is a great example, and we'll be announcing other great deals that speak to the strength in the coming quarters.

Turning now to Seattle, the downtown office market is thriving with continued growth of major public companies such as Amazon, Facebook, Google, and Apple driving demand for large and even full building leases. In the fourth quarter alone, Facebook took 150,000 square feet for immediate occupancy and signed another deal for the entirety of a 350,000 square foot, 2019 delivery.

Amazon announced two deals in the quarter. One for 380,000 square feet and another for 320,000 square feet, all on top of the space that they're already building for occupancy in the next 24 to 36 months. Regarding the broader downtown marketplace, there was another 260,000 square feet of absorption in the fourth quarter, while rents held steady at $42 a square foot and vacancy remained just over 8%.

New supply is still in check with delivered projects 100% leased and 2017 deliveries about 50% pre-leased. We're a little less than a year away from completing our 55% pre-leased 450 Alaskan Way project, yet we're working through multiple proposals with high-tech quality tenants and non-tech quality tenants for the balance of the building. We have a similar level of activity on the remaining two floors of Hill7.

And one final thought before I turn it over to Mark. As most of you know, we completed an equity offering in early January, after which Blackstone and Farallon no longer hold any ownership interest in our Company. The two existing Blackstone Board members have tendered their resignations, which we have yet to accept, as we're looking to have at least one of them stay on board.

And now with that, I'm going to turn the call over to Mark for details on our fourth-quarter financial performance.

Thanks, Victor. Funds from Operations, or FFO, excluding specified items for the three months ended December 31, 2016, totaled $68 million or $0.46 per diluted share compared to $64.8 million or $0.44 per share a year ago. There were no specified items for the fourth quarter of 2016.

Specified items for the fourth quarter of 2015 consisted of acquisition-related expense reimbursement of $100,000 or $0 per diluted share. FFO including specified items for the three months ended December 31, 2016, totaled $68 million or $0.46 per diluted share compared to $64.9 million or $0.44 per diluted share a year ago.

Despite nearly 1.5 million square feet of roll throughout our in-service portfolio in 2016, we increased the leased percentage at both our stabilized and lease-up assets year over year. As of December 31, 2016, our stabilized and in-service office portfolio was 96.4% and 91.2% leased, respectively, compared to 96.5% and 90.7% at the end of the third quarter, and 95.3% and 90.1% a year ago.

As Victor mentioned, I want to take a minute on this call to dig into the drivers of our GAAP and cash rent growth for new and renewal leases signed in the fourth quarter, in case anyone harbors a concern over whether the decline in these metrics quarter over quarter is an indicator of deteriorating market fundamentals. First, to be clear, GAAP and cash rent spreads of 15.5% and 9.5%, respectively, are strong regardless of prior-period comparisons.

That being said, the new and renewal GAAP and cash rent spreads are associated with approximately 317,000 of the 560,000 square feet of total fourth-quarter activity. Over half of that 317,000 square feet was itself comprised of 168,000 square foot early renewal with NFL Enterprises at 10900 and 10950 Washington Boulevard in Culver City. That deal was signed at in-place rents.

If one disregards this early renewal with NFL, GAAP and cash rent growth would have been 32% and 21.1%, respectively, actually higher than last quarter's numbers. 80% of the remaining new and renewal square footage contributing to the GAAP and cash rent spreads was executed in our Northern California portfolio at 32.2% and 24.1%, respectively.

Some of you may have also noted that we added commentary in our press release regarding the fourth-quarter net operating income increase at our 33 same-store office properties, which was 10.7% on a GAAP basis and 4.1% on a cash basis. To reiterate, the cash basis net operating income was muted by September -- by the September 2016 commencement of a lease amendment with Weil Gotshal at Towers at Shore Center that contained both rent and square footage reductions.

The amendment itself was signed in December 2014, several months before we acquired the property from Blackstone. To illustrate the impact of this amendment, it's worth mentioning that we estimate that our same-store office property net operating income would have increased approximately 14.4% on a cash basis in the fourth quarter under Weil Gotshal's prior lease terms. Since the Weil Gotshal lease amendment only became effective toward the end of last year, it can be expected to weigh on same-store cash basis net operating income until later this year.

Victor touched on the growth in office leasing demand that's being driven by streaming content creators and other media and entertainment-related businesses in Los Angeles. Quarter after quarter, we're seeing the increase in companies producing original content and the amount of content they're creating positively impact our media and entertainment operating results.

As of Decembers 31, 2016, the trailing 12 month occupancy at our media and entertainment properties increased to 89.1% from 78.5% the trailing 12 month period ended December 31, 2015. Media and entertainment net operating income in the fourth quarter increased by 29.7% on a GAAP basis and by 36.9% on a cash basis. Year over year, net operating income increased by 33.7% on a GAAP basis and 44.5% on a cash basis.

In light of recent moves in interest rate expectations, I'd like to provide a brief summary of financing activity over the last year, including our success in reducing floating rate indebtedness. During 2016, we closed a total of $500 million of 5-, 7- and 10-year unsecured fixed-rate indebtedness, all proceeds of which were applied towards the repayment of floating rate indebtedness.

This was either through the repayment of floating rate asset level or unsecured term loan indebtedness or by reducing or eliminating amounts under our revolving credit facility. We further reduced our floating rate indebtedness through the use of more than $200 million of proceeds generated by asset sales.

As a result of these concerted efforts, aside from the natural ebb and flow of amounts under our revolving credit facility, we currently have a total of $330 million of unhedged floating rate debt. This represents less than 14% of our total asset level and term indebtedness and merely 4% of our total capitalization adjusted for our revolving credit facility. Moving forward, we will continue to look for opportunities to reduce our floating rate exposure, including through the repayment of amounts under our revolving credit facility with proceeds from our recently completed sale of 222 Kearny and pending sale of 3402 Pico.

Before turning to guidance, as Victor commented on a moment ago, Blackstone and Farallon completed a final clean-up sale of stock and units early this January, marking the culmination of a very successful partnership between Hudson and each of these companies. Among the many benefits of these relationships have been the improvement -- has been the improvement in our trading performance throughout the skillful series of secondary offerings by Blackstone and Farallon dating back to May 2016.

Since that time, HPP stock has outperformed its office peers by more than 1,000 basis points and the RMS by almost 2,100 basis points in terms of total return. Trading volume has also dramatically improved, moving from a 20 trading day dollar volume average of $18 million as of the first secondary Blackstone offering in May 2016, to more than double that level of $42 million following the final secondary in January.

In short, in less than a year's time, these secondary offerings have helped to provide a valuable lift to our stock's total return and trading performance.

Turning to guidance, we are providing full-year 2017 FFO guidance in the range of $1.93 to $2.03 per diluted share excluding specified items. This guidance assumes the use of $45 million of proceeds from the completed sale of 222 Kearny and the use of $35 million of proceeds from the anticipated sale of 3402 Pico in late March, both to repay amounts outstanding under our revolving credit facility. This guidance also assumes full-year 2017 weighted average fully diluted common stock and units of 147,357, which includes 1 million shares of unvested restricted stock.

As is always the case, the full-year 2017 FFO estimate reflects management's view of current and future market conditions including assumptions with respect to rental rates, occupancy levels, and the earnings impact of events referenced in our press release and on this call, but otherwise excludes any impact from future unannounced or speculative acquisitions, dispositions, debt financings or repayments, recapitalizations, capital market activity, or similar matters. Now I'll turn it back to Victor.

As I said at the beginning of our call, the fourth quarter wrapped up a terrific year for Hudson. As we kick off 2017, we're very well positioned. I'd actually say uniquely positioned to capitalize on our market's continued strength and core growth drivers.

As always, we're focused on proactive management across all aspects of our business, whether it be working through our tenant expirations, ensuring that we have excellent capital access and flexible balance sheet, or recycling capital to enhance our portfolio and provide ample opportunities for growth. A big thank you to the entire Hudson team and our terrific senior management.

And to everyone on this call, we appreciate your continued support of HPP and look forward to updating you next quarter. Now, Operator, let's open the call for questions.

Thank you. At this time, we'll be conducting a question-and-answer session.

(Operator Instructions).

Our first question comes from Dave Rodgers from Robert W. Baird. Please go ahead.

Good morning out there, guys. Victor, wanted to start with you, maybe some more questions following up on the Silicon Valley assets. The lease-up over the course of the quarter was fairly flat and just wanted to dive a little bit deeper. It sounds like you're pretty positive on the prebuilt suite program. You talk about kind of more and more activity that you're seeing there and give us some confidence on kind of where that's going throughout the course of 2017?

Yes, absolutely. Thanks for the question. Overall, as I indicated in our prepared remarks earlier, we're seeing a consistent flow of activity in Silicon Valley on our assets. The differentiator is two things, as I mentioned, our VSP program which has really proven itself to be extremely effective, and the size of our tenant base. And the expiration for the next two years typically is tenants under 10,000 feet. So the demand drivers are such that those tenants are looking at potentially what you would call the low cost provider relative to the higher square footage tenants that are looking for the newer, big floor plays. We have a variety of locations for them on our existing portfolio to renew and other locations that we seem to have a fairly good static program there.

I do think that, that doesn't underestimate the fact that some of the big guys are still growing in those markets; and, yes, there seems to be a demand -- conversation and demand around the future development and the projects that are in the mix right now. I'm cautiously optimistic that you're going to see the continued absorption, the continued upswing in rent movement in the Valley overall, and more importantly, the discipline around the development projects that if there isn't demand, they're not going to turn around and build. There is also just a small little adjunct there because we just saw this that Jones Lang Lasalle just came out with a study that Silicon Valley had the strongest momentum of any metro city in the United States last month. They did a report, and it looked at both the economy and the real estate there was more aggressive and more productive than anywhere else in the US. This is the third year in a row they've done that. It's not just around jobs and real estate, but it's about the metro of the Valley. So that's another positive indicator that we're happy with our position there and the prospects.

Would your characterize your level of demand for your portfolio as stronger, equal to, or lesser than maybe 6 or 12 months ago.

I would say it's probably stronger than it was six months ago and for two reasons. As I said, one the VSP plan, which I won't reiterate again. But I think more importantly, I think I think it's the fact that we have established ourselves as the leader in that marketplace and the largest landlord of that marketplace and the ability to transact.

We've proven ourselves out with the transition of the Blackstone portfolio and how we sort of adjusted that portfolio. I think we've got more of a presence there than anybody else in terms of the execution and deals that we've done, and I think that's sort of going to flow through 2017 and 2018 on that basis. We've got an exceptional team there. I know everybody would say that about their team, but we've got an exceptional leasing team. We've done some things in that marketplace that have really paid off. We have a consistent marketing plan and our 100,000 dinner and the likes of that have really taken off in that market, and we've got a lot of legs out of it.

Great. Maybe just a second question from me. You've got about four leases, I guess, by my count, over 50,000 square feet that come up this year, BofA, AIG, Bausch, and then you've got the Cisco early termination option right at the end of the year. Any updates from the last quarter on those four leases? Thanks.

Yes, sure. I'll give you just a snapshot. I touched upon it also on prepared remarks on San Francisco. So that's both the AIG and the BofA leases. On AIG, we've got two tenants negotiating for the entire space at numbers that are pretty spectacular in terms of the mark-to-market, and we're achieving that. It's well beyond our expectations of what we budgeted for. We touched on that before. We are negotiating with both tenants right now trading paper on both, and they're both Fortune 100 companies. So I think we're pretty pleased about that space. In terms of the BofA space, I think you guys have seen Mark produce the numbers, and he's commented on it and Art has mentioned it as well. That space is, I think, on average across the board almost 90 plus percent below market, 80%, 90% or more.

Maybe a fourth of market.

So I just think you're looking at -- and the activity we have at that space -- Art, do you want to comment on it, that space has been pretty hotly sought after, correct?

Yes. So there's optionality there. There's tower space, there's podium space, and lower level space, all of it really has activity in the (inaudible) [stations] (inaudible) [little bit inside] of the year. And we're trading paper with several prospects.

And then the other two you mentioned were Bosch and Cisco. Cisco, we are uniquely positioned on Cisco right now to take over that space if they notify us at all. And as a result, I think their termination notice is March 31. We've not had a formal termination from them; but if we do get it, we have about a year -- we'll have nine months advance notice plus a year's worth of rent plus additional capital on that space. Art's team is fully in place right now getting prepared to market that. I think it's early to tell if we have any activity on that space, but I think we're very well positioned where we're going to get it back and where it is on market.

And lastly on the Bosch space, we're in negotiations right now for the entire 70,000 feet. Remember, that's in Palo Alto, so the market there is extremely strong, and the demand is very high.

Great. Thank you, Victor. Thanks, guys.

Our next question is from Jamie Feldman from Bank of America.

Great, thank you. Mark, I was hoping you could provide some of the assumptions around guidance in terms of maybe same-store NOI, acquisition activity, leasing spreads, year-end occupancy; just help us frame some of the big pieces.

Well, I gave you some of the transactional matters. There's no assumptions built into guidance that's transactional in nature that's not laid out. As you know, we don't attempt to try to forecast for acquisition activity or capital market activity that's not already reported on. So there's nothing to talk about on that front. On same-store NOI, we know that our peers at times will provide some benchmarks on that. I think maybe the closest and obvious one is Douglas Emmett, as you know, provides a range on same-store cash NOI growth. We haven't historically done that, Jamie, if only because historically our same store has been -- hasn't been nearly as meaningful of a benchmark in terms of where we foresee our projections heading.

In all candor, just to give you a little bit of behind the scenes, Victor and I and others sort of debated whether or not there might be enough interest in hearing that, that we could present a number on that; and I guess for the time being, we chose not to revise our guidance methodology for that, although I do think there will come a time when it will be meaningful enough as a benchmark that we'll probably provide that.

So I think it would be a little unfair to try to provide that on this call, although maybe we'll revisit that after this call and maybe on the next call we could provide that benchmark. I can tell you, having run the number, I think we are confident it will be -- this is not a reflection on Emmett, but I do think it will be better than Emmett's same-store expectations. I'm not remembering all the other things you rattled off, Jamie. Anything else you want me to try to touch on, on the guidance?

On the (inaudible)?

If you look at last year or Q4, yes, if you look at 2015, it's modestly higher but it really is more or less in line. I want to say -- (inaudible) is going to quickly pull it up. I want to say it's maybe 2% or 3% higher for 2017, both cash and non-cash over 2016, something like that. Anything else? He'll firm that up. Jamie, anything else?

You mentioned higher than Emmett. I think Emmett is saying 5.5% to 6%.

They're saying 5% to 6% same-store cash NOI, if I'm not mistaken. Like I said, maybe we could give more specifics on this on the next call after revisiting it with Victor. I could just tell you, I think we are confident we'll see better than that on a same-store basis cash NOI growth in 2017 for the full year. We'll see better than that percentage.

Okay. And then maybe as we think about the different regions, can you talk about your year-end occupancy assumption, like where you think you'll be year-end 2017 versus year-end 2016?

Maybe not on this call, Jamie. I mean, I'm prepared to answer 1,000 questions, but I didn't break down by region where our ending lease percentage is by region. I'm happy to put that on the list and try to provide that to you in a follow-up call.

Maybe just year-end occupancy, if you have that?

Well, I'd want to do that in a smart way, right. I mean, as you know, we break down our portfolio between stabilized in-service lease-up. We'll also be -- inventory will be coming into those portfolios throughout the year. So I don't want to just throw out a number without being able to give everyone a clear understanding of what exactly that number includes. Right? We also have asset potential -- we have one announced asset sale. I'd rather do that in a more methodical way.

I guess just switching gears, one more question. The Silicon Valley Peninsula supply, can you just maybe talk us through the projects that -- I know you said because of your tenant size and your prebuilt program you're not really doing it as competitive. But maybe talk us through some of the projects that are out there that you would consider possibly competitive or maybe people think they might be competitive?

Currently right now, Jamie, the projects that are out there that are deliverable for 2017 are all -- 50% or greater preleased, and for the ones that are talking 2018 and beyond, it's a little early to sort of determine that. As I said, we don't have any substantial large blocks of space that we're going to be competing with any of the new product out there, and the preponderance of the new stuff that's out there is going to be tenant built and user-oriented. There's very little spec stuff that's coming out.

The numbers are substantial in the marketplace across the whole Valley, but the stuff that we're looking at other than Cisco, if we get that back, which we're anticipating. So at the end of 2017, that will be probably from our standpoint. Either way we'll walk it through with the guys but my guess is that's a year lease-up process. We're probably not looking to stabilize that until early 2019 is probably what I'm assuming that Mark has in his numbers and then staggers throughout because it's multiple assets in a business market. Whether it's single tenant or multiple tenants, that's yet to be determined.

If you're looking at Palo Alto which is where our largest concentration is, we have zero supply coming in that marketplace, and everything we're rolling is rolling up into mark-to-market. The biggest exposure we have, we've talked about it before, is our Pacific office portfolio, and we're about to announce another lease in that marketplace to take it to high 80%. I think Mark, isn't it like 87%, 88% occupancy?

Yes.

We were in the low 70s. We've done a tremendous job there achieving our expectations. And the last piece would be down in North San Jose. I mentioned that in our prepared remarks a little about what we've done in gateway and with the VSP program there and then the renovation there. We're about to launch another 230,000 feet on that VSP, specifically around that project and the demand and the average size tenant's between 5,000 and 10,000 feet. So we're not going to be competitive on that. I'm super comfortable. We're not looking at disposing of many assets in that marketplace on a recycling basis. Alex's team has come up with a game plan, and we'll visit it based upon demand and our ability to execute on the assets that we can recycle for higher and better use of capital.

That's helpful. Thanks, guys.

Thanks, Jamie.

Our next question comes from Blaine Heck from Wells Fargo. Please go ahead.

Thanks. Good morning. Victor, just a follow-up on Cisco. Obviously, they need to tell you whether they're planning on moving out at the end of the year by late next month. So I guess, I would guess you guys have been in discussions. Can you just maybe handicap their likelihood of moving out at this point?

Listen, the answer is, Blaine, that as I said, we've not received formal notice from them, but we're fully ready in the event that they do intend to terminate. We have gone, toured the space. We have gone and engaged architects and internal construction team around Chris to go out and re-evaluate the existing space as well as the additional space that we can build there and reposition the campus from a single asset, single building complex to a campus facility. We spent, I think, enough time understanding what it would take capital wise and what it would take positioning wise for us to turn around and get that space back.

It's a much lower price point than any new development; and I think as a result, we will have an advantage there. It's also we have the ability because of its size that we can offer a pretty aggressive TI package and capital spend throughout and then materially move tenants in existing space and then build space around them that will be higher and better use, so we can accommodate short, mid and long-term growth there. I'm not -- going back to your initial sort of question on our comfort level or understanding if they're going to move out, if you were to ask me on one to 100, 100 being they're moving out for sure, I think that we're almost triple digits that they are going to move out and they're going to give us notice. You never know. They may miss their notification period, and we have a leverage on that as well. Lastly, this is a -- in the Milpitas marketplace, which is a low cost provider marketplace and where the growth is in some of the other companies in the market. We're going to be competitive. I think it's by far the best product in that market, and we've got a lot of ability to write some pretty aggressive lease terms and make a lot of capital on this deal. And we basically have a two-year window to get it done.

Okay. Helpful. So I guess the follow-up on that, how long a down time do you think you might have for renovation and leasing that back up? I guess, it sounds like it will be a multi-tenant building versus trying to find larger tenants. Is that fair to say?

Yes. I'll just jump in here. One thing, maybe just to let you know, when the asset was underwritten back in late 2014, Alex and his team, as we've often do, took the most -- made the most conservative assumption on that asset, namely without knowing one way or the other what the future plans for Cisco was. It was underwritten as a known vacate. That's to say they assumed no renewal on it. So our own valuation on it started from the premise that they were going to vacate -- early vacate, better to say at the end of 2017; and our valuation reflects that assumption.

In terms of what we're now assuming, we would -- of course, we wouldn't get the space back officially until 2017 but the team is -- if they did exercise early termination. But we're already -- we've already done programming. Chris and his team have done full programming with respect to repositioning the existing three assets. And also if you recall, there's added density that would allow us to expand the campus to a million -- over a million square feet if there was a big enough user out there, and they've done a full master plan for an expanded campus there as well.

With respect to the assumption on the backfill of the three buildings that comprise the 470,000 feet, we've programmed in a staggered absorption more or less in three tranches that correspond to the 170 or so thousand foot building sizes, give or take, and the first one I believe that we assumed stabilizing was 12 months after the end of the lease term. That is to say not until the beginning of 2018. And then we stagger into the next tranche, I believe 15, 18 months, and then the last one we assume is like 24 months.

So we've given ourselves quite a bit of latitude for the full stabilization of the 470,000 feet following us officially getting back the space at the end of 2017. Having said that, if we get early enough notice, we're going to do what we can to obviously, shorten that absorption time frame by jumping on whatever we can do on repositioning as early as possible. And as Victor already mentioned, we already have a team on the ground already geared up for the marketing efforts. So we're going to do everything we can to compress that absorption timeframe.

Okay. That's all very helpful color. Victor, you talked a little bit about the lease-up properties, and then you gave us the 1.5 million square feet of deals in the pipeline throughout the portfolio. Do you guys know how much of that 1.5 million square feet in the leasing pipeline is related directly to that lease-up portfolio and maybe whether that's up or down from previous quarters?

It's an interesting question. The answer -- let me answer the second part of your question first. The flow of the 1.5 million square feet has been consistent for, I think, at least seven or eight quarters between 1.2 and 1.7 million square feet of that activity. Now that we've leased up all of Hollywood, both CUE and ICON, we've taken out the interest level on that, and it's pretty well spread. I do think that you're going to see a preponderance of that activity is in Northern California, and we have a substantial amount of activity in Seattle of that million and-a-half square feet. I think less of it is here in LA only because of the availability that we currently have in place right now.

So we're probably more weighted to the Peninsula first, Seattle second, San Francisco third, and Los Angeles fourth. And my guess is the weighting's probably 50% in the Peninsula right now is what we're seeing and then spread between the remaining 50%, more weighted heavily to Seattle and then equal for San Francisco and Los Angeles.

All right. Great. Thanks.

Our next question comes from Tom Catherwood from BTIG. Please go ahead.

Thank you very much. Good morning out there. I know you guys don't bake in any acquisition to your guidance, but how would you classify the acquisition market now versus, say, the last few quarters? And how do you weigh acquisitions versus development starts at this stage of the cycle?

So, Tom, we look at it a little bit more organically. We don't weigh it out quarter to quarter or for the annual process of the year. If you look at last year, I think we transacted approximately a little over $1 billion in transactions, $350 million, roughly was dispositioned from $650 million was in external growth on an acquisition basis. But as you saw, it was heavily weighted to two large deals in the fourth quarter, only because of the accessibility of those deals. We are a -- I would classify us as being a net buyer on the opportunities that we're seeing and the opportunities that -- the preponderance of the opportunities are consistent with how we've done deals which are off-market transactions.

I think that the second part of your question on the development side from the our standpoint, we've announced our current development projects. We have obviously, our CUE project is being completed. We're got our 450 Alaskan Way project that we are going to be done at the end of 2017, ready for occupancy. And then we've got our two renovation projects in the arts district, which one is ready to go in the next 60 days, and then one we're just starting the construction and we won't be ready to go for a little over a year from now.

Then we have planned out our EPIC project, which is 300 plus thousand square feet where we're fully entitled, and we're going to look at some form of preleasing before we break ground there. The demand has been exceptionally high, and the level of product that is competitive in the marketplace is rather de-minimis here in Los Angeles.

That being said, the remainder of our development opportunities are all assets that we have land plays, and we are positioning it for the demand in the marketplace. And we're not speculative developers and we never have been. It's a smaller part of our external growth process, but it is going to be extremely important part of our external growth process as the markets that we're in continue to have need for the type of product that I think we've designed in the past which is much more indicative to the media, tech, and social media markets and tenants of the likes of that.

So there's not a specific example that says, hey, we're going to do external growth this year of $1 billion and 20% of it's going to be development and 80%'s going to be asset level. It's going to be a case by case, and I think we've consistently performed to the levels of accretively buying assets that match our portfolio. And I still see value add assets out there that our team is bringing to us that we're excited about buying or at least evaluating and trying to buy; and I don't see that waning at all for 2017.

Got it. Makes sense. Sticking with development for a second, do you guys see any potential impact to your -- either your portfolio or your development plans in LA, if the neighborhood integrity initiative happens to pass there.

That's a great question. Listen, I think a lot of people aren't very educated on Measure S. I think a lot of people have basically put it in the back burner. I know our team is very engaged in that process. On a political standpoint, there's no hidden secret that we are against Measure S. I think it is a bad form and function by which a proposition is being proposed in the city of Los Angeles. I think as a Company, it does not bode well if it comes through.

That being said, two things I think are readily apparent around Measure S. I think the first is if it passes, the value of the real estate that we and everybody else has in Los Angeles is going to be worth a lot more. Secondarily, if it passes, the value of your entitled real estate is going to be worth exceptionally a lot more. So when you hypothetically said, hey, I own land that's entitled and it's worth $100 in FAR, there is no limit as to what that's worth because you have a two-year moratorium and there's going to be very little development on that. It is -- from a standpoint of where we sit in the marketplace today, I look at it as -- after my comments on the financial aspects and the fundamentals around it, I look at is as an irrelevant process. Because no matter what happens, if it doesn't pass, the regulations and process to get land entitled going forward is going to be -- is challenging as it has been or even more so because the scrutiny around whatever you want to call, pay to play with the politicians and the city of LA and the likes of that is going to be very challenging. So any project you want to entitle is going to be challenging no matter what. So either it's a two-year moratorium or it's going to be challenging. I think it's a win-win for values. I think it's a win-win for entitled land, and it's a bad precedent for the city of Los Angeles to have this proposition being on the forefront.

Got it. Appreciate the color on that. Your kind of developments in LA over the next year or two, especially EPIC, that's all fully entitled and would have no impact kind of starting getting off the ground if this were to pass, correct?

Exactly. We're fully entitled there, and everything else that we have is by rights in Los Angeles. So we will not be affected by it.

Got it. That's it from me. Thanks, guys.

Thank you.

Our next question is from Craig Mailman from KeyBanc Capital Markets. Please go ahead.

Victor, just curious, on the prebuild program, kind of what's been the history in terms of you -- the whole cycle time between getting it built out, leased up, just trying to get a sense of when we could expect that 120 to be leased and how much the 235 or so could be done and ready to lease in 2017, versus shifting into 2018.

So we've been very aggression in terms of our bid process. I think we've been very aggressive in the team that's there. We have a team in place that, the design is done, and we're banging the work out, Craig. As a result, I don't -- I think it took us -- I would classify it this way, the major lifting is already behind us, in that we put the plans in place, and we now have to execute.

The 130 was exactly on our timeframe. I think the remainder 230 probably we're looking at finishing the construction across the board by -- thematically by the -- staggered over the three quarters, is that what we're looking at, over the next three quarters. And then as a result, we'll start seeing leasing near the end of that process which should be end of third quarter, beginning of fourth-quarter this year, much more apparent because it's ready to go plug and play. That's not to say, Craig, that we're not getting leasing done on this space. I mean, even though we're starting the capital work and building it out, Art's team has seen a lot of transactional velocity around that space, and we can stop or start at any time if it needs to be modified.

How much of the space in the lease-up portfolio do you think is kind of candidate for this type of prebuilt versus just traditional where tenants actually have architects and want to build out their own.

So, I mean, the number we've thrown out -- sort of thrown out there is half a million feet between what we've done and what we're going to do. It's initially -- I think the program's roughly half a million feet. I think after that, the team's going to go out and evaluate the next phase, but that seems to be the 400,000 to 500,000 feet, Josh? It's sort of capped out around half a million feet.

That's helpful. Then just moving to EPIC. You had mentioned earlier that preleasing is sort of the exception not the norm in LA. Just given the -- kind of the track record you guys have with ICON and CUE, why not start that speculatively?

Well, I'm looking at Chris Barton across from me right now. He's just so happy you said that. You make all the guys happy when you call in, Craig. The answer is we will be prepared to start. My guess is, I think we could probably break ground as early as this spring, April or May, if we really wanted to, we could start going in April or May. I think there's is a little bit of magic around our marketing. We have not got our marketing suite to a point that we think it should be ready to launch. It's in the marketplace. People are aware of it.

But we've not really shown what this asset's going to look like publicly. It's a pretty spectacular development, and I think in itself it will market itself very well. I'm confident that we're going to get a lot of comfort level, and I do think that even whenever we start, we're looking at 18 months max to be completed on that sort of thing after we start. So we could get this thing preleased. And when I refer to preleased, I'm not looking at it from 100%. I think we've always talked about as a Company, if we get 25% to 40% of the asset preleased, it's a green light no matter what; and if the activity seems to be strong, we'll consider breaking ground and going more on a spec process. The beauty is, as I said, a lot's going to change in two weeks with Measure S behind us, and a lot's going to change in terms of who the competition is. Right now, we don't have any competition. There's nobody breaking ground on new commercial office buildings anywhere of this magnitude in the near future.

I know it's early to give yield estimates, but just relative to what you guys were able to get on ICON, where do you think it kind of shakes out with where asking rents will probably come in at?

I don't know what the final numbers on ICON are going to be, but I think they're greater than --

Nine.

We're not going to get that. Don't expect us to get that, but I think we're probably talking about a seven. I think that's a pretty fair estimate as to what we're looking at, and that's -- underwriting and based on the current deals that we did at CUE and ICON in terms of the rental rate, I think we're right there at the same numbers. We could be a little conservative on that maybe if rental rates continue to push up the way we expect, but I think Mark sort of has it bench marked at a seven.

Just lastly, Mark, what are you guys expecting for interest expense in guidance?

I'm looking over at -- Craig, I'm looking at Harood. He's got the model.

We see an increase in interest expense of around $20 million year-over-year, and that's primarily related to capitalized interest dramatically slowing down as a result of the icon development coming online and various debt transactions we did in 2016 having a full year effect, the prior placements, the Health 7 acquisition, and debt related to the Page Mill Hill acquisition. So a combination of all that and assumed a little higher interest rates based on the LIBOR curve has increased our assumption to about a $20 million increase year over year.

Great. Thanks, guys.

Our next question comes from Alexander Goldfarb from Sandler O'Neill. Please go ahead.

Hey. Still -- I guess it's still good morning out there. Two questions. First, on the studio side, can you just walk us through how you guys see the economics, if you have a dollar to put to work, how you see it in studio versus office?

As far as new investment?

Yes, as far as new investment. I think we're familiar with office returns, but studios seem to be more of an operations business for efficiency, so just wondering when you think about putting new investment, obviously there was a news article a bit ago. But as you guys think about your opportunity set to acquire new assets, how you view the tradeoff between office, where you can see sort of a mark-to-market in what's going on in that submarket for the demand for office space, versus studios where it sounds to be more like an operational business?

Yes. So Alex, it's Alex. As you know, we obviously like the business. We've always said that if we saw an opportunity to expand that area of the Company we certainly would. But as you also are aware, there's a finite number of those opportunities that exist in LA. We're not going to look in tertiary markets. If we were to expand the business, it'd be here. So there's just limited opportunities to begin with. Each one really is a case by case basis based on previous ownership, what we think the kind of business strategy would be, both from an operational perspective as well as a potential development opportunity. I would say that if stabilized office in LA is trading somewhere between 4 and 5 caps, we would expect a higher return on studios. But each one, like I said, would be a case by case basis of what the going cap rate. It would be more what we think the stabilized cost should be once we've implemented our business plan, and we would expect a premium. That being said, I think it came up on one of the calls that if this trend continues like we're seeing at Bronson with long-term leases getting done with the likes of Netflix and companies of that credit, I think the expectation, how people look and value studio assets, should start to fall more in line with office as you start to see longer-term credit tenancy.

Alex, can you give us a sense of what the spread has been historically or where it is now?

Back in the day as a rule of thumb, we used to say it would probably be somewhere between 100 and 150 basis points from stabilized office, but there weren't a whole lot of comps that we could point to. Some of that was just our own internal view of what we thought the appropriate spreads should be relative to the short-term nature of the leases, even though, as you know, those leases tend to be sticky historically. But that's what we typically would say back in the day.

Okay. And then the second question is, Mark, I know you don't have any additional transaction activity in the guidance, but you guys seem to be stepping up your recycling. But also it seems like you guys are focused on growing the Company, not sort of flat lining it through a lot of sales. So as you guys think about it, is there some sort of earnings growth that you want to hit, and then you'll do recycling around that; or how do you gauge how much to sell relative to being able to reinvest and grow earnings?

We really don't look to drive earnings through some acquisition target. Our goal both on the acquisition side and on the recycling side has been a case-by-case analysis over where we either see an attractive acquisition opportunity, well priced, complementary to our existing holdings and where there's some value proposition by putting our expertise to work.

And likewise on the disposition front, all assets are looked at in terms of where we feel like we've optimized or maximized value, whether or not we see an opportunity to kind of capture profits for the shareholders and so forth. And so, while it has been true that dispositions have been complimentary in terms of capital raising and recycling and redeployed in acquisitions, there's not -- we don't sit and do some kind of acquisition disposition ledger and try to balance out dollars on either side. We really are looking at each of them in terms of what's the best proposition for the shareholders on both sides of the equation. And so really, no rule of thumb to provide for you as it relates to how that translates to guidance.

Okay. But as we think about potential for like Cisco coming out of numbers next year, it's not like that means that you would sell less. You'd look at each thing individually. It's not like you're trying to look for an overall earnings growth and drive your decisions based on that.

That's precisely right. Look, as you know, earnings is a -- it's a short-term benchmark, and fundamentally we're in the business of making the smartest decisions, both acquisition and disposition, for the long term benefit of our shareholders. And we're not going to stray away from that just to try to drive a short-term earnings goal.

Okay. Thank you, Mark.

Our next question comes from Vikram Malhotra from Morgan Stanley. Please go ahead.

Thank you. Just a clarification on the lease-up properties, particularly in the Bay area. I know you don't have a specific leased occupancy sort of number that you can provide in terms of what's baked in for guidance. But if we just look out past 2017, if I just sort of take a two or three year view, can you sort of give us a range, sort of what are you expecting specifically in the Bay area for the lease-up properties to do in terms of occupancy?

Well, we sort of -- Vikram, thanks for the question. Jamie sort of touched on that too. I would say obviously if we take our model and isolate those assets, there is a number that spits out. I would prefer, though -- and maybe we do this next call because I want to make sure that the full group has seen it, and they're aware of what that number is. I'd prefer maybe to table that to the next phone call. And we can --

That's fair.

If people want to see a group of stabilized in-service lease-up, however they want to see it, we can do a grouping on that. The other danger there too, Vikram, is even over the last quarter, the population of what constitutes the lease-up assets has changed. I wouldn't want to mislead anyone. At times, there's been a focus around the nine lease-up assets. That, itself, has changed. We now have 11 lease-up assets. I would want to be clear with everyone exactly what the composition is of that portfolio and where things are heading directionally and be able to talk with everyone about what even the subcomponents are of the lease-up. What's in the Bay area, what's outside the Bay area, so forth, like Seattle, 11601, they're both running through that population right now.

I guess it could definitely be a meaningful part of the growth. I'm just trying to understand sort of what the trajectory could look like even if we sort of forget 2017's number, if you could give us some sense of how it could be, but that's fair. Whenever you have the numbers ready you --

Vikram, it's a perfectly reasonable question. I agree with your overall view and Jamie's as well. Now that it's been asked twice, I think we'll be responsive to it and we'll provide it. I just don't think it's wise to get -- or helpful to do it sort of on one foot. We want to make sure we give you -- .

That's fair. Just on the expirations, you made some comments related to the fact that rent spreads are still pretty strong. Obviously, this quarter there was some variation. I'm just wondering relative to last year when you sort of looked out and said how would spreads trend over the next two years; are you seeing some moderation or your own expectations are lower versus for 2017 particularly versus where you were last year?

Actually, the rent spreads, Vikram, are actually for 2017 and 2018 are higher than they were last year. So we're not seeing any falloff at all. I think we're looking at numbers that are substantially higher than last year and fortunately, the mark-to-market on what we have in the Bay area still is just outweighing everything in terms of the numbers. But across the board, yes, the percentages are higher.

Just to give you one point of reference on that, our two largest expirations in 2017, although one of them doesn't happen until the bitter end, are in the San Francisco CBD and are marked. Our current mark-to-market on the 2017 expirations in the San Francisco CBD is just a bit north of 50%. It's like 51%.

And that's fine. What I was trying to clarify is that your assessment of 2017 has not changed as you've moved throughout the last 12 months.

No, not at all. Actually, as Mark indicated, it is actually -- it's higher than it was. And we anticipate and as I said in my prepared remarks, we've got enough head room there for the spreads that are rolling right now, that even if we saw a slowdown in the marketplace on any material basis it would still be crazy good spreads.

Vikram, I slightly misspoke. I want to make sure it's absolutely clear. Our current mark-to-market on San Francisco CBD is slightly north of 50%, like 50.6%. On 2017 expirations in the San Francisco CBD, it's chose to 100% mark-to-market. It's like 96% mark-to-market. That's not going to be the only mark-to-market that runs through our new and renewal numbers over 2017, but it's going to be a larger contributor in 2017 than it was, say, for example in 2016, given a couple of sizable expirations that will occur this year.

Just a last one, going back to the article that was referenced around, I think it was, Hollywood Center Studios. I'm just curious whether you are or not looking at it, what type of investors would you run into? Who else would be bidding on these type of assets?

Vikram, we're not going to comment on articles that we've not substantiated ourselves in terms of future acquisitions or potential acquisitions. I could say that if there was an asset out there that we're competing on, we would love to say that everybody else is going to look at that -- anybody else is going to look at the same assets are going to be guys that are smarter than we are.

Okay. Thanks, guys.

Thank you. This does conclude the question-and-answer session. I'd like to turn the floor back over to management for any closing comments.

Thank you so much for participating in our fourth-quarter call. We look to reaching out either before or at the end of this first quarter. Thanks again.

This concludes today's teleconference. Thank you for your participation. You may disconnect your lines at this time.