Hudson Pacific Properties Inc (HPP) 2017 Q1 法說會逐字稿

Greetings, and welcome to the Hudson Pacific Properties First Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Kay Tidwell, Executive Vice President and General Counsel. Thank you. Ms. Tidwell, you may begin.

Good morning, everyone, and welcome to Hudson Pacific Properties First Quarter 2017 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 assumption.

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, May 4, 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 in 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 reconciliations to the appropriate GAAP measure and an explanation of why the company believes such non-GAAP financial measures are useful to investors.

And 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, and welcome to our first quarter call. We've wrapped up another very productive quarter marked by strong leasing activity, the successful disposition of 222 Kearny Street and 3402 Pico Boulevard properties, the announced acquisition of our Sunset Las Palmas studio in Hollywood and a well-received public offering that raised nearly $340 million in proceeds.

Starting with leasing. We executed over 525,000 square feet of new and renewal deals this quarter at 63% GAAP and 42% cash rent spreads. Among the leases executed in the first quarter was a 10-year lease with Google for nearly 170,000 square feet at our Rincon Center property in San Francisco. This lease is anticipated to commence in March of '18 and will backfill 2 significant 2017 expirations: a 133,000 square foot lease with AIG and a 22,000 square foot lease with global law firm, Dentons. The blended cash rent spread for this backfill is nearly 70%.

Another important lease executed in San Francisco at our 875 Howard property was Kiva Microfunds to renew approximately 17,000 square feet for 3 years and close to 100% cash rent spreads, further underscores the tremendous embedded value throughout our San Francisco portfolio.

Apart from these noteworthy rent spreads, we also continue to see excellent leasing momentum throughout our Bay Area portfolio. While 73% of our total in-service portfolio square footage is located in the San Francisco Bay Area, over 92% of all new and renewal lease deals executed in the first quarter occurred in this portfolio.

Resilience best characterizes the San Francisco CBD market. It was the fifth consecutive quarter of stable market conditions with essentially no change in asking rents for Class A space at $76.44 per foot, positive net absorption of 73,400 square feet and only a 10 basis point increase in direct vacancy to 6.4%.

Importantly, sublease space availability appears to have peaked and currently stands at 1.8 million square feet, down from 2.3 million square feet in Q2 of '16. The San Francisco Peninsula experienced another strong quarter, with net absorption for Class A space topping 300,000 square feet; and vacancy falling to 7.7%, down from 9% as of last quarter and 10.2% a year ago. And rents for Class A space remain steady at $76.44 per foot, in line with last quarter's but nearly 3% better year-over-year.

In Silicon Valley, market conditions also remain solid, with positive occupancy gains for the 16th straight quarter of almost 420,000 square feet, a 10 basis point drop in direct vacancy to 7.5% and a 0.6% quarter-over-quarter increase in average asking lease rates to $57.12 per foot.

Staying with Silicon Valley for a moment, as we approach the launch of our repositioning plans for our Campus Center property, we continue to carefully monitor new construction and other availability throughout the Silicon Valley and more specifically around Campus Center. New construction within the 71 million square foot Silicon Valley office market currently stands at 10.9 million square feet approximately, of which nearly 70% of that is pre-leased. However, of the 9.5 million square feet under construction scheduled to be completed this year, nearly 90% of that square footage is spoken for. And moreover, very little of the available supply coming to market is likely to compete with our Campus Center project.

The target asking rents for any new construction will exceed those for Campus Center by 40-plus percent, which gives us a considerable pricing advantage. Of the nearly 11 million feet under construction at Silicon Valley, we estimate that less than 600,000 square feet could reasonably compete with Campus Center. As for the existing products, we estimate that approximately 1.5 million square feet of direct availability makes up the entire competitive set for Campus Center. In short, with little new supply and limited competitive availability, we believe Campus Center is well positioned to take advantage of healthy tenant demand as we gear up for its repositioning.

In terms of the current status of our plans for Campus Center, we have already completed conceptual drawings and cost estimates to reposition the 470,000 square foot campus immediately following Cisco's year-end lease expiration.

Plans include entrance and lobby renovations; over 100,000 square feet of contemporary, market-ready office space; master planned landscaping; and enhanced outdoor recreation areas, including dedicated sporting areas, patios, collaborative seating and direct hiking trails. Current cost estimates for the full repositioning total approximately $11.5 million or $24 a square foot. We've also completed a full conceptual plan and rendering to expand the campus by an additional 950,000 square feet of office, R&D and/or industrial space, which together with the existing 470,000 square feet could accommodate tenant requirements of up to 1.4 million feet.

In terms of marketing, we've retained the brokerage firm of Cushman & Wakefield to lead the leasing effort. And while we intend to engage potential tenants well before Cisco's expiration, our current absorption projections allow for the completion of the repositioning strategy through the better part of '18, with the first 1/3 of the campus projected to be leased as of January 1, '19, and the remaining square footage is anticipated to be leased in equal amounts by the 18th and 24th month anniversary of Cisco's year-end expiration.

As for projected rents, those will depend on a number of factors and not the least of which will be the term and the concessions associated with any new lease. Tenant demand in this market ranges from cost-sensitive R&D-type users to more traditional office tenants, including large public and private technology companies. Although rents and concessions will naturally be adjusted to optimize our best opportunities, our current projected asking rents for traditional office users are modestly lower than Cisco's expiring rents.

Obviously, we're in the very early stages of marketing this asset, but at least 4 major prospects have shown interest to the campus. These include 2 new requirements for 1 or more of the buildings; another requirement for the entire campus, including the additional development land; and lastly, a group with interest in potentially purchasing the entire campus.

Before I leave the activity in the Bay Area, I'd like to touch on President Trump's recent America First executive order, which among other initiatives, calls for a series of relatively modest steps like a multiagency report on changes needed for the H1B visa program, under which the government admits 85,000 foreign workers annually, many of them in the high-tech industrial, medical and science field.

The last time the H1B system was changed was over a decade ago. When technology, such as smartphones and the Internet, were not nearly as pervasive for businesses and consumers. And critics of the current program point out that a revamp to the lottery-based selection process is long overdue, often citing abuses by employers using the program to avoid hiring higher-paid American counterparts. And in fact, companies currently being issued the most H1B applications fit this very description. They are technology outsourcing firms that bring in foreign workers with bachelor degrees to perform technical jobs so they can pay lower average salaries than tech companies.

Targeting this practice is likely to represent a big win for bigger tech companies like Google, Amazon and Microsoft, et cetera, which have been in pitched battles for outsourcing firms for much-needed visas. One look at our rent roll will tell you that this bodes very well for our tenant base and for the technology sectors throughout the Bay Area and Seattle.

Now I'm going to turn to the transactional activity for the quarter. In terms of dispositions, as I mentioned, we closed our previously announced sales of 222 Kearney Street in San Francisco for $51.8 million and 3402 Pico Boulevard in Santa Monica for $35 million. 222 Kearney was sold at a 40% premium to our basis. As for 3402 Pico, having recently completed the repositioning in that project, we took the opportunity to sell this vacant 51,000 square foot office redevelopment and the related development land for a 13% premium to our basis.

Perhaps the most eventful first quarter activity was the announcement of our purchase of Hollywood Center Studios, which we recently rebranded Sunset Las Palmas, now part of the Sunset Studio's media and entertainment family, which includes Sunset Gower and Sunset Bronson. Sunset Las Palmas consists of 369,000 square feet of existing improvements, including 13 stages, production offices and support space on 15 acres in the heart of Hollywood near our Sunset Gower and Sunset Bronson Studios.

The acquisition includes future development potential of up to an estimated 575,000 square feet of additional office and production office space. We completed the purchase on May 1, '17, for $200 million with a combination of the 3402 Pico sale proceeds and proceeds drawn under our revolving credit facility.

Capacity for the acquisition was created after we fully repaid amounts outstanding under our facility from the near $340 million of proceeds raised through the successful public offering in early March, and Mark's going to provide further color on that offering in a moment.

We're extremely excited about the acquisition of Sunset Las Palmas Studios and by what we're seeing in terms of the improving long-term fundamentals throughout Los Angeles.

Los Angeles added more jobs in '16 than San Francisco and San Jose combined. And meanwhile, office-using employment has continued to grow into the first quarter with expectations for future expansion through '17. Asking rents for the greater Los Angeles area are likewise expected to increase this year by an additional 5% to 6%, and West Los Angeles and Hollywood continue to lead the Los Angeles submarkets in terms of net absorption and rental growth. And both are important considerations as we continue to evaluate tenant demand for our EPIC development in Hollywood.

Turning to Seattle. Headline announcements by nearly every blue-chip technology company of major Seattle expansions underscore what key indicators confirm with respect to the strength of Seattle's downtown office market. The 53 million square foot downtown Seattle market, where our portfolio resides, saw direct vacancy fall to 6.5%, down from 7.1% as of the end of the year and 7.3% 1 year ago. Asking rents, likewise, continue to improve and reach a total of $39.05 per foot, up from $38.40 as of the end of last year and $38.01 per foot a year ago. Suffice to say, fundamentals in Seattle point to the ongoing strength of this market.

One final note regarding Seattle before I turn the call over to Mark. Some of you may have seen our recent stories regarding the company's participation in an RFP process with AEG to renovate KeyArena in downtown Seattle. We are very excited about the opportunity to align with AEG, the world's leading developer and operator of live entertainment venues such as STAPLES Center in Los Angeles, The O2 arena in London and the more recently concluded T-Mobile Arena in Las Vegas.

To be clear, at this point, we have merely entered into a competitive bidding process for the renovation opportunity. As one might expect, this is early in the process in both timing and economic terms with the city, and they remain fairly high-level conversations at this time. The selection and negotiation process with the city could potentially last into 2018, and the start of the renovation is not likely to commence until sometime in the second half of 2019 after the NCAA basketball tournament is hosted in the arena.

We are currently limited by confidentiality and what we can discuss at this time. And that said, if selected, we are confident that KeyArena's renovation offers a unique opportunity for us to partner with the most successful owner/operator of live entertainment venues, generate returns on both a levered and unlevered basis well above those for conventional office investments and provide us with the additional opportunity to develop the property surrounding the arena with a combination of office, retail and multifamily improvements, which we will control, all within the limited investment commitment from the company in light of the joint venture structure and anticipated financing for the project.

With that, I'm going to turn the call now over to Mark, who's going to talk about our highlights for the first quarter.

Thanks, Victor. Funds from operations, or FFO, excluding specified items for the 3 months ended March 31, 2017, totaled $71.9 million or $0.48 per diluted share compared to FFO excluding specified items of $63.2 million or $0.43 per share a year ago. There were no specified items for the first quarter of either 2017 or 2016. As of March 31, 2017, our stabilized and in-service office portfolio was 96.4% and 91.2% leased, respectively, in line with last quarter and up from 95.8% and 90.7% a year ago.

Victor highlighted the strong activity and tremendous cash and GAAP spreads on first quarter leasing activity. I would add that the strength of leasing activity is further underscored by the steady improvement of our stabilized and in-service lease percentages even as we faced 335,499 square feet of expirations in Q1 '17, again a testimony to the continuing resilience of our core market and a credit to our leasing team.

Net operating income with respect to our 34 same-store office properties for the first quarter increased by 23.4% on a cash basis and 5.4% on a GAAP basis. The cash basis increase includes Cisco's payment of $10.4 million in early termination fees. Ignoring that amount, net operating income with respect to our same-store office properties would have increased by approximately 7% on a cash basis.

Moreover, as we highlighted to you last quarter, the cash basis net operating income will continue to be muted for the first 3 quarters of this year by the September 2016 commencement of a lease amendment with Weil, Gotshal at Towers at the Shore Center that contain both rent and square footage reductions. The amendment itself was signed in December 2014, several months before we acquired the property from Blackstone.

We estimate that the first quarter same-store office property net operating income would have increased approximately 13.2%, ignoring both Cisco's early lease termination payment as well as the impact of the lease with Weil, Gotshal in both areas.

The trailing 12-month occupancy for our media and entertainment property has increased to 90.3% from 89.1% as of the end of last year and 81.6% a year ago. You may note a fairly significant decrease in net operating income during the first quarter, which fell by 17.1% on a cash basis and 20.3% on a GAAP basis. While significant on a percentage basis, the decline represents only an approximately $1 million decrease in first quarter net operating income contributed by our media and entertainment properties compared to last year and amounts to approximately 1% of total same-store net operating income.

The decrease largely resulted from a combination of unusually high production activity by a stage user in the first quarter of 2016, the temporary use by Netflix of the stage for storage purposes as they moved into ICON and higher operating expenses associated with higher occupancy at both studios.

As Victor touched on earlier, in early March, we completed the public offering of 9,775,000 shares of common stock at the public offering price of $36 per share. The net proceeds from the offering were approximately $337.8 million. We used a portion of the proceeds to fully repay a $255 million balance under our credit facility with the remaining proceeds used for general corporate purposes. We subsequently reborrowed $150 million under our facility to complete the acquisition of Sunset Las Palmas Studios on May 1, 2017. The remaining amounts required to fund the acquisition of Sunset Las Palmas came from the 3402 Pico sales proceeds, pursuant to a 1031 like-kind exchange. As for the offering, we would like to thank both our existing and many new investors for supporting what by every measure was an extremely successful transaction.

Turning to guidance. We're increasing our full year 2017 FFO guidance from its previously announced range of $1.90 to $2 per diluted share, excluding specified items, to a revised range of $1.92 to $2.02 per diluted share, excluding specified items. The guidance reflects the company's FFO for the first quarter ended March 31, 2017, of $0.48 per diluted share as well as the transactional activity referenced in this press release and in earlier announcements.

For the sake of clarity, the early lease termination paid by Cisco toward the end of the first quarter had no material impact to first quarter FFO. While Cisco remains obligated to pay rent at our Campus Center property through the remainder of the current year, in addition to receiving that rent, this guidance also includes the amortization beginning with the second quarter of this year of approximately $1.5 million per quarter of income, reflecting Cisco's payment of $10.4 million in termination fees, reduced for GAAP purposes by the write-off of approximately $5.9 million of noncash items, namely straight-line rent receivable and above- and below-market rent lease adjustment associated with their early termination.

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 this press release, but otherwise excludes any impact of future unannounced or speculative acquisitions, dispositions, debt financings or repayments, recapitalizations, capital market activity or similar matters. There can be no assurance that the actual results will not differ materially from this estimate.

One final word about guidance. You will find that we have introduced additional information to our earnings press release, outlining various assumptions supporting our guidance estimates, including same-store office and same-store media and entertainment cash NOI growth estimates, noncash revenue and expense estimates, G&A and interest expense estimates and other amounts.

I believe you will find the additional information to be comparable to that by -- that provided by many of the most seasoned of our office peers. But as this marks the first quarter of providing such information as part of our routine filings, we encourage any feedback you may have.

And now I'll turn it back to Victor.

Thank you. In closing, I'd like to reiterate that we continue to see consistent, strong demand and excellent leasing momentum throughout our entire portfolio across all of our markets.

As always, I'd like to thank the entire Hudson Pacific team, especially our terrific senior management for all their hard work this quarter and the quarters to come. And to everyone on this call, we appreciate your continued support of Hudson Pacific Properties, and I look forward to updating you next quarter.

Operator, with that, I will turn it over to you for questions.

(Operator Instructions) Our first question comes from the line of Jamie Feldman from Bank of America Merrill Lynch.

Mark, can we start with you on the guidance? So it looks like looking at the amortization impact of the termination fee, it adds about $0.028, $0.03 or so to your numbers versus the prior range. I think you raised it $0.02 at the midpoint. Can you just talk about what the moving -- other moving pieces might be in the model?

Yes. I mean, I think we gave you the -- I mean, first of all, your number is right, Jamie. It's slightly below $0.03. If you looked at the prior guidance, our midpoint was $1.95.

I think maybe at the root of your question would be a clarification around that $1.95. That was a soft $1.95. That is to say, it was a mid $1.94 number that was rounding to 1.95. When we brought in the early term fee on a GAAP basis, that's slightly below $0.03. So the combined impact actually takes you to a mid $1.97 number, but that's a weak $1.97.

So I suppose we could have guided to a mid $1.97 number. We don't tend to guide to a $0.005 number. I know some will do it. We don't do it. So at any event, that's what's underlying that $1.97.

As it relates to other factors. I mean, I hope you think that the metrics we outlined in the press release give you a lot more information to go by. I mean, I think it's got all of the other key items that one would normally look to, to try to get a handle on what's going through the number. If there's anything else that you have a question about that's not on that list, I could try to give you some insight on it. But that's effectively what's going on from the last guidance to the current guidance.

Okay. So I guess, just thinking about the core business outside of the termination fee, I mean, things are just kind of in line as you expected. Is that the right way to think about it? Are there any...

Yes, I think so. I mean, that midpoint same-store of 7, taking out those 2 items, I hope you agree that's also maybe the most helpful way to look at the impact of those 34 assets. And of course, you can see even in our footnotes, we try to provide variations on it by providing it without those 2 items, we provided it with the 2 items. You could run variations with 1 in and 1 out and certainly have those numbers as well.

We thought that this one was the one that had the most sort of shelf life in that those 2 items are both temporary in nature. That is to say 2 quarters from now, that Weil, Gotshal impact on a same-store comparison basis will no longer be relevant. I suppose we could have not put in the Cisco fee, left Weil, Gotshal in, and then it would have muted that same-store number for the time being.

And then -- but then next year, when we blew it out of the water because Weil, Gotshal would no longer be impacting it, everyone would be asking what it would look like if Weil, Gotshal was still in there. So we hope that you agree this has the nicest, longest sort of -- and adds the most clarity from a same-store basis. But bottom line is I think the same-store -- that same-store number, core stabilized number at the midpoint of a 7 is in line with our expectations.

Okay. Yes, that's helpful. And then, I guess, just bigger picture on Silicon Valley and the Peninsula. You talked about in Seattle, tech companies really growing aggressively there. We've seen very good numbers -- earnings from tech and media companies. Can you just frame like where growth in Silicon Valley fits versus we're seeing some good leasing in CBD San Francisco and in Seattle as we look forward?

Yes. Jamie, I mean, listen, if you look at what's happened in the last quarter alone -- I'll just give you some of the highlights. I mean, Amazon took 500,000 feet in a couple of projects, Applied Materials took 120,000 feet in Sunnyvale, Bosch took 104,000 feet in Sunnyvale. I think Adobe is rumored to be in San Jose for 300,000 to 400,000 feet. Google still has their San Jose requirement that is rumored out there for 1 million feet.

I mean, the activity and numbers are very strong. If you looked at my prepared remarks, if you look at what's coming online this year, 90% is already pre-leased. And next year through -- I'm sorry, through '18, 70-plus percent is pre-leased. So maybe the temperature around San Francisco with the few deals that are announced seems to be a little bit more popular for people to sort of get their arms around. But the numbers are pretty strong and -- more than pretty strong, I think they're exceptionally strong in the Peninsula, in a lot of the areas.

And I think you're going to see a lot of that continue with those large users, Microsoft -- I'm sorry, Amazon, Facebook, Google and Apple in that marketplace. And then you're going to see a bunch of small deals done, too, which don't get the same kind of credit. And that's part and parcel of our VSP program that we're seeing and we're executing on.

Okay, okay. And then just following up, last question. What do you think it will take to get rents moving again in either San Francisco or Silicon Valley?

Moving again. What do you mean? Beyond where they are right now? I mean...

The rents are flat. Do you see -- is there a certain amount of space that needs to get taken down before you could start seeing upward pressure on rent?

Well, I think -- listen, I think they're flat statistically because that's what we're seeing from the CB reports and the other market leaders reports. I would say -- I'm looking at Art here, and he can jump in and comment on it.

In terms of our deals that are done, we've had consistently a pipeline -- as you know, has been very strong; and secondarily, 0 pushback on rent. So I think we are pushing rents and still seeing it. Overall, the 5% to 6% movement in rents and 3% to 4% in the Valley a little bit, we're seeing that. But I think can achieve greater than that in the stuff that we own. Right, Art?

Yes. Jamie, this is Art. In the CBD San Francisco, literally, we don't have any more space available. The last few pieces or bid blocks that we have had, as Victor said, we've pushed rates really beyond what our expectations were. So it's really hard to answer your question about where we can move them to when we've just done that.

Our next question comes from the line of Rich Anderson with Mizuho Securities.

So on the Campus Center redev, the effort will get you to what you're assuming right now as a rent level below what Cisco was paying. I'm just curious how much did that kind of conclusion alter the amount by which that you're going to spend? $11.5 million seems like kind of a doable number. It could have been much more, I suppose. So is this just enough to sort of keep your head above water there? Or just -- I'm just wondering how you can just describe your pulse of the situation there and how that impacted your redevelopment plan.

Sure, Rich. So listen, I want to temper the conversation because I know that you and your brethren are all going to be very fixated on Cisco.

We just got the game plan in place. And so our initial $24 a foot repositions the existing 4 75 to that $11 million. That's what the broker community is telling us. We need to sort of de-Cisco-fy the assets at the end of the day.

I think it's -- this is a price-sensitive marketplace in Milpitas. We are a low-cost provider. I think it's more than just getting our head above water. The activity that we have seen, as I mentioned in our prepared remarks, is even surprising to us to our standpoint. I think there are -- right now, we've toured or had conversations with 6 users that are 125,000 square feet and greater. We are talking about a stabilized deal January 1, '19. So you're talking -- sorry, starting rent deal of January 1, '19, stabilized at the end of '19 approximately, so you're over 2 years away.

I can't tell you that our number in rent is going to hold up. I think we're conservative in that process. That's where the [roll] to market is, which is slightly below. I think we're also conservative in the CapEx. If we have a couple of tenants we're talking about who want to go on and build the entire second phase, that recapitalized number is going to be reflected to a higher rent and, therefore, more capital improvement dollars put to this project.

Okay, fair enough. And then maybe more broadly to the area. What's the explanation about the 80 basis point lease percentage loss in the Blackstone portfolio?

I mean, you may run the math, you might be -- are you looking at the -- just the lease-up component of those -- of the 8 Redwood assets or [realty] assets that we were referring to, Rich?

Yes.

Yes. So actually, if you do the math, you'd see -- what you see is -- so last quarter, we ended at 80.9% on the lease of assets, but that included 555 Twin Dolphin, which moved up to the nonsame-store stabilized. And you'll see there that, that asset's only -- almost 93% leased. If you adjust for the fact that -- it's an apples-and-oranges comparison that to say it's 8 assets versus 9 last quarter. It's actually on a -- if you add back 555 Twin Dolphin to that pool of assets, you're actually at 80.6%, which is actually only a 30 basis point decline.

You can see right away, if you do a comparison, the main reason for that is Palo Alto Square. That -- we -- Morgan Lewis rolled out of almost 60,000 feet at Palo Alto Square. So we got a fairly large roll-down in lease percentage there. That was a known vacate.

By the way, it couldn't happen practically in a better asset in our portfolio, right? Because -- I mean, in fact, both backfilled out quickly and at a probably significantly higher rent. So that's what's going on there. Really, it's the combination of 1 asset moving into stabilized, which was helping that average; and 1 asset that saw an expiration that we knew was coming.

Okay. Last question for me is the choice of asset sales, 222 Kearny and then the Santa Monica asset, 2 of your maybe somewhat prized submarkets. I'm curious what was it that flipped the switch there for those 2 decisions. And could we be -- expect to see some more monetization in Santa Monica and/or -- well, maybe not Santa Monica, or downtown San Francisco?

So to answer your latter part of the question, the answer is no. I mean, these 2 assets -- I think Richard, you recall, 222 Kearny was on a ground lease. It was 2 buildings. It was in our portfolio. I think we had a 40% return. We had a great upmarket number from a potential buyer who ended up closing.

The issue -- and there was a heavy capital issue going to that asset in the next 1 to 3 years that was on our budget. And so it was just a perfect storm moment for us to sell that.

At 3402, as I have mentioned in the past, I mean, we just completed the reno. We were talking to 2 tenants to lease it, and a third tenant came who was an owner-occupier. And as opposed to doing a long-term lease with them with an option to buy, we just chose to sell it. It's a smaller asset. It's not indicative of our business plan.

Our next question comes from the line of Nick Yulico from UBS.

Couple questions. First, on the same-store NOI guidance, I know you guys gave a couple different versions of it. If you just remove the lease term benefit but keep the Weil impact, just trying to run some numbers on this, looks like it's about 4%, 4.5%?

You got it. I mean, your note had it right. You were at 4% to 4.5%, it's like basically 4.25%. By the way, if you want to just see it in the other direction, in case you want to round out your scenarios here, if you take Weil, Gotshal out but leave Cisco in, it's 11.2%.

Okay, all right. Lot of different options. And then just going back to the lease-up portfolio and specifically the EOP assets, I guess, what I'm wondering is, is part of -- how much of this is due towards having some high lease expirations still in the portfolio versus sublease space being more competitive for what you're trying to -- and then also what seems like it's been demand maybe being a little bit less overall in the market, in the Valley this year than last year?

Yes. Well, I mean -- look, I mean, every asset, to some extent, tells its own story. So I think -- and you can tell, I mean, they're spread out throughout the Peninsula and Silicon Valley. So there's really no one-size-fits-all explanation for what's going on within that set of 8 assets.

I can tell you, we've steadily moved the lease-up portfolio as a whole into stabilization. As you saw just from the last quarter, one of the assets that we're in last quarter has already moved. And it's fair to expect that we'll see more of that as the year unfolds.

Just as a sort of -- maybe it's the most obvious indicator of that. When we bought the portfolio, we had 26 assets. Now 4 of those have been sold. 17 of them were lease-up assets. We're now down to 8. Palo Alto Square saw a recent significant expiration. But suffice to say, with reasonable downtime and buildup, that one is going to go move to stabilization pretty quickly. Other assets we'll continue to chip away at.

So we've made steady inroads on Metro Center. If you recall, that asset had the largest pockets of vacancy in it. That's where Sony was housed. They vacated prior to buying the portfolio. We've undertaken a VSP program. That's had some very positive impact. That will steadily improve. Likewise, Gateway center has really only just seen the benefits of a fairly sizable reposition plan. We're seeing good absorption there. And in fact, we're ahead of our original underwriting in terms of our occupancy there. And we could go on and on about these.

But little by little, we are going to -- we expect to see these assets begin to not only improve in occupancy, but begin to spill into the stabilized portfolio.

Okay, that's helpful. Just last one. Victor, going back to Seattle and the arena possibility. I know that you said there's not a ton you could say. But can you give us a feel for what could be the ultimate office and multifamily square footage opportunity that you're pursuing there?

So Nick, right now, we're not at liberty to get into it because it's way early on, and I understand the desire here. What we're doing is trying to expand the company's footprint in our media and entertainment and ancillary field, like we did with the studio businesses. And we're doing this at a venture and a partnership with the world's leader in this who virtually never partnered with anybody.

So the surrounding area, we'll control. There will be office. There will be retail. There will be multifamily opportunities that we will control, and nobody else will. Plus, the revenue stream in the arena alone and the structure around that will also be very enhancing to the company overall.

And thirdly, it's going to be an opportunity for us to do other things with AEG in other markets that are similar.

But for us to get into the details at this time, it's like you're asking me, we're bidding on an asset in San Francisco, what's going to happen when you get the asset? My response is, hey, we're bidding on it with others. And when we get it, we'll let you guys know what the responses are. And you'll have ample time and ample information to decipher it in how it's positively affecting the company.

Our next question comes from the line of Blaine Heck from Wells Fargo.

Not to pile on, Victor, but I think some of the confusion with regard to the Valley involves the fact that a lot of the reports we're seeing and discussions we're having with brokers point to a softening market in the Valley, especially with regard to increasing sublease space. So I guess, is it just that you think your portfolio can outperform the market? Or do you think the reports or our perception of the report is too negative at this point?

Listen, Blaine, I'm not saying that we're going to -- our portfolio is so good, we're going to outperform the market. I think we have a solid team on the ground, and they have a directive that is going to be indicative of what they've done in the past.

I mean, if you look at what we've done with Redwood, we've sold $360 million at a 15% profit relatively 12 months after we've owned those assets, we've leased the portfolio albeit it is not the same-store portfolio as it was because those assets are sold from the low 80s to -- basically to the 90s -- to the high 80s or low 90s. We've increased NOI there 42% on a cash basis in the last -- less than 2 years. We rolled over Qualcomm, which the market perceived us to lose those guys. We rolled them over early at a 44% rent bump. We've executed 225,000 feet on our VSP plan. That's going to be a 400,000 to 500,000 or 600,000 square foot plan.

All that takes time, energy and effort. Not to say that the market is indicative of how it runs by Hudson. I think the market is the market, and Hudson does what we do best. And there will be assets that will perform better than others.

I do think that the banter around sublease space, the banter around the slowness in the Valley is more related to the quality of assets that are available versus the tenants that are available. These tenants are high commodity tenants who are looking for space in specific markets. When those markets aren't available, they will look at other markets. Fortuitously for us, we've been fortunate enough that they've come to our assets, and I think the quality of our portfolio speaks for itself.

Okay, that's helpful. Shifting gears, on the development pipeline, sorry if I missed this, but you guys have talked about hopefully breaking ground on a couple of projects early this year, including EPIC. So just wanted to clarify whether that is kind of fully entitled and ready to go at this point and get some commentary on when you expect to break ground there and any pre-leasing requirements to start.

Sure. Well, EPIC is going to be approximately 300,000 feet. It's a unique number in that it's got some outdoor space that we are looking to evaluate currently today, whether we're going to get rents on that space. So that number may move. It is fully entitled. It's designed -- I believe, we could break ground on that asset as early as August of this year. We have engaged in the same brokerage team who did ICON and CUE. They are fielding tours through our marketing suite, which is fully up and running right now, on our Sunset Bronson lot that looks at that asset. We have had inquiries by multiple tenants for all or part.

Answering your question if we are going to pre-lease it before we break ground, I can't really state that at this time. I think we'd like to. I do think that the perception between our project in Columbia and some of the other Hollywood projects that have been successful in the last several years on a pre-leasing basis is not the norm. L.A. is not typically a pre-leasing marketplace. But these large tenants are growing, and there's a lot of interest in the media-related tenancy. And we're getting a ton of inquiries on long-term leases on the studios with the office and studio component.

So I'm not ruling out a pre-leasing component. I think it's more going to be a temperature read as to how the market sits and what kind of leasing numbers our team can generate before we break ground. But my anticipation is by the beginning of next year, we will have started construction at the latest.

Our next question comes from the line of Vikram Malhotra from Morgan Stanley.

This is Nick Stelzner filling in for Vikram. My question is, can you provide any color on your mark-to-market or occupancy expectations for the balance of the year?

Well, I would -- I don't -- I think we expect our in-service lease percentage to improve probably modestly by the end of the year. It's already fairly high at 91.2%. But I don't think we expect to see any significant change in that.

And I would say that's not going to be a result of any slowdown in leasing activity. It's just that we have a fair amount of expiration that we -- on the horizon, not the least of which is 470,000 feet that expires at the end of the year, right? So there's an inherent danger in trying to pinpoint a number as of the moment in time because there's -- of the expirations we have on the horizon here, there's -- our 2 largest expirations happen on the last day of the year.

So -- but I do think you'll see healthy activity and accounting for the fact that we'll get those 2 sizable spaces back at the end of the year. I would expect the lease percentage to sort of stay more or less intact with the existing level. What was the second question?

Mark-to-market.

Mark-to-market. Oh, yes, I mean, you saw our current mark-to-market for the quarter. I think in light of the '17 -- the composition of '17 lease expirations, the -- that cash and GAAP number is probably pretty indicative of what we'll see for the balance of the year.

I mean, our bigger expirations, as I mentioned, going into the year happen in San Francisco. One of them has been backfilled with AIG. The other one is BofA. At the end of the year, we'll see what we can do during the year to get ahead of that expiration. That could be a very significant mark-to-market.

But I think every quarter is going to be a reflection of what the actual expirations in that particular quarter are -- quarter is. But over the year, I think you'll see something along the lines of that kind of 40-ish percent mark-to-market in cash.

And then just one other question. I know you just closed on the Hollywood Studio acquisition, but could you talk about what other investment opportunities you're seeing in the market today?

Yes. Listen, the stuff that we're looking at, it's been the same sort of process, as I think we've been successful in the past. Off-market deals lead the way for us. There's a lot less of them that we're looking at right now. And the stuff that we're looking at, that is packaged bid stuff.

We bid on a couple of deals that we lost. We're looking at a couple now that we're in the process of evaluating that we'll be in the middle of. And I think it's a steady flow. I think if you look in L.A., there's a lot less product in L.A. than there is in Seattle on a pro rata basis. And so those are the 2 markets that we've said we're going to focus a lot of attention on. And so I think we're going to execute in both those markets, but maybe more in the L.A. market -- Seattle marketplace than the L.A. marketplace from what -- just sort of on the surface.

The Bay Area, I don't see a ton of stuff that's of interest to us right now. There is a couple of deals that are going to be announced that we were in the mix in, but we're not going to be the successful bidders on.

Our next question comes from the line of Dave Rodgers from Robert W. Baird.

Victor, wanted to ask about the acquisition you just closed at Hollywood Center. I know you've got a couple of development parcels there. So following up on an earlier question, I know one of those is entitled, one isn't. What's the demand that you're seeing for that? And is there any lockup on any of the studio space that would inhibit that from moving forward pretty quickly?

Yes. Absolutely, Dave. So first of all, it's now -- the name is now Sunset Las Palmas. So it falls in the Sunset family in the media portfolio of Hudson. And so we're rebranding it right now as we speak, new signage and the likes of that.

We closed just on Monday. Our team is on the ground and in place, and the efficiencies are already kicking in. We've seen a tremendous upswing in interest. I can get -- Bill's sitting here, he can sort of give a quick snapshot as to what he's seeing.

And in terms of the tenant issues today, there's really no tenant in place that we can't get rid of in a very expeditious time. Preponderance of them are 30-day notices, and Bill has had a number of conversations with extending and blending some of those guys and then bringing new guys in. So I'll let him jump in on that.

But before he does that, we're entitled for 100,000 feet. We're entitled for 300 parking spots roughly. And we've got an additional 400,000 to 500,000 feet that we could build. We have not even started the master planning around that 300,000 to 400,000. There are some outlying parcels that we are entertaining that's going to sort of match out. But the demand is high. Bill, why don't you just jump into that?

Yes. So as Victor said, we are going to be converting the short-term leases at Sunset Las Palmas to longer-term leases. Our objective is to really look for multistage, multi-year deals similar to the type of deal we did with Netflix last year.

We have a pipeline right now of both traditional networks like ABC and CBS; branded networks like Amazon and -- I mean, brand networks like HBO and Comedy Central, MTV and VH1; and streaming networks like Amazon and Netflix who are interested in basically a combination of office and stages for us right now. And we're in the middle right now of actually negotiating, I can't go into details, with some rather large deals at Las Palmas from our pipeline.

Great. And then maybe one last for me. Victor or for Art, could you talk a little bit about the activity you're seeing at Fourth & Traction? I think that's just coming up on completion now.

Yes. So we're seeing -- we've definitely seen an uptick in activity. We're negotiating on a preponderance of the space in the building with both retail and office users. And those office users are made up of -- have been made up of not just entertainment and technology tenants, but consulting firms. And there's actually a law firm in the mix. So we're definitely feeling good about the activity right now.

Our next question comes from the line of Tom Catherwood from BTIG.

Just a few cleanup questions here. Mark, appreciated your commentary on the media and entertainment portfolio. Same-store roll-down in the quarter, makes sense comping to a challenging 1Q '16. But if we look at the back end of the year, your midpoint of cash same-store guidance for the media and entertainment portfolio is 6.4%, which suggests a pretty strong ramp. Is this kind of a recovery that's going to kick in, in 2Q? Or is this kind of going to ramp throughout the rest of 2017?

Yes, that's typically the dynamic of the studios. That is to say we typically see second quarter tends to come in line with -- fairly consistently year-over-year. Third quarter tends to ramp up because that's when production is really in full swing. And that carries over into the early part of the fourth quarter and doesn't really start to taper off again until the holiday season starts to slow production down again.

And so yes, I think the first quarter is anomalous for the reasons we outlined. We just happened to have a really strong production quarter last year that just wasn't replicatable. Netflix took some stage space that wasn't doing production after they were getting -- doing their move-in in the first quarter.

Those will subside. Those types of factors will subside. I think we'll see a normalization into 2, 3 and 4. So yes, that's why we're confident that our same-store growth is higher than what you saw in the first quarter.

Got it, appreciate that. And last one for me. Going back to Campus Center, obviously, 470,000-plus square feet of office there now. It sounds like, though, in the $24 a square foot you guys are allocating to the asset, you're only going to end up refreshing 100,000 square feet of the office. Help me understand kind of what the allocation plan is there.

Yes. No, that's an all-in number. I mean, that's the reposition cost. We weren't trying to give you a TI or a commission number, right? That will follow on from whatever deal gets struck. What we wanted to give everyone was a clear understanding of what we need to do to bring the asset sort of back to kind of the quality it needs to be relative to the market to attract the tenants we're looking for. So that's things like common area upgrades, exterior improvements, lobby improvements, various amenities that tenants in the marketplace are looking for. So think of that as sort of a base building reposition spend.

I get that. I think that makes complete sense. What I was more focusing on is you also made the comment that it's 100,000 square feet of...

Oh, that's -- we're going to target -- sorry about that. We're going to target some of the space for -- like VSP, so it's move-in-ready space. So part of that spend is just to get 100,000 feet of it kind of ready to go as pre-spend. There might be some incremental spend even on that 100,000 feet depending on what incremental TIs need to be done. But yes, that's to enhance some of that space, so it's more move-in ready.

Our next question comes from the line of Craig Mailman from KeyBanc Capital Markets.

Just Victor, earlier you pointed out that regardless of what happens in Seattle, maybe there's some other stuff you could partner up with AEG on. I'm just curious as you guys have always had this entertainment piece of the studios, just if you were to do other potential opportunities with AEG, how big would you want the nonoffice piece of the portfolio to get to?

I mean, listen, Craig, I don't know. It's going to be based on a deal by deal, return by return. I do think that if we have the opportunity, the numbers will prove themselves out to be a unique and a market share position for our standpoint. We're not going to enter into a transaction with a partner lightly. So we cherish the opportunity, and we'll see what transpires in this one and then potentially what it will lead down the road to others.

How far out of your kind of a West Coast focus would you guys go for opportunities in this segment, the entertainment piece?

I think right now our focus is West Coast.

And then just, Mark, lastly, a follow-up on Cisco. So you guys have some TIs built into the 100,000 of prebuild. So as we think about it, we should only have about -- if we wanted to bake TIs onto your $11.5 million, it should only be on that 300 -- whatever, 300-and-change thousand square feet remaining?

Yes. I think that's fair as a modeling assumption.

There are no further questions in the queue. I'd like to hand the call back over to management for closing comments.

Thank you so much for your participation and support of Hudson. We look forward to talking to you all next quarter. Have a good day.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.