Hudson Pacific Properties Inc (HPP) 2018 Q2 法說會逐字稿

Greetings, and welcome to Hudson Pacific Properties' Second Quarter 2018 Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host for today's call, Laura Campbell, Senior Vice President of IR and Marketing. Thank you. You may begin.

Thank you, operator. Good morning, everyone. Welcome to Hudson Pacific Properties' Second Quarter 2018 Earnings Call. Earlier today, our press release and supplemental were filed on an 8-K with the SEC. Both are now available on the Investor Relations section of our website, hudsonpacificproperties.com. An audio webcast of this call will also be available for replay by phone over the next week and on the Investor Relations section of our website.

During this call, we will discuss non-GAAP financial measures, which are reconciled to our GAAP financial results in our press release and supplemental. We will also be making forward-looking statements based on our current expectations, which are subject to risks and uncertainties discussed in our SEC filings. Actual events could cause our results to differ materially from these forward-looking statements, which we undertake no duty to update.

With that, I'd like to welcome Victor Coleman, our Chairman and CEO; Mark Lammas, our COO and CFO; and Art Suazo, our EVP of Leasing. Victor will give an overview of our performance, Art will discuss leasing activity in our markets and Mark will touch on financial highlights. Note, they will be joined by other senior management during the Q&A portion of our call. Victor?

Thanks, Laura, and welcome, everyone to our second quarter 2018 call. We had a very productive second quarter and a [current] start to Q3 as well. We've made good progress on renewal and backfill of significant expirations with strong leasing activity in our Peninsula and Silicon Valley assets, particularly in Foster City, Santa Clara and North San Jose. Those 3 submarkets comprised nearly 70% of our deal activity in the second quarter. We have deals completed or in leases, LOIs or proposals for 76% of the 2018 and 48% of the 2019 expirations portfolio-wide.

For clarity, in 2018, that percentage applies to expirations as of year-end '17. We've got great leasing momentum in all of our active value-creation projects as well, and I'm excited to report that we have leased 100% of our Fourth & Traction redevelopment. I'll give you more on that shortly. And we continue to sell noncore assets and redeploy that capital into more strategic, high value-add acquisitions, and have the winds at our backs in terms of market fundamentals as well. We're seeing positive trends in net absorption, vacancy and rents in essentially every single submarket.

In terms of the second quarter leasing, in aggregate, we completed over 800,000 square feet of new and renewal leases at a 23% GAAP and 17% cash rent spreads.

As touched on last quarter, we early renewed and expanded one of our 15 largest tenants, Nutanix, in the San Jose airport area. Now they lease over 290,000 feet across 3 assets: 1740 Technology; Metro Plaza; and Concourse, all coterminous through 2024. Nutanix' 80,000 square-foot expansion carried with a 20% mark-to-market.

In Pioneer Square, we renewed and expanded RealSelf at 83 King. And with that leased, we've now backfilled about 75% of the former Capital One space. The expansion portion had a 50% mark-to-market.

And in San Francisco, one of our largest tenants, Square, expanded over 100,000 square feet at 1455 Market into the former GSA and Vevo space at approximately 19% mark-to-market.

Last week, we finalized our deal with tech firm Honey Science Corporation and leased all of the 132,000 square feet of our Fourth & Traction redevelopment project in the Arts District. We've seen a notable increase in activity in the Arts District after the first year, no doubt attributable to the market's continued rapid evolution and particularly on the heels of the Warner Music and Spotify deals that were signed earlier this quarter.

Obviously, all the activity bodes well for the lease-up of our 99,000 square-foot MaxWell redevelopment, which we'll deliver at the end of this year. And while we have no specific updates yet, we're in negotiations with multiple full and partial building tenants for our EPIC, Harlow and Westside Pavilion projects.

Regarding acquisitions and dispositions in the quarter, we purchased 2 properties in furtherance of our future development plans for Sunset Las Palmas Studios. Directly adjacent to Sunset Las Palmas, these assets contain 2 soundstages, production offices and support space totaling 41,000 square feet, all of which the seller has leased back for 3 years.

We also closed our previously announced sale of 9300 Wilshire Boulevard in Beverly Hills for $13.8 million, which represented a 19% premium to our GAAP basis. And earlier this week, we announced the sale of the remaining Peninsula Office Park buildings for $210 million. And this transaction finalizes a well-coordinated 2-part disposition of a noncore asset in a noncore market at significant premiums to our original purchase price and GAAP basis.

You will recall, we sold the vacant Building 6 in Q1 for $22.5 million. We had the sale of Pacific (sic) [Peninsula] Office Park on our radar for some time, particularly given the present strength of that marketplace, and it was our only San Mateo property. And from an asset and location perspective, not on par with the rest of our portfolio.

And finally, most of you are probably aware of the passing of Prop C in San Francisco, an increased tax on commercial landlords that will go into effect in January of 2019. We don't anticipate any meaningful near-term impacts. And it remains -- and if it remains in place, we believe the Bay Area amenities and innovation clusters will help offset these additional costs. Mark is going to provide a little bit more commentary on that, and so anticipate his comments.

Now I'm going to turn it over to Art for further commentary on our leasing and markets.

Thanks, Victor. As you noted, West Coast markets and especially our markets continue to shine in terms of fundamentals, which is translating into strong leasing activity throughout our portfolio.

Silicon Valley had another great quarter with nearly 1 million square feet of positive net absorption, vacancy falling 130 basis points to 10.7% and rents increasing just over 1%. That brings the year-to-date positive net absorption to over 2.6 million square feet, driven by a growing demand from tenants with 100,000 square-foot-plus requirements.

To date, Santa Clara and North San Jose, where the preponderance of our Valley assets are located, have been the biggest beneficiaries. Seven of the 8 largest vacant spaces in those markets were leased in Q2. As a result, vacancy in Santa Clara and San Jose dropped quarter-over-quarter, 380 basis points and 280 basis points, respectively.

Further market tightening is positive for all of our Valley assets but particularly for Campus Center, given the rise in large block activity. As of this call, we have about 1.7 million square feet in proposals. That's 2x what we reported in Q1. These prospective tenants are doing real upfront due diligence, space planning, construction pricing, executive tours, and we're tracking another 3.2 million square feet of large 150,000 square-foot-plus requirements, which is up 2.6 million square feet from last quarter.

There's no doubt the demand side of this equation remains strong with lots of tenant interest, particularly in terms of Milpitas from R&D and manufacturing users. In terms of supply, to date, we really had 6 direct competitors to Campus Center, totaling 2.5 million square feet. With Santa Clara County's recent purchase of one of those assets in mid-July for its own expansion, our direct competitive supply now stands at about 2 million square feet.

Now there's porousness in the Valley as to where demand goes, particularly across Milpitas, North San Jose and Santa Clara, and we're mindful of significant availability in those markets. But given our activity and a combination of price point, flexibility and use mix, we're confident we'll get a deal done and it's just a matter of when.

For example, in some cases, tenant interest in building out R&D and/or manufacturing uses at Campus Center is extending the time frame for upfront due diligence. The Peninsula submarkets, for the purposes of this discussion includes Palo Alto, had over 345,000 square feet of positive net absorption in the quarter, with vacancy and rents essentially unchanged quarter-over-quarter at 8% and $81 per square foot, respectively. Vacancy in Palo Alto currently sits at 1.1%, down 100 basis points in the quarter, with 34,000 square feet of positive net absorption and stable rents. The vacancy in Foster City was 16.9% quarter-over-quarter, with slightly positive net absorption and stable rents at $66 per square foot.

We've literally transformed Metro Center's tower and adjacent low-rise buildings. And in the quarter, we renewed Queen Street for 45,000 square feet with a 64% mark-to-market and completed another 52,000 square feet of deals. We've also got roughly 99,000 square feet of deals in leases, LOIs or proposals in the pipeline for that asset.

Collectively, our Peninsula and Silicon Valley stabilized portfolio is 90.2% leased, in-place rents are 10% below market. While we have 300,000 square foot -- square feet of expirations remaining in the Peninsula and the Valley in 2018, those leases are 24% below market.

In San Francisco, 1.3 million square feet of positive net absorption further restricted supply. Vacancy fell 50 basis points in the quarter and rents increased 2.8% to $79 per square foot. The most competitive segment is 100,000 square-foot-plus blocks and demand outstrips supply by a ratio of 2:1. Our stabilized San Francisco portfolio is 94.6% leased, and in-place rents are 32% below market. We've received some questions about Salesforce's 265,000 square-foot sublease at Rincon Center. While I can't discuss the specifics, I can tell you the activity in that space, which is about 42% below market, has been phenomenal.

Los Angeles also had a terrific quarter with Hollywood and West Los Angeles, our 2 primary submarkets, leading that growth. In West LA, tech, media and entertainment companies drove 370,000 square feet of positive net absorption. Rents up 3.9% to $61 per square foot and vacancy down 60 basis points to 10.8% in the quarter. Hollywood had 90,000 square feet of positive net absorption in the quarter with rents up 1.9% to $57 per square foot and vacancy down 270 basis points to 8.1%.

As Victor mentioned, we're very excited about our prospective tenant activity at our under-construction EPIC and Harlow developments. We also continue to field reverse inquiries and are in active negotiations for the entirety of Westside Pavilion redevelopment. And you heard the good news on Fourth & Traction. As for MaxWell, our other Arts District redevelopment slated to deliver at the end of the year, we have about 100,000 square feet of deals in leases, LOIs or proposals.

Overall, our stabilized Los Angeles portfolio is 98.9% leased with no material expirations and in-place rents are about 7% below market.

Finally, Seattle had another great quarter. Location and amenities continue to drive tenant choices. And we like our concentrations in Pioneer Square, South Lake Union and Denny Triangle. In the quarter, the downtown Seattle market had 390,000 square feet of positive net absorption, a 3.2% increase in rents to $47 per square foot and a 40 basis point decline in vacancy to 7.7%. Our stabilized Seattle portfolio is 96.8% leased with very little in the way of 2018 expirations and in-place rents are 15% below market. We delivered our 32,000 square-foot 95 Jackson redevelopment this quarter, which is about 80% preleased to Regus co-working concept spaces. We have a combined 87,000 square feet of interest from very high-quality tenants for the balance of 95 Jackson and the last 2 viaduct-blocked floors at 450 Alaskan, where we just completed a spec suite to help tenants better envision the space.

And with that, I'll turn the call over to Mark for financial highlights.

Thanks, Art. FFO excluding specified items for the 3 months ended June 30, 2018, totaled $71.6 million or $0.46 per diluted share compared to FFO excluding specified items of $75.3 million or $0.48 per diluted share a year ago. Specified items for the second quarter of 2018 consisted of unrealized gains from changes in fair value on non-real estate investments of $900,000 or $0.01 per diluted share, with no specified items for the second quarter of 2017.

At the end of the second quarter, our stabilized and in-service office portfolio was 93.6% and 89.7% leased, respectively, versus 94.4% and 89.7% at the end of the first quarter. The decline in our stabilized portfolio lease percentage represents a 61,000 square-foot sequential loss, 50,000 square feet of which was a single move-out at Towers at Shores Center in Redwood Shores. The entirety of that space is now in leases for backfill.

Net operating income with respect to our 30 same-store office properties for the second quarter decreased 0.2% on a cash basis and increased 1.7% on a GAAP basis. I'll touch on the same-store office cash NOI trend in a moment.

Trailing 12-month lease percentage for our same-store studio properties ended the second quarter at 89.6%, essentially in line with the 89.9% trailing 12-month lease percentage year-over-year. More telling in terms of demand for stages and production offices is same-store studio NOI, which increased in the second quarter by 12.6% on a GAAP basis and 11.8% on a cash basis. This was due to higher rental rates and production activity at both Sunset Gower and Sunset Bronson.

Now I'll turn back to the second quarter same-store office cash NOI. After generating 5.8% same-store office cash NOI in the first quarter, this quarter dropped 0.2%, largely on account of 5.4% higher year-over-year operating expenses compared to 1.6% higher year-over-year revenues. It's worth noting that revenues increased despite modestly lower same-store average occupancy. A combination of items ranging from a few scheduled ground rent adjustments to the reversal of bad debt reserves in the prior year contributed to higher quarterly expenses. That said, year-to-date same-store office cash NOI increased 3%, and we are increasing our 2018 office midpoint guidance from 4% to 4.5%, reflecting our continuing confidence in same-store office cash NOI growth.

Even more importantly, as we've noted in the past and more recently at our May Investor Day, our same-store has never fully captured our NOI growth potential. Of our 45 in-service office properties, only 30 run through our second quarter same-store comparison. Our 15 non-same-store in-service office properties are poised to contribute cash NOI growth in 2018 of 25.2%. Likewise, our 2 same-store studio properties and non-same-store Sunset Las Palmas Studios are poised to contribute cash NOI growth in 2018 of over 10% and 130%, respectively. Collectively, our same-store studio and non-same-store office and studio properties, excluding properties sold this year, will comprise 34.9% of our total projected cash NOI for 2018, thus contributing substantially to our growth this year.

Before turning to guidance, I'd like to add an observation to Art's earlier update regarding Campus Center, specifically as it relates to our future projections. As you know from earlier calls, we have assumed that the first 1/3 of Campus Center would be leased as of January 1, 2019, with the remaining 2/3 leased in equal amounts as of July 1, 2019, and January 1, 2020. As Art indicated, leasing activity remains strong and a lease commencement as of January 1, 2019, remains achievable. Even so, we would be remiss if we did not point out that we are now 5 months out from that first milestone, and that as we work through single building to full campus requirements, the timing and size of any lease or leases remains fluid. We will continue to update you on our progress and views regarding projections in the coming months as opportunities permit.

As Victor mentioned, assuming Prop C is not successfully invalidated, we do not expect the impact to be particularly significant. Adjusted for our ratable share of 1455 Market, we estimate that the tax will impact our NOI beginning in 2019 by 10 to 15 basis points, depending on the level of lease expirations at our San Francisco properties in any given year.

Turning to guidance. We are revising full year 2018 FFO guidance to a range of $1.83 to $1.89 per diluted share, excluding specified items, compared to the prior full year 2018 FFO guidance range of $1.87 to $1.95 per diluted share, excluding specified items. Specified items for the full year 2018 FFO guidance consists of transaction-related expenses of $100,000 and the write-off of original issuance costs of $400,000 associated with the recast of our unsecured revolving credit and term loan facilities, both of which we specified as excluded from our first quarter 2018 FFO, along with $900,000 of unrealized gains from changes in fair value on non-real-estate investments specified this quarter.

As noted in our press release this morning, in addition to all previously announced transactions, our full year 2018 FFO guidance update includes the impact of several significant recent transactions. We estimate the sale of Peninsula Office Park will result in a $0.04 per diluted share decrease to prior guidance. Our lease with Honey Science Corporation at Fourth & Traction specifies a landlord build for tenant improvements, which pushes our assumed commencement date to mid-2019. Previous guidance assumed that a tenant would take possession starting this quarter for construction of tenant improvements, thereby triggering straight-line rents. We estimate the later commencement will result in a $0.015 per diluted share decrease.

Finally, we have also accounted for the early contribution of Westside Pavilion to our joint venture with Macerich, which we now expect to occur sometime in the third quarter. We estimate that property's in-service component will result in a $0.005 per diluted share increase.

As a reminder, our full year 2018 FFO guidance excludes the impact of unannounced or speculative acquisitions, dispositions, financings and capital markets activity.

With that, I'll turn the call back to Victor.

Thank you, Mark. We accomplished a lot in the second quarter and in the weeks leading up to this call. And we expect continued momentum in terms of our ability to realize embedded growth while expanding our pipeline of exceptional value-creation projects.

Our markets continue to outperform. Our leasing activity remains very strong, both in terms of volume and rate. We made great progress on expirations as well as first-generation leases, including leasing the entirety of Fourth & Traction. Our development and redevelopment pipeline continues at the same rate for anticipated projects in our markets. Year-to-date, we've completed nearly $0.5 billion in asset sales. On account of our vision and expertise, the quality of our balance sheet and our liquidity, we're poised to execute on the very best acquisition opportunities in the near future.

I'd like to thank the entire Hudson Pacific team, in particular, our senior management, for their hard work for this quarter and the year so far. And everyone in this call, we appreciate your support of us and the interest in Hudson Pacific Properties.

And with that, operator, I'd like to turn it back over to you and open the call for questions.

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

I guess, Art, going back to Campus Center. So can you maybe just quantify the level of square footage, the kind of -- the different discussions you're having and when they might take occupancy or would take occupancy just so we can get a better sense of the timing?

Yes. So as I mentioned, Jamie, it's -- right now, we're looking at 5 deals, about 1.7 million square feet. Some of which are partial buildings and multiple buildings. Recently, I think the uptick in that activity reflects the users that are out there that involve R&D, light manufacturing, lab components, right, which we're obviously out doing our due diligence with, as they are. We're with the city, trying to figure out how we can expedite construction on our land. So some of these -- I think 2 of these deals are probably -- and if you're asking me when they're going to take occupancy, they're in flux because they have existing locations, right? And so it's a very fluid situation. I'm not trying to be coy with you, but I think probably mid-'19.

Okay. And that would be recognizing GAAP revenue mid-'19? I know this is all...

Well, it all depends, Jamie, on whether or not we're -- we turn it over to them for TI construction or if it's a landlord build. It's ready to turn over on a moment's notice. So it's possible GAAP revenue would kick in upon the signing of the lease. But that's to be determined depending on the tenant that we potentially make a deal with.

Okay. All right. That's helpful. And I guess for Mark. I mean -- so it seems like Fourth & Traction was in your guidance, getting leasing done there. Can you talk about other, whether it's vacant spaces or developments that are also included in your guidance for the back half of the year, where leases haven't been signed yet?

Well, there's no -- nothing like Fourth & Traction for the remainder of the year to sort of focus on in terms of significant blocks of vacancy that we are expecting to get absorbed. Obviously, the guidance is reflecting either backfills or absorption of some existing vacancy, but it's far more granular than that, Jamie. So there's no like single asset with a large block of vacancy to point to in the back half of the year on -- but obviously, we have vacancy here and there throughout the portfolio and still a decent amount -- we have 4%, I think, of the portfolio expiring over the year. So there's going to be some backfills on that. So anyway, I don't think there's any one particular thing really to point you to though, Jamie.

Okay. But in terms of either development or, I mean, I guess, that's one stands out as...

Yes, right. If you look at the development pipeline, nothing has a scheduled commencement date on it, right? I mean, I would say, CUE still has a couple of floors that commence. But we don't have any scheduled commencement at 405 Mateo this year. We're not expecting the 2 floors at 450 Traction to have a commencement this year. Maybe we get lucky on that. Certainly, nothing at Harlow or EPIC or anything like that. So there's nothing on the development side that has a scheduled commencement.

Okay. And then finally, just thoughts on large potential future asset sales and -- that might be -- have a meaningful impact on earnings?

Jamie, I don't think we really have anything that we've earmarked for sale now going forward for the rest of this year, even first half of the next. There's nothing on the agenda. So I wouldn't read into anything else.

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

Maybe just a follow-up on Jamie's guidance question, take the other side. What do you think the probability of a larger acquisition this year is that could kind of bump guidance back up?

I mean, Craig, we don't comment on acquisitions until they're ready to go. So we've got a tremendous amount of capital in the pipeline now with this additional $210 million. I don't even know what the number is. But it's going to be...

$900 million.

$900 million or something like that. I think somebody had written -- it wasn't you, but somebody had written on us this morning some comment about they're selling assets to fund acquisitions and to fund development. I mean, we've got more capacity than we've ever had in the past. And that's clearly not the case. I mean, this disposition was something that I had indicated we were working on something several months ago for a noncore asset. And we've got our eyes on a few acquisition opportunities that I think are accretive. And most importantly, they fit into the mold of the deals that we've done in the past with some value-add and some market expansion in the current markets we're in.

Okay, that's helpful. And then going back to Cisco. Kind of -- it sounds like there could be a change of tenancy there to more maybe R&D, lab space, manufacturing. Does that at all change kind of what you guys have budgeted for TIs at the project or kind of what return thresholds could be?

So let's just sort of clarify. The easy answer there is no, because the TIs are just for the existing office space. So what we found -- and it's all positive news. What we found with the -- more product on the marketplace that has been eaten up recently and the City of Santa Clara's acquisition of the asset of our #1 competitive asset in that landscape has also helped us out. But what we found is a lot of these office tenants have a component of -- and it's almost identical, so like 75,000 to 100,000 feet of some R&D component. And so we've been talking with -- and our leasing team has been entertaining conversations with several of these tenants. And almost uniformly, they all want some component of that, that we would build in addition to taking the office space. So that would be additional square footage and addition of valuation add on an accretive level that we will build out to -- different than what Mark has been just talking about, straight rental income on the asset.

Okay. So you guys will tap into the 1 million-square-foot development capacity at the site, you think, if you land one of these tenants?

Yes. There's 2 components to that. The easy answer is yes on the 1 million square feet, we would tap into that. And secondarily, we've looked at a portion of the parking lot, the surface structure to put one of the buildings for one of the tenants that we're talking to right now. And the city of Milpitas has been very helpful in helping us look to expedite the process here because they're welcoming these tenants. So there's 2 areas. One would be the 1 million square feet and then the other would maybe be taking some parking away and build right on the surface lot.

Okay. And then just separately, the acquisition of the adjacent studio production facility. I know it's kind of sale-leaseback for 3 years. But is there a longer-term play that you guys bought that for or would it stay as is and maybe just bump rents in 3 years?

No. This was one of the several that we had looked at, and we've done one prior too. This is all part of the master plan of additional development for 400,000 additional square feet. And this sort of ties into our Harlow development. This -- right now, it is used as -- on the prepared remarks, a sale-leaseback by the current owner for up to 3 years. After that period of time and during that period of time, we're also using some of them for staging for the development of the parking structure and Harlow. And this will be inclusive of us when we build our master plan out to use this as an additional development opportunity for the additional 400,000-plus square feet that we're looking at. And given the activity we've had at the very early stages of Harlow, we're pretty excited about this being a good acquisition for the future development.

Got you. And then just last one for Mark. You kind of mentioned the same-store portfolio as kind of less indicative of the overall portfolio. But just curious. Kind of seems like the bump to the range indicates sort of back half acceleration. Is it mostly expenses kind of stabilized relative to prior year? Or is it all in the revenue side that kind of drives the ramp?

Yes. So one, it may not be obvious through the number. But even though we had that flat same-store second quarter result in the office component, believe it or not, that was actually somewhat better than we had modeled. So part of the bump in office same-store is driven off of the better second quarter result. We also -- it's not as much driven off of expense. You can see expense has more or less stayed in line, it just happened to be relatively elevated in the second quarter compared to the 1.6% year-over-year increase on the revenue side. So I wouldn't link it to expense. I would rather say, when we go back through and we do this, the team does this every couple of weeks and looks on a suite-by-suite basis and what our backfill and renewal assumptions are, it looks like we're trending really favorably in the back half of the year. And so we were not only able to -- so we were able to bump that same-store guidance, and that's really the bottom line. It's not really tied necessarily to expense. It's more tied to just confidence around where we're trending on the revenue side.

Our next question is from Manny Korchman with Citigroup.

Just going back to Fourth & Traction. Given the timing of the take-up of the space by the tenant between '19 and then a few years later for the other 2 pieces, how much of that is going to impact your expected yield on that project?

So it actually -- our yields are intact, it's really just a matter of timing. Initially, mid-2019 because there's no precise date. It really commences based on when we can -- how quickly we can complete the landlord build. But in 2019, cash yields are relatively light because we've got free rent and so forth, so it's like a little -- it's a touch over a 1% cash yield starting for the 12-month 2019. The GAAP is right in line with where we expect it starting mid-2019. It's actually, we think, between a 6% and a 6.2% GAAP cash -- GAAP [cap rate] starting mid-2019. The cash will catch up to that. It will be just a touch shy of the 6% cap rate , call it a 6% cap rate , starting mid-2020 once all the cash rents kick in. So our -- if you recall, in our fourth quarter 2017 disclosure, we had indicated a 6% yield on the $97.4 million of spend. And once all cash kicks in, in mid-2020, we'll be right at that yield on that $97.4 million. So our underwriting is intact. It's merely a timing matter at this point.

Got it. And then switching to the studio business. You mentioned that part of the NOI growth increase was on more production going on. Is that going to continue to ramp into the end of the year and into '19 or is there a point where you sort of max out the income from that production side of the business and you'll get a good amount of growth until the end of the year but that's going to stabilize into next year?

Well, I think we continue to see high levels of production activity. Indeed, I think, if anything, we haven't had quite the level of production activity from some of our stage users that we expect to see in the back half of the year, just as shows have turned over and so forth. So I think production activity will continue to improve. I would also add that it's not merely -- some of the improved results on the production side aren't purely related to just level of activity. Our team has also done -- like Bill and his team have done a tremendous job of continuing to make inroads on the expense side. For example, they've done a fabulous lighting package that has really brought expenses down. And so we've actually -- we're expecting to see better lighting margins in the back half of the year on account of that -- all those efforts. So it's -- we're seeing better year-over-year results, both on account of higher production activity but also on just better margins.

Our next question is from Blaine Heck with Wells Fargo.

Victor, maybe to follow-up and clarify on Craig's acquisition question. And sorry if I missed this. But you talked about possible expansion into new markets at the Investor Day. Does anything you're looking at now fit into that bucket? Or is it still all within current markets?

So currently now, the stuff we're looking at is in the existing markets we're in. We're still in our due diligence phase. We spent a lot of time looking at some studios in New York, Atlanta and Vancouver, as we've mentioned. We've got more work to do for us in those marketplaces. I think we have sort of earmarked some markets we like better than others, candidly. But there's nothing on the horizon of any studio businesses that we're looking to acquire. The acquisition market that we are -- what we're working through right now is in our existing core 3 markets in Seattle and the Bay Area and here in Los Angeles.

Got it. That's helpful. Art, at the Investor Day, you talked about Metro Center and Metro Plaza specifically, and both had deals in negotiation and active prospects. I think you touched on Metro Center but I'm not sure I heard anything on Metro Plaza. Can you just maybe touch on the updated prospects there?

Yes. So we're busy with our VSP program there, but we've got -- just to get to the punch line, we're probably 50,000 square feet of deals in negotiation. That's 2 [floors] in leases. And probably as we complete some of these additional VSPs, we've got 30,000 square feet of active prospects that are looking at taking those spaces. So activity is strong in both locations. I think we've got an uptick in activity, going back to Metro Center, of about 90,000 square feet in active negotiations there. So that's an increase from what I had reported back on Investor Day.

Got it. Helpful. And then last one, just following up on the development plan for Sunset Las Palmas and Sunset Gower. I guess, where are you guys in the entitlement process and possible timing of starting either of those?

Well, we filed our preliminary entitlement process for Gower. We're probably -- I mean, I'm looking at -- my guess is another 18 months is probably a good guess for Gower. We have not filed yet, but we have broken ground on Harlow, as we mentioned. But we've not filed yet for Las Palmas. And so my guess is that's first of the year filing by the time we get our initial sort of conceptual drawings ready to go and file. And that would be maybe 18 months from that point on. As I mentioned, Blaine, the demand right now -- we had let the market know that we hadn't decided if we're going to lease out Harlow or we're going leave it for the office production space. But it seems that there's a lot of activity around us looking to lease it out. So that would expedite that time frame, but I'm not so sure it's going to expedite the development time frame. But from our decision-making tree, it could.

Our next question comes from Tom Catherwood with BTIG.

Just want to swing back to the studio business. You talked about kind of a pickup in utilization through the second half of the year. But if we look at guidance, even though it's up materially this quarter, it still would imply a pretty big kind of roll down given the run rate through the first half of the year. Is there anything else happening in the kind of -- the same-store business there that's pulling it down through the second half?

Well, you're right. It's not necessarily a pull-down. It's not as if we're expecting some giveback of a bunch of stages or anything like that. You are right that we -- I mean, in our first quarter, we were in the high 30s same-store. But remember, it's not exactly -- it's not indicative, the same-store result isn't indicative of necessarily what's going on trending with any year. It's how it compares to the results of a prior year, right? And so we -- basically, what you're seeing within that same-store portfolio is, there's -- as we go to the later half of the year, there's a little less utilization of some of the stages, not in terms of occupancy but in terms of production activity, when compared to the utilization in the prior year for that same period. And so we're still really -- we still have very high occupancy. We still are -- we expect shows to be in -- there to be high production activity. It's just really a matter of the timing of that activity when compared to the quarters of the previous year, if you follow my point.

I got you on that. I appreciate that commentary. And then maybe for Art. In your prepared remarks, you talked a lot kind of about strong demand and low vacancy rates in a lot of your core markets. How about the trends in tenant concessions? Have you had any success pushing back on that and does kind of your ability to do that differ depending on your markets?

Yes, of course. It varies market to market. But I would say, on a broad brushstroke, we're not -- we're getting rate. We're pushing beyond the rates that we anticipated and we're not getting a lot of pushbacks on concessions. I will say, as a general note here, the cost of tenant improvements are up generally. But that's not really a tenant push.

Got you. And then just one last one for me. I know it's a bit off, but it looks like in the fourth quarter of '19 and then mid-2020, you have kind of two full-building leases, one at -- both in LA that are coming due. Have you been able to engage with those tenants at this stage and do you have any sense of the likelihood of renewal?

Yes. So like any of our large tenants, we're out in front of it early. We're talking to them about what their needs are relative to programming and things like that. So yes, we have -- we're in active discussions. They're both focused on staying within our portfolios and one of the tenants is even talking about expansion into another asset.

Our next question is from Alexander Goldfarb with Sandler O'Neill.

Just a few quick questions here. First for Mark. I don't think I heard in your opening remarks, but do you have an estimate for the lease accounting impact from FASB's change for next year?

We are still -- we run various estimates. We're not really in a position to give you one at this point because we're still doing analysis around how we might be able to approach maybe less of the legal component of it. Because you know, we're losing the ability to capitalize legal cost. And also the payroll component. And as I stare at Art and Derric about doing exclusively overrides for bonuses. But no, in all seriousness, we haven't -- we're not ready to give you that number. We're still analyzing it, Alex.

Okay. And then Art, just going back to the Campus Center, which sounds like it's -- instead of Jan 1, if I heard correctly, it's probably mid-next year. At the Investor Day, you guys provided a rather thorough review of a lot of your big blocks and the amount of leasing. In fact -- I'm sorry, the amount of demand, in fact over-demand for all the spaces. Can you just provide sort of perspective on -- at the Investor Day, you had a lot of demand for that space, but I guess it just takes a while before that demand translates into actual leases or did some of those deals fall out, just to help provide perspective?

Those large blocks, I mean -- I think I touched on 7 assets. I think a couple of them I have already discussed right now. Metro Plaza, Metro Center. Again, for the VSP, as I said, it's kind of carrying the day there. We've built out space. We've leased up probably about 70%, 75% of those. We're reloading. So yes, it takes a little bit of time to re-lease the space. In some cases, Alex -- in some cases, if we're losing -- if we lose a full-floor deal, for example, we're dividing the spaces down and we're doing it in a way that the market is consuming it.

Okay. And then finally, Victor. On the Las Palmas additional space that you guys bought. The implied value on a stand-alone was [7 30] a foot. But obviously, it sounds like it's part of a larger project. So how would we think about the economics of this parcel is -- does this parcel allow you to do the 400,000? Or this was sort of incremental and not necessary but this may open up other possibilities?

So it has nothing to do with the 400,000. The 400,000 is part of the Campus. This is in addition of and enables us to actually do some other things that gets us there, I think, in a much more efficient way. The way our Chris and his team have looked at going to the city with other things that we want to offer up to kind of get the entitlements that we think we need through the process. So it's going to be incremental to the 400,000 feet. And in addition to parking and things like that, that we don't have to put on site, we can put there later on and things like that.

Okay, okay. So it's additive? Okay.

Yes.

(Operator Instructions) Our next question is from Vikram Malhotra with Morgan Stanley.

Mark, maybe last year, you had given sort of a target for the lease-up portfolio. That changed a little bit. And I know you've made some good progress in some of the assets. They moved into stabilized. But can you just give us some sense -- I know you've given a lot of detail at the Investor Day. But can you just give us some sense, if we think about some of the assets, whether it's Redwood Shores, Foster City, what's the time line? Is it 6 months? Is it 2 years? When can we expect these to be stabilized?

Well, I mean, I guess there's any number of ways to think about it. But if you looked, for example, at the [remainings], we're only down to 6 lease-up assets now within the -- that original portfolio. And so Palo Alto now has moved up into stable -- it's stabilized. And of course, we've sold POP. There's a couple knocking on the door. Gateway is at 90.4% leased and Techmart is at 96.3% leased. So it's probably reasonable to think that before the year is over, Techmart will have moved out of lease-up, and perhaps even Gateway because it's like I said, it's so close. That'll leave 4 assets, which are in the kind of anywhere from the high 50s, close to 60 to low 70s and hopefully trending in the right direction. I don't know that it makes sense for us to try to pinpoint a date on this call for when, let's say, for example, those 4 remaining lease-up assets will hit stabilization. Maybe not on this call but on a follow-up call, if that's -- after we get results on the next 2 assets to hit stabilization, maybe we would talk about when those might. But I think thematically, of the 20 assets that we still own, you can see that they are clearly all trending towards stabilization. I wouldn't be surprised, controlling for Campus Center, if they are collectively, by the end of the year, somewhere in the high 80% leased range. I'm not going to try to pinpoint the precise percentage. But I think -- again, we're -- little by little, we're getting them all towards stabilization.

Could any of those [fix] or -- could any of them turn into maybe disposition candidates in the next 6 months?

No. I mean, I think, in response to an earlier question on that, there's nothing we flagged at this point for disposition.

Okay. And then maybe early, but just wanted to maybe get some more color on conversations you're having from major tech players or even smaller tech players. Obviously, this earnings has been very mixed, Apple versus some of the other names. I just wanted to get a sense of -- maybe 2 months ago, the talk was that as big-block spaces come back, you're seeing more companies go back, which is a change from last year. Anything that may have changed in pipelines or conversations or outlooks that you may have heard over the last month or so?

No, Vikram. I mean, listen, our activity has been large blocks, all tech-related and media-related companies. Conversations are still -- lots of the big companies that you know of are looking for a lot more space. And there seems to be still a very good positive aura around future growth and demand.

Okay, great. And then maybe just last one. I know you touched upon this, that you're still looking at -- you're doing due diligence on certain markets for studios, for example. Any sense of the opportunity set there versus -- if you were to sort of bucket your existing markets versus these new markets, would you think you'd venture into some of them? Is that sort of a 6-month time line? Is it that you'd like to do due diligence and could be maybe a 2-year time line? Just want to get a sense of how should we think about you entering new markets from a timing perspective.

I mean, listen, I think you got to think about us -- growing our existing markets is 100% of our priority. We will continually evaluate. As I said, there's nothing on the horizon. So it's not a 6-, or 12- or 18- or 24-months conversation. If there is, we'll give indications that those are the markets or some markets that we will look on a studio basis to go into. But right now, our growth opportunities are still in our core markets. But we need to keep our diligence team evaluating these marketplaces from a competitive standpoint, from a pricing standpoint and a yield standpoint to make our existing portfolio as conducive as it is and also look at what's in the marketplace to see if there's opportunities. But I don't want to give any guidelines as to what we're looking at now and a horizon by which we're going to do it. Because quite frankly, the deals that I'm seeing and the deals that our teams are evaluating are in our core markets right now.

Our next question is from Dave Rodgers with Robert W. Baird.

Just a couple of quick ones left for me. I think in your prepared comments, Victor and Art, you both talked about kind of EPIC, Harlow, Westside Pavilion and MaxWell all in a bucket and said kind of partial or full-building users in negotiations for those. Maybe diving into the 2 larger, in EPIC and Westside, can you talk about how you're feeling about the negotiations for those 2 specific assets and provide a little bit more detail and any timing feelings that you're having?

Well, I don't want to get caught in a time frame standpoint but I can tell you, our feelings have not changed. And the bucket of assets that you looked at, we're in leases -- in conversations and leases on a couple of them. So that gives you sort of an indication. I don't know if that means 3, 6, 9 months, whatever it is. These are large facilities and large single-tenant opportunities as well as multi-tenant opportunities. These leases take time. But I'm very confident that in the near future, Harlow, EPIC, 405 Mateo, Westside Pavilion, we'll have some news on some or all.

In the earlier-than-anticipated acquisition of Westside, was that just you got through documentation faster or was that a leasing catalyst? Any more color on that?

I'm sorry, Westside what?

On the early takedown of Westside.

Oh, no. No. I mean, we took it down just because of the time frame. There was also some conversation around -- there was existing debt that we're trying to get rid of. We wanted to move through that. I mean, we are up and running on our entitlement process on that right now. And so for us to -- it just made a lot of sense for us to take it down because we're fine with the city and doing some changes with our architects. And it made a lot of sense for us to just have full control versus through the venture that we had through Macerich. That's all it was.

Okay. Got it. And then maybe last for Art. On the Salesforce bit that you mentioned at Rincon. I think you said 240,000 square feet, 40% mark-to-market. But I was curious on that particular asset. Have you had negotiations or discussions with Salesforce about taking it back? You kind of avoided maybe that part of the conversation, and would you want to do that?

Yes. Early on, we had -- listen, they've got a lot of activity, probably 5 deals competing for that sublease. Obviously, we can't give you the details of that, but we feel very strongly about the numbers that I suggested on the prepared remarks.

Would you share any of that?

Well, I think it's -- listen, it's too -- this is Salesforce's deal. And I think it's good to say that, from our standpoint, we're going to make a nice bump when they sublease this. We know what those numbers are going to look like and I think it's extremely positive. And on top of that, we're going to have Salesforce's consistent credit going forward. But the tenants they're talking to right now are all great credit and household names. And there's no reason for us to get in the middle of this because we're going to get a lot more cash flow in that asset by the participation and we get to maintain Salesforce. I know there was some banter in the marketplace about -- there's a sublease in the market at Salesforce. We were not concerned nor are we concerned. As Art said, they're negotiating right now with a couple of people, and I think they're imminently going to make an announcement that they've made a deal, maybe a couple of months from now.

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

Thank you so much. And as always, I appreciate the senior management team, the entire Hudson family and everybody for supporting us. Have a good rest of your summer.

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