Hudson Pacific Properties Inc (HPP) 2021 Q3 法說會逐字稿

Good morning, and welcome to the Hudson Pacific Properties Third Quarter 2021 Conference Call. (Operator Instructions) Please note, the event is being recorded.

I would now like to turn the conference over to Laura Campbell, Executive Vice President, Investor Relations and Marketing. Please go ahead.

Thank you, operator. Good morning, everyone. Welcome to Hudson Pacific Properties Third Quarter 2021 Earnings Call. Yesterday, our press release and supplemental were filed on an 8-K with the SEC. Both are available on the Investors 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 Investors section of our website.

During this call, we'll discuss non-GAAP financial measures, which are reconciled to our GAAP financial results in our press release and supplemental. We'll also be making forward-looking statements based on our current expectations. These statements are subject to risks and uncertainties discussed in our SEC filings, including those associated with the COVID-19 pandemic.

Actual events could cause our results to differ materially from these forward-looking statements, which we undertake no duty to update. Moreover, this quarter, we've once again, included certain disclosure prompted by COVID-19 business changes, which we won't maintain as business operations further normalized.

With that, I'd like to welcome Victor Coleman, our Chairman and CEO; Mark Lammas, our President; and Harout Diramerian, our CFO. They will be joined by other senior management during the Q&A portion of the call. Victor?

Thank you, Laura. Good morning, everyone, and welcome to our Third Quarter 2021 call. As we sit today, more than 18 months into the pandemic, the advantages of our focus on top-tier tech and media markets on building and reinvesting in the state-of-the-art portfolio and on maintaining a strong balance sheet, have never been more evident.

In the third quarter, we had a robust same-property NOI growth as our office and studio tenants continue to pay rent and repay deferred rent. We had another solid quarter of leasing activity on positive rent spreads. Our stabilized lease percentage remains over 92%. We're making good progress in our remaining 2021 and our 2022 expirations. We also successfully executed on multiple studio-related acquisitions, all in spite of the pandemic's headwinds.

There's definitely growing momentum around our tenants return to the office. Some have already reintegrated at least a portion of their employees over the last few months, while others are working towards either a year-end or early 2022 return. The combination of record funding and fundraising by VCs, media company spending of over $100 billion on content and significant national health and research spending has led to continued growth and hiring within the industries that drive demand for our assets, primarily tech, media, gaming and life science.

Across our markets, office leasing activity was notably elevated or showed healthy indicators, such as a shift away from short-term renewals to new and expansion deals. Sublease space contracted almost without exception as a result of tenants both pulling listings or backfilling space. We also saw positive absorption around many of our metro areas and submarkets and in most cases, for the first time, since the pandemic's onset. We're obviously very focused on maintaining our leasing momentum as the office market recovers, which Mark is going to discuss further in a moment.

We also made several major announcements around the successful growth of our studio platform in the third quarter. We unveiled plans for Sunset Glenoaks, which will be the first purpose-built studio in Los Angeles area in more than 20 years, growing our studio footprint in that market to 1.5 million square feet in 42 stages. We purchased a major site north of London to fill the Sunset Waltham Cross, which will be a large-scale purpose-built facility with 15 to 25 new stages, and we expanded our services platform with the purchases of the transportation and logistics companies Star Waggons and Zio Studio Services, enhancing our existing clients' experience, while capturing significant additional production-related revenue.

Our combined expertise with Blackstone across transactions, operations and development is second to none, and we're poised to deliver and operate purpose-built next-generation studios that will attract premium production for years to come and create exceptional value for our shareholders.

Finally, earlier this month, we received our GRESB 2021 real estate assessment results. In addition to earning GRESB's Green Star, the highest 5-star ratings for the third year in a row, Hudson Pacific was named an office sector leader for the Americas ranking first among the 22 companies in that category in terms of our development program.

In addition, we earned an A and ranked first among our U.S. office peers in terms of public disclosure. I'm incredibly proud of these results as it showcases both the dedication and the ingenuity of our team as well as the commitment to being a leader on ESG issues.

With that, I'm going to turn the call over to Mark.

Thanks, Victor. Our rent collections remained strong at 99% for our portfolio, overall, and 100% for office and studio tenants. We've collected 100% of contractually deferred rents due to date and 57% of all contractual deferrals. Physical occupancy at our properties has stayed consistent over the last several months at around 25% to 30%. While as Victor noted, activity around a return to the office is accelerating across our markets.

Our current office leasing pipeline that is deals and leases, LOIs and proposals stands at 1.8 million square feet, up over 20% quarter-over-quarter and also 25% above our long-term average. We signed 318,000 square feet of new and renewal office leases in the third quarter at 8.3% and 5.1% GAAP and cash rent spreads with the bulk of that activity, about 65% and in the Peninsula and Valley. That brings us to 1.4 million square feet of new and renewal deals year-to-date.

Our weighted average trailing 12-month net effective rents are up about 4% year-over-year while our weighted average trailing 12-month lease term for new and renewal deals held steady at 5 years. Despite facing about 360,000 square feet of expirations heading in the last quarter, our stabilized and in-service office lease percentages remained essentially stable at 92.1% and 91.2%, respectively. Recall that the addition of Harlow to the in-service portfolio as of the second quarter accounts for more than 30 of the 50 basis point drop in lease percentage since first quarter. Harlow is 54% leased, and we are in leases with a tenant for the balance of the building.

We only have 1.9% of our ABR in terms of our 2021 expirations remaining and those leases are over 20% below market. With strong activity on our fourth quarter expirations and existing vacancy, we remain confident our year-end in-service lease percentage will remain essentially in line with third quarter levels. We also already have 30% coverage on our 2022 expirations.

We continue to work on our pipeline of world-class office and studio development projects. In terms of office, we're on track to deliver our 584,000 square foot One Westside office adaptive reuse project in West Los Angeles to Google for their tenant improvements in the first quarter of next year. We plan to close on the podium for our 538,000 square foot Washington 1000 office development in Seattle later in the fourth quarter.

We're in dialogue with potential tenants and have 12 months post-closing to finalize our construction timeline. We also recently announced plans for Burrard Exchange, a 450,000 square foot hybrid mass timber building on the Bentall Centre campus in Vancouver. We've submitted a development permit application and construction could start in early 2023.

On the studio side, we plan to begin construction for our 241,000 square foot Sunset Glenoaks Studios development in Sun Valley before year-end with delivery anticipated in the third quarter of 2023. We're also working through design and public approvals for Sunset Waltham Cross Studios, the 91-acre site we recently purchased north of London and expect to have more details on scope as well as timing as we head into next year.

And now I'll turn the call over to Harout.

Thanks, Mark. In the third quarter, we generated FFO, excluding specified items, of $0.50 per diluted share compared to $0.43 per diluted share a year ago.

Third quarter specified items consisted of transaction-related expenses of $6.3 million or $0.04 per diluted share, onetime debt extinguishment costs of $3.2 million or $0.02 per diluted share and onetime prior period supplemental property tax reimbursement related to Sunset Las Palmas of $1.3 million or $0.01 per diluted share compared to transaction-related expenses of $0.2 million or $0.00 per diluted share and onetime debt extinguishment costs of $2.7 million or $0.02 per diluted share a year ago.

Third quarter NOI at our 45 consolidated same-store office properties increased 5.1% on a GAAP basis and increased 10.8% on a cash basis. For our 3 same-store studio properties, NOI increased 49.8% on a GAAP basis and 45.5% on a cash basis. Adjusting for the onetime prior period property tax reimbursement, the NOI would have increased by 27.9% on a GAAP basis and 22.8% on a cash basis.

Turning to the balance sheet. At the end of the third quarter, we had approximately $0.6 billion in liquidity with no material maturities until 2023 and average loan term of 4.6 years. in August, we refinanced the mortgage loan secured by our Hollywood Media Portfolio, accessing additional principal, while lowering the interest rate and extending the term.

We replaced the prior $900 million loan bearing LIBOR plus 2.15% per annum with a $1.1 billion loan bearing LIBOR plus 1.17% per annum. The new loan has a 2-year term with 3 1-year extension options and is nonrecourse except as to customary carve-outs. We also purchased $209.8 million of the new loan, which bears interest at a weighted average rate of LIBOR plus 1.55% per annum. Our pro rata net debt after this refinancing remained unchanged at $351 million.

In terms of our 3 studio-related acquisitions completed during the quarter, the Sunset Waltham Cross site in the U.K. and Star Waggons and Zio Studio Services operating businesses. We funded each with a combination of cash on hand and draws from our revolving credit facility. On account of these 3 transactions and other corporate activity at the end of the third quarter, we drawn $300 million under our revolving credit facility, leaving $300 million of undrawn capacity.

Third quarter AFFO grew significantly compared to the prior year, increasing by $10.1 million or over 21%. By comparison, FFO increased by 9% or $6 million during the same period. Again, this positive AFFO trend reflects the significant impact of normalizing lease costs and cash rent commencements on major leases following the burn off of free rent.

Now I'll turn to guidance. As always, our guidance excludes the impact of unannounced or speculative acquisitions, dispositions, financings and capital market activity. In addition, I'll remind everyone of potential COVID-related impacts to our guidance, including variance and evolving governmental mandates. Clearly, uncertainties surrounding the pandemic makes projecting the remainder of the year difficult, and we assume our guidance will be treated with a high degree of caution.

As noted, many companies are still determining return-to-work requirements and the impact on space needs. Because of this, for example, our guidance does not assume a material increase in parking and other related variable income. Overall, we assume full occupancy and related revenues will not return to pre-COVID condition levels in 2021. That said, we are narrowing full year and providing fourth quarter 2021 guidance in the range of $1.95 to $1.99 per diluted share, excluding specified items, and $0.48 to $0.50 per diluted share, excluding specified items, respectively.

Specified items for the full year, including those referenced in our second quarter SEC filings and the third quarter earnings release includes $7.4 million of transaction-related expenses and $3.2 million of costs associated with the early extinguishment of debt.

There are no specified items in connection with the fourth quarter guidance. I'll point out that we incurred $1.4 million of prior period supplemental property tax expenses as noted in the first and second quarter SEC filings, nearly all of which was offset by the prior period supplemental property tax reimbursement of $1.3 million received during the third quarter. So we're not identifying a specified item related to prior period taxes for the purposes of 2021 full year guidance.

And now I'll turn the call back to Victor.

Thank you, Harout. As always, I want to express my appreciation, once again, to the entire Hudson Pacific team for their exceptional work this and every quarter. And thanks to everyone for listening today. We appreciate your continued support. Stay healthy and safe and look forward to updating you next quarter.

And operator, with that, let's open the line for any questions.

(Operator Instructions)

Our first question comes from Craig Mailman of KeyBanc Capital Markets.

Just wondering if we could get a little bit more color on the expanded leasing pipeline here. Maybe give us a sense if it's strengthening in any particular market? And also from a rent perspective, is it -- is that 4% net effective rent growth still kind of staying intact given what you guys have in the pipeline?

Yes. Craig, let me have Art answer that. Go ahead.

Yes, absolutely, Craig. Yes, so the expanded -- you call it the expanded pipeline has been expanding really since the beginning of the year. If you think about where we were. We're at close to about 1.8 million square feet in the active pipeline. Those are unique deals. Just to be clear, those are not duplicative deals in any one of those assets. So it has grown about 800,000 feet since the beginning of the year. It's also grown about 350,000 square feet here in the third quarter through -- really through the Delta variant. And so we're seeing an uptick everywhere. More specifically, if you think about where we're hyper focused on leasing -- Silicon Valley is about 500,000 square feet of that pipeline, so close to 1/3. And then there's probably about 17% in Seattle, relative to the growth that we see in trailing 12, it's interesting.

On the proposals that we're seeing right now, Craig, going out the door that are kind of early stages, we're seeing an uptick. We're probably seeing a very similar uptick in face rent. And we're also seeing really less free rent being given on deals. They're going -- these are deals that are going out the door that are closed kind of end of the quarter and into the first quarter.

And Craig, on your second question on net effectives. We -- looking back, we went back on trailing 12 months net effectives for several years now. And we've been able to hold that net effective rent, if not improve it every quarter since the onset of the pandemic. And I think that trend looks like it will continue.

No, that's helpful. And just curious, I know you guys have talked in the past about Qualcomm and NFL. Just an update there and whether any of that is also in the 1.8 million square feet?

Yes. So I'll start with NFL. NFL as you know, expires at the end of next year, they exercised their termination we are actually negotiating. We're an LOI with 2 users each for the entirety of the space. So only 160,000, call it, 170,000 square feet is in that active pipeline currently.

By the way, I would add that it's over a 20% mark on that backfill.

Right. And then back to Qualcomm. Qualcomm, we're still in discussions about a reduced footprint. We're marketing the space. We're very close actually trading paper on the entire project, those marks are probably closer to 3% on Qualcomm.

Okay. That's helpful. And then just one last one. You guys continue to make good moves here on the studio side of things. I'm just curious, number one, is Blackstone at all interested in joint venturing the new acquisitions?

And number two, just given the lack of comps for that business and the value you guys are creating, I mean, what's the endgame there? Would you guys consider spinning it out into its own company to kind of realize the full value? And -- Or how long would you guys want to keep it in the REIT and maybe not get the credit for it?

So Craig, listen, on the first part, the answer is 100% yes. Blackstone -- and we had commented on that in the past. They are in the process of coming in on those deals and others that we're working on the JV side. So we're fully aligned as partners, going forward in all aspects of that business and in the overall industry. In terms of the aspect of valuation. Listen, we just bought that deal. It's very accretive. As you know, we're going to run it. I think it's more of a greater question down the road to what we do with the entire platform versus just the 2 businesses and the other ancillary income streams that we're looking at right now.

Well, that's what I was getting at because you guys are kind of building a vertically integrated kind of business there. And that's what I was getting at the whole platform, not just deal and Star Waggons.

Yes. And as I said, it's still just too early for us to sort of determine what our next steps are.

The next question comes from Alexander Goldfarb of Piper Sandler.

So maybe just following along on Craig's questioning, on the studios. When you now look at -- you have the Trailer business, which I understand are more glamorous than gross trailers, but you have that business. You obviously have tremendous amount of demand for content. How much of -- when you blend these 2 together and say that there's a tremendous amount of demand for content production.

How much more juice is there, both out of your existing studios and then out of the trailers you just acquired? So in total, as we think about the combination, is this like there's an extra 10% in aggregate NOI that you could get out of the combined platform 20%? Is there just some sort of metric the way that we can think about it?

Yes. I mean, Craig, I think it's useful to think about what...

Actually, it's Alex -- no, different shop unless Craig is replacing me, which is fine and great to hear publicly, but...

The -- sorry, Alex. I think if you look at the historical on NOI growth and recognize, of course, 2020 is unusual. We've always generated in essentially every year in more than a decade, double-digit year-over-year NOI growth. And if you -- even if you consider kind of where we're likely to end up this year, we'll be back to materially in line with 2019, which was our best year on record.

And so we're back to -- we're sort of back to the highest NOI levels that the portfolio has achieved. And I think it's fair to expect that by 2022, that NOI growth will improve at least another probably 10% year-over-year. And there's a couple of drivers around that, which is probably a little too much to get into now.

Zio and Star Waggons have the potential to perform in line, if not better, with that type of growth on a year-over-year basis. And in fact, even if you look at where 2021 is coming out -- the -- it's looking like they're going to be 5-plus percent better on EBITDA for the year than even we forecasted when we last guided. So I think it's fair for you to expect over the long term and -- or at least for the foreseeable future, while the content creation is as intense as it is, that year-over-year NOI growth 10-or-more-percent per annum is fair to expect.

So Mark, if I just understand correctly, so right now, you're back to 2019 levels is what you're saying. You expect the aggregate studio portfolio, including the Waggons and Trailers to grow at that 10% pace? And then you think there's an additional, on top of the entire aggregate, an additional 10% extra. I just want to make sure that we're understanding it correctly.

No, I'm just saying the combined platform, including these operating businesses are likely to generate 10-plus percent year-over-year NOI growth for the foreseeable future.

Okay. And then Victor, question, as you talk to CEOs, industry heads, office managers, we continue to read a lot about return-to-office state getting delayed or some companies even saying indefinitely. Is the reason that you see these companies delaying, is it truly because of COVID fears? Or is it more fears that such a tight labor market that their employees are going to leave and decamp to other companies. And that's why they're hesitant or is it they're saying one thing publicly, but internally, they're putting the screws on?

Listen, it's a great question, Alex. And I think we're getting real-time information from not just people who are our tenants, but other decision makers and companies and CEOs. I think there's a couple of factors here that we're realizing that are obviously coming to fruition. First of all, as the days go by, it's not even weeks and months, people are changing their term on this.

And we're seeing more activity -- physical activity in all of our assets and not just ours, but just in the markets that we're in, people are starting to come back sooner than we thought because it was sort of intimated that would be end of the year, first quarter, but companies are making decisions. I think it has nothing to do with COVID fears, and it has all to do with flexibility and labor and fearful of people moving to other companies that are offering that right now.

The window is closing in our perspective as to the fears. And I think the back to normality is going to happen a lot quicker than any of us even imagine, given what we've even seen since -- really since October 1. And companies are starting to make those moves. So it is a labor issue. In our opinion, it's not a fear issue or a medical issue.

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

I was hoping you can talk more about just what you're seeing in the Silicon Valley submarkets. And if you look at the portfolio occupancy quarter-over-quarter, it looks like Redwood Shores, North San Jose, Santa Clara had the most declines and your kind of L.A., Seattle market looks a lot better.

Can you just talk more about whether it's the small tenant market, the larger tenant market? We're hearing a lot about all the capital that's been raised out there, and that should translate into space demand. Just maybe more color on what's really happening on the ground across the different submarkets?

Yes. I mean, really, let's start with -- I mean, you said a Silicon Valley and the Peninsula. Silicon Valley -- and by the way, there's great news coming out of all the markets right, not just the ones you mentioned, but in Silicon Valley, gross leasing was up 1.2 million square feet, right? It was the second best quarter during the pandemic. Net absorption was down very slightly, but that was after 900,000 square feet was absorbed in the previous quarter. And then tenant demand continues to be strong, right?

They were at 3.2 million square feet, which is close to about 85% of pre-pandemic levels. and that's in Silicon Valley. On the Peninsula, very similarly, overall gross leasing was up 35% quarter-over-quarter and about 1.2 million square feet, again, which is just shy of pre-pandemic levels. And the net absorption was positive for the second time during the pandemic at 190,000 square feet and sublease space dropped by about 300,000 square feet.

So these things are actually happening on the ground, as you say, is it a small tenant market? Yes, really, it's driven by, in our portfolio, small tenants, but we're starting to see an uptick in early pipeline of under 10,000 square foot tenants really coming back out, really drafting off of the larger tenants, midsized tenants that are out there.

For example, we just did -- the largest deal we did was a 27,000 square foot law firm and then really right behind it, the 5,000 to 6,000 to 7,000 square foot deals into our VSP program are starting to appear. So we feel good, not just in the Valley, not just on the Peninsula, but in all the other markets where we're starting to see this buoyancy.

So when you -- I guess, when you think about the large leasing that's been done and when we hear about the pipeline, it sounds like a lot of very large tenants. Can you break out what the leasing pipeline looks like for stuff that's kind of more relevant to your portfolio versus the market overall?

Do you mean the deals done in the market? Those numbers that I recited to you, deals in the market? I would say really probably about 20% are deals -- 20% have been deals under, call it, 10,000 square feet. And we're starting to see in the early part of the pipeline, we're starting to see those numbers increase dramatically.

Okay. And are there certain submarkets of yours that you think will benefit more than others?

From the small tenant activity. I think you nailed it. I think it's Silicon Valley and the Peninsula. I think other markets like Los Angeles, we've already started to see an increase in smaller tenant activity, although we don't have a lot of small space. We don't have a lot of small space in San Francisco and in Vancouver, really, it's always been a mixed bag. That's been our most consistent market from a small tenant and large tenant perspective. And so I have no concerns about Vancouver at all.

Okay. And then where would you put the mark-to-market on, I guess, it's kind of late in '21, I guess, through '22 on your expirations?

Yes, Jamie, it's Mark. I want to just make sure to give you a sense of what the composition of '22 expirations are so you can get an appreciation of that. But right now, the mark on all '22 expirations is a bit above 7%. As with all -- focusing on any particular period, 66% of the expirations in '22 are in the Peninsula and Silicon Valley, where -- not the lease which includes Palo Alto.

So there's not a heck of a lot of mark -- positive mark in those markets combined. And the markets where we do have huge mark-to-market just don't happen to make up that much of the expiration. So for example, Seattle, where we have over a 30% mark happens to only be a little bit more than 2% of the expirations. Or in San Francisco, for example, we have over a 70% mark, but it's only 7% of the exploration.

So '22 -- by the way, we have phenomenal coverage already in '22. We're already over 30% covered in terms of expirations. I think telling the -- by the time we get to 2023, what you see is because of the composition of the '23 expirations, we're back to over a 20% mark-to-market on 2023 expirations.

And so as you see activity roll through in '22, which will be a combination of renewed backfill on '22, but also some renewed backfill on '23. What you're really going to see is more of a blend between the 2 marks at probably in the mid-teens 14%, 15% mark-to-market on what will be a combination of backfilling '22 and '23 space.

Okay. And then last for me, you're starting the new studio development, we keep seeing headlines of new projects out there and just more capital flowing into the space. Can you just talk about what gives you comfort on the supply side in the studio business right now?

Well, I think, listen, I think location is going to be 1 and content demand and the amount of capital going into the content markets, I mean, Jamie, you know what's out there. It's in every single headline. I mean it's -- by any estimation, it's over $100 billion for the upcoming year, and it's going to be -- that on multiple basis is for many years to come.

There will be, in our opinion, some supply issues as time goes by based on some contraction or consolidation of the business. But there hasn't been new studios built in years. I mean, as in our prepared remarks, here in Los Angeles, our studio will be the first completed and it's going to be the first in 20 years. And so there's some room and there's room in the markets that we believe are the ones that are going to be the stickiest that we talked about for several, several years on this. It's getting more headlines because obviously, it's become a space that people are now interested in.

So you said there will be supply issues. Like how far out are you thinking or what market?

I can't even guess that. But clearly, if everybody is going to continue to look to build, there's going to be some supply issues. Not in the near term.

So you're saying it's anytime soon?

No.

The next question comes from Manny Korchman of Citi.

If we continue to focus on the leasing pipeline you have, I guess, over what time frame or I guess what start time of leases comprise that? So is that stuff that is likely, if it all lands to be done in the next 6 months? Is that tenants that are looking for early '23 and they're just starting to look, and so it's in your pipeline? Just what's sort of the timing is that?

Well, generally, Manny, I mean the ones we're talking about are deals that are being papered now. And so I think maybe what you're getting out here is, and maybe I may be a little wrong. And then Art will jump in. What you're sort of getting at here is our tenants looking to lock up space at these rates for the next 12 months out or 24 months out.

And the reality is, I mean, we're real time on trading paper for tenants to move in as soon as the space is complete. So this is -- there's not a lot of lead time around that. So it's really more around 6 months. Now when you look at, obviously, a Qualcomm larger space or an NFL, where we're in the leases on 1 tenant right now. It's going to be a little different, right? Because the lease negotiations are going to get completed, and then we're going to have to rebuild all the space.

So it's going to depend on the amount of TI work and the repositioning of the assets. For the most part, all of our smaller guys, is the space ready or modification. The bigger guys, as you would obviously imagine it's going to be 6-plus months out. And that's been what we're seeing right now. The interest level though, I just want to stress what Art's numbers are. The interest level has picked up dramatically in all forms, not just the large tenant, which is just sort of a timeline, and we're going to be 2 years out of the pandemic from when it started first quarter.

And then as a result, people are starting to realize their needs. And I think the bigger question at the end of the day, Manny, you've had this conversation with our team before is quality of real estate and the quality will shine on the higher-end real estate versus what we feel is second-tier real estate, which will struggle a little bit longer like it would in any cycle. Art, do you want to...

Yes. If I could add some color to that, what you just talked about, Victor, was spot on, but if you talk about the level of the pipeline right now, I mean if you think about pre-pandemic, our average 25 months -- our 25-month average of the pipeline was somewhere in the neighborhood of about $1.4 million, $1.5 million, and now we're carrying close to $1.8 million.

So it gives you some perspective on the volume in the pipeline. And yes, these are deals with minimal downtime, right? We're talking about time to build out the space. These guys aren't land banking. They're not trying to take space way into the future and try to bank on rates now. These are tenants who need space because of demand right now. And I think it's because of -- chiefly because of confidence back in the market from smaller tenants who are, again, drafting off the larger tenants who have had this confidence and are looking past the return-to-work date to strike deals.

And then Art, the numbers you quoted earlier for Qualcomm, which I think you said was a positive 3% roll-up, and NFL, which is positive 20%. Are those on base rates? And if so, how much work or concessions will it take to get there? Or are those net rates?

No. Those are face rates that we're talking about. On NFL really, it's a TI package, it's not going to be time -- downtime to reposition space. So that's going to be immediate. On Qualcomm, there's some level of work we still need to do to clean up the space, but not very much.

The next question is from John Kim of BMO Capital Markets.

Mark, you talked about net effective rents being up 4% over the last 12 months. But just calculating this quarter, it was down about 20% sequentially and a lot of it is probably due to TIs, maybe it's a mix. But I'm wondering, if you see that net effective rent of 4% kind of trending down given the most recent evidence?

Yes, I don't think so. I mean the third quarter is -- it's fairly common for it to be a lower gross lease amount just because of summer and so forth. And so we did 318 of square footage compared to over 0.5 million in the prior 2 quarters. And I think, importantly, new leases were a higher percentage of the overall leases in the third quarter at over 40% compared to prior quarters.

Q1 was only 26% made up of new leases. And if you look at the composition of that 120,000 feet of new leases, there's 1 lease in there for 27,000 feet. It's a 12-year deal on space that hadn't been touched in 20 years at one of the Twin Dolphin spaces. So it needed a fair amount of TIs plus that at 12 years, it had a hefty leasing commission. And so it came in at like $2.16 a foot on a 12-year deal, which skewed the overall net effectives by quite a bit, right?

Because you have -- not only do you have higher new deals as a percentage of overall deals and you have a 27,000-foot deal that makes up 23% of all your new deals. And so if you adjust for that, what you see is your TI/LCs actually dropped to $54 a foot, which is low -- actually lower than prior quarter and well lower than the trailing 9 months.

So what -- as we've often said in the past, if you get too caught up on say, a smaller sample size, in this case, 318,000 feet and don't recognize that you have other footage amounts that are much larger and more impactful in prior periods, you can get kind of a distorted understanding of what's going on. So I do think the positive net effective trend is -- appears to be sustainable. And I think it's important, though, just to underscore the point, it's really important not to get too caught up in any one particular quarter's activity for reasons I just outlined.

Okay. That makes sense. And can I ask what drove the same-store NOI growth of 10%, 20% on a cash basis this quarter? It looks like maybe half of that was free rent. But looking at the occupancy year-over-year, it's down pretty significantly. So I was wondering what else has been driving and offsetting that occupancy drop.

Your observation is not the right. Most of it is -- has to do with free rent burn-off primarily at our EPIC building that asset came online, it's now producing cash NOI. There are some prior year concessions like a ferry that's helping this quarter, meaning in the third quarter last year, we had concessions that didn't reoccur this year. And then finally, on Rincon, Google's lease commenced, I think, in earlier this year from a deal we signed in the previous year. So that's contributing cash NOI and a little bit of the sublease rental revenue from the sublease that Salesforce has. Those are the main drivers.

So parking was not a contributor?

Very little, unfortunately. So there's more upside there.

The next question comes from Blaine Heck of Wells Fargo.

Victor, just a follow-up on the studio side and specifically on acquisitions. Obviously, as you said, interest in the property type has increased pretty dramatically as content creation has become a theme. Can you just talk about the size of the opportunity set to acquire studio properties versus traditional office?

And whether that's going to have any limiting effect on your ability to grow that side of the business? Or are you just more focused on development and redevelopment and the lack of acquisition opportunities or maybe competition for them shouldn't really have a major impact on your plans?

Well, competition is going to have an impact on everybody's plans, right? I mean -- but Blaine, I think the underlying aspect around the competitive set, it's been that we're not making a market now, the market is being made for us. So when you're looking at our valuation of what our portfolio is valued at, what the Street is valuing at and what the real market is valuing at, is a massive disparity. So that's only helping us in terms of that aspect.

In terms of what we see in the market, the competitive landscape has also enabled us to see some deals being marketed and some deals not being marketed. And I think our ability to grow in that area is very consistent, and I do think that you'll see us do a number of deals, not just from the development side, but on existing well-located themed marketplaces that we've identified, and we're going to continue to be a player in that. And there is enough product out there for us and others. And so I do think that, that's going to continue for some time.

Okay. That's helpful. Then shifting gears, can you give us any more color on your Washington 1000 project? Mark, I think you said you have 12 months to determine a construction timeline after closing. I think previously, you guys talked about the possibility of starting that project towards the end of '22, early 2023. Is that still kind of the most likely timeline? Or does it really just depend on prospective tenant interest in that asset?

Yes. I mean that's -- certainly, we have the freedom to commence late in '22. We're monitoring the market. We have really compelling tenant interest -- early tenant interest in it. We're at -- we're so fortunate to have bought when we did. Our all-in costs are somewhere maybe 400 below what anything has traded for of comparable quality in the market where -- and even with kind of -- if we run a really conservative rent assumption on it, we're pointing to close to an 8% cash-on-cash return. So I think probably more importantly is gauging the market, meeting tenant demand and getting underway on that so that we can deliver and take advantage of satisfying that tenant requirement as soon as we see it on the horizon. So I could see a start before then. It really just depends on what we're seeing in terms of like major tenants and their need for delivering space.

Yes. And I just want to jump in on that. There's going to be a couple of announcements that are deals that are about to be signed in Seattle. That's going to take some massive amount of space off the marketplace that's been sitting there. And these are credit -- large credit tenants that are absorbing a lot of the space that we were concerned about. So we'll be the first project when we're ready, that's ready to go because we're entitled and virtually able to build, as Mark said, as early as mid-'22, probably.

Yes. And these deals that Victor is referring to and not just direct deals, but there are also large sublease deals that are out there, and our delivery window couldn't be -- couldn't line up better, especially with the positive momentum in the market right now.

The next question is from Ronald Kamdem of Morgan Stanley.

Just a couple of quick ones. Just going back on pipeline, any more color in terms of the geographic breakdown of the pipeline? Is it sort of properly indexed in the portfolio as one region sort of jumping out in the pipeline?

Yes. I mean, I think I mentioned it before, but as you might imagine, Peninsula Silicon Valley takes up a takes about 1/3 of that active pipeline with activity. And then you really start to disperse evenly kind of 20%, 15% as we talk about West L.A., as we talk about San Francisco. Again, San Francisco is not very much in the way of vacancy right now and then Vancouver with some small tenant activity. But it's exactly how you would look at our portfolio in terms of vacancy and upcoming expirations, and we lined up nicely.

Great. And then the second question was just, obviously, there's a lot of development activity happening. And you're thinking about funding sources and sort of the private market. Does this incrementally make you maybe look at the disposition market more favorably as a funding source? How are you guys thinking about that over the next couple of years on the disposition side?

Yes, Ron, we're acutely aware of the bid-ask process right now with assets. And we've got specifically 3 assets that we've got BOVs out right now and interest in by our brokers and third-party buyers that we're going to evaluate a timeline. I anticipate probably something to be done by late this year, early first quarter in terms of our decision and then some execution on some PSAs. So yes, we are very much on top of that. And as I said, there's 2 or 3 assets for sure that we're looking at very seriously to bringing them out to market.

The next question is from Nick Yulico of Scotiabank.

I guess just going back to the leasing volume in the quarter. I was wondering maybe for Art or Mark, in terms of whether the spike in Delta affected closing of deals, whether there's specific square footage, you can cite that got spilled over here into the fourth quarter and is now going to get signed. Any perspective you can give on that?

Yes, I'll jump in and Mark, you can follow up with that. No, we didn't see that. Deals have their own timeline and their own flow. The deals that did not close -- and again, there's 620,000 square feet in leases or late-stage LOI that we're planning to close imminently. And I just think it was just the timing of those deals closing that you'll see some of them in the fourth quarter and some of them well into the first quarter. But no, it wasn't -- it was surprisingly not due to Delta. And as a matter of fact, the front end of our pipeline, the front end of our activity actually accelerated during the Delta variant.

Okay. I guess just the second question is on occupancy. I know, Mark, you said -- I think you said it should be roughly flat fourth quarter versus third quarter. I mean any rough feel you guys can give us for how to think about occupancy over the next year? And the reason I'm asking is because it looks like your expirations next year are actually higher than your expirations this year, and you did lose -- you're down what, something like 200 basis points on occupancy year-over-year. So just trying to think how we should get comfort in that occupancy doesn't continue to fall based on the lease expiration schedule?

Yes. Look, it starts with the coverage on expirations. As we mentioned on the call, we're over 30% covered on expirations. And it will grow from there. It also is important, I think, to recognize that we'll get 60%, 70% retention before the year is over. But it's also important to realize of the 1.7 million of vacancy we have, we're over 40% covered on deals, at least in negotiation or better on that existing vacancy.

So if we can make meaningful inroads on that and get to that 60-plus percent retention. We have the -- I think this -- our view that we've stabilized in terms of our in-service lease percentage should carry out through the balance of next year.

This concludes our question-and-answer session. I would like to turn the conference back over to Victor Coleman, Chairman and CEO, for any closing remarks.

Thank you for the participation and all the hard work from the Hudson team. We'll talk to you all next quarter. Have a good day.

The conference has concluded. You may now disconnect.