Paramount Group, Inc.
Q2 2021 Earnings Call Transcript

Published: 28 Jul 2021

[Operator:]

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Paramount Group second quarter 2021 earnings conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note that this conference call is being recorded today July 28, 2021. I will now turn the call over to Sumit Sharma, Vice President of Business Development and Investor Relations.

[Sumit Sharma:]

Thank you operator and good morning everyone. Before we begin, I would like to point everyone to our second quarter 2021 earnings release and the supplemental information which were released yesterday. Both can be found under the heading, Financial Information - Quarterly Results in the Investors section of the Paramount Group website at www.paramount-group.com. Some of our comments will be forward-looking statements within the meaning of the federal securities laws. Forward-looking statements, which are usually identified by the use of words such as will, expect, should or other similar phrases are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect, including, without limitation, the negative impact of the Coronavirus, COVID-19, on the U.S. regional and global economies and our tenants' financial condition and results of operation. Therefore, you should exercise caution in interpreting and relying on them. We refer you to our SEC filings for a more detailed discussion of the risks that could impact our future operating results and the financial condition. During the call, we will discuss our non-GAAP measures, which we believe can be useful in evaluating the company's operating performance. These measures should not be considered in isolation or as a substitute for our financial results prepared in accordance with GAAP. A reconciliation of these measures to the most directly comparable GAAP measure is available in our second quarter 2021 earnings release and our supplemental information. Hosting the call today, we will have Mr. Albert Behler, Chairman, Chief Executive Officer and President of the company, Wilbur Paes, Chief Operating Officer, Chief Financial Officer and Treasurer and Peter Brindley, Executive Vice President, Head of Real Estate. Management will provide some opening remarks and we will then open the call to questions. With that, I will turn the call over to Albert.

[Albert Behler:]

Thank you Sumit and thank you everyone for joining this morning. We delivered the quarter with strong operating performance as we continue to experience a steady return to normalcy. For the second quarter of 2021, we reported core FFO of $0.22 per share, which beat consensus estimates by $0.02 per share. Our same-store cash NOI grew 3% year-over-year despite headwinds from our recent vacancies at 1301 Avenue of the Americas at 31 West 52nd Street. I am extremely proud of the team's focused work as we have already backfilled over 62% of the recent vacancy at 31 West 52nd Street. This comprised of the previously announced lease with Bracewell and a new lease with Centerview Partners. As we head into the second half of the year, we are increasing the midpoint of our earnings guidance by $0.03 per diluted share, driven by better-than-expected portfolio operations and higher GAAP rental income. Wilbur will provide additional details.

[Peter Brindley:]

Thanks Albert and good morning. During the second quarter, we leased approximately 247,000 square feet including 35,000 square feet of theater space for 15 years at 1633 Broadway, which further underscores the growing optimism for an accelerated return of consumer and tourist demand in Midtown Manhattan. Aside from the theater lease, we completed approximately 212,000 square feet of office leasing with a weighted average term of 9.3 years. The highlights of this quarter's office leasing was undoubtedly the 81,500 square feet of office space we leased at 31 West 52nd Street, which backfilled over 62% of the space vacated by TD Bank on April 30. We signed leases with Bracewell, which we previously announced in April and with Centerview Partners, a leading investment banking and advisory firm. Centerview is an existing tenant at 31 West 52nd Street that expanded their footprint within the building by over 33% and now leases roughly 110,000 square feet at 31 West or approximately 14% of the building. Taking into account TD's expiration and the subsequent lease-up of a majority of that space, our portfolio wide lease rate stands at 88% at share at quarter-end, which is 60 basis points lower quarter-over-quarter. We believe that this will be the trough for our portfolio in 2021. Our remaining lease expiration profile is manageable with approximately 6.1% expiring per annum at share on a square footage basis through 2023. This is the direct result of our ongoing strategy to pre-lease space and derisk future lease role. Turning to our markets. In Midtown, second quarter leasing activity of 2.1 million square feet, excluding renewals, was up 9% quarter-over-quarter but 45% below the five-year quarterly average according to CBRE. Renewals leases accounted for 430,000 square feet during the second quarter, down 64% quarter-over-quarter, suggesting the pandemic trend is favoring renewals, particularly short term in length is shifting and tenants are opportunistically considering relocations and longer term space commitments.

[Wilbur Paes:]

Thanks Peter. Yesterday, we reported core FFO of $0.22 per share, which was $0.02 ahead of consensus. Same-store cash NOI increased 3% for the quarter ended June 30, 2021, as compared to the prior year's quarter, driven largely by better-than-expected portfolio operations. During the quarter, we executed 20 leases covering 246,922 square feet of space, including 34,570 square feet of theatre space that was leased for a 15 year term. Excluding the theatre lease, we leased 212,352 square feet, of which our share amounted to 197,000 square feet that was leased at a weighted average initial rent of $70.81 per square foot. Of the 212,352 square feet leased in the quarter, 156,117 square feet represented our share of second-generation space for which mark-to-markets were negative 1.4% on a cash basis and negative 5.2% on a GAAP basis. It is important to note that the overall negative mark-to-markets were driven largely by lease renewals at 900 Third Avenue. In fact, the 81,516 square feet that was leased at 31 West 52nd Street that backfilled the majority of the TD Bank vacancy was leased at positive mark-to-markets of 11.1% on a cash basis and 8.6% on a GAAP basis. Moving to guidance. Based on our results for the first half of the year and our outlook for the remainder of the year, we are raising 2021 full year guidance on multiple fronts. We now expect core FFO per share to range between $0.86 and $0.90 per share or $0.88 per share at the midpoint, which is $0.03 higher than our prior estimate. This increase is driven by $0.02 per share from better-than-expected portfolio operations and $0.01 per share from higher straight-line rental income driven by lease renewals in the quarter. Given stronger operations, we now expect the company's share of same-store cash NOI growth to be flat with a range between negative 1% and positive 1%. We have also improved our leasing goal for 2021, which now stands between 700,000 and 900,000 square feet for the year. Turning to our balance sheet. We ended the quarter with $1.5 billion in liquidity comprised of $507.8 million of cash and restricted cash and full $1 billion of borrowing capacity under our revolving credit facility. Our outstanding debt at quarter-end was $3.6 billion at share and has a weighted average interest rate of 3.2% and a weighted average maturity of 4.4 years. The 1301 loan became freely prepayable earlier this month and we are finalizing the completion of that refinancing, which we hope to announce shortly.

[Operator:]

. Our first question is from Steve Sakwa with Evercore ISI. Please proceed with your question.

[Steve Sakwa:]

Thanks. Good morning. Maybe this one's directed to Peter. I know you went through a lot of the leasing stats and you don't have a lot of space rolling the back half of this year. I think it's under 100,000 feet and your share of space rolling next year is under 350,000. But do you have a sense for what the renewal rates may look like on either the second half space this year or as you talk to tenants in 2022? I know the retention rate was much lower this year. But what are you thinking about over the next 18 months from a retention rate standpoint?

[Peter Brindley:]

Well, we are in front of just about every one of these tenants, Steve, as you would expect and we expect to keep many of the tenants that you outlined having lease expirations over the balance of this year and into 2022. We typically lease space 12 months in advance. But we are in discussions with these tenants typically in advance of listing space and our expectation is that we will keep of the majority of our existing tenants.

[Wilbur Paes:]

Steve, let me just, with respect to 2022, I should point out that on that 334,000 square feet that's expiring in 2022, that includes 81,500 square feet at share of Deutsche Bank. So 25% of that activity is a known vacate, right. So really, the number you are dealing with on 2022 is 250,000 square feet or so that is the real activity that we would be looking to attempt to renew.

[Steve Sakwa:]

Okay. Thanks. And maybe as a follow-up, Peter, just as you are talking to tenants and I realize that people's return offices has been a bit slower. The Delta variant may create a little bit of havoc coming into Labor Day. But what kind of discussions are you having with tenants on kind of space needs, expansion opportunities, reconfiguring existing space? Just what are the discussions like with tenants on that front?

[Peter Brindley:]

I think tenants are raising the bar, much like how landlords have raise the bar themselves amenitizing their buildings and so forth. I think tenants are looking to improve their space in new and innovative ways to not only compel their employees to come back but to enhance the overall experience. I think more and more tenants acknowledge the importance of the office and the only way for these companies to realize their full potential is to get people together and so they are looking. And Centerview is a nice example of that. They have taken additional space. They are thinking very creatively about how they are going to create a floor that is more communal in nature that brings people together that allows them to attract talent in new and different ways. And they are really at the forefront and we are seeing more and more tenants think more critically about how we can build really very dynamic space. No longer is it acceptable to deliver a bland space with a sea of cubes and beige walls. Tenants are thinking very creatively now about how they can enhance the overall experience of being in the office and as a result realize their full potential.

[Steve Sakwa:]

Okay. Thanks. And then maybe just last for me on the Barclays space. I realize you guys are working hard to backfill and I realize size of tenant will matter. But just given kind of where you are in the various discussions with tenants and realize you don't know which deal you would make, what is realistic at this point? If you were still able to get leases signed by the end of the year, what's a realistic start time frame for a lease for that space from kind of a GAAP revenue perspective?

[Albert Behler:]

Steve, as we have discussed over the years, these are large spaces and they normally take their time to get negotiated, especially in New York. And so you have to expect that we put out the goal that we would rent half of the space, of the vacant space. And we stick to that and you should expect that you would do more in the second half of this year and that's where we are at this point. So we don't want to give you much more in detail. We will most probably not get much of revenue this year at all on that space,

[Wilbur Paes:]

I think, Steve, you are alluding to, would we be recognizing GAAP revenue really in the second half of 2022? And assuming we hit, which we believe we are going to do what Albert outlined in terms of our goal for year-end. But let's assume a deal gets done in this year, I think the expectation that the second half of 2022 would be revenue producing from a GAAP basis is entirely realistic.

[Steve Sakwa:]

Great. Thanks Wilbur. I appreciate it. That's it for me.

[Albert Behler:]

Thank you Steve.

[Operator:]

And our next question is from Vikram Malhotra with Morgan Stanley. Please proceed with your question.

[Vikram Malhotra:]

Thanks so much. Good morning. Maybe just first one on the pipeline you have outlined of tenants looking at spaces that are vacant this year and maybe expiring next year. I remember last we spoke, you had outlined more demand from small and medium-sized tenants. Can you give us a flavor of kind of the pipeline today, maybe by size and sector for yourselves?

[Peter Brindley:]

Sure. Vikram, this is Peter. I would say that we are seeing quite a bit of activity from financial service tenants. They are, in our experience, leading the charge. I think it's been reflected in the statistics that they represented, I think, contribute approximately 40% towards leasing velocity year-to-date. And so we are seeing more than our fair share of financial services. I think just because a function of our product is such that we are also seeing large tenants, right. Of course, 1301 being our primary focus. There are large tenants in the market as well. But the point I made previously holds true, which is we are seeing quite a bit of demand from smaller to mid-sized tenants as well, predominantly financial services, but not in its entirety. We are working to convert prospective tenants that represent other industries aside from financial services or call it the fire sector more broadly. But generally, we feel that activity continues to increase week-after-week and we feel generally pretty active in our portfolio.

[Albert Behler:]

And you see a little bit of flight to quality. You see tenants that take this as an opportunity to get into a Class A building. Tenants are very focused on the safety and security of their employees in the future and that's where we are focusing on as a company to offer the best product there.

[Vikram Malhotra:]

Okay. And then just the expectation, I know at the TD space you had a nice rollup on a cash basis. I am just wondering, like, how representative is that of sort of your other big vacancies? Just new or updated thoughts on where the mark-to-market could shake out for the Barclays space?

[Albert Behler:]

Look, every building is different. It's like with, if you have children, you have a couple of them, every child different, has a different character. So every building has a different character and every lease is different. And sometimes you have raw space and of course you have to invest more capital to get it leased. And some assets are in higher demand. So it's very hard. You have to look at it asset-by-asset here.

[Vikram Malhotra:]

And well, just specifically on the Barclays space, what's the latest relative to maybe where you started the last year at?

[Peter Brindley:]

I think the expectation, Vikram, is still the same. I think in a pre-COVID environment, we thought it was going to be a low double digit uptick in mark-to-market. And I think we are now in the mid single digit uptick with respect to the Barclays space. Nothing has changed, in our view, relative to where we were when the year began.

[Vikram Malhotra:]

Okay. Great. And just last one, Wilbur for you. Can you just clarify two things? One, the $5 million termination income. How much of that actually is at your share impacting your $0.22? And then I am assuming the termination income is backed out. So the 3% same-store is excluding termination income.

[Wilbur Paes:]

That is correct. So on the same-store question, we typically do not include termination income as part of our same-store. So if look at a reconciliation, there is a negative adjustment that backs out the impact of that termination income to arrive on an apples- to-apples basis. That same-store is organically up 3%, excluding termination income. With respect to the impact of that on earnings, that $5 million was an asset in which we have a 31.1% interest, namely 300 Mission. And so our share of that was about $1.5 million. So the contribution is really $0.005 with respect to this quarter's beat in terms of how termination impacted this quarter's numbers.

[Vikram Malhotra:]

Great. Thanks so much.

[Wilbur Paes:]

Sure.

[Albert Behler:]

You are welcome.

[Operator:]

And our next question is from Derek Johnston with Deutsche Bank. Please proceed with your question.

[Derek Johnston:]

Hi everybody. Good morning. It seems that expectations on leasing for full year 2021 from the guidance range has upticked a little bit. The low-end, I believe, went from 600,000 square feet to 700,000 square feet. So this kind of leads us to believe that you guys are becoming incrementally more positive on maybe perhaps the vacated Barclays space. Is it a fair question if I asked if you guys are trading paper at this time?

[Albert Behler:]

Well, I mean trading paper is a long process, as I just mentioned a minute ago. In New York, these kind of leases, especially the larger ones, take a while. And I think Peter has pointed out that we are having proposals out and I think that's as far as we can go. But we feel generally more optimistic as we were in the beginning of the year. Yes, we do. In both of our markets, the activity on the leasing side has picked up. And that's why we feel comfortable to increase that target for this year.

[Derek Johnston:]

Okay. Great.

[Wilbur Paes:]

Yes. Derek, maybe just to add some color on the leasing guidance bump, as you noted, we bumped the lower end. That implied a 50,000 square feet bump at the midpoint of the guidance. And part of that also stemmed from a lot of the renewal activity we did this quarter which in when we originally came up with our guidance assumptions, we weren't sure whether those tenants would renew. And that has a direct impact on earnings as well. So if you noticed on the core FFO guidance, we bumped $0.01 because of straight-line rental income. That is directly related to that leasing guidance bump as well, right. So you had renewals, which otherwise space that would have been vacated rather and that would not have contributed to a straight-line increase in the current year. But that space got renewed and as a result of that we are picking up some straight-line on the back half of the year.

[Derek Johnston:]

Okay. Great. And then San Francisco has certainly rebounded more slowly, probably because of the prolonged lockdowns. But where do you see demand coming from? Is it coming from the traditional tech tenants? Or are you seeing more fire activity in leasing in San Francisco? And when do you really think we will see an inflection point leasing demand in that city? Thank you.

[Peter Brindley:]

Derek, we are seeing venture capital funding has reached record levels most recently in the second quarter, just shy of $4 billion raised by San Francisco-based companies. So we are seeing a lot of early-stage technology companies that are the recipients of all of this capital expand in the market. We are also seeing a lot of private equity and financial services tenants that are choosing to upgrade the quality of their real estate rather. And so we have been very active. In fact, at several of our buildings, we have had competing offers that we have now advanced to lease negotiations. So I would say, it's predominantly financial services and early-stage tech that have been most active and they are early going, in our experience.

[Operator:]

. And our next question is from Jamie Feldman with Bank of America. Please proceed with your question.

[Jamie Feldman:]

Thank you and good morning. So I guess as we think about Labor Day and tenants coming back, what are your expectations for utilization in the portfolio? And then also how do you think that's going to affect operating margins?

[Albert Behler:]

Well, we as a team, the Paramount team is back 100%. So we want to be leading by example. We know from and we are surveying our tenants by our property managers being in close contact with all of our tenants. We get an indication that after Labor Day, over time companies are getting back to hopefully by end of the year somewhere around 60% or so occupancy and some of them are doing part-time still work-from-home. I think it also depends a little bit of whether the Delta variant is making a major spread into New York and San Francisco. Currently, it looks like because of the high vaccination rates, it's not going to be an issue. But I think that might tend some of the tenants to be a little bit more cautious. We see a gradual uptick already now and we are looking optimistically into the second half of the year for this.

[Jamie Feldman:]

Okay. Thank you. Clearly, the Delta does raise some question, I guess. But I guess, are you seeing the normalized rate, you think whenever things do get back to normalcy or no? I am just trying to, like, think of apples-to-apples. Like what was it before the pandemic and where do you think it return to based on what you are talking to you are your clients, talking about with your clients?

[Albert Behler:]

Yes. This will be more into 2022. If you look at before COVID, occupancies will be more 2022. I am saying it's gradually picking up, especially after Labor Day. And you have seen the announcement that we have seen and we here at from our tenants directly. Some of the service tenants might opt to, especially law firms, maybe take a little longer time to work full-time back in the offices? And others want to be back. We have one tenant who is back 100% and has been even during the lockdown coming to the offices. So each tenant takes it very differently. Our tenants seem to be careful and want to manage it properly. But I think with the vaccination rates picking up further, this will be coming to normalcy in 2022.

[Wilbur Paes:]

Yes. And Jamie, maybe just to dimension it a little bit. I mean our physical utilization in our buildings in our portfolio today hovers around 20%, right. And we have seen that gradually uptick over the summer to where we are today. And as Albert said in his prepared remarks, we expect a meaningful uptick post-Labor Day. Obviously, there are other factors that could derail that. But based on where our expectation is, you are going to see a meaningful uptick from the levels we are today post-Labor Day. And as far as returning to a pre-COVID utilization, that's realistically early 2022 kind of scenario.

[Jamie Feldman:]

Okay. That's helpful. And then I guess, Wilbur as you think about getting back to normal and the cost of operating these buildings, do you think you just go back to your kind of pre-COVID operating margins or NOI margins? Or do you think it's incremental?

[Wilbur Paes:]

Yes. There is incremental. You saw we bumped guidance. We talked about better-than-expected portfolio operations. That was really stemming partially from lower operating expenses, better operating margins in the first half and what we see thus far into the second half. So what would help us to achieve the high-end of the guidance would be, again, in one way depending on how people come back and the velocity at which they come back over the second half of the year. We don't think operating expenses go back to pre-COVID levels until 2022. So we have baked that. We fine-tuned that in our re-forecast and caused us to update the numbers now. And we will continue to pay close attention to that and update you on the progress when we speak next time.

[Jamie Feldman:]

Okay. Thank you. And then as you think about San Francisco versus New York and the return, do you think there is going to be a meaningful lag in San Francisco for San Francisco tenants versus New York tenants?

[Albert Behler:]

There is a meaningful lag already now, Jamie. In San Francisco, it's currently about 7% to 10% the occupancy of tenants in our space. And even so the vaccination rates are substantially higher even than New York, I think it's a different kind of culture that you have in California and maybe some of the technology tenants being more used to working from home. I mean, even before the pandemic hit, many financial institutions had and nobody talked about work-from-home that much. But they had a policy that people could take a work-from-home day per week. So what we see in San Francisco is they are picking up steadily very quickly. And so I think that they will be behind New York this time. But I think they will come the same way to pretty much to the same occupancy levels.

[Jamie Feldman:]

Okay. And are you seeing any real difference in how tenants are approaching their space usage, whether it's space per employee or more flexibility on hybrid? Or just thinking about the demand side of things as we get out of this?

[Albert Behler:]

I think it's too early to say, Jamie. You saw a tenant. You saw that Centerview took another floor. And that's a tenant who approaches it that they want to give their employees a very vibrant and flexible space and they want to make sure that there is enough space to collaborate and meet, but also have privacy. And I think that that will be more important in the future. I think benching will be more limited. So I think companies will be more focused on giving the employees space and flexibility. And I think that will combat that some tenants might think about reducing their space. We have other tenants who increased their space. So I think it's too early to say how this all plays out. We are optimistic about the ultimate outcome.

[Jamie Feldman:]

Okay. And then I guess, Wilbur, any early metric you can provide on the refinancing?

[Wilbur Paes:]

We are, Jamie, as we speak, we are in the process of dotting i's and crossing on t's. I think we will have news to report on that by the early part of next week. I will tell you this, as you have seen through the guidance, obviously we factored the impact of that refinancing in our guidance. It will be a full dollar-for-dollar refi. So there is going to be no cash utilized from balance sheet to paydown that debt. And we received tremendous interest in the market. Pricing was very tight. And so we are very, very happy with where the deal has shaken out. And like I said, we will report on this by the early part of next week.

[Jamie Feldman:]

Okay. All right. Thank you very much.

[Albert Behler:]

Thank you Jamie.

[Operator:]

And our next question is from Blaine Heck with Wells Fargo. Please proceed with your question.

[Blaine Heck:]

Okay. Thanks Good morning. Wilbur, just to follow-up on that last question. I just want to confirm, it seems like there are no contingencies related to leasing at 1301 associated with that refinancing. Is that correct?

[Wilbur Paes:]

Yes. There is no contingencies, as I said, Blaine. I mean it's am $850 million loan that just became freely prepayable earlier this month. It's going to be a full dollar-for-dollar, maybe a slight up-refi to account for some of the transaction and closing costs. And that's it. No other contingencies.

[Blaine Heck:]

Great. That sounds good. And then Peter, we talked a lot about 1301 and 31 West 52nd Street on these calls for good reason. But there are also a couple of other assets that you guys have an opportunity to move the needle through leasing. Can you just touch on any interest you are seeing at 900 Third and 111 Sutter?

[Peter Brindley:]

Sure. At 900 Third, you saw we completed more deals during the quarter than any other buildings, seven deals in excess of 85,000 square feet. So we were very active at 900 Third in the most recent quarter. And we are trading paper with other tenants that are seeking full floors at the building. So you are right. It represents an opportunity for us to increase occupancy and we are heavily focused on that. I would throw in another building at 1325 where we have got some really nice activity in our couple of vacant full floors at the top of that building. So while we always talk about the fact that we are hyper focused, of course, on 1301 and 31 West, which you know we are, there are other opportunities at other buildings to increase occupancy. They show exceptionally well, as you would expect and we have some really nice activity on them. Same goes for 712 where, as I mentioned earlier, financial services are leading the charge. 712 has really seen a huge, I would say, increase in the amount of activity by way of tours and exchanging of proposals that we had there. 111 Sutter, of course, has an occupancy well below our expectation for the building. We did suffer some moveouts most recently. I will say that activity is coming back slowly in San Francisco but is increasing, I will say, over the last several weeks. And we have some real interest at the property on a couple full floors. So we are working very hard to convert and increase the occupancy level at 111. It's building that appeals to tech companies. It's ornate. It has a wonderful history and it certainly has a real presence in the market. So our expectation is that as this funding continues to fuel these especially younger technology companies that we will be the beneficiaries of that.

[Wilbur Paes:]

Blaine, let me just say this, to put in perspective. You are absolutely right. 111 Sutter is sitting at well below occupancy rate that we are accustomed and we would like. That said, it is the smallest building in our portfolio and it's a building that we own a part off. So when you look at an $8.5 billion company or so, that building and that share is less than 1% of our gross asset value. So as much as we are focused on this, not to lose perspective of the impact what that means to our bottomline, I think it's important to dimension that.

[Blaine Heck:]

Yes. Sure. That's fair. Okay. And then last one for me. Albert, can you just talk about what you are seeing on the fund side of things? As you said, the core deals are getting relatively strong bids but there haven't been too many value-add type opportunities yet or commodity-type buildings that have traded. Is that really hindering your ability to put capital to work? And what do you see on that front going forward?

[Albert Behler:]

Yes. I mean, you are correct. I mean we wouldn't be interested in buying a core asset through the fund business. The funds are focused on value-add or opportunistic investments. And the there hasn't been much opportunities in that segment. So that might change because some of the B building seem to be suffering more than the Class A buildings. But for the time being, there haven't been that many opportunities there.

[Blaine Heck:]

Great. Thanks guys.

[Albert Behler:]

Thank you.

[Operator:]

And we have reached the end of the question-and-answer session. I will now turn the call over to Albert Behler, Chairman and Chief Executive Officer and President for closing remarks.

[Albert Behler:]

Thank you all very much for joining us today here. We look forward to providing an update of our continued progress when we report our third quarter results during the fall. Good bye.

[Operator:]

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