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Edited Transcript of PGRE earnings conference call or presentation 30-Apr-20 2:00pm GMT

Q1 2020 Paramount Group Inc Earnings Call

NEW YORK Jun 22, 2020 (Thomson StreetEvents) -- Edited Transcript of Paramount Group Inc earnings conference call or presentation Thursday, April 30, 2020 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Albert P. Behler

Paramount Group, Inc. - Chairman, CEO & President

* Peter R.C. Brindley

Paramount Group, Inc. - EVP of Leasing

* Robert Matthew Simone

Paramount Group, Inc. - Director of Business Development & IR

* Wilbur Paes

Paramount Group, Inc. - Executive VP, CFO & Treasurer

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Conference Call Participants

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* Blaine Matthew Heck

Wells Fargo Securities, LLC, Research Division - Senior Equity Analyst

* Daniel Ismail

Green Street Advisors, LLC, Research Division - Senior Analyst

* James Colin Feldman

BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst

* Jason Daniel Green

Evercore ISI Institutional Equities, Research Division - Analyst

* Omotayo Tejamude Okusanya

Mizuho Securities USA LLC, Research Division - MD & Senior Equity Research Analyst

* Richard Wynn Skidmore

Goldman Sachs Group Inc., Research Division - Vice-President

* Vikram Malhotra

Morgan Stanley, Research Division - VP

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Presentation

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Operator [1]

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Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Paramount Group First Quarter 2020 Earnings Conference Call. (Operator Instructions) Please note, this conference is being recorded April 30, 2020. I would now like to turn the call over to Rob Simone, Director of Business Development and Investor Relations. Thank you. You may begin.

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Robert Matthew Simone, Paramount Group, Inc. - Director of Business Development & IR [2]

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Thank you, operator, and good morning. By now, everyone should have access to our first quarter 2020 earnings release and the supplemental information. Both can be found under the heading Financial Information, Quarterly Results in the Investors section of the Paramount website at www.paramount-group.com.

Some of our comments today 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 operations.

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 future financial conditions.

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 first quarter 2020 earnings release and our supplemental information.

Hosting the call today, we have Albert Behler, Chairman, Chief Executive Officer and President of the Company; Wilbur Paes, Executive Vice President, Chief Financial Officer and Treasurer; and Peter Brindley, Executive Vice President, Leasing.

Management will provide some opening remarks. We will then open the call to questions. With that, I'll turn the call over to Albert.

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Albert P. Behler, Paramount Group, Inc. - Chairman, CEO & President [3]

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Thank you, Rob, and thank you, everyone, for joining this morning. First and foremost, all of us at Paramount hope that you and your family are safe and healthy. We are currently in the midst of an unprecedented crisis. The outbreak of COVID-19 has caused and continues to cause severe disruptions in the global economy, including that of the United States.

The circumstances surrounding COVID-19 continue to evolve at a rapid pace. Specifically in New York and San Francisco, the markets in which we operate and where a majority of our assets are located, officials have reacted by instituting quarantines and pause orders, shelter-in-place rules, restrictions on travel and restrictions on the types of business that can operate. It has us all dealing with extraordinary levels of change and uncertainty in every facet of our daily lives.

While our buildings remain open and are operating responsibly, navigating this crisis is our highest priority, all while ensuring the health and safety of our tenants and employees. We are doing everything we can to support CDC guidelines and comply with all directives from federal, state and local health and safety officials to help protect those most at risk. I'm incredibly proud of everyone on the Paramount team that have taken extraordinary measures to ensure we don't miss a beat as we manage through this extraordinary time.

With that backdrop, I'd like to spend a few minutes talking about our business. We reported our first quarter results last night, which were solid and in line with our internal expectations. Amidst these uncertain times, we found it prudent to withdraw our 2020 guidance we provided pre COVID-19. Wilbur will cover our financial results and guidance in greater detail.

From an operational viewpoint, there has been much focus on the health of our tenants and their ability to pay rent. As you can expect, we have been very focused on this as well. To date, we have received some form of rent relief requests from tenants representing approximately 16% of our pro rata annualized rent. Some of these requests are what I would characterize as opportunistic in nature and are from tenants that we believe have the ability to pay their contractual rental obligations in a timely manner. We are in the process of evaluating these requests on a case-by-case basis and not all of these requests will ultimately translate into modifications to leases or rent deferrals.

Notwithstanding these requests, we have thus far collected April rent at a pace that is in line with our March collections and prior months. To quantify, we have collected approximately 94% of April's total monthly billings to tenants. Our office tenants specifically are collected at a rate of 95%. This result reflects the benefits of our building a high-quality office-centric portfolio where our retail serves as an amenity to the office tenants and total rents we collect from retailers is less impactful for Paramount overall.

That being said, the next several months will undoubtedly be more relevant to monitor as the impact of this pandemic continues to reveal itself. Unfortunately, the extent of the economic impact, the length of this crisis and most importantly, the trajectory to restart the economy remain unknown as of today. But what we do know is that we have built a high-quality portfolio comprised of blue-chip credit tenants, no exposure to co-working and very limited exposure to retail.

On the leasing front, the first 2 months of 2020 were off to a solid start for both the broader markets in which we operate and for our portfolio. Needless to say, the onset of the COVID-19 crisis has led to a pronounced slowdown in leasing activity as it dropped off tremendously, particularly in March. Regardless, we had a decent first quarter leasing over 200,000 square feet. We continue to have active conversations with a couple of tenants, which we hope to report on during our next quarter's call.

There has, however, been a pause on new leasing, and leasing tours have come to a halt. It goes without saying that our original goal to lease 50% of the Barclays space by year-end, which was a tall order in itself pre COVID-19, just got incredibly taller. As I said in my Chairman's letter, most likely, this will now be a 2021 achievement, although it remains our immediate priority.

We are doing everything we can to lease this space. While there is no substitute for a presentation from our leasing team during live tours, in the absence of being able to physically tour space, we will provide virtual tours to prospective tenants.

That said, we believe, much like during the Great Recession of 2008, tenants are less likely to invest major capital and make big decisions on space needs until there is more clarity in the economy. So in the near term, our expectation is that renewal activity will outpace new leasing activity. That also means that capital outlays will be less than would otherwise be required for new deals.

On the capital allocation front, we remained very active during the first quarter. In early March, we entered into an agreement to sell our last remaining asset in Washington, D.C., 1899 Pennsylvania Avenue, for $115 million. The sale of this asset effectively completes our exit from Washington, D.C. market, making us a bicoastal REIT in 2 of the most resilient markets in the world. As previously reported, we expect this transaction to close in the fourth quarter.

Beginning in late February, we began to see the severe dislocation in our share price and we aggressively and opportunistically began repurchasing our shares. By the end of March, we repurchased another $100 million of our stock at a weighted average price of $9.21. As we have stated in the past, our goal is to execute on our share buyback program in a leverage-neutral manner. In this instance, we choose to take advantage of this opportunity in our share price by effectively prefunding the buyback from the sale of 1899 by using existing cash from our balance sheet.

Additionally, on April 1, amidst all the market volatility and severe dislocation of our stock price, we announced a 10% sale of 1633 Broadway. The transaction values the property at $2.4 billion or $960 per square foot and is expected to close next month. 1633 is the largest asset in our portfolio both size-wise and from a valuation perspective. It should certainly give our shareholders great comfort in knowing the underlying value of our real estate versus the levels at which our stock is currently trading.

Notwithstanding all the great feedback we received from the investor community with respect to this transaction, the one thing we also heard from investors is why 10% and not more. The reality and simple answer is tax planning. As I said before, 1633 is the largest asset in our portfolio and also happens to be the longest owned paramount assets. So you can imagine it also has the largest tax gain associated with it given its basis. We needed to ensure that we had the ability to retain the proceeds from the sale while taking some chips off the table at a full and fair valuation.

The importance of retaining proceeds and maintaining liquidity is even more essential in today's environment. Our focus at this point is to manage and improve on the parts of our business we can control since we obviously cannot control the economic fallout from COVID-19. Our shareholders can be assured that their company has entered this period of uncertainty in a strong financial position.

Our liquidity position is substantial and will support our efforts to navigate this crisis. At the onset, we drew down $200 million or 20% of our revolving credit facility, bringing cash on balance sheet to roughly $400 million, and that is after the $100 million that was deployed into share buybacks.

Our liquidity at quarter end was $1.2 billion, including the additional $800 million of undrawn capacity on our $1 billion credit facility. And our liquidity position will only be enhanced upon closing the 1899 and 1633 transactions, which will yield additional proceeds in excess of $215 million after transaction costs.

The severe volatility in the stock markets has been subsiding of late. However, the dislocation in the stock prices of New York City and San Francisco focused CBD office suites, including ours, is not. While it is frustrating, we also recognize the uncertainty in the current economic outlook, which is why we look to maintain a more defensive posture of being measured and prudent. Our priority today is to maintain ample liquidity, and the preservation of capital will be our foremost goal until we have better visibility on the economy as a whole.

As I stated earlier, our focus during this period of uncertainty is on controlling those areas of our business that we can. Given our proven ability to successfully navigate through other challenged economic cycles in history, I'm very confident in our prospects for the future because we have thoughtfully and deliberately built a portfolio of high-quality trophy and Class A assets in 2 of the most resilient markets in the world.

Our portfolio is 96% leased to a diverse mix of larger, high credit quality tenants with weighted average lease terms of over 7 years. Our business is office-centric, which accounts for about 95% of our annualized rent. We have very limited exposure to retail and other incidental operations, which together account for only 5% of our annualized rent.

We have a strong balance sheet with ample liquidity, which stood at approximately $1.2 billion at quarter end. We expect to realize additional cash proceeds of approximately $215 million from asset sales, further enhancing our liquidity position and the strength of our balance sheet.

We have no near-term debt maturities, and our next debt maturity isn't until the fourth quarter of 2021. And all of our debt is secured and nonrecourse. That being said, challenges, no doubt, lie ahead for us, the economy and the country as a whole. But in light of the thoughtful and decisive actions being taken around the world in the public and private sectors, I'm confident that together we will overcome this adversity.

With that, I will turn the call to Peter to provide additional insights of our leasing.

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Peter R.C. Brindley, Paramount Group, Inc. - EVP of Leasing [4]

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Thanks, Albert, and good morning, everyone. During the first quarter, we leased an excess of 206,000 square feet at a weighted average starting rent of $91.59 per square foot. Approximately 30% of this leasing addressed immediate vacancy in the portfolio or space scheduled to expire during 2020 and another 67% addressed space expiring in 2021.

At quarter end, we were 96% leased on a same-store basis, unchanged versus year-end 2019. For the remainder of the year and through 2024, our portfolio's near-term lease roll is a very manageable 7.5% expiring per annum. We continue to execute on our strategy to derisk the portfolio by proactively pre-leasing space to credit tenants, a strategy that we have always focused on and is even more important in today's environment. Given COVID-19 and the public health crisis we face, it has become increasingly apparent that limited lease roll in the near term and a portfolio comprised of best-in-class tenants will serve us well as we work through these difficult times.

Before I address the results in each of our markets, I would like to reiterate what Albert said about virtual tours in his remarks. We are in the process of filming our available space as a way of actively engaging with prospective tenants. The ability to show the quality of our spaces during this time will ensure that we keep our buildings top of mind with all current and future requirements.

Let's review our results by market, starting with New York. The Midtown Manhattan office market performed reasonably well through most of the first quarter prior to the outbreak of COVID-19 with total leasing activity of over 4 million square feet, up 4% year-over-year but roughly 7% below the 5-year quarterly average.

Tenant demand decelerated significantly as a result of the New York state on-pause order issued by the New York state government on March 20 and related social distancing measures taken in Manhattan. With all nonessential businesses ordered to close through May 15 at the earliest, tenants began to take a wait-and-see approach to their real estate decisions.

While tenants continue to focus largely on the well-being of their employees and the stabilization of their business during this crisis, we have been able to advance several of our lease negotiations. It is our expectation that the majority of the market's leasing activity in the near term will be lease expiration driven with renewals representing a larger percentage of total leasing activity in the near term.

Turning to our New York results. Our same-store portfolio was 95.5% leased at quarter end, unchanged from our year-end results. During the first quarter, we leased approximately 49,000 square feet at a weighted average lease term of approximately 4 years, including an approximately 30,000 square foot extension with Goldman Sachs at 900 Third Avenue. We are in the late stages of executing another 50,000 square foot extension with an existing tenant and hope to report on it on our next conference call.

Looking ahead, the New York portfolio is very well positioned with approximately 6% of currently leased space expiring per annum through year-end 2024, which figure excludes the lease expiration of Barclays' 500,000 square foot block as reflected in our 2021 lease expiration schedule.

As we have stated previously, 1301 Avenue of the Americas remains our primary focus as we market the Barclays block of space. The Sixth Avenue submarket remains among Midtown's strongest submarkets, and we remain confident that the strength of the Sixth Avenue submarket, coupled with 1301's central location, large and efficient floor plates, building quality and the size of the block, will yield an accretive result despite the challenges we now face with COVID-19.

As Albert mentioned, while it remains our highest priority, we believe it is now more prudent to expect that our goal of leasing up half of the Barclays block will extend into 2021. We continue ongoing discussions with tenants we were in discussions with prior to COVID-19 and we are in the process of filming our marketing floor to ensure that we do not miss an opportunity during this period of time when tenants are unable to physically tour space.

Turning now to San Francisco. The COVID-19 crisis and the resulting stay home health order through the end of May have caused disruption to business in San Francisco resulting in a slowdown in leasing velocity during the first quarter. Similar to what we are experiencing in New York, tenants are taking a wait-and-see approach towards committing to new space until there is more clarity around the economic outlook as well as when the orders are lifted. As a result, San Francisco realized an uptick in vacancy, negative absorption and a stabilization of average asking rents during the first quarter.

Despite this pause in the market, we are believers in the resiliency of San Francisco and its ability to recover quickly as shelter-in-place and social distancing guidelines are gradually relaxed. The market is better positioned versus prior cycles, anchored by mature, large-cap tech, financial services and the life sciences sector, which will all be integral towards solving the current health and economic crisis.

Our same-store portfolio in San Francisco is 97.4% leased at quarter end, down 10 basis points quarter-over-quarter. During the first quarter, we leased approximately 158,000 square feet at a weighted average term of just over 5 years with initial rents nearing $102 per square foot. The San Francisco portfolio is very well positioned with just 7% of currently leased space expiring per annum through year-end 2024.

At One Market Plaza, we completed 3 transactions during the quarter, the largest of which was the 109,000 square foot extension with Autodesk in the base of the building. This space was set to roll in 2021. In addition, we are currently in the late stages of executing an extension with another 100,000-plus square foot tenant at initial rents of over $100 per square foot.

With this extension in place, which will also have addressed space that was set to expire in 2021, we will have derisked 2021 roll by nearly 70% in San Francisco and by 17% for the entire portfolio year-to-date. These extensions at triple-digit initial rents also reaffirm One Market Plaza's appeal to leading businesses across a variety of industry. One Market Plaza's leased occupancy remains virtually full at 98.2%.

At Market Center, we completed 2 transactions during the quarter totaling approximately 26,000 square feet and stand at 95.6% leased. The building is architecturally significant and appeals to creative tenants and traditional tenants alike. We remain very excited about the long-term opportunities at Market Center as the asset boasts unparalleled transportation access, desirable amenities, efficient floor plates and spectacular view corridors in the heart of San Francisco's CBD, all of which support our team's effort to create tremendous value, much like what we have done in the recent past with our portfolio in San Francisco.

With that summary, I will turn the call over to Wilbur, who will discuss the financial results.

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Wilbur Paes, Paramount Group, Inc. - Executive VP, CFO & Treasurer [5]

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Thank you, Peter. We had another solid quarter of financial and operating performance. We reported core FFO of $0.27 per share and same-store cash NOI growth of 4.3%. Same-store cash NOI grew by 4.1% in New York and 4.9% in San Francisco. Same-store leased occupancy was unchanged at 96%.

During the quarter, we executed 12 leases covering about 207,000 square feet of space at robust positive mark-to-markets of 31.3% on a cash basis and 38.2% on a GAAP basis. Mark-to-markets in New York were 3.9% cash and 8.7% GAAP. Mark-to-markets in San Francisco were 44.2% cash and 51.8% GAAP.

Notwithstanding our solid first quarter, we have withdrawn our original guidance for 2020 that was provided during our last earnings call prior to the COVID-19 pandemic. Aside from the potential impact of COVID-19 on our future results of operation, we had announced 2 transactions subsequent to issuing our guidance that also has an impact to earnings and our previously issued guidance. Let me help connect at least some of the dots.

Our original guidance called for core FFO of $1.03 per share at the midpoint. Subsequent to issuing our original guidance, we entered into contracts to sell 1899 Pennsylvania Avenue and 10% of 1633 Broadway. These sales will result in reducing core FFO earnings by $0.03 per share based on the timing of when we expect the closings to take place. But that would bring our original core FFO guidance, pre any potential COVID-19 impact, to $1 per share. Given the current environment and the uncertainty that lies ahead, we thought it prudent to withdraw guidance at this time.

As Albert touched upon earlier, we are carefully monitoring rent collections from our tenants. Thus far in April, we have collected approximately 94% of total monthly billings to tenants, which is roughly in line with collections in the prior months.

As most of you know, our portfolio is primarily office-centric with office tenants representing about 95% of our pro rata share of annualized rents and the remaining 5% coming from a combination of retail tenants, parking garages and the 2 theaters in our portfolio. A deeper dive into our April rent collections reveals that our office collections are in excess of 95%, and collections from the retail garage and theater group were about 62%. A great result for April. However, the next several months will undoubtedly be more relevant to monitor. We look to provide you an update on collections, guidance and our results of operations during our next earnings call.

Turning to our balance sheet. We ended the quarter with approximately $1.2 billion in liquidity comprised of $400 million of cash and restricted cash and $800 million of capacity under our revolving credit facility. Furthermore, we expect to realize over $215 million of additional proceeds from asset sales.

Our outstanding debt at quarter end was $3.96 billion and includes $200 million that was borrowed under our revolver. Other than the borrowings under our revolver, all of our debt is secured and nonrecourse. This debt has a weighted average interest rate of 3.28% and a weighted average maturity of over 5.5 years. 84% of our debt is fixed and has a weighted average interest rate of 3.3%, and the remaining 15% is floating and has a weighted average interest rate of 3%. We have no debt maturing until the fourth quarter of 2021 and beyond that, our maturities are well laddered.

With that, operator, please open the lines for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Jason Green with Evercore.

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Jason Daniel Green, Evercore ISI Institutional Equities, Research Division - Analyst [2]

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Just a question on share buybacks and capital allocation broadly. I guess given your shares are trading around the same level, you repurchased shares. How are you thinking about deploying capital versus building up a cash position to address potential bad debt?

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Albert P. Behler, Paramount Group, Inc. - Chairman, CEO & President [3]

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Well, I think, at this point, we want to be totally open as to what we do. I think with the share buyback program, we are focused really on liquidity and saving liquidity on balance sheet. So I think it's not the time to aggressively go into the market. But once 1899 and 1633 have closed, then we're in a different situation.

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Jason Daniel Green, Evercore ISI Institutional Equities, Research Division - Analyst [4]

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Got it. And then just on the Barclays space, if we do find ourselves in a prolonged recessionary period, is that still leased out to 2 or 3 tenants? Or do you think you'll have to break it up even further to get it all leased?

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Albert P. Behler, Paramount Group, Inc. - Chairman, CEO & President [5]

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I think it's still the same at this point, but we can lease it floor by floor. We want to be totally opportunistic on this. And we are still quite confident from the calls that come in. As we said in our prepared remarks, that we currently can't have physical tours of the space, but Peter can speak to that himself. There are still calls coming in. So I would say, as we mentioned, the achievement we initially wanted to lease 50%, that might be a tall order to achieve at this point. But we are still confident that we can lease it during the course of 2021 at decent levels.

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Operator [6]

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

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Vikram Malhotra, Morgan Stanley, Research Division - VP [7]

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Just sort of on the portfolio, I know it's uncertain as to timing when folks could return and when things start going again. Some of your peers have talked about plans they have and things they're doing to sort of try to reopen and at the same time, monitor tenants, make it safer, et cetera. Can you talk about some of these -- maybe some of the initiatives you're thinking about as when you -- when we open? Kind how much would you need to spend? What are the initiatives to monitor folks as they come in and make it safer?

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Albert P. Behler, Paramount Group, Inc. - Chairman, CEO & President [8]

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Yes. First of all, as I mentioned in the prepared remarks, our team is really keeping all of our buildings entirely open currently. So the tenants are welcome to enter their space. We have been proactively working on cleanliness and safety. That's the most important part. And we have put a task force in place. It's spearheaded by Peter, and I'll ask Peter to comment additionally.

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Peter R.C. Brindley, Paramount Group, Inc. - EVP of Leasing [9]

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Yes, Vikram. It's something that we're thinking about really in 2 parts. First, we're preparing the buildings in advance of the majority of tenants returning. We're training building staff on Paramount's newly augmented safety and hygiene protocols. We're replacing air filters on fan systems, mostly with MERV-rated filters for improved air quality. We're increasing the frequency of cleaning in common areas and high-touch points, increasing when appropriate fresh air intake into the building, doing a number of things in advance of their return.

And then once we do welcome tenants back into our buildings, we have really refined and established guidelines and protocols that require participation and collaboration by both landlords and tenants. We, of course, will reinforce governmental mandates, but we have our own protocol as well. And all of this really is intended to reduce anxiety and ensure a safe and comfortable physical environment for all building users. Our intention is to be safest in class and welcome tenants back in that manner.

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Vikram Malhotra, Morgan Stanley, Research Division - VP [10]

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That makes sense. And then maybe just a little bit more on the deferral request that you have received so far, can you give us a bit more color if there's any segmentation in any specific sectors or tenant sizes or types and then the breakup between San Francisco and New York?

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Albert P. Behler, Paramount Group, Inc. - Chairman, CEO & President [11]

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Yes. Well, as we've said also, the collection is 95% of office rent. And some of these requests are really opportunistic in nature, and those will definitely get a very clear no. We are evaluating, especially some of the retail requests that -- from tenants that are really hurt by this situation. What comes to mind are restaurants. And we will be, on a case-by-case basis, work with those tenants potentially. But we haven't made a determination. And so far, we have given rent relief only in 1 or 2 cases.

So we will be very, very stringent. We have been through this during the last crisis. We understand this is a very difficult time for tenants, but we have to run a business. And we -- at the end of the day, we selected our tenants very carefully when we signed these leases, and we are focused on credit tenants. And I think now it's a time that it shows.

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Wilbur Paes, Paramount Group, Inc. - Executive VP, CFO & Treasurer [12]

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Yes. Vikram, I was just going to add to what Albert said. In terms of the 16% that Albert referenced in his prepared remarks, it is pretty split by region between New York and San Francisco fairly evenly. So it's not like it's 20% in one area and 10% in the other. It's fairly even between both regions.

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Operator [13]

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Our next question comes from the line of Rick Skidmore with Goldman Sachs.

Our next question comes from the line of Jamie Feldman with Bank of America Merrill Lynch.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [14]

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I guess sticking with the Barclays space, can you just talk about the tenants you've been speaking to? I mean have any just decided, given the uncertainty, to just kind of renew in place rather than think about a move to a new building?

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Albert P. Behler, Paramount Group, Inc. - Chairman, CEO & President [15]

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Jamie, this is Albert. We have been talking to a number of tenants, and I could say, at this point, nobody is reconsidering their discussions with us. They -- some of them have really higher priorities currently, but that is the current situation there.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [16]

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Okay. But it sounds like none of the discussions have just ended.

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Albert P. Behler, Paramount Group, Inc. - Chairman, CEO & President [17]

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That's correct.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [18]

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Okay. And then, I mean how are you thinking about your current leverage level given the uncertainty ahead? Do you think you'll take steps to bring your net debt to EBITDA lower? Are you comfortable where it stands?

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Wilbur Paes, Paramount Group, Inc. - Executive VP, CFO & Treasurer [19]

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Look, I think one of the things, Jamie, we published the leverage today, net debt to EBITDA sits at 8.6x. It's important to recognize that some of these assets were acquired in San Francisco last year that have fully not started to reach its EBITDA potential, right? So that's going to change, and that will bring that number organically down, especially when you see the mark-to-markets that we've been posting in the San Francisco business.

So 2 ways to do that, obviously, is one is your EBITDA increases over time, and that's where we are focused on. We're not going to issue equity at these levels to try to bring that down. We have shown the ability to transact on asset sales at good values if it came to that. But these are some of the most desirable assets in some of the best markets in the world. And not all debt to EBITDA is created equal.

So I think we're focused on that metric. We're focused on bringing it down, but I don't think that a trophy portfolio of our quality should also have a net debt to EBITDA of 6x as well.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [20]

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So what's the glide path? Like what net debt to EBITDA do you get to based on the EBITDA growth you're talking about?

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Wilbur Paes, Paramount Group, Inc. - Executive VP, CFO & Treasurer [21]

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So I think when you start to see some of this come into play, we'll be in the 7.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [22]

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Okay. Is 7 low 7s, high 7s?

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Wilbur Paes, Paramount Group, Inc. - Executive VP, CFO & Treasurer [23]

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Mid-7s, and I think we're comfortable operating at that level.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [24]

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Okay. And then I guess just going back to San Francisco, the statistics did move pretty sharply in the first quarter in the CBD. Can you kind of maybe just help us understand, from your perspective, how much of that do you think is kind of a pre March -- January, February just kind of slowdown in the market and space coming back online versus really just kind of the shutdown impacting things? I think having -- or at least I'm trying to figure out -- had COVID-19 not happened, would San Francisco still be kind of slowing here?

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Peter R.C. Brindley, Paramount Group, Inc. - EVP of Leasing [25]

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Jamie, this is Peter. I think it's difficult to say. I think things really came to a screeching halt in March. The fundamentals in San Francisco remain very strong. You've got vacancy of 6%. You've got average asking rents up 12% year-over-year. The fundamentals remain very strong. I think we'll see how things proceed.

But generally, what we fundamentally believe is that San Francisco is comprised of well-capitalized technology companies, financial service companies, life sciences companies. We have best-in-class leaders of industry in our portfolio. So we feel that San Francisco still has a lot to look forward to. But it's too soon to say in terms of what the fundamentals will look like for the balance of the year.

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Albert P. Behler, Paramount Group, Inc. - Chairman, CEO & President [26]

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And Jamie, the portfolio is 97.4% leased with very minimal exploration, only 1.8% of annualized rent for the remainder of 2020. Peter and his team have done a terrific job over the last couple of years to proactively lease those spaces at a very good rate that you could see from our financials.

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Operator [27]

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

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Blaine Matthew Heck, Wells Fargo Securities, LLC, Research Division - Senior Equity Analyst [28]

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So Peter, you guys have done a good job of capturing some of the additional demand from tech tenants that has come to the city of New York at this cycle. And I think before the coronavirus hit, there was an expectation for a substantial amount of leasing to be done by some of the large tech players that were growing their footprint in Manhattan.

Can you comment at all on what you're seeing from those guys and tech tenants in general? Are they going ahead with any of that leasing? Is it on hold? Or is there any chance of them just backing away from those expansion plans?

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Peter R.C. Brindley, Paramount Group, Inc. - EVP of Leasing [29]

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I think every scenario is different. Some of the larger requirements that we are familiar with that we talked about in advance of this crisis remain in negotiation. And the expectation, and everybody is watching closely, I think we're all familiar with maybe who I'm referring to and several instances here, are that these deals will get completed.

We know that technology made up 25% of Manhattan's leasing velocity last year, usurping financial services for the first time ever. So they, as we all recognize, have become an increasingly important part of the tenant diversity in the city.

But what I can tell you is that we perceive that tech will be an industry that may, in fact, even thrive during this time. And what we're seeing is ongoing discussions with these tenants to transact. And I think, in the coming days and in the coming weeks, we'll see some of this ultimately be finalized. And I think it will be a very good data point for our market.

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Blaine Matthew Heck, Wells Fargo Securities, LLC, Research Division - Senior Equity Analyst [30]

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Great. That's helpful. Maybe for Albert, can you talk about any risks you see associated with the sales that are under contract? Obviously, the 1633 disposition is scheduled to close here soon, but there's some time to closing in 1899. So is that more at risk? And then maybe can you characterize the buyers and whether they're relying on the debt markets to get the deals done?

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Albert P. Behler, Paramount Group, Inc. - Chairman, CEO & President [31]

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Well, I don't want to really comment on transactions that are in the middle of getting processed, but I can tell you that both parties are reliable, well-financed institutions. And we have no doubt at this point that they will be closing.

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Blaine Matthew Heck, Wells Fargo Securities, LLC, Research Division - Senior Equity Analyst [32]

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Okay. That's helpful. Last one, maybe for Wilbur. Can you just talk about what capital expenditures you guys have or might have coming up? I'm imagining you guys had CapEx requirements at both 1301 Sixth and the Henri Bendel space should you guys get those leased. Maybe you have some work to do on the retail cube at 1633, and I guess there's probably some spend left at 111 Sutter to get that one leased up. Can you just frame up the total capital requirements for those spaces?

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Wilbur Paes, Paramount Group, Inc. - Executive VP, CFO & Treasurer [33]

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Sure. And we have gone in great detail through the portfolio to basically go through all of the capital requirements. And every nonessential project or capital that we felt could be deferred has been deferred at this point. Clearly, there's a big focus for us to preserve liquidity in this environment and also make sure that our ratios are in line because any sort of diminution that will be coming from potential rent relief that you give to tenants should get offset by the lower CapEx from an AFFO standpoint.

Having said that, we will continue to spend money with respect to leases that need to be done. So timing of that will inevitably also get pushed because if leasing gets delayed and construction of TIs take longer than it otherwise would have given the current environment, that will organically also defer some of that capital into 2021.

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Blaine Matthew Heck, Wells Fargo Securities, LLC, Research Division - Senior Equity Analyst [34]

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Okay. So that's helpful. But I guess, is there any way you can take a stab at kind of the total requirement? Is it $50 million, $100 million?

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Wilbur Paes, Paramount Group, Inc. - Executive VP, CFO & Treasurer [35]

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Sure. We have effectively deferred close to $50 million of capital that we otherwise thought would have been spent in 2020 into 2021. I won't go specifically by each building, but it's across the portfolio.

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Operator [36]

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Our next question comes from the line of Daniel Ismail with Green Street Advisors.

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Daniel Ismail, Green Street Advisors, LLC, Research Division - Senior Analyst [37]

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Great. Just 2 quick ones for me. Can you discuss any prospective changes on the concession front? Understanding things are so early, but just curious if any -- if you guys have noticed any changes with respect to TIs or free rents.

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Albert P. Behler, Paramount Group, Inc. - Chairman, CEO & President [38]

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Yes, it's a little early. And normally, what you want to give is maybe a little bit more free rent. But the market, at this point, it's too early to say, but we would tend to give more free rent than anything else at this point. The market seems to be still -- I think tenants will be more focused in the future on quality assets, and it will not be too much of a haggle over the last nickel because they want to make sure that they are putting their employees in an environment that's safe and that's run by high-quality teams. And I think we will fare pretty well in that segment. Peter?

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Peter R.C. Brindley, Paramount Group, Inc. - EVP of Leasing [39]

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Yes. I think we likely would perhaps have a discussion about concessions and some increase potentially on the concession side before we talk about a reduction on the rent is my guess. But I think there's, frankly, not a whole lot of clarity just yet in terms of what this all looks like in terms of metrics, transaction metrics going forward. So Danny, it's a good question, but it's something that we're assessing real-time with our conversations now.

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Daniel Ismail, Green Street Advisors, LLC, Research Division - Senior Analyst [40]

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Okay. And just last one for me. Can you maybe discuss the fund business at this point? How you guys are viewing it and maybe how your investor base is viewing U.S. office real estate and various investments in the U.S. office real estate these days?

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Albert P. Behler, Paramount Group, Inc. - Chairman, CEO & President [41]

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Yes, happy to comment. The mezzanine business, the mezzanine fund business is going to get quite active. I think there will be demand. But on the investment side, I think that's the main focus of your question, on the fund investors side, as usual, in these kind of market cycles, so the investors are very busy with their own issues. They are not really focused on new investment at this point in time.

However, they have a lot of liquidity, some of them, and they have to invest them into positive yield-returning assets. And I expect that in the second half of this year, once we have more clarity on this pandemic worked out, that the money will be coming back also from abroad being invested here in the United States because the returns are still looking quite attractive in comparison to other parts of the world.

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Operator [42]

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(Operator Instructions) Our next question comes from the line of Tayo Okusanya with Mizuho.

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Omotayo Tejamude Okusanya, Mizuho Securities USA LLC, Research Division - MD & Senior Equity Research Analyst [43]

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The retail and the parking contribution to your bottom line, I know you said it's 5% of rent, could you actually help us break out what's the retail piece and what's the parking piece? And for your parking, how much of it is just tied to the rents versus more transient parking?

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Wilbur Paes, Paramount Group, Inc. - Executive VP, CFO & Treasurer [44]

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So to answer the first part of your question, that breakdown roughly is about 4% retail and the remaining is parking, the remaining 1% is between the parking and the theater group. And within the parking, it's pretty much split evenly 50-50 between leasing and transient parking.

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Omotayo Tejamude Okusanya, Mizuho Securities USA LLC, Research Division - MD & Senior Equity Research Analyst [45]

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Got you. That's helpful. And then during the comments that were made, 16% of tenants have asked for rent relief. As you kind of think through that, do you kind of see more of a situation where it will be more deferrals, where you guys will defer rent for little bit, hopefully, get it back in a year or so? Or do you kind of see more as abatements where you may actually restructure the lease and try to get more churn?

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Albert P. Behler, Paramount Group, Inc. - Chairman, CEO & President [46]

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Well, the request -- the majority of the requests are deferrals, short term. Tenants respect, in general, the terms of the lease. And that's something that, historically, we have, as I mentioned before, have done in very, very limited cases. And we will look at the cash flow position of the company and looking for financial statements and good reasons why we would defer the rent for those kind of tenants. Rent forgiveness, I think it's part of your question, is really not in our playbook.

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Omotayo Tejamude Okusanya, Mizuho Securities USA LLC, Research Division - MD & Senior Equity Research Analyst [47]

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Okay. Not in the playbook. But I'm assuming most of the requests are coming from the retail portfolio? Or are there any office tenants there?

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Albert P. Behler, Paramount Group, Inc. - Chairman, CEO & President [48]

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The majority is retail, as you might expect. That's correct.

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Operator [49]

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Our next question comes from the line of Rick Skidmore with Goldman Sachs.

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Richard Wynn Skidmore, Goldman Sachs Group Inc., Research Division - Vice-President [50]

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Just maybe Peter and Albert, what type of conversations are you having with regards to tenants and future space needs given the trends in work from home and perhaps the offset of social distancing and perhaps needing more space in the office?

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Albert P. Behler, Paramount Group, Inc. - Chairman, CEO & President [51]

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Well, it's a little early to -- we are informing all of our tenants how our buildings are currently operating. There are discussions by our property managers with the tenants to make sure that the tenants feel safe currently. And every day, the -- most of the tenants represent essential business. So some of them are working in their office space, but it's a limited amount of employees. And we have formed a task force that Peter is heading to get ready to reopen entirely.

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Peter R.C. Brindley, Paramount Group, Inc. - EVP of Leasing [52]

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Yes. I would add to that by saying, I think densification largely worked its way through the system over the last 10 years as tenants try to become ultra efficient and collaborative. And I think the pendulum, as we pointed out previously, started to come back, and I think this crisis will only accelerate that.

I think you'll see tenants requiring more space, perhaps 6 feet between one another, which is certainly not the case nowadays. So I think you'll start to see tenants think about their real estate differently and attribute more rentable square footage per employee to create a safe work environment. That's very much something that's now being discussed.

It may be such that a small percentage of the workforce can work from home. And that may be a trend with some of the technology that enables that to happen. But I think that remains to be seen. I think the experiment is occurring at a time with children home and some other distractions. And so generally, when I speak with my peers, I hear that it's very difficult to be productive. But that's not to say that people can't make it happen as we have here at Paramount.

But I think those are 2 trends that I'm sure you've heard a bit about. But I think the densification is over, and I think you'll see the opposite occur on a go-forward basis.

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Operator [53]

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Since there are no further questions left in the queue, I would like to turn the call back over to Mr. Albert Behler for any closing remarks.

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Albert P. Behler, Paramount Group, Inc. - Chairman, CEO & President [54]

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Thanks, everyone, for joining us here today. We look forward at Paramount to providing an update on our continuous progress when we report our second quarter results during the summer. Stay safe and goodbye.

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Operator [55]

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This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.