Paramount Group, Inc. (NYSE:PGRE) Q4 2023 Earnings Call Transcript
Paramount Group, Inc. (NYSE:PGRE) Q4 2023 Earnings Call Transcript February 15, 2024
Paramount Group, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Paramount Group Fourth Quarter 2023 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 February 15, 2024. I will now turn the call over to Tom Hennessy, Vice President of Business Development and Investor Relations.
Tom Hennessy: Thank you, operator, and good morning, everyone. Before we begin, I would like to point everyone to our fourth quarter 2023 earnings release and supplemental information, which we released yesterday. Both can be found under the heading Financial Results in the Investors section of the Paramount Group website at www.pgre.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 the 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. 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 fourth quarter 2023 earnings release and our supplemental information. Hosting the call today, we 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 and 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, Tom, and thank you all for joining us today. Yesterday, we reported core FFO of $0.21 per share for the fourth quarter bringing our total for the year to $0.87 per share, the high end of our most recent guidance range. We leased 174,000 square feet in the fourth quarter, bringing the full year leasing volume to 740,000 square feet roughly in line with midpoint of our guidance that was established at the beginning of 2023. To date we are initiating 2024 core FFO per share guidance with a range between $0.73 and $0.79 per share. And the leasing guidance range between 650,000 and 900,000 square feet. Wilbur will review our financial results and guidance in greater detail. 2023 was an eventful year for Paramount.
We began the year in rising interest rate environment and one with elevated inflation. We had the regional bank crisis early in the year in which two of our key tenants, SVB Securities and First Republic who also happen to be our largest tenant failed. We worked diligently to make good for a bad situation and we did. We negotiated with JPMorgan Chase to assume 75% of space that was leased by First Republic under the same economic terms. The remaining 25% that they didn't assume was because it wasn't utilized and a large portion was subleased to other tenants. We then entered into a direct lease with the subtenants for most of the remaining space. All said, we took a potential $43 million problem and mitigated it down to $5 million. Concurrently with that negotiation in San Francisco, we also negotiated a new lease with the entity acquiring substantially all of the assets of SVB Securities.
The new entity retained about 62% of the space previously leased by SVB Securities on a long-term basis and kept the remaining 38% on a short-term basis. We focused on protecting our balance sheet by making strategic decisions on which debt maturities we sought to extend, where modest debt paydowns in lieu of favorable interest rates and extended terms made sense, like at 300 Mission Street, and where investing additional capital to support the asset didn't make sense, like at 111 Sutter Street. We deployed capital into Paramount Club, our 32,000-square-foot, state-of-the-art amenity center that will serve the Paramount campus. Paramount Club is set to open this spring, and it already served as a magnet in attracting our New York's most discerning tenants.
We also reduced our dividend, enabling us to retain an additional $40 million in cash annually. Now with 2023 behind us, we will carry that momentum into 2024, where our primary focus in 2024 will undoubtedly be on leasing. Our lease expiration profile over the next couple of years is elevated, and our goal is simple de-risk the role. The biggest expiration in 2024 is Clifford Chance's 329,000-square-feet lease at 31 West, which is set to expire at the end of May. As you know, we have already de-risked 106,000-square-feet or over 32% of this space, and we are underway in dealing with the remaining availability. Peter will provide additional color on this in our leasing pipeline. Though headline vacancy rates in Manhattan remain elevated, it's important to understand each sub-market and the quality of the assets within each sub-market, as variations can be pronounced.
For instance, the 6th Avenue sub-market has among the lowest overall availability rates, over 500 basis points lower than the overall Midtown office market. We have continued to capture more than our fair share of demand in this corridor, where a majority of our assets sit, and that is demonstrated by the same store lease occupancy rate of our New York portfolio, which is at 90.2%. The bulk of our current availabilities also happen to be on assets in this corridor, and we are poised to continue to capture more than our fair share in 2024. We believe this is to be reflective of the quality of our assets and our ability to execute in all different types of competitive market environments. We are confident that we will continue to benefit from the ongoing demand for high-quality office space in the Sixth Avenue corridor.
In San Francisco, the market continues to lag. Although, there are green shoots in the form of record venture capital funding, AI-based leasing demand and an improving return to the office statistics. We are long-term believers in the San Francisco market, and our focus here will be to remain a core portfolio of assets in this market that will flourish as the market recovers. Just last week, we announced the modification and extension of the loan at One Market Plaza, wherein we paid down less than 13% of the principal balance of the loan and return for a three-year extension and a favorable interest rate. One Market Plaza continues to raise the bar in San Francisco. In 2023, we signed two leases over $130 per square foot and the asset is currently 94.7% leased.
Turning to the transaction market. Activity remains muted. However, we anticipate that 2024 will see increased activity. We believe the number of distressed assets coming to market will rise and once interest rates begin to decline as many expect bid-ask spreads will begin to narrow. That said, equity markets have remained volatile, and there have been very few high-quality assets brought to the market. As always, we will be strategic and disciplined in allocating capital towards external growth opportunities. Lastly, we are very proud of the remarkable progress we made in our sustainability initiatives this year. Our dedication to sustainability and ESG as a whole is one of our fundamental operating tenants. We are leaders in the field and we know that, this has not only enabled us to reduce operating expenses, secure high-quality tenants, and ultimately increased portfolio value, but also minimize the environmental footprint we leave behind.
For this reason, we were honored to receive the 2023 ENERGY STAR Partner of the Year Award for the second consecutive year with Energy Star labels for 100% of our portfolio. Additionally, we had a 5-star rating in the 2023 GRESB Real Estate Assessment for the fifth year in a row. We aim to build on these impressive achievements in 2024 as ESG will remain a priority in how we run our business. To close, our priorities for 2024 are clear. We are laser focused on the lease-up of our available space with our portfolio of stable trophy assets and our proven ability to allocate capital, we remain well positioned for the long term. With that, I will turn the call over to Peter.
Peter Brindley: Thanks, Albert, and good morning. During the fourth quarter, we leased approximately 174,000 square feet with approximately 139,000 square feet in Eastern New York and approximately 35,000 square feet in San Francisco. The weighted average term of leases signed during the quarter was 10.2 years. During the fourth quarter, we signed a 49,000 square foot lease with Major League Baseball Players Association at 1325 Avenue of the Americas for an initial term of approximately 17 years. We also signed a 41,000 square foot lease with Smith Gambrell & Russell, a leading law firm for a term of approximately 11 years. Smith Gambrell will relocate within 1301 Avenue of the Americas and expand our footprint by approximately 40%.
These transactions demonstrate our ability to attract and retain high-quality tenants in our Midtown portfolio and service two good examples of tenants expanding their existing footprint. a trend we are seeing more than our own pipeline, particularly in New York. For the full year, we leased approximately 740,000 square feet for a weighted average lease term of 9.6 years. Tenants continue to prioritize the highest quality assets in our two markets, choosing to pursue well located amenity-rich buildings run by best-in-class well-regarded owners. Our portfolio is uniquely positioned to capitalize on these pronounced trends. We remain laser focused on delivering exceptional services and executing on our business plan. At quarter end, our same-store portfolio-wide leased occupancy rate at share was 87.7%, down 40 basis points from last quarter and down 360 basis points year-over-year.
As we look ahead, our 2024 lease expirations are manageable with 9.8% of annualized rent or approximately 764,000 square feet at share expiring by year-end. Our focus for 2024 is the renewal of tenants in our portfolio with expirations over the next several years and the lease-up of currently vacant or soon-to-be vacant spaces. Our pipeline continues to strengthen. We currently have leases in negotiation and proposals in advanced stages for more than 300,000 square feet, a good portion of which is for a vacant or soon-to-be vacant space. Beyond the 300000 square feet, we have a healthy and growing pipeline with ongoing negotiations at various stages. Turning to our markets. Midtown's fourth quarter leasing activity of approximately 4.3 million square feet, excluding renewals was up 49% quarter-over-quarter and 29% ahead of the five-year quarterly average.
While availability in Midtown remains elevated at 18%, select submarkets in Midtown's core have far less availability, covering at or close to equilibrium. The result of this has been improved economics in premier buildings, particularly on upper floors in these sought-after submarkets. Absorption in Midtown was positive during the fourth quarter and positive for the full year, first full year of positive absorption in Midtown since 2018. This was driven by leasing activity, largely by the financial services industry and by space withdrawals attributable to building purchases and residential conversions. Tour activity in our New York portfolio continues to increase as does our pipeline of prospective tenants most notably for the remaining vacancy at 1301 Avenue of the Americas and the block of space we are currently marketing at 31 West 52nd Street.
At 1301 Avenue of the Americas, our market-leading amenity center is set to open in May 2024 and it continues to be a differentiator in our pursuit of leading companies. Our New York portfolio is currently 90.2% leased on a same-store basis at share, down 20 basis points quarter-over-quarter and down 190 basis points year-over-year. During the fourth quarter, we leased approximately 139,000 square feet with a weighted average term of 12.4 years with an initial rent of approximately $78 per square foot. In New York, lease expirations during 2024 will be 10% of annualized rent or approximately 572000 square feet at share, driven largely by the known move out of Clifford Chance at 31 West 52nd Street. Shifting our focus to San Francisco. San Francisco recorded 1.5 million square feet of leasing during the fourth quarter, up 25% above the pandemic era quarterly average but 34.8% below the quarterly average during the preceding 10-year period.
For the full year, leasing activity in San Francisco remained muted with very little demand coming from the traditional technology companies. Despite a lackluster year of leasing transactions, we are optimistic as San Francisco remains a hot bed for premier tech talent with high-growth potential. Return to office continues to accelerate and San Francisco-based companies, particularly AI-based companies continue to attract significant venture capital funding. As a result, total square footage of tenants in the market continues to increase will be closer to San Francisco's historical average. AI-based companies contributed to approximately 25% of the leasing activity in 2023 and have become an increasingly large percentage of the demand pipeline in San Francisco pursuing states of varying sizes in San Francisco's premier buildings.
At year-end, our San Francisco portfolio was 80.8% leased on a same-store basis at share, down 120 basis points quarter-over-quarter and down 810 basis points year-over-year, driven by the known move out of Uber, which we have partially backfilled with the previously announced Waymo lease. Looking ahead, our San Francisco portfolio has 9.3% of annualized rent or approximately 192,000 square feet at share expiring by year-end. We look forward to updating you on our progress. With that summary, I will turn the call over to Wilbur, who will discuss the financial results.
Wilbur Paes: Thank you, Peter and good morning, everyone. I will start off my prepared remarks by covering the details of our fourth quarter results and then get into the building blocks of our 2024 earnings guidance. Yesterday, we reported core FFO of $0.21 per share for the fourth quarter, which came in at the high end of our guidance range and $0.01 above consensus estimates. Same-store growth in the fourth quarter as expected was negative 8% on a cash basis and negative 7.2% on a GAAP basis, driven by tougher comps and the previously talked about lease termination of an 83,000 square foot tenant at 1633 Broadway in our New York portfolio and the Uber lease expiration at Market Center in our San Francisco portfolio. During the fourth quarter, we completed 173,770 square feet of leasing at a weighted average starting rent of $80.17 per square foot and for a weighted average lease term of 10.2 years.
Mark-to-markets on 112,898 square feet of second-generation space was negative 2.5% on a GAAP basis and negative 7.5% on a cash basis. Turning to our balance sheet. Our outstanding debt at year-end was $3.66 billion at a weighted average interest rate of 3.9% and a weighted average maturity of 3.1 years. 87% of our debt is fixed and has a weighted average interest rate of 3.28%, the remaining 13% is floating and has a weighted average interest rate of 8.01%. Our liquidity position at year-end remains strong at over $1.2 billion comprised of $469.1 million of cash and restricted cash at share and the full $750 million of capacity under our revolver. As you all saw last week, we announced that we together with our partner had modified and extended the loan at One Market Plaza.
We paid the loan balance down by $125 million of which our share was a little over $61 million. There was a minimal uptick in the rate, and we pushed out the term by three years to 2027. Needless to say, this was a terrific outcome in a very challenging capital markets environment. As we have reiterated throughout the year, protecting our balance sheet has been and continues to remain our top priority. On the one hand, we have dealt with several near-term maturities by opting to pay down a portion of the debt on certain assets like One Market Plaza and 300 Mission, in exchange for favorable rates and extended terms. On the other hand, we have opted not to pay down any debt or invest additional capital in certain assets like 111 Sutter Street and now Market Center.
111 Sutter and Market Center have been dealt a hard blow with the timing of several key lease expirations coinciding, with a tough leasing environment and upcoming debt maturities. In the case of 111 Sutter at year-end 2022, we wrote down our investment to zero. And in early 2023, we defaulted on the loan and negotiated a cash flow loan whereby we did not invest any capital from our balance sheet. The loan is set to mature in May of 2024 and our position on the asset hasn't changed. In the fourth quarter of 2023, we also wrote down our investment in Market Center to zero. The occupancy at Market Center dropped significantly as a result of Uber's move-out, and currently sits at 55.1%. Furthermore, over 110,000 square feet is set to expire in 2024 and the debt is scheduled to mature in January 2025.
These two assets are in workout mode. We do not know, what an ultimate resolution will look like and there is a strong possibility that these assets may not be in the Paramount portfolio going forward. The value of these assets on our books have been taken down to zero and the fair value of the assets are significantly below the existing debt amounts. They are currently, a drag on occupancy, a drag on earnings and a drag on leverage and we get no credit for it in our stock price. So all that said, we decided to remove these assets from our core and same-store portfolio effective January 1 2024, until we reach a resolution with our respective lenders on a solution that makes sense for all parties involved. To that end, we have provided additional disclosure in our supplemental package and our investor deck, to help investors understand the impact those two assets currently have on portfolio operations.
Now, let me spend a minute on the assumptions used in deriving our 2024 core FFO guidance. We expect 2024 core FFO, which again excludes the impact of the two noncore assets I described earlier, to range between $0.73 and $0.79 per share or $0.76 per share at the midpoint. In order to facilitate an apples-to-apples comparison between 2023 and 2024, we have also presented in our supplemental package a 2023 core FFO figure as adjusted, which is $0.86 per share and excludes $0.01 per share of earnings contribution from the two noncore assets. So on a comparable basis, core FFO is expected to decrease by $0.10 per share from an adjusted figure of $0.86 in 2023 to $0.76, which represents the midpoint of our 2024 guidance. The $0.10 per share decrease in core FFO is comprised of the following: an $0.08 net decrease in cash NOI, driven primarily by significant lease expirations; a $0.03 decrease in termination income that is not budgeted for in 2024; a $0.02 decrease in interest fee and other income net of taxes; a $0.04 increase in interest expense; and a $0.01 increase in G&A.
These negatives aggregating $0.18 per share are partially offset by an $0.08 increase in straight-line rent adjustments due to new lease commencements. Our same-store growth is expected to range between negative 6% and negative 4% on a cash basis and negative 4.5% and negative 2.5% on a GAAP basis. We expect to lease between 650,000 and 900,000 square feet and we expect to end the year with a same-store leased occupancy rate between 86.1% and 88.1%. For additional information on our 2024 guidance, please refer to our supplemental package and investor presentation, both of which are available on our website at www.pgre.com. With that operator, please open the line for questions.
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