Douglas Emmett, Inc. (DEI) Q1 2014 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Douglas Emmett's First Quarter 2014 Earnings Call. Today's call is being recorded. [Operator Instructions] I will now turn the conference over to Stuart McElhinney, Vice President of Investor Relations for Douglas Emmett. You may begin your conference.

Thank you. Joining us today on the call are Jordan Kaplan, our President and CEO; and Ted Guth, our CFO. This call is being webcast live from our website and will be available for replay during the next 90 days. You can also find our earnings package at the Investor Relations section of our website. During the course of this call, we will make forward-looking statements. These forward-looking statements are based on the beliefs of, assumptions made by and information currently available to us. Our actual results will be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control or ability to predict. Although we believe that our assumptions are reasonable, they are not guarantees of future performance, and some will prove to be incorrect. Therefore, our actual future results can be expected to differ from our expectations, and those differences may be material. For a more detailed description of some potential risks, please refer to our SEC filings, which can be found in the Investor Relations section of our website. [Operator Instructions] I will now turn the call over to Jordan Kaplan, President and CEO of Douglas Emmett. Jordan?

Thanks, Stuart. Good morning, everybody. Thank you for joining us. In the first quarter, we increased our AFFO to $0.30 per diluted share, 10% more than a year ago. It's worth noting that despite the intervening recession, we have grown our AFFO per diluted share by an aggregate of 78% since our first full quarter as a public company in 2007. In Q1, our lease rate declined for the first time in 3 years from 92.2% to 91.6%. Although we did 701,000 square feet of leasing during the quarter, that was about 75,000 square feet lower than expected. As a result, we were not able to offset the unusually large amount of move-outs in the quarter, including the expected AIG downsizing. Despite our lower closings, we still saw strong tenant demand across a diverse mix of industries. The lease rate in our markets moved up and, more importantly, so did rental rates. The average straight-line value of office leases signed last quarter was almost 5% greater than the expiring leases. Leasing tours and deals and negotiations during the first quarter were strong. In April, we signed over 400,000 square feet of leases, our biggest month ever as a public company. The performance of our multifamily portfolio remains very strong with average asking rents 5.9% higher than a year ago. Our 2 multifamily development projects continue to make good progress. We have increased the number of expected units to be added in our Moanalua in the Honolulu, where we plan to break ground in the third quarter. In Brentwood, we are in the early stages of the entitlement process. Feedback remains positive, but we don't expect to break ground before late 2015. We have added a development page to our earnings package this quarter with details about both projects. As for acquisitions, I'm optimistic that we will see property sales in our markets this year and that we can make more value-added purchases. I will now turn the call over to Ted.

Thanks, Jordan. Good morning, everyone. I'll begin with our results, then address our office and multifamily fundamentals and finish with 2014 guidance. Compared to a year ago, in the first quarter of 2014, our total office revenues increased by 2.1%. Our FFO increased by 8.4% to $69.5 million or $0.40 per diluted share; our AFFO increased 13.7% to $57 million or $0.32 per diluted share; and our G&A decreased by 4% to $6.8 million, only about 4.6% of total revenue. Comparing the cash basis results for our same properties in the first quarter of 2014 to the first quarter of 2013, revenues increased by 1.7% reflecting increases in rental revenues, parking and other income and tenant recoveries. Expenses increased by 1.8%, slightly below our expectations of 2% to 3%. And NOI increased by 1.7%. The ongoing decline of noncash FAS 141 in straight-line income reduced our GAAP NOI in Q1 by 0.3% but also meant that our AFFO represents an even higher percentage of our FFO, significantly above the average of our peers. Now turning to office fundamentals for the quarter. As Jordan mentioned, we signed 194 office leases covering 701,000 square feet, including a 179,000 square feet of new office leases. Rents continue to rise. The straight-line value of our leases in Q1 averaged 4.7% greater than the expiring leases for the same space. This improvement reflects higher rental rates, which continue to increase by an average of 5% to 10% annually across our entire portfolio, excluding Warner Center. In addition, about 40% of leases we signed in Los Angeles during the first quarter contained annual rent escalations in excess of 3%. Some property owners in our markets have already moved to 4.5% annual bonds. The spread between ending cash rent on our expiring leases and the starting cash rent on the new leases for the same space improved but remained negative at 7.3%. While we would like to see this number continue to improve each quarter, we know that leasing space in Warner Center and other [ph] leased spaces in our other markets can adversely affect this metric, especially when viewed on a quarterly basis. Overall, our average annualized in-place office rent per square foot rose 1.1% during the quarter to $35.26, the first sequential quarterly increase in some time. On a mark-to-market basis, at March 31, our asking rents exceeded our in-place rents by 2.4%, up another 80 basis points in the quarter. As Jordan mentioned, delays in closing leases and the headwinds from AIG and other move-outs caused the lease percentage for our total office portfolio to decline by 60 basis points to 91.6% and the occupied percentage to decline by 50 basis points to 89.9%. Based on April's excellent results and current productivity, we anticipate that leasing in future quarters will return to our expected run rate. Because it will be hard to fully offset a slow first quarter, we have backed out the high end of our occupancy and same-store NOI guidance by 0.5%. On the multifamily side, our 2,900 units were 99.5% leased at quarter-end, with both our in-place and our asking rents again setting all-time highs. During the last 12 months, we raised our residential asking rents by an average of 5.9%. The current asking rents for our multifamily portfolio exceeded our in-place rents by an average of 23.6%, about half of which relates to our remaining pre-'99 units in Santa Monica. Recurring capital expenditures for our apartment communities averaged $81 per unit during the first quarter. Now turning to our balance sheet. At the end of March, we had $12.4 million in cash on our balance sheet and $280.5 million of availability on our line of credit. After refinancing a small $16.1 million loan in February, we have no remaining debt maturities in 2014. Our net leverage was 40% of enterprise value at March 31, well within our target range. We still have ample liquidity for potential acquisitions and other working capital uses. Finally, we are maintaining our full year 2014 FFO guidance of between $1.57 and $1.63 per share. For more information on the factors underlying our guidance, please refer to the schedule in our earnings package. With that, I will now turn the call over to the operator so we can take your questions.

[Operator Instructions] And your first question comes from the line of Michael Bilerman.

So I just wanted to dive in a little bit just on the leasing, just maybe you can give us a little bit more color. So in the first quarter, you still did 776 of total leasing. And I thought this was leases signed in the quarter, so AIG should be out of that number, but correct me if I'm wrong. That was almost 40,000 square feet higher than what the 6-quarter average had been? So it didn't seem like from a velocity standpoint that, that came down much. Then you had a much higher percentage of renewals this quarter upwards of 75%. And so I'm just curious, sort of what -- maybe you can share a little bit more detail. I know, Jordan, you talked about 75,000 square feet and it sounded like that perhaps rolled into April? So I'm just trying to put all these factors together to...

Yes, okay. So we did 701,000 square feet of leasing in the first quarter, which is about on average for what we typically do, in fact. Now we had rollouts that we knew were going to happen that quarter but we also had a tremendously large pipeline going in the quarter, and we -- when we looked at all of that -- and even going into March, we said, "Wow, we are going to kind of overwhelm those move-outs," which one of the move-outs, we knew it was there, but we still thought where we'd have the leasing overwhelm was the Warner Center deal. I don't want to kind of blame cutoffs and stuff on this, but the cutoffs at the end of March, boom, that's what happened. And it does seem as though you would say, "Wow, well, it's like we'll just roll a few weeks into April," which April was an extraordinary month, and it's an indication of course, for sure, of why we felt like even at the -- in the February time zone, when we were giving guidance for like, "Wow, this pipeline is gigantic," and we're still comfortable with our numbers. But when things slowed down a little bit in terms of closing and worked their way into April, we said to ourselves, "Yes, these 2 ranges" -- certainly the lease range and then the way that sort of, at the end of the day, impacts same-store NOI, the high end of these ranges are starting feeling a little less like ranges and more like a hope and we want to bring it down into a reasonable range. And so we felt like it was prudent to lower the -- lower them by 0.5%. Now with that I will say we are also having -- you might say, "Well, did you like -- did April make up for the first quarter, or did it borrow from May? But that does not seem to be happening at all. And we're looking at a relatively strong May, certainly not borrowed from May, too. So we feel very good about leasing and filling the portfolio. I will also mention that when we look at the pipeline, a lot of the leasing that it looks like it's coming down the line where deals are going to get signed, seem to be -- or a good amount of square footage seems to be on Warner Center. And that's great news, right, because there's vacancy there. But leasing in Warner Center is always a little bit hard on the roll-up, roll-down metric. They're longer leases in that same -- and that cash, ending cash or beginning cash, it's just harder to overwhelm that on a longer lease, which is what happens in Warner Center. But overall, just other than refining yourself to those small metrics, very, very good year that we're having. I mean, I know that first quarter doesn't make you say, "Wow, how can you say that?" But it is. We are having a very strong year, and our leasing pipeline is very strong and April is a great evidence of what we're seeing.

Right. And I guess just as a follow-up. I mean, Ted, you were talking about lowering the high-end by 50 bps. You also lowered the bottom end, so you brought the whole range down. So I just want to...

It's tough with ranges. It’s getting precise down to 0.5 a percentage point, which is what would happen, it doesn't make us all that comfortable. So the answer is yes. We did bring down both, but the focus when we were doing that was on the high end.

And your next question comes from Jamie Feldman.

So can you guys just talk about -- you mentioned a couple of leases that fell out of bed in the first quarter that brought you to a lower occupancy number than you had expected. Can you talk exactly about those leases, and what your prospects are to backfill?

It wasn't so much that leases fell out of bed. It was that we knew that there were a bunch of leases that were coming down the pike and there are always other terminations that come in because of the tenant things. But as Jordan said, the real thing that changed our minds about what was happening was that we had this great backlog going in and we thought a bunch of the ones that ultimately close in April we're going to close in March. And so we actually expected that to be the things. But there aren't -- the large lease was, of course, AIG and then there were -- they are always a number of middle-sized tenants that are moving out and/or that are terminating one way or the other.

I'm not sure that was a huge problem. We just found a little slower pace to getting stuff closed. And as we saw that -- not that it's not all great news and great numbers in terms of the pipeline and the deals we're getting done and the economics that we're getting, which is the real important stuff, we just said, "Wow, it went a little slower than we expected and, therefore, let's make an adjustment." That's really what it gets down to. I know that -- we could see from watching the market that there was a reaction to that change which, obviously, we knew when we were doing it that, that could happen but I still thought it was a reasonable change, so we made it.

Okay. I mean, that seems reasonable. I guess I'm just trying to frame the magnitude that you had twice the occupancy lost in Warner Center than you expected and you lost revenue 100 basis points in Honolulu, which seem to be the biggest drivers. What -- how many leases is that? Is it a couple of leases, is it many more?

In Honolulu, there was a 17,000 square foot lease that terminated. We got to build that -- we got to backfill that. And in Warner Center, it was one other -- again, you can -- there's a whole bunch of things that are happening, but there was one other 32,000 square foot lease that happened there. Again, in Honolulu, in Brentwood and at other places where it went down, these numbers get pretty small when you get down to the submarket, and we'd be really careful about trying to draw longer-term conclusions. You look at Westwood last -- in the fourth quarter, it was down 200 basis points, and then we backfilled the space that went out and, in last quarter, it was up 170 basis points. So as you get down to these smaller ones, be careful about it, but the answer is, yes, there was a default in Honolulu of a -- that went bankrupt, and there was a tenant that closed out in Warner Center.

And your next question comes from the line of Brendan Maiorana.

So just first question, just kind of a simple question. So you brought down your same-store guidance by 50 basis points. I think that would be sort of $0.01 on the range. But you didn't change the FFO range. Was there anything that offset the same-store drop of 50 basis points on each and relative to FFO?

Yes. Some of the offset, I think, will come from the -- our income from our funds, which I think we now see as being a little better than we did at the guidance time. But I'd also would just caution everybody that when we're dealing with ranges, to sort of translate them into exact dollars -- I mean, exact midpoints then do the multiplication, there's a lot more sort of rounding that goes off in each range, in some place -- not every range can be precisely in the middle of the range. So the balance of it is rounding. And in the end, I think we're very comfortable with maintaining the FFO guidance per share.

Okay. And Ted, I think we had talked last quarter that the occupancy ramp, you expect it to be kind of back-end weighted because we knew there were some of these move-outs that were early in the year. And I think you even mentioned maybe Q2 wouldn't be a big pickup in terms of occupancy. You've got 200 basis points between kind of meeting your year-end target and where your occupied number is right now. Given that it was weaker than expected in Q1, should we expect to see that number pick up sort of ratably throughout the remaining 3 quarters of the year?

No. For the same reasons as before, we think that occupancy will be back-end loaded. We have more move-outs in both the first and second quarter, just sort of random fluctuations, than we do in the back half of the year. And in addition, since we had relatively slower leasing in the first quarter, even if we make that up in the second quarter, that will also push the occupancy a little later in the year as well. So I think that you should still anticipate that the gains in occupancy, as for whatever reason they have the last couple of years, will be in the last couple of quarters.

Okay, all right. So maybe kind of flattish in Q2 and then the ramp after that. Okay, all right.

And your next question comes from the line of Jordan Sadler.

I wanted to drill down a little bit on the markets, if you could. The move-outs, or at least the exposure, obviously showed up most in Warner Center, which is a spot where you're previously having some pretty good momentum. And I'm just curious, it sounds like, April, you had some maybe momentum in backfilling that. Just where we stand there and maybe a little bit of a digging down into some of the other markets where you see some pockets of strength than weakness will be helpful.

Well, on Warner Center, we're definitely -- as I said when I was answering Michael, I mean we're definitely seeing some momentum in Warner Center and I gave the warning that we could be -- we could have a lot of -- if we have a lot of leasing there, then the one impact from it that's not good, because it's mostly good, is that Warner Center leasing is hard on that roll-up, roll-down metric on the ending rent to beginning rent on the leases that people follow. So it could impact that next quarter but, in terms of Warner Center, we have good, good pipeline in the Warner Center.

You see occupancy continuing to rise is sort of what I'm kind of alluding to as opposed to sort of renewals or replacement rents. You're going to be able to drive that occupancy significantly higher?

Yes. We do see good demand in Warner Center from new tenants. And we, up to now, continue to close those transactions and then move them in.

Yes.

In terms of other markets, as I said earlier, I think that when you're talking about the Westside in Sherman Oaks, we actually feel good about all of those markets and think that they all are showing good strength. And what happens when you get into those small markets, as I said, you get a -- for example, in Brentwood, you got a -- we had a 15,000 square foot tenant move out, we backfilled half of that. But it will take a little while to backfill all of that. So any given quarter, you're going to see 0.5 points to 1 point back -- bouncing around. Westwood was a good example of that as I said. It bounced back up this quarter, so we're not really seeing any problems right now in any of those submarkets.

Let me say to folks on your -- you're asking what the markets are trending. One thing that is interesting about these markets is the markets themselves last quarter moved up which -- if you back up a little bit from the sort of bit more refined looks of whether we gained or loss a 15,000 foot guy because, in general, our company is pretty well occupied. So really what matters on the margin now is moving rents, and that plays a big role in what we're focused on. The best way for us to be able to move rents is to have the market move up in general, not just us, in occupancy. And the market did some good moving last quarter, which was great news. I don't like -- I don't want to see the market move up and us move down, that's not good. But the move down I don't think will be highly impactful to us. And the move-up out in the market will be highly impactful to us in terms of rental rates. And we're feeling it in the leasing that we're doing.

Okay, that's helpful. The -- just a follow-up on the development, the new disclosure is helpful on that. Would it be safe to, if we sort of implied or inferred, that land cost were 20%, 25% of the overall -- if we imputed that into the estimated total cost to get to a value creation number, would that be a safe percentage? And then are you still comfortable -- I think last quarter we talked about maybe 7% to 8% yield on incremental capital.

Yes. So when you say just to get the percentage right, so let's say the number is 66 and you say it lands 25%, do you mean that the land is 33 and, therefore, it's 25% of 100, or do you mean land is 25% of 66?

I would think you'd have to gross it up.

Okay. So I think if you do that, you're in probably in the territory. I mean, it's different land for Brentwood or Hawaii, but I was just trying to think in my mind where I thought all in if I -- we were doing it. You're in the right range, like 25% of the entire cost of doing the deal. You might -- you could get a higher number out of Brentwood, although it will be hard to get a comp that probably wasn't a higher number, though I don't know that you could do it anywhere else. But it's -- that's a probably reasonable number for Hawaii. And then what was your second question?

The yields, the returns. I think we talked, maybe 7% to 8% on incremental capital. I'm just trying to remember from the last...

Yes. I mean, it's -- in Brentwood?

No, this is in Hawaii. We didn't get Brentwood.

Hawaii.

Okay, sorry. In Hawaii...

Brentwood is going to be higher than that, right?

So in Hawaii, it's a little -- I don't want to use a wrong word, I'll just say it's hard to do because we're spending a certain amount of money to build the 488 units, or whatever that...

496 versus the existing 200, yes.

Yes. So we're spending certain amount on that. But what we really also committed ourselves to is just raising the class of the entire project which is almost 30 acres, and it's another huge amount of buildings and we're trying to change the exterior of those buildings, we're changing the parking ratio for everybody and we're doing a big amenities change for everybody. And so, a question you got to ask yourself is first, what's the return on just building the 496? Okay, that's a great return, all right? But what return will we get on? Whatever is allocated to the rest because no matter what we allocate to the rest, it's not a huge number, but if it changes the nature of the project and, therefore, moves the rents up to be more consistent to what we could particularly get on the newer stuff. Well, that's a great day. So that could even be a better return. It's harder to estimate.

I'd be comfortable just knowing the total return on the capital you're trying to -- that you're going to be deploying.

Well, I'm comfortable with the 7% to 8%.

Okay, okay. It's a little high. Well, you are comfortable you're saying.

No. I'm saying I'm comfortable as in if you just want just a comfortable number, 7% to 8%, is a comfortable number. I mean can we get better? I don't know how this other money is going to play out through the rest of the project.

Okay. And Brentwood is still a work in progress?

Yes.

Yes. But Brentwood is obviously a great deal if we can just get it to the city council and get it approved. I mean, we already have not only the land, the parking, I mean, the whole kind of infrastructure. It's just drilling the town and getting it leased in the market that is lease type and there is huge demand for the product.

And your next question comes from the line of Andrew Schaffer [ph].

In regard to the landmark and the comments in the earnings release about this strict zoning in tough development market. Now California has historically been pretty tough to developing. So are these comments more parts of the chorus, or are you experiencing greater resistance than expected?

I would say we're -- having been here our whole lives, we expected a lot of resistance. And if anything, it's a little -- we're expecting -- we're receiving a little less. And I think the reason we're receiving a little less resistance, to be quite frank, is that we have one of the few projects -- and I was actually told by one of our consultants, the only project they have worked on that does not increase the amount of trips in the area. And the communities are so aggravated with traffic that they're kind of against everything. And when you come up with something that actually, in gross, reduces trips as a project and, all of a sudden, they switch over to saying, "Oh, okay, wait a second, I'm not complaining on traffic," so then they look at what were they complaining about, "Well, the height. It's another high-rise, although it's surrounded by high-rises." You get a little less energy out of that than you do if we would have said, "All right, we have 5 intersections that are already absent. We're going to [indiscernible] them hugely, and now they're like F minuses." Okay, that's when they come in, they're just screaming and their hair standing straight. We don't have that situation. So we're not activating a lot of people that would typically come out and really scream. Now on the other side of the coin, what we do have is providing housing that's the exact type of housing that's needed for that area, that the type of people that would live there would be going to jobs right in that area. And I think the kind of city officials and some of the more sophisticated people around this project realize that, that if you're going to allow something like this to happen, in fact this is the kind of thing that needs to happen if we're going to have in any -- constantly deal with traffic, although nobody loves that high-rise -- another high-rise build. And so, so far, so good.

Okay. Then following up on that. Can you remind me if you have a break fee in place with the supermarket or does that still need to be negotiated?

A break fee with who?

The supermarket on the site?

The supermarket. Their lease is over at the end of this year, it's December this year. So having a great day if I had that problem, but we won't have that problem. They'll pay their lease out till the end of this year and, hopefully, we're able to start construction at the end of next year.

And your next question comes from the line of Michael Knott.

It's Jed Reagan, here with Michael. A question on back on the occupancy guidance, it sounds like you need about 200 basis points of occupancy gains to reach the midpoint of your full year guidance. I guess can you maybe just talk about how confident you are at this point, kind of given the ins and outs to be able to hit that number, and then which submarkets we could expect the most gains that will be taking place over the course of the year?

Well, I think -- to answer the second question first, you got to have gains in Warner Center, that's where we have a lot of vacancy. I mean, we have some markets that are like 99%, 98%, so let's assume not much gains there. Okay. So to answer the other question, I would say going into the year, looking at the pipeline, extremely confident. I'd say my confidence was slightly shaken with putting that first quarter out. And then going in April, I went back to extremely confident. Looking at the activity in May, I'm still at extremely confident.

Okay. Does that sort of point you to thinking ...

I only have that amount of information of sitting here today, but we have -- and I was talking to Ken about this, we have the strongest pipeline of deals going through our system right now that we have ever had ever. We both have been here for 30 years. So I mean, it's Ken has a saying of, "We're in an industry where you get 1 good year out of 20, and you got to live on it." Okay. We're in a pretty good year here.

It sounds like maybe your kind of leaning towards the high end of guidance then for occupancy potentially, is that fair to...

The guidance and the range of the guidance is always something that we spent a lot of time on. I always want to be at the high end of guidance, so that's easy to say. Now is that always -- that I always hope it or I always expect it? I don't know that answer. But nobody ever wants to set up a test and set it up where they're going to get the lowest score on the test. They would want to get the highest score. And as Ted said to you, we were focused on the high end, and we said, "Okay, we should bring the high end back 0.5 points," and we did.

Okay. Sounds good. And related to Warner Center, I know there's a lot of expirations still coming up throughout the year. Is there any sort of lumpier or larger move -- known, sort of expected move-outs that are part of that, that we should be thinking about?

I don't think, at this point, they were anticipating any larger move-outs out of that in those things. I think that -- I mean, well, obviously, there will be some move-outs, but there are no larger leases there that we expect to move out.

Okay, great. And then just one other one. Just curious if you guys are seeing any evidence of cap rates and valuations changing in your key markets so far this year? And I guess how are you feeling generally about your ability to deploy capital in this is environment today?

There's more stuff that's trading and prices have moved up dramatically over the last 24 months, but we don't have to tell you that. You guys know that from everywhere that you're covering. And maybe even more dramatically moved up here in L.A. And now at the same time, reasonable pro formas of where rental rates are headed have also moved up. But values have moved up a lot. Now one of the good pieces of news about that when you're a buyer, it means more sellers are selling. More guys are confident to sell and they like the price they're getting. So I'm very hopeful to get some good deals this year.

And do you think that spread -- sort of the bid-ask spreads come in even this year and sort of come closer?

It's come in a huge amount. It's come in -- very little comps to market where -- anymore where the trade is not getting consummated. And if you would have gone back 2 years, a huge amount was coming to market and just falling back out again.

And your next question comes from the line of John Guinee.

Something a little more mundane and boring. Can you kind of explain what's going on, on this health club? It looks to me as if it's maybe $2.7 million of annual rent but then if I look at the other income and the other expense line for this quarter of that other income of $4.3 million and other expense of $1.45 million, which is, if it's only the health club, is $2.8 million just this quarter.

So first of all, there's no rent from the health club that's in our rental revenue numbers because when we took it over, or the subsidiary took it over, now gets eliminated in consolidation. So all of the health club is down in the other income piece. But other income, as you also know, includes a lot of other stuff that gets put in there, and this quarter, it had included some insurance proceeds so -- and so I think that going forward and if -- there may be a little more of that in Q2, but I think going forward, it's likely to be a run rate of about $2 million to $3 million in that.

So what sort of -- if I just -- what will be the net income per quarter from the health club? Is that $600,000 or $700,000?

That's probably a little high right now. We're still in the process of redoing that health club, but that's -- our goal is to move it up to that and go on.

Okay. So maybe $400,000 or $500,000 a quarter?

It's hard to say the health club is moving up at a good clip. I mean, marginal numbers, which -- we're just in the process right now. If anyone has a chance to be out there, we'll be happy to give you a tour. We're just getting the final leg of that finished with food service and made deal with a real good operator. And there's 3 pieces of the food service to open. The third's opening, I think, this month. We're, I think, we're a little ahead of schedule in terms of our signing up of membership but we're certainly up in a very healthy territory. I think -- look, at the end of the day, we want to get the club up and running and going full blast profitable and turn it over to a guy that runs clubs and turn it back into rent, which is the business really is supposed to be in. So we're on or ahead of track for that process.

Okay. And then second, are you still expecting about $9 million of noncash FAS 141 gains or income with the purchase of the ground lease in Hawaii in the third quarter?

Yes, it will be between $8 million and $9 million. I don't think it's $9 million, but it's between $8 million and $9 million of that, and we still do expect that in the third quarter.

Okay. And then the last one is I was just thumbing through your supplemental, very good supplemental by the way, it looks like you have the Time Warner 625,000 square feet, one of the near-term expirations. You've already subleased 100,000 of that. Of the 460,000 or 470,000 square feet that has lease expirations in '19 and '20, are they fully using that space or is that sublet? Or what's the status?

No, they're fully utilizing that space. In fact, if any of you go on the Warner Bros. Tours, or frankly, if you go on the Warner Bros. website, you will see that the lobby of that building -- first of all, that picture of that building is actually on their website as the splash page to be able to do it. And it's the start place for their -- the lobby is where they start their tour to the people, but the building is fully utilized.

Right. The building you built -- you purchased the oval building a while ago, do you still have the John Wayne statue upfront?

What are you reading the local papers? Yes, we do and nobody is taking it down to -- where do they want to take it?

Newport.

Newport. Yes, not going down in Newport. We're going to take our Christmas pictures sitting up there next to John Wayne this year.

And your next question comes from the line of Michael Bilerman.

Yes. So I just wanted to come back a little bit more on the leasing. And so if you look at the target for the end of the year, right, you want to be at the 150 to 250 relative to where you are today, right, where you ended the third quarter. You know your role in the next 3 quarters, which is about just under $1.3 million. So to get the positive net absorption, you need about $1.5 million to, call it, $1.65 million of total leasing, which is only like 0.5 million square feet a quarter to get to this revised high end. You did 700,000 this quarter. Your quarterly average has been 670,000 square feet. You did 400,000 just in April. I'm wondering why this high end is even -- I guess, why did you bother changing it? Because it would seem if you're on the same sort of trajectory that you have been on, you would have hit the old high end.

Okay, you're just amazing [ph]. One of the things that was more kind of noticeable to us was that the -- especially it happened in the first quarter. It's hard to catch up on same-store NOI when you don't have NOI from those deals through the year. So I will admit to you that, that got -- early on, a lot more folks said how could we -- that's a tough -- that's a range it really needs to move down a little bit because you can't go back in time for that first quarter. And we know we have a tough second quarter same-store NOI comparison, which doesn't have as much to do with the second quarter of this year but has a lot to second quarter of last year, which had some -- a bunch of income in it from a few things such as onetime things that aren't occurring this year. So when we knew we were making that change, then we also look and said, well, what's really driving that change is the leasing that got done. So it seemed reasonable to make those 2 changes together. But all you're saying is you sound optimistic about leasing their pipeline and therefore I don't think you should have changed the leasing, and Everyone could have an opinion about that. We felt that to have a reasonable range around this thing for where we sit today, this is a reasonable range. Yes, super hopeful that we're going to go to an even higher number, then we're going to beat the range. But I feel that this is a reasonable range now considering that we missed the 75,000 feet first quarter.

The other thing, just in terms of the numbers, we -- the last couple of quarters, actually, you're leasing -- a lot of the space you're leasing is leased -- is what stuff that would have renewed in 2015. So you not only want a renewal the stuff that's expiring in 2014, but we're typically, as I think we've told you guys, we lease space about, on average, about 5 or 6 months before it expires. So a lot of the last half of the year leasing will be out of 2014. That being said, what Jordan said is 100% right, it's not that we have low numbers of leasings this year. We think we're going to have good numbers of leasing, but it still takes a lot to get back.

And then do you expect the spread between leased and occupied to narrow, expand or stay the same? So you're sitting here today, 170 bps between the 2. As you think towards the end of the year, I mean, we're all talking leasing numbers not -- in your guidance, it's occupied. So that probably plays a part also. So I'm curious if there's everything going on there.

You're right and you would generally expect, if you start doing a lot -- if you change the leasing velocity, and we have low leasing velocity in the first quarter, and if we now have higher leasing velocity for the rest of the year, you would expect that, that spread would widen out. And in fact, the 170 basis points, as you know, is a little on the low side...

It's low for us and that's a very good point. It's an excellent point.

Yes.

All right. And then just lastly, can you just -- the 522,000 square feet of renewals certainly was pretty high, at least in the mix. As a percentage, it was very high level at the total. And I understand there's -- you talk about 75,000 square feet slippage. But was there anything in there and was there any read of what's happening in terms of a bigger percentage of renewals? And because you guys are a leasing machine, doing 200 leases a quarter in very small size, does that tell you anything about what's happening in the marketplace?

I think that there's a good chance it's just quarterly variation on that, but I also would not be surprised. If I were a tenant in this market and I had a renewal that I knew was coming up, I would be more aggressive about moving to renew today than I would've been a year or 2 ago because I would be figuring they all know what's happening with their brokers, all know what's happening in terms of rental rates. So it could be that but it could also just be quarterly fluctuations and what happened.

We're definitely -- we definitely had many buildings that are leased to the point where if a guy doesn't renew early enough, we could lease it to someone else and then we couldn't even accommodate them in the building. So if you don't want to leave and you don't want to move, then you better get in and get your deal done because you take a much bigger risk of being forced to move today than you did anytime in the last 6 or 7 years.

And even if you don't move, you're likely to pay more.

Right. And then -- and just lastly, do you feel -- you talked a lot about how other landlords are pushing the bumps. I think you talked about 4.5% in some cases. I guess, from your standpoint, are you trying to push initial more than the bumps? Or are you pushing bumps at the expenses, initial starting rent?

We just push economics, wherever we can get them. We actually go for the overall best economic package out of the lease, which, if we push initially, we could fix the change. We could fix that beginning and ending rent issue. The only people that ever talked about that is us on the calls with you guys. The leasing guys get rewarded, praised, paid, all that stuff based on the economics they get out of the lease. So they move seamlessly between higher bumps, less free rent, longer leases. They just do all that and it's, I mean, it's just the economics that they get out of the lease.

And your next question comes from the line of Ross Nussbaum.

It's Ross Nussbaum at UBS. So at Warner Center, let's assume you get the space backfilled over the next year or so. Is that an asset you guys would ever think about selling? Is it just doesn't fit with the rest of the portfolio in terms of the chunkiness of the tenants, and just frankly, the sheer location on the other side of the hill?

Well, I don't think that it doesn't fit at all. I mean, I think it fits. I mean, we entered that market because we think it fits. I think that the only reason it stands out is that it happens to have gotten that LNR project developed, and therefore, it sort of underperformed on the recovery from this most recent recession, unlike the way it acted in past times. I mean, I can tell you that if we would back up -- if we could back up 10 years or 7 or whatever years, you would ask the question in reverse because Warner Center was the more premium, higher-rent market. It was thought to be like the high-end area that can be located in the valley above and seeing Sherman Oaks. And in fact, Warner Center does have a very good collection of amenities, travel to housing and actually the quality of the buildings. I mean, we own some of the newer buildings on Ventura Boulevard but the Warner Center stuff is all pretty good quality, high-rise stuff. So it's a very good market, and in fact, that -- well, you guys aren't seeing it in occupancy and you're not seeing it in rental rates because we always say all rental rates are going up, except Warner Center. So that's like a horrible beating we're giving the place. But in every other way, everybody else in terms of the economy over there is investing big. I mean, Westfield is putting a huge amount of money into -- they have like 3 full square blocks, 2 of the them have malls, 1 has, let's say, nothing on it. They're rebuilding and connecting it all together and redoing the entire mall and spending a tremendous amount of money there. And then in terms of new housing and apartment development, I mean, when we went into the last recession, we had an overhang of 2,500, 3,000 apartment units, which I thought would take forever to absorb. Not only are they absorbed, done, leased but they're building some more out there and it's probably one of the primary places of anywhere we look at where a lot of new apartment housing is being built and that stuff's leasing up very fast. At the end of the day, you just want as much housing and population around your office buildings as possible. I mean, I haven't mentioned any office buildings being built. So we have the best office buildings in a market, right, where huge amount of housing, huge amount of retail amenities are being built all around us and great traffic, has the highest rents in the valley at one point with the exception of maybe the media district in Burbank. It's a great market. It just lagged recently and I think -- I hope and think, both of those, that over the next year or 2, you guys will see what we're talking about and what we saw in that market when we went into it in the late '90s.

I agree with Jordan that I think sometimes we tend to do contrasting the rest of the portfolio with Warner Center, and I think it probably highlights that contrast too much. So just to remind you, the median size of our tenant in Warner Center is still only a little over 5,000 square feet. So while we do have some good sized tenants out there, the sort of population includes a lot of tenants, which are very similar in size to our tenants here on the west side. And it still is a, compared to any of the other office markets you're looking around in the country, it's a very small tenant market.

Okay. And then my other question would be, if you look north to San Fran or what's going on in the SoMa District there in terms of, I don't know if I want to call it next-generation space but sort of funkier open ceiling, polished, concrete floors, as you look at your portfolio, do you see any redevelopment opportunities to take some, call it, 20-, 30-year-old assets and make them, I don't know if I want to use the word tech friendly, but make them friendlier to the 20-and-30-something-year-olds that seem to be driving in the economy on the West Coast now?

Well -- so obviously, that opportunity would come from SoMa in an office building that was very poorly leased, where you'd say there's huge vacancy here. So we got to reposition us. A lot of stuff we own. I mean, even though we complain about Warner Center, what we own is pretty well leased. Now we do have many opportunities to do larger tech deals in our buildings, which call for larger TIs, a lot of times get higher rent and they want to strip out all of the TIs and they want to go to that kind of concrete floor and tear the drop ceiling out and do that whole thing. What we feel we've learned over time, at least with the buildings that we own and the way we run our product, is on the day you're doing that deal where you go, well, it's a deal. I'm getting bigger rent. Net-net, over time, we get less net cash flow out of those deals because of the big TI going in and the big TI going out. Then we do out of trying to standardize the TIs in our spaces, keep the TI and the transition costs down and I said to people in the past and we were trying to push our office portfolio to get closer to almost a resi model of like very standardized lease forms, huge amount of space that a person feels like they can just move into. Very few choices like, all right, for changing the carpet, here's 4 types of carpet you can choose from or paint colors. I mean, to have them kind of plug and play, more and more ready to go space. Every time you do one of those tech-friendly spaces, that means it's never what the next guy wants and it's funky and strange and one guy who wanted like a giant corner office with tall glass and the next guy wanted, he says, no, my office had to be in the middle in a circle or -- so you just spend a lot of money going in and out with those guys. So we have -- with whatever force anybody that's leasing has in terms of choosing their tenants, we have tried to make the deals that are the highest net through the entire term of the lease cash deals. And we look a lot at transitions cost from TIs. And those spaces are expensive to do.

As Jordan said in the past, and I think we both said in the past, we really try and manage the company to cash flow and it's one of the reasons why our FFO is such a high percentage of our FFO.

Our AFFO.

AFFO is a high percentage of our FFO because we're trying, as Jordan said, to avoid situations where you pay a lot in capital costs and capital cash in order to get better lease rates in the short term.

And your next question comes from the line of Brendan Maiorana.

Just to follow up. So Ted, you mentioned lease bumps 40% greater than 3% annual bumps in the deals that were done this quarter. What's your average bump in place today across the portfolio?

Well, in place today, I would still say that it's -- I used to say it was just below 3%. It's probably just above because while we're doing these in -- than doing in the last year, that only affects the leases that roll this year. So you'll still probably in the -- as I said, it's just slightly above 3% now in terms of the average.

Yes. So let's call that 3% and if I look at your occupancy changes kind of year-over-year, it seems like probably on a full year basis, if you're, call it, flat in Q2 and you go up a couple of hundred basis points and maybe 100 basis points in Q3 and then Q4 and meet the midpoint of that occupancy guidance by year end, that would be about an average of 100 basis points better '14 versus '13. In-place bumps are 3% on, call it, 80% of your portfolio and you're still rolling rents down on a cash basis. I would think that same-store NOI would be higher on your office portfolio this year based on that kind of top line revenue numbers than I think what's included in your guidance, which is about 1.5% for the office and maybe kind of 4% to 5% for multifamily. Is there something else going on there?

Well, there is -- as Jordan mentioned, we've got a tough comparison quarter in the second quarter just because of some income that came in last year. We do also have some increases in expenses that you have to do in. Beyond that, I can't say that, listening on the phone, I could fully follow and analyze what the differences are. So maybe if we want to talk after the phone, I'd be happy to sort of see if we can work through what it is. But I think those 2 exceptions are the 2 things I would start by mentioning.

And your next question comes from the line of Jamie Feldman.

I know you guys have talked about rent growth in the submarkets, but can you talk a little bit more about the magnitude unless I missed it?

Yes, I'd say on average across all the spaces of the Warner Center, we're seeing 5 to 10 up. And obviously, from individual building submarkets and spaces, you can see some more but we still wouldn't call the overall inflection point has been reached.

You're saying 5% to 10%.

Per annum.

Year-to-date or...

No, per annum.

And compare it with...

Compare it with this time last year?

Yes.

Yes.

And your next question comes from the line of Steve Sakwa.

So look, I don't want to beat a dead horse on the 2014, so I'll let that go. But if you had provided guidance for, say, '15 and '16 previously, given all the positive commentary that you're talking about today about leasing, would you be revising those numbers upward or downward just based on the momentum you're seeing in the market today?

Well, I could tell you this, I'm always so optimistic about the future that, number one, my optimism about the future would have been very high numbers. Then probably, any time you're asking that question, I'll go, yes, and I'll also revise it upward even more. But if you're just asking about the tone of where we see things going, I mean, I'll try every way to say it. I mean, we're having a fantastic leasing here with a great pipeline and a huge amount of deal flow. And obviously, that's going to be very positively impactful to 2015 in terms of just we think our occupancy is going to be higher going into '15 than it was going into '14, if you just want to compare the 2 years.

Yes. I think where everybody's kind of getting hung up on is the leasing is good and I think people can understand the NOI growth if leasing kind of got delayed. I think where people are struggling is the year-end occupancy stat, which is just a point in time is hard for people to understand why that number is down versus, I think, people can understand why the NOI is down if leasing slipped. And I think that's where the confusion is. But it sounds like given the pace of leasing that you've got and presumably market rents are moving higher and bumps are going up, again, I know you haven't given guidance for the next 2 years, but it sounds like those numbers should be revised up just given the commentary you provided.

Okay, so there's a lot of different numbers that go in the guidance. If you want to go to just the core of when you've got more leasing and you have better occupied buildings, do you make more money? Yes, so the number of -- whatever the guidance number that goes to where we have more cash coming out of this place, yes, that number we could happily revise that. Now there's a lot of numbers that are driven by accounting calculations that move around because of comparison periods and comparison leases and FAS and just like any other. And frankly, I don't even know what it is at the end of the day. If you have a great year, sometimes it makes the next year look like a bad year because it's compared to the previous year. But in terms of making money, more cash flow, yes, I would happily revise out 2015 because we're having a great leasing year.

And also, by the way, you did make a little bit of a move between leasing and occupied and I think that Michael's point was correct, which is that delaying a leasing toward both -- later in the year means that there will be less percentage of those people who have moved in and taken occupancy by the end of the year. So it's another reason why we felt that the high end of that guidance was going to be tight to achieve although we're going to push through.

To be fair to you, my guys might have -- read [ph] here, I'm not going to exactly help myself on this, always talk about occupancy and I always talk about leasing. So they're all trying to like figure out, I'm not sure I'm going to mention the word of the model, but they always like to try and figure out the accounting metrics, and therefore, occupancy is obviously what matters. And I'm always trying to look to the future to see how things are going and I'm always saying, what's the leasing pipeline look like? What's our signed leases look like? So those 2 numbers are different from the perspective of giving, in this instance, giving that year-end guidance.

And your next question comes from the line of Tony Paolone.

I was just going to shift gears and ask if there's much in your investment pipeline or what you're seeing in the acquisition markets.

We have deals in our investment pipeline that we're working on, and it feels like if I look head on to a horizon, there's other stuff coming. I mean -- so I would say better looking than the last couple of years and with a more reasonable hope that we will get a couple or more deals closed in this year.

Okay. And then just last thing. Just curious, I know it's not your tenant profile and not your submarket, but just any broad thoughts on Toyota's decision to move out of Southern California?

On Toyota? Oh, Toyota's decision.

Yes, I saw that. Yes, I mean, I felt bad, but I will say this, I was not surprised. In California, Southern California and Northern California is we're a great incubator state and we're great with new industries and developing new industries and new young tenants and all of that. But in terms of mature industries and mature businesses that, in fact, employ a lot of kind of middle-income people, which what everyone says they want around here, we're very hard on them. I mean, we're very business-unfriendly to mature manufacturing industries or even larger and more mature aerospace or -- and so as companies get to a point where their margins are thinner and they're able to hire a broader base of people and the education level doesn't need to be as high and the people that they're hiring can't afford housing that's as expensive as it is in California and then you add into that the fact that California just had some very tough employer laws and I love the environment but tough environmental laws on manufacturing companies, you just -- it just seems to be in our nature. I mean, we built some of the greatest industries ever but then as soon as they get great and they're up to running speed, we seem to kick them out.

Put on another way, California is not a low-cost provider.

Yes, we're not.

So if you're in a situation where low-cost provider is really what you're looking for, people will tend to move. We're more into the -- we sort of are the high-end service provider and so that's why with new ideas and the tech and so forth, people are here because they take advantage of the education and so forth where the costs are acceptable in that range. If you're in a lower-margin business, as Jordan said, you go with a lower-cost provider.

I was sorry to lose Toyota. I'm sorry to hear that Elon Musk is looking in all the different states to build his battery thing and he wouldn't do it any California, where he got all his other stuff going. I mean -- but I understand it.

And your next question comes from the line of Jordan Sadler.

One quick one, I'll let you off. I was curious on the capital front. Where do you guys stand on the ATM in terms of the availability and then appetite, given the price of the stock here? I'm just looking at the chart and you guys are back in the realm of all-time highs and I'm just curious where you stand on the capital side.

Well, I'll answer the question on the ATM and let Jordan answer the appetite since it's really the capital side. But the ATM, we still have a $300 million ATM, which we haven't drawn down on at this point.

And then your question was whether we would want to issue equity in order buy buildings. We have plenty of equity without issuing equity to buy buildings and sources. And as I said, and I understand it applies in the face of saying we're at an all-time high in stock but I feel like we're at an all-time low in terms of our stock discount to our NAV. So I wouldn't want to like issue stock and go buy an expensive building and now I'm selling my buildings at a cheap price to buy an expensive building. So that would be a particularly disturbing trade today, much more disturbing than, let's say, it must have been at some time in the past. I think it's even more out of whack than usual. So -- and we have plenty of equities to issue.

Yes.

And your next question comes from the line of David Harris.

Just picking up on Tony Paolone's point on acquisitions. Is there any way you could characterize what you're most interested in at a moment? Are we talking portfolios, big buildings, little buildings?

Well, I'm not going to go to my obsession because we've almost made it through a call without that. But it's office buildings, reasonably sized office buildings. So there's some smaller ones there. But for our market, reasonably sized office buildings. Right now, if I think about it, I'd have -- I'd have there's one in the valley and there's 2, let's say, current like on my desk that are on the west side.

Okay. So I mean, you might not want to answer this either but you did 150 with 2 deals last year. Is it reasonable to think you could get over that this year in terms of these dollars expended?

Yes, yes.

Yes.

Double?

Well, let me add it up for you. I'm just kidding. But yes, I think we could -- certainly, we have a reasonable chance of doing much better than that number.

Much better. Double?

I don't know, much better.

And there are no further questions in queue at this time.

Okay. Thank you, everybody. It was a pleasure speaking with you, and we look forward to our quarterly call in 3 months.

Thank you for participating in today's conference call. You may now disconnect.