2023-08-18 10:08:19 ET
Summary
- Hudson Pacific Properties is an office REIT that has been struggling lately.
- They have a poorly diversified portfolio that presents a concentration risk.
- Moreover, they have a packed maturity schedule for the next few years and will probably have to refinance at a higher rate.
- I present my analysis, which leads me to a sell rating.
Office REITs have been having a hard time since the work from home trend started, and many office buildings are now empty or less occupied. If you have read my other articles on office REITs you know that I believe that some of the strongest office REITs will stay in the game and thrive in the future, but most will continue to struggle. Today I want to take a look at Hudson Pacific Properties ( HPP ) which is an office REIT that might not be able to deal with the situation at hand.
Overview
HPP has 50 office and 4 studio properties. As you can see in the graphs below, 34.7% of their NOI comes from Silicon Valley, 29% from Los Angeles, and 21.2% from San Francisco. Therefore, three of their biggest markets are in California, and they account for 84.9% of the total NOI by region! To me, that screams concentration risk, and I would like to see more diversification in the location of their properties. As the biggest percentage of their NOI by region comes from Silicon Valley, it should come as no surprise that the biggest industry occupying HPP's offices is technology, accounting for 38.5% of the portfolio .
Technology companies try to get employees to go back to offices a little more rigidly than other industries. For example, Google, which pays 14.7% of the total annualised base rent and is therefore the biggest tenant, is trying to persuade their employees to come back to the office at least for some days of the week. But they have been trying to accomplish this for a while now, so the question is whether they will succeed this time or not. Overall, these percentages are pretty high and present a concentration risk also because 15 of their biggest tenants account for almost 50% of their annualised base rent.
Another thing to be cautious about are the lease expirations. By the end of 2023, 91 leases will expire (accounting for 1.1 million square feet of their properties). In 2024, 194 leases totaling 1.8 million square feet will expire, and in 2025 we are looking at 151 leases expiring, which account for almost 1.9 million square feet. This makes 2024 and 2025 the two years with the most lease expirations by quite a bit. Of course, some tenants will renew their leases and not all of this space will become vacant, however some of it probably will, and in case companies like Google will fail to get their employees back to the office, it could present a big problem for HPP.
However, in a situation where big tech companies that occupy HPP's properties are successful in getting employees back to the office, Hudson Pacific would benefit greatly. This could be a turning point for them since they rely heavily on such companies.
Now I would like to take a look at the new developments of the company. The future development pipeline provided by HPP does not seem very good. The majority of these spaces are still in California, and while there are a few buildings that are not office spaces, a lot of them still are, which could add to their vacancy problems in the future rather than help with them.
The FFO per share for the second quarter is $0.29, for comparison in Q2 2022, it was $0.50, so this presents quite a significant drop. The occupancy stands at 87% and was 87.6% in Q2 2022, so it barely moved. The same-store total NOI decreased by 0.8% YoY, and revenues decreased by 2.3%.
The guidance provided for the full year of 2023 states that the same-store cash NOI should grow by 1-2%, and non-cash revenues should increase by $13.5-$23.5 million. However, as the second quarter results indicate, this might not be fulfilled.
Balance sheet
Now, a look at HPP's balance sheet. The outstanding net debt is $4.5 billion, and 85.3% of it is fixed or capped, which is pretty good. However, the weighted average interest rate is 4.8% which is on the higher side, and they have a significant amount of maturities in the coming years. Even with $109 million in cash and $427 million available on their credit facility, they will most likely have to refinance some of their debt, probably at higher rates.
Dividend
The dividend, which remained at the same level since 2017, was cut by 50% in this last quarter from $0.25 per share per quarter to $0.125. This cut will help the company save over $70 million in cash every year, which can be used for paying off some of the maturities they will face in the near future. Even with the cut, the dividend still yields 8.3% and is covered with a 58.8% AFFO payout ratio.
Valuation
It should come as no surprise that Hudson Pacific is really cheap, and it currently trades at a P/FFO of 3.91x, which is really low compared to their historical average of 17.9x. Peers trade at similar multiples as well. Piedmont Office Realty Trust ( PDM ) at 3.56x and Brandywine Realty Trust ( BDN ) at 3.81x.
While the P/FFO multiples of these companies are similar, their performance metrics aren't. HPP has been struggling and will probably continue to struggle. Their portfolio is not diversified and from their planned developments it seems like they are not planning to change it that much. Their balance sheet poses a threat to the company as they will probably have to refinance at a higher rate, even though they will save some cash, thanks to the dividend cut. All things considered, I do not see Hudson Pacific as an office REIT that will be able to deal with the work from home trend and make it out of this difficult situation. For these reasons, I rate HPP a SELL.
For further details see:
Hudson Pacific Properties: Unlikely To Make It Out Of The Work From Home Trend