Hudson Pacific: Ignore The Noise, Stay With The Trend

seekingalpha11-23

Our sell rating on Hudson Pacific Properties, Inc. in August has proven accurate due to significant issues plaguing this office properties REIT.Occupancy is below 80%, FFO has declined drastically, ...

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Aerial of downtown district at dusk, San Francisco Matteo Colombo/DigitalVision via Getty Images Our sell rating on Hudson Pacific Properties, Inc. (NYSE:HPP) in August has worked out well for those that concurred with the thesis.   Seeking AlphaIt was not hard to make that call with all the problems that plagued this office properties REIT. The occupancy was sub 80% and the year over year FFO had declined from 29 cents to 16 cents. Meanwhile, the debt to EBITDA had risen from 8.7x to 10.3x over a one-year timeframe. The writing was on the wall and the company also lowered its initial guidance for the net operating income. The going was going to get tougher, with close to 19% of the leases coming up for renewal by the end of 2025. The verdict in that piece underscored the pain points. Let's not forget that we have gone to a quarterly run-rate of 10 cents in FFO from a quarterly run-rate of 52 cents, in two years. Any kind of realistic interest rate you put on that 2025 and 2026 set of debt maturities will push both highlighted covenants in default. We are here at this point with credit spreads still rather well behaved. What happens when they are not well behaved? We continue to rate the common shares as a Sell. As the preferreds have fallen sharply, we are moving them to a Sell from the earlier Strong Sell rating. We expect the longer term outlook to result in a complete wipeout or near for both set of securities, but there is a small probability the preferreds could make it. Source: Hudson Pacific: Preferreds Catch Up To Common, More Downside Ahead With the stock losing almost a third of its market cap in three months, it's time to revisit the thesis. Q3-2024 There was some initial euphoria about the results. We are unsure what exactly the bulls saw, but if we had to take a stab at it, we would guess the slightly higher occupancy levels over Q2-2024 (78.7%). No trend goes perfectly symmetrical, and there is always some noise away from the trend. We see this quarter as no different. Whatever little was derived from that occupancy gain, was lost in the new leases signed. The percentage drop in GAAP and cash rents was in the double digits.   HPP Q3-2024 Supplemental The hits did not stop there. Funds from operations (FFO) per common stock unit was down to just 5 cents a share. This was 16 cents in the last quarter. This same metric was running close to 50 cents when we first wrote about this stock. Same property net operating income was down a whopping 22%. One impressive part in all of this was that debt to EBITDA is still only at 10.9X. One final point to bring up here is that the weighted debt term is now down to just 2.9 years (3.2 last quarter) and HPP drew down $23 million on its unsecured revolving facility. Outlook Close to one quarter of the total office annualized base rent expires by the end of next year.   HPP Q3-2024 Supplemental Some investors are clamoring to hang on to any news about a potential turn, and it is not hard to find articles that do just that.  Demand for large chunks of office space in San Francisco has reached a post-pandemic high, according to research from commercial brokerage Avison Young. AI is leading the way on the trend that puts demand for 50,000-plus-square-foot spaces at nearly 44 percent of active tenant requirements, according to Louis Thibault, senior market intelligence analyst at Avison Young. Leases on spaces that large made up more than 60 percent of the demand in 2019 but were at only about 30 percent in 2023.  Source: The Real Deal  The sad reality is that office vacancy rates continue to make new highs. In today's version of \"X Gon' Give It To Ya\", we got some more bad news for the troubled office market.  San Francisco’s office-vacancy rate rose again in the third quarter to another record high, pushed up by Elon Musk’s X putting its Mid-Market headquarters on the sublease market, according to preliminary data. The vacancy rate, which apparently rose a half-percentage point to 37.3% in the third quarter, would have remained flat but for a single, large block of space that “unexpectedly” became vacant at 1355 Market St., said Colin Yasukochi, executive director of CBRE’s tech insights center. That is the address of the longtime headquarters space recently vacated by X, which Musk announced in July he would be moving to Texas.  Source: SF Examiner What is fundamental to look at, is the \"spread\" between HPP's San Francisco vacancy and the city's overall numbers. While the two might never converge completely, there is definitely a tug to get them closer over time. We hence expect HPP's occupancy to drop over time, even if San Francisco's office occupancy has troughed in Q3-2024. Unfortunately for HPP, even if we are completely wrong about that and HPP's occupancy stays flat, the challenges are extremely daunting. If we assume every single lease is renewed over the next 2 years at about 20% lower rent rates, the NOI margins get crushed. In this scenario, occupancy stays flat (highly unlikely), but EBITDA drops another 15%. This should be enough to produce negative FFO, right into the big debt maturity wall.   HPP Q3-2024 Supplemental The odds of violating the adjusted EBITDA to fixed charges covenant is close to 100% in our view by then. Even unencumbered NOI to unsecured interest expense covenant could be triggered.   HPP Q3-2024 Supplemental Verdict But what about NAV? We are glad you asked. The consensus on the street is that HPP could liquidate today for $10.00 per share. Even the low NAV estimate is $5.52.   TIKRBut observe the evolution of that NAV over the last 12 months. The mean estimate has dropped about 40% and the low estimate has dropped by more than 50%. Since January 2020, NAV estimate has dropped from about $46.00, down to $10.00.   TIKRSo NAV does not save you from losses. Knowing where it is going, probably could save you from losses. We maintain a Sell here, as this is the state that the REIT is in, despite the current AI hype helping real estate in San Francisco. We have the easiest credit conditions and HPP has not managed to sell enough assets to deleverage. We don't believe it will have an easy time when things actually break in the junk bond space. Hudson Pacific Properties, Inc. 4.750% CUM PFD C (NYSE:HPP.PR.C) One interesting facet about this entire drama is how the preferreds have periodically diverged from the common shares. You can see that best in the price performance over the last 12 months.   Seeking AlphaWe stand by our earlier conviction that these are also likely to be wiped out over the long run. We will add that we do not expect the preferred dividends to be maintained for more than three more quarters. We are downgrading this to a Strong Sell.  Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. 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