When investors buy real estate investment trusts (REITs), they aren’t just buying real estate companies. They are also buying the large block of tenants that comprise the REIT’s leasing portfolio.
So, before you decide to buy any REIT, consider the stability and solvency of much of its tenant base. Consider these questions: Are any tenants facing bankruptcy or closing a number of locations? Are the tenants high quality? Are the tenants diversified — geographically and by industry? And what is the percentage of each tenant’s annualized base rent (ABR) in the total tenant portfolio?
Take a look at an office REIT that has fallen on hard times, and consider the questions raised above in evaluating its merits.
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Hudson Pacific Properties Inc. HPP is a Los Angeles-based office REIT with 49 office properties and four studio properties with an emphasis on centers of innovation for media and tech companies in California, Washington state and Vancouver, British Columbia.
Hudson Pacific Properties was founded in 2006 by Chairman and CEO Victor Coleman. Soon after its creation, it began purchasing motion picture studios and office buildings on the West Coast. Hudson Pacific Properties went public in 2010. It has a market cap of $690.43 million. The 52-week range is $4.08 to $16.31.
One problem Hudson Pacific Properties has, like some other office REITs such as SL Green Realty Corp. SLG and Boston Properties Inc. BXP, is a lack of geographic diversity. All of Hudson Pacific’s properties are located in only five areas: Seattle, San Francisco, Los Angeles, Silicon Valley and Vancouver.
Office occupancy rates have been decreasing for months on the West Coast. Hudson Pacific Properties’ occupancy of in-service offices has declined year-over-year from 92.3% to 88.7%. Net effective rent per square foot dropped from $41.72 to $40.46 over that same time frame.
The percentage of properties leased by geographic area as of March 31 is as follows:
|
AREA |
Percentage Leased |
|
Seattle |
86.4% |
|
San Francisco |
93.9% |
|
Los Angeles |
99.3% |
|
Silicon Valley |
80.8% |
|
Vancouver |
94.4% |
While it’s true that several tech companies, such as Alphabet Inc.’s Google, Microsoft Corp., Amazon.com Inc. and Meta Platforms Inc. are beginning to mandate employees to return to office work three to four days per week, it’s also true that the office vacancies in areas like Seattle and Silicon Valley are on the rise.
In the three months ending March 31, 466,351 square feet of Hudson Pacific Properties’ office space had either contractual expirations or early terminations. In addition, while renewal space was leasing for $45.36 per square foot, new leases were only garnering $34.56, possibly showing a need to cut lease prices to attract tenants and maintain occupancy levels.
Largest Tenants
The following is a chart of Hudson Pacific Properties’ 15 largest tenants. Notice that the top four tenants comprise about 25% of the total ABR.
Alphabet Inc. GOOGL is a Mountain View, California-based multinational technology conglomerate. It was created in October 2015 by a restructuring within Google to become the parent company of Google. Alphabet is the world’s third-largest technology company by annual revenue and one of the five Big Tech stocks that comprise the Nasdaq 100. Sundar Pichai replaced the original founders, Larry Page and Sergey Brin, near the end of 2019. It has a market capitalization of $1.62 trillion. Google’s share of Hudson Pacific Properties’ annualized base rent (ABR) is 13.9%.
Amazon.com Inc. AMZN is a multinational technology company that is one of the world’s most valuable brands and one of five American technology companies that make up the popular Big Tech stocks on the Nasdaq 100. It was founded in 1994 by Jeff Bezos as an online marketplace for selling books.
In the 29 years since, it has branched out into selling thousands of different products. In recent years, Amazon has also expanded into retail by purchasing Whole Foods Market Inc. and now has subsidiaries in cloud computing, autonomous vehicles, computer hardware research and development and satellite internet.
Amazon.com has a market cap of $1.29 trillion and daily volume of over 11 million shares.
Netflix Inc. NFLX is a Los Gatos, California-based video-on-demand, streaming television service offering movies and TV series in multiple languages. Netflix began in the late 1990s with a DVD-by-mail service. Netflix then developed its streaming service in 2007. Today, it is the No. 1 subscription video-on-demand streaming service with more than 232 million paid memberships across more than 190 countries. Netflix also expanded into original productions and video game publishing.
Netflix has a market cap of $193.24 billion and trades over 1 million shares per day. Like Amazon, it is also one of the Bigh Tech stocks that make up about 30% of the Nasdaq 100.
Salesforce Inc. is a San Francisco-based software company that provides sales, customer service, marketing automation, e-commerce, analytics and application development. Salesforce was founded by Marc Benioff, a former executive at Oracle Corp. Its initial public offering (IPO) was in 2004. It was the first cloud computing company to reach $1 billion in annual revenue, which it achieved in 2009. As of September 2022, it was the 61st-largest company in the world by market capitalization. It has a present market capitalization of $206.63 billion.
The tenants cited above are grade-A companies and not at risk for bankruptcies or failure to pay rent. But further downsizing of office space remains a risk for Hudson Pacific Properties. Amazon has demonstrated it is willing to build its own industrial space, so it wouldn’t be a total shock if Amazon decided to construct its own office buildings.
Another weakness of Hudson Pacific Properties’ portfolio is the heavy reliance upon the tech and movie industries. A more diverse portfolio might minimize some of the risks to its occupancy rates. That Google is responsible for almost 14% of the ABR is clearly a danger.
Performance
Hudson Pacific Properties’ long- and short-term performances both have been weak. Over nearly 28 years, it has a total return of 30.44%, which is less than one could get from a certificate of deposit (CD) or Treasury bond. Since the beginning of 2022, Hudson Pacific Properties has had a negative 75.83% return. Year to date, it’s down 45%.
Recent News
On May 8, Hudson Pacific Properties reported its first-quarter operating results, but the news was somewhat negative. Funds from operations (FFO) of $0.35 missed analyst estimates by $0.07 and were down from $0.50 in the first quarter of 2022. Revenue of $252.26 million was $9.19 million shy of the estimates. The only positive was that revenue was 3.2% better than revenue in the first quarter of 2022.
On June 9, Hudson Pacific Properties declared a quarterly dividend of $0.125 per share. This was a 50% reduction from the previous quarterly dividend of $0.25 per share. This was not a surprise as it was revealed on its May conference call. The quarterly dividend had been stable at $0.25 per share since March 2017, so the news was not well received. The forward annual dividend of $0.50 now yields 10.37%.
Analysts are somewhat blase about Hudson Pacific Properties. Morgan Stanley and Wells Fargo have recently maintained Equal-Weight ratings on it and Citigroup and Piper Sandler both rate it as Neutral. All of them have lowered price targets within the range of $4 and $6 over the last month.
Short interest is also a problem and is now up to 13.2%. Traders are seeing the growing weakness in the California office markets, especially in areas like San Francisco, and betting against Hudson Pacific. The strike at the Writers Guild of America, now up to 50 days, could also hurt demand for Hudson Pacific’s studio properties. Total debt of $4.9 billion, along with a 56% debt-to-capital ratio, necessitated the recent dividend cut. Before the cut, the yield was over 20%.
Despite the many negatives, there are still a few positives. The dividend yield remains high, while the payout ratio, assuming a forward annual dividend of $0.50, is now down to 36%. The price/FFO is abnormally low now at 3.51.
Hudson Pacific Properties is a blood-in-the-streets purchase at this point. Despite the high dividend yield and a payout ratio of 36%, this is not a REIT for conservative income investors as the ongoing risks could send shares even lower, negating the dividend with further loss of principal. The office REITs continue to struggle, and Hudson Pacific Properties is one of the weakest REITs within that subsector.
But Hudson Pacific Properties was a $24 stock when 2022 began, so those with a longer time horizon and a more aggressive approach to investing could do well accumulating shares at present levels and hoping for either a mild recession or no recession at all over the next few years.
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