By Jon Peterson
New York City-based Blackstone was looking for the right partner to grow its business in Northern California and found it in Los Angeles-based Hudson Pacific Properties. The transaction between the two firms will transfer 26 properties and two parcels of land totaling 40 acres into majority (52 percent) ownership by Hudson Pacific. This $3.5 billion deal, when it closes in the first quarter of next year, will create a premier West Coast office REIT that will hold 53 properties with 14.6 million square feet in four key West Coast markets.[contextly_sidebar id=”O8nUGcmlWzzJY7I3E6jpooZfgXbi82MO”]“We are not selling out of our Northern California position but rather we will be a contributor to the future growth of Hudson Pacific. We could have hired Eastdil [Secured] to sell the portfolio in a marketing process, but chose to remain with a stake in the portfolio going forward. We think that the Northern California office market remains one of the strongest in the country,” says Jonathan Gray, global head of real estate for Blackstone in a conference call today to discuss the proposed sale of the assets to Hudson Pacific.
According to a statement by Hudson Pacific, the firm will hold the #2 spot in Seattle, behind Kilroy Realty, with 4 properties totaling 1 million square feet; #2 spot in San Francisco, behind Boston Properties, with 7 properties totaling 2.4 million square feet; #1 spot in San Francisco Peninsula/Silicon Valley, ahead of Boston Properties and Kilroy Realty, with 26 properties totaling 8.2 million square feet; and #3 spot in Los Angeles, behind Douglas Emmett and Kilroy Realty, with 16 properties totaling 3 million square feet.
Hudson Pacific paid an effective price of $425 per square foot, which the firm considers well below replacement cost of the portfolio, according to the presentation that the company attached to its financial statement filed with the Securities and Exchange Commission.
The portfolio is currently 81 percent occupied, which is approximately 10 percent below market levels and around 15 percent below the assets’ historic occupancy in the 92 to 95 percent range. The current vacancy has been impacted by a major tenant leaving one of its properties. “This was Sony leaving the Metro Center [in Foster City]. We also took a more patient attitude with leases to allow rents in the overall marketplace to improve,” said Gray in the conference call.
Hudson Pacific is a great believer in the Northern California property market. It sees the Bay Area as the 21st largest economy of the world, with tech firms of today achieving a level of maturity and capitalization not seen in the previous cycles—the top 150 Bay Area tech firms generated over $100 billion in profits in 2013, according to Hudson’s research. Other indications also point to a healthy stream of innovation generated in the region as venture capital continues to accelerate its investment into Bay Area companies—40 percent of all venture funding goes to companies based in the Bay Area.
The portfolio that Blackstone contributed to Hudson Pacific has an impressive list of tenants. Cisco is its largest tenant with 471,000 square feet of space, Qualcomm is second at 365,000 square feet and Google is third at 305,000 square feet. NetSuite, WalMart, Bosch, Virgin America and Oracle are all in the top 10 list of tenants.
There is a significant amount of the Blackstone portfolio that is not 100 percent fee ownership—around 25 percent of the portfolio’s net operating income consists of ground leases. The company will be considering ways to increase the net operating income of the portfolio. One part of that will be focused on existing rents in the portfolio, which are seen as 15 percent below market. Hudson stated that roughly 60 percent of the leased space will be expiring by year-end 2017. The firm is planning on spending roughly $85 million, including tenant commission, brokerage commissions and capital expenditures to assist it in the leasing up of the empty space in the portfolio once the deal closes, according to today’s conference call.
Another focus will be evaluating the opportunities of the 40 acres of land where future development could total 1.1 million square feet. The two lots, which were part of today’s acquisition announcement, are in the Golden Triangle area of Silicon Valley (Campus Center totaling 34.5 acres) and Skyport Plaza adjacent to the San Jose International airport (5.3 acres).