As Coleman pointed out, market conditions were on the upswing in the second quarter. The REIT saw strong demand for space in its office buildings, enabling it to capture double-digit rental rate increases compared to the prior rates. Meanwhile, nearly all its tenants paid their rent on time, allowing the company to grow its income. That shows tenants fully expect to eventually return to the office in the future.
Headwinds remain (and grew stronger in recent weeks)
While most metrics trend in the right direction, several headwinds remain. The company's parking revenue hasn't recovered since many people continue to work remotely. In addition, it's experiencing some expense inflation. Because of those factors, FFO (funds from operations) continued to decline in the second quarter.
Meanwhile, office market conditions have taken a notable turn for the worse in recent weeks, given the flare-up of COVID-19 cases in the U.S. because of the highly infectious delta variant. That could negatively impact its office lease volume in the coming months. Hudson Pacific has office leases representing 4.4% of its annual base rent (ABR) expiring during the second half of this year. It might have to offer significant concessions to existing and prospective tenants to get them to sign leases. That suggests some potential trouble ahead for its office portfolio.
Hudson Pacific's hedge against the office uncertainty
Hudson Pacific's office portfolio will likely continue facing headwinds for some time. However, what's unique about the company is that it also has a large studio business that complements its office portfolio. The company formed a joint venture with private equity giant Blackstone Group (NYSE: BX) to grow its studio business last year.
That portfolio is thriving these days. Colman noted in the second quarter press release that NOI grew "nearly 30% within our studio portfolio, the latter of which underscores the acceleration in production relative to the onset of the pandemic." Meanwhile, demand for studio space is growing, driven by streaming services pouring billions of dollars into producing new content. As a result, Hudson Pacific and Blackstone recently announced two deals to expand their studio platform.
They acquired a 91-acre site near London, which they plan to transform into one of the largest world-class film and television studio campuses. They envision it becoming a major new center for film, TV, and digital production. They're also developing the first large-scale, purpose-built studio in Los Angeles in over 20 years. The state-of-the-art, 240,000-square-foot project will include seven stages, along with production office and support space.
These projects will help grow its studio revenues in the future, reducing its reliance on offices to increase shareholder value. In addition, the company is working on other studio deals to grow that platform. On the second-quarter conference call, Coleman stated that the company is actively pursuing studio deals, including two marketed studio properties that are value-add investment opportunities. If the company can secure these and other studio transactions, they'll also help mute the impact of its office headwinds.
A bump in the road
There's no doubt that Hudson Pacific's office portfolio faces some headwinds, which have grown stronger in the past month. However, given its leasing volume this year, it seems clear that companies expect their employees will return to the office eventually. Meanwhile, Hudson Pacific is reducing its reliance on offices by growing its studio platform. Those factors suggest the REIT isn't in any long-term trouble.