Kite Realty Group Trust
Q2 2015 Earnings Call Transcript

Published: 2 Aug 2015

[Operator:]

Good day ladies and gentlemen, and welcome to the second-quarter 2015 Kite Realty Group Trust earnings conference call. My name is Lisa and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to your host for today, Miss Maggie Kofkoff with Investor Relations. Please proceed.

[Maggie Kofkoff:]

Thank you and good morning everyone. Welcome to Kite Realty Group's second-quarter 2015 earnings call. Some of today's comments may contain forward-looking statements that are based on assumptions and are subject to inherent risks and uncertainties. Actual results may differ materially from these statements. For more information about the factors that can adversely affect the Company's results, please see our SEC filings, including our most recent 10-K. Today's remarks may include certain non-GAAP financial measures. Please refer to yesterday's earnings press release available on our website for a reconciliation of these non-GAAP performance measures. On the call with me today from the company are Chief Executive Officer John Kite, Chief Operating Officer Tom McGowan, and our Chief Financial Officer, Dan Sink. And now, I would like to turn the call over to John.

[John Kite:]

Thanks Maggie. Good morning everyone. Welcome to our second-quarter earnings call. Appreciate all of you spending time with us today and we are excited to share the results of another strong quarter. We've had an extremely productive quarter, executing on a number of growth and balance sheet initiatives, and we continue to be optimistic about the remainder of 2015 and beyond. Our internal growth prospects have been added to Page 29 of our supplemental to provide visibility on our active redevelopment pipeline, and we encourage our investors to review the added disclosure. The team has worked diligently on prudently recycling the majority of the net proceeds from our $320 million, 15-property disposition, and we have closed on $145 million of high-growth premium assets in our target markets in and around our regional offices so far this year. As a reminder, our original guidance for acquisitions was $80 million. We started the year with a conservative objective as we wanted to ensure that we were able to acquire quality assets in high-growth markets. The team executed on this strategic objective by replacing assets in areas with a population of 61,000, and investing in areas that drew from a population of 250,000. We disposed of assets were the average household incomes were $70,000, and purchased assets with average household incomes of $105,000. We positioned our portfolio to focus on high-growth core markets, and in doing so, we enhanced the overall asset quality dramatically by selling inferior assets with ABR of $13, and adding assets with an ABR of approximately $18.30 per square foot. As a result of these acquisitions, coupled with the strength of our existing portfolio, we are increasing our 2015 FFO as adjusted guidance for the second time to a range of $1.95 to $2.00 per diluted common share. Our updated FFO range includes the efforts of increasing our acquisition assumptions from $125 million to $185 million for the year. Our second-quarter performance is a result of our strategic focus, which remains anchored on operational excellence and consistently executing on our stated objectives. We continue to deliver on our corporate objectives, both from an operational and balance sheet standpoint. Despite being net sellers in our portfolio, we've managed to exceed expectations year-to-date. We generated FFO per share as adjusted of $0.49 for the second quarter and AFFO per share of $0.44. We reported same-store NOI growth of 3.7% while maintaining an average of 4.6% since 2013. We hit our leasing goals for the quarter with a portfolio generating a positive 8% cash renewal spread. As a testament to the quality of our portfolio, we grew our average base rent by 13% to $15.25, compared to this time last year. We've strengthened our balance sheet by expanding our term loan to $400 million, And earlier this month, we agreed in principle to issue $250 million of private placement senior unsecured bonds at a blended fixed rate of approximately 4.4% for an average maturity of 9.8 years. We established a solid liquidity position of nearly $0.5 billion in total capacity, exceeding our total debt maturities through 2018. We generated almost $12 million of net free cash flow and are on target for $50 million for the full year of 2015. Finally, we continue to further upgrade our high-quality portfolio by prudently recycling our disposition proceeds into top-tier assets in our primary markets. As I will discuss in more detail shortly, during the second quarter, we closed on Colleyville Downs in Dallas, Belle Isle Station in Oklahoma City, and subsequent to quarter end, we acquired Livingston Shopping Center in Livingston, New Jersey. Before turning to the balance sheet, I would like to highlight a few of our operational achievements during the quarter. As we discussed on our last earnings call, our increased efficiencies and enhanced expense controls continue to be highlighted in our operating metrics. Our retail recovery ratio was 89%, consistent with our goals of maintaining this metric in the high 80s%. The leasing side of the business continued its elevated pace in the second quarter as our team executed 77 leases for approximately 420,000 square feet. On a comparable basis, we executed 57 leases across over 335,000 square feet with a blended cash rent spread of 8%. Select anchor and junior new and renewal leases executed in the quarter include examples like DFW at Portofino, T.J. Maxx at Beachwood, and Michael's at Draper Peaks. The leasing activity has been consistent across our portfolio as renewal spreads between the Inland assets and our legacy portfolio were a solid 8%. Same property NOI grew another 3.7% for the quarter and 4.9% including redevelopment projects. This strong performance was made up of approximately 250 basis points from contractual rent growth and occupancy gains. The remaining balance is from cost efficiency and our continued focus on maximizing recoveries. We benefited from a 40 basis point pickup in occupancy while our lease percentage decreased slightly. This was largely due to two targeted redevelopment projects at The Corner and at Beachwood. Just as we experienced in our legacy portfolio, we expect our same property NOI growth to fluctuate quarter-to-quarter in the near term, given our healthy redevelopment pipeline. Of the 14 projects still in our operating portfolio, we are in the process of taking spaces off-line, which currently equates to approximately $3 million of adverse base rent as we take the necessary steps to prepare for these projects. It's essential that we selectively allow these leases to expire and temporarily obstruct otherwise available square footage as this facilitates the speed of the completion and our ability to substantially improve the merchandising mix at these centers. We remain focused on our portfolio's positive trajectory and despite potential short-term fluctuations, our strong renewal cash spreads and our redevelopment opportunities support long, sustainable, healthy runway for our overall NOI growth. Turning to redevelopment, we moved our national asset Cool Springs into the active redevelopment pipeline, which includes rightsizing of an office supply store and leasing existing vacant space while expanding the center to accommodate two exciting new junior anchors. We anticipate producing a 9% incremental return on this project and greatly enhancing the quality and sustainability of the shopping center. We had a disclosure on our redevelopment pipeline which includes approximately $115 million of identified potential projects with incremental returns ranging from 8% to 10%. The opportunities span across the legacy Kite, Och-Ziff and Inland portfolios with a skew towards our more recently acquired assets. The pipeline is then categorized into our three Rs, which we define as redevelopment, repositioning and repurposing. Over half of our identified pipeline is classified under redevelopment, which we view as traditional and more meaningful asset renovation. Repurposing, an asset involves altering the real estate product type and use, which constitutes almost a third of our pipeline. The remaining assets are repositioning projects, which we define as minor asset enhancements costing no more than $5 million. We are planning to commence these projects within 18 months or less, and as such, we expect this pipeline to evolve over time as projects are moved in and out of the active redevelopment pipeline. The asset enhancements will further grow our cash flow and the overall quality of the centers, thus driving future NAV growth. On the development side, leasing momentum picked up in the second quarter and in aggregate, our three projects are approximately 84% leased and committed. We are in the final lease negotiation with the sixth junior anchor project in Naples, Tamiami Crossing, and the asset is now 100% committed. Progress continues at the second phase of Holly Springs and Parkside Town Commons developments. Frank's Theatre opened this month at Parkside, joining anchors Golf Galaxy and Field & Stream. And we have had several additional national tenants sign for the center, including a large anchor tenant, Starbucks, Panera bread and Chuy's. We increased our expected cost by $5.5 million at Parkside II to account for the square footage expansion announced last quarter and the revised construction plans which upgraded the theater to a high-end luxury cinema with an enhanced guest experience which includes reclining chair seating format. Additional NOI from this quality upgrade will allow us to maintain the overall return on the project. Phase II of Holly Springs remains on track as Bed Bath & Beyond and DSW tenant deliveries will be completed in the third quarter and we commence construction on Carmike Cinemas. While the acquisition market remains competitive, our teams work diligently to source attractive high-growth assets in core markets. So far in 2015, we have acquired approximately $145 million of first-class real estate in and around our regional offices. Each of the three acquisitions are unencumbered and in aggregate were purchased at a going-in blended cap rate of approximately 5.5%, which we expect to stabilize around 6.25% in the near term. As we talked about on our last call, we sourced a unique opportunity in Dallas in an off-market transaction when we acquired Colleyville Downs. The Whole Foods anchored shopping center is well-positioned in a densely populated desirable market with an estimated population of $80,000 and an average household income of approximately $128,000. Many of the existing leases predate the new Whole Foods and further support our ability to create additional value through lease-up and below-market rent opportunities while substantially increasing the quality and credit of the tenancy. In May, we purchased Belle Isle Station, a 400,000 square-foot power center in the heart of Oklahoma City. The center is located in the premier fashion corridor adjacent to the Penn Square Mall, the top performing shopping mall in Oklahoma City. Belle Isle Station is anchored by best-in-class retailers such as Nordstrom Rack, Ross Dress for Less, ULTA and Walmart. The asset is exceptionally well located, just 1.5 miles south of Nichols Hills, one of the highest income areas in Oklahoma City. The area is well established with an average household income of approximately $235,000 and average home prices in excess of $1.3 million. Most recently, we closed on Livingston Shopping Center which is located in Livingston, New Jersey and expands our presence in the Northeast as we now have three large assets in the New York City metro area. The 140,000 square-foot power center is in close proximity to the Short Hills Mall, a top 10 grossing mall in the country. The center is anchored by Nordstrom Rack, DSW, T.J. Maxx, buybuy BABY, Cost Plus and ULTA. The center's proximity to New York and Newark, New Jersey draws from a concentrated population of over 150,000 with average household income over $170,000. In addition to the lease-up and repositioning opportunity that exists across our recent acquisitions, resetting the leases to market will provide additional growth. In aggregate, these assets alone have a net below-market lease position of over $7 million. Finally, we are currently underwriting a power center with a grocery component which will fully redeploy our 1,031 proceeds from our 15-asset disposition. Upon closing of this transaction, we anticipate any further acquisitions in the near term will be executed on a match-funded basis. In addition to operating efficiencies, we expect the main growth drivers in the near term will be rooted in our active development and redevelopment projects which will result in a current incremental $11.4 million of NOI while utilizing our free cash flow to accretive we fund our redevelopment pipeline. On to the balance sheet. We continue to execute on our strategy of maintaining a flexible and nimble balance sheet. Last quarter, we purchased the remaining interest from our partner at City Center in New York, and during the second quarter, we purchased two other partners' interests at Bayport Commons in Florida and Beacon Hill in Indiana. Maintaining a simple corporate structure allows incremental flexibility with autonomy over these assets for future initiatives and growth objectives. Consistent with our objective of transitioning to an unsecured balance sheet, we exercised the accordion option on our existing unsecured term loan during the second quarter. The option allowed us to expand the amount outstanding by $170 million for a total of $400 million. In July, we agreed in principle to issue $250 million of private placement senior unsecured bond offering. The notes will have a blended fixed rate of 4.41% spread across 8-year, 10-year, and 12-year tranches for an average maturity of 9.8 years. These notes are expected to fund in September of this year subject to customary closing conditions. As a result of the term loan expansion and the anticipated funding of the private placement notes, we were able to eliminate all our 2015 secure debt maturities, execute quickly on our acquisition objectives, and reduce the overall outstanding amount on our line of credit and unencumber three additional properties. Upon funding of the private placement notes, we expect our floating-rate debt exposure to decrease to approximately 10% and extend our weighted average maturity from 4.8 years to nearly 5.5 years. In addition to extending our funding sources, our overall cost of capital will be materially lower by the end of 2015 and throughout 2016. We intend to call the $102 million 8.25% preferred notes in December of this year. As we look to next year, we have $130 million of secured debt maturing, which has an average rate of 5.9%. Retiring expensive near-term funding combined with our other balance sheet initiatives will result in accretive event for our shareholders. We've continued strong momentum that we started in 2015, as evidenced by this quarter's results and our ability to increase guidance for a second time. We are updating our FFO as adjusted guidance for 2015 to a range of $1.95 to $2 per share from a revised range of $1.93 to $2 per share. In summary, we are very pleased with the second quarter results. We exceeded expectations in our ability to execute on the acquisitions and outperform operationally. The team remains focused on our strategic initiatives and continues to deliver strong results that are aligned or exceed our targets. Our industry-leading operational platform, operational excellence and actionable redevelopment and development pipeline provide us with a long-term competitive advantage for NAV and cash flow growth. We are eager to once again showcase to our investors our development capabilities and deliver best-in-class results with our larger portfolio. As previously accomplished with our legacy Kite asset, 2015 is just the beginning and we look forward to the future ahead. Thanks for your time. And operator, we are ready for questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Christy McElroy with Citi. Please proceed.

[Katy McConnell:]

Good morning. Katy McConnell on for Christy. Given your same-store NOI guidance range implies a little slowdown in the back half of the year, can you walk us through some of the main drivers of that?

[John Kite:]

Well, I think, as we talked about on the call, one of the primary drivers that we tried to lay out is the fact that we have 14 projects that are currently in our operating portfolio, that will continue to be in our operating portfolio certainly over the next quarter or two that we are beginning to kind of put the properties in a position to redevelop, which means there is a process that we are undertaking where we take certain spaces off-line, don't renew certain tenants, so that we can accommodate the redevelopment that we are planning. That's a long process. And I think it's why we mentioned in the remarks that in total, year-to-date there's about $3 million of average base rent that we've essentially been taking off-line throughout the year so far. So when you look at that amount versus even the larger same-store pool, that's a significant number, north of 1% kind of number, for a quarter. So that's the real driver in how we are looking at the balance of the year. And I think people will recall we have been talking about that for the last couple quarters because we have been building up this pool of properties that we've now laid out for everyone to kind of follow that this is happening. So I think that's really the primary driver. Dan, I don't know if you have anything to add to that.

[Dan Sink:]

No, I think that is the primary item. It's going to be, as John talked about, it's going to be a little volatile as we work through it, enhance the properties and drive additional traffic with our redevelopment projects that we've listed out. So I think that's going to be the primary driver, but over time, as we get these projects back online and raise rents and continue to grow the portfolio, it's going to be a positive just like it was with the KRG portfolio over time.

[Katy McConnell:]

Okay, great. Thank you.

[John Kite:]

Thank you.

[Operator:]

Your next question comes from the line of Craig Schmidt of Bank of America. Please proceed.

[Craig Schmidt:]

Thank you. Thanks for the Page 29. But on the repositioning efforts, who are some of the targeted junior anchors that you're going to be putting into those spaces?

[John Kite:]

It's kind of across the board when you look at the assets that fall within the repositioning. We've got properties in Vegas. We've got properties in Florida, Indy, the southeast, so it's across the board. And generally what we're doing is we might be adding an anchor to a center where we are consolidating some small shop space, so that would be kind of like a discount anchor, like a TJ or a Ross, people like that. We might be bringing in – consolidating some small shop space for ULTA, for example. We might be adding a small out-parcel building into a parking lot and putting in a few tenants like Starbucks. So it's really across the board, Craig, and it's just we think it's important that people realize these things are different. When you are doing a repositioning deal, it's much more tenant-driven when we are doing a redevelopment deal, it's much more driven by what we want to do, a material change to the property. And repurposing is a real significant situation where we are completely changing the use of a property. For example, a small shop anchored center turns into a mixed-use center with residential and retail. So that's kind of the high-level differences. The good thing is that it's very diverse and we will be attacking it from all angles. If you look at redevelopment, reposition and repurpose, you'll see a lot of consistencies throughout the pipeline and throughout regions and throughout just the way we are attacking it. So a lot of great diversity in that pipeline.

[Craig Schmidt:]

Great. And I'm just wondering if – there seems to be a lot of emerging value concepts that sort of like Whole Foods, 365 and such, it would seem like this could be an opportunity to create space to accommodate those tenants as they look to expand. I'm just wondering. Is this a possibility going forward?

[John Kite:]

Yes. The specialty grocer segment, if you want to put Whole Foods, 365 into that category, I think that's a very active category. It remains an active category. As you know, Craig, one of the things we love doing is adding that segment to an existing center. An example of that, we added a Sprouts in El Paso to one of our larger power centers, and they are blowing the doors off. And that just brings more traffic in, and it's great. So yes, certainly we did that in Indianapolis. A prime example of how to follow these things, we had a redevelopment deal in Indianapolis called Rangeline Crossing that we put an Earth Fare specialty grocery in. It's a good example because when we took over that project, we had a small partner in it. We had a joint venture partner that we bought out. At the time we bought them out, the NOI on that project was $700,000. Today it's $1.7 million. So you can do a lot. It takes time, and that's what we're trying to point out, that these things evolve over time, so you have to kind of track NOI over a longer period of time not really look just quarter-to-quarter. But when you do it, it is substantial. And we did that there. We also did that at Rivers Edge, where the NOI went up 2.5 times. So, we are excited about it. We really are.

[Craig Schmidt:]

Okay. Thanks.

[John Kite:]

Thank you.

[Operator:]

Your next question comes from the line of Collin Mings with Raymond James & Associates. Please proceed.

[John Kite:]

I guess there is no one there operator.

[Operator:]

Your line is open. Your next question comes from the line of Alex Goldfarb with Sandler O'Neill.

[Alex Goldfarb:]

Hey, good morning out there.

[John Kite:]

Hi, Alex. I think you want to get that.

[Alex Goldfarb:]

It's my wife. I will get in trouble for that, I can assure you. So just a few questions here. First, Dan, can you just give us a sense of the pricing difference between the private placement route versus doing a public offering?

[Dan Sink:]

Sure. I think there were a couple things on that out that we were looking at. We spent the time, and as most folks know, we did the non-deal roadshow for both the public and the private within the second and third quarter of this year. And we – as you look at the public markets, just the execution risk and the volatility right now, it's tough to give you an exact number, but the spreads have definitely widened out, especially on inaugural deals. And due to the execution risk and not having that specific knowledge going out, we wanted to hit the private markets and went out and marketed that deal. And the advantage that gives you, as John mentioned, we could do an 8-, 10- and 12-year tenure as well as we can do a delayed funding. With 60 days, it's not funding until September 10, which from a source and uses perspective allows us to match that up better. So the pricing differential, I don't know, it's tough to give you an exact answer, I think there's probably 25 basis points or so difference between what we got in the private and what we would have been able to do in the public at the current time.

[Alex Goldfarb:]

I guess, so, Dan, so obviously enhanced flexibility, but the 25 basis points was better in the private, or you gave up 25 by doing a private?

[Dan Sink:]

No, it was better in the private.

[Alex Goldfarb:]

Okay, so better all around.

[Dan Sink:]

Yes.

[Alex Goldfarb:]

Okay. And then next, John, as you talk about the acquisitions that you did, I think you said sort of in the mid to upper $5s million, it should stabilize in the low $6s million. And obviously you spoke about the $7 million. I think you said $7 million at Livingston of potential upside. Maybe I didn't hear that correctly. But if we think about your implied cap rate, which on our numbers is 7.2% or on an FFO yield you guys are at a 7.6% million, call it, how do you think about the accretion of these deals versus your cost of capital? And then obviously you know you said you did that for 1031 purposes, but still you made a decision to reinvest the proceeds versus paying it out via dividend. So if you could just walk us through on how these deals will accrete above and beyond your cost of capital.

[John Kite:]

Sure. First of all, as you said, to be specific on the $7 million, Alex, that is not just in one property, Livingston. That's spread out amongst the properties in terms of the below-market rents. But in terms of how we look at it, this was a process. And when we sold the $320 million of properties in both – which was spread out over two quarters, so fourth quarter of last year and first quarter of this year -- our equity value is moving around during that period of time. So when you look at -- we looked at this from the standpoint that we really felt strong that we wanted to improve the overall quality of our portfolio, and we wanted to avoid any kind of tax problem in terms of that, which is why we pursued a 1031. And as you said, you mentioned the dividend, but we've actually increased the dividend in the last year and a half by about 13.5%, 14%. So we have paid out substantial dividend increases to the shareholders that way. But clearly, as we sit here in this very moment in time, we would struggle with executing on these acquisitions today based on purely just looking at cost of capital at this very point in time, which is why we mentioned anything we would do after this current deal we are working on would be more on a match-funded basis where we would most likely sell lower-tier assets to buy something we thought had a better growth profile. Secondly, or thirdly, on top of that, when you look at the quality of the assets that we have acquired – now, I can't control how the stock might move in any one quick direction and the volatility in our stock that it might be in one week or two, but when you look at the assets we sold in markets like Hot Springs, Arkansas, and we turned around and Hot Springs, Athens, Alabama, Jacksonville, North Carolina, as an example, assets we sold, and bought in the New York metro area, in Oklahoma City, in the best part of Oklahoma City, and Dallas and Colleyville, which is just west of the airport, just south of Southlake. These are – and by the way, we acquired Summerland in Las Vegas at the end of last year. These are outstanding assets that we think, sure, the near term, we've got work to do to improve them, but it was part of the overall strategy. It wasn't just merely looking at that one particular component of it. So, I understand your question. I get it, and we certainly talk about it a lot and we understand where we are right now. And we think that if we keep doing what we are doing, investors will kind of see that and hopefully react to it, and we won't have to have that conversation.

[Alex Goldfarb:]

Okay. And then just finally, John, going back to I think what Katie was asking, you mentioned about $3.5 million of NOI that's come off-line, if I heard correctly, this year so far. But as you guys roll out this $100 million or so redevelopment program over the next 18 months, I know you're not giving 2016 guidance, but still we are all updating estimates. How should we think about development drag or NOI that's going to be coming off-line out of the second half of this year and into next year? That way – minimize the surprises between where analysts are shaking out and where you guys shake out?

[John Kite:]

It's pretty hard to talk about 2016 right now, but as it relates to 2015, that's all in our guidance. So the 2015 guidance we have given you, both for our total-year earnings guidance and our total-year NOI growth guidance. That's all in there. As it relates to 2016, we still feel strongly that we will be growing earnings in 2016 above our 2015. That's our belief and that's always our goal. So, we take all this into consideration. I think what it highlights is something that's always happening in a portfolio like ours with operators like us, which is we are constantly mining it to improve it because we are more focused on long-term value creation than we are quarter-over-quarter numbers. So, I think it's always been there, Alex. It's always been in our numbers. We are just probably showing a little more to you guys in terms of the properties that we are doing things on that you don't see behind the scenes. That's our job. Our job is to do that, grow NAV and grow earnings and grow cash flow, mind you. Most importantly, our cash flow growth, a lot of guys don't even talk about their cash flow. Our free cash flow of $50 million this year is getting reinvested back into our portfolio, as we said, 8% to 10% returns. So I wouldn't be too concerned about it because it's always part of what we do.

[Alex Goldfarb:]

Okay. It sounds like reinvesting cash flow into redevelopment is definitely an Indy trait. Thanks.

[John Kite:]

Yes, we like to – I don't know what to say about that. It's a good trait.

[Operator:]

And your next question comes from the line of Chris Lucas, Capital One Securities. Please proceed.

[Chris Lucas:]

Good morning everyone. Just a couple of quick detailed follow-up questions. Dan, on the covenant issues between the unsecured opportunity and the private placement, were there any covenant differences between the two deals?

[Dan Sink:]

No, not significant. They both have four primary covenants, and the only variance is that the private placement goes [indiscernible] with the line of credit. So other than that, four primary covenants both in the private and the public world.

[Chris Lucas:]

Okay. And then just can you remind us kind of where the Eddy Street Commons residential unit sales process is, how much is left? When do you expect that to sort of roll off?

[Dan Sink:]

We don't expect any more sales for 2015, but there is another portion of that going out, but there could be in 2016 some additional units being sold. I mean it's tough to give you exact numbers on that because, as we talked about, our primary goal on that was mitigating risk. So we don't take down the land until there's contracts. So we will buy the land from the University of Notre Dame once we have contracts in place that are residential builder constructs, the residential units, and then we take a percentage of profits. So that kind of comes in, so we are getting basically – those residential units are the risk profile that is significantly down. We just – as they are completed, we get a percentage of his profit. But nothing in 2015. As we look out in 2016, I think there's about I want to say maybe 50 units left or something of that nature, but that doesn't help me exactly give you a number because it's tough to put pencil to paper on that because we are not sure the volume of the sales of the sales and the numbers that are going to come through.

[John Kite:]

The only thing I would tell you is that the sales have been very brisk, and as these come online, they should continue to generate through 2016. But it's been pretty amazing, the volume and velocity in which these have sold.

[Chris Lucas:]

Okay. And then – appreciate the Page 29 guidance on the redevelopment development activities. I guess, John, just taking a step back on that kind of activity, when you look out, say, over five years, and I know it's challenging, but you clearly have an idea as to what is doable, I would think. Given the portfolio that you have today, how much from a percentage of assets, not number of assets, how much do you think has redevelopment, remerchandising in a significant way opportunity to it?

[John Kite:]

As you said, it's difficult to say over that long a period of time, Chris. But right now, a little over $100 million that we are tracking of new opportunities against just under $4 billion. So whatever 3% or wherever that would fall out, $3.7 billion of net assets in $100 million, so just under 4%. I think that's a reasonable thing to assume over time, because a lot of this has to do with how the properties are aging, what's the competitive position of the property. It's why we kind of tried to explain that there is not just one redevelopment process. It's a little more complicated than that. So we are trying to make that clear to people that we look to invest dollars across that spectrum, small dollars to large dollars. The thing that's interesting is that, when we look at it, we've got a good representation of legacy assets, Och-Ziff assets and Inland assets of the 16 that we are tracking, and a good, fair balance there. So I think we are always going to be looking to move deals into there. And also as we sell assets out of the bottom tier and buy new assets, we hope we can buy assets that have redevelopment opportunities with them. So, I think this is the kind of thing we want to be doing. I think it's very accretive. I think we know how to do it and not everyone else does. It's complicated. The one thing I wanted to make clear, the reason we talked about how we take stuff off-line, that involves – that can take two or three years to get it in a position to go. You look at some of the Och-Ziff deals that only now we are about to start redevelopment. We've been working on that for three years. So, again, I think it's a good kind of percentage, but really it ebbs and flows based on what's going on within the geography of the assets and the asset itself.

[Chris Lucas:]

Great. Thank you very much.

[John Kite:]

Thank you.

[Operator:]

[Operator instructions] Your next question comes from the line of Todd Thomas of KeyBanc Capital Markets. Please proceed.

[Grant Keeney:]

Good morning. This is Grant Keeney on for Todd. Sorry if I missed this. I actually got disconnected. But back to the Page 29 disclosure, how should we think about the timing for commencement of these projects and just timing until stabilization?

[John Kite:]

As I think we've said and we talked about in the prepared remarks, these things are going to begin in various times over the next 18 months. A handful of them we hope to start this year. A handful of them go into the beginning of next year and then throughout the year. And they take time. We've got permitting to deal with. We've got issues to deal with. But these are – every one of the ones on this list are advanced in our planning stages. And in terms of stabilization, that also varies because these projects are going to vary in size from $20 million to $2 million. So obviously the smaller projects can come online quicker, and the larger projects are more like a full-on development project, which can take 12 to 18 months to complete the construction. So it's going to vary. It's hard to pin down exact quarters for you, which is why we didn't do that.

[Grant Keeney:]

Okay

[John Kite:]

I do think you'll see a consistent cadence of properties coming in on a quarterly basis. So we have a pipeline that's diverse enough that you will see consistency as they come into the fold.

[Grant Keeney:]

Okay, that's helpful. And then I just want to touch on small-shop leasing. In the past, you mentioned a target 90% leased, and then you kind of hovered around that mid-80% range. What do you anticipate that's going to drive the narrowing of that gap? And are you more focused at this point on being tough on rent? I know you also mentioned in the past some annual bumps on small-shop deals around 3%. So I just want to get an update on that.

[John Kite:]

Sure. Let's back up and give a little perspective on the goal. Right now, we're slightly above 86% leased in the small shops, which is the second-highest percentage lease that we've had in the last 10-plus years. So we are pushing the envelope in terms of history relative to how we can do this. That said, we are going to get there. We have a very intense objective internally, and we will get it done. It will take a lot of effort. It takes – this is not something that is pretty. This is a grinded out, go get it done philosophy that we are actively engaged in. The good thing is the approved leases that we have in-house right now in terms of approved in our system but not yet executed is very significant. So, we are making progress. But remember, we also lose tenants throughout the process and we are also pulling tenants out. We tried to make that really clear. Some of this is self-inflicted. That 86% would be higher right now but for some of these redevelopment properties that are still in our operating pool. So, it's a big, complicated picture, but we will execute and we will get it done. And it is an extreme grind-out process that we just will force to happen. I don't know how to make it any prettier than that

[Grant Keeney:]

Sounds good. Thanks.

[John Kite:]

Thank you.

[Operator:]

Your next question comes from the line of Tammi Fique with Wells Fargo Securities. Please proceed.

[Tammi Fique:]

Hi, I'm sorry if I missed this, but did you provide a look-in at the performance of the Inland portfolio maybe relative to the legacy Kite portfolio in the second quarter?

[John Kite:]

No, we didn't talk about it. But in terms of the leasing spreads, again, the Inland portfolio performed well. The renewal spread in the Inland portfolio was 8%, so you can see it was on top of our overall average. So – and in fact outperformed the legacy Kite portfolio, which was 7%. So again, I think the message there is this portfolio is very similar to – it's hard for me to keep talking about portfolios because we are one company and we don't really operate that way. But it is – everything is very similar in terms of our three kind of things that we are tracking, three portfolios that we are tracking, and I don't expect that to change. Certainly, those assets aren't going to drive up or down our NOI any differently than the rest of our assets.

[Tammi Fique:]

Okay, great. And then I guess as you increased your efforts on the redevelopment side, do you have a need to increase some of the professionals to help you with that effort?

[John Kite:]

No. In terms of our leasing side?

[Tammi Fique:]

In terms of just sort of the redevelopment.

[John Kite:]

I'm sorry. No, look. If you remember, it's funny. We sold 15 – we had an organization that was supporting around 130 properties and was supporting all of our activities among leasing development, redevelopment. We sold 15 properties, and in fact we've only bought four, although when you look at the total, it's about $180 million that we bought. They are more significant properties. But we haven't -- we still have the same staff and we still have the same infrastructure that we had previously. So, I think the bottom line is we've always kept our teams intact. And I think, as you know, Tom and I have talked a lot about, during the downturn, we held our development team together, which a lot of people did not do, and we added to our leasing team during the downturn. So really everything on the margin was kind of more back-of-the-house operational issues, or operational groups. And now we've added to that, so we are in great shape. We don't see any material issues there. And not only do we have the same team in place, but we've really enhanced it, just the quality, both through predevelopment and development. So the staff that we have at this point is the best we've ever had as a company. And that even predates prior to some of the economic downturn. This is a very proficient, strong group that we have and are confident that they can execute on all this.

[Tammi Fique:]

Okay, great. Then just maybe turning to expenses, there was a downtick in the second quarter. I guess were there any new efficiencies realized in second quarter on the expense side, or are the savings just from previously discussed initiatives?

[Dan Sink:]

Yeah, Tammi, this is Dan. I think most of it is previously discussed initiatives. I think when you look at the second quarter, we are still hitting our recovery ratio targets in the high 80s%. Some of that just comes into play. As I talked a little bit about, we had the opportunity to reduce our premiums on our property and casualty insurance while increasing the coverage, just being able to maximize the size of the portfolio this year as you're going through that process. I think when you look at some of the true-ups and some of the going through the leases and making sure, maximizing those, the expense recoveries, that occurred in the first quarter, but obviously those same items that we found during the true-up process are going to permeate through each quarter thereafter. So I think those are the two primary items, but as you look on a go-forward basis, that recovery ratio should stay in the high 80s%. And as John mentioned, we are adding some additional properties. So in the second quarter, we didn't have Belle Isle or Livingston in the numbers, so therefore, as we bring in those folks, it's going to help the recovery ratio because we are not adding additional people to bring those properties online.

[Tammi Fique:]

Okay, great. And then maybe just turning over to transactions, the recent transactions and the one that you mentioned you are in the process of underwriting, are these marketed deals or have you been able to source acquisitions off-market?

[John Kite:]

It's kind of a combination. The deal in Dallas that we acquired was an off-market deal. The deal in Oklahoma City was on-market. The deal in Livingston was very selectively marketed to where it was put out on the market. But we were able to kind of what we call jump the process. There was no call for offers. There was no second round or final offer. We were able to vis-à-vis kind of our relationships negotiate a deal very quickly. So we kind of jumped the process. And then the deal that we are currently working on is off-market. So the combination, we generally love to do things off-market. Or even though the deal in Livingston where it was going -- it was kind of selectively marketed, that's always better just not necessarily maybe in the end from a pricing perspective, but just from a control perspective and knowing where you are in the process.

[Tammi Fique:]

Okay, got it. And then I know you mentioned that you have a net zero strategy going forward between acquisitions and dispositions. I guess, as we think about capital recycling into 2016 and as we think about cap rate differences between what may be core and non-core, do you have sort of a number that you are looking to recycle out of at this point on an annual basis?

[John Kite:]

I wouldn't say it's a specific number, Tammi. It's more -- we've done a lot of work around improving the portfolio, so we are very focused on that. I would say that we still have a handful of assets that we would feel like we could do better, so there's definitely a process. And again, since we want to be very careful around our overall cost of capital, if we want to find some new opportunities, we need to find some assets that we would sell to match funds that we think have lost their -- not lost, but have less ability to grow than the assets we're going to acquire. So it’s a little more complicated than us just saying we're going to sell $150 million a year like I see some people do. It's really more we're going to be more focused on the individual assets than we are the total number.

[Tammi Fique:]

Okay. And then just one last question sort of specific to the quarter. What was the gain on settlement related to in the second quarter?

[John Kite:]

The gain on settlement was related to an MS domain kind of situation. So that's why we backed it out. It wasn't going to be a reoccurring event.

[Tammi Fique:]

Okay, great. Thank you, guys.

[John Kite:]

Thank you.

[Operator:]

And your next question comes from the line of Collin Mings with Raymond James & Associates. Please proceed.

[Collin Mings:]

I think that's me. Collin Mings here. Just a couple of questions. I guess first off, I think, going back to the prepared remarks about calling the preferreds in December, maybe I missed this. But how are you thinking about funding that, Dan?

[Dan Sink:]

I think a couple of ways. I think one of the items that are looking at, as John mentioned, some non-core asset sales, if we look at tightening of geography and being able to generate some proceeds from that, obviously the preferred is at 8.25%. And if we could sell some productive assets, that's going to be a net positive event when you look at the cost of capital and from an FFO and a NAV perspective. So there's -- that would be one objective. In addition to that, we will have some funds left over from the private placement once we pay down the line of credit. There will be additional funds that we could potentially use from that to pay off the perpetual preferred. So, as John mentioned, our liquidity position is extremely strong, so it's just a matter of doing it in a balanced way so we maintain our leverage levels as we move into 2016.

[Collin Mings:]

Okay, that's very helpful, Dan. And then, well, just on capital allocation, I'm just curious. Just given where your stock is trading relative to consensus NAV, kind of the high-6%, low-7% type of implied cap rates. What's your thoughts, particularly given your increased scale about just maybe allocating some capital to share repurchases here?

[John Kite:]

First of all, we take that extremely seriously. It's something that I think we've talked about on previous calls. No question it's something that we've discussed at the board level and it's something that we think about and monitor all the time. Now, we are, fortunately, we are in a position where we have a significant amount of opportunities within the portfolio to create returns that would exceed those type of returns that you're talking about relative to the current kind of implied cap rate value of the stock. And again, it's always hard to pin that down. You can talk about buying the stock at a specific number and then the number changes. So we are very focused on two things right now. We are very, very focused on generating significant free cash flow and taking that free cash flow and reinvesting it wherever it's most accretive. Right now, as I said, our net free cash flow, and that is really truly net free cash flow after everything, is being invested back into our redevelopment opportunities which exceed -- our net $50 million, we have $100 million of opportunity, so we still have capital there to make up. But we are trying to grow that net free cash flow aggressively. And we think we will be able to do that over the next few years. So it's something that we are looking at; it's something we would consider. And as this evolves and our redevelopment opportunities happen and get done and our development opportunities get finished, then, if that would still be the situation, then we would aggressively look to take advantage of that. But right now, we can exceed those yields in the redevelopments.

[Collin Mings:]

Okay, now that's helpful color there. I guess just still on the capital allocation front, you guys made some progress really this year and particularly this quarter buying out some JV partners. Just of call it about the half dozen or so JVs left, how do you think about potential other opportunities there? Do you see any other near-term opportunities on that front?

[John Kite:]

Yeah, I think we are trying to set the stage that when we can, we will. A lot of these are -- I think we pointed out in the supp that the economic benefit to most of these JVs adheres almost exclusively to us because of the structure of the deals. The ones we just did, quite frankly, were relatively small dollars, but it was really, as we mentioned, it was more about our ability to control the outcomes. So to the extent that the opportunity exists, absolutely, but there's not a lot of large dollars involved there. Dan, do you want to…?

[Dan Sink:]

I think, as John mentioned, as we look to try to continue to simplify the organization, we aggressively pursue the buyouts of the partners just continue the process. I think when you look at the remaining JVs that we have, there could be a couple that can happen in the near term, and the others in the JV agreements have some specific buyout dates, specifically the ones we acquired as part of the Inland merger. So we continue to look at that for opportunities to buy those partners out.

[Collin Mings:]

Okay. That's helpful. And then I guess just one last one. I know you guys talked a lot about kind of the momentum and kind of the focus on shop occupancy, but just kind of going back to the comments from the last couple of quarters, I know Florida in particular had been something you kind of focused in on as really seeing as an opportunity in shop occupancy. Just maybe update us on the momentum you're seeing there. Any sort of particular emphasis or effort you are placing there?

[John Kite:]

Yeah, I mean – we still are extremely focused on that. It is definitely the biggest opportunity, which isn't a surprise because we have the most assets there in terms of ABR, NOI, etc. So we are focused on resources in Florida. As we mentioned in the last call, we are looking to add resources in Florida and we are in the process of doing that. It's not something that happens overnight, because we are extremely selective. But we think we can -- we will be adding resources there, and we will be executing there. In addition to that we are reallocating resources that we already have, so we are in the process of doing that as well. So it definitely has all of our attention to execute on. And the great part is we own awesome assets there, so we will get it done. And that's why I said in the macro question about how do we get this done, we force it to happen. And we are excited about it because we are adding great tenants. Now, the reality is we are very focused on the merchandising mix when we do these -- when we prepare for these redevelopments, and that takes time. So it's not an easy thing, but it's a thing that will happen. Tom, do you want to add to that?

[Tom McGowan:]

The only thing I would add is we obviously track the pipeline of deals that are actually approved that are in the process of being executed. And we are very encouraged in terms of our progress there, so it's coming. We are focused on it and pushing hard and that will not change over the next several quarters. We've got a very specific goal and we are confident, we're going to get there.

[Collin Mings:]

Okay. Well, I guess to that last, kind of tracking the pipeline as far as deals, is Florida maybe a market or where you maybe not pushing as much as far as on the 3% annual rent bumps or where you are conceding a little bit more on kind of lease terms?

[John Kite:]

No. There's nowhere where we do that. I mean, we are extremely focused on rent bumps and merchandising mix and the whole thing. The only thing that I would say is that to the extent and we walked about this little last time, we are being a little more dynamic in how we price spaces. So historically when we looked at a property whether it was in Orlando or Oklahoma City, it doesn't really matter, historically, we kind of looked at what is the shop rents in that particular property, and what is the shop rents in the competing properties. We always want to beat the competing properties, so we expect our shop rents to be higher and to grow faster, but we will get it in more of a ubiquitous way, and now we are saying wait a minute, there's much like you see in the mall business, when you price from the 50 yard line out, there are definitely spaces within a larger center that aren’t as – let’s say in terms of visibility or access or whatever relative to another space, so we should be a little more dynamic in how we price it. That’s a thing we've been focused on really only I would say for the last quarter, maybe two quarters at most. And as Tom said, we are already seeing impact from that in deals that have been approved but yet not yet signed. So, that's probably an area where we are going to see some pickup because we are really focused on that. And it makes sense. That just makes practical business sense. And many of those spaces may have been vacant for multiple years because of that.

[Collin Mings:]

Okay. Very helpful guys. Thanks.

[John Kite:]

Thank You.

[Operator:]

I would now like to turn the presentation over to Mr. John Kite for closing remarks.

[John Kite:]

Okay. Thank you, everyone, for joining us. As we said, we are very, very happy about the quarter and we look forward to talking to you in the future. Have a great day. Thank you.

[Operator:]

Ladies and gentlemen, that concludes today’s conference. Thank you for your participation. You may now disconnect.