Retail Properties of America, Inc.
Q1 2018 Earnings Call Transcript

Published: 2 May 2018

[Operator:]

Greetings, and welcome to the Retail Properties of America Inc. First Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. It is now my pleasure to introduce your host, Michael Fitzmaurice, Senior Vice President of Finance. Thank you. Mr. Fitzmaurice, you may begin.

[Michael Fitzmaurice:]

Thank you, operator, and welcome to Retail Properties of America first quarter 2018 Earnings Conference Call. In addition to the press release distributed last evening, we have posted a quarterly supplemental package with additional details on our results in the Invest Section on our website at rpai.com. On today's call, management's prepared remarks and answers to your questions may include statements that constitute forward-looking statements under Federal Securities Laws. These statements are usually identified by the use of words such as anticipates, believes, expects and variations of such words or similar expressions. Actual results may differ materially from those described in any forward-looking statements, including in our guidance for 2018 and will be affected by a variety of risks and factors that are beyond our control, including without limitation, those set forth in our earnings release issued last night, and the risk factors set forth in our most recent Form 10-K, 10-Q and other SEC filings. As a reminder, forward-looking statements represent management's estimates as of today, May 02, 2018, and we assume no obligation to update publicly any forward-looking statements whether as a result of new information, future events or otherwise. Additionally, on this conference call we may refer to certain non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP numbers and definition of these non-GAAP financial measures in our quarterly supplemental package and our earnings release which are available in the Invest Section of our website at rpai.com. On today's call our speakers will be, Steve Grimes, President and Chief Executive Officer; Julie Swinehart Executive Vice President, Chief Financial Officer and Treasurer; and Shane Garrison, Executive Vice President, Chief Operating Officer and Chief Investment Officer. After their prepared remarks, we will open up the call to your questions. With that, I will now turn the call over to Steve Grimes.

[Steve Grimes:]

Thank you, Mike and thank you all for joining us today. Back in 2013 when we first announced our target market strategy, we knew we would be a successful, long term in retail real estate if we deployed our real estate first strategy. Fast forward to today, our real estate first strategy is beginning to play out. At quarter end, we own a 106 retail assets that are predominantly closely anchored, lifestyle are mixed-use, driven by density, discretionary spend, convenience and experience. Nearly 87% of the multi-tenant retail ABRs and most desirable US markets with superior demographics, a track record of population growth and a strong and diverse economic foundation. In fact nearly 65% of our multi-tenant retail ABRs sits in our top five markets including Dallas, the Washington DC - Baltimore corridor, New York, Chicago and Seattle. Officially the execution risk of asset recycling is now behind us and we are laser focused internally, dedicating nearly a 100% of our energy on organic growth through the continued lease-up of our high quality portfolio and increasing density of our mixed-use redevelopment. We anticipate there could be some challenges ahead and understand that we are in the midst of an ambiguous period in retail. Our retail land lords are shadowed by the same black cloud, when in fact portfolio quality differs greatly across the shopping center REIT space. That has brought vehement change; one example may be a major tenant bankruptcy such as such as Sears. Do we have any direct exposure? No. There are approximately a thousand Sears and Kmart locations in the US encompassing over a 125 million square feet. Will all of this square footage get back filled by a retail use? Absolutely not. Will this impact some malls and shopping centers where they will be converted in to a different use? Yes. Where will the remaining retailers and those properties migrate to? We think they will move to well-located Class A retail properties which could present us with a tremendous opportunity. And when this happens, we expect to see the continued bifurcation of the shopping REIT space in terms of portfolio quality and our metrics support our belief that RPAI will be in the stronger end of the shopping center REIT spectrum. In the short-term, the reality is that that stores will continue to close, its part of the business, Toys 'R' Us is the latest example. Some will place the blame on Amazon for their demise, but that couldn’t further from the truth. They were outflanked by the likes of Walmart and Target plus they had significant debt issues. They could no longer compete or bring unique value to the customer experience. They simply lacked relevance. Julie will spend time quantifying the short-term potential revenue disruption associated with Toys, but more importantly Shane is going to talk about the backfill opportunities and he will reassure you that these closures represent an important step in our continuing goal of solidifying our cash flow and creating more desirable shopping destinations. From a capital allocation perspective, we maintain a very strong balance sheet to support our development and leasing objectives. We will continue to evaluate acquisition, maintaining our 2018 acquisition midpoint target of 100 million, which will be done on a leveraged neutral basis. As a reminder, we have 22 high-quality assets outside of our target market that we could use as currency to opportunistically allocate capital towards acquisitions and future redevelopment. Overall, I’m very confident that we will continue employ a real estate first approach with our now internally focused strategy. This confidence was validated recently by our banking partners. As we reported, we significantly improved our debt, cost and duration with the closing of our oversubscribed 1.1 billion credit facility. Despite the perceived retail disruption, we improved our covenant cap rate by 25 basis points to 6.5%. This execution is tremendous recognition of our portfolio quality and potential. As we move forward, the RPAI team is completely committed to continuing our real estate first approach by drowning out the noise, focusing and executing. This has and will always be our playbook. And with that I would like to turn the call over to Julie.

[Julie Swinehart:]

Thank you, Steve. This morning I will discuss our first quarter results and our outlook for the remainder of 2018. Turning to our results, operating FFO for the first quarter was $0.25 per share, compared to $0.28 per share in the same period in 2017. The $0.03 decrease was driven primarily by $0.08 from lower NOI from other investment properties due to our capital recycling activities, partially offset by $0.02 resulting from a reduced share count attributable to 2017 common stock repurchases, $0.01 from the increasing straight line rent, $0.01 from the 2017 preferred equity redemption, and $0.015 each from same store NOI growth and lower interest expense net of the impact on earnings from early debt extinguishment. Same store NOI growth decelerated as anticipated to 1.5% during the first quarter. Our same store growth was driven by higher base rent of 115 basis points primarily from a combination of strong contractual rent increases and releasing spreads. In addition, improvements in property operating expenses net of recovery income contributed 30 basis points, which were partially attributable to the closing of certain field offices. Growth in other property income and improved bad debt expense were offset by the decrease in percentage rent and specialty rent. Subsequent to quarter end, we significantly enhanced our balance sheet flexibility with the closing of our amended and restated 1.1 billion unsecured credit facility. We were very pleased with the execution and are appreciative of their continued support we received from bank group to recognize the substantial improvements we have made to the company’s overall credit profile over the last several years. We upsize to the existing revolver to 850 million, an increase of 100 million, while retaining our 250 million term loan that matures in 2021, and paid off the 100 million term loan that was set to mature later this month. We also extended the revolvers duration by more than two years to 2022 and improved the credit spread on the revolver and term loan by 30 basis points and 10 basis points respectively. Also as Steve highlighted, we improved our cap rate by 25 basis points to 6.5%. As a result of this transaction, we now have less than 2% of our debt coming due through the end of 2020. With over $675 million in liquidity and a net debt-to-adjusted EBITDA ratio of 5.4 times, we are very well positioned to be opportunistic with our growth objectives for the next several years which is particularly important considering today’s retail environment. Turning to guidance, as we reported last night, we are maintaining our operating FFO guidance range of $0.98 to a $1.02 per share, and we are also maintaining the related assumptions around transactional activity, G&A expense and same store NOI growth at 2% to 3% for full year 2018. As for Toys 'R' Us, you may recall that our initial full year guidance did not have any specific assumptions regarding the impact of its impending bankruptcy, but we did communicate that our approach to estimating potential tenant fallout including bankruptcy more than covered what we thought was a worst case scenario with Toys, amounting to approximately 1.5 million of impact to 2018. We are monitoring the bankruptcy proceeding very closely, and while we have incremental intelligence to share, there are still many moving pieces. At the beginning of the year, we had eight locations, one of which was sold during the first quarter. With respect to our seven remaining locations, all are on the store closure list and we expect the going out of business sales at our locations to run through mid-year. All seven of our leases are expected to go to auction over the next several weeks, which could lead either a rejection or a purchase of the leasehold interest in each case. However, if the remaining seven locations close on June 30 and are not backed up this year, such closures would attract approximately $11 million or 45 basis points from full year same store NOI, which is more than covered by our bad debt assumption for the remaining part of the year. This coupled with our first quarter same store NOI results in which we slightly outperformed compared to our internal estimates and our limited exposure to other bankruptcies announced thus far in 2018 including Claire, Bon-Ton and Southeastern Grocers allows us to remain comfortable with the 2% to 3% same store NOI assumption. Regarding the shape of our 2018 same store NOI growth, it is expected to decelerate in the second quarter and reaccelerate in the second half of the year especially in the fourth quarter as rent is projected to commence for several box (inaudible). And with that I will turn the call over to Shane.

[Shane Garrison:]

Thanks Julie. On the operational and redevelopment front, we continue to be very busy. In Q1, we continue to meaningfully improve our growth profile across the portfolio. For the quarter, we signed 97 leases representing approximately 637,000 square feet with comparable blended releasing spreads of 6.4% and spreads on comparable new leases at 31.2%. Our negotiated leases contain contractual annual rent increases of approximately 175 basis points. At the end of the first quarter, our retail ABR per square foot was over $19 and our leased rates stood at 94.3%. We expect both to increase by year-end, as we take advantage of our embedded leasing opportunities across our portfolio. As we advance through 2018, the onus continues to be internal focus on execution. Leasing, merchandising and continued investment in entertainment, food, health and those retail partners who demonstrate a keen awareness of omni-channel importance are the principal drivers of long term growth. With the end of our broad repositioning complete and field expense savings realized in the late 2017, the primary drivers of same store NOI growth are now more income driven, and rent commencement, stability of cash flows and specialty and percentage rent are on track for 2018. We currently sit at a spread of 140 basis points trying to occupy and have 270,000 square feet that will generate approximately 6.5 million in annual revenue that is expected to commence largely in Q3 and Q4 with a few leases in the pool commencing in Q1 of ’19. Turning to Toys 'R' Us, we have seven locations in total, with average rents of approximately 675 per square foot. We are significantly under market and are already in the LOI negotiations for six of the seven locations. Merchandizing categories for the backfill of these spaces include discount soft goods, fitness, home furnishing, sporting goods and health and beauty. Average downtime is expected to be roughly 12 to 15 months. While the potential Toys disruption could impact our ability to reach our 95% stated occupancy goal by year-end, we are confident that we could obtain 95% on a leased rate basis. On the development front, you may have noticed on pages 10 and 12 of our quarterly supplemental that we have added incremental disclosure. On page 10, you will see that we rebranded and consolidated our Townson Circle redevelopment project located in the Baltimore market to Circle East. Circle East now includes the 96% leased cinema-anchored assets formerly known as Towson Square. All three blocks of this rebranded project will be a cohesive walkable environment featuring approximately 240,000 square feet of retail, restaurant, and entertainment in addition to 370 residential units. Currently, we are on target to complete construction by late 2019, and we look forward to transforming this site in to a vibrant, community-driven mixed-use asset for the Baltimore area. I encourage you to visit circleeast.com for additional color on the great things we have planned for this project. On page 12 of the supplemental, we added a slight plan for One Loudoun Downtown highlighting another significant mixed use expansion opportunity that we expect to commence in 2019. We have already identified a multi-family partner for this project and look forward to sharing more details on this opportunity in addition to our Capital Center mixed-use project in DC at our property tour and development review in September later this year. Lastly, as stated in our press release, we are currently under contract with [Hard Money] to sell Schaumburg Towers for approximately 87 million, which we expect to close any day with an outside date of May 31. And with that I’ll send it back to Steve.

[Steve Grimes:]

Thank you Shane and Julie for your update. I’ve stated many times that 2018 is the year of internal focus here at RPAI, designed to ensure solid growth through our shareholders through organic means. Our leasing velocity in turns along with our redevelopment pipeline are our key priorities to ensure 2018 is a solid fundamental year on which to grow earnings meaningfully in the years to come. And with that, I would like to turn the call back over to the operator for questions.

[Operator:]

[Operator Instructions] our first question comes from the line of Christy McElroy with Citigroup. Please proceed with your question.

[Katy McConnell:]

This is Katy McConnell on for Christy. Can you talk about your investment priorities including your attitude for buybacks for the rest of the year just given you didn’t complete that in the first quarter?

[Steve Grimes:]

Hi Katy, how are you. This is Steve. It’s a fair question and I would imagine we were going to get this pretty much for everybody, so trying to give you a full response. Just as a reminder, we have transactional roadmap for the year of 200 million of dispose and 100 million of acquisition just the midpoint of the range. So relative small transactional year on which we would get some proceeds for any further buybacks. Coupled that with the fact that we said that we would only do buybacks on a leverage neutral basis. We were pretty staying in terms of our ability and willingness to actually buy back out of the gate. The timing of the transaction as well for the most part complete on the 200 million with tail end of Q1, which essentially would have been probably the best timing for us to consider buy backs, because that’s when everybody in this space was trading pretty of their 12 month lows. But the cash wasn’t in the bank for us to really be able to do that. But again, I think as we look at our roadmap and we look at our initiatives for this year. When you look at the amount of growth orientated leasing that we have in our portfolio to deal with in 2018 and beyond, as well as the redevelopment, we’re really, really focused right now on liquidity. So as we look at liquidity, we think that that’s going to be king for us in terms of going forward in to 2019 to put outsides growth potential out there for the shareholders.

[Katy McConnell:]

Okay, great and just one more. Can you give us an update on the size of the shadow redevelopment pipeline today if that’s still around 400 million or if that’s moved up at all?

[Shane Garrison:]

This is Shane; this is probably a nice ducktail and the (inaudible) commentary around dry powder. So the pipeline continues to grow fairly rapidly and exactly what we bargained for when we started the portfolio recycling initiative five years ago. Just order of operation here; Reisterstown is all in terms of purposes done, and we think it will be 100% leased in the next quarter or so. Towson’s on track and on time so far. We sold the (inaudible) in the quarter call it 12 million net about a $15 million spend in total right now and we expect another 10 million to 15 million next year. So we are getting closer there. And then we move on Loudoun, obviously Loudoun we moved up to the near-term development opportunity. We have chosen a multi-family partner for GNH, 378 units in this case, 40,000 to 80,000 square feet of commercial. It’s in a condo structure, so we will own the retail 100% RPI and the [9010] JV will develop and own the multi-family. That project is a 125 million to 150 million, we will disclose return on cost and more timing in September in DC, but it looks like ’19 has a large spend as it relates to Loudoun. And then on Cap Center that project continues to pick up speed, the hospital is well underway now. We were recently approved for our preliminary plan of subdivision and in that approval we filed for and received 3,000 multi-family units just under 200,000 square feet of retail, 700,000 square feet of office including medical office and 300 hotels (inaudible). Right now we are choosing multi-family partners for phase 1 with rights for further phases in addition to a partner for medical office. Phase 1 alone on that project look like it will close to 200 million and again that is a large spend in ’19, ’20 and ’21. And as a point of reference, we had said repeatedly we want to get to a $50 million to $100 million run rate and it looks like ’19 and ’20 we might actually outrun a 100 million. So I think when you see those numbers and feel that the pipeline is actually tangible. Steve’s commentary makes a lot of sense.

[Operator:]

Our next question comes from the line of Vincent Chao with Deutsche Bank. Please proceed with your question.

[Vincent Chao:]

Just wanted to touch base just on the (inaudible) backdrop on where you are at with those and how that relates to the bad debt expectations. I’m just curious how much room that leaves for additional unanticipated closures or bankruptcies and what your outlook for store closures here after the holiday season we just had.

[Julie Swinehart:]

In terms of the bad debt, we still have approximately 30 basis points of the midpoint of full year same store NOI remaining that we have allocated to both bad debt and unknown potential kind of bankruptcies for the remainder of the year. And that’s above and beyond what we described as the worst case scenario for Toys and that’s still early in the process there. So we’ll continue to make updates. We do feel comfortable with that amount at this point in the year, especially considering our limited exposure to other bankruptcies that have been announced so far. So if in an unforeseen material kind of bankruptcy, we do continue to be comfortable with the amount estimated.

[Vincent Chao:]

And then just maybe another question more on the disposition side which I know you are sort of winding down. But it seems that we’ve (inaudible) from a couple of your peers that capital formation has maybe improved in the recent months and that there’s maybe been a bit more liquidity in the market. And I was just curious if that’s also been your experience.

[Shane Garrison:]

Hi Vin, this is Shane. Admittedly call the 200 million that we have closed or about to close was an overhand from ’17. But it’s hard to – I don’t know if I can be additive in regards to any market intelligence. It feels like secondary and tertiary pricing has found its natural level, so I agree with your it seems like liquidity is alive and well for a broad part of the market.

[Operator:]

Our next question comes from the line of Todd Thomas with KeyBanc Capital Markets. Please proceed with your question.

[Todd Thomas:]

Just back to Toys 'R' Us, Shane you mentioned the $6.75 average rent. Any update there on what you think the potential mark-to-market is assuming you get the mall back. And then any indications on whether or not some of those leases may get assumed, any insight there?

[Shane Garrison:]

Sure, just from a world of operation, the bankruptcy for five of the seven leases in our pool tide is call it mid-June. So we’ll have much better clarity around not only same store but what actually happens with Toys in Q2. 675, this is on a key to be our best comp set ever. H.H. Gregg ended up being mid-40% range. As far as what we’ve gotten down there, I think at 675 we have call it six of the seven boxes in LOI or negotiations right now, really trying to position. So we understand what those are worth and the leasehold auction process. But it looks like that’s about somewhere around 80% to a 100% rent comp assuming it’s a single tenant backfill. So the activity continues to be robust. I would expect given how far we are on our markets; you have pretty active auction process. There are a few we intend to bid on, given the feedback we’ve gotten on LOI right now. And on the tenancy side, the demand continues to be more the same, just on soft goods, entertainment, health and fitness, health and beauty and certain the home categories including furniture. So, at one end on extreme end if all the leases are actually bought and we get none and the bankruptcy process is certainly accretive obviously in ’18. And then on the other extreme if all of them come back, we’re looking at double on rents and probably a lot of tailwind in ’19 and ’20.

[Todd Thomas:]

And then maybe I’m reading in to this a little too much, but you’ve maintained for some of these other bankruptcies and backfill opportunities that the timeframe to backfill is 12 months, I think you mentioned 12 to 15 months. Is there any reason why you’re expecting this especially with some of these LOIs already in place that this would be a little bit of a longer potential backfill process, I guess with the rents at 675 a foot. I’m just curious why you wouldn’t expect the spaces to be backfilled any quicker really just given the lower bases.

[Shane Garrison:]

Yeah, it’s a good question and we’re hedging a little bit. You’re in the middle of the summer at that point pushing July, let’s assume you get it end of June or July. If you look at typical anchor openings either in fall or spring generally and if you – I don’t think you can get it done any sooner than spring, which would take you to nine months at the earliest and I think you’re going to a few that probably drag in to the fall. So I think on the average a 12, but the hedge is to 15.

[Todd Thomas:]

And just in terms of construction cost, so you ran through some of the larger redevelopment projects and expansions they’re in various phases of planning and in process. Is there increase in construction cost here having an impact at all on those projects, on the returns of all the year potentially anticipating and how are you mitigating the risk around rising costs.

[Shane Garrison:]

It’s a great question and I think it’s also very topical. I will tell you the smaller projects, those are really tougher projects to not only get traction from kind of a 3 bps scenario or mandate, but also control cost. So when you think about just backfilling boxes or some of the smaller pad activity, we’ve seen relatively in ordinate pricing, call it 5 CAGR growth in construction cost, a lot of labor driven, but really across the board. When you look at bigger projects, Cap Center, Loudoun and even Towson and of course we have Avalon Bay at Towson so we were able to GMP back the retail shell. The bigger projects are more signature projects, I think have whether revenue building or otherwise, we have a little bit more pricing power conceivably the GEC can be on site for two to three years. So we haven’t seen anywhere near the installation we’ve seen in the smaller projects.

[Operator:]

[Operator Instructions] our next question comes from the line of Hong Zhang with JP Morgan. Please proceed with your question.

[Hong Zhang:]

I was wondering what have you guys seen so far this year that may incrementally give you more conviction than the second half of the year been a (inaudible) will occur.

[Shane Garrison:]

I’m sorry can you repeat the, just the fact did you say whether rent commencements will occur.

[Hong Zhang:]

Have you (inaudible) for the quarter and this year bankruptcy still seem to be occurring (inaudible) you seeing it incremental, it gives you more conviction at the backend or ramp up is still pretty strong still going to occur.

[Julie Swinehart:]

Keep in mind that the back half we have reiterated, but would include a significant jump and that’s in large part due to our H.H. Gregg and Gander Mountain locations that had moved out in 2017 during the second quarter and then very early in the third quarter. They’ve got in some way an easier comp already. And then in addition as Shane noted, we do expect to turn on rents in the third and fourth quarters of 2018 for several of those space and through also certain other (inaudible). So it’s really the combination of those factors primarily that’s expected the results on outside same store NOI print especially in the fourth quarter of this year.

[Operator:]

There are no further questions in the queue. I’d like to hand the call back over to Steven Grimes for closing comments.

[Steve Grimes:]

Well thank you very much for your time again. I know it’s a very busy time for everybody. Look forward to seeing many of you at ICSC and then following up at (inaudible) and then just as a reminder we said it a number of times on the call. Here we are having our property tour and development summary in September, so be on the lookout for some paper dates for that. And thanks again for your time, have a great day.

[Operator:]

Ladies and gentlemen, this does conclude today’s teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.