Retail Properties of America, Inc.
Q1 2016 Earnings Call Transcript

Published: 3 May 2016

[Operator:]

Greetings and welcome to Retail Properties of America First Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to turn the conference over to your host Mike Fitzmaurice, Vice President of Finance. Thank you. You may begin.

[Michael Fitzmaurice:]

Thank you, operator and welcome to Retail Properties of America First Quarter 2016 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 Investor Relations section on our website at www.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 2016 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 3, 2016, 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 Investor Relations section of our website at www.rpai.com. On today’s call, our speakers will be Steve Grimes, President and Chief Executive Officer; Heath Fear, 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. And 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. We have lots of great news to share on a wide variety of fronts

[Heath Fear:]

Thank you, Steve. This morning I will discuss our first quarter results and our outlook for the remainder of 2016. Operating FFO for the first quarter was $0.28 per share, compared to $0.26 per share in the same period in 2015. The quarter-to-date change in OFFO was driven by lower interest expense of $0.02, higher same store NOI of $0.01 and higher termination fee income of $0.01 which is primarily related to Circuit City bankruptcy proceeds. These wins were partially offset by lower NOI from other investment properties of $0.02 due to our capital recycling activities. Same store NOI growth was 3.1% in the first quarter, primarily driven by higher rental income of 220 basis points from a combination of strong contractual rent increases, re-leasing spreads, percentage rent and occupancy improvements as well as lower bad debt expense of 50 basis points and lower expenses net of recovery and other property income of 40 basis points. It's worth noting a few unique items that impacted our quarterly earnings. During the quarter, we reserved 100% of Sports Authority’s receivables, resulting in bad debt expense of 802,000 in the first quarter, of which 688,000 or 80 basis points negatively impacted same store NOI. In addition, during the quarter we received $1.8 million of bankruptcy proceeds from Circuit City, of which $1.1 million was recognized as termination fee income while the remaining $652,000 was recognized as bad debt recovery within the same store NOI, essential a direct offset to the bad debt recognized for Sports Authority. The Circuit City bankruptcy proceeds were unanticipated. On the capital markets front. The unsecured debt markets are stabilizing, and based on meetings with the fixed income investors and issuance by RPAI would be very well received. Despite the pent-up demand, the current pricing gives us pause especially in light of our optionality. At this point we do not anticipate any debt capital markets activity until the fourth quarter of this year. The good news is that we have only $29 million of mortgage maturities remaining this year and assuming our increased disposition activity, we will have sufficient liquidity to address our maturity obligations through 2019. Also, this past February, we had a $300 million LIBOR swap expire. We saw 100 million of LIBOR debt through December 2017 to a fixed interest rate of 1.96% based on the current pricing of our $250 million term loan. Turning to guidance. We are maintaining a range of same store NOI growth of 2.5% to 3.5% and we are raising our operating FFO guidance by $0.02 at the midpoint, to $1.03 to $1.07. This guidance move assumes we issue $250 million of unsecured debt in the fourth quarter of this year and the impact from our 2016 investment activity being concentrated in the second half of the year. As for Sports Authority, you may recall that our initial full year guidance did not have any specific assumptions regarding the impact of their impending bankruptcy. We are monitoring the proceedings very carefully, and while we have incremental intelligence to share, there are still many moving pieces. Here's what we know. Sports Authority is now in liquidation. With respect to our 10 stores, one lease at the dark [ph] location in Concord, North Carolina was rejected, which is reflected in our current guidance. 3 Sports Authority stores located in Dallas, San Antonio and Tallahassee are under going out of business list and we did not receive any third-party bids for these leases last week. For the purpose of guidance we are modeling a rejection of these three Sports Authority leases as of June 30. Our remaining six locations, which were not in the initial store closure list, are still being auctioned which could result in either a third-party taking over those leases, or those leases being rejected. In light of the uncertainty, we are declining to make any specific guidance adjustments with respect to the six remaining locations. But I can tell you, as of these remaining six locations are closed on June 30, and are not backfilled this year on a permanent or temporary basis, and the portfolio does not otherwise outperform, these closures would attract approximately $0.01 per share from our full year 2016 operating FFO and 60 basis points from the full year same store NOI. Consistent with our historical practice, do not forecast speculative lease termination fee income and our model assumes 50 basis points of bad debt expense. We continue to expect G&A expense to be in the range of $45 million to $47 million, inclusive of approximately $1 million in acquisition costs. And with that, I'll turn the call over to Shane.

[Shane Garrison:]

Thank you, Heath. This morning, I will discuss our operational results and provide an update on our investment activity, in addition to details surrounding the Sports Authority liquidation. Lastly, I'll give some color on the significant redevelopment opportunities within our existing portfolio that were highlighted in our quarterly supplemental published last night. We continue to experience a favorable supply demand imbalance that is resulting in strong releasing spreads across our portfolio. During the quarter we signed 140 leases, representing 789,000 square feet with blended releasing spreads of 6.7%, comprised of a 7.3% spread on renewals and a 1.8% spread on new leases. Included in the renewal activity are eight Rite aid leases where we extend the term at flat releasing spreads to maximize the value upon sale. Excluding the Rite Aid renewals, the renewal releasing spreads were 8.9%, a high watermark for us since we began reporting this metric. Our portfolio lease rate at the end of the quarter stood at 94.7%, down 40 basis points sequentially while our same store lease rate was 95.2%, down 50 basis points sequentially, primarily driven by the lease rejection of the Sports Authority in North Carolina, in addition to ordinary course seasonal move-outs. Of note, our small shop lease rate of 87.9% is up 130 basis points year over year. Before moving on to our transactional update, I would like to comment on potential recapture of all nine of our remaining Sports Authority locations. As we have discussed in the past, we have been proactive at reducing exposure to Sports Authority by over 40% since our initial listing in 2012 and those efforts have paid off to date. Retailing is Darwinian and we don't view the Sports Authority liquidation as a systemic indication of mass bankruptcies. It is simply a failed business plan in an increasingly dynamic retail environment. With platform capabilities, asset quality and an authentic posture, we intend to quickly take advantage of this available GLA to further derisk cash flow, enhance tenant equality and maximize the customer experience. Simply put, this is what we do every day. Turning to dispositions. We continue to see strong demand for our non-target market portfolio, which Steve mentioned, continues to increase in quality from prior years. We have been pleased with the buyer pool thus far most of which do not appear to be reliant on CMBS debt. As a result, we remain confident in our ability to execute and have increased disposition guidance accordingly. We continue to expect the cap rate on our planned dispositions to be in a range of 6.5% to 7% and from a timing perspective, assume that our remaining dispositions will be concentrated in the second half of this year. From an acquisition standpoint, we are extremely pleased with our progress to date in terms of pricing, asset quality and strategic fit. Given our analysis of current market pricing on a risk adjusted basis for class A shopping centers, and where we are in the current cycle, we are content to be a net seller during 2016 and will remain very disciplined and selective as it relates to putting new capital to work, focusing on the underlying quality of the real estate and long term value creation. Accordingly, we are maintaining our acquisition guidance range of 375 million to 475 million. Lastly, I'd like to provide additional color on our redevelopment strategy. With a solid pipeline of opportunities within the portfolio, development is now an inherent value proposition for RPAI and the focus will be to further solidify the dominance of our core assets while providing for an accretive capital allocation tool to increase future cash flow growth and NAV through programmatic and opportunistic repositioning of assets, largely through densification. From a platform perspective, we continue to focus on the geography of our human capital and reallocated dollars from non-target markets and disciplines and to those that are a point of focus strategically and we have built a tremendous team with the regional experience and expertise to execute on our current pipeline as well as identifying and executing on future opportunities. With the core of the team in place and several other milestones reached, including 3.2 million square feet in the Washington DC, Baltimore corridor and several large redevelopment projects nearing commencement. We have opened a regional office in Tysons Corner which will serve as our eastern division hub in close proximity to the largest component of our redevelopment pipeline. We look forward to the market tour and team introductions at our investor day in September. From a timing and equity perspective, over the next couple of years we will continue a stair-step approach with smaller albeit somewhat complex projects, while continuing our entitlement and site planning efforts on a larger scale projects in the pipeline. As disclosed in our supplemental, we expect to spend $16 million to $17 million on a net basis this year and next with 9% to 11.5% projected return on costs. Our goal is to create a plan where we deploy capital, net of any air rights in a range of $30 million to $50 million on an annualized basis with return on cost projected in the low double digit range on average. Currently in pre-development today, we anticipate three mid-term projects. Towson Circle in Baltimore, Maryland; Boulevard at the Capital Centre and Merrifield Town Center II in Washington DC. These mixed-use projects are infill and/or transit oriented and will provide for the opportunity to lower our equity outlay and improve our risk adjusted return profile through the monetization of air rights. While it is still too early to share costs and returns, these sites are proceeding through marketing, tenant discussion and municipal consideration. Over the next few quarters we will provide you with updates on these projects with more specific equity, timing and return parameters. And with that, I would like to turn the call over to Steve for his closing remarks.

[Steve Grimes:]

Thank you, Heath and Shane for your report. We are very proud of our efforts and results year to date and look forward to executing on our planned initiatives and guidance for 2016. Needless to say, I am extremely proud of what we have accomplished in such a short period of time, a true testament to the quality of our portfolio and platform. And with that, I’d like to turn the call over to the operator for questions.

[Operator:]

[Operator Instructions] Our first question comes from R.J. Milligan with Robert W. Baird.

[R.J. Milligan:]

In the context of the disposition guidance being increased, I was wondering if there's been any change in pricing expectations since the last call, or the pool of potential buyers for some of those non-target assets?

[Shane Garrison:]

Good morning. This is Shane. I think most importantly, we felt strongly enough to expand the guidance and keep the range. But we're still at the 6.5% to 7%. The buyer profile, I don't think, has changed either. You're pretty vocal on the quality of the pool earlier in the year. I think we still feel that public peers show up for some of this product, we have sold some of the single tenant to a public REIT already. So overall the activity is better than we thought. And the pricing remains the same.

[R.J. Milligan:]

Thanks and I'm curious on those assets that you disposed of year to date, or have under contract, if you could give any color as to what the same store NOI growth has been for those assets year over year, or any idea of leasing spreads, just trying to get an idea of the quality of the assets that have been sold at those cap rates?

[Shane Garrison:]

Sure. We are at $132 million year to date. That’s largely single tenants, so it's tough to give -- obviously those are flat assets. One of the other assets was obviously Gateway, I think we all know the track record there. And the final asset was an asset in Kansas city. From a same store and comp perspective, a relatively challenged asset, probably traded in the 8 cap range and I would guess that the historical same store of that asset has been 1% of that.

[Operator:]

Our next question comes from Jay Carlington with Green Street Advisors.

[Jay Carlington:]

Just thinking about this year's capital recycling activity. Steve, how do you think about that in relation to the strategic transformation? I guess you've been capital neutral a couple years and it looks like you're becoming a more aggressive net seller. So is this just taking advantage of what you see in the market, or is this an acceleration of the strategic plan, or can you maybe walk us through that?

[Steve Grimes:]

Thanks, Jay. As we kind of look to put guidance out, we kind of evaluate what the disposition pool should be at the beginning of the year and then we always revisit at the midpoint of the year. That being said, obviously with the transaction market being where it is and the initial indicators of our ability to sell into this particular market we did decide to up the guidance. And we will continue to look at upping the guidance with respect to dispositions but we always have to be remindful of what that use of proceeds would be. So it is really a bit of a balancing act in terms of making sure that we're not selling out too much and having a requirement to ultimately deploy capital and maybe in non-accretive way. So we’re being very mindful of that. And given the fact that we are selling up in the quality spectrum, we feel as though we aren't going to be particularly impacted initially by any movement in cap rate. So we're trying to be very measured in our approach and maintaining our discipline in terms of what we're selling and what we're looking to buy in the marketplace. So in answer to your specific question

[Jay Carlington:]

Okay, and have you fleshed out what the plans are with the incremental proceeds from the dispositions?

[Heath Fear:]

Hi, this is Heath. So just sort of give you the sources and uses for the year, so let's call it 225 to midpoint from dispositions and proceeds. 75 of that is related to Gateway which is basically a cash-less transaction. And $100 million, started the year on my line, so you paid a line off. And then I've got 50 related to maturities of 35 and amortization of 15. So basically the disposition funds your year entirely and takes out all of your debt.

[Jay Carlington:]

Maybe just a quick one, I think you talked about a 50 basis point tailwind from the re-marginalizing initiative in ‘16. How do we think about that with the moving parts from Sports Authority and as a status or benefits change from that tailwind?

[Heath Fear:]

Well, so let’s just – we will look at it quarter by quarter. So with Sports Authority obviously the impact of it in the first quarter was completely eliminated by the Circuit City proceeds. So on a going forward basis, I think you're asking how maintaining my guidance of 2.5% to 3.5% in spite of the fact that Sports Authority is still moving pieces and that we've actually taken three stores out of guidance. And those three stores by the way -- the assumption we’re making on those three is around 50 basis points. Well, thankfully we've got outperformance, and that outperformance is primarily related to percentage rent and also our renewal ratio is also better than what we anticipated. So we're still feeling very good about the 2.5% to 3.5%. And as far as the 50 basis points of tailwind from last year, I think if you look at the trajectory of our growth, it'll be range bound over the course of the year, but then you'll see a little bit of an uptick in the fourth quarter. Again related to that tailwind from the re-merchandising activity of last year.

[Operator:]

Thank you. Our next question is from Christy McElroy with Citi.

[Katy McConnell:]

Good morning. This is Katy McConnell on for Christy. Can you provide some more color on the financing environment and the reason for the later timing of the bond offering, and maybe where you think pricing could shake out?

[Heath Fear:]

So if we were to issue a ten year deal today, it probably might be around 5%. If we issued a seven year deal it will be probably 4.5%, five-year deal would be 4%. So there's certainly an opportunity – as I said in my prepared remarks, we have a lot of meetings with fixed income investors and there's a lot of pent up demand. So there's not a question for us of execution. It's really more sort of sources and uses. And as we raise our disposition guidance, and we came to the conclusion that it was really necessary for us to go ahead and do the bond deal, especially at a 5% pricing and I'd like to do a ten year deal. But what we plan on doing is basically pushing back the bond deals into the fourth quarter and then those proceeds would likely be used to get – at our 2017 maturities, $200 million of which are coming due in January. And so that would not be really from -- there would be no negative ARB in terms of interest rates, so that's around 5%, so we do a printed around 5% in the fourth quarter. We're not really having too much of an issue – And you may ask me why am I not just doing the bond deal in 2017. A couple reasons why we're keeping in ’16, one, I'd like to show the fixed income market that we're really sort of an annual issuer. And secondly, I’d probably also issue in 2017 but I am really mindful of my maturity later. So I’d like to keep some debt and -- ten years from now in 2026. So this way if I did them both in ‘17 I'd have too much coming due in 2027.

[Operator:]

Our next question is from Chris Lucas with CapitalOne.

[Chris Lucas:]

Good morning everyone. I guess, Heath, just following up. When you think about the pricing, are you quoting sort of a public unsecured offering versus a private placement at this point?

[Heath Fear:]

Yes, the public secured offering, call it, 10-year deals 5% and then you probably do 25 to 35 basis points better in a private placement.

[Chris Lucas:]

Do you have a preference one way or the other besides the pricing issue? Is there anything else that would swing you one way or the other?

[Heath Fear:]

I would much rather do a public bond deal, because -- right now I've got only $250 million of bonds in the market. And one of the constraints for some of the fixed income investors is, there’s just not enough liquidity around my bonds. So I do a private placement, great, I can have a tighter print. But if I do a public bond deal, I think it serves a longer dated purpose for us. So that's my bias. That being said, if I come to the end of the year and there's still a significant spread between the private placement and the public bond deal, I wouldn't rule it out.

[Chris Lucas:]

And then just on the dispositions, can you guys -- with the pool that you have out in the marketplace, do you anticipate generating any significant taxable gains, i.e., will there be any 1031 issues to deal with as part of the sort of process as you guys go through the dispositions for the year?

[Heath Fear:]

Yeah, so I think it's sort of representative of moving higher up in the quality chain of the properties that we are selling. We're starting to see more gain. So you may have noticed in our supplemental that we've got some language around of the VIE which we created for a reverse 1031. You'll see that our restricted cash is up, because we’ve got proceeds of a forward looking 1031. So it's going to become part of our process. Again, because as the assets get better, it's going to -- we're going to have gains.

[Chris Lucas:]

And then just kind of going back, Steve, to the question about the Tysons office that you opened up, what sort of functional roles are involved in that office? And then, how should we be thinking about your organizational structure and how you are managing, particularly as it relates to the sort of 10 focused markets in terms of your boots on the ground in those markets versus managing out of Chicago?

[Steve Grimes:]

So we've basically been operating in four regions but as we had noted last year second quarter we had moved to a divisional strategy, hiring Tim Steffen from Macerich who is ultimately going to be housed out of the Tysons office. That being said, we're now divided in the country and we have all different plans in those particular markets with the exception of asset management is run out of corporate here. So all disciplines, leasing development, property management are located out in the market. And that's really been our focal point over the last several years. To Shane’s credit, I think we’ve moved to the regional strategy probably, I’d say good five, six years ago. And kind of the movement last year was just to tighten things up as we've gained a lot more concentration in our target markets with -- by the end of the year having 70% of our ABR in the top ten markets. It really does require us to be local to the business and Tysons is just really an extension of what we have down in Texas. And as we gain more share in the west, we will do the same.

[Operator:]

Our next question is from Vincent Chao with Deutsche Bank.

[Vincent Chao:]

Hey good morning everyone. I just want to go back to Zurich for a second. I know you'd mentioned that you are expecting to announce a Cornerstone lease in the next couple weeks. Just curious, is there anything under LOI at this point, or is it still just tours that you are seeing right now?

[Steve Grimes:]

Are you asking in addition to the lease we're talking about?

[Vincent Chao:]

Well, I guess the lease you are talking about I guess is under LOI at this point. Maybe I missed that.

[Steve Grimes:]

We're past leased or LOI in lease?

[Vincent Chao:]

In lease, okay.

[Steve Grimes:]

And quite honestly we were certainly hopeful to announce something on this call. But I would say that with the lease of this size and a building of this vintage, call it, late 80s or early 90s, the amenities and common area for Class A have changed from a configuration design standpoint. So it’s less the lease from a delay standpoint and more us being holistic about the reinvigoration of the asset and making sure that we understand what class A amenities look like for an asset of this calibre.

[Vincent Chao:]

And then, I guess once the Cornerstone lease is signed or announced, hopefully done, I mean do you think this will accelerate some interest in the asset overall in terms of the sale or do you think this will be more of a lease-up over the next couple quarters after that, before you can really unload it?

[Steve Grimes:]

That's a good question. We've already had some reverse inquiry. Because of the speculation in the market around the lease. For us I think it was important to establish with a lease of size, the market rent for the asset. So we're hopeful that, yes, this speeds up the ultimate liquidation of the asset.

[Vincent Chao:]

And then, moving back to the dispositions, we talked about the fact that you feel comfortable with how you are being received in the market, so you are comfortable raising the guidance for the full year. It does seem like things maybe got pushed back a little bit. Obviously CMBS disruption doesn’t help with that, but we did see volumes decline pretty significantly in the first quarter. CMBS buyers are certainly not as active. I know that’s not who you are targeting. But are you actually seeing an increased number of buyers for your types of assets that you're selling today? And maybe can you give us some color on who those buyers are and what has changed from your perspective?

[Steve Grimes:]

Well, I would just tell you at the macro, I think sentiment was pretty poor at the end of the year and even into January. For whatever reason sentiment seems to have changed somewhat. That being said, it still largely depends on the assets you're talking. For us we talk about the quality, I think we will prove that over the year. But generally anything that has a brochure regardless of market seems to have a very robust demand and interest, anything also that is value add or has some kind of story whether it's great anchor sales or barriers or things like that also has a great interest. I would tell you we have several assets in the market right now that where we've had 45, 50 TAs signed in the first week. On the other side, the weaker demand seems to be the commodity type power center that’s secondary in nature, albeit highly occupied, call it, 95% to 100% occupied but lower growth, more of a yield play. Obviously that was more of a private REIT market hit in years past those – and these are not active as we all know. So that is not surprising. That being said, those assets at least from our lens are still saleable and again we're still comfortable with 6.5% to 7%. I would tell you we have 45 to 50 assets we contemplate selling in total for the year. If you look at under contract, and LOI and closed, we're close to 300 million at this point, call it, 20 assets. The average multi tenant deal for us this year is over 50 million. So that gives you an idea of the magnitude and quality as well. And also as we sell each that’s I think demonstrable progress toward the midpoint. So I think your earlier question, just from a who shows up, it’s still a broad spectrum. We see funds, we see public peers. When you get into this quality, we have some assets that they trade in the low five this year. You certainly see advisors and institutions in there as well. So pretty broad spectrum but again I think it depends on the story and quality of the asset.

[Vincent Chao:]

And then the Rite-Aid side, I know it sounds like you took some cuts in terms of renewals to get some extensions on some Rite-Aids to get them ready for sale. Just curious, given the duration of the sort of process with the Walgreens, has that diminished any interest in the Rite Aid portfolio? Or are you still pretty confident that that will be part of the disposition plan here in 2016?

[Steve Grimes:]

It's a good question, we are still confident. We started with 35 single tenant assets, beginning of the year. As I stated earlier we're a little over half of that assuming we closed the under contract LOI bucket right now. And the remainder isn’t exclusively Rite Aid, we have CVS or two and a Walgreens as well. So we still intend to get through that and we still intend to at year end to be somewhere around 3% from a single tenant exposure standpoint at the portfolio level.

[Operator:]

Our next question is from Todd Thomas with KeyBanc Capital Markets.

[Drew Smith:]

Hi good morning. This is Drew Smith on for Todd. Just a quick question on leasing spreads. We appreciate the color on the renewals. Is there anything specific that weigh on the new leasing spreads? And would you expect that to rebound to the balance of the year?

[Shane Garrison:]

Hi good morning, this is Shane. There were two junior anchor leases that did weigh on the new, exclusive of those two deals we were closer to 8% or so. And those were two non-core assets that we lost the tenant and signed new leases in the same quarter but the comp was negative 10% to 12% on each box. So that did weigh on the overall spreads for the quarter.

[Operator:]

[Operator Instructions] Our next question is from Lina Rudashevski with JPMorgan.

[Lina Rudashevski:]

Hi thanks. What is your occupancy expectation for year end? Has that changed at all versus the last call?

[Steve Grimes:]

I think same store is the one we feel best about from a forecast standpoint given everything else going on in the portfolio. I think total, assuming we still have – or I guess carving out for Sports Authority on the remaining six boxes which are TBD, we feel pretty good around 96, 97, anchors 98-ish and I think most importantly for us an indicative of quality here is our non-anchor, the inline we feel is 90 to 91 by year end. End of Q&A

[Operator:]

There are no further questions at this time. I'd like to turn the call back over to Steve Grimes for closing comments.

[Steve Grimes:]

Well, thank you everybody. We know it’s extremely busy couple of days with earnings releases going out and we appreciate your time. I know we will be seeing many of you at ICSC coming up and if not at ICSC, at NAREIT. So we look forward to seeing you all then. Have a great day.

[Operator:]

This concludes today's teleconference. Thank you for your participation. You may disconnect your lines at this time.