Retail Properties of America, Inc.
Q2 2013 Earnings Call Transcript

Published: 6 Aug 2013

[Operator:]

Greetings and welcome to the Retail Properties of America Second Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Mike Fitzmaurice, VP of Finance. Thank you. Mr. Fitzmaurice, you may begin.

[Michael Fitzmaurice:]

Thank you, operator, and welcome to Retail Properties of America Second Quarter 2013 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, estimates, expects, intends, may, plans, projects, seeks, should, will 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 2013, 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 10-K, 10-Q and other SEC filings. As a reminder, forward-looking statements represent management's estimates as of today, August 6, 2013, 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 such as same-store results, NOI, adjusted EBITDA, FFO, operating FFO, net-debt-to-adjusted-EBITDA ratio, and net debt plus preferred stock to adjusted EBITDA ratio. You can find a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP numbers and definitions of these non-GAAP financial measures in our quarterly supplemental package and our earnings release, which are available on 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; Angela Aman, Executive Vice President, Chief Financial Officer and Treasurer; and Shane Garrison, Executive Vice President, Chief Operating Officer and Chief Investment Officer. After the prepared remarks, we will open up the call to your questions. With that, I'll now turn the call over to Steve Grimes.

[Steven P. Grimes:]

Thanks, Mike, and good morning. And thank you all for joining us today. Once again we are pleased with our quarterly operational and financial performance. Fundamentals remain strong and our portfolio is realizing the benefit of robust tenant demand and limited new retail supply. Our strong leasing velocity over the last 12 months has resulted in an anchor lease rate of 97.2%, an increase of 240 basis points year-over-year. And as we expected the stabilization of our anchor occupancy has begun to translate into tangible improvement in our small shop lease rate, which is up 100 basis points since March 31. Returning the portfolio to 95% occupancy by 2015 is the primary objective for the company and we feel confident in our ability to execute due to the strength of our leasing platform and the quality of our asset base. For example, our power center portfolio includes 38 assets anchored or shadow-anchored by Target and is now 95.1% leased. Additionally, our neighborhood and community center portfolio has average 3-mile population of nearly 95,000 people, an average grocery sales of approximately $500 per square foot; and our lifestyle center portfolio has average in line sales productivity of approximately $425 per square foot and a low occupancy cost ratio of 9%. These metrics, combined with the strong leasing momentum we are seeing across the portfolio, make us optimistic about our ability to generate strong occupancy and NOI gains over the next 12 months and beyond. On last quarter's call, I began to discuss our longer-term portfolio repositioning plan and the rationale for becoming more geographically concentrated. As I mentioned then, we are pleased with the current size and quality of our portfolio and as a result, we can be patient and strategic as we execute on these plans. That said, it is the right time in the company's life cycle to begin to optimize our footprint in a way that will help us better leverage our robust operating platform. The benefits of active hands-on management in our business can't be underestimated. And the opportunity to build our local and regional infrastructure around our target markets will allow us to create operational leverage and enhance our ability to drive portfolio performance. Our strategic repositioning objective is to become the dominant shopping center owner in 10 to 15 target markets, owning 3 to 5 million square feet in each market. At our Investor Day in June, we announced 10 of these markets including Dallas, Houston, Austin, San Antonio, Seattle, Phoenix, Atlanta, the Baltimore/D.C. corridor, Chicago and New York. We currently have a presence in each of these markets and we will be looking to grow that presence through strategic acquisitions in order to gain critical mass. At the same time, we will exit other markets where we lack scale today and either don't view the market as having compelling long-term risk reward proposition making it an unattractive use of incremental capital or where we don't believe we can efficiently gain the critical mass we seek. Given these substantial improvements we have made with respect to our balance sheet over the last 18 months, we are pleased to be in a position to make 2013 our last year as a net seller. In 2014 and beyond, we fully expect that disposition proceeds will be redeployed into strategic acquisitions. While the market for Class A shopping centers is competitive, our team has been working diligently to source acquisitions in our target market that meet our long-term growth objectives and we are hopeful to have some news on this front over the next several quarters. In the interim, we remain focused on unlocking the embedded growth opportunity we have in our existing portfolio as we drive occupancy and NOI gains. And with that, I would like to turn the call over to Angela Aman, our Chief Financial Officer, to discuss the results of the quarter.

[Angela M. Aman:]

Thanks, Steven. Good morning. Operating FFO was $0.26 for the second quarter and included $5.5 million or $0.02 per share of settlement proceeds received from the Mervyns' bankruptcy. Including non-operating items, FFO was $0.38 per share. Non-operating items were primarily related to a gain on debt extinguishment associated with the settlement of the University Square mortgage and accrued interest balance, but also included income related to hedge ineffectiveness. Same-store NOI growth was 1.5% for the second quarter, overall very positive fundamental trends including occupancy gains and positive releasing spreads were partially offset by lower other property income and higher bad debt expense. You may recall that when we initiated same-store guidance for the year, we discussed that remerchandising effort at a handful of centers with lower same-store growth by 50 to 75 basis points during 2013. We now expect the impact to be greater as the Gateway alone is expected to reduce same-store growth by over 100 basis points for the full year. The offset to the growing drag from remerchandising efforts has been broad-based stronger-than-expected performance across the remainder of the portfolio. And as a result, we remain confident in our full year same-store NOI guidance range of 2% to 2.5%. Turning to the balance sheet. During the second quarter, we increased our financial capacity by over $430 million through the recast [ph] and upsize of our unsecured credit facility and the opportunistic utilization of our ATM program, under which we issued approximately 5.5 million shares at a weighted average share price of $15.30, generating net proceeds of nearly $83 million. As a result, net debt to adjusted EBITDA is now 5.9x or 6.3x including preferred equity. And our leverage ratio, as calculated under our credit facility, is now 42%, which places us in the lowest tier of our leverage spread. While the leverage goals we established at the time of the IPO now achieved, our focus as it relates to the balance sheet red line [indiscernible] and growing the size and quality of the unencumbered asset base. During the second quarter, we repaid or received forgiveness for approximately $120 million of mortgage loans, with a weighted average interest rate of 6.4%. The forgiveness received during the quarter related to the final settlement of the University Square loan. The $26.9 million mortgage and $8.6 million accrued interest balance were settled for $7.3 million in cash and a $1.9 million restricted escrow that had been held by the lender. We are now able to pursue strategic alternatives for University Square and hope to have additional announcements as it relates to this asset over the next several quarters. Subsequent to quarter end, we repaid an additional $181 million of mortgage loans, with a weighted average contractual interest rate of 6.41% or an in-place weighted average interest rate of 7.03% due to some hyper-amortization provisions of one of the loans repaid. Of this amount, approximately $158 million related to longer-dated loan maturity. On July 1, we repaid a $56.1 million mortgage with a schedule maturity date in 2034 and an in-place interest rate of 6.25% based on the hyper-am [ph] provisions of the loan. On August 1, we repaid a $102.3 million mortgage loan that was scheduled to mature in late 2014 with an interest rate of 7.85%. Both loans were repaid at par with no prepayment penalties, consistent with our objective of growing the unencumbered asset base as efficiently as possible in order to continue our progress towards an investment grade credit rating. As a result of the mortgage repayments in the second quarter and the additional repayment subsequent to quarter end, our unencumbered asset base stands at $2.3 billion, up $600 million since March 31 and up $2.2 billion since the end of 2011. Additionally, the unencumbered pool now includes some of the best assets in our portfolio, including The Brickyard in Chicago, Henry Town Center in Atlanta and Walter's Crossing in Tampa. And by yearend, the pool will also include the Shops at Legacy in Plano, Texas. Turning to guidance. Last night, we increased 2013 operating FFO guidance to a range of $0.92 to $0.96 per share and affirm same-store NOI disposition and acquisition guidance ranges. The increase in our operating FFO guidance is a result of both the Mervyns distribution previously discussed as well as additional payouts of higher costs longer-dated mortgage maturity completed subsequent to quarter end. And with that, I will turn the call over to Shane.

[Shane C. Garrison:]

Thanks, Angela, and good morning, everyone. As evidenced by another strong quarter of operational results, our leasing momentum has continued to drive the business, resulting in significant occupancy gains and positive releasing spreads, which is a testament to our portfolio quality and the dedicated efforts of our leasing and asset management teams. In fact over the last 4 quarters, we have signed 4.4 million square feet of new and renewal leases, more than in any other 12-month period in our history, which has contributed to year-over-year lease rate gains of 180 basis points and economic occupancy gains of 250 basis points. One of the main drivers of this improvement has been our small shop leasing. As Steve mentioned earlier, our small shop lease rate was up 100 basis points sequentially and currently stands at 82.4%, which continues to be fueled by growing demand from a broad spectrum of retailers, including those in the health and beauty, home furnishing categories as well as quick service restaurants and service-based tenants. We are also very encouraged by our success of filling small shops space that has been vacant for more than a year. During the quarter, we signed 50 small shop leases representing approximately 100,000 square feet, with an average unit downtime of approximately 3.5 years. In fact, the majority of our forward leasing pipeline is comprised of potential small shop transactions with an average unit downtime of approximately 3.5 years representing over 100 new leases for over 325,000 feet. We believe this is indicative of the progress we are making on some of the most difficult vacancies in the portfolio and is another positive indicator of small shop demand at our centers. In addition, we are seeing the credit quality and financial backing of our small shop synergy continue to improve as we focus our efforts on best-in-class regional and national retailers of smaller-format spaces. Comparable cash leasing spreads were up 4.8% in the second quarter. On a blended basis, with new lease spreads up 5.1% and renewal spreads up 4.7%. Excluding a renewal of an anchor lease at University Square, comparable renewal spreads would have been up 6.4% with blended cash leasing spreads up 6.2%. This strong performance was accomplished on a base of over 1.1 million square feet of comparable transactions, our largest since we began reporting the metric last year. With respect to investment activity, our disposition program remains on track. Year-to-date, we have sold $64 million of assets with an additional $196 million under contractor LOI, including the RioCan transaction we announced last quarter. While the increase in interest rates we have seen over the last several months has created additional volatility in the marketplace, it does not appear or have impacted transaction volume or pricing. As a result, we remain confident in achieving our full year disposition goal of $400 million to $500 million. Lastly, in terms of acquisitions, the environment remains competitive for Class A assets. That said, we believe that our narrowed focus on 10 target markets has enhanced our ability to actively pursue off-market creative transactions. And as a result, we are incrementally more optimistic about our ability to source additional deals above and beyond the $100 million related to the RioCan unwind announced last quarter. And with that, I would like to turn the call over to Steve for his closing remarks.

[Steven P. Grimes:]

Thank you, Shane and Angela. In closing, I am very encouraged by all our accomplishments to date and thankful for the dedicated efforts of our employees and confident about where we are headed. And before I turn the call over to Q&A, I wanted to take a moment to again thank those who either participated in our Investor Day in person or through our webcast. With that, I would like to turn the call back to the operator for Q&A.

[Operator:]

[Operator Instructions] Our first question comes from Vincent Chao with Deutsche Bank.

[Vincent Chao:]

Just a question on the same-store NOI commentary, some of the tougher markets, there are some of the remerchandising efforts maybe taking a little bit longer, I guess, can you give us a sense of when you see those particular assets bottoming at this point? And then just on the back half ramp, that's sort of implied by the guidance here, I'm just curious how much of that is sort of already in place in terms of leases that have already been signed and maybe you're just waiting commencement or things that have maybe commenced earlier this year that will continue to benefit in the back half?

[Angela M. Aman:]

Sure. In terms of the remerchandising efforts, I would say that we think that the asset we called out, in particular the Gateway, has effectively bottomed at this point. It's just a matter of when the comps really start getting easier. This was more -- Q2 is a more difficult quarter than we expected. But our expectations for the back half of the year haven't changed by as much as the drag we experienced in Q2. So we do think that the comps at Gateway do get easier even if the asset effectively stabilizes from here and they move through the back half of the year. In terms of the bridging, sort of where we are on a year-to-date basis relative to the 2% to 2.5% guidance for same-store, I'd known a few things. One is the Gateway comps as we talked about. The second is the issue we've talked about historically, in terms of our occupancy gains and the mix issue we're experiencing with respect to occupancy gains. The fact that for us most of the rent commencement you've seen in the first half of the year has been largely comprised of larger format, lower ABR spaces. So 100 basis points of occupancy gains from those tenants was resulting in less than 100 basis points of occupancy gain on an economic basis that's flowing through same-store NOI. We view that in particular because of all the traction we're seeing on the small shop leasing. As we alluded to in the prepared remarks, we see that mix impact neutralizing as you move through the back half of the year and expect that base on the traction we're seeing, you'll actually see that slip at some point in 2014. So the mix issue is becoming loss of the net issue as we move through the year. The Gateway comps are getting easier. And then the other thing I would note is really the impact of the disposition pool on a full year same-store NOI number consistent with how we treated same-store NOI guidance last year with the impact from the Mervyns' transactions and their impact on full year same-store NOI, as we guided to at the beginning of the year for the same-store pool. This year, we did look at what we expect to report on at yearend. And as a result, in the second quarter in particular, we did have a fairly significant impact from changes in the pool. For example, one asset that we have under contract today had a big lease term fee that hit in the second quarter of last year. So pulling out that one asset from the pool would have impacted same-store NOI by, call it, 70 basis points. So the effective same-store on a pool -- on an apples-to-apples basis for the pool would have been something like 50 to 75 basis points higher. So the gap you're trying to close in terms of the first half same-store NOI relative to the guidance was a little bit smaller than you might appreciate from looking at the numbers.

[Vincent Chao:]

Okay so the 1 5 reported maybe tuck on 50 to 70 basis points it sounds like and then if we think about the first quarter's reported 0.5, but I think you talked about it being more like 2.2 x some of these remerchandising efforts. So it seems like it's fairly consistent there and then back half seems like lease from a comps perspective and the mix perspective -- or non-mix, I'm sorry, the disposition pool that sort of already embedded as opposed to requiring a lot more leasing. Is that fairly accurate?

[Angela M. Aman:]

Yes. I mean, I think a lot of this is just rent commencements from spaces already been leased today. That's accurate.

[Vincent Chao:]

Okay. And just on the disposition commentary, sounds like -- and nobody's really reporting any material change in the environments in terms of investment activity versus the rising rates, just curious, outside of the RioCan, which is already announced and that's about 100 million I think coming on the fourth quarter, do you think the remaining dispositions in the back half will come on rapidly or you think it's more weighted to fourth quarter? And is that consistent with sort of what you are thinking at the start of the year?

[Shane C. Garrison:]

Yes. I think we've got 1/6 [ph] including RioCan locked away today, closing on our contract and then another 100 million under contract of LOI. I would tell you I think that most of that should hit really fourth quarter. That's our expectation or certainly late third quarter. Rio closes, for example, on 10 1. And the overall environment and supply remains very tight, almost regardless of ARB market at this point. And in that regard, we have not really seen any change from a demand perspective or pricing.

[Operator:]

Our next question comes from Cedrik Lachance with Green Street Advisors.

[Cedrik Lachance:]

Shane, you talked a little bit about the non-comp leases that were signed in the quarter. It's a big chunk of what you're signing. Can you give us a little more details in terms of the breakdown between small shop and anchors? And if small shop is a big chunk of it, how do you think about TIs and small shop leases?

[Shane C. Garrison:]

Yes. So I think, Cedrik, the total base renewals and new for the quarter was 257 leases or at 1.3 million feet. The non-comps that was actually I think 200,000. So but your point about the small shop space being over 3 years, it's in middle, even, topper space. I think we've said before that once we had the anchor lights on, now that we're north of renewals 97% was a much easier discussion. And I think that's playing true. From an incentive standpoint, I don't think the market incentives where shopper-anchored really change dramatically. I think it's always been about the income side or the rent side when you're negotiating. In that regard, I feel that we have a little more leverage as supply continues to remain very tight, especially in Class A. If you look at our blended, call it, improvements and incentives of $4, obviously, a lot of that is weighted because of the 1 million square feet of renewals. But even on the new, we've ran half of what we did, call it, the last 2 quarters kind of that $17 number. So I do think supply remains tight. And I do think landmarks have a little better leverage every quarter even in that space that in this case has been vacant for quite some time.

[Cedrik Lachance:]

Okay. If you were to think about the average standard quality of that small shop space that needs to be really sort of needs to be leased, would you say it's representative of the average of your portfolio? Or does it trend more to the upper end and the lower end of the portfolio?

[Shane C. Garrison:]

That's a good question. I think maybe I'll take it a different way. There's quality and then there is, is it overbuilt or not, which is really hard to lease through. I think the quality is what you would expect from a, call it, top 2 grocer and a B market. We do have a couple of centers where the in-line is just overbuilt and that's very tough to lease through, you just -- structurally, you're not going to get there. But I think overall on the average it's more of again that top 1 or 2 grocers and a B market versus the latter.

[Cedrik Lachance:]

Okay. And then, Angela, in terms the -- your expectations for an investment grade in credit rating, has it changed recently and when do you think you might get that?

[Angela M. Aman:]

We said it at the Investor Day at the end of June, we still think it's a 2014 event for us. We have made the progress we wanted to make on the leverage ratio and expect the impact of dispositions as we move through the back half of the year for that to improve, even potentially a little further from here. That said, it's really for us about the structure of the balance sheet today and the size and quality of the unencumbered asset base. $281 million of debt repayments we made subsequent to quarter end, was pulling forward a lot of longer-dated maturities. But that was in line with the plan that we'd laid out in the Investor Day. And it has effectively pulled forward everything we can at this point into '13 without incurring prepayment penalties. Looking forward, 2014 even with the pulling forward, a handful of additional maturities is just a light maturity year for us. And so while I think we do have the ability to look forward and tell a good story about our ability to continue to unencumbered assets, it's going to take us I think looking forward through to some of the '15 maturities in order to demonstrate enough progress. I think the good news for us clearly at this point is that we've created enough capacity on the balance sheet with the upside to the credit facility in order to, I think, to credibly tell the rating agencies that we have the capacity with really no execution risks to take out those maturities in order to get there.

[Operator:]

[Operator Instructions] Our next question comes from Yasmine Kamaruddin with JPMorgan.

[Yasmine Kamaruddin:]

So under disposition timing, can you comment a little bit on that for the second half of this year?

[Shane C. Garrison:]

Yes. I still think we are generally heavily weighted in the fourth quarter now. As I previously said, RioCan, for example, closes in October 1. That's about $100 million. So I think we're very comfortable with the guidance, but it will definitely be heavily weighted towards the back half.

[Operator:]

Our next question comes from Todd Thomas with KeyBanc.

[Todd M. Thomas:]

I'm on with Jordan Sadler, as well. The first question, Shane, just regarding the leasing production in the quarter, the 1.1 million square feet of renewables, was that volume consistent with what you're expecting or did you receive some sort of early renewal requests from retailers?

[Shane C. Garrison:]

Yes, that's a good question. We always field early renewal requests. I would tell you though this has been one of the highest quarters I've ever seen where from a velocity standpoint, option letters just keep coming in. And I think that really speaks to the quality of the underlying real estate and again the supply constraints. So I think we're about where we expected to be, Todd. We've taken care of address, call it, 70% of the renewals for the year, which is kind of where we thought we would be. But we continue to have discussions about proactively renewing as well trying to take advantage of again the real estate and the supply constraints. Petsmart, I think, was the last example there. End of last year, early this year, we did 14 renewals. Portfolio renewals was down for 325,000 feet, which pulled a good chunk of '15 and '16 expirations with that particular retailer forward.

[Todd M. Thomas:]

Okay, and then, Angela, you mentioned that the bad debt expense in the quarter was slightly higher-than-expected. I was wondering if you can quantify what that came in at. What was in your model for the quarter and what drove the increase?

[Angela M. Aman:]

Well, it's -- we're still lower than what we had modeled. We came in at $523,000 for the quarter on a total portfolio basis. I think that same-store portfolio was pretty similar to that. Most of the increase actually related to 1 or 2 tenant-specific issues largely at the Gateway.

[Todd M. Thomas:]

Okay. And then I was wondering if you can provide a cap rate for the office asset that was sold subsequent to the quarter and also, which property specifically was that?

[Shane C. Garrison:]

It was Raytheon in Pennsylvania State College. It's tough to put a cap rate on it. It was more of a per pound play because the tenant had vacated and the lease was terminated. So we were able to effectuate a lease buyout on that termination and effectively sold the building vacant.

[Todd M. Thomas:]

Okay, got you. And then just one last question, I was just curious with regard to G&A after the moves in new headquarters and integrating some of the systems and bringing that stuff in-house, so I was just wondering if we're at a pretty good run rate for G&A here?

[Angela M. Aman:]

Yes. I think that's fair. We've been pretty consistent now for a couple of quarters in the new space and with the new IT platform. So the $8 million feels like a decent run rate at this point.

[Operator:]

There are no further questions in queue at this time. I will like to turn the call back over to Mr. Grimes for closing comments.

[Steven P. Grimes:]

Well, thank you, all, for attending today. As we had stated earlier, we're very pleased with the quarterly results that we've had and that we remain very comfortable with our prospects for the remainder of the year. So we look forward to reporting our next quarter results to all of you, and have a great day. Thanks again for attending.

[Operator:]

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