Retail Properties of America, Inc.
Q3 2013 Earnings Call Transcript

Published: 5 Nov 2013

[Operator:]

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

[Michael Fitzmaurice:]

Thank you, operator, and welcome to Retail Properties of America Third 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, 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 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 Form 10-K, 10-Q and other SEC filings. As a reminder, forward-looking statements represent management's estimates as of today, November 5, 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 into certain non-GAAP financial measures. 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 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; and Angela Aman, 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.

[Steven P. Grimes:]

Thanks, Mike, and good morning, and thank you, all, for joining us today. I'm pleased to share with you our third quarter results and recent transactional news, as we continue to deliver consistently on our operational and strategic objective. As I reflect back on the year so far, I'm thrilled with just how far we have come. 2012 was an outstanding breakout year for RPAI, and 2013 is proving to exceed our expectations as well. What our team has been able to accomplish in such a short period of time is tremendous. As you will hear on this call, our operational prowess continues to deliver and our ability to transact demonstrates our long-range vision for the portfolio and our commitment to prudent capital allocation and a best-in-class balance sheet. From an operational standpoint, our near-term focus has been on returning the portfolio to stabilize occupancy and driving same-store NOI performance. During the third quarter, we continued to make considerable progress. Same-store occupancy was up 250 basis points year-over-year or 90 basis points sequentially, resulting in strong quarterly same-store NOI growth of 3.3%. From a total portfolio perspective, we ended the quarter with economic occupancy of 92.5%, achieving the high end of our full year occupancy guidance a quarter early. Additionally, our total portfolio lease rate now stands at 94%, positioning us very well to achieve our 95% stabilized occupancy over the coming years. The progress we have made this year on occupancy has been driven by broad-based demand from retailers. Notably, small shop demand has been particularly strong, with our small shop lease rate now at 84.6%, up 320 basis points year-over-year. Strategically, we continue to execute on our approach we laid out at our Investor Day in June by refining and refocusing our asset base on high-quality, multi-tenant retail properties in a handful of key strategic markets. A few weeks ago, we were extremely pleased to announce that we entered into an agreement to purchase 2 properties, which will represent our first on-balance sheet acquisition since 2008, Fordham Place and Pelham Manor Shopping Center. Both assets are located in the New York City MSA, one of the strongest and most dynamic local economies in the country. Fordham is arguably the best quarter in the Bronx leading retail corridor where over 200 retailers occupying approximately 650,000 square feet. Pelham is situated approximately 10 miles north of Manhattan in the high-volume Route 1 retail corridor with incredible density. These acquisitions will add approximately 500,000 square feet to the New York City portfolio and represent a substantial first step on the geographic concentration initiative we have discussed with you over the last year. At the same time, we continue to make great strides towards refining the portfolio through our disposition program. Year-to-date, we have closed on $230 million of non-core and nonstrategic asset sales at a cap rate of around 7%, which highlights the compelling asset quality of our disposition pool. For example, we recently closed on the sale of our only asset in Iowa, Duck Creek. Duck Creek is a strong grocery-anchored community center in Bettendorf, Iowa, anchored by a Schnucks and Marshalls and shadow-anchored by Home Depot. While this is certainly an institutional quality asset, we made the decision to dispose of it given the nonstrategic nature of this market to us. Our institutional quality asset in nonstrategic markets continue to see demand in the 7% cap rate range. We remain very enthusiastic about our recent execution in our long-term vision for RPAI. Our recent operational performance demonstrates the strength of our existing portfolio. At the same time, our acquisition activity demonstrates our ability to leverage our deep industry relationship, to source high-quality assets at attractive valuation. We look forward to continuing to share our progress with you as we take further steps to optimize our platform and drive shareholder value. And with that, I would like to turn the call over to Angela Aman, our Chief Financial Officer, to discuss our results for the quarter.

[Angela M. Aman:]

Thank you, Steve, and good morning. FFO and operating FFO were both $0.27 per share for the third quarter as nonoperating items had de minimis impact during the period. Operating FFO guidance for the full year has been increased from a range of $0.92 to $0.96 per share to a range of $1 to $1.02 per share, a $0.07 increase at the midpoint of the range. The drivers of the guidance increase include stronger-than-expected third quarter performance, P&L's acquisitions, which will close in the fourth quarter and will drive us above the high end of the previous acquisition guidance range and a significant lease termination fee that will be booked in the fourth quarter of this year, totaling $6.2 million or $0.03 per share. Same-store NOI in the third quarter was up 3.3%, representing a significant acceleration from earlier in the year. As I mentioned, we expect a sizable lease termination fee to be booked in the fourth quarter of this year. As a result of that transaction, we have elected to begin excluding lease termination fees from our same-store NOI definition beginning this quarter. The change did not impact our same-store NOI performance during the third quarter but did have the effect of increasing year-to-date same-store NOI growth by approximately 10 basis points to 1.8%. We believe this change will provide a better basis for evaluating the operational performance of the portfolio over time. In addition, we have provided expanded same-store NOI disclosure in the third quarter supplemental, including lease rates and bad debt expense detail for the same-store pool. Full year same-store NOI guidance has been maintained at 2% to 2.5%. Looking forward, same-store performance will be driven by both overall occupancy improvements and by the changing composition of tenants taking occupancy across the portfolio. At the time of our initial listing, we reported that the average ABR per square foot on the pool of signed but not commenced leases with $12.44, approximately 12% below our portfolio average ABR, as a result of the concentration of anchor leases in the signed but not commenced category. Today, we reported an average ABR on the signed but not commenced leases of $16.87, 17% above our portfolio average ABR as a result of the higher concentration of small shop leases in the signed but not commenced category, providing us strong foundation for continued same-store NOI growth. Turning to the balance sheet. Our overall leverage level is now in line with our long-term goal, with net debt-to-adjusted EBITDA below 6x for the second consecutive quarter. Our focus is now in continuing to grow the unencumbered asset base and improve our coverage ratio. During the third quarter, we've repaid $186 million of mortgage loans at a weighted average contractual interest rate of 6.4% or an in-place weighted average interest rate of 7.01%, based on the hyper-am provision of one of the loans repaid. Approximately $158 million of the loans repaid were related to longer-dated loan maturities, which were repaid at par with no prepayment penalties. As a result of the repayment activity during the quarter, we have expanded the unencumbered asset base by approximately $400 million since June 30, and that now stands at $2.3 billion. Additionally, our fixed charge coverage ratio at September 30 was 2.04x, the first time this metric has been above 2x since 2009. Our balance sheet efforts over the last 24 months, including our disposition program, our non-goal corporate equity offering and our opportunistic views of the aftermarket equity program in the first half of 2013, have provided us significantly more financial flexibility. During the fourth quarter, we will take advantage of the flexibility that we have created by acquiring Fordham Place and Pelham Manor without the use of secured debt. This will add $200 million of high-quality assets to our unencumbered pool and increase the NOI contribution from our unencumbered property, advancing our progress towards an investment-grade credit rating. And with that, I will turn the call over to Shane.

[Shane C. Garrison:]

Good morning, everyone. I'd like to discuss our operational results and then provide some color on our recent acquisition activity. As Steve mentioned, we had a strong third quarter as we continue to execute on our leasing and asset management initiatives resulting in record performance across a number of key metrics. For example, during the quarter, we signed 235 leases representing 1.7 million square feet of GLA, the highest volume since we began reporting the metric in early 2012, bringing us to 5 million square feet leased in the last 12 months. As a direct result of our significant velocity over the last year, we ended the third quarter with total portfolio occupancy of 92.5%. Subsequent to quarter end, we completed the disposition of University Square, excluding this asset from our September 30 occupancy metric would have resulted in 60 basis points of improvement or an occupancy rate of 93.1%. Our lease rate at September 30 stood at 94%, a 220 basis point improvement year-over-year or a 60 basis point improvement since the second quarter, driven in large part by robust small shop demand. In fact, small shop occupancy was up 200 basis points since June 30 to 81.4%, and our lease rate was up 210 basis points to 84.6%, with over 90% of the new leases signed during the quarter comprised of small shop leases. With continued supply constraints for Class A shopping centers and our current anchor lease rate of 96.9%, we feel it is prudent to take advantage of these conditions and continue to make progress on both flattening our anchor expiration schedule over the coming years, as well as aggressively negotiating lease termination and buyouts in those locations where we feel the rents are below market and/or the current tenant or retail segment is on our watch list. During 2013, we have hosted 45 portfolio review meetings. As a result, we have been able to proactively renew several of our near-term expirations. At the time of our initial listing, we had approximately 30% of our anchor occupancy expiring between 2014 and 2016. As of today, we have proactively addressed about 1/3 of that square footage. For example, as I mentioned on last quarter's call, we completed 14 early renewals of PetSmart for 315,000 square feet, adding almost 7 years to the average remaining lease term. In addition, we recently completed an early renewal package with a national junior anchor tenant representing 24 leases or approximately 700,000 square feet, which added almost 5.5 years to the average remaining lease term. These examples reinforced our continued emphasis on producing sustainable NOI growth and also speak to the quality of our underlying real estate and our relevance with retail partners. Releasing spreads have also been strong, with a 14% cash spread on comparable new leases for the quarter, the highest since we began reporting this metric. Year-to-date, the cash spread on comparable new leases is 10%. For all comparable leases signed in the quarter, our blended cash releasing spreads were up 3.6% or 4.5% on a year-to-date basis. Looking forward, we remain optimistic about fundamentals in our sector. While recent government actions have obviously created some economic uncertainty, supply remains severely constrained, our forward-leasing pipeline is robust and we see strength in health, beauty and home furnishing categories, as well as quick-service restaurants and service-based tenants. Turning to our investment activity. We have been very active in our pursuit of high-quality assets within our target markets. As Steve mentioned, we were very pleased to recently announce an agreement to acquire 2 assets in the New York City market for $192.4 million. In addition, on October 1, we dissolved our joint venture arrangement with RioCan, where we acquired their 80% ownership interest in 5 properties for $99.9 million and in turn, we sold to RioCan our 20% interest in 8 properties for $95.5 million. Year-to-date, we have closed or announced $292.3 million of acquisitions. As a result, we have increased our acquisition guidance to a range of $292.3 million to $325 million, up from our previous guidance range of $100 million to $200 million. The New York acquisitions will allow us to significantly increase our presence in one of our long-term strategic markets. Pelham Manor is a strong community center located in an in-fill submarket approximately 10 miles north of Manhattan, and easily accessible to the 400,000 residents within a 3-mile radius. The center is currently 98% leased to an attractive mix of national tenants including BJ's Wholesale Club, Michaels, PetSmart and Five Below, with indications that many of the tenants at the site are among the top performers in their chains. Fordham Place is a unique mixed-use center. It was redeveloped in 2009 and has a Class A LEED Gold certified asset, with 1.2 million residents in a 3-mile radius. The property sits along Fordham Road in one of New York's busiest and most productive retail corridors across the street from Fordham University and the Metro North Train Station. It is comprised of 143,000 square feet of office and 119,000 square feet of retail space. The tenant roster includes a strong mix of nationally recognized retailers, and its office tenants include government, service and well-capitalized not-for-profit organizations. As we continue to refine our portfolio and optimize our operating platform, sourcing compelling acquisition opportunities in our target markets will be a key component of our strategy, and we believe we will make meaningful progress on this initiative over the next several years. Year-to-date, we have evaluated approximately $2 billion worth of acquisition opportunities, demonstrating both that Class A product is available in our target markets and that we remain very disciplined when it comes to allocating capital. In terms of the disposition market. Despite recent interest rate volatility, we have not observed any significant slowdown in market activity or pricing, and many potential buyers remain anxious to close deals before year end. Including the $95.5 million from the RioCan transaction, we have completed $230 million of dispositions year-to-date, and we have approximately $275 million of additional transaction volume under contract or LOI. Therefore, we remain confident in our ability to end the full year with total disposition volume of $400 million to $500 million at cap rates in the 7% to 7.5% range. And with that, I will turn the call back over to Steve for his closing remarks.

[Steven P. Grimes:]

Thank you, Shane. I'm pleased to be able to continue to share with you our ongoing progress. We are extremely committed to executing on our strategic plan and to demonstrating our ability to do so. I want to thank our employees for their hard work and our investors and analysts for their interest and support. With that, I'd like to open up the line for questions. Operator?

[Operator:]

[Operator Instructions] Our first question is coming from Todd Thomas of KeyBanc.

[Todd M. Thomas:]

First question regarding Pelham and Fordham, I was just wondering if you could give us some background on how those transactions came about. I was just wondering if they were widely marketed or did you approach Acadia directly? And then, I was just also wondering if you could just talk about pricing for those 2 deals, and then what the expectation to create value at those centers were -- was given that they were recently redeveloped and leased up?

[Shane C. Garrison:]

Sure. First, from a marketing perspective, Pelham was widely marketed. I believe Fordham was marketed about a year ago. So when we initially inquired about Pelham, kind of touring the market, the assets are relatively close. And looking at Acadia's fund, we were more intrigued actually with Fordham than Pelham, and accordingly, ended up with both assets. From a pricing expectation, I would tell you, for the year, the $292 million to $325 million, I think we're going to end up in the low- to mid-6% cap range on the pool. And on the growth profile, what we expect to do with the assets, look, longer term, I think they're very compelling. Again, I think we're more excited with Fordham than Pelham, and that's saying something considering the feedback we got on Pelham from the existing tenants. But you've got a site at Fordham and Webster there that has 85,000, 90,000 people that actually walk by a day. So I think there's some great upside there longer term if you could add density, but we're very happy with it as it is today. I think there's still some ability there longer term to drive earnings as well.

[Todd M. Thomas:]

Okay. And then looking ahead at the investment pipeline, putting Fordham and Pelham aside, are you seeing more acquisition opportunities that fit your criteria in the pipeline than you had previously been seeing? I guess, it seems like -- should we expect that you may become a little more aggressive here?

[Shane C. Garrison:]

It's interesting, a bit ironic, some of the tougher markets that have been historically tough to break into, in this case, New York Metro and Seattle were actually the most fractured as well. So you see very granular ownership and we've gotten much better traction in those markets, which has been a bit surprising, again, given how tough it is to get into that -- those markets. So -- and it's really just windshield time driving the markets, spending time on existing relationships and expanding new ones. And I'm certainly encouraged by the progress we've made in pretty short order.

[Steven P. Grimes:]

Todd, this is Steve Grimes. I just wanted to mention too, as Shane is kind of underestimating or I would say under-appreciating the efforts that he's gone through over the last several months, underwritten close to $2 billion in assets. And as I look at the numbers in the breakout, because I want to understand what the hit ratio is, we're sitting at about $313 million that is negotiating LOI or under LOI, which includes the 2 New York assets. But when you look at what he has passed on, underwritten and passed on, it's roughly about $850 million. So the hit ratio from our perspective, I would say, is strong but still demonstrating the discipline that have in our approach to asset acquisitions as we move forward in our concentrated market efforts.

[Todd M. Thomas:]

Okay, that's helpful. And then a question for Angela regarding guidance. I heard your comments about the $0.03 per share lease term fee that you're expecting to book in the fourth quarter. But this quarter, you were in a fairly clean run rate of -- you're at $0.27 a share, I guess. And I know that you're still selling some non-core and nonstrategic assets, which may be dilutive, but I'm just looking ahead at 2014 and see consensus at $0.97 that implies less than $0.25 a share. Is there anything nonrecurring in nature, any reason to think that earnings may moderate from sort of current levels to that extent?

[Angela M. Aman:]

Yes, I mean, I think that's the right question, Todd. I mean, I think as you look at 2013 in total in addition to obviously the lease term fee we mentioned this quarter, which is just over $6 million, and then if you recall, we booked $5.5 million last quarter of distribution income related to Mervyn's. So together, those kind of items are $0.04 or $0.05 per share on 2013 OFFO. But then I would say, I think the biggest factor to consider in looking at 2014 is going to end up being how back-end weighted the dispositions have been in 2013. And then that's going to continue, obviously, after that ahead going to 2014.

[Todd M. Thomas:]

Okay. And just lastly, G&A, what happened there this quarter? It was down considerably. Is that expected to bump back up a bit?

[Angela M. Aman:]

Yes, I think that it will. I think that $8 million we talked about on the last call is a more appropriate run rate. In the third quarter, we did have some moderation in our ongoing legal expenses. But also, and I think more significantly, we're seeing a decrease in G&A costs associated with stockholder administration expenses and all the expenses kind of related to that bucket, and that's a function of the B shares now completely gone away on a continuing rotation of the shareholder base. So we have just a smaller number of total shareholders, which results in savings on the stockholder administration expense. But I think going forward, we plan to continue to invest some of those savings we have in categories like those back into the platform, technology and systems and just continuing to enhance the platform and the portfolio.

[Operator:]

Our next question is coming from Cedrik Lachance of Green Street Advisors.

[Cedrik Lachance:]

Shane, just as you were talking about the time spent on acquisition and thinking about the effort that's already been put there, how do you think about the personnel that you have versus the personnel that you need to carry through your portfolio transformation over the next few years?

[Shane C. Garrison:]

That's a great question, Cedrik. Actually, I was talking to Steve about this yesterday. We will add another core, call it, acquisition person towards the end of this year, early next year. And they will certainly have some help in regards to analysts or people that can source along with them. Additionally, when we talked at Investor Day about the 10 markets and how this is a local business, local people on the ground, asset management, leasing and property management, those offices certainly have the ability and have forwarded potential deals to us. So we look first for boots on the ground to kind of throw properties our way and certainly we have the relationships with brokers and the developers and other owners on the ground to do that. So I think just one more acquisition person and probably another 1 or 2 analysts to help in that regard. So not a significant move.

[Cedrik Lachance:]

Okay. And then you're picking up some small shop occupancy. At what point do you transition from seeking to pick up occupancy from seeking to push rents in the small shop, in particular?

[Shane C. Garrison:]

It's a great question. I was just talking with the rest of the team yesterday actually about the anchors, that we're 97% or so in the anchor side and we're actually more focused now on being opportunistic in that regard. We talked about the large lease bout, that's a great example. So there's friction in that process now. And with the small shop space, we had a great quarter, much better than I even thought we would have, pushing 85% I think previously. We've messaged that 85%, 86% maybe 87% on a great day is kind of max occupancy. In the in-line, I think, we're thinking 88% maybe, 89% now. And somewhere, we're getting close to where we can start pushing rents, but we're very focused -- we're more focused today on the annual growth in the in-line shops versus the going-in rent. And in that regard, 2% to 3% growth, we've been very successful on an annual basis.

[Cedrik Lachance:]

Okay. And as far as the type of tenants that you seek in the small shop side, given that you're getting to leasing out the last piece of the small shops a little later than perhaps some of the REIT peers, what kind of tenants can you put in there? Is it different than what you've seen in the rest of the market? Are you able to focus on more local tenants? Or do you continue to try to attract the national tenants in your small shops?

[Shane C. Garrison:]

I don't -- we look for just well-financed tenants. I don't know if we say national or regional solely from a credit perspective. I think that -- couple of things, externally, Class A continues to be very tight, but more importantly, overall operators are extremely well-financed and seem very optimistic today, which is certainly driving that. And then, internally, of course, as we talked about before, once we turn the lights on the anchor space, it was much easier or it's been much easier to lease around that space. And then the team certainly has renewed focus on the in-line because of the anchor space, the big boxes space we've leased up. So between the internal and external variables there, I think all of those have come together and that's what you're seeing now, the full effect of the renewed focus and the lease of the anchors along with the external factors. So I don't think it's one tenant or one bucket or type. I think maybe 15% to 20% of the tenants today, I was looking at the pipeline, are probably what you'd call mom and pop, but they're almost exclusively in the service and restaurant sectors right now.

[Cedrik Lachance:]

Okay. And then just one final question on real estate taxes, they seem to be moving up a little bit in your portfolio. Is it a function of municipalities having wised up to the fact that real estate values have gone up or is there anything else at play here?

[Angela M. Aman:]

Yes, I mean, I think it was fairly concentrated in our portfolio. In the Texas region, we did have one town do a tax reassessment and some of our larger properties are in that market. So I think it was pretty concentrated. If you look across the rest of the portfolio, we were fairly flat.

[Operator:]

[Operator Instructions] Our next question is coming from Yasmine Kamaruddin of JPMorgan.

[Yasmine Kamaruddin:]

Now going back to your guidance increase of $0.07, so $0.03 of that comes from the lease termination fee, which will be realized in the fourth quarter. But what about the other $0.04? What exactly is driving it, since the acquisitions are supposed to close at the back end of the fourth quarter, right?

[Angela M. Aman:]

Yes, I would assume kind of a mid-quarter impact for the acquisitions. And obviously, given the fact that we're exceeding the range we had laid out before, that does have some impact. So obviously, it's not the largest driver of the increase. The largest driver, as you mentioned, was the termination fee, better-than-expected Q3 performance and then a combination of the acquisition, as well as continued delayed disposition timing relative to when we provided guidance last quarter.

[Yasmine Kamaruddin:]

Okay. And going back to the third quarter performance. What was in the third quarter performance that did not increase the same-store NOI expectation?

[Angela M. Aman:]

We're trending really right kind of where we expected to. Obviously, we saw a substantial acceleration from the 1.5% last quarter, driven by continued growth in occupancy, a better contribution from decreased net expenses or expenses net of recoveries, good performance on percentage and specialty income. So across the board, but same-store was basically in line with expectations. We feel very comfortable with the 2% to 2.5% range.

[Operator:]

Our next question is coming from Chris Lucas of Capital One Securities.

[Christopher R. Lucas:]

Just a quick one, Angela, on the recovery rate, it seemed to take a little bit of a bump up. Was there anything in the quarter that was unique or timing-wise or anything along those lines?

[Angela M. Aman:]

Yes, to some extent. I think it's probably better to focus on the year-to-date numbers. For the recovery ratio percentage, it was fairly flat on a year-to-date basis. But I think some of the noise you're seeing in the third quarter, recovery ratio increase has to do with nonrecoverable expenses. The timing of landlord work related to tenants taking occupancy, as well as lower professional fees.

[Operator:]

At this time, I would like to turn the floor back over to Mr. Grimes for any additional or closing comments.

[Steven P. Grimes:]

Well, thank you, and thank you, all, for your time today. We were very pleased to present yet another solid quarter for RPAI, and we look forward to seeing many of you at the NAREIT next week. Take care.

[Operator:]

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