Retail Properties of America, Inc.
Q1 2015 Earnings Call Transcript

Published: 5 May 2015

[Operator:]

Welcome to the Retail Properties of America, First Quarter 2015 Earnings Call. [Operator Instructions]. It is now my pleasure to introduce your host, Mr. Michael Fitzmaurice. Thank you sir, you may begin.

[Michael Fitzmaurice:]

Thank you, Operator and welcome to Retail Properties of America First Quarter 2015 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, included in our guidance for 2015 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 5, 2015 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 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 the 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:]

Thanks, Mike. And thank you all for joining us today. Last night we reported very strong start to 2015 delivering same store NOY growth of 4.9%. At the same time we’re making meaningful stride in our broader strategic objectives as we continue to upgrade our tenant fee, enhance our concentration in our target markets, dispose of non-core, non-strategic assets and further expand our access to multiple forms of capital. On the acquisition front we have completed or announced 380 million of acquisitions primarily located in the Washington DC, Austin and Seattle MSA. The quality of our recent acquisitions activity combined with the scale we have rapidly achieved in certain of our target markets and our continued capital allocation discipline are positioning RPAI for long term growth and value creation for our shareholders. In terms of dispositions we have closed some 47 million of non-core, non-strategic asset sales during 2015 including transactions closed subsequent to quarter end. Today we also have approximately 130 million of dispositions under contract. The market remains extremely competitive for high quality assets in secondary and tertiary markets and we will continue to proactively respond to transactional environment in order to realize the full benefits associated with our long term strategic plan as quickly and as efficiently as possible. In addition through our strategic anchor remerchandising initiatives we are also aggressively capitalizing on the advantageous retail landscape in order to enhance the dominance of our shopping centers and the long term resiliency of our cash flow stream. While as anticipated occupancy took a step back this quarter, the leasing traction we’re generating on our big box inventory reinforces our conviction that this is the right environment in which to reduce exposure to struggling retailers and categories. Off the 15 anchor locations we expect to take back this year, we have already released three at a blended releasing spread of approximately 22% with expected downtime of less than six months. And finally from a balance sheet perspective we were able to access yet another source of capital on the first quarter of this year with the completion of a 250 million investment grade unsecured notes offering. This milestone represents an important enhancement of our balance sheet strength, our financial flexibility and our strategic positioning and we will look forward to be a consistent issuer in the investment grade unsecured bond market going forward. We’re committed to building a portfolio and operating platform that is positioned for long term growth and value creation and we have made meaningful progress to-date on this objective. Since the announcement of our long term strategic plan in 2013 we have sold 6.1 million square feet of non-core non-strategic assets and we have acquired over 2.6 million square feet of high quality multi-tenant retail assets in our target markets including 610,000 square feet in the Washington DC, MSA. As a result we now own approximately 3 million square feet in the Washington DC Baltimore Corridor making it the second largest market based on ABR and between Dallas and New York. From a portfolio quality perspective we have increased our overall retail ABR per square foot by 9% to $15.70 and substantially improve the demographic profile of our multi-tenant retail portfolio with average stream out population density now at a 116,000. While there is much to be accomplished this year to deliver on our strategic remerchandising opportunities we believe this quarters operational results bode well for the remainder of 2015 and beyond. And with that I will turn the call over to Angela to discuss our financial results in detail.

[Angela Aman:]

Thank you, Steve and good morning. Operating FFO was $0.26 per share for the first quarter down from $0.27 per share in the first quarter of last year. The year-over-year change in operating FFO totaled $738,000 and included just over $800,000 of additional acquisition cost. Including non-operating items FFO was also $0.26 per share down from $0.28 per share in the first quarter of last year. The year-over-year change in FFO totaled $5.2 million and included the higher acquisition cost I mentioned as well as a $4.3 million gain on the extinguishment of other liabilities that was recorded in the first quarter of 2014 and was excluded from operating FFO that included an FFO during that period. Same-store NOI growth was 4.9% in the first quarter driven by higher rental income and lower net expenses. The combination of strong contractual rent increases and releasing spreads along with a 110 basis point improvement in average sensor occupancy during the quarter resulted in 340 basis points of same store NOI growth. In addition total operating expenses net of recovery income contributed approximately 130 basis points of same store NOI growth driven primarily by lower non-recoverable expenses. We do not expect operating expenses net of recovery income to be a significant contributor to same store NOI growth over the next two quarters due primarily to more difficult comparisons in 2014. From a guidance perspective we have narrowed our same store NOI guidance to a range of 50 to 200 basis points from the previous range of 0 to 200 basis points increasing the mid-point of the range by 25 basis points. This increase reflects additional clarity with respect to the impact of our strategic remerchandising activity. We currently anticipate that our same store NOI growth rate will trough in the third quarter before accelerating again in the fourth quarter, that’s the positive impact of remerchandising activity begins to be realized. Nine of the 15 anchor locations representing approximately 245,000 square feet were vacated by the end of the first quarter with three more representing 206,000 square feet expected in the second quarter one representing 35,000 square feet in the third quarter and the final two representing 51,000 square feet in the fourth quarter. We currently anticipate that between 120,000 and 140,000 square feet will be reoccupied and rent paying by the end of 2015. Operating FFO guidance has been reaffirmed at $0.91 to $1.01 per share and our expectations for investment activity also remain unchanged with $500 million of anticipated disposition activity and $400 million to $450 million of anticipated acquisition activity. And finally turning to the balance sheet, net debt to EBITDA at the end of the first quarter was 6.4 times. The increase relative to last quarter's 5.8 times is the result of the front end weighted nature of 2015 acquisition activity. As disposition proceeds are realized over the course of 2015 it will be used to repay secured debt maturity producing overall and secured leverage and continuing to enhance the company's overall credit profile and financial flexibility. We continue to expect it based on the capital plan we have outlined, net debt to EBITDA at year-end 2015 will again be at or below six times. And with that I will turn the call over to Shane.

[Shane Garrison:]

Thank you, Angela and good morning everyone. We’re extremely pleased with our first quarter operational performance. Same store NOI growth was nearly 5% reflecting continued strength in our lifestyle portfolio and the positive impact of remerchandising activity completed during 2014. In addition blended comparable leasing spreads were just over 7% was spreads on comparable new leases at 24%. The new lease spreads benefited this quarter from activity related to our 2015 anchor remerchandising efforts. To recap our progress on 2015 remerchandising activity, we’re pleased to announce that we have assigned four leases to backfill three of the 15 anchor locations we expect to retenant over the course of 2015 These four leases one of which was non-comparable during the first quarter represent 83,000 square feet with base rent of approximately 22% higher than the previous rent and expected downtime of less than six months. In addition we are in lease negotiations on an additional 80,000 square feet related to four of the anchor locations. We expect that the weighted average releasing spread on this space will be slightly better than the overall mid-single digit guidance we provided last quarter with weighted average downtime of approximately seven months. Based on our progress to-date the quality of the space we are remerchandising and the overall strength of the retail environment. We continue to strongly believe that this is the right environment in which to create inventory for stronger or vibrant retailers that will enhance the stability of our cash flow stream while also solidifying the competitive positioning of our shopping centers. Retail occupancy was up 10 basis points year-over-year but down 120 basis points sequentially, approximately 80 basis points of the sequential decrease was attributable to the nine acre locations that they dedicated during the first quarter. Anchor occupancy now stands at 96.3% down 20 basis points year-over-year or 110 basis points sequentially. The sequential change in anchor occupancy again reflects the nine acre locations dedicated during the first quarter. Small shop occupancy is now 84.8% up 120 basis points year-over-year and down 110 basis points sequentially. The sequential change in small shop occupancy was driven by approximately 60 basis points related to seasonal move out activity and the RadioShack bankruptcy and 50 basis points related to transactional activity which was completed during the first quarter. In particular Downtown Crown a Class A lifestyle asset we purchased in early January as a recently completed development is still in final lease-up and stabilization. We’re extremely pleased by the leasing traction we’re experiencing in Downtown Crown and look forward to sharing our progress with you over the coming months. Acquisitions during the first quarter totaled 323 million of previously announced transactions in the Washington DC and Austin MSAs, subsequent to quarter end we closed on the $32 million acquisition of Tysons Corner, a community center in the Washington DC, MSA, located along the silver line metro rail and a dense affluent sub-market with a three mile average household income of over 175,000. During the quarter we closed on 36 million of asset sales which included one-office asset and one multi-tenant retail asset. Subsequent to quarter end we closed in the sale of two additional office assets for 11 million. We continue to expect that by the end of 2015 we will have disposed off -- one of our remaining office assets. As Steve mentioned earlier today we have approximately 130 million assets under contract with closings expected in the second quarter and we expect the balance of the anticipated 2015 disposition pool to be in the market by the time of the ICSC conference in a few weeks. And with that I will turn the call back over to Steve for his closing remarks.

[Steve Grimes:]

Thank you, Shane and Angela. As I said earlier we believe this quarter's operational results bode well for the remainder of 2015 and beyond and with that I would like to turn the call over to the operator for questions.

[Operator:]

[Operator Instructions]. Our first question comes from the line of Jay Carlington with Green Street Advisors. Please go ahead with your question.

[Jay Carlington:]

Angela, on the same store NOI guidance increase, was that due to better core performance or better visibility on the I guess the strategic or merchandize, I was a little bit confused on that one.

[Angela Aman:]

I would say it was a combination but certainly having greater visibility on the leases signed from the remerchandising efforts and what we think will be back online by the end of the year will definitely be a contributor to removing the low end of the same store guidance range and increasing the midpoint.

[Jay Carlington:]

Okay, so was that I guess lower occupancy cost, expense was at expected this quarter?

[Angela Aman:]

In terms of the overall expense contribution we talked about, yes, the driver was really non-recoverable as I mentioned in the prepared remarks and the reason for that was really non-recoverable expenses being sort of unusually high in the first quarter of 2014. So the impact in the first quarter of '15 was expected. There was nothing unusual going on in non-recoverable expenses in the first quarter of this year.

[Jay Carlington:]

And Shane just on the remerchandising, I think last quarter you talked about there is some discussions around some lease terminations that weren't modeled in, is there any update on those discussions?

[Shane Garrison:]

There is no update currently Jay, we’re still hopeful. We’re still talking about [indiscernible] we consider that one of the boxes that are possible yet this year and we still have nothing new to report.

[Jay Carlington:]

Okay. And just last question on the retenanting. On the press release you talked about a downtime of 12 months, it sounds like some of them are going to be seven months but some of these retailers are going miss the holiday season so isn't there kind of incentive to turn these around quicker and is that something that is the potential on the back half of the year?

[Steve Grimes:]

Yes I mean we have got, as we have discussed in the prepared remarks 80,000 sign and another 80,000 negotiation I think we contemplate, call it a 140,000 signed opened and paying by the end of the year and to your point if we don’t have additional traction on some of the LOI space we’re talking about right now by the end of this month we’re going to miss the opening cycle which would push us to the spring so we’re very focused on that and continue to add those discussions and push.

[Operator:]

Thank you. Our next question comes from the line of Christy McElroy with Citi. Please go ahead with your question.

[Christy McElroy:]

Just regarding the 130 million of dispositions under contract, that Steve I think you mentioned, can you give us some color which assets in which market and if this three remaining office assets that you plan to sell this year does that include Zurich?

[Steve Grimes:]

Sure. Let's take office first, so we sold three office assets to year-to-date, that’s in the 47 million the other asset in that pool was a power center in Utah. Zurich will be our last remaining office asset in the portfolio, as a reminder this company an IPO had right around 9 million square feet of office so this has been a long pragmatic approach but I think we have done a great job fixing leases, extending leases and maximizing value to the process. So we’re down to Zurich, 890,000 square foot asset best in class, northwest corridor here in Chicago as we have previously discussed that lease expires at the end of '16 here in Q4, we think the rent comp there is 10% to 20% up and we’re already showing big block users that asset. So we have pretty decent traction, even though the lease is not up until the end of '16 and feel very comfortable about long term valuation and overall capitalization of the asset.

[Christy McElroy:]

Okay just to be clear that asset is not on the market and not an asset that you plan to sell and how much NOI is currently being generated from Zurich?

[Steve Grimes:]

Zurich is about 10.4 million. We will sell it just to be clear but after we retenant it, I don’t think given the rent comp of 10% to 20% spread on the releasing effort given the relatively low CapEx right, it's a clear lease, the [indiscernible] has a very strict standard as far as restoration and R&M [ph]. So when you look at those two factors and the fact that it's best in class and the best asset in the Northwest Corridor we feel good about basically fixing the asset and monetizing it versus selling it vacant.

[Christy McElroy:]

Okay, so given the 10 million plus of annual rate the potentially season downtime there in the region--

[Angela Aman:]

In the 2016 probably a month and then in 2017.

[Christy McElroy:]

And then maybe an update on your G&A expectations for 2015, and the way that the comp grants are expected to divest maybe a sense for what your G&A can look like in 2016.

[Angela Aman:]

Yes I mean I think it's a little too early to comment on 2016. We have an updated G&A guidance on this call. Last quarter we provided guidance of 40 million to 42 million and I think sort of additional clarity as we move through the year on compensation expense and how additional rewards down the road might affect the 2016 numbers [indiscernible] clarity.

[Christy McElroy:]

Okay and then just one last one Angela if I could, you talked about the expense impact just a follow-up on that. It sounds like you’ve tougher comps in the next two quarters, you’re not expecting that to be impactful to the same store NOI growth rate but will the expense comps contribute to the reacceleration in growth that you expected in Q4 and maybe you can give us some color on sort of the trajectory of the recovery read as well.

[Angela Aman:]

Yes I mean I would say Q4 probably there is some positive contribution from total operating expenses net of recovery income let's say excluding bad debt expense but that’s really a function of sort of occupancy inching back up in Q4 as we get some of the anchors back open and operational. So not related to the non-recoverable expenses that we talked about being a factor in Q1 much more on the recoverable side and the ability to push that higher with additional occupancy gains in Q4.

[Operator:]

Thank you. Our next question comes from the line of Todd Thomas with KeyBanc Capital Markets. Please go ahead with your question.

[Todd Thomas:]

Just first question Angela, you mentioned that you increased the same store NOI growth range at the low end by 50 basis points, just curious was there an offset that caused you to keep the FFO guidance range unchanged?

[Angela Aman:]

I don’t think there is exactly an offset, I think that the 50 basis points on the same store NOI guidance range given the same store we expect to have at the end of the year that’s probably less than a penny in terms of 2015 impact and then I think just given where we’re in the year the potential time of disposition activities, leasing up variability that we decided to keep the range where it is today pending additional color there.

[Todd Thomas:]

And then I guess I hear you on the net recoveries a little bit I guess that’s a reason for the big swings in same store NOI growth, but I mean is that it I guess I understand the pull changes and disposition activity in particular can impact the full year number but what's causing the volatility on a quarter to quarter basis like we have seen in the last several quarters.

[Angela Aman:]

Yes, I mean there were different things over the last several quarters right, what happened 2014 was really related to the way to recovery ratio changed '13 so there was some variability there. What you saw in the first quarter again was related to non-recoverable expenses. In Q1 of '14 being a particularly favorable comparison. Looking forward to the rest of this year that sort is off the table in terms of a factor in the analysis I think non-recoverable expenses in totality or actually are pretty flat or are expected to be pretty flat for the rest of the year, so there is not variability that kind of variability on the non-recoverable line in 2015 or that would create additional volatility related to that in 2016. What you’re saying for the rest of '15 is right that contribution kind of comes off the table, we took back 245,000 square feet in the first quarter so you didn’t have a full quarter of impact from those anchor vacancies in Q1 so that is going to affect Q2 in addition to another 206,000 we mentioned we would take back in the second quarter. So from here it's really sort of the remerchandising activity coming to fruition and then as we mentioned NOI is expected to trough in the third quarter as occupancy grows again in the fourth quarter as we get some of that space open and operational. So I think looking forward you kind of take the non-recoverable expense impact out and then you factor in the impact of remerchandising activity in that sort of explains the trajectory of NOI of the share.

[Todd Thomas:]

And then Shane in terms of acquisitions, obviously quite a bit activity early in the year I know you’re closing in on the target for the year. Are you still seeing healthy volume of deals in the pipeline, is there a chance that you could acquire more than you set out through this year?

[Shane Garrison:]

Based on what we see today Todd, 400 to 450 still feels pretty comfortable, we’re 380, 382 year-to-date. We will add another Seattle deal to under contract this week which will still keep us under 450 but it's being, it continues to be a pretty aggressive environment and our success is almost solely based on our local knowledge and relationships, right? 3 of the 4 deals in DC have been off market, a lot of the Seattle volume over the last couple of years have been off market and direct. We think that continues to be a strong ability for us right the people on the ground, the leasing guys, some of the asset management folks even property management, those relationships are deep and in some cases generational and that’s been a great access point for us to look at a lot of these deals. When I look at the portfolio in conjunction with the disposition pool, all right which is largely power center. I think we talked about that on the last quarter's call. This is the most pivotal year we will have from a true portfolio transformation standpoint. Steve mentioned that almost to-date we have raised out three mile demo 50% we’re up to a 116,000 in density right now. Our grocer sales are 535 square foot which is up 8% to 9% since Investor Day. As Steve mentioned our ABR is up 9%, we’re 15.70, likely closer to 16 by year-end. Our Top 10 target market ABR is $18 right now, and when you look at the asset shift, this company two years was really thought of RPAI as a power center company that’s not necessarily the case today. We look at the multi-center retail portfolio in three buckets, lifestyle mixed use one neighborhood and community two and then of course power, power and these are on ABR, all right power center today is 43%, neighborhood and community is 36% and our urban or call it lifestyle and mixed use has grown to about 21% of ABR, and when I look at that on a proforma basis considering the acquisition activity including Tysons which we closed yesterday and the fact that again the large majority of what we will transact on the disposition side is power. We continue that dramatic transformation, you feel it in the ABR, you feel it in the demos but when you look at power specifically it's mid-30s by the end of the year on an ABR basis on the neighborhood community and call lifestyle and mixed use will obviously increase. So again a pivotal year, a great year to transact in and the portfolio you can certainly feel and see real tangible changes at this point. Our Top 3 markets represent 37% of our ABR right now, and remember that includes [indiscernible] which are sitting at reduced occupancy as we contemplate starting the redevelopment here. Our Top 10 markets will be 60% or little north at the end of this year. So there is definitely light at the end of the tunnel from a process and strategic positioning standpoint and again this is a huge year for us. We talk about remerchandising just lastly and we look at our Top 20 tenants in between the remerchandising and the disposition efforts that is probably the most impactful this year best by again proforma at the end of 2015 will no longer be our number one our hold [indiscernible], will be our number one tenant. We talked about sports authority, we started the year at four boxes we will be likely be done by five boxes by the end of the year. Sports authority will be less than 1%, exposure for the company and then lastly the office factor right there, the office category, the total exposure for the company again proforma by the end of the year is less than 2%. So when you look at all the indicatives, density where ABR is and where it's moving to as far as the target markets, the rent roll etcetera, I think we have done a great job and again this is a pivotal year and it continues to be a great environment to do that.

[Operator:]

[Operator Instructions]. Our next question comes from the line of Michael Mueller with JPMorgan. Please go ahead with your question.

[Michael Mueller:]

Just one quick one on the anchor repositionings, talked about 15 of them happening this year. As you look out to 2016, 2017 any thoughts on like what the volume could look like in those years as well?

[Steve Grimes:]

Mike, I think the easy answer is it depends. We’re going to continue to be aggressive, we don’t see this environment changing in '16 certainly so it's just going to depend on our ability to control or get back some of this Phase 2 to continue to drive progress on our rent roll-in and feel better about our long term cash flow and merchandizing.

[Operator:]

Thank you. Our next question comes from the line of Vincent Chao with Deutsche Bank. Please go ahead with question.

[Vincent Chao:]

The mix discussion there, by year-end I think you said 30% would be power so call it roughly the third, third, third in terms of the overall mix. Is that where you would like the portfolio to be or is this more of a concentrated effort to get power synergy even lower overtime or do you think everything, the balance mix is sort of what you want to be?

[Steve Grimes:]

Yes I’ve been talking about the diversity of the portfolio for some time now just in terms of the type of properties, the geographic basis as well as the tenant mix and I think you’re seeing a significant improvement through Shane and his team's efforts over the last couple of years, these statistics are very compelling that I threw out there today. I would say at the end of the day it's not a conscious effort to deprioritize power it's really just an opportunity for us to recalibrate the portfolio into the target markets and build a stronger, better long term growth portfolio. So that’s kind of the basis. The statistics that Shane had thrown out again I think are very compelling but I think at the end of the day we’re just going to be looking to buy good quality real estate and maintain some element of diversification within each of these markets because we think that’s what we do best.

[Vincent Chao:]

And just another question, just a different topic but just in terms of your renewals this quarter curious if you had the breakdown between how many of them were option renewals versus naked renewals? And how that might trend over the balance of the year and whether or not there is really significant difference in the rent spread that you’re achieving on either.

[Angela Aman:]

I would say that probably for the most part they were option renewals, I don’t have the statistic in front of me but I think it's fair to say that 5.1% achieved on renewals was primarily option.

[Vincent Chao:]

Agreed. Okay and does that mix change much over the rest of the year?

[Angela Aman:]

No. We have said and continue to stand by sort of mid-single digit overall releasing spreads for the year and that’s going to be driven in large part by kind of renewals right around this mid-single digit number as well.

[Operator:]

Thank you. Our next question comes from the line of Chris Lucas with Capital One Securities. Please go ahead with your question.

[Chris Lucas:]

Just wanted to ask a question related to the Tysons asset and basically looking at what was the value add that you see there, how did the leases run so that you can actually get at the dirt [ph] and potentially densify and have you had any conversations recognizing that you just closed on the asset with any of your neighbors as it relates to potentially working together on maximizing the opportunity there.

[Shane Garrison:]

So obviously it's phenomenal real estate, it's very FA arts [ph] call it subpoint one at this point. When you look at our neighbors and some of the entitlements today on call it similar square footage or acreage or four acres, we have seen entitlements to size 1.4 million feet and we’re sitting at 40,000 feet today. To your question about the leases, these were longer term leases so any remerchandising or in this case and redevelopment we would certainly have to agree to either relocate the retailers or involve them in the redevelopment. So I don’t see it as a mid-term opportunity but probably longer that being said, we are talking already to some of our neighbors to say what may make sense from an expanded acreage and even greater density standpoint. So right now we’re stabilizing the asset at mid-5s, we think it's got very compelling growth if we do nothing from here annually but again longer term the more important play is densification of the site.

[Operator:]

Thank you. Ladies and gentlemen, we have no further questions at this time. I would now like to turn the floor back over to management for closing remarks.

[Steve Grimes:]

Thank you. Thank you all for joining us today, we understand that first quarter is kind of the first quarter out of the gate in any given year but it's followed ICSC and NAREIT. So as Shane had mentioned we have a lot to transaction volume kind of in play in the second quarter, we’re very excited about how the year started, even more excited about being able to deliver for the balance of the year and we look forward to seeing many of you over the next couple of weeks at ICSC and NAREIT. Thank you again.

[Operator:]

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