Rithm Property Trust Inc.
Q3 2018 Earnings Call Transcript

Published: 4 Nov 2018

[Operator:]

Greetings, and welcome to the RPT Realty Third Quarter 2018 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer will follow the presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Vin Chao. Thank you, Vin, you may begin.

[Vincent Chao:]

Good morning and thank you for joining us for RPT's third quarter 2018 earnings conference call. At this time, management would like me to inform you that certain statements made during this conference call, which are not historical, may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Additionally, statements made during this call are made as of the date of this call. Listeners to any replay should understand that the passage of time by itself will diminish the quality of the statements made. Although we believe that the expectations reflected in any forward-looking statements are based on reasonable assumptions, factors and risks that could cause actual results to differ from expectations are detailed in the third quarter press release. I would now like to turn the call over to President and CEO, Brian Harper; and CFO, Mike Fitzmaurice, for their opening remarks, after which we'll open the call for questions.

[Brian Harper:]

Thank you, Vin. Good morning and thank you for joining RPT's third quarter 2018 earnings call. This morning, I would like to review highlights from our third quarter results, recent accomplishments and our rebranding. I will then take a few moments to highlight of the assets that we believe are significantly undervalued in our portfolio. I will then recap our go-forward strategy, provide details on our disposition plan, and we'll close with benchmarks to evaluate our progress as we execute on that strategy. Mike will then discuss our third quarter results in more detail and provide an update on our outlook for the balance of the year. We are pleased with our third quarter operational results, which represent a strong start as we execute on our plan to unlock significant embedded value. We reported same-store NOI growth of 2.2%, increased our lease rate by 30 basis points for the quarter and increased our small shop lease rate by 90 basis points. We signed approximately 460,000 square feet of leases at re-leasing spreads on comparable new and renewal leases of 13.1% and 4.3%, respectively. We also continued to simplify our balance sheet by completing the sale of a property held in joint venture, and made further progress on our active redevelopment projects, as well as our entitlements for planned projects. We also implemented a number of significant operational and process changes here at RPT during the quarter. We assembled a first-class leadership team and thoughtfully, but quickly, developed a short-term strategic plan to capture near-term growth. We improved internal governance to promote interdepartmental, collaboration and streamline the organizational platform resulting in $2 million of annual cash savings that should be fully in the run rate by the fourth quarter of 2018. We mined the portfolio for growth opportunities and identified a half-dozen assets where we see substantial redevelopment upside, with relatively limited impact on current rental streams. Next, I wanted to touch on the rebranding of the company that we announced yesterday morning, which we believe marks the start of a new era for the entire organization. The new name of RPT Realty represents a clean start on a new chapter in the company's long history. In conjunction with the rebranding, we have moved our corporate headquarters to New York City, a move that is already paying dividends regarding greater access to our tenant, investor and banking constituents. As we noted last quarter, we believe our portfolio is significantly underappreciated and therefore, undervalued. Having previously outlined some of our redevelopment opportunities within the portfolio let me take a few moments to highlight just a few of the key underappreciated operating assets here at RPT. As we look to reshape our portfolio to improve our long-term growth profile, we believe that these are a few of the assets that will provide a strong foundation given their attractive demographics, strong in place tenants and high productivity. Town & Country asset in Town & Country, Missouri is located in an affluent St. Louis suburb with a median household income of $134,000. The center is anchored by Whole Foods, Target and Home Goods, and we remerchandised this center to fit the adjacent demographics. This will happen as tenants’ leases roll, but suffice it to say, we have more demand than we have space. We recently opened Athleta, and they told that it was one of their best openings in the company's history. Let's talk about the Woodbury Lakes asset located in Minneapolis. The center is anchored by Trader Joe's as well as a recently opened Alamo Drafthouse and H&M. We are currently 90.6% leased, so we have room to drive occupancy with higher productivity tenants given all the recent leasing momentum. One example of this is Sephora, who recently opened in October of this year. We also own Market Plaza located in the higher end Glen Ellyn neighborhood of Chicago. The center is anchored by a Jewel Osco grocer doing north of $800 a square foot. The center is nearly 97% leased today. At Nagawaukee Center, a 100% leased center in suburban Milwaukee, 3-mile household income is $143,000. The center is anchored by a high-volume Sentry Foods grocery store as well as Sierra Trading Post, Home Goods and Marshall's. As at Town & Country, this is another center where we have more demand than we have space. And finally, at River City Marketplace, a super-regional center in Northern Jacksonville, tenants range from Walmart, Lowe's, Old Navy and Regal Theaters. Volumes here are high, as is the daily traffic. This is a center that will just continue to get stronger and stronger as the growth in the market is headed north. Turning to our strategy as we look ahead. On a go-forward basis, our strategic focus is executing on our disposition plan, delevering the balance sheet, leasing up our small shop occupancy and preparing our redevelopment pipeline. The key to our broader plan is the disposition program that will fortify our balance sheet for the first wave of redevelopments that we expect will start sometime in late 2019. As our redevelopments take form, these disposition proceeds will ultimately be redeployed into the accretive projects that will be a combination of densification, mixed-use and outparcel developments where we believe we can earn attractive current returns with higher, long-term growth profiles. Throughout this process, Tim Collier, our new EVP of Leasing and his team, will be laser-focused on driving small shop occupancy. In order to hit our 5.5x to 6x net debt-to-EBITDA target, we are planning to sell between $150 million to $200 million of assets located in secondary and tertiary markets where we currently do not have scale. We continue to expect to complete the process by the end of 2019. In addition to reducing our leverage, these sales will improve our tenant credit, strengthen our geographic profile and reduce portfolio management inefficiencies. We expect pricing to be in the 8% to 9% range for the open air centers that we plan to sell. We are already active on the marketing front. And based on early interest, we hope to complete our first waves of sale in early 2019. While we won't fire sale the assets, we are working on the dispositions with the same sense of urgency that pervades the rest of our business. It is important to keep in mind that these sales will be dilutive to our 2019 and 2020 earnings as proceeds will initially be used to repay debt before being redeployed into much more accretive redevelopments. Though our focus will be on value creation, we are sensitive to near-term earnings impacts, and we will thoroughly vet every penny of dilution to understand what we're getting in return. On this front, the assets that we expect to sell have an average ABR per square foot of $11.50, an average household income of $74,000 and an average population density of 60,000 people within a 3-mile radius and have produced an NOI CAGR of 0.8% over the past three years. This contrasts sharply with a nearly $16 ABR per square foot, household income of nearly $100,000, population density of 78,000 people and an annualized NOI growth of 3% for the remaining portfolio. As you can see, the sale of these assets will improve the risk profile of the remaining portfolio's cash flows and will ultimately fund attractive redevelopments where we believe we can further strengthen the growth and risk profiles of the future earnings stream. Turning to benchmarking, I wanted to provide you with several of our own internal benchmarks that we are tracking closely to measure progress against our initiatives. Number one, our leverage level. As we sell assets, our leverage level should fall to the 5.5x to 6x range, a clear indication of our success on the disposition front. Number two, small shop lease rate. Clearly, this will be an internal focus that provides us with the best risk-adjusted return on capital. Look for us to drive small shop occupancy from 88.1% on a signed basis in the third quarter to the 91% to 92% level over the next two to three years. We continue to expect to end 2018 in the mid- to high 88% range. Keep in mind that every 100 basis point increase in shop occupancy equates to about $800,000 of additional NOI or about 50 basis points of same-store NOI growth. Number three, same-store NOI growth. As we sell lower growth assets, drive shop occupancy and increase our average contractual rev bumps, this should translate into higher and less volatile same-store NOI growth. Number four, redevelopment updates. We will keep you posted as we will move through the entitlement process at our key redevelopment asset, and we'll share both project, scope, size and return expectations as they are formalized. Something that is important to share is that these are redevelopments that will have minimal NOI disruption during construction with attractive spreads between our expected development yields and current cap rates that will create significant value for our shareholders. To be clear, all these initiatives support our strategic plan and are designed to improve both the sustainability and growth of our cash flows, which will ultimately be evident in our NAV, FFO and AFFO performance. Though our quarterly results will not always reflect the progress being made in real-time given our portfolio size and lead times for initiatives to take hold, we believe the fruits of our initial labor should be more visible in 2019. If we execute on our plans and communicate our progress effectively, we believe this should translate to both a higher multiple and better long-term growth supporting an attractive shareholder return. With that, I will now turn the call over to Mike Fitzmaurice, our CFO, to discuss our third quarter results and provide an update on our outlook for the balance of the year. Mike?

[Michael Fitzmaurice:]

Thanks, Brian, and good morning. Before I discuss our third quarter results, I'd like to take a moment to thank our sell side research and current and perspective investors for taking the time over the last several weeks to meet with Brian, Vin and me to discuss RPT's new strategic direction. Your support and insight have been invaluable, and we look forward to continuing our dialogue over time. Now let's turn to our third quarter results. Operating FFO for the quarter was $0.32 per share compared to $0.34 per share in the same period in 2017. The decrease in operating FFO was driven by a decrease in NOI from other investments of $0.03 per share primarily related to our 2017 asset sales, partially offset by a decrease in interest expense of $0.01 per share. Non-operating items this quarter were related to nonrecurring charges, largely associated with the former executive management team of $1.6 million, and severance cost of $850,000 related to our previously communicated reduction in force that we experienced in late July. Same property NOI growth with redevelopment was 2.2% in the third quarter. This was driven by a contribution of 210 basis points from minimum rent, and 30 basis points from recovery income net of recoverable and non-recoverable expenses. These items were partially offset by 20 basis points from higher bad debt expense. As expected, our growth was negatively impacted by 110 basis points or $500,000 due to the termination of our two Toys 'R' Us leases. We've already backfilled one of our locations, which is expected to come into occupancy in mid-2019 and the remaining site is at an asset that we expect to sell over the next year. Turning to 2018 guidance and related assumptions, similar to last quarter, we've excluded asset sales from our guidance assumption. If we were successful on closing a portion of the $150 million to $200 million of identified dispositions by the end of the year, it will be negligible to 2018 earnings. We are lowering the high end of our operating FFO guidance range by $0.02. Our new range for 2018 operating FFO guidance is $1.35 to $1.37 per share. This $0.01 reduction at the midpoint was primarily result of a higher estimated weighted average share count attributable to an assumed above target payout ratio for 2018 equity base performance award. This was largely based on a relative stock outperformance during the third quarter. Also, we tightened our assumption on same-property NOI with redevelopment growth to our range of 2.25% to 2.75%, up 25 basis points at the midpoint, or approximately a half penny. This was offset by a modest increase in G&A expense as we also tightened up our G&A expense range up roughly a half penny at the midpoint. As for the cadence of our same property NOI with redevelopment, we expect to accelerate into the fourth quarter, which is largely driven by a lease up of vacant anchor locations. Of note at quarter end, we had approximately 340 basis points of signed not commenced space, representing $6.3 million in economic ABR, of which is $2.5 million will be commencing rent during the fourth quarter. The remaining amount of $3.8 million will commence ratably over the course of 2019. And to touch on Mattress Firm, three of our nine leases have been rejected, which will impact our same property NOI with redevelopment growth by 20 basis points in the fourth quarter or $80,000. As you begin to model 2019 earnings, I'd like to point out a few items. First, the midpoint of our updated 2018 FFO guidance range implies a fourth quarter run rate of $0.32 per share. Second, as Brian mentioned earlier, we expect to utilize the asset sale proceeds of $150 million to $200 million to lower leverage. The weighted average cap rate for the open-air centers that we sell will be between 8% and 9%, and the debt that we expect to prepay will have a weighted-average interest rate of between 3% and 3.5%. By the end of 2019, we expect our net debt-to-EBITDA to be 5.5x to 6x and our floating rate interest rate exposure will be close to 0%. Our balance sheet will be well positioned to support our growth initiatives. As an update to the new lease accounting standard that is set to take effect on January 1 of next year, we are still evaluating how this expense will be allocated between G&A and operating expense within NOI, though we continue to expect an approximately $0.04 impact to FFO in 2019. As indicated on our second quarter conference call, one of RPT's mandate is to provide best-in-class transparency and disclosure. On this front, we have made several updates to our supplemental disclosure. Our occupancy rate now represents economic occupancy versus physical occupancy as reported historically. A 5-quarter look back will be provided in our third quarter 2018 investor presentation that will be posted to our websites. On Pages 23 through 26 of our supplemental, we added property categories to the portfolio detail report to help you understand how we categorize our assets. Also, on the bottom of Page 8 of the supplemental, we consolidated our capital expenditure information to help our sell side research and investors to model AFFO. And finally, we removed ABR per square foot excluding ground lease disclosures to simplify and focus attention on total company economics that include ground leases. There are a number of other smaller changes in the supplemental that will help facilitate your analysis of our results. As always, we welcome any feedback you have on how we can continue to improve our disclosures. With that, operator, please open the line for questions.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from Derek Johnston with Deutsche Bank. Please go ahead.

[Derek Johnston:]

Good morning. Could you share some more details on the small shop leasing efforts? With a 90 basis point increase to the lease rate in the quarter, what do you think is driving success there? And are there any notable leasing trends that you're seeing on the ground that you can share?

[Brian Harper:]

Hi, Derek. Thanks for your question. We do believe we can get to 91% to 92% on the 88%. I mean, we have put governors in place such as lease committees that meets every Monday at 9

[Derek Johnston:]

Great. And as a follow-on for me, can you just discuss the new leasing statistics in the quarter, specifically that the TIs per square foot cost were, I think, over $44. Some color on the previous and new tenant. It does look like the previous rent for the space was pretty high, so seemingly a newer lease that was being replaced. So I'm just wondering if that space would need so much work, and if this is a one-off or a trend that may continue into 2019.

[Brian Harper:]

I think – I mean, there's good in this number. Yes, it was the elevated high TA with the average rate in these deals was a little over $34. We've either had one north of $50. Some were fitness, some were small restaurant users. But the key thing on this, Derek, is the payback was less than two years. So it was a good investment and right merchandising strategy for each seller.

[Michael Fitzmaurice:]

Yes, and the only thing I would add, Derek, is you also note that we did increase our cost for tenant improvement and leasing-related costs during the quarter, which is really related to formerly occupied, bankrupt tenants such as Gander, Toys, Kmart, and Sports Authority. And we'll continue to see the same dynamic as we move into remaining part of this year. And then in 2019, we'll continue to have a transitional outsized CapEx year, and then we'll begin to moderate in 2020. And the only other point that I would make is, this also underscores the importance of reducing our leverage, down to 5.5x to 6x to put us in an offensive position because we continue to put accretive capital into leasing where we can achieve our highest returns.

[Derek Johnston:]

Thanks guys. That’s helpful.

[Operator:]

Thank you. Our next question comes from Craig Schmidt with Bank of America. Please go ahead.

[Craig Schmidt:]

Great, thank you. What would be a normalized projected cost for your redevelopment pipeline as you work your way through 2019?

[Brian Harper:]

I think, Craig, we're going to get back – go to that number on the development spend – already, we've been – we act with urgency. I've seen 95% of assets. We've identified six assets for really marquee densification properties. We've worked with premier and are working with premier architects. We're finalizing those plans. And we're going to start the entitlement process maybe even as soon as the end of this year. We'll keep everybody updated on the spend as we finalize the plan.

[Michael Fitzmaurice:]

Yes. And as you move into 2019 and we prep these bigger densification properties for redevelopment, the spend in 2019 will be muted as it relates to 2018, maybe up to $10 million. But again, as Brian noted, we'll share more details on our long-term vision for redevelopment cost on the fourth quarter call.

[Craig Schmidt:]

Great. And then how many shares were awarded for the 2018 equity base performance?

[Michael Fitzmaurice:]

The increase in the share count, as you probably saw on the press release last night, Craig, was due to the reevaluation of those 2018 inducement awards. The increase in share count was about 500,000 shares. Now you should not see the share count increase because the payout ratio associated with that is now capped at about 200%. But it could ratchet down, of course, but it is capped. Right now, you shouldn't see that number increase going forward because of those awards.

[Craig Schmidt:]

Thank you.

[Operator:]

Our next question comes from Collin Mings with Raymond James. Please go ahead.

[Collin Mings:]

Hey. Good morning, guys. First question for me. You discussed in the press release the difference between signed, but not commenced rent. Just other landlords have discussed some of the delays of actually getting tenants into the space and paying rent. Can you maybe just touch on what you're seeing on that front?

[Brian Harper:]

I have been very, very pleased with our TC and construction team existing both predating me and with Jonathan background in construction TC and development. We haven't had any snafus. And the speed has been, again, felt in this area and this department as well. And I mean, we've even seen tenants opening up a lot sooner. Hence, the hockey stick in fourth quarter.

[Collin Mings:]

Okay. And then just going back to the disposition guidance and appreciate again the detail there. But just on expecting kind of eight to nine cap. Just can you talk about how you view the cap rate spread between those assets and kind of what you're viewing as kind of the remaining core portfolio going forward?

[Brian Harper:]

I mean, if you look at the non-top 40 MSAs and look at the average deal size, let's say, of $20 million, and if they've talked about – in my script, in the prerecorded message of just the demographics alone, that speaks volumes of the cap rates, right? And the average per square foot, ABR is drastically different than what's remaining on the portfolio. So I mean, this is bottom of the barrel, if you will, of these dispositions and doesn't reflect at all of what's left.

[Collin Mings:]

Okay. And then just one other follow-up for me going back to the Derek's question just on the small shop occupancy gain. Can you maybe just talk a little bit more? Kind of, internally is there incentive plan or things like that do you're using to motivate the team to hit some of those targets you've thrown out there? Are there some organizational changes that you've implemented to help drive that statistic higher? Just again, other details on that front would be helpful.

[Brian Harper:]

Yes, Collin So I believe in just boots on the ground leasing; I believe in canvassing; I believe in just knocking on doors, not only for regionals, but for national tenants as well. Tim and I have hit the road and have met with a number of the larger national tenants, which has provided a lot of fruit. But also, as far as compensation, we're evaluating that currently and really wanted to be reflective of true appreciation of the asset, as opposed to just the deal itself. So boots on the ground, decentralized leasing and a really stronger emphasis on national portfolio reviews.

[Collin Mings:]

All right. I’ll turn it over. Thanks.

[Operator:]

Our next question comes from Todd Thomas with KeyBanc Capital Markets. Please go ahead.

[Todd Thomas:]

Hi, thanks. Good morning. Just following up on the dispositions. I was just wondering if you could just talk about the depths of the buyer pool that you're talking to and working with here. And is it the expectation that you're going to transact on a one-off basis? Or is there an opportunity to do a little bit of a larger transaction and maybe sort of clear the deck a little bit?

[Brian Harper:]

Right now, we're going through a one-off basis to just really maximize pricing. And we have seen, I mean, while the assets – it varies between assets. I mean, one asset was over 50 CAs. Another asset would be in the 20s from CAs. So that capital or those operators range from private equity to even some REITs, to even some regional and smaller private operators, just really depending on the deal size ranging from $20 million and higher.

[Todd Thomas:]

Got it. And then the signed but not commenced bucket. So $6.3 million at the end of the third quarter. You have about $2.5 million of ABR expected to kick in, in the fourth quarter. I was just wondering if you could sort of decompose that in terms of what's incremental from an occupancy standpoint in terms of occupancy gains versus what's sort of captured in the renewal leasing activity, and sort of the spreads that we might be modeling.

[Michael Fitzmaurice:]

Todd, this is Mike. I can give you some color on what the occupancy is for the remaining part of this year. Today, we're at – on an economic business, we're at 90.8%. At the end of the fourth quarter we should be about 91.5%. If you look at the 250 midpoint that we have for same-store or same property NOI with redevelopment growth in 2018, it is topline driven. Base rent contributes about 230 basis points, which is a combination of bump, spreads, and average occupancy gains. And then you also have a more modest decrease embedded expense about 20 basis points. You add those two factors up, you're about 250.

[Todd Thomas:]

Okay, that's helpful. And how much annualized base rent commence during the quarter? Was there anything sizable that we should think about making an adjustment for in terms of the run rate?

[Michael Fitzmaurice:]

No, nothing sizable there. The only thing I would repeat from my prepared remarks is that Toys did cause some disruption during the quarter of about 110 basis points or $500,000. So that was a net detractor during the quarter.

[Todd Thomas:]

Right. And what was the timing of that move out that occurred during the third quarter?

[Michael Fitzmaurice:]

Yes, it occurred during July. So the front-end of the quarter.

[Todd Thomas:]

Okay, got it. And then in terms of Toys and apologies if I missed this earlier. But can you talk about where you're at, the backfill opportunities and some of the details around the timing and rent spreads that you're looking at on those replacements?

[Brian Harper:]

So one in Front Range is we replaced the whole box with Urban Air, which was a flat renewal. We think timing on that will be a mid-2019. Jackson Crossing is our other Toys box. We're negotiating LOI's with a number of tenants and hope to have – the goal is to have something papered within the next month or two.

[Todd Thomas:]

Okay, great. Thank you.

[Operator:]

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

[Michael Mueller:]

Hi. Brian, when you were talking about the portfolio on a bunch of assets that you thought were underappreciated by the market. Curious what portion of the company do you think those assets that you flag represent? And then when you were making those comments, is it more along the lines of you think these are the lowest cap rate assets in the portfolio and folks are missing that? Or is it there is upside that people are missing? Just curious as to why those five or so were over flagged.

[Brian Harper:]

I think there's just a number of factors year where – as I'm spending a lot of time on the ground at these assets, one area that I love and is kind of misunderstood and underappreciated is Oakland County. I mean, this is 98% leased. Even in the depths of the recession, I think it just dropped to 94%. Monster Nordstrom Rack volumes in two centers, a grocery anchor in one center, major volumes. Then you go down to Florida, in Southeast Florida, particularly in Miami, every single center down there we have is grocery anchored. And we're seeing great rental spreads in there. Shops At Lane, which might be one of my favorite assets in Columbus, Ohio, very high-performing Whole Foods. And that's where we're looking at densification opportunities where either office or residential. I think that is the lion share of where these opportunities are and the Nagawaukees of the world, I wish I had more real estate to do more redevelopment there.

[Michael Mueller:]

Got it, okay. And then, Mike, just a quick question. For your assumptions, are you assuming that dispositions occur ratably throughout 2019? Or should we be thinking front-end loaded or back-end loaded?

[Michael Fitzmaurice:]

At this point, Mike, I would say it's more front-end loaded. It's the first half of the year.

[Michael Mueller:]

Okay. That was it. Thank you.

[Michael Fitzmaurice:]

Thank you.

[Operator:]

There are no further questions. I would like to turn the call over to Brian Harper for closing comments.

[Brian Harper:]

I am extremely proud of what the organization has accomplished in a little over four months. And I'm excited about RPT's future. I want to end the call with a thank you to every RPT team member for their hard work and their dedication. Have a great rest of the day, and we look forward to seeing many of you at next week's NAREIT conference.

[Operator:]

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