Acadia Realty Trust (AKR) Earnings Call Transcript & Summary

Welcome. Good afternoon, everyone. Welcome to the 4:30 p.m. session at Citi's 2020 Global Property CEO Conference. I'm Christy McElroy with Citi Research, and we're pleased to have with us Acadia Realty President and CEO, Ken Bernstein. This session is for investing clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available up here and on the webcast on the Disclosures tab. For those in the room or the webcast, you can sign on to liveqa.com and enter code Citi2020 to submit any questions or you can just raise your hand. Ken, I'll turn it over to you to introduce your company and your management team and provide the audience 3 reasons why investors should buy your stock today, and then I'll kick off the Q&A.

Great. Thanks, Christy. Hello, everybody. I'm joined here with John Gottfried, our CFO as well. Three reasons to buy Acadia. First of all is our strong and unique Core portfolio with strong embedded growth internally as well as periodic external opportunities there. Secondly is our solid balance sheet. And then third is our use of our dual platform, our Fund business, we're on Fund V now, and see that as a complementary and strong way to drive continued growth. Put that together with a cycle-tested management team that understands how to navigate through the various different opportunities and obstacles, and I think that that poses a great opportunity for long-term growth.

Great. So the question that we've been kicking off all the sessions with ESG is of increasing importance for all company stakeholders. What is the one thing that Acadia is doing to improve your overall ESG score over the next 12 months?

Yes. I think, as you'd expect, as most companies, we're spending a significant amount of time on ESG in various initiatives as we manage our properties. But the one thing we're looking at is a standardized reporting to report. We probably haven't taken as much credit as we should. So moving to when we're [ leading towards credits ] to do that, but you should expect on our next report we'll be having a standardized reporting.

And along with that one part of better disclosure, which is critical, is, those of you familiar with Acadia and our culture, we have embraced ESG and the different important drivers of that throughout the 20 years that we've been a public company. The environmental component of it, I would tell you, is a newer conversation over the last couple of years, but one that we're committed to, along with strong governance and all of the other components of ESG.

So as we think about 2020, and there was a lot of talk on the call about the same-store NOI trajectory, it sounds like there's a few different buckets that we should be thinking about in terms of the impact from fallout. Maybe you could go through that for us. You have about 150 basis -- 150 to 200 impact in there plus a 1% credit loss reserve. Can you just walk us through the time line and how those buckets fit in with the time line?

Sure. So I think in a perfect world, meaning that we have leases roll at the same rents and the same impact as our portfolio is set up to grow 3% to 4% consistently, we've done that historically. And as we put out a projection, we see ourselves, on a long-term basis, continue to do that. What Christy is referring to on the call is in 2020, we had a couple of known items that we identified in the third quarter and then spoke further on the fourth quarter that, in aggregate, are roughly $6 million worth of NOI, that was in 2019, that does -- that is not expected to show up in 2020. And that drag, I also highlighted on the call, was roughly 150 to 200 basis points off of our projected 2020 same-store NOI. So breaking those into, call it really, 4 buckets. First one is we had a grocer that we took back, we'll be demolishing it and replacing with a new grocer. That is -- and these 4 buckets, just to make this easier, are all roughly about the same. That first bucket, the grocer, is out of the same-store pool. You'll see in our fourth quarter supplemental, that's out, that's our Elmwood Park property. The second bucket is Forever 21. There was, again -- which is an equal bucket of the $6 million, that was in all of '19 and in 2020. And on the call, I was debating or highlighting that it could go 1 or 2 ways, it could either be a full redevelopment, which would be a demolition of the building, which is a 16,000 square-foot building in Lincoln Park, Chicago, and a full demolition and a densification into the parking lot, or we could do a ground lease as is. At this point, we are leaning towards the demolition. That would be out of the same-store pool. So that's -- of those 2, half of those are out of the pool. And then the last 2 buckets we have would be Pier 1. So we have 4 Pier 1s in our Core. We haven't got any of them back yet. They're continuing to pay rent, but we expect we will get those back at some point in this year, and we have plans for each of those. So that's a portion of the drag. And then the portion of the drag that I would say contributes to the 1.5% to 2.5% range is really the 12,000 square foot of retail that we've gotten back. So what's unique about Acadia is that we have a wide range of rents from our suburban portfolio to our streets, which creates, in any given quarter, a bit of volatility. So that's where, when we look at the wide range of same store, it's really related to the street retail. That's the driver of that. And we have -- as we announced on the call, the vast majority of this space is already leased. So it's a question of rent commencement on that as to where we roll.

And let me -- before because -- and I realize the math is confusing and noisy and it's the reality. If you're going to be long-term owners of great locations, there's going to be periods where there's some volatility. But almost by every metric that we measure on the leasing side, 2020 demand is better than '19, '19 was better than '18, demand and resulting rents. So as we cut through this noise, while I see that improvement more so on the street and urban, I see it also on the suburban side. The market is improving. Obviously, subject to what's going on currently, we'll all have to figure out what kind of speed bump that creates. But prior to that, the conversations, the negotiations and the completions with tenants are better than they have been in several years.

And so I think just to follow-up on that, to clarify, I think one of the confusing points that people were getting caught up on the call was in regard to the same-store pool and what was in and what was out. And you just sort of explained that, John. I think one -- people get caught up on it because you have these street retail assets that are individual. And so there's some confusion as to whether or not, if that's vacant, whether or not that gets pulled out of the pool. And it sounds like what happens is if it's just re-leased, it stays in the pool. If it's actually a redevelopment where you're putting actual value-enhancing capital into that store then you're...

Yes. So Christy, that's now great. So I think if we look at Lincoln Park, that -- the Forever 21, so this is one that if we decide -- and we're going to make a real estate decision. Kenneth and I don't think about what are we going to do for the same store, it's what's the right real estate decision on an individual asset. So in this case, if we demolish it, which is what we're leaning towards, demolishing and expanding on it, it's out of the same-store pool with no impact. But the second alternative we're looking at that we have several tenants interested in it, is that we ground lease it to someone else. In a perverse way, our FFO would go up because we would have NOI throughout the year. But our same-store, we come in, we would -- that would be a hit to our same-store because we have 3 to 6 months of downtime before we were able to collect the check. So it's really when we are demolishing, adding capital and repositioning the asset is where we would call it a redevelopment.

And last year, when you provided guidance, you kind of broke out the same-store growth between the street/urban and then the suburban portfolio. Are you willing to provide that information to us again in that 1.5% to 2.5% range?

Yes. So I think what Christy is referring to is that we have -- and this is one, again, our portfolio, just for those new to Acadia, is that we have a suburban portfolio, which is roughly, call it, 30 -- on a value perspective, about 30% of our underlying NAV is in suburban, and about 70% to 75% is in the street and urban. And what we have seen historically is that our street and urban portfolio has historically outperformed our suburban portfolio by 300 to 400 basis points. But from an NOI perspective, given the difference in cap rates, it's about 50-50 from an NOI perspective. So I think when Christy highlighted this last year and during the quarters, we spoke about the differential between those 2 portions of our portfolio, and we'll do the same each quarter this year. We're very hesitant to create a just another metric. We try to have one single same-store metric, but to be able to give guidance as to the individual components, and we will do that throughout the years as well.

So you'll tell us as it occurs, but you won't give us what the guidance is.

Yes. Still -- and Christy, I'd say is, we are continuing to see that outperformance in the 300 to 400 basis point range, but we'll give detailed commentary about that each quarter.

And then so you don't include redevelopment in your same-store NOI metric. How do you expect -- well, first, I would say, do you think that leaves you at a disadvantage relative to your peer group because people do use this metric? It's not apples-to-apples, but people do compare them.

I mean I think as long as we're consistent. We see the growth. We're a small company. So I think you could -- we can take you a tour of 10 of our assets, and you would understand our company. So I don't know that it's really a disadvantage, Christy, where we look at our portfolio and where the growth in the cash was being driven from, so I don't think so. And I think if we look at -- right now, we have 2 really large-scale redevelopments, and those will -- we'll think about whether it makes sense to do it when those come online, and it's actually a meaningful -- there it is, meaningful. And City Center, which is in our -- one of our projects and one of our largest assets in San Francisco is expected to really contribute to NOI in 2021. Maybe at that point, we will put that out there. But again, being sensitive to different metrics, we've kind of stuck with what we've done historically.

So up to now, the impact has been 0. It's not been a drag on growth, it's just been 0. So you'll think about what...

If we do start including it, we'll make sure to say this is without and with.

Okay. We like that.

And then we'll let all of you decide what is more important that week.

Good. And so at what point do you expect it to -- the redevelopment projects to start becoming more accretive to your total NOI and FFO?

So I'd say mid, and this is dependent upon -- our largest anchor at City Center is Whole Foods. So it's 57,000 square feet of space. So I think they're in their approval process now, which is a long and extended process before they can even start construction. So best guesstimate, we're in mid '21 to the latter half of '21.

Okay. Ken, I want to talk about the health of retailers today, something that you mentioned on the call. So on one end, you have older legacy retailers that some private equity players are making worse, not better, but are sort of contracting. And then on the other end, you have newer emerging retailers, some of which, in your own words, are experiencing investor-subsidized growth without a clear pathway to profitability, right, in your words. How do you think about underwriting tenant credit when you're faced with this on both ends of the spectrum? And how has that evolved?

Were those my words? They sound brilliant.

I think that's what you said.

Right. So here is where we are, let's talk about some of the good news. Whether you are a successful legacy brand or a new younger brand, whether you started online only and were preaching 3 years ago that you never would need a physical store or you are refining your fleet, there's no doubt that the physical store to all of these retailers -- I cannot think of an online digitally native, DTC or otherwise, who isn't now recognizing that the physical real estate is probably the only pathway to profitability. And you're hearing this from a continuum. So from Target's perspective, and they're opening close to a dozen stores in New York City, for instance, what they have articulated very clearly is store economics are what is going to drive their omnichannel future. To be more specific, what the CEO said was, when you order online, if we can fulfill that out of the store rather than through a distribution center, it takes 40% of the incremental cost out of the equation. When we can get you to come into the store, click and collect, takes 90% of that incremental cost. So the future of omnichannel is not just about these digitally native, it is for a wide variety of retailers who are going to continue to thrive. To answer your question about credit, I think it is fair for us as an industry to assume that we are in a period of shorter-term leases and perpetually higher turnover. We need to price that into our deals, and we need to make sure that the economics of how we're structuring these leases is priced accordingly. Here's the good news on that side. So forget just Target and their omnichannel initiatives that are successful. Now think about the tenants that we have on Armitage Avenue in Chicago and Lincoln Park, for instance, ranging from Warby Parker to more recently, Allbirds and a dozen others. And on Armitage Avenue, where it's supply constrained, what we have seen is the following economics. First of all, there's more demand than we have space for. So rents year-over-year are up about 20%. And then the question is, can tenants afford to pay that rent? And the answer feels pretty darn good, meaning when we look at the rent-to-sales on the 4-wall sales, their rent-to-sales are strong. I'll define that in the 10% to 15% range. And then when you add the fact that these young brands have strong online initiatives, in many instances, they're selling as much online as through the stores, when they open a store that they previously did not have a physical presence, their online sales go up. When they open that store, their customer is stickier, their cost per acquisition of that customer goes down. Let me repeat that. We all thought 5 years ago that you could acquire a customer through Facebook, through Google for virtually nothing. And then we woke up to realize that's not the case, that these are for-profit companies and they are charging more than the occupancy cost for these retailers. So not only is a 15% rent-to-sales an affordable rent, just on a stand-alone basis, but as these tenants grow up, you're going to see them continue to use these stores, and they can afford to pay more than an average retailer who only is selling product out of that store.

And so as you invest capital into these stores with these retailers, and many of them are private, are they giving you a sense for their own revenue growth and profitability that is not as widely known as for public retailers?

Right. So the issue with any of these retailers -- and by the way, the issue with publicly traded retailers who then get taken private or your mom-and-pop, nail salons, et cetera, is how do you underwrite the business? The first thing we look at is what are the sales or projected sales for that store? And then what are the rent to sales? And how profitable is that for that specific business? When we look at these younger companies, we're probably talking to their financial backers as well. We're getting a sense of where are they going to open stores, will this be consistent with the brand. And so far, where we have done that, it has worked out well. It doesn't mean that all of them are going to survive. We are fine with some level of turnover. What we can see, though, is that these leases, while shorter term, have fair market value resets. So unlike being plagued with a 40-year lease with a tenant who lost their way, if these tenants don't work out, we're going to make sure that we can recurate. Another important point, when we sign leases for $12 a foot somewhere in America, we need about a 20% lease spread to cover the TIs because it costs you $40 to $80 a foot depending on what you're going to do. And on these streets, it costs you about $40 to $80 a foot but we're signing leases at $100. So the ratio of what the TI/LCs relative to rent is so much friendlier on these higher rent, higher productivity markets that we can afford some level more of turnover.

We had a -- do we have any questions in the room before I go to veracast? We do have a question on veracast. Given your focus on urban and the greater long-term growth rate of your urban versus suburban assets, why not a more concerted effort to exit suburban?

So within our core portfolio, John mentioned, it's roughly 30% of our NAV. And I think we have been pretty clear that we don't intend to grow that portion of our core portfolio. But it is absolutely within our core competencies. So in Fund V, we've been doing nothing but buying out-of-favor suburban assets. Might there be a point of time where the demand for yield, which exists, comes back to retail, and we have an opportunity on a more concerted basis to recapitalize, spin-off or sell those assets? All of the above. I can't promise you when that will occur because, frankly, the markets are a little confusing, to say the least. But when we see that opportunity, we will make more of a concerted effort.

So you could spend Fund V and your suburban portfolio into another REIT?

So here's the reality. Well...

I'm half-joking.

We, as a country, are getting older. We, as a country, need yield. We have been buying assets in Fund V at roughly an 8 cap, levering them 2:1 and our dividend is about 15%. Now that's a higher leverage, more of a P/E model. But the demand for this yield and the spread differential from our borrowing cost a month ago, much less a week ago, is a wider spread than I've ever seen in my career. As soon as -- now we've been at Fund V for 3 years and our yields have helped. We lost the Toys "R" Us, we put in a T.J. Maxx. No growth but stability. As soon as that stability resonates in the broader markets, we will have an opportunity to do something there. In the past, it's been as simple as a sale, but it also could be a recap. And then to your question, Christy, could we take Fund IV and roll it in as well? Absolutely. You saw us do that in Lincoln Road, we're in Florida. We sold Fund III and Fund IV together. You very well could see us include our Core. A lot of brain damage so it has to be worth it to our shareholders.

You mentioned losing the Toys and backfilling it. I mean there has been a lot of box fallout since you started this initiative, and I know that you've been uber focused on underwriting these assets to try to limit that fallout, but how has that progressed given -- compared to what you underwrote and the Fund V assets?

We are at pro forma. We've done no better, and we've done no worse. So as we've lost tenants, we've made up enough rent to justify the cost, and our yields have been greater than pro forma, having nothing to do with the leasing that I'm talking about, but the fact that I thought we were going to be borrowing at 4.5% and we're borrowing at 3.5%. So an unbelievable time to be a borrower of stable assets and pretty good time to be acquirer.

And so you currently have $650 million invested in Fund V. How much more capacity do you have to invest there?

So that's about 60% of Fund V. So we have another 40% left, and we plan on putting that to work in the next year or so.

And what does the transaction market look like for the assets that you're buying? Have cap rates compressed at all?

So I'd say it's transitioning. And it's a little awkward to talk about any of this in the vacuum that doesn't take into account the last couple of weeks -- the last week of volatility. What we saw in 2018, 2019, most of the sellers were publicly traded REITs, looking to deleverage, looking to get assets off of their balance sheet, and that was a very good -- we had to be selective. It was needles in a haystack, but a very good market for us. Fourth quarter last year, there was a significant rally. A host of folks who were net sellers are now bidding for assets and may very well be net buyers. So I expect that to quiet down, but the private institutions are also seeking liquidity. What I thought we might see fourth quarter was with the REIT rally that private institutions would follow. And so far, I'm not seeing that. So private institutions still seem, especially out of core funds, to be net sellers, and we plan on being there for them.

And you mentioned, notwithstanding the last week of sort of market volatility, it will be interesting to see what the implications ultimately are on the transaction market. What would be your guess, if this is sort of -- I mean the market -- the equity markets are reacting well today but there's volatility. What could we see on the transaction side in what has been a relatively liquid private market for strip center transactions?

So when the Fed starts to raise rates again -- and I realize that's a ways off, right? We're still anticipating cuts. But until then, borrowing costs are going to be at historic lows. You need to be a high-quality borrower. You need to have assets that are financeable. But that then causes me towards the bullish side. That being said, the volatility of the last week indicates to me that our equity may be more precious than it was 3 months ago. That's a long way of my saying, "I don't know." But while we're debating all of this, if we can buy 8 caps, and you tell me I'm overpaying or underpaying and levering them, let the debate continue. We'll continue to clip 15%, 16%, 17%.

What could Fund VI look like just as you think, down the road? I know it's a long way out, but the capital raising environment, you talked about the other side of it, where you see opportunity in private capital partners looking to monetize what they have, how does that impact your ability to raise capital if we sort of stay in this kind of uncertain retail environment as you look to potentially raise capital in the future, right?

Well, we've been fortunate that the majority of our investors are choosing us as a manager as opposed to saying we need a retail allocation. That being said, retail is a challenging market. So we're going to have to make sure that we not only continue to do a great job for these investors, but also that we can articulate where the next interesting investment opportunities would be. I hope, by the time we're finishing up the raising for a Fund VI, that there's clear new demand for interesting, exciting, highly accretive, profitable developments. I got to tell you, I don't see that right now. Right now, when you look at what we're buying in Fund V -- and we can do whatever we want within our Core competencies, the existing yield is far more interesting than buying land, tearing something down and building. So what will Fund VI look like from an investor perspective? Hopefully, it's a bunch of the similar folks, maybe some new ones. What will the investment style be? I'll let you know when we get there. But best guess is if we continue in this environment, it will stay continuing to carefully, selectively find the right centers with the right rent to sales, right rent to market, where we see stability and continue to enjoy the arbitrage between unlevered cap rates and borrowing cost.

Going back to the Core for a minute. So you've been working, obviously, to build critical mass in certain street retail markets. Can you just talk about why this is important? Where do you feel like you have that today? And where are you working to build it?

Right. So I mentioned Armitage Avenue in Chicago where there is enough supply constraint that we see our ability to drive pricing. So that would be one box we need to check. Secondly, we need to own enough buildings in any given submarket, where we can control the curation. It doesn't mean we can drive rents more. In fact, if you own one building, you may be more predatory than if you own a whole bunch of them. But it means we can set the pace for the type of retailing there, and that's a second important piece. And then third, it's better off being a market that we have studied for a while, hopefully, that we know. What you've seen over the last almost decade is we slowly, and on a disciplined basis, built out in New York City and Soho. But I'd still say we're underweight New York, by that, I mean we had yet to acquire the appropriate balance there. We have a fair amount of assets on M Street and Georgetown. So there, I feel pretty good that we can control the curation. We recently added Melrose Place in L.A. Not a huge investment, but 5 contiguous buildings. And for those of you who have been there, one of the few really interesting, pedestrian-friendly shopping corridors in L.A. and the feedback from our retailers, the rent to sales, the demand is right there. The final piece is, and this will sound somewhat counterintuitive, we prefer to buy in when there's some vacancy. Because, obviously, by the time we all can tell why that market is taking off, it's a little late for us to acquire there. So we're looking where is there just enough vacancy that the market is subdued and then we can acquire into it.

So I'm sorry, did you say that you do have enough critical mass in Soho to control the curation or you're just saying you're not there yet?

We're not there yet.

You're not there. Okay.

But on Greene Street, we, through 3 acquisitions now, own 7 contiguous buildings on Greene Street. We feel good about that. I would love to see us, over time, we'll be patient, we're going to be disciplined, increase our footprint there.

And the additional building that you bought subsequent to year-end on West Armitage 917 (sic) [ 907 West Armitage ], is that contiguous to the assets that you already own on the street that's...

It's contiguous. We're right across the street.

Right. Okay. We did have a veracast question. Where are you seeing the most softness in high street retail leasing?

The most...

The most softness.

Unfortunately, I'd say Madison Avenue. It's a long corridor. For a host of reasons, a lot of the energy has moved south in New York City. And the rent reset is underway. Northern Madison Avenue, where we happen to own adjacent to the Carlyle Hotel, has stabilized, and we actually are seeing a bit of pricing power there. We're fully leased on that. Southern Madison Avenue is also similarly getting a cluster of luxury. In between, it's still soft.

Any questions? Go ahead.

Is the dynamic you discussed with the new brands more pronounced in urban or suburban?

Urban. And these brands, Warby Parker or Allbirds or others, they're never going to have a fleet the size of a J.Crew. They don't aspire to it. The market isn't pushing them to do that. So they're saying we want to be in a select number. It could be 6, could be 60, it's not going to be 600. And thus, their focus is to be in great markets where they can extend their brand. And then they're relatively indifferent, whether you shop online or in the store. It's just if you're going to buy Allbirds, you might want to try them on first and they get that. And the data supports and their numbers support them having those stores.

Any -- there is a wide range of transactional income in your 2020 guidance. I understand that can be very lumpy from year-to-year. Maybe you can share some insight into what could drive that closer to the lower end of the range versus the upper end of the range. I think there's not a lot -- there wasn't a lot of clarity on what the catalysts are there for that.

And I'll take the easy part of that, John, and then you -- so first of all, for those of you who may not follow in this level of detail, we break out the FFO from our Core and then all of our transactional activity, which generally has been promotes from monetizations of various different funds. So to answer the easy part, Christy, how do we get into the low end of our range is we do nothing. And that's kind of a joke, but -- right, if we don't do any transactions, then we get to the low end. Otherwise, John?

Thanks, Ken. That was helpful. Great. So I think -- so Christy, as mentioned, as Ken highlighted, we really break it into 2 components, sort of our Core and recurring that we intend to grow off of in each and every year. And then given the dual platform nature of our portfolio, we have a bucket of transactions that could happen either within our Core, but typically within our funds, that could vary very widely, which is, hence, we see a big, big range. So what I'd say is there's probably 4 to 5 -- now probably, there are 4 to 5 transactions that have various degrees of probability that could unwind in 2020, which is when I set the range is how I came up with a range that was there. And they're various things. One of them that I'll highlight is we have a -- within Fund II, a 1% interest in a grocer that could potentially be doing some sort of transaction that would contribute to that gain. So that would be one where we'd be on the higher end, if that transaction were to unwind. And if that didn't unwind, Christy, I think that answers your question as well, where we could be on the lower end of the range.

So -- and let me just add something. One of -- I love being publicly traded or running a publicly traded company, but one of the dumbest things we could ever do was forecast ahead of time what someone might transact with us because when I'm putting our fund dollars to work, if someone preannounces that they're selling an asset to Acadia and we have not gone firm yet, well, we're nice guys, but we're not that nice. So until something is done, it is just silly and not in our shareholders' interest to overforecast it.

Great. Well -- I mean that -- it is a wide range, but it's also -- it represents, at the midpoint, a much higher percentage of your FFO this year than it has in the past few years.

Yes.

So a lot of -- so rapid fire, right? Will the U.S. strip center sector have more or fewer companies a year from now?

More.

What will same-store NOI growth be for the sector overall in 2021? In 2020, guidance suggests 1.8% on average. So 2021?

1.7%.

What will the 10-year yield be 1 year from today? Today is -- I think it's -- right now, it's 1.13%.

5%. I'm joking. 2%.

And then what year will the U.S. enter recession?

2020.

Thank you.