Acadia Realty Trust (AKR) Earnings Call Transcript & Summary

Good afternoon, and welcome to Citi's 2021 Virtual Global Property CEO Conference. I'm Katy McConnell with Citi Research, and we're pleased to have with us today Acadia Realty. This session is for Citi investing clients only. So if media or other individuals are on the line, please connect now. Disclosures are available on the webcast. For those of you joining us here today, I'd like to -- and if you'd like to ask management any questions, please feel free to take them into the question box, and we'll do our best to ask during the session. So to kick things off, I'll turn it over to you, Ken, to start with some opening remarks on the company.

Great. Good to see you, Katy. Welcome, everybody. I can't wait to be back in person, but it is great to be able to at least have this kind of conversation, and I appreciate Citi putting us together. For those of you less familiar with Acadia Realty Trust, we focus on open air retail throughout the United States, with 2 key areas of differentiation. First is in our wholly-owned portfolio, we have about 60% of our portfolio that is focused on street and urban centers in the key gateway markets. They certainly took a punch to the gut during COVID, but thankfully, we're seeing strong rebound there, and I'll get into that later during the Q&A. The second area of differentiation is, we have, for the last couple of decades, run what we call a dual platform, which means we run a series of fully discretionary investment funds that give us dry powder and give us the ability to invest opportunistically irrespective of our stock price when we see interesting opportunities, and I'll certainly get into that as well.

All right. Great. Sorry, that was quick. So to start off each session, we're asking each company if an investor is buying one real estate stock coming out of the pandemic, what are 3 reasons that it should be yours?

So there's -- again, of the 3, first of all, we have a very strong portfolio that's well positioned for this rebound with significant embedded growth driven both by lease-up opportunities as well as contractual growth as well as the reopening that is in front of us. The second reason is, even though our stock has recovered somewhat since COVID, there's still room to run. We still have room for multiple expansion as well as, as our earnings growth occurs. And then third and finally is, we have a team with a proven track record of creating value. Whether it's utilizing our fund capital or wholly owned, we have proven, over the decades, the ability to identify interesting investment opportunities, execute on them well and make sure we're creating shareholder growth throughout it.

And just thinking about where the stock is today, it's obviously seen a lot of improvement year-to-date, but you mentioned it's still not where you think it should be. So what do you think that the market might be missing about the story? And what are you most excited about as you think about the next year?

Yes. And by the way, it's understandable given the year we went through. I totally get why the market had trepidations around some of the major cities around discretionary retail. And now, thankfully, we are seeing a rebound. We are seeing a reopening. Retailers are coming to us, not just in the suburban portion of our portfolio, but for our major assets, whether it's in the Gold Coast of Chicago or Soho or M Street in Georgetown. So I think what we all need to appreciate is the amount of pent-up demand, the amount of savings and how the consumer is climbing out of this recession so much differently than during the global financial crisis. Their savings rate, their stock portfolios, their home values, all of that is leading to, I think, the opportunity for the discretionary spending and the discretionary retail that is that component of our portfolio to really resonate.

And going back to the pent-up demand that you talked about, can you just give us some insights as to how you're seeing that play out in your portfolio?

Sure. So 6 months ago, in the last 2 quarters' calls, initially, most of the retailer demand, what retailers were talking to us about initially during the dark days of COVID, it was all about essentials. And there was a nice boost to that component of our portfolio that meant that necessity in essential demand. Then it started shifting a bit towards the half of our street portfolio that was in less dense markets, whether it's Westport, Connecticut, Greenwich, Connecticut. And now, more recently, what retailers are telling us is they need to be -- given how channels are shifting, how the consumer is thinking about spending, they need to be in these forever markets. And thankfully, we are in a position where we have several mission-critical spaces that retailers can take either to expand or to add additional brands or just to reenter those markets and that's very encouraging.

And we've seen some of the more restricted states and -- including New York City recently announced lifting on some of those restrictions. I think they're back up to 50% dining, which is great news. How is that impacting your portfolio? And are you starting to see some more re-leasing momentum?

Yes, and it is. And we don't have a lot of dining locations in our portfolio, but all of that makes a difference. We've got to get back. And we're seeing restaurateurs see it. There is -- I would describe it as FOMO. There are amongst restaurateurs, amongst retailers, real fear of missing out on this next wave. And thus, while a few months ago, we were all very concerned what's the future for restaurants, what's the future for gyms, it's now pretty clear, at least when you speak to our retailers, that they want to get in front of that. So as we see a successful vaccine rollout, as we see a return to the office, whether it's 3 days or 5 days a week, for our business, it doesn't really matter. But as we see all of that, whether it's the restaurants or all the other pieces of our business, I think, it bodes very well for a very nice rebound.

And then what are you seeing as far as your suburban portfolio? What have you seen as far as suburbanization trends? And how permanent do you think that is?

So a few things. One, the suburban, especially the necessity component of our portfolio, provided us necessary ballast as we get through the storm. And I'm certainly appreciative of that almost irrespective of whether there's some growth or it's just stable. As to the trends of suburbanization, few thoughts. One, there were trends pre-COVID that were playing out that I think we need to acknowledge, understand, and I see some of those continuing. But as it relates to everything else around COVID and some of these more severe shifts, I spent a lot of time talking to my peers, talking to other experts, everybody is guessing. So I'm guessing, too. And here's my guess. For some families that moved out of the city into the suburbs, and it's just easier. I get it, and they may stay there. For others, either empty nesters or younger people, I doubt they're going to live in their parents' basement forever. And my guess is, they're coming back. Now which cities they come back to, which month they show up, exactly how that plays out, it's anyone's guess. But what our retailers are telling us is that from a retail perspective, these must-have locations are mission critical, almost irrespective of what my guesstimate is because, right now, we're talking about reopening. In a few months, we'll be talking about domestic tourism. Then, eventually, in about a year, international tourism. And the ability to capture all of that in an omnichannel world is mission-critical to them.

Yes. And to that point, the focus shifting even more to omnichannel. It was a trend before the pandemic and almost even more so now as we saw e-commerce accelerate, but also shipping costs and logistical pressure accelerate as well. So how are your retailers thinking about using their physical footprint more efficiently or differently?

Yes. and so if you think of -- and it's an overplayed statement, but if you think of COVID as a great accelerant, and then certainly, omnichannel and the halo effect from it has accelerated as well, with the exception of a few really successful retailers who continue to commit to being monochannel. The off-price retailers are probably the best example. With that exception, the majority of our retailers recognize that they need to be there for their customer irrespective of what the delivery system means, whether it's delivered to your house, buy online, pick up at store or come into the store, the retailers need to be there. The most profitable channel remains in-store execution. The most difficult one and, Katy, you just touched on it, is delivery to your house. Now for some retailers, whether it's the digitally native, the Warby Parkers and Allbirds of the world who really understand how to stay digitally connected, or the Walmarts and Targets of the world who, over the last several years, have really developed this business successfully, I'm confident that the kind of real estate that they all want to own is the kind of -- excuse me, that they want to locate in and is the real estate we want to own where they can benefit from all of those different features, and I do think that is the future.

And to the negative, how do you think the industry could be permanently impacted? And are you starting to see any fallout on the lower end of the scale as far as obsolescence risk and just thinking about how the whole landscape could look different, maybe 5, 10 years from now?

Yes. So in -- this has been playing out over the last 5 years as well. But there is going to be a continued separation within retail of the have and have nots. One of the realities of COVID is a bunch of the weaker tenants, the ones that we used to refer to as loose teeth, they've all been knocked out. And so my guess is within the next year or so, hopefully, with a strong rebound, hopefully, with a health crisis behind us, you will see those tenants that are remaining be in stronger positions than they were pre-COVID. You will see retailers doing more with less, using omnichannel, using critical locations, but online sales are not going away. They're just going to be part of the overall shopping experience. So some of the fallout will be for those landlords not well capitalized, those landlords with weaker locations, those landlords without the ongoing connection to their retailers that are thinking through all of the changes that are in front of us, there will be fallout but we've known that's going to be the case for a while. The United States is over retailed, still is, but slowly, but surely, a lot of that space that needed to get repurposed will.

Would you expect the total pace of store closures and bankruptcies to slow down this year relative to last?

Yes. Yes. Again, the range of outcomes is wide. And I think other people have said, it is a mistake to spike the ball on the 10-yard line. We are very close to a healthy recovery. Assuming that's the case, then I believe the majority of the store closures, of the rationalization of footprints, of weak retailers going away, my sense is that's behind us.

And can you just remind us, within your guidance, to what extent did the low end of the range include some sort of a buffer for a negative macro scenario where we could see more restrictions and reversal of collection progress?

John Gottfried, do you want to respond to that?

Yes. So, Katy, so I think we -- with that range, we did put out a fairly wide range. So I think clearly, we're -- we -- our assumption was that base case. First half of this year looks a lot like the last half of last year. So that's sort of what the base case is. But in terms of what could go wrong, could it get extended, additional strain, we factored that into our lower case. And that doesn't look it that's the way it's heading, but that continues for the balance of the year. But we did put that in, build that into our lower case that this could extend longer than we have anticipated.

And at what point would you feel comfortable removing that type of scenario from the range?

I mean, I think, a full reopen, right? So I think if we see New York continuing the path that it is and Chicago, I was just visiting our assets in Chicago, and there, it's coming along nicely as well that, I think, the pace has picked up from where -- when even a month ago when we spoke on just the vaccinations and the states and things playing out, that we'll see. I mean, I think it's going in a real positive direction, but we're not out of the woods yet. The outcomes are still wide, but we certainly feel -- we're feeling better each day as the medical technology is really going to make a difference in how this unwinds. And so far, it's been incredibly positive.

And that positive momentum, are you seeing that on rent collection updates since you last reported?

Yes. So we haven't provided any update since. Since we've done our earnings call, so we haven't done that, but I think with just the remarks you're seeing with the trajectory of what's happening, you should assume that things are remaining on track. And again, I'll point to, we expect the first half to be around that 90, plus 90 collection for the first half, just given the nature of our tenancy. We really see the pivot in in the second half. And as Ken mentioned, more importantly, beyond that. So I think first half, we think, near term, we -- you should expect a lot of what we saw. So it's really -- as we get further on in the year where we really start to see a meaningful pivot.

And I think in the 10-K, you may have mentioned you entered into some more deferral agreements after the quarter end. Can you provide any more color on that?

Yes. And this would have been just cleanup type stuff. There's -- I mean, that's really, really slowed down. So we had -- we won't name tenant names, but there was one that we had handshake agreements with that we were trying to get done that we ultimately inked. But I think that's largely been -- I mean, as the year moved on, we did fewer and fewer of those. And as you know, our strategy was really to focus our deferral agreements and efforts and the time to go through that with credit tenants. So those are ones we did deferral agreements with, with those that we knew had the ability and wherewithal to pay. And it was just nature of the pandemic, we agreed to defer them, but nothing of any significance.

And how much confidence do you have in being able to collect those deferrals on time? And can you speak to any that's already been due, the progress so far?

Yes. So I think it is -- and I think I mentioned this on our earnings call is that we did them with credit tenants, and we remain highly confident that those that we did this with will get paid, and these are -- again, we could debate whether we should or shouldn't have done it. But it was one we needed to do that to move on, and we did. So we remain confident that they'll stay compliant with those deferral agreements, particularly now that the world's reopening and there -- the stores are doing well. We even feel better than we did when we initially made them.

And then can you just update us on the status of the watch list in your bankruptcy exposure today? And how you feel about the cadence of their business recovery for some of the main categories?

Yes. So I think in terms of the watch list, I think the pandemic really accelerated those that have been on our watch list for an extended period of time. So I think that really -- and as Ken highlighted, bankruptcies, we think, are going to be ultimately down given that we are nearly to the other side of this and those that didn't have the ability or didn't see -- have the staying power to get through this already went away. I think our watch list is in pretty solid shape. What I would say, and this is where we talk about our -- that, call it, the 10% we're not collecting, we continue to think half of that 10%, and these are -- it's not a big part of our portfolio, but sort of the local nonessentials. We think that, eventually, we get that -- we get some of those spaces back, and we have a chance to re-lease those. But in terms of the nationals or exposure of the main categories, we feel pretty good about our tenancy and the watch list really, really being in, I think, in pretty good shape as to particularly where it's been in the past.

And then maybe you can just go in just some more detail on what the backfill leasing pipeline looks like today? And deals that you had in various stages, how are they progressing along? And what are the key drivers there?

So Ken, you want to take that or do you want me to take it?

Sure, I will. So as I mentioned briefly before, initially, the backfill was more essential, more suburban. What we said on our last call was it had been shifted in terms of leases within our pipeline being executed to more pro rata, the 60% being street and urban, which was encouraging. And what we said on our last call and continues to be the case, is even further incremental interest for discretionary use in these key street locations. So all of the trends are reflective. Our view of the rebound is reflected because of what our retailers are telling us they want to do.

And you've done a -- you've seen a little bit of an increase in your month-to-month leasing. Can you just talk about your strategy around doing some more short term deals, kind of just to bridge the gap that we're in right now, in this period of disruption?

Yes. And we're doing some of them. It's not a material amount. Here was the good news that most retailers who want the kind of locations we have, they want them not just to show up short-term, they want them long term, and they're willing to step up. Now the first year's rent of an overall 10-year may have a lot of structure in it because of the uncertainties around reopen. But longer term, what we have seen, what we said on our last call and still remains the case and then some, is the retailers are stepping up, non-month-to-month. They are stepping up at rents over that 5- or 10-year period that are consistent with our pre-COVID forecast, if not better. Now for an existing local retailer who has been materially impacted by COVID and needs to go on month-to-month, sure, we're going to be there for those retailers to help them get to the other side, but that's really where it's showing up.

And can you talk about how you're thinking about net effective rents in your portfolio? And how does that differ across the different portfolios, street, urban and suburban?

John, why don't you cover that?

Yes. So I think you know our portfolio well. So we have, within our portfolio, about 40% of our portfolio is traditional suburban, and 60% is street and urban. And the net effective rent portion of those different portfolio are vastly different. So when I look at it, I look at every lease that we sign. And the first thing I look at before I sign off in any capital outlay we make is how long and what return do we get on any capital we put out. And on the suburban portion of our portfolio, the payback period is generally north of 5 years. It could be up to 7 years depending on what type of work we need to do at the space. So the payback period and the AFFO contribution on a suburban lease, particularly if you're cutting up a box or relocating and all the things that traditionally go into suburban, is a fairly expensive experience for us. So we look at credit incredibly hard on that to ensure that it's profitable for us. And then when we go to look at the street asset on the other end of the spectrum, there, the cost per foot when you factor in leasing commissions, which tend to be or are higher because rents are higher. But what we find is the payback period is oftentimes under a year, but, at most, it's 2 years. So a fraction of the payback period, a much stronger contribution to AFFO. So a 75% to 90% of any cash we collect is AFFO positive when we back out the cost. So very, very different between the 2 elements of our portfolio. What I would highlight, and last year at the conference you would have heard us talk about, a really strong growth profile going forward. And the pandemic pushed that growth profile going forward. Given that, the [ tenet ], we weren't able to capture some of the lease-up that we had. So we had lease-up entering the pandemic of some of our highest quality spaces, and those are in the street and urban market. So that's where Ken's differentiation is that our lease-up is not only do we see a good solid NOI trajectory, it's also driving strong net effective rents that our street and urban portfolio was at 87% at the end of the fourth quarter. And that's where we see a lot of our growth and over half of our pipeline is in those markets.

So we have a couple of questions here on the web. I'm going to one of them now. But aside from your portfolio, in particular, as you think about Manhattan rents for street retail in general, how much do you think these will drop post-COVID relative to before it started?

It's really important to keep in mind that generically, Manhattan street re -- and you're talking about retail, correct, Katy?

Yes. Manhattan street [ re ].

That rent -- rents grew too far, too fast 2010 to 2015, and we've been talking about this for several years. Rent doubled, not every street, not every corner, but rents grew at 10%, 20%, 30% a year rates that just were not sustainable. They peaked 2015, '16, '17, and then they had been self-correcting over several years pre-COVID. What our retailers were telling us based on pre-COVID sales, pre-COVID, the 2019 rents was we were pretty close to equilibrium in a lot of the markets we were active in, not all. COVID hit. I do think there's a COVID discount for the next 12 months or so. But what our retailers are showing is they're thinking past that 12-month so-called discount that you might see in some prints in other companies or elsewhere and really thinking over the next 5 or 10 years. And there, it's about the quality of the locations. And there, I think what you will see is post-COVID rents meeting or beating the pre-COVID drop because it's going to be the same separation of the have and have nots. Retailers are going to be picking their spots and where those spots occur, the sales are going to be really strong. And it's a function of rent to sales. Our retailers are excited about that and we are as well. Not all streets will be that way. And if, in general, you're comparing 2016 rents with 2021 rents, the differential could be great. So the devil's in the details. Be careful at how you're thinking about it. And my hope is, we will see a rebound, but not the level of growth that we saw in 2010 to 2015. That was too much. That created unnecessary problems. We'll benefit from steady growth, which is what we're going to curate our portfolio for.

And then another one here. Do you think we're at an inflection point for market rent momentum in your markets?

Yes. Yes. Retailers right now need to get in front of their shopper and be relevant. They're going to do that by continuing to enhance their digital spend. But there's only just so much of that you can do and the profit of that channel is challenging. They need to rethink the other channels. Wholesale is going to be tough. And so we're at an inflection point because these stores are going to be critical if they want to capture their client, their customer when and where that customer is ready. And so what our retailers are saying is, we got to get here, we got to get open. We have choices. So don't expect this to be an overnight turnaround in rents, but we're seeing where they're clustering, it's where we own. It's a combination of the digitally native, all the way on up to the higher end and luxury tenants. And I do think we are at an inflection point.

So on your call and earlier today, you sound fairly optimistic about the path to get back to not only pre-COVID, but beyond that. So in the near term, it seems like a lot of that will be driven by the leasing pipeline. But can you talk about what's beyond that? And when will you get to a point where you're really able to pivot more towards offensive external growth?

So John, why don't you just make sure you're clarifying the rebound, which is real. I just want to make sure we're covering all the different drivers of that, and then I'll touch on the external growth.

Absolutely. So what we've highlighted is that we think we get back to our pre-COVID NOI by late '22, early '23. And that's coming from really 2 factors, the lease-up that we just mentioned as well as the just an improvement in credit collections as the world continues to reopen up, and our retailers are able to get back to full rents. So we think pre-COVID '22, '23. And then what we alluded to on the call was that we see there is extended growth beyond that. So the lease-up that we have in front of us before we get that, we have $8 million in our pipeline currently. So between the $8 million in our pipeline and the credit itself, that gets us back to whole at some point '22, early '23. But there's additional lease-up on top of that. So that's one piece of the driver is the incremental lease-up above and beyond, certainly beyond the $8 million that we have. Other piece that I would highlight is the -- just a handful of densification projects that we have throughout our portfolio. Well along the way, some instances the capital has been spent, and we're just working through, and it should expect rent commencements later in the next couple of years. So densification of existing properties that are relatively near-term actionable is another piece of a growth driver that's out there.

So with that strong embedded growth, now some of it comes because of the 10% drop-off in NOI that we have forecasted, and that's where we think we're bouncing off of a weaker base, but some of it is also the rebound we're touching on. With that strong embedded growth, we can consider adding assets only when it is accretive to our NAV, accretive to our earnings and provide similar growth trajectory. And we're not there yet, but we have certainly come a long way to get closer to it. For those stars to align, on the one hand it sounds complicated, on another hand it's pretty simple. For those stars to align, we need sellers who are realistic about everything we were just talking about. We need enough signs of recovery, and we can choose which markets we are most excited about that recovery. In some cases, it may be new markets, in other cases, it's the existing ones we're in. And then obviously, we need a cost of capital that enables us to be competitive. So we're not there yet. We have a lot of embedded growth that we can continue to harvest. But more often than not, those stars align. And when it does, we'll make sure we're finding the right accretive opportunities.

And can you touch on maybe the more near-term opportunities through your fund business, what you're seeing there today?

Yes. And it is a great asset to have fully discretionary capital to do as we see fit. For the last few years pre-COVID, the real opportunity was to buy out-of-favor shopping centers, where we thought we could get the majority of our return out of levered cash flow. So we're buying at roughly 8 caps, levering it 2:1, clipping a mid-teens return. And if we sell the assets at roughly an 8, it's a mid-teens return. If there's cap rate compression, which, by the way, we're seeing it in the public markets in terms of the rally, then we do even better. And that's -- there's nothing wrong with that strategy, and we'll continue to execute on that for as long as we see those opportunities. There was not a lot of trades in that space or any space of retail during COVID. We're starting to now see that deal flow kick in. Then separate of that, and we have about 40% of Fund V left to invest, separate of how much deal flow occurs there, our more traditional heavy lifting, value-add or distressed buying is very exciting to us. That's what we're built for, and we'll see how and when that shows up, but you don't go through a crisis like this without there being opportunities available. There's far fewer buyers out there for that kind of buy, fix, sell. So I'm pretty excited about what I think the next 12, 18 months hold in store on that side as well.

Another one from the web quickly. Do you have a greater appreciation for the suburban portfolio now? And do you still believe in the longer-term growth rates that you previously held between your urban versus suburban portfolios?

We have always liked suburban, still do. The gut punch that many of these cities took they're still recovering from. And it would be wrong for me to ignore those kind of challenges and say, "Oh, everything will be just back to normal." So it's really case by case. We do think, again, off of reduced rents, we think you may see superior CAGR. But we're going to have to be very careful, very selective in how and when that occurs. That being said, the cities are going to come back. We're not all going to live in the suburbs. The suburbs are going to do fine. There's room for great retail on both.

Great. Well, before we jump into the rapid fire, could you just touch on your ESG integration at this point? And as you think about next year, what do you view as the top 3 priorities to improve upon?

Yes. And this is critical stuff and probably doesn't lend itself to a 30-second answer. But on the corporate governance side, I have always viewed us as being very strong on that side of it. We will continue to make sure that our Board is focused on maximizing shareholder value. We just added Ken McIntyre to our Board. So we're constantly refreshing the Board and making sure that we have industry experts helping management throughout it. On the environmental and on the social side, those are the critical issues. And it's not a 1-year conversation. This is going to be a journey for the generations. The last year has been a wakeup call, and our team gets it. Our team is passionate about it. So here's what it means. On the environmental side, the short-term steps are improving our collection of data. And that sounds mundane, but that is how and what is going to drive scoring, and we need to do that. Secondly is working with our retailers to improve the collection of data. That sounds easy. It's really hard. Think of the age-old statement of does Macy's tell Gimbels. And the reality is they don't like to share. We, as an industry, need to work that forward. And then we are internally driving our initiatives, both in terms of solar gardens for using more renewable energy, a variety of other initiatives that are cost-effective and can work. And I think you will see those kick in over the next 12 months. But again, it's multiple years. On the social side, I have always taken pride in what our team has done in terms of diversity and inclusion. And then we woke up this summer and realized we weren't doing enough. So there are many things that we are doing to continue to advance it. We have a diverse company, but we can do better. One small area that we're going to do, but I would urge all of the companies to, is we have had an amazing summer internship program. There are now junior and mid-level executives who rose up through that, and it is absolutely worth it. Every company should have it. However, we did not focus enough on diversity on that. And going forward, we will, because we need to convince people to come into our industry who didn't previously understand that this was a pathway for them. And we can do it. We will do it. It takes a while, but as I said, this is going to be a long-term journey.

All right. That's great. Thank you. So now I'll do a rapid fire. And the first one is, when we're physically together in Florida a year from today, what will be one thing that will surprise people the most about your business over the prior 12 months?

The rebound to the upside, especially in these key streets.

Okay. What do you think your corporate travel budget will be next year in 2022 as a rough percentage of what you spent in 2019?

100%, but spent differently.

Okay. What will the 10-year treasury yield be 1 year from today?

2.25%, but I'm guessing.

All right. That's it. All right. Thank you both so much. Sorry, we went over a little bit there.

Thank you, Katy.

Have a great rest of the conference. We'll catch up.