Acadia Realty Trust (AKR) Earnings Call Transcript & Summary

Okay. Good morning, and welcome to the 11:15 session at Citi's Global Property CEO Conference. I'm Katy McConnell with Citi Research, and we're pleased to have with us Acadia Realty. Before we get started, this session is for Citi investing clients only. So if media or other individuals are on the line, please disconnect now. Disclosures are also available up on the webcast. [Operator Instructions] And now, Ken, I will turn it over to you to introduce the team and company and provide some opening remarks.

Thanks, Katie. Good morning. Good to see everybody live and in person again. I'm here with John Gottfried, our CFO. And while I recognize many familiar faces, for those of you not familiar with Acadia, there are really 2 key areas of differentiation within open-air retail that we're focused on. First of all is we own a core portfolio that is heavily weighted towards street and urban assets in the key must-have markets for our retailers. And then the second is we operate a series of fully discretionary investment funds that complements our investing and operating activities in open-air retail in the United States. And it's through these 2 key components that we think we're in a really good position to drive growth over the next several years and I break it down into 3 important drivers. First is the internal growth embedded in our core portfolio. As I mentioned, about 60% of our portfolio is street and urban assets. They certainly took a hit during COVID, but the rebound and for reasons we'll get into in the Q&A, the rebound has been exceptional. We are adding assets in the Street portfolio. You may have noticed, we announced very recently, additions in Williamsburg, Brooklyn, out on the West Coast in West Hollywood, another asset in Soho. So the 60% number is probably inching up closer to 65%. And the internal growth that is coming from that portion of our portfolio is going to drive 5% to 10% NOI growth over the next several years, and John can walk through the different drivers of that in the Q&A, but it's going to come from lease-up, contractual growth, reanchorings and then the piece that I'm finding the most intriguing right now is the market rebound. The rebound in rents on some of the streets, which is happening much faster than any of us could have expected a year or 2 ago. Then on top of the internal growth, you will see us add assets to our core portfolio. As I mentioned, both in markets we're active in, like Soho, but then adding on in places like Williamsburg, Brooklyn. And that external growth activity while dependent on our cost of capital can add additional accretion to our portfolio. Retail is still an institutional disfavor, but there's more capital chasing deals. That being said, what we're seeing in terms of street and urban competition, there's far less than I have seen at any other time in my career, especially when we're seeing this amount of growth. So we're enjoying our positioning as being able to acquire these kind of assets with fewer competitors than we have seen in the past. And then the third key driver for our business is our fund platform. We have said on prior calls is you should expect somewhere between $0.06 and $0.10 a year of earnings from our existing fund investments as we harvest those profits. It won't be exactly $0.06 it won't be limited to $0.10 in any given year, but that feels like the run rate from the variety of investments that have embedded gains into them already. And then we will continue to add new acquisitions in our fund business. And on a very simplistic basis, the simple way to think about the accretion from fund acquisitions or from core is roughly every $100 million of acquisitions, whether done in the core or in the fund, throws off about $0.01, which right now is about 1% to our earnings. So if you take those 3 key drivers: internal growth, adding to our core portfolio as well as our fund platform, we're positioned to have significant growth for several years to come, if not for the foreseeable future. And now if we take a step back and celebrate the fact that we're here in person and compare and contrast the world when we were together 2 years ago from where it is today and a lot of horrific events have occurred, and I don't want to minimize those. And there are questions right now, both geopolitical and certainly, I suspect we'll get into discussions around inflation. But when you compare our portfolio today and its growth prospects from where we were 2 years ago, for a bunch of reasons, there's a substantial difference on a much more bullish today on a very simplistic basis and now with some separation of time from 2010 until COVID, the retail industry, both for landlords and tenants faced a decade of deflation. You saw it in pricing, the consumer believe if they waited long enough, everything would be less. The department stores capitulate it with friends and family sale every other month. And e-commerce less focused on profitability, if at all, contributed to this view that physical retail real estate was going to go away. Fast forward to today, concerns of deflation are gone, concerns of inflation exist, and we can get into that. But what our retailers have recognized is that the physical retail footprint is critical. It is often the most profitable channel for them, and it affords in an omnichannel world where online sales will continue to grow. It affords them the opportunity to reduce customer acquisition costs, returns, customer retention, viability and profitability. So as we look going forward, we think we're in a pretty good position to capture that new increased demand, have tenants who are in our locations at attractive rent to sales. And as we're seeing these streets fill in, we're starting to see rents grow certainly to pre-pandemic and now beyond that. With that, Katie, turn it to you.

Great. So for our opening question, we're asking relative to all other REITs, what are the top 3 reasons why investors should buy your stock today?

Internal growth, accretion from external graphs. And then our fund platform, which enables us to remain diversified. And the fourth would be to [indiscernible].

Perfect. The stock's relative valuation has continued to lag relative to history. What do you think the market is penalizing your stock for the most now? And how do you plan to address that?

So to pretend that the pandemic and it's body blow to the cities that we're active in, to the retailers that we do business with, to pretend that people are going to wake up and in a day get that, it takes time. We did a physical tour in Soho. We own a lot on Greene Street. And on purpose, we said, come walk with us, look at all these vacancies, and we had a leasing broker there. And we tried to explain, see that vacant space there. There's a tenant who's already signed a lease. See that one. There's 2 tenants negotiating for it. But what you saw when you walk the street was just a ton of vacancy. Of the 14 vacancies on Greene Street, only one is left right now. People need to get back for many of us, right? This was the first conference we've gone to. It's the first time you see people out and back. And because Katy, you guys are always like music headlines, a year ago, it would be when I would walk in Soho, who are you going to believe, me or your lying eyes, right? And that's a country song for those of you who don't know. They're going to see it now, you're going to see it in tenant sales reports, you're going to see it in leasing activity. You're going to see it in our same store and our lease up. I think that may take time. I'm not a particularly patient person, but my guess is as people come back to these areas and see the results then hopefully that lag will end.

Can you talk about how retailers are thinking about the importance of flagship in street retail today? Especially for some of the retailers that may have started off as digitally native?

Yes. So if we were dialed back 5, 10 years ago, I would attend panels where retailers, the digitally native, which means the Warby Parkers and the Allbirds and a bunch of others like that. And we may never need a store. And then over the last to 5 years, they started collecting the data and here's what they saw. One interesting point is, and now that Allbirds and Warby, for instance, are public, their disclosure is a lot more transparent around that. But the sales revenues out of these stores were multiples of what that street would generally do. So if a traditional retailer was doing $500 a foot, they started seeing their ability out of the stores, separate of online would be $1,000, $2,000 a foot. Interesting fact number 2 that they found, when they open a physical store in a given neighborhood, they do not cannibalize their online sales, in fact, their online sales go up. Fact number three, the most profitable channel in some instance is the only profitable channel. Turned out that Google is not a not-for-profit company that Facebook cares about Facebook, and they charge to acquire that customer. The customer acquisition cost figured in as a factor of rent or otherwise, substantially less. And so what you're hearing from these retailers across the board is if they want to grow and scale up, they're going to need stores. These stores are going to be profitable, profitable quickly. And from our perspective, as a landlord, when we know a tenant is doing $1,000 or $2,000 a foot in a $500 market, we sleep better at night as well. Again, a small piece of our business, these are still young companies, targets our largest tenant, not Warby Parker, but it is a positive trend and again, reaffirms the importance of omnichannel in the stores.

I think one of the concerns with street retail is that the return of office being delayed could impact the pace of the recovery in traffic in these major CBD markets. So can you just talk about what you're actually seeing on the ground in your key markets?

Yes. So if you needed a -- the best metric to look at in terms of our tenant sales, and we thought it would be -- return to office would be really important. It turns out it really wasn't. It was return to the apartments. So you show me a market where you're seeing residential rent recoveries, and we're seeing tenant sales recoveries. Now return to office is still important. But we learned years ago and thus, a very small percentage of our portfolio is driven by office workers because what we realized a long time ago is not all foot traffic is created equal. And that shopper, in the morning, leaving Grand Central Station just wasn't spending the way that a shopper in Soho was spending. And I think that will be true and then -- so for that very small segment of our portfolio, where we have restaurants counting on mid-day office traffic. I think that will be muted for a long time. That is not what we do, but that is one of the areas that we'll have to wait for a return to office.

And do you anticipate the consumer spending environment will continue to be as strong this year, particularly with some of the macro headwinds now at play?

So first of all, I don't know. There's enough uncertainty out there. And let's start talking about how I was incredibly wrong 6 months, a year ago. We all dusted off our last war playbook, which was the global financial crisis. And so I assumed, "Oh, my gosh, the consumer is going to get crushed. And lo and behold, we climbed out of this recession with the consumer feeling better about their jobs, better about their stock portfolio, better about their housing values, bumped that they can't go travel internationally, and so they started spending. And first, we saw it in luxury and then it filled in. Now I'm looking at our tenant sales results compared to pre-COVID, I just saw some results on M Street in Georgetown, which I'd say is coming back that's coming back a little slower. They're already comping well in excess of pre-COVID. So I was wrong then in terms of how quickly this bounce back is, let's talk about what we see going forward. Not counting much on spend increase due to return to office, as I mentioned, not a big piece of what we do. I think we should expect some shift in the consumer in terms of moving back towards services, back towards travel, we do pretty well in that environment because travel includes going to Soho. Travel includes going to Washington, D.C. and going to Georgetown. The piece that we have to figure out is how much of the inflation that exists, and that will continue to exist, how much of that can get passed through to the consumer and which consumers. My hunch is wage growth, which has been strong, job growth that has been strong across the board, we're going to see those of our shoppers living paycheck to paycheck, being pushed the hardest, and then as you move on up towards the luxury scale, probably less so. Final piece of this is, okay, can, but people are going to get back to traveling. We're thrilled to be here in Florida. While international travel comes back, that shopper is a powerful addition that is not showing up yet. So the sales I'm talking about are before we get international tourists back to the U.S. and I think we will be pleasantly surprised by how robust that becomes over the next several years, counterbalancing some of these other concerns.

So maybe the same question but put into the tenant health perspective and leasing demand. Are you seeing that momentum fully continue this year? Or any sort of pullback based on the same macro concerns?

So far, tenant health is as strong as I have seen in a very long time. And let me explain what I mean. Retailers or rents, I'll pick on Soho, rents doubled from 2010 to 2015. Some of you in this room, we had that conversation of my saying trees don't grow to the sky. At that level, tenants performance was priced to perfection. Rents have receded back. So if they're down 50%, they're back to that same level. And sales are already well beyond pre-pandemic and are starting to head in some cases back to those levels. So the rent-to-sales ratio today on top line is as strong as I have seen in a decade. The question is how much of that gets pushed through to the bottom line and 4 of these flagship locations for these high grossing locations, remember, most of the costs are fixed. So a tenant who is pushing sales up 5% or 10% from $1,000 a foot is in a much better position than when they're doing $100 a foot of sales. And -- so far, we are not seeing the consumer complaining. We're certainly seeing supply chain issues that are concerning over the next couple of years, if the top line can continue to grow and even if the bottom line gets hurt somewhat, we still think those dynamics will lead to a very profitable position for our retailers.

And how are your tenants thinking about occupancy costs today in that light? And are you able to get any sort of enhanced disclosure on what the physical store does for their e-commerce sales?

Yes, and disclosure getting incredibly better for a few reasons. One, when companies go public, two, we know them well. But the most important reason is the best disclosure John and I get is when we take tenants out for drinks. You can't do it on Zoom. And so now that we're back, we had an ICSC in Las Vegas in December. We're getting back in front of our retailers in a more casual basis. Tenants are love to give out information publicly that will end up in their competition's hands, but they're more than happy to go out for a drink and there we can see which stores are doing really well, which aren't. What trends are working, what's the right size? It varies from our open-air suburban shopping centers through to our street retail. But almost without exception for those tenants that are winning right now, and there are losers still, right? There are tenants that got caught up in the retail armageddon that may exist today but that are not that exciting. I'm not counting on them. But those that are winning, their tenant health is as strong as I've seen in a long time.

We have a question online here. With vacancies falling and prime space in your core urban areas becoming harder to find, how long do you think it will take for asking rents to get back to prior peaks?

So again, let's use Soho since I was using that math. Rents would have to increase somewhere between 50% and 100% to get back to prior peaks. I hope it happens, but I actually hope it happens slowly. Don't get me wrong. We like to see movement, but we don't want to see a roller coaster ride that prices -- too many tenants out of business. If rents grow by 50%, not 100%, plus some nominal inflation over the next 5 years, and if we can capture our fair share of that. Keep in mind in SoHo, for instance, if the market went from $500 to $1,000 and from $1,000 down to $500, however you want and not every space is created equal. We're at $300 a foot right now, our basis. If we can capture that 50% growth over the next 5 years, we will outperform whatever forecast I was talking about earlier. So I hope tenants remain disciplined. I hope landlords remain responsible. We think as one of the few institutional owners in a lot of these corridors, we're in a position to curate for it correctly. We're in a position to respond to put in the right tenants to spend the money to put them in. But let's give ourselves 5 years.

Have you reached that inflection point where you find that you do have more negotiating power on the landlord side?

Yes. Yes. Well, so here's the other way to think about it. we signed leases during the pandemic. And I was pretty clear, guys, these leases are ugly, but we're not going to hold all our inventory. They were generally shorter term in duration, with fair market value resets, something that you only see in the streets, we do not get that in the suburbs. And so we knew we might be giving away rent for the next 1, 2 or 3 years. And then in years 3, 4 or 5, we get another bite at the apple, and that's playing out. So on Greene Street, we're fully leased right now. We signed a lease 4 or 5 months ago on Prince Street, which was exceeded our expectations, exceeded our pre-pandemic goals for that space. My guess is 3, 6 months from now, we will have been viewed as leaving some money on the table. The nice thing about these leases is we don't have to wait 20 or 30 years the way I have to when we sign a lease with T.J. Maxx rather they tend to rotate more frequently because of the fair market value resets plus while we're waiting, we're getting 3% contractual breath.

And so is it correct to think about that short-term lease expiration schedule meaning that you, in the next 1 to 3 years could have pretty significant upside in converting those back to more permanent leases?

Yes. Yes, not every space is created equal. Not every market has reopened as aggressively, as I said, look at where residential rents have gone in different markets, and that's probably the best proxy, but the short answer is yes.

And can you give us a rough idea of how much upside there is in converting from the short-term rates to more permanent?

John?

Yes. I mean, Kenneth pointed it to the 5% to 10% rather than every market, every lease is going to be different, but I think when we look at the 5% to 10% growth, and that's not a one and done, that's not 22, 23, that's several years. I think that's probably our best indication at this point is where we see the growth in the 3 buckets, as Ken mentioned, the 5% to 10%, it's the contractual with the Street getting 3%. The second piece of that is this market red, where we do have expectations where our basis is and to grow the rents above and beyond that. And the last piece is the lease-up, where we have a bunch of lease up in front of us. But I think we get closer to that 10% to the extent we're able to capture a lot of these pieces we talked about.

Maybe going back to inflation quickly. Can you talk about how that's impacting your ability to raise net effective rents and just your ability to maintain growth that's outpacing inflation going forward?

So let's start with simple math, and you used the word net effective, which is critical, right? It's what is the cost to put us the tenant -- put the tenant in. And in a market where we're collecting $10 net effective rent reverses a market that we're collecting $100. And keep in mind, in streets we're often collecting multiples of that. The cost to put the tenant in the $300 space is going to be more than in the $10 space, but not that much more. And even if it's double, the payback is a fraction of the number of years as for our net effective and our lower rent. So inflation is absolutely hitting tenant improvement costs and it's hitting it significantly. And what I would argue were what our fellow CEOs would complain about, it's really not the cost so much is can you get that HVAC equipment, can you get that tenant over? But that impact is not the same across the board and is hitting our lower rent suburban assets harder than our street. Inflation otherwise has so far not been a problem as long as supply has showed up. And by supply, I mean labor, I mean tenant improvements and I mean goods. And so if our tenants, whether it's a restaurant, apparel or otherwise, if they can get the people to work, if they can stock the shelves, they've been able to grow their top line and their bottom line. The real issue now we have to think about is just how bad will the supply constraint issues be? And how long does that take?

Maybe we can switch gears to your external growth pipeline. You recently closed on $124 million of new core deals. Can you talk about those opportunities a little bit more, the upside you see there and pricing?

Sure. So we have announced both last quarter and then to date, about $200 million of core, and John correct me about $200 million in the fund as well.

That's right. And again, on a very simplistic basis on an annualized FFO in terms of pricing, about $0.01 per $100 million. Let's start with the core. In general, and I think or I hope you can hear my bullishness about where we see rental growth for these key streets that we're active in, where we can buy that existing rents are at or below market. That could be a lease that was signed a year ago or at least that was signed a long time, where we can acquire those accretively day 1 in key markets, we think we will have outsized growth. Williamsburg, Brooklyn. We acquired a portfolio. There was some structuring involved, but ultimately, it was a lender who had started a foreclosure process. We knew the borrowers. We were able to structure a deal that works very beneficially for us where we think, along with the contractual growth, there will be opportunities periodically over the next several years to drive NOI growth well in excess of that 3%. Going in yield varies asset by asset throughout the portfolio. We added assets in West Hollywood, Soho, Washington, D.C.; Williamsburg, Brooklyn, blending plus or minus in the 4s and 5s, and I want to be vague about that because whatever I say comes back to haunt us. So if I said we bought it at 3.5%, well, it's not true first of all. Secondly, then every seller goes, I hear you're buying at 3.5%. And if we say we bought it 5.5%, everyone goes rushing out of this room and said, "Oh, my gosh, [indiscernible] 5.5%. But when we can get 3% growth plus upside, when we can acquire at yields that are accretive day 1 and then have growth, that feels pretty good. We're seeing that on the street side. When you think about the assets we're adding for our core portfolio in streets, it's where we're going to have outsized growth. Outsized growth that has inflation comes into the system, we'll have more bites at the apple, higher growth per year and the ability to pass more of that through. Then on the fund side, for the last 4, 5 years, we've been buying stability out of favor shopping centers where you could buy them at attractive yields and the benefit in the fund business is we can use leverage, about 2:1. And so the majority of our return comes from existing cash flow, held up nicely during COVID, a little trauma, but held up nicely. Those levered returns are there. I'm not expecting a lot of growth out of that. Maybe what we would have talked about as flat a year ago, is now up 1%. These are long-term leases. It's a good business. It's throwing off an attractive leverage yield, and that's continuing as well.

Great. So do you anticipate doing any more of these larger portfolio deals like the one you just did in Brooklyn? Or was that more of a one-off? And how would you say pricing compares for a portfolio deal like that relative to one-off transactions?

So first, you need to take a step back and realize that within the overall retail landscape, institutional capital is starting to come back in a few select areas, but for the most part, retail is still in institutional disfavor. And street retail in the key must-have markets, there's less competition than I've seen in a long time. Then add to that the fact that lenders are saying times up, that partnerships, investors, owners are beginning to say, you know what, this is not my core competency, I really want to focus on my office portfolio. I really want to focus on my residential portfolio, and we are starting to see more people coming out of the woodworks especially because there's price discovery. We now know with some level of confidence where rents and rent to sales should be in a given market. So a seller doesn't feel like they're just capitulating. They're making a calculated decision that this is no longer what they want to do and great for us. So my hope is that you will see interesting opportunities. Now the huge caveat to that is we are cost of capital dependent. We are going to acquire these assets only if they are accretive and it is very dependent on where our cost of capital is to the extent that our cost of capital is not there. There are other levers we have, selling assets, taking capital in from dispositions in our funds, a variety of things, but we are not indicating that we don't care where our stock price is, and we'll just lever up. That is not the case. So it is dependent on that. But I think we are in a very interesting sweet spot, if you will, where we really understand this space, it's hard. It took us decades to learn this side relative to our suburban side, and we think there'll be outsized opportunities.

Great. But 2 more quick ones on external growth. What new markets would you enter if you could gain immediate scale at a fair basis today?

Repeat the second half of that, which new markets?

Right. If you could gain immediate scale at a fair basis?

Yes. So pre-COVID and now through COVID, there are a handful of markets where population is above 1 million people plus where our retailers because a lot of this comes back to we ask the same question of our retailers. Where are you going for sure, not maybe I'll test it out. And there are a handful of markets that have benefited from in migration that are creating the kind of jobs that our retailers want to see their shopper showing up for and those would be, I'm not going to get into the specific markets, but in conversations with our retailers, of look what we did on Armitage Avenue. Look, where we own on M Street in Georgetown, look what is working in Soho or Rush Walton in Chicago. And where might you want to replicate that. And then thankfully, we are a landlord of choice. So retailers say, yes, if you're there, we would love to do that. And those will be the markets. And when we do it, I'll tell you.

Great. Before we go to rapid fire last one, any updated thoughts around Albertsons monetization plans in light of their strategic alternatives announcement?

Lots of thoughts. None of which I will share with you.

Okay. Fair enough. What is your #1 ESG priority for this year?

Quantifying the progress we're making.

Any specific?

I'm sorry?

Anything specific you want to highlight there?

I mean I think it's going to be around diversity hiring, I think that's going to be a big one. I mean our portfolio is very different given the Street nature. So I think certainly, we're, as Ken mentioned, quantifying so electric consumption of utilities is one that we're actively measuring and reporting on. So I think it's between diversity hiring and ensuring efficient and energy usage is one we're focused on.

Okay. What will same-store NOI growth be for your property sector overall in 2023?

3%. What would John say?

That sounds high. I think ours is going to be higher. But we're saying 5% to 10% for us, but I'm going to be optimistic and safer.

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

Saved by the bell. 2.75.

Okay. And will your property sector have more or fewer companies 1 year from now?

Fewer.

Great. All right. Ken and John, thank you very much.

Thank you.