Acadia Realty Trust (AKR) Earnings Call Transcript & Summary

Welcome to the 10:35 a.m. session at Citi's 2023 Global Property CEO Conference. I'm Craig Mailman with Citi Research, and we're pleased to have with us Acadia Realty and CEO, Ken Bernstein. [Operator Instructions] Ken, will turn it over to you to introduce your company, any members of management that are with you today provide any opening remarks, and then we'll go into Q&A.

Great. Thanks for having us. To my right is John Gottfried; to my left, our newest addition, Stuart Seeley. I see a lot of familiar faces. For those of you less familiar with Acadia, we focus on open-air retail throughout the United States, and our differentiated strategy is through what we call our dual platform. That means that we have a core portfolio, and I'll get into some of the specifics around that, that is differentiated as well as we can create additional external growth through a series of discretionary funds and utilize outside institutional capital where we can do so profitably. In terms of the core portfolio, for those of you who not familiar, again, open-air retail throughout the United States, but with an emphasis, about 50% of our ABR comes from high demand retail in the must-have markets throughout the United States, the key streets, the key corridors. Today, that means D.C., New York, Boston, Chicago, San Francisco, L.A. and Dallas, and there are a handful of other markets that would also now thankfully into must-have locations for our retailers. After a bunch of really tough years during COVID, we are seeing a nice rebound in that side of our business. And during the Q&A, we'll certainly get into that. But with the pluses and minuses that are existing right now, what we are forecasting and delivering is same-store NOI growth in the forecasted 5% to 10% range. That means last year, it was 6%. This year, we're forecasting 5% to 6%, and we see several years of that. The good news is we think we're also at a pivot point because as critical as anything is that NOI growth, it's got to show up in the bottom line in terms of earnings growth, and we are now at that inflection point where some of the noise over the last few years, prior period rents, a whole bunch of other stuff seems to be normalizing. The growth in that core portfolio is going to come from lease-up recovery, is going to come from the rebound in rents, and the fact that in our streets, contractual rent growth is 3% and in our suburbs, the growth is 1.5% to few percent. Depending on everyone's view of what inflation might look like after the Fed announces mission accomplished, we believe that, that kind of portfolio with more mark-to-market opportunities after a bunch of tough years, that portfolio is going to drive the substantial portion of our 5% to 10% NOI growth. And then on the external growth side, the ability to leverage off of institutional partners and create external growth has been part of our DNA for decades. We intend to continue to do that, although what we have said is we are cognizant of the complications associated with that and the disclosure around it, and we believe we can manage that business in a more simplified basis and that provides more steady earnings visibility, and our goal for that, again, is to utilize that accretively as we see opportunities. Most specifically, Fund V still has about $200 million, $250 million of buying power left in it. We'll see where the opportunities arise there, and then we'll keep you posted as all of that evolves going forward.

That was great, Ken. So our opening question, what are the top 3 reasons that investors should buy your stock today?

Yes. So number one is the embedded internal growth. If we can be delivering 5% to 10% growth and assuming we can start delivering that to the bottom line, that's point number one. Point number two is for a variety of reasons. I don't believe the street is giving our shareholders credit for that embedded growth, and it's incumbent on us to make that clear to deliver it. And so from a valuation perspective, as the visibility towards that growth shows up, that's another compelling reason. And then the third is we have a proven track record and a team who can figure out how to take advantage of opportunities when there is dislocation, and if anything, in the last few years we've seen, there seems to always be a 100-year flood, every 3 to 10 years.

And you mentioned the valuation discount for some of the perceived complexity and maybe some of the messaging around how that premium same-store growth flows into the bottom line. I think you took a good first step here with the man to your left, my right to help with that messaging. As you guys have been talking to investors and over the past couple of years, John spent a lot of time on this as well, what's the low-hanging fruit from your perspective to dispel some of these miss or get over the hump for some investors who may say, Acadia is great. There's a little bit of complications, but it's a little bit smaller. What's the risk reward of doing the work?

Right, and I'm not a particularly patient person so when I say, well, I know that this should take time, but going through a global pandemic, when a big chunk of our assets were absolutely at the epicenter of the lockdowns and to expect everybody to wake up and say, okay, everything is fine now. I think we need to give people more time. And the fact that we posted very strong numbers last year is a step, but we need to continue to do that. So first and foremost, it's showing the portfolio's resilience. It's going to be showing the portfolio's resilience even with the so-called someday happening, looming recession that is in no way showing up in any of the metrics we're currently operating on, but getting past that point. So that's on the operating side, and I would say that's a significant piece of that. And then it's appreciating in ways that perhaps I know I didn't, when there were changes by the SEC in how we account for our funds. Well, we assumed way back then that everyone could take the time and energy to figure it out and to your point, for folks who don't know anything about Acadia for the generalists, maybe we are a little too complicated during a time of uncertainty. So we need to make sure we add that clarity. But the final point is, we've got to show the FFO growth that I now can see visibility on. And I think that lost the overall view of the ability to grow this kind of portfolio will make the difference.

And if we think about your ability to maybe deliver 5% to 7% same-store growth here, at least in the near term, and put that against maybe some CapEx needs of re-tenanting some of the Best Buy space, Bed Bath Beyond space that you guys have done down in Delaware and may need to do out in San Francisco. How should we think about the drop to the bottom line from an AFFO growth perspective versus that 5% to 10% same-store? Kind of what's the good way to think about that?

John, I'll let you add a little color to that, but just to be crystal clear, because you said best Buy, we have 2 Bed Bath & Beyonds in our core portfolio. One of them we've already announced is pre-leased. That's in our same-store pool, so there will be some downtime. The other one is part of a redevelopment and we can get into that as well. But you're absolutely spot on for our suburban junior anchor space, which is more dominant in our Fund V than in our core because of the cost of putting tenants in, the payback period in that business is becoming increasingly challenging in terms of having true, how I think about it, net effective growth. You articulated AFFO, and John will get into this as well, but very simply, to hold on to the same unlevered yield on an investment, we need about a 20% rent spread ideally to cover all of the costs. If you're really good, maybe it's a 10%, but you need meaningful spread just to hold on. That's a very small piece of our business to use simple numbers, if you have, and this is not the Bed Bath scenario, this is in general. If you have $20 rents, and it cost you $100. Well, that's a 5-year payback. In our street, if you have $200 rents, and it costs twice as much, $200, it's a 1-year payback. So from an AFFO perspective, if we can deliver what I'm articulating, I think that will be a compelling differentiator for our street and the ability to grow AFFO or net effective rents. But John, why don't you actually answer the question since I didn't.

Yes. So thanks, [indiscernible]. And what I would start with, so how much will drop to the bottom line. So if we look at, and we have for those of you that could go to our website and we give you a copy of our book, we have the internal NOI growth trajectory through 2026, and it adds about $30 million to $40 million of NOI. So what that is, is that is through lease-up, contractual growth and what we believe is a very conservative mark-to-market based on where rents are today. We haven't forecasted the rental growth. What I would say is that will be funded through internal operations and cash flow, meaning this will flow through the bottom line, that with our current dividend pay-out ratio, this is going to be sufficient to cover these costs. Then any incremental capital cost to get more than this $30 million to $40 million, that's not in this projection yet, meaning if we see accretion and we have redeveloped throughout our portfolio, if and when the time is right and it's accretive to do that, to spend that capital, we would do that, but we don't need that to get to our growth. So Craig, I feel like that answers your question, but this will flow through our bottom line given we are going to generate the funds internally to our current dividend pay-out to fund this growth.

Yes, without putting numbers around it, it's going to be pretty similar to the growth rate of your same-store versus the growth rate of the flow?

That is the target. Keep in mind, and I'm an accountant so I will apologize for it, but contractual growth is straight lined. So that piece of it will have an equalization effect, but the balance of that, which is both lease-up, mark-to-market, will have a direct correlation to our bottom line.

And we have a follow-up from the audience. May you please speak a bit about the embedded growth from your snow pipeline? How does that look like in terms of your overall ABR? And when do you expect to capture that by?

Yes. So I gave color on the call to that. So it's about, call it, $6.5 million of NOI that has not yet commenced. About 60% of that is going to start first half of the year, 30% second half and then 10% into next year. What is not in there, incremental to that when we look at growth, as are those assets that we do have in redevelopment, so think of City Center, which has an executed lease, 555 9th that has an executed lease, that is incremental to that $6.5 million that's signed, executed and largely paid for.

And the 555 9th that is the container store?

Container store, that's right.

I want to go back to the consumer a bit. I know the Fed is out with a little bit more hawkish commentary today here, but at the same time, unemployment still kind of strong despite their efforts. Consumer spending is somewhat steady, sentiments kind of improved. As you guys think about your portfolio where you do have the street retail aspect of it versus the traditional suburban aspect of it, how do you see this playing out from a leasing perspective maybe within those 2 buckets?

So the range of outcomes is still relatively wide because we will see what happens in terms of is it a hard landing, is it a soft lending, is it a no landing? But from a retailer's perspective and what we're seeing overall, I met with the majority of our retailers out on the West Coast last month at an event. And while they are certainly watching top line and bottom line impact of any shifts in the consumer and it's more consumer shift than it is consumer stopping spending. So when a consumer decides that they're going to travel more, for our portfolio, that's not necessarily bad for our stores in SoHo or our stores on Melrose Place. But what our retailers are really telling us, at least so far, while they're concerned about all of the so-called storm clouds out there, they are not slowing down on their lease execution, because by the time we get these stores open, probably a lot of these concerns will pass. So as it relates to leasing, do not see a sign of slowdown. It's hard to fully appreciate why, but the one thought that I think we all might be missing is what a pain in the neck, the decade of deflation that we oversimplified and referred to as the retail Armageddon, the headwinds from that, that ended in 2019, but then we got preoccupied by COVID, and so we didn't really think about it until retailers came out somewhat recently. And whether it's large retailers like Target or luxury retailers or otherwise, you are consistently seeing retailers saying the only pathway to profitability. The only way to continue to grow their EBITDA is through stores. And there's a tailwind of fact that we won't be able to measure for the next several years. But in the same way, I think that it was hard to appreciate the pain of the headwinds. I think we should enjoy those tailwinds that very likely get us through whatever the so-called landing is. However, what we should watch in terms of our existing tenancy is while increasing interest rates probably don't negatively impact Target or T.J. Maxx in a material way or LVMH for some of our mom-and-pop retailers, we should be cognizant of the fact that their access to capital is a little different. We have not seen a slowdown. We are not seeing any collection problems yet, but we did put out a healthy conservative reserve saying, let's see how this plays out because even though leasing seems to continue, and I think we're going to be in good shape, we need to be cognizant that there is a recession, and generally, it is our mom-and-pop or more thinly capitalized retailers that could feel that pain.

And there's a follow-up here. What are you guiding in terms of bad debt expense as a percent of NOI in '23? And how does this compare to your normalized levels?

So let me start total reserves. So I think if we look at our total reserves for our FFO, it's about 275 basis points. And as we look at it and what that's comprised of and think of it this way, these are 275 basis points of tenants that have a contractual obligation to pay us, right? That's a starting point, which is 4x our historical level. And then I'll get into the same-store question you're asking. And so this is right now, our guidance is 4x is what it's been historically. And I think the obvious next question is, is there something unique about our portfolio? Or can I and Stewart have a unique view of the economy as to why that's so high? What I would tell you is it's not, it's not an era of conservatism given we have some known items within our portfolio. We have these headwinds. You mentioned the one we just talked about. We put that in as what we believe is a very conservative estimate that even on the call I mentioned, we hope we beat this, which again, is 4x what it was historically. And let me talk about what I'm seeing on the ground, too, as we sit today. So each day, I come into the office, I look at really 3 or 4 things. First one is cash collections. So by the 10th of the month, so right around now, our tenants are obligated to pay us. And what I could say as of as we sit here in the third month of the year, it's exactly where it was when our credit reserve was at the 50 to 75 basis points level, meaning we're not seeing a deterioration in tenant credit. Second is tenant sales. We get from a large number of our tenants where our tenant sales coming in. They're hanging in pre-Covid levels. We're not seeing a decline in tenant sales, but then look at disputes. That's an early sign as tenants start disputing, so I'm not going to pay my CAM because, you know, making up whatever excuse they want to. We're not seeing a rise in tenant dispute. So I think the $275 million at this point feels conservative, but that's what we threw out there. And then when you get down to your specific question, in our same-store pool, we have about 220 basis points of credit loss in our same-store pool.

Great. I'm going to combine 2 questions here as well. The first one is just what do you think the mark-to-market is broadly in the portfolio? And then also, can you break out average contractual rent bumps between shop and anchor and then on a combined basis as well?

Yes. So I think what I'll start with is that 50% of our portfolio is coming from our street and that has a contractual 3% bump. So if we look at 50% of our ABR, grows contractually 3%. And then to break down to your actual question, when that blends, we're slightly north of 2% when we factor in our suburban and small shop space. So we're on a blended basis, a little north of, call it, 2%.

And then in terms of mark-to-market, so 2/3 of the street, I think our suburban is at or about market, right, that we have seen suburban rents after getting crushed during the GSC rise over the last decade, and they're pretty healthy. And again, if you have a very old box that had no bumps, there might be a mark-to-market. But the suburban side pretty healthy. And so we would predict and forecast inflation plus or minus growth, but no significant mark-to-market there. The street, about 2/3 of our portfolio is going to have significantly above average growth and a decent chunk of that is mark-to-market. We don't provide store-by-store, mark-to-market, that would do more harm than good for our negotiations with our retailers. And what I would just point out, SoHo, for instance, market rents have probably increased over 12 months, 20%, right? Melrose Place, significant rental growth because luxury is coming into Melrose Place, and that seems to be making a material difference. Supply and demand drives mark-to-market as much as retailer sales. So for 2/3 of it, that's what's driving the significant growth and there's decent mark-to-market that we had not yet given that overall, and we probably won't give that overall mark-to-market. Final point, though. Well, what about the other 1/3? The other 1/3 is not going to have that level of growth. We're seeing some green shoots in some spots, but what you should understand is with that conservative outlook for that 1/3, that is included in our 5% to 10% growth. So net-net, feels pretty good.

And we have a follow-up question on market rent growth. And it's just given the muted supply growth outlook over the next few years, how should investors think about the market rental growth across your markets of interest? Maybe give us a bit of perspective in terms of what the next 5-year growth will compare to the 5-year pre-pandemic historical average.

Yes. So there's really 2 things we think about or our retailers think about when we're negotiating rents, supply and demand, which is very important, and then rent to sales. And in both cases, and maybe rent to EBITDA depending on the quality of the store. But from a supply and demand perspective, we feel pretty good almost throughout our portfolio that the best assets, best locations will continue to drive and have a lot of retailer interest and therefore, we can drive rents to a point. What I don't want to see is what happened in Soho from 2010 to 2015 when rents doubled. That was not good for us. It felt good at the time, but that created a rollercoaster none of us needed. What I am expecting to see is more discipline from our retailers and where they can grow back into a healthy rent to sales. That's true whether you're talking about T.J. Maxx in the suburbs or an Aritzia on a given street. And what I do think is you will see our ability to drive rents in the suburbs, as I said, plus or minus inflation and then on the streets 5% to 10%, hopefully, for many years to come. And then our ability to mark-to-market, we have fair market value resets in our streets. We don't have fair market value resets in our suburbs, the ability to mark to market will be another way we can recognize that.

And it's interesting, because we just talked about the inflation piece of things, right? The cost of occupancy for some of these tenants is naturally going to decline, theoretically, even with the bumps you have embedded, right? So in an inflationary scenario, right? And even running at 6% to 7% is probably not ideal, but if you can get it down somewhere closer, right, if your bumps are 3% inflation is 3% to 4%, that seems pretty healthy for the market even longer term, right, just in general because there's no dislocation in that cost of occupancy for the tenants. When that comes up for renewal they're not claiming poverty.

So we went through, and this is important, I think, for all of us to understand, right? We went through a period of time during Covid especially where everyone is saying, "I want to own those assets with the cheapest rents", so retailers were focused on that, and it made a lot of sense during a period of real uncertainty. But if we get into a period of what I'll define as healthy inflation, so not the deflation that we felt during the retail Armageddon. There, more productive stores, higher sales, higher rents for us, is more affordable for the retailers because not all of those costs, the cost of labor, cost of goods. It's not the same in a store that's doing $40 million versus a store that's doing $15 million. So you're absolutely right. And then what we want to try to avoid is too many of the celebrations we had when we finally got back our $6 Kmart in Westchester a few years ago, put in BJ's and we were celebrating, but that took 20-some-odd years, and they had no bumps. So the way we're thinking about what kind of real estate do we want to own is stuff where you don't have to wait 20 years for us to get that mark-to-market. And again, that probably works better where we have stronger contractual growth, more fair market value resets and then from a retailer's perspective, their ability to drive top line sales because that really is the metric they think about when they're negotiating rents with us and their occupancy cost.

So same store NOI growth for the retail sector, not Acadia in 2024?

2.5%.

Best real estate decision today, buy, sell, build, redevelop or hold?

Hold.

And will the retail sector have more or fewer of the same number of public companies a year from now?

Fewer.

So another question came in, can you start talking about managing in a more simplified basis, still unclear how or exactly what you're going to do? Does this mean exit the fund business, add disclosure to help? Can you provide even more color than you gave.

I love when I say we're going to simplify and add more clarity and then I add less clarity. That is the nature of this evolution. But we recognize that as profitable and helpful as having one fund at a time has been, that probably having a more targeted approach where the earnings are more predictable where our access to institutional capital is still strong, it probably helps. I won't get into all the different iterations of this, but let me just use Fund V, which we have talked about publicly for a while. We have acquired and at our basis, well over $1 billion of high-quality assets. We're in the unlevered yield in the 8s. It has been cycle-tested, defined as it got through Covid, took our hits, we're able to successfully re-tenant. We think that portfolio, which is finite life, buy-fix-sell and would result in a nice promote to our shareholders that could get recapitalized that we could bring in new institutional investors, it could be its own vehicle, and there might be a more steady recurring fee stream that takes into account the profit and the hard work that we all put into this and that our shareholders would have a more predictable stream than one lump sum special dividend. You could then think through 5 or 10 other iterations of that. But you should know that we're thinking about different ways that we can make sure that we're not allowing the complexity of our dynamic model to outweigh the progress that we're making.

Shifting gears to maybe cost of capital, the acquisition market. At what rate would you raise 10-year money today? And how does that compare to your in-place cost of debt?

10-year money. Well, so for $50 million or less the banks are there. For $5 billion or more our last thing to be Blackstone and it's still problematic. So we are seeing spreads normalize to some degree, and then it's really about where the base rates come in. I don't know if there's anything more you want to...

The only thing I'd add to that, Craig, you said if we had a new disclosure in our supplemental that we have swapped 97% of our core. And we've swapped beyond the life of our debt, which means that economically, I could do, and we have the blended rate, I don't know it exactly, but it's about 2.5% is a blended rate of those swaps. I could break those swaps, 2.4% and put a 150, 200 basis point spread on that. And that's what I could borrow at economically by breaking the swaps as part of that. So I think that's where we have protection beyond the life of our debt through the swap market that we are constantly laddering our swaps to align with our maturities.

And before I go into the acquisition piece, just one quick follow-up on the occupancy cost ratios. Where are they now broadly across the portfolio versus pre-pandemic levels?

So thankfully, we took our lumps in terms of rents reset during the pre-pandemic retail apocalypse, and so most of our rents had reset. We don't have a lot of prior peak rents, but a bunch of our retailers are starting to achieve prior peak sales, and so rent to sales, if anyone's quoting one number and they have more than one tenant in their portfolio, they're fooling you, right? So T.J. Maxx's healthy rent to sales is fundamentally different than what Lululemon is or Apple and things like that. What we are seeing is our tenants health defined as their rent to sales for what works for them is at a very good point because rents are low, and sales are approaching prior peaks.

Then moving on to acquisitions. Can you please talk a bit about your external growth? What is your typical annual run rate in terms of volumes, i.e., development deliveries, acquisitions and dispositions? And how does this look like from a forward-looking standpoint, maybe touch on the associated cap rates?

Yes. So the market is pretty frozen right now. Keep in mind, in Fund V, we're sitting on dry powder. All we have to do is call for it. We have lines of credit. So we're highly incentivized to transact when we have willing sellers. The only sellers we are seeing in that opportunistic side are those who are being forced effectively by their lenders partners to transact and there's not a lot of that level of distress yet. But we announced we acquired a supermarket-anchored, but also junior anchored center in the Northeast at 8.75% cap, that felt pretty good even with increased borrowing costs. So there are a handful of assets that was last quarter. We expect that volume to increase, but I can't tell you when. On the growth side, call it, the street retail where we're seeing that, again, we're not seeing transactions that then more importantly, if we're referring to on balance sheet. Right now, our stock is trading at a discount, and it would be incumbent on us to think about buying stock before we were about to add more assets. We'll see where that market levels off right now, the marketplace does not seem to be rewarding or pricing in growth right now. There's not a lot of competition for when the stars aligned when we can go back on offense on that piece of the business, not a lot of competition out there. If we said we're going to go buy a bunch of supermarket-anchored shopping centers, you probably could think of a bunch of names to compete with us. When we say we want to continue to add in SoHo or in Dallas or in other markets, you're hard-pressed to mention folks that a few years ago might have been active, but they're focused elsewhere right now. In terms of redevelopments, we have, in Dallas, the opportunity to do some redevelopment there and elsewhere. That should add some additional opportunities.

Thank you guys very much.