Acadia Realty Trust (AKR) Earnings Call Transcript & Summary

Pleased to have with us Acadia Realty and CEO, Ken Bernstein. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast, at the AV desk. For those in the room or on the webcast, you can go to liveqa.com and enter code GPC24 to submit any questions if you do not want to raise your hand. Ken, we're going to turn it over to you to introduce your team, your company, provide any opening remarks, tell the audience the top reasons an investor should buy your stock, and then we can get into Q&A.

Great. Good morning. Good to see everybody. Thank you for having us. I'm here with John Gottfried and Stuart Seeley. So let's get to it. First of all, in terms of 3 reasons to own Acadia, the way we think about it, we have peer-leading long-term internal growth that should exceed both inflation rate growth and GDP growth on a consistent basis. We have a differentiated portfolio and a differentiated focus that's in the early stages of recovery as well as the early stages of valuation recognition. And then finally, we have the potential for meaningful external growth, both on balance sheet and through our investment management platform. So now let me put a little bit of context around those 3 key drivers. The way we think about our company is to stay focused on 3 critical components. First is maintaining that strong internal growth; second is maintaining a solid balance sheet to give us the flexibility to grow; and then third is to be prepared for the external growth opportunities that are beginning to feel as though they are in front of us. In terms of internal growth, to be clear, last year, we had close to 6% same-store NOI growth. Year before, same. Forecast going forward, same. The reason we can do that is our highly differentiated portfolio where the majority of the growth, majority of the assets, come from street and urban. And the benefit of those assets, not only are we experiencing a nice recovery from the dark days of COVID, but we have, in general, 3% contractual growth, fair-market value resets along the way and important cyclical and secular growth that I'm happy to get into in the Q&A. That was most evident in our street retail, which last quarter had 10% same-store NOI growth, and we're seeing, thank goodness, strong retailer demand, and for reasons I'm happy to get into, a whole host of shifts of why retailers want to be in those kind of locations. Then in terms of a strong balance sheet, we did a small equity raise to get our ratios in line. And we will make sure that we keep our balance sheet intact, and it looks like this year, all of the different metrics are falling into place. Final piece. One of the other areas of differentiation for Acadia is how we pursue external growth, along with pursuing on balance sheet growth, and I'm happy to get into that because we are pretty bullish that, that's going to start showing up. We also have a multi-decade investment management platform that enables us to punch above our weight, add accretion even if the public market is not there and do a wider variety of open-air retail investing, and we think there will be opportunities periodically for that kind of investing as well. You put all of that together, and I like how we're positioned today. The backdrop for retail is positive. The backdrop for street retail is very positive. The debt markets are healing, both spreads and hopefully, base rates. And sellers are becoming more realistic, so the bid and ask spread, the ability to buy feels as if it's going to get incrementally better after a tough and quiet few years.

Let's start with the acquisition market, since you guys are definitely more excited than it feels like you have been in some time, and on the call, we chatted about this. Maybe just for everyone in the room who maybe wasn't on the call, walk through kind of how you guys view the different segments of retail real estate that you've historically played in. What is the most interesting to you today? And then we can have some follow-ups.

Right. And I'll break open air retail into 3 categories. And if you want to say there's 4 or 5, you're right. But we think about it as more junior anchor-dominated power centers, more traditional neighborhood supermarket-anchored centers and street retail. In terms of power centers where we have been active in our Fund platform, the thesis behind that was out of favor retail set to provide more stability than the market thought and we could buy in the 8s back before the Fed pivot. We were able to borrow in the 4s and get the majority of our return in a private fund format out of current cash flow. Needless to say, borrowing costs have shifted. Tenant demand is stronger, but cost of putting tenants in is higher. So net effective growth pretty flat, but you're, still close to 200 basis points wide of where supermarket-anchored centers are trading. And so I'd say that looks, on a relative basis, attractive, but you need to be really careful about CapEx. Supermarket-anchored is arguably the most crowded, most competitive trade in the open air space. They provide a good defensive backdrop. But if half of your NOI comes from low growth supermarkets, you're really counting on your local retailers to drive that growth. Just need to be careful about where we can expect that growth to continue. Finally, street retail went through a painful period. Places like SoHo, during COVID lockdown, was scary as heck. You're seeing a bunch of different tailwinds now that are causing our long-term forecasts to be twice what we're seeing in our supermarket-anchor, long-term forecasts of 3 plus, so call that 4% or 5%, driven as follows: 3% contractual growth, with tenant sales performance, top line and bottom line, being strong enough to easily cover that 3%; secondly, only in street retail do we get fair market value resets, which means rather than in our suburban centers where T.J. Maxx has contractual options to stay multiple decades, here, in order for the retailers today, they have to pay the greater of reset fair market value rents and a contractual bump; and we're also just seeing significant increases in retailer rents. So of all the 3 pieces, that's the one that has the most growth and yet for a variety of reasons, because of the interest in supermarket-anchored, we're seeing the ability to acquire those assets at similar going-in yields to supermarket with twice the growth. So that's how it's all stacking up when we think about where we want to put our dollars.

And post the equity raise kind of -- if you had to do on balance sheet-only, what do you think capacity is given kind of the internal threshold on where you want to keep leverage?

So historically, we have tried to acquire on a leverage-neutral basis, and I think you ought to assume we're going to do that. So I am not going to argue. And I don't think any of the REITs should be arguing. It's good time to lever up, right? Maybe a little bit, but that's not going to meet anyone's acquisition goals. We have institutions who are interested in taking OP units. We have individuals who are interested because of the tax deferral. So you can do it in terms of issuing equity on that manner. There's capital recycling. Expect to see us sell some of our more mature assets or recapitalize them. Maybe we'll hold on to a small piece and capital can come back from that, and other retained and return capital. But any way you slice it, on a leverage-neutral basis, we will only start taking down these deals if they are accretive to our growth strategy. And let me be clear what that means. It means earnings accretion, it means NAV accretion. It means accretion above the growth rate, and we are forecasting 5-plus percent growth out of our existing portfolio. So the bar is relatively high and yet because of the lack of competition, there are just fewer industry experts today than there were 5, 10 years ago in street retail. We are pretty bullish that we can be a consolidator for the public markets on a leverage neutral and accretive basis.

So if I read between the lines a little bit, you guys would probably love to do the predominant amount of street retail on balance sheet.

Correct.

You're constrained a little by capital, to some extent, to stay leverage neutral. And so that's where we would see you guys play more on your own, but you'd still bring partners in. But if you went into that power center arena, you probably do it with a partner because of probably the value-add component to stay above your 5% kind of growth rate, to have it keep accretive to that growth rate on an NAV and earnings perspective. Is that a fair way to think about it?

Yes, so -- that's one way -- that is correct. The other way to think about it is we have a variety of institutions that like to partner with us, like to invest with us. And when we look at a variety of different opportunities, we determine what is best to go on balance sheet versus in partnership. Stock price, cost of capital, absolutely plays into that thought process. And our goal for the REIT is to grow the street retail component on balance sheet to the extent we can. But if the deals are too large, or for whatever reasons, and there are institutions willing to invest with us, we as shareholders benefit by leveraging off of that capital. And we as shareholders benefit because there are additional economic benefits that run to the REIT, whether it was in our Fund business or in joint ventures.

You guys have a long history of good partnerships with deep-pocketed investors. It feels like from the commentary more recently, you want to move away from the fund structure, get away from that complexity, move more towards JVs. But what is the appetite of some of these capital partners today, given maybe some overexposure or other types of commercial real estate that aren't doing as well, to kind of deploy? What's that conversation like?

Yes. So let me be clear to your first point. As the world changes, we have to change with it, and the complexity that was highly tolerated a decade ago amongst Acadia shareholders, I think there's increased demand for simplicity, simplification of that side of our business, and we will do that. So do not think that just because there's compelling opportunities out there, we are going to ask the investment community to tolerate increased level of complexity. We -- and John and I talk about this all the time. We are keenly focused on the simplification on that side. That being said, 2 years ago, 3 years ago, I would define institutional investors as retail-cautious, then about a year ago, they were retail-curious. They're like, "Oh, we might want to invest in retail," but they had lost all the muscle memory around that. They were all in the obvious food groups and only are starting to inch back into it. And maybe now they're going from retail-curious to retail-serious, they need partners like us to be able to execute on that. And so it's actually kind of a fun time to educate really smart investors on the private side about how we could partner together. That being said, it would be for the other strategies that we have been doing off balance sheet. And it would be done with a focus on slowly but surely increasing the amount of our FFO growth that comes from our Core portfolio. Last year, our FFO -- stripping out our Fund IV moats and all that, our FFO growth was 7.5% from our Core portfolio. Our same-store NOI was 6%. Expect to see that internal growth hitting the bottom line. Expect to see the simplification. Even as the investment community, buyers and sellers start to move back to retail, we will position ourselves to take advantage of that as well.

Just a last question on acquisitions, and we'll move on. But you've said historically every $100 million or $200 million of deployments, about $0.005 or more. Can you kind of walk through the math that you guys used to generically get to that in terms of kind of cap structure spread on your cost of capital relative?

Yes. So I mean, here's the good news, bad news. With interest rates higher, borrowing costs higher, especially on the higher leverage private side Fund business, a lot of that accretion has gone away. And I do think that we're heading into likely an era where the utilization of substantial amount of leverage to drive returns, which is the private equity model, if you will, I think that's going to be harder. That's why I'm frankly more bullish today than I've been in a while for the benefits of the less leveraged public markets. And thus, the devil will be in the details as to how much accretion per $100 million. Historically, it was about $0.01. I think it probably today stacks up a little bit less. But like that old joke about having to outrun the bear, and if you don't know, I'll do it when the clock's not ticking, we still can move the needle faster than most, and that's what I'm focused on is we can create meaningful accretion per $100 million and $200 million of acquisitions, not per $1 billion or $2 billion of acquisitions.

Great. And so we have a couple of questions coming in from the audience. So first one, for the longest time, Acadia traded at the richest multiple in the group. What does the company need to do to regain that premium multiple?

Yes. So humbling to go through the pain of COVID and the lockdown. And we've now produced 11 quarters of peer-leading NOI growth. I used to think if we just showed 1 or 2 quarters, that would be good enough, that's just not reality. And so I think as we show the consistency of the internal growth and then have it show up on the bottom line, we will begin to see, and you have seen over the last 12 months, at least some of that progress. But the final piece of this is when it's time for offense. We're getting close to that. But when we have both strong and peer-leading internal growth combined with unique external growth, that's how we will regain that multiple. Between now and then, the outperformance at the stock will have to satisfy us.

You kind of mentioned moving away from the fund model. So there's evolution, but it takes time, right? You don't want to play whack-a-mole with every changing wind on what people like today and don't like tomorrow. So I mean how easy it is to kind of move the ship on some of these ingrained core competencies of the company versus maybe where the wins of sentiment are today and kind of to do something to satisfy a group of investors that may be punitive to kind of value inherent in the company.

So let me be clear. What you have seen us do is move on an incremental basis. You will continue to see us move on an incremental basis. If something was substantially broken, we could jettison it immediately. If something really didn't fit -- we once had a self-storage division. Great business, but it didn't fit. Post GFC, we got rid of that. What I see now are more incremental shifts towards simplification so that people can underwrite a stable stream of cash flow out of our Fund business, and it will be over any extended period of time, stable and reliable. It's just not going to be the engine for growth. And then for the REIT, the majority of our earnings, the majority of our growth is going to come from the street retail component wholly owned. And I think that makes sense given where REIT world has shifted, but we're talking about over many quarters, not over a couple of months. We don't need to do that. The business is quite good because the backdrop of 5 years of headwinds on fundamentals now feels like tailwinds. And frankly, these tailwinds are feeling more secular than cyclical.

Any questions from the audience? All right. So let's transition into -- oh, actually, so -- this goes to what we were just talking about. So it's executing on simplification. Is there any need to buy out partners in funds? Is that even on the table?

I'm sorry, could you repeat that?

Buy out partners in funds.

Not a need. So the short answer is no. And now let me add some context to all of this. I do think that now that we are not in a Fund VI, our investors are incredibly supportive. We have done a very good job for them, but they're also open-minded to concepts like recapitalization of funds, simplification, and otherwise as long as it works for them and we can make that work, we should be able to get closer to win-win. But you shouldn't expect any significant buyouts as much as a normalization, maybe taking some of these finite life funds and making them more long dated or evergreen. All of those are possibilities. Again, think of it more incremental than all at once.

Maybe shifting to sort of internal growth here. What is 6% NOI growth translated to FFO in the past? And just given higher financial costs, what does it translate to going forward?

John, why don't you take that? Assuming we're delivering 6%, and I get that it doesn't always equate exactly because of how the 6% might show up, but what should be the expectations out of our core FFO and otherwise?

Yes. So I think, Craig, if you look at this year would I think be a good metric for that. So I think if you look at combined pro rata -- our pro rata NOI, both Core and Fund, we're up about 6.5%. Removing the promote year-to-year, our FFO is up 7.5%. So that's a good proxy. And I think interest costs, I think on -- we felt the pain of the 400 basis points last year. So I think at this point, our interest costs, we have -- our Core is completely fixed. Our Fund has reset, has been mark-to-market. We've -- as we need to do in the Fund, it's shorter duration debt, a higher level of floating rate. So if anything, we have upside if we do happen to get any cuts throughout the year. So interest costs being fixed, we should, as the -- as our Core grows between, as Ken mentioned, the 5-plus percent over the next several years, that's going to drop to bottom line on a leverage basis, so call that 6% to 7%.

And I think a lot of the questioning around you and your peers this quarter was with maybe Bed Bath in the rearview mirror, as we look at '25, right, that timing drag should turn into a tailwind. And so I know you guys have always given that 5-plus percent, 5% to 10% kind of range, but how should we think about the potential if we don't see a substantial uptick in tenant credit issues manifesting in '25? Without pinning you down for guidance, but just you guys have always given the range. Are we kind of closer to the high end of the range next year potentially? Or -- and kind of how is that part of the story to regain the multiple and bring people back into the fold given that premium growth that you guys do offer relative to peers?

So I think the biggest thing to look at for '25, and we have a lot of leasing left to do that we're excited about re-leasing into a strong environment. But forgetting the speculative leasing, if you look at our Signed Not Open portfolio, we -- I think as Ken mentioned, we are trying to simplify the story, but let me talk about the way we do our pro rata piece of NOI. We're over $13 million, which is a very significant portion of leases that are already signed that are going to open over the next -- partially through '24, but into '25. So I think in terms of just embedded growth of things that are already signed, I think we're well on the way to a strong '25. So not giving '25 guidance, but I think from what we've done already, Craig, we feel really good about '25. And this is even before, as you mentioned, and probably worth repeating is our shareholders, as we felt the pain, as we -- Bed Bath occurred, as North Michigan and Chicago occurred, that's behind us. So I think that's one. When we talk about that next, that's going to be upside. That's not in '25. We're not expecting that to lease in '25, but if that comes back earlier than our models predict, that's upside as well.

And Ken, you talked about the resurgence here in street retail. And you've also talked about the evolution where it's not just SoHo, it's not just certain streets in the country. You're seeing retailers diversify their exposure to Sunbelt markets where in-migration has kind of gone. So I guess talk a little bit about the opportunity there longer term from a tenant perspective, but also just talk about -- one of the questions we got is kind of contrast the current rents and absorption in New York City street retail versus 2019. How does this differ between everyday and flagship locations? So maybe it's a very high-level question about tenant psychology exposures and just bring it down to what you're actually seeing from a rent and demand perspective.

So let's take a walk down memory lane over the past decade plus. Coming out of the global financial crisis, Street retail became an important component for retailers in the 2010 to 2015 period. Rents grew and grew too fast. Rents in SoHo, for instance, doubled. And we were all concerned at that point because the tenant health, the tenant rent to sales ratios, were not strong enough. And then with the onslaught of the retail Armageddon, which from a retailer's perspective was investors demanding online initiatives, you saw a real headwind, a real distraction by retailers and a real dislocations. Rents declined. And probably by about 2019, what retailers were telling us was that online initiatives are really hard to make a profit. Well, COVID hit and thank goodness, they had them for that period of time, but that fact is now well understood. The retail Armageddon, the thought that you can make a profit, that your online sales are pathway to profitability, that issue has passed. The other big important trends to remember at the same time was wholesale, defined as selling primarily through department stores. Wholesale has decreased as well. And what retailers are recognizing is DTC, direct-to-consumer, which in the early days, people thought it meant just the online retailers, now it means the luxury [ arm too ]. They want to control their relationship with the customer, and the best way to do it is to have impactful stores. Now the impactful store you might have on a Fifth Avenue or in a SoHo might be different than what you'd have in a Nashville or in Dallas, where we're developing on Henderson Avenue. But in all of those cases, what our retailers are saying is as follows: we are still going to sell through the department stores, but it's probably going to be less. We need to be in multiple locations. There are some markets where just being in our own store in a mall, it works, and others we want to be on those key streets. What Acadia focuses on is those key streets. So what we have seen in Melrose Place, for instance, rents today are at prior peak. That means better than 2019, and we have a waiting list of tenants. On much more humble but fun Armitage Avenue in Chicago, rents are back to prior peaks. We have a waiting list of tenants. The rent to sales, the tenant health is very strong. And places like SoHo, where rents grew real fast, not at prior peaks yet, but almost every space is spoken for, every space in our portfolio is spoken for. You take the 3% growth less the ability to mark to market more frequently, and that's how we're getting to this 5%, 6% growth. It's before we do any magic, and we pulled off some pretty neat magic where we pried loose the space, a 1-year-old lease, the rent spread after 12 months, 40-plus percent because retailers need to be there. And now this is true nationwide, or more or less nationwide. There's just been a lack of new development, lack of new product, retailer demand, shifting away from online, shifting away from the department stores and into their own stores is creating that phenomenon. Add to it a healthy consumer, especially at the higher ends, strong job market and that's why you are seeing these strong results, and that's why our retailers are making bullish bets. When you look at a retailer buying a location, in my view, that's the longest term lease they can sign. It's forever. And that's an indication of how they are valuing those kind of locations and that channel of business.

I'm going to put a twist here because we have a lot of questions, but I need to get to my rapid-fires, too. So let's do rapid-fires now, and then we can draw the session out until the end. So same-store NOI for your sector in 2025?

$2.5 million.

Will the property set -- will strips have more, fewer, the same number of public companies in 12 months?

Fewer.

And then what's the best real estate decision today? Buy, sell, redevelop?

Buy.

Okay. Perfect. All right. So let's go back. We have a couple of questions about leverage. People asking what your target leverage is and how you kind of -- what's the plan to bring it more in line with peers.

So John, explain how we are going to get our leverage to exactly where you want it this year.

So a couple of things, Craig. So I think when we look at -- from a real estate side, we look at debt to GAV. On that basis, we're very comfortable where our current metrics are. The other piece that we look at public market is debt to EBITDA. So I think post-equity raise, we're in the low 6s on -- just from our Core on a debt-to-EBITDA ratio. We want to be sub-6, and we have a plan to get there by the end of the year. So call that 5.75 is where we're going to be. And how we're going to get there, so I think our -- the equity raise we did accelerated, which would have been a 12 to -- pick that number of months, as our EBITDA continued to grow. So the way we get from the 6s to the 5.75, retain cash flow. Ken mentioned minor amount of recycling we're going to do, but we're going to get there organically just in the normal course throughout the year. And then as we go forward, that is a metric that we are going to be in the 5s. Each time we do an acquisition, it's going to check all those boxes. One of them being it's leverage-neutral, which, depending upon the cap rate that we go in, is somewhere between 30% to 35% is the amount of leverage that we'll put on to [indiscernible]. So retained earnings, capital recycling, normal course of business, EBITDA growth.

That's helpful. And then to revert back to street retail, there have been some very large high-profile street retail sales to luxury tenants. Is their view that they just want to control the location to perpetuity? Is that an opportunity for Acadia to sell an asset this is quoting at a stupid price to recycle capital?

So I won't chime in, whether it's smart or stupid. We have a high level of respect for our retailers and their commitment to locations is critical. Occasionally, it might result in us selling to a retailer, and that's fine. More importantly, though, when retailers are willing to make that kind of a long-term commitment, those are the anchors of the future. Those are the Macy's and Bloomingdale's and Barneys of the future, and we can draft off of that, knowing where they want to be, and we can partner with them, more importantly, because behind the scenes story also includes the reality that there's just a handful of high-quality landlords, well capitalized, well versed in the industry, understanding how to curate a block. And so our retailers are reaching out to us. I have lunch with all of those buyers on a regular basis and understanding where do they want to be, and 9 out of 10 times, they say, we'd much rather Acadia be that landlord. So whether we are selling to them, perhaps, but partnering with them or drafting off of them, that's the critical piece for growth.

And then I think this question is more about operating expenses, but how you managed to pass inflation on your tenants, maybe broaden it out, talk about some of the inflationary pressures you guys are feeling on kind of the cost side.

Sure. And because we are in the painful period of the Fed dealing with inflation, it feels like a headwind. And in the short run, it is, given interest rates. But remember, the decade of deflation or disinflation that we dealt with in the 2012 to 2020 period where, more or less, anything you thought about buying, if you waited 6 months, you felt like it would cost less, that's very problematic for our retailers and not great for growing rents. Conversely, once we get past whatever this period is right now, and I'm rooting for a soft landing but I'll let the economists decide -- once we get past that, if a tenant's top line sales grow at 2-plus percent just due to what I'll call healthy normalized inflation as opposed to zero or negative or disinflation, that's good for our rents. That means our 3% growth. Let's continue through the next session.

All right. Thank you guys very much.

Thanks.