Federal Realty Investment Trust (FRT) Earnings Call Transcript & Summary

Great. Good morning, everyone. Welcome to Citi's 2021 Virtual Global Property CEO conference. I'm Michael Bilerman. I'm here with Katy McConnell from Citi Research. We're extraordinarily pleased to have with us Don Wood from Federal Realty. This session -- and Dan G., who is just walking behind. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available up on the webcast. For those that are joining us on the webcast, if you want to ask a question to management, simply type it into the box, and that will come directly to Katy and myself, those are anonymous, and we'll do our best to weave those into the conversation. Don, I'm going to turn it over to you to introduce Federal, and you can introduce Dan G., too. And we have an opening question, but I'll let you introduce the company, and then I'll come back to the 3 reasons why someone should own federal?

That sounds good, Michael. And as I'm sure you would expect from my opening comments often go a little longer than you prefer. But I'll get it done as quickly as I can. Good morning, everybody, and thanks for giving us the time. I am Don Wood, CEO of Federal. This is Dan G., G for Guglielmone, G. is way easier, our Chief Financial Officer, who is every adept at modeling questions, by the way, so address them there, please. I know a lot of you on this, who are looking at this know Federal pretty well, been around a long time. I thought what I would do with my opening comments is make sure that this group understands the priorities that this company has taken or are set through COVID, which I think are a little bit different, frankly, than some of the other shopping center and the open-air companies. And so let me make sure you get this. Our company came into COVID with a really strong balance sheet, and that's important because that allows flexibility of how you handle things a little differently than if it's not as strong, obviously. It also came into COVID with a business plan that's frankly more complicated than many others. And so when you look at 75% -- 70%, 75% of this portfolio, it feels like essential-based services, grocery-anchored, drug store, et cetera, shopping centers. And those shopping centers, the difference with those shopping centers and others, I believe, is that they are very well located and very high-quality centers, but they are in the states on each coast that are subject to the most restrictive shutdowns and have been throughout that period of time, and still are today, which is a bit frustrating, I will tell you, but is the case. The other 25% or 30% of the company are nonessential, if you will, type of centers, more lifestyle-oriented, mixed-use, entertainment components, et cetera. Those properties, in particular, many of you know them by names like Santana Row, Bethesda Row, Pike & Rose, Assembly Row, Barracks Road, Village at Shillington, et cetera. Those properties have gotten hammered during COVID. And they've gotten hammered in terms of certainly the heavier food component in terms of restaurants that they have, in terms of the theaters, in terms of the gyms, in terms of some of the apparel that are part and parcel of them, in terms of the ancillary parking revenue that goes with them, the hotel revenue that goes with 2 of them, et cetera. That's understandable. Everybody kind of gets that. [ What ] I'm not sure they get is that those are the properties that really differentiate this company in terms of post-COVID. And so none of what I just said is a surprise to anybody. But when we went into COVID, we knew that we were not going to be able to compete with the notion of the highest collections, the least affected company, if you will, during COVID that it just wasn't going to work out that way, for obvious reasons. If you want that, that's a triple net company. Then next, a grocery-anchored shopping center. Got it. And down that list comes Federal. And so our priorities were different. Our priorities completely focused on post-COVID. What were we going to do? Because as many of you who know me know, I believe that retail -- that we are over retailed as a country. I still believe that, although there are sectors that there's been pretty good adjustments that happened during COVID that you need to be the consolidator in terms of your particular shopping center, your particular retail destination on the other side of this, the place of choice. And so if you just say, well, what are your priorities? What were they all through 2020 and 2021 -- with respect to COVID, what'd they be? I can name 4 quick ones. First thing was, we weren't going to fire anybody. And the notion of reducing to save expenses during COVID in terms of personnel seemed, for our purposes, shortsighted. We need those people. You'll need them on the other end. And in fact, we enhanced. We increased our leasing staff. We increased our development staff. And effectively, those are the places that we would be not only necessary doing the planning during COVID, for which we did a ton, but how we were going to be able to be prepared on the other side. Second thing, we allocated an incremental $50 million of capital. Didn't reduce capital, invested another $50 million or allocated another $50 million for about a dozen property improvement plans, we call them PIPs around here, all aimed at making sure that the particular -- this is about a dozen centers, that those dozen centers, which had great bones were better set up after COVID, more outdoor seating, better landscaping, more covered areas to the extent possible, better appearance. And importantly, and this gets to the third one, filled with the tenants that were critical before and need to be critical -- or will be critical on the other side, but not necessarily with the big national companies, those things that make the shopping center or the retail environment important to the community in which it serves. A lot of those are restaurants, other service type of tenants. As a result, we effectively converted out 250 of our 3,000 leases to almost percentage only -- percentage rent only for a lot of those tenants. Basically, what we were saying is we will absorb the volume reductions associated with this period of time when government is shutting things down and people are uncomfortable going into them. That certainly hurt in terms of cash flow, it certainly hurt in terms of collections as a percentage of the original contract. But to us, what it's done is to create a base of important tenants and important properties on the other side of that. The other thing we did. We kept the dividend. And it was really, really important. I know not everybody agrees with us on this. I do. And I do want to make sure that 2 weeks from now when my annual shareholder letter is published that you do read the rationale that I've got in there, we've got in there about the dividend. Because to us, it's part of the REIT bargain. It's a critical thing, not just for today. The first thing, it's easy to say, look, it's the cheapest piece of capital retained earnings to cut. I got it, I understand the math, believe me, I promise. I do. But with respect to the -- to what it says about -- to an investor about what's important to the company, I don't want you to miss that. And so please refer to that down the road. If we have time later, I'll read it to you, but Michael won't let me because we'll be out of time, I'm sure. Anyway, when you get through those priorities, down on #5 or #6 is maximizing the collections that you have. And it's certainly important, but it's not the whole game. So I'm going to stop, Mike, and turn it over to you.

I was going to ask you what that dividend was as a percentage of your FFO guidance for the year, but then I thought that wouldn't be appropriate. So -- and I was on mute, too. So we've started each of them. That's helpful. I mean, if I had to paraphrase what you just said is you took the pandemic to make investments, make investments in your people, your assets and your tenants, right? I mean that's -- instead of stepping back, you stepped in and you leaned in because you have the confidence in your business over the long term, and you weren't going to make short-term decisions in that realm?

I think that's right.

So we started asking every CEO, coming out of the pandemic, if an investor were to choose only one real estate stock to own, what are the 3 reasons why they should invest in Federal?

Yes. It's -- frankly, it's a really good question. And to me, it's a little bit of a softball because I just set you up -- set up for that question, I think. When you think about the 25% and 30% of the assets that we own, that have been disproportionately hurt and you think about what they are in terms of what they offer to the communities, where they're located, how the leasing is going, which I'll talk about in a little bit, that will be outsized growth for this company. And so when you sit and you think about those coming back, and I'll put some more meat around those bones later, #1 is that 25%, 30% of the company that will grow faster than anything else, I believe, the industry has. Secondly, that commitment to pay the common dividend, I believe and -- we've had a bunch of investor discussions in the past 2 days, thanks to you, and I appreciate that a ton, and way more than I thought, really appreciated the continuing of paying that. Of course, it's not guaranteed going forward. But know that it is what we are really trying hard to continue to do. And I think if you think about it, if you believe that we had a very strong portfolio before, maybe the strongest, and it will be on the other side. Today, you invest in Federal, you've got a 4% yielding asset -- dividend that effectively holds you over. First, there is a really nice buffer between direct investment in real estate and investment in stock until our markets are opened up, and we can make hay on the other side. So that's #2. And the third is the development and redevelopment pipeline along with acquisition dry powder, which increases that investor's chances for outsized growth and long-term value creation. Put those 3 things together, I think it's pretty compelling.

Do you think that there are private market investors that share your same enthusiasm about the recovery in that 25% of your portfolio where you're able to -- I know you and I discussed this at the Investor Day 1.5 years, was it 1.5 years ago? 2 years?

100 years, it feels like 100 years ago. But yes, go ahead.

The idea that maybe -- would you even contemplate, if someone is willing to pay you for a 25% interest in some of those projects at full values that you'd want to get, would you go down the road and do that or no?

Well, to me, it's a premature discussion in March of 2021 after this year of the pandemic. What we try to do is to produce, and we have not been successful in 2020, let me be very clear, a steady stream of increasing cash flows. It is to us the reason that we exist from the standpoint of long-term investors. And those assets clearly have those attributes, and we continue -- we expect them to continue to have that. But what other alternatives do we have at those -- at the times that you're thinking about that? And look, I am working for shareholders. To the extent there is a potential partial sale of an asset that is outpriced, I cannot ignore it, I will not ignore it. Not in love with anything other than producing a return that investors find compelling. So of course, it would be on the table. But when you sit and you think about it today, it's not a priority because I think there's years of outsized growth coming from those assets.

Right.

And Don, maybe you can talk, just coming out of the pandemic, does that make you think about your portfolio mix any differently for the long haul as far as how big retail could be as a part of that and the other mix [indiscernible]?

Yes. it's a great question, Katy. It's so interesting to me. I'll give you just one snippet of information how I was -- where I was really worried in April, May and June of last year. I was saying, you know restaurants are a great example of an anchor, if you will, that we used in a lot of that 25% to 30% of the company. It was very clear that thousands, if not hundreds of thousands, I don't know what the number is, of those small businesses will not make it, were not going to make it should we not rely on that going forward to accomplish our -- the way to bring lots of people to our assets. And I was really struggling with that in April, May and June of last year. It's now March of the following year. I'm going to double down. And I'll tell you exactly why I'm going to double down. First of all, the purge, if you will, has adjusted supply, which needed to be adjusted in a category that had, in my view, overextended itself globally or nationally over the last 10 years, as new restaurants and restaurant concepts proliferated everywhere. But what I'm seeing, and I'm just blown away by this, is the demand from either new operators with new capital or the other operators who are really good at what they did, who either we helped or are looking for something different, who are looking, from a demand perspective, at our places. The deals we're doing at Bethesda Row, for example, with respect to Washington DC restaurant tours that we wanted for years and could never get but are now open for that, that's kind of the urban and suburban thing that I'm sure we'll talk about to some extent, it's real in terms of the first-ring suburbs, the same thing is the Village at Shirlington. But it's really interesting to me how that's working out. Same thing is Assembly rather than Downtown Boston. It's -- there has been a change that way. So in relying on the food component, which I do not believe, well, human beings, I don't get how much you cooked at home, how much you worked on being home during this, I believe the takeout business is a different business that will be incorporated in more full service restaurants. That will continue. What has changed about that? The ability to go out, the ability to be more open to sitting outside, I think will be a sustainable thing. So we're adding tables, if you will, to a lot of these restaurants, and I think it will consolidate in fewer places. And I think we've got the mousetrap that works best for that consolidation, which I think will happen. It's a long-winded way for -- to talk about a one big component, but it's illustrative of how I think our mindset's changed based on early in COVID as we came through to, okay, here's -- we're seeing where -- we know where demand is coming from today. So you should expect the same basic things that we do well. And just to be clear, what we do well is, in our humble opinion, we put the right tenants together to create productivity that exceeds what they would be able to do alone. And to me, in environments that work real well for the communities in which they serve and places that work real well in terms of the real estate value. So that's what we do. You should expect us to continue that. I am long-winded. And I'm so sorry.

And now that we've seen some of the -- no, that was good. But now that we've seen some of the more restricted states like California and [indiscernible] Delaware start to lift restrictions, how do you think that's going to have an impact on your portfolio and those tenants, in particular, on classes [indiscernible].

I have to tell you a story that is so illustrative of what we're dealing with. So there are 360-some municipalities in the state of Massachusetts. All but one allowed some way for their theaters to be open. Somerville can't get it open, won't open. The Mayor, who was a good friend, who was really supportive, is very principled and does not want that to open. Even though a resident in that town can go to Boston or can go to Everett and come back and -- from being in a movie theater, et cetera. The impact -- I mean that is a tenant that pays us -- I'm not going to give you the exact amount, but it's more than a couple of cents a share. It's important. And so what that tenant does to the rest of the street and the small businesses on that is completely out of our control. Last night, I think, Maryland's Governor opened up Maryland, no restrictions for restaurants and things like that, for example. But it's going to be up to the Montgomery County, County Executive to decide to follow that or not. I would be very, very surprised if he decided to follow that. And so this is local. This has really been -- this has been something we've never seen before. And having said all that, with respect to that level of unpredictability, I can tell you that residents of the -- in the states that we are doing business in, I suspect you would agree with me, given where you guys are, are just dying to get out and spend. And any time any restriction is taken away or allowed, boom, as strong reservations are hard to get, people are all over the place. I think one of the hard things about the pandemic for the investment community and the sell-side community, both, is without getting out and kind of touching and feeling the real estate, like you guys did such a good job with over the years, it kind of loses a little touch with really what those differences are. And I think it applies to management teams, too, I mean, less so, obviously, because we know our properties are at them, but there is really something to be able to grab a cup of coffee, sit down and watch behavior, watch what people do, watch where they go, and I am extremely optimistic about that with respect to Federal's properties.

Do you think about those -- can you dial us into sort of what the retailers are doing from a leasing perspective because I think that's probably the most insightful in terms of their activities and how committed they are in terms of duration, in terms of rents they want to pay, the structure, how much money they're looking for you to support that and things like that?

Let's talk about retailers for a bit. So first of all, let's be really clear. I don't care whether you're a big, well-capitalized national or you're a small business or you're anywhere in between, you see blood in the water, and you want a great deal. Absolutely, [ barring that ] -- that is one of the few absolutes I can say about this business. That landlord and tenant, that tenant absolutely feels like they have leverage in most cases and are going to extract blood. The question is simply, what do you do with the landlord about it? And the answer to that is almost -- universally comes down to one question, what choice do I have? And the answer to what choice do I have is going to very much determine the structure of the deal that you're willing to cut or not willing to cut. And so from my perspective, going back to our base, when you've got a piece of real estate that is very desirable, and I just -- I'm not going to give you the specifics because I can't on a call like this, but we just did a deal with our largest tenant, which is TJX, I mean a very important retail tenant to us, obviously, great relationships. That -- where they have been trying to get into a particular location for a very long time. They already have another concept that's killing. And we were able to effectively do a long-term strong economic deal that we purposely wanted to be longer term because we liked the deal terms. That's terrific. That's not the case everywhere. In other cases, you don't have as many choices. You're going to have to do a more concessionary deal. And our job there is to keep it short, and effectively have it convert -- have it short for the COVID period, whatever that means, and then effectively go back to a market rent that is similar or better than 2019, as an example. And there's a lot of those that are going through. I'm just talking there about the nationals. Where the value in the company is going to be really added is in the shop going forward. And I just want to -- I'm going to bore you for a second, but I think it's important and it's illustrative, right? If you -- I asked our guys, grab me a list of the deals that we've done, the tenants that we've done deals with, obviously, there are multiple, where that started after COVID and finished during COVID. So these are COVID deals. And the first 7 or 8 titles on here can apply to any shopping center company because we're all doing deals with TJX, Burlington, Target, Amazon, Whole Foods, ALDI, Lidl, CVS, Five Below. Got it, right? We check out the other deals, check out the names on this list of this shopping center company that we cut deals with during COVID, good deals with. Nike Live, Athleta, Sephora, Warby Parker, Room & Board, Serena & Lilly, Arc'teryx, Vuori, Lovesac, Faherty, Bluemercury, CB2, American Eagle, [indiscernible], Ulta, Madewell, J. Crew outlet, Vince, new money, newly capitalized Gold's Gyms, Crunch Fitness, Wren Kitchens, Home Depot Design, NIC+ZOE, Shake Shack, Sweetgreen, CAVA Grill, Levain Bakery, Salt & Straw, Blue Bottle and a list of anchor restaurants as long as my arm. That's so encouraging to me because that's where the 25% to 30% primarily of the portfolio that is something different, is all about tenants saying, this is where I want to be. A lot of those we had not had in places, some we had, obviously, there's a mix in there. And the restaurant component of that, which are from either 1 of 3 places: downtown urban areas, that love what we're seeing -- what they're seeing in the first-ring suburbs and closed mall to open air and poor quality open air to better quality open air. That's a nice -- that's more pockets of demand than we had before COVID for those spots. So it's really interesting to me. It's only March of 2021. There'll be different perceptions in March of '22 and in March of '23. This has been and continues to be something that the world hasn't seen before. But anybody who knows everything doesn't know everything. But keeping your mind open and seeing the demand drivers change has been a very encouraging thing, I would say.

And can you talk about how the structure of some of those leases have changed, the COVID deals in particular and your strategy around signing some more short-term to that?

Yes. Well, first of all, the acceptance of doing concessionary deals to get folks in for the initial phases of 2021, and 2022 even to some extent, accepting that is really important. Once you accept that you think you can get the tenants that will long term really create something special. As long as we're not destroying value in the shopping center by agreeing to long-term subsidized leases, not doing that. I won't do it. I'd rather have it vacant. So as best we can, you're seeing percentage rent only -- or not rent -- I shouldn't say percentage rent only. There are some, but a fixed rent at a lower number, an unnatural breakpoint that effectively makes it very likely that percentage rent will exceed what we're underwriting. In fact, when you look in total, to the extent this economy really pushes it the way I hope it will in terms of people's pent-up demand and stuff, you will see some of those deals that are better even in '21 and '22 than the rents they were paying prior to that. But you got to go back to what it costs to be in our properties. And that's not going to be the weaker tenants that didn't make it through COVID or made it through barely, and -- it's not going to be those. So I guess that's my best answer for you, Katy.

Great. We do have a couple of questions here on the web. So I'll go to one of those. What would you view as your normalized growth rate for the business and then adding on to top of that redevelopment?

Yes. And it's a very fair question. I don't have a number for you today. I expect it to be, frankly, better than it was before COVID. So whether we're talking about 5%, 6%, 7% annually. On a normalized basis, it will be much more than that in '22, '23, '24. But I like the demand drivers. Do I know for sure yet? No, it goes back to what I said before. It will depend on a lot of things we don't know yet as a result of coming out of this. But that's kind of what I think on that. And on the development and redevelopment, there's no question. That's specifically the stuff that we've been building and doing. It is certainly the thing I'm less -- the least certain on at the moment, particularly the office component that we're leasing. We have basically reduced our expected yields on these, like roughly 50% -- sorry, 50 basis points, we that. 50 basis points over that period of time, but still in excess of 6% unlevered, which certainly will be FFO-accretive. And importantly -- more importantly, in our view, value-accretive to it. So that is additive on top. And then I -- it will be interesting to see what we find on the acquisition front because I'm very hopeful that we'll be able to find new raw material to federalize properties with.

And does your target market strategy change at all as you are thinking about future growth and migration trends that we've seen since the pandemic?

Yes. And I don't know if it's changed as much as I would say is we're more open-minded. And to it -- and I talked about this a little bit on the call. What I -- and a few minutes ago, I told you really what I thought our core strengths were with respect to creating value. But there are -- there -- the question of how much of the migration trends from COVID stick are real, how much of it reverts, et cetera. But I know in some of the markets that we've talked about, whether it's South Florida or could be Phoenix and Scottsdale or some others, what has been happening has been happening for the last 10 years. And that is better jobs, more barriers to entry in places that historically didn't have them, et cetera. That was going on anyway, COVID turned it off. And so to the extent what we were looking at superficially in the past as those markets changed are getting a far more focus than they did. But you know me, I don't go all in on anything, ever. So what I'm talking about is incremental change, and it's not to the detriment of the markets we're in. Because as I said, I honestly think the first-ring suburb thing. That's showing promise right now. So I won't be getting out of those markets.

Don, did you shed a tear when the Trump casino in Atlantic City got blown up?

First of all, my job was at the Taj Mahal, which is still standing. I wouldn't have minded if that one had. But anyway, so no, I didn't shed a tear. I haven't shed a tear one bit in 25 years.

I guess, how much retail do you think needs to go away for it to be a more competitive environment?

It's so interesting to me. It's not even about retail going away. It's about really understanding where relevant retail is. To the extent, retail is still there, but is not a choice for the tenants that we're looking at. I'm cool, stay wherever. It's really about the relevant retail that -- for which we're competing with. And we've been talking about closed malls forever. We'll see what happens there. I mean the best ones I would love to own myself as a [indiscernible], but there's a lot of space still out there.

Can you talk a little bit about sort of the acquisition side? But can you talk about your disposition plans and your capital raising plans? And which one is going to come first? Whether you're going to go out and buy something versus selling and raising additional capital?

Yes. Well, first of all, I don't see that changing too much in terms of volumes, from what we've done historically. One of the things that I like about are -- and this -- kind of this ties in with the dividend is, I want all capital markets available to us, whether we're talking -- when you go back to '09, we issued some equity, not a lot, but we issued some equity, we issued secured debt, we issued unsecured debt, we sold some assets. I love that it was all available to us. And I think part of the reason that it continues to all be available to us is because we don't surprise anybody with big pluses or minus. You know what you're getting. And so I want to be open to all of those markets and will continue to be in measured amounts.

I guess how much do you feel -- I guess, how much capacity do you have today? Where do you sort of feel like how much you can go and buy before you have to raise common or sell assets?

I think there's a combination. I think you can look at $300 million, $400 million, $500 million worth of acquisitions along with $100 million or $200 million of sales and even a little bit of common being raised, if -- at the right numbers, that's all fine. As long as it's all in balance, that's what we'll continue to do.

We have a few hundred million of excess dry powder before we get into kind of the choices of recycling and so forth. We're sitting with significant liquidity and feel really well positioned to -- before we have to have a sense of urgency on any one of the capital raising side.

For some reason, you turned on my Alexa. I don't know why, but she started going off when you're speaking, Dan. You have a special voice. All right. So we have our 4 rapid fire to close the session.

Well, am I prepared?

Yes, you got to check your notes. When we're sitting physically together in Florida a year from today, what will be the one thing that will have surprised people the most about your business over the prior 12 months?

Michael, I love that question. I really do. And I think I would say -- and you know me, I'm going to throw a little cold water on everything because I can't help it, right? I think the number of tenant failures that continue -- that happen in '21 will surprise you. I think it's -- there have been fewer in the first part so far. And I kind of get that because it's like there's that carrot and it's right here, keep going, keep going, keep going. But there are businesses that have done the best that they possibly can and our under business plans, anticipating a great result that probably won't happen. I don't think it's anything huge, but I think it will surprise us.

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

Yes, man. And I'm sure the lodging guys want me to say 150%, but I don't think it's going to be. I think it's going to be 75%, 80% of what it was. Now there will be pent-up demand. So there will be the need to get out and do that. I'm not sure it will happen the same way as it has in the past. And so when you talk budget in total dollars, I think there'll be -- I think it will be more constrained.

Okay. Same-store NOI growth for the shopping center sector overall in 2022?

I truly -- I'm not ducking this. I have no idea. I can't even give you a number, '22 over '21, '22 over '19. I just don't know. I don't think you're going to get a number out of me on that. I apologize.

10-year treasury a year from today?

2%.

Perfect. All right. Thank you so much for the time.

Likewise, man. Take care of you, guys. Good seeing you all.

Well, we'll do a session tomorrow just on modeling, is that okay?

I'll be in there. Thanks, man.

See you later.

Buh-bye.

Bye.