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

Good morning, everyone, and welcome to our conference meeting with Federal Realty. Federal owns, operates and develops high-quality retail environment and mixed-use assets in the nation's top market. With us today, we have Don Wood, CEO; and Dan G., CFO and Treasurer. Before I turn it over to management for its opening remarks, I want to remind everyone if they want to ask a question, please use the Veracast software to input your question at the bottom of the screen. We will be looking for these questions and asking them on your behalf. I will now pass it on to Don Wood to start us off with an introduction and overview for Federal Realty.

Thanks, Craig. Good morning, everybody. I hope you're all doing well. I know most of you know Federal and know about Federal, but let me just kind of take you to where we are as we sit here in the middle of September of 2021. The first thing I want to tell you is at least at this point, the concerns about the Delta variant and what it has done to the momentum seems to have affected the company less than I thought it was going to. Sales remain strong. Traffic, certainly at the -- at our places remains strong. The lease-up of our development pipeline, which I can go through in a little bit, particularly as Pike & Rose and at Assembly Row has been really strong, and that includes office tenants and leasing. And so while there still remains uncertainty coming out of COVID in terms of the some of the uses is still like theaters, how that business will be going forward and even health clubs, and what's that like wearing a mask at health clubs. Generally performance is very strong. Certainly, the leasing level of activity is in all the facets of our business, and we're feeling really good. We gave you guidance, as you'll remember, on not only 2021 but on 2022. What we have said in the past continues. We feel very good about what we told you. And so looking kind of forward in the company. What I thought I might want to do is to tell you a little bit about the status of the big investments that we've made in development at an Assembly Row, for example, where you know that PUMA is our anchor office tenant there. That building is now 86% leased either under executed leases or executed LOIs at this point. The residential building that we have started to lease up there is well ahead of schedule. Over 200 leases have been done in that 500 unit building over the past few months, which is far in excess of where we thought that would be. And on our new retail of that Phase III development, we're 72% leased or under executed LOI. So the notion as to whether -- coming out of COVID, how well the mixed-use formula would work, I think that question has been answered frankly. These are those -- properties for us are the properties, which are recovering very strongly and our critical parts to the communities in which they serve. Similarly, at Pike & Rose, the office building that we built here is now 89% leased, they're either executed or executed LOIs there. So the same kind of thing, at CocoWalk, we're done with leasing. The office is fully leased, except for a 2,000 square foot spot and retail is 100% leased. So those tenants will be opening. Now because they're all leased, doesn't mean income is there yet. And that will take 2021, 2022, a couple will go into '23. But clearly, in terms of the development projects at Assembly, Pike & Rose, Coco, even Darien, which is getting going very nicely, very strong. Our largest unleased piece of development remains on the West Coast, and that is at Santana West, although activity has picked up dramatically in terms of tourists to the building and interest in that building. So my view, at least, that's only a matter of time. Last thing I'll say on the preferred -- in the prepared comments, talks about -- will be about our acquisitions. We've made -- Twinbrook was just done and announced last week which is a grocery-anchored shopping center here in Northern Virginia. That really jumps on to the 4 earlier ones that we talked about. And so we put over $400 million worth of real estate to work, and I want to call it, at COVID pricing because all of these were negotiated in the depths of COVID. The values of those shopping centers are far higher today. Trying to do acquisitions today costs far more. And so between the acquisitions we've made, the developments that we're leasing up and the overall portfolio, which was down 89 some-odd percent leased, which will find its way back to 94%, 95%, when you put all that together, we may be over $7 a share in the future. And I'm not saying that's '22 or even '23, but simply the notion of being able to grow through multiple growth channels well beyond where we were in 2019 is a really important thing, I think, a differentiator for investors of this company to understand. Maybe I'll stop there and turn it over to you, Craig, and some questions on any of that stuff or anything else for the balance of the time.

Great. What I'm most interested in is your opening comments about the Delta variant, the increases in COVID cases not really having an impact on leasing, that you're not seeing any hesitancy from your retailers. When you're talking with them, how are you understanding it? Is this something they just -- they want to get through it or they just don't think the situation at this point warrants a pullback in leasing?

Craig, it's -- you know me, I'm a glass half empty guy, I'm always protecting the downside. I'm always worried about everything. And I continue in that vein. But I firmly believe that most people are believing that as I do, that we're going to be living with this for a long time. that there won't be an end of COVID. That this is how we will live. And accordingly, stopping business and not doing business as a result of that is not really a viable option. And obviously, I'm not speaking for everybody. I'm speaking for the majority of the negotiations that we've been in the middle of, and there's always a lag time between events and the financial impacts of those events. But at this point, at least I feel like the momentum that started earlier this year with respect to leasing actually last year, with respect to leasing has continued. Will you see the same crazy levels of GLA that's being leased? Probably not. I mean there is certainly a catch-up period in there, but still very strong. And I see a nice straight even road, if you will, towards 2024, 2025 as these businesses are all living, if you will, with COVID.

Yes, we -- I would -- just having received August U.S. Department of Commerce sales, that was a real positive surprise. We also have our bank card data and it says that the week ending September 11, was very strong for bricks and mortar, clothing, department stores even, which is unique as well as teen and children's apparel. So it looks like maybe back-to-school happened later, but we're surprised how strong the results are. I know that you had a record volume of leasing. I think it was 124 comparable deals in second quarter. You touched on this, but do you think that elevated leasing continues through the rest of the year?

Well, do I think that the record levels of the second quarter will be met again? No, I don't. But I think elevated levels of leasing, yes, will continue. I mean what happened in the first 6 months of the year for this company has never happened before. And when you just kind of step back and think, well, what's going on, this is a portfolio of really high-quality stuff. And when this portfolio gets down to 89% leased or 89% unchanged, wherever we were as a result of this pandemic, that gives an opportunity for a space that hasn't been available before, not for decades. And so the notion of being able to upgrade your real estate. The notion of being able to come out of cities or supplement what's happening in CBDs with these first-ring suburban locations as good as they are, I mean, that's a very unique opportunity. And I think we did a good job selling that notion, but I think it was, frankly, quite obvious to a lot of retailers, a lot of restaurants, a lot of people trying to do business that had an opportunity to get into a federal property that hadn't before. And that will -- that basic notion will continue. So we're back up to 94%, 95% leased like we were as early as 2 years ago. So it will continue, Craig, just not at the level that you saw in the second quarter, I believe.

And is this elevated leasing, is it due to a growing universe of tenants looking for space? Or sort of are you stealing market share where tenants are wanting to use the COVID experience to trade up, if you will, to get into better standard?

I love that question. And I think you got both. I mean look, the way I put it, I -- when we talk about 2019, 2019 wasn't all that great, right? In our business, when you think about the retail real estate business, 2017, '18, '19, lots of things were happening. There were too many restaurants that had grown. The boxes were diminishing in terms of the number of tenants that could fill them, giving them more pricing pressure, et cetera. There were a whole lot of things. The grocery business, my gosh, what's the future of the grocery business. We forget about all of that. Post COVID, I firmly believe that our properties are better -- our business effectively is in better shape than it was even before COVID. And that's because of what you intimated. That is a market stealing -- market share stealing if you will, to the higher-quality assets from those tenants that didn't have the ability to do that before. There's a consolidation, if you will, consolidation to the best real estate, and that is consistent with almost all the leasing conversations that we have. And it's not like rent doesn't matter, of course, rent matters, and the basic notions of supply and demand certainly apply, but I can tell you, for the best real estate, we've got pricing leverage. And there's no doubt in my mind that the notion of almost every retailer wanting to improve their real estate it goes throughout the industry.

Great. And then maybe to pivot a little, I know you broadened the number of target markets that you've been acquiring, but it seems like Federal has gotten a little more aggressive in terms of acquisitions and you just announced Twinbrook. So if that is the case, why have you determined the time to get aggressive? Or what's to account for the, I think, 5 recent acquired properties?

Well, let me adjust your comment a little bit. I do not believe now is a great time to get aggressive. I believe 18 months ago was a great time to get aggressive. And it takes time. to work through those deals and effectively get them to the closing table to be able to be announced. Every deal, including Twinbrook, was negotiated during the depths of COVID, everyone. And as a result, I am thoroughly convinced that the $400-some-odd million of real estate that we got control of and have announced in terms of the 5 acquisitions that we've made were COVID-priced. That's all of them would be significantly more expensive today if you started those negotiations. And so I mean, there's a lot of talk, Oh, okay, let's get aggressive in acquiring. Well, you missed the window because there clearly was -- I mean I can give you specifics about a couple of them that I don't really think this is the forum to do, that really would -- that would have you say, "Wow, there is something to negotiating heavily in June of 2020 and July of 2020 as opposed to that same negotiation in September '21."

Are you looking at this period also to change any of your merchandise mix at your portfolio?

We've talked about that, frankly, ad nauseam internally throughout the past 18 months. And I got to tell you, I think what we got is the right way to go. And when you think about -- I think I made this comment earlier, but it still very much applies. When you think about restaurants and you think about food as a component of a shopping center, it's really an important part that we've effectively doubled down on because what happened during COVID, was, I'm going to get the numbers wrong, I'm sure, but well over 100,000 businesses, restaurant businesses, went away for good. It brought supply back to the 2008, 2009 time frame. That's an important thing. So now what we see, and we know certainly in the mixed-use property, but really in any type of community serving shopping center, having choices for food is a critical actor that brings in lots of repeat trips. And being able to pick the right operators, those that make the place a little different, a little special, are critically important. What has happened, if I could walk you through Bethesda, Maryland and take you through the leasing that we have done in the last 15 months, it would blow you away, Craig, because it would be not only food users, but other users that were historically in Georgetown, in Downtown D.C. and were not even considering moving to the suburbs in Bethesda, Maryland. And COVID allowed that to happen. And so the coalescence, if you will, of good operators in fewer places, I think, is a real positive And am I talking my own book? Sure. Because those are the places we wanted to be in and it's playing out as we thought.

Great. And then how many of your assets in your portfolio have a focus or a curbside feature? And are you hearing anything new in terms of how your tenants are taking advantage of the last mile?

Yes. Let's talk about that. So first answer to your question is most. I don't have it -- we have 105 properties or something like that. Most of those properties have a curbside feature. And let me tell you why, because in some of them, it's used and works much more frequently than it is in others. There's all kinds of variations on how much that works. But in all cases, it's a huge positive in terms of leasing because retailers that know that the landlord is open to and concerned with all facets of goods distribution, food distribution, whatever it is, suggests a much more open and willing to invest landlord. And that's become more important after COVID than it ever was before. So when we think about any shopping center. I don't care if it's Santana Row at the bigger side or Wildwood Shopping Center at the smaller side, every one of them is about creating a place that the community it serves can use for all sorts of reasons. That is -- if that -- mom picks up carry-out food from a curbside pickup at one point in the day, and that fully grown daughter or son hangs out at that shopping center with a cup of coffee and a laptop in the morning, then the whole family winds up coming back with friends for dinner at night, that's what we want the shopping center to be used for. Everything. We want it to be central to the neighborhood that it serves. And to central, you've got to have a full offering and not just a narrow targeted offering. So every place that we have we are aiming to do a better job. It's something that was always our core strength before but an increased focus on it. Yes, let me leave it there.

Okay. And then maybe turning to Dan, what's your current net debt-to-EBITDA ratio for Federal? And what range are you comfortable operating within for your net debt-to-EBITDA?

And from a leverage perspective, obviously, we didn't, during the pandemic, increase our absolute leverage materially. I mean, obviously, in that metric, the big impact was on the denominator, the temporary disruption that occurred. So as EBITDA -- 1 thing we're seeing is that our cash flows are coming back and snapping back a lot faster. Our goal -- before the pandemic, we were in the mid-5s, mid- to low 5s net debt-to-EBITDA. Ultimately, that is our objective. If you look at kind of an annualized last quarter and you adjust for some of the equity that's been raised on a forward basis but not yet taken down because we're still sitting on significant levels of cash at the end of the quarter, and the fact that we invested roughly $330 million worth of equity into 4 of the 5 assets that we bought. And they only had -- most of those were bought kind of in June. You annualize that for a quarter, it brings us back down to just above 6x. So we're well on our way to getting back to those mid- to low 5s. And I think we see that being achieved at some point during kind of the latter half of 2022 on a normalized basis.

Okay. And are we getting to the point where we might start seeing tenants move back to an accrual basis versus the cash basis that they -- so I'll leave it there.

Not yet. That will be done on a case-by-case basis. Once we see some real consistency and some -- yes, I think we need to get on the upside of work more on to the other side of COVID in terms of -- from that perspective -- we've always had a lot of our -- majority of our restaurants on a cash basis. So I don't think there's any intention to move them through accrual. I think we'll -- that will be -- that's how it was pre-COVID, and we expect that to be that way. Nothing in our guidance as any numbers in there with regards to reinserting the straight line from going from cash back to accrual.

I also think, Craig, just to make a couple of comments on that, investors are smart. Investors will back that stuff out in terms of growth should they be -- we are a conservative accountant company, and we've always been. My background, Dan's background. If I had my way, the whole company would be on a cash basis rather than on a straight-line basis, but I never had my way, as you can imagine. But the notion of effectively coming out of COVID and effectively changing cash back to accrual as a source for earnings growth, I think it's kind of bogus. And so you shouldn't expect to see -- you won't see any of it, frankly, in '21. We'll take it on a case-by-case basis as Dan says, in '22 and '23 and '24. But in any case, that difference is disclosed and should be adjusted for, in my view.

Great. And then what are your target volumes for annual development and redevelopment? And what are your projected yields?

Well, I'll tell you a couple of things about it. As you know, in terms of the big development, we are -- we still have money to spend -- a little bit of money to spend on tenant coordination, that kind of stuff in CocoWalk, moving in tenants at Pike & Rose. There's a lot of tenant coordination dollars that are to be spent on the big developments at Santana Row, Assembly Row, Pike & Rose, CocoWalk and Darien. So those are all individually disclosed and still have cash to go. But the other thing we're doing is over $150 million annually on redevelopments of existing shopping centers, which include stuff that is about making the shopping centers more relevant post COVID. It's everything I was talking about. The more outdoor seating areas, the better place-making throughout, the ability to use those properties as the center of those communities. Now it's hard to predict the yield in terms of what that does. It's not a -- it's not like, okay, I will do this and these 2 tenants come in, that we'll pay for. So I'm telling you from experience when we redevelop a shopping center like that, we wind up with effectively double-digit returns on an incremental basis of what we were getting. I can't put proof around that for the stuff that is happening now. We're spending $14 million or so at Bethesda Row for everything I just talked about. With the demand that we're seeing there, I know we're getting payback for that. We're getting paid back for it in space. But our business plan is different from a lot of the other shopping center companies. And so it's a little harder to say, okay, incrementally, this cause has this effect. But we know from experience that will wind up with double-digit returns when we redevelop a shopping center over the 5 years that follow the redevelopment of that shopping.

Okay. I guess I'm just curious, what do you think is the most significant difference between your REIT and the 17 other public stroke REITs?

You just gave me a layup, so I'm going to try to hit the ball, okay? Floris van Dijkum just put out a report. And the report was where the most valuable shopping centers were the top 50 shopping centers. You should take a look at that report. 19 of the 50 were Federal Realty. 19 of the 50. These are big assets. Generally -- our assets are generally double the size of the average shopping center, which is 125,000, 150,000 square feet in America. These -- they have other uses whether it's office, whether it's hotel, whether it's residential, et cetera, we look at things purely for the highest and best use of the real estate driven around retail base retail is what we know to be able to get people to a particular piece of land, but then what we do with them once we're there in the markets that we're in often allows us to densify, often allows us to get the best merchandising. So when I -- when you look at physically where we are and physically, the size of those shopping centers, and in terms of our skill set on what we can build and do in those places, I think it's a huge differentiator. When you look at our growth plans, and I'm going to go back to what I said before, we're not talking about just getting back to 2019, we have a plan in place in place with what we have today that gets us over $7 a share. Can't tell you the day and time we get there, but I can certainly go through the specific things, everything from the acquisitions to filling up the development that's already been built to the improved collections to the improved occupancy that creates that kind of number. Who's got that? It's a really different type of business.

Great. And then maybe you could tell us a little bit about your ESG efforts, ones that you're the most proud of.

I love talking about ESG because in this company, it's natural because of where we are. When you think of our investments that are in Maryland, here in California, they're in Massachusetts, you get the idea. We couldn't ignore ESG if we wanted to, and never have been able to. As a result, when you look at right where we're sitting at Pike & Rose, this is a neighborhood -- what's the designation? Help me with what we've got. Neighborhood lead gold certified. And one of the only ones of any public company in the country, the whole project, all of Pike & Rose. So when you say, well, how do you get that? Well, it's because there's a 17,000 square foot farm on top of the theater. It's because of the vast solar that we have, not just here but throughout the portfolio. It's because of the way we construct the buildings that we're doing, the operating systems that we have in them. It's at the forefront of everything we do from the standpoint of being carbon neutral as getting to that as best that we can. So if you go and you go online, you should take a look at our sustainability report. It's really good. And it's not just window dressing. It's real as how we run our business. Oh my gosh, shouldn't we have women on the Board? We had women and minorities on the board of this company since I got here in 1998, it's nothing new. It's the way we are representative of the markets in which we do business. It's something I'm really proud of. Sorry, you got me going on that.

Okay. And at this point, I'd like to go through our rapid-fire questions, and...

Well, you have rapid fire questions too? Man, I thought like we [indiscernible] All right, go ahead.

Well, but in turn, we allow you to get last 3 rapid-fire questions well, if you choose. But anyway -- and that's Dan's blue shirt aside. First question. One, which of the following is the greatest challenge facing U.S. REITs today? A, fed action and higher rates; b, supply chain issues, which we are including labor and logistics; or c, flow to non-traded REITs?

What do you expect?

I don't know. It's tough one. That's a good question.

Every one of those things is a challenge. If you ask me today, I do think supply chain issue is a big deal because it impacts labor. And these properties have to be able to be open. They have to be able to be good at what they do in order to pay rent. And so the fact that we're sitting in September of 2021, I do believe that will be -- that will find its way through. But it's hard to see today, and that is lasting longer then I had thought it would at this point.

Okay. The second question. Over the next 5 years, which market will outperform, Urban Coastal or Sun Belt?

I would love to give you an answer. It is dependent upon the piece of real estate. I can't be that macro because I don't believe in that. And that from standpoint of running a real estate company is we're making those decisions as to which will be the most effective on a piece of real estate by piece of real estate business. What I tell you is show you what we did at Grossmont Shopping Center with that acquisition in San Diego, California. It makes me want to say, well, that's going to kill us. So I'm choosing San Diego, California. It's not because of San Diego because of that particular asset. And I can go through the whole portfolio like that. So I'm sorry not to play along with that rapid-fire question.

Okay. And then the third one. For your company's office plans post pandemic, will you, a, have no changes from pre-pandemic; b, leave it up to the tenants; c, offer a hybrid; or d, go full remote?

Offer a hybrid.

Okay. I have 1 question from the field, and it says speak to your worst case of customers being impacted by the shift to e-commerce.

So when you think about e-commerce, it's such an important part of the economy and physical shopping centers are such an important part of the consumer economy, marry those 2 things and not separate them, marry them. And so when you talk about things like curbside pickup, when you talk about things like buy online, pick up in store, when you talk about things like socializing out of place that you can also physically buy. All of those opportunities, in my view, need to be available as a shopping center. And so I don't -- the type of stuff that we own, I don't see it as a crazy threat. I do see the United States of America being over retailed. I have forever, I still do. It's what drives us to make our particular real estate better. But if you've got the best real estate, why in the world would you not integrate online buying behavior with the physicality of your real estate and not separate? And that's the driver. So from a worst-case space, I mean, do you want to talk worst-case on a macro basis, it's going to accelerate the need for less physical retail overall. But when you think about real estate being local and might grow, Online shopping is simply an enhancement to the offering being made at the best places to gather.

Okay. That takes us to the end of the session. Dan and Don, I want to thank you for participating. And I hope you have a great conference.

Thank you guys very much. We'll see you all soon.

Thank you.

Thank you. Take care.