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

[Audio Gap] McConnell. We're pleased to have Federal Realty and CEO, Don Wood. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are up here and available on the webcast. For those joining us here in person, to ask management any questions, please step up to one of the mics that are in the middle of the room. And you can also just simply scan the QR code in front of you and also type in questions and those will come directly to Katy and myself. Don, I'm going to turn it to you to introduce the management team that's with you today and make some opening remarks, and then we'll turn it over to Q&A.

Thanks, Michael, and I've said it before, but I just really want to say it in front of you to your face, what a great opportunity this is to have everybody back and doing this in person. The next 2 days, at least, from my perspective, the ability to talk to investors directly, not just on Zoom calls because we should have done a whole lot of them. But to specifically answer your questions and to do that in a collaborative way is really something I'm looking forward to. So thank you very much for that. Next to me, by the way, is Jeff Berkes, he's our President and Chief Operating Officer; and many of you know Dan Guglielmone, who's our Chief Financial Officer, who also will be here to present and answer your questions. All 3 of us are here for questions also. When we last met in person and -- we're going back 2 years now, we were announcing record earnings. We were announcing FFO growth every year for the previous 10 years. So we were the only shopping center company. Nobody else can say this, that grew their FFO from 2010 to 2019, every year. Absolutely, COVID threw us off. No kidding. So the relative makeup of our tenants, restaurants and health and fitness, a couple of theaters, that makeup certainly hurt us more during COVID than more commodity-based shopping center companies. But that's a makeup of tenants. That's same breadth and diversity of property type because we're not just grocery-anchored centers, we're not just power centers, we're not just lifestyle centers, we're not just mixed use. We're great real estate. No matter what format they're in, except malls. And our multifaceted business plan. Dan will get into that a little bit more, but a business plan that doesn't just rely on leasing up. It includes development, includes expansion, includes acquisitions, includes other stuff. All of those things together give us visibility not only exceeding -- or exceeding 2019 record earnings in the foreseeable future but really setting us up for a long run. We expect 2022 to be the second year of another 10-year run of earnings growth that hopefully plays out year after year after year, as it did from 2010 to 2019. Everything we see suggests that it should. And I think you'll see, as we talk forward today, that the reason we have confidence in that is because I think this is the most transparent, the most visible plan for growth among all of our peers certainly. And among a lot of other companies who are not our peers because we can show you precisely how we think earnings will grow significantly. It's not all that popular today to have a long-term business plan and to be all about creating real estate value over the long term. It's much more about what can you do for me lately? And I get that all day long, but we are a long-term company. We've been around a very long time, as you know, 54 years of increasing dividends. And so we live the long term. We don't just say it, we live it. And it's why over the last 2 years, we didn't furlough or lay off any employees during COVID. In fact, we expanded staff in a number of areas where we knew post-COVID demand would require it. It's why we didn't cut the dividend at the first chance we could, believing that the long-term benefit to our equity owners would far outweigh the marginal short-term benefit. That is a 54-year record that we have and that we think is important on the other side of COVID, as we come out now and over the next few years. We didn't curtail expansion at any of the projects that were already underway. We didn't stop focusing or we didn't shut down any of the levers for future growth and value creation because we believed in the recovery and where we are today moving forward. And all of that, along with the lowest cost of capital in the sector, when you put all that together, sets us up extremely well for continued growth multiyear, not just getting back to where we were pre-COVID. This will now be the third economic downturn in this century that I've led this company through: from the 2000 dot-com-led recession, 2000/2001; The Great Financial Crisis in 2008/2009; and now, COVID-19. And in each case, the natural reaction of many companies and the investment community was or is to circle the wagons and simplify, rely on only one way to grow, whether that's leasing up vacant space caused by the downturn or by spread investing on acquisitions or whatever. That one approach philosophy, one way to do it is often prudent and it's often successful in the short term. But the simple fact is that creating real estate value over time, it's a tough business, and it takes a wide range of skills to maximize that value. It's why we choose to take advantage of all the tools in the toolbox to create value whether it's leasing up a portfolio that is still running at higher vacancy than historical levels, whether it's redeveloping our existing high quality centers, expanding all of our established and stable mixed-use communities with sizable investments that really move the needle or using long established relationships with potential sellers to acquire our type of high-quality real estate for future growth. The skills to be successful at all of these ways to create value can't, in our view, be easily turned on and turned off. It can turn down the needle, the knob -- turn up the knob depending upon market conditions, you got to keep it all going if you're going to be good at it over the long term. If you're going to create value over the long term, you need more than being a one-trick pony. And with that, let's see what Dan has to say.

Yes. I just want to spend a little time expanding upon some of the growth levers that Don just outlined. I'd just kind of go through and put a little bit meat on the bone for each. The first one is just internal growth in the existing portfolio that we have. Now we're forecasting comparable growth of 3% to 5% this year in 2022. And that's after 300 basis points of drag from prior period rent falloff and from a lower forecasted term fees, which helped us in 2021. And now without that drag, it would be 6% to 8%. Now what's driving that robust top line growth is really occupancy. Occupancy growth driven by unprecedented new leasing volumes. It's driven by contractual rent growth. Bumps in our leases, we still get blended, 2% per year across our portfolio. It's increasing rents from new and renewal leases. And it's really coming out of COVID, moving temporarily modified leases back to contractual rents that were in the leases prior -- pre-COVID. It's continued improvement in collections back towards pre-COVID levels. But it's also because of the diversity of our portfolio, it's also improved performance from other aspects of our portfolio, our residential, our parking and other segments. Now the 3% to 5% net number translates to roughly $20 million to $30 million of comparable POI in 2022 over 2021. And we expect solid internal growth again in 2023, given the dynamics that we're seeing. The second piece is growth from development and expansions at our existing properties. Properties that are exceptionally successful. Retail environments are ready, which meaningfully derisks the allocation of capital into redeveloping our existing portfolio, doing expansions at our large projects. We already have a $1.5 billion project -- pipeline that's in process, and $1.1 billion has already been spent and largely has not been yielding and contributing in 2021. Now we forecast approximately $60 million to $65 million of incremental POI to come online over the next 3 years with roughly $25 million of that coming on in 2022 alone. Third, the acquisitions that Don mentioned, we had a successful year in 2021 acquiring, but we still see additional opportunities to leverage our long-standing relationships with sellers to acquire new products at attractive returns. And as Don mentioned, we did not turn off the acquisition focus during COVID. And in fact, we turned it up and we acquired 5 assets for gross investment of $440 million at cap rates that would be more than 100 basis points tighter in today's market than where we acquired them. We underwrote them at 5.5% cap, they're yielding a 6%, and they would sell today at a sub-5%.

It sounds like you send a -- sell an interest to a joint venture partner at that value and reap the proceeds.

Don't take the bait. Don't take the bait. Don, what would be -- we've kicked off each of these sessions by -- I'm going to ask every CEO, if you had to summarize 3 reasons why an investor should buy your stock over any other of the 150 companies that are here at the conference. What are the 3 reasons why they should buy Federal?

I just did this long thing about long term, but the #1 reason is a short-term thing. We have underperformed as a short-term thing. We have underperformed significantly over the last 90 days. Bottom line is this is the best entry point on a relative multiple basis to get into federal that there's been in a long time. I think that's #1 reason if you want to make some money now. Secondly, it's a couple of things I've talked about before. It is the most visible path to growth for not getting back to '19, it is the most visible path for a multiple year growth plan because of the things that Dan mentioned, #2. And the fundamental prospects that particularly the mixed-use properties, high-quality centers and first-ring suburbs, they're better post-COVID, they're better positioned post-COVID than pre-COVID, based on what has happened with consumer preferences, what has happened with the need for socialization, frankly.

Right. How much of a risk you talk about having gone through 3 major recessions over the last 20 years. And I think you made a comment about the next 10 years being -- seeing this immense growth. We're in a position today where the macro environment is not as robust as it has been over the last number of months. How do you sort of weigh the next 10 years from a rising rate environment, an inflation environment that seems to be a little bit out of control. And how much can the retailers really push that pricing to have profitability to be able to pay your rents? And like is that not more of a concern as you look forward?

Absolutely, it's a concern. And the -- and it's -- honestly, it's always a concern, right? How -- if you think about how long we've been talking about, it's been 20 years. When we were talking about, gosh, inflation has to start, 20 years, "Oh my gosh, how are rates not higher. They're not going to stay the way they are." When I talk about that next decade of what we're going to try to do. I don't know, obviously, how bad inflation is going to get. I don't know how rates are going to go. But I know how to set the company up for us having a relative best chance to handle it. And I think that's really the most important point. When you think about strength of balance sheet, when you think about where you are physically in terms of the properties themselves and what the ability to backfill is. We're going to take you, and hopefully, I meant some of the people in this room, down to CocoWalk in South Miami tomorrow night for an investor conference. And one of the things I want you to think about with respect to your question, Michael, is how that's going to perform going forward. There are absolutely restaurants and lifestyle tenants that I think you'll see are killing it. But that's not the point you're asked. When they can't, to the extent some of them can't perform, as will be the case. What happens? And when you see physically where they are, when you understand the demographics of the people that live and work around there, ask yourself the question, ask us when you're there -- the question, what's the backfill going to be like? Will you be able to get more rent? Will there be demand that exceeds supply? And it's those things that I am certainly no economic genius. Frankly, I'm not sure there is such thing as an economic genius just based on history. But the notion of being prepared to relatively be able to perform better is really what that whole setup is about.

And then how do you -- you talked a little bit about having -- not being a one-trick pony. I don't know if you said that, but there's something about not being focused on one thing. The joint venture side, and I sort of gave Dan G. a little bit of a push on that, that's not been an area that you have felt that you've needed. I think in part because you've wanted to control the best sites and take all the growth for your shareholders. And to be fair, you always traded at a premium that gave you an equity cost of capital that you didn't need other people's money. Has your mindset changed at all having gone through periods of time where that money may not be available? And you talked about trading at a discount now, so how do you sort of put all those pieces together?

Yes. Well, I love that you know us as well as you do because, first of all, you set that up exactly right. The bottom line is opportunities to invest at places lower risk because you've already created them. They already exist. I mean building an office building at Assembly Row or Pike & Rose or Santana Row, a place that's already been set that we've spent a decade or 1.5 decades, getting to be the key place there, you're darn, too, and you want to put your capital to work at those places because on a risk-adjusted basis. That's a really, really good investment. Sharing that is potentially necessary, it's never been for us, but potentially necessary and an option to the extent that it changes. But the other thing it does, and I think this is underestimated a lot. A joint partner means that partner has their opinion and controls and impacts the way the community, in the case of a large mixed-use property, will work. There are certainly places within that, that we could take money off the table through a joint venture partner. We will look at that over the next period of time to effectively do that but only in places where we do main control because, quite frankly, I think you'll see it at CocoWalk tonight -- tomorrow night. That level of control really adds value over time. So yes, it's on the table. When you've got the opportunity to put your money to work on a risk-adjusted basis, which is one of the key things I don't think investors understand about Federal. I know it's a question coming up, and I'll have some other answers for it then, but the bottom line is when you have established places and a low cost of capital, building a building at one of those places that is already established is on a risk-adjusted basis very, very different than putting capital to work on a stand-alone building in a place that's not tried and true. It's a big important part that I think is critical to what we do.

There's a couple of questions that came in here about construction costs rising and development yields, given those higher input costs. Given that development and redevelopment and building is a core piece of the growth plan, how do you sort of evaluate when the right time is? And are rents keeping up with that level of construction cost increase?

Yes. Let me give you a couple of things on this because it's really -- it's a critical point. It starts actually with inflation, in general. And I didn't want to forget about making this point. Inflation, not runaway inflation, but inflation at 3%, 4%, 5% is a good thing for our business. And if you're in the right markets, when you go in Bethesda, Maryland and that lunch, which used to cost you $11 now costs you $15. You rub your neck and you say, "Gosh, that's a shame." And you pay your $15, and you move on your life.

It's $19 here for breakfast in the...

It's probably not there either, but you get the point. Okay. So the notion of being able to pass through inflationary price increases in certain markets is way different than the ability to do that in other markets. And I just -- I think as you do look out the next 10 years, when you talk about how to best be set up, you want to be in markets where people make money and have the ability to complain about the rising prices but pay them. Same thing at the gas pump. Not saying it's not important, it's relatively easier to push through prices. That applies to construction projects, too, and not completely. So there will certainly be deals that don't make sense because of construction prices that hit a certain level, and we can't get the rent to do it. But generally, in the markets we're talking about particularly at the mixed-use properties, which have come out of COVID crystal clear, more important to their communities than they were going into COVID. Clearly, we see it in the office leasing that we're doing. We see it in the residential leasing that we're doing. We see it in the retail leasing that we're doing. These are the products and the places people want to be.

So does that mean, Don, I remember back at Investor Day, you had the piechart about what you wanted to become in terms of property type, resi, office and retail. Has your mindset now changed that you want to go even deeper and just be a diversified REIT that leads with retail, but is in all these other asset classes, and retail could shrink the 50% of the portfolio?

Unequivocally, no, we do not want to be a diversified REIT. And let me explain this because this has not changed. I'll take a little bit of issue with the characterization just to make sure we get this right. We are a retail-based company. All that means is what we think we're pretty darn good at is bringing people to a piece of land to shop, to live, to eat, to do their -- to live their life. Once we have those people with that curation of tenants in that piece of land, why wouldn't we create value on that site by going up. And I don't think there's a way to do a 13th floor retail building that makes any sense in the world. So you look for other uses. We are, today, about 10% of the income stream is residential base, about 10% or 11% is about office based. The reason that, that is happening is because these -- the large projects that we've built are decades-long projects. And we are in the period of time in their gestation where it now makes sense to add those other uses. We're not trying to become a diversified REIT. We're not building office buildings standalone separately or residential buildings of any size standalone separately. What we're trying to do is to maximize the value of the real estate on the pieces of land that we've taken a decade or 2 to establish. So as you look forward, we're always going to be, as long as I'm around, a retail-based REIT because that's what we do the best. You should assume 75% at least of the rental stream comes from retail. But the piece, the other core, 20% to 25% that will -- does or will come from those other uses are only because they're drafting off of that retail base.

And Don, maybe just going back to the office side of things, given you're starting some new phases of development in office today, can you just discuss what gives you conviction in the sector and the markets, in particular, where you're pursuing growth there?

I'll let Jeff to talk about office, in particular.

Yes. Katy, good question. Look, we've been adding office space in our mixed-use developments for a very long time, starting with the Bethesda Row over 20 years ago. And if you look at our bigger mixed-use projects and some of the smaller ones, too, like CocoWalk at a point, we have 1.6 million square feet of office space today that's 95% leased. Now obviously, that doesn't include the 2 buildings that we are just wrapping up development on or in the case of 915 Meeting Street at Pike & Rose that we've just started development on. But our office space has performed historically very, very well within our portfolio. From a development perspective, we love having office because the office building pro forma pays for the parking that the retail can use nights and weekends for free. We love having the office tenants at our projects during the day, during the week to drive traffic and drive sales at our retailers and restaurants. But more importantly, the economics of doing office in the type of environments we have is very compelling, and COVID has made it even more so compelling. A lot of the leasing that we've done during COVID is because businesses want to get their employees back to the office. So what do they need to do to get their employees back to the office, they need to give them a safe place to come.

Double my comp.

What's that?

I said, double my comp. I'm in the office every day. That was a joke just for the record. Just for the record, it's a joke.

Thank you. They wanted to have a safe place. The employees are demanding a safe place to work. They want a new building with all the state-of-the-art systems for moving air and getting up and down in the building. But more importantly, they want to be -- they want to provide a place for their employees to come that their employees are going to enjoy coming, and amenitized office space is what it's all about. It has been that way in certain of our markets for the last 5 or 10 years and COVID has driven that home even more. So we're very, very bullish about adding office and adding it in the mixed-use environments where like Don says, we've spent 10, 20 years creating a great place. So happy to be doing it.

And just let me add one thing to that point because I think it's important now. Don't misinterpret those results to mean we think the future of office in the United States of America is great. Okay. First of all, we don't know. We have office in precisely 4 locations. And...

Precisely 1.6 million square feet.

And only in places where we have built the retail amenitized base. Every deal we're doing is a tenant who is downsizing. Every retail -- or every office deal that we're doing is a tenant who is in x amount of feet and now they're in 80% of that amount of feet. So the people -- the office tenants are -- we are seeing them taking less space, no question, but they're taking it in our places. In the places that, as Jeff described, are completely amenitized and convenient to be able to hire and retain employees on. That's the importance. It's just like retail. All office is not created equal, all retail is not created equal.

Maybe on the acquisition side of things, we continue to hear about cap rate compression, especially in the shopping center space. So I'm just curious how much lower you think cap rates could potentially go over the next 12 months? And how do you think about your ability to remain competitive in the bidding process for assets with a lot of capital-chasing deals today?

That's kind of like the interest rate question, right? Who knows? Hard to say how low cap rates can go. There's a wall of capital out there that's frustrated by yields in the industrial sector and frustrated by yields in the multifamily sector, and it's found open air, institutional quality, grocery-anchored retail is the next place to go and cap rates have -- in the better markets, have been pushed down into the high 4s to mid-4s, right? We've been in environments like this before. I've been along with Dan for the last several years running the investments at Federal and market cycles and sometimes cap rates are reasonable and sometimes they're unreasonable, which certainly a low to mid-4s cap would seem. Does it really affect what we do? We are in the market to buy well-located retail centers that we can add value to over time. And we have a unique skill set when we look at an investment, because we have 2 or 3 decades of developing mixed-use properties and thinking about other uses on those properties and not just looking at the property as it sits today. So we may turn the knob, as Don said earlier, up a bit in years when those cap rates are a little bit more reasonable and turn it down a bit when they're not. But we're always in the market, and we're always able each year to find enough deals for us to do to continue to feed our development and redevelopment pipeline. And that's really what it's all about for us. We are not a stabilized cap rate, stabilized center spread investor buyer. We're focused on what the property can be in the future and really more focused on the IRR than the going in cap rate.

Just let me add one thing to that. Dan talked about the 5 assets that we bought during COVID -- COVID pricing, as I like to call it. If you look at those 5 assets. Basically, if we were buying them -- the way we bought them versus the way they would be priced today. We bought 3 of them and the other 2 were free. That's effectively what happened based on what's changed with the prices of those 2 things. The value -- the incremental price that you would have to pay for the 5 assets that we bought would have bought -- would have -- is like throwing the last 2 Chester Brook and Hilton Village in for free.

Gift with purchase.

Yes. Correct.

There was a question, and thank you all in the room as well as online for entering questions. A lot of the good ones are coming from you, not us. But there's a question here that with all the challenges in COVID, restaurants, health, et cetera, that hurt you originally as you went through COVID, couldn't those also hurt you in a rising inflationary environment, less discretionary spend in retail, gyms, restaurants as essential goods prices escalate. How do you sort of look at that?

Well, I'd like to answer, but the session -- no, so I've got 5 minutes. You still have to get down to the real estate. You have to get down to where the property is, and most importantly, what the alternatives are. So as I kind of -- as I said before, particularly on the restaurant side, to the extent inflation continues in, again, 3%, 4%, 5%. That's different than 8%, 9%, 10%. 8%, 9%, 10% is clearly tougher. It's tougher for everybody. 3%, 4%, 5% on a sustained basis, those prices can be pushed through. Where it does get tougher is second floor space that was a theater or that was something else that, where those prices are -- it's harder to push that through. What we found over the last 15, 20 years, and we've done this a lot at Santana Row and a few other places, is because the place is so important, because the real estate is so good, we've converted second floor space to other uses: office, the primary place, Health Club at Santana, turned into -- a $28 health club on the third floor Santana turned into a $55 office space for Twitter there, for example. So I hate to say real estate is local because it sounds so trite, but it is. So let's look hard at the particular piece of real estate. And what we found is we've got more options than most in terms of what they turned it into.

All right. We're going to go really rapid here. What is the biggest growth opportunity that you believe the market is not giving you credit for?

It is the importance of the transparency of the growth plan and the importance of having a multifaceted way of getting there. I don't think that's invoked today. I think it's much more invoked to be more simple, but that's what I believe that's critically important at a time where coming out is still unpredictable for all the reasons you said.

For 2022, what is your #1 ESG priority to get accomplished?

I don't have a #1. ESG is not a checklist. It's becoming a checklist, but it's not. ESG is a way to think about how to run your business. And so whether we're talking about continuing our focus on reducing energy usage and greenhouse gases, whether we're talking about making sure every building we design and build is lead gold at least whether we talk about, and it's the most underrated part of it, the importance of the S, the social piece, place making and green space as a priority for the communities that we're in and doubling down and expanding on our recruitment of minority candidates at colleges and in the workforce, trying to help our industry make sure that we are pulling from the widest possible group of qualified people we can.

I guess if you look back when we're sitting here next year at 7:30 on Monday morning because I know you love this slot, who else do you want to wake up with in the morning than Don would. But I guess if you look back a year, what is going to be the one thing that you're going to be disappointed that you weren't able to accomplish? And I know, look, your score -- I know it is an ethos, but there's got to be something tangible that when you look to the next year of like, I'll be really disappointed if I don't get 2 more minority potential...

And I think that's the one. I think as you sit and you think about how to transform a workforce health. And it's not transforming workforce, expand your workforce. How -- to be able to do that, that is a multiple year long process and it has to be a mindset.

Same-store NOI growth for the shopping center sector overall, not Federal in 2023.

Two.

Can you go with that?

Yes, sure.

10-year treasury a year from now. It's trending about 1.80.

2.1.

Will your property sector have more or fewer public companies a year from now?

I wanted to have fewer so bad.

I know you do. You've been talking about putting everyone together for a while.

[indiscernible] exactly. Fewer.

Fewer. All right. Thank you very much. We greatly appreciate it.

Thank you for the time, guys.