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

I'm pleased to introduce the Federal Realty team. To my immediate left, Dan G., Treasurer and CFO; his left, Don Wood, CEO; and into his left, Jeff Berkes, President and COO. I'd like to keep this as interactive as possible [indiscernible]. We have a short overview to start things off and start with questions [indiscernible].

Sure. Well, great. Thanks, everybody, for taking the time today to be here. I think most of you know Federal. One extent or another, I do want to make sure that I do say because I think it's more important now than it's ever been that the quality of the portfolio of both retail and mixed-use properties, I do believe is a giant differentiator. It's been a crazy couple of years. And I'm not sure it matters as much as it probably should in a more normal circumstance in terms of that differentiation. We're sitting here at a time where we don't know what's going to come next year, whether it's going to be better than we think, whether it's going to be worse than we think, but it will be what it will be. But I can tell you from the company's perspective, when you sit back and you think about whichever direction it's going to go, I'd like to make the case for you that this is both a defensive and an offensive stock, a defensive and an offensive company. For all of our 60-year existence, this company was about how to create a sustainable, long-term cash flow growing business plan. And the way we did that was multifaceted. It was not one way only. And that meant, starting with making sure we're acquiring not on a portfolio basis because every portfolio has some good stuff, have some bad stuff and some middle stuff, but rather on a one-on-one basis, selected properties, retail-based always, that we believed we could create IRRs in excess of our cost of capital through both higher rent, or through redevelopment, through development and the -- and certainly operating efficiencies along the way. As you know, we're in 9 major markets, including on the East Coast, down to the Mid-Atlantic, South Florida as well as California and now Phoenix, Arizona also. And when you sit here, you think about what those 3 or what those 9 markets have in common, it really is all about 3 things that matter, a lot of people with a lot of money and barriers to entry. And it's fundamental to the understanding of whether the retail -- how those properties are going to perform over the years in good times and in bad because this is a cyclical business. It always was a cyclical business. It always will be a cyclical business. Frankly, that diverse business plan worked really well through ups and downs, except for one period of time, and that was COVID-19, the global pandemic. And the reason we took our hits disproportionately more than kind of a typical grocery anchored shopping center company was twofold. The first reason and the largest reason was that the markets that we're in, Massachusetts, New York, New Jersey, outside of Philadelphia, Washington, D.C., California, they were shut down. And they were shut down for a long period of time. And then secondly, when you take tenants that include gyms, that include restaurants and that include some theaters, if you think about, it in the middle of a global pandemic, there probably aren't any worse type of uses for a time when people are afraid of getting a virus. And so as a result, for the first time in -- well, my history, and I've been there 25 years now, as has my President and COO, Jeff, here. For the first time, we wound up with more vacancy than we have had. We were down in the 80s -- overall in the mid-80s for the small shop stuff. And when you sat back and you looked at that, you said, "Okay, what is the future? And where are we going to go?" And so here's what happened, and it was a really important thing that happened during COVID. People rediscovered to socialize -- the importance of socialization. When you sit back and you looked at it, there were some great periods of time over the next -- over the last 20 years. The '02 through '07 period was extremely strong. Global financial crisis gets hit. We do extremely well during the global financial crisis. And then we have a run from 2011 to 2016 or so. That was equally good. By '17, '18 and '19, before COVID, the conversation in our industry about online shopping, bricks and mortar, is it necessary at all? What role does it perform? Does it serve? Was really at its zenith. And so there was a malaise of a period of time there in terms of stock performance, certainly, as people figured out what was going to happen. Nonearnings growth, continue to grow earnings, but stock performance was that uncertain period. Coming out -- going through COVID, I think COVID did the industry the best favor it could by saying, "Yes, maybe these things do live in tandem. Maybe there were distribution methods that can work together. But at the end of the day, we need bricks and mortar." And so out we come from COVID. As we come out of COVID ours, along with most of the industries, incomes or leasing was extremely strong. It remains that strong today. And so leasing back up from the 80s into the mid-90s was -- happened much faster, frankly, than we thought it would, and it resulted in our outperforming significantly on an earnings basis over the past 8 quarters or so. So here we are to [indiscernible]. Now we sit here in September of 2022, a more uncertain future than we've seen ex-COVID in a very long time. And so the question really is, what makes this place different? Because it's not all the same. Shopping centers are not all the same. And one of the single biggest things that I need you to understand is that on average, in the United States, about half of the shopping centers that are out there serve communities, 3 miles around them, with less than $75,000 of household income, 10% of Federal's, shopping centers, serve communities with less than 75% -- or $75,000 of household income. 90% are over that. And I bring that number up because there are a number of CEOs of retailers. Macy's is the one that comes to mind first that specifically use that amount of money where they see softness when it comes to the consumer. So if you believe that more affluents, more population barriers to entry importantly, are important to performance of a shopping center without $5 trillion of stimulus in the -- boosting the entire economy, then I'd like you to think about this. Within 3 miles of Federal centers, they are on average 175,000 people. Those households earn on average $150,000. $150,000 or 175,000 people suggest that there's over $10 billion of spending power of earnings power within 3 miles of Federal shopping centers. Nobody else can say it. How important is that? How important is that going to be? If history is any indication, during downturns in the cycle, it's going to be pretty darn important. And so when we take that and build upon that with the other facets of this business plan that do include $800 million, $1 billion of development that was started in 2018, '19, got caught in the middle of '20, the money is spent. It is out. The income is not yet in fully, and that happens more and more per year. That's an additive potential where, by the way, and the rents have not been reduced in anything that we've seen in those assets post-COVID. When you take that, you take the $1 billion or so worth of acquisitions that we've made over this period of time, which, by the way, more than a dozen leases done since those acquisitions are at better than 30% rent bumps since -- from the old tenant to the new as we improve those shopping centers. And we have a few arrows in our quiver to be able to protect on the downside to the extent things are bad, grow heavily on the upside to the things are not as bad or good. So with that, maybe let me turn it over to you. That's us on a nutshell.

[indiscernible]

We are. And I may be the -- I said this the other day, I may be the wrong guy to ask, I've been expecting this tail off I guess, for 6 quarters or so once we came out, and it has not. It has stayed extremely strong. I expect that for the foreseeable future to stay that way. I'm waiting just like everybody else for there to be a tail-off, and tail-off shows itself in a number of different ways, including slower times to get deals done, more coveting to get things over the transom and things like that. But as we sit here on September 22, I feel very good. Jeff, do you have anything to add to that?

No, I echo that. I mean our leasing pipeline now, Craig, is deep and broad as it's been for the last 8 quarters. And in addition to getting new leases signed, we're working very hard and been very effective narrowing our side not occupied gap. And actually getting tenants open and paying rent, which is a good sign, too, because if things aren't good, tenants tend to drag their feet on doing what they need to do to open a store. And that's not the case. We've been able to pull that in roughly 100 basis points over the last couple of quarters.

Let me make that point, if I can. There's -- or add a point to that -- if you were last -- if we were sitting here last year, -- and you said, Don, what are you most worried about? And how did you underwrite for 2022, probably the #1 thing would have been supply chain disruptions and worrying that although we had done a ton of leasing, that a lease is step one. It's not the end. So there's a contract, you've got a design space, build out space, permit space to get rent start. And so we had some conservative assumptions with that, given all the supply chain conversations. I think I'm very proud of the way we managed through that. And through a combination of very strong tenant relationships to be able to share duties, order certain things far in advance, further in advance than we normally would work with contractors and do some business ourselves that we wouldn't normally do. In total, we have been above -- ahead of where we thought we would be in terms of getting tenants open. And that's why signed, but not occupied, that has shrunk. I mean, there's still -- whatever it is, 200 basis points, that should come in another 100 basis points. We should not have 300 basis points of room between something that's signed and not occupied based on the volumes that we've been doing. So we've been very pleased about how we've operated the company also.

[Indiscernible]

I don't have any evidence of that at this point. And again, you're talking about -- it's a little different than in the mall business where you get sales reported from every tenant. We don't have that data. What we do have is traffic. We have traffic that is above 2019 levels and very strong. We have restaurants, in particular. I don't know if that are doing extremely well. And this does take me back and makes me think about 2008 and 2009. And I'm not saying it's the same as that, it's obviously a very different economic time. Every recession is a little different, no question about that. But every investor or analyst told me, in 2007 and 2008, Federal is going to get hurt worse because of our restaurants. 15% or something like that of the income stream, which was restaurants. And as the smoke cleared, and we got into 2009, 2010, the best-performing sector were restaurants. And that certainly wasn't the case nationally or globally. That was the case in Bethesda, Maryland or the case in Santa Monica, California. And there's something just -- it's just very important to keep remembering how local a business that this really is. And by having a company with only 100 assets, not 500 or 600 or some, we're tied to every one of those assets, and we've been around a long time. So we know them, and it's not just about doing a lease with a restaurant, it's the right restaurant or the right other tenant. Because if you do that as best you can, it's very likely that, that entire shopping center will perform better. The merchandising is a very important part of what we do. [Audio Gap] I think about it a lot. The notion of margin pressures and the impacts of inflation in general, whether you're talking the cost of money or the cost of operating your business, clearly, will be a challenge for businesses that many have thought to your point had to deal with to the extent that they'll deal with now. As a landlord, I got 2 things I can do, and there's really only 2 things I can do. Number one, try as best we can to be in markets, and I think we've done this, where the possibility is more of a probability at being able to pass those costs on to the consumer. And honestly, that's a lot easier to do. In Bethesda, Maryland than it is in many other parts of the country, and I still think there's a lot that goes back to demographics [ as well ]. It goes back to demographics for a reason that way in times like this. And so that's number one. I do believe between triple net leases themselves and the ability in the markets they are to pass them on are 2 very important things. The second thing is, to the extent it doesn't work out, how valuable is your property? What choices do you have? Who wants to get back in there? Is it -- you're very -- you don't lose people in the middle of the night as a rule. It happens once in a while. But as a rule it doesn't happen. And so you've got time. And when you see tenants who are beginning to struggle, which by the way, we don't have a lot of those sides yet at all today. You start working on that space. What's very interesting to me is what we were doing as a practice, during COVID,and a lot of the leasing that has been done has been proactive to replace a tenant who was not performing as well as they can with a stronger tenant. The fact that we went in -- weaker tenants kind of vetted out is a positive without question. So overall, balance sheets are better. But your point is spot on. That's how you try to mitigate that as a real estate...

[Indiscernible]

Think so. But I don't know. And I tried -- it's going to sound -- I don't want this to sound the wrong way. I'm not the retailer. I'm a landlord. For things that go wrong. I love to say I just think this is so true, what no investor gives us is the detail in lease amount because what's on the other 78 pages on that lease. And the other 78 pages of that lease, that's the tug of war between a landlord and attendant. The landlord wants controls and protections because we have better properties, empirically, I believe I can't prove it, that over 3,100 contracts that those contracts are stronger. Then they are seeing where we're going through this fall, it will be really interesting, where we can -- week past Labor Day, I don't know how this will play out. But again, my job is not really to know whether they're going to have a good Christmas or not. Job is really to protect the company as best we can to the extent they don't. And that's really been the focus.

There are certain tenants that see a big uptick for back-to-school and for holidays. I mean that's the exception not the rule within our portfolio. There's not many businesses across the [Indiscernible] super holiday dependent like you might find an enclosed mall, for example.

[Indiscernible] Markets as you -- that you've had on your [Indiscernible]

It's always a little too early to narrow know...

But it's disappointed right now, Craig.

I'm going to be disappointed. But Don said in his opening remarks, I mean, and the stuff we bought in the last couple of years, we've done 12 deals at a 30% higher rents than the prior tenants were paying. Now obviously, some of that was expected and part of the reason why we bought the properties. But we're really happy with what we bought, where it sits and the go-forward prospects for all the acquisitions that we've done, and you've noticed for a long time and you know small enough. We're all about buying good real estate that we think we can do something to over time to grow the income stream or densify the property, and we're really focused on IRR and on cap rate and all the assets that we bought fit that bill, if you will. There's something to do at every one of them where we can improve the physical real estate, the operation, the leasing and the income growth. And so far, very happy with everything we bought.

Kingstowne.

Kingstowne, yes. You want to start off?

Sure. Big dominant center, middle and Northern Virginia, with a job base growing like crazy in a market where we believe the property has been under managed, where we see upside in rent rollover and another piece in an increasingly dominant part of our geographic part of our portfolio, and that is those 3 northern counties on the first range outside of Washington, D.C.

[Indiscernible]

$200 acquisitions, basically. 2 $100 million acquisitions, basically, they're both closed now. And the capital, there's no massive redevelopment plan expected to that property. We'll spend some capital to make the assets look a little bit better, freshen them up and a little bit of tenant capital here and there, but it's mostly existing cash flowing like, Don said, under managed asset, We think we can -- into the leasing and do better. So yes, it's management leasing play. It's not a REIT, not a redevelopment play.

There is one other thing to add to that, though, and this is absolutely a bias.

How many acres is this?

40.

45 acres. We want big properties. And the reason you want big properties, and this has just worked out really well over a lot of times you can't handicap or underwrite all the possibilities on a piece of land, when you buy a bunch of leases in a property. Mark my words, something will happen. Something will be able to be moved to create a redevelopment opportunity that's very hard to do in a 6- or 7-acre shopping center. There is -- basically the shopping center business is a commodity business. It is a slow growing alternative to a utility or something like that generally in the country. We didn't think that, that belongs as the business plan for a public company. And so everything we try to do puts us in a better position -- nothing guaranteed, but to put us in a better position to be able to create value. As far as I know, there's only 5 ways to create value in the shopping center, you raise the rents, you redevelop parts of it, you develop in a bigger way, intensify it -- choose that way, acquire and do something with it once you acquire. And there used to be something called balance sheet management that can reduce the overall cost of capital and create value. Well, that was gone for a while. So when you sit and you think about it, the size of the property, not in every case because we do a lot of different things, but gives you opportunities that maybe you can't see at the acquisition date.

[indiscernible]

Go ahead [indiscernible].

Yes. Well, great thing happend last Tuesday, and Apple got all their people to come back to work 3 days a week, and Silicon Valley has been waiting for that for months literally. I mean, everybody was set to bring employees back before Omicron hit. And then Omicron hit, and that delay took 8-plus months before we start to see people come back to the office. And out there, Apple and Google kind of dictate the terms that the rest of the tech companies can put in play for their employees. So getting Apple back to work last week was great. And the tech CEOs that we talked to or the CFO, Heads of HR in the leasing process on 1 Santana West, everybody wants their employees back in the office, maybe not 5 days a week, but certainly for 3 or 4, if they can get a back in. And everybody knows in order to get their people back to the office, they have to give them a great environment and a great place to go to work. It's got to be a new, clean, safe building and the building needs to have amenities. So if you sit back and kind of take a look at the landscape in Silicon Valley, we have in 1 Santana West the only large, state-of-the-art building that's fully amenitized. So we're confident we're going to get it leased, but not exactly sure when, but it will get leased. And there's a lot of movement in the market right now. We saw this one on NetApp, took 700 Santana Row. We saw it with another tenant in the marketing process of 1 Santana West that unfortunately, we weren't able to nail down, and we're seeing in some of the market activity right now. There's a lot of companies that, hey, we don't need the amount of square footage that we have, but it's located in a suburban office park or in multiple locations or their 12-year-old buildings without state-of-the-art HVAC systems and outdoor spaces, and they're looking to consolidate, downsize, relocate to places where they can get their people back to work. And we think that plays great for 1 Santana West. So more to come on that, but we think everything is lining up to be successful to get it filled up.

Maybe it's also a good time to remind folks that of all of that construction that was underway into COVID, we're basically done with lease-up on virtually all, except Santana West. And while we're done with lease-up, only income hasn't started yet. So when you look over at the building we're building for -- the building we built with Puma in at Assembly. And all of the other tenants, it's now 94%, 95% leased building, but all that income hasn't started. When you look at Pike & Rose, we opened up our headquarters on August 10, 2020, as the only tenant in that building. 18 months later, that building is 100% leased, but all the income hasn't started yet. So when you sit and you think through it and even Santana West was basically leased once COVID hit, basically, leased a second time, Omicron hit, back to [ mount ], and yet, is the best product in the marketplace. That's where our confidence comes from. So at the end of the day, there was a $270 million state-of-the-art building in a $13 billion asset company that is delayed in terms of its lease-up -- put in perspective.

[Indiscernible]

Oh, no, we have rapidly...

[indiscernible] 5 years from now, [indiscernible]

I see ourselves -- when you sit and you look and you look at the markets we're in, you say, okay, what do you want? And that's a pretty limited list. We've got a hit list with about 200 properties on it that we work now things get added to the hit list. 200 today, a hit list of what we don't own, okay, that we would like to own. Now you may get in there, you may convince the seller to give you a look, you get a look, you don't like what you see, but there because this preliminary list and things get added to that list and things get taken off of that list. It often takes decades. You're working to create relationships with owners of the properties you want. It's a proactive way to go at it. And so that's why if you look at our last 10 years, we do plenty of acquiring, but we do it in convulsions. There'll be a year with $800 million and then a year at 0. And then a year of $300 million, and then a year of 0, and then $1 billion. And then -- so it depends. It may look like it's random, but it's not random. It is a list of assets that we think make Federal a better company preliminarily, so we can get in there and look at it. And I like that approach so much better than buying a portfolio that's got the 5 assets you were dying to have now you spend in the rest of the time trying to get rid of the 25 that got to get forced as part of it. And so I wouldn't -- I'll give you a number right now, 112. You know what I'm saying, some kind of rational way to keep approaching proactively those assets we want.

112.

What year it was?

What year?

[indiscernible], which of the following is the greatest macro challenge based on the U.S. public [indiscernible] today? A, risk-on rates; b, [indiscernible]; c, the rise of private equity; [indiscernible]?

The rise of private equity and NTRs.

Which is the following greatest sector's percentage risk? One, labor issues; two, [indiscernible]; 3, capital markets?

Capital markets.

[indiscernible].

No.

Okay. Well, thank you for coming. [indiscernible]

Perfect. Thank you guys all for the time. Appreciate it very much.

Thanks, Craig.

Thanks, Craig.