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

Good afternoon, everyone. Welcome to Citi's 2024 Global Property CEO Conference. I am Craig Mailman, joined with Nick Joseph from Citi Research, and we're pleased to have with us 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 available on the webcast and at the AV desk. For those in the room or on the webcast, you can go to liveqa.com and enter code GPC24 to submit any questions if you do not want to raise your hand. Don, I'm going to turn it over to you to introduce your company, the team, provide any opening remarks and maybe start with telling the audience also some of the top reasons that investors should buy the stock, and then we can kick it over to Q&A.

Thank you, Craig, and hello, everybody. I'd love to introduce the team to you, but we're doing these 30-minute things one after the other, it's Tuesday afternoon, and they're still not here because they were in the other. Here they come now. Ladies and gentlemen, Daniel Guglielmone, your CFO. Very nice. Jeff Berkes, your President, COO. He doesn't get -- come in, you got to clap for everybody. Don't you? All right. Yes, I think most of you know something about Federal Realty, but let me make sure, just the big picture, you know what's going on. We're one of the oldest REITs in the country before 1962, this company has always been about high-quality retail, open-air stuff usually mostly coastal markets. About 26 million square feet. And we also have development capabilities within the company. We have redevelopment capabilities within the company. We have a lot of arrows in our quiver to effectively find ways to work through cycles, both good and that to continue to grow. Our earnings growth other than COVID, where we were hurt and we were hurt during COVID largely because we are in states that closed for longer, whether that's Maryland or Massachusetts, California, et cetera. We've also come back stronger than anybody. 2023 showed record earnings for the company, about $6.55 a share. And with -- which also includes a mixed-use portfolio that makes up about 1/3 of the company and the mixed-use stuff includes some of the best assets in the country. Many of you may have heard of Santana Row in Silicon Valley, Assembly Row just outside of Boston, Pike & Rose and Bethesda Row outside of Washington, D.C. The question that you started out with, Craig, is that why you should -- why investors should buy this company now. It's pretty simple. Actually, if you think about it, demographics when it comes to high income and strong populations and barriers to entry. In our view, that matters a whole lot more now in the next 3 years than it did in the last 3 years. And when you sit and you think about the valuation of the company today relative to the underlying assets, I think there's more upside in this company with these high-quality assets than there are in others. That's why you should own us. It's time. Craig, where do you want to go from here?

Why don't we check in a little bit on leasing, particularly maybe starting with rent bumps. You guys have generally had kind of premium bumps versus the group. Talk about maybe where the blended average is today and a little bit on the trends that you're seeing on some recent deals?

This is an important -- it's an important topic because investors in any one of these companies, but certainly in ours, what you're buying is contracts. In our case is 3,200 leases, 3,200 contracts and the details behind what those contracts say in our view should have a lot to do with the value. One of the things that we have always pushed for is inherent in the contracts to effectively, particularly in the small shops to have 3% a year inherent contractual bumps throughout the lease term. For the anchors, the bumps are usually less than that, but still better than other people, such that in total, on that out of those 3,200 leases, contractual bumps are about 2.25%. I believe that's significantly higher than anybody else out there. Why? Because we're so good? No. because we're in markets and we're at properties where we can command that, where we have more leverage in those leases to command that. That's really important because when you look at the internal growth and the foundation that, that provides things like redevelopment, things like development itself, things like acquisitions, the other ways to grow the company are on top of a really strong base. 2023, you saw that we were near the top if not the top of FFO per share growth. It is at the end of the day, about bottom line FFO per share growth, not just about metrics that are partial or inconsistent between companies. In 2024 from what we see, we think we'll be very near the top, if not the top of the bottom line earnings growth. And looking at this business, yes, it's a very good time to be an open air. For the longest part of my 25 years at Federal, I believe that retail supply exceeded retail demand. And COVID did a lot. The combination of no new construction really for 15 years or so since the end of the great financial crisis currently, coupled with not unimportantly, locking people up for a period of time and making them understand that brick-and-mortar actually is an important part of their life. That combination turned supply-demand characteristics on their head. Demand now exceeds supply in the open-air retail business. And I see that being sustainable over the next cycle. That's a good thing. Now everybody, the entire world has to mark-to-market their debt portfolios. From a period of very low interest rates to where probably about where we are today, maybe a little bit less, but somewhere in that notion. And that's going to happen over the next few years. That certainly dilutes the bottom line FFO growth of what the properties are delivering. The property level, it's better than it's been in a very long time. If you normalize effectively the interest cost in 2023, we would have grown FFO per share, 8% rather than 4%. So it's a good time fundamentally for the business. Leasing is strong. I think you hear that all around from everybody. Clearly, during the 2021, 2022 stimulus that was put into the economy, $5.5 trillion in the U.S., a rising tide lifted all boats. And that's all good stuff. When you look out going forward, that's why I believe demographics matter, and they matter a whole lot more than they did in that period of time.

And so Don, you talked about demographics matter. Can you give some recent examples of maybe some leasing wins or leasing trends that you're seeing that are really unique to maybe higher income demos versus more kind of...

Well, let's put it this way. The first thing, overall, when you look at Placer.ai data, when you look at anything with respect to footfall at properties today versus 2019 or anything like that, those traffic levels are at or a bit better than where they were. But the sales are significantly better than where they were. And there's something really important to understand about that. Inflation does not treat everybody equally. While we had 15 years of no inflation before that, we're no longer in that period of time, as you all know and you all feel. But I suspect most people in this room, when you go into a fast casual restaurant to get your chicken sandwich, chips and an iced tea and it now costs you $17, and it used to just a few years ago, cost you $11, I think you rub your neck, you say, gosh, that stinks, and you pay your money and you move on. You don't think about it again for the rest of the day. That doesn't happen everywhere in the country. Inflation is not an equal opportunity person impactor here. And so with higher demographics, the ability effectively for those retailers to be able to push through their higher costs, which are across the board is really, really important. I'm not sure we've seen yet and won't see until -- as the months and the years pass, the impact of that longer term. You really want to be in places that those tenants have the ability to push those cost increases through in my opinion.

Can you also talk about the mixed-use component with some of the assets that you talked about before, and really the differentiator from that live, work, play type of environment? And what that allows you to do from a value creation standpoint over a 5-, 10-, 15-year period versus maybe some other just more plain vanilla type centers?

Craig, you need it all. And you can't buy a share of Santana Row. You can't buy a share of Congressional Shopping Center. You can only buy a share of Federal Realty. And so what's important in understanding from our perspective and how we run the company is we use those mixed-use properties as laboratories for the rest of our portfolio. The notion of having the larger assets, and we have 4 of them in the markets that I spoke about. Having those assets, which draw from 20, 25, 30 miles and draw a type of tenancy, on the retail side, that is unusual, if you will, for a Plain Jane shopping center company gives us relationships that we can use all throughout our portfolio. We learn things from our mixed-use properties like place making, like construction techniques, like relationships with tenants and others in our business that permeates all 105 properties. It's really a pretty cool business plan. And so what has happened post-COVID has become pretty clear that our mixed-use properties even exceed the performance of our homogenous shopping centers in the form of occupancy, in the form of overall rent and income increases. There is absolutely a residential component to that. There's absolutely an office component to it. The reason for that is on these pieces of land that we have brought people together on the ground floor because of the retail component, there's nowhere to go horizontally. You can only go vertically. And in those places with that -- where those environments have changed and gotten so much better places like Bethesda, Maryland, places like San Jose, California. Over the past 20 and 30 years, we have that opportunity to intensify the uses. That's worked out really well in addition to the fact that it helps the rest of our properties, it's pretty significantly also. Jeff or Dan, do you want to add anything to that?

We've taken what we've learned at the bigger mixed-use properties and applied it to properties like CocoWalk here in Coconut Grove and Darien Commons up in Darien, Connecticut, where had we not had that experience when we maybe would have never acquired CocoWalk. And when we looked at Darien rather than rebuilding ground floor retail with some really successful residential on top, we probably would've just redeveloped an existing single-story shopping center had we not had that prior experience with the big 4 mixed-use properties.

Yes, that's true. And I don't know if any of you have seen, I hope you have, over the past couple of years, CocoWalk, which is down in Coconut Grove, South Miami. But effectively, in -- if you tour it, you can get the lessons learned. We have significantly outperformed our underwriting there. It is clear that in these close-in suburbs, if you will, of the major metropolitan markets, they have been beneficiaries of the work-at-home environment. And so you're talking about, in a lot of cases, two income families. Husband and wife, who used to go into the city, whatever city, whether it's Miami, from Coconut Grove, whether it's Bethesda, Maryland into Washington, D.C., wherever it is, they used to go in 5 days a week. And now they go in once or twice a week. Guess where -- guess where those dollars that were spent in the downtown are now being spent being? Being spent in this close-in suburbs, and that's where we own these properties. So there's been a disproportional benefit from our point of view of COVID -- result of COVID in these first-ring suburbs and Coconut Grove is just a great example, maybe think of it.

And maybe just the last question on your 4 kind of trophy properties long term. The value -- the value bank that you have there, for lack of a better term to ultimately tap at some point of lower cost capital that maybe is not reflected in your current leverage level or investors thinking about your blended cost of capital?

Yes. There is an advantage, and it's a hidden advantage effectively of Federal that we deal with a bunch. And that is these large mixed-use properties clearly are worth more than $100 a share in Federal Realty common stock price suggests. And look, there are always periods of time when there are differences in value in terms of how components of the business, if you will, are valued. What is interesting to us, if we had our way, we would maintain 100% of those assets forever. Why? Because they grow better. They're really good assets and accordingly, are worth a bunch. If the public markets recognize that as they have in the past and they do in the future, we would maintain 100% ownership of those assets. That's terrific. It's -- they're great growing assets, et cetera. So to the extent the public markets over the next few years, doesn't recognize that differentiation in the value of those assets then I think it's incumbent upon us to realize that value. And that's where we would look at joint venturing. That's where we would look for effectively capturing or unlocking some of that value in a piece and redeploying it in other open-air shopping centers. So a little bit TBD. Today is not the day to transact with respect to those assets. I hope tomorrow is not the day because the simplicity of a simple capital structure that has been kind of a hallmark of us over the last 25 years. I'd like to keep. But to the extent that the market doesn't pay for it, then we'll JV them.

We have a couple coming in off a live QA here. Maybe we can jump to the one, can you talk about the use of data kind of nowadays that affects the way your tenant -- the way you look at a tenant, the way you lease a portfolio and how it's different than historically the data or the weapons at your disposal to make these decisions?

Yes, there are more tools available and more tools are always a good thing. Placer.ai data is good data. Footfall data, tenant sales, it's good data. At the end of the day, though, tenants are using their own business plans, their own data to figure out where they want to be. It's our job to marry that up what they want with our properties and effectively having the ability to include -- to use more data and convince them, have them convince us that they are the right tenant for us because that's very important to us, is actually easier than it has been in a long time. It will be interesting to see as AI progresses, and alternative uses of artificial intelligence allow us to create even more situations there. That will be great. But at the end of the day, there is a guttural feel to this business that can't be substituted. There is a guttural feel from that retailer of whether his or her customers are there. We'll go to the particular location because it's far better to have that customer go to the location than to ship things to their home profitability-wise. Having them come to places like Federal's places has always been our huge advantage. And I don't see that changing, frankly, I see it becoming more important over the next few years, not less important. And more information available to us only helps that process.

So we have another question. Really around the fact that you guys have the highest rent per square foot in your portfolio. Can you talk about whether or not that is a headwind for rent growth relative to maybe where the market is?

Yes, you know it's funny, man. I've been at Federal for 25, 26 years. I've been CEO for 20 years. Every single year, every single year. Federal, your rents are too high. You can't raise them anymore. That's going to be a headwind. That's the way it is, and yet for 20 years, that has not been the case. Here's what I'd love you to do. Our in-place rents are fully disclosed. They're about $30, $31, something like that. It's in our 10-K. It's all there. Take a look at what we lease new deals at, not 1 quarter, 2 quarters, look over the years. It's regularly 37, 38, 40, 39, how does that not suggest that as leases roll up, there's not 25%, 30% of upside that you get over the 10 years or whatever period the leases go. Our properties are better. They have higher sales. They have higher profitability. When you care less about what you pay in rent? When you're making money. And so the notion is the best operators, the best tenants, take a look now. JOANN's Fabrics, the latest one to go out. What do we have, 2 JOANN's Fabrics? [indiscernible] 10 big -- basis points of what we have. The -- if you look at our tenancy and what's there, it's just better. And within those locations, if you look at those tenants and how they perform relative to other locations, our specific tenant, our stores are always in the top half, top quarter, top 10% of the performance of those stores. That's when rent doesn't matter. It matters less. Our job is to create a group of tenants together on a piece of land that provides the highest productivity for them overall. That's the job. And that's why we can continue to raise rents. So no, I don't see it as a headwind.

You talked a little bit about the escalators. We talked about the quality of the portfolio. The question here is kind of how do that manifest an output of growth, right? AFFO growth longer term? Or should you be relative to peers?

So we should be better. And at the end of the day, we were in '23. I believe we will be in '24. And at the end of the day, when you look at these properties, what we have always thought, I've never wanted to be a one-trick pony. Real estate is cyclical. Parts of the business are cyclical at different times. So the ability to be able to have the strongest core to provide the best growth from the core perspective and then be able to supplement that with development or redevelopment when that knob can be turned up when conditions in the economy allow that to be turned up. Acquisitions up or down when those -- when that can be part of the picture. Having the ability to do that, to look at a shopping center, not just narrowly as the operation of a shopping center, but as a piece of real estate and what can best -- what is the highest and best use for that real estate and then having the ability to create and produce the highest and best use for that piece of property is what it is -- is what our business plan is. If you -- you may care about a dividend or you may not care about a dividend. But just let this sink in for a minute. We have increased our dividends to our owners every single year since 1967. That's a ridiculous statistic. There's not another REIT that can say that. How can that happen without properties that continue to grow their cash flow over that period of time. And so that is our mindset. We do have a long-term mindset. We do. It's -- it doesn't always agree with the shareholder base, but we do have a long-term mindset to be able to grow through cycles. That's the only way you can get a dividend record, anything like that for that period of time.

And over that 56 years, compounded CAGR of 7%.

Can you talk a little bit about the OpEx environment. We talked about kind of pushing rent, but inflation works the other way, too, right, because [indiscernible] your costs. Could you just talk about some of the biggest components and drivers of that? And it's mostly a pass through the tenants, but how does that kind of limit your net effective rent growth?

Sure. We actually have done an exceptional job, I think, coming -- starting in COVID and coming through out of COVID. 2023 was an exceptional year for us in controlling costs. And if you look, we held overall real estate taxes, operating expenses broadly across the company, exceptionally well. I think we had like growth of maybe 1% year-over-year, which is really, really strong. Will we be able to continue to have that operating leverage? I think we're optimistic we can continue to maintain cost controls at the property level, the operating level that allows us to have revenue growth above that expense growth line item to be able to drive higher POI. And that's something that we focused on. And I think we've achieved that. And the proof is in the pudding in our 2023 results.

And the only thing I would add to that is, look, it is a capital-intensive business. There's no question about that. But having said that, the demand supply characteristics that we see today, the way it is out there does -- do give us leverage and does allow us to maintain a lid on capital. The other thing about it is all capital is not equal. Basically, putting money out with -- on a high-quality tenant that you're going to get a return on get back is a whole lot different than putting money out to get a tenant in or to do something with a tenant that doesn't make it over the course of that lease. That's a bad capital decision. It's not the same capital. So I think what we need, and we require, I don't care whether it's my salary or a tenant improvement allowance or it's a maintenance CapEx expenditure. We need a return on any dollar that is paid in this company. And so we look at it from the standpoint of IRR, we do look at it from the standpoint of ROI. And I sometimes don't think there's enough understanding of that. There's -- I have to tell you the story. I'm not going to name the person. It was a long time ago and very respected executive in this business said, every tenant is going to go bankrupt. At some point, you don't give capital to tenants, and I was young in my history with the company, and I met this gentleman later on. I said, "How do you do it?" We wouldn't be doing any deals if we didn't, if we weren't able to expend some capital that way. And he looked at me and he laughed and he said, "If I had your quality properties, I'd invest in them, too." And it was like a light that went off. Every dollar of capital is not the same. So I think we do a pretty good job of controlling it, as Dan says, but I also think we do a pretty good job of getting a return on that capital that's expended.

So we did have a few more questions come in, one of which is about, I guess, acquisition opportunities, but the question specifically is premised on you owning very high-quality shopping centers within the U.S. How many do you not own of your quality that you would -- that would be of interest, right? It's obviously a broader, but kind of what's the consolidation opportunity without going down the quality spectrum?

I love the question, Nick. Thank you. The answer is plenty. When you sit and you think about what is quality? What is -- quality is not pretty. There is a shopping center that we bought a couple of years ago. It's just 15 miles west of where we sit. It's called the Shops of Pembroke Gardens. And it's not pretty. What it is -- what it is, is an amazing piece of land that has the ability to have rents increase dramatically, merchandising changed dramatically, but also because of the size of the land, we're now trying to entitle and design 400 to 500 to 600, we'll see where we get residential units on the parking lot -- on part of the parking lot that's adjacent to an existing residential complex. That opportunity was not underwritten. That opportunity is not restricted by the leases of the tenants that are in the shopping center. That is a high-quality shopping center, yet if I took you through it, you would say that's not a high-quality shopping center. That's the idea. Loving to own those places, and I think there are many more of those opportunities for places like that, that we can bring what we do to create the value there.

And there's another question about leading indicators. So obviously, demand for space is very strong right now. But as a management team, what do you look out for, for kind of those inflection points? And how do you react on that?

What do you think?

Leading indicators. Can you be more specific?

Just the broader economy and retail health overall, right? So right now, there's a lot of demand for space. But what are you looking for to see that, okay, things are maybe softening on the margin? And then how would you react to that? What...

Yes. So normally, what you'd look for is tenants dragging their feet in the lease negotiation process or if they signed a lease, dragging their feet to get their space built out and their store open. That's normally what you'd see at the tip of the spear, if you will. And we're not seeing that. We're seeing quite the opposite. We're seeing tenants pushing to get their stores open as soon as they can because they know every day that they're not open, they're leaving business on the table. And we've been really engaged and successful with our tenants partnering to do just that, oftentimes shifting more of the risk to them than they've taken in the past and oftentimes doing things to get ahead of supply chain issues, to get ahead of permitting issues, dual tracking processes to open space, which is why you've seen our SNO come down. Leasing space is great, but getting tenants open and paying rent is better. So we've been really successful in that. So the two main things that you would normally see if things weren't going well, we're not seeing right now. We're seeing exactly the opposite. People want to get leases done and they want to get stores open.

If I can, let me make a point on signed but not occupied. I think it's important. This is a metric that never existed or was never discussed until COVID. And the reason a lease that's signed but not occupied, became important, makes all the sense in the world. Was there going to be any demand post COVID for retail space. And as evidence that there was -- would be, everybody started asking about and disclosing those leases that were signed but not yet occupied. Numbers like there's 300 basis points, there's 400 basis points. There's 250 basis points of signed leases, but not occupied was important. We're way past COVID. That number should be short because if it's too big, it means you're not getting stuff open. And you don't get a nickel of rent until it's opened. Not signed. So the notion of signed but not occupied, first of all, I think the metric is of little use relative to what it was when it was important in '21 or '22. But I think it's important to understand that the process of going from a negotiated document to a tenant paying rent and occupying the space, that object, that tightening that time up to me should be the primary objective, not growing signed but not occupied.

Perfect. In the interest of time, I think I'm going to jump to the rapid fire questions. So same-store NOI growth for strips in 2025, not necessarily Federal?

Not us, but all strips. 2%.

Will shopping centers have fewer, more of the same number of public companies a year from now?

For Pete's sake, the same.

And then the best real estate decision today, buy, sell, build, redevelop or repurchase stock?

Buy.

Perfect. Well, thank you guys very much.

Thank you guys for your time. Thanks.