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

Next roundtable session with Federal Realty Investment Trust. I hope everyone had a good networking lunch, a little bit of coffee as we emerged for the afternoon sessions. To my right is Don Wood, CEO; and Dan G., CFO; and then Leah, IR Leah is back from [indiscernible].So good to see you. Thanks for coming. And it's Don's birthday today. So happy birthday.

Thanks Jeff...

Am I needed to know that...

I got a warm people. We had to be nice today. So again, thanks for joining our afternoon session kicking off here with Federal Realty. For those in the audience that maybe don't know the company as well Don is going to provide some opening remarks on the company, where it stands today. And then we want to make this as interactive as possible. So if you have any questions, just raise your hands, and we'll get things started. So I'll pass it on to Don.

Thanks, Jeff, and really thank you guys for taking time this afternoon to be here. When I look around the audience, and again, I don't know who's on the webcast, forgive me for going back and giving a little bit of history of the company. For those of you who do know us well, but I don't think everybody does. So Federal is a shopping center REIT. And we've been around one of the oldest REITs in the country, we've been around since 1962. Pretty interesting in that period of time, which is now whatever it is 62 years, there's only been 3 CEOs of this company, and I'm the third and I've been at the company since '98. I've been CEO since 2002. And the reason that -- to me that is important is because it does say a lot about the stability of this place. We're a high-quality company. In fact, I would argue we're the highest quality open-air shopping center company out there with respect to not only population around our centers, but income around our centers, we are largely on the coast from Boston and Washington, D.C., also in Florida. West Coast of Northern California, Southern California, and Arizona. It's a company that was really put together to accomplish one thing. We sat down and said, we know this is a cyclical business. We know that there are highs and lows in the shopping center business. How do you build a growing stream of cash flow that finds its way through the cycles, good times, bad times, whatever they are. And I think if we all came together and set back in the early '60s and said how do you put together a portfolio and grow a portfolio that did that, we'd probably agree on a few things. One, we want to be in places where people have money to spend. People have money to spend when time is good. People have money to spend when times are not good. We want to be in places with lots of those people from a demographic perspective. And importantly, barriers to entry because it's really, really hard to put -- get rents to go up to the extent there's a product that looks very similar to yours. That's right next door. And so those 3 facets led us to put together what we think is a really great high-quality portfolio. The other thing is you want to diversify that income stream. And certainly, we have our share of grocery anchors. Certainly, we have our share of box anchors. We also have our share of mixed-use properties, and that means a residential income stream that makes up 9% of the portfolio in office stream. The bad word of office, but different office that is part of only our mixed-use properties, which makes up 9% or so of our income stream. So you're looking at a way for cash flow to be generated by the company. That comes from a really varied type of tenants. Our largest tenant makes up less than 3% of our income stream. The other thing you probably want to do is recognize that in order to create value in real estate or keep cash flow growing to good times and bad, you need as many arrows in your quiver as you possibly can. So we do have a strong -- not only strong internal growth through the properties that we have, but we also have the ability to use a very strong balance sheet to acquire. We also have a very strong balance sheet to develop. And when it comes to develop, what we primarily do is add on to our existing shopping centers for whatever the highest and best use of that real estate is, what it's turned out to be a lot of are residential properties or assets that for people living in those resins is they appreciate having the amenities of the shopping center adjacent to them. So that's another arrow that's in the quiver. And when you put all those things together, what you found is a company that throughout its 60-year history has been able remarkably to increase its dividend to shareholders every single year since 1967. Every single year since 1967. And if you think about what's happened in this country and over that period of time, whether you're talking about 20% interest rates or whether you're talking about 9/11 or whether you're talking about wars and certainly many economic cycles of inflation and recession. It's pretty remarkable. There's one time that knocked us off our game. One time, it was COVID. And the reason COVID knocked us off our game more than other shopping center companies, still not bad, but more than other shopping center companies is because our markets on the Coast largely closed down and they close down more than other markets. And so as a result, that growing stream of income was interrupted by that and only that over that period of time. It's pretty remarkable. It's also been pretty remarkable that since that time, we've recovered extremely strong. We're well above where we were in 2019 and look at a very, very bright future. I'm sorry, Jeff, you know me, I can talk on forever. So just stop me when you want. I got a few more things to say if I can keep going, if you don't mind. When you look at our business today, the open air shopping center business today, it is a period which is different than much of the last -- much of that history in that it's really the first time that in open-air shopping centers, I can honestly say demand exceeds supply. And for most of that time, some of you got Fed certainly stupid -- stupid, certainly no, as investors that I have preached that supply exceeded demand. We built like crazy through the '90s. We built like crazy in the 2000s. And so we were specifically focused on making sure that our product was differentiated. That's -- that it was better, that it was different, that we had to be a choice for a retailer to come to us because it was not the same thing. And as a result of the lack of development really since the great financial crisis in the country, there has been very little retail supply added. And when you think about that through the teens and into COVID and now coming out of COVID, it's really been a benefit to the entire industry. So anywhere that you invested in open-air shopping centers post-COVID has worked out pretty darn well. And that's worked out pretty darn well because of rising tide does lift all boats. And I think that's great. And that demand supply characteristic really won't change for the next -- for the foreseeable future. It takes time to make the numbers work to plan to entitle to be able to build new product. There's some of it starting in a couple of places, but very, very small. So that supply-demand dynamic, you should expect to continue. Now what probably won't continue is an economy that was so prompt up post-COVID. And lots of money, $5.5 trillion into the economy. It has a lot to do with consumers being able to consume at their leisure. And obviously, that's changing. So the notion of do you expect -- do you expect consumers to continue to consume at the level that they did in '21, '22, '23. No, I don't. I expect a more normalized environment in the country overall, not a bad environment, just not compared to an overstimulated environment of the past 24, 36 months. And so to me, it's pretty likely that it will become more important, like it did for most of those 60 years for the high-quality stuff, the places where consumers have the means to consume are located with respect to the real estate that you own. So I'm looking for -- I'm looking at -- we've been sector-leading growth for the past 2 years. I would hope that to be able to continue into the foreseeable future because I think quality matters. And when you look at tenancy that could -- has not seen a lot of bad debt, has not seen a lot of failures. You've got Bed Bath & Beyond. You've got some of the retailers that are hitting -- that affect lower income consumers, the Big Lots of the world, Joann, if you will, of the world, those notwithstanding. The credit of many of those big boxes pretty darn strong and should be pretty darn strong for the next few years. Question is, can you make money around those tenants with a small shop? And the places that make that shopping center feel different than every other shopping center that in America. I'm going to stop right there because I'm exhausted. And let you ask a question to...

All right. That was great. Thanks, Don. I guess on the subject of quality and demographics. It's something that we've been emphasizing, but the last couple of years, year-to-date, it hasn't mattered as much. It's not a big part of the conversation, demographics. So I guess, first, I mean, and maybe tie into the -- we had a consumer panel this morning with the BofA Institute. And through the -- our credit bank data, we have seen some slowing, but resiliency across the board and then in particular, the lower income consumers starting to be [indiscernible] are you -- when you talk to your peers or retailers, I mean, where do you think we are in terms of the state of the consumer? Is it just normalizing? Or from your experience, this is typically the start of something that could create some issues? Or are you hearing any more issues that we should be aware of?

Yes, there's a couple of things to talk about in there. One is -- and what I'm about to say is obvious, but it's important to keep this in your mind, the landlord, the real estate is not the retailer. There's an inherent cushion between a retailer's performance and whether they're able to pay the rent in the real estate that they own and what can happen with that. And with respect to that, I can sit here wherever we are September of 2024, and say, I have seen very little, if any, reductions in the appetite of retailers to continue to sign leases and to grow. I do think what's important in here. And this is something that's very hard for an investor to get his or her arms around. It's the quality of the operator. And this will be part of the normalization, which I think is what's happening, Jeff, that's important here. If you think about most shopping centers in the United States of America, wherever you live, wherever you've traveled, wherever you go, you've certainly seen places where it doesn't matter other than the TJX box or the Ross box or the Dick's box, whatever that's in the shopping center or the grocer, whoever it is, when you look at the small shop, there is a propensity to lease to whoever will pay the rent. And that to me is shortsighted. Because if you are trying to build a stream of cash flows that gets through highs and lows, what you really need from the best operators in each category. And you've all seen it, your towns and the way you're going to think about any restaurant that is part of a shopping center in your town. When things are great, the mediocre person, they can make it, they do just fine along the way. It's mediocre, but you've got money and there's stuff. When things get tighter and the consumer spending, I don't know, 10% level. Your sales are down 10%, 5% -- something like that. Your margins are squeezed, your costs are up, it gets tougher. The difference between being able to pay your rent and continue to thrive in your business is whether you're a good operator or not. And there's not enough talk about that. And I say that because what we try to do throughout the portfolio, and albeit it's a higher quality portfolio. So we have a better chance of doing it is to find the best operators in each category. When you can do that, and you know you've got tenants that are not worried about making it through the cycle. They're -- they know they're going to make it. They're operating differently. They're operating smarter. They're using technology. They're the people that can get the best employees because they're known in the industry as being the best operators. All those kind of things that are qualitative in many respects are why what happens to us in downturns normally is we are much less impacted by the downturn. And it goes back to where I started from, that's kind of the way I see the next couple of years. A good economy. I do think why -- we'll figure out how to get to a soft landing, I'm hopeful, but I'm not an economist. So if we don't, I want to make sure that it's not what we're going to do now. If you're waiting until now to decide how you're going to -- what you're going to do, it's too late. You had to build up the company with the right cash flow stream with the right tenants with the right balance sheet historically to get to where we are today. That's why I'm hopeful on a relative basis that you'll start to see some differentiation for in a prior period that didn't matter as much because it was all -- because the rising tide was lifting all boats.

Does it take a recession to see these differences...

No, it doesn't...

No. No. this is not a political comment. This is just fact. Federal Realty made more money for its owners during the Obama administration than anybody else by far. And you know why? Because the economy was [ social ] because 2 things. Interest rates were low and that's important but not that important. Interest rates were stable, and that's important. So whether they're stable at 2.5% or 4.5% or 5.5%, that's not a number that you can't make any money with, that's important. But the thing that's most important is that the economy is growing slowly -- economy growing slowly, real estate investment trusts like this look great. Economy growing too fast, you've got other places to put your money. There's other opportunities. Economy going poorly, nobody is interested in anything. So I'm looking for what I think we're going to see over the next few years, and that is a slow growing, more normalized economy, which I think should be good in a space where demand exceeds supply.

And then in terms of the portfolio, you talked about 9% resi. And I believe you said you're also at 9% office.

Yes, 9 or 10...

How has that evolved? And how should investors think about that over the next 5 or 10 years?

For those of you who don't know us well, we have affectionately known as the big 4 within federal, and that is $4-plus billion of 4 assets that are large, mixed use, laboratories for us, the Santana Row in San Jose, California, our flagship, Pike & Rose in North Bethesda, Maryland; Bethesda Row in Bethesda, Maryland; Assembly Row in Somerville, Massachusetts. In each of our major markets, we've got a big one. And what we get out of the big one is the economics of the residential, the economics of the office, the economics of the retail. And the integration of those in the big one, people don't get is what we've learned by doing those billion dollar projects basically trickles through to our other 102 assets. We've learned tons of our construction. We've learned tons about placemaking and how to make a place feels special. We've created relationships with tenants that aren't unusual shopping centers -- that are in our shopping centers. It's found its way all the way through the company. And you'll notice a difference. If you go out and look at our assets, then at the typical shopping center. And so the notion of having those mixed-use properties -- the only reason we have them is because we had shopping centers and places that intensified over the years, over those 60 years, such that we were able to make economics worth by going up -- going up. Not much of a shopping center. It's a shopping center demand on the fifth floor of anything. And so we created communities. The residential at those properties has grown at 3.5% CAGR for -- after 20 years in those properties. It's been fantastic. Because and you all know it, you want the convenience of the amenitized base with the restaurants, with the shops, with the services to effectively go along with you. And in any of those markets, those 4 markets that I'm talking about, and we also have some in Miami too at CocoWalk, something that we did just in the last couple of years, that those rents are premium. The same applies to the office at those places. And got the oh word, how could -- Oh my God, how could we have a conversation with the oh word, it's a bad thing here. It's not a bad thing in these places, particularly when the buildings are new or being built. Now that's the only places where we do have office. And that's the place where we've done heck 1.2 billion square feet -- 1.2 million square feet of leases over the last 4 years, all at premium rents. It's good stuff. Now when you put that together and you look forward about that, we acquire -- we don't acquire mixed-use usually. We tend to acquire great pieces of great shopping centers or great potential shopping centers with maybe the ability to put mixed-use on them, which I love putting residential on properties that we already own. What you should expect that ratio 9 to 9, 10 to 10, whatever that to be roughly 80% to stay. That's an 80% -- just 80% of the income stream is retail all the way through. And I would argue that the residential and office is so tight to the retailer at those places that we're really -- we certainly think of ourselves as a retail company through and through and through.

And on that residential side, when we saw you in March, you said you want to be opportunistic and take advantage of entitled land wherever it's appropriate to add resi. You need that cost of capital. Where are you today in terms of your mindset on adding more residential to your properties?

Yes. It's an important thing to understand. So during any cycle during any time, there are times when math works better to buy and when math works better to build. And it is clearly heretofore it makes much more sense to buy than to build. Construction costs are high. Just that cost of money high, higher all of those things. What we use periods like that for exactly like we did in the great financial crisis is to go through the process of getting ready to be able to build when the market changes. As investors and you look and you say, "Oh, there's development". When you think of development, you think of construction generally, building something. The reality is that's the very last phase of development. The permission to be able to do what you want to do, the entitlement phase takes years and is upfront before that, the designing of what it is and the pricing of what it is that you're going to do. It takes a year before something more than that before that. So you take your down periods and you work like that like crazy. That's what we've been doing with respects over the last couple of years with respect to entitling and designing largely residential adds, apartment adds to our best shopping centers. We've got an opportunity, it looks like, to do 12 of them. Do I think we're going to get to all 12 of them, No. Do I think the math will work on all 12 of them, No. But we got the first one. And it's under construction in Bala Cynwyd in Pennsylvania, which is on the main launch outside of Philadelphia at Bala Cynwyd Shopping Center, a very good shopping center that we did where we did an experimental first 90 units a few years back and it killed. So now we're adding a couple of hundred and we've gotten that with more retail on the ground floor to incorporate this piece of land as a mixed-use project. The going in yield will be 7% unlevered on residential, which is really -- when you can count on 3% CAGR each year from that time because you get to those leases -- not like you're putting this thing away, you're getting to that year after year from my perspective. It makes a ton of sense from a capital allocation perspective. No land costs because you own that land effectively there, which is a huge plus often in some of these places, parkings already, they are partially there, which is another huge component of cost that is advantageous. We're real close on adding a smaller project in Hoboken on a piece of land that on a retail piece of land that we own that should come up next. I think you should expect to see more of that over the next few years as the economy changes. And this gets down to kind of where we are today. Most retail real estate portfolios are fully occupied. And once you get to 95% or 96%, you got -- because you're fully occupied generally. We got a little bit more to go than now. We got another 100 basis points or potentially more in ours because we were hit harder by COVID. So we're behind a little bit in that. So there's a bit more of a tail that way. But if you say, well, okay, once you're fully leased, how do you grow? And I am afraid that the investment community in general, particularly the generalists who don't know this business well, are being led to think that these properties can grow much faster than they actually can. Because when you think about a shopping center, it's made up of the anchor boxes, which almost universally have a CAGR in their leases of about 1% a year. One, maybe 1.2% or about 1.4% because of the way those leases work. So you have to make your money in the shop, small shop, which is very, very important to have distinguishable and not just anybody, and the shop it gets down to the operators, gets down to the sales, gets down to the place making all that. When you put all that together, a good same-store growth portfolio, a really good one, like I think ours should grow about 3.5% a year at the POI level of property operating income. And I think most grow it much less than that. So the point is, well, all right, in a more mature market, in a more normalized market. What other arrows do you have back here to be able to create that growth. And that's why I talked about that residential development because the more you can think like a real estate person and create value and add cash flow to that income stream through the more sources, the better your overall growth is going to be. And so I'd like to have as many arrows in the quiver as possible. We've been doing that for 25 years.

And on the residential development, it will be on balance sheet.

Yes. And that's a big point. Whatever you do, it's got to matter. We're a $10 billion equity cap company. The notion of doing all the work to entitle, to design, to get something ready on your property with your land cost to be able to go do it and have it be a $80 million, $100 million project, something like that, and joint venturing that and investing $20 million or if it doesn't move -- it wouldn't move the needle for us enough. So we would prefer and we've developed the expertise over 25 years, not unimportantly, there. We would prefer to put that capital out. So that it translates to the bottom line. At the end of the day, it's going to come through the bottom line.

I just want to make sure if there's any questions from the group, if not...

You'r doing a lot of click and clear, are you right here...

Wow, no.

There's AI now if they just...

True. I wish they let us use that app...

When you talked about the big 4 you talked about development in [indiscernible] markets. So from a funding standpoint, how do you closely [indiscernible] that equations corresponding developed in? And how do you think about it, whether it's JV standpoint selling certain pieces of....

Yes. I know where you want to be and want me to be on that one, but let me talk about this for a second. So first of all, our job, I think, is to not surprise you. And so the notion of balance and capitalizing your company with balance, capitalizing your company with consistency, making sure that all potential capital streams are available to you is such a key part of what it is that we do, which is why you'll see us as issue equity. But we issue equity $100 million a year, $150 million a year out of time through the ATM program. We've been doing that since 2011 or 2012, something like that each year. I don't think there's an equity investor out there that minds us rating $150 million. If we're putting it to work above that cost of capital there, which I think we've done a good job of doing it. We absolutely recycle assets and sell $100 million, $200 million, $300 million depending on the marketplace. And the opportunistic possibilities we have there in each year, about $120 million or so this year so far along the way. And then the third thing, and I'm getting out to your question now, the third way to do it is so part of what you own, one of a joint venture, et cetera. I've said in the past that we would look to in the future joint venturing those big 4 assets or potential part of those big 4 assets. That is absolutely on the table. Now what has really pushed me to say that is, over the past few years, and to some extent, still the public markets are not paying for those assets. Those assets, those are low cap rate assets, man. They're best in the country. And if any of you want to really dig into and see and understand a Santana Row or an Assembly Row or one of the big 4, I'd be happy to show you. And you'll see what I mean. I mean these are better -- these are really good, stable income streams with future development opportunities embedded in them. When you look at that stuff, $117 stock price doesn't cut it. Frankly, there's $100 -- was $195, I was really saying, "Man, we got to figure out how to exploit that. I mean we got to get paid for that. If I had my way, the stock price would be reflected. We would not have joint ventures. I personally -- I don't want another partner, and they're diluting our growth assets there. When would I do it? When you go [indiscernible] for it -- so there's a number. There's a place, there's a time that can happen. It's not today. I don't need it today with the other measures that we talked about. But it's something that's on the screen. Effectively, if you look, if you really think about it, it's a competitive advantage that nobody else has. There is a big chunk of this company that is undervalued that we can tap at some point in the future. That can't be a bad thing.

When we saw you in March at our retail executive event in New York City, I think in all the years I've known you, you are the most excited on acquisition opportunities. Where do you stand today on I guess, the opportunity set...

Let's talk about how it works, right? There isn't one of you here that wants to sell anything you own for less than you think it's worth. Not one. I don't care if you're talking about a car, you're talking about a stock or you're talking about whatever, unless you have to. And in order for you to be comfortable at a value that you think what it is that you own is worth, you've got to be comfortable in real estate with where your cost of money is going to be. And obviously, for the past couple of years, nobody has been comfortable with where interest rates were going, with what the story was going to be. That changed a bit early this year. And that gave me irrational exuberance, if you will, because what was happening was the difference -- it's always a difference between bid and ask, but what I'm willing to pay and what you need to deliver something. And that historically had been very, very wide really through COVID and what's going to happen? As that came down early in this year, we saw a window. And we jumped through that window in 2 ways, Pinole in Northern California. And to me, one of the best things we ever did was Virginia Gateway in Gainesville, Virginia. So nearly $300 million of assets. Virginia Gateway, we're going to do a 7.2% yield cash on cash to start there. If they had waited 4 to 6 months to today, that would be 75 basis points, 100 basis points inside that because there's far more clarity on what's going on with interest rates. Now that exuberance, let us get those done. Do I wish we did more? Sure. We tried. Not a lot, that was out there. Now the question is, will we be able to because, once again, a seller is going to have an expectation of falling interest rates, their expectation for what they're going to get paid. Is it going to go way up or going to go up. Question is our stock is higher, our cost of capital is lower, we can pay more. If the bid asked before was here and we made it work is the bid ask here and can we make it work? I'm still encouraged that we can. In fact, I'm going to leave here and we get on a conference call about a specific asset, we're looking at right now to be able to do that. So I'll tell you more at 3:00, if you'll wait until then in terms of what's happening. I am still optimistic about it, but I do realize, man, you're not -- we're not going to put out capital that is not accretive to start value producing from an IRR perspective over time. And we've been able to find a couple of those. I'm hopeful that we can find a couple more to go, and that will always be a key part of what it is that we're doing.

Great. That went by fast. We're already out of time. We do have 3 rapid fire rapid answers.

I don't think we're doing right -- wellerman here, what happened...

3 quick ones. First, do you expect real estate transactions to increase once the Fed starts to cut -- yes or no?

I don't know. I don't. It's the best thing. Do I expect more properties to be available, yes. I do. Do I expect there to be able to get to cover the ask with a bid there. I'm going to say yes, just change it to yes, it's rapid fire. I should just say something...

Then if yes, when do you expect them to pick up fourth quarter this year?

You sucked me into that question. I see what just happened.

Fourth quarter this year.

Okay, second, how would you characterize demand for space today, a, improving the steady or see weakening...

Steady?

Okay. And finally, how would you characterize your AI spending plans over the next year, higher, flat or lower?

Boy, that has such an interesting connotation to be. That's a rapid fire. All right, flat. Perfect. Before this, I could really talk about that for a while. But anyway...

All right. Thank you very much to the Federal Realty team. I appreciate the...

Thank you guys for giving us the time.

Thank you.