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

Everybody, why don't we get started here? This is the Federal Realty roundtable. Very happy to have the full management team up here, Don Wood, CEO from the company. Don, maybe -- there's a lot of people here, introduce your team and maybe provide some opening remarks.

Sure. Well, first of all, it's great to give us the opportunity to speak today. This is Dan Guglielmone, the CFO of the company. He's been the CFO for the past 10-plus years. He reminds me of that often. To my left is Stu Biel. Stu is here as basically the head of leasing for the -- most of the company, East and Central region, which is what -- where we've been embarking lately. And so retailer questions, Q&A, this guy is a great guy to tap, whether it's in this meeting or afterwards. I think you know Jill Sawyer, our Head of Investor Relations. And way we go. So I was looking at the questions that Sameer at BofA sends ahead of time. And there's a lot of generic stuff in there. There's a lot of stuff in those questions. How is the consumer, what is tenant demand like, all the stuff that, as I was thinking about and what I'll answer for you, all is going to sound just like every other shopping center company. Demand is -- it continues to be very strong. We don't see any signs of a weakening consumer. All of the stuff that you would expect to hear in one of these meetings. And I don't like that. I would prefer to do things that kind of differentiate us from what is happening, the general. What it is that we think makes this something that's compelling for you guys to dig in a little bit deeper. I see in this room people that have known for many years, frankly, and some that I don't know at all. So I'm dealing with a -- Jamie -- so I'm dealing with an audience here and on the webcast that is both. I do want to refer everybody here to a new product that we put out from a communication standpoint. It's our second quarter investor deck that on my way up on the train a couple of days ago, my final review for -- in preparation for all the meetings of each of those things, and I found myself sitting there and saying, man, this is a really good company. And this is a company that is different. This is a company that not only are the general demand and supply characteristics of the retail business good. But I think we're in a unique position and to be able to be better than good. And I kind of wanted to give you some of the reasons why. And a lot of this is post-COVID, the status of retail, status of geography to some extent, something that I thought you might find interesting. So Federal has been around for a very long time, and we've always been a very high-quality company, and high-quality defined really by income. And income is, from my perspective, the most important thing in the success of a shopping company -- shopping center company. I never want to be in a business where the best way I'm selling you a product, whatever that product is, is by saying, hey, I'm the cheapest. And I can beat you on price and because that's commodity stuff. I want you to pay more for me. I want you to pay more rent, if you're a tenant. I want to pay more for the earnings multiple, if you're an investor because I want you to think that it's worth it. And the way that I get there is not only with high-quality assets, but the ability to have as many arrows in the quiver as possible to create additional value on these pieces of land. We have historically been a coastal company from Boston down through Washington, D.C., then Florida, Northern and Southern California. What has -- what we have decided and what we did because we own our assets and have held our assets on average 20-plus years. So over a 20-year period of time, we've built them up. We've leased them better. We've created better environments effectively to create higher earnings growth, which we believe we can continue. But post-COVID, we said, you know, it feels like we ought to be able to do that in other markets. Work habits have changed, geographic migration has changed. And there are other markets. The first one that we entered was last year, Kansas City, and not Kansas City, Missouri, but the Kansas side, where we thought that we could take what we do as a business on the coast and effectively provide a better product if we owned the most dominant assets in the market. So we bought and it was the WPG sale, which was Oklahoma City, Kansas City and asset in Phoenix that we looked hard at all of them, really looked at Kansas City, Kansas and those assets and said, we can create -- there's a big mark-to-market here to the extent we could bring in our tenants from some of the coastal relationships that we have into the center of town and the centers themselves, and it's made a big difference. We followed up with Omaha. And while it's not completely done yet, and I can't give you all the details, there's now a large acquisition that we expect to close over the next 60 or 90 days or so in a central time zone marketplace that really will have created a big one, nearly $0.5 billion in investment side that will really create a central region for us that is expected in total to be about 3 million square feet of retail space and grow at better than 5% POI annually for the next 5 years. And we still acquire on the coasts in key markets. We fund these with sales of assets that we have created a lot of value in over the past 15 or 20 years, and the ability, if you think about it, the ability to really be able to be -- have a competitive advantage in this business of ours is twofold. One, you want to have the best cost of capital. There's nothing more important in our business in retail -- anywhere in real estate than cost of capital, as you know. If the common stock is not trading at a place that you can effectively feel comfortable using it, what are your other choices? So you'll hear -- you'll hear there being more joint venture use in the world of shopping centers and some other things. But what's better than that is if you can, tax efficiently, sell off assets that you have created a lot of value in and which have limited future upside to at cap rates that are inside what you're investing in to the tune of 150 to 200 basis points. So well this expansion into not only the center of the country, but into faster-growing assets with the sale of other assets, and here's the most important thing in a nondilutive way. And that's a differentiator from anybody, the ability to sell because of what our business plan has been because of the quality of the asset because of the growth that they've created, the ability to [indiscernible] the high 6s overall, makes an awful lot of sense to us. And it's a competitive advantage because we have the ability to do that nondilutively. It's not like we're saying, hey, we're going to sell stuff we should have never owned in the first place. It's going to be dilutive for the next few years, but don't worry, we're going to produce great income. It's not that at all. It is harvesting really good stuff. And reinvesting in new raw material that people like that and throughout the company can use effectively what we do well to be able to create outsized growth. That's what we're trying to do on the external front. On the internal front, in a couple of ways, we also have a full long residential development team effectively in-house that we've employed for the last 25 years because we do mixed use. And that mixed use stuff that we do, some of our best assets, some of the best relationships but can also greatly benefit the average shopping center. And when I say average shopping center, the ones that you're thinking of that happen to be [indiscernible] unutilized parking lots to be able to go [indiscernible]. Again, this investor deck shows all of this goes through this in detail. But when you think about the ability to harvest assets at a lower cost of capital, a development group that can intensify existing assets with low basis land and a team that's got relationships on the coast and some of the best-known assets in America, Santana Row on the West Coast; Assembly Row, Pike & Rose on the East Coast. Imagine, there's not a retailer in America that doesn't know those assets, know them extremely well. And why? And because of the performance of those want to expand relationships into places that we haven't necessarily been before. We're not going everywhere. It's got to be in a metro area of at least 1 million people. It's got to be a big asset I've said this to everybody as many times I can. The average shopping center in America is 125,000 square feet. It's got a grocer. It's got a drugstore. It's got to dry cleaner, you know it well, wherever you are. Nothing wrong with that business, terrific. We would prefer to do bigger things. Our average assets are more than double the size of that. The reason we like that is that there are more opportunities that you can do on that land over time. And that's proven to be a very good fact for us. Sorry for being so [indiscernible] wordy on the introductory question. But I wanted to set up what the really lumped into shopping center companies. And I will stop there.

On the external growth and acquisition, that pipeline, clearly, there's a lot of competition out there today, right? So I mean you bought a few of these bigger assets in the past and you just kind of -- you're looking at the one to close in 60 to 90 days. Talk about pricing given what are you seeing in terms of cap rate and pricing markets?

Listen, there's no question that I don't mean to sound arrogant about this. It's just factual. When a company like Federal goes in and starts looking at new things, others -- it brings more competition. It brings others to come and look. And so when you get 1.5 years ago when we started this, there is no doubt that cap rates have come in 50, 75 potentially basis points inside where they were 18 months ago. Now we happen to be funding it with asset sales, which, guess what, have also come in 50 basis points from effectively where they are. So that's kind of the beauty of that, too, right, thinking about how you match the growth of the company. So yes, it's tighter today. Now what I would also say is when you're talking about larger assets, Kansas City was $300 million effectively for us. When you're talking about that and what we're buying is larger than that, there are obviously far fewer buyers than for a $40 million grocery-anchored shopping center, obviously. And in a rising interest rate environment, it makes it harder for the leverage buyers to be able to make the numbers work. But when you -- so when you talk about the real competition for assets like that, it's often private people that kind of do what we do on a bigger scale. Our largest competitor, frankly, is a private developer out of Boston, named WS Development. It's a great company. And they are -- we run into them often on these type of deals. They do a great job. But again, there are fewer of them. So I said, well, okay, what kind of competitive advantage do we have to be able to get our more than fair share of assets like that? And there are 2. The one is what I've already said, competitive advantage in cost of capital by funding it effectively with 5% asset sales, clearly an advantage. Number two, we can underwrite better results for where we can take that asset because of Santana Row because of Bethesda Row, because of the relation on the assets that we purchased in Omaha and Kansas City, far ahead of where we thought we were going to be because of the momentum of doing the first couple and then having those other tenants follow because of what we own on the coast. It's really a pretty interesting. All of this talk about acquisitions, I don't want you to miss how strong the core portfolio of the company is because it is. And by very definition, if you look at the demographics of our properties, where the affluence is, where the centers are, we're pretty much off the charts. Does that always matter, particularly in a post-COVID environment in the earlier? No, it didn't. Does it matter more and more as the economy gets a little unnerved by what's happening, and there's more uncertainty? You bet it does. It's why that if you looked at our company over its long history, other than closing down the country in our markets and particularly for COVID, we've outperformed doing every down cycle. I would expect that to happen again, should that happen again in time.

With Kansas City and Omaha, which you mentioned, talk about kind of things you've done there, remerchandise -- what are the things you've done at the centers to create value?

Go Tiger.

Yes. I mean, Don touched on the deals. I mean, that's really where we're doing it. And I think where we've been really successful is getting started in the diligence period. And so because of the relationships Don is talking about, and there's another stat, we have 36 relationships we've created through the 4 assets you mentioned on the coast that have turned into 155 deals, not just in the central properties, but also in our peripheral shopping centers, grocery-anchored and otherwise. So we're meeting these tenants really early in their gestation period, getting really deep relationships with them. And so we're able to vet these and get deals started way ahead of even closing, which is happening on the new acquisition as well. So it's really not even physical stuff on the property yet, it is just truly digging to these relationships, getting people who were excited about these markets knew this was the right center, but didn't have the right owner and are ready to now jump in. And in the case of Kansas specifically ready to jump in, there were 2 sides of that center to the side that had been sort of less well maintained and had a big rent spread down, and we are seeing that -- our thesis was we could quickly bring that up to the same levels as the other side, and we've been able to do that very quickly, quicker than we thought.

On the dispositions, what is the growth profile? Like what's the -- where is the line? And then that's what you're willing to sell?

So it's a complicated answer because it's not all one type of disposition. When we look throughout the company, there is a few buckets. Bucket number 1 Santana Row, for example, we've been building for 25 years. It's crazy. It's that amount of time. Now -- but therefore, there's the main street and the retail and residential over that, that doesn't get touched. But we've gone into Block 2, Block 3, Block 4. That -- 2 of those assets were sold, the same thing at Pike & Rose, at sub-5 cap rates. Pike & Rose is 5.25. On the West East Coast, it was mid-4s, incredible. There's still some of that to go. Not right now. I think it's the greatest time to do that right now. But that's a bucket of money that can be monetized and access at very favorable cap rate. The second is more what you would think of, assets that we have done the best we can with. Have -- the markets have changed, and they don't fit any longer. There are assets that have no or -- little or no growth profile at all. Those assets get sold like Hollywood, California, where we own stuff on the Street and place is just not where you want to be anymore. We sold to a local owner, the same thing in Santa Monica, California, where we were -- we made a lot of money over a lot of years. But the condition of the competition, Santa Monica and other things said, get paid, you can get out. We did. So improving the company's growth profile by selling those. The third level of -- the third bucket, if you will, of sales, are the more mature assets, good assets that are stable. They're lower growth. They're still in great markets, if you will. Some of those -- my best example of that is recent sale of an asset called Barcroft, a plaza, nice grocery-anchored shopping center in Northern Virginia, great market, fine center, little growth going forward, get paid really well because of the disconnect to me, grocery anchored, trading at numbers that are pretty darn strong relative to their growth profile if you will. So those are the 3 budgets. The notion is always to effectively take that capital and deploy it into higher IRRs. When we look at IRRs, we don't mess around with exit cap rates. We don't lie to ourselves or anybody else about what those unlevered IRRs are. We look to be in 8.5% to 9%, 9.5% unlevered IRRs. That means you need to grow if you're buying in at a 6% or 6.5%, something like that. You have to grow pretty darn significantly to get there. And we like that over the first 5 years. It's a 5-year IRR and a 10-year that we run, but I want the growth early. The stuff he's talking about, what we love about the most is there was a way to get at a larger part of the income stream sooner than you would necessarily be able to get to. So those are the buckets in total, the timing and the ability to sell ties very much to the timing and the ability to buy. The asset that we're buying will be a 100% fee-owned asset, which gives us a lot of 1031 tax-efficient ability to sell assets and move the tax basis effect. But kind of further along, the -- what we're selling is probably at a growth rate, which is 200 to 300 basis points less than typically what we're buying. in terms of a 5-year CAGR in terms of NOI CAGR over that... Speaker 5 Question in terms of tenant relationships, are there any implications from the sales on tenant relationships, if there are, how do you manage that? Speaker 1 Yes, it's a good question, but no. So the notion of retailers and where their business plans are and what they're trying to do is really at the forefront of our business strategy. So to the extent tenants are looking much beyond the current interest rate environment, these are longer-term decisions that they're making. They're -- by the way, they're making them at in our properties, kind of special properties so that -- if there's an opportunity to get in, they can't just say or they don't say, now, we'll wait until the next -- you got an opportunity to get in, you get in on the sale. It's, as I said, kind of relationships that are -- are fine, but we've done all we can with respect to the asset. They fully understand that and on we go. Speaker 3 Is there a maximum percent that you've determined in terms of the dispositions and acquisitions, meaning as you transform the portfolio from those historical federal markets to the new markets? Speaker 1 It's not -- first of all, Jeff, I got to say it a couple of ways. First, I don't want this to be a transformation from the existing federal markets to new markets because that's not what's happening. This is simply an expansion. I mean the acquisitions we made have largely been in our existing markets, recent acquisitions, Monterrey, California with Del Monte, Annapolis Town Center in Maryland. So there's a balance. So this is an expansion and not a transfer. I think that's really important because if you short the coast, you -- good luck with that. I think you're making a mistake. And again, that's a big generic comment. The real estate is local. You got to be in the right places. You got to do the right deals in those places. There are plenty of those opportunities remaining on the coast. But we were saying, why are we limiting ourselves to that, particularly post-COVID? That's what I'm most excited about because it is fresh, new raw material that I can stick with dogs on and create some money, create some real value. Now practically speaking, in terms of what the limitations would be or, it's likely to be as much as $700 million or $800 million a year or as little as $200 million a year. And the marketplace determines that. We're not buying generic volume-oriented stuff. So it's harder for investors to get their arms around because it's lumpy. When something like Kansas City comes up, grab it because you're not going to get another chance to grab it. It's not like if you're looking for a kind of a typical grocery-anchored center, I'm real comfortable with the market. I'm going to wait 6 months, there'll be another one. Which they will. It's not bad. So when we have a chance for the most dominant center in a marketplace, existing or new, we're going to grab it best we can. So just practically speaking, because of the size of those assets, it's lumpy. 2 to 7 or 8, I'm sorry, for the range, but that's kind of practically how it works.

But your investment in, say, the central time on assets and what, is the opportunity here to buy an undermanaged, underperforming assets -- but you're going to give up on the long run effectively, give up some -- the demographics that you might see come from the coast, as you mentioned, in terms of earnings, income growth and population growth and [indiscernible] what not. Like how do you.

I don't see it that way. a trade-off, okay? I don't see the trade-off. And I guess what I'm saying is, so if you've got a chance to buy the dominant asset in a marketplace that is at least 1 million people big. I'm not talking about small markets here. Kansas City has 2.2 million people in it. But if you've got an opportunity to do that and you look at what is happening in the marketplace with jobs. You look at what's happening in the marketplace with overall business moving. I mean the Kansas City Chiefs moved out of Missouri, and into Kansas. That's not a flash in the pan. That's a 50-year investment that's being made there. When you can start it out with a mark-to-market, like we've talked about and get that immediate, by the way, immediate is take 5, 6 years to effectively get there the way we're doing it. But that's fast when you're creating that kind of growth. With that initially and the overall macro trends of good, steady growth throughout the place, I don't think you're trading anything off.

And the demographics of the markets that we're buying in, in terms of household income, median household incomes [indiscernible] is higher than the rest of our portfolio.

I want to talk about that for a second because where you're probably going, [indiscernible] where's the population. And -- this industry uses a 3-mile convention. Why did they use the 3? What are demographics for income? What are demographics for population within 3 miles? You know why that's the case? Because that's right for a grocery anchor shop, et cetera, of 125,000 square feet because you want to be in 3 miles of your grocer or something like that. That's cool, and it makes a little sense in the world. What we're talking about here, the Kansas City asset pulls from 25 miles. The Omaha asset pulls from 15 miles. The asset we're talking about pulls from 100 miles. And so the affluent piece of it is critically important because that's the neighborhood that's the neighborhood it's in. Think about it if you're the retail. But if we're buying an asset of 500,000 square feet or 900,000 square feet big stuff there, you're not going to make their money by pulling from a 3-mile radius. You got way too much to make a living based on people that live within 3 miles. You have a true regional operation and you look deeper of people that come into an area that feels really good because there's really -- because there is [indiscernible] great neighborhood. It's a great ability around them. That's kind of the secret sauce.

How are you thinking about using JV partners potentially for some of these larger $500 million asset?

It's a real question, and it's a question that I fight myself with in a number of ways. part of the thing with me and Federal has always been because we have all these arrows in the quiver, because we have a full integrated asset plan, I felt that as a public company, the simpler the capital, simpler the right side of the balance sheet was, the better it would always be for transparency. And I still believe that. I would love it if there was no need for JV capital because either through asset sales or through the sale of common stock, you had an advantageous cost of capital. What is becoming clear is with the lack of appreciation for NAV versus the way it used to be and other changes, there's a place for it. Now do I want 6 JVs and 6 new hands in the till, if you will, for how we run the company? No. But I could see 1 or 2. And I could see 1 or 2 at the larger assets where we don't lose control of the asset and kind of a control freak, I apologize, where we don't lose control, but do monetize 30%, 40% of what it is that we've created over the last 20, 25 years at a cost of capital that is far advantageous than what would be available otherwise. So I've switched a bit in my thinking, needs to be a little bit more work done and understanding the marketplace and the opportunity. Devil is in the details, what does the JV agreement say and how exit paces and all the things that need to be understood, but I'm more open than I've ever been.