Kite Realty Group Trust (KRG) Earnings Call Transcript & Summary

Sorry. Good morning, and welcome to the 9:45 a.m. session at Citi's Global Property CEO Conference. I'm Katy McConnell with Citi Research, and we're pleased to have with us Kite Realty. Before we get started, this session is for Citi investing clients only, so if media or any other individuals are on the line, please disconnect now. Disclosures are available up on the webcast. For those of you joining us in person, to ask management any questions, please feel free to step up to one of the microphones located in the center aisle. [Operator Instruction] And now, John, I'll turn it over to you to introduce the team and the company with some brief opening remarks, and then we'll jump into Q&A.

Thanks, Katy, and thanks for everybody for coming today. It's definitely great to be together physically. I think we keep talking about it, but it's a good sign for things to come, I think. So with me today, on my left, I have Jason Colton, who's Head of Capital Markets and IR for us; and Heath Fear, who's our Chief Financial Officer. I'll be very brief on intro. I think most people are aware of the company, but we're excited. We've just recently completed, I think, a transformational merger with RPAI in every respect. We feel very good about the future in terms of the position of the assets, the ability to grow, the ability to grow outsized candidly. And we believe that the combination of people is also very strong. So when we look at the landscape of retail right now, we think we're really well positioned. There's a significant amount of pent-up demand that is still yet to come. There's obviously a lot going on in the world today that's making it a little bit confusing. But we're very bullish as to what lies ahead with -- in the shopping center sector. And we think KRG is perfectly kind of positioned to take advantage of that over the next several years. So that's my brief introduction.

Perfect. Thank you. So to open each of these sessions, we're asking, what are the top 3 reasons why investors should buy your stock today over other property REITs?

Sure. I think I briefly touched on. I think the primary reason is this -- our recent completion of the merger. This is a significantly accretive merger, both from an earnings perspective and a value creation perspective. So we're very, very pleased with what has occurred there. In fact, frankly, as we mentioned on the last earnings call, it has turned out to be better than even what we expected. So I think that's one of the -- clearly one of the primary reasons is that outsized growth that is ahead because of that. Candidly, the stock was quite mispriced. I don't think that's particularly unique in retail right now, but KRG is definitely mispriced as it relates to the peer group and certainly as it relates to other sectors. That's another material reason. And I think the other really interesting thing right now is just the consumer. There's almost $3 trillion of excess savings in the United States right now that is going to be deployed. So when we can kind of get out of this, a little bit of a malaise that we're in right now, we think that it will rip and our shopping centers will benefit from that. So I'd really say the top 3 reasons are specific to us, the merger, and then the overall space and environment.

And when you look across the shopping center space, what would you say differentiates your company and strategy now pro forma for the merger versus your peers?

I think, look, I think it's our portfolio. We have a really well-balanced portfolio. Majority of our assets are in what we've termed to be the warmer, cheaper markets. 40% of our revenue comes from Texas and Florida alone. And when we look at the overall landscape, there's been significant growth there. But also, I think it's the ability for us to have added these very strategic markets -- gateway markets such as Seattle and Washington, D.C. and getting a little deeper into the suburbs of New York. So now I think we have this very interesting portfolio. Retailers really want to be a part of it. So as we're doing new transactions we're doing new leases, we see a lot more increased interest in the portfolio.

And what would you say is the biggest growth opportunity for the company that you think the market isn't giving you enough credit for today?

Yes. I mean, clearly, we've laid out in our investor presentation, if you've seen it, we have $67 million of near-term NOI growth. That's 17% growth right there. It's probably $0.30 a share. That's comprised of $33 million of signed but not yet open tenants. So that's the near-term portion of that. That's back half weighted. It's heavily weighted to the end of '22 and into '23. So we're positioned pretty well for '23 as well in terms of growth. We have -- the balance of that $67 million is in the development pipeline -- the active development pipeline, which are projects under construction. It's about $13 million of NOI that we'll generate there. And then the balance is leasing up to pre-pandemic levels. We're still in a significant lease-up ramp-up period, particularly as the anchors get full, now we're doing a lot more small shop leasing. So I really just don't think we're getting credit for that. And it's quite near term over the next 2 years, so as the quarters go by, I think people will see that.

I want to go back to that later during the session, but before -- just to your comment on being mispriced, what do you think the market is penalizing your stock for the most? And how do you plan to address it? And then we have an investor question, what do you think is a more appropriate cap rate for your portfolio today?

Well, I mean, I think -- I don't know if penalizing is the right word. I think we're just in a process of -- we just closed on this very substantial transaction, doubled in size. That was just in late October. So I think people are still maybe a little wait and see. We came out with guidance that was obviously significantly above where people thought it would be. We think it's extremely achievable. We think it's conservative as it relates to our assumptions. So I think it's a little bit of that, Katy. I think people just need to see us to actually deliver. That's what we do. We're an execution company. We have to execute. And I think particularly, maybe there's a little misunderstanding on the real estate itself. This is an extremely high-quality real estate. When you look at us compared to the top 5 REITs, the other 4, we screen very well on ABR, demographics, super zip. So I think the portfolio is a little misunderstood, and that's the onus is on us to educate everybody on that.

Maybe shifting to operations a little bit. The sector is still enjoying a really robust leasing environment. And you made a comment in your opening remarks about how there's still significant pent-up demand yet to come. Can you just elaborate on that comment a bit more and what that could mean for momentum this year?

Yes. I mean, I think you've got to go back and look at the supply and demand characteristics of any business. In our particular business, supply has been extremely low over the last many years. Demand is now strong. That's creating the ability for us to price in a very effective way. You look at our results over the last few quarters, you see that we're getting double-digit rent spreads. We're getting high returns on capital in the leasing. And it's balanced in terms of where it's happening. Yesterday, in the morning, we had our -- while we were here, we had our Real Estate Committee meeting that we have every week. And 20 deals went through the committee. And those were extremely diversified in terms of where they were geographically. I think we had 4 in Seattle, I think maybe 6 in Texas, a couple in Illinois, 1 in New York, 1 in Michigan, 1 in South Bend. So I think we're seeing good diversity of interest, and they're all at good returns on capital and good spreads. So I think the other interesting thing as we lease up the anchor space, you're seeing more and more small shop activity in effect of the deals we did yesterday. Of the 20 that went through, I think, 17 of them were small shop deals. That's a new element to this, and it's natural because obviously, as the anchors fill, you have more interest in your small shop space. Do you want to add anything? Okay.

Could you elaborate a little bit more on the type of demand you're seeing for small shop space and the tenants that are actively expanding?

Yes. I mean, it's broad-based. We're seeing good activity from the national small shop retailers like a Starbucks, the franchise guys like a Subway. And then we're also seeing great business formation in the mom-and-pop sector. And that's what I meant by that comment about savings in this country at $2.6 trillion. It also enables people to form businesses, right? So I think we're a great beneficiary that the open-air retail sector is a little mini commerce location in east little suburb but it's in. And after COVID, we've exposed this property type to so many more people than before that have been spending more time closer into their homes. And look, Kite owns shopping centers all over the country that are 5, 10 minutes away from your house in these 20-plus states that we're in. So we're benefiting from that, too.

Maybe to that point.

I think you got a question right there.

Go for it. Yes.

You got to get the mike, come on now.

Okay. Well, Katy asked a question earlier that what do you think the cap rate...

Cap rate, did I avoid that?

You did. And -- that's very important because we saw a comp last week, right? And I'll quote a long-only investor who told me Cedar transacted and nothing is the Cedar guys. But I think the quote was "Class C assets and Class B markets". Where I think you guys do complete opposite. I think you guys have phenomenal assets and phenomenal markets. In our calculation, it traded maybe around a 6.7% cap and I don't know why you guys aren't way inside of that by 100-plus basis points. So my question to you is just so everyone understands that, where do you think you're...

Yes. Look, I mean, I think I agree that cap rates have compressed. I think there's continuing to be significant interest in open-air retail, which that wall of capital is opening up to all of us. There's a significant mispricing. Do I think -- look, I think the quality of our company, you look at what's trading today, it's hard for me to imagine that the cap rate wouldn't have a 5% in front of it as it relates to the total portfolio. And so I think it's just a matter of time. I think we have to execute. We have to post the numbers and people I think will begin to see that. But yes, I would agree with you that there is a significant disconnect.

One of the best values in REITs all around. Quick question, sorry, also on this -- you said you leased 20 properties in your meeting yesterday, that came up 17 small shop. How do the rents on that, the 17 small shop, as compared to '19?

I mean we continue to get -- if you look at the fourth quarter and you look at where we are right now in the first quarter, I would tell you that, overall, the leasing spreads and return on capital are very similar to what they have been, if not a little better. I can't get into individual deals, but definitely, rents continue to go up on a cash basis and a GAAP basis.

And then just last one. I know some of your peers are starting to obviously either do a little bit more multifamily or want to get their ABR up in terms of multifamily via ground leases or via actual development. Do you guys have any target in mind in terms of where you might want to take multifamily? Is that something you're thinking about? Is there a set target in mind? Do you even want to get there? Percentage of ABR NOI?

In terms of the multifamily, we don't set targets. We're not setting development targets. We don't want our people to chase deals. We want them to come organically. That said, I think today, we have an ownership interest in around 1,000 units. We have others under construction in D.C. and in Indianapolis. So I think that we will organically continue to grow that. But we are not fixated on owning 100% of that. We're a little more creative. We want to protect the capital. We want to get higher returns. So in a lot of the cases, we'll be a 50% partner on the deal. One case in Indianapolis, we're a 13% partner because all we did is contribute to land. By the way, it was a parking lot. And now they've built 280 units there, and we're a partner. So I think we'll continue to be creative along that, but it's because of the quality of the portfolio, it will continue to grow.

Just going back to the leasing environment a little bit. If you thought we're going into an economic downturn, would you accelerate your leasing even to at this point?

I'm sorry. Can you say that again?

Sure. If you thought we were going into an economic downturn, would you accelerate your leasing even more?

Absolutely. I want more revenue. No, I mean, I think the I environment is good. And as I said, I think that's why the pent-up capital that's out there and the excess savings can insulate us for a while. I'm not sure if we're going to go into -- at some point, there will be some sort of economic downturn, the length of it, the intensity of it. Look, in the last whatever, 12, 13 years, 14 years, we've been through 2 huge shocks in '08, '09 and COVID. And one thing is for certain, this product type, if it's well located and run by pretty reasonable teams, we'll survive and actually thrive in these different types of environments. So I'm really feeling pretty good about being in this business right now.

Can you talk a little bit more about your outlook for consumer spending? And do you anticipate inflation or rising oil prices could potentially impact that in a meaningful way that could dampen this leasing momentum that we're seeing at all?

Well, look, I mean, obviously, we're focused on it and monitor it. Inflation can be good. Inflation can be bad. It really depends on the intensity of the time, what's going on. What I've seen happening is wages have risen in certainly in the middle income area enough that they've been able to offset that. So we haven't seen any significant decline at all. Now the gas price situation, that's a pretty current event. And I think it's speculative to say where that would go. But at this point in time, it doesn't seem to be a problem. And frankly, when you look at what we do in the shopping center business, it's a collective place to shop. It's not a truck driving all over the place, delivering products to homes. So from a fuel consumption perspective and from a gas price perspective, it's pretty easy to say, I'm going to make a quick drive to the shopping center, right? It's 5 minutes from my house. So I think maybe in a way, that's good for us and people will do more of that to try to conserve.

Certainly, also, when you look at margins and for gas prices for our retailers, obviously, the most profitable sale is in the store. If you're squeezing margins on delivery, you're going to have the retailers who, again, have a new appreciation for bricks-and-mortar post COVID, leaning further and further into investing into their stores, right? So you saw sort of pre-COVID, when a retailer had a bucket of capital to spend, usually, it was their e-commerce platform that was getting the lion's share of those capital dollars. Now it's been reversed. So we're seeing -- once the real estate guys now are getting their lion's share of this capital. So again, I think higher gas prices for our retailers is really going to keep pushing them to have you, Katy, as the last mile driver rather than some gutting a big UPS truck, right? So we think it could be a good trend for us.

And how is that turning up in your leasing discussions? Just how are retailers thinking about last mile fulfillment through your stores?

Yes. I mean, look, I think it's a factor in how retailers make decisions and look at their spacing, right? In a particular market. I think they're very focused on spacing. But the reality is you have a couple of different food groups of retailer growth right now. There's a pretty big section of retailers that didn't grow at all for the last 5 years who are catching up -- there's another group who's been growing consistently and continues to grow probably more of the off-price value players. So are they making real estate decisions based on the fact that they think this is a great distribution point. I think that's not the material decision that's made. The material decisions made, is this the right location for me to attract people to the store. That's the biggest decision that has to be made. Now are they all utilizing buy online, pick up in store, curbside? Absolutely. Has that been a game changer? No question. And I think it's very, very sustainable. And I think that the -- as Heath just said, this is a margin-focused industry on retail. So anything that they can do to pick up a little bit of margin, they're going to do and I think that's what their primary focus is and our shopping centers have been very attractive to them because of the spacing, because of the demographics, because of the co-tenancy that we have and the way we manage the assets. I mean you've got to manage these things in an intense way and we do that and the retailer appreciates it.

Based on all the leasing momentum that you're seeing, what do you view as the new peak occupancy level that the combined portfolio can achieve going forward?

Well, part of what I said was one of the -- the disconnects is that our ability to lease back up to pre-COVID levels. So right now, our overall portfolio is around 93% leased. I think we were around 96% leased pre-COVID. We absolutely intend on getting right back there and then trying to exceed that. And I think in the environment that we're in today with the consumer health that we have and the expansion that we're seeing, that's a very probable outcome.

And the 2 portfolios had fairly different operating metrics historically. What do you think is your ability to improve the RPAI side of operations?

Probably the primary difference is the fact that KRG was more than 50% of our portfolio was on fixed CAM. And essentially, 0% of the RPAI portfolio was fixed CAM. It was all triple net. Our fixed CAM is a strong way for us to grow. We have a built-in growth profile there. It is a more efficient way to operate the assets for us. So I think that's something that we'll do. And then just in terms of how we run these assets and how much money we spend to maintain each asset, the G&A associated at the asset level. These are all areas where we can improve the margin, but it takes time. I mean this is not something that's going to happen overnight. You want to add to that?

No. I think this is the gift that's going to keep on giving. The Kite historically ran sort of low to mid-70s in NOI margin. RPAI was more of a sort of high 60s. Combine the portfolio together, we're sitting there at around 70%. So we can push those margins over time. Like John said, it takes time to get these fixed CAM leases put in. But just to quantify, every 25 basis point improvement in our margin on a go-forward basis is $0.01 of FFO. So again, we think this is going to be a gift that's going to be giving for a very long time.

And within [indiscernible] 2022 guidance that factors in the initial accretion from the merger, but can you talk about any additional synergies beyond that, that you're expecting at this point?

Well, first, obviously, John talked about the -- just the straight up lease up, right? We sort of look at this in a short-, medium- and long-term accretion. So again, one is the lease up, just getting the spaces filled, getting our active developments finished. Sort of medium-term, we inherited this incredible land bank from RPAI. It's 86 acres. It's something like 4 million square feet of GLA entitled plus like 3,000 apartment units. And again, we're going to step back and look at that. We are not hell bent on just moving forward. We potentially don't call it a development pipeline. We call it a land bank because that's what it is. And it's in 2 primary locations. One is in Loudon, which is a great asset. And so far, the development activity there has been just incredible. It's been a home run. So we will probably be looking at that very hard and [indiscernible] very, very involved in that particular development. Carolina is a little bit of a different story. We currently have a medical office building, which is being constructed there, which we're leasing right now. That one we're taking a much more careful approach. It's a different area for us. It's one of those things where we step back and we're reunderwriting. I wouldn't be surprised if you see us maybe monetize some of that, maybe do some JVs there. But certainly not do it alone. Like John said, we're not really fixated on controlling all of our development. We feel that if we're in a particular development and we're doing JVs, we think we can get ourselves comfortable that the place making won't suffer, so long as we enter into proper REAs and contractually give ourselves recapture rates, et cetera. So again, we're a bespoke developer. We really look at each partial and do what the real estate tells us. And then the long term, which we're most excited about is, if you look past the next 2 years, we have this incredible leasing spend, we start to kick off with a significant amount of cash flow, which is really a different proposition than pre-pandemic. We've gone through this large disposition program, we had maintained our dividend. So our growth prospects really required us to have a cost of capital and have equity such that we could issue and grow externally. Now we're looking at, again, in the outer years is a significant cash flow, which we can, depending on what the market is telling us to, we can buy back stock, we can acquire assets we can develop. So we just feel so much more nimble post-merger. So there are just many levers of accretion that we have to pull that we didn't have before.

Can you elaborate a little bit more on the development side of things? And given RPAI's development pipeline was somewhat of an area of concern at times. What do you think about the projects that they have lined up, and in particular, the ones that you mentioned having some interest in monetizing?

Yes. I mean, I think as Heath said, we take a very bottoms-up approach to when we underwrite development. We've been doing it a long time. Active, I've been in the development business for over 35 years. So we've seen good stuff, and we've seen bad stuff. And we have a good sense of how to underwrite that and how to look at the risk-adjusted returns, not just the returns, but the risk-adjusted returns. That said, when we look at the 8 projects that are currently under construction in our pipeline, we feel very good about them. The returns are high. There's only about $105 million left to spend on those 8 active developments. For a company with an $8 billion balance sheet, that's very small, very, very manageable. Beyond that -- and we like those projects, and we'll finish them out, and we're excited about it. Beyond that, the land bank that he's referring to, we have to spend time and we have to really, really dig in and figure out what makes sense to -- where we're getting our highest returns on capital. So if that means doing a project, that's great. If it means monetizing and selling, that's also great. So we're not -- there's not a lot of emotion associated with that. It's really about the math, what are the returns and what are the risks associated with each one of those.

And recently, you've done a couple of development projects with a JV partner. Can you talk about the rationale there and why you decided not to do those on balance sheet?

Did you want to add something?

Just going to add -- exactly.

So yes, I think as Heath mentioned, in terms of our development approach and our -- particularly our partnership approach. Again, we've been doing this a long time, very comfortable with partnership structures. I think we're all about getting the best return but protecting our capital. And we have a strong balance sheet. We want to continue to even have a stronger balance sheet. That's one thing we didn't mention, that the merger improved our balance sheet as well significantly. And when you look at our leverage right now, the look-through will decide not open is 5.6x. So we want to operate in kind of the low to mid-5 range. So we're pretty well positioned there. That's why we think hard about where we're going to spend money and whether or not we're going to own 100% or whether we're going to own 50%, I think, particularly for the non-retail components, the multifamily, the office, whatever it might be, then we're much more likely to look at a joint venture. I think as far as the retail components, we're generally going to own 100%, but there's going to be times where we got into a transaction vis-a-vis a partner, so they may own a percentage of the retail. Go ahead.

Yes. Just -- if you look at the 4 projects that Kite had pre-merger, it sort of demonstrates the flexibility we have around development. One of them was Glendale it's an asset that we have in Indianapolis. A multifamily user came to us and said, hey, we think apartments in your parking lot would be a great idea. We said fine, we contributed the land. We took a 12- I'm sorry, 13% interest back, plus we also got a $7.1 million TIF, which TIF proceeds we used to actually use on our retail development at the same place, so that enhanced our returns there. Another one is the corner, another project in Carmel, Indiana, where it's about 40,000 square feet of retail and about 285 apartment units. Again, we contributed the land and we took back a -- not only did we contribute the land, but we actually had a purchase pressure land and we got a 50% interest in that project. Another project we did was at the Trader Joe's development at Eddy Street. Trader Joe's is right over alley. So guess what, we kept 100% of that development, right? That's something that we felt very, very good about. And the final one is Hamilton Crossing, which was a retail center that we had de-leased. We got a $20 million TIF there, and we sold half that partial to Republic, so they could build Republic Airways so they could build their flight simulator training facility and their headquarters. For us, it's -- we don't -- we have no business in our minds owning a corporate headquarters. So for us, it made sense just to monetize the land. We got a $7 million purchase price for it. We're going to stay in as the master developer of the project, so we're going to earn a development fee. Plus, we're going to earn a profit component by virtue of the fact that we're able to go and get this $20 million TIF, right? So again, all these things we sit back and say, what's the best use of our capital? What's the best risk-adjusted return. In every single example I gave you, there was a different solution, right? So that's how we're going to approach this new land bank that we inherited from RPAI.

We have an investor question here. Outside of that land bank, are there other assets in the portfolio that are potential monetization candidates specific geographies, types of centers that make less sense in the combined portfolio?

Yes. I think, again, as we've completed the transaction, we look at the overall portfolio, I just want to be clear, we're very happy with the assets that we own, we're very encouraged with the prospects of the growth from these assets. That said, we do have situations where a particular asset may not make sense. When we gave guidance, we said any acquisition disposition activity would be neutral. We're not looking to do some big -- we don't need to do some big deleveraging sale or something like that. We have a couple of markets where we have 1 -- we only have 1 asset, like 1 asset in Michigan, 1 asset in Pennsylvania, 1 asset in Missouri, 1 in Ohio. But those are logical that over time, we would look to probably pair that with buying something else, buying an asset, selling an asset. That's the kind of stuff we're looking at potentially doing. In terms of huge big geography changes, that's a little less likely. But look, the market is extremely healthy. People are looking for opportunities. We will continue to look to maximize value on each property.

What other steps are you taking to protect your balance sheet and plan for a potentially rising rate environment?

Well, the good news is that our 2022 maturities are already taken care of by virtue of the exchangeable deal we did last year. So we've got zero risk that will be basically paid from cash on hand. And then looking forward to 2023 maturity is the good news, again, another benefit of the mergers now that we have a total of $3 billion of debt, we can make a very convincing case to the unsecured bottom marker, which obviously prices a lot finer than some of the other ways that we raised debt before that we're going to be in the market every year. So we can do $300 million almost on a regular yearly basis. So I think a little bit of a hedge for us against a rising interest rate environment is the fact that we are going to be hopefully enjoying a better spread on a go-forward basis by virtue, again, of our scale. So we will probably be very opportunistic this year. Is there a version where we may do some liability management and then bring forward those 2023 maturities? Sure. But again, it needs to be the right time. And obviously, right now, in our space with the dislocation happening overseas, it's not a great time. So we'll wait. Hopefully, things will settle down, and we'll act accordingly.

In the context of all the internal growth runway that you have ahead of you, do you feel that dividend payout ratio is at the right level today?

Yes. I think we feel comfortable where we are right now with the dividend. I think it's going to naturally grow. I think that we have a lot of -- as we said, we've got a lot of ramp-up on the leasing in 2022 and parts of 2023. So that's our highest returns. So we're putting that cash flow to work there. We still have positive cash flow after those spends that positive cash flow, as Heath mentioned, starts to really, really grow in the next few years. So I think the dividend is definitely comfortable. But we also know that dividend is a part of the total return. So it's important that we continue to have the opportunity to grow it.

Great. And then before we go to the rapid fire, maybe we can talk about ESG. Some of the milestones that your company recently accomplished on that front? And what would you say is your #1 ESG priority for this year?

Yes. Look, I think ESG has become increasingly more important for us. We've always been focused in on it. We haven't been great at communicating what we're doing. We've gotten much better at communicating what we're doing in ESG. We have many things going on internally that are very current, like our LED programs, our water-use reduction programs, our EV programs. We have a green lease initiative in terms of the leases that we're drafting now. So we have 11 goals that we want to achieve over the next 5 years. So it's a significant program. As far as this year, I think we continue to lean into our LED conversions but we also begin to really think hard about our water usage and also what we're doing in terms of trash. So these are -- these don't sound like glorious things, but they're very, very important. And then that's on the social side. And the governance side, we continue to lean in there. We feel like we have good diversity on our Board. And I think in terms of people, the merger has created a lot of opportunity to have better runways, better career paths for people as well in the organization.

Great. Thank you. So we'll do the rapid fire now. First is what will same-store NOI growth be for your property sector overall in 2023?

I'd say 3%.

What will the 10-year treasury yield be 1 year from today?

2.1%.

Okay. And will your property sector have more or fewer public companies a year from now?

Fewer.

Great. Well, thanks so much.

Thank you. Thank you, everyone.

Thank you. Thanks.