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

Good afternoon. Welcome to Citi's 2024 Global Property CEO Conference. I'm Craig Mailman with Citi Research. And we're pleased to have with us Kite Realty and CEO, John Kite. The 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 the webcast, you can go to liveqa.com and enter code GPC 24 to submit any questions if you do not want to raise your hand. John, I'm going to turn it over to you, introduce your company and team, provide any opening remarks. Tell the audience the top reasons that investors should buy your stock today, and then we can get into Q&A.

Okay. And I wanted to thank everybody for joining us today. I have with me Heath Fear, our Chief Financial Officer; Tyler Henshaw, Head of Capital Markets; and Matt Hunt, our Head of IR. So just a quick thing on Kite Realty Group, if you're not familiar, we are the fifth largest open-air retail REIT by enterprise value. We own about 180 shopping centers throughout the U.S., predominantly in the southeastern states. Over 2/3 of our revenue comes from the Southeast and almost 40% of our revenue comes from Texas and Florida. So we're obviously very pivoted in that direction. We are coming off really an exceptional 2 years of operating performance as a company after the merger with RPAI, and we see a lot of upside going forward. The market is strong. The retail macro backdrop continues to be strong, so we think we're well positioned to take advantage of that going forward. In terms of, I think, the reason that we think investors should buy the stock, the top 3 reasons, pretty straightforward. We have a very clear internal growth profile, organically. We're about 94% leased today versus 96% leased pre-COVID. So we're one of the few open-air players that has that trajectory. If you look at what we're looking at over the next few years, we see tremendous amounts of free cash flow growth and AFFO growth in the business as we pivot to where we were before from a lease percentage. We also have a tremendous balance sheet at 5.1x net debt to EBITDA, which is one of the lowest in the sector, which creates and affords us a tremendous amount of flexibility. And frankly, we see a mispricing in the stock today, and it's a very compelling -- in our view, a very compelling story, a very compelling entry point. With a little bit of longer-term view, we believe that shareholders will be rewarded significantly for coming into the stock this year. So I'd say those are the top 3 reasons, Craig.

So John, you guys have kind of put in place this -- the [ 4 for 24 program ] -- or not program, but a series of property tours to kind of highlight some of your top markets here. What other steps are you kind of taking besides trying to get people out to the properties, explain the portfolio to close the valuation gap relative to some of your strip peers?

Well, yes. I mean I think the Four in '24, as we like to call it, is a nice little catch phrase, but the bottom line is we believe there's a misunderstanding or a disconnection in terms of the value of our real estate, but really the quality of the real estate as well. And just -- I think it's -- the onus is on us as a team to spend more time getting investors and analysts to understand that and to see the properties. So physically, we want to get as many people out as possible. Frankly, one of the things I tell everyone that I meet with is sometimes it's as simple as just going on our website and clicking through our properties and looking at them. You actually can see a ton of information and you can do a comparable and pretty quickly ascertain that these are high-quality properties. So number one, I think we need to do that. Number two, I think when you look at operationally the business, we have some uniquenesses to us that others don't. For example, fixed cam is a very important element of our operating platform, and we have over 50% of our portfolio today on fixed cam. And frankly, if we look at the deals we did in 2023, I think close to 95% of the deals we did in '23 were fixed cam. So that creates margin opportunity, that creates a differential for us that we want to lean into as well.

And you guys -- as kind of you go through the portfolio and look at your operating metrics relative to peers, they also line up very well when you look at kind of retention, when you look at NOI margins. This is something that doesn't seem to be kind of approximated in the stock price. Do you feel like the investment community is aware of this in terms of really digging into the different portfolios and seeing the operating differentials? Or is it -- this earning season was a little bit weird where you guys had laid out your -- Heath had put out the sheet of potential kind of headwinds here. Other than the City Center Theater lease, it was all kind of in line with expectations. And you could argue if City Center hadn't happened, you may have been ahead of expectations, right? And so is it just a matter of -- as you've been sitting down with your investors post earnings, has it just been solely guidance? Or do people understand the kind of -- the operating benefits and tailwinds that you guys have had that -- you could argue you've conservatively laid out initial guidance the last couple of years, that you've handily exceeded and then raised expectations over the last 6 to 8 quarters?

Well, there's a lot to unpack there. I would say that, first of all, look, it's not the investor's job to understand some of that stuff. It's our job to explain that, right? It's our job to put in front of investors the entire business model. And I think that's part of what we're trying to do this year is do a little bit better job of -- we're not particularly the greatest self-promoters, right? And it's probably just who we are and maybe it's a Midwest thing. But the bottom line is since we did the merger, there's been tremendous outperformance. And frankly, when you go back and look over longer periods of time, 5 years and 10 years, we've had very strong performance, and we've had very strong total return. That being said, I think the operating platform, that's part of what we also want to highlight in these visits is the individual operating platform differences. And for those that went to Naples, they met a lot of the team that is operating the assets in addition to the management team. And I think the management -- and one of the funny things that we put in the presentation, which, by the way, is available on our website, still the Naples presentation, is little -- a page of little pictures of text messages that have come from senior management during visits on properties. And these are unannounced visits and we do them all the time. And it shows we wanted to give the investment community the understanding that that's not micromanaging a business. It's actually being fully invested in that business. And I think our team knows that we are. And ultimately, none of that matters if you're not driving results. And if you look at our NOI margin, if you look at our G&A revenue, if you look at our recovery ratio, we lead the field. So that also has to come back to us in the term -- in free cash flow, right? And that free cash flow is something we're very focused on growing over the next 3 years and having even more opportunity and flexibility as it relates what to do with that. So I think we're very excited about that, we feel extremely excited about the future. But we need to make sure that the investment community understands that our operating platform is different, and we think quite successful. You want to add.

The other thing I'd add is that when we're thinking about the things that really matter at the end of the day, it's growing earnings, right? And -- but one thing we haven't ever promised is that we're going to run a linear business. We grew earnings in 2022, 28%. We grew FFO in 2023, 5%. And our initial guidance is flat against -- incredibly strong in 2023, and our goal is to provide guidance in a way that allows us an opportunity to outperform. Last year, our guidance started out as $1.92, and we ended up at $2.03. So for us, it's -- we don't like to look at 2024 in isolation, and we're trying to run a business. And we think all these numbers matter, whether it's margins, whether it's spreads, whether it's return on capital, et cetera, all these things matter, but ultimately at the end of the day, we're here to grow the business, and that's what we're doing. So is '24 indicative '25 and '26? I'd say no. So again, it's -- for us, it's -- we're taking a longer-term approach in view to this. And we're happy -- we're tremendously happy with the progress we've put up post merger since RPAI. We were happy with the progress we put up before the merger. So again, it's -- for us, it's -- we can't run this business on a 1-year snapshot, right? We run it for the long term.

And you bring up 24% growth, you guys are slated to put up 1.5% on same-store following years of higher growth. Rather than think about it on a one year at a time, kind of if you thought about it on a 3-year forward, where should we think about sort of the cumulative growth or CAGR of the growth? And how does the setup in '24 compare to '25 to get you within that range?

So same-store NOI in 2022 was 5.1%. It was 4.8% last year. Let's assume we stay at 1.5%, which we don't intend to. That's close to 3.9% over a 3-year basis. Based on the history of this particular business, those are pretty good numbers, pretty darn good numbers. And we shared this during our Naples presentation. And we anticipate that just getting ourselves back to pre-COVID plus in terms of occupancy, that's a potential contributor of 500 to 600 basis points cumulatively of NOI over a 24- to 36-month period. So we are in this temporary period right now. We had 1.5%, which we can go through if you like. There's reasons why we're at 1.5% same-store NOI growth, very explainable. But like I said, I don't think '24 is indicative of what's going to be happening in '25 or '26.

Maybe for the benefit of people in the room, go through what some of the bigger headwinds were and maybe uniqueness of them?

Yes. So for the 1.5%, the biggest delta is really the difference in the bad debt. And so last year, we had a very constructive year in bad debt. We had 40 basis points of total revenues of bad debt. And this year, we're back to a normalized assumption. Typically, the business runs anywhere between 75 and 100 basis points of revenues of bad debt. So we're at $100 million. That differential is resulting in a 90 basis point headwind into same-store NOI. Said differently, but for the difference in bad debt, then we had a really good bad debt last year, we'd be at 2.4%. And -- and then, of course, there's bad debt [ of the analysts ] which everyone knows about. So net of the openings a few will happen at the end of the year. That was another 50 basis points drag on same-store NOI. And then we had a theater tenant in late November that represented a very large rent. It was $4 million of rent in an 80,000 square foot space that we had anticipated to renew, but they did not. So those 3 things together. But for those things, we would have been at 3.5% same-store NOI, which I think we all can agree for this business is a very healthy number.

I think, look, the reality of our business is a much improved macro environment over the last few years. And so I think it's starting to come to fruition in that organic growth. So most people in here would say over the history of the last 15 years in strip centers, you'd be saying 2% to 3% same-store was a decent year. And I think right now, what you're hearing is it's really more like 3% to 4% that you would have that expectation that we could continue to do that. And when you look at the success that we're having in our lease program with rent bumps, it's happening. So it's a matter of us not getting overly pivoted to the short term. We are -- when you look at the space we're leasing and you look at our occupancy versus our peers, sometimes people are judging success by getting back to a lease percentage and not really thinking about what's going on within that, the quality of the retailers that we're putting in these spaces. And equally important, the rent growth, the annual rent growth that we're getting. So our particular company is extremely focused on that. So I mean Heath said it perfectly in terms of it's very early in the year. We've laid out guidance that we think is prudent. And we certainly -- our job is to outperform that, and that's what we hope to do.

Any update on the status of -- you guys have talked about having a potential tenant to backfill in City Center.

Yes. I mean, the update would be that we have multiple theater operators that are interested in the space. It's a unique situation where in that particular business, you can actually -- there are a lot of -- when you see another theater come into an old theater, you don't necessarily have to do a lot of CapEx to turn that back on. So we believe it's another area where we hope to outperform. Our guidance assumed that we had very little coming from that space. And I think, again, we're making good progress, and I would say stay tuned.

And the $4 million of rent you were getting, is that sort of market for that size theater?

I don't -- I think it's a very large rent. I mean it's obviously $50 a square foot gross. It's an old lease that had -- so I think that's probably high, but we'll see how we do.

Any questions from the audience? JOANN's news came out last week. They don't show up on your top tenant list. Just kind of curious if you have any exposure to them. Sounds like it's going to be more of a prepackaged deal. So hopefully, not as big of an impact. But -- and maybe just talk broadly about your watch list at this point.

So we have 40 basis points of ABR attributable to JOANN and we read the same articles about them pursuing a prepack. whether or not JOANN is a business that will or should be viable is a different discussion. For us, in this leasing environment and based on the fact that it is so modest in terms of the ABR disruption for us, we just as soon have those back. Probably whatever -- if JOANN does not survive and it's unable to reorganize, probably be something to the benefit of Michaels, which is another tenant, obviously, that we watch. So JOANN is not the source of any lost sleep over here at Kite, and we'd like to get the space back if possible. The rents in there are attractive. We think we can get some attractive spreads off of those rents. So we'll sit back and see how it goes. And that's really the...

Yes. I mean, I don't think we have any particular -- more color than what everyone else is hearing and reading other than to say we love the real estate. It's well located. The rents are below market. So obviously, if we have the opportunity to mark to market, we will. That being said, we'd be happy to work with them if they restructure. Generally speaking, most of the restructurings have actually gone pretty well. So I would bet that they have a real opportunity to do that. And sometimes when that happens, they all of a sudden reinvest in the physical platform, things get better. I hope that happens. But as he said, if that doesn't happen, we have plenty of opportunity to present those spaces to our customers.

And maybe going back to kind of an earlier -- one question. What's the mark-to-market on the JOANN spaces, I'm getting asked?

So like the rents are between $13 and $14. And just to use a proxy, our Bed Bath rents are somewhere between $17 and $18.

That we've replaced.

Yes. That's what we've replaced. Yes. Again, it's a space-by-space analysis. Yes, but those are just giving you some general numbers.

Look, the spreads have been very strong for the last few years on these mark-to-market opportunities. I would think that would continue is what I would say.

Question here on acquisitions. It feels like the environment may be thawing a little bit. I know you guys have a good amount of CapEx on your plate, $200-plus million over the next 18 months or so. But what are the thoughts there on maybe one-off acquisitions or just capital deployment in general?

Yes. I think for us, again, that's one of the beauties of our business model right now. It's a pretty simple business model. We have this opportunity to lease the portfolio back to pre-COVID levels. That's where we're going to spend our focus. That's a couple of hundred million dollars of CapEx over the next 2 years, as you said. The returns that we've been getting have been 30%-ish returns on cost. So to start thinking about running around looking at other ways to invest that money, I don't think that's smart right now. That being said, the market is thawing. There are transactions happening. We're always in the transaction market. We're always looking to improve and tweak. So there's a potential that we would be doing that. It most likely would be more of a paired trade where we would be buying something and selling something else, maybe repatriating that money in a way. So I do think the market is thawing. I think, obviously, we have a peer that has sold almost $1 billion of product in a very fast period of time, 5, 6 months. That's been in the mid-6 range in terms of cap rates. And when you look at where we are trading, that is a clear indication that there's value in our stock. So I think, hopefully, that you'll see that continue. And I think to the extent that medium-term rates are stable, that gives people the ability to transact.

And I want to go back quickly to the theme of kind of that 3-year out, right? And we talked about the $200 million of capital that you have to spend. But as you guys look at once that's spent, once the leases commence associated with that spend, what does the free cash flow look like for you guys to ultimately be able to either delever over time, reinvest that helps blend down your cost of capital? Kind of what does that do for the flywheel effect? And I don't want to miss out on Heath getting the -- or Kite overall getting to upgrade from Moody's here too, from a cost of capital perspective as well.

Well, I'll start with the free cash flow side of it. I mean we are extremely cash flow centric as an operator. And sometimes I'm surprised that's not a bigger topic of conversation. That being said, we're investing a tremendous amount of capital back into the business right now. So when you look at late 2025 and into 2026 and '27, we get cash flow numbers well in excess of $100 million a year, which gives us, again, even more optionality as it relates to the quality of our balance sheet. Being one of the best balance sheets in the sector, we're not getting credit for that right now. And frankly, if we just redeploy that free cash flow back into the business again and pay down debt, the company will be in the threes. Now whether or not that's the right capital allocation strategy at the time, we're going to have to wait and see. Because then at that point in time, obviously, you have the ability to externally grow with that free cash flow and/or repurchase stock as an example because we do not ever want to impair this balance sheet. We've run the business in multiple cycles with multiple levels of leverage, and we much prefer running one with low leverage because, again, it gives us that opportunity to take advantage of situations like RPAI, for example. So I think from that perspective, we're very excited about that, and we're very excited about what that will enable us to do. But again, we have to execute to get there. We have to complete the lease-up. You want to add anything to that?

No. You mentioned our debt transaction and our ratings and for those who haven't been watching, Moody's upgraded us last week from Ba3 to Ba2. I will mention that it's very rare for a ratings company to go ahead and upgrade you without putting you on a positive outlook first. And I think the reason why that happened last week was because of our bond deal that we did earlier this year. The bond deal was 10.3x oversubscribed, one of the largest oversubscriptions that our dealers had ever seen. We priced 35 basis points inside the initial price talk, which is one of the biggest negative concessions that our dealers had ever seen. So clearly, our balance sheet is being appreciated enormously in the fixed income side. And now, of course, the rating agencies -- surprise, surprise, are a little bit behind the times, they're catching up with our ratings. And so what happens next, S&P has us on a positive outlook. We think within the next 12 months, that will mature into BBB. And then the next step is BBB+. We always say that ratings are not a destination, they're a consistent journey. But if you look at our metrics, you look at our peers, you look at our relative credit risk, we screen very well with a BBB+ rating. And I think the most important thing about our bond deal and even look at the secondaries now, it's trading tighter despite the fact that we've lost 40 basis points to the benchmark in the meantime. It's that we completely repriced our cost of debt. Also ultimately, our cost of capital, whatever it was before that deal, it's different. It's better now.

What would an S&P going to BBB or BBB+ mean for you on pricing perspective?

So if S&P, once they fully mature, then we're BBB across the board, I think then we'd probably price somewhere between 150 and 165 against the 170 that we just priced. So call it a 10 to 15 basis point or up to 20 basis point savings. Take the next step and go to BBB+ and all those, then we're probably pricing somewhere between like 125 and 140. So every little bit helps.

So a couple of questions coming in as well. Thoughts on dispositions into the strong market, maybe beyond just match funding. Is there a chance to -- you don't need the capital right now, but in terms of taking advantage of lopping off some noncore at good pricing?

Yes. I mean, again, I think the onus is on us always to be trying to maximize value. And if we believe that a particular asset doesn't really fit the profile, then we're always going to look at that. I think we could also look at it from the perspective of geography. We might look to really move in a bigger way into one other geography and out of another geography. So the answer is you never say never. Yes. I mean, there's a possibility that we would go larger on dispo. I think the market is still a little -- not firm enough to really lean heavily into that yet, in my opinion. I think we need it to be a little firmer. And I actually personally believe the second half of the year, you probably start to see that. But again, for us, in the micro, we love the portfolio. We like the ability to grow the portfolio, but we're always challenging ourselves to make sure that we're in the right places.

Another question coming in. Are you seeing more medical-related demand for space? And if so, what are the challenges or opportunities?

Are we seeing more demand, you said?

For medical uses. Sorry, I too far away from the microphone.

You have to get closer to the mic. Come on, man. It's not your first rodeo. Medical, absolutely. I mean that's the cool thing about open air retail is the depth -- the pool is so much deeper now than it was even literally 5 years ago, 10 years ago, for sure just in terms of the different product categories. And I think medical is definitely one of them. I think we're very -- we're cautious. We like to merchandise centers in a way that we think is the best long-term play for the properties. So medical is definitely one of them, and it's deep. It's not just a doc in the box. There's all kinds of different medical users. I think the spa business has picked up quite a bit. So I think yes is the answer to that, but I don't think any more so than any other genre of retailer.

Another question, a little bit related to what I asked earlier, but what's the strategy if the market continues to undervalue the asset quality balance sheet, et cetera? Lowest multiple in the group seems completely disconnected from fundamentals.

Can you tell me who sent that? Because I totally agree with that.

It's anonymous.

Yes, I think -- look, I think the strategy is get the portfolio where it needs to be from a lease percentage perspective, generate that free cash flow. And then look at where we sit at that moment in time against the macro backdrop of risk. And to the extent that the stock continues to be priced in a way that creates lots of opportunity for investors, that's great. But over time, we have to correct that. And we, as an organization, the entire organization are made up of very competitive people. And we don't like to lose, so we intend to change that. And again, the onus is on us, we have to do -- we have to execute. We have to get the leaseback to where it was, generate the free cash flow, then puts us in a position that if it doesn't change, we'll do something about it.

Craig, I will mention we're no strangers to re-rating of stock. And between 2018 and 2021, we were trading at an above-average multiple in the peer group, which really made the RPAI transaction viable. Fast forward, the transaction has met with some skepticism and there's more pressure put on the multiple. I think you can all agree that it was a fantastic transaction. I can't think of a better retail transaction in my memory. And we started chipping away again at that multiple. And part of this Four in '24 this year is that's the goal, as we need people to understand the real estate. We need to outperform this year. We need to put the numbers up. So we've done it before. And we're very confident, and we like our chances on doing it again. But it doesn't happen overnight. It was a particularly tough environment over the past 1.5 years with the uncertainties around rate. Now that we have some conviction of what's happening with rates and pricing and we're getting some more inflows back into the space, it's going to become an easier lift for us. And I'd like to have this conversation again. Again, give us 10 months and we'll see where we end '24.

Yes. Look, I think, again, we have to make sure that we're explaining to investors what our strategy is, and we have to execute that strategy. I hate to simplify it, but it really is that. And we also have to get investors to start -- or we want to try to get to investors to think a little further out, right? And when you see the performance that we've had over the last couple of years and then we come into a conservative guidance year and I think very prudently. Let's see how that evolves, but this isn't about 2024. I mean it's really about '25, '26, '27, '28. I mean this is a longer-term business, and the NAV I think will reveal itself, and then I think people will get rewarded.

So Heath, you bring up an interesting kind of discussion. You guys had the currency to do a deal, you did the deal. Unfortunately, you kind of bought the multiple of the target rather than keep your own. Now that you're at scale, and you're one of the larger strip center REITs, I mean, if you get that cost of capital again, what's your view on M&A versus just organically building it out, one-offs, redevelopment? Because I think I've heard that from some people the fear is if you get a cost of capital, do you do another deal, right? So I know it's a never say never scenario, but maybe give some context around that.

Sure. Well, first of all, I think it's not about do you do an M&A deal or -- you do the deal that is going to generate the best rate of return on your invested capital. The rate of return that we've generated and what we've been able to do in terms of the operating platform and synergies that are setting us up for the future are tremendous. That doesn't mean that, that is easy to find. It's rare. From an M&A perspective, we've been a public company for 20 years almost, done 2 deals. I mean it's not like we're doing a deal every third year. But the deals that we've done have been very strong and in our opinion. And when you look in the rearview mirror over time, I think that will get reflected. I understand that someone can be concerned, especially when you do something 2 years ago because it's fresh, but you have to look out over the last 20 years. So I think we've been, in our opinion, very diligent, prudent capital allocators. And now we have a balance sheet and a portfolio quality that enables us to think in a lot of directions, not just one direction, M&A. So if we have the afforded cost of capital, we certainly can look to grow externally, but right now, the internal growth is very strong 3, 4 years in the future. So I think we'll continue to do that. And if the right opportunity avails itself, Craig, we certainly have -- again, we've certainly proven that we know how to consolidate something. It doesn't mean everything needs to be consolidated. It's just -- we're just saying we're pretty good at it. Now again, if it's not there, it's not there. And then you go look to do other things. So I wouldn't want to give investors the impression that we're just baiting our breath to get a higher multiple to go buy something. I mean that's absolutely unnecessary and we're not looking to do that unless it would be a situation like we've had in the past.

Maybe now we can just move to rapidfire as we're coming to the end. So what will same-store NOI growth be for strips in 2025?

I think it should be strong, 4%?

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

Probably the same.

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

Lease-up space.

Perfect option, not on the list. Awesome. Thank you guys so much and enjoy the rest of the conference, everybody.

Thanks, everybody.

Thank you.