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

Welcome, everyone, to our next roundtable session with Kite Realty. On this side of the table with me, we have, in the middle, John Kite, CEO. To his right, Heath Fear. To my right, Tyler Henshaw. Sorry, Heath is CFO. Tyler, SVP, Capital Markets. And then next to my colleague, Andrew Reale, is Matt Hunt, Director of Capital Markets and IR. So thanks for joining this roundtable session. We want to make it as interactive as possible. So if people do have questions, please raise your hand or just shout out. There is a mix of investors in the room. Some are probably very familiar with Kite. Some maybe a bit newer to the story. So we've been asking each company to provide an overview. I don't know, if there's any recent updates, quarter-to-date activity and then strategic positioning, and then we could get into questions. So I'll turn it to John.

Well, great. Jeff, thank you very much for having us. Appreciate being here. In terms of the introduction to Kite, for those of you who don't know that -- so we are in the open-air shopping center business. We're the fifth largest open air -- publicly traded open-air player by enterprise value and market cap. We are pretty heavily focused in kind of the Southeast states. 40% of our revenue, approximately, just under, comes from Florida and Texas alone. But we also have gateway markets as well. Again for those that don't know the company, we recently went through a merger a couple of years ago, where we more than doubled the size of the business. So a lot going on over the last couple of years, but we've been extremely focused on operations. And we continue to be very strong as it relates to our peers. We're one of the highest NOI margins of our peers, one of the lowest G&A to revenues, one of the highest recovery ratio. So we think of ourselves as operators. Been in the business a long time, understand the business. We feel very good about the markets we're in. We feel very good about the demand. It continues -- those are the questions we've been getting is where is demand right now? Demand is strong. Our product is desired by the retailers that we're doing business with. So as of right now, we feel very good about the market, and the quarter that we're currently in is very similar to the past couple of quarters in terms of production. I would say that the retail open-air shopping center world has become very attractive to investors in the last few months. So you're seeing tremendous demand for product on the investment side. And as -- if we continue to be in a little bit of a declining rate market, that probably just picks up even more. So that's kind of where we are right now, Jeff.

Okay. Great. Let's start then with the concentration of portfolio. So you said 40% Texas and Florida how much had total in the Sun Belt? And then where are the other key markets? And like if we think about Kite, let's say, I don't know, 5 years or 10 years from now, is there a certain goal on changes? Or you're happy with the current footprint?

I think -- well, first of all, I think what are we Sun Belt's like 2/3 -- yes, Sun Belt is about 2/3. And then we have these couple of people who we would call gateway markets that we add on top of that, like Seattle, New York. Those would be the 2 bigger ones in terms of gateway. We want to continue to push into the Sun Belt. We're very happy with that. I mean we have exposure -- as I said in Seattle, we have some exposure in California, minimal, and we have exposure in Las Vegas, Phoenix. Those are great markets for us. But in general, Sun Belt is our comfort zone, in general. So we think that we will continue to pivot in that direction. We mentioned, I think, on the last earnings call or we've been talking that we're -- we sold an asset in Chicago, and we're going to redeploy that most likely into the Southeast. We've done that, acquiring a center in the Atlanta suburbs. So that's -- yes, we're very comfortable with that.

I guess besides maybe the rating agencies, like geographic diversity, what are the benefits of, let's just say, owning assets in these other areas like Seattle and California or Chicago?

Yes. benefits for us are that our customer, which is the retailer, wants to do business in those markets. So all we're really doing is reflecting where the customer wants to do business. It's not necessarily we are that brilliant at understanding the future trends around markets. We understand where the retailer wants to be. We understand what our customer is telling us. So to the extent that we have these large relationships, it is important for us to be able to answer the call, do what the customer needs, provide product where they want the product. And also leverage that to better returns, better rents for us, better cash flow growth over time. So that's kind of how we think about it. That being said, there are also markets where you begin to think, boy, maybe it is turning and we should be rethinking about redeploying these assets or redeploying this capital, which is, again, the small example of us selling a deal in Chicago, which was a very micro decision based on its location in the market. So that's kind of how we look at that.

And so overall, 5, 10 years from now, Sun Belt still 2/3? Or do you see that...

I mean, it could be higher and probably will be higher. I mean I think it will be higher, certainly in the next 5 years.

And then I guess just based on that comment, I know you've been very active over the years in terms of growing the company acquisitions, some development. You're talking about the importance of the relationships. Are you hoping to grow the company again in a big way and do another home run deal or...

We've got a lot of home runs.

Or singles? I mean -- because it sounds like, again, maybe some people don't fully appreciate understanding retail real estate that does scale matter, and you're just saying scale does help with the relationship.

Yes. I think scale matters not only with the relationships, but it matters operationally, if you do it right. I mean at the end of the day, our goal is to generate more free cash flow per share than our competitors. That's a very basic, simple kind of a guiding light that we have that we are actively pursuing. So I would say our goal is to generate -- to do that more so than to be big. If getting bigger results in us being able to generate more free cash flow per share that we can in turn reinvest, that's a good model for us. I think we've proven, hopefully, to the market that because of our intense operating focus as an organization and our long history in this business, and how we started in the business with no money, no capital, nothing, puts us -- maybe gives us a little bit of an advantage in terms of what we're willing to do to generate that cash flow. How hard we're willing to work, to grind through each individual deal and get more cash flow out of that asset than the person that owned it before was getting. That's the acquisition side. Does it mean it will happen? No. But I think it's certainly in the right scenario, you do -- if we could figure that out, that's great. But -- go ahead, sorry.

I think the important thing also, Jeff, is that we put ourselves in a position to be able to do something like that again, right? So again, we doubled in size. So here we are sitting at 4.8x net debt to EBITDA, that gives us a tremendous amount of optionality. So while you can't plan for home run deals, they come and they go, but you can put yourself in a position, where if something were to present itself, we can do it and we can execute on it. We've done it before. The balance sheet is in an incredible place. So that's the other thing, is grow the cash flow and put yourself in a position with the cost of debt and, hopefully, an overall cost of capital that allows you to be opportunistic.

But who knows? I mean you don't know. And frankly, there's so much capital, particularly private capital, that is very interested in our space. We have no idea where that goes. And I do think that the world is changing a little bit in terms of its view around this sector, and that may afford other things to happen.

In terms of, let's say, joint ventures or funds or...

Yes, it could be anything. I mean we're a publicly traded company seeking the highest value, right? So I just think that things are happening. There's large amounts of capital queuing. Our business is a solid business that's growing at a better clip than it used to grow at with super strong companies. And as Heath just said, here we are at 4.8x. And by the way, we're at 4.8x. We are spending in '23, '24, '25, spending $100 million a year in TI and LC, tenant improvement and commissions. The normal year for us is $40 million to $60 million. So we're spending all this money more than usual as we lease back to our previous occupancy levels. And we're still deleveraging through that period. And frankly, we'll continue to deleverage unless, as Heath said, we decided that there's some opportunity out there that's worthy of coming up a little bit. So I think that's what I mean by that, Jeff, like the optionality that we have right now as a company is bigger than it's ever been. And it's a result of that work, not only operationally to generate the returns on capital that we're generating internally, but also the fact that this balance sheet has created that flexibility. And it took a long time, as you know, for us to get to a position where were in that conversation as one of the best run, in my opinion, in this space and was certainly one of the best balance sheets in the space.

I guess let's -- I want to dig more into the operations. And you started with that and tying it into the comment that you feel the company is the best at operations. What else do you think you're the best at in the space?

I think we're one of the best at offerings. Let's not make this last night's event, the debate. We're one of the best. There's a lot of good players. I think what makes us unique is just that we have this laser focus on kind of bottoms-up versus top-down. We're a very much bottoms-up organization. Not very steep in terms of the layers of people. It's kind of a flatter, very involved, everybody is involved operationally in our company, which is why we're lean. And I think we're just very good at understanding what the customer wants. And this -- sometimes the real estate companies don't talk a lot about customers, you talk about tenants. But look, these are customers and we have to take care of these customers, and we have to be there for them and we have to have the capital for them, and we have to run these assets in a way that they want to be there. And so I think we're very good at reacting to that, reacting to what we see the customer wanting and delivering that for the customer because that will make everything else happen. All this other talk about signing leases and spreads and all this other stuff, if you don't deliver quality to that customer, that's a very short-term game. And so we're trying to play a long game.

And the capital that is looking to enter shopping centers or, let's say, retail real estate, lifestyle centers, maybe malls, outlets, are these folks that are, we're seeing they are new to the sector, they don't have the expertise? Or some of them have been in the sector, do have the expertise. I guess how could -- how do you think this develops over the next couple of years? Because I'm assuming it's not just a 3-month, 6-month shift, right? Like you've heard from other meetings this shift from, again -- and we've heard throughout the year, office to other asset classes?

Yes. Look, I think it's probably all of the above. You have very sophisticated institutional capital that's been in our business before, got out of the -- maybe it wasn't playing in retail for a while, that seems to be wanting to play in retail again. Those are very different than, say, a sovereign wealth fund, who hasn't invested in retail who is now buying retail, right? So when we go -- when we're looking at transactions, and we just studied a bunch over the last couple of months, and you look at the depth of the buyer pool, it's a little bit different answer, but it's going to the same place, it's all the above. I mean, you have insurance companies, you have sovereigns, you have pension fund advisers, you have pension fund direct, you have 1031, you have REITs. And so I just think there's a very interesting -- it's an interesting period where, let's be candid, for years people are like retail, I don't want -- retail is bad, right? I mean that's just -- there was an assumption of that. And that...

I'm trying to forget that period.

Yes. And now I think you're at a place where people have realized this is pretty stable. And it's gone through, if you think about it, I mean, in the last, whatever, 15 years, we've gone through some really intense financial crisis. And our business has been very stable through that. We've never really had major, major problems, they've been short term. So I think the institutional capital is seeing that and realizing that the growth rate that we're getting versus the stability is a pretty fair trade. That's all I'm trying to say. So I don't really know where that goes, I just think that there's more capital coming into the market than there was.

Is there an opportunity to leverage your development -- ground-up development DNA to use this capital to develop because, again, once again at this conference, we continue to hear about the lack of new supply?

Yes. I think what we're trying to do as capital allocators is to get the highest return on that capital. So right now, for us, the highest return on capital is organic, is leasing space, getting high returns. And -- but over the next 18 months or so, as that starts to get to the point of stabilization-ish, then have to look at outside capital events, right? Where am I going to put that capital? Development is absolutely something that we're very comfortable with. It's how the company started. We -- so because of that, because of our comfort level and understanding, we also understand the risk-adjusted returns. And so you have to be very careful when you underwrite deals. Very -- when does -- no one ever brings in a presentation and says, here's this project. Geez, the returns aren't that good. The returns are always good when someone starts looking at something. It's as -- as you look at it deeper and you figure out the time lines and the risk associated with lease-up. So I'm not saying we aren't doing it, I'm saying we're very selective. I mean we're doing an investor presentation at one of our projects in a couple of weeks, right? One Loudoun in Virginia, and we're highlighting our development arm of our business, and we're highlighting the fact that we're going to develop there on that property. But that's really an addition to an existing project. Also redevelopment, we really like the returns in redevelopment. The risk-adjusted return in redevelopment is higher than it is in ground-up development. So I don't think you're going to see a lot of ground-up development over the next few years, where yields are and where rents are. So that being said, we'll do it in the right situation. But certainly redevelopment and/or adding on to existing projects would be our preference.

Maybe just finishing the topic on opportunities. We've -- I guess, I feel like it's been somewhat mixed, but still may be constructive on, from your peers' acquisition opportunities. How are you seeing the landscape today? You mentioned lower rates, you expect things to pick up. But again, it makes it harder for Kite to do accretive deals. But how are you seeing the acquisition opportunities today? And where are cap rates across your markets?

I mean I think the invest market has picked up a lot in the last -- literally, probably the last 6 weeks. The investment market has picked up quite a bit. I think people have gotten more comfortable. Buyers and sellers are meeting in the middle. But yields are continuing to be very competitive. Most of the deals that we've underwritten in the last couple of months have traded in the mid- to high-5s to low-6 range. That's most of the things we've looked at. That's quality real estate that we would want to own. As I said, we've sold a property, so we're looking -- we're redeploying some of those proceeds. We're looking at a couple more deals actually in Florida. So I think you'll see us transact, but most likely in pods, where we're buying something selling something, selling something buying something. I think right now that's what makes sense for us because of the capital that we're very focused on spending in the -- inside our own pipe -- inside our own business. But certainly, I think -- and I said this on the last earnings call, we were seeing cap rates drop in real time for sure, and they have. And we'll see where it goes. I mean, it's already in a pretty healthy place on a relative basis. Who knows where medium-term rates go. My personal belief is short-term rates come down, medium-term rates probably don't change that much.

Let's go back to operations and leasing. You had your first 2 -- -- 4 in '24 events, 1 in Naples, 1 in Dallas. Can you just -- for those in the room that didn't get to attend over some of the key highlights messages from those events and then the upcoming event is in D.C.

Yes. You want to hit that?

Sure. So the first event was in Naples, Florida. And the purpose of that event was to highlight our operations team and to tour the assets that we have enabled to give a little color on what's been happening in the Naples market. And the theme around the assets we're seeing in Naples, but this is our bread and butter. These are small grocery-anchored centers, extremely productive. Again, the market has just done incredible things in terms of the housing, in terms of the demographics, the growth of both employers and in population. So that was the purpose of the first installment. The second installment was in South Lake, which is one of our trophy assets. South Lake produces -- we already went in Dallas, South Lake produces $30 million in NOI. It's our largest NOI contributor in the portfolio. It's about 5% of NOI. And in Dallas, we showcased our leasing team. And we used South Lake as the sort of poster child of how we think about leasing, how we think about merchandising. We had our senior leasing people there. It was a great event. The next event is One Loudoun in Northern Virginia and the Washington, D.C. metro, and the purpose of this event is to showcase our development team. As John mentioned, this company started out as developers. The tenure we have in our development team is incredible. We have a very talented team. We're going to paint the vision of what's happening at Loudoun. We're envisioning an expansion that involves retail, hotel and multifamily. So we'll discuss what that looks like. We'll discuss scope of the project, sort of the initial returns, et cetera. And we've been working very, very hard on getting pre-leasing. So at that point, hopefully, we'll be able to tell you that is this thing going to be greenlighted or not. So that's we're excited about Loudoun. And the last installment is going to be in Las Vegas in connection with NAREIT. We'll take people off the Strip. I know people typically go to Vegas, they spend their time on the Strip. But there is a very vibrant community beyond the Strip, so we'll take you to our Rampart asset. We'll have dinner. And we'll sort of take all these pieces and we'll pull them together and say, this is how we think about capital allocation, especially that we have this free cash flow on the horizon, which is happening, sort of end of '25 into '26. How we think about returns, how we think about what the company might look like over the course of the next 5 years. So it's really kind of pulling these themes that we had before and drawing a picture of what the next iteration of Kite is. So we're excited. But listen, it was a -- it was borne of this idea that we could have a traditional investor event, where we put people in a room for 4 to 5 hours and we have a 200-page slide deck, and it's all very rehearsed, lots of lights and bells and a Q&A session, or we could break it up at the 4 segments and at the same time, we can get people to see our properties. So it'd be a really, really fun series, and by the way, lots of great comments back.

Yes. One thing I would add to that, like when you back to the Naples tour, and a lot of people here have been to Naples and feel like they understand the market. I think these markets, they evolve quicker than we all think and so I think it was good to actually be on the ground, drive around, see what's going on, but also see how we run the properties. For me, we got a -- there was a slide in our presentation, which was literally pictures of text messages that were sent around the company from myself, Tom McGowan, our Chief Operating Officer, others, literally about why is this there? Why is that there? Trash over here. Bird nest over here. That's how involved we are. And I think people know it. Maybe people think it's too much, but I do think it's what's important for us to differentiate ourselves against the competition.

Yes. I think one -- you asked before, Jeff, what are some of the things that we do well at Kite, maybe it's a little harder internally. But having been different shops and different regimes, I can tell you one thing that we do incredibly well, and John, in particular, is flying at 5 feet and flying at 50,000 feet at the same time. And it's being completely detail-oriented without losing sight of the bigger picture, which I think translates itself into our capital allocation decisions. So I think that's something we do really well, is we are a detail-oriented, ground-up organization. Every asset matters. However, we also understand that we're a nearly $9 billion enterprise and that requires us to think bigger, right, so?

In terms of initiatives over the past couple of years, leasing operations and then tying in technology or even AI, we've heard from a mall peer to do this, that the new CEO, he's revamped leasing. And how they are doing it. How are you leveraging technology to lease and operate, right? And how will that improve over the next couple of years? Some of these things that are hard to figure out on a long-term basis.

Well, I think, we're pretty d*** good at that. So I mean I think we -- that is our skill -- that is the tip of the spear. If you are not good at leasing, you probably shouldn't be doing what we're doing here. So there's the tip of the spear in our business is leasing, it always has been. And that's with no disrespect to the rest of the organization, because the entire organization enables that tip of the spear to get done what it needs to get done. So for us, I don't feel like -- I think that's our strong suit. I'm not really sure what they were talking about AI from a leasing perspective. I think this is -- leasing is a human business. Now do we -- are we looking -- does technology help us be more efficient? Absolutely. Does technology help us get more deals done? Absolutely. So as we evolve in and certainly -- and Heath can talk about it, we're spending quite a lot of time around studying what's going to really be best for our organization in terms of more intense management around these assets, vis-a-vis artificial intelligence, that's still developing. I don't think anyone fully appreciates or understands where that's going to go. But it will never change, in my personal opinion, the human element of convincing people to lease space. That is a very important thing that we do. And if we have technology that enables us to do it quicker and more efficiently, that's great. But we have to have the right people in the right places throughout the country to represent the specific shopping center. That's sacrosanct.

Okay. Sometimes when we meet with you, you brought up -- last week in our leasing meeting, this happened. If we were in that room, in your most recent lease meeting, could you share with us what was discussed? You mentioned that leasing demand remain strong. How is activity? Can you quantify? Sometimes you have even quantified and said like we had this amount of deals versus a couple of months ago, we had other X amount of deal, Y amount of deal. So...

Yes. Do we have the 7-second delay on this thing? Can I really tell you what happened? No. I think each week, we go through this every Monday and we have -- as you've heard before, I mean, there's generally between, I don't know, 50 to 60 people involved in this process every time we meet. And we -- as Heath just said a minute ago, we're going through each individual opportunity. It is not easy. It's not easy for people to come in and present these deals. We have a lot of experienced people looking at each element of the transaction, not just what the lease is -- I mean, I'm sorry, not just what the rent is, what are our returns on capital, what is our payback period, what is the IRR, what is the credit quality, how did we underwrite it. So it's long. And that's just how we do it. And I know everybody does it a little differently, but this is a very important kind of part of who we are. I don't know if you want to add...

No, I think the greatest thing about having -- we have 250 employees. So you say, why are 50 to 60 of these people on your leasing call? But at the end of the day, it's what we do as a business, right? And so when you have people on that are able to join and understand the discussion and hear what John or Tom or myself care about, we have a smarter organization for it. This is what we do. This bleeds into every single person's responsibility in their day-to-day job. And John said, we are super rigorous. And so how the process works is we have this thing called the bypass. And if your deal hits all these things, it hits a return, a payback period, a spread, et cetera, you don't have to come to committee. So the deals that are coming to us in committee are deals that, for some reason, didn't hit one of the bypass criteria. So the leasing people have to be prepared to defend their deal. Why this one particular thing was -- this one box wasn't checked? So they're prepared. It's a robust conversation. And we turn deals down. Sometimes it doesn't make sense. Sometimes we're protecting the tenant against themselves. Sometimes the credit is just a leap too far. And you say to ourselves, you know what, the period is x, we don't see a sightline for this tenant, so we're just not going to do this transaction. So it is a very iterative process, it's a competitive process. Internally, we compete for capital and our leasing people do that as well. So we're really proud of that, how the whole thing shapes up. And we've got a really sophisticated workflow system that feeds into this whole thing. And our dashboard and sort of our KPIs, when we're looking at individual deal, it's on 2 pages. And you can really understand, 360, what's happening with this one particular lease transaction. So it's a really great process. Again, having been at other shops, I've seen the sausage making, this is pretty...

I mean one of the things, I think, that's come out of this is, as Heath mentioned this bypass and, generally speaking, we like to move the goalpost on that. We don't keep it stagnant, it gets harder and harder. But one of the great things that's come out of it, for example, as you've heard me talk about our uber focus on rent growth. We're very, very focused on annual rent bumps in the business. Particularly we've talked about our success in the small shops. And a lot of that is a byproduct of this. And if you look at this year, through today probably, 70% of the small shop deals we've signed this year are at 4% annual growth or better. In 2018 and '19, pre-COVID, those numbers were just below 3%, like 2.7%. So the change that's occurred post-COVID and intensity around this particular issue for us and our shop has been tremendous. That's cash flow. That's just more cash flow growth. And that comes out of the intense focus that we have in these meetings where people are trying to get the deals positioned to not have to go through the gauntlet.

By the way, the BofA answer to yesterday on a panel cited one of the biggest increases they're seeing is rental revenue in this Sun Belt. So small shops.

Yes, there you go.

No, no. All friendly. All friendly.

Good. All right. I know we're out of time, but just to confirm, in terms of leasing volumes transactions, visibility into '25 on openings, how would you characterize the strength today versus when we saw you, let's say, the May ICSC?

Yes. I think we're in a very similar place. The market continues to be at a very good equilibrium, perhaps slightly tilted in our favor in terms of supply and demand. I think that, that probably continues. Obviously, if we're in a declining rate environment -- I shouldn't say obviously -- if we assume that we're going to be in a declining rate environment, that's generally going to help that. It's really going to come down to the consumer and the retailers in terms of where does the economy go, how do they think about that. But right now, people are very interested in continuing to acquire great space. I think, if you go back -- and if we -- if you're talking about where is the economy going, if you go back to the last real downturn, which was horrendous, '08, '09, a lot of retailers look back on that period and actually regret that they didn't do more. They didn't take advantage of the period to get space. So I don't see right now any issue with that. I see that demand being there. Even if XYZ tenant goes out of business next year, there will be demand for that space. Now is it great if that happens at once? No. But generally, that isn't the way it usually happens, it's usually trickling. So we should continue to see pretty good tailwinds, I think, as of right now.

Great. I know we're out of time. We have 3 rapid fire questions. Just rapid responses. Andrew, please.

First, do you expect real estate transactions to increase once the Fed starts to cut yes or no?

That's not a real question. Yes.

And then when do you expect that to pick up, fourth quarter this year, first half of next year or second half next year?

Fourth quarter.

Second, how would you characterize demand for space today, improving, steady or weakening?

Steady.

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

Higher.

Great. Thank you to the Kite Realty. Thank you all very much.