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

Good day, and thank you for standing by. Welcome to the Third Quarter 2024 Kite Realty Group Trust Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand conference over to your speaker today, Bryan McCarthy, Senior Vice President, Corporate Marketing and Communications. Please go ahead.

Thank you, and good morning, everyone. Welcome to Kite Realty Group's third quarter earnings call. Some of today's comments contain forward-looking statements that are based upon assumptions of future events and are subject to inherent risks and uncertainties. Actual results may differ materially from these statements. For more information about the factors that can adversely affect the company's results, please see our SEC filings, including our most recent Form 10-K. Today's remarks also include certain non-GAAP financial measures. Please refer to yesterday's earnings press release available on our website for reconciliation of these non-GAAP performance measures to our GAAP financial results. On the call with me today from Kite Realty Group are Chairman and Chief Executive Officer, John Kite; President and Chief Operating Officer, Tom McGowan; Executive Vice President and Chief Financial Officer, Heath Fear; Senior Vice President and Chief Accounting Officer, Dave Buell; and Senior Vice President, Capital Markets and Investor Relations, Tyler Henshaw. [Operator Instructions] I'll now turn the call over to John.

Thanks, Bryan, and welcome, everyone, to our quarterly conference call. KRG delivered another very strong quarter, leasing approximately 1.7 million square feet of space, which is the highest quarterly volume in the company's history. Heath will walk you through the details of our quarterly results and our updated 2020 guidance, and I'll focus on the progress we continue to make on the leasing front and our longer-term growth levers, including the recently announced development project at One Loudoun. Over the last 3 years, the primary focus of our capital allocation efforts has been leasing. Our portfolio now sits at 95% leased, which represents a 160 basis point year-over-year increase. We're optimistic that in this environment, we can continue to drive both the anchor and small shop occupancy to historical heights. Year-to-date, we've executed 17 anchor leases at 38% comparable cash spreads and 33% returns on capital. Demand continues to be strong in both our anchor and small shops. Year-over-year, our small shop lease rate is up by 100 basis points as a result of signing over 180 new leases, with tenants spanning a wide spectrum of complementary uses. The credit profiles of our new small shop tenants are also strong, and these leases are expected to generate a 57% return on capital. Our signed-not-open pipeline remains elevated at $33 million. It's important to note that the average ABR in our signed-not-open pipeline is over $26, which is nearly 25% above our current ABR in the portfolio. Based on the current leasing velocity, we expect our signed-not-open pipeline to stay elevated through the first half of 2025 and start to drift down to our historical average as we head into 2026. As KRG enters the latter part of our lease-up phase, we remain acutely focused on levers of growth beyond occupancy gains. The organic mark-to-market opportunity embedded in the portfolio continues to be strong as highlighted by the year-to-date blended non-option renewal spreads of nearly 13%. We consistently promote this statistic as the most reliable indicator for movement of market rents as it's not influenced by landlord capital. We're successfully driving higher embedded growth, especially on the small shop front. For new and non-option renewal leases signed in the first 3 quarters of 2024, the average annual growth was 3.5%, which is 50 basis points higher than the small shop new and non-option renewal leases executed in 2023. The progress we've made over the past 3 quarters represents a significant step towards our long-term goals of generating a more sustainable stream of cash flows and driving an outside cruising speed for NOI growth. On the development front, we recently announced our expansion plans for One Loudoun in the Washington, D.C. MSA. As we detailed in our third installment of Four in '24, the development will include 86,000 square feet of retail and 33,000 square feet of office. We're also in the late-stage negotiations with 2 developers to incorporate 170-room hotel and a 400-unit multifamily complex into this next phase. Our philosophy on non-retail uses for mixed-use projects is to manage our capital contribution while maintaining a stake in the project. We'll share our plans for both the hotel and multifamily phases once the agreements are finalized. One of the takeaways we communicated at our Four in '24 event was our significant amount of developable land adjacent to One Loudoun. Excluding the proposed next phase, we have entitlements for an additional 1,300 multifamily units and 1.7 million square feet of commercial GLA on over 30 acres of entitled land. While we're focused on executing this next phase, we have plenty of optionality for additional phases to continue creating value. One Loudoun is on track to becoming one of the premier open-air, mixed-use projects in the country. While on the topic of premier open-air, mixed-use projects, we hosted our second installment of our Four in '24 series at Southlake Town Square in the Dallas MSA, which is currently our largest asset. When we took control of this property in 2021, it was generating just over $20 million of NOI. 3 years later and Southlake is producing over $30 million of NOI, which speaks to the intensity of our leasing platform and the underlying quality of the real estate. The combined impact of One Loudoun and Southlake on KRG as a whole is extremely compelling. While generational assets like these trade infrequently, there's one currently in the market and another that will be in the market by the end of the year. We're confident that these assets will trade at levels which will underscore the importance of One Loudoun and Southlake to our portfolio. This past quarter, we acquired Parkside West Cobb, a Sprouts-anchored shopping center in the Atlanta suburbs for $40 million. We locked up this property in advance of the recent compression in cap rates, which allowed us to acquire this asset at a positive arbitrage to the asset we sold in Chicago earlier in the year. For the past several years, we've been disciplined in our desire to remain relatively net neutral on our buying and selling activity. It's important to note that the number of high-quality assets in the market continues to increase as does the liquidity for all open-air product types. With our current leverage meaningfully below our long-term targets, KRG is well positioned to take advantage of any compelling opportunities that may arise. Our Board of Trustees has authorized an increase in our dividend to $0.27 per share, which represents a 3.8% sequential increase and an 8% increase year-over-year. As occupancy and NOI ramp over the next few years, we anticipate our dividend to follow suit. For many of our long-term investors, the dividend is a critical aspect of REIT investing. And with the strength of our balance sheet, KRG's dividend is an extremely attractive risk-adjusted yield. In closing, thank you, as always, to our incredible team for their hard work and dedication. But before turning the call to Heath, I wanted to specifically recognize the dedication and grit of our Southeast team for their efforts related to the recent hurricanes. As a result of their vigilance and preparation, our assets suffered minimal damage and downtime. We proudly serve our Southeast customers and our communities, and are grateful for their support and patronage. I'll now call -- turn the call to Heath to walk you through results and 2024 guidance.

Thank you, and good morning. For those of you that have attended one more of our Four in '24 events, we are grateful for your time and travel efforts. We will be hosting our final event in Las Vegas on November 18, which is the Monday prior to the Nareit Conference. We hope to see many of you and look forward to sharing our views on capital allocation and providing a glimpse into our long-term vision for KRG's future. While the response to Four in '24 series has been overwhelmingly positive, you can rest assured that the intellectual property rights to Five in '25 are currently available. Turning to our results. For the third quarter of 2024, KRG earned $0.51 of NAREIT FFO per share and generated same-property NOI growth of 3%. Same property NOI was bolstered by a 280 basis point increase in minimum rent and 120 basis point increase in net recoveries, offset by 80 basis points of bad debt relative to the comparable period. Based on our third quarter results and revised outlook for the balance of the year, we are increasing our 2024 FFO guidance by $0.01 at the midpoint to a range of $2.06 to $2.08, primarily driven by improvement in our same-property NOI growth assumption. At the midpoint, we assume a full year same-property NOI growth assumption of 2.75% and a full year bad debt assumption of 70 basis points of total revenues. The full year bad debt component is a function of combining the actual bad debt we experienced year-to-date, which was approximately 60 basis points of total revenues, with the continuing assumption of 100 basis points of bad debt for the fourth quarter. As our updated guidance implies, we are anticipating an acceleration in same-property growth for the fourth quarter due to the commencement schedule of our signed-not-open pipeline and the favorable comparable period. In August, we returned to the public debt market by issuing a 7-year $350 million bond at a coupon of 4.95%. We felt it prudent to minimize the capital markets risk heading into 2025 and we are pleased with the execution. On our July earnings call, we mentioned that we anticipated a significant improvement in credit spread compared to the levels we achieved in January, and we were able to achieve a 38 basis point compression in a spread in less than a year. As for the proceeds, we are currently holding them in a short-term deposit account, generating interest income in excess of the yield on the debt maturing in 2025. In September, we amended and extended our $1.1 billion revolving credit facility, which now matures with extension options in October of 2029. With a very dynamic macro environment in front of us, it's important to note that our availability under the line of credit, together with our cash on hand, can satisfy all of our maturing debt through the third quarter of 2028. Looking through a more opportunistic lens, with over $1.2 billion of available liquidity and a net debt to EBITDA of 4.9x. We have the ability to deploy significant capital, while still remaining within our long-term leverage target levels of 5 to 5.5x. Thank you to the entire KRG team for another spectacular quarter and we're looking forward to seeing many of you in Las Vegas. Operator, this concludes our prepared remarks. Please open the line for questions.

[Operator Instructions] Our first question is going to come from the line of Todd Thomas with KeyBanc Capital Markets.

Heath, it seemed like a little bit of a better outcome in the third quarter than you previously talked about. I think you talked about the third quarter being a little more muted and followed by a sharper increase in the fourth quarter. It sounds like that's still the case, but where did you outperform versus expectations in the quarter? And was any growth this quarter pulled forward from the fourth quarter? And then as we think about ending this year and into '25, any sort of goalposts that you can put up around -- the next few quarters around the trajectory for NOI growth?

So Todd, basically, I think just doing better on bad debt wasn't the primary driver of what gave us a little bit better outlook into the same-store for this particular quarter. And I wouldn't say that we pulled forward anything from the following quarters. In terms of the trajectory of the same-store for '25 and beyond, we're not going to give guidance this time. But we said before in our remarks that we're pretty bullish and optimistic with respect to the occupancy contributions we're going to see in our signed-not-open pipeline, so I'll leave that to our '25 outlook.

Okay. And then my second question for John, curious to just get a little more color on the acquisition environment and also the assets that you mentioned that are being marketed or on the market that you're comparing to One Loudoun a bit in that sort of ilk. Is Kite interested? What's the company's appetite like for being on the buy side of a transaction like that and adding another asset like that to the portfolio today?

Sure, Todd. I mean in terms of your macro question, I think the environment is strong. There continues to be more and more capital flowing into open-air retail from, as we've talked about before, all sources that you can imagine -- pension funds, sovereigns, insurance companies, REITs, 1031 buyers, advisers. I mean I really think that the volume of capital that's flowing into our space in the past 6 to 9 months has dramatically increased over the previous year. So that obviously leads to compression in yields that people are willing to accept, as well as the growth rates in these assets are clearly better than they were historically. So all in all, I'd say it's a very competitive market. As we mentioned in the prepared remarks, yes, there are assets that are now coming into the market that are similar to centers like Southlake and One Loudoun and Crown and Union Hill, and I can go on and on. I mean we have a lot of assets. We mentioned 2 of them. But we have a lot of these high-quality assets that I think people maybe don't quite think of when they think of our company. So that's our goal, is to make sure people do understand that. As it relates to would we participate in something -- in assets of that nature, would we look to buy those. That's why we specifically mentioned our balance sheet. We believe that we have, if not the best, and one of the very few best in the space. And again, don't feel like we're quite recognized for that. Debt-to-EBITDA at 4.9x and dropping. We have a lot of firepower, a lot of optionality. We're going to absolutely be looking at what's available, as we always do. And if we feel like that we think we add value and appropriate returns, we will certainly be in a position to execute it if we so chose. I think what we're trying to say is that we're undervalued as it sits today. But the good thing is we have so much capital and our balance sheet is strong and our cash flow is growing, that we can still participate in the market if we choose to.

Our next question is going to come from the line of Alexander Goldfarb with Piper Sandler.

John, maybe just keeping with that theme of going on -- looking at more centers to buy some of these potential larger centers. One of the things that you've spent many years, almost a decade doing, is improving the balance sheet, getting really low leverage and putting the company in a really good spot. At the same time, unfortunately, the stock continues to trade at a discount versus peers. So how do you balance increasing leverage to buy assets if that risk sort of goes against what you guys have tried to do, which is say, hey, we've got a great company, great cash flow, great leverage and, therefore, deserve a higher equity multiple?

That's a great question. I think that's the point we're trying to make is that we do have a great balance sheet and having a great balance sheet affords you that optionality. So I think we have to look at each individual opportunity under that lens of what is the potential growth rate of the asset, what value does it bring to the total portfolio and what comfort level do we have impacting the balance sheet of the asset and/or assets [ in full ]? So -- but when you're sub-5 and we've been clear that our long-term goals and objectives are low to mid-5s. That's a lot of runway. So I think, Alex, it's just -- I don't think we can say it's one thing. I think we have to look at each individual component of what we're pursuing to say does this add value to the overall business. But again, where we are today, we have plenty of room. So I think that we're studying and looking, and let's see what happens. But again, if it doesn't happen, we continue to generate free cash flow out of the existing portfolio. Frankly, if we did that, we would continue to delever, and that just creates even more optionality.

Okay. Second question is, you mentioned residential, which you showed us at One Loudon. As you guys have been assessing the portfolio and more investment opportunities, is there a sense of how much multifamily potential there is in your existing portfolio? And also, is that something that is actively on your investment plan is to say, hey, let's add more multifamily? Just trying to get a sense of if One Loudoun is more special case? Or if there's a lot more across the entire Kite portfolio?

Well, I mean I think, as you know, Alex, we generally don't set these numbers out there and say we have to go chase them. I would tell you that we currently have an equity interest in, I think, about 1,400 units. We mentioned that the next phase of Loudoun is going to be another 400 units. And I think we mentioned on top of that, there's another 1,400 units there alone and entitled. As it relates to the balance of the portfolio, we generally let the real estate do the talking. And so we're not going to drop and say we have to have 5,000 entitled units. The reality is we will have several more thousand units over the next few years that we can pursue if we choose to. But again, I mean, the real estate needs to talk to this, the returns have to make sense. And we do generally like to have partners and share the risk and manage our capital contributions going in. I know some others don't do that, but that's what makes sense for us. So it's a part of the business. It's clearly -- this densification is clearly a part of the business. And as we pointed out, we have a lot of these high-end assets that -- where you can do this. But we're not trying to force it, we let it come to us.

Our next question is going to come from the line of Floris Van Dijkum with Compass Point.

By the way, John, I think your -- maybe it's just me, but your voice sounds a little muffled. Maybe you're too close. I'm not sure what it is, but it seems to be a bad connection. It's probably just me. But a question on your SNO pipeline. And obviously, as you project this forward, I mean, it's almost 5% of NOI, most of that's going to start to impact next year and in '26. I mean it's a pretty heady underlying growth. So I mean if things work out, we should see an acceleration in underlying growth. Maybe if you can talk about the composition of that growth and how that's changing. Particularly as you start to get into the later innings of your anchor box repositioning, how much more upside do you see on your shop space? And where do you think the greatest growth opportunity on the leasing side lies for -- that's still untapped for KRG?

Sure. Does that sound better? Can you hear me? Or is it the same?

It's still not as great. I apologize.

Okay. I apologize too. I don't know what to say. Now I'm moving microphones all over the place for us. So hopefully, you can hear me. The bottom line is, I think the question is when I look out at the growth rates and where are same-store has been and I think when we looked at where our occupancy gains are coming from, if you're looking at it like that, we clearly have more room to run in the small shops. The anchors are becoming close to where we were pre-COVID. So I think that when you combine the lease-up efforts that you've seen us do over the last couple of years and you look at the growth that we're able to get in the shops and it's 50% of our revenue, I think I would point that there's real upside there. I also think if you look at the point that we made at our same-store -- and you look at the signed-not-open rents versus our existing rents and the spread there, that's really encouraging. And then also just the implied cash flow growth that we're able to generate as we have a better cruising speed, as you said. So overall, I think it's a combination of those 2, but I hope that helps what you're looking for.

Yes. I'd also add that the nice thing that is that, that will split between anchors and shops. So we're not seeing pockets of demand, we're seeing broad-based demand. And as John mentioned, $26 in a blended ABR, that's over $37 in the shops and close to $18 in the anchors, those are really, really strong rents. And again, that's just indicative of the continued strong demand on the leasing front.

Yes. And the way to look at it is we have 20 remaining boxes right now and we are activating those, [ more than half of them ]. So it just says that momentum continues and we're able to continue to drive the strong spreads and returns.

Maybe my follow-up, and this is related more to capital allocation. But obviously, your bigger assets have grown -- particularly if you look at Southlake having grown NOI 50% over the past 3 years, bigger assets tend to grow at higher rates. As you think about deploying capital and other real estate, is that one of the key things that you consider when you're making investment decisions?

Floris, I think that it's so specific to each individual asset. Obviously, if you're deploying more capital on a pro rata basis and you have the growth opportunity, that's going to move the needle more than a smaller deal. That being said, it really comes down to the individual quality of the asset. And Southlake, as an example, was an asset that was kind of -- it was perfect timing in the sense of the merger and kind of applying our leasing machine and being able to get those results. And we're seeing the same thing at One Loudoun. So yes, I would say that the bigger assets are intriguing in that way. But by the same token, we're really focused on the quality of the real estate. And there's several large assets that we've looked at recently that we passed on based on the fact that we felt like the quality of the real estate, in the long run, wasn't going to support that growth. I mean we can get short-term growth, but we're really looking to get long-term growth.

And our next question is going to come from the line of Craig Mailman with Citi.

Heath, you had mentioned bad debt came in a little bit better than you had expected. As you guys look out though over the next couple of months, I know The Container Store is being mentioned in the news now, they're not -- they're less than 1% of ABR for you guys. But like how are you thinking about tenant credit broadly, maybe for them specifically, over the next couple of months?

Yes. So as we're looking out in the course of '25 d '26, nothing right now, Craig, is giving us pause or wanting us to sort of separate and have a separate reserve for a particular tenant. We feel comfortable now as we go into next year that we're going to be able to manage any kind of fallout with a general bad debt bucket. Now as it relates to The Container Store, yes, it's 7 locations that's been [indiscernible] of ABR. And if you've been following it, you'll see that they had a bit of a blip on their stock yesterday because of [ some accounting notes there ], they have no [ disclosure ]. But conversely, they also have a $40 million investment from the folks at Beyond. So there's good things happening there. I think they did get their debt extended. This good sponsor, the amount of debt that they owe actually isn't a huge amount. They just [ have like $ 125 million ] coming due in 2026. So -- and I think the business and the brand is something that's going to survive. So we feel good about Container Store continuing to do business. But there's good news. The good news is that it's 7 spots in some of our best real estate. And if we have to, we will to release it. So again, we feel good about them. We think that's an ongoing business. But of course, we monitor [indiscernible].

That's helpful. And then I don't want to belabor the point on acquisitions here. But just maybe how you guys are thinking, you clearly have more runway in the near term with the SNO pipeline and the premium returns you're getting on that capital that's invested. But as you get through that, right, assuming your equity continues to trade where it is today, you will have the benefit of the higher cash flow as the leases commence. But you guys are at a lower leverage point, you talked about potentially ramping that a bit. How do you think about if, say, the stock is still trading around this area in a year or 2, right, you have a huge spread relative to debt. How comfortable are you or how high from a leverage perspective would you be willing to go to kind of grow the portfolio accretively even if cap rates are still inside of where the equity is trading? Or is that just a scenario where you guys are less interested in growing overall?

Well, let me start with that. I think the bottom line is, yes, we're very aware of where our total cost of capital is and we are aware that the equity isn't where it should be. That being said, we've been extremely prudent and, quite frankly, have done a great job in terms of what we've done in the bond market. So I think we're in a good position, Craig, to kind of see where this plays out. We're still in that leasing mode. I mean we talked a lot about the accomplishments, that's great. We still have more leasing in front of us that can generate high returns on capital. And so that continues to be the highest return on capital. As we move into late next year and into 2026, and as that starts to kind of absorb, then I think we're in a position and we're generating even more free cash flow in '26 and '27, that all of this will come together and we will make some decisions around more treasury decisions, where are we investing those dollars. And to your question specifically, can we increase leverage? We can absolutely increase leverage. And frankly, if we let the 5.5, we'd still be low relative to the peers, and we're at 4.9. So I think there's real movement there. And what we want to do is if we were to increase leverage at all, we want it to be very accretive, obviously, and I think that will come to us. So I think we're in a great position, actually, as the market continues to improve, as lease-up continues to happen and as supply-demand characteristics are working in our favor, which I think at this point looks like it will continue into next year. So we'll just be really selective and make very good capital allocation decisions. And that's our primary job, is to make smart capital allocation decisions, and we'll do that and we'll do it accretively.

I'll just add, Craig, that kind of putting it in perspective, we could acquire somewhere between $500 million and $600 million of assets, take a cap rate and remain at 5.5x, which is within our long-term target. And if you think about it, we're doing that with debt. So when we think about the cap rates, they're very sort of sales and [ results ] driven, And I mean in the context of what's [indiscernible] in average of cost your capital, it may not make sense. However, based on our size of debt, we just issued a bond at 4.95%, that allows us to lipid assets and use it. And even if we go 5.5 and something accretive and still maintain the quality that we want to make.

And our next question is going to come from the line of Andrew Reale with Bank of America.

Just on the Parkside acquisition, could you speak to the cap rate on that deal and the degree of compression after you lock that up? And your messaging continues to be that internal deployment is your best use of capital, but just curious if this latest transaction might signal a shift into more external opportunities?

Yes, sure. In terms of the cap rate, we didn't give a specific cap rate. I mean what we did say is that it was accretive to the assets that we sold in Chicago. And I would tell you that the cap rate that we were able to acquire it at is probably 50 to 75 basis points higher than it would be today based on the timing and the length of time it took to -- for the seller to be in a position to close the deal. So it's a great deal for us. And in terms of cap rates overall, my commentary there would be that they are compressed versus where they were 3, 4, 5 months ago in a significant way. And the type of assets that we own and the quality of assets that we own generally trades in the kind of mid-5s to low 6s. I mean that continues to be the market. But you gladly point that out as it relates to the imputed value of our stock price today. What was the second part of your question, I'm sorry?

Just more broadly, I mean, your messaging is still that internal deployment is your best use of capital. But just curious if that transaction is signaling a shift into a wider array of external opportunities?

Right now, I think we do continue to be maintained -- maintain that desire to grow internally because it's very high returns on capital. And also the overall environment is aggressive right now in terms of us be able to find accretive opportunities. That being said, the point we're really trying to make today is that we have such a strong balance sheet that we can lean into that at a time that we choose to. And I think as things -- if they move the way we think they're going to move, certainly in the next couple of quarters, that will be an opportunity for us to look to grow.