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

Welcome to the Kite Realty Group roundtable here. Happy to have Heath on with us today. Heath Fear is the CFO of the company. Heath we've got a big group here. So I'll turn it over to you for some opening remarks.

First, I want to thank everyone for joining us today. After yesterday, the majority of people told us they weren't going to be here today. So I'm actually surprised we have a full room. So thanks all of you for joining us here. I'm Heath Fear. I've been the CFO of Kite Realty now for just about 7 years. We are an open-air shopping center, have about 180 properties in 24 states, predominantly concentrated in the Sunbelt, and 80% of our properties have a grocery component. We have one of the best balance sheets in this space, 5.1x net debt to EBITDA, over $1 billion of liquidity and a very well-staggered maturity ladder. Our strategic focus at this time is really twofold. We're keenly focused on leveraging the strong tenant demand and leasing across the portfolio. We're looking at historical levels, Kite by far screens the best in terms of it's remaining [indiscernible] upside. Most of our peers have reached their pre-COVID levels and beyond. We still have 280 basis points. So many of our peers are in sort of the later innings of their absorption tailwinds we were at the very beginning of our absorption tailwinds and expect to see the fruits of that labor bear in the late parts of '26 into '27. So again, I think leasing is our primary focus and taking advantage of this great supply-demand dynamic. Our second focus is really improving our stabilized long-term cruising speed. We've been very vocal in the past about leveraging this current environment to really drive terms, to drive leasing terms, specifically to really improve our embedded escalators across the portfolio. Today, we've had a lot of luck with our small shop tenants, over 60% of our small shop new and new option renewal tenants in the last quarter were 4% or better bumps. And based on this success in the shopping and then the small shop space and to a lesser extent, the anchor space, we've moved our embedded escalators from 160 basis points over the course of 18 months to now to 171 basis points. So it's 11 basis points in 18 months. However, I will tell you that our long-term plan is to be in excess of 200 basis points of embedded rent bumps. So we're not going to get there just by leasing. So the second part of our focus to improving our cruising speed is really to selectively cull the portfolio of our larger-format lower-growth assets. These assets also happen to have a disproportionate exposure to the credit tenant watch list. So with these 2 things happening, it's our goal to get to 200 basis points, we are very, very disciplined sources and uses allocators. So as we dispose of these assets, our goal is to match fund them and to deploy the proceeds in a way that it's minimally or not at all dilutive to earnings. So again, our goals here are to lease up our existing space and to improve our embedded long-term growth.

Thank you for that, Heath. Maybe take a step back, post 2Q earnings, talk about kind of what you're seeing on the ground, still a lot of question around -- there's a lot of the consumer, the uncertainty. Talk about kind of the leasing environment as you kind of see, let's call it the next -- last 30 days.

Yes. At risk of sounding like a broken record amongst us and our peers. On the ground feels really, really good. The depth of demand is still there. It's in the small shop space. It's in the anchor boxes with our -- the 29 boxes that we got back from the latest rash of bankruptcies in late '24 and '25 and 83% of those are basically taken care of. So again, on the ground, we are not seeing the narrative that's being played out. I think a lot of the narrative is born from consumer sentiment numbers that seem to be eroding. But you saw, for example, BofA's credit card numbers came in yesterday. And those are showing increased spending across all income classes. So again, we see the headlines as well as you do, but it's not a beta tenant demand and actually been very, very pleased with the resilience of our tenants. We saw very little disruption in terms of people changing opening or store plans based on all the tariff chatter and they continue just to push through. And I think there's a recognition by the tenant community that the supply demand dynamic is really in the landlord favor at this point. And if you wait, you will miss the space and these tenants have growth plans that they're trying to achieve. So again, we have not seen anything happening on the ground, will lead us believe that the demand is going to dry up anytime soon.

So just to be -- so just to make sure, I mean, on the anchor side, yes, everything seems to be fine. And even I would assume on the shop side as well...

The shop side is incredibly vibrant. I've been so surprised personally by just the willingness of small business formation. We have these real estate committees every Monday. And again, we're doing anything from a mom-and-pop store to a large anchor store. And every week, I'm like, wow, just it's just great to see this couple taking on this new franchise agreement, and they're going to open up a small shop space. So we have not seen any slowdown in the appetite for people to take a risk and open a new business. So again, it's been fun to watch. It's been to contrast it against the headlines.

The 83% you talked about kind of it seems like the activity on kind of the box space, right the bankruptcies. Talk about kind of the rents on those, what was the upside? I mean, let's talk rents sort of adjusted for CapEx, right? I mean yes, let's make sure to kind of talk about that. And help us understand because there is a lot of questions around growth in the next year, and it's not really for you, it's for the sector. Help us think about when -- the timing of that rent coming back in.

So those particular boxes, the 29, spreads are averaging around 20%. So we're still seeing a good cash spread. But to your point, the returns on these boxes is a little lower than what we saw with Bed Bath & Beyond and in Bed Bath & Beyond we're seeing 30% returns. The good news is that our returns are a little lower, I think more like 20%, Matt, on those boxes?

Yes.

20% returns. So basically a 5-year payback. The reason why it's a little more expensive because we have a larger set of grocery stores in this particular set of refilling. So those deals are naturally a little bit more expensive. So while their -- while our return is a little lower, happy to take a grocery store, put it into a center where there wasn't one and compress the cap rate against the balance of the NOI. So really happy with that progress. Then in terms of when will we see the fruits of this labor of these 24 or 29 boxes that we're getting ready to sign or have signed already, that's really a late '26/'27 story. So we get them signed soon or signed them recently you came to get them open in 12 months. Some of them you can. Some of them will then want to block you out during the holiday season, they won't open until the following spring. So again, as I mentioned in my opening remarks, KRG is poised to experience some accelerated growth based on sheer occupancy that we have left to fill up. And why are we still 280 basis points shy of where we were pre-COVID part of it is because we had a disproportionate amount of exposure to Bed Bath & Beyond. It was the highest exposure in the space. We had a disproportionate amount of exposure to the last rather bankruptcies, which was American Freight, Conn's, Big Box, Party City, Joann. So that sort of set us back. And I think probably the second piece to all that is, and we've been saying this over and over again is that we're really hyper-focused on quality. And the part of the quality is I already talked about driving rent bumps, but it's also trying to improve other terms around the leases that are really going to help us on a long-term basis, make sure we don't find ourselves in this situation again where we've got this watch list of tenants and we're losing multiple units at once. So one of the things you've seen us doing is we're super focused on limiting options. So in the past, you did a 10- to 15-year anchor deal, you'd grant them 25 years of options. And so basically the space is tied up for 40 years, as they're an owner of the space. We are very strict now, and we try to limit it to options which are no longer than the initial term. In addition, rather than fixing the option rent, we've been very focused on making it fair market value. So that this way, at least I haven't seated the table to decide what the rent is going to be, and I can actually realize the mark-to-market and not wait for years to realize the mark-to-market on the rent. We've been more aggressive around cotenancy and making sure that we don't get caught if someone leaves it's going to impact other NOI at the center. We've been harder on exclusive uses. So we had been so quality focused and if that means that we are a little slower to fill up our space, that's fine. Again, we're trying to do what's right for the long term aspects of the portfolio and drive value in ways that are beyond just the headline rent.

And what about the balance of those boxes, right? You talked to 83% and talk about the balance, how they...

Yes. I mean so there's 5 left. And we're still prospecting and listen, when you have 29 and there's going to be 5 of them that are going to take longer than the rest. That's just how it works out. So nothing structural about those boxes, nothing that's going to keep them vacant for a very long time. It's just a matter of us cycling through and seeing who's available to want to take the space. So listen, I'm not going to tell you we're going to have 100% box occupancy rate anytime in the future. You always have some frictional occupancy -- vacancy. So again, we're working on them. Will we get them all done? Hopefully.

It doesn't mean that there's no activity -- this means that we're not currently negotiating with -- haven't selected a negotiating with one specific tenant.

Yes.

Okay. And then again, while we're on that topic, talk about the watch list as well. I just want to make sure we understand kind of the positives and negatives in the next year. what does that watch list look like over the next 12 months?

So I think the one tenant that's probably garnering most of our attention over the next 12 months is The Container Store. We have 7 Container Stores at 70 basis points of exposure we were in recent discussions with The Container Store and their management team. They have hired a new CFO, they don't have a CEO at the time, maybe that's changed since I've talked to them 2 or 3 weeks ago. But this was a very much of a cost-cutting person that was really there to sort of stem the expense bleed and get them basically stabilized. And so what we didn't really hear a whole lot during the conversation is what's going to change in the business since it's going to make this a viable sort of a viable go-forward plan with them. They're also out looking for some relief from their various landlords. They have not filed. It seems like their liquidity is going to be good enough to get them into '26 and they're also in discussions with potentially having some more recapitalization dollars come in to buy them some more time. But I think the way that we're looking at it is if there's an opportunity for us to sit down with them. Typically, when we get tenants ask us for net relief outside of the process, bankruptcy process, we say no. There may be a little bit more willingness for us to sit with them and see if we can't cycle out of it in a more sort of measured way rather than waiting for the road to get pulled out can we take a handful of these back in a more measured way. There are stores -- there are some good stores in our portfolio, and there are some not-so-good stores on. So is there some win-to-win solution for us. and that's something that we're looking into right now. So again, trying to mitigate The Container Store situation right now. And then looking further out to the watch list, a lot of them, I think it's more of a '28, '29 story when you really start to have some concerned, you've got some maturity walls happening with Petco and Michaels. Michaels we're -- we haven't got any new intel, but the setup seems to be pretty darn good. we know anecdotally that they have dedicated more of their floor area to fabrics to sort of act as the person that's going to absorb the void from Joann. They've dedicated more of their floor area and more SKUs to party supplies to be the beneficiary of the consolidation of the Party City. So I think the setup for them is good. But TBD, we'll let you know. And we do hear rumors that they would ultimately like to go public, but that's a question for them.

Okay. So the setup in terms of watch list looks pretty good into next year. I mean, 70 basis points is sort of in that normal 75, 100 basis points -- it's just that you got to work through some of the bankruptcies drag from this year, the downtime.

Correct. Correct. I mean if you think about our growth this year, we did 3.2% same-store in the first half, and we're guiding to 2% that obviously suggests the deceleration in the back half that deceleration is just 2 things. One, it's obviously we don't have the rent from those tenants that we had in the first half of the year. And second is we have more difficult comps in '24, we accelerated into the year in terms of growth. And so when we're looking at '26, '26 is going to look the mirror opposite of '25. You will see us have probably modest growth in the first half of the year with growth accelerating in the back half of the year, as we're not comping against this bankrupt income that we had in the first half of '25.

I just want to make sure if there's an opportunity for everyone to ask questions. Anything on internal growth? Okay. Maybe some comments on Legacy West here. Help us think through kind of the opportunity there. Is it mark-to-market on new leases, densification, development, kind of walk us through that.

So it's one of, I think, 15 A++ ranked assets in the country. So the opportunity to own something like Legacy West is not something that comes along very often. Also, though, understanding where our cost of capital is and the size of that transaction, we brought in GIC as a partner, which we can talk about later. And really the attractive part about Legacy West was the mark-to-market opportunity. It's a fairly dense site, so there's not a whole lot of densification possibilities. There's some that may be something we can do with garages later, but that's far enough, we're not the major driver of the underwriting. Yes, we're seeing 30% of the rents are turning over the next 3 years, which is going to give us an opportunity to really look at the merchandising and see what we can do in terms of the rents. I will tell you, the ABR now is averaging around $60 a foot on the retail side. Some of our leases were doing deals in excess of $150 a foot. And we recently had a tenant that we underwrote that was struggling when we closed on the transaction, we underwrote them leaving. Sure enough, they left -- they're leaving at what, a $43 rent, in that and we're replacing them with $140, right? I'm happy to pay that TA for that kind of tripling of the rent all day, almost quadrupling the rent. So that was the opportunity there. And in addition to that, we own Legacy East, which is across the street. And if you look at the evolution of Legacy West, it's moving higher and toward more luxury tenants and so some of the tenants that were sort of the original tenants of Legacy West, and then we had the original developer added on this luxury wing. Some of those tenants aren't really appropriate in that lineup. And so we feel like by owning Legacy West, we have the perfect outlet. So legacy West is sort of luxury and high aspirational luxury. Legacy West. Legacy East is really more of an aspirational luxury sort of outlet. So we'll have some good synergies between those 2 projects. So that was a second motivating factor for Kite to want to be a part of Legacy West.

Maybe expand on sort of GIC and that JV platform yes. So how big can that be? How active can it be?

It's -- first of all, they're a great partner. We don't have a mandate on size with them. We don't have an exclusivity clause that requires us to use them to the extent we're looking at acquisitions I will tell you that it took a lot of calories to set this arrangement up. Listen, we're already $1 billion in gross value. So I'd tell you that's a nice sizable stand-alone JV already justifying the time and effort we put into credit, but I think both parties are like-minded that we'd like to grow both parts of that portfolio. So to the extent there is attractive acquisition opportunities in that sort of higher-end mixed-use space. They are expressed willingness to want to chase things with us. After Legacy West, we looked at a couple of things. We didn't get there on pricing. But they're also looking forward to growing the other part of the portfolio. As you recall, we contributed 3 larger format assets into a joint venture, they owned 48% of that. And the beauty of that transaction, especially Legacy West, and if we can repeat it, is that when we bought Legacy West, our effective yield on Legacy West due to the management fees is 6.5%. And you guys can back into what you think the cap rate is, but that's a 50 to 75 basis point improvement in our yield because of the management fees. The yield at which we sold the 48% interest in the 3 larger format power centers, was also 6.5%. So we partially funded the acquisition of Legacy West with power center currency, which I think all of us can agree is a home run, if not a grand slam. So if we can repeat this with them. And listen, for them, it's for them. It's a very interesting trade. And it's actually the way we originally presented the joint venture. Why don't you chase this wonderful trophy with us. And in the meantime, because that has a certain risk-adjusted yield. It trades at a tighter yield, but it's got better growth. And why don't you also take a look at some of these higher-yielding assets that have lower growth and won't that be a nice blend for you in terms of your investment objectives, and they agreed. So there's certainly a version where we will continue to put in some of our higher-quality box year assets. into that side of the portfolio or that side of the joint venture. So it's been great. They're great partners. Good news is that we -- and when you're a partner with someone like that, you want to make sure that you can deliver on what you've promised and thus far, Legacy West is exceeding.

Got it. The one factor that -- one segment I want to talk about was CapEx.

Sure.

And I know you talked about the backfilling of the boxes and it seems -- look, you'll have growth next year from an FFO perspective as well, but there's a lot of folks here that also focus on AFFO. As we think about sort of that the CapEx trend into '26 and even into '27 as a percentage of NOI. Talk about that CapEx trend given all the backfills. What is the internal view here?

Yes. So we've been pretty vocal that the sort of the lease-up spend has been around $100 million to $120 million a year while we're in this lease-up phase. That's against the backdrop of a stabilized CapEx leasing number around $40 million to $60 million, assuming the portfolio is fairly full. Prior to the last rash of bankruptcies in '24 -- late '24 and early '25 we were communicating that we thought that the leasing spend would diminish and the AFFO would ramp up sort of in -- as a late '25, '26 story, now with that -- with the bankruptcies happening in '25, with Joann and Party City, that AFFO ramp-up is now a late '27 to '28 story. So you'll see elevated spend in that $100 million to $120 million range happening in 2025. You'll see it happening in 2026. And you'll probably see that run rate happening in the first half of 2027. And then in the back half of 2027 per our model and our absorption rates, you'll see that start to diminish. And then hopefully, 2028 will be much more of a normalized year going back to that $40 million to $60 million spend of leasing capital. And then the other piece of capital is just maintenance CapEx, and that's pretty regularly $25 million, that's a point on the range. Sometimes it's a little less, sometimes a little bit above.

Okay. So still elevated in -- well, certainly in '25 and then '26 and then maybe first half of '27?

Correct. Correct.

Okay. Just these JV structures you see, [indiscernible].

100%. But it's interesting. If there was a -- I mentioned earlier in my remarks that we would look to probably cycle out of some of the larger assets that have lower growth and higher exposure to credit watch list. Those aren't the assets I want to put into this joint venture with GIC. This is a long-term partner. So we do have some box here, larger format assets, which are really great real estate. Yes, they yield lower, yes, they have lesser bumps. Generally, these have less of an exposure to credit watch list tenants. And so those are the assets that we're willing to hold on a long-term basis. And isn't it great that I took a high-yielding asset and not even put an extra higher yield on it because I'm getting a management fee, right? So that's almost like a beautiful hold vehicle for us to continue to want to work with that. And I don't know what their ultimate appetite is, but we're willing to grow that along with them. Again, it will be paired because if I'm putting assets in there, I need something to do with the proceeds, right? So I would love to be able to repeat that. But those things are hard to get. But I mean the good news is that in that -- we can talk about the transaction market, but that particular part of the market, sort of lifestyle mixed use, especially the high-end stuff, you've seen things hit the market that normally don't. And part of it is that there was so little price discovery on that product type for so long. I think we're sort of help sort of to thaw the market and that you saw price discovery on Legacy West. You saw price discovery at Scottsdale Quarter in Phoenix. You saw price discovery on Birkdale Village in north of Charlotte, and you're starting to see even lifestyle in more tertiary markets and secondary markets starting to demarketed. Again, I think sellers are getting conviction. I think before there was this worry that it was lifestyle, it automatically inherited a mall cap rate, not an open air cap rate, but you're seeing the cap rates and that stuff compressed. It's been fun to watch all these things come out. I will also say that GIC and Kite alone, we are extremely disciplined IRR buyers. And we're writing something and I'll make a number up to 8.5% unlevered if it's 8.51%, we're out. So that's kind of that's how we approach our acquisition mandates.

It's interesting you bring up the comment on the lifestyle because nobody wanted to touch them in the 2000s in those days. And now it feels like everybody, every asset that everybody is buying is a lifestyle and maybe -- is that just a function I mean, WPG has been pretty active. Right? You've seen a lot that product come through.

Correct. Yes.

Or let me shift from mall tenants going into lifestyle where maybe that's kind of what you're seeing?

Yes. I think it's a number of factors. Number one, you are seeing obviously a lot of the lifestyle or traditionally enclosed tenants are really wanting to be open air. That's simply a matter of the triple nets are so much less. You're not heating or cooling or et cetera, et cetera. But I think the other thing happening with lifestyle is -- and as a CFO, whenever I'm looking at a leasing plan, I'm thinking about balance sheets, right? What do the balance sheets look like? As I'm going through this, and I think the mall tenant base or the lifestyle tenant base is further along in its purging cycle, I think, than some of the larger boxier tenants. And so when I go through some place like Legacy West or looking at the roster at South Lake or One Loudoun, I feel pretty good about most of the balance sheet. Now Container Store is the one lifestyle tenant. I'd tell you that still has a larger footprint, they're over 20,000 square feet, and they're obviously on the ropes. But for the most part, I feel pretty good. So I think some of the conviction around the space is saying, "I'm getting better growth. These are typically 3% or better bumps A lot of these tenants have been there for a while. There's great merchandising opportunities. Can I cycle out some of the traditional White House, Black Market names or Chico's and put in someone more exciting, like Alo or Aritzia. So I think that's been the cache. And I think also just the pricing discovery. People like, you know what, now I understand what this is worth, and I know where the bid is, and we're going to go ahead and make an offer or we're going to go ahead and sell because now I have conviction that it's not going to sit out there and someone is going to come to me with a crappy 8% or 9% cap rate on it, right?

So let me ask you some of the heat. So every year, I feel like there is -- we have this conversation of a drag on NOI because of some of these tenants, right? So my question to you is, is there a scenario here, you kind of alluded it to earlier where you just say, you know what, we've got these box, your tenants, let's rip the Band-Aid Here's a bucket of assets that we could potentially sell and you talk about the market out there for transaction to be pretty active. And let's go sell those, right? And then take the proceed, maybe buy back stock, I mean, help us think through kind of what happens, the conversations you're having at the Board level [indiscernible] at this point.

It's a great question. First, I'll set it up with this. There is definitely a bid right now for larger format boxier assets. And really, I'm really seeing 2 pockets of capital. I'm seeing private players that are happy to own yieldier, boxier stuff probably because their source of capital has a pretty high return hurdle, so this is how they're going to make their money. And they're also seeing private equity retail has become one of the better ideas in private equity in the real estate side. And when you're staring at having to produce your investors a 16% to 17% levered IRR, you're not going to do it with a 5.5% cap grocery, right? So what you're going to do buy 7% to 8% cap larger format. So how does that relate to Kite? So opening remarks, I told you that we'd like to diminish this boxier part of our portfolio. However, we're also very mindful that, a, we need to do something accretive with the proceeds; and b, we would like -- while we'd like to do something more than just small, we want to make sure that we're doing it in a very tactical way so that we're doing very little damage, if any, to our earnings. So how do you do that? Well, number one, you mentioned it. Can you sell boxier assets? And can you put that into stock buybacks? Well, the current FFO yield on our stock would tell you that those things trade inside of that. So that's certainly a use. Good news for us since our balance sheet is so strong, we're at 5.1x net debt to EBITDA, we can do it. And we don't have to do it on a leverage neutral rate. We're happy to go to 5.5x how some of these assets, however, have built-in gains. So do you send out the gain in the form of a special dividend? Or do you go ahead and just do a 1031 because you don't want that particular leakage. So for us, it's all of this idea of -- and I think that one page we had 2 quarters ago on Legacy West, it shows you how we think internally. Here are some of the assets that we'd like to sell, they've got lower growth. They've got these watch list tenants. We can kill two birds with one stone. Well, let's make sure we're smart about how we deploy. And I think the hardest part about our job as capital allocators is you have these different time horizons on things you're trying to achieve. And so when you say swapping, selling assets, buying back stock, sounds very simple in theory. But you've got something that takes 6 months to transact versus something that is obviously trading in the market every day. So how do I ensure I don't get caught? How do I -- okay, I want to sell X, Y and Z asset. It's $100 million. Do -- does that mean I immediately go run out and buy stock for $100 million saying that I'm going to sell this asset. Well, I don't know, there's a very real reason that maybe your buyer disappears, something happens in the market and all of a sudden, you can't transact. So maybe what you do is you say, okay, I'm going to get this thing under contract. -- and then maybe when it goes hard. Now I feel like I have a certain measure of conviction. Now I'll start activating the other side of the trade. By the way, let's hope I'm not in the blackout period, Right? So there's -- it's a little bit more of a Tetris exercise than it is Pacman. And when you're trying to navigate through capital allocation. So to answer your question, we have no desire to do this multiyear dilutive, let's dribble out a little bit every year until 5 years from now, we're in some kind of -- we have some kind of portfolio that we really like. We would do something more meaningful and doing it in a way that's more tactical and trying to take advantage of two things right now. Number one, our stock is letting us do it. And number two, there's a market, right? So that's a long way of answering your question is sizing-wise, we're not talking billions and billions of dollars of assets, right?

Those are going to be my next question.

Exactly. So let's say we're 20% pure power right now, if we go to 10% or 15%, that's a win. That's going to take that credit watch list exposure down. And I think if everyone looks at Kite and you say, okay, why is this stock underperforming in the past 2 years? It's 2 things or 3 things. One, we had lower same-store FFO growth in '24 and '25. That's easy, right? Just let's look at the tape. Three, I think, as people are concerned and even after we've had a disproportionate amount of exposure to bankruptcies that we continue to have one of the higher exposures to credit watch list tenants. We don't want to be that in that list anymore. We want to be more toward the middle. How do you accomplish that? You accomplish that by selling because, unfortunately, I can't reduce my exposure to some of these folks because they have options forever and every time they hit them, right? So we wanted to be -- have way less party cities than we have every single time. An option came up they'd ask for rent reduction, we would say no, and they would hit the option, right? So that's kind of the struggle. So the answer is yes, we'd like to get some things done. But all of it is market dependent. And I think the big highlight we were seeing yesterday, this is about optimizing the portfolio. This is not about fixing a broken portfolio. This is about certain assets that are encumbered on a long-term basis. with things that they're going to get people concerned that we're not going to be able to grow proportionately or actually grow in excess of where our peers are going because we have that exposure. So again, it's -- but we want to do it in a way that's not going to just have a throwaway year in terms of our earnings.

Okay. Any questions here? Then I've got some rapid fire. I know we're kind of at the end of time. I think it -- All right. ready for this Fear?

Sure.

All right. When the Fed starts to cut rates, do you expect long-term to decline, stay flat or potentially rise, choose one.

I think flat.

Okay. Last year, the majority of companies stated they are ramping up spending on AI initiatives. How would you characterize your plans over the next year, higher flat or lower?

Higher.

Number three, we believe same-store NOI growth for your sector will be higher or same next year.

Lower.

Okay. Thanks a lot.

Thank you.