Regency Centers Corporation (REG) Earnings Call Transcript & Summary

All right. Welcome everyone to the Tuesday 2020 -- 2:20 p.m. session at Citi's 2020 Global Property CEO Conference. I am Christy McElroy with Citi Research, and we're pleased to have with us Regency Centers and CEO -- President and CEO, Lisa Palmer. This session is for investing clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available up here and on the webcast on the Disclosures tab. For those in the room or the webcast, you can sign on to liveqa.com and enter code Citi2020 to submit any questions or you can just raise your hand. Lisa, I'm going to turn it over to you to introduce your company and your management team and provide the audience 3 reasons why investors should buy your stock today, and then we will kick off the Q&A.

Perfect. Thank you, Christy. Michael, Brian, thank you. Since you heard them offer me a standing mic, just -- I actually ruptured a disk in my back about a month ago. So if you see me stand after all of this, during Q&A, please just don't think that I can't sit still for 33 minutes or 35 minutes. So with me today are Mike Mas, our CFO; and Laura Clark, our SVP of Capital Markets. Regency has been in the retail real estate business for nearly 60 years, and there are so many things that you could say. I don't know that we've ever been through a Citi conference like this. I think it's my 24th Citi conference. And it's -- there's a lot of interesting things happening. But as we transition into the new decade, our team is more focused than ever on the future. We're making decisions and taking actions to keep Regency at the top of the shopping center sector. And I do believe that our proven strategy and ability to evolve and adapt, not just to changing retail, but to things that are happening as to what we're experiencing today, have really allowed us to deliver superior results over the long term. And maybe even more importantly, for those of you that know us well, I think we've developed a reputation for delivering these results in the right way and doing things the right way. We've been really committed to that. And despite the unique challenges for Regency in 2020 and, certainly, the uncertainty of the impacts of the coronavirus, we believe we are well positioned to continue to deliver results that will lead the sector. And it's a combination of, really, 4 key strategic advantages. And I know many of you have heard us say this before, but I think it's really important to remind you of what they are. First, a high-quality portfolio of over 400 shopping centers, located in really the best markets in the U.S. with a focus on necessity, value, convenience and service. We believe that this is going to enable us to continue to average same-property NOI growth of 3% over the long term. Second, our development and redevelopment team. I think they're the best in the business. And we have a visible pipeline that should result in the delivery of over $1.25 billion in value-add projects over the next 5 years. Third, our blue-chip capital structure. We have a really conservative balance sheet with a low AFFO payout ratio, and this is providing us safety and coverage of our dividend as well as significant free cash flow that allows us to fund our developments and redevelopments, but in extremely favorable and cost-effective basis. And lastly, Regency's exceptional team. We have offices in 22 markets across the country, and it really does provide us a local sharpshooter advantage. And we have a special culture, again, as I said, committed to doing what was right. We've always been that way. It's at the core of who we are. It's at the core of our values. And I think this has been even exemplified more with Regency's leading corporate responsibility practices. This unequaled combination of these 4 strategic advantages will support our objective to grow core earnings and dividends by 4% plus over the long term, generating total returns of 8% plus. Just briefly on the macro retail environment, and this is certainly pre-coronavirus impacts. Because I think there really is so much uncertainty that even I don't have the crystal ball to know what's going to happen. But I do remain, over the long term, very confident in the future of retail real estate, especially shopping centers that are close to customers. The industry continues to evolve. And obviously, we're all very well aware of the growth in and disruption from Amazon and e-commerce. But retailers continue to validate the importance of high-quality physical locations. These are an important part of the retailers' omnichannel strategy because, again, it provides shoppers with the best possible combination of convenience, service and experience. And while retailers clearly have been very intentional and selective with their expansion plans, they continue to seek out the best locations. And we're seeing this and living this on a first-hand basis. We said we have real evidence with our healthy, full leasing pipelines. And the bottom line is that with the combination of our strategic advantages, we really do believe that Regency is well positioned to prosper in this ever-changing, evolving shopping center industry. So with that, I'll close with 3 reasons as to why to buy Regency stock today, and I'll just hit these really briefly. They mirror a little bit of how I opened with our strategic advantages. One, we have a very high-quality portfolio; two, a sector-leading balance sheet in terms of the amount of free cash flow that we are generating; and a track record of sustained dividend growth and total shareholder returns at or near the top of the sector.

Great. Well, thank you for that, Lisa. We started each of these sessions asking about ESG, which is of increasing importance for all your company stakeholders. What is the one thing Regency is doing to improve the company's overall ESG score over the next 12 months, looking into the future?

I had someone long time ago teach me to answer the question I want to answer. So I'm going to answer the question first that I want to answer. And then I'm going to toss your question to Laura. So I said it in my prepared remarks, Regency has always been committed to doing things the right way and the right thing, and I believe it's part of our core values. And I believe we are truly a leader in this area. And while I won't talk about all the things that we've done to this point that I think that has positioned us that, I'm really proud of something that happened in the last couple of months, and that's -- Regency was selected as one of America's 300 most responsible companies by Newsweek for 2020. And this was not something that we applied for, if you will. This was completely independent. They looked at over 2,000 companies, and it celebrates achievements in each category, E, S and G. And I do believe that is a reflection of all that we've done. It's pretty impressive. We were ahead of Walmart, Coke, Disney, Apple, Amazon. I mean that's a pretty impressive achievement. And I say it's a reflection of everything that the team has done to put us there. And Laura actually is really running that effort. We have dedicated resources that are responsible for corporate responsibility. Then we have a committee that reports directly to our nom/gov committee on the Board. So with that, I'll let Laura answer what we plan to do over the next 12 months.

Thank you. As Lisa mentioned, we're really focused on doing what is right as long as it's good for the business. And what I'm really excited about over the next 12 months is our climate change study that we're -- that we've actually just kicked off. So we have an in-depth climate change study that we're -- that we've started where we are -- okay, my mic wasn't on -- where we are assessing not just the risk, but the opportunities in our markets and in our portfolio, all around climate change. So we'll use this analysis to inform our strategic planning process as well as to enhance our reporting and our corporate responsibility report around TCFD, SASB as well as the UN SDGs, and we believe all those will also increase our scores.

Great. So starting with sort of internal growth. So in the earnings call, you outlined space recapture impact to your growth projections, both known and unknown, in addition to downtime impact from redevelopment. As you look to 2021 and you're expecting an improved growth rate, how are you thinking about mitigating the potential fallout risk on the horizon?

I mean I'll start just with kind of bigger picture, sort of how we think about the business generally and how kind of the buildup to that same-property NOI growth, and I'll -- Mike can follow up with any additional color. But when you do -- when -- for those of you that know Regency, you've heard us talk about kind of our same-property NOI buildup. So we have contractual rent steps that contribute about 1.3% same-property NOI growth. And then approximately 10% to 14% of your space can expire or roll every year. And with the renewals and the new leasing that is done, the rent spreads that we've been able to achieve and as well as our strategic objective of the mid- to high-single digits will actually contribute another 70 to 80, 90 basis points, getting you to 2% and, call it, 2.25%, that's sort of built in. And then with that -- so that would assume no occupancy change or percent rent commence and no contribution from redevelopments or capital spend, reinvestment back in the business. However, for those of you that follow us know that we have a really -- we have an excellent track record of investing back into our properties and actually getting accretive growth from that. So that 2% and 2.25% we've been able to -- a contribution of from redevelopments, if you will, 75 to 100 basis points, getting us to that 3%. And I think, as you know, over the past couple of years, 2019 and what we're projecting in 2020, just as a result of some timing and the mix of properties, that redevelopment contribution has been 0. And that is what has kept us a little bit lower. As I mentioned in my prepared remarks, tenant failures and replacing of tenants, it's been part of the business for as long as I've been in the business. It's been a little bit elevated over the past 2 years, and that is what we have -- that is what we have been dealing with in terms of why this year, 2020, is going to be a little bit lower along with some unique bankruptcies. But even if you think about the life cycle of re-leasing that space -- and again, I will reiterate, we have really healthy demand for the spaces that are coming back to us. And in many cases, we're having the ability to upgrade that merchandising. So if you think about that, the life cycle of re-leasing that space of being, call it, 18 to 24 months of -- from when you get it back to when you can rent them once again, even if we stay at that elevated level, it's now a stabilized elevated level, if you will, and we're going to be able to get -- we'll be able to re-lease and get that rent commencement back and so that occupancy and percent rent commence will stay stable.

Yes, if I may, just a couple of comments on why we feel like our return to our strategic objectives beyond 2020 are more visible. I'd encourage you to take a look at our supplement as well as a new slide in our investor presentation, where we've outlined 4 specific properties where we have great visibility into that NOI coming back online. The buildings are coming out of the ground. We're making great progress on leasing activity, signing many leases at those redevelopments, so we just feel more comfortable with that contribution, to Lisa's point. Secondly, the leasing activity we accomplished in 2019, while delayed during the year, we hit our leasing objectives for 2019 on a total volume basis. Most of that back-end-loaded, primarily in the fourth quarter. Those leases are executed, working through the build-out process and will commence towards the end of '21 and -- '20 and into '21. So again, this added visibility of how we see our trajectory of same-property NOI growth and, therefore, earnings growth returning to our objectives gives us that confidence to make those statements.

We had a question on -- Eric asked about...

Yes, I was going to frame it in the sense that it was just about sort of online and grocery. And I'll make the analogy. I mean clearly, e-commerce has been a big growth area. It was, I think, like 5 or 6 years ago, everyone said, you won't buy clothes online because you want to go to the store, you want to touch the clothes, you want to feel the fabric, you want to try it on. Yet today, that's not the case anymore, right? Everyone's very comfortable getting their -- those soft goods sent. And so why won't that same thing happen to grocery in 10 years? And why will the physical grocery environment, which is where your bread and butter is, still exist in that sort of world?

First, I would say that you have had the ability to buy clothes online for quite some time. And it's -- and yes, it's growing. But I've been saying this for a long time, people could literally stay in their household today and get everything they want online and never leave, but they're still...

Which is great for corona, I guess.

Yes. They're still a part of human nature that people are social human beings, right? I mean for everybody in this room, think about -- I think about the last time that you just went out to a local -- I did it Saturday night, right? Those of you -- I'm a Virginia fan. I went out to watch Virginia play Duke at a local restaurant, and people were literally just sitting at the bar, having a drink, watching the game. They could have done that at home. Generally, people want to be out and social. So I think that that's not going to change. And so that's always going to be one thing that's going to keep people going. Shopping is -- it's an experience. And it is up to the retailers to make sure that the interior in those 4 walls of the store are welcoming and a place where people want to go. Or else, people will stop going. And you see that with failed retailers. It has -- they have to be a good operator. So that's within the stores. The same as an owner of shopping centers, we have to make sure our shopping centers are well kept, well maintained, have great place-making elements, are well merchandised. So again, there's so many choices for consumers. It's got to be a place that they want to go. So those are little things. But then also to get to the cost of getting goods to consumers, for grocers, for all retailers. It is -- there's no question and no one can argue that, that is more expensive to deliver it to them. And so the retailers have an incentive and so do the grocery operators of bringing the consumer to the store. So they're going to continue to invest in their business just as all others have to incent their customers to come to the store. The most cost-effective way for them to get their goods to consumers is for the customer to come into the store and pick it themselves. And you're seeing that even with the one that I mentioned in my remarks that has the largest share of delivery, which is Amazon, opening grocery stores, physical locations across the country so that they can be close to their customer and again be part of an entire omnichannel strategy so that they can capture all aspects of that customers' needs and desires. And it's going to include -- it will include delivery.

If I may add to that, just paying attention to the behaviors of these online merchants and the traditional bricks-and-mortar merchants rather than reading the headlines is what I would encourage everyone to do to. To Lisa's point, Amazon's going to open their first full-line grocery store here in Los Angeles in the next several weeks. Excited to see that offering. By all accounts, it looks like a traditional grocery store. This is with checkouts and freezers and fresh goods. Again, I think that's the world's -- one of the world's greatest online merchants realizing that the most cost-effective way to deliver goods is to have their customers come in. Watch their behavior with the acquisition of Whole Foods, encouraging their Prime members to come in by way of discounts. Again, economically, that's the best way to continue that experience with their customers. We're seeing the -- Target, in fact, today, announced the success they're having with buy online, pick up in store. Kroger rolling out the same throughout. That appears to be the winning strategy from the retailers' perspective. And we're seeing that in our centers, and that's a very -- it's a -- for us, it's a very easy give to strike a few parking spots. And Kroger is reporting that sales within the store are up when they can convince their customer maybe to start their order online and finish it up within the 4 walls. So I just -- just paying attention to these behaviors is really important.

The follow-up question to that was, is Amazon structurally changing the convenience aspect of this as they're pushing to same-day and next-day? Are they structurally changing the business? And this is a firm that doesn't really have -- doesn't really care about the cost of that, right?

Right. They're making changes. And there will be -- we don't discount the fact that there will be -- continue to be penetration rate of online with respect to grocery will continue to rise. But the fact of the matter is there's 40,000 grocery-anchored shopping centers in the country. Regency owns about 425 of those in the most well-located corners in those trade areas. Online -- discovery of products, specifically from a grocery perspective, it's very difficult to do online. There will continue to be a need for that bricks-and-mortar presence. Those retailers, whether Amazon or others, will continue to want to have a vehicle to accept returns as well and will want that bricks-and-mortar strategy. The best defense to this online merchandising is competing on price, competing on product and being right next door to your customer, which you can't -- in our portfolio, we're within a mile of their customers. There's really nothing more convenient than that.

And there's no question it is changing it, but I think that that's a good thing. And the only analogy, and it's an old one, but it's still relevant, is when Walmart entered the grocery business and how much -- and I remember because, again, I was sitting -- I think I was sitting at one of these tables when that happened. And we talked about what it was going to do to grocers. And you know what? It was an incredible amount of disruption and a lot of failures and a lot of store closures. But the winning companies, the survivors, the better operators actually got better. And they will tell you that that's the case. And I think you're seeing that today with Wegmans and Kroger and Publix and Albertsons and even Trader Joe's even though they're in a different space and H-E-B. All these grocers are investing back in their business. They're forced to. They're investing in their store experience as well as in their supply chain as well as in technology. They're testing different things, and every single one of them are getting better as a result of that. So are they changing the business? Absolutely. And I think it's a good thing for consumers.

Fitness has been a growth driver for new demand. You guys have Orangetheory, LA Fitness, Planet Fitness are big tenants for you. How do you think about exposure to that category and tenant credit and the differences in lease structure for that category and the risk that, that represents when you have a tenant like 24 Hour Fitness that is having issues and, potentially, there's some cracks in the system there?

Again, I can start. Mike can add. I think, first of all, I think you can't lump all fitness together. There's certainly a difference between the smaller shop operators, if you will, my favorite being Orangetheory, versus the larger boxes, just by the fact of our business, right? Small shop spaces tend to turn a little bit. They do. They turn faster, more often, and that is really truly part of our business. Anchors typically longer leases, more capital involved. And so when we are looking -- but we -- when we are looking at those uses and those operators, we certainly approach it as we do any and in terms of we want to partner with and lease to the better operators. We like fitness as a use. It drives traffic to the center. And we certainly believe that the fitness sort of trend is here to stay. Again, there are some things that are happening in today's environment that may put stress on large-format gyms. So that's -- we don't want to keep our head in the sand. That remains to be seen. But generally speaking, we just have to approach and make sure that we are dealing with the better operators, and we have been -- we diligently review and evaluate the returns based on rents and capital that's put into the boxes.

As you've ramped up redevelopment activity in some of the larger-scale redevelopments, construction costs have also risen. And so there's been some compression in terms of yields expected. You've also increased the size of the pipeline, and so you're funding less of that as a percentage with free cash flow, right? So your cost of capital on a weighted average basis has increased as well. How do you think about that spread to your cost of capital and your investments on a go-forward basis on a risk-adjusted basis?

Yes. Our construction costs have risen, and you have seen that in terms of the returns that we've been achieving. We were in an environment where we were developing too close to 8% with cap rates that were still in the sub-5% range. And that spread was more than healthy and -- which allowed us to be able to absorb those construction cost increases and have reduced returns. We're now averaging 7%. We have some that are lower, some that are better than that, but in the 7% range. And the cap rates for the quality of the property that we are still -- that we are developing is still sub-5%. And so we still have a very healthy spread and feel really comfortable with that. In terms of the size of our development/redevelopment pipeline, we've had a target of $250 million to $300 million for a really long time. So that hasn't changed. What has changed is, with the company's acquisition of Equity One, our free cash flow actually grew pretty significantly. And that has enabled us to almost on a leverage-neutral basis still fund that same $250 million to $300 million.

Any questions from the audience? In terms of JV, so you're losing some JV fee income this year. You've also added some risk language to your 10-K, at least it looked new around buy/sell clauses. What's the risk of further JV partners? I mean we've certainly seen that across the space where capital investors are pulling back on retail. Do you see further risk there of JV partners wanting to pull out and losing that fee income?

Sure. Thank you for the question. So first in your comment is the joint venture, in particular, that we will -- are working to unwind this year, and that's what we've talked about in our disclosure. That's a relationship we inherited with the merger with Equity One, really not -- those are 2 institutions who are forced to be together, and that wasn't a statement on us or around them, and they just knew that they weren't going to grow that relationship with Regency and decided to move away. As you extend that to our other relationships, I think, actually, the feedback from your comment is consistent across whether it's GRI, who's investing in CalPERS Capital or CalSTRS, who has a long-standing relationship with us or the State of Oregon. They actually want to grow their allocation to grocery-anchored retail. Regency, as a partner, has outgrown that business a touch. We are looking to add to our portfolio, to the extent we can, on balance sheet. And the growth opportunity for those partners has been limited. So if you're in their shoes and you have relatively small vehicles between 2 large institutions, the efficiency of managing those becomes less. And at some point in time, it's more likely than not that they would just move that capital elsewhere. So I don't think it's a statement that those partners are making on the state of retail and grocery-anchored specifically. They'd actually like to do more with us.

At the Investor Day, which I think about 2 years ago, I got it wrong on Brixmor. So that was a year ago. You outlined the different buckets in your portfolio, the different buckets of assets, and that's helped to define sort of what goes into your disposition pool and what you're investing in. Have those buckets changed materially since then? How do you think about what's a riskier or lower growth on a future basis going-forward asset versus 2 years ago? How is that changing?

The -- so that -- you're referring to what we call our DNA model. The inputs to our DNA model haven't materially changed. We do refresh that on an annual basis. Over time, those thresholds start to actually increase, and we raise the bar for our own internal quality metrics. But the end result of that, there hasn't been a material change to our overall quality. Roughly 75% of our assets grade out in our internal model as premier or premier plus is the words we would use to describe that. That would, in effect, mean that the quality on those metrics is better than -- Regency's average is premier plus -- and better than the peer sector average is premier. So 75% of our assets are better than the balance of the publicly traded peers. And that's important. The public shopping center companies are pretty high-quality, institutional-grade real estate. And that is not -- we own a very small sliver of what this 40,000 universe of grocery-anchored shopping centers is. So we believe that to be a very high bar. Nothing's really changed on the bottom end, Christy. Still, materially less than 5% of our assets we would qualify as lower growth, and those would be the opportunities to redeploy that capital to the extent we see some acquisition opportunities. We don't have to sell properties. We like the portfolio we have. We have plenty of free cash flow to fund our investment needs. We will sell assets when it makes sense and when we see an opportunity to redeploy that capital into an acquisition. Those acquisitions will likely come with some sort of redevelopment opportunity, some sort of opportunity to add to the density of the site. We find that, in the acquisition market, if it's a purely core asset, our capital is not competing well. These are trading and clearing the market at pretty low 4 cap rates, and the pension plans and potentially some other REITs are outbidding us on that.

Would you expand the scope of your -- of what you would look at in retail from an acquisition standpoint? You've always stayed true to a traditional grocery-anchored shopping center, some larger-format community centers that have a grocer component in a big box. But with the Equity One deal, you got street retail. Some of those didn't -- and certainly, the asset in New York didn't work out, so maybe that -- you wouldn't go that direction. But you had Serramonte, which was a mall that was being redeveloped into a larger-scale-format center. Does that give you any sort of view to expanding the scope of what Regency does at all?

When I think about our investment strategy, I think that when you think about what we own today and what we've been buying, traditional high street retail, we're not going to never say never. But I don't see us expanding into something like that today. But there are many near urban opportunities that -- like, for example, in Lincoln Park, where we bought a center that's essentially street retail with some teaser parking. So I don't view that as an expansion of our strategy, but more of what we have done in the past. We will use our DNA model, and we like to invest in areas in the top markets in the country in affluent and/or dense trade areas that have significant traffic. And specifically, we are still very grocery-anchored-focused, and that grocery-anchored focus is something that's got the daily traffic and the convenience. So it's a very vague answer to your question, but we like really good real estate, and we're going to continue to invest in and whether it be developing, redeveloping or acquiring shopping centers that look a lot like what we own today.

And then you think about the densification opportunities. In some cases, you're bringing in venture partners on your own sites to go vertical. In some cases, you've partnered with someone like AvalonBay to split the purchase, where they're buying the multi-year buying, the retail. Is there any change there as you sort of see your methods on that -- on external?

Again, I think that REIT, as I said, right, for a very long time, Regency has been adapting and evolving. And we have done horizontal mixed use for as long as I can remember, where we would essentially sell off the parcels that were non-retail. And over time, we did lean in a little more where we would take an interest, but always ground lease if we certainly could. And we have evolved where we are now -- where we prefer for non-retail uses to partner with best-in-class sector developers, in most cases, because we're developing from ground up in that class, like AvalonBay, for example. And so yes, we're taking larger interests, but we still are investing in the retail -- retail is driving the site, not the reverse in terms of the assets that we're investing in. So we hired a gentleman -- I think it's been 5, 6 years ago, to be Senior Vice President of mixed-use, so that we can actually develop the internal expertise ourselves as well in terms of mixed-use and understanding and helping us structure some of those partnerships and knowing -- developing the muscle, as we would say internally, in Regency. It is not a core comp -- we are not apartment developers or office developers. It is not a core competency. And again, never say never. But we are leaning in, and we prefer to partner with best-in-class operators.

There's a question that came on here, and I'm conscious of time, but it says, in a tough retail environment, how sustainable is both the ability to maintain double-digit leasing spreads and include contractual ramp-ups on new leases, particularly in light when CPI is almost nonexistent?

So we have been very successful in maintaining 3% contractual rent steps. We're averaging -- even in larger boxes, so averaging 2.5% to 3% in over 90% of our leases. So we have been successful in doing that. And then in terms of -- we actually have been in the high single digits on a blended basis for rental spreads. We haven't been in double digits, and high single digits is our strategic objective. Still feel really comfortable getting that today. And that's -- if a recession hits, then obviously, there's going to be some -- there will be areas that are going to be a little bit softer, and I think that's to be expected, but still very much believe that, with the quality of our portfolio, that we will be able to -- we will weather an economic cycle. If you think back to the Great Recession, we did lose occupancy. We fell from 95% to 92% lease, but please recall how bad that recession was. And our shop space percent lease actually remained highest in the sector for those that report it.

All right. Rapid fire. Will the shopping center sector have more or fewer public companies a year from now?

Fewer.

What will same-store NOI growth be for the shopping center sector in 2021? And this year, it is...

1.8%.

2%.

10-year treasury, a year from now? It's now below 1%.

1.5%.

What year will the U.S. enter a recession?

2021.

2021. Great. Thank you very much.