Regency Centers Corporation (REG) Earnings Call Transcript & Summary

Good afternoon, and welcome to the Regency Centers NAREIT panel today. My name is Hong Zhang, and I work with Mike Mueller on the REITs team at JPMorgan. Today, I'm joined with Lisa Palmer, President and CEO; Mike Mas, CFO; and Alan Roth, Senior Managing Director of the East region. Before I start with the Q&A, I'd like to turn it over to Lisa with some initial comments.

Thank you, Hong. And I -- we only have a short window today, so I'll keep these brief. Hong did a nice job of introducing my colleagues. We also have Katherine McKee with us from our Investor Relations department. And also recently announced with Jim Thompson's retirement, will become EVP National Property Operations and East Region President. So it's been great to be here. Back in New York with all of you, it's a lot better than same boxes on Zoom. And I do believe that the Zoom meetings are actually even more tiring if that's possible. So we've really enjoyed these last couple of days, shoveling down lunch in 40 minutes and having about 50 meetings over 2 days. So I will provide some brief remarks before turning it back to Hong. We've been asked quite a bit, obviously, with all of the macro pressures about the environment. And the environment for high-quality open-air shopping centers still remains really, really healthy. And that healthy environment has supported robust leasing activity for us and really across the sector. For the past 5 quarters, when you look at leasing as a percentage of GLA, Regency has actually led the sector. So we have generated a lot of new good leasing. And that has continued -- that strength has continued into the second quarter. This was evidenced in real time at the ICSC conference in Las Vegas just a couple of weeks ago. It was very productive for us. We took approximately 65 people had great meetings with a host of tenants, and there's still real demand for space in high-quality open-air centers. As we've talked about over the past quarters, we are really pleased with this strength because this is in the face of macro pressures, especially inflation and labor shortages. We continue to monitor these impacts from these pressures on our business. And while we all have seen mixed -- these mixed headlines from the retailers, especially those that are in -- some of those that are in our shopping centers in recent weeks, we have not seen an impact on leasing in our portfolio. We know our centers and our tenants are not immune to these types of impacts to economic downturns. But we also know that they're really resilient, especially given the trade areas in which we operate and the essential nature of many of our tenants. So with this strength in leasing, our NOI in 2022 has recovered to pre-pandemic levels. We continue to make steady progress on returning our occupancy to historic highs, and that's really important as well because we've also talked a lot about that. When we have been through other economic cycles and downturns, the starting point was usually at a peak, whereas the last 2.5 years of COVID, we did lose 200 basis points of occupancy. So our starting point today is actually still allows us to have that growth even in the face of these macro pressures. So we continue to make steady progress returning that occupancy back to historic highs. Our portfolio of grocery-anchored neighborhood and community centers are located in strong suburban trade areas, and there are real structural tailwinds coming out of the pandemic. We continue to benefit from micro migration trends, so the move from urban to suburban, and we also continue to benefit to the move to hybrid work. So people are spending more times -- more time in their homes. So therefore, they're closer to their neighborhood shopping centers. And I think all of you can attest to that, if you spend 8 to 10 hours working in your house, in your room, you're very anxious to get -- or I should say, eager to get out to go to your neighborhood shopping center, whether it's to work out or whether it's to go grab a bite to eat. So again, we are really benefiting from that. Worth repeating. We absolutely understand and acknowledge that our centers will not be fully immune to any macro impacts, but we believe that our tenants are more insulated in the trade areas in which we operate. I think you also know that we're a pretty active developer and also in the transaction market, active acquirer. Our investment pipelines remain really -- remain active and strong. After completing nearly $500 million of grocery-anchored acquisitions last year, we've already closed roughly $170 million of acquisitions so far in 2022. We also currently have about $350 million of development and redevelopment projects in process, including a new ground-up development project. While I believe it's only about 30 miles from here, I think it will take you a lot more than 30 minutes. We started earlier this year in Old Bridge, New Jersey. It's anchored by Target and ShopRite. We also, during the pandemic, started an HEB anchored shopping center in Houston and a Publix-anchored shopping center in Jacksonville. So we have remained active and I'm a little biased, but I do believe we have the best development national development team in the business. And with that, we remain really well positioned to continue growing externally. We still have one of the strongest balance sheets in the sector, with net debt to EBITDA just below 5x. We never cut our dividend throughout the pandemic, and we're still generating nearly 100 -- it's about $130 million plus of free cash flow this year and expect that to continue to grow. So with that, Hong, I'll turn it back over to you for questions.

Awesome. If there are any questions from the audience, feel free to ask them at the microphone. But I guess to kick things off. We say, you touched on this a little bit about how we are facing a little bit more macro uncertainty these days. When I look at how -- when I look at the stock reaction to this uncertainty, it seems like the market is pricing in a much worst-case scenario than what it seems like could actually happen. I guess, where -- what do you think investors are missing between the strength of your portfolio and the fears?

I think I'll repeat, what's different. Regency has been in business since 1963. We've been a public company since 1993. We have worked through many different cycles. And as I said before, and it is -- we are all adaptive to those. And as I said before, when we went into other recessions, 2001, the global financial crisis late -- in late '08 going into '09, we really were at peak occupancy levels and didn't really have anywhere to go, unfortunately, but down. This time, it's different. We've just been through 2 really difficult years for retail, for people. And we did lose, as I said, 200 basis points of occupancy. So the pandemic unfortunately, in many cases, but in some cases, it was bound to happen, it weeded out the weaker operators. So what we are left with occupying our centers are stronger operators, stronger retailers, merchants, service providers. So the starting point, we're 94% leased. And I believe that we should get to north of 96% leased on a sustainable basis. So we still have room to grow. And so while there are headwinds, we have room to go to grow, the starting point is lower. And again, we go back to the type of shopping center, the type of uses. It's neighborhood community shopping centers, value, convenience and not recession-resistant, but certainly a lot more immune. Even when you think about some of our foodservice or restaurants that are in our shopping centers, in many cases, they're quick service restaurants, they're more casual. So people may cut back from more fine dining and they will trade down. And we see that also for the shopping centers where we may have discount department stores like TJX and Ross, again, people tend to trade down. So we will benefit from that. So while not resistant to it, I'm still really confident that we will be able to deliver on our growth model going forward, even with a potential recession, which none of us are certain if that will happen.

Got it. And I think it's worth also asking just how has your tenant watch list changed pre-pandemic to today because it feels like during the COVID pandemic, it cleared a lot of troubled tenants essentially.

Mike, do you want to take that?

Yes. I'd be happy to take that, Hong. So from pre-pandemic to today, our tenant watch list is smaller as you indicated. From a credit risk perspective, just under 2% of our ABR, I would tell you is on our watch list. I wouldn't surprise you, Hong, with any of the names that are on there. I think we can all rattle off the names of those retailers. And there have been a dearth of bankruptcy filings over the last couple of years. What -- in bankruptcy filings, historically speaking, and even in store rationalizations or fleet or store closures without even a bankruptcy filing, Regency's portfolio does very well. So we -- on average, we're going to have those stores that are in the upper quartile, upper half of those respective retailer fleets. They're going to be the must-have locations, not the nice to have locations. And we find that more often than not. And in many cases, Alan, would like to get those spaces back to recapture and release those opportunities. More often than not, we do end up keeping that retailer in place.

Got it. And then I guess on the leasing picture, you touched on how retailers are continuing to play offense and leasing space. In your conversations recently, has concerns about recessions, inflation, costs crept into these conversations at all?

Yes. Hong, I'll take that. It's interesting with all that we have been reading and experiencing with inflation, you would expect to hear. I think people pulling back perhaps, but it's just not the case. We had, as Lisa mentioned, an extremely active ICSC convention in Las Vegas. Tremendous amount of meetings. They are productive meetings. Retailers are still actively expanding and executing on the transactions that we have in process to a point where it's still a little bit of a slower process given the abundance of deals that a lot of these real estate leasing attorneys have. But we don't have blinders on and we're aware of what's going on out there, and we're certainly preparing to the extent that, that could happen. But it's active, and it's active in a lot of categories. Medical is enhancing their growth in the retail sector. Certainly, the restaurants, particularly the QSR restaurants are opening fitness from a boutique fitness perspective, maybe not as much so in the larger format, although there are some that are expanding, is happening, personal service uses. And it's a lot of creative concepts that are out there to replace perhaps some of those weaker ones that in Lisa's comments, that 200 basis points we lost of occupancy through COVID that have left, it is creative concepts like a Torchy's Tacos, [ Tawa Grill ], Dave's Hot Chicken, things of those nature that are actually now expanding even more so and add a little bit more vibrancy and more of a synergistic merchandising than perhaps some of those yesterday's retailers provided to us.

Yes. I guess with this strong leasing demand, could you remind us -- can you talk a little bit about how market rents compared to pre-COVID? And are you doing anything different in terms of lease structure or contractual rent bumps to kind of capture more of this demand?

I'll start, and then Alan can talk to what we're doing currently. Many, many years ago, we really began to focus more on getting annual contractual rental increases. And the team has done an excellent job in actually accomplishing that. And as we've done that and really embedding 2.5% to 3% on an annual basis, specifically in shop spaces, anchors average closer to 2% annually, but you may get it 10% over 5 years. With that, that then when those leases will roll to market, if we can then get another -- our target is to be in the high single digits, new rent spreads on renewal leases and leased and new leases. That is success to us. And I'll let Alan to comment on whether he has seen anything change in the recent past.

Yes. No, that was a great answer. And I would just say, I think inflation has provided an opportunity for us to push harder on those embedded rent steps. We're in the relatively early innings of that, but we are north of 3% in terms of our pursuit, which in many cases, we're going to be successful and others were not. But I would hope and expect that, that needle certainly drives that 2.5% on the small shop basis. But that doesn't change really kind of the thought process of there's 3 legs of that stool and higher rent growth in many instances, can come with higher capital contributions or TI allowances to our retailers, and we're very thoughtful on making sure that we're capital conscious in terms of not getting out over our skis at the sake of just driving a higher rent growth. So to me, it is those embedded rent steps that tend to be more sustainable and something that, at the end of the day has been successful for us.

Has there been any discussions about potentially putting in CPI-based rent bumps, just given all the inflation talk?

Yes. It's unfortunately, yes, Hong. We've had a tremendous amount of conversations with it. And in some instances, we do it, but by and large, we've kind of made the decision that that's something we're not going to push for across the board. A lot of reasons why, just to kind of maybe note a few, it's which CPI index are we going to use? As you start to get into that conversation, what happens if CPI is below 2.5%, and now we have to put a floor on it, and it just kind of complicates things. And so for us, we felt like adding fair market value options at lease expirations, we're in 5-year increments, where applicable, is a better way for us to manage that. If we can get that 3% to 4% of embedded rent steps and know that if CPI does, in fact, outpace what we've embedded in there, there's a reset capability through fair market value. again, fair market value with a floor. So at the end of the day, that's a bit more of kind of our thought process on how to approach that. Never say never. There are certainly a time and place where we're going to approach CPI, but it's not a common tool in our toolkit.

And I think another important factor is that we have triple net leases. So where we may be seeing impacts of inflation for our -- the cost of operating the shopping centers, we're able to pass that through to our tenants. So they're sharing in the increased operating costs.

You talked about mid-single-digit blended cash leasing spread target, which I think you're achieving right now. I guess just given the strength of leasing demand, but also being a little mindful that there is a certain level of occupancy that you need to claw back. What would need to happen potentially for you to achieve, say, high single-digit rent spreads? Do you think that's possible in the near term.

Yes, I do. And we're…

Less vacancy is the answer. I mean it's pretty definitive looking back over our shoulder, that rental lease spreads on a cash for cash basis tracks with our occupancy. So as we lease up this vacancy, and we will, we feel we're pretty confident in our ability to achieve 96% leased, 94.5% commenced levels of occupancy. We'll again gain even more strength in our negotiations and they able to drive that. I would like to -- I think Alan hit it perfectly and let me just jump on, jump on that pile from a 3-legged stool perspective. We also track internally GAAP spreads. So midpoint to midpoint, that's capturing that embedded contractual rent increase element that Alan indicated, we pushed really hard for. And then we also attract net effective rents to the capital component. Both of those metrics as we look at them internally, are tracking in that lower double-digit range as opposed to the mid-single digit range as you indicated on a cash re-leasing spread basis. We actually think we still have room to run on that metric as well. Historical peaks are in the more of the middle of the 15% plus or minus range. So we're on our way there, gaining leverage every day as we soak up this vacancy.

Got it. I think if I look at your occupancy as of the first quarter, there is a, call it, 230 basis point spread between leased and occupied. Could you remind us what that spread was like historically and how you expect that to trend?

Sure. Historically speaking, we're in the 175 range of pre-lease as we would call it. We are north of that today. And I think that's reflective of the vacancy opportunity we have to lease up. It's also maybe to pile on to some of Lisa's comments on our timing, which are absolutely 100% spot on. It's that pre-lease percentage that even in the event of a struggling economic backdrop, together with the shedding of the risk that we've already had through COVID and delivering that space, Hong, to answer your direct question, about 2/3 of that space should come online by the end of this year. It's that situation that we think sets up for an argument to be made that we can actually grow through what may or may not be a mild type of recessionary environment because of, again, circumstantially our position from an occupancy standpoint and the great leasing activity that the team has done over the last 12 months.

Got it. I'm terrible at mental math right now. But I think that implies physical occupancy growth, maybe 40, 50 basis points plus, is that right?

Our internal targets today are plus or minus 100 basis points for '22. And if we can hold this economy together and if the backdrop is supportive, I think we can do another 100 basis points in 2023 is what we've talked about to this point.

How do you think -- what do you think that occupancy growth happens if we do hit a real economic slowdown?

So we're going -- this is going to be theoretical on that giving '23 guidance at this point in time, although we haven't come off 22%. In the event of a real economic slowdown, what -- classically what will happen is move-outs accelerate, right? New leasing activity moderates. It never goes to 0. So how does that compare to where we are now? Again, much of that expectation for move-outs has occurred. So we're always going to move outs, but that the amplified move-outs, one would think would not be there. So -- and then we have this pre-leased pipeline, 230 basis points. Again, historically speaking, ahead of an economic recession, we didn't have that benefit. And this is that setup, I'm talking about of providing us a great opportunity to kind of grind out some good growth even through an economic pullback. What impact on the delayed leasing, maybe the leasing pipelines on Alan's teens, maybe they do temper, maybe they do reduce. What does that mean for Regency? Well, while I might think we can do 100 basis points in '22, 100 basis points in '23, maybe that recovery period extends for another year beyond that. Maybe it's less than 100 basis points in '23, maybe less than 124, but we eventually see our portfolio getting back to these peak occupancy levels of 96% leased.

Are there any questions from the audience? Okay. I guess moving to external growth. You've been active throughout the year so far in acquiring assets. And I think in your NAREIT presentation, you disclosed that you bought Baederwood post the first quarter. I guess given the recent rise in rates, what are you -- are you seeing any different, any changes in terms of cap rates, volumes?

Nothing that we can really point to evidence wise from our activity. But what we're hearing from the brokerage community is that there's been a slight move, maybe 25 basis points. I think the larger impact of what we're seeing is the actual deal flow has slowed down a little bit. And we believe that, that may continue to be the case. So you're there should probably be -- and again, nothing that Regency is working on actively that can support this, but just from our relationships within the market. We believe that there should be -- the leverage buyers are going to -- there are going to be fewer leverage buyers exiting the market. But they're still public companies, even in private REITs that have access to capital that will continue to pursue high-quality opportunities. Regency will continue to pursue high-quality opportunities. We have -- as I mentioned, we generated over $130 million of free cash flow. Yes, we will direct much of that to our development and redevelopment spend. But to the extent that there is a compelling opportunity from an acquisition standpoint, cash is fungible. And we also have a history and a good track record of match funding with dispositions. So disposing of lower growth and relatively low cap rates so that we can invest on an accretive basis. Any time we are looking at an acquisition has to check 3 boxes and that's -- this is true, whether it's a single asset, a small portfolio of assets or even a large M&A transaction. What we are investing it must be accretive to the quality of our portfolio, so above the average accretive to the long-term growth rate, so above our projected growth rate and accretive to earnings.

And if I did my math, right, I think with the Baederwood acquisition, it brings you up to your acquisition guidance for the year. Does that -- or do you still expect to be on the -- you talked a little bit about still being active, but is there anything more concrete in the works?

As a practice, we don't guide on speculative acquisitions, never kind of looking back, never have liked the disincentives that may or may not put on our acquisition team. But rest assured, you kind of also look back at our history, we are an active acquirer of properties over time. We average anywhere from $150 million to $400 million or so of acquisition opportunities. We are uniquely positioned with the balance sheet today that's -- we're underlevered. We're at 4.9x net debt to EBITDA. Our targets are to operate in the 5 to 5.5x range with EBITDA growth, which we are expecting without acquisitions using debt as a funding source. We would continue to fall below those targeted levels of leverage. So yes, the team is engaged. The team is looking. I think lease is right on that activity has seemed to decline from 12 months ago, but 12 months ago, it was scientifically termed crazy, very frothy. Lots of activity. We had never been that busy, frankly, in 2021. So I think we are down still healthy levels of opportunities for us to take advantage of.

Got it. And if I think about the returns between acquisitions and your development, redevelopment pipeline at usually associate acquisitions more immediate accretion to earnings, whereas development, redevelopment may be a little bit higher yield, but more cash flow and earnings positive down the line is where we stand now? How do you think about allocating between the 2?

Development and redevelopment is that the first use of our free cash flow. And I appreciate the comment that it does take years and it does to get the benefit of that. But if you are consistently starting and completing $150 million to $200 million a year, then you actually will get the benefit annually. We did hit the pause button in 2020 due to so much uncertainty with COVID, and we've restarted and we've rebuilt it. So it will take a little bit of time to get back to that sustainable level of $150 to $200, but we're not far away from it. So with that said, we really will -- we will have the ability to direct our free cash flow to development and redevelopment. And from an acquisition standpoint, again, we can generate a source of capital for that. So I don't see it as limit -- we're not limited by capital. It's really limited by the opportunities that come through the door that are compelling that do check all of those boxes, as I mentioned.

Got it. While I look at yourself, it seems like you have a very deep pool of potential development, redevelopment properties in the pipeline, at pipeline. Is that right?

Yes. We do have a solid pipeline, and it is a mixture of ground-up and redevelopment. And we -- again, I'm biased. I do believe that we have the best team in the business. We have 22 offices across the U.S. And in many of those offices, we have investment professionals. So boots on the ground, local market knowledge and really able to generate to get back to that sustainable level of development on an annual basis.

Got it. And then just shifting to a couple of one-off questions. Your balance sheet is in a very good position right now. I don't think you have any significant maturities until 2024. Is there anything to be done in the near term?

Absent some -- an increase in acquisition opportunities, Hong. No, you've identified our next refinance opportunity in middle of '24. I think it's fair to say that as with many of the peers in the sector, we've done a great job of reducing our coupons on our in-place debt. So we're going to hang on to those as long as we can in an environment like today. But if we can find opportunities to grow, that would be a reason for us to access the capital markets.

Great. And ESG is becoming much more of a talking point these days. And I think you published your report a few weeks ago where you highlight your workaround environment community. Are there any highlights that you'd like to touch on?

There are…

A lot of highlights.

Yes. In particular, on the E front, so we did introduce a long-term net carbon zero strategy. We have committed ourselves to that strategy. So by 2050 is what we have identified for Regency the net carbon neutral. And then in the interim target by 2030, we have now introduced an SBTi endorsed greenhouse gas emissions goal objective, which is new for Regency. We have taken a long time in the planning process and are very proud to introduce those objectives and put a pen to paper and commit ourselves to that. We will largely get there through LED light conversions in our parking lots. Again, this is Scope 1 and 2, so under our control. And then we'll also use solar energy on site for our own consumption as well as selling that into the power grid as well to achieve those objectives.

I think it's in -- but I want to just to go back, I believe that Regency has been a leader in this area for quite some time. In 2007, we hired a VP of Sustainability. I heard Mike in earlier meeting, making the comment that we're about ready to refinance our 10-year green bond. We are only the second company in the U.S. to issue a green bond, Bank of America was the first. So we were definitely the first REIT. And I'm really proud of that position. And I expect that we will continue to keep that to be a leader. And it's just ingrained in everything that we do in the culture and the DNA of the company.

Great. I think we're done with a lot of time, but is there anything we should have touched on that we didn't?

We just -- we thank you for your time. We thank all of you for your time.