Regency Centers Corporation (REG) Earnings Call Transcript & Summary

Our roundtable presentation with Regency. Today, we're joined by Mike Mas, CFO of Regency and Christy McElroy, Investor Relations. I'm Lizzy Doykan, and I work with Jeff Spector, covering the retail REIT at Bank of America. So right now, we'll pass it off for opening remarks by the Regency Team and then we can open it up to Q&A. And please feel free to jump in at any time with your questions.

Thank you, Lizzy. We appreciate that, and thank you, Jeff. You guys have done a remarkable job of hosting a really effective conference for us. We appreciate that. I am joined by Christy McElroy, our Senior Vice President of Capital Markets. And if I may, I just have a couple of minutes, just say a few words about Regency. As noted on our earnings call last month, our second quarter was one of the strongest we've had in our 60-year history, which I think is saying something. And that's the combination across all aspects of our business from leasing activity remaining very robust to we had one of our largest quarters from a development starts perspective with $175 million. And we're especially proud to have announced and have recently closed on the acquisition of Urstadt Biddle Properties. Through the first half of the year, our leasing volumes were 40% above our historical averages. That includes executing on the highest level of new shop leasing that we've had in over 10 years. So again, speaking to the demand that we are experiencing in our space. Operating trends, tenant demand for space remains strong. We do continue to benefit from the post-pandemic kind of secular tailwinds that we've all been talking about at some length. Those include suburban growth. Those include hybrid work occurring to our benefit in our shopping centers. We're seeing solid demand across all of our markets and in fact, around the country and from a broad range of tenant categories as well, just to name a few that would include grocers, off-price, medical, fitness, restaurants, pet services, I could continue. We have also had meaningful growth in our development and redevelopment pipeline, as I mentioned earlier. Over $400 million of projects currently in process. And in the second quarter alone, we started 12 projects, and I mentioned totaling $175 million of investment opportunity, highlighted by a project in Long Island in this market, we called SunVet 170,000 square foot Whole Foods anchored development that we'd be happy to discuss in more detail. Beyond those starts, our pipeline of projects grows as we confidently pursue the strategic objective to deliver more than $1 billion to starts over the next 5 years. And we think that our competitive set is positioning us to accomplish that strategic objective. We did announce the closing, as I mentioned, of Urstadt Biddle. Just to remind everyone, an all-stock transaction we closed in middle of August. We've grown Regency's footprint of high-quality grocery-anchored centers in premier suburban trade areas here in the Tri-State area. Our resulting portfolio is unequal in its combination of scale, national reach, trade area demographics, high-performing, largely grocery-anchored neighborhood shopping centers, and we're pretty proud of that. The transaction is immediately accretive to core operating earnings per share. We're calling for $0.01 per share to 2023 and about a 1.5% accretion to 2024. And for us, from a capital markets perspective, we're proud of the stock-for-stock nature of the trade, preserving our best-in-class balance sheet position in the low end of our 5 to 5.5x net debt to EBITDA range. So before we open it up to questions, we've had a great first half of the year. We are well positioned to continue the momentum. The strength of our assets, the strength of our trade areas, the activity within our development pipeline and the security of our balance sheet and our free cash flow generation, all supported by solid fundamentals in the space. So we'd be happy to take your questions.

Great. Thank you, Mike. And as Lizzy said, we want to make this as interactive as possible. So if you have questions, just raise your hand. I guess -- let's start off with retailer demand. I know we've been asking each of the companies about the retail demand. You commented on that. I think since [ ICMC ] the market investors have been really surprised by the strength of that demand. And as you -- it sounds like, again, across all categories and equal across markets, again, just asking because we get the question, any changes in that -- anything you've seen in the last couple of weeks? Any concerns as we head into the back half of '23? And is most of this now -- I guess -- sorry, let's stop there and then I'll ask the second part.

Sure. Short answers now. We've continued to have a very productive year. I went through some of the stats on a historical basis. They're pretty eye-popping. And the teams just continue to report good solid, healthy demand. I think it'd be -- when you have a record-setting quarter like we did in the second quarter, I would be hesitant to say we can replicate that level of productivity. But that doesn't mean we're not going to have success. We have about -- our pipelines give us about 6 months or so of visibility into leasing activity. And that looks good, looks healthy, again, across the region, across the -- from a tenant perspective. We're not seeing any evidence of any slowdown. We have great assets in great trade areas. And tenants looking to upgrade and move into high-quality grocery-anchored centers where we afford them the best prospects for success.

And the second part is on, I guess, the '24 leasing. One of your peers said they're mainly done with '24 leasing at this point. It's hard to validate that. But I don't know, I guess we are getting questions, of course, already on '24, I'm not asking for guidance, but visibility in '24. We all know that the leases you're getting -- the leases you're signing today, these stores, I assume are not opening to maybe...

There's a lag. And I think that's what they're speaking to is there's a lag in that.

So I guess, where do you stand at this point on like the 24 leases? Is it mostly done at this point? And you're really -- the new leases are more of a -- you're talking about 2025 openings? Or no, these are -- the leases signing today are still 2024?

We have work to do Again, I'm being short of giving '24 guidance, but I think we're set up for a healthy base rent growth set up. Again, let's put the macro aside for now, but just talking about the situation we find ourselves in. We're growing top line percent leased, and we have room to run. We want to get the portfolio to 96%. That's where we've been historically. We believe we can -- the portfolio should be able to achieve those levels going forward. That's approximately 100 basis points from where we are today.

And that small shop?

No, that's total -- 96%. So if you break that down, 98% or so anchor occupancy, 93% or so shop space, that blends to that 96 objective. However, as you know, there's a gap between percent leased and percent commenced. And is that 250 basis point SNL GAAP spread, that's where we need to commence that and deliver that space. And that's really what's going to drive near-term growth is that movement in commenced occupancy. We are doing a lot of leases today that won't have an impact until 2025. That is true. But we have a lot of shop leases that we can sign today that will have an impact on 2024 and the teams are actively engaged in that. And we're excited to continue moving that pipeline forward.

You've been outside of maybe your developments. There's very limited new construction. So how -- where do you see that small shop occupancy increasing to -- you're saying it's is 93% today...

93% is our objective. That's where we've been in the past percent leased. And you're asking can it be higher than that, I think, is what you're suggestion. We always want some churn in our portfolio at the same time. We're an active redeveloper of our properties. Some of the vacancy we have is we would call strategic and you also want to be mindful of your merchandising mix. You don't want to renew every tenant. In fact, you want to encourage some churn and some upgrading to your merchandising quality all of that leading to better foot traffic, all of that leading to a more synergistic experience for our retailers. So I still think 93% is the right -- the right eye level.

And just to confirm on the regions, again, the strength is really equally across all regions. There's not a particular regional focus?

From an operations perspective, no, we are seeing success across the board and through the portfolio. We are -- so no, on the geography. From a capital allocation perspective, we are mindful of our gap in Phoenix. We like the Phoenix market. We don't own anything currently in Phoenix. We would like to allocate some capital to that market, and we're dedicating some human capital to that effort. But we're going to do it the right way with the right assets and patiently and with some discipline. Otherwise, from a geography -- the other element I'd add to the leasing is on the tenant front, medical is a theme that has been growing in our portfolio and our leasing activity. And in the first quarter, in fact, it was our highest level of new leasing activity, which is saying something, typically, if you would ask me that question, the answer would be restaurants. We typically do more restaurant leasing than anything. Medical popped up, and that's -- I think that's emblematic of this growing theme. The wellness theme throughout our tenant roster is pervasive, and we're taking advantage of that going forward.

How would you characterize your watch list today? And especially if you could talk about Rite Aid, which that's been more so in the headlines recently. So if you could talk about your exposure there and what we can expect?

Sure. So our watch list, generally speaking, has historically hovered in the 1.5% to 2% of ABR area. That's the nature of our business. You're going to have retailers come and go, so to speak. We are closer to the bottom end of that range today than we have been historically, so closer to the 1.5% area. The highlights are the watchiest of the watch list, you would -- I would agree, is Rite Aid. We have 50 basis points of exposure to Rite Aid. That would include our recently picked up exposure to Urstadt Biddle. Next up would be [indiscernible] from a 20 basis point perspective. These aren't -- I don't think these are surprises to you, Lizzy. What we have confidence in is the quality of our locations and the quality of -- actually the quality of their productivity in our locations. So in our experience at Regency, we tend to have less exposure. We also tend to have the right exposure so that when tenants are forced to reorganize themselves, our sites are generally the winning locations within their portfolios and they continue. Or, as in the case of Rite Aid, with high-quality locations often benefiting from drive-throughs, endcaps, outparcels, pretty -- these are locations that are sought after. And we believe that the re-leasing effort will be successful for us.

And then I know -- so Kroger, Albertsons is set to sell over 400 stores to CNS, a new grocery operator and we've been gathering thoughts on what it means for your portfolio exposure to both grocers and maybe just overall thoughts on the deal?

Sure. And I'll stop short on the deal because I think these are some -- there's some headlines and some narratives out there, but we're still short of a lot of details, frankly. But as we kind of zoom out and just think about the announced potential deal, a few thoughts. One, if afforded the option between a SpinCo solution to satisfy regulatory concern and CNS -- we like that CNS option incrementally to the SpinCo option. You have a proven entity with a long track record of success in the grocery business, largely from a wholesale and back-of-house perspective, but they understand the business. They also have operated stores from a retail perspective, and they have that in their pocket as a skill, and we value that. One element of the announcement that we also like is the fact that brands seem to be tied to the locations. So you're not dealing from a consumer perspective of a change in brand, which can be very disruptive as we've seen in the past. Examples would include Safeway acquiring the Dominick's chain in the Chicago market, the Haggen experience with respect to that transaction in Southern California, we like that consistency. So on balance, I think, marginally positive for Regency. But what's most important, it all essentially boils down to our real estate. We have a lot of confidence in the locations of the Kroger and Albertsons portfolio within our assets. In combination, it's 103 locations across both brands, including Urstadt. Only 17 of those locations are located within 1 mile of one another. But when you look into the details of why you clearly see that, that overlap is not really overlap. Those markets are high density, high -- good demographics and high degrees of productivity. Those -- the overlap is an overlap. It's necessary distribution to high-density markets. So at the end of the day, we have very high-quality locations, proven grocery store locations that will be successful through the ownership.

Turning back to leasing. Can we talk a little bit about pricing power, leasing spreads, how do you feel about pricing power? And one of the questions we're getting across all retail strips and malls is still on the quality of the leases. How are you, I guess, how are you trying to take advantage of the strength in demand besides, of course, the leasing trying to get as much rent as possible.

You're going to -- number one, it starts with asset selection and just picking the right market within which to invest, picking the right trade area within that market and then being hyper selective about the asset. And when you have that, that's when you can start to build leverage, right? And Regency, our approach, I mean, this won't sound different to other landlords is we want to maximize on all fronts, and that would include merchandising. We want to make sure we have the right mix of tenants at a shopping center. Credit -- we want to make sure that we're commanding the market appropriate rent on a per square foot basis. You have to -- you want to maximize your ability to capture pass-through expenses. You want to maximize lease provisions and flexibility within those lease provision control provisions, have you? You want to maximize our control. You want to maximize your contractual embedded rent increases. And I think we do a really good job of that at Regency and the teams are exerting that control and that power where we have it to a really positive level. If we can deliver on the surface, what you see is rent spreads, and those are cash point-in-time metrics, last rent to new rent and if we can deliver upper -- mid- to upper single-digit rent spreads, we're going to meet our strategic articulated objectives, which are to grow same-property NOI in the 3% area over a sustained period of time. And that within below that kind of surface level rent spread metric, now you can get into factors such as contractual rent increases. We are benefiting from 2% in-place contractual rent increases in our portfolio today. So effectively, kind of on an annual basis writing up closer to where market growth is. So maybe a better way to think about the spread at the time of lease execution is comparing GAAP rent spreads. And in that metric, we're in the mid double digits, like the mid-teens from a GAAP rent growth perspective. And that, again, I think, is a pretty healthy indication of the power that our portfolio has. So we're pushing on all fronts. We realized the power and the quality of our real estate, and we're going to command kind of market-leading terms across the board.

One of the pushbacks we get on strips, and it's not a Regency pushback is CapEx and the amount of money, the landlords are giving to the tenants to build out space. And if we disagree with this, please counter it -- but it just -- it's even come up -- a few people have mentioned it to me at the conference, look at the gap between FFO multiples and AFFO multiples. Again, strips are in such a great position and there's this pricing power. Why is there this differential?

We agree. And we do think it's something to highlight, and we do place a lot of emphasis on the amount of CapEx and Mike talked about the cash re-leasing spreads. He talked about the impact of the contractual rent growth and the GAAP release expense, but we also provide disclosure on net effective rent as well because we do focus on that in terms of the holistic leasing economics, right? And a case in point, and our disclosure, the way we look at it is what is the net effective rent over the life of the lease, including the impact of that CapEx of that capital outlay as a percentage of your GAAP rent, again, over the life of that lease. We trend in that mid-80% range, which we think is really, really good. Case in point is -- and we've had a lot of these discussions over the last several weeks to months about re-leasing the Bed Bath boxes, right? So there's been a lot of talk. We ourselves included 20%, 25% cash re-leasing spreads on the Bed Bath boxes. But what is the true economics of that? Like what is the bottom line impact on your AFFO, which we are intently focused on. And when you do the math, we've talked about $50 to $70 per square foot capital outlays on those boxes. When you do the math on that and you think about that upward lift on your cash rent spread the embedded contractual rent growth and that capital outlay, you're getting to about a mid-70% range on a net effective over your GAAP rent percentage basis, that's right in line with where we do anchor leasing. So if you think about that on our overall portfolio, we average about mid-80%, anchor space, we're getting about mid-70%. The Bed Bath boxes are right in line with that from an economic perspective. And our shop space, we're doing better. We're doing mid-80s, upper 80%. So agree with you, intently focused on CapEx. And I think as you look at AFFO growth over the last 10 years, over the next 10 years, we will do better.

Just let's follow up on your comment that you are looking to enter Phoenix. I guess can you talk a little bit more about that why Phoenix -- and is that -- does that mean acquisitions first versus development or looking at both at the same time?

So first -- so -- it's the obvious kind of hole in our national platform. And what I mean by that is, it's a very large market, a liquid market, so there's an opportunity set there. And there is a multitude of -- we see the world in 3-mile rings, like we -- there's a multitude of 3-mile rings, like trade areas within which we think we can have success. And we think that the portfolio should have an allocation to that market for those reasons. We're not -- we're going to go in with discipline. There's a reason we haven't invested there. I doubt that we'll jump into the market from a development perspective. I think our experience has been you acquire and then over time, you build market relationships and then you build and we'll be careful. We don't -- while we aspire to invest in that market, we're going to be smart and disciplined with our incremental funds and our incremental investments going forward, and we're not going to jump into Phoenix just to put a flag on the map. So it's -- I've mentioned it before, it's an opportunity from a geography perspective for us, but we could be sitting here a year from now and having the same conversation because of our disciplined approach to asset selection.

Okay. One topic that came up this morning on one of the thematic panels, I was mentioning to Christy, we did a logistics panel, was retailers and retail boards discussing theft in the stores, and it's such a major problem. This expert was saying that some retailers have started to have less inventory, ship more often. And I was sitting there thinking that, again, the benefit of the brick and mortar is having that store experience. The store experience is having that inventory and then if -- from a retailer standpoint, if I'm there, -- and I'm seeing different things I'm probably buying more than I initially thought I would. I know you guys have very good relationship with your retailers. I don't know if this is a topic you guys are discussing or you're hearing about, but I'm just going to say that it came across as a bit of a negative, right, on brick-and-mortar and a concern. Again, this was a logistics panel, but I just thought I'd mention it.

We talk our book too.

Yes. It's fair. It's a fair observation. We read the same headlines. We've seen the same examples. Our commentary will be limited to what we see though in our portfolio. And across our portfolio, we're just not seeing evidence of that theme resulting in significant changes in foot traffic or sales productivity, we are seeing in select cases. And remember, again, our perspective is so important. We're largely suburban. But where we are -- where we are more urban or near urban, you see -- you do see changes within the store, whether that be more care around self-checkout and -- which interestingly has been, I think, part of the shrink problem is trying to figure out how to use technology and without being without it being abused, but also 2 smaller ticket items being behind glass doors, and that does impact the experience. But Jeff, it's just not -- it hasn't been a material narrative in our conversations with our tenants nor has it been a material growth line item in our expenses. We are spending on the margin, more on security appropriately. We want to ensure that we have the most inviting safe shopping experience that we can possibly offer for our end consumer and for our tenants. And I think we've been largely successful.

I will make one comment. Nor has it changed this greater appreciation for brick-and-mortar stores that we've kind of continued to see post pandemic and is a real structural positive trend for us in terms of the value of the brick-and-mortar store and the profitability of the brick-and-mortar store.

Can we talk about the latest on your development pipeline and any opportunities you might see in the near term and maybe expand on the funding strategy there, your pipeline?

Sure. Let me talk about opportunities because we're super excited about it. Christy can speak to funding. We -- I'm kind of sitting up straight because we do see this -- we think we're uniquely positioned in this marketplace at this point in time to really take advantage of dislocation. Tenant demand, we just talked about how healthy it is. And specifically from a grocery perspective, the need and desire to expand their footprints and to grow their platforms, we need some development. On the right side here or the other side, we have -- the vast majority of development in our business happens locally. And what a local developer can't do is what's in the middle, the financing of these projects. The dislocation that's occurring in the capital markets from a construction lending environment and investment perspective is more limited. Regency afforded by its financial position, complemented by our tenant relationships and our expertise in development that's where I think -- we think we can fit in really nicely and start to really drive opportunities and grow our investment pipeline over time. Development -- we're in the development business. We have been for a long time and we did $175 million of project starts last quarter over 12 projects. That's an incredibly large number that we have, and we continue to see a growth in that pipeline over time. And the hallmark of that will be our funding strategy. And I'll let Christy speak to that.

Yes. And as we think about growing that spend, that annual capital allocation from $130 million today of spend in 2023 to -- our eye level is at $250 million annually that is largely self-funded, right? So as we think about $150 million of free cash flow today on a balance sheet leverage-neutral basis, that gives us upwards of $300 million plus of total investment capacity. And so again, including the allocation of debt. And so without the need to raise equity, we can fully fund where our eye level is from a development -- redevelopment perspective. And then anything excess capacity that we have, we can put towards acquisitions, we can buy back stock, we can delever. We have a lot of options in that regard. Again, without the need to raise incremental equity and that equity decision can then be opportunistic.

And can you just provide a bit more color on where these developments are regionally? And what's sparking the developments? I know years ago, let's say, a tenant relationship like a Target would come to you and say, "Hey, we're thinking about this market or this area, what's sparking the -- I mean first, where is it happening? And then second, why those locations?

Sure. And I think -- let me start with both, I've been calling it the both end scenario, we can have limited overall development exposure in the sector of our -- of where we play in commercial real estate. And Regency can thrive in that environment as a developer because there will be a more limited, but appropriate amount of development occurring. And it depends to your point where you have Publix as a southeastern base grocer moving and migrating up into the north. You have H-E-B doing the same in Texas market kind of moving and migrating up north into Texas looking for new stores. You have Kroger and Albertsons talking collectively or individually and maybe soon to be collectively about the need for new stores to grow their footprint. Whole Foods continues to grow their footprints and we all know that they play a major role in our tenant roster. We will be there to help satisfy these winning grocers in their growing platform plans. And the evidence is supporting that. We're seeing it across our platform. We have development expertise in just about every market within which we invest in just about every office that we have opened, which is north of 22 offices at this point in time. And we're having conversations in all of them about opportunity sets. And those conversations, to your point, like I think SunVet here in Long Island is kind of the poster child of why we're excited is a local developer adds land in control. They owned it and they controlled it. And they had a Whole Foods lease near execution. And the sticking point was capital. And that's where, again, Regency can come in and with that combination. Again, because we're a developer, we understand the process because we have tenant relationships as a landlord and we have capital. We can help those deals become unstuck. We can create win-win solutions where the tenant gets the expansion they need, the developer maybe gets a little bit of equity and/or upside potential. We're happy to structure deals creatively. And we had a big track record of doing that. We can be debt. We can be equity. We can be a JV partner. We can be all -- we can be -- we can own the project. So long as these projects qualify within our strict quality standards, we can be pretty creative in helping solve an equation. And by the way, we can create value because I still -- we're developing the spreads that are north of what we're seeing in the marketplace from a cap rate perspective.

And what is that exactly?

Listen, there's very few data points to point to, but there's some, and there is an active and kind of growing percolating market, we're seeing more packages being circulated. What we think is happening is now that the banking disruption is seemingly behind us, at least from a maximum perspective. Whether it's funds coming across their 10-year horizons and maybe that tenth year was 2021, which was COVID and now they're in year 13 time to monetize and move on. Maybe it's a local owner of a shopping center who now has to refinance their secured lead and hey, maybe I don't want to absorb the higher cost of capital. Maybe I don't want to bring that equity check to the table. Maybe I'll sell my property. That activity is starting to come up. We are seeing, again, very limited data points, but we're seeing core grocery-anchored, high-quality neighborhood shopping centers in the 6% to 7% band. I'd say the bias is towards the 6% on that -- in that range. And it can depend on the growth profile and the geography and the quality of the asset. But that's generally what we're seeing on a limited number of -- we have seen lower cap rates, by the way, interestingly. And I think when you see something lower, 5 handle, unusually high growth prospects or there does seem to be a pocket of capital looking at in-place assumable to rehandle debt as an asset, and maybe that will bridge them to a better financing day of 3 to 5 years from now. We're seeing some of that capital as well.

And on the 6% to 7%, is the -- are these larger price tags. A couple of your peers have talked about discounts on larger price tags right now?

The comments I'm making are -- again, I go back to perspective, it's -- we're only looking at grocery-anchored shopping centers of high quality that would fit our parameters. That's -- my comments will be limited to what we're seeing. We're not -- we're a buyer of our strategy on an accretive basis. We're not a buyer of deals like because there is a discount.

But do you think the 6% to 7%...

Would have prior to...

I guess some are claiming that there's a few buyers out there. So they're taking advantage of opportunity. And so if they're buying at a 7% -- don't, that's not the market at this point, right? They're taking advantage of situation.

I would say the deals that we are pursuing, there are surprisingly more bidders in the temp than you would otherwise expect and it can be a pretty competitive process, for, again, a smaller format, grocery-anchored high-quality shopping center.

Thank you. With that, we are out of time, but we have 3 rapid-fire questions we've been asking each management team. They're very quick answers, Lizzy.

First question on the Fed, do you believe the Fed has done hiking, yes or no? Do you expect the Fed to cut rates in 2024, yes or no?

Maybe it's not an option? I'll go with no and no.

Do you believe real estate transactions will meaningfully pick up by the fourth quarter of 2023, the first half of '24 or the second half of '24?

I think we're seeing a right now. So I'd say -- I'll just say first half of next year.

And last, are you using AI today to help you run your business? Yes or no? Do you plan to ramp up spending on AI over the next year? Yes or no?

Yes. We are using it today. No, on the ramp-up, but the color there would be if we see a real opportunity to meaningfully decrease costs or add value, we'll do it. But there's no plans to do it just for AI's sake.

Thank you very much.

Thank you.

Thank you.

Thank you, guys. Appreciate you.