Brixmor Property Group Inc (BRX) 2018 Q4 法說會逐字稿

Greetings, and welcome to the Brixmor Property Group Fourth Quarter 2018 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Stacy Slater. Thank you. You may begin.

Thank you, operator, and thank you all for joining Brixmor's fourth quarter conference call. With me on the call today are Jim Taylor, Chief Executive Officer and President; and Angela Aman, Executive Vice President and Chief Financial Officer; as well as Mark Horgan, Executive Vice President and Chief Investment Officer; and Brian Finnegan, Executive Vice President, Leasing, who will be available for Q&A.

Before we begin, let me remind everyone that some of our comments today may contain forward-looking statements that are based on certain assumptions and are subject to inherent risks and uncertainties as described in our SEC filings, and actual future results may differ materially. We assume no obligation to update any forward-looking statements.

Also, we will refer today to differ certain non-GAAP financial measures. Further information regarding our use of these measures and reconciliations of these measures to our GAAP results are available in the earnings release and supplemental disclosure on the Investor Relations portion of our website. (Operator Instructions)

At this time, it's my pleasure to introduce Jim Taylor.

Thanks, Stacy. Good morning, and thank you for joining our 2018 fourth quarter conference call. I'm really pleased to report on how our team's accomplishments in 2018 were consistent with and even better than the plan we set forth at our Investor Day in December of '17. Through record-setting anchor leasing and compelling spreads, a value accretive reinvestment pipeline that's delivering now, growing small shop leasing, our opportunistic capital recycling of the bottom quartile of our portfolio and a strengthened balance sheet, we've set the table for accelerating NOI growth of 3% or better in 2019 and beyond.

In a few minutes, Angela will provide some additional color on the fourth quarter and, importantly, the impact of the Kmart bankruptcy that we previewed on last quarter's call. In short, the recapture of the Kmart space created 90 basis points of drag. That, coupled with prior year headwinds below the ABR line, created a tough comp for the quarter.

However, even with those drags, we delivered 190 basis points of contribution from the top line and were able to hold the full year range we had originally provided of 1% to 1.5%. But perhaps most importantly, recapturing those Kmart boxes has eliminated uncertainty for us, allowing us to advance accretive reinvestment plans that will transform those centers at very attractive returns.

For the year, we signed a sector-leading 8.5 million square feet of new and renewal leases, achieving average new and renewal rents of $15.72 at comparable spreads of 14%. Our spreads on the 4 million feet of new leases averaged 34%. Importantly, we created over $45 million of additional rent with better tenants.

Let me dig into that a bit further. First, we achieved record small shop leased occupancy of 85.7%, a number that we believe had several hundred basis points of additional growth as we continue to recapture space from weaker anchors and bring in concepts that are relevant to the communities we serve. Expect to see this follow-on growth continue this year and beyond.

Continuing our trend of growing our market share of new store openings, we signed a record 84 anchor leases for 2.5 million square feet. Incredibly, that record was achieved on a smaller portfolio. Many of these leases triggered accretive reinvestment projects and also quickly addressed boxes recaptured through bankruptcy. We signed new leases with thriving tenants like Kohl's, LA Fitness, Sprouts, ALDI, Burlington, Marshalls, At Home, Maya Cinema, El Rancho, Schnucks, 24 Hour Fitness, Ross, Total Wine, Five Below, Ulta and many others. As some of you have noted, our progress here in improving tenant quality has led to one of the lowest at-risk tenant percentages in our peer group.

Demonstrating the tenant demand to be in our older well-located centers, we now have leases in our LOIs on over 80% of the space recaptured through bankruptcy over the last few years at average spreads north of 50%. As some of you have also noted in your research, our track record of capitalizing on bankruptcies compares very favorably. It also underscores the very important point that disruption can present a great opportunity when you have attractive rent bases.

Our overall leasing production has now driven the largest gap between build and lease of 350 basis points since IPO. That represents over $46 million of signed but not yet commenced rent, setting much of our expectations for this year and beyond.

Finally and importantly, as many of you have also noted, we've remained disciplined with leasing capital and terms, keeping capital relatively flat and average term in line by leveraging tenant demand and our low in-place rents. This strong leasing productivity continued to drive our reinvestment pipeline. This year, we delivered $131 million of reinvestment at an average incremental return of 9%, creating well over $70 million of incremental value.

This quarter, we commenced an additional $54 million of projects, bringing our active pipeline to $350 million at a 9% return. And our pipeline continues to grow with over $1 billion of opportunity identified throughout our portfolio at attractive returns. We expect to deliver over $161 million of reinvestment in 2019, which is on plan with what we highlighted at our Investor Day. And importantly, our active pipeline will improve centers with over $100 million of in-place NOI, which, as I discussed on last quarter's call, highlights how our projects not only deliver very attractive incremental returns, they grow the intrinsic value of the centers impacted.

It's important to note that the projects we are gearing up for redevelopment are creating over a 100 basis point drag on occupancy, but the projects that have already delivered or are delivering now, this year, offset this investment and continuing future growth. Simply put, the continued execution of our multiyear pipeline moves us relentlessly towards our purpose of owning centers that are the center of the communities we serve.

We also capitalized on attractive market valuations and liquidity to dispose of over 60 assets this year, raising $1 billion in proceeds at an average cap rate nearly 150 basis points inside our average market implied cap rate. By executing these as one-off transactions, we not only captured an additional $50 million to $75 million over what would have been achieved in larger portfolio trades, we also unlocked over $250 million of NAV versus where our shares are trading.

We achieved that on assets that are in the bottom quartile of our portfolio with population densities and incomes that are significantly below our portfolio average. We also exited over 50 cities, allowing us to focus our capital in markets that we believe have strong underlying supply-demand fundamentals.

We also repaid approximately $800 million and refinanced nearly $3 billion of debt, reducing our debt to adjusted EBITDA to 6.2x or 6.5x if you adjust for straight-line rents and FAS 141. We now have no debt maturing until 2021. We've built an all-weather balance sheet that provides us maximum flexibility to continue our value-added plan to harvest the value intrinsic in our portfolio.

You will also note that we've reached an agreement in principle with the SEC regarding the events that we announced in February of 2016 and which led to the departures of the prior CEO, CFO and CAO. We are pleased to have reached this agreement as well as the settlement of the class actions previously announced and believe that there will be no additional proceedings relating to these matters brought against the company.

In sum, just a few weeks into this new year, we are focused and excited for what we expect the year to bring. Our retail partners continue to demonstrate demand to be in our centers. Our leasing and reinvestment efforts continue to drive additional growth in our intrinsic value. And most importantly, our team is energized and ready to deliver continued outperformance. Angela?

Thanks, Jim, and good morning. I'm pleased to report on another quarter of strong execution across our platform as we continue to position the company for long-term sustainable growth.

Fourth quarter FFO was $0.40 per share, which reflects a charge of $0.02 per share related to the SEC settlement in addition to the previously disclosed $0.06 per share of loss on debt extinguishment. Full year FFO was $1.85 per share. Excluding loss on debt extinguishment, the SEC settlement and other items that impact comparability, FFO was $2 per share versus our original guidance range of $1.95 to $2.04 per share despite having executed on nearly $1 billion of noncore and nonstrategic asset sales during 2018, far in excess of our original expectations, as we responded to strength in the private market and raised attractively priced capital to fund our accretive value-enhancing reinvestment projects, deleveraged primarily through the repayment of high-cost secured debt and repurchased our stock at attractive valuations.

Same-property base rent contributed 190 basis points to same-property NOI growth in the fourth quarter, reflecting strong leasing productivity and redevelopment execution over the last 12 to 18 months despite the headwinds experienced in the fourth quarter due to the rejection of 6 of our 11 Sears Kmart leases, which detracted 40 basis points of base rent growth and 90 basis points of NOI growth during the quarter.

As Jim discussed, while the 6 locations we took back in the fourth quarter and the additional 3 locations we expect to take back in the first quarter of 2019 will detract from growth over the course of the year, we are well underway with re-merchandising and redevelopment plans for nearly all of the space and strongly believe that this bankruptcy has unlocked substantial value creation opportunities at these assets.

In total, same-property NOI growth during the fourth quarter was negative 0.2% with strong base rent performance being offset by net recoveries and provision for doubtful accounts, which detracted 220 basis points from growth in the quarter. Net recoveries were negatively impacted on a year-over-year basis by significant positive real estate tax refund and appeal activity in the fourth quarter of 2017.

While provision for doubtful accounts or bad debt expense was impacted in the current quarter by the Sears Kmart bankruptcy, we also recognized an unusually low level of bad debt expense in the prior period, only 40 basis points of total revenues versus our historical run rate of 75 to 100 basis points. You may recall that difficult year-over-year comparisons in bad debt were the primary reasons that our original same-property NOI guidance for 2018 included a 50 basis point detraction related to bad debt, which is in line with where we ended on a full year basis, with the most difficult comparisons in the second half of the year.

These items and their disproportionate impact on our fourth quarter growth rate underscore the inherent volatility in same-property NOI growth metrics and serve as an important reminder of why it's critical to have a somewhat longer-term view as it relates to the performance of a long-term business.

Same-property NOI growth for 2018 was 1.1%, within our original range of 1% to 1.5% with base rent contributing 210 basis points, above the midpoint of our original guidance range of 175 to 225 basis points. The Sears Kmart bankruptcy acted as a 20 basis point drag on full year NOI growth, and absent that event, same-property NOI growth would have been in the upper half of the original range.

Turning to 2019, as Jim highlighted, the coming year will be an opportunity for the investment community to see accelerating results from the work that has been done over the last 3 years to create a platform positioned to take full advantage of the opportunity embedded in this portfolio. Our same-property NOI growth guidance for 2019 remains 3% at the midpoint of the range, with a growing contribution from recently completed repositioning and redevelopment work across the portfolio more than offsetting additional drag in the future redevelopment pipeline that's being incurred as a result of the timing of recent bankruptcy activity.

Our FFO guidance for 2019 is $1.86 to $1.94 per share. In addition to the previously disclosed impacts of the continued deceleration in noncash GAAP rental adjustment and the lease accounting change, this range also reflects the strength in same-property NOI growth as well as the impact of significant back-end weighted disposition activity in 2018.

The range also includes the potential impact of future capital recycling activity. We expect that disposition volume will be lower, and the use of proceeds from such activity will be more balanced as we head into 2019. The substantial improvements we made with respect to solidifying our balance sheet last year put us in a position to focus capital allocation on our reinvestment pipeline, stock repurchases and/or acquisition activity in the coming year.

As it relates to same-property NOI and earnings trajectory, please note that as a result of the Sears Kmart bankruptcy, build occupancy is expected to trough in the first half of the year following the additional rejections expected in the first quarter before reaccelerating in the second half as redevelopment completions also accelerate.

We expect the contribution from base rent and the detraction our contribution from net recoveries to follow the occupancy trajectory throughout the year. I would also note that our most challenging bad debt comparison will occur in the second quarter of 2019 as we recognize significant cash payment of amounts previously reserved due to bankruptcy activity in the second quarter of 2018.

In summary, we entered 2019 well positioned to execute on the business plan we laid out for you at our Investor Day over a year ago. We believe the coming year will demonstrate the growth potential of our asset base, the internal capabilities we have developed with respect to redevelopment execution, the capital allocation philosophy with which we manage investment activity and the strength and stability of our balance sheet.

With that, I'll turn the call over to the operator for Q&A.

(Operator Instructions) Our first question comes from the line of Todd Thomas with KeyBanc Capital Markets.

Last quarter, you mentioned that Sears and some other activity would impact '19 but suggested that it could set up the company for better growth in 2020 and you have a little more clarity around Sears. You're a few months into lease negotiations for some replacement tenants. So maybe for Brian, can you talk about the mark-to-market expectation a little bit on some of the backfills for the Kmart specifically and the general time line for commencements to begin? Then Jim, can you touch on early thoughts on how this activity might impact 2020 in light of your comments last quarter?

Sure. Go ahead, Brian.

Yes, I'll take the first part. As Jim mentioned, we're pleased with the progress that we've made on Kmart so far. We've got roughly 80% of the GLA committed, meaning executed lease, at lease or final LOI with a range of uses, many of the tenants that Jim mentioned in his opening remarks. This quarter, we announced a deal with Kohl's at our box in London, Kentucky, which we expect to announce other national tenants later this year, and we'll start opening those spaces towards the end of the year. That comes on the heels of the box that we announced in Greeneville, Kentucky with Marshalls, Hobby Lobby and Five Below. So we've been excited by the demand. We're not surprised by it. The team's continuously demonstrated the ability to get ahead of these bankruptcies so that we're in a position to quickly address when we get them back and expect to see us continue to announce tenants throughout the year. From a rent perspective, we're just over 2x the rents in place on the Kmart boxes, incremental returns in line with what we've been seeing historically on our Kmart spaces. And we're excited about the opportunity because we still have boxes in places like Miami, in Metro Philadelphia and Cincinnati that we expect that to be bringing online here towards the back half of '19 and into '20.

Yes. And Scott -- or Todd, excuse me, I will just add that the activity does set us up well for 2020 and beyond. And importantly, it eliminates a lot of uncertainty. At this point, we only have 2 boxes remaining with Kmart, one of which we've negotiated the elimination of options in Hamilton, New Jersey. We already have a lot of interest in that box. So what we've been working on over the last 2 years, what you've implicitly suggested, has been setting up the ability to drive value in these Kmart boxes. And not only, importantly, are we getting great returns on the boxes, we're also opening up pad opportunities as we get into these 40-year-old leases and importantly, improving the balance of the center by bringing in uses that are relevant to the communities they serve. So as we talked about last quarter, the timing of the actual bankruptcy was a little bit sooner than what we thought, but we've been working for the last 1.5 years to set ourselves up to capitalize on what we think is a great intrinsic growth opportunity in addition to a lot of other opportunities throughout the portfolio.

All right, that's helpful. And then Angela, in terms of the 3% midpoint for same-store NOI growth in '19, which is consistent with what you had said last quarter, how much additional reserve is there for additional or incremental speculative fallout? And how much visibility or insight do you feel you have about potential future bankruptcies and move-outs at this point in the year?

I would first state, we expect continued disruption, right? And I think that's reflected. Angela?

Yes, I would just add to that. It's always tricky to pinpoint a number because of the variety of ways we budget for additional retailer distress or disruption. So from a bad debt perspective, we consistently model and guide to about 75 to 100 basis points of total revenues as a bad debt reserve. We came in at the lower end of that range this year, again despite significant bankruptcy activity during the course of 2018. So we feel like we're well covered from a bad debt perspective. From a top line perspective, we budgeted -- as we do a zero-based budget for every space in the portfolio, we're taking a thoughtful look at each space and the spaces we may get back because of retailer distress or disruption, and then there's an additional kind of portfolio reserve employed on top of that. So it's a very thoughtful process, I think, in terms of deriving the 3% midpoint and the overall same-property NOI range. But to Jim's point, I think we feel very comfortable that we have, within that range, incorporated our expectations for additional retailer distress or disruption.

Our next question comes from the line of Jeremy Metz with BMO Capital Markets.

Jim, you guys stopped disclosing the impact of redevelopments on your same-store NOI. I don't think it had a huge impact on 2018 at the end of the day. But you've obviously talked money in recent quarters and even in your opening remarks about the increasing redevelopment activity. You have a few hundred million delivering here in the next 12 months or so. So can you talk about that decision and then maybe help us -- help quantify what sort of impact it's actually expected to have on your 3% same-store expectations for the year?

Would love to. As you think about our business plan and the opportunities that are intrinsic in our portfolio, it really runs the gamut, Jeremy, from pad opportunities to end cap repositions to anchor repositions to façade renovations to larger redevelopments. And importantly, we provide you detail on the significant anchor repositionings, all the outparcels and the redevelopments. It seems to be -- us to be a bit of a distinction without a difference, given the breadth of reinvestment opportunity that we have in the portfolio. It kind of forces weird decisions about timing as to when things are rolling in and out. So we thought it was better to basically show you our aggregate capital that's going into the portfolio, where it is, what the timing is and what that overall impact is. So that's really it. It's really just how we think about the business. And the other thing I would highlight for you is it's a very clean overall NOI number because it includes basically the entire portfolio, which I think is important. But as we stepped back again and just thought about this, it's really opportunity that's intrinsic in the real estate itself. We're not creating large mixed-use projects. We're not taking centers down completely. We're not changing drastically their use. This is sort of core business stuff. It's granular. I love it because it's lower risk, it's higher return. And I also like that it's really spread across the portfolio. One thing I'm particularly excited about is that we see the ability to impact nearly half of the assets we have through accretive reinvestments, everything from a pad to, again, an endcap, an anchor repo or a larger façade redevelopment type project. So we're showing you that we're making money on the capital that we're putting to work. And importantly, I think we're also creating a lot of value on the balance of the center that are -- that's being impacted here. But again, it's core to our business. And it seemed to us that, that particular disclosure was somewhat limited. Angela?

Yes. No, I would just -- I would agree with that. I would point out that, that disclosure was really a legacy disclosure that we had inherited and didn't really match up with the way that you've heard Jim and I and Brian and Mark talk about the business over time. If you think back to Investor Day last year, we talked about not just redev, what was recently completed and currently in process, which is what that disclosure was, but we also talked about the other part of the life cycle of redevelopment, which was the future pipeline and everything that we're teeing up, vacancy we're incurring in order to prepare for the next wave of redevelopment. None of the future pipeline was shown in that disclosure before. So I think, as we think about and manage the business and try to communicate externally, that disclosure really didn't tie to the way we think about it, to the point that Jim made as well. And as a reminder, we've always guided to the total number including redevelopment. That's what you've always seen the more detailed same-property disclosure from us in the supplemental around -- and to the point Jim made, if you look at the reconciliation in the glossary of our supplemental, you'll see there are very few exclusions from our same-property pool. It's effectively nearly 100% of the portfolio we show you in that number.

Yes. No, I think that's all fair. I mean, from a broad level, it just sounds like that it is going to continue to play a bigger role here near term in kind of driving that accelerating growth you highlighted in your opening comments. That's a fair statement.

It absolutely is. It's part of what excited us when we came on board the company was how broad based the opportunity is. But again, it's a wide gamut. It's not all extensive.

Appreciate that. And second for me, just in terms of the asset sales, you obviously sold more in 2018 than you had initially expected, so obviously expecting less here in 2019. Wondering if you can maybe comment on how much you currently have on the market today, how much is under contract. And then if pricing firms up even more, could we see you accelerate some sales to further clean out that bottom tier in single-asset markets and perhaps just warehouse some of that capital for future redevelopment.

We always reserve the right to be opportunistic. It's part of why we don't provide pinpoint guidance on things like transactional activity. So we did provide a range of what we think the impact will be from the capital recycling. In terms of where we expect to be for the year, it will be less than where we were in 2018. And I think the important point to note is that we're opportunistic in take advantage of the liquidity that we found for these assets. And the second thing I'd note is that we dealt with a lot of the bottom of the portfolio, and that's really important. So as we look forward, we have a few more assets that we're going to be sellers of, but we've dealt with many of the ones that just weren't consistent with our long-term plan. And all of that hard work, it was what I was trying to allude to in my prepared remarks, had set us up in '19 and '20 and beyond to be more balanced. And the other comment I'd make is I think that any good long-term business plan has some degree of capital recycling. So because of all the work that we've done in '18, it sets us up to be balanced in '19, balanced in '20 and so forth. As it relates to some of the remaining single-asset markets, please understand that some of those will be growth markets for us. And I'm very pleased that we've exited as many of the cities as we have because it has greatly simplified the portfolio and, frankly, sharpened the focus of the team on the execution of the value-added strategy and opportunity that we have.

Our next question comes from the line of Craig Schmidt with Bank of America.

Your combined leasing spreads remain double-digit, but when you look at the trends, they tightened over the course of 2018. I wonder what was driving this trend and what you're expecting from leasing spreads in 2019.

Part of that was really driven by mix in the latter part of the year. We executed some shorter-term renewals to facilitate redevelopment, which had some drag on that new and renewal spread for the quarter. But we do expect our spreads for new and renewal leases to be in that mid-teen range going forward. I would point you to, importantly, what we've been doing on the new lease spreads, which, for the year, averaged 34%, and also some of Brian's commentary in terms of the embedded mark-to-market, for example, that we see in the Kmart boxes. So we're still seeing that opportunity. One of the other things that I'm excited about is we're also driving acceleration in the small shops, right? And that's really important. You're beginning to see it this quarter and you're going to see it for the balance. And the reason I highlight that is that we're capitalizing on what we're doing with these larger boxes and anchors as follow-through throughout the portfolio. And frankly, we're setting new records as it relates to small shop rents. So I expect that combined spread for next year to be pretty consistent with what it's been over the last couple of years, and I'm excited about how we're leveraging our improving centers.

Great. And then second, I would just say, how active are the grocers in pursuing buy online and pick up in stores? And what is the longer-term impact for cross-shopping with that increase?

Craig, this is Brian. They're very active and we had been very encouraging of our grocery partners to add this. It's a very low investment for us, almost none. We give a couple of parking spaces, and it creates several more trips and engagement with the consumer. And obviously, more traffic to the center means more sales for the rest of our tenant partner -- our retail partners. We have click -- progress click lists at roughly half our locations. We've been doing this with H-E-B. We're working with Stop and Shop. So across the spectrum, we're working with our traditional retail grocers to add this where we can. We're doing it with Walmart as well. So we're going to continue to do this as much as possible.

Okay. And just the people I noticed that are using this service really seem to be focused on saving time, that they're actually willing to pay a little more money to have somebody walk up and down the aisles of the grocer to have a (inaudible). Is that also going to limit their willingness to cross-shop?

It might allow them to work out at Orangetheory or have a cup of coffee at Panera. And I actually love that the grocers are focused on their -- that strong grocers are focused on the customer and the customer experience. And early on in these discussions, to Brian's point, we jumped all over this program of adding these pickup lanes to our centers. What's actually interesting is that there is, oftentimes, shopping within the store that occurs with the pickup of groceries. And I do also think that the interaction between the grocer and the customer is improved by that level of service, so particularly, when you look at how some of the better grocers are executing upon it. So we think it's a net positive. And the last thing I'd say on this is that I think strong retailers are going to continue to evolve, adjust their formats, importantly, have capital to do that. And we want to be supportive of them, and we want to have shopping centers that give them the flexibility to do that, which we're demonstrating effectively now as we are dividing boxes, adding space, doing other things to try to make sure that we're getting tenants like our recent downsize of Burlington or our recent downsize of Kohl's to the format that they want to be in, the format that they're going to thrive in. And what's fun is that we're doing it off of pretty low rents, so we're able to do it and make money in the process. So a little bit broader than your question, but the point I'm trying to make is that I think retail is going to continue to evolve. And the important thing as a landlord is that you have the flexibility and, importantly, the rent basis to meet the needs of your tenants. And if you look at the market share that we're capturing at the new store openings, I think it shows you that we're really doing a very good job on that. So I'm excited about the change. I don't really see it as a threat. I think you've got to be clear-eyed about what its implications are. And certainly, in some instances, it's informing our capital recycling decisions, right? It's part of why that will always be part of our plan. But again, I'm kind of excited for what these changes are bringing.

Our next question comes from the line of Greg McGinniss with Scotiabank.

Angela, there was a lot of work done this year extending debt term, bringing down the London interest rate, but I'm curious if there's any ability or desire to proactively address total debt to EBITDA leverage in 2019.

Yes. I think, Greg, to your point, we did make a tremendous amount of progress on the balance sheet this year, not just in terms of working down that debt to EBITDA number but, like you said, extending duration, putting us in a position where we have no debt maturities at this point until 2021, expanding the flexibility of the balance sheet. Repaying all that secured debt has created a tremendous amount of operational and financial flexibility across the capital stack. So we're really pleased with the progress we made in 2018. I do think we're sitting at a point in time now where, while we remain committed to getting down to that 6x number, a lot of the additional progress you're going to see is going to come from EBITDA growth. And all of Jim's earlier comments about the benefits of all the work we've done over the last couple of years in terms of repositioning and redevelopment work really coming to fruition is going to be a significant driver of how we make additional progress on that leverage metric from this point going forward.

And so the second question. With the signed versus build occupancy gap of 350 bps, how much does that translate to on an NOI basis? And what's the expectation on closing that gap?

Well, again, we have over $46 million of rent that's been signed and not yet commenced. And that rent is going to be commencing over the next 6 to 8 quarters. And it is a clear driver of what we see our NOI growth to be for this year and next year. Timing this year is going to be critical. I mentioned it on last call. But because of the deals that we've signed up, every day of rent commencement is worth about a couple hundred thousand dollars for us on average. So it's a good problem to have. And I'm glad, at this point, that we're able to drive the demand and the leasing activity for the spaces that we're taking back, the spaces that we're recapturing proactively or, in the case of Kmart, dealing with the timing issue of that bankruptcy being sooner than we expected, which certainly helped contribute to that gap between build and lease. And as Angela said, our build number is likely going to continue to drag a little bit in the first part of the year as we take back those Kmart boxes. But again, when you dig into the leases that we're signing, the redevelopments that they're setting up, it's really a big component of the visibility that we have on our growth. There's not a lot of speculative assumptions as it relates to where NOI is coming from. We know it. The leases are signed. We have rent commencement dates scheduled, as I mentioned, over the next 6 to 8 quarters. And so for us from an execution standpoint, the real focus is going to be on timing.

Our next question comes from the line of Samir Khanal with Evercore ISI.

I guess, getting back to that 350 basis points [Y] in leased versus occupied, what is the -- I know that's going to narrow, but what is kind of the normalized spread going forward? I mean, is it 250 -- yes?

Yes. I would say historically, it's been probably between 150 and 200 basis points. So you should see, over time, significant compression in that number.

Okay. And then Brian, I guess, for you, just taking a step back. Can you generally talk about where your watch list is today versus this time last year, maybe excluding Sears and Kmart? So where does that watch list stand today?

It's definitely smaller. Obviously, those were 2 names that we had been watching for a while. There are still some uses and tenants out there that we're keeping a closer eye on. But the magnitude of last year's bankruptcies are certainly smaller as we look into this year.

Okay. And so as part of your watch list, I mean, do you have any concerns of sort of the traditional grocers going forward? I mean, what is kind of your thought on that segment?

Yes. Let me take that initially. The concern or the focus on grocers is always on occupancy costs. And you look at that per square foot sales productivity relative to your rents. And as we've said many times, we're benefited by average occupancy costs that are well below 2%. So even in the instance of a grocer that may not continue, it gives you a lot of optionality in terms of backfilling that space with another grocer or, quite frankly, with another use.

Yes. And it's interesting, this quarter, we announced Hearthstone Corners in Houston. We backfilled with an El Rancho for a traditional grocer that hadn't put a lot of capital into that store in some time. They're coming in. They are much more relevant to the community. They're probably going to do 30% to 50% more in volume. It's allowed us to really advance our follow-on leasing at the center. So as we look out, and Jim mentioned capital recycling earlier, we're looking at areas where our grocers are not investing and where they are and making sure that we're focused on -- that our anchors continue to invest in their locations.

I guess, as a follow-up, Jim, are you seeing any sort of cap rate expansion on some of these grocery anchor centers kind of in these secondary markets especially when buyers are becoming a little bit concerned on kind of traditional grocers?

Our cap rates have held pretty firm for what we've actually transacted on. Mark, I don't know if you're on. Do you want to take that?

Yes, I think you hit the nail on the head, Jim. When we looked at our assets that we traded on a year-over-year basis, so like for like, so similar assets in our markets, we actually saw pretty stable cap rates. So we haven't really seen a big impact on the cap rate movement from that factor.

Our next question comes from the line of Christy McElroy with Citi.

Angela, sorry if I missed this, do you have an assumption in your guidance for unsecured debt issuance in 2019 later this year? And maybe you can talk about sort of any indications of pricing today. And then what do you plan to do with the swaps that burn off in March?

Yes. Thanks, Christy. I would say, if you look at the guidance walkdown we provided, we do have a $0.10 -- or excuse me, a $0.03 range between $0.07 and $0.10 on a line that includes the impact of leverage reduction last year, the share repurchase activity from last year and then all other items. So it would be embedded within that $0.03 range. What I would say as just a reminder, and I mentioned this in response to Greg's question earlier, but we don't have any debt maturities at this point until 2021, so we've really put ourselves in a position where no additional unsecured issuance is necessary. But obviously, we've embedded within the range the ability to do something should it be opportunistic to do so and continue to advance our goals of extending term and weighted average duration across the balance sheet. In terms of the swaps, as you mentioned, we have $400 million of swaps burning off in March. We would look to -- we'll evaluate the market as those burn off and determine what the optimal outcome is for those. And that sort of plays into the first question you had about do we term out some of that floating rate debt to begin with. So any expectations with respect to both the unsecured debt issuance and the swaps would be embedded within that $0.03 range in that other line in the walkdown.

Okay. And then just in terms of the recaptured Kmarts in Q4 and Q1, how much capital would you expect to sort of go into those boxes in terms of re-tenanting? And would that be considered sort of the normal leasing CapEx bucket or would that be the redevelopment bucket? And then just longer term, as you think about sort of the $350 million active pipeline but just in terms of the $1 billion of opportunities going forward that you talked about, would you expect that pipeline to continue to be self-funded with free cash flow?

Yes. I mean, as we look out, I think this year, we're probably running somewhere around $75 million of free cash flow after we fund the dividend, which gives us a great base from which to continue to invest in value-accretive reinvestment activity across the portfolio. The remainder of what we need to fund that activity will come from primarily disposition activity. But we view that, as Jim said earlier, capital recycling is a fundamental part of the business. You would see us do some of that activity no matter what, really in any given year, to continue to reinvest in the portfolio and generate growth from that point forward.

And then, Christy, in terms of the Kmarts, I mean, we've been seeing those, on average, around, call it, $80 to $90 a foot, inclusive of the demising split, when we're putting new façades on, working with loading docks and the tenant TIs that are a part of that. And that's been very consistent throughout markets. And I think I mentioned it on the last call, one of the benefits to the platform and continuing to grow share with a lot of the retailers that Jim mentioned is the team is getting pretty good at being able to deliver to prototype in what is an irregular box. And it's not the typical ground-up scenario. We've done a number of these, so we've been able to keep some cost efficiencies in line in working with our retail partners on the operations side.

And again, yes, I think the numbers that Brian quotes are numbers where we are going to split the box. We've had a few executions where we haven't split the box, but that's a pretty good estimate, that $80 -- $70 to 80, $90 a foot, generally speaking, to demise the box. And then, where it sits within the pipeline just depends on what we're doing outside of the box. Are we adding pads? Are we changing the balances of the façade? Are we adding space? That then tends to move it into one bucket or the other.

Our next question comes from the line of Jeff Donnelly with Wells Fargo.

Maybe just a first question for Angela. I'm just curious, compared to prior years, can you talk about some of the assumptions in the 2019 budget that you're making on things like tenant renewal rates, particularly around the at-risk tenants when their leases mature this year and maybe perhaps the length of downtime you're assuming between leases because I know that bad debt expense doesn't effectively capture all the assumptions that you're making in -- around revenue recognition.

Yes. So to my comment earlier about kind of how we budget, what the process really is, the only line item, I would say, in our budget process that's more sort of a portfolio metric is really that bad debt expense, to your point. And that will capture some of the retailer distress or disruption you have, but it's also embedded in the ABR line to your question, Jeff. Our budget process is a very granular space-by-space budget process, so we are making very specific assumptions for each tenant in the portfolio, not just for the watch list tenants but across the board based on feedback we're getting from tenants about their sales and their productivity in those locations as well. So that certainly is sort of how we budget and inform the process. And like I mentioned earlier, we then take a portfolio look and sort of right-size those. I would say across the board, renewals probably look, excluding redevelopment assets where we might not be renewing people because we're completing something bigger or more holistic at the asset, I would say that retention rates look pretty similar to previous years. But again, sort of underlying that is specific lease-by-lease assumptions for every tenant in the portfolio.

Understood. And then, I'm just curious, the value-enhancing projects that were added to the pipeline this quarter, I think you guys said were coming in at around an 8% yield. Is that indicative of where the -- you expect the yield to be on your Kmart boxes, where they'll ultimately pencil out? And maybe a second part is that yield is a bit below the 9% to 14% range for the overall value-enhancing pipeline? Is that just a mix issue or is that maybe reflective of a broader trend in rents or capital costs?

It's absolutely a mix issue. And as we look at those Kmart returns, they can be in the low teens. We've had a couple in the high single digits. It's kind of across the board. And it, again, Jeff, depends on how much value we're able to harvest by recapturing that 40-year-old lease and then, frankly, are we a longer-term holder of the asset or will we drive more value and a better IRR simply by backfilling the box and finding liquidity for the center in the markets. But we are seeing continued strong demand from our core tenants for the spaces that we're recapturing, I think that's most importantly. We are also seeing increases in costs, construction costs, in particular, which are having a bit of a drag in terms of returns. But it's -- you're going from an 11% to a 10% or a 9% to an 8%, 12% to 11%, that type of thing. It's not rendering the decision to move forward with the value-added investment no longer viable.

Our next question comes from the line of Ki Bin Kim with SunTrust Robinson Humphrey.

So curious about one thing. If I look at the TI per square foot, it's been pretty steady for the past couple of years. But if I look at the maintenance CapEx, it's actually grown over the past 2 years, even though the portfolio size has shrunken. So just curious about what's causing that.

Well, one thing to highlight is you're including, I think, in that the leasing capital, which reflects the fact that even on a smaller portfolio, we've leased more space, right? So our productivity continues to be strong. So you need to look at it, as we also show you in the disclosure, on that net effective basis. We are spending more in recurring maintenance capital per foot. We were, I think, around $0.55 or $0.60 a foot, reflecting our effort to bring these assets up to our proudly owned and operated by standard. I would expect that rate of spend to begin to moderate as we get through more of the portfolio and address some of the items in deferred maintenance. But importantly, that investment that we're making is driving momentum in small shop and it's also driving some of our rents. So we think it's the right thing to do from a stewardship perspective. And again, I can't emphasize this enough, capital allocation is something that we take very seriously. And if we see an asset that requires more capital than is warranted by the rents and the growth in rents that we can get, we sell it. And that drove a huge amount of the decision in 2018. As we move forward, again, our mission as a company is to own the center of the community we serve. We want it to be relevant. We want it to be local. We want it to thrive. And to do that, we need to make sure that we're operating them to a certain standard. So some of the pickup in the recurring capital you're seeing there, but again, I think it's being more than paid for by the rents.

Okay. And in your lease negotiations with tenants, has there been any notable change in the level of expense pass-throughs that you're able to push onto tenants?

No, Ki Bin, and actually, it's come from our side really is we've gone to tenants and talked to them about the increased investments that we're making in our centers and talk to them about what we're going to do. We're seeing receptiveness on their side to contribute to those investments. So it has come up in our negotiations, but we're proactively doing it because we want to make sure, particularly where we're making investments in some centers that have needed it, that we're getting reimbursed for those investments.

And as a result of those efforts Brian's referring to, you will see our recovery percentages continue to improve. And that, I think, is an area -- it's an opportunity for us going forward.

Our next question comes from the line of Wes Golladay with RBC Capital Markets.

Looking at the value-enhancing projects for 2019, what are you budgeting for capital expenditures? And do you plan to start any of the major developments that are on the shadow pipeline?

Yes. I think in terms of capital expenditures, as Jim said, in 2019, I would expect that maintenance CapEx runs probably somewhere in the $0.45 to $0.50 a square foot area. Leasing capital, as you know, will be entirely dependent on productivity. But given, as we talked about, the strong tenant demand we're seeing for a lot of the bankruptcy space, we're still in the process for addressing it. It could certainly be a high-productivity year from a leasing standpoint. The value-enhancing bucket, we've continued to talk about ramping that bucket of capital spend, the $150 million to $200 million range. We were about $170 million in 2018 in total. I think you could be at the higher end of that range if not a touch above as we head into 2019, based on the acceleration of some of the Kmart projects that had potentially already been scheduled for late 2019 or into 2020, but we'll be spending that capital a little earlier in the process.

And importantly, we expect to deliver over $150 million this year. So we're not asking you to wait, we're getting these projects done. We're delivering them on time, on budget, on return.

Yes. In the shadow pipeline, 2 projects, in particular, had a residential component potential there. Is there any updates to that? And could more properties have residential components?

We've identified over 50 assets that, based on market in-place rents, might make sense to support residential or senior assisted living or some other complementary uses across the portfolio. But as I've said on the last couple of calls, really into 2019, we're focused on the lower hanging fruit, and we're working very hard to set up some of that additional value extraction that we think presents itself in markets like Miami and Southern and Northern California and throughout the Northeast. But not a lot this year, so don't expect us to talk much about it other than to say we're setting it up and it's coming.

Our next question comes from the line of Derek Johnston with Deutsche Bank.

This is Shivani on for Derek Johnston. Just on the private market side, we heard some commentary from -- that there's a greater demand for larger pools than this time last year. You guys had mentioned that there were north of 60 individual disposition transactions last year. So just curious if you could sort of comment on demand across transaction sizes and what you're sort of targeting into 2019.

Mark?

Well, sure. Yes, I think you certainly are starting to see some larger deals get done. However, I do think, as we've looked at that market last year and going into next year, the most critical factor continues to be size, and I think that's pretty consistent across the markets. There are really just a wide range of buyers for assets in that $30 million to $40 million area and below. It's driven by the private REITs, certain traditional funds, the high net worth buyers, and there's been a growing private equity bid for power centers. In part, it's driven by the attractive financing environment, given where we're seeing the tenure. But really, when you start to get above that level, I do think you see a drop in buyer demand and I think you see some more price sensitivity. So we have seen some big assets going to market that haven't traded, and I think that may be where we'll see some pricing movement and some opportunity, even in some of the core primary markets. And as we continue to capital recycle, I think that's a pretty important opportunity for us to take advantage of.

And then, Brian, if you could just give us an update on sort of leasing sentiment, what you've seen so far in 2019 versus last year. And maybe just remind us of the Payless exposure that's in the portfolio right now.

Yes, sure. I'll take the first part first. In terms of demand, we've continued to see strong open-to-buys from the retailers in categories that have been thriving in our space for some time. Jim mentioned our anchor activity last year was a record on a much smaller portfolio, and those retailers continue to have strong open-to-buys for '19 and '20, whether that's in the value apparel, best-in-class fitness, specialty grocery, health and wellness or home categories. And then in terms of Payless, we've been monitoring the situation there. There's obviously nothing that's been announced, so we don't have visibility if there will be some type of event or if we will get any spaces back. What I would point to is the progress that we've made on the Payless spaces that we have taken back, which we've addressed roughly 70% of those through either lease executions or as part of a redevelopment or outparcel development. The ones that we've executed, we've had spreads of over 30% recently with tenants such as Club Pilates and America's Best, uses that are really driving that small shop growth that Jim mentioned earlier. And the spaces that are part of redevelopments and outparcels, we expect to drive considerable value out of those. So as we look at what we've done with Payless, the momentum that we have in small shops and the depth and breadth of demand that we see in the small shop space, we're pretty confident that, should we get some of these spaces back, we'll be able to put better uses in at higher rents.

Yes, the total exposure, Shivani, is about 20 basis points of GLA or 30 basis points of ABR for all of the locations.

Our next question comes from the line of Hong Zhang with JPMorgan.

I was wondering under what circumstances would you return to being, I guess, the significant net sellers that you were in 2018? And is it relates to the volume of capital recycling, in your 2017 budget, you laid out a target of $400 million to $600 million of annual capital recycling. Do you expect to be within that range this year or under that?

Thank you for the question. I think it's probably going to be close to that range. Again, we're not going to provide specific guidance, but we are reverting to a more normalized level, which we see as 3% to 5% of the portfolio. And what drives us to sell more, honestly, having done the hard work last year is going to be the opportunities that we see on the other side, what types of acquisitions, additional reinvestment activity, share repurchases, et cetera. So we're real pleased to be in the position that we're in now because it allows us to be opportunistic. And frankly, as cap rates move up and down, because we're more balanced, we can capitalize on that on the other side.

Our next question comes from the line of Vince Tibone with Green Street Advisors.

Can you provide an update on the former Toys"R"Us spaces? Just curious how backfill demand and net effective rents have trended against your original expectations.

Sure. This is Brian. So of the 10 we took back, 8 are committed, meaning either leases executed or at lease final LOI. We announced another one this quarter in Ann Arbor, Michigan with a regional furniture operator at a 54% rent spread. We had said on prior calls that we thought our rent growth expectation on these would be between 20% to 30%. We're trending towards the higher end of that range. And the range of uses is what I alluded to earlier in the call. We still are seeing demand from best-in-class fitness, home, family, entertainment, value apparel, very similar to who we've been talking about when we're splitting some of the Kmart boxes. So been pleased with the demand, and like Kmart, expect us to continue to announce lease signings as we progress throughout the year.

That's really helpful. One last one for me. Just the anchor build occupancy declined by about 170 basis points compared to the third quarter. Just wondering, besides the 6 Kmarts, what other closures contributed to this decline?

Sure, we did have the bankruptcy impact that came in from Fallas that happened in the fourth quarter, which -- we took those spaces back towards the end of the year. We also had some proactive downsizes that we did, one, on a development that we had outside of Philadelphia, where we're downsizing a Burlington for Sprouts; another, where we're downsizing a Kohl's as part of our development in Speedway in the outside of Indianapolis, Indiana; and one in a project in Naperville, Illinois where we're working with a fitness operator that we're close to finalizing something with. So that was -- that's really what drove it in addition to the Kmart bankruptcies.

That's helpful. And for the Fallas, is that a big issue? Or just is there any way you can quantify? Was it just, what, a few locations? Or how big an impact was that bankruptcy?

Yes. We had, I want to say it was close to 10 locations that we've had with Fallas overall. It wasn't a big issue to say, plus we have demand for those boxes. We're already at lease on a handful of the spaces, so it was someone, again, that was on our watch list, so we had been marketing a number of these spaces. Expect some of them to start coming online this year and many of them paying rent in 2020.

Our next question comes from the line of Linda Tsai with Barclays.

Just a follow-up on tenant fallout. Angela, you noted that 75 to 100 bps was budgeted for unknown tenant fallout in 2018, and that came in at the low end. That said, NOI growth for 2018 came in a little bit below the midpoint at 1.1% versus 1.25%. Why was that?

Yes. So the 75 to 100 basis points isn't really for unknown tenant fallout. That's for bad debt expense, that provision for doubtful accounts line that you see in the same-property NOI reconciliation. That takes into account things like bankruptcy activity or fallout for outstanding AR balances but also other AR across the portfolio. Stepping back, I think, in terms of where we -- how we had originally budgeted tenant fallout versus what materialized during the year, I think we were even clear back at Investor Day that something like the Sears Kmart situation and the impact that could have to us was not fully contemplated in the range. And so I think what you really saw was a big impact in the fourth quarter like we talked about, 90 basis points related to Sears Kmart hitting the fourth quarter, but we more than offset that with strong leasing productivity over the course of the year and execution on redevelopments that really helped make sure that we stayed comfortably within that original range we had given.

So tenant fallout or -- well, the 75 to 100 bps for that category came in at the low end, but then...

But then you had other things offsetting it in the ABR line.

Okay. And then I read back -- a while back that Kohl's was going to provide space to all the tentative locations. Have you seen any of these openers that's going to occur at any of your properties?

Linda, this is Brian. It's not occurring at any of our properties, but I think it speaks to their view to drive to get into the best footprint that they can. As I just mentioned in a prior question, we're doing that. We're doing it. We just announced another one with Burlington where we've downsized and we're bringing another specialty grocer in, in Seminole, Florida in addition to what we've done in Marlton. So we have had discussions with Kohl's. They're a great partner of ours in terms of the footprint that they're in, in our centers. And there are a handful of locations where we're talking to them about proactively taking space back because we know the tenant demand and we can execute on it ourselves. But we haven't had any throughout the portfolio yet where they've just gone ahead and downsized and backfilled with all the -- or any of the other tenants that they've been talking to.

Our next question comes from the line of Caitlin Burrows with Goldman Sachs.

I just had a quick follow-up one to the -- a few questions ago on the capital recycling. I was just wondering if you could discuss, as you go forward and you're more balanced in terms of dispositions versus -- and the uses of those proceeds, what do you think would be a cap rate spread? And do you think it would be positive? Or could it start out with being, I guess, negative and then growing as you put more effort into leasing or what have you at the various properties?

Well, I think that what we've capital recycled to date and the work that we've done represents really the bottom of the portfolio. So as we move forward, all other things being equal, we would expect to see good performance in cap rates. It's going to be driven by mix. And then, on the reinvestment side, it's going to be driven by the reinvestment yields that we disclosed. Certainly, cap rates on acquisitions can be 100, 200 basis points inside of the assets that we might be selling. Again, our focus on the acquisition side is to make sure that we buy assets that have growth similar to our entire portfolio. I mean, when you think about our portfolio as an asset, what sets it apart is the below-market rents and the ability to put accretive capital to work. So that would imply, as we continue to find other assets that are complementary to our portfolio, lower cap rates. People pay for IRR. And then of course, share repurchases are an opportunity for us as well. But again, because of the work that we've done with the capital recycling, with the balance sheet, it allows us to be much more flexible going forward and balanced as we make those capital allocation decisions.

Got it. So just in terms of potential property acquisitions going forward, we might see that the acquisition cap rates could be relatively lower than disposition, but the idea is that, long term, they would have higher growth and that's why they would make sense.

Absolutely. We're not interested in assets that don't provide a view of how you're going to grow your ROI.

This concludes our question-and-answer session. I'll turn the floor back to Ms. Slater for any final comments.

Thanks, everyone, for joining us. We'll see some of you over the next few weeks.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.