Kite Realty Group Trust (KRG) 2013 Q2 法說會逐字稿

Good day ladies and gentlemen, and welcome to the second-quarter 2013, Kite Realty Group Trust earnings conference call. At this time, all participants are in listen-only mode. Later, we will conduct a question and answer session.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Adam Basch, of Investor Relations. Please proceed sir.

The Company's remarks today will include certain forward-looking statements that are not historical facts and may constitute forward-looking statements within the meaning of the Private Securities and Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties, and other factors, which may cause the actual results of the Company to differ materially from historical results or from any results expressed or implied by such forward-looking statements.

The Company refers you to the documents filed by the Company from time to time with the SEC, which discusses these and other factors that could adversely affect the Company's results. On the call with me today from the Company our Chief Executive Officer, John Kite; Chief Operating Officer, Tom McGowan; and Chief Financial Officer, Dan Sink. And now I would like to turn the call over to John Kite.

Thanks Adam. Good afternoon and welcome to our second-quarter earnings call. We continue to execute on the primary areas of our business plan. Consistently improving operating portfolio performance, pushing for the completion of our development and redevelopment projects, acquiring high quality shopping centers, and continuing to de-lever and improve the balance sheet. These areas of emphasis have driven our Company's actions during the second quarter, and will continue to be a focus throughout the remainder of the year. The operating portfolio performed well again this quarter, as we generated $0.10 of FFO per share, which met consensus estimates. Our same-property NOI growth was 4.4%, our ninth consecutive quarter of same-property NOI growth.

Additionally, our aggregate cash rent spreads increased 19.7%, consisting of 28% for new, and 5% from renewal leases, our 15th consecutive quarter with positive leasing spreads. The retail lease percentage increased to 95.4% from 94.5% in the prior quarter, and shop lease percentage increased to 84.5% from 83.3% in the prior quarter. The spread between the lease and occupied percentage is 380 basis points. This will begin to decrease as the number of our anchor tenants signed in the last few quarters begin to take possession.

Some of these tenants include The Fresh Market, The Shops at Eagle Creek in Naples, and The Fresh Market at Lithia Crossing in Tampa, LA Fitness and Stoney Creek Commons, in Indianapolis. Total Wine at International Speedway Square in Daytona Beach, and a recently signed Sprouts Farmers Market, at Sunland Towne Center in El Paso. We're looking forward to these tenants opening for business as they will drive additional traffic, as well as increase NOI by another $1.9 million on an annualized basis.

We continue to drive our development and redevelopment assets towards stabilization. During the quarter Rangeline Crossing became operational and 91.7% leased. The majority of the tenants at this center opened in the second quarter and our anchor tenant, Earth Fare, opened with strong sales at the end of June. We anticipate approaching stabilization on Holly Springs Phase I in the second half of this year, Delray Marketplace near the end of this year or the beginning of next, and Parkside Phase I during the first half of next year.

Parkside Phase II has progressed well in generating solid industry at ICSC in May. The site has been cleared and we plan to begin vertical construction late fourth quarter of 2013 or early first quarter of 2014. We are 58% pre-leased on the project, with sign anchor tenants including Field & Stream, Golf Galaxy, and Frank's Theater. We anticipate closing on a construction loan for Phase I and II of Parkside in the fourth quarter.

Holly Springs Phase II has also progressed well on the heels of the huge success of Phase I. Phase II is already 81% pre-leased or committed, and we're working with the town on final site plan approvals. In the second quarter, we reclassified Broadstone Station from construction in progress, to land held for development. We were pursuing a national anchor tenant for the site and they have delayed their timing. Without a solid timeline to begin the construction, we have ceased capitalization of the interest and taxes on the project.

We will, however, continue to aggressively pursue a strong anchor, to compliment the open and operating Super Wal-Mart and the recently completed apartments. We currently have two redevelopment assets under construction, and two that are pending commencement of construction. Our Four Corner project in Maple Valley, Washington is 87.1% pre-leased and we plan to analyze the market value of this asset for possible sale at the end of 2013, or the beginning of 2014 as the asset stabilizes. The disposition of this asset will reduce our presence in the northwest to three small properties.

As planned, we moved Gainesville Plaza into redevelopment in the second quarter, as we finalized plans for the former Wal-Mart space. The lease with Wal-Mart recently expired when they moved to a newly constructed supercenter a few miles away. They consistently generated very strong sales from this location, but the site could not accommodate an expansion to a supercenter. We're in discussions with a number of potential junior anchor tenants and we'll provide updates as plans materialize.

At Fulton Plaza in Jacksonville, the LA Fitness is now under construction and should open in early 2014. The recently completed development and redevelopment's at Rangeline crossing, Holly Springs Phase I, Delray Marketplace, and Four Corners Square, have a total project cost of approximately $195 million with an aggregate yield of approximately 6.5% on total cost. The NOI contribution was about 48% in June, and we anticipate that the third and fourth quarter to be 65% to 75% respectively on an annualized basis. We continue to make significant progress on our deleveraging strategy, by acquiring high quality properties with equity, leasing out our portfolio, and generating NOI from our recently completed development and redevelopment projects.

During the quarter, we acquired two well-located shopping centers in our primary markets, using a portion of the proceeds from our April equity offering. The acquisitions in Nashville and Indianapolis will create future opportunities to add to an already diverse tenant lineup, as we look to maximize value on this well-located real estate. Both of these properties have generated significant interest from retailers during portfolio meetings, as well as during the ICSC conference in Las Vegas in May. And we'll continue to discuss options for both of these centers as we move forward.

After the end of the quarter, the [tenant] on our Kedron Village property in Peachtree City, Georgia initiated foreclosure proceedings and acquired the property. Our intent was to restructure the debt to increase cash flow and improve the loan to value on the asset. As a result of the foreclosure, however, we reevaluated the fair value of the asset on June 30, and recognized a non cash impairment charge of $5.4 million. We expect to recognize a gain in the third quarter of $1.5 million relating to the extinguishment of the property's $29 million of debt. In addition, our third-quarter financials will include a $1.1 million reversal of the previously accrued default interest.

Overall, this transaction benefits the Company, reducing debt to EBITDA by approximately 20 basis points, and improving our future same-property growth profile. Also on the balance sheet, we are aggressively looking to reduce our exposure to variable rate debt, as our development projects reach stabilization. We are currently in the market to expand our term loan to $200 million, and subsequently reduce the line of credit. In addition, we plan to secure 5, 7 or 10-year fixed rate debt on several stabilized assets, and utilize the proceeds to pay off floating rate construction debt. Our goal is to have variable rate debt at approximately 15% or less of our total outstanding debt by year end while maintaining over $100 million of liquidity.

Turning to guidance, we are increasing the low end of our full -- the low end of our adjusted full-year 2013 FFO guidance to be within the range of $0.45 to $0.48 per diluted common share, from our previous guidance of $0.44 to $0.48 per diluted common share. This guidance excludes from FFO the debt extinguishment gain mentioned earlier. In closing, based on our very strong operating fundamentals, consisting of occupancy gains, NOI growth, and cash rent spreads, it's clear that our portfolio quality has significantly improved over the last few years. 80% of our annualized base rent comes from 31 properties, averaging in excess of 160,000 square feet.

Our five-mile demographics for these properties consist of average household incomes of $84,000, and population averages of 130,000. In addition, our properties are extremely well located within their sub markets, as demonstrated by our immediate household income significantly exceeding the median household incomes in their respective MSAs by 44%. This overall portfolio enhancement will continue as we deliver our development pipeline and continue our acquisition program. Combining our high-quality portfolio with our value creation skills, in an extremely supply-constrained environment, will lead to top -- continued top tier operating performance. Operator, this concludes our remarks, and we would like to open it up for questions.

(Operator Instructions)

Quentin Velleley, Citigroup.

John, you've been pricing some pretty strong portfolio metrics. The balance sheet's been improving, and you've made a lot of progress with developments. However, shares have under performed some of your shopping center peers year to date. Can you maybe just talk through what you think people are missing in terms of some of the things you've been able to achieve recently and some of the things that are likely to occur in the next -- in the next year or so?

Sure. Well, I think, Quentin, kind of as I said in the closing remarks. I think maybe people have missed the transformation we've made over the last couple years in the portfolio and have been kind of focused maybe on some areas of the balance sheet that we're obviously focused on improving. But I think we think they are kind of missing the results of what we've been doing the last couple of years. If you look at -- we think our metrics from a same-store NOI perspective, from a percentage lease perspective, are pretty much as good as you see in the space. I tried to point out that really 80% of our rent's coming from 30 properties that are extremely strong and large. And I think maybe -- maybe not understanding that part of the reason that we have higher leverage is the fact that we have such a strong, large development pipeline that's in the final stages.

And, without that leverage, it would be difficult to have that pipeline, so it's kind of a catch-22. But when you look at the embedded growth that we have from that over the next two years, it's all going to become very clear soon. So, I think that's part of it. And remember, during this expansion with the development pipeline, we have actually improved the balance sheet and improved our liquidity significantly in the last two years. Although we're not finished, I mean, we're -- we're clearly -- when you look at how we present our debt to EBITDA which is slightly different than others, but it's clear how we do it in our supplemental, we're kind of that mid-8 range, on our way to being and 8 or slightly lower by the end of the year, and with a goal of being at 6.5 within the next year.

So that's going to happen. We're going to push towards that and all the while we're going to grow NOI pretty darn significantly. And we look at our tendency, sorry to drag on with this, but if you look at our tenancy, and it's just getting better and better. I mean our top five tenants are Publix, Bed Bath, Dick's, TJ and Lowes. That's all really strong credit. And you look at the tenants in our development pipeline, and you've got similar names, Plus, [adding] Marshalls, Harris Teeter, Field & Stream. Anyway, so I really believe that just it's coming. Sometimes it's hard for people to see the future, but when you combine all of that and you look at where our FFO growth is and we're going to deliver over 8% FFO growth this year, pay a 4% dividend, we're doing a great job. It's just going to take time for people to see it.

Okay. And you spoke about reducing that floating rate debt down to around about 15%. I believe you're in the market at the moment. What are you seeing in the CMBS market in terms of demand and pricing levels?

Dan, do you want to cover that?

Yes, I think from a pricing level, Quentin, REITs for CMBS's debt debit, 65% of LTVs are in the mid-4s for 7 and 10-year debt. And we're also looking at life company debt on some stabilized high-quality asset and those ranges are in the mid-4s to upper-4s. So I think there's definitely the ability to utilize those markets and we're definitely out looking to see what's the best way to structure that, to not only increase the size of the term loan, but pick several assets to either go on bank balance sheet, like company debt or CMBS, utilize those stabilized assets to pay off some floating rate debt. So, between now and year end, we're going to make a lot of progress in that regard because these developments are as you can see in the supplemental, quickly progressing towards stabilization.

All right. Thanks guys.

Todd Thomas, KeyBanc Capital Markets.

I'm on with Jordan Sadler as well. Just first question on acquisitions, I was just curious to get your view on whether or not you've seen any evidence of sellers either pulling property from the market or chatter around cap rate movement with the increase in interest rates? We've sort of heard a mix of comments so far this quarter. Would just be curious to hear what you're seeing in some of the markets that you're targeting.

Sure. We're not seeing any cap rate back up. If anything it's getting more competitive. Maybe that's -- maybe that's based on the number of assets in the marketplace. That's hard to see. But, we're looking at stuff all the time, Todd. And I think clearly assets that are unleveraged, which is what most people are trying to find, are just scarce. So I think you have to quantify whether you're buying an asset that has debt on it or not. So if you're buying an asset that doesn't have debt on it, or one that can be prepaid, there is a real premium to that, so that people are probably missing that component. But certainly in our markets, we haven't seen any backup at all in cap rates, in terms of closings and in terms of assets being put under contract.

And obviously there's been a bit of a backup in rates, but there's just not enough of that to matter to what the type of quality that we're buying. So when you're buying a quality asset, there's definitely more guys chasing it than there was before. And there's definitely more people looking in markets such as the markets that we're in, which is I think another thing people miss when you think about how people kind of judge shopping center companies. When you look at -- the point I was trying to make on how well located our assets are within their respective sub markets, that's really the most important thing you got to look at, because I would much rather own the greatest real estate in Nashville, than very average real estate in LA okay. So whether that would be LA, Boston, Miami, you name that gateway market, there's a lot of places there I wouldn't want to be. So either owning or walking around. So I think it's something that people are missing and that's what's driving these values.

Okay. That's helpful. And then thanks for giving us an update on the yield for the four key projects in the quarter. Just following up on those projects, I had a question on how the interest expense is being treated for the financing that's in place with those projects. I noticed that there was a pretty big decrease in capitalized interest in the quarter. I just didn't know if we should think about that ratio essentially, in terms of the percent of NOI that's online being similar for what's being capitalized versus what's expensed or maybe you could help us understand that a little bit?

Yes. Todd, the big thing on that is what we do as the pro rata of the lease percentage and the tenants become occupied. Not lease percentage, but as they occupy we're just matching the rate and expense. So when the tenant begins paying rent, we'll begin expensing the interest. It's more of a pro rata. You're right, as the percentages come in. Now, the issue on that some of it might be GAAP, where a tenant might have there might be some range between a 30-day period where they have a free rent before they begin paying cash rent, but I mean, pretty much you can look at it and say it's a pro rata from capitalized interest to interest expense as the tenants occupy.

Okay. So on page 24, the in construction pipeline, the column, the percent of owned GLA occupied, that would more or less represent how much of the loan is being capitalized, if the interest is being capitalized?

Yes, the occupied would be the amount of loan being expensed.

That's right, that's right. I'm sorry. Okay. Perfect. And then, John, you made some comments about Broadstone early in the prepared remarks. I think I may have missed it a little bit. I was just wondering if you could talk about what happened there and why that property was moved to land held for development.

Sure. Broadstone is in the Apex, a suburb of Raleigh. And we have a -- it's kind of a mixed use site in a way because we have an open Super Wal-Mart that's open and operating. We have approximately 30 acres adjacent to it that is what we're pursuing development on and then we had an additional 15 acres, which is an apartment -- we sold to an apartment developer. And the apartments just opened. And basically what we're doing there, Todd, we've been pursuing it, frankly pursuing a particular anchor for a while. We were kind of laying the site out around that particular anchor, has kind of delayed their timing.

And the way we usually look at these developments in terms of how we, looking whether we're capitalizing or not, is whether we can prudently know that it's going to start within a reasonable timeframe. And due to this kind of delay, we're not able to really set a clear path on the timing. So it's prudent for us to take that, move it into land held for development, cease capitalization of the interest expenses, and it doesn't mean we're not working on it. It just means that we're not certain of the timing. So still love -- love the property, great asset. Now we're just working on other -- other kind of site plans. And maybe this guy comes back, maybe this anchor comes back or maybe he loses out and we do a deal with somebody else. But that's it. It's that simple.

Okay, great. Thank you.

Carol Kemple, Hilliard Lyons.

Earlier in the call, you all mentioned your new leasing spreads, which sounded really nice. Can you kind of talk about what tenants moved out and what types moved in?

Sure. I mean, Carol, we have in total, we did during the quarter in terms of our comparable spreads, there were 30 deals. So it's a combination obviously of new deals in the developments, existing deals, et cetera. But, in terms of our cash spreads it's a combination. We had, we obviously had an anchor tenant that came in that was a large spread. We had a lot of mom and pop deals. So, on the renewal side, we had several small shop renewals, probably 13, mix of national and mom and pops. So, pretty much a spread across the board.

And would you say your list of tenants that you're worried about is decreasing or increasing from December?

Well, I mean, definitely it's decreasing. If you look at our accounts receivable, our over 90 is extremely low relative to our total receivables. The best it's been in forever, I can remember honestly. I think that just kind of shows you what's going on. We're in a market -- I'd probably underscore it -- when I said the word extremely supply constrained, that's an understatement. We're in a market that is extremely favorable to us. We're going to take advantage of that. We're going to continue to push this, and that's why you're seeing our NOI growth. That's why you're seeing our cash rent spreads. And that's why you're seeing our occupancy at 95%. So it's a great question, because frankly it's the business. I mean, the business is in a very good place relative to supply and demand. And by the way, all this is happening in light of a moderate retail inventory growth, not a super strong growth. Moderate. So to the extent that grows, which it will, this is only going to get better. And it takes quite a long time to begin development deliveries for the entire sector. So, yes, we're in good spot, real good spot.

Okay. And how has the dividend -- the Board's conversation been surrounding the dividend lately?

The conversation around the dividend, in fact we have a Board meeting next week, and we'll talk about it. But generally, we're in a place where we are -- we feel very comfortable with our coverage on our current dividend. We are still in the process of building out developments and redevelopments. So cash flow and capital is very pristine. So we want to be cautious. But we're also quarter -- every quarter that goes by, we're growing cash flow. So we're certainly starting to be in that position where these things will be talked about more than they were, and that is what it is. But we've got very good coverage. We like where we are. But ultimately increasing our -- ultimately increasing cash flows should lead to increasing dividends because it's part of our total return. And I mentioned earlier that this year we're going to deliver 8% to 9% earnings growth and paying a 4% dividend. So anything that we grow there is substantial. We're already delivering double-digit growth there. But we're talking about it, that's for sure.

Good. Thank you.

Tammi Fique, Wells Fargo Securities.

Hi. I just wanted to follow up on Hendron Village. Sounds like the outcome wasn't exactly what you wanted and I'm kind of curious, it was an asset you developed. It's a pretty significant contributor to rents and seemed to have some outside [capacity]. Just you walk us through the conversation that you had with the special servicer and maybe why they weren't willing to negotiate with you on the rate?

Sure. First of all, Tammi, we did not develop it. We acquired it, just to be clear. Yes, no, we didn't want this to be the outcome. We were frankly surprised that the lender kind of at the last second took a position that was there was no ability for us to work with them unfortunately. Frankly, it's the first time in the history of the Company, which is a very long time where this has happened. So we took it very seriously and it wasn't something we did lightly. However, the asset unfortunately due to the timing of when we acquired it, was heavily over leveraged, from a debt to EBITDA perspective, I think it was about 15 times levered debt to EBITDA.

And that's why we mentioned that we reduced our corporate leverage just by this one asset going back. So it was just the situation where the, unfortunately the debt was too high. It was a kind of loan that even if we would have wanted to inject equity to reduce the debt, we couldn't, due to the CMBS nature, and the above-market a little bit above-market interest. And also frankly we felt strongly that the rents due to the timing of when we acquired it, were significantly above market and we were certainly concerned of material roll down in the next couple years. That's what led us to our decision. Not sure what led them to their decision, but it's just one of those things.

Okay. And then just to make sure that I understand, the debt extinguishment gain related to this is not included in FFO guidance, but the reversal of the interest accrual is included in FFO guidance?

Yes, but Dan, do you want to go ahead?

Yes. Tammi, that's correct, because the reason for that is when we -- when the loan went in default in October of 2012, we began accruing default interest at about $300,000 a quarter. So beginning in that year, we've had going through interest expense for Q1, Q4 -- Q1 of '13 and Q2 of '13, $300,000. So all's we're doing is reversing the interest from the line that it came from.

Okay. Okay, and then just turning over to NOI growth, it's obviously been very strong year to date. But you I don't think provided NOI growth guidance update for this year, and the second half implies a steep slowdown. Do you have an update on NOI growth guidance that we should anticipate, or are you seeing anything that would cause it to slow in the second half?

No. I mean, I think we're Tammi, first of all, first half of the year, so obviously we have a sense of it. But we still have two quarters to go. We still are at the, I believe 3% to 4% guidance. Certainly, we believe we're going to be at the top end of that, so we aren't anticipating significant slowdown there. We hope we've seen it, but I don't think we're -- being that we believe we'll be at the top end, I think we're being prudent and we'll see how it goes. I think that's probably a little bit of why we when we looked at it, we brought the low end of guidance up, but we didn't change guidance, but we still have two quarters to go. So I think it's a reasonable number.

Okay. And then just lastly, you talked a little bit about the acquisition market in general. But are you actively bidding on anything today?

Right this second?

Right this second.

Actually, we are. No, we are working on stuff and that was my comments around cap rates were live comments. I know for a fact that deals that we have pursued have traded below where we thought they would. So we are in the market and we are looking at stuff and we're definitely eager to add high-quality assets, but it's very competitive. So to the extent we can find unique assets, we're trying to. But there's no question that power centers in the markets that we operate in are trading in the 6's. Just kind of depends where in the 6's. And grocery anchor can be there or lower, depending on where it is. So it hasn't changed a heck of a lot. It's been talked about way more than it's actually occurred.

Okay. To the extent that you do win some of these deals, how should we expect you to finance that?

I think we're going to continue to do what we've been doing in terms of we're first of all, we're generating some cash from some sales that we've been doing. We're looking at trying to find assets that we could, in the appropriate situation, that we might match with equity. But that's not the driver. So, it really kind of depends on where the flow is going to come from at that point in time. So it's always hard to time that. But bottom line is I think we kind of feel like based on our access to capital right now, despite the hiccups of the markets here and there, these things play out over a long enough period of time that we would be able to figure it out pretty well. We're not -- we're certainly not looking to increase our leverage.

Okay, great. Thank you very much.

Ladies and gentlemen, this will conclude the question and answer portion of today's conference. I would now like to turn the call over to John Kite for closing remarks.

Okay. Again, thank you for -- everyone, for joining us today and just like to say that we're very much looking forward to speaking to you next quarter and looking forward to the results we'll deliver then. Thank you very much.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation and you may now disconnect. Have a great day.