Kite Realty Group Trust (KRG) 2016 Q4 法說會逐字稿

Good day ladies and gentlemen and welcome to the Kite Realty Group Trust fourth-quarter 2016 earnings conference call.

(Operator Instructions)

As are reminder, today's program may be recorded. I would now like to introduce your host for today's program, Ashley Underwood, Investor Relations.

Thank you and good morning. Welcome to Kite Realty Group's fourth-quarter earnings call. Some of today's comments contain forward-looking statements that are based on assumptions and are subject to inherent risks and uncertainties. Actual results may differ materially from these statements.

For more information about the factors that can adversely affect the Company's results, please see our SEC filings, including our most recent 10-K. Today's remarks also include certain non-GAAP financial measures. Please refer to yesterday's earnings press release, available on our website, for reconciliation of these non-GAAP performance measures to our GAAP financial results.

On the call with me today from the Company are 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.

Good morning everybody. The fourth-quarter rounds out another successful quarter and year for the Company. I wanted to take the time to recognize the teams hard work and achievements, which have positioned the Company to capitalize on our future opportunities.

Some of the objectives and milestones we achieved during 2016 were; FFO as adjusted for the year of $2.06 per share, which was at the midpoint of our guidance range. We achieved same property NOI growth of 2.9% for the year or 3.7%, excluding our 3-R properties. Our same property NOI growth for the fourth quarter was a solid 3.6% or 4.5%, excluding the 3-R initiative.

We began construction on 14, 3-R projects during 2016; completing four of them and generating an annualized 11.3% return as we continue to strengthen our current portfolio. We executed 390 new and renewal leases for over 2 million square feet and increased our ABR to $15.78.

As a point of comparison, our ABR is now almost 20% higher than it was just three years ago; which is an indication of just how dramatically we've improved the Company's portfolio over that time period. Back to 2016, we grew our small shop lease percentage by 130 basis points to 88.9%. This increase was led by our Florida properties which grew 240 basis points.

We executed on a $300 million inaugural public bond offering with an attractive 4% coupon. We now have only $90 million of debt maturing through 2020 with approximately $430 million in liquidity. And most recently, we increased our quarterly cash dividend another 5.2% for an overall increase of 26% since 2013.

For the fourth quarter, we ended the year on a solid note with FFO as adjusted of $0.50 per share. Our retail recovery ratio increased 190 basis points over last year to 89.2% as a result of our continued efforts to work on expense management. We executed 92 [new and] renewal leases in the fourth quarter, with approximately 570,000 square feet and an aggregate cash rent spread of 11.5% on comparable leases, a high for 2016.

We also had some exciting tenant openings in the fourth quarter. We opened 48 new or expansions basis for over 300,000 square feet. Our focus on continuing to enhance the quality and profitability of the retail portfolio has delivered a diverse base of highly trafficked shopping centers.

Our portfolio continues to strengthen as we welcome high-quality necessity driven tenants with a focus on restaurants, health and beauty, service, and entertainment concepts that complement our value oriented retailers. Some of the tenants that recently opened our Carmike Theater, PetSmart, DSW, Old Navy, Chipotle, Thai 5, Five Guys, J.Crew Mercantile, Blaze Pizza, DXL, GNC and Crunch Fitness to name a few. We do not have a single tenant that makes up more than 3% of our ABR and over 70% of our ABR is from the top 50 metropolitan areas in the country.

Along with the completion of our four projects in the fourth quarter, we commenced construction on two additional reposition projects from the 3-R pipeline in the fourth quarter. At Market Street Village we recently added a Party City. At Portofino Phase II, we are replacing vacant shop space with a Nordstrom Rack, as well as right sizing the existing Old Navy.

We added an expansion of Holly Springs Phase II, with the addition of O2 fitness and well positioned small shops. The Holly Springs project has been a very successful ground-up development including the recent opening of Carmike Ovation Cinema, which is a great entertainment option at this 500,000 square-foot development.

We received proceeds from the last residential sale at Eddy Street Commons at the University of Notre Dame this quarter and are now making substantial progress on Phase II of the project; which will once again include a public incentive component. The Phase II project is proposed to span two additional city blocks. As we reflect back on the success of Phase I of the project, we are very proud to have developed one of the finest University sponsored, mixed-use developments in the country.

The retail space continues to remain almost 100% leased and the office component is 100% leased and anchored by several prominent business units of the University of Notre Dame. The highly successful multifamily portion of the project includes a total of 266 units; which leads the market in both occupancy and rate. The success of the fully leased multifamily portion of the project is a catalyst to Phase II.

Eddy Street Commons Phase I, also includes numerous residential components totaling 205 units. The demand for the townhomes, multilevel flats, garage wraps, and city homes, far exceeded our expectations. I also want to provide updates on our disposition activities and our efforts to release the two Sports Authority boxes and the Field & Stream location at Parkside Phase II.

On the remaining two Sports Authority boxes; we are in discussions with multiple tenants to backfill the space at Colonial Square, Ft. Myers, Florida. In addition, we are also aggressively marketing the space at our Landings at Tradition Center in Port Saint Lucie, Florida and have a couple of viable alternatives as we were not able to come to economic terms with the previous prospective tenant.

We don't anticipate opening tenants for either of these spaces in 2017. The [recentering] of the former Field & Stream box at Parkside Town Commons has progressed nicely, as we are negotiating a lease with the replacement tenant for the entire 50,000 square feet. This tenant, along with the planned March opening of Stein Mart, would solidify and strengthen the anchor lineup at Parkside Phase II, as Parkside Phase I remains 100% leased.

In December, we sold one asset in Florida for approximately $15 million. Given the unique circumstances near the end of 2016 with the election and related volatility, we chose to pause on the sale of several additional assets and are now focused on the disposition of $45 million to $55 million of assets in the first half of 2017.

Throughout 2016, we worked hard to strengthen our balance sheet and position it to its strongest position it has been in our Company history. In the fourth quarter, we unencumbered three additional properties and reduced the ratio of secured debt to under appreciated assets to 16.9% from 23%. Our weighted average debt maturities have increased to a strong 6.4 years, while our floating rate debt is down to only 7%, both significantly mitigating the near-term impact of any potential rise in interest rates.

Before we get to our 2017 guidance, I'd like to provide a quick update on the three-year roadmap that we issued last year. As we said at the time, the roadmap laid out our aspirational goals for 2018 and we couldn't build into those goals all of the various contingencies that would happen over that three-year period. So for example, as we discussed during our earnings call last quarter, the roadmap did not include the public bond deal that we did in 2016.

It also didn't anticipate that some of our redevelopment efforts would proceed as quickly as they have; which required some tenants to vacate sooner than we originally expected. Both of these factors, combined with some changes to our disposition assumptions, while prudent for our portfolio and balance sheet are dilutive to our near term FFO. That said, we do to continue to focus on growing our dividend as laid out in the roadmap as well as increasing our small shop to occupancy to 90%. And by the way we are well on our way, as we ended the year at just under 89%.

We also continue to focus on growing free cash flow and lowering our net debt to EBITDA to the low [6s] and we've already hit the floating rate debt target with 93% of our debt now at fixed rates. Lastly we are introducing guidance for 2017 FFO as defined by NAREIT in a range of $2 to $2.06 per diluted share. The earnings press release and supplemental, which was filed yesterday, detail all of the assumptions to achieve the range.

Three primary items affect FFO between 2016 and 2017. First, the proactive public bond deal was diluted by approximately $0.06 but was a good strategic long-term move as we paid off our lower rate debt term loan and construction debt and significantly extended our maturities. Second the proactive de-leasing of our 3-R projects, created an acceleration of non-cash below-market lease amortization in 2016 of $0.05 per share that we aren't projecting to recur in 2017.

And third, the projected asset dispositions totaling approximately $65 million between the end of 2016 and early 2017, net the related interest savings, created a $0.03 dilutive effect. These items combined effect on our year-over-year FFO, was approximately $0.14 per share. However, we are tracking a healthy AFFO growth of approximately 5% in 2017, as we continue our focus on free cash flow growth.

In conclusion, our business operations are strong, as we opened 48 diverse tenants and expansions for over 300,000 square feet in the fourth quarter. We generated 3.6% same property growth, we raised the cash dividend by over 5%, and we have $90 million of debt maturities through 2020; along with approximately $430 million of liquidity and 3.5 times debt service charge. Our team is very motivated and looking forward to a productive 2017.

Operator, we're ready for questions.

(Operator Instructions)

Our first question comes from the line of Alexander Goldfarb from Sandler O'Neill.

Good morning out there. The [fund] topic, can you talk a little bit about your credit reserves for 2017 versus your historic trends and how you view tenant health and if your guidance assumes or contemplates any store closings?

Sure, I will talk a little bit about the second part of the question and how we view our health and then Dan will probably get into details about the reserves which I think our reserves are what we traditionally do. Look, I think we are trying to make the point, Alex, that we feel like we're in a pretty good position right now.

We have opened quite a few tenants in the last couple of quarters, a very diverse group of tenants. When you look at our top 25 tenants and you look at our concentrations, it really hasn't changed much in terms of any watch tenants so to speak. The other thing I like to talk about is the fact that, we have over 360, I think 365 boxes, spaces, that are anchor spaces above 10,000 feet and out of that 365 we basically have four vacant.

We are in a position of strength I think right now. Obviously, when you start the year you want to be conservative so I think we are being reasonably conservative with a fairly volatile world and trying to position ourselves to grow from here. Dan, if you want to get into the --.

John, then on the reserve perspective, we typically do 1% of cash then rent and like in 2016 our total bad debt was less than that by say 20 basis points. When you look at anchors that we have projected, we spend -- we go through a very, very detailed budget process and tenant by tenant, space by space and when you go through that, Alex, we had a couple tenants that we have that aren't going to be renewing.

A couple of the office supply guys, one in the first quarter and one in the fourth quarter, and then a couple other 10,000 to 12,000 square feet tenants will also be closing at the end of their term. I think we look at our projected retail lease percentage we're overall going to be pretty steady in that regard. We are obviously going to lose some tenants, pick up some during the year, but we definitely have factored in those tenants that we don't think are going to renew.

Dan, you said for 2015 it was 20 basis points lower? Or you're meant for 2016 it was 20 basis points lower?

I meant for 2016, sorry about that.

(Multiple speakers). No worries. The next question is on the same-store NOI guidance for 2017. In 2016 you were able to put it up pretty healthy number, but what is the impact from the redevelopments on the [2000] same-store NOI guidance?

I think when you look at it, it's been pretty consistent. We have had roughly 70 to 80 basis points, you can see the spread. That is going to start closing.

For instance, this quarter when we deliver the four repositioned assets, and we're going to have -- as you can see on the supplemental page we have the deliveries set up and the development team and construction team, those projects are going very well. The timing, on time on budget.

So we feel like we can hit those markers laid out. So the drag that we have had in the past, I don't have specifics per quarter but you're going to see that come down as we start delivering some of these repositioned assets; while right now those are affecting our same-store guidance that we are providing.

But even if it's coming -- even if drag is coming down though Dan, your same-store growth is slowing down, so what is causing the slowdown then?

Look, we've got some anchors that we've talked about that are going to be affected by that. I think when you start out as John mentioned, you start out at the beginning of the year, there is some headwinds relative to some retailers and we want to be sure that we've factored that into our guidance that we are providing.

Alex, I think we're leaving ourselves room. It's the beginning of the year so I think we're leaving ourselves room. Not to mention, we didn't mention in our press release but we are still impacted by Sports Authority. I think in the fourth quarter that was 75 basis points. With that and assuming that there might be other fallout, it's a good place to start.

Perfect, thanks a lot, John and Dan.

Our next question comes from the line of Christy McElroy from Citigroup.

Good morning. Just a follow-up on the same-store NOI guidance, what are your expectations for expense trends in 2017, given the declines that you saw in 2016 embedded within that 2% to 3% guidance range?

Christy, this is Dan, I think when you look at that we continue to have some additional pickups this year. Our insurance continues, our premiums continue to come down as we have been performing well with the properties. Our reserves relative to the various events of the properties, we haven't had any issues so we have been able to drive down insurance premiums.

We've been continuing to work on the direct bill from a trash perspective and those things when you get them out of the [camp pool], we are about done with about half of the portfolio so I think you will see that as a net pickup. We continue to look at [fixed cam] as we have renewals for shop tenants so that will be a net pickup.

I can't say that we are going to continue, like this quarter, we had net recoveries and a plus $500,000 but I think as you see, we will still continue to get some additional lift from the efficiencies we are seeing from the expense side.

Christy, I would just add to that, on the positive side on the rent side, our rent bumps were almost 1.5% this quarter, just under 1.5%. That's up probably 25 basis points from what it has been historically. We are also starting to see good push from the specialty leasing side. That was almost 1%, like 80 bps. So those two items are a real positive as we look into the future because those rent bumps are contractual and that has a lot to do with the work that we have done in the last three years relative to forcing in those rent bumps on an annual basis on the small shop side; which we, I would say, get 95% of the time.

Okay. Just to clarify on the $45 million to $55 million of dispositions guidance in the first half of 2017, are those the same properties that you had originally targeted for late 2016?

Can you provide some more color on why you decided to delay those sales? Was it based on what you were seeing in the market in terms of demand and what gives you the confidence that you can complete those deals in the first half?

First of all, yes, the disposition we did in the very end of the year; which was the second week of December, was approximately $15 million. A small center in Florida that was one of the original centers that we had talked about selling. As it relates to the $45 million to $55 million, if we are at the low end of that, that is the exact same portfolio that we were thinking we were going to sell.

If we were at the high end of that there's probably another property in there on top of what we were originally looking at selling. Yes, generally it's the same properties. And generally it's the same kind of mixture of properties, which are the smaller ones that we are looking to dispose of. In terms of why, at the end of the year everybody was trying to take advantage of volatility. As I mentioned earlier on the call, we are in a really, really good position as it relates to our balance sheet with $90 million of debt maturing between now and the end of 2020. So we don't have to do anything.

We have no capital markets needs at all. As it relates to this, this is something we want to do to improve the portfolio and continue to prudently delever. We just felt like some people were trying to take advantage of that and we said no. I think we will be rewarded for it in the first half of this year.

I think we can already see there is more interest than there was in November and December right now, so we feel good about that decision. I think that's what gives us confidence based on the conversations that we are having with the buyers and again, we will not sell something in a distressed way, because we don't have to and we've done a heck of a lot of work to be in that position so that is why, Christy.

Got it, thank you so much.

(Operator Instructions)

Our next question comes from Jeff Donnelly from Wells Fargo.

Good morning. We've been hearing from brokers and some of your competitors, that there has been a discernible increase in cap rates on what I would call commodity power center product in the last three to six months and that spread has been widening versus the grocery anchored. What do you see in the marketplace and does that lead you to think there is more opportunity for you on the acquisitions side in another area? I would just love your perspective.

Sure, as I was just saying I think the end of the year was a very difficult time to try to figure out where cap rates were. I think there was just a lot of indecision and there was just a lot of volatility. And frankly the end of the year is always tough because you also have -- most of the institutional buyers have already put their money out the door so usually the first half of the year is better. That said, it's all dependent.

No question there has been some fluctuation and movement in certain cap rates on certain properties but I think you've really got to look at what you are selling and when I think about the meat of our portfolio, the core strength in our portfolio, I don't think that has moved a lot. I would say maybe the bottom end of the portfolio has moved, so that idea there has been cap rate movement of 25 or 50 or whatever, sure, I think on some of the lower end quality that has happened. It might create opportunities, as you said in the second half of the question, where depending on where our cost of capital is, which right now is not where it should be, but if it was in a better place it would create opportunities to find some unique situations where we could buy something, add value, create significant NAV appreciation that way.

I think it's a bit early, Jeff. I still think there is a lot of people wondering where we are going, what's going to happen and it's normal. When you're into the first two weeks of a new administration after eight years, there is going to be lots of questions.

I know I guess I will call them B-malls are outside your focus today but you had some experiences with those redevelopments such as at Glendale in your own backyard. And the pricing that we've seen on some B-mall transactions in the country have been as some pretty remarkable cap rates. Does that ever, under select circumstances, would it lead you to want to look at some of those as redevelopment projects? Maybe not into a mall but into some other form of retail? Or do you think based on your experience that is just not a worthwhile effort?

I think it's a very challenging thing to do because of the time -- it really depends on the situation. If you have anchors that are still in place, it is very challenging just because of the difficulty of the REAs, the reciprocal easement agreements that exist between the landlord and those anchors, generally the language in those anchor leases requires a certain number of department stores. It's difficult.

If you are finding something that has already been gutted, so to speak, and it happens to be good real estate, yes, that could be interesting. I think it's few and far between. And that's not going to be our focus. But if something was to come along and again our cost of capital was right and it was in that scenario where it was just great real estate that was barely hanging on, then that would be fine because we have done that before and been very successful at it. But tough circumstances to get there, Jeff.

Yes, maybe to switch gears on the leasing side, can you talk a little bit about where you were seeing the strongest demand by anchor box size? I am curious is that depth of demand greatest at 20,000 to 40,000 square feet or 40,000 to 60,000 square feet, I'm curious where you see that? I know every space is different and certainly every market is different, are there any rules of thumb you can give people as to where rents are on those types of boxes as the size grows?

We will touch on it a couple different ways and I will have Tom kick in on it as well. My perspective is, the box size is -- the nice thing about the office supply business is those boxes are generally in the 20,000 to 30,000 square-foot range if they haven't been right sized down to 12,000 to 15,000 square feet.

The good thing about 20,000 to 30,000 square feet, is that is a very leasable box not only in its current form at 20,000 to 30,000 square feet but also very easy to divide into two or even three spaces. It gets more challenging as you go up in space and one of the things I mentioned on calls before is as you get north of 40,000 square feet, 50,000, 60,000 square feet, it gets a little harder. Although I did mention on the call, our 50,000-foot box we are working on now, we have a lease that we are negotiating for that entire box.

It's all very situational but as it relates to sizes, that is the nice thing about our portfolio is most of our boxes are, I would say in that 15,000 to 35,000-foot range. That probably covers the majority of our boxes and that is a very nice box size relating to potential tenants. Maybe Tom can talk about those types of tenants and those type of rents.

If you think about it in terms of the type of tenants, you have the TJ concepts, you have Ross, you have PetSmart, ULTA, all of those boxes are being very productive. And then as you rise up in terms of the square-footage you have the Academy Sports, you have a new player like Sketchers and then we've been spending a lot of time on entertainment as it ties back to specialty theaters. There is a host of those out there. When you get higher you really have to look a little deeper to find the right uses.

I think Jeff when you get a chance to go back and read this transcript because I know I was reading the deal that we opened in the quarter, but when you open 50 new tenants in the quarter, and the diversity of what we opened in the quarter with entertainment, restaurants, some apparel, some value, and the quality of the tenants that we opened in the quarter, I think it shows you that our space, the type of center that we own, is extremely attractive in today's market.

And this idea that the narrative, which is so frustrating, that the narrative on where retail is, where you paint the entire space with one brush, our part of this space is as active as I have seen it in a very long time. It doesn't change. We are in a great supply demand metric.

There has been no supply. We own good-quality. Everybody wants to talk about over retail. That is such an oversimplification. We are definitely not over retailed in our high-quality, open air centers. We are under if anything probably.

I would say the diversity of our tenant base continues to expand, which is additional hedge in terms of any strains we may see, so that has been a huge help as well.

I can tell you are a big fan of the narrative that's out there.

It reminds me of the narrative in October. Turned out to be wrong.

One last question, I know this is specific but in one of your repurposing projects is The Corner in Indy -- I think it is mostly mixed use between residential and retail. It's a fairly tight site, I'm curious how that lays out? Is that going to be residential over retail or is it just going to be all on-grade?

It is a fairly tight site, so yes the plans that we have been discussing is residential over retail and its one of those situations where when you change a use like that in a very dense area like that, it takes time. We've been working on that and spending a lot of time and still working on how we are going to reposition it.

But the real estate is outstanding. It is kind of a good example of the resiliency and flexibility of retail real estate, which is another thing I think doesn't get talked about enough, when you hear so much about the other sectors of real estate, multifamily, industrial, self storage. I think from my view, retail real estate is probably the only one that has that flexibility because generally the real estate is so well located, positioned and it's also something you can, from a zoning perspective, almost anything is a down zone.

We are able to have extreme flexibility on our properties, which is why in the case of The Corner that you brought up, Courthouse Shadows in Naples, these are projects where maybe the retail component of it isn't the highest and best use but there's two or three other things that we can do. I don't think you can do that in those other segments, suburban office, apartments, industrial, or whatever. Good question and something we ought to talk about more. We own the best real estate and that makes it the most flexible.

What a great example that you are able to get your first level retail, you are able to get 300 multifamily units on top, able to get public incentives for interior garage space. So it's a great model for us.

That's great, thank you.

Our next question comes from the line of Todd Thomas from KeyBanc Capital.

Thanks, good morning. Parkside Town Commons and the move out of Field & Stream which you talked about, what's the timing to get that replacement tenant in occupancy and paying rent? And then in terms of the merchandising of the Center, I'm curious if you can share what kind of retail or retail category that replacement tenant is in?

Todd, I don't think we are in a position to get into specific timing or specifically who it is since we don't have an executed lease and we are still in the negotiation phase. I can tell you that we are -- we said we are negotiating a lease with someone and we hope that we get to the finish line here soon.

The good thing is in this particular case, we also have other people interested so it's one of these situations where we are very focused on our primary target but the good thing is there is other people. We hope to get it done soon. It would be in our belief very additive to the merchandising mix, which we think is very important in a center of this magnitude that you're always focused on that merchandising mix.

It's a little early to get into timing and impact and suffice to say, that we have been conservative in how we have looked at it for the year in the guidance we laid out.

Okay and then in 2016, pretty solid leasing results of about 10% rent spreads achieved over the four quarters. What are you expecting in terms of leasing spreads in 2017?

I think our goal is to continue to do what we've been doing, which is we generally focus on trying to get our renewal spreads that are non-option renewal spreads in that 10% range. This quarter they were around 8%, very impacted by anchor leasing. As a matter of fact, interestingly, this quarter about 75% of all of our renewal deals both option and non-option were anchors. That is unusually high, last quarter it was about two thirds.

When you are at 75% of your deals you are renewing are anchors and you're still able to generate 6% spread or 5.5% spread on that total, that is pretty darn good. I feel that it will continue the way it is.

Look, anything can happen, which is why to the earlier question, when you sit here at the beginning of the year you have to be thinking about things that you are not anticipating happening. But as it relates to, as I said, where we are right now with the amount of demand and frankly the most I've seen us have in terms of the breadth of the different retailers that are beginning to look at our spaces, everything from the local player to the entertainment concept to J.Crew Mercantile, as I said we did a deal with them that we just opened that's just killing it. So there's just a lot of interesting things going on.

And you just mentioned local retailers, are you seeing a little bit of a pickup in interest in demand from local retailers, relative to prior years?

Yes. We definitely are. It's early this year, but when you look at what happened in November, December, and January, I think we definitely have seen a pickup of people looking to -- it reflects the environment of feeling more bullish in the overall economy despite the anemic fourth-quarter GDP that closed out several years of that.

I think people are thinking there is a better opportunity to grow going forward so that's going to create more business formation, which would lead us to believe that we would have more opportunities.

Okay, lastly for Dan, in that other property income line, where you are expecting $1 million to $3 million of out parcel sales gains or some condo sales, what is the range for that line look like overall for the full year?

I think when you look at the lease term fees and other items go in there, Todd, so this year we generated about $1.4 million of lease term fees. I think for next year, as we look out, that's hard to budget but we will probably be slightly less than that when we look at 2017. When you look at gains on land sales that is $1 million to $3 million, is what we have recorded in guidance, so I think those are the two primary factors.

You have overage rent which is in the other property related in the face of our financial statement but when you go to the NOI page of our supplemental we break that out and I think again that was $1.5 million this year. I think we will maybe be slightly less than that depending on how sales coming from tenants if everything is pretty static. Those are the three primary metrics, looking at that line, so year-over-year not a big variable, maybe down slightly because of any street residential sales. We won't have any of that in 2017, although we are working on Phase II and might have some other types of other income.

Okay, got it. Thank you.

Our next question comes from Carol Kemple from Hilliard Lyons.

Good morning. Can you all talk a little bit about the Phase II at Notre Dame? What kind of tenant demand you have and when you expect to start that project?

Yes, in terms of Eddy Street Phase II, we are really focused on zoning right now. We are working on zoning, we are working on our tax increments financing, the public incentive components. Right now we are starting to get into the depth of the design. It's key to get those primary components put together.

This is a project that we will be in a position to start in 2017, so we are moving along extremely well in that regard. This is a two city-block project that has the potential to add about 400 units. It's going to be a well devised plan in terms of the way we take the land down just like we did at Eddy Street Phase I.

Okay and have you all had conversations with any other Universities or even from the student housing providers about doing a project similar to this with retail and multifamily or student housing?

Yes, we have. We have met with a handful of different Universities and discussed the concept. Eddy Street gets a lot of attention based on the fact it has been a very successful model and a lot of Universities come to the University of Notre Dame to see it. So we always have our eyes open for that opportunity and we will continue to look at that.

Okay, thank you.

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

Hi. Realizing that it's always location dependent and given what is happening in retail, is there a short list of two, three, four, five, nationally known retailers that you are generally quite happy to welcome to your centers?

I think there is a long list, not a short list. I think as I said, I think we are in an interesting time right now because we are seeing a lot of interest from such a wide degree of retailers. I think it really depends on if we are talking about the big box side or if we are talking about, what we call the medium box side like an ULTA or Beauty Brands, that type of thing or the small shop side. The small shop side has gained quite a bit of momentum as you can see from the fact that we are hovering around 90% leased in the shops.

There is no doubt that even the traditional value retailers are very aggressively looking to find opportunities like TJ and Ross. These guys are doing extremely well. Even Dick's Sporting Goods is definitely looking at deals. PetSmart and Petco are both still expanding. You can go down the list.

I would say that the health and beauty side has definitely gained significant momentum and what LA Fitness has been doing very successfully for the last six or seven years, is now really growing into a lot of specialty guys. We mentioned O2 Fitness in Raleigh, that is a high-end facility that attracts the right demographic, so it's a little more niche than someone like an LA but they are an awesome retailer. It's much more of a regional retailer.

Then you have the guys in every other element again really looking around. It was interesting we opened a J.Crew Mercantile deal this quarter and is doing extremely well. I think we are seeing such a wide variety. It is really the variety that has changed I think the most, which really gives us a real good feeling because of the amount of space that is being produced is almost nil.

The only one I would add is really tying back to specialty theaters and entertainment concepts. There are so many opportunities in that space and a great part of that component for us is it's a huge traffic generator. It does tremendous things not only for the in-line but also for the restaurants, so we are aggressively pursuing those and where we can make capital investments to upgrade, we will continue to do that as well.

I would just add to it and the reason I mentioned about the stores that we opened and what kind of users they were, we just aren't in our space and in particularly what we own, we just don't have much concern around the dramatic headlines about the department stores and the death of all of that. It just doesn't really impact us.

The fact of the matter is, of our 50 deals we opened, two of them had anything do with apparel and one of them is killing it; which as I mentioned was J.Crew Mercantile. I don't know, it feels much better than what you would read.

Thanks, that's really helpful.

Our next question comes from the line of Chris Lucas from Capital One Securities.

Good morning everyone. John, you mentioned early in the call that you had a couple of office tenants or office supply tenants that were not renewing, one in the first quarter and one in the fourth-quarter. Just curious if you could talk a little bit about what prospects you have for backfilling those spaces and whether or not you're looking at a single tenant or whether you are looking at devising the space?

We definitely have a couple of deals that we think are going to close this year, two of the office supply players. In terms of the backfill deals, it's interesting, we have got a couple situations where one of them would be one user, another one is dividing into two users. So it's a little early to get specific on that but when you look at what we've done with these historically, either we have leased it to one tenant, which often has been a specialty grocer or we have subdivided it into two and generally when we have done that, we've been doing subdivision with a guy like ULTA, who will then drive in a very strong tenant adjacent to them.

Again as I said and as I was pointing out, it has a lot to do with the size. The size is kind of like perfect dimension because it enables us to split it or not. And then the rents that we have generally had in these spaces have been reasonable, so we haven't been way outsides on rent and have either been at par or sometimes better.

Is that the same outcome you are expecting with the backfilling of the TSA boxes you are working on?

I think the TSA boxes are little more complicated because they are twice the size. They are 42,000 square feet, one is 42,000 square feet and one of them is a little over 40,000 square feet. In fact, I mentioned that we had been really working on a deal where we were going to significantly expand one of them which was very unusual and became very difficult to execute on.

The 40,000 is a bit of a tougher scenario because if you're going to split it you basically need two boxes. And if you want to split it into several small shops that becomes very expensive and very difficult to do logistically. It's more challenging, which is probably why we still have the two, although we had one go away very quickly. I think we'll be able to execute but that's why it's taking longer and that's why we were conservative in assuming that we're going to keep those vacant all year.

On the office supply we are chipping away at these. We already have two renewed. We are working on five new stores in the future, so we are aggressively pursuing these, decreasing the amount of risk that we have with them. It's something that gets a lot of attention but we will have a couple and we will figure out ways to get those filled and as John said they are the right square-footage for us.

One last question for me, you mentioned that the bad debt for this year ran about 80 basis points and you bumped up your expectation as it relates to budget or guidance for this year to 1%. Is the bump related to one small tenant concern or is it a bigger box concern or is it just a general concern that you have about and being more conservative about what you were seeing related to bad debt this year over last year?

Chris, from my perspective, I think it is us trying to be prudent in the beginning of the year coming off the end of the year and the volatility that exists in the macro world. It's not specific. It's more macro.

That said, we have got a lot going on and we have got a couple of these box deals that we just mentioned. I think it's the prudent thing to do because it could very easily be 1% but it's not specific to a retailer.

Great, thank you for taking my questions.

Our next question comes from the line of Collin Mings from Raymond James.

Hello, good morning. Just going back to your comments in response to Jeff's question earlier around cap rates, can you touch on if you are seeing maybe any trends regionally across your market that relates to some of the upward pressure? You talked about differentiating across quality of property but curious if you are seeing anything regionally?

Not as it relates to the regions that we are operating in. When you look at our six regions I think it is pretty similar across the board. It becomes extremely micro as it relates to the specific assets. There is significant examples that I have of things trading at cap rates lower than you would imagine in markets that the narrative would tell you are weaker markets.

That said, there are other assets where you think, boy that is a well-known market in a primary top-10 market, and it traded a little wider than you thought it would because for whatever particular reason. I think now is a tough time to try to say that this is where cap rates are settling in. It is too early in a very significant change over the last three months. It is just far too early to see where that's going to go.

My personal belief it's going to be reasonably stable and I think as people being to look and see what we are doing and the fact there is absolutely no new supply and there is very limited supply of high-quality product that institutional investors will look to buy those assets. I think depending on where things settle out, with where rates go, that's only one element.

You have to look at the massive amount of capital that is just accumulating in real estate and not being deployed. I mean, multiple billions. You add all that together, you look at how we're performing. Operationally when you look at a company like us, I think it is a good example for people to think, well, how will my real estate perform?

If we can grow our NOI on a comp basis over the last three years at close to 4% in a less than 2% GDP, that tells you something.

Fair enough. Just switching gears as it relates to the 3-R pipeline, just an update as far as construction costs and how you see that playing out into 2017. And just more broadly as you think about rolling additional 3-R projects, maybe just an update if you think that combination of some slowing rent growth in some markets as well as some upward pressure on construction costs there could be some moderation in 3-R yields going forward.

Just a start off on construction costs, if you look at the numbers in 2016, overall construction costs went up about 3.9%. Looking forward, there is likely going to be some pressure on the labor side, there is a lot of infrastructure projects that are going to press forward but for the most part if you are looking at the actual commodities, asphalt, steel, et cetera, you're going to see a fairly stable market. So that is not of a great concern to us.

In terms of the pipeline as a whole, I think we are executing as best we ever have, with the 10 projects that are under construction. We are certain all of those will be delivered on time, hopefully with the double-digit returns that we've talked about. I think that is proven by the fact that before we delivered, we're also delivered on time with 11% returns.

As you look at the opportunities, and we have got 10 very strong opportunities and when we look at it we see three or four that are very close to being able to move to the under construction pipeline. We feel like we have a very robust process of identifying opportunities and then moving them into the under construction pipeline and, most importantly, being able to deliver.

The only thing I would add, Collin, is, once you get through the 10 that are in the pipeline; these are all very real and very significantly advanced opportunities. And in fact an example is, we just signed a lease yesterday with Kroger for a ground lease for a 120,000 square-foot store in one of those pipeline deals.

These are real deals. These are deals that will happen. Once you go beyond that, it's going to be dependent on where we are from a demand perspective, where we are from a return perspective, and we will ebb and flow in that regard. If we feel like that there are better opportunities elsewhere in our capital structure to deploy that money, that free cash flow. It all comes back to free cash flow.

It always amazes me how little I hear about that in our space, but we generate free cash flow, a significant amount of it and we are deploying it in an extremely accretive way and will that maybe sometimes create some short-term volatility in a particular metric? Maybe, but is it going to create a lot of long-term value? Yes. Absolutely.

I think we are pretty good at that and I think as Tom just said we are delivering things right on the dime. That's hard to do and everybody thinks they can do it but once they get into it they find it's a little harder than they thought. I feel very good about what we've done and I feel even better about how much more cash flow we are going to generate over the next couple of years.

That is what this business is all about. That's why we have raised the dividend almost 30% in the last three years. That's why our cash flow has grown a tremendous amount in the last four years and our ABR is growing. All in all it is a real positive thing.

Appreciate the color.

Thank you. This does conclude the question-and-answer session today's program. I'd like to hand the program back to John Kite for any further remarks.

Well, we certainly appreciate everyone taking the time today. We look forward to talking to you all soon. Thank you.

Thank you ladies and gentlemen for your participation in today's conference.