Regency Centers Corp (REG) 2012 Q2 法說會逐字稿

Ladies and gentlemen, good day. Welcome to the Regency Centers Corporation second quarter 2012 earnings conference call. Please note today's conference is being recorded. At this time I would like to turn the conference over to your moderator, Senior Vice President, Capital Markets, Lisa Palmer. Please go ahead.

Thank you, Peter. Good afternoon, everyone. Good morning to those of you on the West Coast. Thank you for joining us. On the call this afternoon are Hap Stein, Chairman and CEO; Brian Smith, President and COO; Bruce Johnson, CFO; and Chris Leavitt, Senior Vice President and Treasurer.

As always before we start, I would like to address forward-looking statements that may be discussed on the call. Forward-looking statements involve risks and uncertainties. Actual future performance, outcomes and results may differentmaterially from those expressed in these forward-looking statements. Please refer to the documents filed by Regency Centers Corporation with the SEC,specifically the most recent reports on Forms 10-K and 10-Q, which identify important risk factors that could cause actual results to difficult from those contained in these forward-looking statements. Hap?

Thank you, Lisa. And good afternoon, and good morning to those out on the East Coast. I am extremely encouraged by the continued and significant progress that is being made toward the key objectives in all aspects of our business. We realized another quarter of improving operating fundamentals. It is gratifying that these results are meeting Regency's high performance standards. While Brian will spend more time in this area, I want to highlight a few key accomplishments that are evidence of the quality of the portfolio and the focus of Regency's management team.

Leasing volumes remain robust, with continued strengthening of our small shop spaces. Percent leased 94% for the first time since 2008. Bad debt expense is still trending toward pre-recession levels, and pricing power, while uneven, is steadily moving in our favor. These improved underlying fundamentals translated into same property NOI growth on a year-to-date basis of 3.8%.

In addition to the positive operating results of our portfolio, the $300 million of development started since the beginning of 2009 continue to register impressive performance. Currently they are more than 90% leased, with projected average returns on a incremental basis of 9.3%. I really like the [forward] development started this year, which will ultimately represent investment of close to $150 million and create meaningful value for our shareholders. These new developments reflect Regency's narrowed focus on building and redeveloping dominants in fill shopping centers, with demonstrated demand from best-in-class retailers.

Substantial progress was made on executing our clearly articulated capital recycling strategy that hasalso enabled us to further strengthen the balance sheet. Last week we closed on a $321 million portfolio sale. Bruce and Brian will describe this in more detail, as well as how this and other recent and pending recycling transactions are enhancing what was already a high-quality portfolio and its future NOI growth.

Together with acquisitions to date and those in our pipeline, we will have meaningfully increased the allocation of capital at dominant centers with good prospects in core markets, whilelowering our exposure to non-strategic assets and markets and reducing debt. We think some caution with the balance sheet [to] lower leverage makes sense, given the uncertainty that we're all experiencing and seeing in today's world.

Most important of all, despite the dilutive impact from the portfolio sale, being a significant net seller, and operating at a lower level of leverage, we will be even better positioned to compound per share core FFO, including moderate growth in 2013, by the sustaining growth of 2.5% to 3.5% from our portfolio of dominant centers, with annual grocer anchor sales averaging more than $26 million and $500 per square foot, and trade area household incomes of approximately $100,000 and average population densities of 100,000 people. And those aren't future targets. That's the existing portfolio and the key metrics for that portfolio.

Biannually developing $150 million to $200 million of dominant shopping centers at compelling returns on invested capital from Regency's a unique combination of in-house capable, presence in key markets, anchoring retailer relationships and impressive track record. And by opportunistically enhancing an already solid balance sheet and access to capital. And last by continuing to focus energy from our dedicate and talented team toward achieving these critical goals and objectives.

I also want to note that since the portfolio sale was at a minimum NAV neutral in the short-term, the growth we are generating NOI and the value being created from developments should translate into 5%-plus growth in per share NAV this year and into the future. Bruce?

Thank you, Hap, and good afternoon to everyone. From a financial results perspective we had a really good second quarter. Core FFO per share was $0.69, which is higher than our stated guidance range. Continued improvement in operating fundamentals was a principal driver, with same property NOI growing by 3.6% this quarter. 85% of the same property growth came from increased base rent, and the remainder was mostly lower bad debt expense.

As we mentioned in last quarter's call, we changed the fiscal year of our captive insurance company to end in April. As a result we recognized the revenue in the second quarter of this year rather than in the third quarter as we have done in prior years. This was incorporated in our second quarter guidance and made up the majority of the current quarter increase in other income. Going forward the revenue will be recognized quarterly in an estimated run rate of between $600 (sic) and $1 million, and as always will not be included in same property NOI.

On the capital market side we extended our option to draw the remaining balance of the term loan to January 2013. After quarter end we used the proceeds from the portfolio to pay down the $120 million of our revolving credit facility and to pay off the $150 million balance on our term loan, butstill retain the right to draw the remaining commitment of $100 million. The net result is access to nearly $700 million of available capacity. Our balance sheet is now in even better shape, with no significant near-term maturities and given today's uncertain -- the uncertainty of today's world, we intend to preserve a substantial portion of the increased availability in our bank facilities through opportunistic capital market activity.

Turning to the portfolio sale, this was an important transaction that will provide us with long-term benefits. To summarize a few key details of the sale, we sold 15 properties to an affiliate of Blackstone, representing 2.1 million square feet, for $321 million. The properties were wholly-owned, unencumbered and 90.5% leased. And as part of the transaction we retained a $47.5 million preferred equity investment in the portfolio that earns a 10.5% annual return. The investment is callable by Regency after 12 months and by either party after 18 months.

With the sale we took advantage of an opportunity to efficiently accelerate the disposition of the non-strategic assets and reduce leverage. The dilutive impact of this accelerated capital recycling and lower leverage is partially offset by improved NOI growth,allowing us to maintain the low end of the range of core FFO per share guidance. We also increased guidance for percent leased, which is now 93.5% to 94.5%. While we expect same property NOI growth to moderate in the third and fourth quarters from our year-to-date rate of 3.8%, we have increased our full year guidance to 2.8% to 3.8%. Brian?

Thanks, Bruce. And good afternoon. While we are certainly aware of the weakening economy and are closely monitoring our portfolio, we have yet to see any signs of deteriorating tenant health or shrinking retailer demand for space. The leasing volumes remain very strong. Including developments, we leased more than 2.1 million square feet of space on a gross basis, including almost 1 million square feet of new leases. To put that in context, that's nearly 60% more than the quarterly average of total new leasing since 2006.

We had substantial net absorption in the operating portfolio, picking up 160,000 square feet of leased space in the quarter and building on momentum of the previous three quarters. In fact, when compared to the second quarter of last year, same property percent leased increased 170 basis points, which represents 0.5 million square feet of net absorption.

What's even more notable are the gains we've made and are continuing to make in small shop leasing. Spaces less than 10,000 square feet gained 280 basis points year-over-year and are now 87% leased. All signs point to a continuation of this progress. Our pipeline of leasing activity remains robust, and as a percentage of vacant space it is even stronger than it was at this time last year.

Rent growth increased and average base rents for shop space were positive, both for the fifth consecutive quarter. And accounts receivable balances over 90 days continue to fall and are now less than 0.3% of revenues. I say this really just to give you a further indication of the health of our tenants. Lisa, Bruce, Hap and I have the good fortune to work with a team of experienced a diligent asset managers who are proactively monitoring our tenants' health, so the well publicized Supervalu issues have certainly not caught us by surprise.

What we have learned from prior tenant failures is that are is that the underlying real estate can provide insulation to the poor performance or bankruptcy of individual operators. With respect to the Supervalu exposure in our portfolio, we believe the significant majority of their stores are in high-quality properties where we anticipate readily finding good replacements. And in most cases we would expect the rent spreads to be positive since our current Supervalu leases are on average more than 20 years old.

Turning to developments, I would like to take a moment to reiterate our development strategy. Development is a core competency and a competitive advantage that sets us apart, and a way to create value for our shareholders. Our right size and more disciplined strategy is focused on creating dominant shopping centers intended to be hold long-term and located in target markets with infill characteristics.

The performance of the more than $300 million of development, redevelopment and expansion starts in the last few years under scores the success of the strategy. Developments and value-add redevelopments started since 2009 are currently over 90 percent leased and committed and have generated an average return on invested capital of 9.3%. And that's with three quarters of these projects still under construction.

As you know, these returns from high-quality centers would be impossible to replicate through acquisitions. Further, the properties that were in process at the end of 2011 have gone from 58% to 85% leased in the first two quarters of this year. That's a lot of leasing in a short period of time and reflective of the quality of the developments.

In looking at this quarter's two new development starts, the first Erwin Square in Durham, North Carolina, is a prototypical grocer anchored center. It is an excellent infill opportunity in an established business district adjacent to Duke University. Already nearly 75% of the center is either leased or committed, with Harris Teeter as the anchor and many best-in-class retailers taking shop space.

The second, Grand Ridge Plaza, located in one of the most desirable areas of Seattle, Washington, is a much anticipated infill town center positioned next door to a planned Microsoft campus in part of a high end master plan community. With average household income in excess of $130,000 and extreme development barriers, this is a prime example of the type of community center development that we would undertake. Anchor tenants include Safeway, Regal Cinemas, Dicks Sporting Goods, Ulta and a Marshalls HomeGoods combination store. Despite having just broken ground, we have leases in various stages of negotiation for over 90% of the leasable area, including executed leases with top-notch local and national operators.

Now I would like to share some color on the portfolio sale. In essence, the portfolio was comprised of properties that are not consistent with our current investment strategy and don't enjoy the long-term NOI growth potential of the vast majority of our existing portfolio or of the shopping centers that we are buying and developing. Population densities and average household incomes for these assets are 55,000 people and $80,000 respectively, compared to roughly 100,000 people and incomes of a $100,000 for our portfolio as a whole.

Grocery sales for the portfolio assets averaged $21 million, compared to $26 million for our total portfolio. Several of the centers are located in non-core markets like California's Central Valley and Inland Empire, and Akron, Ohio. And in some instances we had concerns regarding the amount of shop space, rents in relation to market, the suitability or productivity of the anchor ten, and co-tenancy and kick-out issues.

On the acquisition front we are negotiating the purchase of four dominant shopping centers. If we are successful, Regency's a total investment for the centers will be in the $200 million range. Each is an exceptional property, with superior growth prospects that together are expected to pound NOI in excess of 3%. The average household incomes in three mile populations of these centers are well above those of the properties we have sold, and most importantly grocery sales for the four centers averaged $1,000 per square feet. Given these attribute, we expects the dominants shopping centers that we are buying to generates substantially higher NOI growth than those being sold. In time the compounding higher NOI growth rate will over come the initial earnings dilution and ultimately outperform.

In summary I am proud of the results that the team has produced so far this year. By continuing to fill our vacancies with proven operators, acquiring and developing dominant shopping centers, and disposing of I believe the portfolio is in greatly and should be more resilient in the next downturn. Hap?

Thank you, Brian, and thank you, Bruce. In closing, while one cannot ignore the uncertainty in the macroenvironment, I am extremely encouraged by the continued and significant progress that is being made towards our key objectives of growing NOI, of creating value in dominant centers through disciplined development, of enhancing the quality of the portfolio and its NOI growth, [and] focused recycling and strengthening a solid balance sheet with reliable access to capital. Which, when combined, will translate into growth per share core funds from operations and NAV.

It is gratifying that these results are meeting Regency's high performance standards and positioning us well for the future, whetherit be prospering in a growing economy, even if the growth he is sluggish, or weathering another recession. We thank you for joining us on the call and now welcome your questions.

(Operator Instructions). We'll take our first call were Paul Morgan, Morgan Stanley.

Hi. Good afternoon. On the dispositions, there was just a couple of questions. First, in terms of the Blackstone deal, why did you put the Lifestyles Centers in there in Texas, and did that -- were those below the cap rate of the average? I mean, and if so -- or if not, is there a potential roll-down there and maybe that cap rate looks higher than it otherwise would be for newly developed centers? And then second, why the sale of the San Pedro assets?

The San Pedro asset, I will start with that. I mean, that was in a partnership. Our partner thought it was time to sell, and we had major capital improvements to in effect maintain and continue the NOI growth rate on that asset.

We put together this portfolio, and we felt it was -- bottom line is we're pleased with the sale that occurred, and not because we feel that we sold Blackstone a bill of goods, but because it really -- the sale met our objectives. It was an efficient transaction with certainty of close, and the assets, as Brian mentioned, did not meet -- not up to the standards as far as our $100,000 household income, the supermarket sales in our portfolio, and density. And as Brian said, they don't have the growth potential.

And there's some risk, which obviously Blackstone is very aware of, including anchor co-tenancy and shop space. And for example, I would talk about one of the Lifestyle Centers there, the shops at Highlands Village. As you may are may not be aware, Blackstone has added or signed a lease with Whole Foods to go in there, and we were obviously aware of Whole Foods' interest, we communicated their interest to Blackstone. But still given the rents, the risk associated with the co-tenancies and kick-outs, although there's not a high probability that those risks are going to manifest themselves into occurrence, we just were not comfortable with the amount of management time or the consequences if something went wrong by continuing to hold the asset.

Okay. Thanks. My other question is just on the core. I mean, you are seeing kind of great results in terms of occupancy and same-store NOI. The rent growth on new leases has been kind of stubborn, and I'm wondering of you're seeing any potential for movement there. Obviously they seemed to be dragged down by some of the older vacancies, but give on your leasing velocity and the commentary, do you think we could see that turning positive over the next several quarters?

We definitely think that's possible. As you indicated, we aren't yet seeing the levels we want to see, but what we're really talking about here is pricing power, and there's no question that power is improving, that the trend is in the right direction. We have had five consecutive quarters ever positive rent growth, and 80% of the transactions this past quarter were positive rent growth. So what's still holding us back a little bit would be, as with anybody, some large deals. They always move the needle.

For example, we had to put in a new -- we had to renew the medical user at Martin Downs 40,000 square feet, in order to get that property sold, and so we took a hit there, And we've got some significant negative spreads on leasing activity in Arizona. But rent growth is all about leverage, and we are hearing from across the country the return of leverage, multiple tenants competing for spaces. You can see the demand for the shopping centers. More and more of the properties are getting the 95% level where we do have pricing power, and we're starting to exercise a lot of termination rights that's allowing us to put in better tenants, strategic move-outs, and that's also going to give us better options in the future.

So we aren't there yet, but I do think the trends is holding where you're talking.

Great, thanks.

Moving on let's go to JPMorgan's Michael Mueller.

Yes. Hi. First question, it seems like you're getting good traction on the Grand Ridge leasing for the developments, but when you're looking at new starts today, what are you underwriting for a period to ultimately stabilize the project? And how does that compare to what you were underwriting before the downturn?

It depends on the property. In the ones where we have 10,000, 14,000, 15,000 square feet, we're obviously going to underwrite it a little bit to happen faster than if we have more square footage. But in all cases we're looking to put the amount of shop space in there that would allow us to lease that up and get to 95% within no more than two years from the first anchor opening.

And we would like to see good visibility and a good probability of making that within a year.

Okay. Great. And then the second question -- oh, sorry. Go ahead.

Go ahead.

Yes, I was going to say, and the second question, the $200 million in acquisitions that you referenced, the four properties, are they individual transactions, or is that a portfolio?

Those are individual transactions.

Okay. Great. Thanks.

Let's go to Quentin Velleley with Citi.

Hi, good afternoon. Just speaking to the Blackstone transaction in terms of the 8%-plus cap rate, and you commented that they were lower growth assets. Could you maybe quantify that a little bit more? Were they -- were you expecting flat NOI or even negative NOI over the next five to seven years versus, 2.5% to 3% growth in your portfolio? Is that how you were thinking about it?

I think -- looking at it it's flat NOI, maybe some upside but there's also -- to that, but there as also, as I indicated, some risk to that. And once again, Blackstone is a very astute buyer, and from their perspective I'm sure they feel like they made a good buy, but the transaction achieved our objectives, and from our point of view it was a win-win transaction and -- but I think the best way to look at that from our perspective is flat NOI growth.

Did you offer Blackstone substantially more assets, or were these the only assets that they looked at.

This was the portfolio, and there was no [cherry picking].

Okay. And then just lastly on dispositions, given the ramp this year, how should we be thinking about 2013 and beyond? Are you going to get back to a more normalized $1 million or $2 million of dispositions? Or given where capital markets are at the moment and given where risk is in some of the supermarket retailers, should we expect to see this kind of volume of dispositions next year and beyond?

I think we feel real good about what we've accomplished, and that was one of the reasons why we wanted to do an efficient transaction like this and a large transaction. And I think it's a -- in our view, as you just said, I think we feel comfortable with where we are, and that we are going to be able to get back to a more normalized rate of dispositions in the $150 million to $200 million range.

Perfect. Thank you.

Let's now go to Tayo Okusanya with Jefferies.

Good afternoon. Two quick questions. First of all, the $200 million of upcoming acquisitions, could you let us know what cap rate that is -- at what cap rate those transactions are being done at?

Well, they're not finalized yet, but they are -- I think you may have seen we slightly reduced our guidance on where acquisitions would be, so you can imagine they are lower than what we've done so far. And so let me just dwell on that a moment. The whole reason that we're doing this -- the key objective is to maintain sustainable NOI growth of 2.5% to 3.5%, and the capital recycling, including the acquisitions there, are a key component of that.

We want to buy the kind of shopping centers that are highest quality, because our experience is they generate the most growth. So what with do when we price those is we look at total return from the asset. So we look at the initial return, plus the average compounded growth rate over the ten year period. So the only way that we can get to those -- to forward lower cap rate deals would be if these properties are going to generate higher growth rates.

So that's -- and the properties that we're buying just -- and we're not done with them. We do control them all, but we are going through due diligence. You just don't know what may happen. They're all A-plus locations. One is a generational kind of product that just does not come on markets but every 30 years or so. One has a redevelopment component. So those are kind of ways that we're getting to the growth, and much of it is either through redevelopment or contractual anchors.

And our growth expectation is on the higher end of that 2.5% to 3.5% range, sometimes above that especially the one property that has the redevelopment opportunity.

Got it. That's helpful. Then on the small shop space, could you just talk a little bit about opportunities to actually consolidate small shop space for tenants kind of looking for more kind of 15,000 to 20,000 square feet of space? Are you seeing a lot of that kind of demand?

We always look for that. We have several examples of that this past quarter. We have three different centers where we had small shops, three small shops in each case where we consolidated them. Some were just tenants that we had given rent relief to and had termination rights. We triggered them. And in three we all put in the larger pet stores like Petco. And then we had a situation in Maryland where we had three small space, and we terminated a couple, relocated one to make room for Michaels. So we look for that as often as we can do it.

But I think more than -- just to be clear about that, more often than not we're playing offense with that as it relates to merchandising and as it relates to rent growth. Not as it relates to -- because we're scared [of the space].

Got it. Okay. Thank you very much.

Thank you.

Let ease go to Cowen and Company's Jim Sullivan.

Good morning. First of all a question for Brian. Kind of a follow-up to the comment just made about the 2.5% to 3.5% same-store NOI growth rate. When we look back at the prior cycle, from I think is about 2005 to 2007 or so, the same property NOI growth rate was averaging pretty close to 3.5%. And I know every cycle is different, and it may be that the uncertainties today are causing people to be a little more conservative. But given how your occupancy is ramping, and you mentioned I think in your prepared comments pricing flexibility, are you pretty optimistic that we're going to have a period here where we should see multiyear same property NOI growth in excess of 3%?

Yes. We -- for the reason you talked about. I mean, occupancy can drive it right now. We do have contractual rent steps that have helped us throughout the period, good times and bad, and then we are seeing the pricing power for the rent growth. So that plus we've significantly upgraded the quality of the portfolio. We'll continue to do that. I think we have better retailers who are going to be able to drive sales better. We have more productive grocers, so I think yes.

I think given a range of 2.5% to 3.5%, but I think the expectation of being on the upper end of that, as long as the economy holds together, is realistic.

Okay. And second question. The -- obviously Supervalu has been in the news recently, and there's always one or other supermarket chain that seams to be losing market share and suffering, and I'm just curious, given what we have been through and obviously you guys maintained a very substantial development pipeline for many years when the cycle was strong. I just wonder, as you think through formats, and as formats change in the industry, both for grocers as well as total center size, what can we expect or should we expect going forward in terms of your appetite for either the larger supermarket formats or the larger format centers all together? I'm talking about in terms of what you want to commit to in terms of your development pipeline.

I think what we started this quarter is indicative of an infill grocery neighborhood shopping center near Duke Universities and Duke Medical Center and a larger formatted grocery anchored, multi-anchored center in one of the better areas of Seattle.

Jim, we want to make sure that, where we can, we want to focus on the grocery anchored shopping centers. Now it so happens that would typically be a neighborhood center, and we want to do an infill locations or those areas where strong infill characteristics. But if you look at Issaquah or the center in Seattle, that one is a community center, but it does have the leading grocery store up there in Safeway, and it is such a high barrier market. I mean, the last shopping center was built in that area was 20 years ago. It's a 100 percent lease now. This one took years and years. So we're really comfortable to develop a larger center in that kind of a space, but the focus is on grocer anchor centers.

And in general if the focus is infill, presumably it's difficult to find these sites. I know you have to work on them for a long time, and getting approvals can take a long time. And as you think about what kind of level of development starts you can ramp up to as the market strengthens, I'm assuming you are still thinking it's going to be well below what it was in the peak previously?

Yes, because we were at $500 million a year. We were staffed to are that. We were capable of doing that, but that's a very difficult problem -- or program to manage. We plan to be at $150 million, $200 million a year. To the extent we see opportunities greater than that, then we're just to going to start picking which ones we like the both of those, and we do not plan to grow it larger than that. But we think we're there now, and the outlook for starts down the road is pretty promising.

Okay. Then final question for me, also on development. The level of quarterly development costs being capitalized is running about $2.5 million. I'm assuming we should assume that's the run rate that you will be at if you maintain this level development.

That's correct.

Okay. Thanks.

A question Samit Parikh, International Strategy and Investment Group.

Good morning. I wanted to see, Bruce and Lisa, if you can help me get to your guidance range for 3Q? I know that the captive insurance would go down, call it, $0.04 to $0.05 of FFO sequentially. And then there's the Blackstone sale as well, but I'm having difficulty getting from, call it, 69 core to the mid-to-high point of your 55 to 59 range next quarter.

I think it probably is related to disposition activity primarily. I think that's always going to be the difference when analysts can't get to our numbers. Our assumptions versus whatever you're going to assume.

Okay. And then I --

Really, quickly because the captive, it is buried in the other income line. It was a little bit larger this year than it's been in typical years. On a combination basis it was north of the $4 million. When I say combination, I mean what's coming through equity income, pickup as well as on the consolidated income statement. So a little bit larger than normal.

Okay. That's helpful. And then I guess also could you comment maybe on Safeway and their plans on developing their own shopping centers? It seams like clearly they're developing in markets that you covet. How much of a competitor are they for you guys to gain these sites that you want to develop on?

Well, we know that Safeway development team well. We like them, we respect them. In fact, a former employee of ours is part of that team. They're not new do development, and we have been competing with them for some time. Probably ten years ago we competed with them on our Folsom and Tracy projects, and we prevailed on those. They do obviously have a new focus, an emphasis on it.

But the reality is we don't run into them very much, and I think it's just because we're different. We're focused on new ground-up dominant centers anchored by whoever is the best grocer in the given market, and Safeway focuses on Safeway stores. So that means where they have a store presence they may not be very active, and from what we have seen in the market is that most of what they're doing -- and this may not be entirely true because we don't have access to their who pipe, but most of their capital is going to redevelopment other single tenant buildings for a Safeway store, maybe a fuel center.

So we don't run into them. The only two projects that I know of that we've competed with them recently would be the Grand Ridge project in Seattle, where they're going to be an anchor of it. And then we both went after a project in San Jose and neither one of us got it. So I don't think it's -- like I said we just don't run into them that much. We could, and when that happens, sellers make their own decisions as to what it is that they're looking for. I think personal relationships still matter, solving seller's problems matters. And then in the case of a master plan community like Grand Ridges, I think the seller felt that having multiple relationships with different kinds of retailers was an advantage in terms of creating an amenity for that community.

Okay. That's helpful. Thank you.

RBC Capital Markets,Rich Moore. Please go ahead.

Hi. Good afternoon, guys. The two new development projects and ones I guess you're looking at going forward, are those primarily on land that you are identifying as new parcels of land that you want to develop? Or do you have any legacy land in your portfolio that may also make its way to the development start status?

We certainly have legacy land that we want to move into development, and I think we have about $60 million worth of that land -- with a cost to date in land like that we plan to develop. But in terms of the ones that we're talking about this year and next year, the vast majority of those would be new properties. In fact, for 2012 they're all new except for the South Bay Village.

Last year we started the project in Petaluma, Southern Sonoma County, which was land held, and we're actively working on several other sites.

Okay. Good, thank you, guys. And then on the Blackstone transaction why the preferred position? I mean, what is the rationale behind hanging on to that?

That was a transaction -- that was a structure that they offered up, and you may or may not be aware, Rich, they used in other transactions where they bought properties, and we negotiated that down to a short period of time of 12 to 18 months.

And higher return.

And higher return.

Okay. And so they -- yes, I was aware, thank you, Hap. So they just basically insist on a strategy like that?

I wouldn't go there, but that was part of their offer. And that's where we ended up.

Okay. I got you. Thanks very much.

Thank you.

Let's move on to Cedrik Lachance with Green Street Advisors.

Thanks. You acquired a [CVS] small property this quarter. I know it's not a lot of money, but what is the strategy behind it?

Cedrik, that was one that was brought to us by a joint venture partner we have done multiple developments with, and it was just a frankly just a no brainer opportunity to get development returns with zero risk. I mean, it's Tysons Corner. It's grounds zero in terms of Washington DC real estate. And that was a situation where the partner identified a building that because of earthquake damage had been emptied out. It was a three story office building, and we went ahead and bought that. We just had the grocer take the center -- I'm sorry -- the drug store take the center as is. Complete bondable lease. We don't put a nickel into it. We get a development return. We literally didn't do anything, and we've got a 9% return project with great credit.

Okay. So there's nothing else that will be done there over time? It's a simple long-term lease with quality credit tenants.

Quality credit tenant. Like I said, total bondable lease. We don't' -- we're not responsible for anything, so we have no operating dollars going forward, we have no construction dollars going forward. And really it is just the ancillary benefit to that is you get your name in that market as continuing to be active in development or redevelopment opportunities of that magnitude and nature.

Okay. And then what is the current gap between your lease space and physically occupied space in your portfolio?

240 basis points. 240 basis points total, of which about 230 is preleased. 250 total. 230 prelease and 20 for slow pay.

Okay.

Which isn't much different than what it's been for a while now.

Okay. I mean, we've been anticipating, I guess, the shrinking of that gap. When do you think you go back to the nor normalized 100, 150 basis points?

Well, I think the reason it's so volume of leasing. I mean, this was a huge quarter of new leasing for us, so that's what's keeping that line up there, the preleasing line, and that will start to fall as we get -- as there's less space to lease.

If you look at the he effective rent paying occupancy, all that preleasing has been translating into rent paying occupancy. It's just that we keep continue to do a lot of leasing.

Okay. Thank you.

Thank you, Cedrik.

(Operator Instructions). Moving on, let's go to Deutsche Bank's Vincent Chao

Hi everyone. Just going I don't understand the Blackstone transaction, just wondering if you could provide some commentary about the general interest in B class or secondary market properties today?

Sure. I think what's happened probably this quarter versus last quarter or the quarter before is with all the uncertainty out there, what's happening at the end of the year, that buyers are less -- I mean, are more risk averse, and they're not going to go out on the risk spectrum without getting compensated with yield. So I think what you're seeing is that buyers will pay up for high-quality properties that have strong grocers that are generating strong sales, but if you start to lose any of those things, then the pricing falls off pretty fast.

And leverage can also be an impediment to pricing.

Okay. But so you're not seeing any improvement in the secondary markets, which is something we heard on some other calls?

Well, there's improvement in leasing markets, but in terms of specific to dispositions and acquisitions of B properties or in second-tier markets, I think if anything it softened.

There is a modest -- because of the huge amount of demand for core institutional quality real estate, there is a modest expansion of the definition of core, but beyond that it's -- people are interested in -- there is a lot of buyers for core, and -- as Brian indicated, and a lot of buyers for value-add. But the commodity secondary, tertiary markets, it's not a deep pool.

Okay. And just going back to the acquisitions quickly, on the cap rates they've been coming -- in terms of your guidance, they've been coming down over the last couple quarters, and I think you commented earlier that to pay that you would need to see some additional growth in those properties. And I'm just wondering, at this point is your changing growth assumptions, is that coming more from your expectations of market rent, or are you looking more and more at very under market leased properties and/or, lease-up type of properties?

It's really just the structure of each individual asset. As I mentioned, one of the properties we're looking at has a redevelopment component. We would be adding some GLA. And other properties you have significant contractual rent steps. Very little of it -- we focused on the difference between what is contractual and what is speculative, and the vast majority would be contractual. And there's another A quality property that's out there. It's an A plus trophy. Everybody want it, but it did not have this kind of growth profile that we're looking for, so in that case we walked away. So we're not changing our underwriting assumptions at all.

Okay. And I mean, is that pool -- I mean, I'm assuming that's a shrinking pool, so at some point do you stop acquiring?

If we can't meet our total return hurdles, and especially -- I think as Brian indicated, number one focus is if we can get -- we've said a range of 2.5% to 3.5%, but if we can take with the incremental help and the meaningful margin of what we're buying and what we're recycling out of, if we can get that sustainable NOI growth rate to the 3% to 3.5% range, that's our primary focus there. So if we can't find it, we won't.

Yes, andI would just add as Brian mentioned earlier, I mean, capital recycling is really a key part of our strategy. It's an important to part to be sure that we can sustain that 2.5% to 3.5% same property NOI growth. But we monitor very closely our ability to invest those proceeds, and we try to be certain that our dispositions don't get way ahead of our acquisitions.

This year was unique because clearly we're contemplating this portfolio sale, if we go back to the guidance we provided back in December. And so we are well aware. That's why we did the term loans, so we had the flexibility to have debt to prepay, and we had a use for proceeds. So it's something that we watch very closely.

One of the assets we're looking at is a fantastic center, grocer center as it is, but there's some small space, kind of a little mini mall almost area, and we would look to convert that into an anchor, which would be accretive. And then there's some adjacent land right next to it. So there's many ways to get to that growth profile.

Okay. Thank you.

Thank you.

A question now from Tom Lesnick with Robert W. Baird.

Good afternoon. I'm standing in Paula Poskon. What line items and operating expenses drove such a huge sequential improvement in the operating margin? Are those true savings, or just timing related that might reverse in the second half?

They're -- I would say from a trend standpoint we typically see a reduction in expenses in our second quarter. [Just did it] last year. You saw it from the first quarter to the second quarter, primarily in our general operating expenses. Cost related to winters declined. We start paying and truing up to our true real estate taxes that we're paying, and so those for the most part drive those improvements in the second quarter.

And occupancy. Increased occupancy clearly helps that as well.

Okay. And then relatedly, what trends are you seeing in real estate property taxes? Are you seeing those coming down?

It's continued to come down, though I would say at this point we would expect to see that to moderate. I don't think you would continue to see the declines that we saw through last year and what we have seen since the first quarter. So I think that the second quarter would be relatively typical of what we would see in the future, with the exception of if we start significantly ramping up acquisitions where you get those adjustments for values. But I don't think you're going to see significant declines from here on out.

And then likewise, what drove the G&A saves this quarters?

When you say G&A savings, this quarter the prior year or --

Sequentially.

Our net G&A for the quarter that we reported 14-4 is down from 14-6. I would tell you that in general --

Yes, I mean, it was pretty flat quarter-over-quarter.

Some slightly higher capitalization as we increased our development activity, but not what I would call significant. Maybe a $200,000 impact quarter-over-quarter.

Okay. And then separately, how much do you think land prices and construction costs will rise in, say, the next couple years?

Well, construction pricing has been fairly flat. I mean, we were just looking at a week or so a go, and probably over the last three years we have seen a total increase of maybe 10% to 15%. It's not in labor. It all depends on which commodity prices -- a few years back it was oil. It was cement, and now it's metals.

So I don't see anything right now that's going to drive -- certainly the labor component of it. And land prices, until the development program across the country for other people starts dramatically ramping up, I don't think you're going to see it will. Prices are high for -- have held steady for well located infill properties, but anything other than that frankly we're not interested in.

All right, great.

Thank you.

Moving on to Andrew Rosivach with Goldman Sachs.

Hey, team. Really fast one. I pulled out the same-store NOI groups for the first and second quarter, and the pool dropped about $8 million. Is that because Blackstone was in the same store pool and now it's not?

That's correct.

And how much did just the change of mix contribute to the increase in your same store guidance? I just kind of took an envelope -- sorry?

Absolutely none. It was --

None in the first six months.

Yes.

But our expectation is we're more comfortable and probably had some moderate positive impact on a go forward basis.

Yes year-to-date it was -- literally it was neutral, and as Hap said, from a guidance perspective that portfolio sale gave us more comfort of increasing the lower end of our guidance by more than we increased our upper end. There is just a little bit wider range of out comes from the portfolio sale -- from the properties that were in the portfolio.

So what you sold to Blackstone on a year-to-date basis had been running at about the 3.5% NOI growth range.

That's correct. We increased occupancy --

87% to 90% within the what 18 months. And some of that has occurred recently, so a lot of that is baked into the numbers.

Terrific. Thanks a lot.

Thank you, Andrew.

And a question next, Citi, Quentin Velleley. Please go ahead again.

Yes, it'sMichael Bilerman speaking. You think back to -- over the years you've always been a pretty active capital recycler and have been pretty disciplined at culling our the bottom tier of the portfolio and trying to keep on enhancing the rest. And I'm curious with the amount that you sold this year, if you take your what's called $4.7 billion of wholly-owned assets, how much more fits into this 8% cap rate range in terms of quality, in terms of stuff that you would want to get rid of?

Well, I don't want to get specific in that regards, but I will say is as a result of the sales that have occurred this year and that are pending, we intend to move back to the -- what I call moderate levels of annual recycling of $150 million to $200 million a year. Another way of looking at it is that is over 95% of our properties are now located in core markets. So I think we made significant progress, but we're going to continue to be a capital recycler.

Brian talked about the issues related to Supervalu, and there's going to be another Supervalu down the road. I mean, for the most part we want to good real estate where, as he says, bad news is good news. But I think that -- I think the best way to put that one in context is you can expect and we're expecting to return -- not to say that we might not be opportunistic -- but $150 million to $200 million of annual recycling a year.

Well, I guess how would you stratisfy the portfolio? If you're buying core assets today in the low 5%s, and you're selling these weaker assets in the 8%s, you're talking 250 to 300 basis points spread in value, which is pretty substantial. So if you were to take your portfolio, where would you bucket it in terms of value today? How much is in that % category? How much is squarely in the middle of the fairway, a 6.5%, 7%. And what percentage is in that 8%?

That's really -- I mean, you're basically asking us to telling you what we believe our cap rate to be. I mine, I will defer to Brian for in terms of the percentages that we believe As, but I think as a whole you would say that our A properties would be in the 5.5% to 6% cap rate range. Our B properties would be more in the -- call it 6.5% to 7.5%, and then the Cs would be 7.5%-plus. Andfrom a percentage standpoint.

Half to two-thirds -- I mean, 60% to two-thirds in the A, A-plus category, and the vast majority of the balance are going to be in the solid B category.

And then just last question in terms of portfolio you sold to Blackstone, when you go back to the historical cost of those assets, those assets were developed for about $413 million. Obviously a big chunk of the cost is in the Lifestyle Centers in Dallas, between shops at Highlands at a 100 and Preston Park at 60. So from $413 million, a current yield on historical cost about 6.25% for the entire portfolio that you sold. And, Hap, I think in the press release you talked about a $20 million net impairment. How should we think about this gross -- what is a $90 million drop from what you built or bought these assets for to what you're selling them for today?

You said it. I mean, we think -- the current values are what are the current values are , and we're making decisions, where do we go from here? And where we go from here is maximizing our growth in net operating income.

Okay. Thank you.

With no further questions at this time, I would like to turn the presentation back over to Hap Stein for any additional or closing remarks.

We appreciate your time, and we hope you have a great rest the week and great rest of the summer. Have a great day.

Ladies and gentlemen, once again, we will conclude our presentation for today. Thank you so much for joining us. You may now disconnect.