Site Centers Corp (SITC) 2022 Q3 法說會逐字稿

Good day, and welcome to the SITE Centers Reports Third Quarter 2022 Operating Results. All participants will be in listen-only mode.

(Operator Instructions)

Please, note this event is being recorded. I would now like to turn the conference over to Monica Kukreja, Head of Investor Relations. Please go ahead.

Thank you, operator. Good morning, and welcome to SITE Centers Third Quarter 2022 Earnings Conference Call. Joining me today is Chief Executive Officer, David Lukes; and Chief Financial Officer, Conor Fennerty. In addition to the press release distributed this morning, we have posted our quarterly financial supplement and slide presentation on our website at www.sitecenters.com which is intended to support our prepared remarks during today's call.

Please be aware that certain of our statements today may contain forward-looking statements within the meaning of the Federal Securities Laws. These forward-looking statements are subject to risks and uncertainties, and actual results may differ materially from our forward-looking statements. Additional information may be found in our earnings press release and in our filings with the SEC, including our most recent reports on Form 10-K and 10-Q.

In addition, we will be discussing non-GAAP financial measures on today's call, including FFO, operating FFO and same-store net operating income. Reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures can be found in today's quarterly financial supplement.

At this time, it is my pleasure to introduce our Chief Executive Officer, David Lukes.

Thank you, Monica. Good morning, and thank you for joining our third quarter earnings call. We had another very productive quarter with results ahead of budget, significant leasing volume despite having less available space, a number of asset sales with proceeds used to continue to invest in our convenience thesis and a balance sheet that remains in great shape with debt-to-EBITDA in the low 5s, which remains well ahead of the peer group and the sector overall.

Leasing demand continued to be very strong with national tenants looking to expand their footprints in the wealthiest suburban markets where we operate and existing tenants looking to lock in their locations with renewals. This activity, along with execution from our leasing team, resulted in a 60 basis point sequential increase of our portfolio lease rate to 95%, which is consistent with our commentary and goals for the year. I'll start my comments for the quarter, shift to leasing, then move to the transaction activity.

As I mentioned, third quarter OFFO was ahead of budget primarily on better operations, which Conor will provide more details on later. Despite no shortage of headwinds, our tenant coordination and construction teams continue to do an amazing job working with tenants to get open ahead of schedule, which drove part of our outperformance this quarter.

Moving to leasing. As noted, demand and activity remained very high in the third quarter with 1.5 million square feet leased, which is the largest amount of total square footage this company has leased in 5 years despite a materially smaller footprint. In terms of new leasing, we had another quarter of over 200,000 square feet of new deals with strength from national shops as a standout.

Our shop lease rate was up 180 basis points sequentially and 520 basis points from the third quarter last year. Quite a bit of this leasing was in our tactical redevelopment pipeline with deals from Cava, Starbucks, Sweetgreen, Visionworks, Drybar, Club Champion and a few other first-to-portfolio deals expected to be signed in the coming months. The projects broken out on our tackle-development pipeline that are under construction are now 84% leased with deliveries beginning this year into 2024 with immediate expected accretion. Looking forward, we have another 250,000 square feet at share in lease negotiations, which we expect to be completed over the next 2 quarters with activity from a mix of national publicly traded credit tenants.

Based on the trending strength of small shop leasing and considering our current pipeline of unexecuted lease negotiations, we believe that the lease rate on our portfolio will continue to climb marginally through the end of the year, absent bankruptcies. That said, the absolute level of activity will moderate as we simply have less space to lease.

Shifting to transaction activity. We had another quarter recycling capital, highlighted by the sale of the previously announced Madison Pool A portfolio for $388 million. Net proceeds were used to pay down debt and reinvest in convenience assets in Atlanta and Phoenix. We also opportunistically sold 1 wholly owned property in Columbus at a cap rate in the 6% range and use the proceeds to pay down debt and to repurchase stock at a double-digit FFO yield and a mid-8% implied cap rate.

The largest investment this quarter was the acquisition of a 4-property portfolio for $23 million in Phoenix, Arizona, which is a top 10 market for the company and a market we've transacted in a number of times in the last year. The properties are 100% leased to a mix of service and quick service restaurants with 76% of the tenancy National Credit and a drive-through unit at all 4 properties.

We underwrote a 5-year NOI CAGR of 3% plus with minimal CapEx, which is consistent with our existing convenience portfolio and one of the key attributes of our thesis. Moving to Atlanta. We bought another convenience asset in our largest market and remain excited about the potential for more opportunities to grow our portfolio in this key MSA given our presence on the ground.

The property is located as a few miles west of Hammond Springs, which was another convenience asset we acquired in 2021. Going forward, we remain encouraged by the unique opportunities in the convenience subsector that are a direct result of local relationships formed over the past several years. Future acquisitions would allow us to continue to grow our portfolio of properties with strong credit and low recurring CapEx located at high-traffic intersections within wealthy suburban communities.

Because the cash flow growth profile and risk-adjusted IRRs of this property type are elevated with rents accelerating with inflation, we will continue as we have in prior years, to utilize retained cash flow and proceeds from recycling fully stabilized assets into the sub-asset class when the right opportunities arise.

The decision, as always, will be measured against other capital-allocation options that we have at the time and consistent with our goal to generate sustainable OFFO and AFFO growth. In summary, we're pleased with our portfolio and the current strength of operations, our investments, which have increased our long-term growth profile and future investment prospects, which we believe will create stakeholder value while prudently managing our balance sheet.

Thank you to the entire SITE Centers team for another very productive quarter. And with that, I'll turn it over to Conor.

Thanks, David. I'll comment first on quarterly results, discuss our revised 2022 guidance and some of the moving pieces heading into the fourth quarter and 2023 and then conclude with the balance sheet. Third quarter results were ahead of plan, as David mentioned, due to a number of operational factors, including earlier rent commencements and higher occupancy and higher overage and ancillary income.

These operational factors totaled about $0.01 per share relative to budget. The quarter also included $200,000 of unbudgeted straight-line rent from the conversion of cash-basis tenants and $300,000 from payments and settlements related to prior periods. In terms of operating metrics, the lease rate for the portfolio was up 60 basis points sequentially and 270 basis points year-over-year, with our lease rate now at 95%, which is well above the company's pre-COVID high watermark of 94.3% back in 2017.

Highlighting our leasing volume and backlog, we had over 250,000 square feet of new leases commenced in the third quarter, representing over $5 million of annualized base rent. Despite that, the SNO pipeline was effectively unchanged at $22 million as new leases were added and offset the impact of commencements.

These signed leases continue to represent over 5% of annualized third quarter base rent or over 6% if you also include leases in negotiation in our pipeline. We provided an updated schedule on the expected ramp-up of the pipeline on Page 6 of our earnings slides. Same-store NOI grew 1.1% in the third quarter with the uncollectible revenue line item, a 160 basis point headwind to year-over-year growth.

Included in uncollectible revenue this quarter were $510,000 of reserves related to unpaid revenue from Cineworld as a result of its recent bankruptcy filing. Moving on to our outlook. We are raising our 2022 OFFO guidance to a range of $1.16 to $1.17 per share. Rent commencements, uncollectible revenue and G&A are the largest swing factors expected to impact fourth quarter results and where we end up in the revised full year range.

We are also raising expectations for fee income to the top end of the prior range and leaving same-store NOI guidance unchanged, which we believe is prudent considering the macro environment despite third quarter outperformance versus budget. To date, outside of the Cineworld bankruptcy, we've had no unbudgeted fallout or other bad debt headwinds.

Details on same-store NOI are in our press release and earnings slides. For the fourth quarter of 2022, there are a few moving pieces to consider from the third quarter. First, as I previously mentioned, we had $300,000 of nonrecurring, uncollectible revenue and $200,000 of nonrecurring straight-line rent in the third quarter. Second, the Madison assets sold in July generated almost $200,000 of NOI at share and almost $750,000 in JV fees in the third quarter, which implies total JV fees of about $1.8 million for the fourth quarter.

Lastly, the third quarter included $1.3 million of lease termination income, which is about $1 million higher than our trailing 2-year quarterly average. A summary of these factors is on Page 9 of our earnings slides. Moving to 2023. We are not providing guidance at this time, but wanted to provide clarity on a few line items heading into the new year.

First, on fees. We expect JV and RVI fees to total about $5 million with minimal contribution from RVI. This assumption reflects activity to date along with additional expected JV asset sales. Second, we would expect G&A to be about $50 million. Third, 2022 year-to-date results include $2.8 million of nonrecurring reserve reversals and based on remaining AR on the balance sheet, we expect reversals to be relatively muted in 2023.

And lastly, we have 3 Cineworld or Regal Cinema locations with total annualized base rent of $2.9 million as of September 30. None of the leases have been rejected to date but it is likely that we will recapture at least one location based on our initial conversations. The 3 leases are generally evenly split in terms of rent and recoveries across our total exposure.

Finally, ending with our balance sheet. At quarter end, leverage was 5.3x, fixed charge remained over 4x, and our unsecured debt yield was over 20%. In the third quarter, we repaid the debt associated with the Madison Pool A portfolio as part of that sale and swap the $200 million term loan to a fixed rate for the remainder of the loans term at an all-in rate of 3.8%.

Pro forma for these transactions, the company has just $87 million of unsecured debt maturing through year-end 2023, $870 million of availability on our recently recast line of credit and floating rate exposure is just 6% of total debt. This leverage profile and significant capacity provide substantial liquidity and allows us to take advantage of potential future opportunities as they arise and to drive sustainable growth. With that, I'll turn it back to David.

Thank you, Conor. Operator, we're now ready to take questions.

We'll now begin the question-and-answer session.

(Operator Instructions)

Our first question comes from Craig Mailman from Citi.

David, I just want to touch on the leasing. You've seen the detail there and the (inaudible) velocity actually did improve quarter-to-quarter kind of led by renewals. There seems to be still some consternation in the market about the headlines you're seeing among the retailers and the kind of the steady fundamentals we're seeing among the landlords.

And I'm just kind of curious if you could give kind of some updated color on what you're seeing quarter to date? And also, just curious how much, if any, do you think of demand is being pulled forward this year with a higher pace of renewals?

Craig, it's a little hard to hear you. So I'll try and answer that, and then you can let us know if we miss any pieces of it. But the leasing activity just remains to be very strong. I think we've had a number of people speculate when that's going to slow down, some of the macro concerns about the consumer or inflation or pending recession is going to kind of put an abrupt halt to leasing.

But at this point, we're just not seeing a slowdown in demand. I would say that we're seeing a slowdown in supply. I mean our properties at this point at 95%. And we mentioned in the prepared remarks, the additional square footage, the center negotiations now feels like it's going to continue to move higher through the remainder of the year.

I guess the only color I can give you on that is that it feels like in the wealthier suburban communities where we operate, there's 2 things that have come out of the pandemic that remain very clear in the retailers' minds. One is that convenience matters. And that's either from in-store personal trips that are kind of short duration and quick trips from your local community.

And the second is that the larger retailers are using a store fleet for fulfillment and so they're trying to get as much square footage out into these wealthy suburbs as they can, and there's just not that much space left. So I think part of that is prompting them to action where they see rents rising, and they want to secure space in 10-year leases.

And that's why most of our leasing activity is with national credit tenants, and we just haven't seen that much demand, and we haven't executed many leases with local small shops. It's mostly the national chains.

That makes sense. And just one quick follow-up on that. Conor, through the Cineworld impact, and you had mentioned that there could be some room for lease rate going forward absent any bankruptcies. Can you guys just give us a sense of how you feel about some of the tenants in your portfolio that have kind of been in the news, whether it's Bed Bath & Beyond or others, and what type of reserves you may have embedded right now? Or how we should think about maybe for '23 with bad debt?

Craig, it's Conor. Again you're hard to hear. So let me know if I miss any pieces of response. On Cineworld, I said in my remarks, we expect to recapture 1 of the 3, and the revenue is fairly equally split between the 3 locations. The reserves taken in the third quarter were entirely related to the unpaid rent from the third quarter or unpaid revenue, I should say, excuse me, we had the tenant on cash basis previously.

So there is no additional AR hit or bad debt hit from that specific tenant. As for the other tenants that you named and some other names that are on folks watchlist, we can't speak to individual tenants, I would just tell you, we feel really good about the quality of our portfolio, the level of demand we have and we've had periods before, we've had bankruptcies.

And I think if you look back in the last 5 years of this portfolio and our track record, we've been able to successfully backfill those locations at higher rents with better tenants. So if there is an uptick in bankruptcy, obviously, it's outside of our control, but we feel really good about the backfill prospects and the portfolio in general. And comment on 2023, happy to address that as we get closer to the next year and provide guidance.

And this is Nick Joseph here with Craig. Just one more. As you think about deploying capital, how have your return hurdles adjusted given the change in your cost of capital? And then how do you think about that in terms of either share buybacks or acquisitions from here?

Well, certainly, our return thresholds have gone up. I mean they've gone up with commensurately with the borrowing costs. I think that -- there's not a ton of deal flow out there. So it's hard to say where cap rates are settling in, some things have moved so fast.

But we have been buying at higher cap rates this past quarter than we were 2 quarters ago. With respect to the allocation decision of capital as to whether we're buying assets or stock or paying down debt, it really depends on the source and to date, we've really been using proceeds from asset sales, and we've done a little bit of everything. And that is a strategy that will likely continue.

Next question comes from Samir Khanal from Evercore.

David, you mentioned the 250,000 square feet of activity that's under negotiation. And maybe walk us through kind of any changes you're seeing in those leases versus maybe what you've both signed over the last 6 months, any pushbacks you're getting from those potential retailers, whether it's higher TIs.

Just trying to see what -- given all sort of the higher costs and potential slowdown out there, I mean what are the concerns that they kind of come forward in those leases in terms of negotiations?

Samir, if you look on Page 13 of our stuff, which has got the -- particularly the net effective rent category, you'll see that one of the changes over the past year that we've kind of shifted from more box leases to more shop leases.

And I think that's the trend that's going to kind of drive us through the remainder of the year because we've really leased all of our larger square footage locations. There's very few left. And so the demand right now is coming from national shops. Those leases are less of a negotiation than the larger anchor leases.

And so I don't think the terms have changed very much. Certainly, the cost of building out a space has gone up in the past year. But rents have also gone up. So I think, if anything, we're just starting to see the speed at which some of these retailers want to get into local shops has improved.

And that's kind of the only trend I can come up with. I really haven't seen a lot of change in terms. Even the request for TI dollars hasn't gone up as much, even though I think the spaces are a little bit more expensive.

The next question comes from Todd Thomas from KeyBanc Capital Markets.

David, just following up on the topic around capital deployment. I'm just wondering if the market for dispositions is still there to raise capital for reinvestment in new properties or buybacks? And if you could just talk a little bit more about the appetite for stock buybacks in the current environment with the share price below the level at which you repurchase shares at in September?

Well, on the disposition side, it is kind of interesting. You remember, there's one important piece of the transactions world in this country, and that's 1031. And there have been a couple of situations where a 1031-positioned buyer has called us and talked to us about other things that we might want to sell.

And so I do feel like there's one-off activity with smaller or mid-sized properties. Even in the brokerage world, you haven't seen a lot of large portfolios marketed right now. But I do think there's still a lot of activity kind of under the covers where you're getting 1031 money that has to be redeployed quarter-to-quarter. And in certain cases, that's an opportunity for us to recognize, if you would say, yesterday's prices, with today's transaction.

And even if it's just a little bit, Todd, it gives us an opportunity to have some recycling. The decision as to whether we're buying assets or paying down debt or buying stock, I think, has everything to do with the sourcing of those funds. And so the way we thought about last quarter, notwithstanding the fact that the price at which we bought back stock was higher than today's price, but the cap rate at which we sold the asset and then repurchased stock was awfully accretive.

And so I think we feel comfortable with that trade because the cost of that capital is a mark on the asset you're selling and not necessarily where the stock is trading that day.

And Todd, the only thing I'd just add to that is we don't need to sell assets to buy assets. We think it's prudent at this point in time. We still have $40 million to $50 million retained cash flow and other sources of liquidity. So to David's point, we think it makes sense right now to match fund, but it's not a requirement given the balance sheet position we're in.

Okay. And then you did mention though, I mean, it seems like you're still very much focused on acquiring convenient oriented centers. Like you've been acquiring over the last several quarters here. And I would think that, that market is a little bit more fragmented in general and might lend itself well to this environment.

Maybe not a lot of distress at the asset level, but do you expect to see some financial distress perhaps begin to surface the longer this environment persists? And is this an opportunity for you to be a little bit more aggressive, maybe a catalyst to -- for a joint-venture arrangement or a partnership? Or do you think that you pause and sort of await more visibility and slow down a bit here?

Well, to your first point, I certainly agree that it is a fragmented sub-asset class. The dollar value of the transactions tends to be smaller. And I think we've seen that the movement in cap rates up and down happens a little bit faster simply because the dollar values are smaller.

Our hope is that we're going to find even more better inventory than we've seen to date when people's mortgages mature and the cost of refinancing is high. And therefore, sale is more likely to happen. I know John is sitting next to me here, and he's still reviewing an awful lot of deals on a weekly basis. And so I think we can be very selective. But the pricing of those seems to have been moving in our benefit. To your second question on joint ventures, I think at this point, given our capital position, we feel pretty confident that we're finding deals that we like, and we can decide at that time whether we want to buy and continue to grow.

We're open-minded about joint ventures. But if you look at the reduction in JVs at this company in the last 5 years, the quality of our earnings is just much higher than it was 5 years ago. And a lot of that is because it's wholly owned assets that we bought as opposed to legacy joint ventures where some of that income is coming from fees.

Okay. Got it. And just lastly, Conor, you gave a little bit of color on '23, which was helpful. But any thoughts about the May '23 maturity, $87 million, about 3.5%? How should we expect that to be repaid or funded or refinanced, I guess?

Yes, it's a good question, Todd. I mean, thankfully, we still have 7, 8 months until that maturity. And to your point, thankfully, it's a stub bond. It's not a full-size bond. So look, there are a number of options to date. We just recast our line of credit. So in a worst-case scenario, we've got 5 years of term there, and we could put on the line.

That's obviously not a sustainable long-term solution. But other solutions are we approach the IG market if we see a little more stability or our secured debt ratio is 2%. So we could go down the secured debt route if we need be. So there are a lot of options, to your point. It's quite a bit of ways and it's a stub bond not -- it's not significant relative to enterprise, but we've got a lot of options.

And then the last one is just retained cash flow and paying that down over the course of the year. So TBD until we get closer to that date, the good news is we've got quite a bit of time and we will address it as we see fit at that time.

The next question comes from Alexander Goldfarb from Piper Sandler.

So 2 questions. David, you mentioned upfront that you were surprised how strong leasing has been. And the same breath said, Hey, look, at some point, expect overall leasing volumes to just moderate given running out of space. So 2 parts to that. One, small shop is still sort of in the mid-80s. So it seems like there's still plenty of runway there.

But even still, presumably, as you run with less leasing just because you're running out of space, presumably, we'll see accelerating rents or something of the sort that would sort of signify more pricing power. So I'm curious, are you suggesting that we should be bracing for slower leasing and slower rent growth?

Or is it just heads up to us to be aware of the composition of the leasing stats and maybe focus more on rent growth rather than overall leasing volumes?

Well, certainly, I would focus less on overall leasing volume, total square footage of new leases, and that's simply because the amount of inventory left is getting pretty skinny. I do feel like the market rents are still increasing. And in certain locations, it's surprisingly high in terms of how much more rent we're getting than we had maybe 2 or 3 years ago.

A lot of that is simply because the locations that someone wants, particularly end caps and drive-throughs are in such high demand that those rents are escalating far more than in-line space. With respect to my comment about being surprised, I think I'm only surprised because, like all of us, we hear the negative news every day, skepticism about the economy, nervousness about a slowdown, rising inflation.

There's a lot of macro conversations that are scary. And sometimes sales -- any sales environment, including leasing is sentiment-driven and retailers can change their sentiment and get nervous and pull back. It just hasn't happened. And I think part of that confidence from the retailers is when they look at high-income suburbs, remember, our average household income is $115,000.

These high-income suburbs don't have that much space that's available that is convenient. It has a parking lot. It's got curb cuts that has visibility so the demand is there. And it feels like even if demand slows down, there's enough tenants that are all going after the same space, but it just feels like we've got a little bit more room to run.

Okay. And then the second question is -- and if you already sold it then my bad for forgetting, but I believe you guys still have a Chinese JV that David, you arranged a number of years ago. Just given changes we've seen other Chinese real estate entities pull back, whether it's because of debt or political pressure for Beijing.

Is there anything with your Chinese JV that could result in that potentially unwinding or some transaction occurring? Or that seems -- feels pretty safe and comfortable to you guys?

We haven't seen any change to date. We were just on the phone with them for their quarterly distribution call last week. Our partner there is an awfully large institution. They're happy with the dividends and the collection rate through COVID. I think if you look worldwide at real estate, a company that can deliver a 7-plus percent dividend through COVID is seen as a pretty secure investment. So I don't see any change in the structure of that joint venture in the near term.

Next question comes from Ronald Kamdem from Morgan Stanley.

Two quick ones from me. Just staying on the JVs. You just tossed on the Chinese institutional investor one. But just on Madison and Prudential, just maybe any updates on the plan there? Is there a long-term thinking of doing more selling? Just how should we think about those?

I think it's status quo, Ron, right now. I think that the larger institutions are very aware of what's happening in the credit markets right now. They're heavily engaged in looking at the quarterly reports that we give them from the operations.

I think like most people, they're very happy with the operations, and there's a question mark around valuation. And so because of that, I think status quo is probably more likely going forward on those smaller joint ventures we have. Madison has been selling assets for the past couple of years. And so I think as we mentioned in our prepared remarks that, that is likely that we continue to see some asset sales coming out of that joint venture.

Got it. Helpful. And then going back to the question on sort of the maturity next year. I know, Conor, you mentioned there's a lot of options. But just can you just remind us like where could you issue sort of longer 10-year paper today? Or just give us a sense where the market is today and so forth?

Yes. It's a good question, Ron, and it really depends to your point on the day. I would say the range we've gotten quoted from working with our DCM desk that's kind of across our banks we work with has been anywhere in the last 6 months between 5% and 7%.

And so kind of my early response, it depends on the day. So thankfully, we've got -- I would say, extreme flexibility or optionality when it comes to secured debt, the IG market, the term loan market, whatever it might be. We've shown kind of proven access to all 3 of those markets over the last 5-plus years. And so again, we're talking about a stub maturity that's $87 million relative to a $5-plus billion enterprise value.

Again, we will address it as it comes due in May of next year. But when we think about kind of risk to the system or risk to the company that put down the low end of the risk spectrum.

(Operator Instructions)

Our next question comes from Mike Mueller from JPMorgan.

So I know it's not a lot of volume, but can you give us a sense as to what the cap rates were on the third quarter acquisitions? And then second question, the commenced rate on same-store is about 91.5%. If we look at your signed but not open schedule, where would that take your commenced level, do you think by the end of '23?

Mike, it's Conor. I think last quarter, we talked about the blended cap rate on acquisitions over the course of the year was, I think, just under 5.5%. And I think it's fair to assume with the third quarter acquisitions, it's modestly higher than that.

I mean it's a small, it's only $31 million and the $336 million we bought to date. To David's point, though, we are seeing some upward movement there. So I think it's fair to assume our going in cap rate if we were to buy something going forward, it would be higher than that and obviously more conducive to our cost of capital, more in line with our cost of capital to kind of Craig and Nick's question.

And I missed the second question. I think it's related to 2023. So I'll think of a dodge, but I can't recall what the second part of the question was.

I was looking at your commenced rate of 91.5% and if we follow that signed but not open schedule, where would that put your economic occupancy?

Yes. If you look on Page 6 of our slides, Mike, we've got the commencement schedule for the SNO pipeline by year. We obviously will break that out by quarter in February as we provide more disclosure on the ramp of 2023. The hard part is the SNO pipeline is in dollars and your question around the lease rate and the commenced rate is in square footage.

So it's a little bit of a mismatch. But I would point you to Page 6 and think of that as your guide over the course of '23 and '24 and the SNO commencement deliveries.

Got it. And then maybe going back real quick to the cap rate question again. If we -- if you think about -- I know volumes are lower and you just are not seeing all the data points, but if you think of -- on your comment where you're seeing higher -- you have been seeing higher cap rates, would you say that the cap rates have been moving up kind of in lockstep with what you've seen rates move up? Or do you think cap rates have moved up less than what you've been noticing on the rate side?

Mike, I'll answer that but warn you that we're talking about a pretty small volume of transactions. I mean $10 million, $20 million, $30 million is not going to really be a great indicator. But I think it's fairly easy to answer that rates have moved up much faster than cap rates have. And I don't think that's going to surprise anybody because the rates have moved up the fastest in 4 years.

So I think it just takes a little while for cap rates to reset. The thing to remember is when we're buying convenience assets, about 1/3 of the rent roll matures with no options in the next 5 years. So even though the cap rates are moving up marginally, the market rents are also moving up faster than anticipated. So I think the unlevered IRRs are the ones that are growing a little bit faster than going in cap rate.

Next question comes from Floris Van Dijkum from Compass Point.

Wanted to get your comments on what you think -- talk a little bit about the Kroger Albertsons merger transaction, what that could mean in terms of the impact for the shopping center sector and for the listed sector as well?

Floris, I will suddenly dodge that a little bit. It feels to us like many times when there's retailer mergers and you end up getting in a study of overlap, we've only got 1 property that I think even has an overlap with multiple brands. So I think our data points are pretty small on deciding what that means to the overall sector.

But I could kind of sum it up by saying that any time there's a merger of 2 large entities like that, you do have to wonder whether store closings are a part of that or the outcome. And I think it remains to be seen.

Yes. No. And clearly, you're less impacted than some of your peers. I just -- I was curious to get your take on what you thought this could mean for the grocery sector and frankly for tenant exposures as well.

I will learn with you over time. We'll see.

Yes. Floris, I would say, from our perspective, we're excited that the majority of our exposure is to Kroger. I mean, they've obviously done a great job investing in your stores in the last couple of years or the last couple of decades, excuse me. So to David's point, we think the impact to us is fairly insignificant.

And again, to David's point, if the overlap and you're thinking about overlapping stores, we feel better about owning the stores that have been recently invested in than the ones that haven't.

Great. And maybe just a couple of other minor points here, but I noticed your operating margin actually dropped marginally even though your occupancy was higher. Is that simply an impact of the high -- the rise in operating expenses and not being able to call that back in your recoveries?

And where do you see -- and how has that changed how you think about negotiating new leases with your tenants?

Floris, it's Conor. It's a great question, and I had the exact same question when I saw the first draft of our operating metrics for the quarter, it related to some nonrecoverable expenses that I would call, the majority of which were onetime in nature related to the ancillary income, that's just a mismatch between the income and the expense.

So I would expect that kind of operating margin to continue to trend higher as it has in the last 2 years especially when you think about commencements and obviously, tenants paying recoveries as their leases commence. So I think the majority of that was kind of a third quarter blip and would point you towards kind of the longer-term last couple of years and trailing 12-month metrics as a better kind of indicator of where we're going from a margin and a recovery percentage perspective.

I guess last question maybe on perimeter point, you -- I know you sold a portion of that, I think, for $35 million. Your redevelopment pipeline only has, I think, a $1.3 million project on the books. Presumably, the redevelopment of the remainder of that asset which cash -- it could be quite attractive. It's in a very good location. It's going to be larger. Can you guys give us any more color on the latest thinking and developments there?

Perimeter Point, it's been an asset that we have kept liquid for the last couple of years, Floris. We've had a couple of tenants move out. We've not renewed several tenants, and we've tried to get the site in a liquid state, but we have not sold any of that piece of land.

I think in our opinion, that's a piece of property that is likely to be split up and sold to mixed-use developers, but we have not consummated any transaction there.

Our next question comes from Linda Tsai from Jefferies.

What's your overall expectation for CapEx for next year? I know for a while, you're expecting elevated CapEx, but now your occupancy is getting pretty full, but then we're also in an inflationary environment. So any kind of general thoughts for CapEx in '23?

Linda, it's Conor. It's a good question. Look, I mean, leasing volume remains elevated, and there's a lag, obviously, between when we sign a lease and when we spend the money. And generally, it's usually fair to assume half the cash is spent before the commencement and half post commencement.

So I would expect CapEx to remain kind of elevated versus certainly in '19 and '20, '20 in particular, given the lack of leasing that occurred then. But we'll provide more disclosure on that with 2023 earnings or excuse me, guidance. The only thing I would say is even this year with our heavy spending, we had, call it, $40 million plus of free cash flow.

Just given our payout ratio, even if CapEx is pending next year, which I think it's fair to assume, I think it's also fair to assume that we have a decent amount of retained cash flow just given the payout ratio today. So TBD will provide more color on that with February results, but I would expect it to remain elevated just given the amount of activity we have going.

And then just on bad debt, you highlighted Regal in the presentation, is there any kind of general thoughts on bad debt levels for '23?

Yes, it's a good question. Look, I don't think it's going to be a source of income like it was or has been for the year. Like I said, some of the CapEx question, we'll provide more guidance. But I certainly don't think it will be a source of income given the amount of AR we have left on the balance sheet and just the amount of kind of the macro headwinds we're seeing. But TBD on what that number looks like.

There are no more questions in the queue. This concludes our question-and-answer session. I would like to turn the conference back over to David Lukes for any closing remarks.

Thank you for joining our call, and we will talk to you next quarter.

Conference has now concluded. Thank you for attending today's presentation. You may now disconnect.