Whitestone REIT (WSR) 2023 Q1 法說會逐字稿

Greetings, and welcome to the Whitestone REIT First Quarter 2023 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, David Mordy, Director of Investor Relations. You may begin, sir.

Good morning, and thank you for joining Whitestone REIT's First Quarter 2023 Earnings Conference Call. Joining me on today's call are Dave Holeman, Chief Executive Officer; Christine Mastandrea, Chief Operating Officer; and Scott Hogan, Chief Financial Officer.

Please note that some statements made during this call are not historical and may be deemed forward-looking statements. Actual results may differ materially from those forward-looking statements due to a number of risks, uncertainties and other factors. Please refer to the company's earnings news release and filings with the SEC, including Whitestone's most recent Form 10-Q and 10-K for a detailed discussion of these factors. Acknowledging the fact that this call may be webcast for a period of time, it is also important to note that this call includes time-sensitive information that may be accurate only as of today's date, May 3, 2023.

The company undertakes no obligation to update this information. Whitestone's third quarter earnings news release and supplemental operating and financial data package have been filed with the SEC and are available on our website in the Investor Relations section. We published first quarter 2023 slides on our website yesterday afternoon, which highlighted topics to be discussed today.

I will now turn the call over to Dave Holeman, our Chief Executive Officer.

Thank you, David. Good morning, and thank you for joining Whitestone's First Quarter 2023 Earnings Conference Call. We are pleased to deliver another quarter of strong results on multiple fronts and are solidly on track to achieve our FFO guidance for the year and the underlying key drivers we previously have communicated. In terms of leasing activity, 2022 was a record year for us and 2023 has shown no slowdown in demand for spaces in our centers as evidenced by our sector-leading leasing spreads in Q1. It seems commercial real estate is often one category in many of the headlines today.

So I wanted to make a straightforward point that investors know, but sometimes seems to get lost. Simply put, not all commercial real estate is the same. Whitestone is in the most desirable markets, have the right types of tenants, the most flexible and in-demand size of leasable spaces and continues to benefit from limited supply and strong population and job growth in our markets and also continues to benefit from hybrid work as consumers spend less time in offices and urban centers and more time at home and in their neighborhoods.

The lane we've been in for the last decade is exactly what is in greatest demand today. We specialize in smaller spaces and populating our centers with service-oriented businesses. As people continue to migrate to Texas and Arizona, we see the fundamental drivers of our business are not just remaining strong, but accelerating in the current environment. 

In the first quarter, we signed new and renewal leases at a blended 20.8% increase over the prior leases on a straight-line basis and 13.3% increase on a cash basis. During the first quarter, we grew our top line revenue over 5%, produced strong 2.8% same-store growth, NOI growth and achieved FFO per share of $0.24. And we strengthened our balance sheet, reducing our exposure to variable rate debt and improving our liquidity. Our occupancy at quarter end was 92.7%, up 170 basis points from a year ago, and our net effective annual base rent per square foot was $22.22, up 4.7% from 2022.

Christine and Scott will provide greater detail of our operating and financial activities and results in their comments. We are pleased with our start to 2023, and our focus for the remainder of the year will be growing shareholder value through operational and financial performance, FFO share, FFO per share growth and delivery of consistent results. The new management team has delivered 5 quarters of strong results and understands the value of building on those results. We will continue to focus on the balance sheet and cost of capital with improvements to debt leverage in 2023 and future years and remain disciplined stewards of capital. 

We recognize the value of a strong balance sheet, and we recognize the importance of reaching the leverage milestones we have set. We will continue to focus on accretive recycling of capital. As we highlighted on the fourth quarter call, in 2022, we made a number of strategic dispositions that funded our Lake Woodlands acquisition and allowed us to improve our debt leverage. We are targeting similarly accretive activity, probably of about the same magnitude within the next few quarters.

And finally, we will continue to focus on monetizing our underperforming joint venture investment in Pillarstone. Our team is aligned, our focus is clear, and we are confident in our ability to add value from a unique business model and a great portfolio of high-quality, open-air, convenience and necessity-based centers that are positioned to serve their respective communities on a daily basis and drive consistent cash flow growth.

With that, I will now turn the call over to our Chief Operating Officer, Christine.

Good morning, everyone. As Dave mentioned, we remain confident in terms of achieving our 2023 objectives and are on track with our internal monthly and quarterly goals. Our leasing efforts remain very strong in the quarter, although the actual leases signed were a little lower than previous quarters.

We expect a very active first quarter to show positive results in future quarters in terms of leases signed, leasing spreads and overall occupancy. Occupancy remains high at just under 93%, up 170 basis points from a year ago and down slightly from the last quarter as a result of remerchandising efforts, which are going well. We achieved renewal spreads of 23% and new leasing spreads of 9.5% for a combined overall positive leasing spread of 20.8% in the quarter.

It is gratifying to see the number of trends that we acted upon a decade ago really accelerated in the recent quarters, and we're working hard to capitalize on those trends. Probably the most important activity we do in order to ensure we're skating to where the puck is going is the mix of businesses we select for our centers. Getting this mix right drives traffic for every tenant in the center and paves the road for additional leasing successes, both with new and renewing tenants.

It underpins our philosophy that shorter leases allow us a better share in the success of our tenants, providing our investors with a better protection against inflation. In turn, the shorter leases allow us to be much more nimble in terms of optimizing our tenant mix to best service the surrounding neighborhood, where active managers are by centers and the shorter refresh rate allows us to ensure that our centers are thriving for their communities. 

Proactive management requires that we know how our tenant businesses are performing, and we do. We're continually verifying that local customer demand is being met and were designed Whitestone to take better action of the business is not meeting those needs. We have a very low number of big box tenants outside of grocery stores and a risk dispersed tenant mix with minimal tenant concentration.

Our largest tenant makes up only 2.2% of our base rent. In the news recently, we have one Bed Bath & Beyond. Our mix focus is instead on restaurants, medical, self-care education and entertainment offerings. The Bed Bath & Beyond we have is located in our center of McKinney, Texas, just north of the Dallas Platinum corridor. The center is anchored by a Trader Joe's, and we look forward to having this space back as it is already in very high demand.

Instead of big-box tenants and power centers, we have entrepreneurial tenants, often fast-growing regional franchises, and we've anchored either by grocery restaurants or a combination of high-traffic tenants. We've averaged over 25 tons per center, and we have a very high retention rate, providing a high dispersion of risk for our investors. One of the advantages that arises from the closeness that we have with our tenants is that we have a very good pulse on the current business environment in Texas and Arizona.

Consumer demand remains very strong within our markets. Additionally, many service-oriented businesses within our center are low capital businesses because they don't have capital tied up in inventory. We're keeping an eye out to see if credit conditions become a concern, but we're seeing no evidence currently in either Texas or Arizona. Scott?

Thank you, Christine, and good morning. Our solid first quarter results demonstrate the strength of our high-quality portfolio of properties as evidenced by robust leasing spreads and positive same-store NOI growth. Our NAREIT funds from operations per diluted share was $0.24 for the quarter versus $0.30 for the same period in 2022. Notably, last year's figures include a benefit of $0.04 from forfeiture of restricted equity compensation stock.

Our first quarter results were driven by strong NOI growth, largely due to higher base rent of $900,000, offset by a higher interest rate cost. In addition, pro rata FFO from our joint venture was lower by approximately $500,000. Same-store NOI was a positive 2.8% increase fueled by strong leasing spreads and increased year-over-year occupancy.

In addition, furthering our ability to narrow in at our guidance target and minimize interest rate risk, we entered into an interest rate swap on $50 million of variable rate debt on the last day of the quarter, reducing our variable rate debt to $63 million or approximately 10% of our total debt. While the SOFR curve would indicate rates will flatten or fall soon, we are well positioned to sustain a higher interest rate market duration.

As shown on Slide 9, while we estimate higher interest rates to be a drag on 2023 earnings, we expect same-store NOI growth and scaling of G&A infrastructure to positively contribute to our 2023 results. We continue to strengthen our balance sheet with improved debt leverage from $8 million in lower net debt and increased EBITDAre with lower variable rate interest exposure. Our EBITDAre ratio improved to 7.8 turns as compared to 8.1 turns a year ago, excluding stock forfeiture benefit in 2022, and our variable rate debt as a percentage of total debt improved to 10% from 17% at year-end.

We have a well-laddered debt stack with limited maturities coming due over the next 3 years, and we expect to continue to focus on strengthening our financial position to position us for opportunities as they occur. Let me conclude my prepared remarks by reaffirming our full year 2023 guidance. As Christine and Dave both said, our results are in line with our internal monthly and quarterly expectations and have us well on track for achieving our 2023 full year targets.

And with that, we'll open the line for questions.

(Operator Instructions) Our first question comes from Anthony Hau with Truist Securities.

Can you guys please provide a little bit more color on the interest on the step back beyond space and the mark-to-market opportunity there? And what's getting the space back for the guidance?

So a couple of things regarding that space. It's a nice size, it's well sized for the market. It's right across from a Trader Joe's. So it's a heavily traffic center. The Trader Joe's does very, very well there. I would say that we are getting an interest from kind of a broad range really. It goes from fitness to possibly splitting the space. It's something we're taking a look at, which whenever we do a splitting of the space, we're looking for a premium.

In addition, furniture, I can tell you, just it's ever since there has been trouble with Bed Bath & Beyond, we are receiving inquiries that's been happening since the beginning of the year. And I think it's just important for us to evaluate all those opportunities, pick the best one for the mix. And because that center has so much traffic and has a little bit of challenges with the parking lot being so full from the Trader Joe's that we blend that appropriately with the right user.

Anthony, it's Dave. I think the second part of your question was, is it included in our guidance? I'm going to let Scott respond to that.

Yes. The answer to that is no. We didn't anticipate Bed Bath & Beyond bankruptcy, but we view that as upside. There might be a short re-tenanting period, but no, that's not in the guidance. A very small percentage of our NOI.

It's small, but we also look forward to -- when you get the opportunity of a well-placed box like this, number one, it was heavily restricted. And at the same time, we had a number of caps on it as well. So I think when we turn this, we're going to see some upside.

Do you mind quantifying that mark-to-market upside?

I think it would be premature probably to do that. All of us are kind of looking at each other, but we feel very strongly that there is upside. As Scott said, it's granular. If you remember, we have a really nicely risk diversified tenant base with no huge tenant concentration. So biggest tenant is 2.5%. So Bed Bath & Beyond is one tenant is not a large part of our revenue, but we do feel confident that it's going to be a positive upside and a positive to the center when we re-tenant that space.

Got you. And how will the Whataburger space that wins are part? Because I think right now it's categorized as a 24,000 office space. Just curious what's the plan for that space and what's the interest for that space as well?

So similar in nature, let me just walk back and explain how we look at when we get these spaces back. It was very similar to when we -- last year, when we replaced the Randall's within EOS. First of all, we look at the demand in the market, number one. What do we need to do to blend that center with the right merchandising mix. That's the first thing we look at as far as -- and then we look at the comp set to not directly compete necessarily with what the comp set is, but what's missing in that market.

And then the third thing is that we look at the space itself and say, what do we need to do here that we utilize that space in the appropriate way, whether it means demising it so we get the best premium for it? Or does it mean keeping the current infrastructure in the space, so we're not having to make an extreme change to the value of that space. So in this case, this is a little bit of a different type of space that we normally have in our portfolio.

So we're being very, very selective as to who we should put in there. So this might be, in this case, we're a little more selective than because of the infrastructure already built into the space. So we have interest in it, but I think it's making again the right choice. And I'd rather evaluate making the right decision because these tend to be a little bit longer leases than what's normal in our portfolio.

And I'll just add that, that vacancy is factored into the guidance.

Anthony, it's Dave. I'll add one more thing. This one was -- obviously, we've known this. This is a training space for Whataburger University, knew that they had plans to move out. And so once again, this was known and is part of our re-tenanting efforts, we think that once we re-tenant it, it will be a positive for the space. But this was known included in the guidance, and we feel very good about the re-leasing.

And when does that office people lease expires at the center?

I think I heard a little bit. Windsor office people do what?

The lease expires at this summer.

The Office Depot lease at our Windsor Center in San Antonio. I think that's a couple of years out. So it's not -- yes, I mean, that center is very stable, really hasn't had -- I think the turn that occurred in that center was years ago. That's really about 7 to 10 years ago. And that center has been very stable ever since. It's well established at sort of a gateway entrance into San Antonio with 2 major highways in coming in.

So it's a desirable location. It's a little bit of an unusual center for us. It's part of the legacy portfolio. But again, it's not our type of center generally speaking, but it has the Office Depot. It has a PetSmart, has Ross and a Berks, and those tenants really haven't -- they've been there for quite some time. So relatively stable. Again, a little unusual center for our type of mix.

Our next question comes from Mitch Germain with JMP Securities.

Just back to the decline in occupancy. I think you characterized it as remerchandising efforts, but we're at about 100 basis points. So anything more specific you can provide there?

Yes. I think really, our focus on quality of revenue has been to look through the current portfolio. And so I'm going to walk this back a little bit. But we started this during COVID and looking at what type of tenants were successful, really diving into understanding their performance during COVID and then going forward and rather than nurse a tenant along if they're not really serving the community successfully, we've taken an active role in making changes quicker and faster because I find that if you leave a tenant on the rules that's not performing well rather than taking an active stance against them, the leasing agents don't market as they should.

And so we changed our philosophy. It's worked really well for us. I think I'll be showing some data the next time around about retention and why this is healthy for our portfolio. And so I think a number of those active stance that we've taken over the last year has probably pushed some tenants out quicker than we normally would because I'd rather have the space actively marketed in a very, very hot market right now. In addition to that, it's not unusual that we do have this on the first quarter. The last 2 years, we had such hot demand in the first quarter. It was a little unusual. But normally, we always have a little bit of a falloff in the first quarter. It's not out of theme for us. But that being said, we're right on track with where we expect to be for the year.

It's Scott here. I'll just mention that when we do our forecasting, we look at all 1,500 tenants and forecast those out for the entire year. And we're just a little bit above the forecast actually for first quarter in terms of occupancy. So there's nothing unexpected with where we are right now.

To that point, Scott, is there a little bit of a bias maybe towards the lower to the midpoint because of some of the uncertainty that -- or the unknowns like Bed Bath or are you still confident that the plan can evolve as the year progresses?

I think we're confident that we're going to end up where we expected around the midpoint of the guidance.

Okay. Last one for me. Just curious about tenant demand. I think Christine said or maybe what Dave said, obviously, it's kind of the sweet spot is that smaller part of the market, but I'm just curious about how the pipeline looks this year versus kind of -- or pipeline looks today versus like maybe this time last quarter?

Let me just clarify, Mitch. Are you talking about the leasing pipeline?

Yes, please.

Okay. Great. I'll let Christine comment on that.

What we're seeing is that the stronger operators are very, very active in the market, and that's what we prefer. So this last quarter, we've had the same thing with our restaurant spaces, which if you have a second-generation restaurant space, I'd rather have that available to market if we have a weak tenant, which again, we've been very active in replacing. I haven't seen the demand pull back for restaurants at all. In fact, it's still increasing.

And again, what we're finding is those that are seeking those types of locations are quality, well-developed operators that have scale. So we haven't seen a change with the exception of, I would say that there's a little less new entrepreneurs coming to the market with less experience, if anything, it's been consistency with those that know the strength of our markets, have strong businesses and are continuing to grow.

Great. Last one. Scott, was there any onetimers this quarter? I think I saw a lease term fee. Is there anything that we should be aware of?

No, not really. We list out the lease term fees in our same-store reconciliation, so you can look to see that. If anything, we'll lock in the interest rates, we might have a little bit of upside on interest rate versus where we forecasted. And so no, I can't really think of any one-timers that we need to call out.

Our next question comes from Craig Kucera, B. Riley Securities.

You've had a significant amount of variability in your pillar storm results. I think it was about $0.01 per share year-over-year. I guess can you give us some color on how we should think about what Pillarstone will contribute or maybe take away from Whitestone this year? And I know you mentioned there were the one timers, but speaking specifically to the Pillarstone results, we were there any adjustments there?

This is Dave. I'll start out and then I may hand it over to Scott to talk more financially about it. But one of the things we've communicated is a goal for us is to exit our JV relationship with Pillarstone. We've said we'd like to monetize that. The asset is underperforming and not returning what we expect for our shareholders. So we, as a company, are working towards that in a lot of ways toward exiting that partnership. That's largely through the court system at this time, but we are committed to exerting that partnership.

That said, right now, I think we are doing our best to estimate the financial performance. Pillarstone is a public company and is delinquent in their SEC filings for a few quarters. And so we're using the information that's available. We're having some communication and doing our best estimated, but that investment is significantly underperforming and we are committed towards working toward an exit of that. Scott, do you want to add anything?

Yes. I would just add that when we think about Pillarstone from a cash flow perspective, it's a 100% upside for us at this point. There's no distributions coming from Pillarstone, and we do have some legal fees that are embedded in our G&A cost for the last year or so. So exiting, I think we'll see improvement in G&A when we're able to exit and when we ought to monetize some of that investment that we have on the balance sheet right now. So from a GAAP basis, while we see some amount of loss right there, there is no cash flow going out other than legal fees to try to monetize it. And I think in the future, it should be thought of as upside from a cash flow perspective.

Got it. And we're able to transact successfully in the fourth quarter, and I know you kind of are thinking about capital recycling again. But I guess I would be curious sort of what your thoughts are on this year and in this current environment and what you're seeing.

Yes. Dave, once again, Craig. The transaction market continues to be shallow. I think you've probably heard that theme from others. We are seeing a little bit of movement in cap rates, but not a lot. We're targeted very much in the markets we're in. So we are deeply looking for opportunities. I think there's obviously a need for the interest rates to stabilize or get some predictability, but as we did last year, last year, we recycled about $40 million in dispositions. We used those proceeds to buy a great acquisition in Woodlands, Texas as well as contribute to our deleveraging.

So I think we would expect to do the same this year. We're actively looking for opportunities. We're continuing to recycle to think about our portfolio, just like a portfolio of stock, it's important that we look at each asset and look to when is the right time to sell and when is the right time to own. So not a big amount, but probably similar to what you saw us do last year from a recycling perspective with the goals being to sell assets and buy new assets that are more accretive kind of day 1 and in the future as well as contributing to strengthening of the balance sheet.

And just one more for me. Chris, circling back to your remerchandising efforts. I'd be curious if there's any sort of themes that you see that are either consistent with where they were last year or maybe changing in this environment. I feel like last year, Whitestone was pretty positive on a number of the restaurants and the strength of the QSRs and fitness. And I guess kind of what are you looking dramatically if there is a theme as far as moving tenants in versus getting rid of some other categories?

Yes. restaurants still very hot this year. I mean, again, this is why we're proactively making changes because if you have a restaurant that's not performing well in this market, we believe being active with that tenant and making a shift to somebody else that would better serve that community is the right thing to do. It has not slowed down in that space at all. It's the same thing. It's QSRs. In addition to the QSRs, I think it's still that affordability factor that we look for.

Restaurants that really serve in the ticket price that works for families, works for a consistent stickiness to a client that comes back off and is we're staying within that range, and that's really worked well for us. In addition, we're seeing -- so this is something that, again, I'm just watching this more than anything. But we are seeing had an interesting change with the workforce coming back and owners of businesses that want to attract talent going into horizontal I call horizontal office space. 

It's kind of unusual. But it's something that when we have a space available at some of our mixed-use centers, which have a little bit of this component, it fills up and those space sizes or they tend to be, again, the same range, small, about 1,000 to maybe 1,500 square feet and when they're ready, we just clean them up, paint them up, maybe have to re-carpet them sometimes, but they lease up. They've been leasing up very, very quickly in our markets. A little unusual. It's not something that we focus on too deeply, but it started with some of our cube exec space, which has always been well occupied in our centers, and it drives that daytime traffic. So really, the last 2 quarters, we saw the last quarter of last year and this first quarter, we've had some interesting trends there.

Again, we look at that as being closer to the suburbs being out where amenitization is really important and convenience is really important as well. In addition, I'd say a little bit of a pullback in fitness. I think that's just because last year, there was such a demand for it, and I think it's just normalized. But just across all of our groups, we've seen pretty good strong demand, especially again in the size spaces that we have, which, again, about that 1,500 to 2,500 square feet, easy to lease, flexible to shift towards the demand of the market.

Our next question comes from Gaurav Mehta with EF Hutton.

I wanted to ask you on your asset recycling comments again. So if you were to acquire any properties this year, should we expect that will be match funded by dispositions?

Gaurav, this is Dave. I think your question was on the disposition acquisition side, should we expect those to be in balance? Is that your question?

Yes.

Okay. Yes, I think that's absolutely correct. We are given right now, given the position and we're very disciplined on our capital allocation. And right now, given the current market conditions, we've identified that from an acquisition disposition standpoint, we believe that recycling is what's best for us to do. Obviously, we continue to look for opportunities in the marketplace and be aware of those. But right now, we -- from an acquisition perspective, we've targeted funding that through recycling.

Okay. Second question I wanted to ask you on your debt maturity for '23, the 4.28% note that you're expiring in June. Should we expect that you will replace that with credit line?

I think right now, that's the most likely scenario. We'll look at all refinancing options, but more than likely, we'll roll it into the revolver. As part of the reason we locked down $50 million of debt, we're down to 10% floating rate debt right now, and that gives us the ability to be flexible and use the facility to handle these maturities that are coming due in the next 3 years, which are on the smaller side.

Okay. And where are the rates today for fixed rate notes?

I'm sorry, I didn't understand the question.

What are the rates for the fixed rate notes versus credit line, if you were to issue a new note?

I think the question was what are the rates, fixed rates versus the credit line. Credit line is -- the revolver is priced at a variable rate that is SOFR plus, I think we're at about 160 today. So I think that's in the SOFR is around 4-ish I believe. So in the 5% to 6% range, fixed rates, Scott's looking at that and should be able to give it from you from our sub data.

Yes. It looks like the fixed rate note that's expiring '23 is around 4.25% and '24 closer to 4.5% or 5%. So a bit of an increase on the rate, but that is factored into our guidance. And the way we've forecasted that is to roll it into the facility using the SOFR curves.

Our next question comes from Michael Diana with Maxim Group.

I think you may have partly answered this on your -- when you talked about recycling your recycling plan. But is there any update on outparcel developments or any redevelopment?

I'm going to give you just a quick thought, and then I'll ask Christine to maybe give more on it. As we've communicated in the past, one of the things that Whitestone has as far as embedded value is the opportunity to develop some pad sites and a few land parcels that we acquired when we bought centers, really looking for future value add. So continue to have those, and I'll turn it over to Christine to give a little bit of an update on those activities.

The demand is there. I think it's frustratingly slow with cities, with approvals. That started during COVID, and you would think that some of the pipeline has moved through a little quicker, but we're just finding that it's been very challenging from what you would consider the predevelopment aspects of a project. And the predevelopment aspects of our project are working with the approval rights with the city, working with your architects and engineers.

It has not been for lack of demand. It's really been for what I would say is the timing. It's taking twice as long as it normally takes to work through the early, it'd be again be the preconstruction of a project. And so we are finding though that costs are coming down a little bit for those. So that's been good. But just that it's been very sluggish working these things through the approval process.

But think about it in terms of I think one of our assets we recycled in 2022 was the pad site that we had built for Dunkin' Donuts. We've got a few of those in our portfolio that we can do similar, but I think we've built that pad site at probably about double the return that -- or closer to a 10% kind of return on cost, and we were able to sell it at probably half of that from a cap rate perspective. So a small amount. We've got the number of pad sites.

I think one of the things that Christine has commented on before is from a use perspective, we continue to see smaller pad sites. There's some really interesting folks out there that are doing even smaller sites. So the ability to put those on our properties continues to increase because they take up less space and potentially less of our parking.

There are no further questions at this time. I would now like to turn the floor back over to Dave Holeman, Chief Executive Officer for closing comments. Please, sir, go ahead.

Thank you, and thanks to all for joining today's call, and we really appreciate your interest in Whitestone. I would like to share that we're very pleased to have Julia Butman as a nominee for the Whitestone Board of Directors at our upcoming Annual Meeting of Shareholders on May 12. Julia will be our third new addition to our Board since the beginning of last year, and she brings strong skills to our Board after a 35-year career really investing in senior debt, subordinated debt and structured equity with Prudential largely.

Julia's upcoming addition to our Board is going to continue to strengthen our governance, continue to strengthen our alignment with shareholders and really making our Board a better reflection of society and our customers with 50% female representation on our board. We're super excited and really wanted to welcome Julia. And with that, I will now conclude the call and wish everyone a great day. Thank you.

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