Acadia Realty Trust (NYSE:AKR) Q4 2022 Earnings Call Transcript

Acadia Realty Trust (NYSE:AKR) Q4 2022 Earnings Call Transcript February 15, 2023

Operator: Good day and thank you for standing by. Welcome to the Fourth Quarter 2022 Acadia Realty Trust Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to Romero Reyes.

Romero Reyes: Good morning and thank you for joining us for the fourth quarter 2022 Acadia Realty Trust earnings conference call. My name is Romero Reyes, and I am a Property Accountant in our Accounting Department. Before we begin, please be aware that statements made during the call that are not historical may be deemed forward-looking statements within the meaning of the Securities and Exchange Act of 1934, and actual results may differ materially from those indicated by such forward-looking statements. Due to a variety of risks and uncertainties, including those disclosed in the Company’s most recent Form 10-K and other periodic filings with the SEC, forward-looking statements speak only as of the date of this call, February 15, 2023, and the Company undertakes no duty to update them.

During this call, management may refer to certain non-GAAP financial measures, including funds from operations and net operating income. Please see Acadia’s earnings press release posted on its website for reconciliations of these non-GAAP financial measures with the most directly comparable GAAP financial measures. Once the call becomes open for questions, we ask that you limit your first round to two questions per caller to give everyone the opportunity to participate. You may ask further questions by reinserting yourself into the queue and we will answer them as time permits. Now, it is my pleasure to turn the call over to Ken Bernstein, President and Chief Executive Officer, who will begin today’s management remarks.

Ken Bernstein: Thank you, Ramiro. I bet, we didn’t tell you about having to do this when you joined us, and you did a great job. Welcome everyone. As you can see in our release, our fourth quarter results represented another strong quarter with operating fundamentals coming in above our expectations and same-store NOI for the year exceeding our guidance. Looking back, our leasing activity for the year was strong in terms of both volume and rent levels achieved, and this momentum continues. In the fourth quarter, we increased physical occupancy by 150 basis points, and this occupancy gain is worth noting because over the last year, due to supply chain issues, getting tenants open on time and on budget has been a significant industry challenge, and our team rose to the occasion.

Notwithstanding this progress, we are certainly keeping an eye on the macro data, which has been recently sending mixed signals about the consumer, and the retail environment for the next year. In a world where good news is bad news and bad news is often well bad news also, landlords and tenants alike are trying to prepare for the most anticipated consumer recession in a generation, while reconciling this with the strongest job market in a lifetime. And while we’ll let the economist in the financial markets debate whether this is the best of times or the worst of times, in the interim, we’re staying busy leasing space. In fact, when looking at our current leasing pipeline, activity remains on track with our prior forecast, and we haven’t yet seen any fallout and tenant demand.

Now, this does not mean that retailers are ignoring the potential macroeconomic challenges over the next year and nor are we. And while we are expecting that there will be a higher level of tenant disruption in our portfolio in 2023 compared to last year, most specifically Bed Bath & Beyond, we have conservatively incorporated this into our guidance. Most importantly, we also expect our leasing progress to more than compensate for this disruption in thus should lead to continued internal growth. So given the near-term economic pressures, why do fundamentals feel more resilient today, then at this point in prior cycles, and there’s a few likely reasons for this. First of all, the headwinds from secular concerns of the so-called retail Armageddon have passed, as we have been discussing for several years now.

Retailers have universally recognized that the physical store, especially in mission critical locations, is the most important and profitable channel for their execution in an omni-channel world. Second reason, there is a scarcity of high-quality space. The combined impact from the lack of new development and then the growth of DTC direct-to-consumer stores means that retailers, whether they’re luxury brands or more mass market are increasingly choosing to add their own individual stores to enable them to connect with their customer directly. Third, and somewhat specific to our portfolio, our continued internal growth is being driven most significantly from that portion of our portfolio that is still in the early stages of recovery and thus has room to run.

This above average internal growth is driven by a combination of occupancy gains, lease structure, and market rent improvements. As we have said in the past, our occupancy gains are not of equal economic impact. So while overall, we’re about 95% leased within our much higher rent than dollar value street and urban Portfolio, physical occupancy is still only 89%, and based on the increasing demand and leasing progress on most of those streets, we are well positioned for multi-year growth here. With respect to lease structure, as we have discussed in the past, our street leases typically have about a 100 to 150 basis points, higher annual contractual rent bumps than our other retail formats. And if rental growth runs hotter than in the past, our street leases will capture more of that growth sooner, both from contractual growth as well as from more frequent fair market value resets.

Then in terms of future growth from improving market rents, while scarcity and tenant demand is true throughout the majority of our portfolio, both urban and suburban, the greatest market rebound is now showing up on our street and urban corridors, where after several challenging years, tenants are aggressively pursuing space. Furthermore, the strong sales performance of those stores is once again leading to competition among desirable retailers for their best locations. While retail rants has thankfully rebounded to pre-pandemic levels in many of our streets, in some cases beyond, rents remain well below prior peak levels of 5 to 10 years ago, even though many retail sales are starting to approach those prior peaks. Now, even within our street portfolio, the trajectory of future growth is going to vary and really depends on where in the recovery stage the various streets are.

Some markets such as Greenwich Avenue in Connecticut actually got a COVID bump. Other corridors such as Melrose’s Place in Los Angeles were hit hard during COVID, but quickly rebounded past pre COVID rants as there is very limited vacancy due to new tenants entering that market. Now other corridors are still fighting to recover, but even in those markets, we are seeing signs of Green Street. On North Michigan Avenue in Chicago, last quarter, we signed up high demand on trend retailer Alo Yoga at 717 North Michigan Avenue for their flagship store in Chicago. This lease is whether as well as other current activity is a very strong sign of support for this important corridor that has been struggling. Then in San Francisco, another market slow to rebound, in the fourth quarter, we signed an important lease with the Container Store at our 559th property.

You may recall that the property is a well located two level shopping center, and given the current tenant layout, shopper access to the stores has been historically limited to just the street level. The container store lease will anchor and activate the upper level, converting it into its own self-contained open air shopping center with its own dedicated parking and shopper access. Furthermore, as John will discuss in contemplation of recapturing all or perhaps a portion of our Bed Bath & Beyond store there, we should be able to activate the balance of that second level. In short, as it relates to our internal growth in our conversations with our retailers, they indicate that they are for the most part, looking past, the short-term uncertainties and remain focused on 2024 and beyond.

All of this simply reinforces our view that our internal growth forecast for ’23 and beyond remained on track. Turning to external growth in new business, given the extreme shifts in the debt markets last year, the spread between bid and ask has gotten very wide and so far there have been fewer actionable opportunities in the private markets. While the investment sales market is currently relatively quiet, especially for larger transactions, our team remains very active, underwriting a variety of opportunities, since sooner or later the bid and ask spread is going to narrow and we want to be ready. First, in terms of our core business as it relates to core acquisitions, our cost of capital kept us on the sidelines last quarter. It is still too early to predict on balance sheet acquisition activity for the year, but the public markets often lead sentiment and pricing on the way down, but then are often quicker to bounce back.

So, we’ll make sure we are positioned if and when accretive on balance sheet opportunities arise. But in this market, what we can do is periodically harvest gains with opportunistic an accretive sale. An example of this, is last quarter we were able to sell a stable urban asset in Boston at a sub five cap rate, and thus was a very good an accretive source of capital. And while, we don’t expect the disposition market to be particularly deep where we can opportunistically monetize assets will continue to do so. Now looking at our fund business. In terms of fund investment activity, last year we were able to both put new dollars to work, and then successfully sell several assets. In fact, we sold just under 200 million of fund properties and bought just over 165 million.

Continuing these efforts last quarter, we completed the fund four disposition of Promenade at Manassas generating a 17 IRR and a 2.2x multiple on the funds equity investment. Terms of new fund investments, we made a Fund V acquisition post quarter end for 61 million, and we believe that the strong going in yield on Mohawk Commons, a grocery anchored community center with a solid credit tendency reflects very attractive pricing in a period of relative uncertainty. With the remaining equity in Fund V, we have about 250 million of gross acquisition activity and while things are a bit quiet right now, and thus, we have plenty of dollars for the deals, we are seeing signs that there could be good opportunities in front of us. And thus, expect to add to the strong gains already embedded in our Fund V investments.

Furthermore, in addition to focusing on profitably deploying the balance of Fund V capital, we are actively exploring additional sleeves of capital and partnerships that could be additive to our current dual platform and drive further external growth opportunities going forward. In terms of our funds asset operating performance Fund V shopping centers continue to perform consistent with our expectations, and as the capital markets heal, this should provide us with some interesting monetization opportunities. Terms of Fund IV and Fund III assets, the team’s busy, both stabilizing the few remaining assets like 717 North Michigan Avenue, and monetizing others like the Promenade at Manassas. Finally in terms of City Point, we continue to successfully execute on our business plan there and our lease up and stabilization targets remain intact.

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Primark, a new anchor for City Point opened in late December with both foot traffic and sale volumes exceeding our expectations. The energy from the strong Primark opening contributed to December shopper traffic at City Point approximating pre-pandemic levels, and we’re seeing this energy throughout the center. In November, sales at Alamo Draft House exceeded pre-pandemic levels, and with their expansion now underway as well as the build out for Court 16, the upper levels of the property are approaching stabilization. We are about 60% occupied, but 90% leased on the upper floor. The final and most significant push will come from the street level leasing where we are making strong progress with several exciting new leases executed or in the final stages of negotiation.

Finally, as a testament to the strength and depth of our senior and junior management team, we issued a press release last week detailing the annual promotions of our professionals. In that release, we noted that Amy Racanello, who you know from her reporting on these calls as to fund operations, has moved on and we wish her the best of luck. The press release also gave a snapshot of promotions of several of our most senior members, as well as the addition to our team, Stuart Sealy, who many of you know well. Stuart, welcome to the show.

Stuart Sealy: Thank you.

Ken Bernstein: And as significantly, we had almost -promotion of rising stars throughout the organizations. Congratulations to all of you. Watching team members advances by far the best part of my job. So to conclude, while we recognize that macro news headlines are not all positive, our leasing fundamentals remain strong and internal growth intact. While we wait for exciting external growth opportunities, which we are confident will eventually arrive, our leasing team will continue to provide record levels of internal growth making any future external growth that much more additive. And with that, I’d like to thank the team for their hard work this quarter and turn the call over to John.

John Gottfried: Thanks, Ken, and good morning. Before diving into the results, I want to reflect on a few of our team’s key accomplishments during 2022. First, we grew our FFO in excess to 7% in 2022, raising our guidance three times over the course of the year as the rebound in our street and urban portfolio began to take hold. Secondly, we increased the physical occupancy in our core portfolio by 270 basis points with solid rent cash rent spreads, resulting in 6.3% same store ROI growth, which exceeded the upper end of our guidance. Lastly, and in a turbulent capital markets environment, we completed both profitably and accretively over $800 million of transaction volume comprised of over $0.5 billion of new core and fund investments along with nearly $300 million at dispositions.

As I’ll touch on later in my remarks, we see these trends continuing in 2023 and beyond. Now, starting with the quarter, we had another strong quarter with earnings of $0.27 a share coming in above our internal expectations. In terms of same store NOI, we reported growth of 5.7% for the quarter and 6.3% for the year with our annual growth exceeding the upper end of our initial 4% to 6% range. And we achieved the 5% fourth quarter growth despite over 200 basis points of headwinds from prior period cash collections. If we were to exclude these headwinds, our same store growth for the quarter would’ve exceeded 8%, and this fourth quarter growth was driven by both occupancy and market rent increases. During the fourth quarter, we increased our core physical occupancy by 150 basis points to 92.7% at December 31st, as compared to 91.2% at September 30th.

The 150 basis points of occupancy gains represented $3.3 million of incremental pro rata ABR net of expiring leases. And when we breakdown this incremental occupancy, $1.1 million of the total $3.3 million increase represents lease spreads or said differently, market rent growth of about 50% over the prior in place tenant on a same space basis. As highlighted in our release, we reported cash leasing spreads consisting entirely of renewals of 4.7% in the fourth quarter. This moderation and growth from prior quarters is simply a function of the population of leases that were up for renewal during the quarter. Now, in terms of lease occupancy, I wanted to provide an update on our signed but not yet open pipeline. We added an additional 60 basis points of lease occupancy during the fourth quarter, increasing it to 94.9% at December 31st, as compared to the 94.3% that we reported at the end of the third quarter.

Our signed but not yet open port pipeline of 220 basis points represents about 5.6 million of pro rata ABR and $6.5 million of NOI, and we expect that 60% of the pipeline will commence in the first half of 2023, followed by another 10% in the second half with the remaining 30% at the first half of 2024. Please note that given the timing of rent commencements, we won’t get the full benefit in our reported results until the subsequent full annual or quarterly period. Now moving on to our 2023 guidance and starting with same store NOI, as outlined in our release, we are guiding towards 5% to 6% same store NOI growth in 2023. And I want to highlight a few things in our guidance. First, our same store guidance is unadjusted for the headwinds from prior period cash collections, which I estimate will have a negative drag of about 200 basis points or said differently our 5% to 6% of projected same store growth would’ve been closer to 7% to 8% absent the headwinds from prior period cash collections.

Secondly, our street and urban portfolio is projected to drive our 2023 growth with an expectation of 6% to 7% growth coming from our street and urban assets, and 2% to 4% from our suburban portfolio. Third, I wanted to highlight our assumptions on tenant credit. Please note, that I will give detailed guidance assumptions on both Bed Bath & Beyond and Regal Cinemas in a moment. Our historical credit loss, excluding periods impacted by the pandemic has ranged between 50 to 150 basis points, and while we have yet to see any significant signs of retailer distress or declines in our monthly cash collections, given the realities of the macro environment, our 5% to 6% projection of same store growth, conservatively factors in 150 basis points of a general credit loss.

I also wanted to highlight that the 150 basis points is in addition to the known exposures within our portfolio, including Bed Bath & Beyond and Regal Cinemas, which I will discuss in a moment. Lastly, our 2023 same stores pool excludes the accretion from our 2022 acquisitions, which include Williamsburg, SoHo and City Point in New York City, along with Henderson Avenue in Dallas and our acquisition in Los Angeles. These investments will not be included in our same store pool until the first quarter of 2024 and are projected to add further accretion to our multi-year growth trajectory. And as previously discussed on our last call, our core North Michigan Avenue investments will be placed in redevelopment in the first quarter of 2023 as we execute alternative uses and formats.

Now moving to our 2023 FFO guidance. As outlined in our release, we are anticipating 2023 FFO before special items of a$1.17 to $1.26. While our 2023 FFO guidance at the midpoint is up moderately over 2022, it’s worth highlighting that absent the impact of prior period cash collections, our projected 2023 FFO would’ve increased in excess of 5%. And as we think about the projected FFO contributions from our core fund platform, I wanted to highlight a few things that we see playing out in 2023. As detailed in the guidance assumptions that we provided within our supplemental, you’ll see that we have separately broken out the projected NOI and the related costs from our core fund businesses. In starting with our core, we anticipate that our core cash NOI will grow about 5% in 2023 when using the midpoint expectation of about 145.5 million of NOI for 2023 as compared to the 139 million that we reported in 2022.

Our overall projection of about 5% core NOI growth encompasses both those assets embedded in our same store, which as we’ve said is projected to grow at about 5% to 6%, as well as those assets included within redevelopment and excludes any assumptions for core acquisitions or dispositions. This cash NOI growth is counterbalanced by anticipated non-cash decline of about $0.03 to $0.04 from lower straight line rent and below market lease adjustments. Now moving to our fund platform, consistent with our strategy of operating a buy fix sell fund business, net-net, the contributions to our 2023 earnings are relatively flat year-over-year. With the expected increase in profits from our ongoing monetization of fund assets, along with our investment at Albertson’s, being offset by additional interest cost, and the positive — dilution from fund asset dispositions.

I now wanted to highlight our guidance assumptions for Bed Bath & Beyond and Regal Cinema. Now keep in mind, as I shared a few moments ago, our assumptions related to these tenants are separate and in addition to the 150 basis points of credit loss that I discussed earlier, as a reminder, we have two Bed Bath locations and one Regal Cinemas in our core portfolio with an aggregate exposure of approximately 3% of ABR. First off, each of these tenants are current on their monthly rents, meaning we have received February rents for each of these locations. Secondly, we are fully reserved and have been for several quarters, all straight line rent balances for each of these tenants. Starting with Regal, as we’ve discussed in our prior call, we have a single location in our core portfolio and this has and continues to be a productive location for Regal.

In over the past few months, they have confirmed that they intend to retain our lease at its current rent without modification. And while we continue to report Regal on the cash basis of accounting giving its bankruptcy, our 2023 guidance assumes they remain in place and continue paying us throughout the year. In terms of our two Bed Bath locations, both of our core locations are included on Bed Bath’s, recent store closure list. As we have discussed in prior quarters, our Bed Bath exposure is in prime locations at variable replaceable rents, which we were able to in fact demonstrate. As reported in our release last night, we are excited to announce that we have successfully signed a new lease at our location in Wilmington, Delaware. The tenant has requested that we hold off on identifying them, so please stay tuned, but it is a high-quality credit retailer that will be taking the entirety of the Bed Bath space.

In conjunction with an expansion and add a rent that will exceed our current in place rents. Although, we have not yet reached an agreement with Bed Bath on an early recapture of Wilmington, our guidance conservatively assumes that we get this space back as of the end of the second quarter, and incorporates an expectation of about 12 months of downtime associated with the tenant build out. As it relates to our second location in San Francisco, Ken discussed the strategy of re-anchoring and accretively activating the second floor of 555 9th Street. We commence the strategy with the signing of a lease with Container Store in the fourth quarter, and as it relates to our plans for the Bed Baths space while still in the early stages, given the recent announcement of its closure.

Please stay tuned as our leasing and development teams continue to refine our plans to unlock the value of this below market space. And if we were to have the opportunity to get controlled the space in 2023, it will not result in a downward revision to our earnings guidance as we have conservatively built in reserves to reflect an earlier recapture. So, in summary, when factoring in the 150 basis points of credit loss as a general reserve, we have an additional reserve baked into our guidance of about 125 basis points related to known exposures for a combined credit reserve of about 275 basis points. Lastly, I want to touch on a few items on our balance sheet. We have ample liquidity with no meaningful core maturities over the next several years.

In terms of interest rate exposure, approximately 97% of our core debt is fixed, our hedge with long dated interest rate contracts, and under 15% on a look through basis inclusive of the pro rata portion of debt from our fund business. And we remain on track with achieving our near-term balance sheet goals, which as a reminder involves moderately decreasing our leverage and targeting a low six core debt to EBITDA ratio. And given the multiple levers available to us, we should be able to achieve these goals without diluting our earnings to a combination of retained earnings, selective core and fund dispositions, and proceeds from our investment and operations. So in summary, we ended 2022 with very strong results and momentum continuing into 2023 and beyond.

We will now open up the call questions.

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Q&A Session

Operator: Our first question comes from the line of Floris van Dijkum with Compass Point.

Floris van Dijkum: Thanks for the information, guys. A lot of details to us to shift through, but just want to make sure that I understand this correctly, so your same store guidance for ’23 of 5% to 6% incorporates275 basis points of credit loss. Is that the right way to think about it?

Ken Bernstein: Of course, I would say the 275 apply that to FFO, right, because some of for example, 555 9th is not in there.

Floris van Dijkum: Got it. Okay. But the 150 base points, presumably is part of your same store?

Ken Bernstein: Correct. As is the Brandywine location. So, it’s somewhere in between those two. So, it’s somewhere in between those two because the Brandywine, Wilmington that downtime is reflected in the same store pole. So call it roughly 200 basis points and same store.

Floris van Dijkum: And then, obviously, you talk a little bit about your 89% street and urban occupancy and the potential to lease that space. Wanted to get maybe a little bit more granular on that detail from you guys, where is your remaining vacancy? How much of that is at City Point relative to some of your other properties? And where — and how much of that is in Chicago and San Francisco? And when can we expect, I guess the timing of that is that dependent on the market improvements or some redevelopment that are taking place?

Ken Bernstein: So, you’ve mentioned a bunch of different buckets and John, I’ll have you add some color to this, but first of all, Floris, you should understand that the 89% is within our on balance sheet core portfolio. So City Point for instance is not in that number. So while there is significant lease up in City Point, that’ll start showing up in ’24. The embedded lease up of our physical occupancy for our core portfolio, about half of that is with leases already signed. So there, we just got to get those stores open as we did with 150 basis points before. Final point before I hand the details to John is physical occupancy is not a great metric for us NOI growth because some of these smaller stores can be much more impactful than are larger. So, it’s one data point and the upside in NOI is pretty significant. John, any color or data you want to add?

John Gottfried: Yes, I think you hit most of it and maybe add some more about what we’re seeing in SoHo, but, but Floris said Sprinkle throughout, but we have some opportunities where that are currently already leased. So for example, in SoHo, we have some spaces that leased that are ready to get commenced that’s not yet started. And we have some as well that we have opportunities to lease that will drive attractive rents. Chicago, we have some opportunities, well in prime locations. So we have a location in the Gold Coast, which is booming, as well as some in Lincoln Park. So Sprinkle in Chicago, and then Ken, maybe talk about DC because we have some room to grow in DC and we’re seeing rents recover there and we have some occupancy uplift opportunities in DC.

Ken Bernstein: So one of the final areas is the M Street Georgetown corridor and DC as got hit hard during COVID, but even pre COVID M Street was suffering from getting a little stale. Last year or so, we’ve had several new retailers showing up and the shopping experience has improved dramatically and now other retailers are following suit. So we should be able to drive both rents and occupancy there over the next couple years as that early stage reopening place out.

Operator: Our next question comes from the line of Linda Tsai with Jefferies.