Federal Realty Investment Trust (NYSE:FRT) Q4 2022 Earnings Call Transcript

Federal Realty Investment Trust (NYSE:FRT) Q4 2022 Earnings Call Transcript February 8, 2023

Operator: Greetings, and welcome to the Federal Realty Investment Trust Fourth Quarter 2022 Earnings Call. At this time all participants are in listen-only mode . As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Leah Brady. Thank you. Ms. Brady, you may begin.

Leah Brady: Good afternoon. Thank you for joining us today for Federal Realty’s Fourth Quarter 2022 Earnings Conference Call. Joining me on the call are Don Wood, Dan G., Jeff Berkes, Wendy Seher, Jan Sweetnam and Melissa Solis. They will be available to take your questions at the conclusion of our prepared remarks. A reminder that certain matters discussed on this call may be deemed to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include any annualized or projected information as well as statements referring to expected or anticipated events or results, including guidance. Although Federal Realty believes that expectations reflected in such forward-looking statements are based on reasonable assumptions, Federal Realty’s future operations and its actual performance may materially differ from the information in our forward-looking statements, and we can give no assurance that these expectations can be attained.

The earnings release and supplemental reporting package that we issued this afternoon, our annual report on Form 10-K and our other financial disclosure documents provide a more in-depth discussion of risk factors that may affect our financial conditions and results of operations. Our conference call tonight will be limited to 60 minutes. and with that, I will turn the call over to Don Wood to begin our discussion of our fourth quarter results. Don?

Donald Wood: Well, thanks, Leah, and good afternoon, everybody. We ended 2022 on a very strong note and reported FFO per share of $1.58 in the quarter and therefore, $6.32 for the full year, ahead of both internal and external consensus expectations and a precursor to the strong guidance that great real estate with class-leading demographics will allow us to forecast. We’re more than a year ahead of where we thought we’d be in recovering from the depth of the pandemic in terms of leasing, occupancy and bottom line earnings. We executed a record 497 leases for over 2 million square feet of retail space in 2022, and the comparable deals were done at 6% more rent on a cash basis and 15% more rent on a straight-line basis than the leases that were expiring.

We did that while simultaneously increasing our inherent contractual rent bumps to over 2.25% annually overall. And by the way, based on what we see looking forward into 2023, at this point, while I doubt that we’ll do 497 leases again. I would expect a higher lease rollover percentage in 2023 as continued strong demand and inflationary pressures are helping negotiations. We leased up the portfolio at 94.5% at year-end compared with 93.6% a year before and still have room to further increase in 2023. Most importantly, that intensified focus we’ve been talking about over the last year or so, aimed at minimizing that difference between percent leased and percentage occupied, i.e., getting tenants rent paying more quickly. Well, it’s working. While our percentage lease continues to grow, up 90 basis points in 2022, our percentage occupied is growing even faster, up 170 basis points in 2022, suggesting some of the quickest times between lease signing and rent paying in our history, a particularly impressive feat during the supply chain struggles of the past two years.

So all of these things resulted in 2022 FFO per share of $6.32, 13.5% higher than the year before and right on top of our pre-pandemic record. I know you’ve heard me say it many times before, but it bears repeating. Demographics matter, especially in times of economic pressure, past cycles have convinced us that families simply have to have money to spend for retail real estate cash flow to grow. 68,000 households with annual average household incomes of $150 to $1,000 sit within 3 miles of federal centers. That’s $10.2 billion of family income generated within a 3-mile radius, and more than half of those people have a 4-year college degree or better. I know no other significantly sized retail portfolio that can say that. So it’s manifesting itself in a myriad of ways, including a wide variety of tenants who saw their sales exceed the percentage rent threshold in the lease in the fourth quarter.

While not a huge absolute number, since we strive for strong fixed rent in our leases, the broad-based percentage rent contribution in the quarter, particularly among our restaurants and soft goods tenants over and above the fixed rent is notable and contributed an additional $0.02 per share compared with last year’s fourth quarter and is a continuation of the trend that we’ve been seeing all year. Now as economic activity falls and higher interest rates affect everything from car loans to mortgage payments to deal underwriting, we would certainly expect to see a slowdown in consumer spending which very well may cause retailer reticence and a slowdown in the period. It hasn’t happened so far. Leasing — that kind of change is pretty obvious.

But that’s okay. This business remains more solid. And if history is any indication, federals real estate will outperform given that superior demographics, along with a very strong diversification of rent. No one tenant makes up more than 2.8% of our rental stream, and that tenant is TJX. To put a finer point on that, when you think about today’s troubled tenants, Bed Bath, Party City, Rite Aid, Tuesday Morning and even Regal Cinemas, of which we have no exposure, all of them combined comprise less than 1% of our 2023 forecasted rental stream. Average in-place base rent at our 9 Bed Bath & Beyond and Buybuy Baby locations is $15 a full. Rental will be more than replaceable as we navigate through the expected bankruptcy process with. We continue to opportunistically prune the portfolio of non-core and slower-growing assets.

And in the fourth quarter and the last few days of the third quarter, we sold three smaller properties, all in Maryland, for proceeds of about $135 million at a combined flat 5% cap rate: one, a legacy residential community from Federal’s earliest days; the second a Federal developed residential building on excess land in Towson Maryland; and the third, one of our earliest small retail developments in Rockville Maryland. Those and earlier sale proceeds were reinvested into assets like Kingstown and the shops of Pembroke Gardens, which are generating better going-in yields and add significantly better growth process. The ability to sell non-core assets accretively is just one of the differentiating tools that we have to manage this company through economic cycles.

And of course, you only need to look at the $600 million-plus construction and process number on the year-end balance sheet to identify a large source of future income, much of at least not yet reflected in the results. Okay. So that’s about it for my prepared remarks this afternoon, so I’d like to leave you with one final thought before turning it over to Dan. The run-up in interest rates will surely pressure everybody’s earnings to some extent in the years ahead, as included, beginning in 2023. Dan will go through the expected impact in a few minutes. But keep in mind that Federal has been around since 1962 and has raised its dividend every year since 1967. This business plan doesn’t need money to be virtually free to thrive. It’s proven that.

In terms of 2023, know that significant incremental rent from contracts that are already in place, particularly where demand is strongest at our mixed-use operating properties like Assembly Row, Pike & Rose, Santana Row, Darian and CocoWalk, along with a full year of contributions from ’22 acquisitions, will more than cover incremental interest and lead Federal to what we believe will be an all-time record earnings year in 2023 with sector-leading growth. Dan?

Photo by dillon kydd on Unsplash

Daniel Guglielmone: Thank you, Don, and hello, everyone. Our reported FFO per share of $1.58 for the fourth quarter and $632 for the year were up 7.5% and 13.5%, respectively, versus 2021. For both periods, we’re at the top of our previously increased guidance range. Primary drivers of the outperformance: acceleration in occupancy up to 92.8%, a gain of 70 basis points for the quarter and 170 basis points for the year. Other drivers: higher percentage rent, which more than doubled 2022 versus the previous year; and continued strength in consumer traffic at our mixed-use assets, driving marketing revenues higher. This was offset by higher property operating expenses and higher interest expense. Comparable growth, our GAAP-based metric for same-store in the fourth quarter and the full year came in at 5.4% and 7.7%, respectively, strong metrics despite the negative net impact of prior period rents and terms.

On a same-store cash basis, we came in at what we believe to be a sector-leading 5.5% for the quarter and 8.5% for the year. Excluding the negative impacts of prior period rents and term fees, cash same-store growth was 7.8% and 10.8% for the fourth quarter and full year, respectively. For those analysts and investors to keep track, we had $1.1 million term fees for the fourth quarter against a 4Q ’21 level of $1.7 million. Prior period rent contributions related to COVID-impacted negotiated yields were $2 million this fourth quarter versus $4 million in the fourth quarter of ’21. Please note that in our investor presentation on our website, there are updated slides plus an appendix which provide all of these figures. Don already highlighted continued strength in leasing, but let me point out a few more statistics of note.

The 94.5% and 92.8% in leased and occupied metrics represented growth of 90 basis points and 170 basis points, respectively, over 2021 and 20 and 70 basis points of sequential growth over the third quarter. We continue to see strength in our small shop leasing, which now stands at 90%, a level not seen since 2017, but still short of our targeted and historical peak levels. The 80 basis points of relative pickup in our SNO spread over the course of 2022 demonstrates our ability to get tenants open and rent paying. More upside to come in 2023 as we target an SNO spread at more typical levels of 100 to 125 basis points long term. I mentioned leasing activity has been strong to start 2023, and our pipeline of deals executed to date in the first quarter and those under executed LOI is in line so far with 2022’s strong leasing volumes.

Additionally, we remain optimistic so we can continue to drive favorable lease terms in 2023, including both strong lease rollover growth and sector-leading contractual rent forms. A big driver of our growth in 2022 was the continued stabilization of a large portion of our redevelopment and expansion pipeline. We expect that to be the case in 2023 as well. Having placed $800 million of projects into service in 2021 and 2022 at Assembly Row, Pike & Rose and CocoWalk, we saw a $24 million of incremental POI 2022. We expect another roughly $12 million of incremental POI in 2023, just from those 3 projects alone. The balance of our development pipeline now stands at roughly $730 million which will deliver incremental POI starting this year and continue for the next few years but is less than $300 million remaining to spend.

Now to the balance sheet, a quick update on our liquidity position. We ended the year with $86 million of cash available and an undrawn $1.25 billion credit facility for a total liquidity in excess of $1.3 billion. Our leverage metrics continue to be strong. Fourth quarter annualized net debt to EBITDA is roughly 6 times. That metric is forecasted to improve over the course of 2023 as development POI comes online and occupancy drives higher. Again, our targeted level is in the mid — is in the low to mid 5 times range. Fixed charge coverage was 3.7 times for the fourth quarter and 4 times for the full year. Now on to guidance. For 2023, we are introducing FFO guidance of $6.38 to $6.58 per share. This represents 2.5% growth at the midpoint $6.48 and 4% at the high end of the range.

Despite the challenging capital markets environment and embedded headwinds, as promised, Federal will grow in 2023. This is driven by a comparable growth forecast of 2% to 4%. This assumes occupancy levels will increase from 92.8% at 12/31, up above 93% and by year-end 2023, although that progression will not be linear throughout the year. Additional contributions from our redevelopment and expansion pipeline will total $15 million to $18 million. For those modeling, let me direct you to our 8-K on Page 16 and 17 where we provide our forecast of stabilized POI and timing by projects. Accretion from our 2022 acquisitions being online for a full year will also contribute. Those $500-plus million 2022 acquisitions are expected to outperform our original underwriting by at least 50 basis points.

This will be offset by lower prior period collections with a net 2022 level of $9 million that’s expected to fall to a range of $4 million to $6 million in ’23. And lower net term fees, we had $9.5 million in 2022 and forecast $5 million to $6 million in 2023, more in line with our historical averages. Despite over 100 basis points of headwinds, our comparable growth forecast is 2% to 4% for 2023. It would be 3% to 5% without the headwinds from prior period rents and term fees. Quarterly FFO cadence. We’ll have one quarter being the weakest with sequential growth thereafter. Other assumptions include $175 million to $200 million of spend on redevelopment and expansions at our existing properties; $175 million to $225 million of common equity issued throughout the year, refinancing our $275 million of unsecured notes, which mature in June in the mid-5% range; G&A in the $52 million to $56 million range for the year; and capitalized interest for 2023 is estimated at $20 million to $22 million which includes the continued capitalization of interest at Santana West.

Given our change in leasing strategy from a single tenant leasing approach to a multi-tenant building as we build out tenant floors and add tenant amenities. Dispositions completed in ’22, contributed roughly $5 million of POI during the year. That POI will not be there in ’23. We’ve assumed a credit reserve, excluding the impact of Bed Bath & Beyond of roughly 75 basis points. With respect to Bed Bath, we are adding another 25 to 60 basis points of reserve depending on the uncertain outcome with respect to this tenant. Please note, in 2023 and moving forward, we have less than 70 basis points of exposure at our Wynnewood location had a natural expiration in January 2023 and has not been on our ’23 forecast since mid-last year. As is our custom, this guidance does not reflect any acquisitions or dispositions in 2023, except what has already been announced.

We will adjust for those as we go given our opportunistic approach to both. This guidance also does not assume any tenants moving from a cash basis to accrual basis revenue recognition. Please note the expanded disclosure in our 8-K on Page 30 provides a detailed summary of this guidance. And before we go to Q&A, let me take a minute to highlight the strength the outperformance that our signature mixed-use retail assets demonstrated in 2022. The big four of Santana Row, Assembly Row, Pike & Rose and Bethesda Row, took a disproportionate hit during COVID, because of government shutdowns in their respective markets, but they now sit they finished 2022 at 99% leased. Reported retail sales were 15% to 20% higher than the prior year and are back up above pre-COVID levels.

Consumer traffic was up 20% versus the prior year and 7% above pre COVID levels. Comparable retail POI at these assets were up 30% versus 2021 and over 6% above pre-COVID levels. Plus, we are forecasting comparable growth in retail POI for 2023 of 6% to 8% if these four assets given continued strength in leasing demand. The retail components of our mixed-use assets are unique and have driven and should continue to drive POI growth materially above that of a typical open-air shopping center, providing an additional point of differentiation between Federal and its peers. Further, our operational mixed-use capabilities in design, construction, leasing, operations are unrivaled and a unique competitive advantage moving forward in the continued evolution of open-air retail, capabilities that are applicable across our entire retail portfolio and a big reason why we expect that sector-leading retail growth for years to come.

And with that, operator, you can open up the line for questions.

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Q&A Session

Operator: And our first question is from Juan Sanabria with BMO Capital Markets. Please proceed with you question.

Juan Sanabria: Good afternoon, and thanks for the time. Just curious on the total portfolio to one of your later comments in your prepared remarks where NOI sits relative to 2019 levels and when do you expect to get back to that. You kind of made the comment for the big four, but just curious on the broader sample set?

Donald Wood: We’re back. Yes, we’re, in fact, well above 2019 levels. So I know one that what Dan was just talking about was specifically with respect to the 4 mixed-use assets and for obvious reasons there. But the whole portfolio is on overall back above 2019. It’s the higher interest expense that effectively brings us back down to about the same FFO but certainly, operationally, significantly above.

Operator: And our next question is from Craig Schmidt with Bank of America. Please proceed with your question.

Craig Schmidt : Thank you. I just wondered if you could just give us what the drag will be on the increased interest expense of ’23 versus ’22?

Daniel Guglielmone: Roughly $0.30 per share, plus, minus any above where we end up.

Craig Schmidt : Okay. And then just real quick. Small shop was relatively flat sequentially, do you still see that as a major opportunity for growth on your POI?

Donald Wood: Yes. And Wendy, I don’t know if you want to add to this or not, but I’m very, very positive about our small shop occupancy. And I think we’re sitting there at 90% or so now, which is back to place that we haven’t been for quite some time, and we’re not done. We’ve got some more room to grow there.

Wendy Seher: And I would add to that, there’s a real sense of urgency on the leasing side overall, especially on the small shops. Through COVID, the weaker guys, as we know, have gone away and our small shops are thriving right now. Obviously, we’re heading into maybe some headwinds, but some of the technologies and so forth that have come post COVID are really driving sales for a lot of the retailers, including the restaurants.

Operator: And our next question is from Greg McGinniss with Scotiabank. Please proceed with your question.

Greg McGinniss: Hey, good evening. Dan, I was hoping you can just touch on what would be driving you to either the bottom or top end of guidance this year?

Daniel Guglielmone: Look, I think a big variable is what happens to the Bed Bath bankruptcy. I think that probably at the top of the range, we’ll expect to have a more normalized Chapter 11 where we expect to get a few boxes back whereas, if it’s a liquidation, that will push us towards the bottom of the range. I think that’s probably one of the bigger drivers that takes us either up or down.

Greg McGinniss: Okay. And if I could just

Operator: Our next question is from Samir Khanal with Evercore ISI.

Samir Khanal: Thanks for the question. Maybe you can touch upon the transaction market and kind of what you’re seeing from pricing or cap rates today. I don’t know if there’s a way to bifurcate between sort of your suburban open-air centers versus any color you can provide in lifestyle centers. That would be great. Thanks.

JeffBerkes: Yes. Hey, Samir, it’s Jeff. Not a lot of color because there’s not a lot of transactions. We’re always in the market looking for stuff regardless of what’s going on, but there’s just not a lot out there right now. I mean, if you want a data point, back in the day, when the market was active for the best grocery-anchored centers or maybe 100 to 150 basis point spread cap rate over the 10-year treasury. But we haven’t seen many trades, and I don’t expect to see a ton of trends this year. So kind of anybody’s guess at this point.