Kite Realty Group Trust (NYSE:KRG) Q1 2023 Earnings Call Transcript May 8, 2023

Operator: Good day, and thank you for standing by. Welcome to the Kite Realty Group Trust First Quarter 2023 Earnings Conference Call. At this time, all participants are in listen-only mode. After the speaker’s presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Bryan McCarthy. Please go ahead.

Bryan McCarthy: Thank you, and good afternoon, everyone. Welcome to Kite Realty Group’s first quarter earnings call. Some of today’s comments contain forward-looking statements that are based on assumptions of future events and are subject to inherent risks and uncertainties. Actual results may differ materially from these statements. For more information about the factors that can adversely affect the company’s results, please see our SEC filings, including our most recent Form 10-K. Today’s remarks also include certain non-GAAP financial measures. Please refer to yesterday’s earnings press release available on our website for reconciliation of these non-GAAP performance measures to our GAAP financial results. On the call with me today from Kite Realty Group, our Chairman and Chief Executive Officer, John Kite; President and Chief Operating Officer, Tom McGowan; Executive Vice President and Chief Financial Officer, Heath Fear; Senior Vice President and Chief Accounting Officer, Dave Buell; and Senior Vice President, Capital Markets and Investor Relations, Tyler Henshaw.

I will now turn the call over to John.

John Kite: Thanks, Bryan, and good morning, everyone. KRG’s strategy for 2023 is a straightforward plan anchored in our best-in-class platform. We intend to lease space at attractive risk-adjusted returns, operate our high quality portfolio at sector leading margins and maintain a rock-solid balance sheet. This plan focuses on our key strengths with the ultimate goal of delivering sustainable value for all stakeholders. I’m pleased to report that KRG’s first quarter results exceed our 2023 plan, and our streak of outperformance continues. We generated FFO per share of $0.51, beating consensus estimates by $0.04 per share, and representing an 11% increase over the comparable period last year. Our same property NOI growth for the quarter was 6.5% as compared to the same period in 2022.

Heath will provide more details around the components of each metric. KRG signed 144 leases, representing over 830,000 square feet, producing 13% blended cash spreads on comparable new and renewal leases. Excluding the impact of option renewals, our blended cash spreads on comparable leases was 21%. More importantly, KRG earned a 42% return on capital for comparable new leases, which translates into an average payback period of only 2.4 years. The retention ratio in the quarter was nearly 90%, which is well-above historical norms. Based on our ability to drive pricing, produce strong returns and retain existing tenants, it should come as no surprise that we are experiencing strong demand for our Bed Bath & Beyond boxes. Our current guidance assumes that we will recapture all of our Bed Bath locations, and that we will not be paid any rent beyond what we have already collected to date.

Open air retail will always be Darwinian, and tenants that are slow to adapt will be nudged-decide by more agile competitors. It’s what makes our business so dynamic and interesting. We’ve been through this exercise before. And as it relates to Bed Bath or any struggling tenant, we’ll gladly trade any temporary disruption for the long-term value creation associated with re-letting these spaces to vibrant and traffic-generating tenants. The good news is that Bed Bath boxes are attractively sized and located in prime spots within our centers, which we expect will translate into healthy re-leasing spreads and strong returns on capital. Currently, we have significant interest in our locations from a variety of categories, including specialty grocery, discount, sporting goods and home furnishing.

We have persistently maintained that leasing existing space offers the best risk-adjusted use of our capital, and we’re poised to swiftly address the backfill potential for these boxes. The past two and half years serve as a great example. We’ve executed 58 anchors, representing over 1.4 million square feet at 18% comparable cash-leasing spreads and 20% returns on capital. You’ve often heard us say that, the only permanency in our business is the underlying land. Everything on top of it can change. When asked which open-air format we are most likely to invest in, our answer is always, we invest in great real estate. We’re starting to see the same philosophy implemented by our retailers. Retailers are focused less on the type of center and more on the underlying quality of the real estate.

This growing trend is supported not only by the increasing body of data available to our tenants, but also by the post-COVID realization that brick-and-mortar stores are the primary distribution point along a supply chain that requires convenience, speed and healthy profit margins. As a result, we focus on the underlying quality of the real estate across a variety of product types. Our portfolio is well balanced among the open-air retail categories, thereby offering a wide array of options to our retailers. Furthermore, our product is pliable enough to reconfigure the real — to reconfigure, if the real estate dictates a different use. These trends, together with the lack of meaningful new supply in the open-air retail space, have created an extremely favorable supply-demand dynamic for KRG.

The culmination of all these great things I’ve just mentioned is allowing KRG to increase its NAREIT FFO guidance by $0.03 per share, moving the midpoint from $1.92 to $1.95. We’re also increasing the midpoint of our same-property NOI growth assumption by 25 basis points, moving the midpoint from 2.5% to 2.75%. I’ll now turn the call over to Heath to provide additional details.

Heath Fear: Good afternoon, and thank you for joining us today. I’m pleased to report that KRG has kicked off 2023 with another quarter of outperformance. For the first quarter, KRG generated $0.51 of NAREIT FFO per share, which was 11% higher than the comparable period in 2022. This year-over-year increase was primarily driven by higher same-property NOI, which grew by 6.5% in the first quarter. Increased occupancy was a primary driver of our same-property NOI growth with a 440 basis point increase in minimum rent, a 120 basis point increase in net recoveries, and a 90 basis point increase in overage rent. As John alluded to earlier, we are raising our NAREIT FFO guidance to $1.92 to $1.98 per share, representing a $0.03 increase at the midpoint.

$0.01 is attributable to the 25 basis point increase in the same-property NOI growth assumption due to lower-than-anticipated bad debt and higher-than-anticipated overage rent and tenant retention. Another $0.01 is attributable to a short-term lease we entered into with the legal theaters for the location in the Los Angeles MSA. The final $0.01 is a result of higher non-cash items related to a reversal of certain below market lease intangibles. Our revised full year guidance range relies on the following additional assumptions at the midpoint; same-property NOI growth of 2.75%; neutral transaction activity, full year bad debt of 115 basis points of revenues; and an additional 75 basis point reserve specific to Party City and Bed Bath & Beyond.

It appears that Party City will emerge from bankruptcy in the near-term, and we will not be losing any locations. Our assumption is that Bed Bath is in liquidation mode and that we will not collect any additional rent going forward. It’s important to note that of the total 75 basis points of potential disruption, only five basis points was experienced in the first quarter as Bed Bath continued paying rent on the vast majority of its locations. For this reason and others, we caution against annualizing our first quarter results. Specifically, the first quarter benefited from items that are not budgeted to repeat themselves during 2023. As it relates to the same-property NOI, for the balance of the year, we are assuming no additional rent from Bed Bath and elevated bad debt run rate in a lower overage rent.

Consistent with last quarter and based on comparable 2022 periods, we anticipated very strong first quarter same-property NOI growth that moderates over the course of the year. Outside of the same-property NOI, the first quarter benefited from lower interest expense related to retired mortgage debt and the previously referenced non-cash contribution. As we demonstrated last year, it’s early and a lot can happen between now and the end of 2023. We are extremely confident with respect to the things we can control. Prudence dictates that we remain conservative with respect to the things that we cannot control. On the balance sheet front, we retired $162 million of mortgages using our revolving line of credit and cash on hand. Over 96% of our NOI is now unencumbered.

Subsequent to the end of the first quarter, we closed a $93 million mortgage at KRG share, secured by our One Loudoun Residential joint venture project at a fixed interest rate of 5.36%. KRG is a 90% owner of the 378 multifamily units at One Loudoun, which are currently 96% leased and continue to outperform our initial underwriting. The proceeds of the mortgage were used to pay down our $1.1 billion revolving line of credit, which currently has a balance of $68.5 million. We are a battle-tested management team that has navigated a variety of challenging cycles, but never with a balance sheet of this caliber: net debt-to-EBITDA of 5.3 times; debt service coverage ratio of 5.2 times; over $1 billion of liquidity; minimal floating rate debt; a well-staggered maturity schedule, deep banking relationships, a huge unencumbered asset pool, and multiple capital sources.

These formidable attributes inspire a calm confidence across the entire organization and allow us to remain intently focused on operational excellence. Thank you for joining the call today. Operator, this concludes our prepared remarks. Please open the line for questions.

Q&A Session

Operator: Thank you. At this time, we will conduct the question-and-answer session. [Operator Instructions] Our first question comes from Craig Mailman from Citi. Your line is now open.

Operator: Thank you. One moment, as I prepare the next question. Our next question comes from Todd Thomas of KeyBanc. Your line is now open.

Operator: One moment please. Our next question comes from Floris Van Dijkum from Compass Point. Your line is now open.

Operator: Thank you. One moment for our next question. Our next question comes from Alex Goldfarb of Piper Sandler. Your line is now open.

Operator: Thank you. One moment, as I prepare the next question. Our next question is from Michael Mueller of JPMorgan. Your line is now open.

Operator: Thank you. One moment, as I prepare the next question. Our next question comes from Anthony Powell of Barclays. Your line is now open.

Operator: Thank you. [Operator Instructions] One moment, as I prepare the next question. Our next question comes from Lizzie Doykin [ph] of Bank of America. Your line is now open.

Operator: Thank you. At this time, I would now like to turn it back to John Kite for closing remarks.

John Kite: I just want to say thank you for joining us today and look forward to seeing you soon. Bye.

Operator: Thank you for your participation in today’s conference. This does conclude the program. You may now disconnect.