Retail Opportunity Investments Corp. (NASDAQ:ROIC) Q4 2023 Earnings Call Transcript

Retail Opportunity Investments Corp. (NASDAQ:ROIC) Q4 2023 Earnings Call Transcript February 15, 2024

Retail Opportunity Investments Corp. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Welcome to Retail Opportunity Investments’ 2023 Fourth Quarter and Year End Conference Call. Participants are currently in a listen-only mode. Following the company’s prepared remarks, the call will be open up for questions. Now, I’d like to introduce Lauren Silveira, the Company’s Chief Accounting Officer. Please begin.

Lauren Silveira: Thank you. Before we begin, please note that certain matters which we will discuss on today’s call are forward-looking statements within the meaning of federal securities laws. These forward-looking statements involve risks and other factors which can cause actual results to differ significantly from future results that are expressed or implied by such forward-looking statements. Participants should refer to the company’s filings with the SEC, including our most recent annual report on Form 10-K to learn more about these risks and other factors. In addition, we will be discussing certain non-GAAP financial results on today’s call. Reconciliation of these non-GAAP financial results to GAAP results can be found in the company’s quarterly supplemental, which is posted on our website. Now, I’ll turn the call over to Stuart Tanz, the company’s Chief Executive Officer. Stuart?

Stuart Tanz: Thank you, Lauren, and good day, everyone here with Lauren and me today is Michael Haines, our Chief Financial Officer; and Rich Schoebel, our Chief Operating Officer. Notwithstanding 2023, having been a year of extraordinary challenges for certain commercial real estate asset classes and certain CBD markets across the country. In distinct contrast, the long-term core drivers of the grocery anchorage sector remain fundamentally sound, especially as it relates to our portfolio and highly protected sought after West Coast markets. Capitalizing on the strong fundamentals, we achieved a number of new leasing records and milestones for the company. For the fourteenth consecutive year, we leased essentially double the amount of space that was originally scheduled to mature.

Specifically, in 2023, we leased over 1.7 million square feet achieving a new record for the company in terms of overall leasing activity. Additionally, we again achieved releasing rent growth for a record eleventh consecutive year, including 11 years in a row of achieving double-digit growth on same space new leases. Importantly, we worked at strategically renewing early a number of key valued anchor tenants, including longstanding grocer tenants. By doing so, we enhanced the long-term strength and stability of ROIC’s core anchor income stream well into the future. We also continued to implement our long-standing strategy of proactively enhancing the tenant mix across our portfolio through seeking out opportunities to recapture early and release select spaces.

Going forward, this will not only serve to enhance the strength of our tenant base and appeal of our properties, it will also serve to grow our income stream having achieved higher releasing rents. In terms of acquisitions, in light of the considerable uncertainty in commercial real estate during 2023, the West Coast acquisition market sat essentially idle through much of the year. While it was sitting idle, we continue to maintain an active dialogue with our long-standing off market sources in order to be in a strong position to capitalize on unique opportunities when the market began to pick up again. To that end, during the closing months of 2023, certain private owners started to become more active in seeking to transact. Capitalizing on this, in December, we acquired an excellent neighborhood grocery-anchored shopping center that we had our eye on for some time.

The property is located in the Los Angeles market in a densely populated, mature diverse community. The center is anchored by a well-established supermarket that’s a long time national tenant of ours. The seller was a private owner that was in need of a closing before year end. Given our knowledge of the market together with our knowledge of the property and tenant roster, we were in a strong position to facilitate an efficient closing and in return achieved attractive pricing, including at cap rate in the high 6s for what is irreplaceable sought after real estate. Looking ahead, based on what we’re currently seeing, market activity for acquisitions could resume on the West Coast in 2024, potentially in earnest. Turning to our balance sheet.

During 2023, we were diligently to enhance our long-term financial strength and profile through implementing a number of strategic capital market initiatives, including re-entering the public bond market, balancing our debt maturity schedule, while also reducing our floating rate debt and extending our credit line maturity, as well as raising a bit of equity in connection with the acquisition. Now, I’ll turn the call over to Michael Haines, our CFO, to take you through the details of our balance sheet initiatives as well as our financial results for 2023 and initial guidance for 2024. Mike?

Michael Haines : Thanks, Stuart. Starting with our financial results. For the year ended of 2023, total revenues reached a new record high of $328 million, offsetting record revenues, interest expense during 2023 increased notably as a result of higher interest rates. In terms of net income for the year 2023, GAAP net income attributable to common shareholders totaled $35 million or $0.27 per diluted share. With respect to funds from operations, FFO for the year 2023 totaled $141 million, equating to $1.6 per share. Net operating income for 2023 on the same center comparative cash basis increased by 3.7% over 2022. According to our financing activities, during 2023, we raised in total approximately $363 million of capital, $350 million of which were raised in September through a public offering of unsecured senior notes.

As Stuart noted, it was the first time raising capital in the public bond market in nearly a decade. Reportingly, we made a concerted effort to fully engage with the market, having discussions with a broad and diverse mix of investors, a number of which were new to the company. We utilized the proceeds from the offering to retire the 250 million of unsecured senior notes that matured in December. Additionally, we retired early $100 million of floating rate debt. Also, in the midst of the fed’s rate tightening, we swapped $150 million in floating rate debt fixed rate. As such, at year end, just 9% of our total debt outstanding was effectively floating rate, down significantly from a year ago when our floating rate debt was 28% of our total debt outstanding.

Along with proactively lowering our floating rate debt, earlier in the year, in light of the regional banking turmoil, we proactively extended the maturity of our credit line, sending in the maturity data to 2027 with the ability to extend it for an additional year to 2028. We also have the ability to double the capacity of the credit line from its current capacity of $600 million up to $1.2 billion. Additionally, in the context of what happened in the regional banking sector this past year, it’s important to note that we just had two mortgages that together only total about $60 million. Looking ahead, come April, when one of the two loans mature, we were down to only one mortgage remaining. In addition to lowering of floating rate and secured debt, during 2023, we continued to work at enhancing the company’s financial ratios, including the company’s net debt ratio.

We ended the year with a net debt ratio of 6.2x for the fourth quarter, which is the lowest that our net debt ratio has been dating back to 2014. Looking ahead, our debt maturity schedule is well laddered over the next five years with approximately $300 million maturing each year on average. Having now reestablished ROIC in the public bond market, our objective is to be a consistent annual issuer going forward. Looking at 2024, in addition to refinancing the senior notes that mature at the end of the year, we may also look to refinance our term loan and credit line borrowings of long-term fixed rate bonds, depending upon market conditions as the year progresses. With respect to equity capital, in light of the acquisition that Stuart discussed, in December, we issued common stock through our ATM, raising approximately $13 million.

In terms of guidance for 2024, we currently expect our core portfolio NOI will continue to grow, driven by a combination of contractual rent increases together with expected releasing rent growth. Additionally, as Stuart touched on, we are anticipating that the acquisition market will become active and favorable again. Accordingly, we currently expect to acquire between 100 million to as much as 300 million of shopping centers net of dispositions. The fund acquisitions are guidance assumed that we will issue equity in step of the acquisition activity as we move through the year with the goal of keeping our financial ratios intact as we grow our portfolio. Moderating our expected external internal growth will be interest costs. Based on the bonds that we issued in 2023, together with our projected acquisition and refinancing activity, we currently expect that the company’s interest expense will be in the $78 million to $80 million range for 2024.

Additionally, in terms of bad debt, our guidance assumes a range of $3 million to $5 million, although our current expectation is that we’ll be more towards the lower end based on the overall strength that we’re tenant based today. Taking into account all of these factors and other various assumptions, we have set our initial FFO guidance range for 2024 at $1.03 to $1.09 per diluted share. Now, I’ll turn the call over to Richard Schoebel, our COO. Rich?

Richard Schoebel: Thanks, Mike. As Stuart highlighted, 2023 proved to be one of our best years in terms of leasing. Demand for space across our portfolio continues to be consistently strong as a diverse mix of longstanding tenants together with new concepts and businesses seeking to expand to the West Coast, continue to buy per space. These diverse businesses are predominantly destination type tenants in the wellness, self-care, restaurant, service, and entertainment segments. Most important from our perspective is their keen interest in leasing space at select shopping centers that are well located in diverse communities and have an established grocer as the core daily draw, which is exactly what our portfolio offers. Capitalizing on the demand, as Stuart highlighted, during 2023, we achieved a new record for the company, leasing over 1.7 million square feet in total.

The bulk of our activity centered around renewing long-standing tenants. Specifically, we renewed approximately 1.3 million square feet during 2023 and over half of that involved renewing valued anchor tenants, including long-standing grocers with a number of tenants coming to us early to renew. Some by as much as over a year in advance of their lease maturities. In terms of new leasing activity, given the lack of available space across our portfolio and the modest amount of space that was scheduled to mature during 2023, we made a concerted effort to proactively recapture select spaces focusing on sought-after anchor and pad spaces, spaces that are well suited for the type of businesses that are leading to demand. In total, we successfully executed upwards of 400,000 square feet of new leases, a good portion of which were with tenants new to our portfolio.

In step with our renewal and new leasing activity, we again posted another solid year in terms of re-leasing rent growth including a 7% increase on renewals and a 22% increase on same-space new leases. With respect to Rite Aid, as we discussed on our last call back in October, out of the 15 leases we had with Rite Aid across our portfolio, 3 of the stores closed in the fourth quarter, which is reflected in our portfolio lease rate, which was 97.7% at year-end. We already have much of the space spoken for with new synergistic tenants that we are excited about. We expect to achieve a notable increase in the average base rent. In terms of the remaining 12 leases with Rite Aid, all of the stores continue to perform well, and Rite Aid has indicated that they intend to keep operating the stores and plan to implement new merchandising and operational strategies aimed at enhancing their performance going forward.

As 2024 is getting underway, demand for space continues to be strong across our portfolio such that we expect to have another solid year. In terms of occupancy, we expect to maintain our overall portfolio lease rate in the 97% to 98% range as we move through the year. In terms of lease rollover, specifically anchor lease maturities, at the start of 2024, we had seven anchor leases scheduled to mature during the year, totaling 281,000 square feet. Three of the seven have already renewed their lease and we currently expect another two will renew as well. As to the remaining two anchor leases scheduled to mature, one is with Rite Aid, which is 1 of the 12 stores that they intend to keep operating. We’re currently in the process of amending their lease to extend it for another five years.

With respect to the other anchor lease, we are in the process of re-leasing the space and are currently in discussion with several national destination entertainment business that will be a terrific added draws to our property. Additionally, we expect to achieve a substantial increase in base rent over the prior tenant’s rent. Looking out further at 2025, we currently have 22 anchor leases scheduled to mature. Based on our early proactive discussions with the tenants, we currently expect that 21 of the 22 anchors will renew, the bulk of which we expect will renew early as we move through 2024. The remaining anchor lease is 1 of the 12 leases with Ride Aid that we are currently in the process of extending the lease term. Lastly, in terms of non-anchor space maturing in 2024.

At the start of the year, we had 484,000 square feet of shop space scheduled to mature. Similar to our anchor re-leasing activity, we are already hard at work and having good success at renewing and re-leasing the space. Additionally, we are also proactively pursuing recapture opportunities and expect to have another productive year as we did in 2023. Now I’ll turn the call back over to Stuart.

Stuart Tanz: Thanks, Rich. Our ability to post another strong year of leasing underscores the resilience and competitive strength of our grocery-anchored portfolio and the intrinsic value of our operating platform and singular West Coast focus. To echo Rich, looking ahead, we expect to have another strong and productive year in 2024. In terms of same-center net operating income, we fully expect to continue growing our NOI in 2024. However, on a cash basis, the growth rate for this year will be moderated as a result of Rite Aid stores that closed in the fourth quarter and the anchor lease that Rich mentioned. While we are already close to having new tenants lined up for the space is at significantly higher rents on average, there will be downtime as we get the new tenants in place, which is reflected in our same-center NOI guidance growth for 2024.

Once the new tenants are in place, together with what we expect to be another strong year of leasing in 2024, looking out further at 2025, we currently expect that same-center NOI growth will be in line with our historical growth rate in the 3% to 4% range, if not better. In terms of acquisitions, as 2024 is getting underway, we currently have close to $100 million of off-market transactions in our pipeline. All of which is truly irreplaceable real estate in the heart of densely populated sought-after communities. While the transactions are not yet finalized, we currently expect that the potential pricing on a blended basis will be comparable to our fourth quarter acquisition. Safe to say, we are excited about these opportunities and look forward to growing our portfolio in 2024 and continuing to build long-term value.

Now, we will open up the call for your questions. Operator?

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Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Jeffrey Spector with Bank of America Securities.

Unidentified Analyst: This is Levi on for Jeff actually. So, I guess just starting with — going back to the rationale around issuing equity in the quarter and then putting out guidance for the year. Could we just maybe get some more color around expectations of cost and kind of why that range is a bit wider? Presumably it looks like that would be dilutive kind of depending on your view of NAV. But just wanted to get some more color around the plans to issue equity.

Stuart Tanz: Sure. Well, look, in terms of the fourth quarter, we issued the stock specifically to finance the acquisition on a balance sheet neutral basis and to maintain our financial ratios. Based on the cash cap rate and the FFO yield on the acquisition, the transaction is accretive with good growth opportunities going forward. Looking forward, obviously, it’s going to be a function of cap rates in terms of where we’re acquiring any future assets and the price of our stock.

Unidentified Analyst: Okay. Great. And I guess just a follow-up. Where are you seeing cap rates for the centers you’re interested in trend today? Have we seen more of a compression there since maybe we last touched on this in October, November?

Stuart Tanz: Sure. Look, there’s very little activity in the market. So it’s very tough to pin cap rates in this market because depending on the asset and depending on the growth profile, cap rates continue to sort of move around. But going forward, we’re expecting with what we see in our pipeline in terms of the off-market opportunities, that cap rate, again, in the mid-6s or even a bit higher.

Unidentified Analyst: Okay. Great. And then separately, just wanted to touch on your same-store NOI outlook. And can we clarify what the exact step-ups are to that 1% to 2% range, is most of the drag really from the downtime associated with backfilling spaces that were lost? If there’s any more color you can add on the building blocks to that range, which implies a deceleration from this year — last year’s growth, that would be great.

Stuart Tanz: Sure. It’s purely a function of the three Rite Aids that we mentioned back on our last call and what Rich was good enough to articulate today. Along with some other anchor tenants that is vacating or has vacated at the end of January. Those are really the building blocks to our same-store NOI. The good news is that we’re making some very good momentum in re-leasing those spaces. And as I said in the closing sort of part of my presentation, we’re expecting most of that to be leased in the next, let’s call it, first quarter, early second quarter, and we’ll see the positive impact of that as we move through the balance of the year and into ‘25.

Operator: One moment for our next question. Our next question comes from the line of Dori Kesten with Wells Fargo Securities.

Dori Kesten: Back to the net acquisition guide. I guess, I understand that you have $100 million in the pipeline today. What gives you confidence in the $100 million to $300 million? Are you rather close to having an LOI on that $100 million?

Stuart Tanz: I think we’ve been hard at work over the last several quarters in terms of reconnecting with our, what I would call, our pipeline of sellers. And we are seeing some of these sellers come under pressure as it relates to debt coming due. So we’re feeling pretty good about really going out and finding very high-quality assets at compelling prices. So as we sit here today, look, we do have some exciting opportunities ahead of us. Obviously, we’re still in the due diligence stage in terms of buying these assets. But we still — we’re feeling very comfortable sitting here today that we’ll be able to achieve certainly that lower end of our guidance.

Dori Kesten: Okay. And I believe on the Q3 call, you were talking about potential acquisitions funded with OP units. Are these that you’re referring to? Or were those other ones?

Stuart Tanz: No. Those opportunities are at our doorstep as well right now. And obviously, that equity, if we end up doing these transactions, we’ll be at a much — or a higher price than where our stock is currently trading.

Dori Kesten: Okay. And last question. In your interest expense guide for the year, what assumptions are embedded for refinancing swaps paying down with cash?

Stuart Tanz: Well, the guidance is going to take into account refinancing the ’24 bonds later in the year. It’s really kind of tied to the forward yield curve. That’s the best thing we can use to model that interest cost out. And in terms of cash flow, Mike?

Michael Haines: Well, free cash flow for the year, whether we use it to pay down debt or fund acquisitions, about $20 million to $30 million, depending on actual CapEx costs and interest costs through the year.

Operator: Our next question comes from the line of Juan Sanabria with BMO Capital Markets.

Juan Sanabria: Good morning. Just hoping you could talk a little bit about the builder commenced occupancy and how we should expect that to trend over ’24. I’m not sure if all the Rites Aid stuff is in the base as a starting point for the year or if you expect a seasonal dip in the first quarter. But if you could just give us a sense of the trend for the year and how we should expect the year to end that would be great from a build occupancy perspective?

Richard Schoebel: Sure. Well, we’re still making very good progress on getting the rent commenced. But as you know, as commencing rents, we’re adding new uncommenced rents to the bucket. And with the Rite Aids and the other anchor space we spoke of, it will take some time to refit those spaces, but we expect that we will continue to bring on the rent consistent with our historic averages.

Juan Sanabria: Okay. But it sounds like the one anchor, the Rite Aid, the couple of closures are in the phase to start the year, thinking about where you entered last year, and then you have one more anchor closure. Is that kind of all the meaningful declines or negative impacts we should be factoring in for the year? I’ve seen some kind of random puts and takes here and there.

Richard Schoebel: Yes.

Juan Sanabria: Okay. Great. And then just curious, any update on the assets where you guys are pursuing entitlements and kind of the processes there? And what, if anything, is assumed in guidance with starts or for monetization of that value creation?

Stuart Tanz: Well, in terms of the crossroads, we are getting to end in terms of the permitting process. Given the current market environment, we plan to sort of sit tight for the time being in terms of breaking ground. We did, during the fourth quarter, finally get full entitlements in Nevada. So both the other two projects are at this point fully entitled, and we are engaged with a series of builders and/or buyers in the market right now to potentially sell these assets. However, the multifamily market right now is still in, what I would call, in a sort of a stalled stage in terms of transacting. And my personal opinion is that as we move through the year, if we can get some cap rate compression in the multifamily business, then there’s a good chance that we’ll be able to transact on these properties.

Operator: One moment for our next question. Our next question comes from the line of Todd Thomas with KeyBanc Capital Markets.

Todd Thomas: A couple of questions. First, the additional anchor vacancy that you mentioned. I’m just curious, how much occupancy that might represent if you can share that? I’m just curious how much lower occupancy may go before bottoming out here, so we can just think about the trajectory of occupancy? And maybe help us understand the trajectory of same-store NOI growth a little bit throughout the year. And then, Rich, can you talk about the potential mark-to-market on that space and the Rite Aids that you’ve discussed recapturing and re-leasing?

Richard Schoebel: Sure. In terms of the occupancy hit, it really won’t have a significant impact, and we’re still comfortable with maintaining the 97% to 98% range throughout the year. The mark-to-market on that one anchor space is, it could be very significant. It’s a very low single-digit rent. So we’re expecting a big spread there. And then on the Rite Aid, on a blended basis, it’s going to be a very nice increase as well.

Todd Thomas : Okay. Is there any additional impact from Rite Aids at all assumed in the guidance, it didn’t sound like it, but just curious as things are still ongoing over there. Just curious if you have any additional assumptions at all embedded in guidance either around space being recaptured or potential lease negotiations.

Stuart Tanz: Well, we’re really finished — when I say finished, we have gone through and spent a lot of time with Rite Aid over the last several months. And at this point, we’re just waiting to have these leases confirmed through the bankruptcy process. Anything can happen as we know as we get through the process, but we feel very comfortable we sit today that if things continue to go well and the Rite Aid comes out of bankruptcy, the extent of what we’ve articulated today in terms of what we’ve seen in vacancy will remain where it is.

Todd Thomas: Okay. And then just shifting over to the acquisitions and the guidance there. I guess, as it pertains to the funding and the equity issuance that’s assumed alongside the investments, the range that you’ve provided. How price sensitive are you to the stock price as you kind of look ahead here with the growing pipeline of deals that you’re seeing?

Stuart Tanz: Sure. Well, look, we are very sensitive to price. But again, we feel pretty good looking at the pipeline in terms of possible accretion in terms of if we decide to issue equity will be — I think will — again, will be a function of the price where we’re buying these assets and the price of our stock. But certainly, we’ll monitor things as we move along, both in terms of timing and in terms of issuing equity if we decide to build that route as it relates to issuing that equity.

Todd Thomas: Okay. At the midpoint of the guidance, I guess, for acquisitions, for equity issuance, I mean, how much accretion is built into the guidance that you’re anticipating from this investment activity and, I guess, the capital raising activity inside all that. On a leverage-neutral basis, just with where the company’s blended cost capital is today, equity debt also in the sort of mid- to high-6% range. I’m just wondering how much accretion that you’re anticipating or what’s embedded in the guidance?

Michael Haines: Scott, it’s Mike. So looking at the low and the high end. On the low end, we acquired about $100 million, we’re expecting that to add about $0.01, $0.01 and on the high end of it about $0.03. So at the midpoint, if you do $200 million, it’s going to be $0.02. That’s just kind of ballparking the use of equity and debt to buy those acquisitions.

Todd Thomas: Okay. All right. That’s helpful. One last one, Mike. On the interest expense question from earlier, though, that is tied to the acquisitions, right? And you’re assuming about I guess 40% debt financing or really maybe 30% or 35%, assuming you reinvest your free cash flow into acquisition. So if you do not acquire assets, the interest expense would be below the guidance range, right?

Michael Haines: Presumably, yes. That’s correct. And then we also have the refinancing activities we have to do, and that’s going to be depending on where the yield curve as we move through the year. Obviously, we had a hiccup this year, early this week with the CPI, but we’ll see where the 10-year treasury goes as we move through the year.

Todd Thomas: Okay. But the debt portion of the acquisition activity that you’ll be funding that you’re assuming is being funded on the line?

Michael Haines: Correct.

Operator: Our next question comes from the line of Paulina Rojas with Green Street.

Paulina Rojas-Schmidt : Last time we spoke, I think we talked about one of the Rite Aid leases being rejected and the other two being in a sale process. So I’m curious why weren’t those leases acquired? They had meaningful mark-to-market. And I wonder if it’s because of the term, if they have legal-term left?

Richard Schoebel: Sure. Those two locations, you’re right, were offered for sale by Rite Aid. But the feedback we received from Rite Aid was that they were not willing to pay the debt rent, the administrative rent that’s required to be paid on those locations. So if people didn’t step up immediately and agreed to pay that debt rent while they were doing due diligence, they were just moving forward with rejecting those leases. So that was sort of the strategy out of the gate. And those two locations, no one jumped fast enough. However, as we touched on, there is a good mark-to-market on those leases and we have had very strong interest in the spaces.

Paulina Rojas-Schmidt: My other question is the Kroger Albertsons merger is, it’s a risk, right, and it’s potentially weighing under stock as well. So is there anything you can do today proactively to prepare for the consequences of this merger, but it could have not immediately, but in the medium term? Or you’re really, there is not much you can do today. You’re putting the topic to rest until there are more news.