Whitestone REIT (NYSE:WSR) Q4 2023 Earnings Call Transcript

Whitestone REIT (NYSE:WSR) Q4 2023 Earnings Call Transcript March 7, 2024

Whitestone REIT isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings, and welcome to the Whitestone REIT Fourth Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. David Mordy, Director of Investor Relations for Whitestone REIT. Thank you. You may begin.

David Mordy: Good morning, and thank you for joining Whitestone REIT’s fourth quarter 2023 earnings conference call. 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, March 7, 2024.

The company undertakes no obligation to update this information. Whitestone’s fourth 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 fourth quarter 2023 earnings slides on our website yesterday afternoon, which highlight topics to be discussed today. I will now turn the call over to Dave Holeman, our Chief Executive Officer.

Dave Holeman: Thank you, David, and good morning, everyone. Welcome to our fourth quarter 2023 earnings conference call. I’ll break my comments into three parts. First, what we’ve done, second, ongoing initiatives that continue to drive value, and finally, how our core strategy thinks very well with the current environment. I’ll get straight into it. In terms of what we’ve done, this management team began in January of 2022, so we’re two years into our run. Here’s a high-level list of our accomplishments. Core FFO per share has grown from $0.86 in 2021 to $0.91 for 2023. This is despite higher interest costs, primarily as we renewed and extended our credit facility in the third quarter of 2022. With that in place until 2027, we anticipate a higher earnings trajectory ahead of us.

I’ll have Scott cover our projections in greater detail. We’ve rapidly improved our balance sheet metrics, bringing our debt to EBITDAre down from 9.2x for the fourth quarter of 2021, to 7.5x for the fourth quarter of 2023. This is despite significant litigation expense impacting our numbers. We’ve focused and prioritized our disciplined leasing efforts on high quality tenants, resulting in record occupancy in our portfolio, up 290 basis points from 91.3% at year-end 2021, to 94.2% at year-end 2023. Breaking this down further, we’ve grown our small space occupancy by 320 basis points to 92.1%, and our larger space occupancy has grown by 200 basis points to 97.5%. We had same-store net operating income growth of 7.9% in 2022, followed by 2.7% in 2023.

Scott and Christine will provide more detail on this important metric later in the call. We’ve strengthened our board, bringing on three new board members or half of our six-person board of trustees. This refreshment has been accompanied by a host of shareholder-friendly actions, including right-sizing our executive compensation, splitting the role of chair and CEO, and providing shareholders with access to bylaws. We’ve worked hard to successfully conclude the litigation with our former CEO and exit our investment in his related party joint venture. We are nearing conclusion. Whitestone has a very clear strategy and path to value creation that continues to be more clear as this noise is removed. And finally, culture. We’ve simultaneously brought on very talented individuals, reduced our headcount, and improved employee satisfaction.

In short, we’re improving G&A while achieving better results. I’m super proud of the team and their long list of accomplishments over the last two years, only a few of which I have highlighted. I’m equally excited about how we’re continuing to drive value. Three initiatives are at the heart of our creating value, our quality of revenue initiative, our balance sheet improvement plan, and our capital recycling plan. I’ll have Christine cover the quality of revenue initiative, and I’ll provide a bit of color on the other two. We’ve had significant progress with our balance sheet improvement plan over the last two years, obtaining an investment grade credit rating. We have more work to do here and have the right people, the right plan, and the market tailwinds supporting our efforts.

Our debt metrics will continue to improve as we grow EBITDAre, apply free cash flow to reduce debt, monetize our Pillarstone investment, and activate the land parcel and pad site development opportunities within the portfolio. We expect debt to EBITDAre below 7x by year-end 2024, and we anticipate further improvement in 2025. Our asset recycling program has allowed us to upgrade the overall quality of our portfolio, selling properties with lower upside and ABR, and redeploying the proceeds into acquisitions with significantly higher upside, higher ABR, and characteristics that capture more of the key demand drivers in today’s market. We anticipate that since October of 2022, we will have completed approximately $80 million in asset sales by the end of the second quarter at an aggregate cap rate of 6.2%.

I say anticipate because we have a sale upcoming but not yet announced, and we believe we’ll keep the effort going at about the same pace we’ve had over the last two years. I think it’s important to note here that we are very capable of driving results via organic growth. so, we’re not reliant on the transaction market or the equity market cooperating in order to drive earnings growth. However, we are starting to see valuations adjust slightly to the higher interest rate environment, and our team is ready to take advantage of those opportunities that align with our strategy. The final area I would like to cover today is what we’re seeing in terms of the current environment. Frankly, this is a great environment for most of the retail REITs, as limited supply of retail centers is driving good results across the peer group.

The limited supply, combined with country-leading job and population growth in our markets, and Whitestone’s ownership of the right type of retail centers, makes this current dynamic especially powerful for Whitestone. Our strategy and our assets are very well matched to take advantage of this environment, and we’ve made a number of strategic decisions that are producing great outcomes. Specifically, we have shorter leases with annual rent bumps, the ability to capture mark-to-market rents quicker, a high quality diversified tenant roster, and limited CapEx needs as compared to other peers. This strategic decision to operate with shorter leases and be more active owners, is fundamental to what we do. Because of the confidence we have in our team to populate centers with fast-growing tenants, we are better positioned to share in their success.

We are 100% Sunbelt-focused in business-friendly States. Migration trends in our markets lead the country and are acting as a strong tailwind, not only in terms of our operating results, but for the underlying value of our centers. Lastly, our centers have a much larger percentage of small spaces than most of our peers. We and others continue to see strong demand from businesses seeking out spaces in the 1,500 to 3,000 square foot range. We’ve intentionally acquired centers and made modifications to meet this demand, and we believe this trend will continue as businesses adjust to properly meet the needs of the surrounding communities. We introduced 2024 core FFO per share guidance yesterday of $0.98 to $1.04. We have a few more near-term unknowns than I’d like, but I’ve never been more bullish about the fundamentals driving our business and the strategy we have in place.

I’ll have Scott walk everyone through our 2024 projections and the assumed variables. Once again, let me say I’m very proud of the team here and everything we’ve accomplished, and I’ll now turn the call over to Christine.

Christine Mastandrea: Thank you, Dave. We’ve had a real strong quarter in operations. Occupancy rose to 94.2%, up 50 basis points from last year’s record finish. Occupancy may dip a bit for the upcoming quarter as it did for the first quarter of 2023. This is because we closed a large number of deals in the fourth quarter, and we intentionally are re-merchandising in the first quarter for revenue quality. However, while we may see a first quarter dip, we have a strong pipeline of deals and we’re forecasting an occupancy of 93.8% to 94.8% by year-end 2024. Occupancy for 10,000 square foot plus spaces came in at 97.5%, with our higher ABR small spaces coming in at 92.1%. Straight line leasing spreads were 21.8% for the quarter, with 37.3% on new leases, and 15.3% on renewals.

For the last 12 months, combined straight line leasing spreads were 21.7%. Frankly, as strong as our leasing spreads are, it keeps getting better if you dig into the numbers. Just recently, Marcus & Millichap showed asking rents in Phoenix, our largest market, jumping 12.6% between 2022 and 2023. Not only did we capture those jumps more quickly because of our shorter-term leases averaging four years, but the recency of the jump bodes well for our leasing spreads in 2024, 2025, and 2026. This isn’t just a number on a spreadsheet. It matches what our leasing agents are seeing in the ground. Migration trends, Phoenix manufacturing boom, consumer trends, and a shortage of retail neighborhood centers, are all combining to make this one of the strongest environments we’ve ever seen.

Some of our peers have recently been talking about the value of vacancy, and that vacancy allows them to better align a center to the surrounding demographic, often a new younger demographic, rather than letting a center get out of touch. However, as you can see from the fact we just hit the record occupancy, vacancy at our centers is limited. This leads us to our quality of revenue initiative. We strongly believe that upgrading our tenants during the good time creates long-term shareholder value as we drive traffic with fast-growing businesses and further improving collection rates and lowering our intended and unintentional turnover. We often compare what we do to gardening, and that intentional pruning is key to make sure that you have high quality tenants primed for growth.

Oftentimes, we’re swapping in a business with higher long-term growth potential and the ability to drive center traffic is necessary because over 60% of our centers are at the 95% or greater occupancy. Given our average lease length, I like to think of this initiative as halfway through from when the management team stepped in. By 2026, we will have intensely reviewed the large majority of our tenants. We’re confident investors will benefit from these efforts as we set this up for a long-term robust same-store NOI growth. Despite our great success in smaller spaces, we’ve had a number of positive things going on in the larger spaces too. Our former Bed, Bath & Beyond space is being transformed into a high-demand Pickleball and entertainment venue.

Our new tenant, Pickler, is an extremely strong operator, and we’ve recently signed a long-term contract with them at El Dorado, our Trader Joe-anchored Center in Dallas. In the locations they’ve opened so far, Pickler has enjoyed a strong first-mover advantage, and they’ve shown themselves to be adept at going after a younger demographic. Our EoS buildout at Williams Trace is taking longer than anticipated, pushing back the commencement date. While this impacted our same-store NOI growth in 2023, it will have some impact on 2024, but I want to remind everybody it’s a great replacement of an underperforming grocer, and triples their revenue for 51,000 square feet of space. This change is anticipated to drive strong center traffic for years to come.

Many of the businesses that are cycling out right now are those challenged by the higher capital costs in the current environment. The businesses moving in are adjusted to the higher capital cost. However, this has been a limited number of businesses in our portfolio as the margin of the bulk of our tenants are low inventory and low capital businesses serving the communities that we have. I’d add one comment to Dave’s regarding our capital-recycling initiative. With the sale of Spoerlien in Chicago, we’ve exited our one property that didn’t fit our geographic profile. At this time, we only have one property that doesn’t fit our strategic profile, that is owning services that serve the nearby community. That property is our headquarters office building, Woodlake.

We’ll take a hard look at exiting Woodlake this year. We strongly believe in having a very focused strategy of sticking to our expertise. I often comment on categories of tenants that are showing strength during the quarter. However, almost every category of tenant type is performing well right now. From restaurants, health, beauty, education, fitness, and financial, and other service-oriented businesses, we are seeing growth. I’m eager to drive results and see what leasing team can accomplish in 2024, and I’m eager to report those results as the year progresses. And with that, we’ll have Scott cover the financials.

Scott Hogan: Thank you, Christine. We delivered $0.24 in core FFO per share for the fourth quarter of 2023 versus $0.23 in the fourth quarter of 2022, and $0.91 for the full year 2023 versus $1.03 for the full year 2022. Now I’ll walk you through the 2022 to 2023 core FFO per share of earnings variance, and you may want to follow along on Slide 11. Same-store NOI growth was our key positive driver, as it should be every year, adding $0.05. G&A drove a $0.05 reduction in FFO core per share, including $0.04 of benefit in the first quarter of 2022, associated with a forfeiture of outstanding restricted share from our former CEO and other employees that was not repeated in 2023. While G&A normally reflects year-over-year increases in compensation expense, ours also contains litigation expense related to Pillarstone and our former CEO.

Other items drove a $0.01 reduction, and interest expense drove an $0.11 reduction. As a reminder, we amended our credit facility in the third quarter of 2022. So, the variance between the former and current credit facility primarily impacted the first three quarters of 2023. As Dave mentioned, we introduced 2024 core FFO per share guidance yesterday, with a range of $0.98 to $1.04. Let me walk you through the forecasted changes between the 2023 core FFO per share amount of $0.91 and the midpoint of the 2024 guidance of $1.01. Same-store NOI is expected to improve $0.07 in 2024. G&A cost reductions should drive a $0.01 increase, primarily as our former CEO and Pillarstone-related litigation expense is expected to be significantly reduced. Other items primarily driven by non-same-store NOI and no longer reflecting earnings deficits from our equity method investment in Pillarstone following our OP unit redemption in January of 2024, are forecasted to add $0.03.

interest expense is forecasted to drive a $0.01 reduction in core FFO per share. We anticipate higher interest expense in the first part of the year, both because the shape of the SOFR curve, and because we assume some paydown of debt, with partial Pillarstone monetization in July. Overall, if you divide our annual guidance into four quarters, I anticipate the first quarter will be a couple of cents under the average, primarily due to interest expense. And I anticipate the fourth quarter to be a couple cents over the average due to lower interest expense, percent sales clauses, and growth that’s expected to occur over the course of the year. In addition to the headline, let me cover a few other elements of our guidance. Same-store NOI is forecasted to be between 2.5% and 4%.

The delay in EoS commencement is a reason the change is a little lower, but we are still expecting strong growth. Bad debt is expected to be between 0.6% and 1.1%. We improved bad debt by 18 basis points in 2023, bringing it down to 0.65%. Our quality of revenue initiative should help keep this number low. Finally, our debt to EBITDAre metric is forecasted to improve to between 6.6x and 7x by the fourth quarter of 2024, and that assumes we’re not able to monetize the majority of our Pillarstone investment until 2025. We are very pleased to announce a 3% increase in our monthly dividend level. We believe dividends should grow with earnings, and we believe we’ll have good earnings growth in 2024 and continuing in 2025 and beyond. Thank you all for joining our earnings call, and with that, we’ll open the line for questions.

Operator: [Operator Instructions] Our first question comes from the line of Mitch Germain with Citizens JMP. Please proceed with your question.

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Q&A Session

Mitch Germain: How are you?

Dave Holeman: Good morning, Mitch. I think you broke up a bit. Good morning, Mitch.

Mitch Germain: Yes, sorry about that. My bad. I wanted just – obviously, you talked a little bit about quality of revenue and it’s – I don’t know, it seems like your bad debt is forecasted to be a little bit higher in 2024. I’m just curious in terms of, I’m sure there’s a little hint of conservatism in that number, but is there anything specific that is driving that midpoint of that number to be higher year-over-year?

Scott Hogan: Hey, Mitch, it’s Scott. The bad debt assumptions we put into the forecast are a range that we’re comfortable with. The midpoint isn’t necessarily where we expect to end. And no, there’s no specific tenants that we have identified that are going to drive higher bad debt next year.

Mitch Germain: Okay, that’s helpful. What percentage of your portfolio comes from the smaller tenants relative to the larger ones? How should we think about that? Obviously, we talk about that obviously trend above peers, but what is it specifically?

Dave Holeman: Yes, I think – hey Mitch, it’s Dave. In our PowerPoint for the call today, I think David Mordy is going to give me a page number, but there’s a page number that breaks out – Page 6, breaks out our tenant base. Approximately 75% of our ABR is in the smaller spaces that are really in high demand today. So, we think that’s a key differentiator of Whitestone versus many others in the sector, and we have the type of spaces that are in high demand.

Mitch Germain: Agreed. Okay. Obviously, we’ve got a lot of products that seem to be going smaller and smaller. Dave, talk about – obviously, you’re in the process of deleveraging, but you interestingly mentioned activating your land parcels and some of your redevelopment opportunities. Clearly, that creates a little bit of higher leverage initially before the EBITDA commences. So, maybe if you could just provide some perspective on the potential opportunities that you’ve got embedded in the portfolio and how you feel some of those potential opportunities could be monetized.

Dave Holeman: Yes, Mitch, I’ll give a couple of high level comments, and maybe I’ll ask Christine to share some more about the development opportunities. I will tell you, our goal and our challenge is to do a number of things. Over the last couple of years, we’ve improved our balance sheet. We’ve driven earnings. We’ve capitalized on development opportunities. So, it’s always a balance. We’re focused on the balance sheet improvement plan and have made strong progress. And then we’re obviously top-line-focused on value creation. Maybe I’ll let Christine comment a little bit on the development opportunities.

Christine Mastandrea: Mitch, I think the best way to look at our portfolio is most of these are pads and smaller buildings. And so, the timeframe it takes to get these positioned through an approval process, which is a low-cost venture to start out, right, but it just takes time. By the time you get that in place and then you actually build, which is when you start your significant capital costs, that’s like a six-month timeframe. So, it doesn’t take that long to build these pads out. It takes a while to get them approved within the zoning districts that you have to work with. So, I like you to say, I think these things are very easy once you get an approval, then your capital costs are your significant capital costs and that’s maybe six months. And then once you get them out of the ground, then of course you’re able to achieve on your returns with the rents. So, most of ours are smaller pads.

Mitch Germain: So, how many of these pads have entitlements right now?