Kite Realty Group Trust (NYSE:KRG) Q3 2023 Earnings Call Transcript

Kite Realty Group Trust (NYSE:KRG) Q3 2023 Earnings Call Transcript October 31, 2023

Operator: Good day, and thank you for standing by. Welcome to the Third Quarter 2023 Kite Realty Group Trust Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to turn the call over to the Senior Vice President of Corporate Marketing and Communications, Mr. Bryan McCarthy.

Bryan McCarthy: Thank you, and good afternoon everyone. Welcome to Kite Realty Group’s third 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 are 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 thanks everyone for joining us today. KRG demonstrated another quarter of exceptional execution across our best-in-class operating platform. Since the outset of project focus in late 2018, we have strategically positioned our portfolio and balance sheet to thrive in any environment. As a result of our operational intensity, we’ve outpaced our peers in three key metrics: ABR growth, blended cash spreads, and FFO growth. Regardless of how the next few years unfold, KRG is in the enviable position of moving forward with confidence. Turning to our third quarter results, we generated FFO per share of $0.51. Our same-property NOI grew by 4.7% as compared to the same period in 2022, primarily driven by minimum rent growth, lower levels of bad debt, and overage rent.

Our outperformance year-to-date is allowing us to increase our NAREIT FFO guidance by $0.03 at the midpoint. We’re also increasing our same property NOI growth assumption by 100 basis points, moving from 3.5% to 4.5% at the midpoint. Heath will give more details around the quarterly results and our updated guidance. During the third quarter, KRG signed 214 leases, representing approximately 1.4 million square feet, producing 14.2% blended cash spreads on comparable new and renewal leases. Notably, our non-option renewal spreads for the quarter were 17.8%. This is an incredibly strong number for deals that require minimal capital. More importantly, KRG earned a 30% return on capital for all new leases for the trailing 12-month period. In addition to the strong leasing, volume spreads, and return on capital, we’ve been successful in achieving higher fixed rent bumps and CPI protection.

Through the first three quarters of 2023, 82% of our new and non-option renewal leases have fixed annual rent bumps that are greater than or equal to 3% and 41% of those leases includes CPI protection. The average annual fixed rent increases for the new and non-option renewals year-to-date was 2.5% for both our small shop and anchor tenants, which is a 100 basis points higher than our portfolio average. Redefining our long-term embedded growth profile remains a top priority. Last quarter we noted our plan to leverage our robust leasing demand by being more proactive in recapturing small shop space. The initiative has been very successful, as evidenced by the 80 basis point sequential increase in our small shop lease rate. Small shop demand has been very diverse and in the past quarter, we signed deals with restaurants, medical users, health and beauty, and fitness concepts.

On the anchor front, our lease rate took a predictable step backward due to the Bed Bath & Beyond situation. But we could not be more pleased with a flurry of activity on our empty boxes. This past quarter, we signed a total of five box deals at 53% comparable cash spreads. To date, we’ve addressed five of the Bed Bath boxes with an additional eight leases in negotiation, seven in LOI negotiation. I am confident we should have the vast majority of our Bed Bath exposure addressed by our next earnings call. What’s even more impressive is the variety of anchor tenants we’re partnering with, including grocery, big box wine and spirits, home furnishings, sporting goods, and discount retailers among others. For the next 18 months to 24 months, our best opportunity is to drive value simple, lease space, and commence rent.

KRG has a significant organic growth opportunity at a time when open-air retailers are experiencing favorable tailwinds. While our top priority is leasing, we’ve been consistent in our match funding transaction strategy to further improve the portfolio and minimize earnings dilution, while keeping our rock-solid balance sheet intact. Our transaction activity year-to-date has been a perfect example. We sold four assets, bought an asset, and used excess proceeds from the dispositions to pay down debt. We recently sold Reisterstown Plaza in the Baltimore MSA and Eastside in the Dallas MSA. We determined the downside risk at each asset eclipsed our ability to drive above-average returns. Conversely, we acquired Prestonwood Place in Addison, Texas, an affluent highly desirable suburb of Dallas.

The assets existing tenancy shows demand for the property is strong but will further upgrade the merchandising mix and drive operational efficiencies. Prestonwood Place instantly enhances the quality of our already dominant Dallas footprint. We will be showcasing several of our assets to the investment community next year with our 4 and 24 series. We look forward to seeing many of you at our first event in February in Naples, Florida. I started the call discussing the transformation KRG has made over the past five years. We’ve always been a team with unparalleled operational acumen and pride in ourselves being a real estate first organization. Now we’ve implemented a best-in-class operating platform onto an expanded high-quality portfolio while possessing one of the best balance sheets in the sector.

Thank you to our team for its continued dedication and commitment. And now I’ll turn the call to Heath.

Heath Fear: Good afternoon. In this industry, we are fond of saying good things happen to good real estate. With that in mind, I’m pleased to report that KRG team has produced another spectacular quarter. For Q3, KRG earned $0.51 of NAREIT FFO per share based on same property NOI growth of 4.7% on a year-over-year basis. The quarterly same property outperformance was driven by a 240 basis point increase in minimum rent, a 30 basis point increase in net recoveries, a 160 basis point increase due to lower bad debt, and a 40 basis point increase in overage rent and other revenue. Year-to-date KRG has earned a $1.54 of NAREIT FFO per share and increased same-property NOI by 5.5% on a year-over-year basis. The components of our year-to-date outperformance closely track the quarterly themes.

We are raising our NAREIT FFO guidance to a range of $1.99 to $2.03 per share, representing a $0.03 increase at the midpoint. $0.025 is attributable to same-property NOI outperformance, while the other half penny is related to noncash front associated with rejection of certain Bed Bath & Beyond leases. At the midpoint, our updated full-year guidance assumes bad debt of 45 basis points of total revenues for the full year of 2023. No additional termination fees and no further transactional activity. We continue to operate the business from a position of strength, in large part based on our balance sheet. I’m pleased to report that S&P has upgraded our rating outlook to positive from stable. And we are optimistic that this will result in a full upgrade to BBB rating in the next 12 months to 18 months.

We’ve come a long way in five years, and we are uncompromising in our commitment to maintaining a balance sheet that affords us a disproportionate amount of security and optionality. We continue to remain opportunistic as it relates to the unsecured bond market, while our abundance of liquidity affords a patient posture as we contemplate our 2024 maturities. KRG is a dedicated and committed organization anchored in an efficient operating platform and a strong balance sheet. I’m proud of the progress we’ve made, and I’m excited for what the future holds. Thank you for joining the call today. Operator, this concludes our prepared remarks, please open the line for questions.

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Q&A Session

Operator: [Operator Instructions] Thank you so much. One more moment for our first question. And it comes from the line of Craig Mailman with Citi. Please proceed.

Craig Mailman: Hi, guys. John, just wanted to go back, it sounds like Bed Bath actually going to be done pretty quick here and you had always said, you want the right opportunity versus kind of just a speed and backfilling them. But clearly, you obviously feel like you’ve got the right tenant mix here. How did the rents kind of stack up versus what your original pro forma was on the backfill those boxes and how many of them were able to keep single-tenant versus ultimately having the split up?

John Kite: Sure. I mean, overall, it’s tracking as we’ve been talking about, I would say, the rents are probably in the 20% to 30%, you know, range in terms of a premium over past rents. We continue to get very strong returns on capital, just as important as the spread. And the timing is, you know, look, I think, I think it’s probably been more robust than then we thought in terms of how quickly we’ve been able to assimilate the roster. But we were still maintaining the discipline around making smart decisions around which tenants were doing business with. So, no, no real there, Craig. Tom, you want to add anything?

Tom McGowan: Yes. I think a simple way of looking at it is, right now we have 16 boxes that we’re negotiating leases with 14 negotiating LOIs, and inside that we have nice numbers of Bed Bath eight on negotiating leases and seven in negotiating LOIs. So you can see there is tremendous activity on that front. But in reality, we look at it, we have 35 vacant anchor boxes and that’s what we’re really focused on is making sure we get those, those all taken care of in Bed Bath simply a subset of that. So as you go through these numbers that we’re talking about today, we’re going to be down to just several, several boxes and we’re going to continue to bang on those as we work through the end of the year. So we’re very encouraged on our progress and what all we’ve accomplished.

Craig Mailman: Great. Thanks for that. And then Heath you had kind of touched quickly on evaluating opportunities in the debt market here. I believe you guys have some legacy RPAI debt rolling. Could you kind of talk about what may be the – you know, the cash impact or GAAP impact of those, where you had some purchase accounting issues? And what the ultimate impact could be? And I don’t know if you have it handy, but just in ’24 and ’25, kind of what the GAAP part of those RPAI maturities look like relative to kind of maybe turning to the P&L?

Heath Fear: Sure. Thanks, Craig. So we discussed last time in the call that the noncash impact from retiring the RPAI debt in next quarter, it’s around $0.02 in 2024. And then in terms of the cash impact, unless you can make your own sort of assumptions here. And based on timing, do we take out the 270 maturities early do we take it out late that the debt that we are paying off is at 3.75% and so currently indicative rates right now on a 10-year deal are somewhere around 7%. So obviously there will be some negative interest rate arbitrage into 2024. But again it will be very dependent on timing, the earlier obviously the more impacted into 2024. But yes, so on the cash basis, it’s $0.02. And then on negative refinancing arbitrage, you know, call it somewhere between $0.02 and $0.04 depending on –

Craig Mailman: Okay. And if I just looked at one year, looking at your total debt at the interest rate, I think you get like $31 million or $32 million of annual interest expense run rate versus ’25, it’s running through that $7 million gap. Is that predominantly all, this is RPAI differential or is there anything else running through that?

Heath Fear: Yes, predominantly, yes.

Craig Mailman: Okay. And then just one last quick one. Did you guys have any below-market lease adjustments that impacted same-store FFO this quarter?

Heath Fear: Yes. I think it was like – no, not saying – mean FFO, not same store.

John Kite: Now, we had about $1 million impacted from Bed Bath & Beyond rejections in the quarter on an FFO basis but not on a same-store basis.

Craig Mailman: Great. Thanks guys.

John Kite: Thanks.

Operator: Thank you. One moment for our next question, please. And it comes from the line of Lizzy Doykan with Bank of America. Lizzy, please go ahead.

Lizzy Doykan: Hi, good morning. I was hoping to get some more color around the dispositions that closed during the quarter, particularly just – you know, on pricing?

John Kite: During the quarter, R&D, I mean, look, I think we talked a little bit about the fact that the assets we’re selling, we believe didn’t meet kind of our long-term goals. So that being said, I mean, the pricing was pretty attractive. So I would say the assets that we dispose. And if you look at the total of 2023 versus just the quarter, so – all the assets we’ve disposed in ’23 would be like in the high five cap range. So we’ve done pretty well on the dispose. Again a lot of that is not – people aren’t really necessarily pricing things that just going in cap rates that are looking at what their potential IRR is. So some of these had some lease-up opportunity as well.

Lizzy Doykan: Okay. And just there – one of the slides in your most recent deck details anchors like Adidas, Kendra Scott, Sephora for opening in power centers and we’re definitely seeing tenants become increasingly agnostic to center format. So just curious on what the pricing power is like on tenants of this type, you know, wanting to open in space is not so typical to their typical format and how that might impact in terms of the lease?

John Kite: Well, let me just start with macro and Tom can kind of jump into. I mean, the pricing power that we believe we have is really a function of the real estate, and that carries through regardless of the tenant that we’re working with. I would say, that tenants, such as the ones you mentioned, generally speaking, are coming out of shopping centers or malls that have higher costs to operate in. Then they would in an open-air center. So it gives us plenty of opportunity to price it effectively. But certainly, we still see excellent opportunities to drive the spreads, as you can see from our results. So – but Tom, if you want to give any color?

Tom McGowan: Yes. I mean, we have quite a few tenants in that category. If you think about it RE, Athleta, Aritzia, Nike and the list goes on and on. So we are able to drive rents without question sometimes when you deal with this type of tenant. The tenant allowance number may be elevated a little bit differently than what we would see typically inside our shopping centers. But what we’re looking for ultimately is up as a strong return. And we’ve been successful on all counts getting those type of tenants to pay what we need and generate strong, strong leasing spreads. But they have – you know, it’s been – they’ve been a welcome addition to our tenant lineup for sure.