Retail Opportunity Investments Corp. (NASDAQ:ROIC) Q3 2023 Earnings Call Transcript

Retail Opportunity Investments Corp. (NASDAQ:ROIC) Q3 2023 Earnings Call Transcript October 25, 2023

Retail Opportunity Investments Corp. misses on earnings expectations. Reported EPS is $0.06329 EPS, expectations were $0.27.

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

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. We are pleased to report that our grocery-anchored portfolio continues to perform well. Notwithstanding our portfolio being essentially fully leased at over 98%, we continue to make the most of the ongoing strong demand for space. In fact, through the first nine months of 2023, we have leased a record amount of space thus far. Additionally, in step with capitalizing on the demand for space to achieve record-leasing volume, we are also capitalizing on the demand to continue driving rents higher, posting our strongest quarter-year-to-date in terms of releasing rent growth on both new leases and renewals.

With respect to acquisitions, the West Coast has largely been idle this year with only a limited number of grocery-anchored shopping centers trading. Interest rates continuing to rise throughout the year and the related uncertainty and difficulty in terms of obtaining reasonable debt financing has compelled many would-be buyers to stay on the sidelines. Notwithstanding buyers being on the sidelines, certain private owners are starting to become more active in seeking to transact. We view this as an opportunity. In fact, we currently have an acquisition that we are close to having under contract. It’s an excellent grocery-anchored shopping center that we’ve 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 natural food supermarket that is a longtime national tentative of ours. The seller is a private owner who is seeking an efficient closing, which given our knowledge of the market and the specific center and its tenant roster, we are in a position to facilitate their closing objective. Beyond this acquisition, we have several other opportunities that we currently have our sites on, each with seller circumstances that we are well positioned to capitalize on. Turning to our balance sheet, during the third quarter, we completed a public bond offering, raising $350 million in total. The offering drew considerable interest in the marketplace and was over-subscribed at tracking interest from 60 investors in total, which we think speaks to the long-term strength and stability of our grocery-anchored portfolio and business.

Now, I’ll turn the call over to Michael Haines to take you through the details of the offering and our third quarter results. Mike?

Michael Haines: Thanks, Stuart. Starting with our financial results, for the third quarter, GAAP net income attributable to common shareholders for the three months ended September 30, 2023, was $8.4 million, equating to $0.07 per diluted share. And in terms of funds from operations, for the third quarter, FFO totaled $36 million, equating to $0.27 per diluted share. With respect to our financial results for the first nine months of 2023, GAAP net income attributable to common shareholders totaled $26.5 million, or $0.21 per diluted share. In terms of FFO, it accompanied $105.4 million in total FFO, or $0.79 per diluted share for the first nine months of 2023. In terms of net operating income, NOI, on the same-center cash basis, increased by 8.2% during the third quarter and increased by 3.6% for the first nine months of 2023.

Our third quarter results were impacted by two items. First, other income increased notably primarily as a result of recapturing three leases, which we have already lined up new tenants to take the bulk of the recaptured space at notably higher rents. Partially offsetting the increase in other income, GAAP net amortization declined, primarily as a result of removing a Buy Buy Baby lease from our portfolio during the third quarter. It declined to the one-time non-cash GAAP adjustment. And just like the recaptured spaces, we already have several new tenants lined up for the Buy Buy Baby space, both at a higher rent and on the same-space cash basis, one of which is already open and operating. With respect to our balance sheet, as Stuart touched on, during the third quarter, we raised $350 million through a public bond offering of senior and secured notes.

It was the first time raising capital and public bond market in the early decade. As such, we made a conservative effort to fully engage with the market, having discussions with a broad and diverse mix of investors, the number of which were new to the company. We intend to utilize the proceeds to retire the $250 million of senior notes that mature in December. Additionally, we have paid down $100 million over a $300 million turn loan. Looking out over the next five years, our debt maturity schedule is well-attired, with approximately $300 million maturing each year on average. Having now reestablished ROIC in the public bond market, our objective is to be a more consistent annual issuer going forward. Taking into account the bond offering, as of September 30, over 96% of our debt is effectively fixed rate, over 96% of our debt is unsecured, and over 96% of our portfolio is unencumbered.

Additionally, for the third quarter net debt to annualized EBITDA was 6.4 times, down from 6.6 times from a year ago. Lastly, with the year coming to a close, we have updated and narrowed our FFO guidance rank for 2023. On the positive side, leasing activity this year has far exceeded our initial projections that we set back at the beginning of the year. However, the persistent rise in interest rates impacted our initial projected interest expense and our projected investment activity, both of which have been adjusted accordingly, and interrupted the guidance range for the year. Now, I’ll turn the call over to Richard Schoebel, our COO to discuss property operations. Rich?

Richard Schoebel: Thanks, Mike. As Stuart highlighted, we achieved another successful active quarter of leasing. The demand across our portfolio continues to be consistently strong with a broad range of prospective new tenants actively seeking space. Given our property’s location attributes, together with the strong draw of our long-time supermarket anchors and other core service and destination tenants, our centers continue to be sought out by prospective tenants as the shopping center of choice in their respective communities. Capitalizing on the demand, we continue to lease space at a record pace. Year-to-date, we have leased approximately 1.5 million square feet, which is a new record for us in terms of leasing volume for the first nine months.

In step with our record leasing activity, we again achieved a portfolio lease rate above 98%, finishing the third quarter at 98.2% leased. Breaking that down between anchor and non-anchor space, our anchor space continues to be 100% leased and our shop space is close behind at 96% leased. During the third quarter, we executed 95 leases, totaling 465,000 square feet. The bulk of our leasing activity continues to center around renewing long-standing, valued tenants, with a number of them continuing to come to us early to renew, particularly key anchor tenants. Specifically, during the third quarter, we renewed six anchor tenants, five of which were not scheduled to mature until next year. Additionally, as Stuart indicated, we continue to have good success in terms of releasing rent growth.

Specifically, during the third quarter, we achieved a 36% increase in same-space cash base rents on new leases and a 7% increase on renewals. Underscoring our strong leasing activity and consistent performance is a proactive approach of seeking out, identifying, and capitalizing on opportunities to recapture space well in advance of leased maturities and releasing the space quickly, enhancing tendencies, and driving rents higher in the process. Just to cite an example, during the third quarter of two of our centers, we recaptured prime, free-standing pads, each with a drive-through. The pads have been leased to a regional tenant whose business was recently acquired. Anticipating the acquisition could bring about some consolidation, we reached out to the tenant and successfully recaptured their spaces, and now have several new, national, quick-serve restaurant operators lined up with base rents that represent a 44% increase on average over the previous tenant’s rent.

In addition to the strong rent increase, the new restaurant operators will be a much stronger, daily draw to our centers, which in turn will enhance future leasing demand at the properties. Along with our recapturing initiative, we also continue to have good success getting new tenants open and operating. Year-to-date, new tenants representing approximately $6 million of incremental base rent on a cash basis have opened and commenced paying rent, including $1.9 million opened in the third quarter. In terms of new tenants that haven’t yet opened, including those that we just signed during the third quarter, the incremental amount stood at $7.3 million as of September 30, the bulk of which we expect to commence over the next several quarters.

With respect to Rite Aid and their recent announcement, at September 30, we had 15 leases with Rite Aid across our portfolio, which altogether accounted for 1.7% of our total base rent. Three of the leases are on Rite Aid’s closure list. The three together account for 0.3% of our total base rent. The average base rent for the three is 50 to as much as 80% below current market rents. In terms of the remaining 12 leases with Rite Aid, they all continue to perform well, and their rents are below market on average as well. Turning to lease maturities going forward, as of September 30, we only had 141,000 square feet maturing during the fourth quarter, including two anchor leases totaling 44,000 square feet, both of which we expect to release before year end.

Looking out further to next year, we have seven anchor leases currently scheduled to mature in 2024, of which we currently expect that six of the seven will renew. In terms of non-anchor space, we have about a half a million square feet of inline space scheduled to mature next year, which we expect to renew and release consistent with our historical performance. Now I’ll turn the call back over to Stuart.

Stuart Tanz: Thanks, Rich. Based on our leasing performance year-to-date and our leasing activity here early in the fourth quarter, we were on track to finish the year strong in terms of property operations and post another successful year of maintaining our high portfolio lease rate and achieving record leasing volume, while also achieving solid releasing rent growth and enhancing our tenant base. In terms of growing our portfolio, it’s safe to say that 2023 has been a frustrating year as the market has been largely idle and slow to adjust to the higher interest rate environment, as I mentioned. Along with the market also adjusting to the ongoing challenges that certain commercial property sectors and certain prominent markets across the country are currently faced with.

Fortunately, the long-term fundamentals of the grocery anchor sector remain sound, especially as it relates to our specific portfolio and our highly protected markets. As we look towards to 2024, the current expectation in the market is that acquisition activity could potentially accelerate. At property level, low interest rate debt begins to mature in earnest next year and private owners could have limited viable refinancing options. In anticipation, we’ve been strategically tracking a number of potential off-market opportunities across our core markets, working to establish and maintain an ongoing constructive dialogue with private owners. Over our team’s nearly 30-year history of specializing in the grocery anchor sector on the West Coast, this strategy has proven instrumental time and again in our ability to gain access to acquired exceptional properties that rarely ever hit the market.

While it’s early in terms of the acquisition market becoming fully active and favorable again, we are encouraged from what we are currently seeing and look forward to the opportunity to strategically grow our portfolio in 2024. Now we will open up the call for your questions. Operator?

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Q&A Session

Operator: Thank you. [Operator Instructions] And our first question comes from Juan Sanabria of BMO capital Markets. Please proceed.

Stuart Tanz: Good morning Juan.

Michael Haines: Good morning.

Juan Sanabria: Good morning Stuart. Just hoping you could talk a little bit more about Rite Aid and the potential uses that you’re looking at to back sell space. And if you have any color on any incremental space that may look to give back, in an article today that through the bankruptcy process they might hand back more than the initial list of rejections and divestitures that they were initially planning. So just curious what extra intel you may have?

Stuart Tanz: Yes. So in terms of uses, right now we are speaking to a broad range of potential new tenants including fitness, grocery, automotive. There seems to be a lot of demand. I mean what really has happened here is, opportunities that we were unable to fulfill from tenants have now become possible. So I think as you know, so far they’ve only rejected one lease of ours. There’s significant interest in that space.

Michael Haines: Yes Juan the demand has been a bit overwhelming.

Juan Sanabria: Okay, and then a second question. Could you just talk a little bit about how build occupancy was flat but base rents were down quarter-over-quarter. It just seems a little in progress and just hoping for some color there.

Michael Haines: Hey Juan, it’s Mike. I think the, without digging into the details of my hunches, it’s probably a, I mentioned my preparatory remarks that the GAAP adjustment for the Buy Buy Baby lease which had an above market lease. So when that lease was terminated we had to recognize that above market rental revenue, which is a hit to revenue, is probably the cause of the decrease.

Juan Sanabria: And then just one last one if you don’t mind. What’s the expected cadence of the lease commencements for the 7.2 million of [Santa Barbara occupants]?

Stuart Tanz: I think it’s about, I think 60% of it or so is supposed to come online by March 31 and another 15% by June. So that’s majority by June.

Juan Sanabria: Thank you guys. I appreciate it.

Stuart Tanz: Excellent. Yes.

Operator: Thank you. One moment for our next question. And our next question comes from Craig Mailman of Citi. Please proceed.

Craig Mailman: Hey, good morning.

Stuart Tanz: Good morning Craig.

Craig Mailman: How are you doing?

Stuart Tanz: Good.

Craig Mailman: So just wanted to follow up on your commentary Stuart about the acquisition environment and potentially that it could reflect here as some refinancing to come and do next year. I’m just kind of curious on the assets that you’re tracking at least, is it just that they can’t get financing or the debt service coverages don’t make sense? I’m just trying to kind of square the circles. Sellers looking to monetize here into a weak environment versus just kind of eating the higher interest expense, giving the NOI growth that you’re starting to see here in the retail space. So I guess just commentary on that and then how, what price you guys would be given will cost the capital is moving for you and just debt rates to make these work in accretive and interesting.

Stuart Tanz: Sure. Well, it’s primarily a combination of the challenges in the financing market and the fact that they have to in not all cases, but in a lot of cases have to come out of pocket in terms of providing more equity in order to get new financing. In terms of our cost to capital, the goal with what we’re looking at buying right now as well as what’s in the pipeline is to try to find that sweet spot in that 6.5 to 7.5 cap range with the ability to drive rents through either vacancy or operating margin efficiencies, about 150 basis points within an 18 months period, that’s the goal and what we believe in terms of what we’re seeing right now that subjects doing due diligence on a couple of these deals, we will be able to close on these transactions creatively as it relates to our cost of capital.

Craig Mailman: Okay, so you might have a little bit of delusion or a push relative to where you can finance is going in, but ultimately you’re going to be an eight to a nine cap if you could execute on that plan. How do you finance that here? Debt, equity, OP units, asset sales, kind of what’s the optimal mix look like? In particular for the asset that you’re talking to, I know you’re not in contract yet, but it sounds like you’re close. Is that in the realm of returns that you just talked about? And again, how do you finance that?

Stuart Tanz: Well, the financing is done through a combination of OP units and we do have an OP unit transaction that I believe will come to fruition now. If not in the first quarter and the second quarter of next year, that’s certainly at a stock price that will be higher than where our stock is currently trading. But it’s a combination of that transaction, OP units, a combination of selling some more assets and our ATM. That’s how we’re going to help finance the upcoming opportunities as we look into the end of this year and into next year.

Craig Mailman: Okay, just lastly, I know you guys haven’t given guidance yet, but just the thought here, you guys lowered ’23 guidance this quarter, partly as a result of the acquisitions coming out of it. As you guys think about presenting guidance next year, should we assume no acquisitions baked in that are under contract? How are you going to approach that just given the volatility in the macro and how that’s impacted the transaction market?

Stuart Tanz: Sure. Well, I mean, obviously, we’ll be giving guidance on our year-end call in terms of filling in some of the questions that you’re asking right now. But I think you’ll see, again, as you’ve heard in our remarks, a bit more activity on external growth, a bit more activity on dispositions, along with potentially creating a bit more growth or more growth in terms of what we’re seeing at the property level, because operations continue to be very strong, as you’ve heard from our remarks today.

Craig Mailman: Great. Thanks, guys.

Stuart Tanz: Yes.

Operator: Thank you. One moment for our next question. And our next question comes from Jeffrey Spector of BOA Securities. Please proceed.

Stuart Tanz: Good morning, Jeff.

Unidentified Analyst: Good morning Jeff. This is actually [Livy] for Jeff. So I was just wondering if you could provide more color on your confidence in the narrowed range for same-store NOI. Is that more so a function of greater visibility on the timing of store openings and commenced rent? What would kind of swing that to the lower end versus the higher end there? And just to follow up on that, to confirm, is there any amount of rent fallout or lost occupancy that’s assumed from Rite Aid or troubled retailers for the full year?

Stuart Tanz: Do you want to answer the question as it relates to fallout, Rich?