Federal Realty Investment Trust. (FRT) — Q1 2018 Transcript

Good morning. I'd like to thank everyone for joining us today for Federal Realty's first quarter 2018 earnings conference call. Joining me on the call are Don Wood, Dan G., Dawn Becker, Jeff Berkes, Chris Weilminster and Melissa Solis. They will be available to take your questions at the conclusion of our prepared remarks. I would like to remind you that certain matters discussed on this call may be deemed to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include any annualized or projected information as well as statements referring to expected or anticipated events or results. Although Federal Realty believes the expectations reflected in such forward-looking statements are based on reasonable assumptions, Federal Realty's future operations and its actual performance may differ materially from the information in our forward-looking statements, and we can give no assurance that these expectations can be attained. The earnings release and supplemental reporting package that we issued yesterday, our annual report filed on Form 10-K and our other financial disclosure documents provide a more in-depth discussion of risk factors that may affect our financial condition and results of operations. These documents are available on our website. Given the number of participants on today's call, we kindly ask that you limit your questions to one or two per person during the Q&A portion of our call. If you have additional questions, please feel free to jump back in the queue. And with that, I will turn the call over to Don Wood to begin our discussion of our first quarter results. Don?

Thanks, Ms. Brady, and good morning everyone. It was a really good quarter for us with all metrics from FFO to lease rollover growth to comparable property income growth and others exceeding our expectations. Strengthened across the board, and while I always caution about reading too much into any 90-day period, our performance here was encouraging. FFO per share of $1.52 beat consensus estimates by a couple of cents and was nearly 5% better than the 2017 first quarter. That growth came despite the 60 basis point hit to occupancy caused by a couple of big vacancies from tenants like DSW and Hollywood, Walmart, and from LA Sardines and Mart at Grand Park. Those vacancies were all anticipated and have either been or are nearly released or are part of a broader redevelopment plan, as is the case at Grand Park. In any event, those rents will be more than replaced when we bounce back. Rental income was up nearly 8% in the quarter, reflecting both the Primestor acquisition midway through last year and the fruits of strong leasing over the past few quarters in both the core and mixed-use divisions. When those things are combined with lower operating expenses in G&A in many areas, the overall result is powerful. So let me go through some of the results and let me start with leasing. We completed 78 deals for over 400,000 square feet at an average rent of $31.4 to $51 a foot, which is 22% above the $25.91 that the previous tenant was paying in the last year of their lease. By the way, Tenant Improvements this quarter were a lot lower than last year; it’s not a trend but just a function of this quarter. Examples of strong rollover deals were evident in both small shop and anchor tenants on both coasts. Floor and Decor replaced one of our two Kmarts in the portfolio, a deal we’ve been working on for quite some time, and so did Bob's Discount Furniture, which has taken the old Walmart space in one of the Primestor assets in greater Los Angeles. Our restaurant offerings at places like The Avenue at White Marsh and Linden Square at Wellesley, Massachusetts also contributed. Quarter-after-quarter, the evidence suggests that tenants will pay higher rents when they’re confident that they’ll do the business to support it, and good deals are getting done. Earnings growth at comparable properties were stronger at 3.8% quarter-over-quarter, and lease termination fees at those properties contributed 90 points to that result. As you know, we feel very strongly that lease termination fees are often the result of landlord leverage and stronger negotiated leases and, therefore, belong in a comparable number. Sometimes it helps the comparison; sometimes it hurts, but it's always an integral part of how we run our business. It was a particularly strong quarter in our core shopping center business. I mentioned earlier that the big store openings like Burlington at the Assembly Square Power Center and Michael’s Brick Plaza in Melville, for example, resulted in strong leasing in past quarters, which really made their impact felt in this first quarter. Tighter cost controls and renegotiated vendor contracts also helped us drive the numbers to the bottom line. These results were posted despite the slightly dilutive impact of new residential lease-up at the Henri and Pike & Rose and the Montaje Assembly Row, but based on the current pace of lease-up, those two buildings will be accretive to earnings by the latter part of this year. Given current residential cap rates, we’ve already created about $100 million of value in those buildings. So let’s talk about our residential portfolio for a minute, and I’ll start with an update on residential leasing at our two buildings currently under lease-up. The 272-unit Henri is now 82% leased and 76% occupied at net effective rate rents of $2.35 a foot, which is ahead of budget on lease-up pace and meeting budget on rate. When you factor in the other two stabilized residential buildings, Pike & Rose, which are already open and not significantly impacted by the new supply coming on, the combined residential lease percentage is now over 90% at that project. Adding to that, the condos there are more than halfway sold out at about $600 a foot, which is above pro forma, and there are nearly 800 families now living at this former strip shopping center. Pike & Rose is quickly establishing itself as the region’s residential destination choice. At Assembly Row, the 447-unit Montaje High-Rise is now over 69% leased and 40% occupied at net effective rents of $3.37 a foot, well above budget. As far as the condos are concerned, all 107 market-rate units are sold out at $850 per foot, and as of last week, 96 of them have been closed on and delivered. To our knowledge, the Avalon base product at Assembly continues to perform very well, which combined with our other developments makes Assembly Row the residential destination of choice in the surrounding area. At Pike & Rose and Assembly Row, not to mention Santana Row, Bethesda Row, and Congressional Plaza, we believe we've beautifully made the case for the strong demand for quality residential products at various price points and well-planned Massachusetts communities. In its first 15 years of existence, the compound annual growth rate of the overall residential offering at Santana Row approaches 4%. I like this business. By the end of this year, Federal will own and operate nearly 2,700 residential units in major coastal markets. Those apartments are expected to generate about $55 million in operating income by calendar 2020, roughly a $1.2 billion residential portfolio. As for other components of our development program, the 177-room Canopy Hotel by Hilton opened at Pike & Rose at the end of the first quarter, which was a real plus for the product. The grand opening parties saw nearly a thousand guests, including dignitaries. We now strongly encourage investors, analysts, and anyone else for that matter, to experience this hotel anytime you come to Montgomery County, Maryland. As you may remember, we own 80% of equity in the hotel in a joint venture with local developer BPG Group. We continue to make progress on completing the phase 2 retail lease-up at Pike & Rose and Assembly Row, as they are 91% and 80% leased, respectively. Both of these projects are creating very significant real estate value. Construction at 700 Santana Row, our 300,000 square foot, $210 million office building, is on budget and on time for a late 2019 delivery. Leasing efforts are ongoing, with a lot of interest from the community for this heavily amenitized office environment. In Greater Miami, we’re now under construction at CocoWalk, a roughly $75 million redevelopment of this well-located multi-story retail center into a mixed-use project that will certainly offer services to the Coconut Grove community with the addition of 80,000 square feet of prime office space on five floors. We’re currently well along in lease negotiations with our national tenant for roughly half of that space, in line with our pro forma rents without showing them any drawings; it’s a great start for this transformation. Nothing more to say on Sunset Place given the challenges regarding additional height and uses at this shopping center, and so we’ll continue to operate it as it is for the time being. That’s about it from my prepared remarks for the quarter; it was a really good one that we hope to follow with another and another. Let me now turn it over to Dan for some additional color and then open the line to your questions.

Thank you, Don and Leah, and hello, everyone. Another solid quarter to start the year for Federal, with FFO of $1.52 per share, almost 5% above the first quarter of 2017. This result was a few pennies ahead of our expectations and $0.02 above consensus. Year performance was driven by higher NOI, primarily due to less impact from failing tenants, higher other property revenues, and lower property operating expenses with a slight offset from higher real estate taxes. On the same-store front, our comparable POI metric of 3.8% was driven higher by term fees, which boosted the result by 92 basis points but was offset by additional proactive releasing activity that produced a drag of 42 basis points. With respect to our former same-store metrics, which we will provide for a couple of quarters for comparability, same-store with redevelopment was 3.6% for the quarter, and same-store without redevelopment was 3.5%—very solid figures that highlight strength across the core portfolio. Now, to put in context Don’s earlier comments regarding lease termination fees, which are an integral part of Federal's business strategy: Over the past 10 years, Federal has averaged roughly $5.5 million of term fees annually. Since 2000, term fees have averaged roughly $4.25 million annually. While it does vary somewhat from year to year and quarter to quarter, it is a consistent and recurring part of our business. We had a strong lease rollover number for the quarter of 22% on over 400,000 square feet of leasing, but not extended capital of just $18 per square foot, roughly half of what we spent in 2017 on a per square foot basis. With prior rents of around $26, that represents $5.60 of positive rollover per square foot or $2.3 million of incremental rent from when leases start. However, as Don mentioned, let’s not get caught up in one quarter’s results. We expect lease rollover for the year to be consistent with the past two years’ activity in the low to mid teens, and capital has also normalized, but we expect to see consistency in our ability to push funds across our best-in-class portfolio. On the occupancy front, our overall leased and occupied figures were 94.8% and 93.3%, respectively—both metrics growing by 20 basis points relative to the first quarter of 2017. While there was roughly a 50 basis point decline relative to year-end levels, that can be attributed to our proactive releasing activity, deleasing at our Sunset Place and Grand Park assets, as well as some seasonal impacts following the holidays and our remerchandising activity. On a proactive releasing front, we initiated vacancy downtime with the objective of creating long-term value and an enhanced merchandising mix across the portfolio. In addition to the large leases we have already disclosed, such as the Anthropologie flagship, Bob's Discount at Les Sardines and at Los Angeles, Target at Sam's Park & Shop in Washington, DC, and a couple of deals on Third Street Promenade in Santa Monica, we have added a TJ Maxx deal replacing two non-credit tenants at West Gate and Silicon Valley, along with a deal in the Kmart bar in Greater Boston. So the list of value-enhancing leases were produced from downtime and drag in our 2018 metrics and FFO per share are roughly $0.03 to $0.04 of drag on 2018 FFO, but we will drive the long-term value of our company by $50 million to $60 million net of capital. Regarding full-year 2018 guidance, we are maintaining our range of $6.08 to $6.24 per share. There are no changes to our assumptions, although with respect to our comparable POI metric, we should end up in the upper half of our 2% to 3% range given this quarter's outperformance. Now, onto the balance sheet. We entered 2018 extremely well positioned from a capital perspective, and as a result, there was not a significant amount of activity in the quarter. As Don mentioned, we began closing on the condos under contract at Pike & Rose and Assembly Row in March, and this continued throughout April and into May. We raised $51 million by quarter-end and roughly $100,000 in total year-to-date. As a result, at quarter-end, our net debt to EBITDA ratio improved from 5.9 times at year-end to 5.7 times currently. This positive trend from a leverage perspective should continue throughout the year as condos close and EBITDA ramps at Assembly Row and Pike & Rose. With respect to other credit metrics, our fixed charge coverage ratio improved from 3.9 times during the fourth quarter to 4.1 times for this first quarter. Our weighted average debt maturity remains a sector-leading 11 years, and our weighted average interest rate stands at 3.8% with nearly all of it fixed. As continued volatility in capital markets and rising interest rates prevail, our A-minus rated fortress balance sheet continues to position Federal to outperform in a challenging environment ahead. And with that, operator, you can open the line for questions.

This is Nick with UBS. Just thinking about the development pipeline between Assembly and Pike & Rose as you are quickly winding down on over $600 million in development. Are future phases of those sites or other large development projects likely to be announced soon, or are you expecting to take your foot off the gas this year?

The cool thing about both of those projects is that there is sufficient critical mass regarding what has already been developed. So we let us be opportunistic. Construction costs are up, certainly. Our use of capital at this time is one that we are spending more effectively than we had done before. Having said that, we got deals in terms of the ability to build the next phase of Pike & Rose, as well as the ability to push out incremental profits or residential products at Assembly that we are working through. You can think about the situation as cyclical to some extent, and in a larger way, my point of view is that the last time this happened was in 2008 and 2009; we did not take our foot off the gas regarding planning and being ready to go at all in terms of future phases or in that case the initial phases. We are doing the same thing now: developing our plans, working through drawings, working with contractors, etc. so that we are ready to pull the trigger when we feel like we got a project that works in terms of our cost of capital. You can expect that all of that lead-up work, which is significant as you can imagine for those types of buildings, is still ongoing depending on where we are later in the year regarding construction cost and G&P, and that kind of stuff, as well as the rest of the condo proceeds and some asset sales that Dan will talk about. We may very well announce the next phase of those projects.

And is there any update on fund side; is there another vote in the work expansion?

You know we’re not spending a lot of time there. Yes, this is me speaking, Chris. I’ve kind of done those things for now. The rest of our team is running it. Chris Weilminster is spending more time down there specifically for CocoWalk. But right now at Sunset, those guys don’t want anything more; we’re a big company, and we have plenty of other things to do. That sounds a little bit right; yes, it is.

Does that asset make sense to own if there is no redevelopment underway?

I am not sure. It certainly carries itself, and we will continue to carry itself for the time being. But in terms of what we do long-term if there is not a bigger play, I am not really excited about it. So we’ll have to evaluate that, but it's not a 2018 decision.

Don, I was wondering if you could give an update on Primestor?

Sure. In fact, I am looking for Jeff Berkes. Jeff Berkes, want to provide an update on Primestor at this point?

Primestor is going as expected. We've been closed for about seven to eight months, and the operating team has come together and is functioning efficiently. We’re actively looking to make some new investments. We don’t have anything to talk about on that front yet, but we’re getting close, and hopefully in the next quarter or two, we will be able to tell you something. So I think everything is as expected and going well. The portfolio is very well leased, and as Don mentioned in his prepared remarks, we had some success with the former Walmart market space that will certainly contribute to our performance. So I’m happy with how things are progressing with Primestor.

The other thing I would add to that is that I cannot help myself, Craig, is that with respect to the development that we've mentioned in the past, we hopefully will be there in the next quarter or two, but it has made its way through our investment committee and that was approved at our investment committee level. So we’re ready to go, to the extent they are on track with respect to the other specifics with the city.

And then just a question on CocoWalk: Are you essentially done with any zoning or municipality approvals that you need for that project?

Completely.

Just following up on the hotel opening taken room, you had a loss in equity and income noted in the Q. Just wondering from a cash flow perspective, given your 80% equity interest, how should we think about the impact of this investment coming online in March, as we have the rest of the year?

The impact in our financials was really just a preopening cost and marketing cost where there were 28 days of operation in the quarter, so clearly, that was expected. Yes, we would expect some ramp-up in the hotel over the course of the year, clearly, but this is a new hotel and we don’t expect a lot of contribution until later in the year with regards to our investment in the Canopy. But we are really pleased with the product and we're pleased with the opening thus far.

And just related to that, Don. In your shareholder letter, you highlighted that 17% of Federal’s minimum range comes from residential and office tenants, not retail. You also highlighted the mixed use and the diversification of the income stream. I'm just wondering if you think about where Federal could be five and ten years from now, and in the context of your views on retail per capita shrinking in the U.S., how should we expect your mix and diversification to continue to change? Where could that 17% go? And you also highlighted in your remarks how the residential portfolio is growing. So everything coming online presumably increases this. Just wondering how much of an acceleration you expect.

First of all, it will increase or be a larger percentage, but not a much larger percentage. And let me explain why that is. Obviously, the point I’m making is that the diversity of any income stream lowers the lows during uncertain times. We are and should always be considered, as long as I'm here, a retail company. If you think about it, the reason residential and office are important parts of our income stream—yes, 17% is an important part—is because we've created that environment with retail on the ground floor. That is a very important thing to remember. Our strength is figuring out how to take a piece of land or a location and get a lot of people to it on a regular basis. Then, in places that can handle densification and intensification, the way to make money is up. So up we go. The notion of the mixed-use business is 25% of our total business, including retail. That’s about where that will remain. It could go a little bit higher, but about like that. Just like last year when we made a $350 million investment in Primestor that was all retail, that would bring that 17% down or did bring that percentage down. So it's balanced. We're growing and trying to use all the arrows in our quiver, to do as much as we can. You should think about this as a retail company through and through, even in 2018 or 2020 or 2022. We know how to create places, and with places comes the ability to maximize real estate value. Maximizing real estate value means residential on those properties and office on those properties. The value of Santana Row, Pike & Rose, or Assembly Row is very much tied to how those pieces work together. I hope that’s helpful.

You had a strong start to the year with a 3.8% comparable NOI. You mentioned the benefit from the termination fees, but you're holding onto that 2% to 3% range. It sounds like you're pointing towards the high end now. How much of not formally changing the range at this point is just adding caution given the current retail environment? There are maybe more known items that could potentially drag you back down in that 2% arena when it’s all set and done. And then as a follow-on, can you comment on the demand you’re seeing, and maybe break down the demand side a little bit in terms of traditional retailers? How much are retailers now looking to enjoy fresh air and how's that appetite from e-tailers to brick and mortar?

Look, it's May 3rd. As a company that has a lot of parts to our business, as Christy mentioned, we are bringing in new products being developed. We have some uncertainty with respect to some extent, bankruptcies. But the biggest thing is we’re not a commodity company. There’s a lot going on. We are going to keep our forecast where it is. It’s not any specific known thing we anticipate going the other way, which is specifically what you’re asking I believe. In the latter part of the year, it is caution, but the caution comes from the complexity of this business and the number of things that could happen. Regarding the second part of your question, nothing is more interesting than looking at UNIQLO choosing Pike & Rose in terms of what retailers are trying to do to figure out their future. Every one of these retailers is grappling with how many stores they need, what size the store should be, and most importantly, where they should be. Every one of those retailers has a different business plan, and what we are finding is that there is more certainty in 2018 compared to 2017 with respect to the direction these retailers are heading. What we don’t know is whether they will be right and whether those plans will make sense in 2020 or 2022 or 2024. What the landlord can do is create a place and that environment in which they can do the best business. It starts with location; it includes place-making and also the other merchandising happening within the center—and that’s where we believe we have a big competitive advantage.

I just have one follow-on here on toys. I think you only have the one box, I know it’s almost backfilled; can you talk about that existing store lease? And then I think you had some adjacent unknown toys at various assets. So any color you can share there in terms of the process? Are you bidding on those, and do you think you can shake out some more fleet that could create potentially larger opportunities?

We did get control of the one that we own, which is great news; it's way under market, and we have demands, so that will be a good story when that's back on. The real interesting one to me is the box that we did not own, but as you mentioned, was adjacent to East Bay Bridge, which is a traditional power center. If you listen to the common dialogue, it's a power center adjacent to a defunct Toys R Us; that sounds like good news. But that particular piece of land and the performance of that particular power center has meant that the auction process we went through was for the Toys R Us box, for which we submitted a big number in terms of our ability to control that box. And by the way, that big number meant that we could have either backfilled it with another box retailer or, providing a really good residential site. Given what's happening there, we bid aggressively—there were 14 others for that site—and at the end of the day, we lost it. We did not get it to a number we could make sense with. Supply and demand matters, and the specific issue really matters. Those were the two toy boxes that were in play. There is a third one in the Primestor portfolio that hasn't made its way through the system yet, and we're hanging around to see how that plays out.

I guess your competitors reported that they are seeing weakening pricing in lower cap rate markets. Do you believe that to be the case, and do you think the 7 to 8 cap rate dispositions coming into market are providing a source of competition for retail capital?

So kind of two thoughts on that question. First, for high quality product, we really haven't seen pricing change. There haven't been a tremendous number of trades, but the trades that have happened have been priced very, very aggressively, and we don't think cap rates have backed up at all for the high-quality assets. What has changed, I think, is how people define high quality. It used to be that if a shopping center had a grocery store in a major metro area in the United States, it was considered high quality. People are now a little bit more discerning and wiser, wanting to see true brochure-quality assets, or what we like to buy, which are properties with a lot of people and reliable income around these assets and some definable go-forward growth. The definition of quality has changed a little, but what people are paying for quality hasn’t changed at all. Second, outside of that, it’s anybody’s guess what the cap rate is going to be on an asset or whether the asset will even trade. It could be a 6, 7, or 8. We are seeing many deals not happen right now because the buyers aren’t showing up. My personal view is that the market—whether the equity or debt market to buy those centers—is nervous that the values haven’t bottomed yet, and they are undefined. So it’s an interesting time—hopefully, that answers your question, but if not, let me know.

Yes, it does. And maybe just as a follow-up to that: What is your thinking regarding traditional grocers? I think for many years now, having a traditional grocer, depending on the region of the country, really defines that. What has been the reaction to Walmart or Target with food offerings or Trader Joe's? Are lenders or buyers viewing those as grocery anchors right now, or is there still a chasm between traditional and the emerging types of food retailers?

Lenders are looking at it, but we don’t feel secure debt. I spend a lot of time talking to life insurance or securitized communities to figure out what they think of those alternative grocery anchors; if you like. My view has been that what’s most important is having the right grocer in the right trade area. So could that be an old leader like Kroger, or could that be Trader Joe's or a small local chain or Whole Foods? Yes. As you look at Walmart and others putting more food items in their stores, that absolutely can take the place of the traditional grocer in certain trade areas. It’s very trade-area specific, but I do think the shine is off traditional grocer-drug anchored 125,000 square foot neighborhood sites.

You touched on this in an earlier question, but it just seems that last year there was such a flood of closures and announcements—this year feels a bit quieter. But there is still that overhang regarding retailers. I am curious about leasing—have you seen any change in the tenure of the appetite for leasing? Specifically, have you seen any change in resistance to certain provisions such as tenant improvement clauses or seeking more TI or lease duration?

I would say no to 12 months ago, but definitely yes over the last five years. I’m making a distinction here; I think importantly, the notion that tenants want to pay less rent and gain more control of their space through other options is not new. Those negotiations have been ongoing for quite some time. There is no question that over the last five years, tenants have pushed harder for tenant improvement dollars and for terms, including kickouts or usage restrictions in the leases. So I mentioned only one thing, but I see a significant difference in places where we have leverage versus places where we don’t. Where we have leverage, there’s no difference; they either want it or they don’t want it. In places where you only have one option one day, yes, they are going to negotiate hard for better terms. Over the last 12 months what I appreciate is that tenants are picking their direction—more of them, certainly, than a year ago—and that’s a very positive development.

And may I just ask one last question, Don—I think it was about a year ago you mentioned a greater need for data as landlords in this business. Have you explored that further? I am curious what your thinking is.

I believe that we have not made any investments yet to this point. We’re looking at some opportunities hard, and I’m not sure that we’re looking at this from an investment perspective as much as trying to get a good sense of what matters. There are a lot of—what I would call—fly-by-night consulting firms and data firms attempting to capitalize on this market. Landlords fear, “Oh my gosh, I have to have more data, I have to understand.” We’re making good money consulting, but how much of that is actionable and relevant today versus what might be changed in six months? Those are open questions. Therefore, we have a taskforce consisting of upper management including Jeff Berkes who are exploring and talking to various companies to determine if they have something of value or not—and how we should effectively play in that arena. That’s where we are in the genesis of figuring out the best way to engage with technology without diving in the shallow end with products that may not be nearly as valuable as portrayed.

Don, can you talk about the average occupancy cost in your portfolio and how that’s trended over time?

I can try, Ki Bin, but one of the things about us is we don’t have a lot of reporting in terms of sales reporting. Roughly 30% of our tenants report sales, allowing us to figure out what occupancy is with usable data. Our active property management group is working to accumulate this database and try to determine trends. Our best guess is somewhere around 8.5%-9.5%, something like that, but it's based on limited data. That number has trended up as we would expect over the past three years, but we’re also doing a lot of work on changing out tenants and renewing leases. This proactive leasing initiative we’ve been driving over the past three years means we’re working around the edges to keep our data accurate. In terms of answering your question, that’s our belief regarding the overall portfolio.

I see, and perhaps this is even more complex: When you think about the leasing spreads on renewals that are up 20%, are these retailers mostly those who have been in business for a while and their sales have increased over the life of the lease? Have their occupancy costs dropped, and when you renew it up 20%, are you bringing it back to the portfolio average, or is it more the case where it goes above the portfolio average?

Look, I get your point regarding a 110%. It's not a commodity company. If you were to look at the standard deviation around lease rolls up and lease rolls down, expect it to be what it is. The 22% don’t expect as a run rate for this company; that 22% was a couple of deals in particular I mentioned with respect to old spaces that were long under market. As a result, we were finally able to put market-rate tenants in there, and boom, rents went up significantly in those cases. That’s always been the case with Federal. The other thing associated with that, as you think of tenant sales, we have tenants across the board whose occupancy costs vary dramatically depending on whether we’re talking about a restaurant versus a furniture store or a grocer. So, rather than putting us in the same place as others, we're running individual spaces and locations where we’re constantly trying to change out tenants to get the best. As a result, you might see occupancy cost ratios going up and down, which would add to the portfolio volatility. That said, I don’t have perfect information, but that’s effectively how we are running this.

I was wondering if you could talk a bit about acquisitions. As you’re looking at new deals, has your underwriting changed, and what is your focus, unchanged over the years given the changing environment?

Daniel, it's good talking to you. I can’t imagine Alex not being on the call; I’m very disappointed, and you can tell him that.

It's harder now to find a deal. Underwriting deals appropriately is certainly more challenging than it was. We’re in the market in real time, leasing space and operating centers, and we’re in relatively few markets but understand them well. That diligence is constantly evolving to ensure we’ve made investments and find assets where we can create value. The approach we take isn't static.

And I'm just wondering about Pike & Rose and Assembly Row; if you have a guess where you would be on the retail leasing front during the holiday season this year, what would you say?

Well, I think in both cases we will be nearly fully leased; we won’t be fully open. That’s the difference with regards to the build-out. I was just looking at this this morning related to a couple of new deals that we did at Pike & Rose and there are some concepts we’re doing that are exciting, but they won’t be open until the spring of 2019. So when you think about Pike & Rose being a fully opened experience in terms of the street, we’re talking 15 or 18 months from now; the leases and commitments will certainly be done by the end of the year.

I was wondering when you look at the redevelopment pipeline and think about the mix of spend over the next five years or so, coming from Assembly, Pike & Rose, Santana, versus other catch-all buckets. Do you anticipate the mix will change?

I do, Mike. Let me talk about that in a couple of ways. First of all, the redevelopment of our core shopping centers is an important part of our business. The initial yields are typically better; obviously, the risk is lower. It’s the established places we’re adding to, but it's very hard to put hundreds of millions of dollars to work in any period of time; it doesn’t work that way. There are smaller projects but still very important. For the bigger projects, there’s a plan of about $1 billion that could be deployed over the next three years across all big projects, including Coco, Santana, Pike & Rose, and Assembly. Whether we deploy that or not goes back to what I mentioned earlier: can we understand our cost of capital? If we can get construction costs under control and feel confident regarding meaningful returns, we’ll be ready to go to the extent that we have positive responses to those questions. We’ll be ready to go depending on asset sales and other financing.

And then switching gears for a moment on the Primestor portfolio, is there any notable differences you’re seeing regarding lease spreads, NOI growth, or mark-to-market versus your comparable assets along the coast?

I want to just think about these numbers before giving you a full answer. My strong view is that while the Primestor assets don't look or feel the same way as Third Street Promenade or Plaza El Segundo, they act similarly. The reason they act similarly is that demand exceeds supply. That’s critical here. I don't know, Jeff, if you want to chime in, but I don’t see remarkable differences in terms of renewals or new releases compared to other properties. We have a more high-profile asset like Third Street Promenade which has been delivering for us for nearly 20 years, so while we don’t have a long history for the Primestor assets, what I see today is not remarkably different.

No, I don’t either. I think it’s a good question to ask, but we’ve only managed the portfolio for a few months. There hasn’t been a tremendous amount of space renewal yet. What we have done has generally stayed in line with what we underwrote, with the exception being the Les Sardines deal which was significantly better than we underwrote. Therefore, it’s just not enough time for me to give you a truly definitive answer, but generally, the results thus far have aligned with our expectations in California.

Don, you made a comment earlier, alluding to some asset sales, and then suggested that Dan was going to give some more detail. But I’m curious what you meant by that.

Floris, it’s funny; I do that a lot and then Dan doesn’t give more detail; I don’t know, let’s see if he can hold on for the good.

Look, we have discussed before a pool of high-tax-basis, tax-efficient assets that are worth around $500 million or more. We feel we can be very opportunistic about entering the market and taking advantage of the strength in the investment sales market, where it’s robust. That’s just one avenue for us in terms of capital usage. We generate approximately $70 million to $80 million annually of free cash flow that can be redeployed into the business, in addition to these identified asset sales. Thus far, we’ve closed $100 million worth of condos recently—very cash-efficiently—but we have another $50 million more to sell over the course of this year into 2019. We have an A-minus rated balance sheet that grants us flexibility going forward. We will operate within the metrics of this A-minus balance sheet, but there’s tremendous capacity within it. Additionally, we receive a lot of interest from institutions wanting to partner with us, and we will explore that if it makes sense. In short, multiple avenues can help us sustain our business going forward. That’s the essence of having a strong balance sheet.

Maybe, Floris, the only thing I would add to that is that I like the mention of raising $100 million so far with condos; that cannot be overlooked. It’s been really significant—a total of $35 million worth this year, while the rest will carry over to next year. That’s great tax-efficient money we can fully utilize. Regarding the $500 million of assets we identified, we build anticipation to bring roughly $75 million to the market by the end of June or early July. Therefore, when you look at that, that could represent more than $200 million in 2018 alone through asset sales, all of which are quite tax efficient.

One more question, Don. You mentioned the Santana Row apartment NOI growth has averaged around 4% over the last 15 years. I’m curious to know how that compares to your retail NOI growth in that area, and do you see similar trends in the future for Assembly and Pike & Rose?

Floris, I love the question; it’s significant in this context since we have some real history regarding our performance metrics. I certainly recall that Santana Row could not have sustained initial growth, even in terms of rent in the early stages. However, we observe now that as that location became a destination choice, our residential product has performed very well; we were able to even produce products with rents below $2,000 per month and those units have sold out. So, over the past 15 years, the compound annual growth rate for residential at Santana Row is about 4%. Retail, similarly, does particularly well in thriving economic periods. Currently, our retail growth at Santana Row is slower than it has been previously due to market fluctuations. In conclusion, we can appreciate the incremental value that residential brings as it keeps retail more stable.

So the question for you a couple here quickly: I am curious about your view on potentially converting some retail space to create office space. Certainly seems to be gaining traction as a relevant opportunity; how do you view that for your portfolio?

Yes, I love that question. The distinction arises in whether it's defensive or offensive, and I make that distinction because it’s important. When you see a location without retail demand for whatever reasons, converting it to some form of office space may yield decent results but far less than we initially aimed for. Assets can still serve purposes effectively. What we’re focused on is being offensive. When you’re dealing with something like CocoWalk, a multi-level retail property with office space, it becomes an office situation. Given the area’s demographics, converting from all-retail to both retail and office is an exciting strategy. We don’t have signed deals yet but the office demand is substantial. So I don't think it's an industry trend, as much as parsing through opportunities between offensive and defensive strategies. In our case, converting retail to office predominantly comes from an offensive perspective.

And sort of an earlier question looks like reading the pipeline here, the next three, four years you need to find a billion-ish. It sounds like asset sales are now part of the consideration, but I’m curious if you look at potential JV interest. What type of cap rates do you think you can fetch if you use partial interest?

Let me reset your premise if you don’t mind; how to fund development, redevelopment, or acquisitions is something we are proud of, not relying on just one alternative. We’re doing a little bit of everything. You'll see more debt issued, increased asset sales, and yes, we will look at the JV market for certain assets. However, I don’t want joint ventures used as a sole fundraising tool; they need to create strategic benefits. The Primestor partnership is an example; they provide strategic value we can’t ignore. Therefore, that will certainly be one component of raising funds, but it's imperative to view JVs in this light.

And one last question. It’s regarding Primestor and maybe it’s not fair to ask, but I’m going to try anyway. I’m wondering if the change in political climate is impacting your thinking about your Primestor JV and potential future investments. I was surprised to hear there doesn’t seem to have been any impact on sales and traffic, given the demographics of the neighborhoods involved here. But I’m curious how the political climate is altering your underwriting thinking on future investments.

Yes, and first of all, nothing wrong with that question. It’s something we were grappling with 12 months ago when we were finalizing negotiations. Dan G. and I were outside, on calls with Berkes to understand the political climate's impact. After some deliberation, we bypassed those concerns and, focusing on empirical facts regarding sales trends, we remained supportive of the diverse populations we can serve. To exclude ourselves from these communities appears to only limit our potential. A year later, I can confidently say I am 110% committed to this strategy as I was before. Ignoring 50% of the population in Los Angeles is not a path to success.

Thanks everyone for joining us today. We look forward to seeing many of you at the May REIT in a couple of weeks. Thank you.