Federal Realty Investment Trust. (FRT) — Q1 2021 Transcript

Good morning. Thank you for joining us today for Federal Realty's First Quarter 2021 Earnings Conference Call. Joining me on the call are Don Wood; Dan G.; Jeff Berkes; Wendy Seher; Dawn Becker; and Melissa Solis. They will be available to take your questions at the conclusion of our prepared remarks. A reminder 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, including guidance. 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 achieved. 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. We've also provided some additional information for you in our investor presentation, which is available on our website. Given the number of participants on the call, we kindly ask that you limit your questions to one or two per person, and feel free to jump back in the queue if you have additional questions. With that, I will turn the call over to Don Wood to begin the discussion of our first quarter results. Don?

Thanks, Leah. Good afternoon, everybody. Good morning. What a difference a couple of months makes. The natural positive annual sentiment of spring, fall and winter, coupled with the productive team rolled out, stimulus money and end-in-sight mentality, has really validated our optimism for a strong 2022 and 2023. First quarter FFO per share of $1.17 was sequentially better than the 2020 fourth quarter of $1.14, a positive surprise for us and the result of far fewer tenant failures than anticipated during the quarter and far better cash recoveries than anticipated. As a result, we're confident enough to update our 2022 earnings guidance and provide some clarity on the next three quarters of 2021. Dan will cover that in a few minutes. Pent-up consumer demand is real. We see it in virtually all of our properties in all of our markets despite government-imposed restrictions that still persist in our market. Coupled with government stimulus cash, it's really powerful. PPP and other COVID-related programs that many of our tenants have taken advantage of have served an important role in buying time and getting both current and deferred rent paid. The $29 billion Restaurant Revitalization Fund, earmarked specifically for restaurants and similar places of business, as part of the massive COVID relief bill, will undoubtedly also create a strong tailwind for that retail category. The GYMS Act, if authorized, will allow the Small Business Administration to make COVID-related grants to privately owned fitness facilities. These programs, among others, are particularly good news for Federal's lifestyle-oriented properties, which are recovering very nicely. It's quickly become a very optimistic time in our business. Now, as you would expect from me, a warning about over exuberance this year is in order as many retailers, particularly small owners, along with theaters and gyms are in a weakened state. While buoyed by temporary stimulus, there is a need for more growth in their sales than they're currently generating to be viable long-term businesses. Having said that, they'll certainly have the opportunity to succeed because traffic is back in large numbers across the board. Perhaps the greatest indication of a bright future is the continuation of exceptionally strong leasing volumes, including first quarter deals for over 0.5 million square feet of comparable space, 35% more deals than last year's largely pre-COVID first quarter for 9% more GLA, actually 24% more GLA than the average of our first quarter production over the last five years. By any measure, we're doing a lot of leases. The fact that it was also done at 9% higher rents than the previous tenants were paying for the same space bodes extremely well for 2022 and beyond when those deals are earnings contributors. The rate and volume of new deals as opposed to renewals was particularly impressive. 54 new deals for more than 220,000 square feet at 18% more rent than the previous tenant would pay. What's particularly encouraging to me is how broad-based our leasing continues to be. In the first quarter, we did grocery and drugstore deals with Giant, Whole Foods and CVS. We did box deals with Dick's and Bed, Bath. We did fitness deals with Crunch and Planet Fitness. We did lifestyle deals with CB2, American Eagle, Madewell, Athleta, Blue Bottle Cafe Coffee and a couple of dozen restaurant specialty service-oriented retailers. Strong demand all across the board, particularly in California. In fact, let me take some time today to focus in on California because it really is a microcosm of our portfolio, particularly our nonessential lifestyle product and, in my opinion, a leading indicator for the future of the Bethesda Rows, the Pike & Roses, the Assembly Rows in our portfolio. Whether good or bad, things always seem to come first to this huge and complex market. The governor there has previously announced that all COVID restrictions will be removed next month. This is great news. We did 50% more new deals in California in the first quarter than we did in the fourth quarter, which itself was strong. As you know, we're heavily invested in and around Silicon Valley in the north and in the Greater Los Angeles area in the south, and are fully committed to investing in California in the future. Tenant demand and consumer traffic are among the highest anywhere in our portfolio, and 2021 should be an all-time record for us in terms of the number of new retail leases we expect to do there. It's really hard to short great real estate in California despite the headwinds. Let me start with San Jose and Silicon Valley, which has become a beneficiary of urban and suburban migration in San Francisco to the north. Santana Row car traffic, as measured by our parking systems, rose 69% in April compared with January and is fast approaching pre-COVID levels. Residential occupancy is back up over 95% after dipping to a COVID low point of 91% in the middle of last year. As you may have seen late last month, Santana Row was the recipient of the first large Silicon Valley COVID era office lease site as Fortune 500 cloud-led software company, NetApp, decided to relocate their headquarters to Santana Row in 700 Santana Row, the 300,000 square foot building not yet populated but previously leased to Splunk. The stated reason: to better facilitate a winning employee experience in a more connected space. State-of-the-art facilities in a fully amenitized environment make retaining employees and hiring great talent easier. No lost economics to us versus the Splunk deal, but two more years of term and a better diversified tenant base. By the way, another candidate for additional office space at Santana as their Silicon Valley footprint grows. Splunk, of course, remains fully committed to Santana Row at 500 Santana Row. Now across the street at Santana West, our 375,000 square foot spec office building under construction remains unleased and has certainly been set back in terms of timing of lease-up with the pause in overall office leasing during COVID. But we are more optimistic about its leasing prospects than we've been since COVID hit and are encouraged by the office-centric back-to-work comments made by the Silicon Valley tone setters like Google, Amazon, Apple, and Netflix there. These and others are all hiring in the South Bay and are showing a heightened desire for newly constructed office space with walkable amenities and ample parking. In Southern California, our Primestor portfolio, which caters to a largely Latino population in Los Angeles, remains among the top-performing group of shopping centers among all Federal centers nationwide in terms of rent collection and property operating income compared with pre-COVID levels. Big assets like Plaza El Segundo and The Point are recovering nicely and serve the beach cities of Manhattan, Formosa, and Redondo Beaches, places that are even more attractive to live in than they were pre-COVID. So I guess a somewhat obvious conclusion here is that California is as big and complex an economy as any region can be, actually bigger and more complex than most countries. And as with every major market, it varies greatly within the submarkets where the supply and demand characteristics of the specific real estate dictate performance. We've got some great real estate there. A few other proactive comments before turning it over to Dan. While always a key part of our business plan, we've turned up the heat on the number and the scope of shopping center redevelopments and repositionings that are or about to be underway. A combined capital budget in excess of $75 million over 17 projects aims at ensuring relevant best-in-class community-centric centers in a post-COVID environment. More gathering areas, more outdoor seating, more designated curbside pickup spots, better landscaping, covered walkways, you get the idea. Everything is aimed at ensuring our properties are the consolidators in their given submarket. In terms of our developments, we're really looking forward to showing off the new CocoWalk when investors are back to traveling regularly. Today, tenants continue to open where retail space is 98% and office space 82%, underleased or executed LOI. The initial market acceptance of this revitalized center at Coconut Grove has been phenomenal and should only get better over the next 12 months as more retailers open their doors. Heading north to Darien, Connecticut, we're very bullish about our mixed-use neighborhood that's well under construction here, especially given its perfect location for a hybrid New York City work model. For those of you who live near or are familiar with our project, you should start to be able to get a sense of what that mixed-use development is going to feel like as construction and leasing move forward as anticipated. Office leasing activity has picked up markedly this past quarter at 909 Rose - Pike & Rose, where 75% of both POI and GLA at a 219,000 square foot office building is either under lease or executed LOI. Not only activity, but deal-making feels so much more productive than it did just a few weeks ago. In Assembly Row, PUMA is just a couple of months away from opening their new U.S. headquarters and welcoming employees back to work. And we'll begin to market our residential project there in earnest this month. Like CocoWalk, Pike & Rose office leasing activity has picked up here too, but not to the same extent. The Boston Metropolitan area is poised for recovery but clearly lagged behind the others by what feels like several weeks or a month. Okay. From developments and redevelopments to acquisitions. We closed on our first acquisition in 2021 last week in the form of Chesterbrook Shopping Center in the affluent first-ring DC suburb of McLean, Virginia. We paid $26 million at an initial five cap for an 80% controlling interest in this 83% leased Safeway-anchored center. With a market repositioning plan and under-market in-place rents, we expect strong short-term growth and significant value add. We're also under contract and in our due diligence period for several other acquisitions that, absent negative surprises, will close later in the year. I'm not ready to talk further about them at this point, but more to come here over the next few months.

Thank you, Don, and good morning or good afternoon, everyone. To reiterate Don's initial comments, we have benefited from the broad recovery in the open-air retail real estate sector during the first quarter. We significantly exceeded our expectations for the quarter, reporting FFO per share of $1.17, which is a 3% increase from the previous quarter and above our internal projections. We transitioned from the challenging conditions in December and January, when government-mandated shutdowns affected over 90% of our assets, resulting in decreased consumer traffic and collections, to a more stable situation over the last 90 days. Thanks to another round of PPP supporting our tenants, successful vaccine distribution, and the reopening of our markets, things appear more sustainable. This newfound stability allowed us to surpass our internal forecasts due to higher revenues and improved collections compared to expectations both for the current period and prior periods, along with less fallout from small shop tenants than anticipated, and higher term fees and percentage rent, despite an increase in property-level expenses mainly caused by snow. The trend in COVID-19 collectability reserves continues positively, with just $14.8 million in the quarter, representing a 20% sequential decrease from the previous quarter. We anticipate this progress to persist throughout the year. A portion of this amount, $10 million, stems from our strategic choice to be more accommodating to our tenants, which I will discuss shortly. We have also improved our collections, achieving 90% for the quarter, showing steady progress even with the weakness in January caused by the aforementioned shutdowns. Our decision to be more flexible with our tenants sets us apart from many competitors. In our disclosures, you'll see negotiated abatements in the form of temporary percentage rent and other arrangements totaling $10 million, which is about 5% of billed rent for the quarter. This accounts for approximately 50% of our uncollected rent, with these agreements scheduled to expire throughout the year and into 2022. Combined collections, deferrals, and abatements reached 96%, leaving around 4% of our billed monthly rents unresolved, compared to the typical 1% to 2% before COVID. Another area where we exceeded our forecasts is in occupancy. Our tenants have shown surprising resilience, reflected in better-than-expected renewal activity and fewer tenant failures. Our leased occupancy rate was 91.8% at the end of the quarter, and our occupied rate decreased slightly to 89.5%, both stronger than our initial predictions for the year. The gap between our leased and occupied metrics has widened by 230 basis points, presenting approximately $20 million of potential revenue upside in the future. Given the strong pace of leasing activity, I believe this gap will likely continue to grow in the coming quarters. Although we anticipate continued pressure on our occupancy in the next quarter or so, we do not foresee the decline being as substantial as previously feared, given the ongoing leasing activity and the robust pipeline we have established, which should pave the way for more growth in 2022. Now, turning to our balance sheet and liquidity update. We finished the first quarter with a total available capital of $1.8 billion, including $780 million in cash and an undrawn $1 billion revolver. We amended our term loan in April, extending the maturity to 2024, with an option to extend through 2026, and reduced the spread to 80 basis points over LIBOR while paying down the loan balance to $300 million. We successfully sold a land parcel at Grand Park Plaza for $20 million to a local townhome developer, where we have a participation interest that could yield additional returns due to the strong suburban DC housing market. We have further strengthened our well-structured maturity schedule, with only $125 million of debt maturing between now and mid-2023, all secured and planned for repayment using cash on hand. This will increase our unencumbered pool to 92% of EBITDA. Additionally, we issued common equity through our ATM program for $124 million at a blended share price of $105 at the beginning of the year. Our remaining expenditure on our $1.2 billion development pipeline is just over $360 million. As we've maintained throughout the past year, we are well-prepared financially. Now for our guidance for 2021 and 2022. Please note that there is still significant uncertainty in our forecast due to the ongoing pandemic's effects on our business. That said, we are projecting 2021 guidance in the range of $4.54 to $4.70 per share. Despite a strong first quarter, some of that performance is not expected to recur. For the second quarter, we anticipate results to be roughly flat compared to the first quarter, estimated at $1.15 to $1.20 per share. The latter half of the year will face challenges mainly due to our large residential project at Assembly Row, which will negatively impact our performance during lease-up and reduced capitalized interest. We expect the third quarter to range from $1.10 to $1.15, and then the fourth quarter to align more closely with the first half's levels at $1.15 to $1.20, leading to a midpoint of our range at $4.62 per share, reflecting a $0.10 increase from the guidance shared last quarter. Our assumptions for this guidance include comparable growth of about 2%, as we foresee some fluctuations in the upcoming quarter or two, and we do not expect term fees in 2021 to reach the levels of 2020 or 2019, which both exceeded $14 million. The utility of comparable growth as a metric remains limited in this environment. We anticipate improvements in collectability metrics over the year, but expect not to return to pre-COVID levels until 2022. As mentioned, we foresee lower occupancy levels in the next quarter or two before stabilizing later in the year, but we remain hopeful that it won't be as severe as originally thought, targeting a trough around 88% for occupancy rates, while the leased percentage stays above 90%. General and administrative expenses are expected to average between $11 million and $12 million each quarter. On the capital front, we predict spending on development and redevelopment to be around $350 million to $400 million. The contributions from our major projects are expected to have a modest negative impact in 2021, as revenue from CocoWalk's lease-up will be offset by the launch of Phase IIIs for both Pike & Rose and Assembly Row, including the residential component, which will initially be dilutive during lease-up. We estimate an additional $150 million in equity issuance through our ATM for the year and, as usual, this guidance does not factor in any acquisitions or dispositions for the remainder of 2021. However, our recently acquired Chesterbrook shopping center in McLean, Virginia will be included in these figures. For 2022, we are projecting a range of $5.05 to $5.25, indicating nearly double-digit FFO growth. This growth is supported by fewer COVID-19 collection challenges as deferrals are repaid and abatements expire, an expected increase in occupancy rates back into the low 90s, and stronger contributions from our development pipeline as leasing activity converts to revenue more significantly. We will provide further details on 2022 as the year progresses. Operator, please open the line for questions.

Hey, good afternoon everyone. Don, can you provide some color on the guidance for the year? Mainly, what are you assuming to get to the low end here, the 450?

Well, I think there's a fair amount of uncertainty still as we're relying upon better performance for PPP money and so forth. Let's wait and see how well our tenants do later in the year to see how well they perform without PPP money. I think that the expectations that cash collects generally kind of are consistent with where we are. We have more weakness or occupancy weaknesses where we're probably at the lower end of the range, closer to 88% is a driver there. It's also dependent on how continued lease-up performs over the course of the year.

Okay. Got it. And then I guess, Don, for my second question is on trends. How do you think about your acquisition strategy today on the other side of COVID? I mean, do you find yourself targeting non-gateway markets given the migration trends we've been seeing? Or are you targeting close markets at this point?

Yes, Sameer, that's a great question. Several things have become very clear since COVID. The migration that is widely discussed is primarily from the city to the first ring suburbs. Observing the developments in our locations, I am confident that we will continue investing in these areas for all the reasons we have valued them over the years. It's important to note that Federal is strongly committed to the markets we are currently in for future acquisitions. Additionally, I've mentioned Arizona and the potential for south and west acquisitions before. This mainly relates to our preference for high-quality assets with leasing and redevelopment potential. We're seeking a few more opportunities since we're currently active in just seven or eight markets. Markets like Phoenix, Scottsdale, possibly Dallas, and maybe Atlanta, as well as South Florida, exhibit similar characteristics to those where we've seen success. I can't disclose too much about the assets we're currently working on, but I can tell you that one is in our existing market and the other is in a new Southwest market. We hope to secure both of these assets. When you invest in Federal, you're focusing on markets with high barriers to entry, a lot of jobs, and excellent education, which includes our current markets and potentially new ones in the coming years. Keep that in mind.

Thanks so much.

Hi, everyone. Thank you. It's no secret that you have the highest ABR among your property peers. Would rent slowing a bit lower actually be that bad of a thing given the significant spread of peers and, of course, acknowledging the quality? So how do you look at balancing occupancy and rent growth in this emerging post-COVID environment?

It's a great question, Derek. The conversations about rents have to be talked about in the same conversation as productivity. The occupancy cost for a retailer is dependent upon what they do in terms of top line or total business as well as the cost structure throughout the whole business. Sometimes, I feel we’re so focused on the absolute rent number, we don't focus on the business that creates value for that company, owners, and shareholders. From a rent perspective, I feel confident that we will see enhanced demand. We've seen enhanced demand at our properties. This doesn't mean you won't make accommodations during COVID, and we certainly will have demonstrated that we would do that probably to a greater extent than others are willing to do that, but only because we have great faith in our properties going forward. We're always going to try to get the best economic deal that we can that works for that particular tenant. The key is to find the right tenants, to find those that can do the volumes and not just pay the highest rents but can do the volumes to create synergies within a shopping center. I don't think it's so bad if rents roll out. We think about it as how do we make the overall total sales of that shopping center go up. Because if that happens, whether online or a combination of online or in-store, if that happens, rent is a byproduct. If you're competing in a business based on being the cheapest guy, that's not a business I want to engage in. That's not fun. I've got to be the guy that you want to come to because you can make the most money. If all you're looking at are cheap rents, I think it's pretty myopic.

Thanks, Don. Very helpful. I'll pass the baton. Thank you.

Hey, good evening. So two questions. First, Don, there've been a number of stories, articles, etc., on labor shortages caused by people who might have been working in restaurants being paid more to sit at home with extended unemployment than actually taking jobs. Across your portfolio, are any of your lifestyle tenants experiencing issues with hiring labor, or are they not seeing that impact?

Oh, no. First of all, there's two questions there, Alex. First, are they expressing it to us? Not particularly, but I don't know why they would. And that's not the same question. Are they experiencing problems in getting labor? The answer is obviously yes. I bet people who have either been to restaurants or stores have seen the understaffing that persists right now and the quality of the labor force; it's a problem. It is good to be the landlord as we're talking about commitments for the long term, and I do not expect this to be persistent in terms of being able to find qualified help. But right now, with unemployment where it is, the state of mind the country has been in, I absolutely believe that there are numerous businesses, not just restaurants that are struggling to find qualified help.

Okay. And then the second question is, you laid out guidance for this year and next year. Don, knowing you over the years, you don't lay out anything unless you're certain that you could achieve it, which suggests that your real 2022 number may be above the 525 that you laid out at the top end. Help us understand why we shouldn't believe the real number is better than the range you laid out.

Well, the basic reason is your logic is flawed. I'm certainly not laying something out because you had pointed out that I'm absolutely positive on it. I do. Here we are with lots of accommodative deals that we will be burning off. We know that when they burn off, they will return to rent. Hopefully, those tenants will be able to pay that full rent and continue to do that. We have residential projects that are being delivered, and when you deliver a big residential building there's dilution associated with it. We know the volume of leasing we’ve already done and the income stream it's going to produce is pretty predictable. '22 is more predictable than '21 for any particular period, and I think that still hangs out there. I don't know how to get there. There are things that could go wrong from there, and a few things could go right. I need to emphasize that we expect a range there based on the accommodations that comprise the income, the developments coming on, their impact, and the leasing that’s being done. I hope you appreciate where I'm coming from.

Well, no. I mean, it's positive for you, right? You guys had pre-COVID growth, and that was the hallmark for your track record, which is kudos to you.

I appreciate that, and you can bet that that's what we will try to do all the way through. I just didn't want you to take it to mean this is what's going to happen because you'd be a whole lot better than I am if you could be that precise.

Great, thank you. Well, first of all, we really appreciate the added disclosure on both 2021 and 2022 guidance. So just digging into the drivers a little more, can you provide some goalposts around how much development completion and lease-up is contributing to the range each year? And I assume you have noted that the primary driver is the wider range in 2022, in particular.

For 2021, the contributions from development are going to be actually negative as we at Highland. That being said in 2022, we've got primary drivers being the two big buildings at Assembly. They will begin to contribute in 2022, but will not fully contribute until 2023. Cocowalk should begin to stabilize in 2022, and we want to get a full run rate at some point over the course of the year, as should, at some point, the building here at Pike & Rose. I'd say there should be probably an additional 10 million of incremental relative to the '21 contribution over the course of the year. But we can deliver a big residential building. The pace of lease-up determining how you get through 500 units is crucial and will determine how quickly the dilution burns off when you start being accretive. Not a lot of clear visibility there, but I feel good not only about where we’re headed but the volume we're doing and the progress we're making on the development. We have good visibility, given the fact that we are a while off.

Don, it's Michael Bilerman. I also want to express my gratitude for the detailed guidance and actual numbers you provided. Can I ask you to include that in the supplemental each quarter?

Michael, that's a bait and switch. Katy started with a question, and you jumped right in there. I would have put you at the end of the line for Pete's sake. You can certainly ask that. That is something Dan G. and Melissa Solis, along with the financial side of the company, will reach a conclusion on with the help of our general counsel about what should go in there.

It would be great if there were no confusion over the numbers.

The focus on California. Did you want to know whether we are seeking additional capital or whether we want to highlight California as an area of the country? The short answer is both. I hope we are making incremental investments in California. We spent so much time on this as a headline buster. I think it's a great microcosm of a predictor of what you will see as the Massachusetts economy opens back up. The warmer it gets, the nicer the weather seems to be the biggest predictor of traffic levels and sales. That's very fair. And the short answer is both. I hope we are making incremental investments in California. We brought that up to break headlines because we did indeed sit there and debate how important California is as a market today and where it will go tomorrow. The labor market is going to improve. The supply and demand characteristics of the markets we're in are where we want to continue to invest.

Hey, good evening. First, Don, on development, maybe residential more specifically. I understand there's some uncertainties on the speed of residential lease-up at Assembly Row. Just curious what the expected stabilized yield is there. How do you feel about starting additional residential development at this time? And when might you break ground on future development phases?

The stabilized yield is not different. Yes, are we going to take another year to get there? We may need to see progress on that over time. The best part of residential is everything on the last residential call is the same thing as the worst part; it's one-year leases. A little bit less, a little more. So it's not like you build something in a great market, and you're stuck in purgatory forever, as happens on the retail side and the office side. We see progress with leasing in our mixed-use properties. The real question is on projects, are we going to be able to make the number of work with construction prices, which have been out of control lately. Supply chain disruption has been significant since COVID. We're still bullish on residential within our mixed-use properties.

On the accommodative tenant agreements we were talking about, I'm just curious what the total magnitude and cadence of those agreements are going to be as they burn off later this year and into '22?

Primarily we've talked about this on calls before. We made accommodations for a fair amount of restaurants. We did greater of fixed rent that's less than their contractual rent for a temporary period, or a percentage of sales. We'll see how well that burns off in particular, depending on the pace of demand for rent collection. Those agreements should burn off over the next 12-18 months.

So these are not new agreements. They're just continuations of those already in place?

Yes, correct.

Hi, thanks for the time. If you could give us a little color on the leased versus occupancy spread. You talked about a $20 million number. How much of that is truly additive versus a musical chairs-type situation between tenants or space? And how do you think the timing plays out in terms of coming online?

That's primarily additive. Not a lot of musical chairs; it's additive. You will see that starting in the second half of '21 and in '22.

Great, thank you. And on the leasing side, you had a huge increase in the leasing spread for new deals, 18%. Anything unusual in the numbers in the quarter that skewed that? Or is that how you're thinking about future volumes for the balance of the year?

No, I don’t know how it will come out from the rest of the year, but there are always good deals that are skewed, including a couple of strong deals at Assembly Row. Overall, I like the trajectory with us doing and progressing.

I wanted to discuss the increase in leasing volume. Are these leases more essential or discretionary? Are you adding new names to your portfolio, or are they existing clients looking to expand within your portfolio?

This is about as broad as it's been. I have been looking for places to say that there's a category very active right now. I'm not seeing that. We have grocery deals, CVS deals, and new restaurants come in. The thing that keeps striking me through this process is how broad-based the leasing has been, and I think it's a factor of a groundswell that is becoming increasingly accepted.

Thanks everyone for joining us today. We look forward to seeing you at NAREIT and please reach out to the virtual meeting. Thanks.