Federal Realty Investment Trust (FRT) Bank of America 2023 Global Real Estate Conference

Federal Realty Investment Trust (NYSE:FRT) Bank of America 2023 Global Real Estate Conference September 13, 2023 1:25 PM ET

CorporateParticipants

Don Wood - Chief Executive Officer

Dan Guglielmone - Chief Financial Officer

ConferenceCall Participants

Lizzy Doykan - Bank of America

Lizzy Doykan

So hi, everybody. This is a roundtable presentation with Federal Realty. I'm joined by Don Wood, CEO; and Dan Guglielmone, CFO. I'm Lizzy Doykan. I work with Jeff Spector covering the retail REITs at BofA. So I'm going to turn it off to Don and Dan to start off with any opening remarks, just given an overview of the business, state of the business today, and then we can head into Q&A and open it up. So we like to make this interactive. So feel free to jump in with questions at any time. So Don, you'll kick it off with you.

Don Wood

Thanks, Lizzy, and thanks, everybody, for giving us the time this afternoon. I know there's a bunch of different levels of understanding of Federal and what they are. So I won't do it at the most basic level, but there are some things I do want you to understand. We are one of the older streets around. We're a very high-quality shopping center company.

The assets that we own are largely in the first-ring suburbs of Northeast, Mid-Atlantic, Florida, Northern California and Southern California first-ring suburbs, great quality stuff, have been around a long time. This is a company that has increased its dividend to shareholders every year since 1967. There's not another REIT that can say that. The only way you can do that is with really high-quality stuff. It's been a couple of years where certainly the open-air shopping center space is experiencing very positive dynamics.

I think anybody you talk to in this business says that demand has exceeded supply in the past few years. I think that's really important. There's nothing more important than -- or nothing more effective and locking people up for a couple of years, keeping them in your house and then letting them out and understanding how they are social creatures, like to be social creatures, want to eat, want to shop, want to entertain, et cetera. And it's a little tongue in cheek, but not really.

For the longest period of time between 2016 and 2020, really everything was about why do we need bricks-and-mortar and the notion of shopping online, having stuff delivered conveniently to your home and I also having trouble with what kinds of boxes, by the way, in cardboard being delivered to your house so what to do with it. That really took over the industry. And COVID changed that.

But now we're sitting in a period where clearly many of the companies in the shopping center world, both public and private, have had these high great dynamics and are therefore, mostly leased up, 93%, 94%, 95%. And really, over the past few years, demographics haven't mattered a lot. We have the highest demographics in the sector. Average incomes in excess of $150,000, number of households within 3 miles of what's the number.

Dan Guglielmone

68.

Don Wood

68,000 households, basically spending power within 3 miles of our shopping centers of over $10 billion. But now when a rising tide lifts all boats, that doesn't all that matter. Basically that same dollar of rent in Greenwich, Connecticut was treated pretty much the same as the dollar of rent in Indianapolis, Indiana. And the question for investors in this group now that there's been 3 years of post-COVID lifting up, if you will, and occupancy gains, what about going forward, will demographics matter?

Does it historically mean that when you're in places with more affluence and more people and strong barriers to entry that you are likely to outperform other areas with lesser demos. We certainly think so. I'd like to talk about that a little bit today as we get into some Q&A. There'll be no question that we duck from. One of the most important things I'd like you to take away is something that's not talked about an awful lot. And that is in a lease what are the contractual bumps in those leases? There would be nothing better than taking a lease, handing it to you and having you promise to pay me more money each and every year.

I believe our bumps are significantly better than virtually anybody else's. I believe that for a couple of reasons. First of all, we have more small shop then as a percentage of total GLA space than most. And the anchor boxes are nice, they're important, but they don't grow very much. The small shop tends to grow 3%, 3.5% a year in an inflationary time, critically important, far more important than the last 15 years when inflation was very much under in check.

Secondly, we do have a residential component of what we do that makes about 10% of our income stream, that our residential component is only at our mixed-use properties. That is basically all about the retail, bringing people to the place and then supplementing it with that residential. That residential pretty regularly grows somewhere between 3% and 4%. When you sit and you put this stuff together, overall, we think we inherently grow 2.25% to 2.5% contractually. And I think that's about 100 basis points, 75 basis points at least, better than most other of our competitors. That's really, really important in a time that you start to worry about a consumer potentially in terms of their spending because it's contractual.

Let me stop there for a second and go to you, Lizzy, and see if you've got anything else to go with before I just dominate the rest of this conversation.

Question-and-Answer Session

Q - Lizzy Doykan

Yes. Thanks, Don. I think if we start with the overall leasing environment because volume spreads, the growth has kind of remained unabated since we've spoken at May ICSC, obviously, earnings. Can you just talk about maybe your thoughts on consumer spending trends today? Has there been any impact we've seen on plans for store openings, lease negotiations? If you could just talk about the state of leasing.

Don Wood

I'll give all of it. This is a very good time to be in this business. And leasing has remained extremely strong. I would have expected at this point to see some more weakness than we have. The one thing I will say, and I think that's really important is that tenants look far more longer term and strategically in what they are trying to do in setting up their portfolios than investors do.

And so accordingly, when you have, I don't mean to be glib about this. I don't care what back-to-school sales are or what Christmas sales will be because I'm the real estate person, not the retail. And those real estate people at the retailers are looking for positioning 2, 3, 4, 5 years from now. And that's a really critically important thing. Now that does not mean to the extent over the next year, year-and-a-half, if you cease consumer weakness, and there are some signs certainly of that happening. That does not mean that there may not be cutbacks in what they're seeing. But it is not this cause in effect month-to-month changes that drives most businesses.

I think if you were in Board meetings of most retailers, you would see that those board meetings have two different sections. One section is about the current results and what's going on in those current results. And then there's a second section, that's strategy. And that strategy is about positioning and positioning against their own competition. I've seen nothing that says that those strategies are [indiscernible] from where we've been. So it's the time to be in the open air business, for sure.

Lizzy Doykan

You recently signed a lease at Pentagon Row with the Aaron Spaces Forces Association. Can you discuss the health of tenant demand for office assets in your mixed-use centers?

Don Wood

I can. I appreciate you asking me that. Yes, I ask the investor base this question, in a sector, the office sector, which is clearly oversupplied in the United States of America, nobody would argue that, I don't think. Is it possible that there's a subsector that is undersupplied where demand effectively exceeds supply because I would argue with you that over the last 3 years, I mean, all I know about office is the 4 or 5 mixed-use communities that we own, where we have them. So I only know about office effectively in the first-ring suburbs of Washington, D.C., in the first-ring suburbs of Boston, Massachusetts, in the first-ring suburbs of San Jose, California, Coconut Grove Florida outside of Miami. So that's all I know. So my answer on office is going to be through that very narrow prism.

And I know that over the past 3 years, we've done over 850,000 square feet of office that other than one building, which I'll be happy to talk about in Silicon Valley called Santana West, we are 98% leased in office at rents that are higher than we have underwritten. And the reason for that to me, what all those tenants have at common, they had more space somewhere else. They signed a lease for far less space with us at far higher rent per square foot because they wanted the fully amenitized environment that a Pike & Rose, an Assembly Row, a Santana Row, a CocoWalk can provide.

And so interestingly, I mean, we moved into our office, new building in Pink & Rose on August 10, 2020, we were the only tenant within 15 months from August of 2020 into 2021, that building was 100% leased. And so while this is only 10% of our income stream, these make me wonder from an investor perspective, isn't there a way somehow in this country to effectively play the office investment market has a way to make money because it's not all created equal. I don't know how you do that. I leave that to you. But I will tell you that the product that we have is extremely desirable an important component of the other income streams associated with our retail base.

Lizzy Doykan

When it comes to your portfolio today, you have a wide mix of products being skewed more towards the mixed use and the super-regional. Do you see any material changes to that mix in the medium to long-term? And any changes maybe from a geographical standpoint?

Don Wood

No, Lizzy. I really don't. Let me kind of make this clear. What we do for a living, and I think we do really, really well is to gather people to a piece of land in an existing shopping center through retail. In certain places, there is the ability to take what you've done by bringing those people together and exploit and intensify that piece of land further. It's why if you look at our shopping center portfolio today, we've got the opportunity over the next 4 or 5 years to add 2,000 more units of residential at our properties because they're already there for the retail.

Having said that, these are locations that are all in densely populated areas. And so when I think about how we grow our company? It's always from a retail base because that is what we do well, it is likely to remain. We'll grow the retail side. And on the mixed-use side, we'll probably add more residential as we go on the shopping center side, we'll probably add more residential. But generally, you should think of us as 75% to 80% retail income stream with the other uses supplementing that.

Lizzy Doykan

On the residential side, you recently secured entitlements at Federal Plaza. What are the next opportunities after there, if we can get an update on Federal Plaza?

Don Wood

Well, when you look at development today, acquisitions make a whole lot more sense. Construction costs are very high. It's hard to pencil developments today. It's a cyclical business. It's always been, it always will be. But that doesn't mean you stop going through the entitlement process and making sure that you are set wherever you can, and we have about 20 places where we are effectively working heavily on entitlements for incremental residential or other uses. You do that during these down periods so that you're ready to go when the market shifts.

Now in the meantime, there's an acquisition, [indiscernible], there's the existing portfolio. There is money that has previously been spent on development that is not yet producing. When you put all this together, I think the business plan of this company should provide, particularly, frankly, if the consumer gets weaker, a growth portfolio or growth prospects that are superior. That's what I see happening.

And then when it does pencil whether we're talking about Federal Plaza or we're talking about Pembroke clients or we're talking about Willow Lawn in Richmond or we're talking about half a dozen friendship heights in Chevy Chase, Maryland. There is a plethora of entitlements that we are pursuing so that when you can begin construction and have it make some sense that you're ready to go and you're not starting your entitlement process at that time.

Lizzy Doykan

And can you describe your risk return approach to [indiscernible] and development today? Has that changed at all? Are you taking on higher risk with projects or --

Don Wood

No. We're requiring a higher return. And so the entire industry, the entire world, not the entire industry, we'll be effectively repricing their debt portfolio over the next couple of years from whatever it is 3.5% of 5.5% or 6% depending upon where your company is. That's happened. That's happening everywhere. You have to accept that. It's frankly just fine. We operated that way for a long time. We'll operate that just fine on a going-forward basis. The question is, can rents be increased above that in a way that your property level income can more than compensate for your higher interest costs.

And this is something I'd love you to think about. When I think about today's tenants that you worry about a little bit, whether it's big lots or it's a JoAnn Fabrics or it's a Rite Aid or the at-home potentially. When you think about those tenants, I do think there's a common threat. They are the tenants where there is really price sensitivity of their customers. Think about that for a minute. Because if inflation stopped today, every cost is 20% or so higher than it was 2 or 2.5 years ago, whether we're talking about construction, whether we're talking about operating costs, whether we're talking about labor.

And so the notion when you listen to the earnings calls and you understand what the issues they are with those companies, it's margin contraction because it's been difficult to pass through those cost increases to the customer. That is from what I can tell, far more likely to happen in price-sensitive demographics, in price-sensitive businesses with respect to the customer than in other businesses.

When you take a look at the Lulu Lemons of the world, and you may complain that the price of yoga pants has gone up tremendously. But yes, the price of yoga pants has gone up tremendously because they were able to pass them through. Those type of tenants, in those type of environments, I would rather take my chances within terms of the ability to continue to raise rents and continue to grow the income stream than with the more price conscious customer. It's a really interesting time to kind of reassess that, I think, when it really hasn't been an issue over the last three years.

Lizzy Doykan

When it comes to the troubled retailers. So we've discussed Bed Bath & Beyond for a couple of quarters now, and you and many of your peers are expecting a larger mark-to-market increases on the boxes of 20% or higher. So yes, there's a lot of questions more so around the CapEx that you got to factor in when re-leasing those boxes. So how do you think about the economics of that? And maybe where you stand today with the --

Don Wood

All true. And it's really important to talk about the boxes for a few minutes. Every conversation I ever get into, whether I'm on panels, whether I'm doing this year, no matter who we're talking to, it's always around the 20 or 30 public company box tenants in the United States of America. Whether we're talking about Kruger or we're talking about Dick's or whether we're talking on TJX, whatever. And I understand that because that's where there's information available. public companies, you can understand sales, you can understand it. That's not the only part of this business. And in fact, those leases are not the best leases in the world.

And I'll tell you why. They wind up getting, you get the best rent that you can, depending on where you are. Most of them are likely to be flat for plan years with no increases to that rent, some flat for 10 years. Think about that in an inflationary economy. If you have a flat 10-year lease, your shopping centers worth less after 10 years and it is today like in a bit. Most of them that we have, and I think we have better ones because of the locations that then, but even flat for 5%, up 15%, up 12.5%, some up 10%. When you look at that take on those things is 1.5%. So that's not an important fact, they're extremely important. They bring people to your center, great. But you better have some other way at that shopping center to grow income because those deals are going to be much better than that. And so that's why the small shop is such an important part of the componentry.

When it comes to capital, well of course but you'll talk to a number of them, a number of them will demand effectively that, that box is all up and ready to be moved into, is that okay? It's okay if you get enough rent. So you better get an up brand on that. And even if you can't, you better get it from the adjacent tenants. And so one of the, to me, big advantages of this company, and I'm proud of this is that the average shopping center in this country is 125,000 square feet. It's got a grocer, it's got drugstore, and it's got some small shop, and it's on 5 acres of land. Federal's average shopping centers double that. It's 250,000 square feet on much bigger pieces of land, sure, it's got that box. Maybe it's got that grocer, it's got whatever, but then it's got shop tenants that make the place special, shop tenants with 3% growth at least in those leases. And when you look at the combined shopping center, you are far more likely to be, in my view, to be able to create value that you can both underwrite like that you can't underwrite that happen over the years on a bigger piece of land. That's why I feel as good as everybody in terms of re-leasing the Bed Bath & Beyond boxes.

We're almost done now, frankly, between the ones that have been assumed, the signed leases and the LOIs that we have on the remainder. But as important as that is for short-term earnings, when it comes to long-term growth, the question is, who did you replace them with because they've been doing nothing for your shopping center for a better part of 6 or 7 years now. It's not a COVID thing. That's a Bed Bath thing in terms of how they were run. You better put in somebody there that is going to add to the overall product mix of that shopping center. I'm going to appreciate it and really important. And I think there should be more focus on that, including how whatever happens in that box can be exploited through the rest of the shopping center.

Lizzy Doykan

There's been a lot of talk lately about public-to-public M&A and more consolidation in the space. So with several deals announced in the past few months. Is there more pressure for Federal today to acquire or to be acquired? Any thoughts on --

Don Wood

There's some, Lizzy, yes, I have some the thoughts that I have in particular. If you're a smaller company, and you've had a pretty darn good run of a few years because as I said earlier, rising tide has lifted all boats, so the demand has outpaced supply. So you had a good few years of 15 years before that, you were basically running your business with very cheap capital. But now it's 2023. Your cost of money going forward is far higher. You have a capital disadvantage compared to the bigger companies. You're already well leased up, how do you grow? What do you do? And so there's certainly more interest on the smaller companies to be able to be taken at. And so it's not surprising to me today that M&A activity is more active.

I expect that I wouldn't be surprised if that were to continue. And the larger companies who do have a cost of capital advantage, it is pretty good to be able to have a willing smaller company to be able to do that and create a level of FFO earnings accretion for a period of time, the acquisition itself. The question is then, what can you do with those assets to be able to keep that growing? And listen, real estate is very, very local. And every portfolio is going to have some good stuff, some average stuff and some bad stuff in it. And it gets tricky because if you have to sell off the bad stuff dilutively to what you just paid for it. That means the stuff you keep, you just pay a lot more for it, right?

And so we, as Federal, have a hard time finding portfolios that we don't think would be dilutive to our overall quality level, and we think that's really important from our perspective. So I don't think you should think about Federal as being in other portfolios that are out there. I think you should see us far more selective, if you will, in the one-off acquisitions in the way that we tend to do it. And that is we maintain a living, breathing document called a hit list of 150 or 160 shopping centers that in the country that we want to own. And we work with those owners trying to get them to become sellers. Sometimes we're successful, sometimes we're not. It's lumpy. It's why right after COVID, we completed about $1 billion worth of acquisitions during that period of time when owners who we had relationships with for years, they came a little panicked, and we're more willing to transact than they were before. But we're not the kind of shop, I can tell you, yes, we have a target of doing $300 million, $400 million, $500 million a year of acquisitions because we are opportunistic.

And working that list, there were periods of time when that's better and periods of time when that's worse. If I were to guess, I would believe that it would be more likely that more of those owners would become sellers over the next 15, 18, 24 months than has been the case historically as debt is debt comes due and needs to be refinanced, most private owners do not own the shopping centers to make them nice places. They made their money somewhere else. They bought a shopping center, and they want the cash flow. Having to invest in them is not a positive thing. So what we love is an under-invested not particularly pretty, but extremely well-located shopping center in markets that have gotten better over the 20 or 30 years that they have owned them such that we can effectively combine them within the Federal portfolio.

And given the size of Federal, I think we're plenty big enough. But we're a whole lot smaller than 2 or 3 of our competitors. And therefore, these things matter more. They move the needle. And one of the things I always strive for is if we're going to work on transactions, if we're going to work on any initiative, it better move the needle and not just be a good talking point but really not matter very much at all in terms of the results, so think about that also.

Lizzy Doykan

Are you seeing any change in pricing today for such deals? And what have you seen out in the market?

Don Wood

I think we're just at the beginning of that. But yes, I think there's some capitulation generally, and that's a general comment, not a specific comment. On the part of owners who had a -- where the bid ask difference was extremely wide. The realization that money cost is going to be far more than it was before and the leverage that we're going to be able to get is probably going to be less than it was before. And again, they've had a good period of time of lease-up as the whole industry has. So I think you'll likely see continued capitulation and therefore, more opportunities to be able to transact.

Lizzy Doykan

Turning to capital funding. Could you talk more about your near-term and long-term plans for funding your redevelopment, development, your larger projects? And then, maybe any indications for more partnerships, joint ventures in order to define that you might be considering more seriously today than before?

Dan Guglielmone

I think that we have always tried to keep a very, very balanced approach to how we fund the business and kind of avail ourselves to the broadest spectrum of potential sources of capital. We've always run it with kind of moderate leverage. And so we've got the capacity, I think, to kind of run the business through more challenging times, higher cost of capital periods. Always periodically tapping the equity market on a programmatic basis, not being in the market when we don't like where the stock price is.

Having a balance sheet that allows us to have an undrawn $1.25 billion, $1.25 billion credit facility that's undrawn gives us a lot of capacity. And we've got trying to keep the business simple. We look to keep the capital structure transparent, not having a lot of joint ventures, really trying to fund the business simply with unsecured debt, primarily in common stock. But avail ourselves to all the arrows or tools in the toolbox from a capital markets perspective.

So from a JV capital perspective, which we've touched upon in terms of potentially tapping that market, that's something that I think because we've got assets, particularly great high-quality trophy one-of-a-kind assets across the country and in places like Santana Row, Bethesda Row, Assembly Row and Pike & Rose that are not being valued in our stock price and really have a significant amount of untapped or unrecognized equity relative to the private market value. At some point, that's something that we could tap in the future is not something we would do today. But it's something that is an arrow in our quivers that we could certainly access at some point in the future. And Don, I don't know if you want to add anything too?

Don Wood

No. It's really interesting to me when you go back and you think about the great financial crisis, when you think about COVID crisis, basically all markets were open to us. We were able, certainly in GFC to issue secured debt. We were able to issue unsecured debt. We did do a joint venture. Back at that time, we even issued a little equity. And while we didn't do all those things during COVID, it was all open to us again. There is something to a long track record. There is something to a high-quality portfolio. There is something to this portfolio that effectively financing, you should assume that the full plethora of opportunities are available to us, you should assume that opportunistically we will do everything that we can in balance to not surprise investors. And you'll see that continuing. I think that the point Dan is making on the untapped value in those big trophy assets is an interesting one. It's not something that we would do today.

But if you look over time, if you look over the next few years, if effectively over that period of time. The public markets don't recognize what that $1 of rent from Santana Row was different than $1 of rent from somewhere else that we would have to look at the notion of a joint venture for 49% or something less than that. It's just an extra arrow in the quiver. And everything I talk about is about being flexible and being able to take advantage of a situation when the opportunity avails itself to us and that's something nobody else has.

Lizzy Doykan

Do you all plan to fix more of your debt, given the floating rate exposure? And what are your thoughts about -- would you plan to fix more of your debt?

Dan Guglielmone

Like ideally, I think that we will, again, try and be as flexible as we can. I think we've liked having a little bit of floating rate debt in our capital structure and I think we'll take advantage, and we'll gauge the importance of maintaining that flexibility. And I would anticipate that we will opportunistically look to access the fixed rate unsecured market, one that's attractive to us. And we will look to use that floating rate debt to over time, deleverage our company and be able to pay that down as flexibly as we can.

Lizzy Doykan

Well, thank you. I think that's all the time we have. But before I end, I'd like to finish off with 3 rapid fire questions.

Don Wood

You're doing rapid-fire questions still?

Lizzy Doykan

Of course, every year. So first question on the Fed. Do you believe the Fed is done hiking, yes or no? Do you expect the Fed to cut rates in 2024, yes or no?

Don Wood

Pretty near done hiking if there's another one. There's another one. I don't have an opinion on that 50-50. And I would expect rates to come down a bit next year.

Lizzy Doykan

Second, do you believe real estate transactions will meaningfully pick up by the fourth quarter of '23, the first half of '24 or the second half of '24?

Don Wood

First half '24.

Lizzy Doykan

And last, are you using AI today to help you run your business, yes or no? Do you plan to ramp up spending on AI over the next year, yes or no?

Don Wood

Well, I believe AI will be transformative to our business and a number of businesses. What we have done is I've got a very senior executive that is basically in charge of AI for the company. And her responsibility is to make sure that we are -- first of all, we know what's going on. I'm not spending a lot of money on it yet. I don't want to but it's early on. We want to make sure that we are fully informed that we understand the impacts on all parts of our business, and we stay close to the vest on that. So we're investing people time as opposed to dollars at this point.

Lizzy Doykan

So no to the first question, yes --

Don Wood

However you want to interpret it.

Lizzy Doykan

Okay. All right. Thank you.

Don Wood

Thanks, everybody, for your time today, appreciate it a lot.