Rouse Properties Management Discusses Q2 2013 Results - Earnings Call Transcript

Aug. 6.13 | About: Rouse Properties, (RSE)

Rouse Properties (NYSE:RSE)

Q2 2013 Earnings Call

August 06, 2013 10:00 am ET

Executives

Steve Swett

Andrew P. Silberfein - Chief Executive Officer, President and Director

John A. Wain - Chief Financial Officer

Benjamin Schall - Chief Operating Officer

Analysts

Alex Avery - CIBC World Markets Inc., Research Division

Daniel Busch - Green Street Advisors, Inc., Research Division

Operator

Greetings, and welcome to Rouse Properties Second Quarter 2013 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Steve Swett, moderator from ICR. Thank you, you may begin.

Steve Swett

Good morning. We would like to thank you for joining us today for Rouse Properties' Second Quarter 2013 Earnings Conference Call. In addition to the press release distributed last evening, we have filed a Form 10-Q with the SEC and posted a quarterly supplemental package with additional detail on our results in the Investor Relations section on our website at www.rouseproperties.com.

On today's call, management's prepared remarks and answers to your questions may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ from those discussed today.

Examples of forward-looking statements include those related to revenue, operating income, financial guidance, as well as non-GAAP financial measures such as same-store results, FFO and core FFO. We also caution that prior period results that are referenced in any comments today may not necessarily be reflective of the results had Rouse truly been a standalone entity during the periods presented.

As a reminder, forward-looking statements represent management's current estimates. Rouse Properties assumes no obligation to update any forward-looking statements in the future.

We encourage listeners to review the more detailed discussions related to these forward-looking statements contained in the company's filings with the SEC and the definitions and reconciliations of non-GAAP measures contained in the supplemental information package available on the company's website.

This morning's conference call is hosted by Rouse Properties' President and Chief Executive Officer, Andrew Silberfein; Chief Operating Officer, Benjamin Schall; and Chief Financial Officer, John Wain. They will make some introductory comments, after which, we will open up the call to your questions.

Now I will turn the call over to Andy.

Andrew P. Silberfein

Thank you, and good morning, everyone. I will begin by covering the operating performance for the quarter and the continuing improvement of our portfolio metrics, then update you on our progress with regard to our strategic initiatives and recent acquisition activities. And finally, I will turn the call over to John, who will review our balance sheet, provide more detail on our financial results for the quarter and review our guidance for 2013.

As we reported yesterday, our second quarter core FFO was $0.34 per share on a fully diluted basis. This represents an increase of $0.05 per share or 17.2% year-over-year.

Our core NOI for the second quarter increased by 5.8% to $78 million as compared to $73.7 million in the second quarter of 2012. As expected, our same-property core NOI for the quarter was flat from the prior year. And for the first half of 2013, our same-property core NOI has increased slightly up 0.83%. After a protracted period of declining same-property NOI in the years prior to our formation, our targeted property improvement initiatives and outsized leasing efforts relative to the size of our asset base are beginning to produce the expected results throughout the portfolio.

Moving on to the quarter's leasing activity. We signed a 102 permanent leases in the second quarter, totaling nearly 610,000 square feet. This production was a 10.7% increase in the amount of permanent leasing over what we achieved in the same quarter of 2012, and it represents the fifth straight quarter of leasing in excess of 525,000 square feet.

Including anchors, we leased over 840,000 square feet in the second quarter. At midyear 2013, our total portfolio, inclusive of anchors, was 92.8% leased, an increase of 210 basis points year-over-year. Excluding anchors, our portfolio was 89.9% leased, which represents an increase of 220 basis points since our formation, 150 basis points year-over-year and 70 basis points sequentially. As we have stated previously, our goal is to improve the portfolio's non-anchor leasing level to 93% by early 2016, however, which was previously attained by this portfolio. This means that we are already 42% of the way to our goal in just 18 months.

We also continue to make substantial progress converting temporary leases to permanent leases throughout the portfolio. The percentage of permanent leased space improved by 393 basis points, and temporary leased space decreased by 242 basis points year-over-year. We are almost halfway to achieving our targeted goal of being 86% permanently leased.

We ended the second quarter with a record inventory of over 769,000 square feet of tenants' signs, but not yet opened. Of this amount, 590,000 square feet or over 75% will occupy previously vacant space. Just to put this in perspective, our SNO represents roughly $10.3 million in incremental NOI being added to the portfolio, which we expect to come online over the next year or so.

For the quarter, initial lease spread on a suite-to-suite basis improved 8.5% as a whole, including a 40.5% increase on new leases and a 2.1% increase on renewal leases. Leasing spreads for the year-to-date increased 9.9% as a whole, up 32.4% on new leases and 3% on renewal leases.

Our portfolio of sales increased to $297 per square foot, up 1.3% on a comparable basis. At the end of the second quarter, our occupancy cost ratio per tenants under 10,000 square feet was 12.4%, a reduction from 12.7%, which we reported in the second quarter last year.

We continue to see solid demand across our portfolio and our markets from both larger sized and inline tenants. As you know, the addition of big-box retailers is a key focus for Rouse, both in terms of reconfiguring and leasing excess inline space and increasing the frequency and duration of shopping trips to our malls.

During the second quarter, we executed 221,000 square feet of leases over 10,000 square feet. For the year-to-date, we are running significantly ahead of last year's pace, having already executed 462,000 square feet of large-format tenants. We are extremely encouraged with our continuing leasing momentum, which can clearly be seen both -- in terms of both inline and box leasing categories.

A few highlights in the quarter include the releasing of the second of 2 Sears' anchor boxes that became vacant in the first quarter of 2013 for the state-of-the-art 50,000-square-foot Regal Cinema at our Three Rivers Mall at Kelso, Washington. We also announced the addition of a 35,000 square foot Forever 21 at Pierre Bossier Mall. As Forever 21 is only opening in a handful of new markets in the U.S. this year, the completion of this transaction is a testament to the quality of our middle-market mall, the effectiveness of the cosmetic renovation we recently finished and to the energy level of our leasing teams.

Turning now to our capital projects. We continue to implement our strategic and cosmetic capital improvement plan. We are beginning to see the impact of our improvement from the physical quality, customer experience and retailer offerings throughout our portfolio.

In the second quarter, we commenced an $8.3 million strategic repositioning project at Bayshore Mall, our 620,000 square foot mall in Eureka, California. We executed leases with T.J. Maxx, ULTA Beauty and The Sports Authority, and expect to achieve a yield between 10% and 11% on this capital investment. We will be simultaneously completing a number of cosmetic enhancements to the mall as well, including a new tile floor, soft seating, new common area amenities and upgraded interior lighting.

During the quarter, we also commenced a $15 million strategic capital project at Lansing Mall, which includes the addition of a 50,000 square foot Regal Cinema and a number of new high-volume [indiscernible] restaurant tenants. This project is expected to achieve a yield of 9% to 10% on our investments.

With regard to our cosmetic renovation projects, since our formation, we have completed 3 projects. In the second quarter, we commenced 1 new project at Sikes Senter Mall, the only mall serving Wichita Falls, Texas where we are installing new tile floorings throughout the common areas, enhanced lighting and upgrading the interior and exterior signage. We are focused on unlocking the potential of each asset through a targeted upgrade and enhancement program designed for each mall.

Based upon what we have experienced to date, our cosmetic capital projects have, in general -- resulted in not only increased leasing activity, but an upgrading of the customer profile, raising the number of families visiting our mall and increasing the frequency and the duration of visits to our mall. As we move into the balance of the year, we expect to commence an additional 1 to 2 strategic capital projects and 1 to 2 cosmetic renovations in addition to those already underway.

The total capital spend on these projects, inclusive of those we have already commenced, is estimated to be between $65 million and $75 million, with completion expected within the next 12 to 18 months. This reinvestment is a crucial component of our long-term strategy to increase cash flows and maximize value. We look forward to updating you on our progress as these programs unfold.

Now we turn to external growth. Just last week, we announced the acquisition of Greenville Mall in Greenville, North Carolina for $50.25 million. Greenville Mall opened in 1966 and was renovated in 2001 and is a perfect fit with our portfolio of dominant middle-market regional malls. Anchored by Belk Ladies, Belk Men & Home, JCPenney and Dunham Sports, which is scheduled to open in late 2013, the Mall enjoys a dominant competitive position as the only mall serving its marketplace and features leading national retailers such as Victoria's Secret, Buckle, American Eagle, Bath & Body Works and Foot Locker. With inline sales of $375 per square foot, low occupancy costs of approximately 10.4% and an attractive initial cap rate of approximately 8%, we believe that our platform can significantly improve the economic metric -- metrics, tenant quality and sales productivity of the mall.

Since our formation, we have acquired over $230 million of malls. We believe we are one of the few companies with the size, established operating platform, retailer relationships and balance sheet necessary to successfully operate middle-market malls on a national basis. We continue to pursue a pipeline of various acquisitions that fit our criteria and remain confident in our ability to source and close attractive investment opportunities going forward, as we continue to allocate more of our resources and attention to external growth opportunities.

With that, I will turn the call over to John to discuss our financial results.

John A. Wain

Thank you, Andy, and good morning, everyone. In my comments today, I will first address our balance sheet, including recent financing transactions and their impact on our capital structure and liquidity. Then I will review our second quarter operating results. And finally, I will comment on our 2013 guidance for core FFO.

Starting with the balance sheet. As we have previously communicated, we continue to make significant progress in executing on our 4-point strategy to strengthen our balance sheet by: decreasing the amount of our recourse financing, lowering our interest rates, extending and laddering our maturity and generating excess refinancing proceeds to further support our growth strategy.

On the financing front, in May, we closed on a new $71.5 million floating rate mortgage loan secured by NewPark Mall. The initial funding of the loan was $66.5 million with the remaining $5 million to be advanced upon achieving certain conditions. The loan has a 4-year term with a 1-year extension option and carries the rate of LIBOR plus 405 basis points. The loan that we repaid was scheduled to mature in 2014 and has been Rouse's most expensive debt at a fixed rate of 7.45%. We elected to use shorter-term interim financing in this case to provide flexibility with regard to long-term financing options as we execute strategy to reposition and improve this mall.

In June, we closed on a new 10-year $68 million CMBS mortgage loan secured by Valley Hills Mall. The new loan bears interest at a fixed rate of 4.47%, which compares favorably with the rate on the repaid loan of 4.73%. Since our formation, we have refinanced 6 loans for a total of $392 million, not only extending our maturity ladder and lowering our interest rate, but resulting in aggregate net proceeds to the company of approximately $62 million.

At the end of the second quarter, we had total debt of $1.15 billion, of which 78% or $893 million was fixed rate mortgage debt with a weighted average interest rate of 5.18%. We had $187.9 million outstanding on our term loan facility as well.

Since our spin, we have lowered the weighted average interest rate on our debt by 50 basis points to 5.05% and extended our weighted average term to maturity to 4.11 years from 2.93 years.

With regard to our financial flexibility, we ended the quarter with approximately $313 million of liquidity, including $62.7 million of cash and callable deposits; a $150 million bank revolver, fully undrawn; and a $100 million subordinated revolver, also fully undrawn. This provides us with sufficient capacity to support our operational and strategic growth objective. We have no maturities for the remainder of 2013 and are actively working on our remaining 2014 maturity.

As previously mentioned, we have $448 million of existing CMBS property debt, which is freely prepayable without penalty. This affords us flexibility in being able to refinance these loans at any time without incurring make-whole costs or other penalties. We are busy implementing our planned improvements to these properties and expect to refinance them at the appropriate time. We continue to receive strong interest from a variety of lenders and anticipate that we will continue to take advantage of favorable rates and market conditions as we further execute on our refinancing strategy.

On another note, as we've communicated previously, in June, Boulevard Mall was conveyed to its lender in a tax deficient 10/31 exchange. We recorded a $14 million gain on the debt extinguishment in the second quarter, which was excluded from FFO and core FFO. The conveyance of Boulevard to its lender has lowered our debt and our leverage and it has improved several of our portfolio metrics.

Now let me turn to our results for the second quarter of 2013. Rouse reported core funds from operations of $17.2 million or $0.34 per diluted share compared with $14.4 million or $0.29 per diluted share in the prior year. The year-over-year increase of 17.2% in core FFO is primarily attributable to 2 items: one, net operating income increased by $1.9 million, which is primarily related to the contribution from Turtle Creek, which was acquired in December of 2012. Same-property NOI is essentially flat. Two, interest expense was $764,000 lower, mostly due to $1.3 million of additional interest on the debt associated with Turtle Creek, which was offset by $2.1 million in savings due to refinancing at lower interest rate.

With regard to our dividend, on August 1, 2013, our Board of Directors approved a quarterly dividend of $0.13 per share. This dividend will be paid on October 31 to stockholders of record on October 15.

Looking forward to the balance of 2013. Based on our results to date and our expectations going forward, including the impact of publicly announced and completed transactions to date, we are reaffirming our guidance for 2013 core FFO of $1.49 to $1.55 per diluted share. This range represents 18% to 23% growth compared to 2012 core FFO of $1.26 per share.

The affirmation of our guidance reflects the offsetting impact of several factors, including the positive contribution from the acquisition of Greenville Mall and the refinancings completed in the quarter, offset mostly by the impact of the transfer of Boulevard Mall to its lender.

Please note that our guidance does not include the effects of any future property acquisition, disposition and refinancings.

With that, I will turn the call back to Andy for some concluding remarks.

Andrew P. Silberfein

Thanks, John. We are pleased with our progress through the first half of 2013 as we continue to pursue the principle goal that I have communicated for more than a year now.

Our portfolio metrics continue to improve. Our tailored asset-by-asset capital programs are underway, our balance sheet continues to strengthen and, in July, we were able to add a new dominant protected mall to our portfolio with the purchase of Greenville Mall.

With that, we would be happy to answer any questions you may have.

Question-and-Answer Session

Operator

[Operator Instructions] Alex Avery with CIBC.

Alex Avery - CIBC World Markets Inc., Research Division

I guess just a general comment. It seems like things are going pretty much according to plan, so congrats on the evolution of the business overall. I just had a few questions, I guess, more detail-oriented. On the JCPenney, I guess, the percentage of minimum rent, even from Q1 2013 dropped pretty materially, 1 store less. And presuming that's at -- that went with Boulevard Mall?

Andrew P. Silberfein

Alex, thank you for the comments. I'm going to have Ben take that question.

Benjamin Schall

Alex, the impact on the 1 store was at Boulevard, a fairly large store for them. The top 10 tenants and the percentage of income is opulent [ph] . The main differences this quarter were Boulevard and other normal variances quarter-to-quarter depending on certain billings were [indiscernible] and other types of recoveries.

Andrew P. Silberfein

And the thing that's interesting, as we ended the quarter as well, we have 14 Rouse-owned JCPenneys with an average size of just under 70,000 square feet. So as you know, they don't pay a lot of rent and it's easily dividable. So that's the story with JCPenney at the end of the quarter.

Alex Avery - CIBC World Markets Inc., Research Division

I was going to ask you if it was a particularly high rent store, but I guess it's the size that had the major impact there. How large was that store at Boulevard?

Benjamin Schall

It's about 200,000 feet.

Andrew P. Silberfein

Yes. I think that was the largest store in our portfolio, Alex, for JCPenney.

Alex Avery - CIBC World Markets Inc., Research Division

Okay. And then just I wanted to dig into Gateway Mall. You had a particularly large jump in leased occupancy at that property in the last 90 days. Can you just tell us about what's happening there? And perhaps what's next when you get it up to about 97%, 98% occupancy?

Benjamin Schall

What you're seeing at Gateway is the results of -- and this is true throughout our portfolio, some of our increased activity on our larger format and box tenants. Some of the new lease activity at Gateway will start to become part of that strategic redevelopment project that we're in the planning phases for. So that's what's driving the bulk of that increase, Alex.

Alex Avery - CIBC World Markets Inc., Research Division

Okay. And is that one of the properties that's used as security for the term loan?

Andrew P. Silberfein

No. I believe that, Alex, is the -- I believe that's the CMBS one.

John A. Wain

Non-recourse CMBS deal.

Alex Avery - CIBC World Markets Inc., Research Division

Okay, that's great. And then just on the tenant inducements. You paid out, it looks like 0.0 on renewal space. Is that -- anything unusual in there or is that something we can expect to see on an ongoing basis?

Andrew P. Silberfein

We've been running pretty much that level since formation, so we don't expect it to materially change on renewal. And I think what's interesting to note is when you look at the tenant allowances that we're achieving on, frankly, both under 10,000 and over 10,000, we're not having to spend extra money to add these tenants to our portfolio. We're doing it at very reasonable, tenant allowance numbers.

Operator

Your next question comes from Daniel Busch with Green Street Advisors.

Daniel Busch - Green Street Advisors, Inc., Research Division

Andy, there sounds like there's still a lot of great work going on in the leasing side and there seems to be still a substantial gap between kind of occupied and leased space. And I know you covered it to an extent, but can you just remind me or help me out on how that's supposed to work together and how the occupied space will grow over the next year that you alluded to?

Andrew P. Silberfein

Well, obviously, in terms of the portfolio, just to understand its biggest effect, the portfolio, we would certainly say is far healthier than it was when we took it over, nearly 2012. So what's interesting to note is that our retention rate has actually significantly improved, which means we are delivering a better product for both retailers and consumers alike. And our spread's certainly up 9.9%, the figure is quite good. So in terms of yes or no, the number has grown to a number, say, of a 770,000 square feet. As we've said before, 75% of that's taking vacant space. So in terms of where we expect that to go, it's run pretty consistent, actually it's grown since the last quarter. We don't see -- we see that momentum on the leasing front continuing. So in terms of when it comes online, we've been pretty consistent that we expect the third quarter or the second quarter to be pretty much flattish, but then we expect to see most of it -- most of the impact that we're going to see for this year be in the fourth quarter. But that SNO should roll in depending on the time we've reached -- predict at least sometime over the next, I would say, 12 to 15 months at the outside.

Daniel Busch - Green Street Advisors, Inc., Research Division

Right. So I guess, when I look at almost 90% leased versus 86.5% occupied. On the call, a year from now, could I -- is it safe to assume that we'd be closer to that 90% occupied or is there some fallout in there as well?

Andrew P. Silberfein

That's a very good question. I would expect that you would expect it to be closer to that number. The reason we showed the occupied and the leased is because we have that big gap. And others don't show that, but we want everybody to understand the momentum and what's coming down the line. And the easiest way to show that is to show the gap between what we have already in occupied today versus what we've leased. And I would expect that, that gap to narrow considerably substantially over the next 12 to 18 months.

Daniel Busch - Green Street Advisors, Inc., Research Division

Okay. And then the leases that you've signed, where -- what OCR are you targeting right now or what OCR have you been successful signing new tenants at?

Andrew P. Silberfein

I think it depends on the category of tenants. Obviously, certain categories are going to have higher occupancy cost ratios and certain ones ran lower. But in general, we try to target 12% to 13% type number, and that's an average. So obviously, jewelers, you have food tenants and others that will pay a higher number and some others that will pay a lower number, so that's really an average type number.

Daniel Busch - Green Street Advisors, Inc., Research Division

And then on -- when I look at your tenant recoveries, it's quite a bit lower than some of your mall peers. As you put more money into your properties, is there an opportunity to increase your recovery rate?

Andrew P. Silberfein

In terms of the triple mix? [ph]

Benjamin Schall

Alex -- I mean, Daniel, this is Ben. Part of that -- part of those is reflected in terms of the changing lease dynamics, but really, relative to our peers, most of the gap is reflective of our occupied percentage relative to our peers. So that gap of nonrecoverable is greater and we expect that to improve over time.

Andrew P. Silberfein

There was a -- and this is Andy. There was a gap built in when we inherited the portfolio, of course, so that will change. But there are certain assets embedded in what we started out with. But we do expect that to improve.

Daniel Busch - Green Street Advisors, Inc., Research Division

Okay. And then switching gears to Greenville. Now it seems you've talked about it being a great fit for the portfolio. Is there a one -- it seems like there's a lot of -- there's still some B malls out there in the market. What makes this one a better fit for your guys' portfolio? Is there one trait or metric that you guys are looking for when you go out to look for an acquisition?

Andrew P. Silberfein

It's really a combination of different things. I think the most important things that we look at are as follows: first of all, our preference is to buy malls that are the -- that have a dominant protected position, preferably being the only enclosed mall in the market; has to have strong anchor sales; has to have good inline sales. In this case, we're talking about $375 a foot. And it has to have a very low -- not very low -- but low occupancy costs that we believe we can move significantly higher. In terms of this transaction, that number was 10.4%. And we think that given [indiscernible] price that we paid, when you wrap it all together and the fact that we can -- we believe we can apply our platform to improving the metrics of the portfolio, we think it's really pretty close to what we're looking to do in terms of the acquisition front. It's little bit on the smaller side, but we like that, because it doesn't have too much inline space. And we think we can really make great progress on that property. And as we've seen from some of our previous acquisitions that have lower occupancy cost, we're having success in that regard as well. So it's turning out exactly what we thought, which is we can take our platform, and we could use it to improve the quality of the retailer sales and bottom line NOI at the end of the day.

Daniel Busch - Green Street Advisors, Inc., Research Division

Okay, okay. And then, I guess, maybe just one last one for John. And as you look for further acquisitions and you add properties to your renovation or redevelopment program, I guess, your debt will start to creep up, I think. Just with Greenville, it goes up about 100 basis points in leverage. How do you plan to offset that or how do you plan to bring your leverage back down?

John A. Wain

Well, basically, I think I got this to you last quarter, too. We expect our leverage to come down over the next couple of years by the improvements in the NOI in the portfolio. So again, after we look at the give-back of Boulevard going into year-end this year, we should be somewhere of 7.9 or 8x. But we would expect to get down to 6.5 to 7x net debt-to-EBITDA, kind of going into '16. So we do have quite a bit of natural deleveraging that will take place.

Daniel Busch - Green Street Advisors, Inc., Research Division

Okay. And then maybe one last one if I may. When I look at Greenville, the "only game in town" malls are interesting, do you see -- are those being underwritten different than a normal B mall? I guess said differently, the NOI growth may not be that much different from a normal middle productivity mall, but the risk of that mall being obsolete in the near-term is much less? How do those "only game in town" or malls are ones with no competition, how are those underwritten differently than maybe the second or third best mall in the market?

Andrew P. Silberfein

By who? By lenders?

Daniel Busch - Green Street Advisors, Inc., Research Division

So when you guys are looking at it from an acquisition side, excuse me.

Andrew P. Silberfein

Yes. So one of the things that's interesting is -- take Greenville for example, there were 2 malls in that market and one has since been scraped and turned into a power center, so Greenville Mall is the last remaining mall in that property. So it's going to be "only the game in town" for -- obviously, for a long time to come. And in terms of our underwriting, we believe that given the leverage of being able to be the only close mall in a market, you can push rents certainly higher than if you had a competing mall nearby, where you're competing over each tenant that's coming into the market. That obviously, tends to tamper down a little bit on some of the increase that you will get because they negotiate with one off of the other. So there is some of that going in play, if you will, for the "only game in town" malls in terms of being able to achieve, we think, higher returns and greater improvement at that mall.

Operator

[Operator Instructions] There seems to be no additional requests for questions. I'll turn the conference back to management. Thank you.

Andrew P. Silberfein

Thank you for joining us this morning, and we look forward to reviewing our third quarter with you down the road.

Operator

This concludes today's conference. All parties may disconnect. Have a great day.

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