DDR's (DDR) CEO Dan Hurwitz on Q2 2014 Results - Earnings Call Transcript

Jul.31.14 | About: DDR Corp. (DDR)

DDR Corporation (NYSE:DDR)

Q2 2014 Earnings Conference Call

July 31, 2014 10:00 AM ET

Executives

Meghan Finneran – Financial Analyst

Dan Hurwitz – CEO

Paul Freddo – Senior EVP, Leasing & Development

David Oakes – President and CFO

Analysts

Christy McElroy – Citi

Jeremy Metz – UBS

Alexander Goldfarb – Sandler O’Neill

Craig Schmidt – Bank of America

Kalan Beril – Goldman Sachs

Jonathan Pong – Robert W. Baird

Albert Lin – Morgan Stanley

Jason White – Green Street Advisors

Todd Thomas – Keybanc

Ki Bin Kim – SunTrust Robinson

Michael Mueller – JP Morgan

Christopher Lucas – Capital One Securities

Rich Moore – RBC Capital Markets

Operator

Ladies and gentlemen, good morning and thank you for joining the Second Quarter 2014 DDR Corp. Earnings Call. My name is Ryan. I’ll be the operator on the event and at this time all participants are in listen-only mode. We will be opening the call to facilitate questions and answers. And at that time we do ask that you limit yourself to one question before putting yourself back into the queue. (Operator instructions) And as a reminder we are recording the call for replay. And now I will pass the call over to your host Ms. Meghan Finneran, Financial Analyst.

Meghan Finneran

Thanks, Ryan. Good morning and thank you for joining us. On today’s call, you will hear from CEO, Dan Hurwitz; Senior Executive Vice President of Leasing and Development, Paul Freddo; and President and CFO, David Oakes.

Please be aware that certain of our statement may be forward looking. Although we believe such statements are based upon reasonable assumptions, you should understand that these statement are subject to risk and uncertainties and actual results may differ materially from the forward-looking statements. Additional information about such risk and uncertainties that could cause actual results to differ may be found in the press release issued yesterday and filed with the SEC on Form 8-K and Form 10-K for the year ended December 31, 2013 as amended.

In addition, we will discussing non-GAAP financial measures on today’s call including FFO and operating FFO. Reconciliations of the non-GAAP financial measures to the most directly comparable GAAP measures can be found in our earnings press release issued yesterday. This release and our quarterly financial supplements are available on our website at www.ddr.com.

Last, we will be observing a one-question limit during the Q&A portion of our call in order to give everyone the opportunity to participate. If you have additional questions, please rejoin the queue.

At this time, it’s my pleasure to introduce our CEO, Dan Hurwitz.

Daniel Hurwitz

Thank you, Meghan. Good morning everyone and thank you for joining us today. I’d like to start today’s call by reiterating that we are very pleased with the consistency and the strength of the operating results achieved during the second quarter, and the strategic transactions we announced since our last earnings release. Our second quarter results mark a pivotal point in the continued execution of our strategic plan as we closed on the sale of our investment in Brazil, identified an attractive user proceeds and formed our their joint venture with Blackstone to acquire prime assets and posted strong operating results with more than 3 million square feet of leasing completed in the quarter and new leasing spreads of 19%. While the near-term benefits of these accomplishments are obvious, the longer-term positive impact of this quarter will be realized for many years to come and significantly enhances our ability to focus on our core business.

As the back-to-school season approaches, I’d like to take a moment to address the significance of this selling season, the impact it has on our retailers and the trends we are following in the market. Back-to-school was the second retail season of the year and a time when retailers are highly invested in their inventory level as goods have been purchased for both back-to-school and the Christmas Holiday by this point in time.

Over the past few weeks we have seen a steady increase in retail sales due to improve weather, pent-up demand and those increased inventory levels at each of our retailers. As a result, retailers are beginning back to school sales earlier than in past years to further incentivize consumers to shop and realize gains and market share. Not all sales and promotional activity however should be viewed as an indicator that retail sales are in a slump and tenants are getting anxious to simply move product. In fact, most early promotions are well-planned and margins will be maintained for those retailers.

With the highly promotional 2013 holiday season still linger, the consumer’s unwillingness to pay full price and the necessity of offering verifiable value, retailers are carefully planning their sales and product offerings as promotions remain the primary motivation for consumer spending.

In regard to merchandising trends, we continue to observer strong demand for branded goods at discount prices further demonstrating our preference for merchants offering this product type. For example, we are witnessing value-oriented retailers such as Coles offering a much broader assortment of branded goods this back-to-school season. The back-to-school season is indicative of the coming holiday season and it will be very important to identify which retails won consumer dollars and which lost market share. After a long winter and spring and the slow transition into summer, the next few months will surely be an exciting time to study retail trends and follow merchandising strategies. Rest assured we will be spending a lot of time surveying the tenant universe through a variety of store visits.

As we focus on the delivery of goods to the consumer, it is impossible and imprudent not to consider the impact of technology and the disruption it has had on the retail landscape over the past several years. Technology and retail has been and continues to be a significant topic of discussion and I’d like to take a few minutes to address the confluence of technology in the brick-and-mortar retail operations.

As we continue to observe the lines of distinction between the physical store the virtual world blur, the retail industry is steadily undergoing a progressive transformation that is providing consumers with more convenience in value than ever before. From innovative mobile technology that continues to drive foot traffic and sales at bricks-and-mortar locations to buy online, pick in store and ship from store initiatives, brick-and-mortar retailers are continuously evolving their operational capacity. To date, retail efforts show real promise as they not only translate to enhanced operational efficiencies but also progressively fulfilling shopping expectations of the consumer.

Overall, the impact of technology on our universe of retailers has been exceedingly positive. As the most successful and profitable retails of the industry continue to be those that have established both a strong physical and online presence and are striving to achieve an integrated omnichannel operating platform.

One concept we continue to observe growth and expansion is that of buy online, pick up in store. Examples of tenants within our portfolio offering and continuing to roll out the convenience of buy online, pick up in store include Wal-Mart, Target, Bed, Bath and Beyond, PetSmart, Dick’s Sporting Goods, Best Buy, Home Depot, Lowe’s, DSW, Nordstrom Rack and Whole Fruits.

We are also seeing our retail partners growing their ship-from-store initiatives which will allow stores to double as distribution facilities and offer retailers operational efficiencies that were previously unrecognized. Even fast casual restaurant tenants are realizing the advantages of investing in technology for the benefit of their brick-and-mortar operations, offering consumers the ability to place online and mobile orders for convenient pick up, Panera Bread and Chipotle represent two innovative fast casual operators leading the transformation with the restaurant sector.

We continue to see significant investment activity from retailers and restaurant operators as they aim to provide consumers with desirable experiences associated with both the physical and the virtual realms.

It is important to note that in the vast majority of cases, technology integration in the retail industry is focused on enhancing the bricks-and-mortar experience, whether synchronizing a website with local store inventory for successful buy online, pick up in store fulfillment, investing in an algorithm to launch an efficient ship from store program or developing a mobile application with an array of in-store capabilities, retailers investing in technology are directly investing in their physical presence.

As our tenants in the retail industry as a whole continues to adapt and evolve in an ever changing environment, so too has our portfolio of prime power centers. As previously announced, we formed our third joint venture with Blackstone to acquire 76 shopping centers from ARCP for $1.975 billion. The 16.4 million square foot portfolio primarily consist of prime power centers located in large markets like Los Angeles, Houston, Denver, Chicago, Atlanta, Washington DC and Phoenix and is occupied by high-quality retailers including Whole Fruits, Trader Joe’s, The Fresh Market, Costco, Target, Wal-Mart, Coles, Dick’s Sporting Goods, Bed, Bath and Beyond, and the TJX Companies.

Within an expected closing of mid-September, this transaction further enhances our partnership with a best-of-breed capital partner as we again team up to create value in ways that align with our respective investment philosophies. This transformation showcases our continued ability to efficiently recycle capital and further advance our portfolio transformation.

Having an underwriting history that dates back to several months prior to deal announcement, we have identified significant opportunities to enhance the value of the portfolio through active portfolio management. We are confident in our ability to generate outsized asset level growth by leveraging our proven operating platform and have appropriately structured our investment to produce attractive risk-adjusted returns while securing access to acquisition opportunities in the future.

We look forward to maximizing value for our shareholders as we capitalize on the many opportunities available to us through the newly announced portfolio, our existing portfolio and the future opportunities that we are currently pursuing in the market. At this point, I’d like to turn the call over to Paul.

Paul Freddo

Thanks, Dan. Strong leasing momentum continued in the second quarter resulting in 364 new deals and renewals for 3.1 million square feet matching the highest quarterly deal volume in company history. Similarly, spreads were also indicative of the strong leasing environment with an 18.8% pro rata new deal spread and 7.5% pro rata renewal spread. Our 2.4 million square feet of renewals represents that highest quarterly volume in company history and is further evidence that retailers are focused on securing high-quality locations in prime power centers.

While I typically spend some time addressing the supply-and-demand dynamics, we all know that it remains heavily in the landlords favor as demonstrated by our quarterly results. Instead, I’d like to focus on how we’re taking advantage of this environment to continue to grow NOI and improve portfolio quality through our previously announced Project Accelerate initiative as well as ground up development.

As we announced in late May and discussed with many of you at Nayreed [ph] Project Accelerate is allowing us to collaborate with retailers in the books, electronics, toys, office and traditional department store categories to regain control of locations in advance of natural lease expirations where we can then re-merchandise our assets with market share winning tenants and recognize rental upside of 30% to 40%.

As we have discussed before, this is an ongoing multi-year initiative and we continue to work with these retailers on a regular basis to right-size their real-estate footprints. As such, in addition to the 21 previously announced recaptured boxes representing 550,000 square feet of prime power center space, we have finalized deals to recapture an additional five boxes totaling 160,000 square feet in prime assets in Boston, Miami, Charleston and Rowley [ph].

It’s important to remember that while we’re finalizing deals in 2014 to proactively recapture space, the benefits of the remerchandising and the mark-to-market opportunities will commence in the second half of 2015. Additionally, with the ability to know for certain which spaces we are recapturing, we have the ability to sign leases in advance of store closings, limiting the impact to our lease rate and resulting in minimal downtime.

While we are certainly sensitive to our retail partners who have not yet informed their employees of specific store closing, I would like to provide a few examples of our success with this initiative. In the books category, we have several great examples underway. In one instance at a 530,000 square foot prime power center we’re backfilling a 24,000 square foot Barnes & Noble with Ulta and GAP Factory Outlet at a blended comp of 100%. This will enhance the center’s overall merchandise mix with two best-in-class retailers, drive NAV and provide enhanced credit quality of cash flow.

In a separate 165,000 square foot prime power center, we are replacing a 23,000 square foot barns with a new Fresh Market at a 20% positive rent comp and introducing a grocery component to the center driving daily traffic. This will result in further upside in adjacent space as those leases come up for renewal and reduce the overall cap rate of the asset due to the market’s infatuation with grocers.

In our final example, which takes place in a 1 million square foot prime power center we are splitting the 28,000 square foot barns box into several units featuring White House Black Market, Five Below and Carter’s resulting in a significant positive rent comp of over 130%, adding exciting new retailers to the mix and outperforming the original underwriting assumed at acquisition in 2013.

In the office category, we have been strategically partnering with Office Depot as they right size their footprint. One example is the recapturing of a 23,000 square foot office max box at a 220,000 square foot prime power center acquired in 2013 providing the spark for a larger redevelopment. After recapturing this box, we will proceed with the downsizing of the adjacent and oversized DSW. With the office max recaptured and DSW downsized, we can then accommodate a Nordstrom Rack, dramatically improving the merchandise mix, credit quality and traffic at our center. Additionally, the new Nordstrom Rack deal represents an 80% rent comp on the office max space and 40% positive comp on DSW space.

A second example is in a 435,000 square foot prime power center acquired in 2012 where we will recapture and split an Office Depot box for Ulta and Carter’s achieving a blended comp of 100% and driving both stability and growth well beyond our initial underwriting of this asset. While these are just a few examples of the types of deals we are making, they demonstrate that by recapturing below-market leases we are driving incremental growth, improving the credit quality of cash flow, further positioning our asset as dominant shopping centers, enhancing the merchandize mix offerings and eliminating potential risk with certain retailers.

The list of retailers we are dealing with to back fill the recaptured space goes well beyond those named above and include Shoe Carnival, Cost Plus World Market, Total Wine, Bed, Bath and Beyond, Academy Sports, Ross, Marshalls, HomeGoods and many more.

The concept of incentivizing our leasing team to create vacancy in highly unusual in our business, but it speaks to the opportunities presented by the current supply-demand dynamic and the dramatic transformation of our portfolio quality over the past several years. Also directly related to strong retail demand, one of the key takeaways from our 1,000 plus meetings at this year’s ICFD [ph] in Las Vegas, but that retailers are now willing to commit to new develop projects without requiring a major tenant. As a result, we’ve made exciting steps towards effectively monetizing our existing land bank through ground-up development and I’d like to take a moment to update you on that progress.

For those in attendance at our Charlotte Investor Day this past October, you will recall Belgate Shopping Center which represented our first ground-up development in over four years. Belgate opened ahead of schedule in May of 2013 and is a 100% lease, 900,000 square foot power center located in Charlotte anchored by IKEA and a complimentary line up of junior anchors including Marshalls, Ulta, Old Navy, PetSmart, Cost Plus World Market, Hobby Lobby, Shoe Carnival.

Given the project’s success, we are now finalizing a second phase of this project which will represent 75,000 square feet of space occupied with other best-in-class junior anchors while continuing to achieve an unlevered cash on cost return in excess of 10%.

As you saw earlier this month, we announced the grand opening of Seabrook Commons, our most recent ground-up development project located Seabrook New Hampshire, a northern suburb of Boston. Seabrook Commons is a 96% lease, 380,000 square foot power center anchored by Wal-Mart, Dick’s Sporting Goods, PetSmart, Michael’s, Ulta, Famous Footwear and Five Below and includes a complementary restaurant line of consisting of Panera, Outback Steakhouse and Noodles & Company. The opening of Seabrook Commons which achieved an 8% unlevered return on incremental capital results in the second consecutive year that we have added a fully stabilized prime power center to the portfolio through ground-up development.

In a few weeks, we will officially break ground on Gilford Commons, a 130,000 square foot power center consisting of three junior anchors including a specialty grocer and 40,000 square feet of shop and specialty space located just east of New Haven, Connecticut. With a planned opening in the second half of 2015 and projected unlevered incremental yield of 8%, this project will represent our third consecutive year of delivering a new ground-up development project.

Lastly, we will be breaking ground on a multi-phase development project in Orlando, Florida later this fall with an expected opening of the first phase in fall of 2015. Once complete Lee Vista will span 450,000 square feet and will be anchored by theater or for a lineup of best-in-class junior anchor retailers and consist of an array of high-quality restaurant operators. This mix will take advantage of an abundance of surrounding office space, dense hotel offerings at close proximity to Orlando International Airport.

Lee Vista will represent our fourth consecutive year of delivering a new group-up development project and we’re projecting an 8.5% yield on incremental invested capital. These strategic development projects enable us to assist the external growth aspirations of our retail partners, monetize our land bank and achieve attractive returns on incremental invested capital.

As the supply-and-demand dynamic continues to heavily favor the landlord community, we are accelerating our efforts to take advantage by being extremely aware that our industry is cyclical and opportunities are often fleeting. As highlighted by Project Accelerate, our recent ability to generate new NOI through ground-up development and our previously discussed $1 billion redevelopment pipeline, we are continuing to find creative ways to grow NOI, improve merchandise mix, enhance credit quality of cash flow and expand the overall market share of our portfolio, all in an effort to not only benefit from the current landlord favorable environment but also to deliver long-term stability in any economic environment. And I will now turn the call over to David.

David Oakes

Thanks, Paul. Operating FFO was $101.3 million or $0.28 per share for the second quarter including non-operating items. FFO for the quarter was $82.1 million or $0.23 per share. Non-operating items primarily consisted of impairments related to land held for development that is currently being sold.

The second quarter was again representative of DDR’s execution of its strategic transactional and balance sheet objectives. First, we closed on the acquisition of four prime power centers, three of which were sourced off market for $265 million. These acquisitions were focused in the top-30 MSAs and included anchors such as Target, Costco and Whole Fruits.

The most significant acquisition was the Maxwell, a 240,000 square foot prime plus power center locate Chicago South Loop. The Maxwell features an impressive lineup of junior anchors including Nordstrom Rack, Dick’s Sporting Goods and T.J. Maxx sits directly adjacent to Whole Foods and offers a demographic profile of household incomes on $105,000 and population of 681,000 people in the trade area.

DDR previously made a $21 million mezzanine loan on the project that was accompanied by advantageous acquisition rights allowing for a seamless acquisition prior to completion and stabilization, with additional upside for DDR given the 90% lease rate.

We closed on the acquisition in May for $118 million and we expect the majority of the NOI to come online in the fourth quarter of 2014. The acquisition was partially financed by the issuance of 1 million OP units in order to provide tax efficiency and the remainder of the acquisition was financed through asset sale proceeds.

Another acquisition that I would like to highlight is Waterstone Crossing [ph], a 425,000 square foot prime power center in Cincinnati that is anchored by Target and Costco. DDR sourced the acquisition off market as a result of a strong local relationship which allowed us to achieve much more attractive pricing than a marketed sale for a class A center in a large market, providing for significant net asset value creation before we even plug the center into our platform.

DDR not only achieved favorable pricing but we will look to increase the yields by bringing in top-tier organic grocer to the asset in the coming months to replace a weaker merchant.

We also announced that we have formed a 95-5 joint venture with Blackstone to acquire 76 assets from American Reality Capital Partners for $1.975 billion. The acquisition is scheduled to close in late 3Q, subject to loan assumptions. Consistent with previous acquisitions and joint-venture with Blackstone, DDR secured acquisition rights to the top-tier assets which represent 10 of the 76 assets with over 40% of the total value. As Dan mentioned, this transaction continues to build on our deep relationship with Blackstone and highlights the partnership’s ability to source off-market opportunities below market pricing.

On the domestic disposition side we sold 11 operating assets and six land parcels or $51 million at DDR share and we currently have $335 million of operating and non-producing assets under contract for sale. Additionally, we also completed the sale of our Brazilian investment for net proceeds of $344 million, a transaction that dramatically simplifies our company and decreases our risk profile.

The remaining wholly-owned non-prime assets now consist of only 32 assets, down from nearly 200 shopping centers at the end of 2009, and all of which are either being marketed for sale or a subject to either pending leases or anchor rollover in the short term.

Regarding disposition pricing, for the full year 2014, we estimate a blended cap rate in the low 7% range comprised of mid-7% pricing on operating assets that we are selling into a strong market as well non-producing land.

On the capital market side, DDR also notes the closing of a $75 million nonrecourse mortgage loan secured by Plaza Escorial and 636,000 square foot shopping center in Puerto Rico. The loan was completed with a leading life insurance company and included a 7-year term and a fixed interest rate of under 3.6%. The financing highlights the strong property level supply-demand fundamentals and the attractive financing environment that continues to exist on the island despite the macroeconomic headwinds.

In July, DDR paid off a $304 million balance of the [indiscernible] and previously secured 27 prime assets and a loaned value in the 30% range further reinforcing our desire to grow the sides of our unencumbered tool, which now stands at $6.5 billion, up from $3.6 billion in 2009.

Disposition proceeds and plus the carry on [ph] loan were immediately utilized to repay the [indiscernible]. However, we will look to issue long duration on secured bottom [ph] in the second half of 2014 to replace the CMBS debt at a comparable rate.

Finally, as a result of the significant transaction and capital markets activity, I would like to address DDR’s sources and uses of capital for the remainder of 2014 and the subsequent impact on operating FFO guidance.

As we currently stand, we are on target to exceed our current guidance for both acquisitions and disposition activity. Year-to-date, we are closer on a contract to acquire $296 million of one off acquisition plus $384 million associated with DDR share on the ARCP acquisition totaling $680 million.

Disposition activity including assets under contract includes $548 million domestically and $344 million in net proceeds associated with the sale of our Brazilian investment totaling $892 million.

The transaction activity highlights DDR’s desire to be a net seller in 2014 given a strong pricing environment and further reinforces the lack of need for equity issue in trade or transactional activity or debt repayment for the remainder of the year.

For some recent commentaries that encourages us to remind analysts and investors that neither investment nor refinancing activity will be funded from our line of credit for a long period of time. So it is much more appropriate that we might have a long-term debt issuance in the next several quarters.

At this point, I’ll stop and turn the call over to Dan for closing remarks.

Daniel Hurwitz

Thanks, David. Before turning the call over to questions, I would like to let you know that we are planning to host a property tour in Atlanta on November 4th in conjunction with Navy [ph].

As many of you know, Atlanta represents our largest market by square footage and second largest market by base strength and highlights numerous assets that clearly illustrate our investment thesis.

Following the tour, we will host a dinner during which you will have unlimited access to ask senior management team as well as our local management team from our Atlanta office which is responsible for 116 assets totaling more than 30 million square feet in Georgia, Alabama, the Carolinas, Tennessee and Virginia. We look forward to our productive day and exchanging thoughts with those of you who can make the trip to Atlanta that would like to join us.

Again, thank you for joining us today. I’ll now turn the call over to the operator for your questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first questions come to you from Christy McElroy with Citi.

Christy McElroy – Citi

Hi, good morning, everyone.

Daniel Hurwitz

Good morning.

Christy McElroy – Citi

As recourse is built out there by online and pick up in a store and other initiatives, the high eCommerce, the bricks and mortar, Dan, as you talked about, are you finding any changes in retail or space needs at the center level or any differences in the way even with retailers are kind of looking at their space needs in a specific market as stores become increasingly a method for distribution?

Daniel Hurwitz

That’s a great question, Christy, because it is something we discussed with a number of our retail partners now. And it’s really not a function of space needs. It’s how they’re going to configure the space to make the experience pleasant for the customer.

Right now, as many of you know, in order to pick up goods or to experience the shop online pick up in store program, you either have to go into the store specifically and then in which point there’s someone to assist you to your car with whatever good it is which is not really convenient or you have to go to the back of the store where the dock is and unpleasant things like dumpster and bailers and things of that nature.

So natural physical presence of the store is in question and how they layout the store and how they make a customer pick up experience pleasant is a topic of conversation for sure. And there’s no great answer yet to how to do that, although, one of the things that we are seeing is for those of you who are old enough to remember the Sears catalog and JC Penny catalog and Montgomery Ward catalog, et cetera, where they had specific areas for catalog people to pick up goods at the store, that does give you a clue as to probably we’re going back to the future if you will in a lot of those types of environment.

So I do think that we’re going to continue dialog with retailers on this. I don’t think there’s an easy answer to it. But I think there will be not necessarily square-footage reductions or expansions, but there will be different space layout to try to create an environment that is exceedingly convenient for the consumer to come to the site, go to the store, pick up the goods, get in and get out quickly with the merchandise.

And I think it will require us to make physical changes to some of our shopping centers and physical changes to the overall experience in the near future.

Christy McElroy – Citi

Thank you.

Operator

Our next question comes to you from Ross Nussbaum with UBS.

Jeremy Metz – UBS

Hey, good morning. Jeremy Metz with Ross. You guys talked about a number of developments you have going on. Can you just talk about what sort of spreads versus acquisitions you are underwriting today? Is that higher than say a year ago? And then just more broadly where institutional assets are trading on a cap rate basis today and if that’s compressed further?

David Oakes

Sure. As we referenced a little bit in the opening commentary and certainly it hopefully shows up in our actual transaction activity, the private market for quality shopping centers is extremely hot, it’s extremely competitive.

There is a reasonable amount of product being listed, but it’s being overwhelmed by the amount of capital that’s looking at the space. And so the acquisition environment is very competitive, very challenging, that’s why you saw our activity for this quarter dramatically more focused on off market opportunities, more opportunities where we had some sort of advantage on the deal and that’s why we were pleased with the acquisitions that we created that we were able to complete this quarter.

But that’s why you don’t see us out actively winning a great majority of the deals that we looked at. We’d say at this point, quality power centers are clearly trading no higher than the low six cap range and seeing many, many more deals not just in the beloved coastal markets but in a broader list of markets and not trading below 6% cap rate. And so an extremely competitive environment for acquisitions.

We had sought other places to invest our capital. In some cases, it just means a timing issue where we’re patient and we’re disciplined and we’ll wait to put that capital out where we do find opportunities. In other cases it means that capital gets redeployed in a redevelopment activity which we’ve talked about quite a bit or some of the new development activity that Paul referenced to where I think consistently we are talking about getting 250 basis points or more of expected return beyond where we think those assets would trade in the private market.

Obviously, there are some development risk in the projects we’re talking about, but we’re more discussing projects where we already own the land, is already entitled land, we think you’re talking about a considerable development spread there where you’re only taking a fraction of the traditional development risk if we were to be going out and buying unentitled land to work that to the process where we would need an even wider spread for that sort of activity.

Jeremy Metz – UBS

Thanks.

Operator

Our next question comes from Alexander Goldfarb with Sandler O’Neill.

Alexander Goldfarb – Sandler O’Neill

Good morning out there. Just a question, if you look at a number of the expanding concept like store [ph] cycle and the ballet concept and yoga, et cetera. And then you also see that expanding dental chains and things of that sort. Are retailers more accepting of those sorts of contract, co-locating it as the showing centers or are they still resistant because of legacy parking concerns or rather issues like that.

Paul Freddo

It’s gotten better Alex in terms of the retailer’s acceptance. I believe you mentioned a couple of different concepts. So I would have a separate dental from fitness especially some of the smaller fitness users like life cycle.

The retailers have gotten to accept the L.A. Fitness of the world certainly not so of the huge, lifetime fitness type units. [Indiscernible] has become very common in a lot of shopping centers, well-planned and well-positioned is the key. That’s the comment we get back a lot of the time when we’re asking for consent for some of the ready to wear merchants or other anchors in our centers.

So to position properly, it seemed they have their own parking, a terrible influence on the parking lane from the store, they’re accepting.

Dental, medical, that’ a different thing you’re going to have some centers where there is some small shops base, or some outline space that makes sense for. But we’re not excited about putting that in line with our traditional retail centers anywhere and then we’d like to keep it in an off location if you will. And again, I don’t think you can compare the two uses.

Daniel Hurwitz

Yes, I think the short answer, Alex, is yes. People are more – the retailers are more accepting. But particularly for the medical use, we’re not more accepting. And while certainly there are certain centers where that maybe appropriate, in most cases we’ve determined that those are centers that are non-prime and those are centers that we should shell. And so we are not actively in that market because once you go non-retail for a shopping center – and there are obviously certain services – fitness is one and there’s other spaces that are difficult to lease that may be appropriate.

But once you go to the medical field and that becomes a major priority for a shopping center, it’s going to be very difficult to maintain the retail presence in the market share gains and achieve market share gains that you like.

And we typically put those centers on the sale list and we’ve had success obviously selling them. And as you can tell where our leasing numbers without doing those deals, we’re doing just fine. Leasing to the people that we want to lease to. So we really haven’t needed to go to that level. And I don’t suspect that we will anytime soon.

Operator

And our next question comes to you from Craig Schmidt with Bank of America.

Craig Schmidt – Bank of America

Thank you and good morning.

Daniel Hurwitz

Good morning.

Craig Schmidt – Bank of America

The top national retailers continue to grow its market share of the total shares, I’m just wondering what this means by shopping center format and particularly what that might mean for small shops in shopping centers.

Daniel Hurwitz

Well, you want to see in our case anyway, Craig, where the small shops are becoming less relevant. The power center format, let me start with that, we don’t have a lot of small shops space. We think about it in small grocery and the local community centers.

So we’ve been very focused on taking it to the point you’re talking about where we’re consolidating shops space, bringing in some of the national anchors, converting 3,000-foot units to one 9,000-foot unit. So you will see a reduction in it. I think the key in our business and certainly the way I look at it is, how much office space should any center have, right? And it’s not going to be a big component when you talk about the power center format.

So we’re going to focus on the national retailers. We’re going to focus on the large 10,000 and up primarily. Certainly there’ll be some smaller that complement the mix. But we will see less and less shop space. And that is a little bit of a function of what’s happening with the business. There’s always going to be room for service and food, fast food particularly, some of the cell phone operators. So you will see shop space in all sort of categories.

But in what we’re doing and what we’re focused on, we’re not going to see a heavy concentration of how to build the shop space as we used to know it.

Operator

Next question is from Kalan Beril [ph] with Goldman Sachs.

Kalan Beril – Goldman Sachs

Hi, good morning. Is Dollar Tree on your list of largest tenants? And I’m sure you also have exposure to Family Dollar. Could you talk about any impact you expect the merge of those two companies to have on their square-footage plans?

David Oakes

Yes, Dollar Tree is quite a large player on our portfolio. But there is only one Family Dollar, so impact in terms of the merger. And we think it’s a great idea. I think that we’d like to see this growth exposure in some of our markets. Eighty-six is the number of Dollar Trees we have today. So again, just with one Family Dollar, we’re up to 87. And again, no impact on the merger in terms of growth

Daniel Hurwitz

And we think the merger is a positive thing. When you have multiple retailers in the similar category with a similar pricing strategy, it makes sense for them to join forces. We’ve seen it with Office Max and Office Depot. We thought that was a good idea. And we certainly think that this is a good idea as well.

We think that in general, though, one of the reasons why these events occur is because if you look at the companies individually, both of them had very, very high aspirational new store GLA growth strategies. Both of which were going to be extremely difficult to achieve on an independent basis particularly as we have rising occupancy rates. We have nothing new being built. And finding the square footage necessary to sustain those growth aspirations was going to be very, very difficult and I think near impossible.

So I think as the combined chain looks for its growth opportunities, it is more likely to succeed in the guided square footage that they have planned than they would individually. And I think that was a big part of the conversation that leads to the merger because retailers as you know have to grow internally or externally. But internally is tough. Internally is tough in a non-inflationary environment. So external growth is actually critical for a successful retailer and growing market shares is absolutely critical.

And independently when very little is being built and the supply-demand dynamic is they heavily favor the landlord, joining of the forces in that effort makes a lot of sense.

Operator

Next is Jonathan Pong with Robert Baird.

Jonathan Pong – Robert W. Baird

Hey, good morning, guys. Dave, S&P has a positive outlook on your credit rating. Can you share anything about how those discussions are going [indiscernible] it will be and then what’s the biggest hurdle to getting that done?

David Oakes

Yes, I mean the outlook is obviously very important to where their headed that in terms of their bent to continue to have the rating more positively reflect our credit. They do very critically their own research. We try to be as open in front of them as possible with our disclosure that we share with everyone as well as with specific rating agency, business and disclosures.

So we have no secret intel as to what their plans are, but obviously I think we keep making considerable progress, de-risking the company. That includes lowering debt to EBITDA, but a much broader list of de-risking activities like the Brazilian exit. And so we think as we continue to make progress, the rating agencies have recognized that we think they’ll continue to recognize that maybe even more importantly, I think if you look at where our bonds [indiscernible] the fixed income investment community has certainly been supported of our name that I think positions as well when we choose to return to the bond market.

Operator

Next comes through from Albert Lin with Morgan Stanley.

Albert Lin – Morgan Stanley

Hey, good morning guys. Year-to-date, I think you guys are attracting around 3.2% same stores NOI growth which is slightly towards the higher end of your full year guidance, 2.5% to 3.5%. I’m curious what your thoughts are for the back half of the year. And how long do you think you can sustain this level of plus 3% NOI growth?

David Oakes

We’re please with that activity for the first half of the year. I would call it very consistent to modestly ahead of that guidance range. And we think it continues to be achievable for the second half of the year.

I think everything we talked about for use of the upgrade of the portfolio quality with the upgrade of the underlying tenant base was meant to create a portfolio that could deliver this. And while there is much debate in the past as to whether our portfolio quality warranted pricing on par with the other shopping center companies, I think as result show up, it becomes harder and harder to justify the discounted which we trade.

When you see that the underlying cash flow does not only grow on part and better than peers, but also I think represented the sort of consistency that is important to us and we think important to what stocks get attracted multiples or NAV premiums or small NAV discounts over time. And so we’re pleased with the activity to date. We think everything that we put in place with the portfolio as well as the leasing team not only the caliber of the people we have but the mandate that they very clearly have from all of us to continue to drive growth that focus on project to accelerate, to find those opportunities where we can create additional rental spreads, creating year [indiscernible] over and prove the quality and value of the portfolio, but also absolutely push things to NOI.

Now counter intuitively, it may have a slight negative impact in 2014 where we’re creating vacancy or at least in the first half of 2015. But we think even with that, we can maintain very attractive same store NOI growth on an absolute basis in this 2.5% to 3.5% range and I think very attractive same store NOI growth relative to the peer group.

Operator

Next question comes from Jason White with Green Street Advisors.

Jason White – Green Street Advisors

Hi, guys. Just a follow up on the previous discussion over [indiscernible] some of the [indiscernible] and some of those hands in your centers. How will you be able to add the specialty grocers and with the parking they demand, is it hope to find the place to fit them in your centers or is it pretty easy to restructure some of the other retailer’s expectation?

Paul Freddo

It’s actually been quite easy Jason. I mean, most of the specialty grocers [ph] we’ve done have been takeovers of existing space. Like the one example I gave with a fresh market where we’d be taking a Barnes location, fit into the exact footprint, no expansion, no reduction necessary.

And Barnes and some of the other spaces we have recaptured, they were very demanding in the amount of parking in front of their stores initially. So we’ve got plenty of parking and then we’re [indiscernible] to fill those folks like the specialty grocers. But we don’t see any issue in terms of the parking demand at all.

In fact, many of the centers we’ve built, we’re probably over-parked and now coming in with somebody who’s going to use up a little bit of that parking is a great add to the center.

Operator

Next we have Todd Thomas with Keybanc.

Todd Thomas – Keybanc

Hi. Thanks, good morning. Dan, in light of your comments around the retail environment, you noted that you’re spending a lot of time analyzing retailers promotional campaigns and inventory levels and merchandising. And we’ve seen a modest uptick in bankruptcies and closures this year relative to prior years. Your comment seems to be focused more on the importance of this back-to-school and holiday season. I was just wondering, do you feel that this season is more important than in recent years for many retailers, maybe a tipping point of sorts or a situation where things shake loose a bit with regard to closure or even bankruptcies. I was just curious if you could elaborate a bit on your comments.

Daniel Hurwitz

Sure. I don’t think this season is any more important than any other season from that perspective. Particularly because I think in general, if you look at the bulk of our cash flow and the credit quality of our cash flow, the tenants are going into this holiday season in good shape. Balance sheets are in good shape.

I think they’ve figured out obviously, over the last several years, regardless of the news we heard yesterday, they figured out how to operate in a low GDP environment with modest wage growth and modest employment growth. And I think they’re well prepared for the holiday season and we’re all prepared for back to school.

I think what’s interesting though and we did a property tour up to New England the last two days. And one of the things you are seeing is that inventory levels and promotional activity in retailers is early. It was early for back-to-school and I suspect we’ll see the same thing now for the holiday season.

We’ve always waited sort of for after Thanksgiving and then everything moved to before Thanksgiving and I think everything is accelerating a week early or two early. And I think that’s a result of the inventory levels. I think it’s a result of the cooperation between the vendor and the retailer and the fact that the consumer isn’t skittish. The consumer smart and the consumer doesn’t like to pay full price and they need to be incentivized to shop and the retailers are figuring out how to do that.

So I don’t really think this is any more important than any other important selling season. But I do think that you will see some changes in inventory levels. You will see some changes in promotional activity. I also think that we saw some changes in merchandise mix because of the importance of branded good off price.

And that’s just something to watch, to see if it works quite frankly. To see if it’s the right move and to see if that’s what the consumer is looking for as we head into the two most important shopping seasons which obviously are back to school and holiday.

Operator

The next question is [indiscernible].

Unidentified Analyst

Hey, good morning everyone. I just want to go back to follow your comments about project accelerate. I appreciate the details and some of the examples you shared.

I was just curious though, if we take a step back and think about 21 recaptured boxes and the five that are being recaptured. Of those, how many are released at this point and how many have you actually taken back at this point.

Paul Freddo

Basically, we’ve only taken back one but they’re happening – they’d staggered [indiscernible] and that’s part of the beauty of this. Part of our deals on the 26th now are controlling exactly when we will we get the space back and made the point that we want to be in a position where we’re signing leases with the replacement tenant prior to physically getting the space back.

There will be a few more in the third quarter, several more by the end of this year. Pretty decent wave of recaptures early in 2015. And David mentioned, obviously, there will be a little bit of a hit with that.

The stuff we haven’t captured, we have certainly concrete ideas on every one. Deals are not done with all 26 but we’re recapturing for a reason. We want that space. And so in many cases – and if I just had to give a percentage I’ll tell you 50%. We’ve got deals soon to be executed and the others are in LOI and negotiation stages but very comfortable with the space.

Daniel Hurwitz

I think it’s very important to note to Paul’s point though is that we will stagger the take-backs. And in most cases, we will have signed leases before we actually take back the space because our agreements with these retailers give us the optionality of when we can take it back, obviously giving consideration to their peak sales times et cetera.

So we will stagger it out to minimize the downtime as much as possible or maximize the cash flow as much as possible. But we’re in a good shape from a documents standpoint. So there are optionality on these spaces is what’s really creating enormous value. So as we announce these deals and as these deals come through, you will actually see deals that are signed, ready to go but might not have taken back the space yet. And we still have some time before we do that.

Operator

Next question is from Ki Bin Kim with SunTrust Robinson.

Ki Bin Kim – SunTrust Robinson

Thanks. Just a couple of quick follow-ups. Along that similar lines. I feel like [indiscernible] there’s still maybe 25% of space that’s not owned by you. What are your plans on those types of spaces. And does that make sense for you to take some of those back into the own portfolio.

Daniel Hurwitz

The one you’re looking at is typically where you have a shadow anchor whether it’s a Target or a Lowe’s or Wal-Mart. And we have looked in certain cases where it makes sense to convert to lease. But that’s not typically the preference of those larger retailers.

Paul Freddo

Yeah. You think about some of the costly capital standpoint as much as our positioning has dramatically improved in capital, the decrease, it’s a real struggle to say that are our cost of capital could compete with the Costco or a Wal-Mart who have consistently wanted to own a larger portion of their store base. At least for Wal-Mart’s large format stores.

Operator

Next question is from Michael Mueller with JP Morgan.

Michael Mueller – JP Morgan

Hi. I was wondering for the Blackstone [ph] JV, did you consider taking, I guess, a higher ownership stake initially or not really because you have access to the top 10 centers that you wanted anyway.

Daniel Hurwitz

I think the importance for us is the risk-adjusted return. And so to be able to get a very low-risk return on a preferred equity piece for a period of time during which we’ll be doing the extremely detailed underwriting above and beyond what you do in an acquisition process but what you do when you truly own and manage a center to see what would make sense. Assuming we can figure out another transaction with Blackstone to take several of those assets on a wholly owned basis.

I think it speaks to our focus on risk overall. Our focus on portfolio quality overall where we didn’t have an interest to take on 100% of these 76 assets. But we think we have a very attractive structure here where we absolutely expect to help our good partners at Blackstone on this transaction and end up at the day with something that works extremely well for them and very well for us when we can achieve a good return and a consistent return up front.

And potentially, an ownership interest of 100% of the smaller pool of highest quality prime assets. Do we want longer term? So there’s a structure that’s worked well. They are a partner that has worked extremely well, and so we’re excited to another one with them. And hopefully, we see it progress over the next several years the way that the first one has.

Operator

Next we have Christopher Lucas with Capital One Securities.

Christopher Lucas – Capital One Securities

Hi. Good morning everyone. I just wanted to [indiscernible] on the last question which is David, maybe you could give us a sense of the aspirates between [indiscernible] in that ARCP portfolio.

David Oakes

I think there is a relatively widespread when you simply say there are 76 assets. When you truly look at where the value is focused, I think it’s pretty tightly focused on high quality shopping centers in major market.

But to answer the most extreme thought of your question, I think there are high quality, major, major market asset that recent transactional activity would tell us our five caps or some five cap sort of assets in the Los Angeles area. And on the other end, there are some smaller market, single time in assets with less attractive demographics are underlying tenancy. They would probably be in the mid-eights.

And so I think you do have a wide range of cap rates by that broadest definition of thinking about each one of the 76 assets. But when you truly look at where the value is, it is highly concentrated in the high quality major market prime, large scale power centers.

Operator

Next we have Rich Moore with RBC Capital Markets.

Rich Moore – RBC Capital Markets

Hi guys. Good morning. Hey, I’m curious, now that development seems to be making its way back into the conversation not just with you guys but with others as well, where you are in terms of your development platform, in terms of your staff, your expertise, say, which of course you’ve had before. And I’m wondering where that is today post recession from a development standpoint.

Daniel Hurwitz

We’re in good shape, Rich. And we had the redevelopment platform and we were very careful as we went in to the recession and during the recession. We knew we needed the development folks in the department and we kept a couple of key ones and we’ve added since.

And we continue to look by the way. We’re always looking for quality people in that area, construction and development but we’ve kept enough of a pool of activity, if you will, going with the redevelopment pipeline and the occasional development that we feel good about where we are. We continue to look. We certainly don’t feel that we’re in a position where we’re short on quality staff for the extent of the pipeline we played out for you.

Operator

And it looks like we have some follow-up coming through from Ki Bin Kim with SunTrust Robinson.

Ki Bin Kim – SunTrust Robinson

Thanks. Just a quick question, a follow up on Rich’s. What do you think – have you guys looked at your total portfolio and just maybe put some parameters around what you think the total redevelopment opportunity is, maybe within the next three years or so?

Daniel Hurwitz

Yes, we have. I mean, there’s quite a bit that’s active today. I will tell you that we’ll be north for bringing about $100 million plus online in ‘14. And that number should be right around 150.15 million. That’s kind of the run rate we’re looking at. It could obviously bury it from year to year based upon when projects are brought into service.

So we’ve got several hundred million in progress right now, different stages. That just means we’re not just thinking about it. We’re actually doing something about it whether it’s entitlements or consents or working deals. But a good run rate would be about 150 million to 200 million a year of activity and probably bringing in around 150 million a year for the next few years.

Operator

And we have no further questions in queue, so I’ll pass it back to DDR CEO Dan Hurwitz for any final remarks.

Daniel Hurwitz

I just want to thank you all once again for joining us for our update on what was a busy second quarter. And hope that you will be able to join us in Atlanta on November 4th in conjunction with Navy.

So thanks again. Have a good day.

Operator

Wonderful. Thank you very much for your time. [Indiscernible] and have a great rest of the day.

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