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Retail Properties of America, Inc. (NYSE:RPAI)

Q2 2014 Earnings Conference Call

August 5, 2014 11:00 AM ET

Executives

Michael Fitzmaurice – VP-Finance

Steve Grimes – President and CEO

Angela Aman – EVP, CFO and Treasurer

Shane Garrison – EVP, COO and CIO

Analysts

Todd Thomas – KeyBanc Capital Markets

Christy McElroy – Citigroup

Jay Carlington – Green Street Advisors

Michael Mueller – JPMorgan

Operator

Greetings, and welcome to the Retail Properties of America Second Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Michael Fitzmaurice, Vice President of Finance. Thank you. You may begin.

Michael Fitzmaurice

Thank you, operator, and welcome to the Retail Properties of America second quarter 2014 earnings conference call. In addition to the press release distributed last evening, we have posted a quarterly supplemental package with additional details on our results in the Investor Relations section on our website at www.rpai.com.

On today’s call, management’s prepared remarks and answers to your questions may include statements that constitute forward-looking statements under Federal Securities Laws. These statements are usually identified by the use of words such as anticipates, believes, expects and variations of such words or similar expressions. Actual results may differ materially from those described in any forward-looking statements, included in our guidance for 2014, and will be affected by a variety of risks and factors that are beyond our control, including, without limitation, those set forth in our earnings release issued last night and the risk factors set forth in our most recent Form 10-K, 10-Q and other SEC filings.

As a reminder, forward-looking statements represent management’s estimates as of today, August 5, 2014, and we assume no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Additionally, on this conference call, we may refer to certain non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP numbers and definition of these non-GAAP financial measures in our quarterly supplemental package in our earnings release, which are available in the Investor Relations section of our website at www.rpai.com.

On today’s call, our speakers will be Steve Grimes, President and Chief Executive Officer; and Angela Aman, Executive Vice President, Chief Financial Officer and Treasurer; and Shane Garrison, Executive Vice President, Chief Operating Officer and Chief Investment Officer. After the prepared remarks, we will open up the call to your questions.

With that, I will now turn the call over to Steve Grimes.

Steve Grimes

Thanks, Mike, and thank you all for joining us today. This morning, I will begin with an overview of our second quarter financial performance and operational metrics. Angela Aman, our CFO, will provide additional color, while also discussing our balance sheet execution and updated earnings guidance. And Shane Garrison, our COO and CIO will discuss our operational performance in greater detail and provide some update on our transactional progress.

During the second quarter, we maintained the strong momentum in which we started the year, as we continued to execute on our strategic initiatives through successful repositioning progress on both, portfolio and balance sheet.

During the quarter, we closed on the acquisition to our partner’s interest in MS joint venture, which we discussed last quarter and six high-quality multi-tenant retail assets to our wholly-owned portfolio in further simplifying our structure. In addition, we closed on our inaugural $250 million unsecured notes transaction, which also was announced in our first quarter call.

This transaction represented an important expansion of our asset to additional forms of capital, creating further financial flexibility for the company and positioning us well to continue to execute on our balance sheet strategy through further growth of the unencumbered asset base.

In addition to our substantial transaction activity in the first half of the year, we have also continued to post very strong operational statistics. Same-store NOI during the second quarter was up 4.8% compared with the prior year, as we continue to realize the benefits of both, occupancy gains and positive re-leasing spreads.

As of June 30, our portfolio occupancy was 93.5%, up 200 basis points year-over-year, and including leases signed but not commenced, our lease rate was 94.8%, up 140 basis points from the prior year. In addition, we signed leases for just under 1 million square feet at weighted average blended re-leasing spread of 6%.

I am pleased with our leasing progress as we approach occupancy stabilization as part of the portfolio. We have successfully re-leased anchor vacancies and underperforming locations with high-quality tenants which in turn can solidify the dominance of our centers and result in a meaningful small shop [ph] leasing traction.

Looking ahead, we remain focused on delivering compelling operational results through a thoughtful combination of our occupancy and rental rate gains. We will continue to evaluate our assets for additional remerchandising opportunities and potential redevelopment projects. And we will continue to successfully execute on our portfolio evolution [indiscernible] net proceeds into multi-tenant retail centers in our target markets.

Our continued execution will be supported by a positive macroeconomic environment and a favorable supply and demand landscape. And finally, growth and sustained comp price depreciation are taking hold while businesses are increasing in both staffing and investments, which is providing support to consumer sentiment and spending.

While we anticipate that there will be some volatility as the recovery progresses, we believe if the economy continues to move in the right direction, combined with the continued rack of new retail supplies, creates a favorable environment for retail landlords.

Before concluding my opening remarks, I would like to take a moment to welcome our newest board member, Peter Lynch, who joined our Board of Directors at the end of May. Peter is a former Chairman, President and Chief Executive Officer of Winn-Dixie Stores, and brings a wealth of relevant embedded experience to our board.

This addition represents yet another step we have taken to position RPAI for continued success in a highly dynamic environment.

And with that, I will turn the call over to Angela to discuss our results in more detail.

Angela Aman

Thank you, Steve, and good morning. Operating FFO was $0.28 per share for the second quarter, up from $0.26 per share in the second quarter of last year. The improvement in operating FFO was driven by growth in same-store NOI, lower interest expense, as we continue to realize the benefits of the balance sheet improvements made over the last several years and lower G&A.

These factors were partially offset by lower lease termination fee and joint venture fee income. Including non-operating items, FFO was $0.27 per share, down from $0.38 per share in the second quarter of last year. Non-operating items this quarter were primarily related to the early repayment of debt.

Same-store NOI growth was 4.8% in the second quarter, driven by continued positive fundamental revenue trends and lower expenses net of recovery income. Year-to-date same-store NOI growth was 4.6%, and we have maintained our full-year same-store NOI guidance range of 2% to 3%. As discussed when we provided original full-year same-store guidance in February, the contribution from expense improvement, net of recovery income, is expected to moderate as we move through 2014. It is considerably more difficult comparison as we go early in the fourth quarter.

During the first half of 2014, total operating expenses, net of recovery income, contributed approximately 200 basis points of the 450 basis points of same-store NOI growth. Looking towards the second half of the year, we expect these items to detract approximately 100 basis points of growth, although the contribution for the full-year is expected to be positive.

Operating FFO guidance has been increased to a range of $1.04 per share to a $1.07 per share, representing a 4.5% increase at the midpoint of the range. The increase in operating FFO has been driven by the favorable timing of acquisition and dispositional activities, additional lease termination fee income, which we expect to record in the second half of the year and lower than expected G&A, primarily related to lower-than-anticipated acquisition costs.

Original G&A guidance was $35 million, and we now expect that G&A will be approximately $32 million to $33 million for the full-year.

At this point, we expect the disposition activity for 2014 will come in at the high-end of our guidance range at $300 million to $350 million. Our acquisition activity is likely to come in at low-end of $300 million to $350 million range.

In addition, it’s worth noting that our private placement unsecured notes transaction funded on June 30 as expected, and as a result, no interest expense related to the notes was incurred in the second quarter. Proceeds from the unsecured notes transaction were used to repay amounts outstanding under our revolving line of credit in advance of secured debt maturities over the next several months.

Our net debt-to-adjusted EBITDA ratio ended the quarter at 6.3x, which was slightly elevated as a result of the timing of the MS transaction. For the quarter, end-debt balance includes 100% of the debt associated with the MS portfolio, consolidated EBITDA is only included for the MS portfolio from June 5 through the end of the quarter.

On an adjusted basis, net debt-to-adjusted EBITDA would have been approximately 6.1x. Based on our current expectations for disposition proceeds in the second half of the year, we expect to end 2014 slightly below 6x, quite in line with our long-term targets.

During the quarter, we repaid $35 million of mortgage loans with a weighted average interest rate of 6.54%, and subsequent to quarter-end, we repaid an additional $77 million of mortgage loans with a weighted average interest rate of 5.85%.

Throughout the remainder of the year, we effectively pay an additional $70 million of mortgage loans with a weighted average interest rate of 6.39%. We are extremely pleased with the financial capacity and operational flexibility that we have created through continued and sustained execution of our balance sheet objectives, and we are well positioned meaningfully cover [ph] the unencumbered asset base over the next several years.

And with that, I’ll turn the call over to Shane.

Shane Garrison

Thank you, Angela, and good morning. Today, I will discuss our second quarter operational results and provide an update on remerchandising opportunities and transactional activities.

Over the last several years, our primary operational focus has been on the lease-up and stabilization of the portfolio. As a result of our concentrated leasing efforts, occupancy has improved by 440 basis since early 2012 to 93.5% at June 30, and we are on track to meet our stated goal of 95% of occupancy by year-end 2015.

At the same time, we have been successfully driving rents as evidenced by the 6.7% re-leasing spread that we reported year-to-date. These results are a testament to the strength of our assets, the desirability of our locations and the ability of our team to execute.

While additional occupancy gains and continued rental rate growth will remain key value drivers in our portfolio, we will also continue to support additional means of driving our above-average organic growth. These will include remerchandising opportunities and potential redevelopment projects, aimed at improving the competitiveness of our asset base and the growth opportunities.

On previous calls, we alluded to a handful of remerchandising opportunities across our portfolio that were slated for 2014, and I would like to take a few minutes here to highlight the successful outcome of these efforts.

Our remerchandising efforts at our mixed use lifestyle centers have focus on upgrading both tenancy and sales take advantage of the strong competitive positioning and existing above our average sales productivity of these assets. For example, at Eastwood Towne Center in Lansing, Michigan, we recently added Apple, Sephora and expanded Forever 21 replacing Casual Corner, Children’s Place in a long-term basis [indiscernible] center.

As we continue to optimize the tenant mix to meet the needs of the center’s young and vibrant demographic. At The Shops at Legacy is mixed use lifestyle center in Plano, Texas, we’ve continued to create value with the active asset management of both the retail and office components of the project.

Recently, we signed an 18,000 square foot office lease with Nike, bringing our office occupancy asset projects to 100%, the first time we have ever achieved this milestone at this asset. The success of our office leasing efforts here is directly intertwined with our robust retail leasing strategy whilst continued to upgrade the tenancy and followed by the asset positioning at one the premier workplace play destination in the Dallas, Fort Worth market.

Our remerchandising efforts in our power center portfolio have been primarily focused on reducing exposure to at-risk category, while driving significant rental rate upside. For example, we recently mitigated our exposure to the [indiscernible] stores with the execution of leases with Ulta and The Gap at Central Texas Marketplace in Waco, Texas, as well as in Ross Dress for Less at the Best on the Boulevard in Las Vegas, Nevada.

The weighted average improvement rent around 40 basis points [ph] to 60%. Similarly at Northpointe Plaza in Spokane, Washington, we downsized an office of supply store [ph] with a clear footprint in order to accommodate Party City, recognizing positive rented re-leasing spread of nearly 30%.

These transactions demonstrate our continued focus on maximizing the value of each individual property in order to create long-term sustainable growth in net asset value.

In the strong tenant demand and the [indiscernible] classified retail supplier, our asset management family continues to remind our portfolio for additional opportunities in the landlord favorable environment.

Turning to transactional activities. Large transaction during the second quarter was the MS portfolio, in which we purchased [indiscernible] interest in six high-quality properties for $244 million. We also acquired an outparcel at Southlake Town Square in Nevada for $6.4 million. The building was occupied by Del Frisco’s Grille, a high-quality and complementary national project, and the acquisition also add additional space for [indiscernible] investment centers in our portfolio.

With [indiscernible], we now start portfolio acquisition volume to come in at the low-end of our guidance range of $300 million to $350 million. The acquisition pipeline remains extremely competitive and we will continue to act with discipline as we move through the remainder of the year.

Our transactions team remains focused on identifying assets and building relationships, local owners and operators in outside the markets in order to create competitive advantages, as we continue to focus on quality, not yield and quantity during our portfolio transformation.

With respect to dispositions. During the second quarter, we disposed three centers for approximately $72 million, representing our multi-tenant retail asset from the Milwaukee, Wisconsin, Sarasota, Florida and Palm Beach. Florida, San Jose. We continue to work to optimize the composition of the 2014 [indiscernible] buyer interest that we are seeing in secondary and tertiary markets as investors continue to move out on the risks spectrum.

As a result, we now believe that full-year disposition volumes will come in near the high-end of the guidance range of $300 million to $350 million.

And with that, I will turn the call back over to Steve.

Steve Grimes

Thank you, Shane and Angela for your prepared remarks. The results continue to showcase that our measured repositioning plan, with simplified low leverage balance sheet allows us to continue to deliver growth and long-term value for our shareholders. We couldn’t be more pleased with our results to-date and execution against our long-term strategy.

And with that, I’d like to open up the call for questions.

Question-and-Answer Session

Operator

Ladies and gentlemen, time for our question-and-answer session. (Operator Instructions) Our first question comes from Todd Thomas with KeyBanc Capital Markets. Please state your question.

Todd Thomas – KeyBanc Capital Markets

Hi, good morning. First question regarding dispositions. The timing is a little later in the year than initially expected, but it sounds like you have decent visibility now given your comments that you should fall towards the high end of the range. I’m just curious whether the later in the year timing is a result of deals that initially fell out of contract from earlier in the year, or was this strategic in nature to sort of hold properties off the market and wait for sort of better pricing and some leasing to commence?

Shane Garrison

Hi Todd, good morning. This is Shane. No, I think it’s more strategic to your point than the first. As you know, the market has just gotten harder even in tertiary and secondary, as investors continue to go out on the risk spectrum because there is lack of supply in the core markets. Outside of just dollars, just deal terms have also gotten much more compelling and much easier to transact.

While we’re talking about dispositions, I’ll just take the opportunity to go through our expectations for the remainder of the year. So from a timing perspective, we post $95 million year-to-date. I think we have pretty good visibility on $130 million or $150 million Q3 to close, and then the balance to close in Q4 again $300 million to $350 million guidance I think we’re going to be looking at coming in on the high end of guidance on the dispose side.

From a composition standpoint, we will end up somewhere around 15 multi-tenant retail centers, and I think the majority of which will be power, that’s just happenstance. Seven to 10 additional single-tenant assets, most of which will be drugstores, including three Rite Aids. And then the remainder of the pool looks like it will be three to four of the remaining office and industrial assets, and that’s just a matter of us continuing to extend leases from an asset management perspective and continuing to perform there.

So that should we leave us, call it, 5 to 6 remaining office and industrial assets to work through at year-end.

Just a quick update on geography. Since Q1 of ‘13 we’ve closed out two states and eight non-core MSAs. And it looks like we expect to close out another three to five by the end of the year.

And then lastly from a cap rate standpoint, just a quick update again dispositions, year-to-date we’re at just north of 7.5%, call it 7.6% cap, but looking at the remainder of the remaining composition of pool, especially with single-tenant retail and drugstore, we expect cap rates to come down through the remainder of the year and should put us well inside the 7% to 7.5% cap guidance at the beginning of the year.

Todd Thomas – KeyBanc Capital Markets

Okay. That’s really helpful. And then as we look at the leasing activity in the portfolio going forward from here, I think, Steve, you mentioned that the portfolio is sort of approaching stabilization, you’re working with portfolio that’s over 94% leased today. Some properties, the markets are over 98% or more leased. I was just wondering, as you have discussions with retailers here, are they getting – are you able to increase rents more than you had over the last couple of quarters. Should we really expect to see new and renewal spreads start accelerating from here?

Steve Grimes

Yes, Todd, I’ll just take that quickly. This is Steve. Thanks for the question. As we talked about, we do expect to be at 95% towards the tail-end of 2015. I think we are taking advantage of looking into repositioning opportunity, the remerchandising opportunities as we go through this process.

And a couple of examples that Shane did mentioned have demonstrated that we have been able to drive rents through that process. That being said, the closer you get to the 95%, the more frictional vacancy you need to create in order to drive those rents. And I think Shane has a little bit of visibility there, but continues to do things on a lease-by-lease basis.

I don’t know if, Shane, if you want to add any color there?

Shane Garrison

Yes, I would just add looking at the portfolio today to your point, 95% feels about right from a stabilized occupancy. The vacancy we have today averages a little over 3 years vacant. So the new lease comp pool is basically dependent on our ability to continue to be proactive in both our tenant watch list and our remerchandising efforts.

Assuming we continue to be aggressive and successful in that regard, we expect the new lease comps to be consistent with what we’ve put up for last year.

Todd Thomas – KeyBanc Capital Markets

Okay. And if we look at 2015 for example, what’s expiring there? I mean it’s expiring – the expiring rents are right around 15.50. Is that a big mark-up opportunity I guess, and what percent of the expiring leases have options that can be exercised?

Shane Garrison

Yes, again the portfolio is fairly young, still a large percentage are going to be encumbered with options. I guess it remains to be seen what the mark-up opportunity is. I think it depends on the asset and obviously the specific retailer, but broad-based, we do so think we’re generally below market and certainly feel good about our comps going forward.

Todd Thomas – KeyBanc Capital Markets

Okay. And then just lastly, I know it’s early with regard to the densification project taking place at the Boulevard Cap Center in Maryland, but any thoughts around the timing and scope of that project overall that you could discuss, and also should we expect to see occupancy and NOI decrease at that property in the near-term as work commences?

Shane Garrison

Yes, we actually already have had some occupancy decrease and corresponding NOI decrease there. We obviously have to prepare and maintain flexibility from our space standpoint. So that’s already happening. The hospital looks like at this point, it’s a’16 event. Right now we’re trying to optimize the site plan. Obviously there is a lot of in-depth studies that go with the high-density complicated mixed use project like this, especially when you add a hospital as a new anchor, MOB, and possibly hotel and multi-frame as well.

So it’s complicated I guess in a nutshell, and there are a lot of moving pieces. We don’t have anything to announce currently, but look to tighten that process here going forward.

Angela Aman

And Todd, I would just add, this is Angela, that as a reminder, the Boulevard Cap Center came out of the same-store pool for 2014 as a result of the changes happening at that asset. So it’s not a same-store property today.

Todd Thomas – KeyBanc Capital Markets

Okay, great. All right, thank you.

Operator

Thank you. Our next question comes from Christy McElroy with Citi. Please state your question.

Christy McElroy – Citigroup

Hi, good morning everyone. Angela, I just wanted to follow-up on the same-store NOI guidance a little bit. You said that the favorable expense comps impacted the range by 200 basis points I think in the second quarter, while the reversal of those trends will negatively impact the growth rate by 100 basis points in the second half. Does that mean that you’re expecting a range of 1% to 2% same-store NOI growth in the back half of the year? And what does mean for the level of recovery rate that we should be looking for?

Angela Aman

Yes. You’re right, Christy. That is the delta, sort of, if we are 4.6% in the first half of the year, where you have a 200 basis point contribution from expenses net of recovery income, and that includes bad debt expense. That contribution as you mentioned is going to negative 100 basis points in the second half of the year creating that 300 basis point delta. So that effectively gets you to kind of mid 1% range.

From a recovery ratio standpoint, I think the important point to mention here is that the recovery ratio has been very consistent in the first half of 2014 at right around 68%. We expect it will continue to be pretty consistent, plus or minus 50 basis points in the back half of the year as well.

The volatility you’re seeing in same-store NOI growth related to these categories are these items are really related to the way the recovery ratio changed during 2013. So the recovery ratio went from a very low base in the first quarter of ‘13 due largely to the impact of CAM reconciliations, but we really had significant improvements in the recovery ratio each quarter as you move through 2013, which is creating that more difficult comp in the back half of the year.

It’s not related to the recovery ratio changing materially in the second half of 2014. Does that make sense?

Christy McElroy – Citigroup

Got you. Yes, it does. And then how does the Gateway play in the second half?

Angela Aman

The Gateway is certainly – and that’s part of why you’re seeing such a consistent recovery ratio, I think in 2014 as opposed to seeing further improvements related to the occupancy. There is some drag from the Gateway impacting the recovery ratio overall, but given the strength of occupancy gain on a year-over-year basis, we’re still holding that number pretty stable throughout the year.

Christy McElroy – Citigroup

And then in terms of the 4.5% increase in guidance. Was that solely the dispositions timing or was there anything in Q2 same-store that maybe was beyond your expectations?

Angela Aman

No. As I mentioned, given that we’re keeping same-store NOI guidance flat, the guidance increased – the OFFO guidance increased. It wasn’t really related to same-store expectations changing there.

Again the trajectory of the recovery ratio in this dynamic in terms of first half of the year versus second half of the year was known to us when we provided initial guidance back in February. So the drivers of the operating FFO guidance increase from our perspective was really related to the timing of acquisition and disposition activity. Dispositions as we’ve talked about are happening a little bit later in the year.

MS Inland closed about a month earlier than we have expected, just given the timing of loan assumptions in that process. I also mentioned in my prepared remarks, we have about $2 million lease termination fee that will hit the back half of the year, probably in the fourth quarter, so that was little under a penny. And then G&A was sort of one of the other larger drivers in terms of the OFFO guidance increase.

Christy McElroy – Citigroup

Right. Okay, got you. And then Shane, I appreciate the clarity on the timing of dispositions. Can you break out the cap rate on power centers versus single-tenant assets you’re working to sell in the second half. What are your expectations for cap rate?

Shane Garrison

Sure. I think the power that I talked about, the remaining power centers basically in, call it, tertiary markets are going to trade closer to 7.5%. There are a few that will be sub 7%, but generally it’s closer to 7.5%. The single-tenant drugstore which is generally a pool outside of one or two assets, three Rite Aids included in that pool, average remaining lease term, call it, as 10-years blended will trade right around 7% on a blended basis.

Christy McElroy – Citigroup

Okay.

Shane Garrison

And then the office and industrial products, that’s single-tenant. We’ve expensed the leases there to high-grade credit, those are going to trade sub 7%.

Christy McElroy – Citigroup

Okay. And then just lastly, what was the cap rate on the Del Frisco’s Grille acquisition at Southlake, and what is the remaining term on that lease?

Shane Garrison

The new lease to built-to-suit, year one mid 5%, but it’s also got a percentage rents clause in it that we feel gets us north of 7% pretty quickly.

Christy McElroy – Citigroup

Okay. Thank you.

Operator

Thank you. (Operator Instructions) Our next question comes from Jay Carlington with Green Street Advisors. Please state your question.

Jay Carlington – Green Street Advisors

Great, thank you. Hi Angela, I think last question you mentioned rental income was going to be pretty consistent at probably 200 basis points throughout the year. And I guess we’re coming in at 340 basis points this quarter. Was that expected or is that expected to moderate towards the back half?

Angela Aman

Yes, that’s a good question, Jay. The contribution from minimum rental growth within that 3.3% you mentioned is about 240 basis point to 250 basis points. That line item in the same-store scheduled the supplemental also includes percentage rent and specialty rent as well and that impacted to some extent the second quarter stand-alone number, but in terms of minimum rental growth in the first half of the year, we were between 240 basis points and 250 basis points.

We expect that number to be very consistent in the back half of the year as well, 240 basis point to 250 basis points, where you are seeing a little more variability is in the percentage rent, and especially the specialty income line item that’s buried within there, we obviously have less inventory for seasonal and temporary leasing this year and that’s going to create some variance in the back half of the year. But the contribution from true minimum rent growth is very consistent throughout the year.

Jay Carlington – Green Street Advisors

Okay. And Shane maybe just on the acquisition market. I think last quarter we were talking about mid-6s on some of the deals you were looking at. Where is that shaking out right now?

Shane Garrison

Yes, obviously the market remains awash in unallocated capital. I think the good news is here – well, when we started were 270 year-to-date closed. For my prepared remarks I think we’ve very comfortable at the low end of the guidance number. And I think it’s appropriate in this market.

We’ve added – and that’s looking at core market this year, we’ve added an asset in San Antonio, Atlanta, New York, Chicago. It looks like we’ll add three net assets in Dallas and three in Seattle, one of them being a smaller asset, which is contiguous to our Lakewood Towne Center deal.

80% of the deals are off-market, which I think just speaks to you again our continued focus on expanding relationship in our core markets, but to your immediate questions from a cap rate perspective on, call it, $300 million, Jay, we expect to be 6.4% to 6.5%, which obviously is much better than expected from the year one transactional dilution standpoint. So great execution, and we’re pretty happy here.

Jay Carlington – Green Street Advisors

Okay. And maybe as a follow-up, Angela. Is there a possibility you could accelerate pace of debt pay downs more than what was originally contemplated, or are you kind of maxed out with respect to prepaying debt to what you originally planned?

Angela Aman

Yes, it’s a good question, and we evaluate it all the time. I think it becomes a question about the amount of prepayment penalties at this point that makes sense for us to incur. Over the last year, it’s either been on a stand-alone basis economically efficient to incur the prepayment penalty, as in the case of the MS repayment last year.

So there are some of those instances I think there is very little of that remaining in the portfolio. There have also been instances in which we’re willing to incur the prepayment penalty in order to accelerate dispositions, where we think pricing is maximized today and it makes sense on a, sort of, holistic view of the transaction to go ahead and do that. But outside of those opportunities, we think there is limited ability to really accelerate additional debt pay downs in an economically efficient way.

So this has really become about just measured progress in terms of continuing to grow the unencumbered asset base over the next 12 to 18 months.

Jay Carlington – Green Street Advisors

Okay. Thank you.

Operator

Our next question comes from Michael Mueller with JPMorgan. Please state your question.

Michael Mueller – JPMorgan

Yes, hi. This maybe a little hard on the call, but I was wondering, can you walk through if you were $0.28 this quarter, $0.55 first half, it implies $0.25, $0.26 for the balance of the year. It sounds like your dispositions are going to be a little more back-end weighted in terms of impact towards the fourth quarter, and you’re going to get that lease term in the fourth quarter. So can you walk us through, I guess, going from $0.28 down to that $0.25 or $0.26 run rate in the near-term. How you get from A to B?

Angela Aman

Sure, Mike. This is Angela. The largest factor which I tried to mention in my prepared remarks is really interest expense, and the fact that the private placement closed on June 30. So in your $0.28 run rate for the second quarter, you’re not seeing any of the interest expense associated with that transaction. So that has been not insignificant impact on a quarterly basis over the back half of the year.

The other variables are G&A. Obviously, we brought G&A overall guidance down by, call it, $2.5 million at the midpoint of the range, but the second quarter level was still, even based on the new guidance, abnormally low, so there is probably half a penny or so related to that. NOI as you mentioned and the dispositions coming in the back half of the year, creates additional variance as well.

And then the contribution from non-cash items in the straight line in particular will likely moderate or continue to moderate as we move through the year. That’s related, we had mentioned on the first quarter call, to some extent due to reversals of straight line bad debt expense and there were some of that activity in the second quarter as well. So that will be a variance, albeit smaller than the other factors in the run rate as well.

Michael Mueller – JPMorgan

Okay. And it sounds like your G&A, the acquisition costs that are in there are in your operating FFO guidance?

Angela Aman

That’s correct. We don’t make any. Yes. That’s right, we don’t make an operating FFO adjustment for acquisition costs, but we have started just this quarter to provide on Page 4 of the supplemental a break out of what those costs are.

Michael Mueller – JPMorgan

Got it. Okay, great. Thank you.

Operator

Our next question comes from Christy McElroy from Citi. Please state the question.

Christy McElroy – Citigroup

Hi, just a couple of follow-ups. So, you mentioned your guidance couple of times of 95% occupancy you’re in. I’m assuming that means the leased rate. Can you say where you would expect the commenced rate to be at year-end?

Angela Aman

Right. The numbers we have been talking about is the long-term target we’ve laid out of 95% occupancy by year-end 2015. We believe we’ll be around 94% commenced by year-end 2014.

Christy McElroy – Citigroup

So that’s 94% commenced 2014, 95% commenced 2015?

Angela Aman

That’s right.

Christy McElroy – Citigroup

Okay. And then, Angela, you talked about additional prepayments near-term being unlikely. Assuming that’s the plans, just sort of unencumbered debt becomes due, can you talk about the timing of when you would expect to do another unsecured debt raise and how does your conversations with the rating agencies and ultimately going for a concessions investment grade change that, does it?

Angela Aman

So, I think we’re very much on track. It’s not a little bit ahead of where we had laid out sort of the longer term capital plan at some point last year. I think the progress on continuing to grow the unencumbered asset base has been pretty significant, and we feel very good about the trajectory of where we are.

We have harvested a tremendous amount of optionality in the balance sheet and bringing forward those opportunities we had across the secured debt stack to bring that forward and prepay it early. We took advantage of a lot of that in 2013. So there is not much left, but as we communicate with the rating agencies, we’ve been very clear about over the last really 12 to 18 months as we talk to them what is available, what the plan is, and what we expect to do, really through the end of 2013.

So I don’t think the lack of additional debt repayments is in anyway a surprise given sort of the cost associated with some of those prepayments. And I think in general, there has been very much a supportive tone about not incurring costs that aren’t truly necessary in order to get a rating. I think there has been increasing willingness to look out on the maturity schedule and see what is in particular a fairly active debt maturity year in 2015. And given the commitment, I think we’ve demonstrated to the strategy really over the last two years. There is a willingness to look at the 2015 maturities and believe that those are going to get replaced with unsecured alternatives.

Christy McElroy – Citigroup

Thank you.

Operator

Ladies and gentlemen, there are no further questions at this time. I will now turn the conference back to management. Thank you.

Steve Grimes

Well, thank you all for your attendance today. We continue to be very optimistic about our long-range prospects. Just a little over a year ago at our Investor Day we announced our long-range plan and I mentioned that a good measurement date for us was in about three years time. We are now in a year into that plan and I must say that we are happy with the progress that we’ve made to-date. With the balance sheet in order, our leasing and transactional velocity strong, the first half of 2014 extremely solid, we are confident that we will finish the year in line with expectations.

This puts us on very solid foundation for 2015, and we will look forward to the prospects of further portfolio transformation remerchandising efforts and looking deeper into the portfolio for redevelopment opportunities. Thanks again for your time today.

Operator

This concludes today’s conference. All parties may disconnect. Have a great evening.

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Source: Retail Properties of America's (RPAI) CEO Steve Grimes on Q2 2014 Results - Earnings Call Transcript
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