Acadia Realty Trust (NYSE:AKR)
Q1 2016 Earnings Conference Call
April 27, 2016 12:00 PM ET
John McMahon - Assistant Property Manager
Ken Bernstein - President and CEO
Amy Racanello – SVP of Capital Markets and Investments
Jon Grisham - CFO
Todd Thomas - KeyBanc Capital
Craig Schmidt - Bank of America
Christy McElroy - Citi
Jay Carlington - Green Street Advisors
Paul Adornato - BMO Capital Markets
Michael Mueller - JPMorgan
Rich Moore - RBC Capital Markets
Ross Nussbaum - UBS
Good day, ladies and gentlemen, and welcome to the Q1 2016 Acadia Realty Trust Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.
I would now like to introduce your host for today's conference, Mr. John McMahon. You may begin.
Good afternoon, and thank you for joining us for the first quarter 2016 Acadia Realty Trust earnings conference call. My name is John McMahon and I joined Acadia as an intern in the summer of 2014. I turned full time in the summer of 2015 and I am now the Assistant Property Manager for our NYSE assets in the Property Management department.
Before we begin, please be aware that statements made during this call that are not historical may be deemed forward-looking statements within the meaning of the Securities and Exchange Act of 1934 and actual results may differ materially from those indicated by such forward-looking statements. Due to a variety of risks and uncertainties, including those disclosed in the company's most recent Form 10-K and other periodic filings with the SEC, forward-looking statements speak only as of the date of this call, April 27, 2016 and the company undertakes no duty to update them.
During this call, management may refer to certain non-GAAP financial measures, including funds from operations and net operating income. Please see Acadia's earnings press release posted on its website for reconciliations of these non-GAAP financial measures with the most directly comparable GAAP financial measures.
President and Chief Executive Officer, Ken Bernstein will kick off today's management remarks with a discussion of the company's core portfolio, followed by Amy Racanello, Senior Vice President of Capital Markets and Investments, who will discuss the company's fund platform. Then Chief Financial Officer, Jon Grisham will conclude today's prepared remarks with a review of the company's balance sheet, as well as earnings and operating results. Once the call becomes open for questions, we ask that you limit your first round to two questions per caller to give everyone the opportunity to participate. You may ask further questions by reinserting yourself into the queue and we will answer as time permits.
At this time, it is my pleasure to introduce Ken.
Thanks, John. Great job. God afternoon. Thanks for joining us. I am going to start today's discussion with what we saw in the first quarter both in terms of operating fundamentals as well as the transactional market. Then Amy will discuss our activities in the fund platform and Jon will discuss our operating metrics, balance sheet and earnings.
For much of the first quarter we saw increased volatility in the global financial market and this has caused periodic concern that this turmoil would lead through to the US economy and potentially impacting both operating fundamentals as well as valuations of real estate. So with this volatility in mind let’s first look at our operating fundamentals.
In terms of our portfolio’s property level performance, notwithstanding some concerns about the potential US slowdown, when we look at our first quarter results we saw steady performance consistent with a positive albeit low GDP growth environment. We saw solid performance in terms of occupancy, in terms of tenant demand and in terms of tenant performance. Then in conversations with our retailers we continue to look for signs of material softness as well as any shift in their focus and so far while we see a few retailers facing existential issues, most are showing discipline and a commitment to address the changes, the challenges and the opportunities that they are facing.
Retailers recognize that their shoppers are demanding them to be authentic, experiential, differentiated that in a global omnichannel world the risk of blurring channels is increasing, retailers recognize that key locations in major live, work, play, gateway cities are becoming even more important to them to establish and maintain their brands and to meet their customers' needs. And then conversely, more generic low rent, but lower quality locations that are not particularly profitable and more importantly don’t advance their brands continue to be the main area of pruning by retailers.
So with that in mind when we look at the composition of our portfolio currently about 50% is street retail, urban is about 20% and suburban is 30%. Looking at the street retail component of our portfolio in the first quarter, it performed consistent with our thesis with once again stronger operating metrics in our other components. It contributed over 100 basis points more to our same-store NOI than our suburban component. The street retail properties in our core portfolio have comprised of properties in the major gateway cities D.C., New York, Boston, Chicago, San Francisco.
While we generally focus on the superior growth potential in these retail properties, there is also several reasons why we think this half of our portfolio at least at this point in time actually may provide superior defensive attributes as well. And that's due to the nice cushion that has developed between our in-place rents compared to market rents. Now, while there's been some discussion of increased vacancy in some streets including New York City, we feel we are well insulated as a result of this cushion and furthermore our anecdotal observations are that much of this vacancy has been landlord initiated.
In other words, over the last year or two landlords have been aggressive in their rental growth assumption and in their attempts to recapture space and this was supported at least somewhat by the significant annual growth that has been achieved over the past several years especially on these key streets. But as we have said many times we never believe that trees grow to the sky and we’ve remained disciplined in our assumptions and in our pricing.
In fact, one of the main reasons that we were not particularly successful in winning bids for street retail last year was that we couldn’t justify their projection of 10% plus per annum market rental growth in perpetuity that sellers, brokers and winning bidders were hoping for. Additionally, we should also not confuse landlords recapture space in hopes of record setting rents as a shift in retailers’ desire to these high-quality locations. If anything, these vacancies are beginning to create a reset in expectation and we're seeing some acquisition opportunities for us based on more realistic growth assumptions.
Then when we look at the other half of our core portfolio that is the urban and suburban components, those two are performing consistent with our expectations with a nice balance of necessity based retailers and discounters with a strong defensive profile and the continued trend towards urbanization is also causing almost all of our retailers to focus on expansion in that area.
Turning now to the capital markets and transactional activity, in 2016 we got off to a very strong start. Starting around year end and for much of the first quarter it appears as though the volatility in debt markets and various other factors have sidelined certain buyers and made sellers more focused on certainty of execution thus willing to negotiate more directly with companies like ours.
In general, as it relates to both core and fund transactions, our sense is that pricing for high-quality A assets is more or less holding, but for secondary assets there has been a re-pricing as these assets are more sensitive to a widening of non-investment grade debt spreads. For some sellers, this means that they are heading to the sidelines, but others are seeking certainty of execution and thus opportunities for us.
So first in terms of our core portfolio acquisition activity, we continue to focus on street and urban retail in our key gateway markets. While last year our core acquisition activity did not include street retail due to overly ambitious underwriting assumptions by winning bidders, this year we are seeing more rational growth expectations by sellers and it looks as though we will see a nice balance between street and urban acquisition opportunities. Thus in the first quarter we closed on $115 million of core acquisition, executed contracts for $156 million, thus assuming the deals that we now have under contract closed, we're already past the low end of our annual guidance and with the prospect for strong deal flow for the balance of the year.
In January, as we previously discussed, we closed on Gotham Plaza on 125th Street in Harlem. More recently we acquired a controlling interest in 991 Madison Avenue through a 49-year master lease. This is the street retail on the block between 76 and 77 Street on Madison Avenue under the Carlyle Hotel and the residential co-op that controls this retail.
The retailers anchored by Vera Wang's flagship store with the balance of the leases providing long-term upside as they turn. This section of Madison Avenue is surrounded with the right retailers, museums, hotels and significant localized affluence. And while we recognize the short term concerns about luxury retail performance, we have structured the master lease to provide us appropriate protection by using a more conservative base ground rent in exchange for a sharing of the rental growth. This not only provides us with downside protection but also creates a high alignment of interest between us and our master lease partners.
Our equity investment is estimated to be between $7 million and $10 million in total and after payments of ground rent, we will receive a mid-single digit return on all of our capital invested and then we will receive about two-thirds of the cash flow above that. While it’s a relatively small equity investment we have found that good things come from great real estate.
Now with respect to the $156 million of properties under contract in our core pipeline, the assets are high quality, street retail assets in existing core markets with strong defensive profile and long-term growth potential. The most significant portion of this portfolio is subject to existing lenders consensus which we're working through and we hope to have close in the second or third quarter.
On the fund side, as Amy will discuss, in the first quarter we were active on both new investments as well as dispositions. Last year we were net sellers with nice profit. This year starting this quarter promotes our being realized and we expect that to continue. The market volatility is also starting to create some interesting buying opportunities as well.
And then on the management front, as we recently announced John Gottfried will be joining us later this year as our new CFO. John joins us after 18 years at PricewaterhouseCoopers heading up most recently their New York metro real estate practice. His experience and personality will make him a great fit at Acadia. Jon Grisham has known him for many years and as we began the search John Gottfried was quickly on the top of our list while we saw a great variety of candidates and have been very flattered by the level of talent that has expressed interest. I believe that our CFO needs the kind of background that John Gottfried brings to us. As those of you on the phone get to know him, I'm sure you will agree.
So to conclude, we got off to a strong start this year. As we look out into 2016 and beyond, we're well-positioned for the volatility and the opportunities that often come from it. We have a differentiated high-quality growing core portfolio with the right balance between defensive and offensive assets. We have a profitable fund platform as Amy will discuss. The buy, fix, sell model is working very well. We have a balance sheet as Jon will discuss. Our liquidity is excellent, our low leverage puts us in a great position to capitalize on the opportunities in front of us and we have a management team eager for the opportunities that 2016 are beginning to present.
With that I'd like to thank the team for their hard work this past quarter and hand the call over to Amy.
Thanks, Ken. Today I will review the steady progress that we continue to make on our fund platforms, buy, fix, sell, mandate. First, consistent with prior quarters we continue to make important progress across all product types on our existing fund redevelopment pipelines. For example, on the suburban fund, in April we executed a new 20 year lease with Giant for an extended supermarket at Fund III’s Arundel Plaza in Glen Burnie, Maryland. As a result, we can now begin the redevelopment of that shopping center.
Then, with respect to our next-generation street retail, which targets more experimental retail corridors with strong economic drivers, we continue to see strong demand from national and international retailers for Fund IV’s Broughton Street collection in Savannah, Georgia. As of the first quarter, the portfolio’s lease rate totaled 55% which includes leases with Victoria Secret, H&M, J.Crew, Lululemon and most recently Mac Cosmetics.
And on the urban and street retail funds, Brooklyn remains an important market for our retails. Here, as you know, Fund II is developing city points, a 1.9 million square feet mixed used project with about 540,000 square feet of retail. The retail components is already two-thirds leased on the basis of square footage and is anticipated to open as follows. Alamo Draft House on level five will open in late June, Century 21 on level 4 and 3 opening in mid-August, Target on level 2 opening in late July and Trader Joe's and Decal Market on the below grade of concourse level opening this fall.
However, from the perspective of projected rent revenue, the project is only about 40% leased with a significant amount of the remaining value attributable to the street level small shops. These jobs are anticipated to begin opening around the holidays, this includes our newest REIT with an exciting international retailer. We will announce the tenant's name at a later date in coordination with the retailer; however their fun and unique products are sure to be a hit with the Brooklyn shopper.
Now with respect to dispositions. Pricing for high-quality assets is holding steady. According during 2016 we continued the profitable monetization of Fund III, completing 154 million of dispositions at a blended 42% internal rate of returns and a 3.4 equity multiple. As detailed in our press release and as we previously discussed, in January Fund III sold a 65% interest in Courtland Town Center in Westchester County, New York at $165 million valuation for $107 million. In doing so, Fund III retained a meaningful 35% ownership interest in this now 97% leased power center, a high level of control and the upside in an adjacent development site where Fund III is planning to build a new 150,000 square foot shopping center. The sale generated 45% internal rate of return and a 3.6 multiple on a 65% share of Fund III's total equity investment in that property. Then in April, we completed the sale of Heritage Shops at Millennium Park in Chicago, Illinois for $46.5 million this compares to $33 million cost basis. Heritage Shops is an example of one of our high yielding investing.
In 2011, we were able to opportunistically acquire this property at an attractive cap rate. During our five year hold, this property maintained its strong lease rates. At exit, we generated 34% internal rate of returns and 3.0 multiple on Fund III's equity investment with about half of the profit resulting from property operations. As John will discuss in further detail, as a result of these transactions, Fund III has now returned all of the capital that it has invested to-date plus a 6% preferred return on that capital and additional profit. Meaning that the fund is currently in a promote position. Now turning to new investments, as previously discussed, in addition to adding another street retail property to our Fillmore Union collection in San Francisco, during the first quarter we also added sale into other top urban markets Boston and Chicago. In both instances, we invested in trendy up and coming neighborhood. One investment is in Boston's Seaport District where Fund IV acquired 16,000 square foot retail condo for $12 million. Due to solid growth in market rents, the property's existing leases are well market.
The second investment is in Chicago's Fulton Market district, an authentic west route corridor known for its restaurants, galleries, residential lofts and creative office space which includes Google's new Chicago headquarters. Here, Fund IV made a $14 million preferred equity investment in a portfolio of 10 buildings which are all contained within one city block on West Randolph Street. We have now allocated about two-thirds of the Fund IV capital. As Ken mentioned given volatility in the capital market and a renewed desire among sellers for certainty of execution, we are not only excited by our prospective deal flow, but also we have the discretionary dollars immediately available to deploy into new opportunistic and value add investment. So in conclusion, we had another productive quarter in our Fund platform, we made continued progress on our existing redeveloped pipeline, we very profitably recycled capital through asset sales and we planted seeds for future profit taking by making new investments.
At this time, I will now turn the call to Jon, who will review our balance sheet metrics, operating results and earnings.
Good afternoon, along with the strength and stability from our core portfolio and Amy just discussed the profitability from our Fund business. The third key component of our business is our balance sheet which continues to serve as a strong platform to both our core and funds. We historically match funded our growth on an accretive and disciplined basis; we've grown our total market cap from $1 billion to $3 billion and doubled our core revenues from $70 million to $140 million over the last five years. And over this period, we've averaged about $200 million a year of equity issuance using both stock and OP units on an accretive basis to fund this growth. Year-to-date '16, we secured another $190 million of equity on match fund basis at an average net price of $34 per share. This consisted of $20 million of OP units, $37 million of stock issuance under our ATM and $125 million offering which we structured on a forward basis. We use this forward structure in connection with $150 million street retail portfolio which we expect to close on over the next couple of quarters as Ken discussed. In terms of debt, we continue to use very conservative leverage as reflected in our current net debt to EBITDA about 5 times which is consistent with our leverage levels over the last few years.
That being said, even though we don't have much debt, we remain focused on minimizing interest rate and maturity risk and diversifying our capabilities to access a wide range of types of credit. During the quarter, we continued to develop our ability to borrow unsecured by closing on an additional $50 million unsecured term loan which now puts us at 40% unsecured in the quarter. And other than any balance which we may carry on our line, our core debt is 100% fixed, having staggered maturities with no more than 15% maturing in any given year. In terms of operating results, our core is performing consistent with what we would expect from high-quality street, urban and suburban assets. Same property NOI for the first quarter was 3.6% which is at the higher end of our expectation for the first half of this year. On our previous call, we discussed that we expected the first half of '16 to be below the 3% to 4% annual guidance range and the second half would be above this range. The first quarter outperformance versus expectations resulted from combination of both top and bottom line factors including lower than expected tenant turnover and lower net operating expenses.
And although first quarter is ahead of expectations, we still expect the second quarter will be below our annual guidance range as we build a turnover and related temporary down time with a significant portion of this attributable to the space currently leased with our suburban portfolio but for which the new rent has not yet commenced. A few other noteworthy items to keep in mind when evaluating our reported NOI growth are one similar to what we seen over the last few years, during the first quarter our street retail outperformed the rest of the portfolio by about 125 basis points and to remind everyone, our results does not include the following three items. Does not include any significant contribution from property redevelopment as we engaged in those activities primarily through our Fund platform which we don't include in this metrics. Two, about 15% of our NOI primarily from urban assets is not in the same property pool. And then third, we do not include termination income in our reported result. Occupancy in our core portfolio, in all of our core portfolio components remains high and stable. We are currently over 96% occupied and we've been so since 2013.
Leasing spreads for the quarter were 10% on a GAAP basis, 4% on a cash basis. Some relevant factors related to this are, one there is no significant turns during the first quarter. And as a result, there was only about 43,000 square feet of leasing activity. Also, most of this activity was from lease renewals and then lastly, about two thirds of this activity was within our suburban portfolio. Turning to earnings, as we reported first quarter FFO of $0.41 includes $0.06 promote income from the recapitalization of our Fund III Courtland Town Center. Within our Fund platform, the outperformance of our funds clearly benefits all of our Fund investors of which we are one. And as we participate in this both as an investor and through our promoted share of Fund profit, it's an important driver of value creation at Acadia. And as Amy reviewed, in the first quarter, we crossed the promote threshold for Fund III, effectively increasing what was a 24.5% co-investment share into 39.6% promoted share of future fund cash flow.
Consistent with what we've discussed on previous calls, we expect the incremental earnings contribution from the promote position in Fund III will total approximately $15 million. And as we've also covered, this amount is net of the related dilution from our long-term Fund incentive alignment program, the reduction in net operating income and the reduction in fees associated with sold Fund assets. And while we continue to think about the net promote in this context, it's important to keep in mind when looking at our reported promote in our supplement that the dilution in NOI and fees is not included in the net promote line item. Rather, that dilution is captured in the Fund NOI and fee income line items. So keeping this in mind, in the first quarter we reported $4.7 million or $0.06 of promote income.
And with the sale of Heritage, as Amy mentioned, during the second quarter, we will be reporting additional promote income of $2.1 million which brings the total year-to-date promote to $6.8 million or $0.09. This compares with our full-year '16 forecast for other fund income which is primarily promote income of $9 million to $11 million or $0.11 to $0.14. So comparing our $0.09 of promote income which we realized year-to-date versus the mid-point of this forecast, we are already three quarters of the way there. And according, we are reaffirming our full-year '16 earnings guidance of $1.52 to $1.60. Lastly there is obviously a number of factors which may impact our taxable income and our REIT distribution requirements, but based on completed Fund III sales to-date, we will be evaluating a special dividend later in the year which if paid would be the third consecutive year of special dividend. So in conclusion, we continue to maintain a strong balance sheet and we continue to focus on building value in our core and Fund platforms which are already contributing to positive 2016 results.
With that we'll be happy to take questions. Operator, please open the lines for Q&A.
[Operator Instructions] And our first question comes from the line of Todd Thomas from KeyBanc Capital. Your line is now open.
Ken, you started your comments by outlining the portfolio weightings between street, urban, and suburban at 50%, 20% and 30%. And in your annual letter to shareholders you commented that Acadia now has an ideal blend of properties both by product type and geography. Just curious you know what shall we read into that as it pertains as how you think about allocating capital going forward for the core portfolio here?
In general, I think you should expect the allocation to be substantially focused on street and urban. Now, the specific of whether or not it's what we call street versus we call urban, it is going to be primarily if not all in those core markets that we are involved with, Washington DC, New York, Boston, Chicago, San Francisco. Right now, our bias has been and last year we were not successful in acquiring street retail because of assumptions that I outlined. But even on a street retail, we are going to take a very realistic view as to how much of a defensive portfolio do those assets have and they'll have a defensive profile either because of low market rents or high credit quality and almost in every instance they have to have great location. So, in short, they need to be and will be either street or urban in great location in our core market. As it relates to the specifics of 5% one degree or another, we’re relatively small company, so each acquisition seems to move out a little bit.
Okay. And then my second question, just switching over to Fund IV, Ken or maybe Amy, you mentioned that the market volatility has potentially created some opportunity for new investments in Fund IV. But the pace of acquisitions overall has been a little slower than expected. Do you end up being fully invested by August when the investment window closes or do you roll some of the committed unfunded into Fund V or do you extend the investment period for Fund IV, what happens there?
So let’s start with what we won’t do, which is make silly investments and any of the other possibilities are there and here is what we are seeing on the fund side as opposed to on the core. When the market volatility and debt spreads widen, sellers do what they normally do at least initially and they move to the sidelines. We are starting to see now sellers or borrowers recognizing for a host of reasons that they need to transact and perhaps the fear of cap rates backing up a 100 basis points as some people were either predicting or wishing for or fearing. Perhaps that was overstated, but there has been a reset on secondary assets and that’s creating an opportunity for us and we are seeing an opportunity to and/or starting to see an increase in the deal flow from that. Exactly, the amount of dollars, exactly the time, I don’t know. But there was a bit of lag and now we are starting to get some interesting looks at opportunities with wider spreads than we certainly saw a year-ago.
So let’s see what make sense, and we have a pretty good point of view as to both high quality great locations on through to the second locations in terms of where our retailers are interested in maintaining or expanding and we will play that accordingly.
And our next question comes from the line of Craig Schmidt with Bank of America. Your line is now open.
Great. I was just wondering, Ken, given your street retail in Manhattan and your street retail outside of Manhattan, where do you think you’re going to see your strongest rent growth in the next say, three or four years?
So Manhattan being a country into itself, there is going to be all different pieces of Manhattan that experienced stronger growth some streets versus others. In general, we had taken a somewhat conservative view over the last 5, 10, 15 years as to New York growth and has always been pleasantly surprised to the upside. It is a very dynamic market and hesitant to bet against it. That being said, Chicago has been great, Boston is an important to our retailers, San Francisco is another very important market. So Craig, as we look at the opportunities, our expectation is that growth is going to look more like contractual plus a bit and contractual I am saying is partly 3% a year growth and then what we have seen there is some amount in excess of that that provides rather than a 100 basis point spread relative to our suburban. It’s more like 200. Any of the markets we are in could easily provide that and protection and we need not see 10% growth that I was talking about earlier in our prepared remarks and any of them.
So the short answer is, I don’t know. Each street will be different, each of the markets will be different and where we see the opportunities and the right balance between upside and protection, that’s where we are going to execute.
Okay, great. And then maybe to Jon, the expectation that maybe second quarter same-store NOI would be a little less than the first quarter. What will be different between those two quarters to cause for that may be slowing of the growth?
So second quarter, we are expecting some more tenant rotation and more so actually within the suburban part of the portfolio. Case in point for example, we have a least at one of our Long Island shopping centers, CVS drug store that will be rotating out and we have already signed a replacement lease for that, but there will be downtime as a result of that. So there will be a couple of instances of that during the second quarter, which again will lead to a lower result for that quarter. As well as, as I mentioned in the first quarter, we did have some relative expense savings versus historical quarter, which also drove the result in 1Q. So all of those factors will lead to what we expect to be a lower second quarter. But then as I discussed on the previous call and I reiterated on this call, second half of the year, we think that that reverses and we actually pick up above the average such that we will be in that 3% to 4% range for the year.
Great, thank you.
And our next question comes from the line of Christy McElroy with Citi. Your line is now open.
Hey, good afternoon guys. Jon, just a follow-up on Craig’s question, just in terms of the turnover impact, just to get a handle on the occupancy trajectory, is that turnover, is that downtime already reflected in the Q1-end occupancy numbers or should we see further downside in occupancy through Q2. And could some of that spill over into Q3 same-store NOI growth given that you didn’t really see much of an impact in Q1 and you didn’t change your guidance range?
Yes, so some of the occupancy decline this quarter is reflective of that example that I just gave you. So for example that one lease, that CVS lease is about 10,000, 12,000 square feet, that’s 25 basis points of occupancy right there. So that was a contributing factor. Again, we expect a couple more, so we may lose another 25 basis points of occupancy, but then that turns around again later in the year. In terms of does that lead into the third quarter, the exact timing of some of this is obviously – to pin point it exactly which quarter some of this happens is difficult to time, but more or less that’s our expectation in terms of a rebound in the second half of the year. So we will obviously keep everyone posted, but that broad trend of a little bit under first half, over the other second half is the current expectation.
Okay. And then just with regard to the ground floor leasing at city point, you mentioned, one – I think one lease that would be announced at some point, but what percentage pre-lease is that safe today? And is that now sort of a full leasing effort at this point? I know you’re holding back for a while. Maybe you can talk about some of the leasing dynamics there as the upper floors and the concourse start to open this year?
Yes, we are now ready to lease because we have all the anchors slated for their grand openings and now we can know how to slot it in. And so the first time, relatively recently we can do high quality tours to the smaller retailers who are going to occupy the street level. So that is currently going underway as Amy mentioned. We signed our first lease and as Amy mentioned, she won’t let me say who it is, but we are excited about it. So we expect that to continue to pace over the next three to six months as we head towards the holiday season.
And our next question comes from the line of Jay Carlington with Green Street Advisors. Your line is now open.
Great, thank you. Hey, can you talk about lower embedded rent growth assumptions and some of the recent street retail deals I guess some outlier bids have disappeared. Can you maybe talk about the impact of street retail cap rates given what sounds like lower growth expectations?
Right, and so here is where it gets a bit tricky, because on one hand, and a lot of what I am speaking about is looking at other third party trades and anecdotally determining where pricing and cap rates where. But a very, very small segment of retail that traded over the last couple of years on street retail had leases at market and that was because rents were growing. Rents doubled in some of the markets we have been involved with over the last five years. So the rental growth was significant enough that to the extent that the leases were turning in 1, 2, 3, 4, even some cases six years. Sellers were acting buyers, and buyers were capitulating in pricing in that future growth. So when you looked at the going in cap rate, it wasn’t representative of the way we think about cap rate. It was simply then reverting back to where that growth when that lease comes due in two years out. The problem -- because we are happy to pay for future growth, the problem was that sellers were saying, hey rents doubled over the last five years, why won’t they double over the next five and we said they weren’t and we took a fair amount flak from some shareholders like how come you’re not adding more of these assets and brokers et cetera, but there was no reason to expect that. It’s not healthy, it’s not rational, it isn’t and shouldn’t be required to own great street locations and it doesn’t change retailers point of view, which is they were thrilled to come in 2014, 2015 and they are going to come in in 2016, 2017, 2018, but they can’t come in at 20% higher per year in perpetuity.
So we saw that pause. We saw some buyers last year over-reaching. So when you looked at cap rates and you saw a print two cap, it wasn’t as though you were saying, using stabilized cap rates should be two, or was that embedded into that with the expectation of growth. Many of those bidders have lose their license to practice and so we are seeing them not showing up as much. There is a lack of debt and there are certain lack of credibility for some of them. The reality is these are still great locations, these are expensive. Retailers are going to have to pay meaningful dollars to get in and you will see these locations back still and when we meet with retailers, their focus is absolutely on advancing their brand in these street locations and these urban locations. That enthusiasm has not shifted, it’s just the ability to set record rents every month that has changed.
So expect cap rates to hold on to their rational spread to risk free returns on rents that are rational today that were signed a year ago, two years ago, et cetera. But if we ever articulated the extrapolation of this, I apologize that’s not been our thesis. Our thesis has been we should be able to get about 3% same-store NOI growth contractually and over time pick up about another 100 basis points of NOI from street retail so that it should be providing us 100 to 200 basis points stronger than in our suburban component.
Okay. So maybe as a quick follow-up, I mean – maybe you weren’t participating in these, but at the end of the day, the cap rates that were done were printed lower, maybe with 2s or 3s on them for that growth. And today, maybe you could benchmark some of your recent street retail deals, but are you seeing some normalization where you’re getting more rational cap rate, but albeit it’s a little bit higher today than what it was last year?
So for those deals where the leases are more or less at market with 3% growth and a high quality credit, good location et cetera, they are very low cap rate. Depending on the city, the street, the specifics of it, it ranges from in the 3s to maybe in the upper 4s, and I don’t see them in the 5s much. But they are continues to be superior growth in those. Then as you move into more secondary locations, you can see cap rates moving up, but that’s kind of where it starts and where we think the trades are going to occur.
Okay, it’s very helpful. And maybe just lastly, I guess as you look at your acquisition guidance for the year, given I guess you’re almost at the mid-point four months in. Can you talk about where you think you will end up at the year and if your equity cost of capital influences how aggressive you will ultimately be?
Well, thankfully you broke up on the part of the cost of capital piece, but –
Just determining, given how your cost of capital for your equity trades, will that impact how aggressive you will ultimately be for the year?
What determines our acquisitions are, are they great real estate, do they have good embedded upside and protection and then most importantly, are they thesis consistent which is within the four markets that we are currently active in and great locations. If they check all those boxes, and the pricing is acceptable on a match-funding basis, then we can proceed. If they don’t, if they are not accretive, accretive to NAV, most likely accretive to earnings, if they are not accretive, we don’t do them and that’s why you saw us under-acquire last year. So to predict what we don’t have under contract now and what might occur one or two quarters out, I don’t need to do that other than historically. The pace that we have done certainly would get us to the higher end of our current guidance. And stay tuned, if the deals make sense, and I think that they are additive to our portfolio, we will do them and otherwise we won’t.
That’s perfect. Thank you.
And our next question comes from the line of Paul Adornato with BMO Capital Markets. Your line is now open.
Thanks. Good morning. Ken, sometime ago, you were very early in discussing Macy’s plans to open up some small shops in some of your properties, and first as a first question was wondering if you had any update on their experience in small shops.
And second perhaps more broadly, since you’re in touch with so many mall based retailers, any grumblings or movement of the mall based retailers too greatly or maybe not greatly, but just to reduce their fleets in order to provide for more capital for street level retail?
So, I’m not going to speak about any one retailer specifically, but we can talk about an ongoing trend, which is that what our retailers are telling us is, they need to be protective of and I talked about a blurring of channels. They need to be protective of and focus on making sure that they’re in front of their customer in a brand enhancing way through all of the different channels that is 21st Century retailing. And by the way, it’s not just fashion, so it’s not just the enclosed mall and apparel side, it’s almost every piece of business that we’re involved with. And the channels are not just bricks and mortar versus online, it’s enclosed malls versus street retail, it’s street retail versus outlets, et cetera. And, retailers realize that if they devote too much time and attention to any one channel at the expense of others, they regret it. So if all their focus is on factory outlets, which is a great business, their brand diminishes and they lose their ability to sell through in that channel. Any retailers who think that they’re going to be online only or online dominant, they’re missing the importance of bricks and mortar.
So with that said, there is going to be high productivity locations and low productivity. The high productivity ones, whether they’re enclosed or factory outlet, or street or suburban and whether it’s fashion or food or discounters, et cetera, retailers are recognizing, they need to pick great locations that present their brands to their shopper when the shopper wants it and that means 24x7 live work play where the shopper is heading. I read in the journal, I think it was yesterday, a day before that the populations as they move and urbanize, there has been an increase of close to 50% in college graduates moving to the major cities. Retailers recognize that data and they shift accordingly. So there is a shift to street retail from a lot of different areas. There is even a shift and we talked about it in the past of online retailers to street retail. We’ve opened Warby Parker and Bonobos in Lincoln Park, Chicago accordingly. So all of those factors are at play and what retailers are recognizing is just opening stores for store sake is 20th Century. Now, they’re focused very much on picking the right locations, getting their brand in front of the customer and the kind of real estate we own, we think lends itself very nicely to that.
Thanks. So maybe just one quick follow-up, can you tell us where occupancy costs are as a percent of rent in terms of the new leases that you’re signing?
It runs the gamut for, the retailers, I was just mentioning Warby Parker, Bonobos, their occupancy cost relative to sales is very low, because they’re killing it. For other retailers, they may start off a little slower, and be at the higher end of their goals, but ultimately every lease we sign with our retailers, they have every intention of it being profitable and that means probably getting below 20% in a more traditional way of thinking about it. But it really varies, Paul.
And our next question comes from the line of Michael Mueller with JPMorgan. Your line is now open.
Thanks. Hi. So just looking at the -- real quick on the suburban properties, we see a bunch of states like Vermont, Illinois, Indiana, Michigan, Ohio, where you have one asset in a state and just wondering I guess do those tend to go away overtime or how do you think about something that may be a good standalone investment, but be isolated relative to the rest of the portfolio?
So the short answer is they tend to go away overtime, but I’m not particularly concerned and do keep in mind that if you overlap where we’re active on the fund side, having those assets also gives us some good market reads on what’s working and what isn’t in a bunch of areas that I promise you, we won’t be adding assets to our core portfolio, but that we may be adding trading assets and that we do and that we’re active. So they’re not as lonely as they sound, but they go away.
Got it. Okay. And then just a quick promote question, what are the current thoughts on, if you’re thinking about the visible promotes beyond 2016 relative to the 9 million to 11 million, $0.11 to $0.14 that you’re going to book this year. So what’s visible beyond that?
Yeah. So recall last year when we were talking about the promotes, we were saying that our expectation was, it’s a multiyear process obviously in terms of monetizing Fund III and it could take anywhere from 2 to 4 plus years. So probably a good way to think about it is if you take the 15 million and you average it over 3, 4 years, that is probably not a bad way to forecast, we’re a little bit heavier this year obviously at the 9 million to 11 million and again a little bit of a mismatch, we’re talking about 15 million, net of the NOI and fee income and the 9 million to 11 million doesn’t include that. So if you take that 9 million to 11 million, it’s more like 5 million to 7 million, net of those other dilutive factors, 5 million to 7 million relative to the 15 million, about a third, a little bit over. So a good way to think about it is, if you do three years, 5 million a year obviously, that would be the expectation for the next couple of years. It’s going to depend on the timing of the fund dispositions obviously, but that’s as good as an assumption as any.
Got it. So the 9 million to 11 million, so just taking that way, because I think that’s the way at least most of our conversations go with folks and that’s how they tend to stick it into the model. So with that 10 million, once 2016 is wrapped, about how far through the process are you? Just thinking about from that perspective.
About a third of the way through.
One third of the way through at the end of 16?
And our next question comes from the line of Rich Moore with RBC Capital Markets. Your line is now open.
Hi, guys. Good afternoon. Looking at the fund acquisition guidance that you have of 200 million to 400 million, it sort of strikes me that there isn’t enough capacity really in Fund IV to get to the high end of that guidance, which one suggested that, is that guidance actually good still? Two, does it also mean maybe that we go right into Fund V, i.e., there is no lag getting Fund V going and you pretty much feel like this Fund V will contribute to this guidance as well?
Yes, Rich. It is likely and since 2001, we have never gone without one fund being active. So I’ve no concern one way or another that we’ll have capital to deploy when we see the right opportunities.
Okay. So Fund V, I guess short answer, will be going Ken, right after Fund IV expires?
That’s historically. Assuming we do it that way, that’s historically how it has worked. There is always, as other people have pointed out, you can roll forward or there is co investment opportunities, but to paraphrase my Brooklyn friend, we have 99 problems, but capital one of them. So we’ll be fine.
Okay. Got you. And then the other thing is on the structured financing portfolio, I mean you guys -- you paid off some of the pieces of the mortgage notes in the mezz debt in the quarter and then you have other maturity dates that appear to be near term too, I can’t tell exactly, I mean what happens with those, do we just keep paying those balances down, is that more or less what happens with these maturities?
So we have rotation in that portfolio and that’s nothing new. You should expect that we replace those dollars and in fact, maybe even increase those dollars. We’ve talked before about how our target for the structured finance portfolio is $100 million to $200 million. So it could be increased, but certainly I don’t think that it’s going to be a lot less than it is now.
Okay. So if something leads, kind of something comes in Jon, is that what you’re thinking?
Yeah. That’s right.
And our next question comes from the line of Jeremy Metz with UBS. Your line is now open.
Hey, guys. It’s Ross Nussbaum here with Jeremy. Ken, I’ve known you for quite a long time and I’ve never seen you dance this well around the funds question, because I think it’s been asked a couple of different ways and you’ve dodged it as well as a politician could, because it sounds like you’re not definitely committing that there is going to be a Fund V, and I guess the question is we’re four months away from the expiration of Fund IV, why the dancing around the definitive answer to what’s next?
So let me be 100% crystal clear, Ross. I’m not a politician. But that being said, and yes, we’ve known each other for a long time, we tend to make sure we’re keeping our options open and thinking through each of the components of what we do and then we’ll announce it at the appropriate time. Until it’s done, until we have everything signed and delivered, whether it’s the core acquisitions that we just announced or other things, I tend to try not to overpromise and then ever either under deliver or deviate. We take a lot of pride in. Here is what we’re going to do and doing it. So don’t read too much into it. If you look at how we have run our business over the last 15 plus years, then you probably have a pretty good sense to what we’re going to do, but you and I have had many conversations about as the company grows, how we might tweak it and fine tune it and et cetera and we take all of that into account as well. So stay tuned.
All right. It’s reasonable. I know what I would do, but let’s see if you agree.
And as long as not building a wall, fine, but I’m not a politician and I never will be.
Okay. The second question I have is along the, I think it’s page 46 of your PDF, it’s the development activity in your funds in the supplemental, and as I go through it, you’ve quite a few projects as I’m sure you know that are estimated to complete construction in 2016, yet, you’re showing lease rates, there is a whole bunch of dashes for a bunch of them and some lower numbers for others. Can you perhaps walk us through at least some of the bigger projects in the Fund III and IV development pipeline, what the leasing status is given that construction is complete?
So the only two Ross that I think you’re -- couple that you’re referring to. So within Fund IV, we have 210 Bowery and we have 61st Street which is of Madison. Those two are smaller buildings under 20,000 square feet. In the case of 210 Bowery, construction activities are still ongoing. Part of that is residential. The bottom floor is retail and we will lease that in the upcoming year or so, but that’s on track. And 61st Street, again, there, we’re working on the leasing and that will be in the next.
Both of those are somewhat binary in their -- for the non-residential component of the Bowery and then for 61st is they both will be leased to one tenant.
And then within Fund III, we have 3104 M Street in Broad Hollow Commons, Broad Hollow Commons, we’re going through the approval process at this point on leasing after that and again, 3104 M Street, small property, it’s 10,000 square feet. To Ken’s point, very binary. That lease will happen quickly when it happens and expectation would be in the next 12 months or so.
Got it. And just one accounting clarification, once these are complete, and you’ve got CFOs, are you going to be ceasing the capitalization of interest, G&A, et cetera or can you find a way to continue that until you’ve got tendency?
Yeah. So once it is complete, it comes online. Typically though, we’ll have a tenant and in paying rent at that point is certainly the expectation and intent, but to your point, once the property is available for occupancy and in service, then it comes online.
Okay. And that’s obviously reflected in your earnings?
And I’m showing no further questions at this time. I would now like to turn the call back over to Mr. Bernstein for closing remarks.
Great. Thanks everyone for joining us and we will speak to you next quarter.
Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone, have a great day.
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