Taubman Centers' (TCO) CEO Robert Taubman on Q2 2016 Results - Earnings Call Transcript

| About: Taubman Centers, (TCO)

Taubman Centers, Inc. (NYSE:TCO)

Q2 2016 Earnings Conference Call

July 29, 2016 10:00 AM ET

Executives

Ryan Hurren - IR

Robert Taubman - CEO

Simon Leopold - CFO

Analysts

Haendel St. Juste - Mizuho

Todd Thomas - KeyBanc Capital Markets

Craig Schmidt - Bank of America

Caitlin Burrows - Goldman Sachs

Jeremy Mets - UBS

Vincent Chao - Deutsche Bank

Rich Phil - Morgan Stanley

Michael Mueller - JP Morgan

DJ Busch - Green Street Advisors

Alex Goldfarb - Sandler O’Neill

[Call Starts Abruptly] ….second quarter conference call. As you know, during this conference call, we’ll make forward-looking statements within the meaning of Federal Securities Laws. These statements reflect our current views with respect to future events and financial performance, although actual results may differ materially. Please see yesterday’s earnings release and our SEC filings, including our latest 10-K and subsequent reports for a discussion of various risks and uncertainties underlying our forward-looking statements.

During this call, we’ll also discuss non-GAAP financial measures as defined by SEC Regulation G. Reconciliations of these non-GAAP financial measures to the comparable GAAP financial measures are included when possible in our earnings release, our supplemental information and our historical SEC filings. In addition, a replay of the call is provided through a link on the Investor Relations section of our website. Non-GAAP measures reference on this call may include estimates of future EBITDA, NOI, after tax NOI and/or FFO performance of our investment property. Such forward-looking non-GAAP measures may different significantly from a corresponding GAAP measure net income due to depreciation and amortization tax expense and/or interest expense some of all of which, the company has not quantified for the future period.

When we get to questions, we ask that you limit them to two, and then if you have more, queue up again. That way everyone has the opportunity to ask a question. Now let me turn the call over to Bobby.

Robert Taubman

Thanks, Ryan, and good morning, everyone. Yesterday, we released our second quarter earnings. Our result was solid. EPS was $0.57, FFO per share was $1.04. This included a $21.7 million payment receive to termination of our leasing agreement at The Shops at Crystals in Las Vegas. Our adjusted FFO, which includes the one-time payment, was $0.79, up about 4% compared to last year.

Our results included an unexpected two cent legal change. Despite this, we still met our expectations for the quarter. Comparable center NOI growth excluding lease cancellation income was 6.2% bringing year-to-date growth to 6%. Late last year, we back filled many of the well-publicized store closings that occurred in early 2015. So year-over-year, our occupancy was up nicely during the quarter.

At June 30th, our comparable center occupancy was 93.8%, up 80 basis points. Accretive redevelopments that we’re completed regionally at Dolphin Mall, Cherry Creek and International Plaza also boosted our results. In addition, average rent per square foot growth was strong, up 5.4% in the quarter. We also continue to benefit from releasing spreads that for the eight consecutive quarter were greater than 20%.

At June 30th, our trailing 12 months releasing spreads we a robust 24.2%. Leased space in comparable centers was 96.2% at June 30th, this compares to 97% last year. All-in-all, the spread between leased and occupied space at 240 basis points continues to be a very healthy number. For the quarter, sales per square foot were down 0.7% compared to last year. Most of our centers were up, however the strong dollar and prolonged weakness in South American Tourism are continuing have an impact on the South Florida market.

Retails with strong results included Zara, Pink, Henri Bendel, Saint Laurent, Louis Vuitton, Sephora, Microsoft, TuneIn, [indiscernible], Foot Walker and Champ Sports. Traffic in our centers appears to be steady, as sales of both fast and specialty food are up.

Turning to our developments. Our first project in Asia CityOn.Xi'an has now been opened for three months. Leasing of the center is complete with over 99% of the space signed. Today we're about 90% occupied and expect to be fully occupied with over 220 stores by year-end. To date traffic in the center has been good and retailers are happy. In China we're collecting daily sales from nearly all our tenants, at Xi'an 89% of them.

In the first nine weeks since opening, sales have grown at a compounded weekly rate of more than 5%. We expect traffic and sales to continue to increase as a result of the completion of a subway connection to the shopping center in the next two weeks and the expected opening of the supermarket Anchor in mid-September. This center is also part of a nearly 6 million square foot mix used project that includes two residential towers, two office buildings and two hotels. We expect that these components will eventually house about 8,000 people per day and then many of them will find a way into the center on a regular basis. We are really pleased with this first investment China and expect it will continue to grow and meet all our expectations.

At CityOn.Zhengzhou construction and leasing continue to progress well and have both been on schedule to open in the fall. We had picked November 12th as our opening date. However, a new main power station being built by the government is now delayed, this delay coupled with the retail calendar in China is causing us to move our opening date into March of next year. Nonetheless, we do not expect any impact on our stated project cost. We've been modestly under budget and the increased cost of the delay which are primarily capitalized interest are minimal, so they can be absorbed by the remaining project contingency. On the leasing side, opening in March will allow for even greater leasing and occupancy levels. We will likely be fully leased in nearly all the tenants should be open. We do not expect any changes in project yields and we continue to believe our stabilized year will be 2019.

Recently, we were able to increase our ownership in the center from 32% to 49%. Much like Xi'an we had the opportunity along with Wangfujing to buyout our local land partner at a point when the projects leased up and development risk has been largely diminished. Our share in the additional investment is expected to be about $60 million which is a combination of the land price and our increase to share of the expected cost to complete the project. We now own 49% of the center with Wangfujing owning the other 51%, we share governance equally with our partner.

Moving to Korea. We couldn’t be more pleased with the progress of our Starfield Hanam project. Construction is on schedule and today is nearly complete ahead of our opening on September 9th. Total project cost which were reduced $100 million last quarter to about $1 billion may have an opportunity for yet further savings. Leasing has gone exceptionally well. We are now 100% leased with about 270 tenants and we anticipate nearly all of them will open with the Mall.

Leasing has exceeded our expectations including having a significant representation of international luxury brand nearly 3 dozen, a number very few projects in the world have ever reached. Tiffany, Louis Vuitton, Fendi, Sandro and Gucci, Prada, [indiscernible], Burberry in Tiffany, Burberry, Ferragamo, Balenciaga, Coach and Michael Kors will all be among them. We also have a strong representation of fast cash, H&M will open three stores, H&M, Kos and Other Stories. Inditex will open four Zara, Zara Home, Oysho and Massimo Dutti. There will be a luxury car service by BMW, Genesis and Hyundai and Harley-Davidson motorcycle shops.

In addition, we are finalizing a deal with Tesla to have one of their first two stores in the country. Further, we have 100,000 square feet of food [ph] in all kinds of formats. We’ll also have three strong entertainment components including AquaLand, a 140,000 square foot indoor water park. A 10 screen Megabucks cinema and Sports Monster, a sports and entertainment complex where people can play basketball, rock climb and experience many other athletic activities. The merchandising is just outstanding.

As previously discussed, we expect stabilized yields on this center to be 7.5% to 8% in 2019 we’re thrilled with this project and with our partnership Shinsegae, it’s a clear winner and our combination team has done a great job. We encourage all of you to visit the centers and are happy to raise logistics and property tours for each of you. We will also be assessing interest in the potential investor tour of all three projects sometime next year likely in the second quarter.

Our next U.S. asset, international marketplace in Hawaii will open in four weeks. This is a highly anticipated center that is expected by the local community to created completely new destination for both towards and residence alike. It is program to fulfill the significant demand for a high quality and differentiated dining and retail options. It is also planned to extend the tremendous pedestrian traffic of Kalakaua Avenue, which is fifth most productive shopping street in the U.S. directly into our center.

Our site is on the 50 yard line of Waikiki’s primary regional shopping area with over 30,000 hotel rooms within a mile. The average tourist length of stay in Hawaii is nearly 10 days and 7 days on Wahoo. That equates to a lot of people looking for a variety of places to shop during the day and new places to eat every night. And that drives the traffic to this street on average 55,000 people each day. Leasing is progressing nicely and construction is nearly complete.

We’ve previously discussed total project costs of $465 million were increased in the total amount of $500 million. This incorporates the modification of our lease with Saks Fifth Avenue and some additional leasing costs. While costs have increased income associated with those costs is sufficient for us to maintain our stabilize yield expectation of 7%. At opening we continue to anticipate will be about 80% leased and are expecting to be 90% leased by year-end. As is customary for us our tenant line up will be revealed just prior to the center's opening date. However, our collection of tenants will include unique to market retailers such as Christian Louboutin, Stuart Weitzman, Shinola, Trina Turk, Intermix, Jo Malone, Free People, Yogasmoga, Hanna Andersson, Oliver Peoples, Robin's Jean, Harvay Lajar [ph], Sugarfina and Fabletics, 45RPM, Seafolly Australia, Penhaligon's, Catamina [ph], Anondimar [ph].

We'll also have well known retailers like Anthropology, Banana Republic, Michael Kors, Mac, ECDG [ph], Max Azria, Lush, Vera Bradley and many more. These tenants join our impressive lineup of restaurants that will also anchor the center. Our restaurants which include the Street and StripSteak both by Michael Mina. Also Eating House 1849 by Chef Roy Yamaguchi, Yaocho and Herringbone by the Hakkasan group [ph], Gomuti [ph], Flour & Barley and Kona Grill should draw significant customer traffic into the shopping center.

Notwithstanding a strong U.S. dollar and perceived weakness in tourism according to the Hawaii Tourism Authority visitors year to date through May have actually increased 2.8% visitor days are also up 1.7% visitor expenditures on the island are down 2.5% but through May we're still nearly $3 billion with the Yen, Canadian and Australian dollars bringing to appreciate we understand spending is now improving.

We remain extremely bullish about the prospects at the center and welcome everyone to visit the center on our August 25th grand opening or soon afterward. The least modification with Saks in Hawaii during the quarter was part of a broader negotiation that also included the agreement to buy out the Saks lease at Short Hills for about $50 million. During the quarter we also bought back the leases on two sports authority boxes at Great Lakes Crossing at Dolphin Mall and assume their lease at Cherry Creek in total about a 130,000 square feet.

Taken together, the three sports authority boxes in the Saks space and Short Hills will create additional redevelopment pipeline to add to our projects underway at Beverley Center and Green Hills. We have preliminary plans for all of these spaces and are delighted to have been able to recapture them. We are confident that they will be re-leased very accretively and add to the traffic and merchandise strength of these highly productive centers.

Now I will turn the call over to Simon and return at the end for some closing comments.

Simon Leopold

Thanks Bobby. I'll first review the year-over-year FFO variances for the second quarter. They're listed on Page 11 of the supplemental. This quarter, our FFO per share was $1.04, included in this result is the $0.25 payment received for the determination of our leasing agreement at Crystals in Las Vegas. Excluding the payment our adjusted FFO was $0.79 this compares to the second quarter of 2015 FFO of $0.76.

Here are the rest of the year-over-year variances. Minimum rents up $0.075 from the prior year this is due to increased occupancy and strong average rent growth fueled by the redevelopments we completed late last year.

Next, net recoveries were up $0.015 due to higher occupancy. Net management leasing and development services income was down $0.015. Last year, we earned greater fees in the city of Macao leading up to the October grand opening. Other operating expenses were unfavorable by $0.06 due to an unanticipated legal charge, a largely bad debt provision and a number of miscellaneous items. Interest expense was favorable by $0.015, we repaid The Gardens at El Paseo loan and refinance both Cherry Creek and Waterside Shops at favorable rates during the quarter.

Next, non-comparable centers effected our results unfavorable by $0.025. Interest expense is higher on our new centers as the expense reduction from interest capitalization has ended. This is partially offset by the positive contribution from Country Club Plaza. Finally, the impact of our prior year share of purchases added $0.01 this quarter as we now have fewer shares.

Moving to our balance sheet and the quarter’s financing activity. In April, we repaid the $82 million loan on The Gardens at El Paseo. We also refinanced our loan on Waterside Shops in Naples. We maintained the same level of proceeds, but reduce our state of rate by nearly 170 basis points to all in fixed rate 3.89% for a 10-year term. Both of these transactions were discussed on our last call. In May, we referenced the loan on Cherry Creek at a 50% owned joint venture. The new $550 million loan is not a recourse and has the maturity of 12 years. It’s interest only during the entire term at an all in fixed rate of 3.87%.

This loan replace the previous $280 million, 5.24% level. Our share of the excess proceeds was approximately $135 million, which we use to pay down our lines of credit. The Cherry Creek loan is another illustration of our ability to finance our business at favorable rates and terms. Post Brexit interest and assets of our quality is continuing to be very strong and lending metrics including coupon and proceeds levels have noticeably improved from over already exceptional levels.

As of last reporting period, we have a lowest average borrowing rate and longest weighted debt maturities among our publicly traded regional malls peers. Our balance sheet is in great shape as we continue to execute on the financing plan and development program. Now an update on our guidance. For the full year 2016, we’re updating earnings per share would be in the range of $1.73 to $1.93. Adjusted FFO per share is now expected to be in the range of $3.50 to $3.65.

As we said, we’re adjusting FFO to include a one-time Crystals payment. We’ve narrowed our FFO ranges slightly from $0.20 to $0.15 because many of the variables that we had at the beginning of the year remain were maintaining a wider range than we typically have. We took $0.05 of the top because we now believe the high-end of our previous range was unlikely for two reasons. The previously mentioned legal charge and lower expectations for lease cancellation income. When we gave initial guidance, we believed that our lease cancellation income will be around the average we’ve experienced for the last five years, which is $6 million.

Given that we’re now halfway through the year and our share of lease cancellation income is just $1.6 million to-date. We now think about 3 million for the year is more likely. As a reminder, summary of all our key guidance measure is listed on Page 23 of our supplemental. Before I turn it back to Bobby, I want to take a moment to talk about the effect we expect our centers in Asia to have on our income statement. As we’ve mentioned in China, we expect the unlevered after tax cash on cash returns to be between 4% and 4.5% for Xi’an in 2017. In Zhengzhou we expect a similar 4% to 4.5% unlevered return pro rata for 2017 given our opening in March. We expect those returns to reach between 6% and 6.5% of stabilization which for both centers is 2019.

With sales expected to grow at a much faster pace than in the U.S. we believe we'll achieve an unlevered 10% return sometime in the seventh or eighth year and by the tenth year earn an unlevered return 13% to 14%. In Korea we expect to achieve higher initial yields compared to China, but with slightly lower growth. In Korea we expect the unlevered after tax cash and cash returns to be between 4.5% and 5% for the first full year of operations which is 2017. Returns are expected to reach 7.5% to 8% at stabilization which for Hanam is 2019.

We anticipate we'll achieve a 10% return sometime in the ninth or tenth year. For all three Asia centers we assume the after tax NOI will grow ratably in the years between opening and stabilization. In terms of the lease structures as you know in China and Korea there is a considerable higher proportion of sales base rent which effectively marks leases to market. Our goal is to have about 50% fixed rent in China and something greater than 50% in Korea. We have met our target in China and in Korea we've exceeded our goal as only 30% of the rent is projected to the sales based.

With the successful construction of lease up we've had in Xi'an, Zhengzhou and Hanam, we will not be capitalizing interest on the projects beyond our openings. This will impact interest expense in a material way as our share of the development costs of the three projects is a little over $700 million. The capitalized interest on the cost of consolidated projects and the equity contribution on unconsolidated JVs under development at our average consolidated borrowing rate which for the last year has been 3.5% to 3.75% this will result in a significant increase to interest expense later this year and into 2017 and beyond.

We are pleased with our progress in Asia and we said we expect we'll be in a position to break ground on our next Asian project in Korea in the second half of 2017. Now that we're nearing the end of the construction phase of this major development cycle it's important to focus on what we expect the financial impact for the company will be. As we look beyond 2016, we believe we're poised to produce substantial NOI and NAV growth. We expect to materially increase our overall revenue and company NOI likely by at least 30% by 2019. There are three significant components to this growth development, redevelopment and growth in the core.

First from the three Asia development and Hawaii we anticipate a total of approximately 80 million NOI this 2019. Assuming a conservative growth rate in our core, we expect another 50 million of NOI and we expect redevelopment say another 20 million to 30 million. In total we expect to deliver a 150 million to 160 million of additional NOI in 2019 above where we are today.

On a percentage basis this growth looks a lot like our last major development cycle in the early 2000s. Between 2000 and 2003 our share of EBITDA grew nearly 28% over that period the company delivered outside earnings and NAV growth and our shareholders were rewarded with the highest performing stock in the U.S. publicly traded regional mall sector.

With that I'll turn it back to Bobby.

Robert Taubman

Thanks, Simon. In summary, our high quality portfolio is performing well and we expect excellent growth over the near and medium term.

With that, we'll now open the call for questions. As Ryan said, please limit your questions to two. Beth, are you there?

Question-and-Answer Session

Operator

Yes, sir. [Operator Instructions]. Your first question comes from the line of Haendel St. Juste from Mizuho. Your line is open.

Haendel St. Juste

Let’s talk a bit more about the plans for the [indiscernible] Short Hills and the three sport stores in some sense on how you thinking that impacts your near-term growth and any color around the plans for the box [ph] as well?

Robert Taubman

Well, I mean Short Hills as we said, we effectively have bought the box back and we’ll be taking the box back after the first of the year. And we expect, we’ll probably have to spend some additional money and top of that to reconfigure the box. But there are so many different options, we have tremendous demand from various large scale retailers that want to be in this center. I mean, as you know Saks is a -- I mean Short Hills is widely successful mall and there is a lot of interest in the center.

So we do believe that we said it would be very accretive and traditionally in the recent redevelopments that were done we were in the 7.5% to 8% range, we see no reason that we shouldn’t be at that level. But a lot of it depends on the merchandising that we expect within this center. On the sports authority boxes, we have again a lot of demand in those shopping centers, a very successful centers Dolphin Great Lakes and in Denver and Cherry Creek. So we have a lot of different ideas. We bought them back, because they were at relatively very low market rents.

So again we expect have very accretive transactions there. The exact timing my guess is late in 2017 as we -- if we move quickly we’ll be able to do something. But likely in 2018 is when you’re going to see the run rate.

Haendel St. Juste

Got you. And also the bad debt increase. Can you talk a bit about that, who -- where you might be having some trouble and could this be a signal of, I mean rise in the pricing power?

Simon Leopold

So the bad debt expense that we had in this quarter is higher than we have typically seen. There is not a lot of somatic take away from that, however. We’re seeing that bad debt expense it’s in broad mix of tenants, it’s mostly smaller non-credit side tenants and in a number of different centers. So based on this, it’s very difficult to draw material conclusions about what that means for the health of the business. Clearly in a flat sales environment, this is typically what you would see, but it’s not possible from other data we have right now to draw any meaningful conclusion product.

Haendel St. Juste

Fair enough. Thank you.

Operator

Your next question comes from the line of Christy McElroy, Citi. Your line is open.

Unidentified Participant

Good morning. This is Katie [indiscernible] on for Christy. Can you update us on the construction progress in the impacts you’ve seen the mall traffic and performance to the retailers that are still open during construction?

Robert Taubman

Hi Katie. Yes we remain on schedule, on budget, the traffic in the center remain steady. For those of you’ve been in the center, I think the construction barricade work incredible, the best I’ve ever seen, with this whole art program that we're implementing both on the exterior as well as in the interior has got a lot of very positive media and so far the disruption has been very minimized. So, we're on budget, we're on schedule and I think that brings you up today.

Operator

Your next question comes from the line of Sameer [indiscernible], Evercore ISI. Your line is open.

Unidentified Analyst

Can you provide a little bit more detail on how you were able to absorb the $35 million cost increase in Hawaii and kind of keep the yield flat? I am trying to get a better understanding on the leasing there and that hasn't been much better than expectation because you can kind of hear the negative headlines coming from retailers sort of on tourism and it's got sort of the luxury tenants possibly taking a pause in expanding. So I’m not sure if you can provide any kind of color on the leases there.

Robert Taubman

I think the bottom line is that the we really have been very focused on the merchandising there, you've seen in our list of names that we brought out that they are really excellent tenants that we're bringing in the shopping center. It's very expensive to build there and in many cases we've worked with our tenants to encourage them to deal with those construction costs and as that we said in our comments we've been able to bring income where we've had to encourage tenants to complete their work. So, I think the bottom line is that we think we're making positive investments on accretive basis.

Unidentified Analyst

And I guess the second question is Simon if I do apologize if you mentioned this before, but did the two cent legal charge what was that exactly related to?

Simon Leopold

So the two cent legal charge was a center related expense, so it's very specific to a center it's something that we do not anticipate will lead to any additional charges in the future. Half that it's our general practice not to talk about legal issues in the life, but I can tell you that we expect this to be the last of its nature certainly related to this center.

Operator

Your next question comes from the line of Todd Thomas, KeyBanc Capital Markets. Your line is open.

Todd Thomas

I was just wondering if you could give us an update on mall in Saint Laurent I know there are bunch of openings in the last month or two. Where is the occupancy today and any sense on how sales have trended over the last couple of months now and how that yield is tracking relative to your prior expectations?

Robert Taubman

Well, obviously there have been a lot of headwinds on sales, but we have created one of the best merchandise centers anywhere and our second quarter 2016 total sales from those centers went more than double. Our second quarter 2015 sales when we were just getting opened. So we're clearly making progress there and we've recently opened a whole bunch of tenants, Tiffany, Swatch, Aveda, Tumi, Krispy Kreme H&M we opened. Very important which generated a tremendous amount of traffic, it's raising awareness with the local customer even more especially the moderate customer that we're not just a luxury tenant, we got a slew of tenants opening in the coming months. Gucci is opening, extra [indiscernible] urban outfitters again for that modern customer, a moderate customer, Diesel and we still expect to be about 90% occupied at year-end.

So I think obviously there is some concern about Zika and you’re seeing it in the bookings and the hotel occupancy bookings were actually up year-to-date through March, but the hotel occupancy was down almost 3%. So you see cancellations occurring. But the sales are increasing in the center and the merchandising in the center is excellent. We believe over the long haul, we’re going to have one of the great centers in our portfolio.

Todd Thomas

Okay. It’s helpful. And then Bobby you touched on the sales environment in Southern Florida. Can you just elaborate a little bit there in terms of the magnitude maybe of the sales decreases and then are you seeing any sequential improvements when do we start anniversary the easier comps there?

Robert Taubman

Well we have the anniversaried the easier comp. So the Latin American customer is not there the way they were. We think these are broad cycles, we don’t think anything is changing about Florida. When you look out over 10 years and 20 years it’s going to continue to grow, it’s going to be one of great places to own real estate like this. We have great assets there, we have some of the best assets, if not the best asset in every market we’re in down there.

So it’s -- but there are cycles and we’re in a down cycle. Very strong dollar. A reduced international tourism and specifically the Latin American customer is being impacted dramatically into that market. And we have the anniversaried, so this is a couple of years now of declining sales. But eventually it will turn the other way and we’ve got great assets with great tenants in them.

Todd Thomas

All right. Just one last quick follow-up on the Saks box at Short Hills, will that redevelopment the isolated to that box or is there any additional work being contemplated at that all alongside that redevelopment?

Simon Leopold

No it’s isolated to the box.

Todd Thomas

Okay. Thank you.

Operator

Your next question comes from the line of Omotayo Okusanya, Jefferies. Your line is open.

Unidentified Participant

Hi, this is George on for Omotayo. Just question on the overall retailer outlook and what additional store closings, would you be expecting for the back half of the year, what other retailers are you keeping your eye on?

Robert Taubman

Well, I don’t want to comment any specific retailers. But when sales are flat and they’ve been flat for a few quarters. You tend to get pressure and challenge from tenants. But we look at our metrics, our metrics have been sensational. You look at lease spreads, you look at occupancies, look at leased space, look at average rent growth and the average rent per square foot. All of those metrics are excellent. Now I do think that lower quality assets are going to get more pressure now, I think there is a lot of reasons for that. But, we feel very good about our portfolio and the way our core is performing.

Operator

Your next question comes from the line of Craig Schmidt, Bank of America. Your line is open.

Craig Schmidt

Thank you. I know you mentioned the softness in the South Florida. But how about some of your gateways any markets. How are they doing, vis-à-vis, the international shopper?

Robert Taubman

Well, there is no question the international shopper, if you own High Street in New York City right now you have an impact, if you are main streets in New York City or Bloomingdale's, you're going to have an impact. You're going to see it in Los Angeles, you're going to see it in Miami, we've talked about. So the gateway cities that are big international tourism you're going to have impact and the strong dollar is not helping and all the events out there around the world are not helping. But these are broad cycles, now in our view you'll see a return to the shopping international shopping at the same level that's there I don't think anything's changing about America being a great place to visit.

Craig Schmidt

Great. And then may be some thoughts on the impact of the America Dream on Northern New Jersey retailing when it open next year?

Robert Taubman

Well, in terms of what we own there Short Hills we’re 25 miles away. So we're a long way away and while there is a projection about them opening, there -- they still from what we understand lack the financing necessary to get the thing done. And clearly they have very strong competition from Westfield to Garden State, from Simon at Rriverside, Simon obviously the outlet collection of the Old Jersey Gardens.

So it's got tremendous competition in their face. But we've seen no diminished interest in fact we've very strong demand for tenant in Short Hills. So it's not, it is not impacting us at all so we can see. But, we'll see whether it gets done.

Operator

Your next question comes from the line of Andrew Rosivach, Goldman Sachs. Your line is open.

Caitlin Burrows

Hi, good morning this is Caitlin Burrows. On the topic of sales I was wondering if you could give some clarity on how or how often [indiscernible] sales are accounted in your portfolio and how of much of an impact they can have on your reported numbers?

Simon Leopold

Well, we're not going to comment specifically about the impact of one tenant, but they are a very high sales performer. They are reporting in several of our centers and we have a number of other deals with them that we're moving forward with. We mentioned in Korea that they're going to be one of the two -- that Hanam will be one of their first two stores. They are a terrific new idea and new tenant and other car companies as you've heard in my conversation on Korea are also thinking about how they can learn from what Tesla has done?

Caitlin Burrows

Okay. And then in terms of the lower lease termination income is there anything we could read into that I think may be on the positive side or do you think that's more of just the timing thing and any sort of lease termination income that didn't happen this past quarter might just be pushed on the road a little bit?

Robert Taubman

Well, I think on balance you can reach something positive, I mean the reason we reduced our guidance by $3 million is because we don't expect that to materialize. The average for us over the last five years has been about $6 million lease cancellation income a year, last year it was almost eight, the year before that it was closer to 11. So we have been on an upward tick in terms of available. The fact that we’re at 3 million this year, I mean on a very simplistic level. So there are less people trying to get out of their leases, which should mean that they’re doing business.

We’re not going to jump up and down here and tell you that this is a huge, huge positive for the company, obviously bad debt expenses is up a bit as well, so that kind of balances. But on balance, the fact that less people are canceling leases is a positive for our portfolio and says a lot about our quality.

Operator

Your next question comes from the line of Jeremy Mets, UBS. Your line is open.

Jeremy Mets

Bobby you touched on the Saks leases at Short Hills a bit earlier. So I just wanted to know if you could give us more color on the decision in the process there between you and Saks and was this at all linked to getting Saks down the Hawaii.

Robert Taubman

Well, we’re happy with the overall transaction and we felt that it was good for the company. Saks has not been performing at the level of other interest at Short Hills for some time. We talk to them a lot over a period about the idea of taking the space back. As I mentioned earlier, we have a tremendous large tenant demand with no space to satisfy it. So this is an opportunity for us to do that. So Saks at Hawaii was essentially financing transaction where we exchanged capital ready for higher rent of future. Where we, as we said, we expected it to be additive to our overall returns. So again we’re happy with the overall transactions, it was good for our company, it was good for Saks, so it was win-win for two of us.

Jeremy Mets

Okay. So it wasn’t necessarily that Saks wanted to get out of Short Hills in exchange for Hawaii. That’s the right way to think about it?

Robert Taubman

Well, I mean, we’ve had a commitment, I mean we have a REA that’s signed with Saks in Hawaii. So it was a good overall transaction for us and it was good for both companies.

Jeremy Mets

Okay. And then in terms of the Zhengzhou, it looks like your partner sold out it share at cost versus taking maybe any profit area, I know you’re almost a year away from opening. But I was wondering what drove their decision to sell out at this stage and at cost given that it sounds like leasing is actually going okay there right now?

Robert Taubman

Well, I mean, they were essentially the land developer. And this is not unusual, we think about what we did Xi’an, the land developer there as well, we were able to buy them out. Again at a very attractive basis, when we de-risked Xi’an just like we’re doing here in Zhengzhou. Essentially, the construction leasing are done, we really have our arms around that. So they’re happy, because their profit is primarily in that land cost. And they did get a full mark-up on the land cost and get off the requirement to finish the funding for the project. So it was good for them, so it was good for us.

Jeremy Mets

Thanks guys.

Robert Taubman

And we did it totally very pursue as we did it can with [indiscernible] our local partner.

Jeremy Mets

Okay. Thanks guys.

Operator

Your next question comes from Vincent Chao, Deutsche Bank. Your line is open.

Vincent Chao

Just going back to the lease termination discussion so that gets cut by half, but I am just curious that should mean that some NOI that was previously thought to be lost would be coming back. So just curious the guidance for same stores is held constant and obviously outperforming that in the first half I know you mentioned that second half we’ve seen last year was very strong, so may be the comps were more difficult, but just curious if you could comment on that, unchanged same store outlook?

Simon Leopold

The reason why we're maintaining our guidance to 5% of comp center NOI growth this year is while this quarter clearly was a very good number. Typically, if you notice with us we typically have more growth same store growth in the first half of the year than we have in the back half that's typically the way that it works for us and we anticipate the same thing. When we look at lease cancellation income, we aren't necessarily going space-by-space and trying to predict which tenants will cancel their leases and which will not. What we try to do is we try to project based on our overall feeling of the retail environment and what we've seen in terms of income in the past and we try to make a judgment as to what we expect in the future, it's always a number that is variable, it's one of the hardest things for us to predict, but it isn't space by space. So just because that income is well it doesn't necessarily mean that you're going to see higher occupancy over the course of the year, there are a lot of other ins and outs.

Robert Taubman

Yeah, and I would bring back to what Simon said previously. The average number of lease cancellation income for last five years has been $6 million which what our guidance was for this year. But it's been $2.5 million and it's been $11 million. So it's very unpredictable and there are all kinds of factors that play in to what we get, how we get, when we get, and they are all individual negotiations. Remember a tenant that’s going out of business has to have a good balance sheet in order to pay you to leave and so you got to find those unique circumstance. But we have taken it down to $3 million for this year.

Vincent Chao

Okay. Just for the occupancy as well I mean that was dropped just a little bit there 50 two basis points and I guess what's anything in particular driving that?

Simon Leopold

Yeah, that's almost all attributable to sports authority.

Vincent Chao

Okay, got it. Okay and just may be one last question in terms of Stanford and what you're thinking there with that asset in terms of potential redevelopment or what you're thinking about doing with that asset over time?

Simon Leopold

Well, we're working with our partners on a number of different ideas, I know a number of people have asked us about Stanford in the context of GDP's announcement if the project does go forward it will put some pressure on Stanford, but we remind people that in terms of our shares it's less than 2% of our NOI. So we're interested, we're focused on it and we're doing our best, but it's a smaller asset in the overall portfolio.

Vincent Chao

Okay. Thanks a lot.

Operator

Your next question comes from the line of Rich Phil, Morgan Stanley. Your line is open.

Rich Phil

Hey good morning. I had some questions or just one question really about the timing of the Asian development projects. When you delay something like that and obviously for something like the power plant how quickly do you sort of here that news and how much comfort do you have that the other projects are going to remain on the timeframe that you had previously projected given if some uncertainty with developing in Asia. So really the question would be how much certainty do you have about that and how real time and getting updates from Chinese government or things like that?

Robert Taubman

Well, I would say there are challenges in development anywhere in the world. That’s why, whenever you build something especially in the public company setting, there are real risks and there is lots of questions that you have to answer along the way. We’ve had all kinds of issues facing us in the U.S., let alone in China. So I don’t think it’s dramatically different. We talk about Xi’an opening on April 28th, we didn’t move the date. We talked about Hanam opening actually in November originally then in October and then we said September 9th so in that case we actually moved things up slightly.

In this case, we’ve been focus for long time on November 12th opening. We’re ready to open on November 12th and we had, as we said on the last call, we had similar level of leasing ready on Zhengzhou that we were at Xi’an when we opened, which was 90% plus lease and 80% plus occupied. So we were ready, the fact that we have this main power plant issue, we were tracking it a lot, we felt there was a very good opportunity, we looked at all kinds of alternatives and we came to the conclusion that for a number of reason, the best option and we really only came to this conclusion after a lot of discussion and thought process and watching this for the last really year. But we’ve really only come to this session in the last couple of weeks.

And that it was best for the project to delay it and given the retail calendars, the next time you could open it was really in March. So we’re on track to reach our yields, as I said we were under budgeted and we may still end up slightly under budget. But we certainly hope to be at budget on the increase costs. Most of it is interest capitalization, because we’re affectively done with the shopping center. So we feel very good about it and the fact is will be more leased and more occupied four months later.

Rich Phil

Great. Thank you. That’s helpful.

Operator

Your next question comes from the line of Michael Mueller, JP Morgan. Your line is open.

Michael Mueller

Hi. Just quick clarification on the Saks. Bobby you mentioned $50 million. Is the 50 -- and you talk about a broaden negotiation. Does the 50 cover, should we look at it as the 35 pick-up in Hawaii plus 15 for the Short Hills box or 50 for the Short Hills box plus the Hawaii pick-up on top of that?

Robert Taubman

Yes. I mean Saks announce 99 million Canadian, which is $76 million in total. So if you have roughly 50, Short Hills you have, roughly 25 at Hawaii and that’s the number U.S. dollars versus Canadian dollars. We are -- that’s just for the box at Short Hills, we then are going to have-to-have some cost to convert the box into a multi-tenant use.

But when you added all together, we expect a very accretive deal. As we've said historically we've averaged about 7.5 to 8 and we see no reason that we shouldn't be in that range.

Simon Leopold

And so Mike just to be really clear about Hawaii. Of the $35 million increase that we now expect approximately $25 million of that was related to the lease modification with that.

Michael Mueller

Got it. Okay, that's helpful. Great. And just one other follow up, any color at this point on Beverly and just how you're expecting NOI to trend into 2017 is that a fourth quarter discussion or a third quarter discussion?

Simon Leopold

So, when we were originally talking about Beverly we were saying that in 2016 it expect it to be NOI disruption from frictional vacancy and I like to be minimal that was covered within our range for 2016. We are finding that to be the case, we're right now it’s early in the project, right now things are pretty good, pretty much exactly what we were expecting. For ’18 we believe that any disruption in NOI will be offset by the additional leasing we're doing over 2017, so again we expect that to be very minimal disruption there.

’17 has always been the larger question given the timing of the construction, the timing of the additional leasing, it still is a question for us. I am not in a position to give you a much better view than we were early on, we will be able to do that when we give guidance, but we're little bit of ways from being able to give you the clarity that I know, Mike you and a lot of folks want.

Michael Mueller

Got it. Okay, thank you.

Operator

Now turn the line of DJ Busch, Green Street Advisors. Your line is open.

DJ Busch

Bob you mentioned that sales have been flat for several quarters now, but rents continue to be quite healthy, moving higher. So it's caused your occupancy cost ratio to creep into I guess the low 14% range, outside of some of the big sales disruptions in early 2000 and 2008-2009 where it spiked over 15% I think mid-14s is kind of been a stabilization point. How many more quarters or even years can sales kind of sputter along and remain flattish but you're still able to push rent and how high can we see the occupancy cost ratio actually go?

Robert Taubman

Well I would argue this 14% is low against our historical portfolio averages. Historically you're right it's in the low 14%, today it's up about 50 basis point, 60 basis points from a year ago at this point on a trailing 12 month basis. The 15% has sort of been the number that we circled when you look at over 20 years you go up and down but 15% is the number that we've circled and we've been as high as 15.5% north in those periods of down sales that you referred to.

So, we feel that there continues to be opportunity to push rents and for some period even if sales remain flat. Having said that, we've always been consistent, rents will follow sales over very long periods of time, again assuming that quoted 15% margin capture rate doesn't move dramatically. So, you're going to see periods that higher or lower based on accelerating or decelerating sales especially when it increased quickly.

DJ Busch

Okay. And then when you think about some of the new tenants that are coming in the mall, whether its restaurants or the deals you’ve done with Tesla or maybe even some of the online retailers that are taking space, maybe like [indiscernible]. Are any of those deals, leased deals being done without occupancy costs in a traditional sense even coming into the conversation?

Robert Taubman

I’m not sure, I understand question. Are you saying that, they don’t paid their full share of costs?

DJ Busch

I’m just saying, you don’t necessarily -- because I guess [indiscernible] maybe not selling stuff out of their location or Tesla just given the high amount of sales. Are you more tagging or targeting a market rent for a certain location as opposed to saying well? We expect you to do x-percent of sales therefore 15% of that is this amount of rent. I mean, I’m just wondering how much of those non-traditional tenants are following the same rules as maybe the traditional, apparel retailers have done for the past several years?

Robert Taubman

So I think the generic answer is, they’re following the same pattern of other tenants over many years. The concept of market rent as opposed to sales based rent is constructed around a business model of a merchant. But I’m trying to say is a jewelry store has higher margins than a normal women’s wear retailer, different than shoe retailer. The shopping center has to be a critical mass for one-stop shopping. It has to be a place bring it all the merchandise cover, otherwise that customers as want to come, they want to be able get all the shopping needs done. So we as the sponsor and as the manager be as that have to create a broad merchandise mix.

So some tenants are always going to pay more than other tenants. And some tenants can afford to pay more than other tenants. So when you get to this question, there is always been a differentiation in the amount and the percentage of costs and rents and overall tenant occupancy is for a different type of merchant. So that will continue, but generically, everybody is going to pay based on how much they can afford and what their profitability is. And so market rent is a concept. And I know others of our peers are pushing that and it’s valid. But at the end of the day, the tenant is not profitable, they’re not going to stay and pay rent, they’re going to figure out a way to get out of store.

DJ Busch

Got it. Thank you.

Operator

[Operator Instructions]. Your next question comes from the line of Alex Goldfarb, Sandler O’Neill. Your line is open.

Alex Goldfarb

Two questions, first on Beverly center Simon. Did you say that to Mike Mueller’s question, did you say that you expect no impact in ’17 or that was a reference to ’16 and that ’17 is unknown as far as the impact?

Simon Leopold

I have said that ’16 and ’18 we expect any disruption to be minimal. ’17 is still the question, it’s always been the question. We’re feeling good about where we are right now, but I’m not in a position today to give you a guidance for ’17 in terms of NOI disruption at ever.

Alex Goldfarb

Okay. And then having toured the center and seeing what you guys are doing do you expect that you'll be able to sign full term leases throughout the renovation or your view is that there will be tenants who will just go to sort of temporary leases until they get a sense of what the center is going to look like and especially with all the scaffolding there and as it moves around the center. So do you think you'll be able to sign full term leases or is it going to be some temporary leases and maybe that's what will depress NOI in the short term?

Simon Leopold

No, we're going to sign full term leases, there may be a reduced rent initially to deal with the construction timing, there may also be some tenant that we move around that will be temporary, but we're not going to sign temporary leases to see what happens. There is tremendous demand for this center, the retail community response to what we're doing is extremely high and we're talking to tenants that we were not able to talk too previously that we'll continue to make this the kind of iconic asset that it was in the future.

Robert Taubman

Something that I'll add to that Alex is that not only are we signing full time, full term [ph] leases we're actually doing that as we speak. So, this is not a theoretical conversation, we're having a very good response and signing long term leases with excellent timing.

Alex Goldfarb

And then the second question is as far as the Saks deal in Hawaii, how do you guys breakdown? When you're going to sort of additionally finance a tenant, yes they are going to pay you more rent, but it’s costing you capital upfront and I am sure this is part of the business overall. But how do you guys make the determination, I mean as a company you guys have only so much capital and you can't do this for every tenant, Saks doesn't strike as like the must-have these days versus some of the other tenants out there. But how do you strike how much capital you put in to a particular tenant versus that you don't end up in that situation with a lot of different tenants to use that and say hey you did it for this one, do it for me.

Simon Leopold

Well, it's an individual negotiation based on the demand supply of tenants per at specific location and I would argue that Saks is a very important tenant in Hawaii and that we're very happy that they're going to be opening with us on the opening day.

Robert Taubman

Yes, past that we're not really going to comment on individual tenant conversation though.

Alex Goldfarb

Okay. But you haven't had demand from other tenants in that center to do similar?

Robert Taubman

We're very happy with where we are Alex, about 80% leased, going to be at opening and we hope to be 90% leased at the end of the year and we expect nearly all of that is going to open in 2017 or before. So we're pleased with the merchandising and where we are on the overall returns expected.

Alex Goldfarb

Okay. That's helpful. Thank you Bobby.

Operator

Your next question comes from the line of [indiscernible]. Your line is open.

Unidentified Analyst

Question Bobby in terms of as you outlined your growth of 30% of NOI by 2019 or maybe you signed and then you went through this. Half of that growth will be coming from Asia. How should the market think about that, how should we think about that and what kind of tax rate do you think is appropriate to value that?

Simon Leopold

Yeah, it's not half coming from Asia the $80 million which I assume is because the math you're doing is $80 million is half of the $160 million in total, that includes NOI from Hawaii. So it’s not in and of itself, half of the 150 to 160 that we’re talking about, but still substantial amount of that growth, no doubt about it.

In terms of cap rates, you have to think about Korea and China a little bit differently in my opinion. Korea is much more developed market, it’s more observable evaluation for the real estate there. There is a transaction that’s been work on right now, where if that comes to frustration, I think we’ll have pretty good data points on what cap rates are. And interest rates there also very similar to the U.S. and financing similar, a lot more visibility and the like.

So we would expect that cap rates in Korea or high quality type assets like what we’re building in Hanam and don’t forget 36 luxury tenants, one of the most, one of biggest luxury line-up still see anywhere in the world in an assets. Fabulously build and planned assets. We would expect cap rates for assets like that to be very similar to cap rates in the U.S., for assets of that quality.

In China, there is probably less observable trades of high quality type retail than you have in the U.S. and then you have, what we’re expecting in Korea. But at the end of the day in a world environment, where you’re seeing yields being depressed consistently, high quality real estate it’s leasing doing business should continue to demand very good valuation metrics going forward.

Robert Taubman

Yes. Let me add that what Simon said the, all those returns we talked about, unlevered returns and growth overtime, all after-tax. So we expect very good cash flow coming out of these assets and growing cash flow overtime. And I would say, well there is been very little observable cap rate that you can really assign to the type and quality of assets that we’re building in Xi’an and Zhengzhou. There have been transactions below four and there have been transactions even below three, that are in China.

So they’re not of this quality frankly in my opinion. So once you get something built, that is a high quality income stream, it’s a great assets, there is tremendous demand for and we expect that here.

Unidentified Analyst

Great. And in terms of occupancy costs, to follow-up on in Asia. What kind of occupancy costs do you targeting there, do you think it similar to, what you can achieve in the U.S.?

Simon Leopold

Yes. But we are not anticipating sales productivity at the same level that we have here in China. We do hope to achieve near our productivity in Korea. But with similar kinds of occupancy cost margin.

Unidentified Analyst

Great. Thanks.

Operator

There are no further questions. I will turn the call back to our presenters for closing remarks.

Robert Taubman

Well we are delighted you all join us. We had a very good quarter and we are looking forward our openings in Hawaii as well as in Hanam and we really look forward to creating an investor tour those interests over there sometime in 2017. So thank you for your interest. Good bye everybody.

Operator

This concludes today’s conference call. You may now disconnect. Thank you.

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