Call Start: 11:00
Call End: 12:18
Taubman Centers, Inc. (NYSE:TCO)
Q4 2016 Earnings Conference Call
February 10, 2017, 11:00 ET
Ryan Hurren - Director of IR
Robert Taubman - Chairman, President and CEO
Simon Leopold - CFO
Alexander Goldfarb - Sandler O'Neill
Caitlin Burrows - Goldman Sachs
Steve Sakwa - Evercore ISI
Haendel St. Juste - Mizuho
Todd Thomas - KeyBanc Capital Markets
D.J. Busch - Green Street Advisors
Craig Schmidt - Bank of America Merrill Lynch
Vincent Chao - Deutsche Bank
Michael Mueller - JPMorgan
Christy McElroy - Citigroup
Michael Bilerman - Citigroup
Jeremy Metz - UBS
Floris van Dijkum - Boenning & Scattergood
Tayo Okusanya - Jefferies
Thank you for holding and welcome to the Taubman Centers Fourth Quarter 2016 Earnings Call. The call begin with prepared remarks and then we will open the line to questions. On the call today will be Robert Taubman, Taubman Centers' Chairman, President and Chief Executive Officer, Simon Leopold, Chief Financial Officer and Ryan Hurren, Director, Investor Relations. Now I will turn the call over to Ryan for opening remarks.
Thank you, Operator. Welcome to our fourth quarter conference call. As you know, during this conference call we will 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 earnings release and our SEC filings, including our latest 10-K and subsequent reports for discussion of various risks and uncertainties underlying our forward-looking statements.
During this call will 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 in the investor relations section of our website.
Non-GAAP measures referenced on this call may include estimates of future EBITDA, NOI, after-tax NOI and our FFO performance of our investment properties. Such forward-looking non-GAAP measures may differ significantly from the corresponding GAAP measure, net income, due to depreciation and amortization, tax expense and/or interest expense, some or all of which Management has not quantified for the future period. Please limit your questions to two. If you have more, queue up again so that everyone has the opportunity to ask a question. Now let me turn the call over to Bobby.
Thanks, Ryan and good morning, everyone. Our financial results released yesterday were solid for the fourth quarter and full year. For the quarter, our adjusted FFO was $1.01, up 3.1%. For the year, it was $3.58, up 4.7% at the midpoint of our guidance range. Comparable center NOI, excluding lease cancellation income, was up 3.9% for the year and flat in the quarter. Our NOI for the year benefited from increased minimum rent and recoveries.
For the quarter, while minimum rent and other income were up, percentage rent was lower than we expected. Percentage rent is very difficult to predict and it is highly dependent upon the sales performance of specific tenants in specific centers and is typically paid by a small number of tenants in any given period. This quarter we were also up against tougher comps due to delivery of a number of accretive redevelopments in the fourth quarter last year.
Average rent per square foot was up 2% for the quarter and 2.8% for the year. Our releasing spreads remain robust at 18.8%. As of December 31, our comparable center occupancy was 94.7%, down 50 basis points compared to last year. Comp center leased space was 96.1%, down 80 basis points.
Both of these stats were impacted by the closing of three Sports Authority spaces that totaled 130,000 square feet, representing about 1.3% of in-line space in our comp centers. All three spaces have very accretive redevelopment efforts underway.
Comparable tenant sales per square foot were $792 for 2016, up about 1% from last year. In the fourth quarter we were encouraged to see sales per square foot up 5%. This was our best quarterly growth rate in more than three years and led the sector. It is reflective very strong holiday season, as well as the steady of sales in our tourist-oriented centers in Florida.
Sales growth was well distributed across our portfolio with increases in all but two of our comparable centers. Sales per square foot accelerated each consecutive month during the quarter, with December concluding as our strongest month, with sales up more than 6% year over year. December was the fourth consecutive month with sales per square foot up at least 3.5%. Based on parking comps and anecdotal evidence from our center management teams, we estimate that traffic in our centers was better this year, particularly in December. As one example, at Short Hills, literally every single parking space was full on Black Friday throughout the day for the first time in over a decade.
Even with strong sales and traffic, we believe results could have been better, as general inventory levels in many of our key specialty stores appeared low. More and more, retailers are using in-store stock for online order fulfillment. As a result, in-store inventories of the hottest merchandise, especially in their best stores, many of which are in our centers, were depleted early in the season. Having said that, retailers will adapt and the issue should remedy itself over time.
Our industry-first Santa's Flight Academy experience, as well as other special events across the portfolio, drove significant national media attention and foot traffic. This helped both our established in-line tenants and new concepts achieve strong results. Our most successful tenants included Coach, Louis Vuitton, Champs Sports, Gucci, Apple, Foot Locker, Sephora and Sunglass Hut and relative new newcomers like Tesla, Athleta, Free People, Fabletics and Madewell.
Outside of our comp centers, sales were also positive at our newest center. At the Mall of San Juan in Puerto Rico, total sales of in-line tenants were up 40% over the fourth quarter of 2015, driven by new tenants and successful marketing. With the recent openings and Gucci, Diesel and Ferragamo, we're now substantially occupied, with 95 tenants that span from fast fashion to luxury. We partnered with Sony and Universal Music on a concert series featuring renowned Latin artists which has already driven considerable traffic to our center.
Also, Royal Caribbean Cruise Lines now feature the Mall of San Juan as part of their excursion package which has established an inflow of dedicated shoppers to the center. Any passenger that participates is provided transportation to and from the Mall. The center is moving in the right direction.
At CityOn.Xi'an, the center is now fully occupied. Total sales were up more than 30% in the fourth quarter as compared to the third quarter and have now grown an average of 10% per month since our late April grand opening. The positive momentum at the center continued throughout the Chinese New Year which ended last week. January was our best month yet, as total sales were nearly 20% higher than our previous best month which was December.
At Starfield Hanam, sales are very strong. The center continues to average more than $2 million in sales per day which is ahead of expectations. The center is already producing sales and NOI comparable to our very best assets. The center's over 99% occupied and will be full when South Korea's first Tesla store opens this month.
At International Marketplace in Hawaii, holiday shopping resulted in heavy mall traffic and increased sales. Our five restaurants on the Grand Lanai, now including Michael Mina's Stripsteak, are performing particularly well, drawing both tourists and local shoppers. In the coming weeks we have Yauatcha, the first of two Hakkasan restaurants, opening on the Grand Lanai. Yauatcha is a Michelin starred dim sum concept. Herringbone, Hakkasan's outstanding fresh seafood restaurant, will open in May.
In addition we have Mitsuwa, a prominent Japanese grocer with high-quality prepared foods, opening its first Hawaiian location in May. It is greatly anticipated by the important Japanese tourist customer. Also in May, we have chef Michael Mina's The Street opening. We'll talk more about him in a moment. As we complete the center's leasing program, we anticipate we will be 75% to 80% occupied by the end of June.
Turning to our development and redevelopment activities, we're really looking forward to the March 16 grand opening of our second project in China, CityOn.Zhengzhou. The Zhengdong new district is rapidly developing. Within three miles there are already more than 2 million residents. The center will also serve greater Zhengzhou, the capital city of Henan Province in East China, an area of more than 9 million people. Over the past five years, this market has achieved a compound annual GDP growth rate above 10% and an annual retail sales growth rate above 13%.
CityOn.Zhengzhou will be 99% leased and about 90% occupied at open. We expect it will be 97% occupied by the end of March and fully occupied by the end of April. The center will feature nearly 200 stores, many opening their first locations in Central China.
The merchandising is very similar to our project in Xi'an. In addition to our partner, a department store anchor Wangfujing, the dozens of international brands opening with the center include Forever 21, UNIQLO, Zara, Zara Home, Nike, Massimo Dutti, Skechers, La Chapelle, The North Face, H&M, Mango and Adidas. As planned, about 30% of the space is dedicated to a wide variety of foods and other 10% is occupied by entertainment and other family-oriented tenants. We remain on budget and continue to anticipate stabilized yields of 6% to 6.5% in 2019. We're very confident in the future of this asset and I must again comment on how proud I am of the work of our Taubman Asia team.
In fact, with our centers in Asia wrapping up leasing efforts, we're pleased to be bringing our Head of Leasing in Asia, Paul Wright, to the United States and promoting him to Global Head of Leasing. Paul was an early employee at Taubman Asia, now 10 years ago. We look forward to leveraging his strong relationships with many international brands. On January 1, we officially welcomed Peter Sharp, our new President of Taubman Asia.
Stepping back, we're very pleased with the status of Taubman Asia. We will soon have three successful investments operated. They are impressive projects that will be meaningful to our growth. We have an excellent platform of talented, experienced people that will contribute to our Company both in Asia and in the U.S. in the years to come.
Here in the U.S., the re-imagination of Beverly Center in Los Angeles remains on time and on budget. With phase one construction nearly complete, you can now see how the redevelopment will truly be transformational. The reaction from tenants is been incredibly positive. They're very encouraged by progress to date. We've managed to limit the disruption within the common areas of the mall and sales of been relatively stable during construction.
As we've discussed, improving the food offering is a critical focus area for the project. We're adding 10 dining destinations, with 8 at The Street level that will open the center to foot traffic and engage it with the vibrancy of the neighborhood. Nearly all eight are fully committed, an amazing well-curated group.
Within the center, we previously announced a multi-concept gourmet food hall called The Street, a Michael Mina social house. Mina is a Michelin Star James Beard award winner. Located on the center's eighth floor and more than 25,000 square feet, The Street will offer extraordinary views of downtown LA and the Hollywood Hills, with both indoor and outdoor seating.
The Street is a next-generation food hall that will feature multiple concepts in one place. The hallmark of the experience will be 10 to 12 offerings from Chef Mina and other well-known chefs, creating an experience suited to all tastes. The Street was featured in the LA Times this week. The article provided a first look at four of the great concepts expected to debut, including International Smoke, a barbecue stall by Ayesha Curry; Kai Poke, a Japanese influenced sea food stall by chef Gerald Chin; the Ramen Bar, with ramen bowls by chef Ken Tominaga; and a branch of well-known LA Mill Coffee from Craig Min.
The Street will also open in 13,000 square feet at International Marketplace in Hawaii in May, along with Stripsteak, Mina's steak house concept which is open today. The Street in Hawaii will differ from Beverly Center, as the overall design and food concepts are unique and merchandised for each market. This is not a one-size-fits-all strategy. It reflects the newest movements in retailing and dining to create local fresh food that produces a distinctive customer experience. As the world is recognizing, food is a critical component of creating a successful retail destination, whether in Asia, Hawaii, Los Angeles or elsewhere.
Michael has been instrumental in helping us attract other well-known restaurateurs, both at Beverly Center and International Marketplace. Given his reputation, relationships and organization, we have chosen to form a joint venture to fund and operate these four concepts together. While this does not represent a material equity investment, we do anticipate a good return on our capital.
Elsewhere in our portfolio, we're also improving the food and entertainment offering. Great Lakes Crossings here in Detroit serves as a perfect example. Within the last two years, we've added a 35,000 square foot sea life aquarium, a 30,000 square foot LEGOLAND and later this year we'll replace the vacated Sports Authority with Round 1, a 59,000 square foot entertainment concept with bowling, dining, karaoke, billiards, darts, ping-pong and arcade games.
Dolphin Mall serves as another example. Last year we added six new restaurant locations. We expanded the center by 32,000 square feet and all the incremental GLA was dedicated to food. Dolphin is a food Mecca. In total, we have 38 food offerings.
Our most recent acquisition, Country Club Plaza, is yet another example. The center has a huge food presence, with over 35 dining establishments producing over $100 million in sales last year. Food clearly anchors the Plaza and is an important regional draw. Experiences are key to reaching customers, especially in this evolving climate.
Now I'll turn the call over to Simon. I will return at the end with some closing comments. Simon?
Thanks, Bobby and good morning, everybody. Let's first review the year-over-year FFO variances for the fourth quarter. They're listed on page 11 of the supplemental.
For the quarter, our FFO per share was $1.10. Included in this result is a $0.12 gain recognized on the conversion of a portion of our investment in Simon Property Group partnership units to common shares. We'll touch on that more in a second. We also had $0.035 of unexpected legal and other advisory costs unrelated to our business operations. Excluding these items, our adjusted FFO was $1.01 which compares to $0.98 at fourth quarter of 2015.
Taking a look at the other variances, first minimum rents were up $0.03 due to higher rents per square foot. Percentage rent was down $0.02 due to a combination of lease rolls and lower sales by certain tenants in certain centers. Net management leasing and development services income was down $0.01. Last year we received higher fee income at Studio City in Macau related to its grand opening and we're no longer receiving fees at Crystals in Las Vegas.
Net recoveries were down $0.01 due to greater holiday promotional expenditures and lower occupancy. Other operating expenses were $0.02 favorable, primarily the result of lower bad debt expense and [Technical Difficulty] legal expense incurred in the fourth quarter last year. Interest expense is $0.015 favorable, largely related to the April repayment of the loan balance on the Gardens on El Paseo and refinancing of Waterside Shops and lastly, our non-comp centers in aggregate were favorable by $0.02.
Turning to the balance sheet, in the fourth quarter we converted 250,000 Simon OP units which is a little less than half units we received in 2014 as a portion of the consideration of the sale of our 50% interest in Arizona Mills and Oyster Bay land. We converted the units to common shares for tax purposes. We have no immediate plans to sell the shares, but we never intended to own them long term and we will sell them some time in the future.
We recently completed two financing transactions. The first was an additional $100 million financing on the mall at Millenia. The asset was significantly under levered and we received very attractive terms. The new loan is eight years non-recourse and bears interest at an all-in rate of 3.87% which is inside the rate of 4% on the first mortgage. In addition to the Millenia transaction, very recently amended and restated our $1.1 billion primary line of credit. Transaction included the addition of a new five-year $300 million unsecured term loan and an extension to February 2021 of our revolving credit facility. The line of credit also had two six-month extension options.
Both loans bear interest at a range based on the Company's total leverage ratio. As of today, the leverage ratio results in a rate of LIBOR plus 1.6% on the term loan and 1.45% on the revolver. We intend to swap the $300 million term loan to a fixed rate at some point in 2017. We used the proceeds from the term loan to pay off our lines of credit. After the payoff, we had $21 million of excess proceeds and $1.165 billion of undrawn capacity on our line.
We only have one meaningful maturity left in 2017 and that's the construction loan on the Mall of San Juan. We have several options for this maturity, including refinancing the loan with the existing bank group or paying it off with our line of credit. We'll make this decision soon.
In terms of capital spending this year, we had our share. We expect to invest approximately $400 million of capital completing our new developments and funding our redevelopments at Beverly Center, Green Hills and other smaller projects. Our development and redevelopment project commitments will be fully funded with our line of credit and once completed will have significant availability remaining. Our balance sheet remains solid. Our coverage ratios remain strong. At year end 2016, our fixed charges and interest coverage ratios were 2.7 times and 3.6 times, respectively.
Now let's turn to guidance. As we stated in the release, for the full year 2016 we're introducing FFO guidance in the range of $3.67 to $3.82, at the midpoint an increase of 4.6% over last year. As reminder, our range is based on the following assumptions which can be found on page 23 of the supplemental.
For the year we expect comp center NOI, excluding lease cancellation income, to be up about 3.5%. Further note that 2017 is more of an organic growth year for us as very little of our redevelopment initiatives will be complete before the end of the year. As for the rest of the key guidance measures, average rent per square foot is expected to be up about 1% year over year. December can be volatile due to the size of our portfolio and this year's being impacted by two large tenants.
We expect to receive higher rent from fixed bumps and growth in the CPI. Although we've modified our standard lease language to include fixed annual rent bumps, the majority of our leases still contain annual rent escalations that are based on a formula that includes CPI. That said, our rent per square foot growth in 2017 will be tempered by lease modifications which reduce rents in the short term but preserve occupancy while we release those spaces in 2018.
Year-end comp center occupancy is expected to be around 96% which is up 1.5% compared to the end of last year. By the end of this year, we expect to backfill the majority of the three Sports Authority spaces and to replace the seven stores closed by The Limited with permanent or temporary tenants. Net third-party revenues from management, leasing and development for services performed in both the U.S. and Asia is expected to be about $1 million, down from $2.3 million in 2016. The decline in third-party fees is largely the result of the sale of IFC mall, where we have provided management leasing services in the past.
We're estimating lease cancellation income to be $5 million to $6 million at our share, up slightly compared to $4.6 million in 2016. Total predevelopment expenses are expected to be between $6 million and $7 million. We're assuming a non-core asset sale that will occur in the first half of the year which will create roughly $2 million of FFO dilution.
A couple quarters ago, we outlined a path to $150 million to $160 million of NOI growth for the Company between 2016 and the full year 2019. This range assumed that our four latest development projects in Xi'an, Hawaii, Hanam and Zhengzhou would contribute about $80 million. It also assumed that we would have about $50 million of growth in our core and receive another $20 million to $30 million from redevelopment. We remain on track to meet these goals.
We've been in a period of substantial development activity for a number of years. As a result, we've been capitalizing a considerable amount of interest, as we highlighted on our last call. In 2017, we expect a significant interest -- increase in interest expense, primarily due is the mechanics of capitalized interest. In 2017 our share of consolidated and unconsolidated interest expense is expected to be $170 million to $175 million compared to $130 million in 2016. At 100% consolidated and unconsolidated interest expense is expected to be $250 million to $255 million compared to $190 million last year. We've also included the breakouts of the consolidated and unconsolidated portion of these ranges in our supplemental.
Lastly, we reached the end of yet another major development cycle and as we have done in the past, we have reduced our expenses. For 2017, our quarterly G&A run rate is expected to average $10 million to $11 million which is down roughly $1.5 million quarter -- per quarter over last year. With that, I'll turn the call back to Bobby.
Thank you, Simon. Despite a challenging retail environment, our 2016 results and those of our high-quality peers demonstrate that the best real estate continues to outperform. Nearly all our key metrics were up and importantly, we're encouraged by the recent growth in tenant sales productivity. As new retail concepts emerge and replace the old, we will continue to see them gravitate to the highest quality real estate which will outperform over the long term.
As we have throughout our history, we continue to invest for the future. We're creating value in our centers that will lead to sustained NOI, NAV and FFO growth for our shareholders. With our development pipeline completed, our emphasis is on stabilizing our newest projects, continuing to strengthen and grow our core assets and executing on our Beverly Center and Green Hills redevelopment.
With that, we will take your questions. As Ryan said, please limit your questions to two. Emily, are you there?
[Operator Instructions]. Your first question comes from the line of Alexander Goldfarb from Sandler O'Neill. Your line is open. Please go ahead.
Good morning out there in Michigan. Just a few questions here. First off, just going on the predevelopment spend, Bobby or Simon, it's going up for the guidance for 2017 versus 2016 and yet you guys talked about being at the end of a development cycle. I know you've spoken before about a potential for second Korea project. Is there anything -- is this a read-in? What's going on here? I would think that it would be, your predevelopment stuff would be going down if you guys are at the end of a cycle.
Overall it is going down, but when you look at predevelopment spending, what you have people that have been capitalizing on projects that are under construction and opening and now you have a number of those people that are now expensing because you don't have a job to put on the books. We don't know yet on Korea, as an example, are we going to be under construction with something this year. It now seems unlikely that we actually will be under construction because of entitlement delays that we're now experiencing there. But we're looking for new projects in Asia and we're looking here.
Having said that, we think it's very unlikely in today's environment in the U.S. that we're going to see another project over the next two to three years. We think it will be some time before the volatility of the retail market calms down. As we said, we've completed a big cycle and we really want to focus on the two big redevelopments and the newest developments that have just opened here in North America.
Okay. Maybe as a segue into the second question, you guys had $3 million of expense related to the shareholder activism, so one, what was in the $3 million? Two, should we expect $3 million a quarter for 2017? With that, if you guys have received a lot of pushback from a number of folks about some of the external activities, I would think that dialing back external activities and focusing on the redevelopments and what's going on in the existing portfolio for the next few years would probably help mitigate some of these external activist campaigns. If you could just comment on that, Bobby, both what we should anticipate for spend, what's in the spend and what's driving it?
Well, as far as the costs go, this isn't something that we ask for. We're absolutely committed, though, to do what is best for our shareholders and we're going to take all the appropriate actions, including hiring the strongest legal and advisory council we can find to ensure that our stakeholders are very well informed. The costs are what they are and as the costs occur, we will talk about them, probably on a quarter-to quarter basis and so what you're hearing is what we've booked thus far.
Just to finalize that point, Alex, we booked $3 million of cost in 2016, net for legal and other advisory services. You should not take that as a quarterly run rate; you should not take that as an annual run rate. It's one of those things that is going to occur as we move forward and it's not -- importantly, it's not our guidance. We will be adjusting for those costs as they're incurred. You should not take what's been spent to date as a run rate number.
Your next question comes from the line of Andrew Rosivach from Goldman Sachs. Your line is open. Please go ahead.
This is Caitlin Burrows. Last quarter you guys had mentioned in the partial guidance that you gave an expectation of $40 million to $45 million coming from the new four development projects. I was just wondering if that was still what you are expecting for 2017?
We put that $40 million to $45 million out there last quarter really as a way to make sure that the different research analysts who were modeling it differently had a common understanding. It was never our intent to update that every quarter and we're not planning to do that. What I can tell you is that based on everything we've seen since we put that out there, we feel good about being on a track to realize the $80 million from those core assets in 2019 [Technical Difficulty].
Okay. Also, you mentioned that in 2017 the new redevelopment projects wouldn't be coming online so it would be more of an organic growth year, but I guess as those projects do ramp up and also as San Juan is still stabilizing, kind of when you look out don't have those sorts of projects coming online faster than a stabilized project would, what kind of sustainable future organic growth rate do you think Taubman could sustain?
We never want to give guidance past the year, but you can look at -- we're about 3.5% which is what we've guided for this year at comp centers. That feels like a good number. It's a healthy number. You're seeing that number in different ways coming out for our competitors as well. I'm not going to give you guidance for the future, but that number has been a pretty good consistent number for a couple of years now.
Your next question comes from the line of Steve Sakwa from Evercore ISI. Your line is open. Please go ahead.
Simon, I guess could you just maybe help us understand the range, the $3.67 to $3.82, what are some of the biggest swing factors that gets you off the midpoint, either to the low end or the high end of that range?
Steve, you want me to compare that to the $3.90 consensus or you want to just talk about [Technical Difficulty] where we might be able to [Technical Difficulty] number?
I guess to the extent you could maybe help us think where consensus was sort of wrong coming in to the quarter and then what are the big swing factors that would push you down or maybe put you to the top end of the range?
Sure. Let's talk about the $3.90 versus our midpoint of $3.75 first. We have 18 analysts that cover our stock and everybody looks at a little bit differently. I'll be the first to say it's not a lay up to model or FFO right now given the on a development that is coming online. I can't give you very specifically analyst to analyst, but I can give you a few items that I think can help explain the $0.15 delta between $3.90 and our midpoint.
First, we're anticipating lower percentage rent this year. I think if you look at the average in the consensus, that probably accounts for $0.05 of the difference. Our third-party income is lower. That accounts probably up for about $0.02 of difference there. Third, we're expecting the sale of a non-core asset which nobody, I would think, was focused on before we got on this call. That's probably $0.02 of dilution right there and that is in our guidance numbers.
One of the bigger challenges is recoveries which are hard to model. In general, our expectation is that our ratio will be lower in 2017 and that's largely because Hawaii and San Juan are still stabilizing, so you essentially got the full boat of expense but you're not quite there yet on the income. That could be as much as a $0.05 to $0.10 swing between our guidance and analyst's models. I think -- finally, San Juan, it's now in our comp center pool. We expected it'll provide some growth in 2017 but it's still not stabilized, as I said before, so we put an appropriately conservative near term outlook there and I think that, that's probably another variance for folks.
If you take it all together, you add those numbers up, its $0.15 and $0.20 of potential differences before any variance for San Juan or ramp-up in the development as a whole. I guess is the last piece to focus on there is that those items which are all likely to reduce people's feelings for 2017, that's being offset by approximately $6 million less G&A than we expect in 2017 over 2016. That's, I think, the bridge that a lot of people want to hear between $3.90 and our midpoint.
To the second piece of what you asked, Steve, the reality for us is that sales are still the most important thing for us. It is going to lead to being in the higher range -- higher end of the range of guidance if we're there. We're encouraged by what we've seen over the last four months of 2016. If that were to continue, that would certainly give us a better chance to be up in that higher end of the range. Similarly, if sales decline from here, that would probably lead to a lower beat. There's a lot of other little things but I think sales at the end of the day is the biggest factor to where we and up in our range.
Okay. That was very helpful, thanks. Bobby, could you comment little bit more in the sales trends? Obviously it sounds encouraging. I guess I'm trying to take the sales trends you talked about with the lower percentage rents. I realize it's very tenant specific, but could you just talk a little bit about the sales trends by region or by category and if there's anything noticeable that you're seeing?
We put out there a bunch of tenants that have done well and it really is very much across the board. Clearly food did well. Our jewelry, for the first time in several years, was up and we had some of the luxury guys up very, very well. Luxury was a little spotty, but I would say generally luxury was good and I don't want to call out too many names, but tenants like -- I've said some earlier, but I would add people like Louis Vuitton, Gucci did very well in our centers. So you have good luxury. You had apparel was for the first time starting to show some sign but -- so I would say it's across many categories.
As I said on my comments, there were only two shopping centers that were not up in the comp pool and one of those was in South Florida. We find the assets have steadied there, as we said and hopefully they're going to start to move up as tourism does come back and we have a very strong dollar still. But we're starting to see that has sort of settled down and we're hopeful now that we're going to see some growth.
It is really three years that we've had flat sales, but remember sales grew for four years coming out of 2008 and 2009 and that four years of growth really led to the nine quarters that we had of lease spreads north of 20%. We were almost 20% this quarter, but you're starting to see the impact of the three years of flat, so if it starts to turn around that you're going to again see a movement up. Simon's point about sales are very important. It doesn't sometimes translate directly. There are a very small number tenants that actually pay percentage rent in any given year and any given quarter, for sure, so you can't necessarily see the thread from high sales to percentage rent. But there's no question the number one thing is sales. It will change how everybody feels about making deals.
Your next question comes from the line of Haendel St. Juste from Mizuho. Your line is open. Please go ahead.
Haendel St. Juste
I was hoping you guys could talk a bit more about same-store guidance for this year, the 3.5%. It seems a bit lower than many of us were expecting, given the strength of your sales and leasing spreads and along with the 170 basis point gap between leased and occupied. Curious what else we might be missing there. It sounds like it's probably just some conservatism in light of the choppy backdrop with some Sports Authority impact, probably, so just curious as to how that plays over of the course of the year. Should we expect a stronger back half of the year and then again, in my initial question, sort of what else should we be thinking about there?
We don't break it down by quarter in terms of guidance, but in general 3.5% for the year with really very little redevelopment income coming in is a good number. I will tell you that we, as we usually are around this time, we're probably about three quarters done with all of the leasing that we expect to do in this year. You're not going to see a huge amount of variability there in terms of the growth, not likely to, anyway, in terms of that 3.5% number. It is likely to be a pretty good number for the year.
In terms of FFO, though, that's where the non-comp centers and everything else comes in there. That's where I think you might see some more variability along that range. I would tell you that given where we're the leasing cycle, that 3.5% number feels like a pretty good number. It shouldn't very all that much.
The redevelopments that were doing and the occupancy that's coming in, that's going to come in later in the year most likely and that's where you get the almost 150 basis points higher by year end.
Again, I would comment that to the extent that sales flow through to percentage rent, percentage rent matters a lot. In this last quarter, if we had just been flat in percentage rent, instead of a 3.9% number we'd be at a 4.3% number, so there can be volatility because of the size of our portfolio and how things can shake out.
Haendel St. Juste
One more on the near term outlook for your ABR growth, should we expect continued pressure from rent reductions there or is this maybe a temporary phenomenon, a few assets that might work itself out. Just curious if you find yourself under some more pressure like some of your larger and lower productivity mall peers, so just curious about the near term outlook for that.
The 1% average rent growth number, it can be affected swings in a few tenants. It's a volatile number for us year over year, because we have a relatively small portfolio. One thing to remind everybody about is that our number includes all non-anchor tenants in our comp centers, so that's small in-line stores all the way up to 50,000 to 60,000 square foot boxes. In 2017, we had two large tenants account for as much a 60 basis points of downward movement in that number. One of the tenants, it's an excellent new concept and they pay good rent relative to other large users, but it is a drag on overall rent per square foot just on the size of that box versus our portfolio.
The other tenant's in a great center but they're not doing all that well and we're in the process of replacing them at a higher rent with a tenant that will be better for merchandising and for occupancy. To the point that you were asking, Haendel, to preserve occupancy and some rent there, we put them on a short term arrangement which has an overall effect on our rent per square foot.
I think the last piece of that answer is, we're experiencing some short term drag on rent as we replace struggling retailers with stronger ones. We frequently choose to leave tenants in place on short term arrangements with the ability to remove them as soon as the tenant's ready to take occupancy. Is a natural and good thing for the center. It improves merchandising mix and productivity, but it can bring that number down in the short term.
Your next question comes from the line of Todd Thomas from KeyBanc Capital Markets.
First question on San Juan, next quarter when that mall comes into the same center pool, can you just, given the size and magnitude of that asset, can you talk about the impact that transitioning that mall into the same center pool is expected to have on same center NOI growth and maybe sales per square foot for the portfolio?
We never give specific information like that on a center-by-center basis. It's in the comp center pool now. It's in all the guidance numbers for 2017 and past that, I don't think we can really comment.
Okay, but San Juan will be in the trailing 12-month sales per square foot metric that you provide starting next quarter?
That's actually going to take a little bit longer to get in there. It's not in that number now. I'm trying to think exactly what is going to get. I'm going to get back to you exactly when [Technical Difficulty] but it's not going to be in this quarter or next quarter.
Okay. Bobby, just given your comments around that you made around the depleted inventory levels at many stores and the number of malls during the holiday season and how that may have held back store sales, any sense or anecdotes around what percentage of sales are taking place in store versus those sales that are taking place in store that are just for fulfillment online? Do you have any sense for what's happening at some of the stores?
No, I really don't. I can only say that, look, online shopping, the use of mobile technology, the sort of omni-channel way of retailing today is everywhere in everything you do. We do believe that as much -- around 70% of our customers are researching their purchases in some way online before they are actually going in the center and doing it. They can be in the center and still be doing it. We talked for some time about we don't believe -- we're saying traffic is positive. It's up. We don't believe for some time the traffic has been down as sort of the common to refrain out there.
We've seen it in our specially tenants. We've seen it in our specialty food operators, specifically. In our minds what's happening clearly is that people are walking into less stores. Instead of shopping six, seven stores they're shopping three, four stores and those stores are getting much higher conversion rates and much higher transaction amounts.
How much of it is fulfillment and how much of it is going outside the center, being ordered elsewhere, we don't know and it does change dramatically by the tenant. It'll be different for Foot Locker than it will be for, pick a tenant, Zara. I can't really give you, but all we know is that the technology in omni-channel is here with us forever and everybody's adapting. We're adapting and retailers are adapting.
Right, but as landlord, I'm guessing you don't want the stores in your portfolio to have depleted inventory levels, so is this a discussion with the retailers that you're having? I mean, how do you approach them and talk about this? Is there anything you can do to prevent that from happening? What are you doing to help them with this change in retail that's taking place?
We're certainly talking to them about the depleted inventories, absolutely. Whether or not we can actually change behavior, I don't know, but it is logical that the key product items in the best -- are in the best stores, they are going to go the quickest. To the extent they are pulling from other location -- they are pulling from your location to satisfy other requests, that's what happens.
They're going to figure this out, because the best stores are going to have to have the hottest merchandise so they can sell through it at greater numbers. But we absolutely are talking to them. We're talking to them about all kinds of things in the context of omni-channel, trying to figure out how we can encourage delivery, how we can encourage ordering elsewhere, how we can encourage pickups, all that stuff. All of us are doing it. We're all working trying to figure it out.
[Operator Instructions]. Your next question comes from the line of D.J. Busch from Green Street Advisors. Your line is open. Please go ahead.
You mentioned one of your centers where sales was down was in South Florida. I guess this is one of your best centers and a dominant center in the market. I guess if sales have been down, have you still been able to push rent or are rents still rolling up? When I think about it, just because sales have been impacted by tourism, tenants are signing 5- and 10-year deals, this is a center they want to be at. I'm just trying understand the dynamic between the last couple of years where tourism has been pressured but the demand there is still really strong and trying to understand what rents have doing at that center.
We can't talk about a specific center rent, but I will absolutely say the demand is extremely strong in Dolphin Mall, unquestionably.
Okay. You mentioned a non-core asset sale coming in the quarter. You have the non-core malls you sold a couple years ago to Starwood and then this pending deal. After this one, is there any other assets in the portfolio that you would consider non-core?
Well, this is not a retail asset. It's a non-retail asset that was acquired. Again, it's in our guidance and we will announce it in the quarter that it occurs.
When you look at the -- I guess when you look at the retail portfolio, is there anything that you would consider non-core?
We always look, but not today.
You shouldn't build into your expectations for the future that we're going to sell the assets we have today other than what we've identified. Sure. Okay. Thank you.
Your next question comes from the line of Craig Schmidt from Bank of America. Your line is open. Please go ahead.
I was just wondering if some of the drag on percentage rent came from department stores?
I don't believe so. We get very little percentage rent from our department stores. Most of the department stores actually own their buildings, Craig, in our centers and where they don't it's tantamount to them doing so. They do contribute, they pay their own taxes, insurance, things like that. They'll contribute on some common area, but I'll say it's the exception, not the rule, that we get percentage rent.
To the extent, Craig, that percentage rent was lower in the fourth quarter versus our expectations, it was not due to the department stores.
Okay, great. On the three Sports Authority redevelopment efforts, could you give us a little more color? Are you putting multiple retailers per space? What your expected returns for the repurposing of the Sports Authority stores?
Well, I don't want to give a specific number, but it's very, very accretive because we did buy these three back out of the court, bankruptcy court. One of the locations is going to be replaced by a single tenant. The other location -- the other two locations are likely going to be multi-tenants. I'll say the second of the locations is definitely going to be multi-tenant because were all but done with that second one as well. The third one we would expect to likely be multi-tenant as well.
Your next question comes from the line of Vincent Chao from Deutsche Bank. Please go ahead. Your line is open.
I just wanted to do a follow-up on the same-store guide one more time here. I know most of that is baked just given the amount of leasing that's done already, but I think another swing factor is the CPI portion of the escalator which, if I recall correctly, is set in February. Can you just comment on what that contribution is expected to be?
Right. We get, in the middle of March, the result for February. That is the key number for us so. Call it March 15, give or take, we'll know where that's come in. We have a CPI assumption in our guidance at 1% and that is generally enough to get us to the rent growth numbers, the max rent growth numbers for a number of the tenants, most of the tenants. We're anticipating that, that's where it will be. All the indications are that we should be at least there if not higher but if we're not, that could be a slight drag on that number.
Just quickly on Short Hills, if there's any update on the Saks space?
We have nothing that we can disclose publicly yet, but I will say that there's tremendous demand from a whole group of retailers that are interested in that box. It will likely be more than one retailer. It will be multiple retailers as we expected. It would bring new merchandise into the shopping center that would be very desirous for the asset. We're very pleased with how that's going.
Okay. Last one just on the conversion of the units. That was for tax purposes, I think is what I heard. Should we interpret that as there was a loss that was trying to be offset here with the gain on that?
We had a cushion at the end of the year for a variety of reasons that allowed us to convert 250,000 of the shares that we have which is a little less than half and to use those proceeds for corporate purposes. We did that. We paid a little bit of state tax, about $0.5 million worth of tax. We still have though shares. We will be selling them some point. We don't know yet when. The timing of the conversion was tax driven and we'll end up most likely converting the rest of those at some point and hopefully as soon as the next year if we're in a position to do that.
But there's no requirement that we have to sell them. We're going to try to pick a good time to sell them. There's no pressure on liquidity or anything like that. We were just taking advantage of the tax opportunity that was in front of us.
Right. I mean, understand that the way our sale was structured was to be tax efficient. It was never our intent to invest in other companies. It was always the intention to use this capital when the time was right to do that.
Just to be clear, the tax -- future tax burden on that share sale would be whatever you converted that -- this amount to whatever the price is when you sell it. Is that right?
That's generally correct.
Your next question comes from the line of Michael Mueller from JPMorgan. Your line is open. Please go ahead.
Simon, a couple of questions. First, for the term loan that you're going to swap out to fixed do you plan on doing the whole $500 million? What's the rate you're assuming? The second question is it looks like you had about $24 million at a pro rata share of capitalized interest in 2016. Where does that trend to in 2017?
On the term loan it's $300 million. The reason we would be swapping it is just to maintain the percentage we'd like in terms of floating-rate debt versus fixed. We haven't done it yet today. We're going to continue to monitor rates and it's likely we will do it at some point in the first half of the year when we think the rates look like they're in the right place. In terms of what that bogey is I couldn't tell you exactly right now, but for us it's really for us a way to manage the floating-rate exposure on that $300 million.
I guess in terms of capitalized interest versus others, we give guidance on interest expense. We gave quite a bit of it but that does not include the capitalized interest number and is generally something we don't [Technical Difficulty] It's net of it. I should say more succinctly, it's net of that number.
Your next question comes from the line of Christy McElroy from Citi. Your line is open. Please go ahead.
Just with regards to the comments that you made on the 1% rent growth impacted by couple of tenants and lease modifications. How should we think about the expected trend in releasing spreads through the year? Do you include modifications in rent spreads? Aside from the modifications impact, are you seeing any change in your pricing power in regards to the normal course of leasing?
Christy we had nine quarters of 20%-plus releasing spreads and that 18.8%, that still a very healthy number. We've been saying for a while now that if you didn't see meaningful sales growth you weren't going to see those numbers stay above 20% forever and that mid-teens is always a good number. We still feel that way on average. We don't calculate the spreads, including lease modifications. It is not how we calculate it; it's not how we manage our business. We think the 18.8% number is still a very good number and if you start to see sales pick up it's possible that it's more sustainable over the long term. Sorry, what was the second question?
That was it. Just in terms of the leasing environment, but I think you answered it with the second part of your answer. Just on leverage, what does your 2017 guidance assume for year-end net debt to EBITDA and at what point should we expect that to peak?
I think you're going to see our debt to EBITDA ratio in 2017 and into 2018 be above the eight times which is the high end of our six to eight times target. It will start to decline in the back half of 2018 and we should be back within our range in late 2018, early into 2019, but we will likely be above eight times by the end of this year.
Simon, it's Michael Bilerman. I know you tried last quarter to manage expectations a little bit with the development and the interest expense disclosure. Clearly, it wasn't enough in terms of the items in your guidance. As we start thinking about 2018, obviously one large variable is going to be the run rate of NOI from the development. You've talked about $40 million to $45 million for this year making its way upwards to that $85 million, $90 million by 2019. I think would be extraordinary helpful as we start thinking about 2018 is where are you going to end up in the fourth quarter from an annualized basis and then how that trajectory goes into 2018 so that 2018 numbers start a little bit more robust. Obviously those numbers have come down pretty meaningful over the last six months, so just start allocating where that value creation's going to be into 2018.
A couple comments there, Michael. One thing I can tell you is in that $40 million to $45 million number, just remind everybody, that's four assets, the three in Asia and the one in Hawaii. Just given where those four assets are, the three Asia assets are -- you're seeing sales -- you haven't seen the third one yet, but of the two that are open, you're seeing sales increases that are very, very, very healthy.
For those, because they're 100% leased and because Zhengzhou, when it opens, should be 100% leased and very quickly 100% occupied, I think that the growth in NOI you're going to see there is really going to be based on sales but it's not going to be -- you're not going to have this outsized increase like I would expect you would see with Hawaii in that you're going to have a very different occupancy number to begin 2018 in Hawaii than you have certainly today as we get those tenants opened.
That's just a comment around the trajectory of those. We're very encouraged by what we see in Asia. We're feeling good about where were going to be in Hawaii, but it's too soon for me to give you really where I think we're going to be in 2018. I can tell you that we're still comfortable with what we've given for 2019. I hear your comment and we will give it some thought.
Yes, I mean, you've given the $40 million to $45 million. You clearly know where that's going to end the fourth quarter. You've come up with a forecast having that range of what 4Q NOI is would give us a pretty good indication, even on an annualized basis, where what a minimum should be for 2018. So I don't know why you can't provide that disclosure to sort of help people modeling quarterly so that there's not negative surprises, right? If the bulk of its coming in more in the back half of the year, that something that we should know.
Right. I hear you, Michael and we will give some real thought to your comments.
Your next question comes from the line of Jeremy Metz from UBS. Your line is open. Please go ahead.
Sticking with that same line of questions, Simon, you mentioned some of the discrepancies between the Street and your guide. Zhengzhou specifically wasn't one of them, but just if we kind of isolate that asset, I was hoping you can help us think about that yield ramp here and impact to 2017. It sounds like leasing and occupancy is strong but you still talked about 2019 stabilization. Again, sticking with what Michael was thinking about, this modeling perspective, should we assume, in particular for Zhengzhou that, that's an earnings drag in the first few months after it opens before turning moderately positive in the year end? Is that the right way to think about that?
Well, there's lots of issues on Zhengzhou. We're going to be totally leased but -- and at really wonderful merchandise, but a lot of it is sales based. Remember, we been talking forever about the fact that about half of the income is going to be sales based. As you're seeing in Xi'an, sales have begun and as successful assets in China have shown over the years, they start low and they really gain and if they're good assets, they really start to perform and they become very strong assets.
Where on that ramp-up right now with Xi'an. We expect the ramp-up to be similar in Zhengzhou, but until it's open, it's very hard to say. We originally forecast about 4% of the first year of unlevered cash on cash, three years later stabilization being at 6% to 6.5%. We actually feel comfortable on Xi'an and on Zhengzhou that we're going to be there.
We actually feel better and we've said this, at Hanam, but Hanam has a little less at risk in terms of the sales and it started out very strongly. We had the cost reductions along the way that increased our overall expected yields. But telling you what we're going to be on Zhengzhou as against that 4% that we threw out there. We also have -- it's a complicated funding that includes loans in China that are also at a high rate. So when you start to look at what the overall return is, you have to take all this stuff into consideration. I think it's very hard for us to tell you today where we expect to be this year in 2017 on Zhengzhou which is not even open yet.
Okay, no, I think some of that was helpful. I just wanted to ask one quickly on Country Club Plaza. You've owned the asset for about a year now. I think and Macerich acquired it and there was some redevelopment expansion potential there. Can you just give us an update on how that asset is performing versus your initial expectations and then whether that's something we can expect to see to move into the pipeline at some point, maybe in 2017? Thanks.
I think both Macerich and us are very pleased with our acquisition. It is a terrific, interesting asset. We talked earlier in my comments about the food there which is over $100 million of food is being produced there. We think -- we actually believe that there's some significant development opportunities there and we're working through them.
These kinds of things do take time. They don't get done and when you come up with the idea, you can't just go do. You've got lots of constituencies, starting with the users, that you have to deal with, especially if they are larger users. We're working through it, working with the community and all of that and when we have something to say, we will. Bottom line is we're happy we bought the asset and we believe that Macerich as well.
Just to finish that thought, when we bought the asset, we underwrote the asset believing that in the near term the value creation would been in releasing tenants that rolled in the first few years up to higher rents and maybe taking occupancy up a little bit, but mostly rolling existing tenants up to market. In the medium to longer term, we saw that there could very likely be some redevelopment opportunity. We still believe that, that is the case but you won't likely see it in 2017. It was always more of a medium to longer term thought. But we're on pace of where we hope to be from a cash flow perspective and over the medium to longer term, I think you will see some opportunity there to add to our redevelopment.
Your next question comes from the line of Floris van Dijkum from Boenning. Your line is open. Please go ahead.
Floris van Dijkum
Thank you. Bobby or Simon, a question on your operating expense recovery ratio which slipped in the fourth quarter. You mentioned a number of items. Should we expect this number to stay at the fourth quarter levels or how should we think about that going forward for 2017? The other question I have for you is -- or a related question is, how are the inclusion of your Asia numbers going to impact that and maybe walk us through the structure of those leases and if you have the same cam structure in place as you do in the U.S..
All right. I will take the first piece. We always have higher expenses in the fourth quarter. That always affects our recoveries, plus we have some new centers and there, so you put it in -- and revenue is generally flat. It's pretty difficult for us to have that situation. The question about Asia --
It's similar. Today we're on a gross as opposed to triple net lease with most of our tenants, so it similar there and if you heard me earlier talk about percentage rent or sales-based rent being about half in China of all rent, obviously all of the cam costs are included in those as well. We do get -- we're intended over time to, as the assets stabilize, to have some margin in that as well. We'll see how it goes.
Floris van Dijkum
Okay. I think year over year we saw, I think, around a 4% reduction in your expense recovery ratio. That should stay flat, if I think about it. Should we think about that being flat in 2017 relative to 2016 or is there -- with the influx of Asia, should we think about maybe that is going to go down a little more? I guess that was what I was trying to get at.
I think in general it's improving. The new centers obviously have an effect on that. Exactly what's going to happen with Asia is difficult to tell you right now.
But we will get back to you on it.
Floris van Dijkum
Okay. The second question off the top of my head, you've got something like 10 million square feet or 10.4 million square feet of anchor space in your U.S. portfolio and you mentioned that you're not going to be doing any sort of new developments in the U.S.. But I guess one of the key ways that some of your peers have been creating value, you're creating value at Short Hills with the Saks box or expect to, in redeveloping that box. How do you think about the opportunities in the non-owned space in buying that back and what should we think about maybe your investment in some of that space and some of the capital that you might could work in your properties?
Well, I mean, given the quality of our real estate, most of our department stores are doing well. Macy's made their announcements, there were no store closings. Sears has made announcements. We only have three Sears stores. There were no closings. Penney has made announcement. We only have four Penney stores. There were no announcements. We don't think we're going a lot of opportunity as our peers are to buy back our boxes because generally the real estate is strong.
We were delighted to have the opportunity to buy back the Saks store in Short Hills and as I said earlier, we have very strong retailer interest. If we have the opportunity, we will. In all three Sears spaces -- one of them is Seritage, but two of them is owned directly by Sears. In all three of those, we would be very happy to get them back. It's not like we haven't tried. We have tried, but we haven't been able to make a deal and again, we're not going to have the same level of opportunity that our even the high-quality peers will have.
Your next question comes from the line of Tayo Okusanya from Jefferies. Your line is open. Please go ahead.
Mine is more of a broader question, Bobby. Just kind of given that retailers are getting so much more selective about where they are taking new space and they want to just be in highly productive centers which you guys have a meaningful amount of. When you do end up in situations where you can't strike a leasing deal with a retailer that's looking to expand, what are the typical reasons why that happens?
I think generically they think they can make a profit wherever they're going to build a new store, open a new store. I think Sandeep said on his call about quality real estate. David said the same thing on his call. It's all about great real estate and that great real estate is going to continue to take market share, because tenants are not going to go into secondary locations, especially with omni-channel retailing alive and well. I think when you look at good real estate, it's going to get all the good tenants and whoever the emerging tenants are, they're going to be there.
The social experience that we're all creating in our real estate with entertainment, with restaurants, with the newest merchant, all of this is because they want to be where shoppers are. They want to be in the best markets and that's the best real estate. We feel very strongly that good brick-and-mortar is going to get better and frankly going to take market share, because as weaker real estate goes by the wayside and atrophies, better real estate is going to get stronger and stronger.
Okay. Is there anything within your portfolio that you don't have within that portfolio that they would like? For example, did you not get a deal done because you don't have a lot of outlet centers and omni-channel-wise, they want both full-service and as well as outlets? I'm just kind of curious what could be preventing higher leasing volumes at your Company.
When you look at our occupancy, it may be down 50 basis points but when you look at the Sports Authority, it's 130 basis points. If we hadn't taken back the boxes which were extremely accretive to make that decision, then we would actually be printing an 80 basis points higher number right now in terms of occupancy. We'd be at our highest occupancy maybe ever.
We think almost all our key metrics are up. In fact, I think they're all up except for occupancy that I just discussed. We think -- our NOI growth of 3.9% is a healthy number. These are healthy numbers. So we think that our real estate is showing that it's solid and that it's going to continue to improve, especially as others get weaker.
There are no further questions at this time. I'll turn the call back over to the presenters.
Thank you, Emily and thank you all. We'll be talking to you in the coming weeks. Bye, bye, everybody.
This does conclude today's conference call. You may now disconnect.
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