Pennsylvania Real Estate Investment Trust (NYSE:PEI) Q2 2018 Results Earnings Conference Call August 2, 2018 11:00 AM ET
Heather Crowell - SVP, Corporate Communications & IR
Joseph Coradino - Chairman and CEO
Robert McCadden - EVP and CFO
Christine McElroy - Citigroup
Hongliang Zhang - JP Morgan Chase & Co.
Caitlin Burrows - Goldman Sachs Group
Ki Bin Kim - SunTrust Robinson Humphrey
Spenser Allaway - Green Street Advisors
Karin Ford - MUFG Securities Americas
Good morning. My name is Rob and I will be your conference operator today. At this time, I would like to welcome everyone to the PREIT Second Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]
Thank you. Ms. Heather Crowell, you may begin your conference.
Good morning, and thank you all for joining us for PREIT's second quarter 2018 earnings call. During this call, we will make certain forward-looking statements within the meaning of federal securities laws. These statements relate to expectations, beliefs, projections, trends and other matters that are not historical facts, and are subject to risks and uncertainties that might affect future events or results.
Descriptions of these risks are set forth in the company's SEC filings. Statements that PREIT makes today might be accurate only as of today, August 3rd, 2018, and PREIT makes no undertaking to update any such statements.
Also, certain non-GAAP measures will be discussed. PREIT has included reconciliations of such measures to the comparable GAAP measures in its earnings release and other documents filed with the SEC.
Members of management on the call today are Joe Coradino, PREIT's Chairman and CEO; and Bob McCadden, our CFO.
I will now turn the call over to Joe Coradino.
Thanks Heather and good morning everyone and thanks for joining us as we share our enthusiasm for a bright future. As we sit here today, we've completed the transition into a high quality mall REIT as evidenced by the impressive roster of recently executed leases, our successful anchor replacement effort, improving operating metrics and a realizable vision for our marquee project, Fashion District Philadelphia.
As the recovery -- as the retail recovery gains momentum, we continue to be positioned to take advantage of the recovery underscored by increases in FFO, same-store NOI, occupancy, sales, average rental and new deals, and renewal spreads this quarter.
With a distinctly different tenant base and completion of our first multifamily addition on the horizon, we are leading the way into the new mall paradigm. We've reached an inflection point, having paired the portfolio, improved anchor offerings at more than half of our properties, and introduced new tenants to the portfolio that were not prospects available to us in the past.
Having accomplished all of this amidst the uniquely challenging retail backdrop has distinguished us. We believe that how we manage through tumultuous situations defines who we are. And the foundation we've established and strengthened ahead of the sector allows us to move into a phase of growth driven by our redevelopments coming online, our compelling portfolio concentrated in Philadelphia and D.C., attracting both the continuous flow of new tenancy and vast opportunities to densify with apartment, hotel properties.
It's almost exactly two years ago the news of Macy's plan to close 100 stores rocked the retail landscape. Since then, we've been steadfast in our innovative approach to merchandising, forging a new mall definition.
Today, we're proud to report that we have filled all of our anchor boxes that we had available and we continue to reduce our Sears count with plans underway to replace two additional stores, which will take us down to only five Sears stores.
We're pleased to announce that we've signed three leases for our final Macy's box at Plymouth Meeting and we have fully executed the lease with Studio Movie Grill to bring their immersive luxury movie going experience to Willow Grove. Our first asset to eclipse $700 per square foot in sales.
These new anchors, along with Von Maur at Woodland will complete our anchor repositioning program in 2019. The success of our anchor replacement program and robust tenant demand is a testament to the strength and compelling nature of our well-positioned portfolio.
Further validating improvement -- improved quality of our portfolio, we've executed leases with an impressive roster of high performance and many new-to-portfolio tenants. Our redevelopment program at Woodland Mall slated to open in Q4 2019 is ramping up as we secure catalytic tenants that are new to our portfolio almost cement Woodland Mall as the dominant mall in its strong marketplace.
We have signed leases with REI, Altar'd State and the second Urban Outfitters in our portfolio. Tenants of this caliber reflect the brand that PREIT has created and the speed to execution inherent in our work.
Among other first-to-portfolio names across our platform, we've signed new leases with Maggie McFly's, Fatburger, &pizza, Phenix Salon, Edge Fitness and Ardene, a Canadian fashion retailer, evidence that the retail world has evolved well beyond its homogeneous past and that retailers and other destination tenants have expanded their world view to consider the new more -- mall model as a vibrant destination for their business expansion.
Furthering this view toward the future is our announced partnership with 1776 to bring the retail incubator to Cherry Hill Mall where we can be among the first to bring innovative, emerging digitally native retail concepts to our consumers.
Our approach to reinventing the mall experience is also apparent in yesterday's Fashion District announcement where the partnership revealed an exciting line-up of tenants to create a vibrant destination here in Philadelphia, we have long envisioned.
These tenants include City Winery, Dallas BBQ, AMC Theaters, Polo, H&M, Forever 21, Asics, Levi's, Columbia, Skechers, Francesca's and others delivering the next generation of consumer experiences. The retail landscape evolves to further integrate lifestyle and dining concepts.
At a press conference held yesterday, Michael Dorf, CEO of City Winery, comment about what a great opportunity Philadelphia offers with its affinity for great food and music.
As our partner, Macerich, mentioned on their call yesterday, we made a conscious decision in order to ensure maximum success for our tenants and shoppers to have one high impact opening, which could best be accommodated in September 2019, given the evolution of the project and the incorporation of several exciting dining and entertainment concepts.
Over 80% of the project is either leased or in advanced negotiations, and we're really excited to deliver this transformative project to our world-class city and deliver to you a steady cadence of new tenant announcements, including transactions and progress with the top quality entertainment tenant, featuring bowling, ping-pong, and billiards, as well as in artisanal Italian market with culinary events, restaurants, and retail space.
Further evidencing our evolution is improving operating results. Excluding lease terms, we showed strong improvement over Q1, representing a 300 basis point swing. While termination fees can be inconsistent, there is value in considering them in our performance as we get paid for the value of these -- of the lease, while maintaining the near-term ability to release the space leading to future NOI growth and tenancy improvement opportunities.
We recognize this is a change from prior guidance assumptions, but consider this as the next step in improving the quality of our portfolio and being more consistent with our peers. When you have a quality portfolio, the decision to take a termination fee is a positive.
During the quarter, we recognized several material termination fees. These weren't amount greater than 100% of the remaining lease obligation for these tenants. Where we have signed leases are in negotiations for over 90% of the space previously occupied by these tenants.
Sequentially, we generated an improvement in average renewal spreads in our wholly-owned portfolio to 7.5%, average rental and new deals were up 25%, and the volume of small format leasing more than doubled in our wholly-owned portfolio.
NOI-weighted sales are over $500 per square foot with Willow Grove, Springfield Town Center, Moorestown, and Plymouth Meeting Malls growing by 5% or more, led by Mall at Prince Georges, which is over 9%, evidencing increased productivity following our remerchandising.
Our top five properties are reporting weighted average sales of $607 per square foot, growing at a weighted average of 3.1% clip. On the anchor repositioning, we have 280,000 square feet under construction for 2018 openings and 230,000 square feet executed for 2019 openings and we have 230 basis points of non-anchor occupancy leased, but not yet opened.
As we continue to look at opportunities to improve our portfolio through disposition, in tandem with our capital allocation strategy, we initiated the process to transfer the mortgage loan secured by Wyoming Valley Mall to the special servicer. This property has $74 million mortgage loan and has two anchors closing this month.
Looking to the future, we're well-positioned for growth. We've leased our available anchors, obtained commitments for 90% of the spaces we took termination fees for, we're curing co-tenancy, we're improving rents on new, and renewal deals and Fashion District will come online with a great tenant mix.
The densification of our assets is another great opportunity to enhance our growth trajectory, while improving our capital position and diversifying our income stream, a natural step in our continuous portfolio improvement and value creation endeavor.
With that, I'll turn it over to Bob to review our results and expectations for the year.
Thanks Joe. We had a strong quarter across all facets of our business. I'm going to start with an update to our earnings guidance, review our financial and operating results, and then cover our capital plan.
We are reaffirming our FFO guidance for 2018 after giving effect to employee separation costs and the write-off of costs associated with the refinancing of our bank credit facilities. FFO as adjusted is expected to be between $1.50 and $1.60 per share.
We're adjusting our estimates of GAAP earnings to give effect to these items, plus the asset impairment charges recorded in the quarter. We expect a GAAP loss of between $0.62 and $0.73 per share.
Our same-store NOI guidance range of 1.25% or 2.25% include lease termination fees. As a point of reference, our original guidance range was roughly the same both with and without term fees.
For the full year, bankrupt tenants net of the replacements are expected to reduce 2018 revenues by an incremental $2.6 million, on top of the $5.6 million impact we experienced in 2017. That number is up $200,000 from the last quarter, reflecting second quarter events.
Co-tenancy adjustments are expected to be approximately $3.1 million in 2018 compared to $1.3 million in 2017, again reflecting the full impact of anchor closings.
Income from anchor replacements, higher temporary leasing and other common area revenues further CAM cost savings, and additional lease terminations will help to mitigate the impact of these factors.
Key replacement tenants slated to open it in the second half of the year include Belk, Tilt and Onelife Fitness at Valley Mall and HomeSense and Five Below opening at Moorestown Mall with additional tenant openings in the first quarter of 2019.
During the second half of the year, we will experience the impact of store closings from terminated tenants and bankruptcies, while facing tougher comps up against 2.5% and 3% from last year. Fashion District was expected to contribute $0.01 to $0.015 in 2018.
We anticipate spending an additional $100 million to $125 million on our redevelopment and anchor replacement program over the balance of 2018. Combined with the $70 million spent in the first six months of the year, we're on target with our original business plan.
Turning to operations. We reported FFO as adjusted of $0.39 a share, which was above analyst consensus. After adjusting for the dilutive impact of asset sales, FFO was up 9.5% for the quarter.
Same-store NOI growth of 10.7% was driven by 6.4% increase in revenues, including lease termination fees. Total occupancy at our core malls was up 20 basis points to 93% and non-anchor occupancy was up 30% -- 30 basis points to 91%. When factoring in executed leases, we would add an additional 140 basis points to our total occupancy and 230 basis points to a non-anchor occupancy.
We have over 800,000 square feet of executed leases on our pipeline for future openings and our same-store portfolio with almost 360,000 square feet slated to open this year, contributing about $4.5 million of annualized revenues. The balance will open in 2019 and will contribute an additional $4.8 million of annualized revenues.
Sales per square foot at our core malls increased 2.1% to $489 per square foot and NOI-weighted sales are over $500 a square foot. Our leasing team was active delivering 83% more leases during the quarter than the first quarter. This momentum has carried through to the early part of the third quarter as well. Average renewal spreads in our wholly-owned portfolio during the quarter remained in the mid-single-digits at 7.5%.
With respect to our same-store performance, we were able to more than offset the negative impact of bankruptcies and co-tenancy claims with incremental revenues from anchor store replacements and higher lease termination revenues.
To be specific, anchor replacements added $1.7 million to our topline and lease termination revenues were up $5.2 million over last year's second quarter. Bankruptcies at our same-store properties reduced NOI by $900,000 during the quarter compared to last year, and co-tenancy claims reduced rents by an additional $800,000.
Operating expenses were relatively flat reflecting ongoing cost management efforts and an improvement in our utility margins, reflecting the benefits of a mild spring weather.
Interest expense for the quarter, including our share of joint ventures increased by $1.7 million. The increase was due to an increase in weighted average borrowings, 15 basis point increase in the average interest rates. These were offset by higher amounts of capitalized interest. Interest expense also included the accelerated amortization or deferred financing costs associated with our refinanced bank facilities.
During the quarter, we recognized $34.3 million in impairment charges for Wyoming Valley Mall and our undeveloped land parcel in Gainesville, Florida. The Gainesville property is under contract and the buyer has posted a hard deposit.
I'm going to wrap-up with some highlights from our capital plan. In May, we successfully completed the recast of our $400 million unsecured credit facility and a total of $300 million of unsecured term loans ahead of the scheduled maturities in 2019 and 2020. We were pleased with the execution of this transaction, as we were able to maintain substantially all the key economic terms of the previous facility.
No change in interest rate spreads, no change in cap rates, and no change in leverage covenants. We also extended the maturity out until 2023 with the available extension options on a credit facility.
The $27 million non-recourse mortgage loan in the Valley View Mall matures in July 2020. Beyond that, our next debt maturity doesn't occur until 2021. Our liquidity position continues to be strong with $298 million of available liquidity at the end of June.
Our bank leverage ratio was 51.5%, and our net debt to EBITDA was approximately 8.3 times, in line with our expectations. With 92% of our debt, either fixed or swapped, we continue to be well positioned to manage through a period of rising interest rates.
On a rolling 12-month basis, our FFO as adjusted payout ratio is 52% and our FAD payout ratio was 88%. Last week, we announced our 166th consecutive dividend maintained at $0.21 a share for the third quarter, payable in September.
And with that, we'll open it up for questions.
Your first question comes from the line of Christy McElroy from Citi. Your line is open.
Hi, good morning everyone. Hey Bob, just wanted to follow up on the guidance. So, in terms of the same-store NOI revision, it sounds to me from your comments like the term fees are higher than the rent that you're leasing in 2018.
So, just in keeping same-store NOI including lease term fees unchanged, that implies other degradation in core growth that you're seeing. So, maybe you can provide some color on that.
Sure. We had -- the tenants where we received termination fees it was $1 million of income that we otherwise would have received in 2018 had it not been for the early termination of those leases.
And then just maybe some color on what's driving that, just in terms of bankruptcies or what else is -- what are the other kind of moving parts within the same-store?
I'm sorry; can you just repeat that second question?
Yes, sure. Just -- so in terms of the other, the additional degradation that you expect in same-store on top of the rent loss from the termination of those leases, just provide some color around that. What are the other moving parts that's driving same-store NOI growth, excluding those lease termination fees lower?
Okay. I think in addition to, obviously, the impact of the store closings, it was -- could be some variability around bad debt sponsorship revenue and timing of tax appeals in last year's second half of the year we received a favorable benefit of our real estate tax appeal, which we don't anticipate having at the same level this year.
We also saw a little bit of erosion in one of our tenants who pay a percentage of their rent in sales, a percentage of their revenue based on sales. And we expected some improvement in that. We haven't seen it yet, but that still remains to be seen. So, that's not a factor that we're going to be factoring into our revised guidance assumptions.
Okay. And then just to be clear on lease termination fee guidance. So, I think at the beginning of the year you were around $1.5 million to $3.5 million. Last quarter you guided to the upper end of that range and now you've -- you're at about $7.5 million.
So, inherent in that in one -- inherent in the new guidance range, are you assuming no additional lease termination fees in the back half of the year or should we expect a higher -- a number higher than the $7.5 million?
Yes, we -- at the upper end of our range, we would expect maybe up to an additional $1.5 million of lease term fees. That's again going to be a binary transaction; we either get all of that or none of that.
Your next question comes from the line of from Hong Zhang from JP Morgan. Your line is open.
Yes, hi guys. I guess, as it relates to the lease termination fees you received this quarter, was this one large tenant that closed down a lot of shops or a lot of small tenants closing shops?
It was a combination that had a couple of tenants with the large number of stores closing and we had one large -- one tenant with the large termination fee. But again, I think the important point that -- we're focused on the wrong aspects of the -- of this discussion, I think the point is that 90% of that space, these are leased who are under commitments for lease, so we would expect to receive the benefit of that most likely in 2019. But that's the, I think, the key point to be made in this discussion.
Got you. Thank you.
And your next question comes from the line of Caitlin Burrows from Goldman Sachs. Your line is open.
Hi, good morning team. I guess, I was just wondering on Fashion District now and how should we think about on the expected build up to stabilization in 2020. So, I guess, when you guys open in September next year and say that stabilization is in 2020, does that mean by the first quarter you expect to be there or kind of build throughout 2020? I realize that's pretty detailed, but it is a big driver of future numbers.
Yes, I think the -- pertaining to your question, I think we're going to start with a higher level of occupancy when we open in 2019. So, we'll have certainly a buildup throughout 2020. But in all likelihood, you would see the stabilization occurring in the second half of 2020 as you have your normal to seasonal openings occurring in the second half of the year.
Okay, got it. And then I was just wondering on -- you mentioned Wyoming Valley probably going back to the lender, what sort of timing you expected there? And then also, I think, Valley View with the other Bon-Ton property you also mentioned there's a mortgage that matures in 2020. So, any update on what you plan to do at Valley View?
On Wyoming Valley, I don’t think it's appropriate for us to comment on that process. But in Valley View--
In Valley View, I think -- this is Joe Coradino. I think with respect to Valley View, we are still working through our options there, I mean, obviously it's non-recourse debt and we have that to consider, we're also looking at backfilling anchors.
We will be very careful about our capital commitment as it relates to that, but we're still looking at all of our options at Valley View. And as Bob said, at Wyoming, we're going through a process; I don't think we want to comment at this point.
Your next question comes from the line of Ki Bin Kim from SunTrust. Your line is open.
Ki Bin Kim
Thanks. Good morning guys. So, the lease renewals, the percentage -- the leases that you're doing on a percentage rent basis has been growing over the past couple of years now, I think it amount to -- amounted about to a 20% of all renewal activity. Can you just help me understand what's going on there?
Hey, Ki Bin, this is Bob. Just want to kind of put some things into context, the number of tenants that we have in our portfolio that are paying a percentage of their sales in lieu of minimum rent is relatively modest by historical standards. It's probably less than 60 tenants in total.
And I think what you've seen in the last couple of quarters is just reflecting of the working through of some of the tenants that were either coming out of bankruptcy or in a trouble tenant state where we were using that methodology as a way of maintaining occupancy, while we continue to find a replacement tenants.
If you look at the term of those percentage sales leases, it's generally a year, year and a half. So, we don't see that as an ongoing part of our portfolio rather kind of a short-term fix dealing with some of those specific tenant situations.
Ki Bin Kim
Okay. And in terms of the new lease accounting language, it looks like you're about $8 million for this year, that's what you're trending to in terms of internal leasing costs. How much of that do you expect to expense next year?
No, I think if you look at our historical run rate, it's been on average about $5 million -- I'm sorry, $6 million per year. And if you look at, I think you covered it in your report. So, roughly about $5.25 million or $0.07, $0.08 a share will be the impact to our 2019 results.
Ki Bin Kim
Okay. Thank you.
And your next question comes from the line of Spenser Allaway from Green Street Advisors. Your line is open.
Thank you. Just another on guidance. So, co-tenancy adjustments were up relative to 1Q. Is the $3.1 million you referenced in your opening remarks, is that based on known closures today or is there any cushion baked into guidance in the event the closures increased?
It's generally based on known or anticipated closures. But for the most part we don't have any -- we don't expect in the balance of 2018 to see any additional anchor closures that would result in any increase in that estimate.
Okay. Thank you.
Your next question comes from the line of Karin Ford from MUFG Securities. Your line is open.
Hi, good morning. I was wondering if you could give us more detail on why the cost went up at Fashion District and why, I guess, commensurately why the return came down?
Sure. Hi, Karen, this is Joe. Essentially, the -- when we originally conceived that project, we were not going to have an entertainment component and, in fact, probably not build out the top level. And for a couple of reasons not the least of which, as you go around this country, and you look at vertical developments, you'll see lots of vacancies on the top floor.
We saw an opportunity to fully occupy the top floor with entertainment and at this point we have an executed lease with AMC as well as in lease negotiations with the entertainment concept that I mentioned on the call, bowling, ping-pong, et cetera.
And the cost for that was not in the original project cost. In the case at a movie theater, we had to literally raise the roof in order to accompanied the stadium seating and that was the -- and that was really the biggest reason that entertainment component that drove the cost increases.
And it's just because that third level is not fully leased yet that you're not getting incremental return, as high an incremental return on those incremental dollars? Is that right? I think that'd be right.
No, actually the third level, the numbers for the lease up of the entire top level is in that -- is in the pro forma and is reflected in those revised returns.
I would add, by the way, that as it relates to the project about 85% of the project is either completed, contracted or bought out our allowances. So, we have a very little cost exposure on a going forward basis.
Great. And then just last question on the guidance, again. So, is my math correct, that is you did 4.3% same-store NOI growth in the first half that in order to hit the midpoint you're implying kind of 0% NOI growth in the back half and if so, just what are the puts and takes that bring? I know you're having a lot of anchors come online. What takes that down to zero?
Yes, I think your math is right and we expect kind of flattish second half of the year. But I think the key point is that we haven't really recognized the impact yet on our operating results of the Toys"R"Us and Bon-Ton bankruptcy closings and associated co-tenancy. Those closings didn't occur until late in the second quarter, or obviously the early part of the third quarter.
So, that's going to be the biggest drag that we have. Again, just the point there is that, yes, we have made some pretty good progress on identifying backfills for some of those bankrupt tenants.
The additional thing which I mentioned in my, I guess, response to Christy's question is that, we had -- we were up against some tough comps from last year, again, we received the benefit of a couple of favorable real estate tax appeals last year which we don't anticipate for this year.
And then as I mentioned also, we have international tenant that's had some sales issues that's going to be potentially impacting our percentage sales and percentage rent revenue from that tenant, which we have in multiple properties.
And there are no further questions at this time. I will turn the call back over to our presenters for some closing remarks.
Well, thank you all for participating in the call. Enjoy the rest of your August and I'll see you all in September. Thank you.
This concludes today's conference call. You may now disconnect.