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Text: Additionally, transactional activity continues to pick up.
So, before I turn over the call to John and Amy to delve into the details of the progress that we made last quarter, I want to reflect on an interesting inflection point that we find ourselves.
Because after a couple of years of meaningful headwinds for retail real estate.
First, from the so-called retail apocalypse and then from the impact of COVID, we're now at a point where not only are we seeing solid leasing fundamentals that should provide strong internal growth for the next several years, but the other drivers of our business, most notably our external growth engines, both from our on-balance sheet investing as well as through our fund platform are in a position to add important growth as well.
In short, we have the potential to be hitting on all cylinders in a way that we have not seen in a very long time.
So, let me walk through the key drivers of this trajectory.
First, there's internal growth.
NOI growth is poised to be well above trend for the next several years.
Now granted, some of this growth is from the rebound from the short-term setbacks from COVID.
But we positioned ourselves to not just recapture past income, but then to grow nicely past that benchmark.
This growth is going to come from a few key components.
First, we anticipate taking our occupancy back to approximately 95% from the current level of approximately 90%.
Now occupancy for us is a very rough and very imprecise proxy but, however you choose to measure it, the growth associated with the restabilization is going to be impactful and we're seeing this take hold.
Year-to-date, we have signed over $11 million of leases and considering our initial pipeline with $6.5 million this is a pretty good start.
And the growth is coming across the board but notably, it is showing up in our key streets that were boarded up and left for dead a year ago and now they're coming back.
For example, we recently signed a lease with FILA sportswear for the corner of Prince and Broadway in SoHo and notwithstanding the dire predictions as to the future of SoHo.
The economics of this lease provided a positive spread and was largely consistent with our pre-COVID expectations.
Then the next driver of growth is coming from the contractual growth and lease roll in our portfolio.
Now trees never grow to the sky and not all leases roll up, but the green shoots that we are seeing in SoHo are beginning to take hold in other markets as well.
We recently achieved positive lease spreads in Melrose Place in Los Angeles and in Armitage Avenue in Chicago, both at rents that were in excess of our pre-COVID expectations.
And importantly, tenant sales, as John will highlight, are supporting this trend.
Many retailers are already comping positive to pre-COVID sales in many of the corridors that we're active in.
Now this fact is so different from what most of us expected during the early days of the pandemic.
In fact, if COVID has commonly been viewed as an accelerant of trends, what it has really been for retail real estate is a cleansing and a validating mechanism.
Cleansing in that the retailers who have made it through the storm seem to be in a much better position in terms of balance sheet strength and in terms of productivity and then validating in that the importance of the physical store has clearly been validated in the post pandemic omnichannel world that we are in.
And this is true not only for the Target and Walmarts of the world who validated the importance of the store in their omnichannel success.
But it's also true for luxury and bridge apparel, where you are seeing tenants, recognizing the power of their stores as critical in connecting directly with their customer, especially in the must-have streets where we own.
And it's also true for the digitally native retailers, where our tenants like Warby Parker and Alberts are making it clear that the physical store is essential to their growth and essential to their profitability.
And keep in mind, as recently as a year ago, many wondered whether these retailers would even want stores on these streets.
And while everyone was wondering, the retailers doubled down.
Then along with our growth from lease-up, we will add additional internal growth from a series of redevelopments that are actionable and profitable.
It's a bit early to update our progress on this front right now, but we should have some worthwhile updates by our next quarterly call.
Then complementing our internal growth are the multiple components of our external growth engine.
Firstly, we are doing on-balance sheet investing to add to our existing core portfolio accretively.
Deal flow during the pandemic was quiet as most owners hunkered down, and most lenders were highly accommodative.
Distressed opportunities were underwhelming in almost every segment of real estate other than stock prices.
And frankly, we did not have a cost of capital that enabled us to be competitive, but sellers are once again emerging.
And as we look around, there are certainly fewer well capitalized and knowledgeable competitors for our areas of focus.
And we're beginning to see a recovery in the debt and equity markets such that we should have a cost of capital to accretively acquire, and it should be a good period to put dollars to work.
Then along with on-balance sheet investing beginning to heat up, our fund platform is in a position to continue to add to our growth.
We can add to our fund acquisitions, both similar to Fund V or similar to other successful value-add or opportunistic initiatives that we've done in the past.
In terms of Fund V, and as Amy will discuss, we are continuing to buy out of favor [Indecipherable] 10:23 open air retail at substantial discounts to replacement cost with attractive mid-teens yields.
These investments have proven stable through COVID and while I think we may have a couple more years of buying these yields at a discount, we're also seeing signs of cap rate compression.
And if and when cap rates do compress we'll have well over $1 billion of retail in Fund V alone, clipping mid-teens yields, while we wait and keep in mind, buying out of favor existing cash flow is just one of the many ways we have created value in our fund platform over the years, whether it's buying retailers with significant embedded real estate value, such as our investment in Albertsons and the rest of our RCP activity or opportunistic acquisitions where we saw significant rent bumps and then monetized opportunistically as was the case in Lincoln Road and Miami or a variety of redevelopments and value-add projects where tenant demand warrants it.
Our team and our balance sheet are built to do multiples of this volume, and we're starting to see the stars align.
Finally, keep in mind, at our size, roughly every $100 million of new investments, whether core or fund, adds about 1% to our earnings.
So to conclude, as we are climbing out of the horrors of the global pandemic and recognizing that the impact that was felt was especially hard on so many of our assets the rebound is becoming clearer every day.
And it's also becoming clearer that our company, both in size and ability is well positioned for accelerated growth from this recovery.
The combination of strong embedded internal growth and the ability to drive external growth, both on balance sheet and then through our funds, should enable us to maximize value in multiple different ways.
I will start off with a discussion of our third quarter results, followed by an update on our continued progress on the $25 million of anticipated internal core NOI growth and then closing with our balance sheet.
Starting with the quarter.
Our third quarter earnings of $0.27 a share exceeded our expectations, landing us in the upper end of the $0.25 to $0.27 range that we had guided toward on our most recent call.
And this was driven by rent commencement on new leases, continuous improvements in our cash collections, along with some accretion from the approximately $140 million of external investments that we completed during the quarter.
In terms of near-term FFO expectations, we continue to anticipate $0.25 to $0.27 of quarterly FFO, excluding any potential Albertson sales for the next few quarters.
In terms of Albertsons, as I shared on the prior call, although a sale of shares before the end of the year is possible, we continue to believe that it's prudent to assume that the realized gains start showing up in 2022.
And as a reminder, keep in mind that these gains are simply timing.
So whether it's next quarter or next year, using Albertson's most recent share price, a sale of our position would result in a gain in excess of $30 million or in excess of $0.30 a share of FFO.
However, I think it's worth drilling into the components.
As it actually represents a beat in excess of 10% off of our initial midpoint.
As you'll recall, within our initial range of $0.98 to $1.14, we had incorporated $0.05 to $0.13 of core and fund transactional activity, which, as we highlighted, was primarily attributable to the sale of Albertson shares in 2021.
So after adjusting for the $0.05 to $0.13 of transactional income, we had guided toward $0.93 to $1.01 for a midpoint of $0.97.
And given our expectation of near-term FFO of $0.25 to $0.27, this gets us in the [Indecipherable] 15:04 106, 108 in range for 2021, and that's without any Albertson shares, which is more than 10% above the midpoint of our initial range as well as 5% to 7% above the high end of our range.
And as I had updated on our progress throughout the year, this beat was largely driven by approved fundamentals within our core business around lease-up and credit improvements and not onetime accounting adjustments related to reserves taken in prior periods.
In terms of cash collections, we received over 97% of our core billings during the quarter.
And as a reminder, each 1% increase in collections equates to increased earnings of approximately $500,000 per quarter or $2 million, representing over $0.02 of FFO when annualized.
While we are virtually back to pre-pandemic collection rates, the remaining portion of our uncollected billings is largely coming from the small population of quick service restaurants in our portfolio.
I now want to spend a moment on what we are seeing on our tenant sales productivity.
Given the high-quality inventory we have available to lease, we are closely watching the sales productivity of our new tenants, particularly those recently leased street locations as this educates us not only on the level of future tenant demand, but more importantly, the potential upside to drive rents beyond the $25 million of core internal NOI growth that we are anticipating.
Both we and our tenants are incredibly pleased with their performance to date.
In fact, Art Street tenants are seeing sales well in excess of their internal projections.
For example, some of our recent openings in Chicago and New York Metro are already seeing early results trending in the $2,000 a foot range.
And keeping in mind, this is even before the return of international tourism, back to office and the lingering pandemic concerns.
Now moving on to our same-store NOI.
Same-store NOI also came in above our expectations at approximately 7%, and this was driven by improving occupancy and a continued reduction in our credit reserves.
It's also worth highlighting that the 7% is a pretty clean number.
As we had highlighted in our release, the vast majority of prior period adjustments that were recognized this quarter arose from a property that was not included in our same-store pool.
And as Ken mentioned, we are seeing actionable rental rates returning, and in some instances, actually exceeding pre-COVID rents across our market.
In fact, this was evident in our leasing spreads this quarter as we saw a cash increase of approximately 11%, along with a GAAP increase of 19%.
And this was driven by our street leasing during the quarter, including a cash spread in excess of 20% on one of our key street locations on Melrose Place in Los Angeles.
It's worth highlighting that this rent substantially exceeded our initial underwriting for this space, which, as a reminder, we closed on our acquisition of Melrose Place just before the onset of COVID in the fourth quarter of 2019.
Additionally, as Ken mentioned, we are seeing similar trends on Armitage Avenue in Chicago, with recent trends in excess of 30%, which is also well above our initial underwriting.
Now it's also worth mentioning the structural differences between our street and suburban leases and why the point in time lease spreads that are disclosed in our quarterly results are often not really comparable when evaluating deal profitability or more importantly, future growth expectations, given that we tend to reset our street leases to market every five years or so as compared to 10 to 15 years or often much longer on a suburban lease.
Coupled with the fact that street rents contractually increase 3% annually as compared to 1% of suburban lease.
And just to illustrate the difference, if we were to assume that a street lease grows contractually 3% a year and achieves a fairly modest 5% spread every five years.
In order for our 10-year suburban lease that has grown at 1% to achieve an identical CAGR, it would need to achieve a spread of approximately 25%.
I now want to provide an update on the internal core NOI growth that we see playing out over the next few years.
And as a reminder, we anticipate growth of $25 million by year-end 2024, resulting in over $150 million of core NOI.
And as it relates to the short term, we remain on track, if not ahead of our previously announced expectation of achieving our pre-COVID NOI by late 2022 or early 2023.
As a reminder, the three key drivers of our approximately $25 million or 20% increase in our core NOI off of our 2020 NOI include: first, net absorption, which is the profitable lease-up of our core portfolio and is offset by anticipated tenant expirations over this period.
And we are anticipating that this generates us $10 million to $15 million of incremental NOI, representing $0.11 to $0.16 of FFO.
Second piece is further stabilization of our credit reserves, contributing $5 million to $6 million of incremental NOI or $0.05 to $0.06 of FFO; and lastly, contractual rental growth of $8 million to $10 million.
In terms of the most impactful are the $10 million to $15 million of net absorption, I want to provide some insights on how we see it playing out over the next few years.
Given the significant volume and profitability of the new leases signed to date and using our anticipated rent commencement dates on these executed leases, this should largely replace the NOI of the previously discussed tenant expirations at 565 Broadway in SoHo and 555 nine Street in San Francisco for the first half of 2022.
As previously discussed, the impact of these two expirations, which occurs in October 2021 for 555 nine and January 22 for 565 Broadway is approximately $4 million or roughly $4.6 million of annual NOI when factoring in recoveries.
As Ken discussed, we have already profitably leased 565 Broadway several months in advance of the current lease expiration, thus significantly minimizing any downtime with an anticipated rent commencement date in the second half of '22.
So when coupled with the remaining portion of our $16 million lease pipeline coming online, this sets us up for solid NOI growth in the $2 million to $3 million range in the second half of 2022, with the balance of that remaining growth coming from positive absorption split fairly evenly between '23 and '24 as the balance of our pipeline kicks in.
The second driver of our NOI growth expects our ongoing stabilization of credit reserves.
At a 97% cash collection rate, we are continuing to incur charges in the $1.5 to $2 million range or $6 million to $8 million when annualized.
Assuming the continued momentum of reopening and retailer strength, we are optimistic that the majority of this should largely return in the second half of '22.
And the last piece comes from internal growth of contractual rental increases.
We are continuing to see the 3% contractual growth in our street leases.
So when blended across our suburban and urban assets, this averages to about 2% a year, contributing approximately $3 million of incremental annual NOI.
So given the significant progress our team has made this year and accelerated recovery within our portfolio, we are anticipating meaningful NOI and FFO growth for the next several years, and that's before we layer in the impact of any accretive redevelopments, external growth or the profitable transactions that we anticipate will continue to occur within our fund business.
Now moving on to our balance sheet.
We have not issued any equity since our most recent call.
As Ken mentioned, given our size, each $100 million of investments, whether it be core fund, should result in FFO accretion of approximately 1%, and our balance sheet is well positioned to capture this accretion with ample liquidity available in our corporate facilities, along with the cost of capital that we believe enables us to accretively transact on a growing external investment pipeline.
So in summary, we had another strong quarter as the recovery continues to play out across our portfolio, and we are feeling increasingly optimistic on our internal growth outlook as we look forward the next several years.
Today, I'd like to provide a brief update on our fund platform, beginning with Fund V. First, we are pleased to report that fund deal flow is kicking in.
Like the balance of our Fund V portfolio, these two properties were acquired at a substantial discount to replacement cost.
Including land, our blended cost basis for these two centers is approximately $130 per square foot.
In comparison, the cost to construct a new suburban shopping center is approximately $200 to $250 per square foot, and that's excluding land cost.
Additionally, both properties rank number one in their respective markets based on foot traffic, consistent with our best game in town acquisition strategy.
The resiliency of Fund IV stems from our needle in a haystack approach to acquiring these types of centers.
Due to our selectivity at acquisition, we've seen a Fund V collections rate that is now in the high 90s, consistent with our core portfolio and a stable mid-teens leverage return, which we're able to achieve given our use of 2/3 leverage in our fund platform.
Even during the pandemic, our cash-on-cash yields only dipped to approximately 13%.
Looking ahead, we expect to be back to 15% relatively quickly.
Similarly, on an unlevered basis, our 8% yield dipped to approximately 7% during the pandemic and is now on a projected path back to 8%.
Over the life of our investment, we expect to generate most of our return from operating cash flow.
That said, as previously discussed, there is a very tangible opportunity for outsized performance due to cap rate compression and thus property appreciation.
Here are a couple of indicators we're watching.
First, real estate borrowing costs have returned to their pre pandemic levels in the mid-3% range.
Additionally, public market cap rates for the shopping center REITs are approaching a decade low level.
While private market cap rates for the type of product we're targeting have remained flat at approximately 7.5%.
In fact, transactional cap rates in the private market are at a historically widespread to underlying borrowing costs.
As a result, we believe that signals are pointing to a reversion to the mean in the private markets too over the next few years and when that happens, we will have aggregated a $1 billion portfolio, where every 50 basis points of cap rate compression would add 250 to 300 basis points to our projected IRRs, increasing overall fund profitability and in turn, our GP incentive compensation.
In the meantime, we are continuing to clip attractive returns and selectively adding to this portfolio.
To date, we've allocated approximately 75% of our Fund V capital commitments, and we have until August of 2022 to deploy the balance.
Given the amount of capital on the sidelines and recovering retail fundamentals, this is also a good time to opportunistically harvest properties in our older vintage funds.
One area of focus is our grocery-anchored properties, which have gotten a pandemic boost and remain in favor in the capital market.
Last quarter, as previously discussed, we completed the sale of four grocery-anchored properties in Fund IV.
Looking ahead, we anticipate that our disposition volume will be focused on this product type.
Finally, turning to Fund II and City Point.
We continue to see positive momentum at this iconic property with shopper traffic and tenant sales both continuing to increase and the recent opening of BASIS Independent and Elementary School in approximately 60,000 square feet in Phase III.
On the leasing front, we're pleased to report that last week, we executed a lease with an international retailer for 70% of the space formerly occupied by Century 21.
We look forward to sharing more details over the next several weeks, but in the meantime, know that we are excited by this addition, which nicely complements our existing merchandise mix.
The new lease replaces nearly all of Century 21's prior rent obligations with 30% of the space still remaining to be leased.
Construction is anticipated to commence shortly, and the retailer is expected to open in the second half of 2022.
With all these positive indicators, this is an appropriate time for us to go to market to refinance this project over the next several months.
So in conclusion, our fund platform remains well positioned with a successful capital allocation strategy and a portfolio of existing investments that continue to march toward stabilization.

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q3 ffo per share $0.27 excluding items.

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