Phillips Edison & Company, Inc. Q1 FY2023 Earnings Call

Good day, and welcome to Phillips Edison & Company's First Quarter 2023 Earnings Conference Call. Please note that this call is being recorded. I'll now turn the conference over to Kimberly Green, Head of Investor Relations. Kimberly, you may begin.

Thank you, Operator. I'm joined on today’s call by our Chairman and Chief Executive Officer, Jeff Edison; our President, Devin Murphy; and our Chief Financial Officer, John Caulfield. Once we conclude our prepared remarks, we will open the call to Q&A. After today's call, an archived version will be available on our Investor Relations website. As a reminder, today's discussion may contain forward-looking statements about the company's views of future business and financial performance, including forward earnings guidance and future market conditions. These are based on management's current beliefs and expectations and are subject to various risks and uncertainties as described in our SEC filings, specifically in our most recent Form 10-K and 10-Q. In our discussion today, we will reference certain non-GAAP financial measures. Information regarding our use of these measures and reconciliations of these measures to our GAAP results are available in our earnings press release and supplemental information packet, which are on our website. Please note that we have also posted a presentation with additional information. Our caution on forward-looking statements also applies to these materials. Now, I'd like to turn the call over to Jeff Edison, our Chief Executive Officer. Jeff?

Thank you, Kim, and thank you, everyone, for joining us today. The PECO team delivered another solid quarter of growth with same-center NOI increasing by 4.9% and achieving record highs in occupancy, renewal leasing spreads, and retention. The consistent strength of our operating performance is attributed to both our differentiated focus strategy of exclusively owning grocery-anchored neighborhood shopping centers and our team's ability to drive results at the property level. I know you've heard the PECO team say it many times before, but it bears repeating: format drives results, and not all space is created equal. We focus on exclusively owning right-sized neighborhood shopping centers anchored by the number one or two grocer in the market, with over 70% of our rents coming from necessity-based goods and services. Why? Because we know the average American family visits a grocery store 1.6 times per week. Our grocers draw consistent daily foot traffic to our shopping centers, benefiting our small store spaces. While our right-sized grocery-anchored format is a critical pillar of our long-term success, we believe the quality of our portfolio continues to be another important differentiator. At PECO, we define the quality of our portfolio through the use of the acronym SOAR. This includes spreads, occupancy, the advantages of our markets, and retention. PECO's high new and renewal leasing spreads are driven by demand from our neighbors. Our retailers provide necessity-based goods and services that serve the essential needs of our communities. We pride ourselves on being locally smart and creating neighborhood centers that have the optimal merchandising mix for the communities they serve. Our leasing pipeline continues to remain strong, and there are currently no signs of its slowing. The most active categories continue to be medical, quick-serve restaurants, and health and beauty. We're also seeing consistent strong demand across all geographic regions. PECO's record occupancy level of 97.5%, combined with the leasing spreads I just mentioned, are a sign that retailers are successful at our centers. Our neighbors want to be closer to the customers and in the neighborhoods of the communities they serve. Our lease portfolio occupancy increased by 10 basis points sequentially from the fourth quarter and by 130 basis points year-over-year, reaching an all-time high of 97.5%. We still believe there's occupancy upside in the portfolio. When occupancy as a driver of growth is no longer available, we believe our NOI growth will continue as our rent spread growth increases because of our pricing power. In addition, our exposure to at-risk retailers continues to remain limited. This is deliberate and a result of our grocery-anchored strategy focused on necessity-based goods and services. PECO's unique advantages in the market are driven by our focus on the number one or two grocer. Our strategic presence in the Sunbelt and other fast-growing suburban markets. Our top neighbors are strong grocers; Kroger and Publix are PECO's number one and two neighbors, respectively. PECO is Kroger's largest landlord and Publix's second largest landlord. PECO's trade area demographics are in line with Kroger's and Publix's store demographics. Our centers are close to the end consumer where America's leading grocers make money and in turn, our neighbors make money, which allows PECO to make money. In addition, our portfolio is geographically diverse. Rather than focusing exclusively on coastal markets, we focus on well-located suburban markets with growing populations and strong demographics. We compete on the corner of Maine and Maine. Our neighbors are a healthy and diverse mix of national, regional, and local retailers who run successful businesses and enable us to grow rents at attractive rates over time. We continue to have excellent success retaining our current neighbors, as demonstrated by our first-quarter retention rate of 95%, a record high and well ahead of the historical five-year average of 87%. Our local neighbors remain resilient and are successful retailers who have been in our centers on average for 8.8 years. Importantly, they differentiate and enhance the merchandising mix that our neighborhood centers offer. With more than 30 years of experience in the grocery-anchored shopping center industry and an informed perspective on what drives quality and success at the property level, we believe SOAR provides important and sustainable measures of quality which drive long-term growth: spreads, occupancy, the advantages of our market, and retention. If history is any indication, PECO's right-sized grocery-anchored neighborhood shopping centers will continue to be resilient in all market cycles. Devin will provide more details on our cycle-tested performance in a moment. Looking ahead, we continue to benefit from a number of positive structural and macroeconomic trends that create strong tailwinds and drive neighbor demand. These trends include the healthy consumer, hybrid work, migration to the Sunbelt, population shifts that favor suburban communities, and the importance of physical location in last-mile delivery. These demand factors are further amplified due to the limited new supply and lack of new retail construction since 2008. When we consider our pricing power indicated by continued strong demand and record high renewal spreads, occupancy and retention, combined with the advantages of our markets, our necessity-based retailers, and the aforementioned tailwinds, we believe our growth strategy will continue to generate more alpha with less beta. With higher interest rates and constrained capital availability in the market, we continue to be patient and use our national platform to be opportunistic. On the transaction front, we're pleased with our strong acquisition volume in the first quarter, which was largely driven by activity that started last year. These high-quality right-sized grocery-anchored neighborhood centers fit well with our PECO portfolio. These properties will drive incremental earnings growth that will allow us to achieve and exceed our acquisition hurdle of a 9% unlevered IRR. We are also pleased with the performance of our acquisitions relative to our underwriting. On average, assets acquired since our IPO are outperforming relative to the underwriting. The transaction market continues to be fragmented and sporadic, and we're seeing a slower pace in the second quarter. While we're seeing cap rates move in the private markets in response to higher interest rates, there are still wide gaps between buyer and seller expectations. That being said, we are affirming our guidance for $200 million to $300 million of net acquisitions this year. We provide a wide delta in our range because it allows us to be strategic based on current market conditions and still deliver on our expectations. We remain focused on accretively growing our shopping center portfolio, and we will continue to be opportunistic as we always are. There's no question that record inflation, rising interest rates, global conflict, and bank failures continue to create challenges. Despite these headwinds, we remain focused on investing in our portfolio and driving cash flow growth. With our combined internal and external growth drivers, we continue to believe our portfolio can deliver mid to high-single-digit FFO per share growth on a long-term basis. In addition, we still have one of the lowest-levered balance sheets in the shopping center space. With a fortress balance sheet and ample liquidity, we remain prepared for challenges and opportunities that may arise for the rest of this year. I would like to provide a quick update on the proposed Kroger and Albertsons merger. While there haven't been any major new developments in the merger, we remain positive on the impact that it will have on our centers. We continue to believe it is ultimately a positive for PECO, for our centers, and for the communities our centers serve if the merger should occur. If the merger does not occur, our Albertsons-anchored centers will continue the strong performance that they have enjoyed to date. With that, I will now turn it over to Devin.

Thank you, Jeff. Good afternoon, everyone. Thank you for joining us. The operating environment remains strong. Our leasing team continues to convert strong retailer demand into higher rents at our centers. Jeff highlighted earlier the continued strength in leasing, but let me emphasize a few metrics of note. Our anchor occupancy increased to 99.3%, and our inline occupancy increased to 94.3% during the first quarter. Year-over-year increases of 120 basis points and 170 basis points, respectively. Leasing activity remains strong, and our volume of deals executed in the first quarter increased year-over-year to 263 leases executed, totaling 1.1 million square feet compared to 244 leases executed and 800,000 square feet leased a year ago. PECO's retention rate this quarter was exceptional at a record high of 95%, driven by increases in our small shop retention rate to 83.3%. High retention means no downtime and lower tenant improvement costs. As a reminder, our tenant improvement spend on renewals over the last five years has averaged below $2 per square foot. We continue to remain optimistic that we can drive favorable lease terms, including attractive re-leasing spreads with solid contractual rent bumps. Comparable new and renewal rent spreads for the first quarter were strong at 27.4% and 16.1%, respectively. On average, our new and renewal inline leases executed in Q1 had annual contractual rent bumps of 2.8%, another important contributor to our long-term growth. The leasing spreads that we are continuing to see, combined with our record high retention rates, are clear evidence of the continued high demand per space in our grocery-anchored centers. Our strong and steady pricing power is a reflection of the strength of our strategy and the quality of our portfolio. Turning now to our redevelopment and development activities. We continue to invest in value-creating ground-up outparcel development and repositioning projects. This activity remains a great use of our free cash flow and produces attractive returns with limited risk. We are making great progress on these projects and we are working hard to continue to build our future pipeline. In the first quarter, we stabilized three projects, which delivered over 74,000 square feet of new space to neighbors and added an incremental NOI of approximately $930,000 annually at returns on cost of approximately 10%. These projects provide superior risk-adjusted returns and have a meaningful impact on our long-term NOI growth. For the full year of 2023, we continue to expect to invest $50 million to $60 million in ground-up outparcel development and repositioning opportunities with average estimated cash-on-cash yields between 9% and 12%. We continue to see the many benefits of our grocery-anchored portfolio with a healthy mix of national, regional, and local retailers. More than 70% of our rents come from neighbors offering necessity-based goods and services. And our top grocers continue to drive strong recurring foot traffic to our centers. Our foot traffic in Q1 remained strong and was in line with the first quarter of 2022 levels. Looking ahead, we and our neighbors believe consumers will continue to visit our centers and spend on necessity-based categories, even if they reduce spending on luxury items and other discretionary purchases. Our portfolio has proven to be resilient through economic downturns historically. When we look at PECO's performance following the 2008 global financial crisis, it highlights the resiliency of our grocery-anchored portfolio. We currently own 29 centers that were owned by us in 2008. We went back and reviewed the performance of those assets. By 2010, NOI had decreased by 270 basis points but recovered to pre-GFC levels by 2011. Occupancy declined by 180 basis points to its lowest level in 2009 but fully recovered by 2010. Looking back at 2020 and the COVID-induced downturn, PECO lost just 70 basis points of occupancy during the peak of the pandemic, and we fully recovered by the middle of 2021. We lost the weaker operators during 2020, and today our small shop neighbors, including our locals, are strong and thriving in our centers. Our neighbors continue to demonstrate their resiliency and ability to manage the many challenges they face, including inflation, supply chain issues, and labor shortages. Despite these many challenges, our neighbors continue to invest in their stores and technology platforms in order to provide high-quality customer experiences. We believe PECO's portfolio continues to be well-positioned given our grocery anchors, our right-sized format, and our necessity-based neighbor mix. We enjoy a well-diversified neighbor base. Our top neighbor list is comprised of the best grocers in the country, and our largest non-grocer neighbor makes up only 1.4% of our rents. That neighbor is T.J. Maxx. All other non-grocer neighbors are below 1% of our ABR. To put a finer point on that, PECO has no exposure to luxury retail, office, or theaters, and very limited exposure to distressed retailers. The top 10 neighbors currently on our watch list represent just 2% of our ABR. As a reminder, our combined exposure to Bed Bath & Beyond, Party City, and Tuesday Morning is minimal at just 40 basis points of ABR. In summary, our differentiated strategy continues to position PECO well for continued steady growth in all economic cycles. Due to our exclusive grocery-anchored focus, our necessity-based neighbor mix, our right-sized format, our well-positioned locations in growing suburban markets, our record high occupancy with continued strong neighbor demand, our high leasing spreads, and record high retention rates, our strong credit neighbors and diversified neighbor mix, the lack of exposure to distressed retailers, our strong balance sheet, and most importantly, our well-aligned and cycle-tested teams. I will now turn the call over to John.

Thank you, Devin, and good morning, and good afternoon, everyone. First quarter 2023 Nareit FFO increased 13.9% to $76.3 million or $0.58 per diluted share driven by an increase in rental income, partially offset by higher property operating expenses. First quarter core FFO increased 7.7% to $78.2 million or $0.59 per diluted share driven by increased revenue at our properties from higher occupancy levels and strong leasing spreads, partially offset by higher property operating expenses. Our first quarter 2023 same-center NOI increased to $98.6 million, up 4.9% from a year ago. This improvement was primarily driven by higher occupancy and an increase in average base rent per square foot, driven by our strong leasing spreads. In addition, we collected approximately $2 million in overage rent in the first quarter, a 69% increase over last year, reflecting the strong sales performance of our grocers. Overage rent is typically annual and is highest in Q1, so I will note that we do not expect this again until Q1 of next year. During the quarter, we acquired four Publix-anchored shopping centers for $78.7 million. These neighborhood centers are located in suburbs of Atlanta, Miami, and Nashville with strong median household income and growing populations. We expect to drive growth in these assets through occupancy increases and rent growth. From a balance sheet perspective, we ended the quarter with approximately $622 million of borrowing capacity available on our $800 million credit facility, and we have no significant debt maturities until the second quarter of 2024. Between annual free cash flow of approximately $100 million generated by our portfolio and the significant capacity available on our revolver, we are confident in our ability to fund our growth plans. We continue to closely monitor the debt capital markets for the right opportunity to extend our maturity profile, and this is a high priority for us. In this uncertain market, we are considering all available options in order to obtain the lowest cost of capital for our debt, including the unsecured public bond market, private placements, secured, and bank markets. We anticipate addressing our 2024 maturities along with long-term funding for our acquisition volume later this year. Our low leverage ratio continues as a result of our strong earnings growth, as well as our prudent balance sheet management, with our net debt to adjusted EBITDAR remaining at 5.3x as of March 31, 2023. At the end of the first quarter, our debt had a weighted average interest rate of 3.8% and a weighted average maturity of 4.1 years. Approximately 82% of our debt was fixed rate. During the quarter, PECO opportunistically executed a three-year forward-starting swap effective September 15, 2023, with a notional value of $200 million at a rate of 3.36%. We are pleased with the continued strength of our business and are affirming our full-year guidance for Nareit FFO and core FFO per share. We are also affirming our same-center NOI guidance of 3% to 4%. We do anticipate earnings to moderate in the remainder of the year due to the seasonality of our earnings, as well as a result of higher interest expense, which is reflected in our guidance assumptions. As Jeff mentioned, we believe we continue to be well-positioned for long-term growth, and we are delivering strong internal and external growth. Importantly, we have the flexibility to be patient and pursue accretive opportunities as they arise that we expect to provide meaningful NOI contributions in 2023, 2024, and beyond. Maybe most importantly, as we consider the current economic uncertainties, we continue to have one of the strongest balance sheets in the sector, allowing us the ability to remain on offense and pivot quickly and respond strategically to market conditions. With that, we look forward to taking your questions.

Your first question comes from Craig Schmidt with Bank of America. Your line is open.

Thank you. When reviewing PECO's results and position, it seems unlikely that anything could hinder your operating results. The leasing continues to be strong, and even if consumer activity declines in the latter half of the year, that would likely affect 2024 more than 2023. I'm curious about what factors you are observing that might result in a downside for your earnings this year.

Craig, thanks. This is Jeff. Thank you for the question and the call. And I think your analysis is accurate. I do think that 2023 is fairly well baked. There are always questions and concerns out there, but as you point out, I mean, we don't have exposure to the big box potential closures that are out there. And obviously, we are impacted on the interest rate side to an extent, but we are highly fixed. I think we're fixed in the 80% range, but those would be the things that we're looking at. And then obviously a change in the consumer. But as you point out, that's really an effect for 2024, 2025 than it is for 2023.

Great. And then just I noticed the last four assets were acquired in the suburbs of some more major markets. I just wonder if you're looking to grow in the larger MSAs, and then what is the current occupancy level of these four assets?

I would like to know the exact occupancy number of the four assets. However, I want to highlight that our top 10 markets include Atlanta, Dallas, Chicago, Sacramento, Denver, Minneapolis, Washington, D.C., Las Vegas, Tampa, and Phoenix. These key markets are quite similar to the two projects we purchased in Florida and the one in Nashville, where we have significant experience. Specifically, Atlanta, Nashville, and the mid to Southern Florida regions are critical areas for us, and we plan to maintain our focus there. John, do you have the occupancy numbers?

I do have those. They're about 93% occupied across the four of them. And so we have opportunity, as Jeff said, to grow through both occupancy gains as well as pushing rents.

Yes. We have also acquired some land that will provide us with additional opportunities in the future, which we are excited about, and we are already making significant progress with those assets. So, I believe we are on track to achieve our initial projections, which were consistently high. We anticipate returns well above nine unlevered, and we consider that to be a strong return in the current market.

Jeff, the only thing that I would add, Craig, John gave you the average occupancy of the four, but one of the properties has an occupancy level in the mid-80s, and we see pretty attractive upside in that particular asset.

Your next question comes from the line of Caitlin Burrows with Goldman Sachs. Your line is open.

Hi, good afternoon, everyone. Jeff, I think you mentioned that a lot or maybe all of the acquisitions that you did in 1Q had been started in 2022. So I was wondering now as you think about the pipeline that you have and your expectations for the year, is the guidance that you guys laid out based on activity that you're already seeing, or to what extent is it just activity you think will come to fruition as the year goes on?

Well, Caitlin, thanks for the question. I think we had a strong first quarter, and our backlog going into the second quarter is much more muted than what we got in the first quarter. So that's why we're keeping a pretty wide range on the acquisition target for the year. I would say that we are less than certain about where the market is going to be between now and the end of the year. And that's what's really going to drive our results in terms of how much we acquire. And again, we've got to feel confident that we've got that number one or two grocer and that we're in markets where we can really grow rents and grow occupancy. And if we can get that and get to that nine unlevered, we will be at the high end of the range. If we can't, we'll be at the lower end of the range, and that's how we're sort of thinking about it.

Got it. Okay. And then maybe switching over to the balance sheet. So you guys have the interest rate swaps expiring in September, and you've now addressed $200 million of that. I guess going forward, how are you thinking about the remaining $55 million, but maybe bigger picture, what the right amount of floating rate debt is to have and how that may play into your decisions for addressing the 2024 maturities?

Great. John, do you want to take that in terms of our plan?

Sure. Good afternoon, Caitlin. So we are floating, we're about 81% fixed today, and we did execute that swap opportunistically. I think as I said in the prepared remarks, we are trying to keep all of our options open and the different strategies come with either fixed or then we can kind of synthesize it with a swap. Our target is certainly to be higher; I would say certainly above 90%, 95% would be our long-term target. But at this time, as we are evaluating our opportunities to extend 2024 maturities and fund our 2023 acquisitions, we will swap and fix at that time. But part of it was just taking some pieces off the table over time as well.

Your next question is from Tayo Okusanya with Credit Suisse. Your line is open.

Hi, yes. Good afternoon, everyone. Congrats on another solid quarter. I wanted to talk about just guidance. You guys maintained it, but when you look at your 1Q performance, again, granted maybe there's some overage rent in there and that's not going to recur for the rest of the year, but if we should just annualize your first quarter, you kind of are even further ahead than the high-end of your current guidance, and you're probably going to do more by way of acquisitions in the rest of the year. So just kind of curious how you're thinking about guidance right now, especially kind of like the low end and the high end relative to your strong performance in 1Q.

Yes, thanks for the question. We will be conservative in the first quarter as we gain more visibility into the rest of the year. We had a strong percentage of rent paid in the first quarter, which was positive, driven by robust sales at our grocers. This pattern will recur each year, particularly in the first quarter. Overall, our approach is to be relatively conservative when it comes to affirming or accelerating our guidance. In this current environment, we will lean towards caution due to the uncertainty in the economic landscape, including interest rates. As we obtain more clarity, we will become more confident as the quarters progress.

That's helpful. And then just curious again for your kind of some high-level thought heading into ICSC that's kind of given you confidence about future demand or not, and also specifically to kind of see the new kind of retailer categories that are meeting with your leasing team. And just a general sense of heading into ICSC, what's that's telling you about kind of the demand environment?

Yes, we have a very robust backlog of meetings related to leasing. All signs indicate that retailers continue to show strong demand based on ICSC bookings. We're also hearing informally that there will be a significant number of products entering the market, especially from our target grocery-anchored projects involving one or two grocers. Several of these projects are expected to launch as part of the ICSC. Historically, this has been cyclical, and our brokerage indicates that there should be solid demand at ICSC, but we will need to observe how it unfolds. Activity looks promising, and they are estimating around 25,000 to 30,000 attendees. While this isn't quite back to pre-pandemic levels, it's a positive sign. We're optimistic but will wait to see the final outcomes from ICSC.

Hey, Jeff, the only thing I would add to that, Tayo, in terms of where we are seeing retailer demand by category for your question, is it's in line with the current portfolio. So quick-serve restaurants continue to have strong demand for our centers. Medical continues to have strong demand and is a growing percentage of the demand; our current pipeline is approximately 20% of medical. Lastly, health and beauty are also categories where we are continuing to see strong retailer demand. Those retailers do not seem to be concerned about the strength of the consumer and are being very aggressive in their growth plans.

Great. Thank you.

Yes. Did we address your question, Tayo? I want to make sure we covered everything.

All right. I guess we did hopefully.

Your next question is from the line of Mike Mueller with JP Morgan. Your line is open. Take you off mute there. That would help.

So quick question in terms of the small shops, is the mix today any different than it was, say, heading into COVID? I mean, has it evolved significantly?

There are two answers to that. One is that there was a considerable amount of time between the great financial crisis and the pandemic. As a result, some weaker retailers managed to survive due to market conditions. When the pandemic occurred, it eliminated many of those marginal players. Looking at the current situation, we believe we have a strong, if not stronger, base than we have ever had regarding our small tenant makeup. Over a long period, we have maintained a local presence that remains around 25% of our small stores, with regional and national retailers making up the larger portion. I’m not sure if Devin has any additional points about the mix we have.

Yes, Mike, the only thing I would add to what Jeff said is that in terms of medical, a number of those retailers tend to be more local neighbors. As we look at our portfolio, what we like about that use is, number one, they typically sign longer leases and they're very resilient. On average, in our portfolio, the local medical neighbors have been in our centers for 10 years on average. So they sign long leases and they stay in the space. The other use that has evolved is health and beauty. Again, we like this because it tends to be e-commerce resistant. You can't get your hair done and your nails done on the internet. And so with medical, it's an e-commerce resistant use. Again, similar to medical, these local tenants tend to sign longer-term leases. In our portfolio, they've been in the space for on average over 11 years, so again, resilient. So that's been the evolution in the local neighbor base in those particular categories. We believe that that evolution is highly constructive given the length of time that the tenants are signing up for and the fact that they're continuing to be tenants for over 10 years.

Got it. And then just a quick follow-up; I think the inline occupancy is 94.3%, if I'm not mistaken. Where do you see the ceiling for that?

Mike, as we've said consistently, we think we've got another 100 to 200 basis points of upside in that metric. As we continue to emphasize, we know that the level of occupancy that we've been able to achieve in the portfolio is potentially perceived as a weakness, which is an interesting concept with a strength being highlighted as weakness. But as we've continued to state what we are doing, given the high level of occupancy that we have is we're pushing spreads. As you can see in the first quarter, our spreads were 16%, which is higher than they've been at any point over the last five quarters, and is meaningfully higher than that metric has been historically. That's how we'll continue to drive NOI growth, which as we bump up against this ceiling in terms of occupancy, we will continue to push rents. And as you've seen from our metrics in the first quarter, we've been able to do that.

Your next question is from the line of Haendel St. Juste with Mizuho. Your line is open.

Hey there, thanks for taking my questions. My first question's on the watch list. I think you mentioned in your remarks that it's about 2% overall, but then you also mentioned you have about 40 basis points of exposure to Bed Bath, Party City, and Tuesday Morning. So I guess can you talk about what else is on that list, what other categories you're concerned about? And also remind us what you've budgeted in your guidance this year for known or anticipated tenant risk and what your bad debt reserve for unanticipated tenant risk is? Thanks.

Great. Thanks, Haendel. Thanks for calling in. Devin, do you want to take the first and then John, do you want to talk about the bad debt question?

Sure. Hi Haendel, thank you for joining the call. Regarding the three tenants – Party City, Tuesday Morning, and Bed Bath – I want to emphasize that we have five Party City locations in our portfolio, and we anticipate all five leases will be assumed, meaning we won't need to find replacements for those stores. For Tuesday Morning, we have three locations; two have already been backfilled, and one is currently being negotiated. The rental metrics for those locations are significantly better than the current rents, with increases in the range of 20% to 25%. As for the two Bed Bath locations in our portfolio, we haven't backfilled them yet, but we are optimistic about the future rental rates. One store has a $6 rent that we believe can increase to the low double digits, while the other is expected to decrease slightly from an $11 rent to a $9 rent. Overall, we are not worried about the impact of these three tenants on the portfolio. Regarding our watch list, we have our top 20 tenants monitored, which includes a diverse array from physical therapy retailers to pet and personal care businesses. None of these tenants account for more than 30 basis points of our annual base rent. The diversity in our rental income continues to provide us with stability, so we do not have significant concerns about any specific category on our watch list.

And I will jump in on the bad debt. So we do provide guidance disclosure, and this portfolio has consistently delivered over a long period of time between 60 basis points and 80 basis points of bad debt. That is what our guidance is based off of. Our experience in the first quarter is right down the fairway on that. We do space-by-space budgeting, but with regards to unexpected fallout or things like that. But to Devin's point, we just don't have that volatility. So I think we're in a good place from a guidance perspective.

Great. That's very helpful. I think that's all I had on my list, so thank you. I'll yield.

Yes. Thanks, Haendel.

Thanks, Haendel.

Your next question is from the line of Ronald Kamdem with Morgan Stanley. Your line is open.

Hey, just two quick ones. Some of these have been asked already, but just going back to the acquisitions, I see the cap rate. Just remind us how those deals came about, number one, and then number two, after the events of the past month and a half, do you think that people are still on pause and that activity is going to pick up in the second half of the year? Or just trying to figure out when does this tight lending environment translate into more deal activity, more opportunities for the company and for your pipeline? Thanks.

Thanks, Ronald. If you look at the four projects, each one has a very specific story. That story at its core is about a seller that is motivated because in this environment, you're seeing a transition; we're really trying to find motivated sellers who will accept the new pricing. We were able to do that by finding assets that had significant upside to them. A lot of that was in new leasing spreads, and a lot of it was in new development opportunities and then contractual ramp up. These were things very specific to the property, but they allowed us to have what could be perceived as a more aggressive cap rate, but with a lot of upside. One of the ways we were able to bridge the gap between the seller and our pricing expectations. Those would be things like the last asset in a fund, institutional owners with alternative needs for portfolio management in terms of what they were selling. So it was a variety of different pieces, but all sort of had the similar story, which was a motivated seller. In terms of pace, we'll see a lot from FDIC, I think that will tell us a lot about what type of pace we can anticipate for the second part of the year. I do think it'll be muted this year. I think across the board it will be difficult to find appropriately motivated sellers. But it's a big market; we have 5,800 centers across the country that we'd like to buy and with the number one or two grocer and the demographics that we want. It's a big market, and there is always volume in it. But obviously, it's a lot more muted today as pricing gets recognized. Does that answer your question, Ronald?

Yes, that was perfect. And then just my second question was just going back to the swaps. I'm just looking at the debt page on the supplemental. I guess I'm trying to figure out, when I look at 2024 and I see those three term loans coming due, what's going to happen to those? What's the mark-to-market on the interest cost there? Where do you think you can issue today and how should we think about when those come due? What are you guys planning for that? Thanks.

Sure. Yes. So Ron, we are very focused on those 2024 maturities. As we look at the various options we have, they come with different rates. From a swap-in rate perspective, there can be some variability, but it goes anywhere from the low-5s to the low-6s. When you look at where those interest rate swaps are at close to 2%, that's probably in the 3.25% to 3.5% range. The swaps we just executed were at 3.36%. If you look at what those swaps are fixing, there is that headwind, but I think the growth of the operating performance of the portfolio is allowing us to continue to grow at a full level. But it is something we're very focused on because it does play into funding our acquisition plans and the like. The reason that I'm less exact on that is because, as I mentioned, we are examining various forms and durations of maturities. But hopefully, that gives you a sense for the rates that we're looking at.

Your next question is from the line of Juan Sanabria with BMO Capital Markets. Your line is open.

I just wanted to follow up on the earnings trajectory off a strong first quarter again. So I guess if you could just break down what's assumed in the sequential drop-off from the percent rent overage rents from the grocers that was one kind of annual event in the first quarter. And then secondly, anything that you're budgeting from an occupancy perspective; there were two Bed Bath stores and a little bit on Tuesday Morning. How should we think about occupancy trending throughout the year? Just thinking about your first quarter performance relative to the bottom end of your guidance range for earnings.

Great. Hey, Juan, thanks for calling in. John, do you want to take that one?

Sure. In the first quarter, we saw an increase of about $0.01 in overage rent compared to the same period last year, which we anticipate will continue into 2024 as our grocers raise their sales volumes. However, we don't expect this increase to occur at the same level moving forward. Additionally, in the second quarter, there tends to be some seasonality in certain expenses that are relatively minor, but they might contribute a bit more than $0.01. Overall, we expect better growth that will shape the range we are aiming for. Normalizing the results from Q1 will yield a different outcome than looking at a full year. When it comes to occupancy, as Devin mentioned regarding our leasing plans, we believe that due to the diversity of our base, we will continue to see growth in our occupancy levels. It’s important to note that the economic conditions have narrowed the gap between our economic and leased occupancy, which highlights our ability to execute leasing and onboard new tenants promptly.

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

Yes. Hi, thanks. I just had two questions. One, John, so in terms of just following up on that guidance a little bit more, you mentioned the seasonality that you anticipate. What exactly are you referring to in terms of seasonality outside of the overage rent that you just discussed? What sort of seasonality are you pointing to in the second, third, and fourth quarters?

It was really my comment was more specific, I would say, to the second quarter. As we look at it, Tayo brought up ICSC. There's a cost, and then you've also got kind of proxy costs, so not a big dollar amount, but then in terms of the sequencing. The stability of our base, it's just that the $0.59 we had had those items that would be difficult to annualize off of. But then as you get to later quarters, then you can see that increase there; there's nothing more than that that I was referencing.

Okay, understood. Regarding the portfolio being well-leased and well-occupied, your leasing spreads have been strong so far. Jeff, you mentioned that you anticipate an improvement in pricing power. How do you determine if you're pushing rents too high, especially considering that around 25% to 26% of your tenants are local businesses? Is this a concern given the uncertainties around the consumer and the economy that you've mentioned, and how do you assess the health of the portfolio?

Yes, that's an excellent question. We discuss this often, and ultimately, when a retailer decides to remain in our shopping center, it directly relates to their profitability in our negotiations regarding retention. Our ability to retain 95% of tenants and achieve 16.1% growth indicates they are not doing this out of charity; they're doing it because they can profit at these locations. Those figures show we are not facing the issues you mentioned about rents being too high for profitability. While there are challenges, many retailers are still eager for long-term business relationships. On average, our smaller stores have been with us for nine years, and they want to secure their space long-term. Therefore, we work diligently on a daily basis to manage options and ensure we receive appropriate rent increases that reflect market conditions. Contractual rent bumps during the lease term have become a more reliable factor of our pricing power. With consistent 3% increases each year over the five-year term for small store spaces, along with bumps at the time of renewal options, we are confident in maintaining market rents. Does that make sense?

Yes, absolutely. Thank you.

Okay. Yes. Thanks. Thanks, Todd.

Your next question is from the line of Floris van Dijkum with Compass Point. Your line is open.

I apologize for that; I was on mute. Looking at a few points, I believe we've previously touched on this. Your shop space seems to present the greatest upside potential, especially in terms of occupancy and rent recovery, as you can regain that space more quickly. You mentioned that your average lease term for shop space has 4.1 years left, but 8.2 years including options. Do all of your shop tenants have an option for an additional term that seems to be around four years, or how does that function? Additionally, I noticed that 13% of your rents are set to expire next year, which represents a substantial opportunity, particularly since the current rents appear low at 13.58%. Could you elaborate on this opportunity and how it could help drive earnings in the future?

Floris, thanks for the call. Devin, do you want to take that or John? Maybe you can walk into the sort of where our mark-to-market feeling is for the leases that are coming due next year.

Sure. Floris, the simple answer is that not every small shop lease has an option. As Jeff indicated, the national retailers push hard for options in order to sign new leases, and that's where the option comes in. John, what's the percentage of our tenants that have options based on the inline guide? Do you know the number off the top of your head?

I don't know that off the top of my head, but it is a mix. I think the 8.2 is a blend of multiple options. The percentage that have them versus someone that has, say, two options versus one option factors into that 8.2.

Yes. We will follow up with you on that and provide the exact specifics. Our leasing team is working hard to negotiate this, as it's an important point for national retailers when signing leases; they look for options in those agreements. What we're aiming to do is account for the annual increases in our market rent and incorporate that into the option rent we are prepared to accept from the retailer. It's a complex consideration that we're factoring in during negotiations. However, your understanding is correct, as with 13% of our rent expiring in 2024 and the current rent levels, there is significant potential for growth in the portfolio that we will realize moving forward.

Yes. Of course, if you look at the renewal spreads that we've got and the fact that we did get 95% renewals. I mean, that's a 16% spread on 13% of your income. I mean, that, that's obviously a real positive impact, maybe slightly overstated depending upon market conditions, but there is certainly opportunity there.

Great, great. Thanks, guys. And maybe Devin, you mentioned something else which sort of caught my attention as well. You said, is it 29 assets that you've owned since 2008? And you talked about how they had limited downside in terms of occupancy during the Great Financial Crisis. I'd be curious, have you guys looked at what the long-term same-store NOI CAGR on those assets that you've owned since 2008 has been? I'm just curious to see if you'd be willing to share that with us.

We owned 29 assets in 2008. Some believe that our portfolio has more potential risk in a downturn. We reviewed how those assets performed during the Great Financial Crisis. Net Operating Income decreased by 270 basis points but recovered by 2011. We saw a loss of 180 basis points in occupancy, yet those assets performed well. We have not yet analyzed the same-store Net Operating Income for those assets over the past 15 years, but we are able to do so. However, from 2017 to 2022, the PECO portfolio achieved same-store Net Operating Income growth in the mid-3s. Many are inquiring how we plan to achieve market-leading same-store Net Operating Income growth. The reason is that we have done it historically, with our same-store Net Operating Income growth in the last five years being in the mid-3s, which is 160 basis points higher than our peers. We believe our strategy is unique and will enable us to achieve better growth than what is generally expected for the sector.

Your next question is from the line of Paulina Rojas with Green Street. Your line is open.

Good morning. In your presentation.

Good morning, Paulina.

Hi, in your presentation you show foot traffic by region, and you have the West lagging other regions. It's not by a huge margin, but the spread has been sticky. So what do we make of this? Are there any implications for the way you are thinking about your asset or portfolio management?

Can you repeat that, Paulina? I wasn't completely clear. You're saying that our traffic numbers indicate that the traffic in the Western states was higher, or I wasn't exactly following which segment you were discussing.

Yes. Yes. You showed the West lagging, so your assets in the West lagging in terms of foot traffic. I think you're indexing everything against 2019, if I remember well.

Yes. It doesn't make total sense because if you look at where we've been able to grow rents and occupancy, the West has actually been one of our strongest regions. My gut is we just don't trust the placer numbers to be accurate to that degree. We look at general trends with that. We look at the sort of pieces, but we just haven't found it to be accurate enough to say that 3% is a real number. We're looking at more directionally how it is. If you look at our grocery sales, you look at our occupancy, and you look at our rent spreads, the West is still performing very well. I don't know how to answer that other than we're not seeing in terms of operating results what placer is seeing on the traffic side.

Yes. I mean, Paulina, the only thing that I would add is we are benchmarking it to pre-COVID to give people perspective on what foot traffic looks like today relative to what it was like pre-COVID. If you look at our 2022 foot traffic, it was 8% higher than 2019, again, the pre-COVID metric, and our foot traffic in Q1 of 2023 relative to Q1 of 2022 was comparable. It was a slight tick lower. Our view on foot traffic is that it continues to be strong. The leasing and sales metrics that we've touched on, we think support that. But the bottom line point is, as we dug into the placer data in detail, to Jeff's point, it can be relied on directionally, but it can't be relied on to give you actual meaningful pinpoint accuracy.

Yes.

Yes. That's exactly right.

Yes.

Yes.

All right. Thank you. I appreciate it.

This concludes our question-and-answer session. I would like to turn the call back to Jeff Edison.

Great. I want to thank everybody for being on the call. This is a great quarter for us. When you have 95% retention, 16% spreads, and you've got 4.9% same-center NOI growth, your record occupancy numbers, we're ahead of consensus on our FFO per share. We're ahead of pace on our acquisitions at returns that are above what we underwrite. Our balance sheet is disciplined and in great shape. So we're very excited about the quarter. We hope that we can continue this positive momentum through the rest of the year. We think our strong results continue to highlight the strengths of our focus and differentiated strategy. Getting that number one or two grocer in there, driving the traffic, making it the right demographic so our small stores can be successful. We give a lot of credit to the team; this team has been doing this for a long time. We've got a fully integrated platform. We are focused on a very specific niche of our business. We think that's going to not only get results for this last quarter but also for the next five years or ten years as we continue to grow this business. So on behalf of the management team, I want to thank our shareholders, our associates, and importantly our neighbors for their continued support, and thanks to everybody for being on the call today.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.