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

Thank you, operator. I am joined on this 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 Once we conclude our prepared remarks, we will open the call to Q&A. After today’s call, an archived version will be published on our website. As a reminder, today’s discussion may contain forward-looking statements about the Company’s view 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 have been posted 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 would 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 3.2% and continued strength in portfolio occupancy and rent spreads. This performance has allowed us to reaffirm the midpoint and tighten the range of our 2023 core FFO guidance. The midpoint represents year-over-year growth of 2.6 %, despite interest expense headwinds of $0.10 per share. We believe we will continue to deliver positive earnings growth despite interest expense and other macro headwinds. The continued strength of our operating performance is attributable to our differentiated and focused strategy of exclusively owning grocery-anchored neighborhood shopping centers anchored by the number one or two grocer by sales in a market, and our ability to drive results at the property level through our integrated and cycle-tested operating platform. Today, we see a continued strong operating environment, and a transaction market that has improved. The consumer continues to be resilient and our grocers continue to drive strong foot traffic to our centers. We remain 98% occupied, which gives us pricing power. Leasing demand continues to be elevated for our inline spaces, and we have limited exposure to big-box retailers. We have a great balance sheet and are well-positioned for accretive acquisitions. We have seen an increase in deal activity beginning in the third quarter as cap rates continue to adjust in response to higher interest rates. Based on our current pipeline, we have increased the low-end of our guidance range for acquisitions. While it’s still a market in transition, we are confident in our ability to close on $250 million to $300 million in net acquisitions this year. We continue to have a very disciplined acquisition process. We remain focused on accretively growing our shopping center portfolio at the right price, while achieving our acquisition hurdle of a 9% unlevered IRR. The acquisitions that we will complete in the second half of the year underwrite to a 9.5%-plus unlevered IRR. With PECO’s experienced in-house acquisition team, we are well-positioned to continue to grow our portfolio. The PECO team looks forward to sharing an update on our acquisition strategy, including case studies, our underwriting process and our targets for 2024, during our Investment Community Day on December 14th. In September, Kroger announced the divestiture plan with C&S Wholesale Grocers in connection with the proposed Kroger and Albertsons merger. We remain cautiously optimistic about the impact on PECO. We continue to believe it is ultimately a positive for PECO, for our centers and for the communities that our centers serve. While the market still gives the merger a low probability of occurring, should it close and 413 stores are sold to C&S, the impact on PECO is a net positive. C&S has been operating for over 100 years, and they are one of the largest wholesale operators with demonstrated experience in retail operations. We believe the recent announcement is potentially a better outcome for PECO than a new SpinCo that Kroger and Albertsons had considered. Importantly, should the merger occur, the majority of our Albertsons stores will be operated by an excellent operator in Kroger. If the merger does not occur, our Albertsons anchored centers will continue the strong performance that they have enjoyed to date.

Thank you, Jeff. Good afternoon, everyone. And thank you for joining us. Our leasing team continues to convert strong retailer demand into higher occupancy with higher rents at our neighborhood shopping centers. Anchor occupancy ended the quarter at 99.3% leased, representing a year-over-year increase of 40 basis points. Inline occupancy increased 10 basis points sequentially to 94.9%, representing a year-over-year increase of 130 basis points. We believe there is still upside in our inline occupancy, given the continued strong demand for space. As of September 30th, in-place ABR per square feet for our inline neighbors increased 5.2%, compared to a year ago. We continue to capitalize on strong renewal demand, and are making the most of the opportunity to strengthen key lease terms and drive renewal rents higher. Specifically, for the third quarter we achieved a 16.9% increase in renewal rent spreads. In terms of new lease activity, we continue to have success in driving meaningfully higher rents. New rent spreads for the third quarter increased 26.3%. We expect that leasing spreads will continue to be strong through the balance of this year and into the foreseeable future. PECO’s retention rate remains strong this quarter as well at 93%. An important benefit of high retention rates is that we have much lower TI spend on renewals. In Q3, we spent less than $1 per square foot on TI for renewals. The exact amount was $0.88 per square foot. On average, our new and renewal inline leases executed in Q3 had annual contractual rent bumps of 2.5%, an important contributor to our long-term growth rate. The leasing spreads that we are achieving combined with our strong retention rates are clear evidence of the continued high demand for space and our grocery-anchored centers. Our continued pricing power is a reflection of the strength of our strategy and the quality of our portfolio. During our upcoming investor day, you will hear from our operations team leaders on how the PECO team delivers growth at the property level and why we remain confident in our ability to deliver long-term same center NOI growth of 3% to 4% on an annual basis. The team will be prepared to share insights on why our assets are successful, our strategic locations and suburban markets, our right size format, and the other advantages we enjoy in the markets where we operate.

Thank you, Devin, and good morning and good afternoon everyone. I'll start by addressing third quarter results, then provide an update on the balance sheet, and finally, speak to our updated 2023 guidance. Third quarter 2023 Nareit FFO increased 70 basis points to $72.5 million, or $0.55 per diluted share, driven by an increase in rental income from our strong property operations. Results were partially offset by higher year-over-year interest expense of $4 million as well as a one-time non-cash impairment charge of $3 million related to a third-party investment. Third quarter core FFO increased 50 basis points to $77 million or $0.58 per diluted share, driven by increased revenue at our properties from higher occupancy levels and strong leasing spreads partially offset by higher interest expense. During the quarter, we acquired Lake Point Market, a grocery anchored center in the Dallas Texas suburbs for $12.9 million. We expect to drive growth by increasing occupancy and enhancing merchandising mix in addition to the potential for development of outparcels. In addition, we purchased a land parcel adjacent to the marketplace at Pabst Farms located in a Milwaukee, Wisconsin suburb. We expect to drive growth through expansion development opportunities. Subsequent to quarter-end, we acquired one property and one outparcel. Mansell Village, an 89,600 square foot shopping center is anchored by Kroger in an Atlanta, Georgia suburb. We expect to drive growth in the asset through occupancy increases and rent growth. As of October 31st, PECO is under contract to acquire additional assets that are expected to close during the fourth quarter of 2023. This will bring our net acquisition volume for the year to between $250 million and $300 million. In the third quarter, PECO issued approximately 2 million shares under our ATM facility, which resulted in net proceeds of $70.1 million. Our gross weighted average share price was $35.59. Assets acquired year-to-date and currently in our pipeline are accretive to earnings per share at these levels. We were intentional in match funding these acquisitions with equity at a time when our access to the equity market was favorable, while keeping our leverage low. In addition to the recent term loan extensions, this issuance delays our need to go to the long-term debt market, which we believe is currently unfavorable. From a balance sheet perspective, we ended the quarter with approximately $714 million of liquidity, including cash and capacity on our $800 million credit facility. Our leverage ratio continues to decrease as a result of our strong earnings growth and our equity issuance with our net debt to adjusted EBITDA at 4.9 times as of September 30, 2023. Our debt had a weighted-average interest rate of 4.1% and a weighted average maturity of 4.4 years when including extension options. 82% of our debt was fixed rate. As we look at our floating rate debt exposure, our long-term target is to limit our floating rate debt to less than 10% of our total debt. We are currently in an unusual environment, given the inverted yield curve, wider spreads, and other factors, which is why we are exercising more patience before locking in long-term rates. Our lack of near-term maturities provides us with flexibility to be patient. That said, we remain focused on all options to meet our long-term target as soon as possible. Between the free cash flow generated by our portfolio and the significant capacity available on our revolver, we remain confident in our ability to successfully fund our growth plans. Turning to guidance. We’ve updated our Nareit FFO and core FFO per share guidance. Primarily due to a one-time non-cash impairment charge related to a third-party investment, we have lowered our Nareit FFO guidance to a range $2.23 per share to $2.27 per share. We have reaffirmed the midpoint of core FFO guidance and tightened the range to $2.31 per share to $2.35 per share. As Jeff mentioned, the midpoint represents year-over-year growth of 2.6%, despite interest expense headwinds of $0.10 per share. We also reaffirmed our same-center NOI guidance in the range of 3.75% to 4.5%. Importantly, despite the impact of higher interest rates and other macro headwinds, we are delivering earnings growth due to the continued strong performance of our portfolio, driven by leasing spreads, occupancy, and high retention. We plan to provide preliminary guidance for 2024 and update on our long-term growth drivers during our upcoming investor day. With that, I'll turn it back to Jeff.

Thanks John. Before we get to your questions, I’d like to acknowledge the press release we issued yesterday announcing changes to PECO's leadership team. Devin will step down as President on December 31st. At that time, Bob Myers, currently COO, will become President and Joe Schlosser, currently Head of Portfolio Management, will become Chief Operating Officer and an Executive Vice President. This is the culmination of our long-standing succession plan. I would like to extend our sincere gratitude to Devin, who has worked side by side with me to transform PECO into one of the largest owners and operators of grocery-anchored neighborhood shopping centers in the country. Bob and Joe are extremely talented, proven leaders and team players, who have been critical to the consistent strength of our operating performance. They have played an important role throughout the majority of PECO's 30-year history, growing the portfolio into what exists today. Bob and Joe have been with PECO for over 20 and 19 years, respectively. They have successfully managed operations, development, acquisitions, and dispositions through multiple cycles. I am confident they will continue to scale the portfolio from here, and I look forward to continuing to partner with them in delivering long-term growth and value creation. Devin will serve as a Managing Director of Investment Management through his planned retirement at the end of June. During this time, he will work closely with me and the team to ensure a seamless handoff of his current responsibilities. Devin is also in discussions with the nominating and governance committee about joining PECO's Board of Directors following his retirement. I would also like to highlight the recent appointment of Tony Terry to serve as an independent Director of PECO's Board, effective October 30th. We're delighted to welcome Tony to the Board. With more than three decades of public company business experience, working with senior management and boards to drive growth and innovation, Tony brings a proven track record of strategic planning, corporate and operational finance, regulatory matters, and capital allocation. We're excited to have Tony on our Board. With that, we look forward to your questions.

We'll take our first question from Caitlin Burrows at Goldman Sachs.

Maybe to the topic of the floating rate debt exposure. You guys mentioned the long-term goal of under 10% floating rate. And then, you also mentioned that the equity issuance during 3Q was to match fund acquisitions. I know, you don't have meaningful debt maturities in ‘24, but there are interest rate swaps expiring and other floating rate debt out there. So I'm just wondering if you can comment on kind of your ability, and then separately the willingness to use equity to reduce that floating rate debt.

Thanks Caitlin for the question. John, do you want to take that question?

Sure. Good morning, Caitlin. At the end of the quarter, we had 82% of our debt at a fixed rate and higher interest rates are definitely a challenge. We estimate that this will have about a $0.10 impact for the full year, but we are still experiencing positive core FFO growth. Given the uncertainty in the market, we are opting to float more of our debt than our target of 10% for floating rates. We believe that the long-term debt market remains unsettled due to wide spreads influenced by a volatile treasury environment and macroeconomic factors. Our aim is to be a long-term issuer, and while we have a target of 10%, we feel it is more suitable to access long-term fixed-rate instruments when market stability and liquidity improve. Our approach to issuing debt and equity aligns with our acquisition strategy. Looking at our upcoming acquisitions and past ones, we've determined that raising equity is beneficial to earnings, which is important to us. Therefore, we expect a combination of both borrowing and equity raising, depending on what's available. Overall, with our leverage at 4.9 times and no significant maturities for about 24 months, we have the flexibility to be patient. In this market, you will see us float more than we usually would.

Got it. Okay. But it doesn't sound like you're necessarily looking for, or maybe the option is open to use equity to address some of that in the near term.

Yes. I was going to say that, exactly.

Yes.

Yes. Got it. Okay. And then maybe just turning to acquisitions in order to make the guidance range that you guys put out with the updated range, it seems like there's either a lot of properties or some larger deal that you're expecting to happen in the fourth quarter. So, I'm just wondering if you can comment on the types of properties you're seeing for sale and then which are most attractive to PECO at this time?

There are no major transactions, just multiple transactions with various sellers. This aligns with our strategy, and we've been cautious in recent quarters regarding acquisitions. Many of these deals have been in the works for a longer time, involving price concessions and other tools to make them feasible for us. We are optimistic about the projects, and they align well with our core strategy. When we assessed them and noted a mid-9% plus unlevered IRR, we felt the risk-reward was appropriate for being active in a currently fluid market. One key factor that gave us confidence was the price per foot we were paying, which was below $260. This pricing will allow us to maintain strong pricing power in these markets, enabling us to drive growth and increase our earnings from these properties. We're excited about the properties we've secured and are comfortable being in the 250 to 300 range.

Just one quick thing. You mentioned price concession. By that, do you mean that the seller was willing to settle on a lower price to complete the deal?

I mean, I think, in this environment you've got to have sellers who are eyes open to the market and what's changing within this interest rate environment. And so, I think that getting a seller who is realistic about where the market is today is one of the more important things in the acquisition process and continues to be front of mind for us to make sure that we're not wasting our time, we're actually spending on things. And fortunately, these deals have worked through.

We'll go next to Jeff Spector at Bank of America.

First, congratulations to Devin, Bob, and Joe. I have a follow-up question regarding acquisitions. Did you discuss the cap rate range? I heard you mention an IRR of over 9%, but do you have any information on cap rates?

I believe our perspective is that we are not focused on cap rate underwriting but rather on unlevered IRR underwriting. If we consider the recent 100 to 150 basis points shift in cap rates, we are observing that in the market today. While the volume is not significant, we can see this change happening.

Okay. I know these things are hard to forecast, but it seems like conditions are improving since we last met. You mentioned that the transaction market is getting better. Do you think things will open up even more in 2024? Are conversations with sellers improving, or is 2024 still uncertain at this point?

I would say it’s uncertain at this time. There continues to be significant variability in acquisition volume. We are trying to provide as much guidance as possible, but it's a challenging environment. Transitioning to a buyer's market from a seller's market is particularly tough, and these transitions typically take a long time and are difficult. Therefore, during these times, it's essential to maintain discipline in underwriting and patience to achieve the right pricing. I wouldn’t focus on 2024 just yet. I hope to provide more clarity at our investor meeting in December. The situation is unstable, as each deal has its own circumstances. This suggests that it will be a volatile environment. However, I remain optimistic that we will have a decent backlog going into next year, placing us in a solid position moving forward.

Thanks, Jeff. Devin, you mentioned improving inline occupancy, which I assume will continue next year and the following year. However, we are noticing more retailers reporting misses and increasing concerns about the consumer, as John pointed out regarding macro headwinds. How are you balancing your leasing decisions? Are you focusing on local, regional, or national tenants? How is your strategy adapting to the changing consumer environment? You've been in this industry for a long time, so how do you adjust your leasing strategy, if at all?

We are very focused on the health of the consumer and the volatility among retailers. We believe we can grow our inline occupancy by about 100 basis points, increasing it from just under 95% to 96%. We feel confident about this because our retention rates and spreads show strong demand for our space. Our renewal spreads have been increasing each quarter; for example, our re-leasing spreads on renewals were 15.5% in the third quarter of last year and increased to 16.9% this quarter. Retailers, aware of their business models, are opting to stay in our centers at higher rents and are also agreeing to higher rents with greater growth rates. The current environment remains strong, and we expect this to continue, based on feedback from our leasing team about our pipeline. In terms of rental uses, over 70% of our rents come from necessity retail, which we believe will be more resilient during economic downturns. Certain retail segments are thriving; for instance, foot traffic data shows fitness and beauty categories both up 7% year-to-date. Our foot traffic has also remained consistent over the past year and a half. All these factors contribute to our confidence in growing our inline occupancy and maintaining our strong spreads.

We'll go next to Mike Mueller at JP Morgan.

I guess following up on the prior acquisitions and balance sheet questions, should we think of the 4Q transactions as having a pretty healthy equity component in there as we saw in Q3?

Yes, I think that's fair, Mike. I'm not exactly sure how you're laying that out, but when our debt-to-EBITDA is below 5, we have a strong equity component in the acquisitions we are making. As you can see, we are using the ATM for match funding to ensure that we maintain a solid balance sheet while driving our external growth through acquisitions.

Yes, I may have not expressed it clearly when I referred to using the ATM in the fourth quarter, similar to what was done in the third quarter to maintain that.

Yes, we'll see. Again, we've focused on the current acquisition pipeline. A lot of that will be influenced by the acquisitions we anticipate accumulating over the next couple of months and into January.

Got it. On the portfolio side, I think the spread between your economic and leased occupancy is 20 basis points. Where do you see the more normalized level? Is it around 50, 60, or 70?

John, do you want to take that?

Sure. Historically, over a long period, it is usually 60 basis points. As we approach higher occupancies, I expect this to continue to compress, but there will always be some gap due to the natural turnover of residents until we reach a 100% retention rate. A 20 basis point difference is quite strong. However, I would consider 50 to 60 basis points to be reasonable on a more normalized basis, depending on the timing of deliveries.

We'll go next to Haendel St. Juste at Mizuho.

My first question, I guess, is on the updated same-center NOI guide 3.75% to 4.5% still seems pretty wide with where we are left in year and implies some decline in the fourth quarter here. So maybe some color on what's going on there, maybe what the range kind of assumed at the top or bottom, and perhaps why it's still so wide at this point in the year. Thanks.

John, do you want to take that one?

Yes. The guidance we've provided is based on our analysis. In the third quarter, we experienced strong performance, although it was slightly slower due to the impact of activities from 2022 rather than anything specific to 2023. As we approach the fourth quarter, we're still seeing operational strength, but we've noted a return to more typical levels of bad debt. This quarter, bad debt stands at about 57 basis points, while for the full year, it’s at 48 basis points. Typically, this portfolio operates between 60 and 80 basis points. This situation is putting some pressure on our fourth quarter, but we still expect good year-over-year growth and a solid performance on a full-year basis. We're maintaining our overall guidance but anticipate it will skew towards the middle of the range.

Maybe a bit more then on potential bad debt or the watch list specifically. Can you talk a bit about maybe any neighbors or categories that you're concerned about? And if you're seeing anything that gives you any pause, like perhaps a delay in timing upfront payments? Thanks.

Devin, do you want to take the sort of the retailer point of it? And then John, if there are any specifics on the numbers, that would be great.

So Haendel, our watch list continues to be moderate. The top-10 neighbors that currently sit on our watch list represent 2.4% of our total ABR. As you know, given our strategy, we have very limited exposure to distressed retailers. The retailers that have filed bankruptcy year to date, Bed Bath, Party City, Tuesday Morning, they aggregated 40 basis points of ABR in our portfolio. So, again, given the strategy we have and the well-diversified neighbor mix that we have, we do not have any meaningful concerns in the portfolio. We have zero Rite Aid. And so, our neighbor mix is extremely well diversified. We do not have exposure to the weaker retail categories. And so, we don't have a concern, Haendel, in terms of fallout from distressed retailers.

I have one more question. Recently, one of your competitors announced a spinoff focused on convenience assets. I am wondering if you have considered this type of asset. If you have, do you believe it could align with your overall strategy of investing in necessity-based retail with low anchor risk? I would appreciate any high-level insights you might have. Thank you.

Yes, Haendel, we are familiar with this area and see potential here. It's not a standard business; it's based on individual properties with small asset sizes. You'll need the right team in place to identify suitable opportunities at appropriate prices while managing overhead due to the smaller asset size. We find this concept intriguing and have explored it many times, successfully owning various centers in this category over the years. The key takeaway here is the strength of small store retailers, which is essential in this sector. Our experiences with these retailers have been very positive, showing resilience across various economic cycles in terms of delinquencies and bad debts. The current lack of new construction combined with the robustness of small retailers presents a strategy worth pursuing. It'll be interesting to see how the market responds since this idea hasn't been universally embraced, and there's still skepticism surrounding it. I look forward to observing how the market evolves in its perception of this concept.

I appreciate the color and the perspective. But just for the final dot at the end there, it doesn't sound like that's something that's imminent for you. You see enough opportunity with the core asset that you are looking at, where this perhaps won't be a focus for you anytime soon. Thanks.

Yes, Haendel, we never say never, and we are always exploring opportunities like this. However, there is a difference between having a strategy and searching for specific opportunities. For us, it’s more about identifying specific opportunities. Are there particular opportunities near our centers where we have a strong understanding of the market? Are there additional opportunities available? You can see from some of our acquisitions there is evidence of this belief. We believe that our local knowledge at our specific properties gives us a competitive advantage in acquiring in those markets.

We will go to our next question from Juan Sanabria at BMO Capital Markets.

Hi. Good morning. Just wanted to follow up on the fourth quarter acquisitions. I believe last year, the weighted-average cap rate for acquisitions was about 6.1% So, would you say, at a 100 to 150 basis points as per your prior comment like a low- to mid-7s cap rate is indicative of where the market is today, or is that more for acquisitions that would close in the fourth quarter and maybe backward looking, because the market, like you said, is fluid and maybe cap rates would inch up further from that kind low to mid-7s range?

So, Juan, are you asking us for a cap rate? It seems like you're trying to get to that. Yes, I think the movement of 100 to 150 basis points was more reflective of the past, specifically when cap rates were around 5.5%. Take that into account. However, I had already noticed movement when we were in that low-6s range compared to where we believed the market had peaked. This suggests that the current market is more in the mid-6s range rather than the low-7s range from our perspective today. Those projects still have substantial upside potential. When stability returns, we prefer to discuss unlevered IRRs rather than cap rates. There are deals with a 7 cap rate that can yield an unlevered IRR of 7.5% or 8%. While these have attractive yields, they do not align with our market outlook.

One of your peers, Simon, mentioned noticing some weakness among lower-income consumers. I understand your point about not being affected by recent bankruptcies and that the watch list is relatively small. However, if lower-income consumers are impacted, where do you think we might see some pressure among your competitors? Are there specific categories or areas that could be affected? Any insights would be appreciated.

Yes. It's important to clarify what we mean by the lower end. If we're talking about median household incomes of $50,000 and below, we actually don't operate in those markets. Those markets have lower income levels than ours. However, when we refer to around 10% above the median household income, which is our target, we're not noticing any signs of the issues you're mentioning. The median household incomes in our areas are in the high $70,000s, which are comparable to or even higher than those of Kroger and Publix. Therefore, I would say we are not experiencing those challenges. In terms of where we might expect to see shifts, as we have discussed previously, we are lucky to be focused on the necessity side of the market. The impacts we are considering are different from those felt in discretionary spending. Even in our sector, during tough economic times, we would generally see shifts where consumers move from brand-name products in grocery stores to private labels for better pricing. We can observe transitions from Whole Foods to Kroger and from Kroger to Aldi. However, based on our discussions, we are not witnessing such transitions in the market right now. But that reflects our specific niche, where we’re not seeing any significant changes.

We'll take our next question from Todd Thomas at KeyBanc Capital Markets.

First question, circling back to the fourth quarter acquisitions, it seems that the opportunity for growth is quite significant. I was wondering if you could provide more detail regarding the blended average occupancy rates within the acquisition pool and the expected occupancy lift. Additionally, could you discuss the mark to market opportunity over time? I am also interested in a more detailed breakdown of the growth you are anticipating. Lastly, are these assets currently under contract?

Yes. They are either under control, in contract, or nearing closure, with some being firm. Todd, thank you for the opportunity to promote our investor day; we will go into much more detail about this in December, and we hope everyone on the call can attend. We will provide the clarity you’re seeking. To offer more insight, the projects we are considering align with our concept of having the number one or two grocer in the market; they have vacancy and, in our view, below-market rents where we see potential for growth. I believe these will represent our largest opportunities. We also have some development prospects within these assets that we intend to utilize, along with potential adjacency opportunities for purchasing additional land to expand them. They are very much in line with our typical growth components in our portfolio, and since we've completed many centers, we see even more upside. We will definitely discuss case studies on these assets in detail during the investor meeting in December.

Is there any appetite for ground up development today aside from the outparcel program? It seems like there's a lot of demand from smaller format grocer, specialty and discount. Does development pencil at all, and is there any appetite for some smaller scale developments?

Yes, I would say it’s very anecdotal. The answer is no. There are examples of some activity, but it’s such a small portion that it isn’t significant. It’s really difficult. We are acquiring these projects at $260 a foot or less. To undertake new development and achieve anything in the $300 a foot range is extremely challenging; it’s more likely to fall in the mid-400s. So the reality is that it doesn’t work out in most cases. There are exceptions, but we don’t see any substantial opportunities for new ground-up development. As you know, we've engaged in that many times in our history. However, I would say the prospects are very limited, and it requires a lot of effort for what we perceive to be only marginal returns at this point, with no returns in many instances. Therefore, we are not currently inclined toward ground-up development, seeing it as an opportunity, except for outlot projects where we are primarily involved in triple net leases, which continue to be very profitable for us.

Okay. And John, just last question, what was the $3 million non-cash charge related to the investment in the third-party company. What was that related to?

Sure. So, in the quarter, we recorded a non-cash impairment on an investment that we made several years ago. There was a neighbor that was seeking a high capital investment to open in several of our shopping centers. And as part of the deal, we negotiated for an investment interest in the company with those funds to be invested in our centers. Unfortunately, that operation was not successful in our centers. And as such, we wrote off our interest in the company this quarter. This is the first and only time we have invested in a neighbor. So we don't have other instances of this. I would note that that's where we do talk to our core FFO guidance, which we did affirm and tighten that range, which we use the metric that best highlights our ongoing recurring business.

We will move next to Floris van Dijkum at Compass Point Research and Trading.

Thank you. I would like to wish Devin the best in his new endeavor. I hope you can still benefit from his insights if he joins the Board, as he is highly regarded in the industry. Congratulations to him and to the newcomers. I have a question for you. Issuing equity seems to be quite sensible. If you were to issue it at 35, you might even be able to do so at today’s share price. This is an opportunity that other companies in the shopping center sector cannot access, so I recommend considering it to finance future acquisitions. Regarding growth, I notice that the underlying growth has decreased slightly. I am aware that there have been some isolated incidents, with a significant impact from higher bad debt. Could you provide some insights into your underlying growth expectations? It seems that the fourth quarter might also be slower than what we've seen up to this point this year. Should there be concerns about reaching peak growth and a subsequent slowdown from the current rate?

Floris, thank you. We're not letting Devin go; he'll be here to assist us as he has for the past 10 years. I don't foresee any major transition in that regard. John, maybe you can provide insight on the growth aspect, but I want to ensure we don’t overlook it. We're currently in a very strong operating environment, with no signs indicating imminent changes. I expect that may occur at some point when a recession hits, but right now, there are no indications of that. Our retention rates and retention spreads are really strong, which will help us achieve solid internal growth, with more stemming from spread than from occupancy increases. We're in a good position, and as reflected in our guidance, we believe there are also significant external growth opportunities, which we are leveraging while carefully managing our balance sheet to fund these opportunities. As John mentioned, these initiatives are not only initially accretive but also hold great growth potential for us. Therefore, we're quite optimistic about how our external growth will contribute moving forward. John, would you like to discuss the details of that and our perspective on it? Would that be helpful, Floris?

Sure.

Yes. So, hey Floris, I would say that as we look at the fourth quarter, as I mentioned with the bad debt, that's really more related to 2022 activity than anything we see in ‘23. I mean, when we look at the end of the quarter at kind of our reserves relative to our AR, those reserves as a percentage of the AR just continues to come down. But ultimately, when you're at 57 basis points, and I put that up against anyone else in terms of performance there, you do see that change. And so, I would say that when you look at the full year, we're going to be over 4%. And then, as we look to next year, and again, quick plug for our Investment Community Day in December, we're going to highlight that we believe that this portfolio organically can continue to deliver 3% to 4% same-store growth. And we've provided the pieces before. But I think there's a concern around occupancy, but occupancy is a sign of strength, and we're actually turning that into pricing power with renewal spreads and even new leasing spreads and using that to push embedded rent bumps. And so, we'll get into the components at our Investment Community Day, but we feel very strongly that we will be able to continue to deliver 3% to 4% growth for the foreseeable future.

Thank you. I wanted to follow up on something I noticed. It seems that your spreads on local tenants are higher than those on national ones. Does that indicate that their initial rents were lower? Are the new rents now aligned with the national tenants, or are they actually paying a premium to be in your centers?

Dev, you want to take that one?

On the local neighbors, their spread is slightly higher than the non-locals. So, in the third quarter, the renewal spread on locals was 19.8%, and on our total portfolio it was 19.6%. So, it's fundamentally the same number. The reason we like the local neighbors and the reason we believe that they're a strength of our portfolio is, number one, they've been in our centers for an average of nine years. So, they're successful retailers that are sticky. Number two, the average cost per square foot that we have to spend on TIs for the local neighbor versus the nationals to achieve the same rent is about 50% of the TI that we have to spend on the national tenant. So, we're getting comparable rents, comparable spreads, they're sticky, and we're spending a lot less. That's the economic side of the equation. And then, on the non-economic side, they are much less difficult in terms of leasing terms such as non-competes, et cetera. And so, our view of the local neighbor is that we're getting a meaningfully better economic deal, a better non-economic deal, and these tenants are meaningfully more resilient in our portfolio than a lot of investors believe.

We'll move next to Ron Kamdem at Morgan Stanley.

Just a couple of quick ones. So going back to the interest cost question, I think last quarter we sort of talked about, I think it was like a $10 million headwind year-over-year in ‘24. So, obviously rates have moved, but just wondering, is that still sort of the right ZIP code we should be thinking about or has anything changed there? Thanks.

John, do you want to take that?

As we look ahead to 2024, we'll discuss this further at our Investor Community Day. You're correct that the curve has shifted, but it continues to change. We believe that our low leverage is one of our greatest strengths as we evaluate different options. Regarding the interest expense, we intend to provide initial guidance for 2024 during that event. When considering your models, it's important to note that the interest figure closely depends on your acquisition assumptions for both this year and next year. This makes it challenging to provide a precise dollar amount right now. However, we estimate it's a headwind this year that will impact our earnings by about $0.10 in 2023 and likely around $0.40 in 2024. That said, based on our operating performance and the strength of our centers, we expect to see positive FFO growth in 2024. While I'm not directly answering your question due to the various factors at play, we aim to offer more clarity in December.

Great. That's helpful. And then, I want to go back to something else that was brought up, which is the record occupancy target. We’ve talked about sort of new tenant verticals, right? I think medtail was one that that you guys had mentioned. Just maybe can you remind us on when you are thinking about that new occupancy, record occupancy target, how much of that is from the sort of new tenant verticals pushing occupancy up versus just being smarter about sort of how you use space in the portfolio?

Dev, you want to take that one?

Sure. Ron, thanks for the question. Again, we believe that we have upside in our inline occupancy of circa 100 basis points and that will be realized over the next five quarters type of timing. The type of tenant use that we are seeing, the strongest demand firm is, again, medtail as we’ve discussed on a number of recent quarterly calls. So medtail today is 6% of our ABR, and it is 20% of our leasing pipeline. So, the demand from medtail tenants continues to be extremely strong. Again, health and beauty is another category where we are seeing strong leasing demand, that's 11% of our current leasing pipeline. We like medical for a lot of reasons. Most importantly, they are very sticky. The medtail tenants that are in our portfolio have been in the centers for an average of 10 years. Health and beauty tenants are also very sticky. The health and beauty tenants in our portfolio have been in place for an average over 11 years. So, those are the uses where we are seeing continued strong demand. Those are uses that we like a lot. We think they add to the merchandising mix. We think they drive consistent traffic to our centers, and then they stay in our centers for a meaningful amount of time.

Great. That's it for me. Congrats, Devin and the rest of the team. Pleasure working together.

I appreciate it, Ron. Thanks.

And we’ll go next to Dori Kesten at Wells Fargo.

Thanks, and congratulations on all the management changes. What percentage of your small shop leases have contractual bumps over 3% today? And where do you think that you can push that to over the next year?

Dev, do you want to take it, or John?

Dori, I don't know, off top of my head, what percentages have bumps above 3%. We will come back to you on that. Our average in the third quarter was 2.5%. So we’ll have to come back to you on what percentage have above 3%, and we will do that.

When we examine the overall contributions to NOI growth, we see that up to 80 basis points of that growth is attributed to escalators. We anticipate that this figure will continue to increase. We believe that this is an area where we can grow to 100 basis points or more.

Okay. Thanks. And then, when you look at assets you've sold this year and last, what has the realized unlevered IRR been?

So Dori, are you asking what the unlevered IRRs were for our hold period?

Yes.

Yes, I don't have the specifics. We conduct a comprehensive analysis of each property as we sell it. Generally, they have exceeded our targeted 9% unlevered IRR. However, I don't have the exact figure for the overall performance, but I can certainly provide that information to you.

Hey Jeff, I'll just jump in there. The answer is that when we look at the assets we sold over the years, the actual underwriting would have been lower because at that time, in a low interest rate environment, the underwriting was certainly lower. We outperformed by over 100 basis points, and the actual realized was over 9. However, relative to what we anticipated, we actually exceeded that underwritten unlevered IRR by 100 basis points on assets that we've taken full cycle from acquisition through management to disposition.

And we'll go next to Paulina Rojas at Green Street.

My question is about the Kroger Albertsons merger, and excuse me if you mentioned this at the beginning and I missed it. But my question is, C&S experience seems to be more in the wholesale world. What gives you confidence that they would be good operators of grocery stores at a large scale?

Thank you for the question. That's a significant uncertainty. They have been a wholesaler for a century and do operate stores, but I don't believe they meet our standards for store quality. Still, they do have experience in running stores. From our perspective, compared to a property company that operates as a separate entity, they clearly outperform that model. The key issue is assessing their operational capabilities, and we won't really know until they start managing stores. It's important to highlight that the market currently indicates there is a low probability of the merger being finalized. There is still a noticeable discount between Albertsons' stock price and its expected value in the Kroger merger. Therefore, skepticism about the merger's success persists, and there are significant questions about their effectiveness as a grocery operator.

My other question is, of course, you raised money, probably you’re not the best company to ask, but what are you seeing in the lending environment? Have you seen more distress from owners? It seems so far that it's more a matter of rate, but that financing is available. So, anything you can share in terms of what you're seeing especially from…

Yes. We are not observing many owners in the market facing financing issues yet. It may be a bit premature for that to occur, if it happens at all. However, we haven't seen it so far. We are aware of some pressure, especially within regional banks, which have historically funded many family office projects. When loans are due, negotiations can become more complex, and some assets may eventually become available on the market. However, there hasn’t been a significant surge in this regard yet. It is certainly a possibility, but as you know, our business in grocery-anchored shopping centers involves very fragmented ownership. Therefore, with the recent changes in interest rates, some disruptions in ownership can be expected. Looking at the deals we've executed or have under contract in the latter half of this year, they haven't involved distressed family offices; instead, they've come from other types of sellers overall. So, while we expect to see some changes, we haven’t actually observed it yet.

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

Thank you, operator, and thanks everybody for being on the call today. In closing, we remain focused and committed to successfully executing our growth strategy, both internal and external. We believe that we continue to generate more alpha and less beta in the markets we're in and the properties and given our very specific strategy. In addition, we still have one of the lowest levered balance sheets in the shopping center business. This gives us the financial capacity to successfully meet our acquisition objectives. We look forward to providing additional information about our outlook and business plans during our upcoming investor day. On behalf of the management team, I'd like to thank our shareholders, PECO associates, and our neighbors for their continued support. Thanks again for being on the call today, and have a great day.

And this concludes today's conference call. Thank you for your participation. You may now disconnect.