Rithm Property Trust Inc. Q2 FY2023 Earnings Call

Greetings and welcome to RPT Realty's Second Quarter 2023 Earnings Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Craig Benigno, Senior Analyst, Investor Relations. Thank you. Mr. Benigno, you may begin.

Good morning and thank you for joining us for RPT's second quarter 2023 earnings conference call. At this time, management would like me to inform you that certain statements made during this conference call which are not historical may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Additionally, statements made during the call are made as of the date of this call. Listeners to any replay should understand that the passage of time by itself will diminish the quality of the statements made. Although we believe that the expectations reflected in any forward-looking statements are based on reasonable assumptions, factors and risks could cause actual results to differ from expectations. Certain of these factors are described as risk factors in our annual report on Form 10-K for the fiscal year ended December 31, 2022, and in our earnings release for the second quarter 2023. Certain of these statements made on today's call also involve non-GAAP financial measures. Listeners are directed to our second quarter 2023 press release, which includes definitions of these non-GAAP measures and reconciliations to the nearest GAAP measures and which are available on our website in the Investors section. As a reminder, last quarter, we introduced our quarterly earnings presentations, which we will reference throughout the call to highlight key messages for the relevant quarter. You can find the second quarter 2023 earnings presentation on our website in the Investors section. I would like to now turn the call over to President and CEO, Brian Harper; and CFO, Mike Fitzmaurice, for their opening remarks, after which, we will open the call for questions.

Thank you, Craig. Good morning and thank you for joining our call today. As we pass the midpoint of 2023, I'm very proud of our operational and financial results that exceeded our own expectations despite an elevated impact from bankruptcies. With the bankrupt tenant disruption now largely in the rearview mirror, we are set up for outsized same-property NOI and operating FFO growth in 2024 and beyond as we expect to benefit from our sector leading signed not commenced backlog of $9 million with an additional $19 million in our leasing pipeline. Starting with the operating fundamentals. We continue to experience a historically strong leasing environment with no slowdown in sight, highlighted by our elevated leasing volumes, record rent growth and enhanced credit quality. We had our fourth consecutive quarter of over 500,000 square feet of leasing volume, putting us well on our way to accomplishing our goal of 2 million square feet for the year, for the second year in a row. Our SNO pipeline remains full at $9.3 million with the vast majority expected to commence over the next 12 months. As I mentioned earlier, we have an additional pipeline of deals totaling $19 million, of which $6 million is incremental to our second quarter revenues. Tenant categories are primarily comprised of high-quality grocers, off-price, home improvement, fast-casual, boutique fitness and service tenants. The leasing and legal teams are firing on all cylinders and remain focused on signing these deals in the near-term. Regarding our embedded rent upside, it continues to accelerate. Over the last 3 years, we have averaged over 34% on new re-leasing spreads, highlighted by our second quarter print of 56%. Rent growth on renewals has been equally impressive, steadily rising from the low to mid single digits in early 2018 to about 11% during the quarter. While leasing volumes and rent growth are important, tenant credit is also a critical ingredient to grow earnings on a sustainable long-term basis. We remain disciplined on this front and have signed many leases with strong national high-credit tenants, specifically on the grocer front. Since 2019, we have added 17 grocers through leasing and acquisition activities, bringing our percentage of ABR from centers with a grocer to 72%, up from 65% at the end of 2019. The performance of our grocers has also been strong. Since 2019, average grocer sales per square foot have grown by 45% to $831 per square foot, reflecting the quality improvement of our portfolio and the enhanced traffic at our grocery-anchored centers. Notable grocers in our portfolio include Wegmans, Publix, Trader Joe's, Giant/Ahold, Whole Foods, BJ's and Aldi. Additionally, during the quarter, we signed a lease with a strong regional assent grocer at Olentangy Plaza in Columbus that will backfill a Tuesday Morning location. In July, we celebrated the grand reopening of a newly remodeled and expanded Publix at The Crossroads in the Miami market. We were able to deliver this new prototype in July, generating a 7% incremental return on cost while locking in a high-quality, high-credit tenant that will anchor the property for years to come. Our proactive approach with Bed Bath & Beyond is beginning to pay dividends. We have released four locations to leading national retailers at our Bridgewater Falls and Deerfield Towne Center assets in Cincinnati as well as Winchester Center in Detroit. This is on top of the HomeGoods deal at River City Marketplace in Jacksonville that we signed last quarter. The blended spread on these deals was about 60% with 2 locations opening in the fourth quarter 2023. All of our remaining locations are in either advanced lease negotiations or at LOI. Tenant categories range from grocery, off-price, wholesale clubs and high credit national beverage outlets. We expect that all but one box will be backfilled by single-user tenants. The space that Shops on Lane will be the only site that is expected to be divided given the demand from high-quality shop tenants that we are in negotiations with at rents per square foot of $45 to $50 triple-net, and that's replacing a $17 ramp from Bed Bath. We also continue to invest in TJX, which remains our largest tenant, representing 5% of our ABR. We recently opened Marshalls and HomeGoods stores at Northborough Crossing in Boston, replacing a former Pottery Barn outlet. When a brand new Sierra store opens later this fall, Northborough will become the only shopping center in the country with all 5 TJX concepts, demonstrating their commitment to this property, which is only a few miles from their headquarters. Including signed leases, Northborough's NOI has grown by 14% since our acquisition, while occupancy has increased by 6.5%. The robust anchor demand we are experiencing is also driving occupancy, rent and retention for our small shop portfolio. Our small shop lease rate now sits north of 87%, up 120 basis points year-over-year. Our blended re-leasing spread on small shop spaces has averaged 9% in the last trailing 12 months, and we are expecting to retain nearly 87% of our small shop tenants in 2023. Most of our small shop exposure is weighted towards national and regional tenants, which account for nearly 70% of our total small shop ABR. Additionally, our top 15 small shop tenants are comprised largely of leading national brands, such as Five Below, Ulta, AT&T and Dollar Tree. Turning to Mary Brickell. Our clear low-risk and actionable Phase 1 and Phase 2 redevelopment plans for the West side of the center are progressing steadily. We are in active negotiation on approximately 80,000 square feet of new leases. Tenant categories range from first-to-state wellness, food and beverage, soft goods and service brands, many of which are international brands. Our goal at MBV is to create a truly unique gathering space that caters toward the dynamic 24/7 environment, while maximizing rents, which remain in the $120 to $150 per square foot range. While rent is important, the curation of merchandising is equally important. Renewals with tenants we want to keep are being signed at $150 per square foot. With in-place rents of $48 per square foot, we have a material mark-to-market opportunity at MBV over the next several years. With that, I'll turn the call over to Mike.

Thanks, Brian, and good morning, everyone. We are pleased to report another strong quarter that exceeded our expectations on both the top and bottom line. Same-property NOI growth of 30 basis points came in ahead of plan and on the heels of a 4.4% increase in the second quarter of last year. Our performance in the quarter was fueled by better-than-expected bad debt net of abatements, lower expense growth and stronger other property income. Our top line performance drove operating FFO per share of $0.25 in the second quarter, in line with the first quarter despite several expected move-outs, of which many have already been released at high double-digit rent spreads, as Brian noted. It is also important to note that we achieved base rent growth of over 3% for the second consecutive quarter after adjusting for some offsetting accounting movement between base rent and rental income not probable of collection highlighted on Slide 20 in our earnings presentation. As Brian mentioned, this quarter, we made significant progress backfilling our Bed Bath & Beyond locations, highlighted on Slide 15 of our earnings presentation. We continue to expect to generate rent spreads between 30% and 40%, which we expect to contribute an incremental $1.7 million to NOI growth over the next few years. We have also negotiated amendments with both Regal and Party City to keep our remaining locations. And given the core approved sale of David's Bridal, we now expect to retain both of those locations as well. Additionally, subsequent to the end of the second quarter, our lease with Tuesday Morning at Merchant Square was assigned to Dollar Tree, leaving us with no exposure to this troubled tenant moving forward. Our SNO pipeline continues to hold steady, down only slightly versus last quarter given sustained levels of leasing demand and on-time rent commencements. The pipeline continues to be comprised of high-quality grocers, discount retailers, proven regional medical providers and off-price concepts. We expect the SNO backlog will add an incremental benefit of $0.10 per share of annualized operating FFO by 2025 with $0.07 hitting in 2024, translating into a 5% contribution to same-property NOI growth in 2024. Additionally, when including the impact of the SNO pipeline, our leverage ticks out at 6.3x, well within our target range of 5.5 to 6.5x. RPT's proactive balance sheet management has largely insulated us from the headwinds related to the uncertainty in the capital markets. With over 96% of our debt fixed and no debt maturing until mid 2025, the impact of rising rates is contained in the near-term. Additionally, our liquidity remains strong at $477 million in the second quarter, positioning us well to reengage in the acquisition front as opportunities arise. We are maintaining our operating FFO per diluted share guidance range of $0.97 to $1.01 and updating our same-property NOI growth expectation to 1.75% to 3% from 1.5% to 3.25%. Our beat for the quarter was offset by the slightly earlier-than-expected recapture of all remaining Bed Bath & Beyond and buybuy BABY concepts, with the last few recaptured at the end of July. The midpoint of our operating FFO guidance continues to assume an unfavorable impact of 300 basis points of NOI, which includes our expectations regarding bad debt as well as the impact of lost rent from bankruptcy and at-risk tenants, primarily Bed Bath & Beyond. And with that, I'll turn the call back to the operator to open the line for questions.

Thank you. The first questions come from the line of Haendel St. Juste with Mizuho. Please go ahead.

Hi, good morning. This is Ravi Vaidya on the line for Haendel. Hope you guys are doing well. Can you estimate what your watch list is right now as a percentage of ABR? And what is the embedded mark-to-market opportunity within that subset going forward?

Yes. So I mean there's really no movement on the watch list, Ravi. I can say this, we are extremely confident on the portfolio that we've transformed over 30% of from the legacy portfolio. Additionally, as you see in our deck, our small shop is really geared towards more national as opposed to local. It really isn't anything that's keeping me up at night just given our proactive asset management. We are obviously thankful to get back Bed Bath and Regal and pass that shadow over the company for the last 2 years. But we have greatly enhanced the portfolio over the last 5 years. And if you just look at our grocery sales per square foot, it went from $5.73 to $8.31, which is up 45%. So this is a lease, lease, lease environment, pent-up demand throughout our entire portfolio. And we are aggressively monitoring each and every at-risk tenant, but there hasn't been much movement since the last call.

And Ravi, the one thing I would mention, over the last couple of years, our new re-leasing spreads have eclipsed at least 40%, which is a great indicator of what the mark-to-market is for some of the opportunities we've had over the last couple of years. And we absolutely believe that we'll achieve double-digit re-leasing spreads on any other spaces that we do get back in the event there's future bankruptcies out there.

I think the thing to keep in mind is the average center lifespan, particularly from the legacy portfolio was 39 years. So a lot of these leases, as the case of Bed Bath & Beyond, were cut. Those deals were cut 19 years ago. So leases being signed 19 years ago that we've recaptured in July, that's a significant mark-to-market opportunity. And we see that not only with Bed Bath but throughout other tenants as well.

Thank you. That's helpful. And just one more here. You mentioned a bit in your prepared remarks, I just wanted to maybe ask for more color regarding the impact that the Bed Bath re-leasing and the Tuesday Morning re-leasing, what sort of impact is this having towards your small shop merchandising, occupancy and rent growth and the synergies?

Yes, it’s significant. Currently, we are at 320 basis points. We have an additional $6 million in the pipeline, making it $15 million on top of the previous $9 million, with $6 million of that being incremental growth. This represents visible growth. The halo effect is particularly strong for major tenants like grocery stores, Nordstrom Rack, Burlington, and wholesale clubs, which have substantial positive impacts. However, this halo effect has not been factored into the SNO I mentioned. We have larger anchor deals with investment-grade retailers set to come online late in 2023 and into 2024, which will greatly enhance our cash flows for 2024 and 2025. For instance, replacing a Bed Bath with a Trader Joe's or a Total Wine will significantly increase rental income.

I'd like to add to Brian's comments regarding Bed Bath. As of today, we have signed four leases: a HomeGoods at River City, a Total Wine at Winchester, a Nordstrom Rack at Deerfield, and a Burlington at Bridgewater Falls. These four deals will contribute approximately $1 million in additional rent that we will recognize over the next few years. Additionally, considering the eight locations we took back in July during the third quarter, we could see another $700,000 in incremental rent. In total, this means we expect about $0.02 of incremental growth from these Bed Bath locations, and we are very pleased to have reclaimed all 12 properties.

And let me just reemphasize, SNO, $9 million today with $6 million incremental coming online, so $15 million in total.

Got it. Thank you. That's helpful. Just one more here. Can you offer any commentary as to what you're seeing in the acquisition markets and what your appetite is to do large deals at this time? And what sort of portfolio discount could you potentially see on that front?

Yes. I mean I would say for us, RGMZ will be doing most of the buying given our current cost of capital. And really just we are IRR driven internally, and we are seeing 20% returns in that large $9 million SNO bucket. So 20% returns is obviously where my attention is gravitating over 6, 7, 8 cap type transactions. With that said, we have three unique platforms that could create opportunity. If we could buy accretively for earnings, quality and growth, we are looking. Amy Sands has joined the team. She's leading our investments team. She is actively scouring the markets to see if there's any dislocation whatsoever. I can tell you from groceries, particularly under $50 million, the demand in our markets is still very aggressive with all cash buyers. Anything north of, call it, 80%, the cap rate widens as there's just less buying pool, obviously bringing in more lack of debt. So we are looking for opportunistic deals, but for the near-term, we are very focused on these 20% internal returns.

Got it. Appreciate the color guys.

Thank you. Next question comes from the line of Mike Mueller with J.P. Morgan. Please go ahead.

Hi. Just a quick one on the shop occupancy. I mean where do you think you can take that to from a high watermark? And what sort of timeframe do you think it will take to get there?

I believe the transformation we’ve implemented has led to a 45% increase in grocery sales. We have six additional grocers set to join the SNO bucket, raising our total ABR of grocers to 78%. These small shops will be placed in non-grocery anchored centers. We anticipate achieving approximately 93% to 94% occupancy in small shops relatively quickly, especially within the next 24 to 36 months. The presence of established brands like Publix, Whole Foods, Trader Joe's, Total Wines, and Meijer creates a favorable environment that attracts tenants, driving significant growth in small shops.

Got it. Okay. That was it. Thank you.

Thank you.

Thank you. Next question comes from the line of Floris Van Dijkum with Compass Point. Please go ahead.

Good morning, everyone. I appreciate the presentation you prepared; it's very clear. I have a question regarding leasing costs. Some may argue that your spread seems very attractive. However, when I look at your average costs, they have increased threefold to $30, which is three times the 12-month average, and your new leasing costs are $96. Are there any one-time factors influencing this? Additionally, could you clarify if this is linked to your 20% return, given that the rental rates are sufficiently high to support such investments?

Yes. There were two instances of higher costs due to additional landlord work that was more extensive than initially planned. However, I want to emphasize that these instances involve investment-grade tenants, and we've already seen adjacent shop space rent increase by 20% following the announcement of these tenants. While the net effect is certainly one consideration, we also evaluate tenant credit, cap rate compression, market vacancy analysis, co-tenancy, and halo effects. For example, when we introduce a new grocery store, I recognize that while the yield on cost for that store is crucial, I also need to consider the potential rent increases for nearby small shops. That's just one aspect of our analysis. Furthermore, as I mentioned earlier, replacing Bed Bath with some prominent tenants, which are showcased in our investor deck, is enhancing rent across the center. Though those two instances had higher costs, the average replacement cost for Bed Bath deals stands around $75 per square foot.

Thanks for the information. I’d like to ask if you believe that your occupancy will likely decrease slightly in the third quarter as you regain the Bed Bath spaces. However, it seems that you expect to see significant growth from those spaces starting next year. Can you also discuss whether your expense recovery rate has dropped by about 130 basis points? Should we anticipate another slight decrease before it improves when new tenants occupy those spaces?

Hi, good morning, Floris. This is Mike. Thank you for your comments on the earnings presentation. All credit goes to Vin and Craig for their excellent work on the disclosure. To answer your question, yes, the lowest point will be the third quarter as we took back the remaining eight locations for Bed Bath, which will negatively impact our occupancy rate by about 200 basis points. At the quarter's end, we finished with about 90%, and this will drop to 88%. However, the signed but not commenced leases will raise it back to around 89% to 90% by year-end and should pick up momentum from there. As I mentioned in my remarks, we expect to see about $0.07 from the signed but not commenced leases next year, leading to strong same-property NOI growth of over 5%. This will be a significant driver. Additionally, as you pointed out, we anticipate an improvement in our recovery rate. Our same-store recovery rate was about 84% at the end of the quarter, and we expect it to rise to the high 80s by year-end and reach the low 90s next year. This will also be a crucial factor in enhancing our operational performance and contribute to our same-property NOI growth for 2024.

Thanks, Mike. Appreciate it.

You bet.

Thank you. Next question comes from the line of Alec Feygin with Baird. Please go ahead.

Hi. Thank you for taking my question. Kind of to go on the theme of the leasing rates and the elevated renewal rate, are there any specific regions driving the elevated renewals with the lower TIs?

Alex, our growth is being seen nationwide. We have experienced significant growth in all our regions, from the Midwest to Boston and the Southeast, extending to Austin, as well as in Front Range and Fort Collins. This broad-based growth can be attributed to the transformation we initiated in 2018, including our remerchandising and reallocating cash flows to new geographic areas. The addition of 17 new grocers to our portfolio has fundamentally changed our company. I view this as widespread growth. We have completed the sales we planned in 2018, and while there may be some selective asset trades, this is a broad conversation about rent.

Another point to mention is that we experienced increased renewals where the tenant had no options. During the quarter, we completed approximately 40 leasing transactions amounting to around 95,000 square feet. We achieved a rent growth rate of about 11% to 12%. In situations where we have influence, we are seeing double-digit growth in renewals. Additionally, regarding new leasing spreads, as mentioned earlier, we have seen a 40% increase over the past couple of years. This growth is evident not just in new leases but also in renewals where we have leverage with the tenants.

Got it. That's helpful. And kind of to go to the Bed Bath boxes you're getting back and specifically the box split that you'll be doing, what's the approximate return on invested capital you guys are targeting? I know you threw out the number 20%. Should we expect that? Or will it be even higher?

Yes. We will obtain more data, and it could certainly reach double digits. We're taking a $17 Bed Bath and dividing it into smaller shops priced between 45 and 55. There is a space in the back that we will likely develop. The property has excellent real estate, featuring a Whole Foods anchor costing $1,200 or $1,300, with a vacant Bed Bath located on the other side. The quality is impressive, and we have many first-to-market tenants for this asset. We are truly eager and excited to begin leasing that space.

Thank you for that. That’s it for me.

Thank you.

Thank you. There are no further questions at this time. I would like to turn the floor back over to Brian Harper for closing comments.

Thank you, operator. RPT's second quarter was marked by record spreads and elevated leasing volumes. The mark-to-market opportunity afforded to us by Bed Bath & Beyond locations should continue to enable us to sign strong national retailers and enhance our tenancy and drive spreads in the second half of the year. We hope you all enjoy the rest of your summer and look forward to seeing you on the conference circuit in September. Have a great day.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.