Earnings Call Transcript - SITC Q2 2023

Operator, Operator

Good morning, and welcome to the SITE Centers' Second Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. Please note, this event is being recorded. I would now like to turn the conference over to Stephanie Ruys de Perez, Vice President of Capital Markets and Asset Management at SITE Centers. Please go ahead.

Stephanie Ruys de Perez, Vice President of Capital Markets and Asset Management

Thank you, Operator. Good morning, and welcome to SITE Centers' second quarter 2023 earnings conference call. Joining me today are Chief Executive Officer, David Lukes; and Chief Financial Officer, Conor Fennerty. In addition to the press release distributed this morning, we have posted our quarterly financial supplement and slide presentation on our website at www.sitecenters.com, which are intended to support our prepared remarks during today's call. Please be aware that certain of our statements today may contain forward-looking statements within the meaning of the federal securities laws. These forward-looking statements are subject to risks and uncertainties, and actual results may differ materially from our forward-looking statements. Additional information can be found in our earnings press release and in our filings with the SEC, including our most recent report on Form 10-K and 10-Q. We will also be discussing non-GAAP financial measures on today's call, including FFO, operating FFO, and same-store net operating income. Reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures can be found in today's quarterly financial supplement. At this time, it is my pleasure to introduce our Chief Executive Officer, David Lukes.

David Lukes, CEO

Good morning, and thank you for joining our second quarter earnings call. We had another strong quarter with results ahead of budget, an uptick in leasing volume and demand across all unit sizes, and continued progress sourcing investments which are additive to the long-term growth profile of the company. The net result of all this activity is a significant Signed Not Opened pipeline, with commencements ramping over the next few quarters into 2024, providing a tailwind for the next several years and an offset to the impact from recaptured space from bankrupt tenants. I'll start with some comments on leasing and tenant activity, and then move to transactions before handing it over to Conor to give more details around the quarter and 2023 guidance. Leasing activity has remained strong over the past few quarters, and much of our conviction and continued demand has been the result of population movement to the suburbs, and the choice by most retailers to favor a combination of in-store shopping, curbside pickup, and ship-from-store. When combined with the growth in service tenants following their customers in a hybrid work environment, it's not surprising that demand across our wealthy suburban portfolio has been elevated. While the occupancy uplift has been nice, we are equally pleased to see rent growth move in tandem. In fact, the growth in rents has been supported by the lack of new construction, thereby putting a pretty tight cap on competitive new supply. There are two reasons why we believe this situation will continue for some time in the sub-markets where we operate. First, it's notoriously difficult to achieve new open-air retail zoning in high-income neighborhoods, so land available for development is low. Secondly, construction costs have surged with inflation, and the rents required to justify construction are well above our in-place rents. We recently priced a ground-up junior anchor building as part of a redevelopment plan, and the cost for that box came in at almost $300 per square foot. We also recently started construction on several multi-tenant buildings whose average cost to build is just above $500 a square foot. As both of these examples exclude land, the total cost to build a blended new shopping center containing both shops and anchors remains a challenging math exercise, and is the primary reason why we are seeing tenant retention at very high levels, as tenants with current leases are unwilling to relocate to more expensive space. Our tenant retention has been well above historical averages over the last two years, excluding forced move-outs. Of course, one form of new supply has come from bankruptcies. Our exposure today remains limited to Cineworld, Party City, and Bed Bath & Beyond. With Cineworld nearing its exit and no material updates on Party City, I'll limit my comments to Bed Bath & Beyond as we don't have real exposure to other tenants that have filed to date. As of the first quarter, we had 17 Bed Bath & Beyond locations, which represented 1.8% of base rent. Of the 17 locations in the first quarter, one lease was sold as part of a JV asset sale, four leases were acquired as part of the bankruptcy auction, and four leases were rejected, leaving eight remaining locations. As expected, the bankruptcy process has been drawn out with multiple rounds of auctions, but we are nearing clarity on timing and control, and our leasing team is well underway with replacement tenants. Consistent with our prior commentary, inbound activity over the last several months has been elevated, and we expect that the majority of our stores will have executed leases over the next 12 months, with rents commencing by the end of 2024. We already signed one of our 12 available units in the second quarter, with two more at lease, and two with executed LOIs. These five deals represent roughly 60% of our expected pro forma backfill rent, and are all within a mixture of public, national credit tenants. Moving to overall portfolio leasing for the quarter, the breadth and depth of tenant demand remained high, translating into an acceleration in activity. In terms of total leasing, we signed over 1 million square feet of leases in the second quarter, including 170,000 square feet of new deals. Despite this uptick in volume, our leased rate was down 40 basis points sequentially to 95.5%, with the decline attributable to the rejection of four of our Bed Bath & Beyond leases. Looking forward, we have just over 250,000 square feet of share in current lease negotiations, including the Bed Bath & Beyond deals that I mentioned, with blended spreads ahead of our trailing 12-month average. We expect this leasing pipeline to be fully completed over two quarters. That said, the absolute level of quarterly activity will remain volatile as we simply have less space to lease until we take possession of all of our remaining Bed Bath locations in the third quarter. In terms of redevelopment, we are ramping up the final phase of our West Bay project here in Cleveland. All three of our tenants are now open at the TGI Fridays redevelopment at Shoppers World, and Starbucks is set to open in Carolina Pavilion and Shoppers World in the next few quarters as well. We've made quite a bit of progress on our tactical redevelopment pipeline in the last few quarters, and are getting closer on a few more small-scale projects to be launched within the next 12 months in New Jersey, Florida, and Virginia, which include a handful of first-to-portfolio tenants. To my previous point about construction costs limiting supply, the aforementioned projects have signed leases or executed LOIs that average $60 per square foot net, which supports our required returns for construction. It also shows that shop tenant rents are growing due to the supply-demand imbalance. I'll end with transactions. We acquired three convenience properties for $49 million, with two properties in our largest market of Atlanta, and one property in Houston. We are finding quite a few opportunities since our first acquisition in that market in June of last year. The assets are consistent with investments to date, centered around strong credit and low recurring CapEx, located at high traffic intersections within wealthy suburban communities. Average household incomes for the second quarter investments are over $125,000, and the lease rate of over 98% highlights our focus on acquiring properties where renewals and lease bumps drive growth without significant CapEx. Going forward, we remain encouraged by the unique opportunities in the convenience subsector that have arisen as a direct result of local relationships we've formed over the past several years. Because the cash flow growth profile and risk-adjusted IRRs of this property type are elevated with rents accelerating with inflation, we will continue to utilize retained cash flow and proceeds from recycling fully stabilized assets into this sub-asset class when the right opportunities arise. That said, capital markets volatility and availability is having an impact across the real estate industry, and I would expect overall transaction volume to remain low for the time being. In summary, we remain pleased with our company's position and outlook. Our team remains focused on growing occupancy, rents, and our convenience portfolio. We also want to wish congratulations to those who retired or are retiring this year after successful careers at SITE Centers. We are extremely grateful for your dedication and service, which contributed to all of our accomplishments over the last several years. With that, I'll turn it over to Conor.

Conor Fennerty, CFO

Thanks, David. I'll comment first on quarterly results, discuss our revised 2023 guidance, and then conclude with the balance sheet and capital plans for the year. Second quarter results were ahead of plan, as David mentioned, due to a mix of operational factors including higher than forecast rents and recoveries from higher occupancy levels along with higher percentage and overage rent. The operational upside totaled just over $0.01 per share relative to budget. Results also benefited from just under $800,000 of non-cash rent from the conversion of cash-basis tenants and below-market lease income from the rejection of a Bed Bath lease. In terms of operating metrics, trailing 12-month leasing spreads were steady across new and renewal leases, with blended spreads unchanged at just under 9%. We continue to see strong leasing economics for the pipeline, though quarter-over-quarter volumes and spreads will remain volatile given our denominator. The SNO pipeline was down modestly sequentially to $18.3 million from $19 million as rent commencements accelerated from the first quarter. Signed leases continue to represent just under 5% of annualized second-quarter base rent and over 5% if you also include leases in negotiation in our pipeline, providing a tailwind to cash flow over the next 18 months. We provided an updated schedule on the expected timing of the pipeline on page six of our earnings slides. Same-store NOI grew 1.7% in the second quarter with the uncollectible revenue line item providing a 190 basis point headwind to year-over-year growth. The deceleration sequentially was due in part to lost revenue related to Bed Bath, along with higher uncollectible revenue, partially offset by the aforementioned rent commencements. Moving on to our outlook, we're revising 2023 OFFO guidance up to a range of $1.13 to $1.17 per share, driven primarily by first-half 2023 outperformance, including better than expected same-store NOI and a higher outlook for full-year occupancy. Rent commencements, transaction activity, and potential tenant bankruptcies remain the largest swing factors expected to impact where we end up in the full-year range. We are also raising our same-store NOI guidance to a midpoint of 1.5%. Prior period reversals of $3.4 million in 2022 remain a roughly 100 basis point headwind to growth, and we continue to include an annual bad debt reserve along with specific bankruptcy assumptions related to tenants that have filed for bankruptcy, along with others with well-publicized liquidity concerns. Through the second quarter, uncollectible revenue and lost revenue from bankruptcies have totaled about 125 basis points. We have three national tenants in various stages of bankruptcy as of today, including Cineworld, Party City, and Bed Bath & Beyond. For Cineworld, the executed agreement at all three of our locations remains subject to completion of the company's bankruptcy exit, which is expected in the third quarter. That said, second-quarter earnings reflect the expected amended terms. For Party City, we have not had any rejections or store closures as part of the company's restructuring. The company has paid second and third-quarter rents to date. Similar to Cineworld, the outcome and no expected closures is subject to the bankruptcy process. Lastly, for Bed Bath, we expect all eight of the remaining locations that David outlined to be rejected this month. Revenue from leases rejected and expected to be rejected totaled $1 million in the second quarter. As part of the third-quarter rejections, we expect to recognize additional non-cash revenue related to below-market leases, but that is not included in our forecast at this time. We will provide additional details with third-quarter results. Moving to the third quarter of 2023, there are a few moving pieces to consider in the second quarter. First and most impactful is revenue related to Bed Bath. As I just mentioned, we recognized $1 million in revenue related to rejected leases and leases expected to be rejected in the second quarter, which we do not expect to recognize in the third quarter. Second, we recognized just under $800,000 of non-cash revenue in the second quarter, which is non-recurring in nature. And third, we expect to incur the estimated remaining charges related to our previously announced restructuring plan in the third and fourth quarters. Excluding these charges, which are excluded from OFFO, G&A is expected to average approximately $12 million per quarter in the back half of the year. A summary of these factors is on page nine of our earnings slides. Finally, ending with a balance sheet and capital activity, at quarter end, leverage was 5.5 times, fixed charges were four times, and our unsecured debt yield was over 20%. The company had $175 million outstanding on a line of credit, and our expectation is that the balance will move forward over the remainder of the year as a result of retained cash flow and net investments in capital markets activity. The net result is that we continue to expect debt-to-EBITDA to remain below six times through year-end, generating almost $50 million of retained cash flow with an AFFO payout ratio of roughly 70%, and have no unsecured maturities until August of 2024. This leverage profile and liquidity provides substantial capacity and optionality to fund the company's business plan. And with that, I'll turn it back to David.

David Lukes, CEO

Thank you, Conor. Operator, we are ready to take questions.

Operator, Operator

The first question comes from Dori Kesten with Wells Fargo. Please go ahead.

Dori Kesten, Analyst

Thanks. Good morning. As you considered your new guidance, where do you think you have built in the most conservatism at this point?

Conor Fennerty, CFO

Hey, Dori. Good morning. I don't think I would call it conservatism; I think it's a prudent budget, given macro uncertainty and capital markets uncertainty. As I mentioned in my script, there are three factors that could impact where we fall in the range the most: occupancy driven by bankruptcies, transaction activity, and the timing of rent commencements. At this point, we have better clarity on rent commencement of those three, and we feel really good about our occupancy and our forecasts for the year, but all three of those could impact where we end up in the range.

Dori Kesten, Analyst

Okay. And then, just one more, as you push more into convenience assets, where do you think your same-store NOI growth could stabilize over the next few years?

David Lukes, CEO

Dori, this is David. I think the next few years are most impacted by the SNO pipeline. I would say that the convenience portfolio has a same-store number that's higher on average once it gets to stabilization. But relative to the next few years, I think the existing portfolio is going to have higher same-store numbers simply because of occupancy uplift.

Conor Fennerty, CFO

Yes, and Dori, remember we like the convenience asset because it's a higher run rate on an occupancy-neutral basis. We also like the portfolio, given it's CapEx-light. So, to David's point, it's dilutive in the near term from a same-store perspective. It's accretive on an occupancy-neutral basis, but it's incredibly accretive to us from an AFFO perspective. CapEx as a percentage of NOI will continue to go down as the convenience portfolio grows, which we're most encouraged by.

Dori Kesten, Analyst

All right, thank you.

Operator, Operator

The next question comes from Todd Thomas with KeyBanc Capital Markets. Please go ahead.

Todd Thomas, Analyst

Hi, thanks. Good morning. David, I appreciate the detail on Bed Bath. I think you said the leases that you have executed related to backfills for space recaptured to replace 60% of pre-bankruptcy Bed Bath rent. Is that right? And then can you provide an update just around your expectations now that you're sort of a quarter deeper into the process around what you think the blended mark-to-market may look like on the Bed Bath box re-tenanting activity?

David Lukes, CEO

Sure. Good morning, Todd. I think what I meant to say was that the combination of the signed leases, the leases that are currently renegotiated, and the signed LOIs represent about 60% of the backfill number. We know the economics of those signed deals and the ones that are under negotiation today, so I would say that we're on target to see somewhere around a 20% to 25% increase to the existing in-place Bed Bath rents.

Todd Thomas, Analyst

Okay. And then on the convenience portfolio, you highlighted the lease maturity scheduling in the earnings deck, where you have 11% of AVR expiring through the end of '24 for that segment. Can you talk about the mark-to-market on those leases, and discuss the environment for rent growth that you're seeing in that product, in light of your comments around elevated retention and the lack of new construction taking place?

David Lukes, CEO

Yes, sure. I mean, the reality is that the convenience subsector is generally a renewals business. Right now, relative to my previous comments about new construction, to generate new multi-tenant shop buildings at $500 a square foot minus land, you really need to have rents pushing $60 or $70 a square foot, which we have been achieving in some markets. The flipside is that tenants in high-income markets that have been in these properties for a long time will need to pay market rent to stay. We're learning from underwriting when buying properties that renewals are growing faster than we had anticipated, so we feel very happy with the renewal probability and what the upside is in a lot of the shop rents.

Todd Thomas, Analyst

Okay. And so, a good portion of those expirations include renewals with stated rent, or do you expect to be able to negotiate extension options with the higher market rents that you're seeing?

David Lukes, CEO

Some of them have fixed rent options. The nice thing about this subsector is that we have the ability to capture upside with naked renewals, which is certainly a much higher percentage than you would find in an anchored property.

Todd Thomas, Analyst

Okay. And just lastly for Conor, how much in annualized G&A expense savings is the voluntary retirement program expected to yield in '24? And you mentioned the $12 million run rate in the back-half of the year, is that appropriate to assume as we think about 2024?

Conor Fennerty, CFO

Hey, Todd, good morning. We mentioned in our 8-K that the annualized savings would be just over $3 million. It's not all in G&A, but that is where the vast majority of it will fall. When we come to 2024, we'll provide guidance. You're right to assume the back-half run rate is closer to the right run rate for next year.

Todd Thomas, Analyst

Okay. How much of the $3 million is expected to be in G&A? And is the balance in operating expenses today?

Conor Fennerty, CFO

Just over 80% of it would be in G&A. There are some pieces that will fall into depreciation; we'll have lower, effectively non-real estate depreciation on a go-forward basis.

Todd Thomas, Analyst

Okay, thank you.

Conor Fennerty, CFO

Welcome.

Operator, Operator

The next question comes from Craig Mailman with Citi. Please go ahead.

Craig Mailman, Analyst

Hey, good morning. David, I just want to go back to the leasing commentary and maybe the construction cost increases here. You guys are getting good rent increases, as are a lot of your peers. But when you factor in the bump in TI costs and just overall cost of capital, from a return perspective, even with the higher rents, where do you think the return on that capital is today versus maybe 6 to 12 months ago? Is it still in the same range, or are these increased costs biting into the returns even with the higher rents?

David Lukes, CEO

Hey, good morning, Craig. If you're specifically thinking about ground-up shop developments, purely on leasing economics, if you look at our sub-portfolio and the trailing 12 months by quarter of net effective rents, it's staying pretty consistent. Rent growth is closely keeping up with tenant improvements across the board in the portfolio. Even if costs to backfill a tenant have increased by 20% or 30% in the last couple of years, it's a relatively small number compared to building a brand new building. So, the highest return on capital is leasing existing vacant spaces, where most of the leasing CapEx has gone in the past few years. Switching to new construction, it's difficult to make the math work unless your shop rents are north of $60 a foot, which is why we've been prudent about breaking ground on small projects.

Craig Mailman, Analyst

Okay, that's helpful. And I'm just curious, are you starting to see any segments or tenant types that are just pushing back on the rent increases at this point where they just don't feel like the business is supportive of these new rents?

David Lukes, CEO

Yes, there are some junior anchors that are well into the 20s, and shop rents that are well north of $50 or $60. There are concepts that don't generate enough 4-wall EBITDA to pay rent at these levels. The benefit now is that there are multiple choices, which is different than five or six years ago. The demand for space has been so strong in these high-income suburbs that tenants who can't afford to pay these rents simply lose out on negotiations.

Craig Mailman, Analyst

Okay. And then I asked this last quarter of you and your peers. Are you guys seeing any issues with some of your shop tenants being able to access capital through their banking relationships or any kind of change in AR balances, anything that would start to give you pause that shop leasing could begin to inflect?

Conor Fennerty, CFO

We have not seen anything to date. I ask that question daily, definitely weekly, and maybe even daily.

Craig Mailman, Analyst

And then just last quick one. I think you said, Conor, you did 125 basis points of bad debt year-to-date. How does that compare to budget, and can you give us updated numbers on bad debt bankruptcy?

Conor Fennerty, CFO

Sure, Craig. You are right, the last quarter when you asked, it was about 225 basis points. As we said in our prepared remarks, we're running ahead of plan on occupancy year-to-date. For the back half of the year our expectation, that number is closer to 200 basis points today. Of that, between Bed Bath and other tenants falling out, we've utilized about 125, so we still have a cushion or reserve of around 75 basis points in the back half.

Craig Mailman, Analyst

Awesome. Thank you.

Conor Fennerty, CFO

Welcome.

Operator, Operator

The next question comes from Haendel St. Juste with Mizuho. Please go ahead.

Ravi Vaidya, Analyst

Hi, good morning. This is Ravi Vaidya on the line for Haendel St. Juste. You referenced a 20% mark-to-market on leases from Bed Bath. I think last quarter you mentioned it to be a little higher, 25% to 30%. Any reason for the downtick? And can you discuss any of the capital costs associated with generating that sort of spread?

David Lukes, CEO

The capital costs really haven't changed in the last 90 days. I think if you're hearing us say the difference between 20%, 25%, and 30%, it's likely a management team that can't remember 90 days ago. I would say if we're talking about 60% of the leases, we see the economics are baked at somewhere between a 20% to 30% increase. We won't know until all leases are signed, but that's generally the direction of where the spreads are.

Ravi Vaidya, Analyst

Got it, that's helpful. Just one more here, moving past that Bed Bath, can you discuss what your watch list is right now, and what it is on an AVR basis across the portfolio, and what the potential mark-to-market and demand could be for that?

Conor Fennerty, CFO

We generally don't outline what exactly is on our watch list as a percentage of AVR. I will say we had about $600,000 of non-cash rent related to taking tenants off a cash basis, which implies that we feel more comfortable about our tenant roster today than ever before. There are, without fail, a number of tenants we have in our top 50 that we are concerned about. Our reserve continues to wind down, and the most encouraging factor is that the depth and breadth of demand to back those spaces remains robust. There will be bankruptcies and we expect others in the next six to 18 months, but given the quality of our portfolio and the level of demand today, we feel good about backfilling those spaces.

Operator, Operator

The next question comes from Samir Khanal with Evercore ISI. Please go ahead.

Samir Khanal, Analyst

Hey, good morning, everyone. Conor, I know you mentioned there hasn't been much change in shop space. When I look at occupancy, it was down a little bit in the quarter. I know you had big increases sequentially over the last few quarters. So, I'm trying to figure out if there's anything to read into that at this point.

Conor Fennerty, CFO

Hey, Samir, good morning. One of the challenges with our definition is that everything below 10,000 square feet falls into the shop category. If you broke that down between 5,000 square feet and under 5,000 square feet, you'd see a different story. Less than 5,000 square feet continues to tick higher. The 5,000 to 10,000 square feet, we had a few re-tenanting decisions, but I feel good about backfilling and it will just take a little bit of time. So, nothing we are seeing on shop demand.

Samir Khanal, Analyst

Got it. Thank you for that. And then, I guess just my second question on the transaction market. Are you seeing more assets come to market in the second half here? Whether it's the convenience centers or just open air in general? Anything on cap rates would be helpful. Thanks.

David Lukes, CEO

Yes, Samir, we are not seeing more volume on the market for sure. There remains a bid-ask spread. We are seeing lots of convenience properties to underwrite. The transactions fall into two categories: those where the seller is still looking for last year's prices and those where the seller is open-minded to current values. We've been careful and prudent about executing transactions.

Samir Khanal, Analyst

Thank you.

Operator, Operator

The next question comes from Alexander Goldfarb with Piper Sandler. Please go ahead.

Alexander Goldfarb, Analyst

Hey, good morning and thank you. So, two questions; David and Conor, just big picture, you spoke about the Signed but Not Yet Commenced ramping up over the next few years. And I think you said that it was either more than enough to mitigate the store closings or equally offset. But I am just trying to understand so that when we look at the company going forward, it sounds like the demand from tenants is more than enough to offset these store closings that you are experiencing in Party City and Bed Bath, et cetera. But I just want to make sure that we are not getting too excited about the Signed but Not Yet Commenced relative to the immediacy of tenants giving back space today?

David Lukes, CEO

Hi, good morning, Alex. You are reading this correctly. With a 310 basis points spread, the SNO pipeline is progressing well with executed leases with credit tenants. The confidence there is that when we layer in which spaces are coming back and what the spreads are on those spaces, we feel the SNO pipeline is tilting the scale more heavily than future moveouts at this point. That could change if leasing slows down and bankruptcies pick up, but for now, the scale is tilted towards growth given the SNO pipeline.

Conor Fennerty, CFO

Yes. This year is a perfect example. We just lost our seventh largest tenant, Bed Bath & Beyond, which as of the first quarter represented 1.8% of base rent. We expect to do 1.5% same-store this year at the midpoint. Adjusted for prior period reversals, we were doing mid-2s despite losing our seventh-largest tenant. This growth, with no pipeline, is unique and very different from prior periods.

Alexander Goldfarb, Analyst

Okay. And then, Conor, as we go from the second to the third quarter, you mentioned that there was $1 million of cash rent that's going away. There is also $800,000 of straight-line rent that's going away. I just want to confirm that and see if we can link where third quarter is headed versus second quarter. Assuming no more credit issues, it sounds like third quarter is going to be a new run rate for the company because it will have your reset G&A and no more Bed Bath in it. Is that correct?

David Lukes, CEO

I'm not saying it's the new base for the company, Alex. Your math is correct that we're losing $1.8 million sequentially, but the offset is the SNO pipeline. We have about $4 million annualized coming in, so called a million a quarter, in the third quarter. Commenced occupancy cash should be about flat quarter-over-quarter. And you are correct that we have a good run rate ex-Bed Bath in the third quarter.

Alexander Goldfarb, Analyst

Okay. And then just for humor, if you could indulge me, the OP units that you bought back, the press release said that it saves you some tax and accounting expense. Is that minimal expense, or is that sort of meaningful dollars?

David Lukes, CEO

It's fairly minimal. It was a significant use of time for our tax and legal department, but the OP units dated back to the 90s, so it was more about the unitholders and the structure they were in.

Operator, Operator

The next question comes from Floris Van Dijkum with Compass Point. Please go ahead.

Floris Van Dijkum, Analyst

Good morning, guys. Thank you for taking my question. So, it's very encouraging in terms of leasing; I'm looking at shop occupancy up 300 basis points year-over-year. That should really drive your growth and your confidence going forward. I wanted to get your comments on a couple of potential bumps on the road, particularly AMC and Jo-Ann, which together account for 2.3% of your AVR. I know there was something that came out over the last weekend about AMC and its ability to keep the lights on. How are you thinking about that? And if you can provide a little bit of an update on that, that would be appreciated.

David Lukes, CEO

Hi, good morning, Floris. The sentiment on theaters has been difficult to predict over the last three years. We were very careful to spin off the assets that had underperforming theaters, and kept those that had strong sales pre-pandemic. We also kept properties with strong land beneath them, meaning substantial density available. While we tried to get some theaters back during the pandemic, we were unable to do so. What happens going forward with theaters is uncertain. However, the land we own is valuable and there’s likely a higher and better use in those locations.

Conor Fennerty, CFO

I don’t think we need to comment on individual tenants. However, when we get space back we have a great track record of backfilling that space at compelling economics. Large format tenants mentioned have particularly low rent per square foot, which could increase mark-to-market potential. As for debt capital markets, I would say that the transaction you referenced is irrelevant to us in the open-air sector for a variety of reasons. Broadly speaking, for five-year or ten-year money, you are looking at all-in rates between 6% and 7%. The leverage profile of our company is drastically different, and the NOI growth is also favorable.

Floris Van Dijkum, Analyst

Thank you for that. I figured I’d get a response close to that. Just following up on AMC and the five locations. Could you give us a little more insight into those locations? Even if you get those back, you think you will make money on them longer-term?

David Lukes, CEO

Floris, I'm happy to send you the list of locations.

Operator, Operator

The next question comes from Ki Bin Kim with Truist. Please go ahead.

Ki Bin Kim, Analyst

Thanks. Good morning. Have you noticed any type of incremental change from your attendance and overall top of the funnel demand?

David Lukes, CEO

The short answer is no. Ki Bin, we are continually surprised by the depth and breadth of demand. We own a relatively small portfolio, so it's challenging to extrapolate that to the broader 30,000 square foot shopping center universe out there. However, I do want to emphasize that we have healthy demand.

Ki Bin Kim, Analyst

And with student loan payments mostly resuming, how do you see that impacting your customers or tenants?

David Lukes, CEO

Our tenant roster primarily does not reflect a student or middle-income market portfolio. We have long-term leases with large publicly traded companies, and the rent we receive that is not fixed rent is almost zero. Therefore, I do not foresee it negatively impacting our rental stream.

Ki Bin Kim, Analyst

That makes sense. It wouldn't make an immediate impact to your rental stream. I just meant in line with how that overall environment may lean retailers.

David Lukes, CEO

The demand is so fierce that even if it cools a bit, the demand is still robust, and there’s simply not enough space left.

Operator, Operator

The next question comes from Linda Tsai with Jefferies. Please go ahead.

Linda Tsai, Analyst

Hi, good morning. In recent filings and news articles, it seems like Party City's restructuring is going worse than expected. They're missing internal sales estimates and might emerge more levered than previously expected. How do you feel about their health post-restructuring? Are you reserving for what you anticipate post-bankruptcy rents might look like?

Conor Fennerty, CFO

Hey, Linda. Good morning. It's Connor. I think it's appropriate to opine on specific tenants. Party City is on cash basis and in bankruptcy, but we have not had any store closures to date. Until they come out of bankruptcy, it's a risk. We have reserves in place for a reason, as noted for the back-half of the year. If we get a few stores back or all of them back, we feel good about the depth of demand.

Linda Tsai, Analyst

Where do you expect occupancy to be year-end? I know you said you will get the remainder of the Bed Bath boxes back in 3Q?

Conor Fennerty, CFO

Yes, I expect occupancy to be flattish from second to third quarter, meaning we lose revenue related to Bed Bath, which is offset by commencements from the SNO pipeline. In the fourth quarter, depending on how the bankruptcy situation develops, we should see occupancy uptick from third to fourth quarter, assuming no further significant bankruptcies.

Linda Tsai, Analyst

Thanks.

Conor Fennerty, CFO

You're welcome, Linda.

Operator, Operator

The next question comes from Mike Mueller with JPMorgan. Please go ahead.

Mike Mueller, Analyst

Yes, hi. Could you give a little color on some of the redevelopments you cited in the prepared comments that may be starting in the next year or so?

David Lukes, CEO

Sure. The recent redevelopments result from negotiations with anchor tenants during COVID, where we agreed to defer rent in exchange for the removal of restrictions on our land to add density. Pre-leasing has been underway, and we’ve been preparing these projects for launch. These properties are primarily in Southern New Jersey, Boston, Miami, and Atlanta, where there’s a lack of shop space, and demand for shops remains strong.

Conor Fennerty, CFO

The projects added to the pipeline resemble those currently on the pipeline, consisting of drive-throughs and quick service restaurants. We are continuing with what has been built, just at different sites.

Mike Mueller, Analyst

Got it. So, mostly out parcels, is that right?

Conor Fennerty, CFO

Yes, it's generally multitenant pad out parcels and a few single-tenant drive-through out parcels.

Mike Mueller, Analyst

Got it. Okay, that was it. Thank you.

Operator, Operator

The next question comes from Ronald Kamdem with Morgan Stanley. Please go ahead.

Ronald Kamdem, Analyst

Hey, just two quick ones for me. I think the bad debt comment of 125 basis points, how much of that was Bed Bath, number one?

Conor Fennerty, CFO

About 100 basis points of the 125 is directly from Bed Bath and that 100 basis points reflects the full year impact.

Ronald Kamdem, Analyst

Helpful. As we roll into 2024, thinking about the SNO pipeline, rent bumps, and releasing spreads, is the biggest factor affecting same-store NOI growth going to be bad debt assumptions due to bankruptcies, or are there other things we should be mindful of in the portfolio?

Conor Fennerty, CFO

That's right, Ron. It's a function of Bed Bath, which will get a clean number in the third quarter, it's G&A which Todd discussed, and then it's interest expense, which I mentioned in my response to Alex. These three factors will drive 2024 performance.

Ronald Kamdem, Analyst

Got it. So, lastly, on acquisitions, can you provide the cap rates for the deals in the quarter and any targeted IRR metrics that you use?

Conor Fennerty, CFO

The biggest competition continues to be local real estate investors. They want to buy their local property, which remains the largest competition in the space. Cap rates have differed widely from sellers' expectations. I would say the unlevered IRR is more important; we target high single-digit unlevered IRRs with low CapEx burn and renewal probability.

Ronald Kamdem, Analyst

Great. Thank you.

Operator, Operator

And the last question comes from Paulina Rojas Schmidt with Green Street. Please go ahead.

Paulina Rojas Schmidt, Analyst

Hello. Good morning. I'm curious about your takeaways from the auction process of Bed Bath. For example, were you surprised by the players that did or did not show up, the variety of bids, or dollar amounts paid?

Conor Fennerty, CFO

Good morning, Paulina. I don't think we were surprised; it was anticipated and generated significant interest, especially with the overlap at ICSE Vegas. We had said that the duration on chain leases for a junior anchor was not enough to generate large portfolio transactions. Our expectation was that we would not have many purchased leases at auction; we ended up with a couple more than expected, which was encouraging.

Paulina Rojas Schmidt, Analyst

Okay, thank you.

Conor Fennerty, CFO

Thanks, Paulina.

Operator, Operator

This concludes our question-and-answer session. At this time, I would like to turn the conference back over to David Lukes for any closing remarks.

David Lukes, CEO

Thank you all for joining us, and we'll speak to you next quarter.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.