Whitestone REIT Q4 FY2020 Earnings Call

Greetings, and welcome to the Whitestone REIT Fourth Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Kevin Reed, Director of Investor Relations.

Thank you, operator. Good morning, and thank you for joining Whitestone REIT's fourth quarter and year-end 2020 earnings conference call. Joining me on today's call are Jim Mastandrea, our Chairman and Chief Executive Officer; and Dave Holeman, our Chief Financial Officer. Please note some statements made during this call are not historical and may be deemed forward-looking statements. Actual results may differ materially from those forward-looking statements due to a number of risks, uncertainties and other factors. Please refer to the company's earnings press release and filings with the SEC, including Whitestone's most recent Form 10-Q and Form 10-K for a detailed discussion of these factors. Acknowledging the fact that this call may be webcast for a period of time, it is also important to note that this call includes time-sensitive information that may be accurate only as of today's date, February 25, 2021. The company undertakes no obligation to update this information. Whitestone's fourth quarter earnings press release and supplemental operating and financial data package have been filed with the SEC and are available on our website, www.whitestonereit.com, in the Investor Relations section. During this presentation, we may reference certain non-GAAP financial measures, which we believe allow investors to better understand the financial position and performance of the company. Included in this earnings press release and supplemental data package are the reconciliations of non-GAAP measures to GAAP financial measures. With that, let me pass the call to Jim Mastandrea.

Thank you, Kevin, and thank you all for joining us on our fourth quarter and year-end 2020 investor call. We continue to hope that all of you, your families, and your businesses remain healthy and are doing well as we continue to navigate these most unusual times. Let me discuss the many positives that can be derived from the last year of challenges, and how our unique business model successfully passed a gauntlet of stress tests over this past year. The proof of Whitestone’s concept has become a reality, well before COVID hit. In previous investor calls, we've often talked about the necessity of being local, the essential tools of convenience, leasing to well-capitalized tenants that have skin in the game, and the evolution of retail to smaller, more flexible spaces. From its inception, Whitestone has differentiated itself from our competitors by avoiding big boxes and hard and soft goods-selling national retailers and by favoring smaller-footprint, service-based entrepreneurial tenants. Our tenants are triple-net. In normal times in the real estate world a disruptive contrarian concept like ours would take years to play out. What we have witnessed, however, is that in the real estate industry 10 years of change was condensed into 10 months. The result, we make this statement given the results our team has been able to achieve facing such difficult headwinds this past year. I would like to highlight six key factors in achieving our results. First, we had strong cash rental collections. Over the past year Whitestone has consistently been near or at the top of the shopping center industry regarding quarterly cash rental collections. In the second quarter, we collected 81% versus an industry average of 73%. In the third quarter, we collected 90% versus the industry average of 88%. And in the fourth quarter, we collected 95% versus the industry average of 93%. We are pleased to see the continued upward trend and are happy to announce 96% collections for the month of January. Second, solid tenant leasing: our leasing team was extremely productive, and our leasing spreads were quite strong, as we ended the year with blended leasing spreads of 8.9% for new and renewal leases. This productivity underscores the quality and desirability of our properties and the well-coordinated work of our leasing team. Within a time of distress and uncertainty, tenants exhibited a flight to quality and signed leases where they knew their businesses would thrive. Third, we have steady occupancies, and it is a testament to the quality of the tenant mix we strategically crafted. Our higher occupancy has held consistent over the past three quarters. We have maintained levels between 88% and 90% and ended the fourth quarter with an occupancy level at 88.2%, roughly just 2% below Whitestone's 2019 year-end occupancy. We consider the upside of bringing our occupancy into the 90% to 95% range very doable, and we will report our progress during 2021. Fourth, with minimal tenant bankruptcies, another example of the sustainability of our tenant mix is that we have less than 0.5% of our Annualized Base Rent (ABR) tied to tenants in bankruptcy—only six out of almost 1,400 tenants are in bankruptcy. Our diversified entrepreneurial tenant base brings stability to our cash flows without these interruptions. Fifth, our foot traffic: one of the most encouraging signs and a good harbinger of things to come is the significant foot traffic we're seeing at the properties. A December article by S&P Global highlighted Whitestone's number one ranking for the shopping center industry in foot traffic recovery on Black Friday with an 81% year-over-year recovery. This far outpaced the industry average of only 48%. It also supported and confirmed our internal research using third-party artificial intelligence software that showed over 80% year-over-year recovery at the properties for the entire month of November. Sixth, we had uninterrupted monthly dividends. As one of the few monthly dividend-paying public REITs, we're very conscientious of the importance of the monthly dividend to our shareholders. Albeit at a reduced rate during COVID, we continued with a monthly dividend while many other REITs suspended distributions. With the strength, stability, and predictability of our cash flows, we continued uninterrupted payouts, now going on 126 consecutive months. As we navigate this pandemic, I have often said we are not looking to win the pandemic, but we are looking to win the recovery. These results are putting us in a great position to do so. Highlighting the success of these six factors gave us the ability to do three things. First, we increased the dividend; most recently our Board decided to raise the dividend by 2.4%. This increase underscores the team's confidence in the consistency of our operations and the ability to enter 2021 with a winning recovery and profitability with our base of high-quality properties. Second, we repaid the $30 million of COVID borrowings. The strength of our operations mitigated the need for our precautionary $30 million drawdown of our credit facility availability during COVID. By year-end, we had repaid the entire $30 million of borrowings and strengthened our balance sheet. Third, we published our inaugural corporate responsibility report. With a look to the future and continued enhancement of our ESG efforts, we published our inaugural corporate responsibility and sustainability report in December. We view ESG as an integral element to Whitestone as we move forward. Taking a step back, all these results in aggregate are a true testament to the uniqueness of our business model, our forward-thinking management team, our high-quality properties, and the high-growth markets we specifically chose to be in. The nature of our business model begins with owning properties located in areas with high household income neighborhoods in the fastest-growing MSAs in business-friendly states. One of the key differentiators that separates Whitestone is we own properties in places where people want to live. COVID has accelerated the pace of migration already in motion out of states with higher regulatory and tax burdens into business-friendly states like Texas and Arizona, where we presently concentrate our work. Another key differentiator and further proof of Whitestone's small-footprint concept is that we own the right-side retail. A recent article published by Forbes in September discusses the acceleration of national retailers like Target, Kohl's, and Macy's transformation to get stronger. The obsolescence of larger big-box retailers and malls continues to move ahead, and we continue to benefit from this shift away from traditional mall tenants to open-air shopping centers. The essential convenience of our community center properties was never more evident than during the pandemic. Ninety-nine percent of our businesses were open as of year-end. This important fact is further emphasized by year-over-year foot traffic continuing to increase at some of our properties. We eagerly anticipate getting back to our growth, value-add strategy that includes our $250 million of internal intrinsic value opportunities and a $500 million external acquisition pipeline of prospects, with a proven model, stronger platform with greater financial flexibility, and a leaner, more cohesive team to scale our business. The performance of our team and the execution of our business model is deeply rooted in Whitestone's culture. Throughout this past year, I have often been reminded of a classic book titled The Little Engine That Could. This inspiring story illustrates the human determination displayed at Whitestone. Despite our current size, we continue to deliver large returns with a purpose and a mission to serve our shareholders regardless of the challenges we may face ahead. I am very pleased with the dedication of our management team and what they displayed in navigating this crisis. I am proud of how Whitestone's operations team stepped up, met the daunting challenges head-on, ignored the naysayers, and overwhelmingly exceeded expectations. Given these results and staying true to our values, I remain very optimistic for the future and the potential to create increased value for our shareholders. With that background, I would be pleased to turn the call over to Dave Holeman, our Chief Financial Officer. Dave?

Thanks, Jim. First, I would like to echo Jim's comments regarding the strength of the economic recovery in our markets and properties. Our foot traffic recovered strongly, and our cash collections continue to build toward pre-COVID normal levels. Our occupancy has been impacted, but only by about 2%. Our leasing activity has rebounded to pre-COVID levels and leasing spreads have remained strong throughout 2020. We have a highly dedicated team that works every day to create local connections and communities that thrive. We continue to see the strength of our geographic focus and our forward-thinking, well-crafted tenant mix. Despite having a significant number of our tenants' businesses impacted, we only had a handful of tenants close for good, such that the portfolio occupancy rate held up well, ending the year at 88.2%, down 2.1% from last year, or approximately 100,000 less leased square feet, representing the net loss of only nine tenants year over year. Also, our annualized base rent per square foot at the end of the quarter was $19.43 and $19.58 on a cash and straight-line basis. This represents a 1% decrease on both a cash and straight-line basis from a year ago. The change on a straight-line basis is largely related to the conversion of 102 tenants to cash-basis accounting and the associated write-off of accrued straight-line rents. During 2020, the impact to funds from operations from these cash-basis conversions was approximately $3.5 million, or $0.08 per share. At year-end, we have 54 tenants on a cash basis, representing 4.2% of our gross leasable area and 4.6% of our annualized base rent. Cash-basis tenants paid 65% of contractual rents in the fourth quarter, up from 63% in Q3 and 41% in Q2. Our square-foot leasing activity was 10% higher than the fourth quarter of 2019 and our blended leasing spreads on new and renewal leases on a GAAP basis was a positive 8.9% for the year. As Jim mentioned, for the quarter, we collected 95% of our rents. This includes base rent and triple-net charges billed monthly. Our deferred rents for the quarter were 2.6% of our total contractual billings. While we are encouraged by how things are progressing, the pandemic has had an impact on our full year 2020 financial results. Funds from operations — core — was $0.24 per share for the fourth quarter and $0.93 per share for the full year. Same-store net operating income was 4.2% lower for the quarter and 4.4% lower for the full year. The impact on FFO core for the quarter and year from incremental COVID reserves was approximately $0.02 and $0.13, respectively. Let me provide some further details on our collections and related receivable balances. Included in our supplemental data package is a breakdown of our tenants by type. All of our tenant categories were above 90% collections in Q4, with the exception of fitness, representing 4% of our revenue at 82%, and entertainment, representing only 2% of our revenue at 48%. Our largest tenant categories, restaurants, grocery, and financial services were at 96%, 99%, and 99%, respectively. At year-end, we had $23 million in accrued rents and accounts receivable. The components of the $23 million consist of $16.3 million of accrued straight-line rents and other receivables, $20.7 million of billed receivables, $2.2 million of deferred receivables, offset by a bad debt reserve of $16.4 million. Since the beginning of the year, our billed receivable balance has increased $4 million and our deferred receivables have increased $2.2 million for a total billed and deferred receivable balance increase of $6.2 million. Against this increase, we have recorded an uncollectible reserve in 2020 of $5.6 million, or 90%. Turning to our balance sheet: since March, we have implemented various measures to strengthen our liquidity and navigate the economic pressures caused by the pandemic. Our liquidity, representing cash and availability on our corporate credit facility, stands at $44 million at year-end, down only 6% from $47 million at year-end 2019. During the fourth quarter, we paid off all COVID-19 liquidity borrowings, and our total net real estate debt is down $12 million from a year ago. Currently, we have $131 million of undrawn capacity, and $18 million of borrowing availability under our credit facility. We are in full compliance with our debt covenants and expect to remain so in the future. 2020 has been an unprecedented year, in which our team has worked together through this ongoing crisis, and our shareholders will reap significant future benefits through greater collaboration, a more robust exchange of ideas, better and more effective communication, and improved systems and processes that provide Whitestone new actionable data and allow us to more efficiently scale our infrastructure. Whitestone operates in many of the most highly desirable growth markets in high population growth states and we expect these markets to continue to lead the country in economic recovery from the pandemic. And lastly, regarding guidance, it is our intention to resume providing guidance later in 2021 as the pandemic and macroeconomic uncertainty continue to dissipate. And with that, we will now take questions.

Our first question is from Aaron Hecht with JMP Securities. Please proceed with your question.

Hey, John, hey, Dave. Thanks for taking my questions. Want to start with Texas? Obviously, the weather's been really tough there over the last week or so, wondering if there's any damage that's occurred at the properties, any sort of impact we should be aware of for Whitestone from the weather conditions in Texas?

Hey, Aaron, it's Dave, thanks for your question. Yeah, it has been a strange week. We had some unprecedented cold weather in Texas. Whitestone has done very well and had minimal damage to our properties — a couple of small pipe breaks, but nothing significant. A lot of folks in the area have been impacted, but Whitestone did very well throughout it.

Okay. Good to hear. And then on the demand side, it sounds like the foot traffic's really starting to pick back up, which is good. Looking at the new leases and the renewals, looks like new leases are down about 5% while renewals are up double-digit — pretty big divergence there. Any sort of takeaways between the new leases and the renewals to give us better insight into what's going on? Is it a certain group of tenants that have lower demand for their product moving out and the higher demand tenants wanting to renew that's causing that, or any insight there?

Sure, it's Dave again; I'll start off and Jim might have some comments as well. One of the things we do obviously is try to give some transparency as to the leasing spreads. I will tell you, we like to look at it more on a 12-month basis than an individual quarter because in any given quarter, there are not that many leases that come through. So our leasing spreads, as you said for the quarter, were a little lower on the new leases. I think the renewal leases were kind of consistent. There really isn't a trend we've seen. We saw a couple of shorter leases where we were doing smaller amounts, but not a trend. Historically we've been around the 10% kind of level with blended spreads, and that's where we are for the 12 months. We're very energized by the activity we're seeing; we're seeing a lot of demand. One of the things we talked about a little bit on the call was the migration, and I think in our markets with the amount of population migration, as well as some business migrations, we're seeing very good activity.

Aaron, thanks for asking the question. Company-wide, we're seeing a lot of enthusiasm from the leasing team. We meet once a week for about two hours with every single leasing person and we screen the deals and the letters of intent and the leases that are out for signature. So we're seeing a lot of activity in that regard. It's interesting at these meetings we learn things, and this is something that ties to the migration into Texas and Arizona. We learned this past Monday that one of the large homebuilders in Arizona is now in a lottery system for selling lots. They've separated the sale of the house from the lot. So you can buy a house, but then you have to go into a lottery system for a lot. That's part of the reason for the influx from California into Arizona. That in effect will trickle over to the demand for our centers. We're watching that very closely, and you'll see those numbers change a bit in future periods.

That's great insight on the net migration. Appreciate that. Nice quarter, guys. We'll jump back in the queue.

Our next question is with Craig Kucera with B. Riley Securities. Please proceed with your question.

Yeah, hi, good morning, guys. Dave, I'd like to talk about your bad debt assumptions. I think we've seen bad debt fall half from the second quarter, but it didn't materially change from the third quarter. It was sort of midway through the first quarter, you're looking at collections that are relatively flat and even modestly improving. What are your thoughts there as we move through the first quarter and the first half of the year?

Hey Craig, thanks for the question. Obviously, it's been a year of assessing collectability on our tenant base. We've done that at a very granular level, really looking at the tenants and understanding their financial position. We've converted about 104 tenants to cash basis. You're right: I think our highest bad debt quarter was the second quarter, and we've seen that come down in the third quarter. The fourth quarter was fairly consistent with the third quarter. We do expect, obviously, to see that dissipate in 2021, but there's a lot of continued uncertainty with the pandemic and the impact. Our collections are improving — 96% in January — and we're very pleased with that. For the year, we recorded about $6 million in reserves for COVID collectability, and I think with the increasing trends in our collection rates, we should see that improve in 2021.

Okay. Thanks for that. And we're hearing that there's an increasing amount of money looking to buy shopping centers here in early 2021. Are you considering at all maybe selling some assets to possibly deleverage the balance sheet? Or is that not a consideration at this point in time?

As prudent owners of real estate, we're always looking at investments. We do think there are a lot of benefits to Whitestone from continuing to scale our platform. One of the things Jim mentioned is we are seeing some opportunities out there from the acquisition side. We're going to be very prudent with our capital allocation. Right now we always look at individual assets and evaluate what's the best way to get a return to our shareholders from owning those assets.

Craig, there's always a right time to sell properties. We've got some really terrific properties that we've hand-picked and we're in the process of getting those to what we call a stabilized level. We consider a property stabilized when it's at a 95% occupancy and when the rents are equal to or greater than the market rents in the surrounding three- to five-mile area. Each property we buy usually has some turnaround and value-add features. We like to get them to the point where they match that stabilized characteristic. We are also in the market looking to buy properties. We think we have an enormous pipeline — about a half a billion dollars, as we mentioned in our remarks. We're seeing some really good opportunities, mostly from sellers who may not have wanted to sell their properties before but, since COVID, realized that life is getting too short. We've been introduced to some properties we've carried in our pipeline for some time, so we're looking at some really attractive deals right now.

Craig, one further comment: I am very pleased that we were proactive in reducing our leverage this year. Even given the collectability issues of COVID, we brought down our total net debt about $12 million year-over-year.

All right. Thanks. One more for me: I know you've got about 16% of your leases expiring this year. Can you give us a sense of how many of those are month-to-month, roughly?

Yeah, historically if you look at our leasing activity, this year we signed about 900, almost a million square feet. So we're very comfortable with the level of leases we have expiring in 2021, which is about 800,000 square feet. We typically have a small amount of month-to-month square footage, and we typically roll tenants over — when they go to month-to-month, we roll them back into leases. So we don't have a significant amount on month-to-month leases. We're also very comfortable with the leases that are maturing in the next year. If you look at the square-foot price of those leases, it's around $17, a little below our portfolio average. So we're very comfortable with our lease roll this year.

Got it. So it doesn't sound like there's any known large move-outs in 2021 that you're aware of?

That's right. We have a very diversified tenant base, with our largest tenant making up a little about 3% of revenue. We have no known significant move-outs coming up.

Nothing large. Our average tenant size is about 5,000 square feet, so when a tenant moves out we can absorb that space very quickly and releas it to a new tenant.

Okay, thanks. That's it for me.

Our next question is from Michael Diana with Maxim Group. Please proceed with your question.

Thank you. You said you expect to increase your occupancy to 90% to 95%. You already talked about the role that migration from California may play in that. What sort of assumptions are behind that in regard to opening of the economy and just general growth in Texas and Arizona?

Hi, Michael. In terms of how we see our occupancies increasing, one of the key factors is adding people. We've added three new leasing people to our team. We have a very specific business model that requires certain characteristics in our leasing effort. By adding new people, we will be able to fill more of the vacancies that we've had. The second factor is we have a large space in Terravita — it was an Albertsons that went empty, approximately 60,000 square feet — and we're now about two-thirds of the way under lease contracts to get that occupied. So we have a couple of holes like that that we're filling, and we see those filling up very quickly. Then there's a matter of a lot of small spaces that we need to fill, but we're very optimistic about the opportunity we have this year.

I can touch on market conditions. The recovery is happening at different levels throughout the country. We sit, as we said, with 99% of our businesses open today, and in Texas and Arizona many are able to operate at pretty close to pre-COVID levels with some distancing and spacing. So we anticipate that the economy in our markets will continue to improve, and we're in a relatively strong position today compared to some other parts of the country.

Okay. Great. Thank you.

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Jim Mastandrea for closing remarks.

Well, thank you. Thank you all for being here. I'd like to close by reiterating Whitestone's proof of concept: our business model is focused on the necessity of being local, the essentialness of convenience, leasing to creditworthy tenants that have skin in the game, and the evolution of retail to smaller and more flexible spaces. These small spaces have really captured the delivery process directly. Our work has served us and served our shareholders very well by stabilizing our business quickly in the early days of the pandemic. We've delivered solid results in significant headwinds. This has enabled us to really refocus on our pre-COVID goals of targeting accretive acquisitions and extracting the significant embedded intrinsic value in our properties, and then to further scale our platform. Along with the Board, we're pleased to recognize the quick stabilization and momentum of our business and the confidence to increase our dividend earlier this month to prioritize the people we ultimately serve, and that's our shareholders. As we continue to serve our shareholders, employees, tenants, and all of our stakeholders, we know that God's hands are on our shoulders, and we truly thank you all for your continued confidence and support in our efforts. With that, I'll close. Thank you.

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