Acadia Realty Trust (AKR) Q3 2012 Earnings Report, Transcript and Summary

Welcome to the Third Quarter 2012 Acadia Realty Trust Earnings Conference Call. As a reminder, this conference is being recorded. We will conduct a question-and-answer session following the formal presentation. [Operator Instructions] I’ll now turn the call over to Amy Racanello, Vice President of Capital Markets and Investments. Please proceed.

Good afternoon, and thank you for joining us for the Third Quarter 2012 Acadia Realty Trust Earnings Conference Call. Participating in today’s call will be Kenneth Bernstein, President and Chief Executive Officer and Jon Grisham, Chief Financial Officer. Before we begin, please be aware that statements made during the call that are not historical may be deemed forward-looking statements within the meaning of the Securities and Exchange Act of 1934 and actual results may differ materially from those indicated by such forward-looking statements. Due to a variety of risks and uncertainties, including those disclosed in the company’s most recent Form 10-K and other periodic filings with the SEC, forward-looking statements speak only as of the date of this call October 24, 2012, and the company undertakes no duty to update them. During this call, management may refer to certain non-GAAP financial measures, including funds from operations and net operating income. Please see Acadia’s earnings press release posted on its website for reconciliations of these non-GAAP financial measures with the most directly comparable GAAP financial measures. With that, I’ll now turn the call over to Ken Bernstein.

Thanks, Amy. Good afternoon. As most of you are aware, there are 2 broad and complimentary components to our business. The first is within our core portfolio where the key drivers are, first growth from our existing assets, and then coupling that with our core acquisitions where we’re selectively adding high-quality properties to our portfolio. The second component is through our fund platform where in the third quarter, we continue to pursue new opportunistic and value add acquisitions. We continue to develop lease up stabilize and selectively monetize existing investments and then most importantly, we completed the capital raise for our Fund IV. So I’ll begin today’s discussion with our core portfolio activity and then I’ll follow it up with an update as to our fund’s activity. At that point, Jon will conclude with a more detailed review of our third-quarter earnings and operating metrics. So first, with respect to our core portfolio operating fundamentals, as is set out in detail in our press release, our third quarter same store results were solid even after stripping out the re-anchored properties from our 6.2% same-store NOI growth, our same-store NOI growth for the balance of the core portfolio was still a solid 3.2%. In terms of our re-anchorings, the final significant moving pieces at our crossroad shopping center here in Westchester, New York. And as you may recall, we bought this lease back from A&P when they filed bankruptcy. The rent on the lease at the time was about half of market rent. And as we stated during our last call, we recently opted for a slightly more complex expansion of the existing space so that we could add a more significant anchor tenant to the center during the third quarter, our teams made significant progress towards the signing of this…

Good afternoon. First, I’ll touch briefly on earnings. FFO of $0.27 for the third quarter was consistent with expectations. A few noteworthy items, one, results included $500,000 or a penny of acquisition costs. Secondly, with the final closing of Fund IV, we’re now earning a full asset management fee of $1.5 million dollars a quarter from the Fund. And finally, in terms of our key re-anchorings, this was the first full quarter of Bloomfield Hills being online and contributing $400,000 to quarterly NOI. As Ken mentioned, LA Fitness, which replaced the former AMP at the Branch Plaza opened this month. So it will start to contribute to earnings during the fourth quarter. Turning to our portfolio performance, the core portfolio continues to perform above expectations. Same-store net operating for the quarter of 6.2% was driven primarily by top-line revenue growth of 7%. About half of this was from our re-anchoring activities with the balance of the portfolio driving the other 3%. Based on our year-to-date performance, we continue to track above the high-end of our full-year guidance for same-store NOI. We originally forecasted 2% to 3% growth, we now think we end up between 4% and 5% for the year. Occupancy at September 30th was 92.9%, which was up 30 basis points over second quarter. And with LA Fitness at the Branch Plaza now open and operating, as of October were 94% occupied. Small shop occupancy at September 30th was 87.1%, up another 90 basis points from the second quarter and up 540 basis points since the beginning of the year. As we noted, we continue to make progress in our core property re-anchorings, 2 of the 3 projects, Bloomfield Town Square and Branch Plaza are now substantially online. And together, these represent about $2.6 million of the total $3.5…

[Operator Instructions] Our first question comes from Todd Thomas from KeyBanc Capital Markets.

First, I was just wondering if you could touch a bit on the core acquisitions that are under contract $175 million pool. I was just wondering if you can give us a sense as to what the composition of those deals looks like, and perhaps what the timing might be for them to close in terms of the composition of basically what percent street retail versus some of the other densely populated suburban markets that you touched on?

Yes. The vast majority of this is going to look very much like the past year’s acquisitions. So I’d say looks to be at least 70% street or urban, $40 million of it is our expected and hopefully we’ll get in the next 30 days, then completed the final tranche of the Chicago portfolio and you may remember Todd on previous calls we said there was a final piece that we have to get through the securitization approval, and I think we’re now there on that piece. So expected to be in the markets that we continue to operate in, so there will be scale expected to be assets similar to those that we currently own and probably 70% street urban, 30% dense suburban.

Okay. And then for the $175 million, what’s the expected equity requirement overall?

Well, I think Jon was pretty clear when he articulated that we want to stay on a leverage neutral basis. Jon, why don’t you walk through our cash on hand?

Sure.

But -- and keep in mind, because one thing I didn’t then specifically said, some of these fields are still subject to due diligence. So you can handicap that as you might choose to, I’d say about a third of the properties. We still need to make sure we’re comfortable with. And then from a timing perspective, I wish I could tell you that they’ll all close tomorrow, but I bet we will get half of them done this year and then the other half may lead into next year in terms of delays with lenders approvals, et cetera. So Jon can walk through both cash, as well as how the ATM seems to have worked quite nicely.

Sure. And as I mentioned in my prepared remarks, the ATM to-date has worked very well in terms of match funding of the acquisition set that we’ve completed. And looking at, what we currently have in terms of available capital, there is $65 million available under our current line of credit. We have $25 million plus of free cash or available cash that we can apply towards the acquisitions. And then we have $100 million dollars available under the current ATM. So depending on the timing, we should be able to, for the most part, match that up and cover those acquisitions with that combination of capital. Keeping in mind that leverage neutral means 2/3 equity, 1/3 debt, so we’re talking give or take $120 million of equity versus the $55 million to $60 million of debt. So we think it all works, and again we’ll see how the pieces fall and close over the next quarter or 2, but should work well, as it relates to that.

How much of that is in place on the $175 million that you’d be assuming?

Not much. Not much to tell, probably less than $10 million.

Todd, I’m sorry. By the way, that doesn’t – obviously, as we close, we can put property-specific debt on at closing as another means of putting the debt piece in place.

Okay. And then I was just wondering if you could share an update on the monetization of the storage first portfolio. Is that being marketed today? And if so what’s the interest has been like?

We have not gone out to the market yet to-date. Our team has done a terrific job as I mentioned in terms of getting occupancy up, and now what we’re seeing is significant I mean I think year-over-year a 20% same store NOI growth. So it may be a little early for a formal marketing. We are getting some reverse increase and if it plays out that way, that’s fine with us too. So we are not going to be holding this portfolio for a extended period of time because in our Fund business we don’t do that for any businesses and I think we’ve been pretty clear that self storage is less core to us than retail. And as you saw last quarter, we sold less port. So be a little patient because we want to make sure we maximize the value, but we’re not going to be greedy and we’re not going to hold on to this longer than we should.

Our next question comes from Craig Schmidt from the Bank of America.

A question on City Point, given the high profile opening of Barclays center and now your announcement of a Armani Exchange, has that raised or broadened the tenant interest in the project?

Certainly has. And then, Craig, I don’t know if you’ve notice today, but we not only have to become net stands but now have to become Rangers, excuse me, Islander stands as well. For Nixon Ranger person like me this is a little bit of a stretch. Brooklyn is on fire residentially, in terms of the restaurant, and then in terms of retail. It’s going to be a combination of the fact that a host of retailers whether it’s H&Ms of the world or the Armani Exchange is now coming to our side have recognized that Bolton Street has the potential to be doing and serving a much broader part of Brooklyn than historically Fulton Street did. But now everything that’s going on in downtown Brooklyn, I don’t know how far this could go, but I am amazed that how many people that I talk to especially young professionals, they want to live in Brooklyn, now in terms of technology, a lot of people want to work in Brooklyn. So we’re trying to be relatively patient and thoughtful about how we finish the lease up of this project, but our main focus is to get this done in deliberate fashion. Get Phase-I open with Armani and then get Phase-II’s, the construction started and then Phase-III, which will be more likely they’re not pure residential and that will then be sold off to a residential owner developer.

And what are you targeting for your Phase 1 and Phase 2 openings now?

So Phase 1 should open this year with Armani Exchange. And then Phase-II, we will start construction this year, we already have and that should open 2014, 2015. And that’s -- those are the 2 phases we will be actively developing and a part of Phase 2 will have 200 units of affordable housing, which I think is very important for the community, as well as another residential market Phase as well, both of those we’re not doing, we’ll be handing those off to very talented developers. And then the timing of Phase III is to be determined, because as I mentioned before, our goal will be to sell that land to a developer and the ability to build something very substantial there existed to be well over 1.5 million square feet.

And just one last question on Fund IV. May there be opportunities that exist for that fund that weren’t available to Fund V, II, III that may be a few actually investigate new areas?

Yes. Every fund seems to have a theme in one form or another. When we try not to stray too far from what we consider our core competencies. But if you think about our, what we like to articulate is our 4 different buckets in terms of fund activity. One is opportunistic. And you tell me, what year it was and I’ll tell you what opportunistic look like. But certainly in 2009, it may be just having the guts to write a check and buy asset. And then, I have a feeling now opportunistic what we’re seeing is more of the opportunity to buy that at a discount and foreclose or workout those assets and 2 years from now who knows. Then, there’s the distressed retailer component, and you’ve seen us play in that arena a lot of different ways in fund II that was the Albertsons and Mervyn’s transactions. Today it’s more about us buying one off pieces of real estate subject to Shaw’s or A&P’s, but unfortunately distressed retailers are always going to be a part of our business in good times and bad. So we’d like to have that theme as well. And then there are times, when it feels better, safer, better risk adjusted returns to the developer, redeveloper. We’ve historically limited our development to real dense infill locations. My guess is that would stay the case over the next few years. So the one piece that intrigues me is and we’re not -- don’t expect to see any announcements right now but there seems to be a very wide bid and ask spread for secondary asset. And for our core portfolio, we’ve been crystal clear that the separation between the haves and have nots continues, and we want to make sure that for the core portfolio of assets that we intend to own for a very long time that we’re owning these great locations, the SoHo, Linkin parks of the world. But it seems as though there is a lack of transactional activity on some of the secondary assets and it yields continue to move up on that, maybe there would be an opportunity. So far, we have not seen enough transactions that make us want to jump into it, but I look at some of the deals that Blackstone has accomplished in multiple different spaces, very smart guys and I think they’re going to make a lot of money on the deals they acquire. So that could certainly be an opportunity within retail for Fund IV, it is certainly a skill set we have, so stay tuned.

Our next question comes from Cedrik Lachance from Green Street Advisors.

Just want to ask a question regards to development, and just getting your take on how attractive is it right now to go after restart the development versus continuing to acquire properties?

I think given the locking in interest rates for development. We need to be very careful in this need compressed rate environment, that the old rule, that I didn’t love even back then well 200 basis point spread to current cap rates doesn’t feel wide enough. So when you were developing to a 12, because you’re assuming you’re going to sell at 10 cap if, that makes some sense and 200 basis points feels like a widespread today, but they feel like there is so much spring-loaded risk. That interest rates move on you, after you’ve already locked in your rents. Enough risk similarly in terms of locking in your leases and cost moving on. We’ve been fairly cautious to make sure that the spread to development is wider than it was historical. And then to add to that or bias that, we really only want to be in infill markets that we know we have the tenant demand upfront, we’re finding that there is other people far more willing to take the typical speculative risks associated with the development. And our team is more inclined to focus then on the value-add proposition, which is buying well located real estate hopefully with tenants in place, but either way a more straightforward path towards cash flow over 1, 2, 3 years as opposed to -- even, we were very pleased with our developments and thankfully we’re making money on them, but we can see what happens when the tide changes and what it can do in terms of delaying these developments.

Okay. So in your mind it’s so much more interesting to go find, let’s say, re-incurring opportunity than to try to develop roundup even in some of the better markets where you are active?

Yes. Again, I don’t want to overstate it in one direction or another and the devils in the details and I could say all this and whole (inaudible) up and say we really want this site, we’ll sign a lease, we’ll hedge your risks and all of a sudden we very well may do something like that. We have very good tenant relationships and if the pricing works great, but for the most part what we’re seeing is for every development field that we’re spending time on, there is probably 10 deals on the re-development or acquisition and lease up phase or occupying more of our time and probably more of our capital resources.

Our next question comes from the Rich Moore from RBC Capital Markets.

I think, Ken, you are not part of the Cerberus bid for Supervalu at this point.

Why do you think that?

Or maybe you don’t want to answer that, sorry.

Yes. I think that’s probably. We wouldn’t get into those specifics. You know we’re a partner in Albertsons and I’ll let you conject on what any of that means.

Okay, fair enough. Then on the same vein, in the RCP and Mervyns II and Fund II, I think you guys paid out your part, which was $1.7 million of the legal settlement with Mervyns, is that right?

Yep. Rich, to be clear, we didn’t pay that amount out. What -- look back up for a second in terms of the litigation, so this is a settlement and we’re pleased with the results and the settlement and putting all this to bed. This was not in the amount of cash that was paid out of our fund. This was paid out of the assets at the consortium at the Mervyns entity level. And so it doesn’t impact our historical return at all. And so just to be clear on that, it’s not cash out of our pocket.

Okay. Good, yes, got you, Jon. And so is that the expense of that legal settlement on $166 million aggregate for Mervyns?

Yes.

As far as you guys are concerned?

Yes.

Okay, okay. Good, thank you. And then, the extra G&A that you had in Fund II, I think was legal fees for PA and Malinsky, I think that’s correct. And if so is that -- is that situation over at this point, has that all been sort of taking care of in the courts.

Yes. Thankfully, they were fully exonerated, which was great relief to them and to us. And it’s all fully cleaned up.

Okay. So your relationship can -- with them at this point is, is there much left at that relationship?

This is an earnings call, not a therapy session, but if the relationship’s just fine, we had to step in and take over certain aspects towards finishing the projects. But they remain investors in the projects, partners in the projects, and our relationship is just fine.

Okay, all right, good. Then, Jon, you have an acquisition facility in Fund III, that I saw in the supplemental comes due 10/10 -- October 10th. Has that -- I think it’s $83 million, has that been addressed I guess at this point?

Yes. So obviously, Fund III of the acquisition phase is complete. So going forward, we’ll not be in need for line like that.

Okay. So is that -- that was actually outstanding on the line, wasn’t it?

It was.

And then what happens to that?

That will be replaced with equity.

With the fund equity.

All right, good, got you. And then, Ken, you were talking about upgrading the portfolio through acquisitions and -- the core portfolio, and I wasn’t sure if that was simply adding good properties to the portfolio or if you would continue to sell out of some of the lower end of the portfolio at the same time?

Yes. And it’s probably both, Rich. Again, keep in mind the lost small numbers. Our portfolio is a $1 billion in total. So by definition, if we have an upward quartile that’s $250 million, we have a bottom quartile as well as, and unlike children you’re allowed to have favorites and less favorites. So in that bottom quartile, we can afford to patiently sell, look Bloomfield Hills in Michigan. You would quickly circle as not being in one of our core markets and the team has done a great job now of leasing that stabilizing and has -- adjacent to -- with a top performing Costco, it’s very high credit and I wouldn’t -- the exporting goods open et cetera. And I would expect us to sell that at some point. Now remember $250 million, if we’re to get rid of the entire bottom quartile and I doubt we would, it’s just not that many assets. So we will selectively sell, we would never have sold Bloomfield Hills 2 years ago, you couldn’t sell anything. And my guess is, now that we’re being relatively patient we can selectively sell some of those. But the more important piece of this is, let’s selectively add a couple of $100 million a year to the portfolio and I think you should see far more growth, you should see far more net accretion than you might see the historic asset recycling or in companies that want to sell billions of dollars of so called non-core, just a relatively small piece. And then on the core additions, I am fascinated by what we’re seeing in terms of tenant demand for the kind of properties we’ve been buying. In many instances, we’re seeing rents that are now well ahead of or ahead of, our previous highs in terms of rents and in terms of sales. In the bottom quartile of our portfolio, we’re not seeing that and we’re hopefully going to catch up, but the ability to add assets that are similar to our upper quartile, to me it’s going to be a pretty compelling opportunity and positions us in a pretty exciting place.

Our next question comes from the Paul Adornato from BMO Capital Markets.

You mentioned that in the acquisitions under contract about 70% would be urban or street retail, I was wondering if you could let us know where you expect the proportion of street retail to be in the portfolio of -- let’s say in the 2 or 4 year?

Interesting. Normally I pitch about having to give the quarterly guidance and then I also resist saying 2 years out, because it’s a really exciting street portfolio came available in the market that we’re not in, I wouldn’t hesitate if we felt that it made sense. But, my guess is 2 to 4 years from now us being creatures of habit that we are. The markets that we’re in, the tenant response has been the most positive, has been Lincoln Park, Chicago as well as other key parts of Chicago. And I would venture to guess that’s going to the only Midwest market that we’re active in on the street retail. I would expect that not to be the majority of our street retail, but I think it could be a significant portion. And our tenant interest there is just fabulous. Our team is doing a great job harvesting that. So I would expect to see that continue to grow, they’re some assets on North Michigan Avenue that we’re intrigued by, and there is bunch of other properties there that we think we could add and create long-term value owning us. Then Boston is in streaking. You know we’re up in Cambridge, maybe we get more involved there. We have to wait and see. That’s a pretty competitive market, so we’ll be patient. We really like SoHo, we really like Brooklyn, we really like couple other markets, we’re on the value add side, we’re down in Lincoln Road in Miami and it’s all our same tenants. So if opportunities for core acquisitions there emerged, we would certainly consider those. And then there is a few key markets in Connecticut, we made a nice profit in Westport, it wouldn’t shock me to see as go back to Westport someday. We like the asset if we own in Greenwich Avenue, Greenwich Connecticut. So those probably are what the high street in the street retail looks like. The urban piece is going to be in the dense boroughs or few other of those kind of areas as well.

Okay. And so given perhaps a little bit more emphasis on this part of the portfolio, does the investment math change to something that’s more lower risk, lower return with these assets or what’s the long-term return look like in these assets.

It’s interesting, Paul because you’re talking about for street retail for instance and we spend time looking at these assets with you. You’re talking about a more fragmented industry in terms of the fashion retailers and they -- in their specifics have their ups and downs, and it’s tough business, but when you think of the retailers that are on M Street in Georgetown, not all of them are going to succeed. So there is volatility and risk on that side, but what we have found is that for every tenant who moves out in M Street Oregon SoHo, there is 2 or 3 ready to step up and take that space. And if you pick the right market and so far we’ve been fortunate and being able to identify those. The tenant demand and the tenant sales and tenant sales performance is really important for this, is such that we’re seeing about 3% growth, same-store in our street retail as opposed to, I’d say, 2% for our stabilized suburban and the 3% is both contractual meaning that the tenants agreed to these bumps. But probably more importantly, it’s also backed up by the market meaning that even if the tenants default and go out, we’re able to replace those rents. So from a risk return perspective, we think that you’re giving up perhaps a little on credit vis-à-vis if it’s the Costco anchored property or Home Depot anchored property or in some instances, it’s supermarket anchored, but as long as it’s enough of a diverse portfolio, this 3% growth can be pretty compelling and I won’t spend any time on this question talking about how retailing is changing, but when we think about multichannel retailing, we like the profile of the street we deal.

Our next question comes from Quentin Velleley from Citi.

Just sticking with the street retail, we’re sort of hearing that, cap rates are continuing to compress. Can you sort of give us a sense of where cap rates are and what your expectations are for how -- how that moved, just maybe if you can talk through that.

Sure. So there are some outliers and we’ve not yet participated in the outliers, which is you will occasionally see a sub-4 cap request and someone may meet that request for some very sexy building in one of the key markets. And the sellers are out there looking for high network individuals who want to own a trophy asset, so there are trends that are four caps or better and put those aside for a second. The deals that we are looking at generally are in the 5 to sub-7 cap range, and depending on the details of it, not every leases below markets, some are in fact above market, and you need to be careful that you’re not taking more risk in that to push the cap rate up. Some may have more deferred maintenance et cetera, but expect to see it in that range, which makes sense because that’s the range that we’re also seeing for high quality supermarket anchored centers. And as I was just talking about before, if I had a choice all things equal, I like both we have supermarket anchored centers that we like a lot, but I like the growth profile and the risk profile of the street retail. So yield-to-yield, it doesn’t surprise me as that they’re competing with each other and then occasionally for the main high street retail for the Fifth Avenues of the world, for the Times Square, they easily below 5. And as long as rates remain relatively low, as long as when tenant demand remains strong, I think that we are going to see cap rates in this range and the spreads relative to the tenure treasury, relative to the BBBs. We can scream at the screen and say, cap rates should be higher, but there seems to be a lot of capital flowing in.

Okay. And then your comments earlier about development would suggest that the side adjacent to Cortlandt Towne, the development return should be quite strong. Can you may be just talk through what your expectations are with that thought?

A little early Quentin for us to give the kind of detail of that, I would normally like to. And the tenant demand is very strong and because we -- we’re the only shell in that pound, it’s 650,000 square feet. And so our leasing team has done a great job of knowing who wants to be. If you want to be in that part of Northern Westchester, you want to be there. And so I think they’ve wind up a nice group of tenants and we’ll be pretty excited about that addition. But think of that more as an addition as opposed to us waking up and say, oh, let’s go, develop another property.

Right. And then, just lastly and I may have missed this, but the other form of A&P box. Can you just give us an update on leasing on that...

Crossroads?

Crossroads. Yes. We are very close to signing a lease where we’re going to expand that box and I did mention on my prepared remarks, but I don’t blame you if you napped through those, I hear a lot of people do. So we bought the lease back from A&Ps, it’s about half of market rent and I’m hoping in the next few weeks, we have that lease signed. We have somewhat I think will be pretty straightforward approvals associated with the expansion, and then adding that tenant will be a real plus to the balance of the center. And that center -- great location, but it have gotten tired over the years, so the ability to bring in a new anchor, give the property a face-lift, I think will be a big plus for that property.

[Operator Instructions] Our next question comes from Michael Mueller from JP Morgan.

Most questions have been answered. But just have one for Jon. It sounds like your same-store guidance almost doubled, but your 2012 FFO guidance didn’t really change, I was wondering if you can just reconcile or talk about what maybe offsetting that.

Sure. So yes part of it is on the redevelopment side, the Crossroads because of the plant that can just went over, that’s been pushed out a couple of quarters into 2013. The other component is, every 1% of same store NOI is give or take a penny plus, penny to penny and a half, so that additional one to 200 basis points doesn’t push us to that earnings guidance range.

We have no further questions at this time.

Great. Well, I appreciate everybody taking the time. Good luck with earnings season and we look forward to seeing everyone again soon.

Thank you. Ladies and gentlemen, this concludes today’s conference. Thank you for participating. You may now disconnect.