Acadia Realty Trust (AKR) Q4 2012 Earnings Report, Transcript and Summary

Welcome to the Fourth Quarter 2012 Acadia Realty Trust Earnings Conference Call. My name is Trish and I will be your operator for today’s call. [Operator instructions] Please note that this conference is being recorded. I would now like to turn the call over to Amy L. Racanello, Vice President of Capital Markets and Investments. You may begin.

Good afternoon and thank you for joining us for the Fourth 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, February 6, 2013, 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 reconciliation of these non-GAAP financial measures with the most directly comparable GAAP financial measures. With that, I will now turn the call over to Ken Bernstein.

Thank you, Amy. Thanks for joining us. Today I’ll start with an overview of our accomplishments in 2012 as well as our business plan and goals for 2013, and then Jon will review our fourth quarter and our year-end operating results, as well as our guidance for 2013. So when we look back at 2012, we’re very pleased that we were able to achieve the vast majority of our goals, and we were able to do that despite several cross currents impacting our sector. First, in terms of our operating fundamentals, in 2012, we were still in the middle of a modest and uneven economic recovery, and that was further exacerbated in the retail sector by the ongoing impact of e-commerce on certain of our bricks and mortar retailers. But notwithstanding these issues, our portfolio performed at the upper end of our expectations, and that was due to several factors, including the fact that there’s a lack of new supply of well located retail product out there. And then more importantly for us, certain retail markets, especially select high street and urban retail, and that’s where we spend a fair amount of our time, these locations experienced strong sales growth, they experienced strong tenant demand and rental growth and they seem to be enthusiastically embraced by both our shopper and our retailer as part of the future of omni channel retailing. Then in terms of the transactional markets, on one hand, 2012 and certainly 2013 continues to be a competitive acquisition market. That’s driven by the fact that there’s plenty of capital out there in search of attractive yields in an otherwise lower turn environment. But counterbalancing that, at least from Acadia's perspective is how we view our positioning. And that’s our dual platforms, our Core Portfolio platform plus our…

Good afternoon. I’d like to recap 2012 results and then I’ll go over 2013, our forecast for 2013. First, related to 2012 earnings, FFO for the fourth quarter of $0.29 and for the year of $1.04 were at the higher end of our original 2012 guidance, which was $1 to $1.05. Several items to note for the fourth quarter were, first, we incurred acquisition costs of $900,000 or $0.02 in connection with the $250 million of Core and Fund acquisitions. Second, related to Fund II and III sale of self-storage in Canarsie, we paid off the related debt on these assets and recorded debt extinguishment charges of about $600,000. And then third, offsetting these first two items, these - we had an adjustment of our year-to-date tax provision, which was related to our evaluation and implementation of certain tax-planning strategies. Year to date, FFO was $1.04 and, excluding the debt extinguishment charges that I just mentioned, it would have been $1.06. Our Core Portfolio performance for the quarter and year to date exceeded our original 2012 forecast. Same-store net operating income year to date was 3.7% versus our original 2012 forecast of 2% to 3%, which included the impact from our re-anchoring activities. Excluding the 80 basis point effect of these re-anchorings, NOI growth was 2.9% for the year. Occupancy at year end was 94.2%. And physical versus leased occupancy was essentially the same, only 20 basis points different, as the anchor at the Branch shopping center is now open. We also made significant progress on our key re-anchorings during 2012. Recall that we had three projects that we were working on, representing approximately $3.5 million of additional net operating income. Bloomfield and Branch, which represent a little over 2/3 of this, are now complete. And for the third, the…

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

First question, on the mezzanine investments, I was just wondering if your guidance forecasts that you hold the mortgage investments throughout the entire year in 2013. And then, what’s the expectation to grow this portfolio? Should we assume additional investments in 2013?

So we do forecast that we hold these throughout the year. In terms of additional mezzanine investments and/or first mortgage investments, our expectation is, is right now we’re at about 5% to 6% of our total market cap in terms of the mezzanine book and first mortgage book. We think that we maintain it somewhere around that level. And then we've talked about this target previously. So we don’t currently forecast any significant additions to the book.

Okay. And then Ken, I was just wondering if you could discuss the SUPERVALU transaction a bit. I know Acadia participated in the Albertsons deal earlier on, and I’m assuming you had some discussions with the investor group. And I was just wondering if you could talk about the company’s decision to either -- to not participate sort of this go around or what your involvement was throughout the process?

Sure. We’re slightly curtailed in terms of the levels of detail. But you’re right, yes, we are partners in the Albertsons transaction from our original investment. And so we were certainly offered, and then we opted not to, make an additional investment into this now SUPERVALU transaction. But first, most importantly, as an existing partner, our interests are rolled into this transaction. And we think, not only with the original investment where we’ve more than tripled our equity, a very good investment, but the management team, overseen by Cerberus [ph], the guys at Albertsons who are now going to run all of this, they did a tremendous job. And we have every reason to thank them and expect that, as it relates to our existing investment, they're going to continue to do a great job. Our decision not to put more dollars in had absolutely nothing to do with our faith in that investment going forward. I think this is a very good sign for our industry. Because whether you’re a landlord to Shaw’s, which we are, I think that this team has a really good shot at turning around a bunch of these portfolio companies. So we’re very bullish on their abilities. We’re very happy with the profit we've made already, but we’re looking forward to even more. And I’m not going to get into the specific details of why we decided that it wasn’t the right fit for us, but it could be a very good investment and we’re rooting for them.

Okay, that’s helpful. And then just lastly, on the Fund investments that you outlined for guidance at $250 million to $500 million for Fund IV, I was just wondering if you could provide some thoughts on what those deals might look like, whether or not they'd be similar to what we’ve seen thus far or if you think that they could take on sort of a different type of real estate investment at this point?

So, one, our ability to see the future is very limited. But we really have four areas that we focus on that we think cover a broad range that's true to our core competencies. And those are the areas that I would really expect to see the vast, vast majority of these investments to go into. So one's opportunistic. And that’s a very broad range. But when there are inefficiencies in the marketplace, if we go through some difficult financial times, often we can buy things inexpensively because we have fully discretionary capital that we can close immediately irrespective of where the REIT market is, irrespective of where the debt markets are, et cetera. So that’s a pretty broad range, but expect those to look like Cortlandt Manors or other types of very opportunistic fields that we’ve done over the past decade plus. The second area then is distressed retailers. And what we’ve said in the past and I’ll continue to do, is we want to be more focus where there are distressed retailers where we can buy the real estate underneath where there's a cap rate arbitrage. So we bought several A&Ps, we purchased a Shaw’s, we purchased Best Buy, all where we felt the risk adjusted return was compelling because there was concern over the retailer, but the real estate was going to hold up. So that’s the second segment. And again, it depends on where we are in terms of our retailers and their level of distress. But we have found in any 3-year period, there’s a fair amount in that. The third area where we have been very active is street retail. Of all the different segments of our business, the one that seems to have the most tenant demand and some of the most interesting opportunities is the street retail component. So whether that's Lincoln Road in South Beach where we just made an acquisition or whether it’s here in the 5 boroughs of New York or other markets such as Chicago that we’re very active in, we think that there'll be those contingent opportunities. And then finally, there is the heavy lifting associated with urban mixed use, and we’ll selectively be involved in that as well. So expect it to be in any of those 4 and my strong guess is, that will be the limit.

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

I guess just following up, have you had any conversations with the consortium at - on Shaw’s, not so much as your investment, but what they plan to do with the Shaw’s supermarkets in the Northeast?

Yes, Craig, we speak to all of our tenants as much as we can. But I’m going to let them, when they’re ready, speak as to their own plans, because I think they could do a heck of lot better job explaining it than I could, other than we think that this is a very good, important step for them.

And then second, could you just tell us a little bit about the Alamo Drafthouse that’s coming to CityPoint?

Sure. They are a Texas-based, high-end movie theater chain that attracts a clientele much hipper and younger than I am. But we think it’s going to be a real nice complement to what’s going on in downtown Brooklyn. So they’ve targeted a few key markets that they’re going to expand into. Brooklyn was high on their list and we were thrilled to have them come join this project, which is going to have that right blend. Remember, downtown Brooklyn has really become a 24/7 live, work, play area. And so it’s going to be important through our food marketplace that we address some of the interesting food needs in that area; there’s going to be residential; a lot of very exciting soft goods, retailers; and then Alamo will be there as well.

And as an aside, Craig, this is a full service theater with food. And I’m told that they have 20 plus different types of beer on tap. So I plan on being one of the first customers there when they open up.

Sounds fun. So outside of Century 21 and Armani X and now Alamo, have you announced any other tenants coming into CityPoint?

No, not yet. So stay tuned.

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

I was wondering if you could talk a little bit about your future plans with respect to self storage, since you’re keeping an interest in the management company. Do you think that you’ll do what you have done, which is storage related to retail, or would you consider potential standalone storage?

It would be highly unlikely that we through our Fund or Acadia Realty Trust, so highly unlikely period, that we’re going to do standalone storage. So the first thing we’re going to do is thank our lucky stars that we made a top of the market transaction that was arguably outside of our core competency. There were lot of good rationales, and you touched on some of them, Paul. But first, we’re going to be very thankful that we’re able to go through that learning experience profitably. And I credit the quality of the real estate locations that were developed, as well as the tremendous job that the Storage Post team did. We always liked self storage, still like the business, especially in these urban markets. And we are continually intrigued by putting self storage on top of urban mixed-use developments. So we have enough of an interest here that, as you see us do urban mixed-use where self storage would go on top, the most logical solution to that is to see Storage Post there. And sure, we would have an economic interest in that. But what became abundantly clear over the past several years is it’s a separate business. It’s a B to C business that’s fundamentally different than what we do. And while, again, I’m very pleased with our returns, I think that the business is great, we think we best serve our stakeholders staying focused on those four groups that I talked about.

Okay. Could you tell us if the public storage operators had a look at the portfolio and if it went to the highest bidder, the best outcome for AKR shareholders?

Yes. So all we have is our interest fully aligned with our stakeholders. So there’s no other business out there and it was absolutely in our best interest to get the best execution. So we absolutely went out to other private and public buyers. Sometimes we do a broad marketing using a third-party firm. Other times we do it more quietly where there’s a more select group. But we had made it abundantly clear to a wide group of people that we were sellers. And we signed confidentialities and we got very good execution. And on top of that, Paul, we still also have a retained interest. So I have absolutely no doubt that this was the best execution for our shareholders, best execution for our Fund investors, and then we’ll see if there’s any gravy on top.

Our next question comes from Quentin Velleley from Citi.

Just in term of the Funds, could you maybe talk a little bit about, I guess I’ll call it the embedded promote income. It just seems with Storage Post and Canarsie that your unlevered IRRs was sort of 500 to 700 basis points above what your return or your preferred return on equity requirement is. So I guess or I calculate that the embedded promotes from those sales would be significant. So can you just sort of just maybe talk a little bit about that? And then also what you’re sort of thinking on Fordham and Pelham, which you’re getting closer to selling as well?

Sure. So I don’t forget, let me start with Fordham and Pelham, so the easy answers and, Jon, chime in, as I’m sure I’m going to get a bunch of this either oversimplified or...

I’ll touch on them.

Now Fordham is a 100% leased. You should expect to see us go to the market on that. And it will be very interesting to see how it prices, but my expectations would be that will be a 2013 transaction. I think Jon, you forecasted midyear.

Midyear, that’s right.

And Pelham's not that far behind. And I don’t think it’s appropriate right now for us to give pricing guidance on it. But these are great assets and we would expect to see good execution. From a Fund basis, you can’t, unfortunately, do asset-by-asset and calculate the promote, although we all want to do that. But remember, they are pooled. So for Fund I, and the case will be Fund II and Fund II, et cetera, first you have to return all the capital plus the preferred return.

That’s right.

So we’ve always been fairly to very hesitant to count our chickens before they are hatched. But yes, we have sold a bunch of it. And you were referring to both Fund II and Fund III assets. Last year, we sold a bunch of Fund III assets as they reached stabilization and the returns were in that spread to our preferred hurdle. So if we can keep that up, it still could be a couple of years out there, then I think the math will get easier and easier to help you do that calculation. But we’re just superstitious enough and cautious enough to not want to forecast that amount at this juncture.

And if you look at, for example, Fund III to date as a result of these sales, so of the $475 million of capital in the Fund, about $160 million has been returned at this point. And that’s based on sales of some assets that I’ll call pre-Lehman genre assets. So if we can continue to make profits on some of the post-Lehman acquisitions, which arguably have more inherent profit embedded in them, I think our track looks pretty good here, but as Ken said, until we cross that threshold of returning all capital and all accumulated preferred return, we don’t start to recognize the promote. And interestingly, it creates some timing difference in terms of, I speak about earnings dilution from the sale of those assets and we’re going to have, hopefully, promote income down the road once we’ve crossed that threshold. But the timing between those two is obviously separated. So it'd be nice to be able to accrue it. Unfortunately, that’s not our practice, and I think it’s the right practice. So there’s always going to be that differential in terms of the two events.

Okay. I guess from our perspective we should really start thinking about putting something in from an NAV perspective, but from your perspective it’s sort of too early to try and give that kind of guidance to us.

Yes. I mean we provide pretty good disclosure, Quentin, so that you guys can do your estimates. And I think you’re absolutely on the right track. From our point of view, it’s really more about NAV and value creation than it is about how all of this layers in, in terms of earning. And we’re pretty excited about a bunch of the successes that we’ve had over the past 12 and 24 months, both in terms of stabilizing assets as well as exiting others. So it makes us feel a lot better about that.

Okay. And just lastly, the first mortgages, the $43 million on the New York City and Chicago assets, given that yield's so high, I assume that the value of the underlying assets isn’t far off that first mortgage amount. Is that a fair assumption?

Well, there was a fair amount of equity, I don’t remember off the top of my head, that went in junior to these. At year end, there was a bunch of transactions out there. We tried to get our hands on as many as we possibly could. Some were tax planning related or otherwise. And where people needed to close quickly on assets that we're like, well, fine, you go fix it up and there may -- in some cases they needed to complete a lease or something, we’d be happy to own it at that point. So we made the bridge loan, it's an attractive yield. We probably get paid back in the next 12 to 24 months. And then let’s hope I get to talk about it as rolling into our Core Portfolio. But there was equity defined as real people putting real money in junior to us.

Also keep in mind that the 10%, or it was a little bit under 10%, is an all-in effective interest rate that includes various fees. And if you look at the actual interest rate on the loan themselves, it's closer to 8%.

Right. But that high yield basically reflects their need to close quickly on these deals?

Yes, that’s true.

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

The first thing, on the RCP income, that’s running negative. I mean how should we think about that? Does that continue that way or what, I guess, exactly is happening there?

Yes, what that reflects is, in the current year, there was a settlement related to the Mervyns investment and we picked up our share of that settlement. It wasn’t a huge number. But that resulted in the negative number that you’re looking at. I think on a go-forward basis, I think you won’t see any more negative as it relates to that situation. And I would expect our Albertsons investment still has inherent value in it and would hope to see some positive results from that.

Okay, good. Gotcha. And then, Jon, also on the provision for income taxes, I think you might have touched on this a bit at the beginning but I wasn’t quite sure understood. In the fee income, the provision for income tax is very positive for the quarter. And I'm not quite sure what to do with that either.

Yes. So looking at it on a full year basis and on a 2013 basis, because of restructuring and certain tax planning, including for example, as we grow the Core Portfolio, obviously our 5%, what I’ll call bad income bucket grows or expands as well. So we’re able to take advantage of that. So items like that have enabled us to reduce the tax bill here. So that I think on a full year basis for 2013, you’re looking at an all-in tax bill of somewhere between $0.5 million and $1 million. So that’s the way you should be thinking about it in terms of 2013.

And Rich, when I touched on scalability, as our Core Portfolio grows, these are some of the operating efficiencies that start to inure to all of our benefit.

Okay, yes, good. I got you guys. And then the last thing I had, I was kind of curious about this gain on involuntary conversion of an asset. I had a picture of the fiscal cliff settlement occurring and the feds coming to take away your guy’s assets. And just wanted to make sure I understood what was going on.

So this actually wasn’t a bad involuntary event from our perspective. This related to our center near Wilkes-Barre, Pennsylvania. It was a Kmart-anchored shopping center that incurred some flood damage back in September 2011. We received insurance proceeds as it related to that and they were in excess of our basis, which creates a gain, if you will, in terms of those proceeds. So cash in our pocket and monetizing part of that investment at an attractive cap rate is, in our minds, a positive event.

Our next question comes from Jason White from Green Street Advisors.

Question on the two smaller Fund IV acquisitions. When you look at those two smaller deals, I guess what’s the strategy there and what’s the upside potential? And how do you move the needle with those smaller deals?

Yes, so for a company of our size, we still need to be a little careful about doing deals that are too small. But thematically, and I was just touching on them before, where we can buy properties that we think that there's an underlying opportunity, but the retailer is distressed, we will do those and we will try to do them programatically enough. So we acquired outside of Baltimore, a 50,000 plus square foot box that is leased to Best Buy. There's about 4 years left. And we bought that on an unlevered cap rate of high teens. So our equity will come back just through lease term provided Best Buy stays from lease term. If they don’t, and we’re rooting for them, but if they don’t, we’re comfortable that we can re-tenant and successfully do so and make a very nice entrepreneurial return. If that turns out to be the only of those kinds of deals that we do in the distressed retailer category, Jason, you’re absolutely right, it’s a fair amount of listing for just one transaction. What we have found over the years, though, is we can do these more programatically, you have to start somewhere, and so let’s see how that plays out over the next couple of years. We’ve certainly been successful doing this with a bunch of A&Ps, made a very high return converting an A&P into a ShopRite and then selling it relatively quickly thereafter, with Shaw’s. So we think there'll be a host of these kinds of opportunities and it’s worth being in it and in that business so that you’re seeing that deal flow. The other deal, and I promised my acquisition team I would talk very little about it, but it’s a street retail acquisition, relatively small, on one…

Okay, that’s helpful. And then last question, it looks like your cash leasing spreads were pretty flat in 2012. Are you expecting rents to kind of start trending in your favor? Is that a small sample size issue? I guess, what are you looking forward to in 2013?

Yes, '13 we expect a better result. Not that 2012 was that bad or anything. It is an issue of small numbers, unfortunately. And we’re quickly growing out of that, but we still have to talk about it. I’ll give you an example. We had one lease during the fourth quarter, a new lease for 3,600 square feet, where the rent was actually down 20%. It was a situation unique to that space and to that particular situation. But that actually pulled down the leasing spreads for new leases for the fourth quarter by 150 basis points. So we still get a little bit of distortion, but hopefully we quickly grow out of that so we don’t have to talk about small things like this.

One bad pizzeria lease and it screws up all our numbers.

And we have no further questions in queue at this time.

Great. Well, I’d like to thank everyone for their time. We look forward to speaking to everyone again soon.

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