Kite Realty Group Trust (KRG) Q3 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Third quarter 2020 Kite Realty Group Trust Earnings Conference Call. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Bryan McCarthy, SVP of Marketing. Please go ahead, sir.

Thank you, and good afternoon, everyone. Welcome to Kite Realty Group's Third Quarter Earnings Call. Some of today's comments contain forward-looking statements that are based on assumptions of future events and are subject to inherent risks and uncertainties. Actual results may differ materially from these statements. For more information about the factors that can adversely affect the company's results, please see our SEC filings, including our most recent 10-Q. Today's remarks also include certain non-GAAP financial measures. Please refer to yesterday's earnings press release available on our website for reconciliation of these non-GAAP performance measures to our GAAP financial results. On the call with me today from Kite Realty Group, our Chairman and Chief Executive Officer, John Kite; President and Chief Operating Officer, Tom McGowan; Executive Vice President and Chief Financial Officer, Heath Fear; Senior Vice President and Chief Accounting Officer, Dave Buell; and Senior Vice President, Capital Markets and Investor Relations, Jason Colton. I will now turn the call over to John.

Thanks, Bryan, and good afternoon, everyone. Thank you for joining us today. The KRG family appreciates that this continues to be a challenging time for everyone, including our investors, tenants, customers, vendors and employees. And we hope that this call finds you all doing well. COVID is an opponent that we respect, but are not paralyzed by, while COVID is causing a significant dislocation in our society, it will be temporary. Our scientific community continues to make progress as it relates to testing, therapeutics and vaccines. We will find a way to stop this pandemic. Hopefully, sooner than later, but either way, it will come to an end. This is why even in the face of the spike in cases, it feels like we are closer to the end than we are to the beginning of the pandemic. We are beginning to see this school of thought reflected in our business. Today, I'd like to give you an update on our collection activity and address some of the more common questions that we've been receiving from our investors. As of today, we've collected 92% of third quarter gross rent. Another 2% has been contractually deferred, bringing the total of addressed third quarter rent to 94%. Currently, October collections are tracking slightly ahead of September. Heath is going to spend some time walking through our methodology. But suffice to say, our collection numbers are straightforward and pure. A question we -- that were unanimously asked by investors is why our collections have been so strong. We believe our success is a product of 3Ps, properties, people and process. In terms of our properties, 74% of our ABR comes from centers with a grocery component. These grocers, together with other essential retailers, continue to drive traffic to our centers, resulting in 97% of our tenants being open and operating as of today. The average size of our centers is only 141,000 square feet, which translates into unparalleled ease and convenience for our customers. With very limited capital investment, we were able to help our tenants successfully adopt and embrace the accelerating click and collect trend. As we discussed last quarter, buy online pickup in-store is swiftly becoming a central part of operations for retailers. Our open-air centers are uniquely positioned to leverage this trend. With 77% of our ABR coming from the South and the West, our properties are located in areas that are benefiting from pre-existing migration patterns that we believe will continue to accelerate post COVID. We own assets where state and local governments opened their economies earlier and are less likely to close them down again. Furthermore, in our warmer markets, tenants will continue to employ creative measures to ensure current survival and future success, such as temporary outdoor dining and fitness areas. Bottom line, we own assets where people increasingly wants to live and shop. It's not just about being in these markets though, it's about owning the best real estate in these markets and combining that product with our best-in-class operations. Of equal importance are the [Technical Difficulty] processes at KRG. We have some of the most talented people in the industry, and this dislocation has allowed them to highlight their skills. When COVID hit in early March, our team circled the wagons and went to work battening down the hatches at KRG and preparing. When the lockdowns were lifted, our team shifted to helping our tenants reestablish themselves and open as quickly and safely as possible. As tenants began to get back on their feet, our focus turned to collections and ensuring successful tenants pay their rent while continuously working with our most impacted tenants. Through each of these steps, our team set up a variety of processes to organize all our data, maximize our visibility into the business and tackle issues at the appropriate time. The process has worked and our people outperformed. I can't thank the KRG team enough for their efforts during this trying time. The next most frequent question we get around the impacts of COVID on our business. More specifically, what will be the extent of the permanent NOI erosion? The first thing that we're quick to point out is the word permanent is a misnomer. COVID is a temporary dislocation. It's a fact that we're getting inventory back. But our track record for releasing space at accretive returns speaks for itself. Over a matter of 2 years, we were able to backfill 22 anchor boxes, representing 561,000 square feet while generating over 21% cash lease spreads and over a 17% return on capital. At the end of 2019, our shop space occupancy was at a sector high of 92.5%, and we only had 6 vacant anchor tenants. The second point is the sheer number of remaining unanswered questions and confusion. When will the new stimulus package gets passed? Who will be the next President? When will we learn the results? How long will this latest spike in cases last? What is the timing and adoption of disease treatments? Despite all these unanswered questions, we feel the ground underneath us has begun to stabilize, with 8 months of COVID under our belt and in the spirit of transparency, we included additional disclosure on Page 17 of our supplemental. The additional disclosure shows that reoccurring revenues in the third quarter are approximately 6% lower than in the first quarter. This is a far cry from the dislocation that the industry initially projected in March and April and even a further cry from the continued implied dislocation in our stock price. Last question I'll address is about our path forward. Many investors have asked when will KRG get back to pre-COVID NOI levels? While we don't know exactly when that will occur, I do know that internally, we are asking ourselves a bolder question. When and how do we exceed pre-COVID NOI levels? The good news is that in 2019, we prepared the company for what we thought could be a disruptive 2020 and ensured that we had one of the best balance sheets and liquidity profiles in the sector. But we couldn't have predicted a pandemic, obviously. But it is a huge advantage to start from a position of strength, but trying to get back to and ultimately surpass pre-COVID levels. KRG is well positioned to take advantage of this disruption. The priority, which is well underway, is to fill vacated space during the pandemic and with the retailer bankruptcies that have occurred. Our ABR exposure to retailers that have filed for bankruptcy in 2020 is approximately 5%. It's important to realize that many retailers assume leases at key locations and continue to operate those stores when they emerge from bankruptcy. As further detailed in our investor presentation, 2/3 of the at-risk ABR is leased or in active discussions. During the third quarter, we experienced a significant uptick in our leasing activity, having executed 21 new leases and 57 renewal leases, representing 457,000 square feet. This marks the highest quarterly leasing volume over the past year, and we're further encouraged by the diversity of the new leases, which include two grocery stores, off-price retailers and a wide variety of small shops. This quarter's comparable leases resulted in blended GAAP and cash leasing spreads of 14.7% and 6.7%, respectively. It's also important to note that the 28 non-option renewals we did, which means that the tenants that have the ability to vacate have blended GAAP and cash spreads of 26.8% and 11%, respectively. This clearly demonstrates the desire of our tenants to stay in our shopping centers. Additionally, let's remember certain vacancies provide opportunities. The Stein Mart locations may be a great example of our ability to unlock value and turn short-term pain into long-term gain. Stein Mart intends on closing all of their stores, including 7 in the KRG portfolio. Stein Mart has been an unproductive retailer for a long time and brought limited value to our properties. The average base rent for these 7 locations is $8.21. We plan on backfilling these locations with high-quality tenants at much higher rents and strong returns on capital. We've long maintained on a risk-adjusted basis, filling empty boxes is one of the best uses of our capital. We were highly successful with this -- with the big box surge, and we plan on doing that again. In addition to leasing, KRG is actively exploring ways to generate accretive returns by putting our strong balance sheet to work. This past quarter, Phase 3 of our Eddy Street Commons Project became an active development. Eddy Street Commons Phase 3 will be anchored by a Trader Joe's and will serve as the crowning jewel of the mixed-use development project. The net capital required by KRG will be $7.5 million, and the project is estimated to return between 8.5% and 9.5% yields on cost. We tip our caps to Tom and the development team, who have spearheaded this very successful development with the University of Notre Dame over the past dozen years. This pandemic has been disruptive to so many people in so many different ways. Despite this disruption, our people have risen to each and every challenge and will continue to. I'll turn the call over to Heath now to discuss the balance sheet and our capital situation.

Thank you, John, and good afternoon, everyone. Prior to COVID, whenever I heard the number 2020, I would recall the phrase 2020 hindsight, that ability to evaluate past choices more clearly as compared to the time that choices are actually being made. With that in mind, maybe it's no coincidence that we are facing a global pandemic and one of the most divisive elections in recent history in the year 2020. There is no doubt that we'll spend the next decade analyzing the choices we are making right now and the choices we will make next week. Regardless of what happens in the remainder of 2020 and into 2021, KRG is well positioned for all potential outcomes. We continue to maintain a strong balance sheet, and our posture remains cautious with a focus on capital preservation. As John stated, we continue to feel incrementally more confident about the business as evidenced by our decision to reduce our outstanding line of credit balance to $50 million, down from $300 million back in March. As of September 30, our net debt-to-EBITDA is 6.9x, lower than last quarter, but still elevated due to the impact of the COVID pandemic. As I mentioned last quarter, it's important to note that we calculate NDE by annualizing our most recent quarter of EBITDA. Therefore, the disruption caused by COVID will immediately impact our NDE metric. More importantly, though, our liquidity position remains strong. No debt maturing until 2022, only $15 million of outstanding capital commitments and approximately $580 million of liquidity available to KRG. Our liquidity position continues to be bolstered by our strong collection results. This past quarter, we collected 92% of gross rents and deferred another 2%. As John mentioned, our collection rate methodology is very straightforward and represents a simple percentage of our total billed rents. As detailed on Page 17 of our supplemental, our billings have decreased by only 1% from the first quarter, and our net revenues, removing any one-time items, have decreased 6.4% over the same time period. Many of you may be tempted to use this 6.4% decrease as a future run rate, but I caution against making any sort of linear assumptions in what we feel will be a very non-linear recovery. As you know, detractors to revenue are usually instantaneous, while any additions take time to come online. As previously discussed, we are in the midst of releasing space and the financial impact of those deals will be a lagging indicator. The most important takeaway is that the level of disruption implied in our stock price is nowhere close to the current decrease in our recurring revenues. As a reminder, on bad debt, we estimate the quarterly reserve using the same process we do every quarter. We examine each outstanding balance tenant by tenant and determine who is at risk of not paying their balances. Due to the potential confusion with respect to what amounts to a very simple exercise and collectability, we made a conscious effort to provide as much transparency as possible. Please refer to Page 17 of our supplemental for a detailed breakdown of bad debt and accounts receivable. At the end of the third quarter, $5.9 million of our billed rent was outstanding, of which approximately $3.1 million has been deemed uncollectible. The $5.9 million that remains outstanding at the end of the third quarter is a vast improvement compared to the $15.1 million at the end of the second quarter, a further indication of an improving situation. We are pleased with the progress on all fronts, but we are far from out of this crisis, and we remain guarded with our capital. While we are actively looking for opportunities that may come out of this distress, we would be hard-pressed to pursue anything that would be detrimental to our strong capital and liquidity positions. Our total committed capital to new developments and redevelopment projects stands at $15 million, which is just 2.6% of our current available liquidity, a very manageable level, even in the midst of a pandemic. Thank you to everyone for joining the call today. Operator, this concludes our prepared remarks. Please open the line for questions.

[Operator Instructions]. Our first question comes from Katy McConnell of Citi.

Great. So for your bankruptcy exposure, can you walk us through the portion of space that's already come back to date versus future fallout to get a better sense for how occupancy could trend going forward? And then for the portion of space that you're currently working on negotiations, can you talk about how replacement rents are trending so far? And what are tenants looking for as far as CapEx commitments or other incentives?

All right. It's a good question on the bankruptcy. Some of them are still in the occupancy because they had not rejected their leases at 9/30 and some of them will come out after. So again, we don't remove a tenant from occupancy until they actually stop billing them. So it's sort of a mixed bag. So I can't give you an exact number of what the percentage of bankrupt tenants that were out of occupancy at the end of 9/30, and which ones will come out of occupancy post third quarter.

Okay. And then another one on rent collections. Can you just update us where 2Q collections stand to get a sense for what you've recovered since last update? And then you had to revisit any previous deferral to convert them to abatements?

So Katy, Q3, I think, is up to 83% or Q2, I should say, up to 83%. So there was another 3% collected, I guess, since the second quarter. And then what's the second part of that? I'm sorry.

The second part was whether or not you've had to revisit previous deferral agreements to convert any of those to abatements?

No. I mean the -- as we've said before, we're really in the deferral business when it comes to those conversations. We're not in the abatement business and that has really been less than like 1% of what we've done. So it's de minimis and continues to be.

And our next question comes from Floris Van Dijkum of Compass Point.

Great. A quick question for you guys on what you see -- I noticed your TIs were down a bit for your new leases. Is that a sustainable trend in your view, particularly as you get some of the space back from bankruptcies going forward?

Yes, Floris, I mean, if you look at the trend, it's kind of been in the range of that -- the total number, I think, is at $53 on average. That's really going to depend, obviously, on whether we're doing a lot of small shop deals at a point in time or doing more box deals. As we mentioned, there's the Stein Mart out there. This particular quarter, we just had a lot of shop activity. Actually, the majority of the deals on a deal-by-deal basis were shops, although when you look at square footage, it usually tilts towards anchors. So I think it's a reasonable number. But things haven't changed a lot there in the sense of if you're doing a box deal and you're not splitting it, that number is probably going to exceed the $53 number on a case-by-case basis. But box deals, kind of, they can be quite wide in the range of costs. The shop deals, we're just spending a lot less money there, as you know. And the great thing about renewals is we spend almost no money. Tom, do you want to add anything to that?

Yes. I would just say on our standard big box tenants in terms of their standard package, their packages have not changed. So we're going to expect to see the same levels of TI. And that related to, I think, the previous question that, that run rate is to be fairly consistent.

But again, to be clear, I mean, $53 is an average, and it's a trailing average, and it included shops and boxes, right? So that number is going to -- especially a company our size can move fairly significantly in a particular quarter if it's weighted towards boxes, for example.

Got it. Got it. And so would that be a reasonable assumption to make for the 2.6% of unaddressed bankruptcy tenants? Is that sort of spend required to get new tenants in there?

Well, yes, I think when you look at the average, because right now, those bankruptcies tenants are tilted towards small shop tenants and a handful of box deals in there. But once we get back the Stein Mart spaces, then you're talking about several box deals that will probably occur in a couple quarter period. So then that number would elevate up because you would be tilted more towards boxes whereas the unaddressed bankruptcies right now are tilted towards guys like Ascena and Pier 1 and people like that, that, again, are smaller spaces. So I think it's a -- I just want to caution you not to think about that in that it's a static number because it definitely moves around.

Yes. Floris, this is Heath. I think the best way of giving a sense for let's just go look back 2.5 years of our prior cost to lease space. And you can see sometimes you got lumpy, come up and come down again, like John said it could be bit of a volatile number. But if you go back and look at what we did during the big box surge where we had a lot of boxes in a particular quarter, they would get elevated, and we have mostly small shops would come down. So I think it just look back at our record, and probably a pretty good indicator of what it's going to look like on a go-forward basis.

Great. Another question I have for you guys. I mean, you've done a nice job with your -- with the balance sheet, obviously. As you think about opportunities going forward, where do you think you're going to find potential acquisitions? And what kind of things would you be looking for? Presumably, they would be in your existing markets, but are the opportunities going to come from over-levered private owners? Is it going to be from banks who control assets? Or where do you see things shaking out in '21?

Yes. I think, again, as Heath mentioned in his remarks, we're pretty focused on the fact that we have this very strong balance sheet. It is being -- it's a great thing that we do because it buffers us against what's been occurring. He did mention, obviously, that we will selectively look at things. So I think you got to break that down between 2 areas. You talked about acquisitions, but when you look into next year, we've got a couple of the redevelopment properties that are still in play. Those would be, as we pointed out before, joint ventures that would be mixed use. There'll be some capital there at strong returns, but very limited, as Heath pointed out. Secondly, in terms of the acquisition side, I think right now, based on our cost of capital, the reality will be that anything we do in the near term there would need to be match funded. So you may see us do that. You may see us sell an asset or 2 in a geography that we believe isn't -- doesn't fit our long-term objectives and then move into a geography that does fit the warmer, cheaper initiative that we have that has been paying off handsomely during COVID, but as you know, so -- and by the way, it's not just during COVID, it's going to be -- it will be growing at a faster rate than markets that are losing people. So it's a really long-term smart strategy in our view.

And our next question comes from Alexander Goldfarb of Piper Sandler.

So just a few questions here. First, there's been clearly an improvement in bad debt. You already talked about Stein Mart, you talked about the 5.4% bankruptcy, the fact that you've already backfilled about 65%. But at this point in, call it, end of October, do you guys feel pretty good about having a handle on which of your tenants are going to make it and which are going to shake out, meaning right now, can you sort of frame out how much more fallout there's going to be from tenants who can't survive? Or you can't -- you don't have that level of clarity yet at this point?

Yes. I mean, I think we certainly have a feeling internally that we will have a lot of work to do, and we have work to do. It's too early to say who won't make it. I mean the one thing about COVID, as you know, that it's kind of created an interesting situation where tenants that we thought were weak going into this have come out stronger. And then there's been some that were stronger going in and have come out weaker. So I think it's a little early to say, but we definitely track all of the tenants. We track their health. We look at the rents we plan out over a 3-year period, what we think might happen so that we're prepared. And also, Alex, remember, some of these tenants that people are talking about they're not going to close all their stores, but they may close some stores, right? So we may get back a few stores out of a retailer that we have multiple locations with. And then we also may get, as Heath pointed out, some of the bankruptcy tenants will keep their spaces when they come out of bankruptcy. So net-net, I think we've a pretty good handle on it. And it's why we talked about the successes that we had with the original big box surge. So I guess we're going to have to have a resurge and get this done, and that's what we do.

Yes. Alex, it's Heath. It's kind of interesting. The question you're asking is really the same exercise we're doing in when we're looking at collectability, who's going to survive and who is not. And then as you can see, even in the last quarter, so folks that we didn't think we're going to pay, they pay. Some folks we thought they were going to pay, they didn't pay. So it's dynamic. It moves all the time. And so to say that we have a tremendous amount of conviction, plus we do our best job. But at the end of the day, listen, it's not about tenant survivability, but it's also about having the best real estate. So we feel confident either way.

And the way we've handicapped this, we have never had as many discussions. Direct discussions with tenants, probably in our history through this COVID period. So we've learned a lot. We understand what their pinch points are and there are situations where we can help, but in terms of what we've handicapped, I think we have a pretty good sense of where we're headed.

The only thing I would add to that, Alex, is you mentioned the bad debt. Our bad debt has obviously gotten better, but the reality is the visibility is much better right now than it was last quarter. And I think that's reflected in the sense that last quarter, we had $15 million of billed and unpaid rent, which is down to less than $6 million this quarter. That's the story. I mean, that's a massive change which kind of shows that strengthening stability that we have. So as we move into needing to lease these boxes, we're doing it from a much stronger position. And like last time, we will take our time to do these deals. And we've said that before that the hits come immediately and then it takes time to build these spaces. That's just the way it works.

Right. But I guess, putting it simplistically, you guys have addressed 94% of your rents. So it's like there's 6% left. I mean it would seem like the simplistic thing is to say, half of those make it, half don't. So I mean, it seems like at max, you guys would potentially take a 6% hit from this. Hopefully, it's not that far. But I mean, is that too simplistic of a way to look at it, at most, you could only suffer sort of 6%, it's probably something you're looking at?

Yes. No, no. I think it is -- I won't use the word it’s too simplistic. It's just a point in time. So as we sit here today, that's the math. But what we're pointing out, and I think Heath said this, that it's not linear because there will be other tenants that take hits down the road. I think that's widely known. We mentioned one, which is Stein Mart, and that's several deals that we'll have to lease. And so we'll take those hits. I think what you should learn or take from that is that there's a really stable base, okay? The tenants that are in business that we know will continue in business are paying our rent. That's why I said we went from $15 million to less than $6 million. Now over the next couple of quarters, some of these guys that have been hanging on won't make it. I think everybody knows that, Alex. But this team here is way past thinking about that and it is already acting on that. And that's what I mean by the hits come immediately, and then we backfill them but at higher returns on capital, just like we did last time. So I just don't think investors should be thinking short term right now. They sure shouldn't be thinking about whether you hit an FFO number that's out there that I don't even know why it's out there because bad debt is a very, very volatile moving piece that no one can predict. So the story is we have a super stable base in great markets with great properties, that we will absolutely lease whatever comes our way. And I think we've proven that. That's what we want investors to know is that we are the right team for these circumstances and sure as hell own the right property in the right location for this circumstance.

I mean, John, agreed. I mean, it's evident in your results. So I think the hard work that you guys have done has shown off. As far as FFO, I mean, we analysts need to have something that we can show. So apologies on FFO. Just a final question. COVID, I know you guys are all health experts. You're in Indy. So it's sort of COVID capital for research. But when you look at your properties across the different markets now that you've had 6 months of experience, you certainly have done a lot of leasing, record levels. So have the spikes in COVID or the waves in COVID, have you seen them translate to any impact from tenant leasing thoughts or customer shopping or these waves that come and go are sort of news headlines, I won't say fake news, but are news headlines. So the reality is that the retailers and the shoppers, it doesn't really phase them and they continue to get back to normal. I'm just trying to understand how the headlines affect what's going on at your properties?

Yes. I mean, I think that's what I meant when I said that we respect COVID, but we will not let it paralyze us. And that has played out at our properties, Alex. And in the sense that we respect it. So we've done everything you can imagine at the property level to enable our customers, our tenants to serve their customers in the most efficient way. That's why we mentioned curbside pickup and things of that nature, the cleaning that goes into this and just the overall feeling of safety. So certainly, the headlines are pretty dramatic. But when you actually go like we do to the properties, and we happen to benefit from the geography and the type of properties that we own. We haven't seen that be a huge impact yet. But we're also -- that's the part -- that's the respect part. We respect that it could change. We respect that people want to feel safe in their endeavors, and we're helping them do that and so are our retailers. And right now, in this open-air platform, quite frankly, it makes people feel a little more comfortable. So I think so far, that hasn't really played out where a particular spike, for example, when we saw the spikes in the South that we saw in the summer, we absolutely didn't see any material change in our tenants paying rent and in the business that our tenants did, but we help them and deal with it, and we help them make sure that they were delivering a product that people had faith in. So I think it's really -- depends on each particular location, and we benefit as we said from our geography.

Alex, you started the question by making an apology on the FFO. I just want to put the FFO miss, I would put that in quotes, "of $0.02 this quarter." Just to put in perspective, if we would have done half of the bad debt reserve in other words instead of $3 million, we did $1.5 million, which we've been 25% of our unpaid rents. That would have been $0.02. So when we're reading some of the notes and saying that the headline is that we missed on $0.02, it feels a little unfair. In light of the fact that we've collected 92%. So it's actual real erosion. We have the least amount of to date. So again, just want to say that, that $0.02 based on what people are doing with bad debt, which by very definition is a very subjective measure. We think that we hit every metric and every mark this past quarter.

And our next question comes from Todd Thomas of KeyBanc Capital Markets.

Heath, first question and sort of following up, I guess, on the previous discussion a little bit and your comments that the change in revenue from 1Q to 3Q is not going to be linear. After taking into account the revenue that you've reserved against and sort of offsetting that with leasing in the pipeline and scheduled commencements. Are you expecting that decline in recurring revenue to stabilize around these levels? I presume the hits like Stein Mart are accounted for in those adjustments. I'm just curious if you have any sense on how much more of a decline in recurring revenue you might expect in the near term?

Todd, I really hate to speculate. And I said in my comments that 6.4% certainly wasn't meant as some run rate that I want folks to start using on a go forward. It was really just a data point to say, okay, here we are. We're at 6.4%. We've got lots of questions. John mentioned, when is the next round of PPP coming? Who's going to be the President? What's the composition of the Senate? When are we going to find out? What are the vaccines? When are people going to adopt? There's so many unknown questions. I just would think it would be irresponsible for me to take that 6.4% and draw any kind of conclusions around it. But again, John said the hits have been right away and the lease-up takes longer. So it's not going to be something that's going to be very smooth line when you look at the sort of where this thing settles out. It's going to be a dynamic trajectory.

Yes. Todd, to be clear, even you brought up Stein Mart. I mean it's less than 1% of our ABR. But they're having going out of business sales post the bankruptcy filing, so they're still paying rent. So we'll take -- we'll feel some of that in the future, but it's less than 1%, and we're leasing other spaces to absorb. And frankly, that's when I look at what's been going on, you look at the last 2 quarters, I mean for every tenant going out of business, there's another tenant stepping up. And you look at the retail landscape right now and just throwing out some names. I mean, you look at what DICK'S has done, what Bed Bath is doing, what Best Buy is doing, what Ross is doing, TJ, the grocery guys, I mean you have a whole multitude of grocery players that would be great prospects for those Stein Mart boxes that, frankly, pre-COVID wouldn't have spent the capital. And now they're flush with capital. So I want the investment community to think a little longer term here because we will ultimately come out of this stronger, Todd. It will ultimately be a higher NAV for our properties because the guys that are going down are being replaced by much better long-term retailers. In a way, it's a good thing for us because we just couldn't -- with all due respect to Stein Mart because we keep talking about them, but we couldn't get them out of the locations for years. And now we have this opportunity to bring in much better retailers and increase the NAV property by property. So I think if people think a little bit longer term here, especially with a company like ours with a super strong balance sheet and a strong foundation, the reward will definitely come.

No doubt. When you look at Stein Mart, you're about a $8 range ABR, you're a tenant that generates very little traffic. So it is a huge opportunity in a situation like that to bring someone much better, better co-tenancy. So we're actually looking forward to those.

What do you think -- so Stein Mart's at $8. In terms of that -- the 64 spaces, I guess, the 540 basis points related to the bankrupt tenants. What do you think based on what you have in negotiation and what you're working on? What do you think the potential mark looks like on those spaces as you work through them?

I think when you look at the whole thing, Todd, it's too hard to predict right now. When you talk about Stein Mart since it's $8, it's pretty easy to predict that we're going to beat that. I don't want to get into what on all 5% of those BK tenants. But the shop spaces are very different than the box spaces, right? So -- but certainly, our track record is very strong there. So we would anticipate, we do what we do.

Okay. Can you talk about the grocery demand that you're seeing across the portfolio? And maybe in some of the various formats? I know you signed a lease with Trader Joe's to anchor Phase 3 at Eddy Street. But just curious if you're seeing demand across the portfolio at centers that currently do not have a grocery component today and whether we should expect to see maybe an increase in grocery lease deals in the coming quarters?

Yes. From my perspective, and then I'll turn it to Tom. But from my perspective and on a macro level, the difference today versus pre-COVID is that the specialty grocer component or section, whatever you want to call it, has really strengthened post in the COVID crisis. And the traditional grocer has also strengthened. But when you look at the real change, I'd say the real change would be in the specialty area, guys like Sprouts and The Fresh Market, but also a little traditionally in the sense that someone like an Albertsons is now putting up really strong numbers, and you see Winn-Dixie looking to file an IPO, et cetera. So macro thought, there's just a lot more going on. But Tom, why don't you get into the...

Yes. One of the things we like about the space right now is just the diversity in square footage. You have a Trader Joe's scenario where you're 13,000 to 15,000 and then you have Whole Foods, Aldi, you got some expansion of Lidl, Sprouts. So we have a wide array of square footages to look at, which is always helpful as we're trying to slot spaces inside these centers. But the conversations have improved without question, there's more energy, even some of the companies that struggled pre-pandemic are talking to us. So we look good on that front. And then on the box side, we feel like we got a strong stable. The value guys, even in some of the smaller spaces, the Five Below is being very active, Total Wine, et cetera. So the inventory is out there for us to react just like we did last time.

Okay. And John, you talked about some of the fulfillment and omnichannel strategies that the retailers are employing in the current environment here and sort of accelerating those efforts. Are you seeing any incremental investments by them in the stores? And are they coming back looking at all to lock in term or exercise early options or anything like that?

I mean in terms of the omnichannel and what I've referenced there, Todd, I think that's really more of me saying or us saying that our properties, particularly in the open-air genre, are very easily suited to adapting to what needs to be done and that we, like many of our brethren, really quickly adapted our parking lots, created signage and then also allow for areas to do curbside pickup, which is not as easy to roll out in the sense that not every single one of these small shop guys or retailers can have curbside. But in the long run, I think what we're saying is, it's happening very quickly and has been adapted very quickly and it's just a whole another chain for us. So -- but as far as them coming to us and saying, "Hey, we want you to spend money at our stores to adapt them. No, that's really happening. It's really signage and doing things on the inside."

And our next question comes from Craig Schmidt of Bank of America.

The small shop occupancy fell a little bit in the third quarter. I just wonder if this is the bottom? Or do you think it could go a little lower from this point going ahead?

Craig, I mean, look, it was a significant drop in 1 quarter. So when you look at it, it really -- it was actually -- when you look at the last 3 quarters, particularly the last two, it's really centered around a couple of the major players like Ascena. Obviously, we had a lot of Ascenas, Pier 1, Destination Maternity. So I would say in terms of that much happening in 1 quarter, that feels like a lot to me in 1 quarter from our previous experience. But certainly, you can never say never. We also had significant pluses and minuses in the restaurant category, where we lost several restaurants, but also replaced them. So I don't know. I think it's too early to say that, that would be -- it couldn't be repeated, but it was frankly quite a bit in a -- in 1 quarter. And as I said, pretty focused in on a couple of national small shop retailers.

And Craig, one other thing is as we're moving into November, the time it takes to do a deal, get through a lease, get through natural occupancy, we're starting to put tenants in positions that they will be able to open in a much better situation. So that growth on the small shop is a much easier forecast for us moving forward.

Okay. But aside for some restaurants, it sounds like the local players are pretty healthy. Is that true?

Yes. I mean when you look at the deals that we did in the quarter, interestingly enough, I mean of the 78 total deals that we did in the quarter, 64 of those were shops. So we did a lot of shop deals. So again, we took a hit because it was concentrated with these national guys that have multiple locations, but definitely demand in the small shop space, and it is pretty wide in the sense of just various types of retailers. And probably the most interesting thing that will come out of this when we get into 2021 is the rebirth of a lot of these smaller restaurants and fitness guys, for example, that will -- there'll be new operators that step in and do different types of similar products, but different. So I think the demand is out there, and it's a pretty healthy environment. And again, I think we've seen in our economy, I mean, everybody saw the print this morning in GDP. I mean when you're open, we do business, and that's an important element in all of this.

And Craig, one thing I'll mention, a function of the loss in our small shop occupancy is the fact that it was so high beginning with -- we were at 92.5% sector leading at the end of the year. So that demonstrates one that we are incredibly good at filling our small shop space. And my prediction is that we continue to make progress on a relative basis in that area.

Okay. And then just last, how many -- how long is it going to take to refill some of that smaller national space to get the newer tenants in with the higher rents?

Yes. I mean, we can't tell exactly. We can only tell you that generally, small shop leasing from vacancy to the next tenant paying rent is significantly less than what we see on the box side. So depending on the shop, depending on the location, it could be as quick as 3 or 4 months, it could take 9 to 12. It really depends on the situation, Craig. There's so much variability. I would tell you, on the small shop side, you have a much better chance of a tenant stepping in and taking the space as is, which means that our turnaround time could be 3 months. That almost never happens in the box category, right? So that's, I think what Tom was just saying a second ago is that our ability to turn these spaces quicker is absolutely there. But I don't want to make a macro statement that we know that it will be x because there's too much variability.

And our next question comes from Barry Oxford of D.A. Davidson.

Great. John, when we think or look at valuation in the retail sector and at your property-type level, well-located assets. And we look at pre-COVID and post-COVID. I know you're not in acquisition mode, but I'm sure you're looking at some of the stuff that is up for sale. My guide is telling me that for properties like that, the cap rate expansion probably hasn't been as great as maybe some people think that it is.

Yes, Barry. We talked about this last quarter, I would tell you that the term cap rate expansion just doesn't exist in the type of properties that we want to own and generally speaking, the type of properties that we do own. In fact, as we said last quarter, I think you'll see some things trade. I think it will be very few and far between trades. And once they do start to trade, they would be probably at or below cap rates that you've seen in the past for high-quality properties. We're going to go through this period where very little trades. But then all of a sudden, I think a lot will trade. So my guess is, as we get into 2021, you probably will see a lot more activity just based on more capital flow. And I think the cap rates will be exactly where they were. So when you look at properties like ours, it's kind of why we mentioned what we said, I mean, the dislocation has occurred, the decline in these values is just stratospherically wrong. And it implies really high cap rates that just don't make any sense for too many reasons to even mention, right? So long story, short, yes, I don't see that happening. There will be a handful of trades that strong -- at whatever words you want to use, whatever adjective you want to use aggressive cap rates, there'll be a handful of them. But in terms of the dislocation and cap rates going up on deals, that just is -- that's in a whole another sector. It's in a whole another part of retail. And even in particularly weaker open-air centers that they might trade and then one of these services picks up -- picks it up and there's this attribution to all of retail. It's just silly. I mean, I think smart institutional investors know the stuff that we own is very hard to come by.

Barry, I would add, actually the stuff that we own or would like to own, you’ll probably see cap rates tighten on a nominal basis because they're going to have folks go in there and realize there's some upside in the occupancy. So I think when you start seeing the transaction market open up again, on a nominal basis, you're going to see some pretty eye-opening cap rates.

Yes. And then I think when you look at our investor presentation, Page 12 of our investor presentation highlights this a little bit. Frankly, the cap rates that we use there on applied cap rates, even the lowest one is probably too high. So -- but we're just trying to say, this is silly.

Right, right. And John, just carrying through on that. What is the appetite for banks to do retail loans? Or look, there, you got to kind of bifurcate it.

Yes. I'd say the latter. I'd say there's a bifurcation. I'd say that banks, insurance companies, other institutional investors, clearly, during this summer were saying, "Woah, we don't know what's going on in retail." And then you have the confusion of the mainstream media pounding away at a narrative that is a broad-brush stroke on retail that, again, makes no sense. So, I think that right now, there's probably very little in the way of that activity. But when you look at the stuff that we own, insurance companies, banks, they're going to begin to lend in our lending against that high-quality retail that has a grocery component, neighborhood centers that are smaller. And remember, tons of liquidity as we sit here today with 10/31 activity, maybe that even rolls heavy into the fourth quarter if people worry that, that's potentially a risk, but who knows? So, I think that it's starting to trickle, Barry, and there'll be a lot more later.

[Operator Instructions]. We do have a follow-up question from Floris Van Dijkum of Compass Point.

Just a follow-up question here on something that Heath, you mentioned on your renewal spreads on non-option tenants of 11%, which seems pretty healthy. If I were to ask you guys, so if you were to mark your whole portfolio to market, is that sort of the delta? Or I mean, what is the risk of rents going down in your opinion?

I would say, Floris, to put it different, that's the best barometer, I think, of what's happening in our portfolio because, again, when you're -- it's a non-option renewal, the leverage is equal. The tenant and the landlord are staring across the table at each other. We haven't set the rent yet. And the tenant decided, they would like to stay in the space and so we end up negotiating a rent. And last quarter, it was 12% and this quarter it’s 11%. So even in the peak of the pandemic, we had tenants that were willing to tick their rent up. So I think I made a broad brush review when I think the total mark-to-market in the portfolio is, but rather just -- let's go back to that fact that's the best barometer because it doesn't have the TA dollars in there that's really influencing your spreads.

And sometimes these tenants will actually look at alternatives to compare it to our real estate. And that has consistently worked in our favor where people assess options and say, "Hey, this is where we want to be. This is the center, this is the location." So I think all of those point towards positive trends for us.

The other thing, Floris is, in this particular quarter, there were 28 of them, which is a lot, number one. And number two, they were all small shops. So I wouldn't try to -- there is no linear connection to anything there other than to say as Heath just said, 2 quarters in a row of double-digit non-option renewal spreads indicates that we're in a pretty healthy business, okay? That's the takeaway. We get so focused on thousands of metrics that everybody wants to know what color sock we're wearing today. But the reality is the business doesn't move quarter-to-quarter. You got to look at longer term trends. It's why we talked about -- I don't think people should really care right now quarter-to-quarter FFO or quarter-to-quarter anything. The reality is we've gone through a huge shock to the system and are going through. We are recovering from it. Our particular company is very strong from a balance sheet and a stability perspective and very well positioned to take advantage, but it takes a little bit of time to do that. But from an investor's perspective, the stock is trading as though this is forever, which is really silly. So I think we're now in this mode of, hey, we're moving forward man. We're not afraid of this thing. We're dealing with this thing. And that's the message we want you guys to take away. We're dealing with it. We respect it. We did a lot of stuff really early that other people didn't do, which is why we're now doing what we're doing. So without getting too much on the soap box there, I think we're really ready to move forward.

Actually, just making sure I understand it correctly. So that was -- the 11% is basically -- that's all small shops. So that had no anchor boxes in there. Typically, your -- some of your peers have said that the spreads that they get on their anchor boxes are typically much, much larger. Is that your experience in the past as well?

Well, it just depends on the deal. The typical anchor deal has built in options, right? There's very few anchor deals. It's occasional that you've just an anchor expires that you've -- the options are gone, right? So most anchor deals will have 4 or 5, 5-year options with automatic built-in increases, generally 2%, 3% every 5 years in that option period, depending on the deal. So no, I think it's a very different analysis. And I think that's why we say this is really more an indication of the health of the overall industry because if the shopping center was weak and was dying, why would a small shop tenant be willing to pay 10%, 11% and 12% more when they have the opportunity to say to us, "Hey, guys, we're leaving. So we're not going to pay any rent increase." And that's the point we're trying to make is the industry itself has got some health in it. Otherwise, we couldn't do that more particularly our properties. So yes, this particular quarter Floris, it was all small shops. There is no -- there were no anchors in this particular quarter. But when an anchor expires, you might get a really big bump if it was a 30-year-old lease that has run out of options. And we've had that happen, too, okay? But it's not -- it's just much more rare.

And ladies and gentlemen, this does conclude our question-and-answer session. I would now like to turn the call back over to John Kite, CEO, for any closing remarks.

Okay. Well, again, thank you, everyone, for dialing in today, and we hope that you continue to stay healthy. Thank you.

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