Kite Realty Group Trust (KRG) Q1 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to the Q1 2014 Kite Realty Group Trust Earnings Conference Call. My name is Mark, and I’ll be your operator for today. At this time all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Adam Basch. Please proceed.

Thank you and good afternoon everyone. Welcome to Kite Realty Group’s first quarter 2014 earnings call. The Company’s remarks today will include certain forward-looking statements that are not historical facts and may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results of the company to differ materially from historical results or from any results expressed or implied by such forward-looking statements. The company refers you to the documents filed by the company from time to time with the SEC, which discusses these and other factors that could adversely affect the company’s results. As you now on February 9th, we signed a definitive merger agreement with Inland Diversified Real Estate Trust. This call is our regular quarterly earnings call and we will be talking about our first quarter results of operations and related matters. In light of filings that we have made and will be making with the Securities and Exchange Commission relating to the merger transaction, we are limited in this call with respect to discussions about the merger transaction. We request that you refrain from asking questions about the merger transaction on this call and refer any questions regarding the merger transaction to the proxy statement and prospectus we have filed with the SEC. We appreciate in advance your adherence to this request. On the call with me today from the company are Chief Executive Officer, John Kite, Chief Operating Officer, Tom McGowan, and Chief Financial Officer, Dan Sink. And now I would like to turn the call over to John Kite.

Thanks Adam. Good afternoon and welcome to our first quarter earnings call. Before we get started discussing our first quarter results, I’ll provide a brief update on the pending merger transaction with Inland Diversified. The transaction continues to proceed as expected. As you are probably aware, we filed an amendment to our proxy statement and prospectus with the SEC earlier this week. In that amendment, we noted that we currently expect KRG and Inland Diversified to hold our respective shareholder meeting, seeking approval for the merger on June 24th. Based on the schedule June 24th day, the 10 day trading period to set the exchange ratio will begin on Friday June 6th and at the market close on Thursday June 19th. Assuming we receive the necessary approvals, we expect the closing to occur shortly thereafter. Okay, moving on to the operating results for the quarter. We’re off to a very strong start in 2014. The first quarter FFO per share at $0.13 as adjusted for Inland merger costs. Revenue from property operations increased 55% year-over-year as we were able to continue delivering our development and redevelopment properties such as Rangeline Crossing, Four Corner Square and Delray Marketplace into our operating portfolio, as well completing the successful integration of our $304 million portfolio acquisition last November. These internal and external growth initiatives have significantly increased our free cash flow, enhance the overall quality of our portfolio and continue to improve our balance sheet. Our same-property net operating income increased 4.7% in the first quarter, reflecting our team’s continued focus on increasing occupancy and generating positive re-leasing spreads. We also received overage rent during the quarter as a result of strong tenant sales, which demonstrates the strength and productivity of our real-estate. As a result of the strong same-store performance in the…

(Operator Instructions). Your first question comes from Todd Thomas, KeyBanc Capital Markets. Please proceed.

Hi, thanks. Good afternoon. First question at Delray, so you transitioned it into the operating portfolio in the quarter and spoke about the traffic at the site and the need for more parking, still about 87% leased. So, I was just wondering what it will take to get that leased up to 95% or so and how long you think it might take at this point.

Yes, Todd, I mean we’re pleased with where Delray is. Obviously we’d like to be over 90%, but are not totally surprised where we’re right now based on the cycle. I think we certainly think that this year the project will fully stabilize and it will be over 90%. At this point, small lease up moves the needle pretty significantly. So it doesn’t take many, many deals to get over 90%. And frankly, we’re happy that we’re in a position right now to be leasing up the balance while we’re adding the additional parking. I mean the center has been received extremely well by the community. And so we’re -- we see this as really strong upside. As you can see the rents that we’re getting are pretty high relative to the average rents in the portfolio. So we think we’ve got a lot of upside here.

Okay. And then as you think about the leasing environment just more broadly, small shop leasing does seem to be coming along but it appears that there is a little bit more demand for big box at this point in the cycle still. I was just wondering if you’re seeing signs that there is more meaningful pick up in small shop leasing on the horizon or does it seem like slow steady gradual improvement?

I mean right now I think we’re approximately 86% leased in the shops. I mean when you look back over the last 10 years that’s very close to the top for us on average. So, I’d say small shop leasing has been strong. And we have an internal goal to keep pushing that percentage up. And I think it’s very reachable to assume that we can gain another couple hundred basis points there. So, the environment right now is very strong because you have not only the national retailers expanding on the small shop side, you have the regional players and the mom and pop shops are expanding too. Tom, is there anything else?

Yes, I would say on Parkside phase I, is by a great example where we basically have every space spoken for and at this point, we are working towards trying to get deals done. And so you have Target, Harris, [Theodore] anchored center. And there is just not that many new opportunities in markets like this. So we have strong anchors, new product coming in, new redevelopment. We actually see quite a bit of strength on the small shop side.

Okay. That’s helpful and then regarding the overage rent that you saw in the quarter, definitely nice uptick year-over-year. Is that broad based throughout the portfolio or was it more specific to just to handful properties? And Dan, this shows up in other income on the consolidated income statement; is that right?

Yes, that’s correct. And then we break it out in more detail on page 12 of the supplemental, where we get a separate overage rent line item.

Yes, I mean to answer the question relative to -- it is actually very broad based across the portfolio. I mean we’ve got percentage rent coming from EL Paso, got percentage rent coming from Rivers Edge, we’ve percentage rent coming already from Delray Beach. I mean you are talking about multiple centers where we are generating pretty decent percentage ramp. Cobblestone in Fort Lauderdale, couple of properties in Atlanta, so it’s pretty well diversified and again I think it shows an environment where you see people talking about retailer sales and a concern around it. It’s quite the opposite in our portfolio right now, they are strong.

Okay. Great and just one last quick question on the dispositions. So you mentioned last quarter the average cap rate you expected on the sales here would be around 6.5%. Is that consistent with the three properties that you sold in the quarter and then what else teed up here, there still little bit of a little bit more to do that to meet that $40 million to $50 million of guidance?

Yes, in terms of the cap rate it’s stayed on consistent with where we thought would be in that mid fix range, so we are very excited about being able to sell assets in a mid fix cap that we deem as not strategic to us. So obviously we generated $35 million I guess approximately of the 40 to 50. So we have a couple of other properties that we are looking at, we have another Walgreen’s net lease properties that makes some sense to sell. So I think we are very comfortable in reaching that guidance.

Okay, great thank you.

Thank you.

Your next question comes from Christy McElroy from Citi. Please proceed.

Good morning, this is [Katy McConnell] on for Christy. Can you talk about new and branded releasing spreads, what has been excluding the impact of the Walmart [tenant gain]?

Sure, the new leasing spread without the Walmart [retaining] would have been about 14% and the aggregate would have been about 8%.

Okay great, thanks. That’s it from me.

Sure.

I would now like to turn the call over to John Kite for closing remarks.

Okay. Well again, thank you everyone for joining. As I mentioned early on, we are performing really well. Actually operator, I think we have someone that wants to ask another question, so you might want to check that

Yes, he just came in as I turned it over to you. Your next question comes from Nathan Isbee from Stifel. Please proceed.

Hi, good afternoon.

Hey, just fairly (inaudible).

Yeah, (inaudible). Just focusing back on Delray, it seems like it’s getting some decent momentum there. Can you talk about how the Publix supermarket is performing, relative to your expectations and relative to Publix’s expectations?

I mean relative to our expectation is excellent, because they’re paying rent on time. But as it relates to their expectations, I think it’s within their plan and is our understanding and I think they’re happy, obviously we’re still finishing out the center, but our understanding is they’re within their plan and based on just anecdotally what we see it looks pretty good and as far as what the impact of the center that we thought it would have, it’s exactly what we thought it would have bring the daily traffic. So we’re very happy with it.

Okay. And then the, I’m sorry

I was just going to say we just had a portfolio review of the entire public team and this is a strategic position form and those growth numbers will continue to pick up it’s a solid store and they made a very good move there.

And then just moving to the small shop side, the 87% leased, has there been any first-generation kickouts so far that are still flowing through that occupancy number?

No I think Nate, I think the only think between the leased and the occupied number that we have now primarily anchors, we have some couple of anchors that embark for paying rent, but as far as all shops are concerned, I don’t think there is anything material that quarter-over-quarter looking into the second quarter that would be impacting that percentage negatively.

Okay. Thank you.

Thank you.

(Operator Instructions). Your next question comes from Stephen Bush from Crown Health. Please proceed.

Crown Wealth. The question I had was, could you recap the meetings? You said something about June 6th, June 19th and June 24th?

Yes, I’m sorry. Could you ask that one more time, I couldn’t hear real clearly.

Just recap, if you will you said something about Friday, June 6th, and another event taking place June 9th, and then one June 24th?

No, okay. What we’ve said is that the actual shareholder meetings for approval for both companies are set to be held on June 24. And then what we said is that the based on that June 24th day, there is a 10 day trading period where the exchange ratio is set. And that’s an average of the volume weighted average price during that 10 day trading period. And that 10 day period is between Friday, 6th and Thursday June 19th, obviously doesn’t include the weekend. So, it’s 10 business days.

Okay. I thought you said June 9. That’s fine. Thank you.

Sure. Thank you.

Your next question comes from the line of Craig Schmidt from Bank of America. Please proceed.

Yes, I was wondering -- we are heading into ICSC. And is there any leasing that can be done there that would impact or get open by the end of 2014? I know people say it’s more relationship than actually deal doing. But I was just curious what might have happened at the ICSC this year.

Yes, hi Craig. I mean from our perspective we’re there to do deals, so we do think that certainly on the small shop side, we can still have deals where we’re in discussions with tenants that we can push into lease and actually still get opened this year. On the big box side it’s a little tougher you have to be going into an existing space, but didn’t require a lot of build out. But as you know we’ve always said the way we prepare for Vegas is it’s all business, we’re there to get deals done we have a very detailed process we go through where we force our dealmakers to justify even being there. So we take it very seriously and we believe that our guys should come out of there with deals.

Okay. And I don’t know if you have a sense of this, but are you getting more requests for meetings from retailers this year than last year? Or is it operating pretty much on par?

Definitely we are getting more, I mean, I think quite frankly the announcement of the Inland Diversified merger within a week or so of that we clearly saw the impact relatively to retailers interest and discussing deals with us. So I mean, I think as it relates to us on a micro basis there is no question we have a lot more activity, we’re kind of I’ll let Tom speak to this a little bit, but we’re essentially co-discussing the assets with Inland in certain situations, but I think two things, one just our micro that we have this deal going and two the environment is strong, anybody that has product their plenty of users interested in it, you want expand.

I’ll just, I’ll give you one quick example, we’ve been really push them portfolio reviews we’re going to their office and coming prepared, to now only talk about our existing assets, but new opportunities and in the past when you have that meeting, you may be able to steer one or two people inside that organization and the most recent one we had the head of real estate, the President of the company popped in and all seven real estate managers. So it shows you the power of the scale, it shows you the things that are improving, but the bottom line is with the scale and these in-house enhanced assets in terms of both quality and the numbers them we’re going to get a lot more looks a lot more attention which will prove to be extremely beneficial to the portfolio.

Okay. Thanks I appreciate it.

Thank you.

Your next question comes from the line of Chris Lucas from Capital One Markets. Please proceed.

Thanks a lot guys. Just following up on that last comment, do you anticipate being able to start or have discussions on either land that you currently have that’s held for development that might generate a project, or even looking at beyond that different development opportunities that you might be having conversations with this year? Are we getting to the point in this environment and this cycle where that is becoming a possibility?

Yes, I think for sure, we’re at a point where tenants are approaching us for opportunities, and are interested in situations where we have land, land held for development that could obviously become centers and we have one deal in particular that we’ve mentioned in Naples, Florida that we refer at 9.51 and 41 where we are very actively engaged in discussions with tenants. And so we will certainly be doing that in Vegas this year on that particular project. And then, in addition to that we have some projects that people have approached us on that we’re annualizing whether or not we would be interested in reviewing and those are also deals that tenants would be interested in hearing about. So I don’t the issue is that all tenants interest in this deals is whether or not they are willing to pay the rents that would open up our desire to do the projects and really comes down to the returns not interest. We are getting much closer to those things coming in line, but there is still a gap and tenants obviously are going to realize with no new construction for the last six, seven years there is only so long they are going to be to hold out for that.

So John would you be able to characterize sort of what that gap is right now?

I mean it’s just from our perspective it’s the yield, I mean we would like to get, we like to see depending on the risk parameter of the project larger scale power center, we would like to see a 10% return on cost. Historically over the last couple of years the things we have look at, the way under write it, that’s not the where everybody else might, but the way we underwrite and kind of discount things for risk have been coming in closer to 7% to 8%, so which is why we have been pursuing redevelopment because it’s a lot lower risk profile. But again that gap on a per square foot basis for rents could be a couple bucks of foot, most likely if the box tenants were paying a couple of bucks more than that would probably move to needle.

Okay. And then just shifting a little bit, you guys have had the opposite for portfolio now for five months I guess roughly. Is there anything that’s coming out of there in terms of redevelopment opportunities that you either -- or ready to act or incremental to what your underwriting was at the offset?

Yes, I mean there are, I think there is a couple of things going on there. First of all, we’ve already actively taken over in terms of how we lease space. And just quarter-over-quarter, our small shop lease percentage in that portfolio is up 60 basis points and the total is up 20. So it’s not just a redevelopment process that I am going to have Tom talk about here in a second. But it just shows you that, when you buy a portfolio that is kind of actively managed and you bring it in and you do what we do, you can immediately see those results. So I mean that’s why we’re excited about the [next year] we’re doing. But also Tom you want to talk about redevelopment opportunities.

Yes, we have absolutely try to make a big physical programs on side, I mean one of the ways we do is the simple fact of you see (inaudible) lawn sign or you see parking lot lifestyle, trash not been removed properly and we made an immediate change to these assets and it’s been recognized by the tenants. And that’s just simply bringing together a platform of both leases and managed of these assets that takes the time to do that. So we’re doing extremely well from an operations standpoint. As it relates to the redevelopment, if you take a look at the nine assets, we have two to three redevelopment programs that we’re deeply engaged. And these are exciting projects like Portofino in Houston, Texas and Lakewood in Jacksonville, where we’re really deep into the engineering concepts. And then we have quite a few opportunities of simply re-leasing, upgrading the tendency of existing boxes and reformatting some of the shop configurations. So, it’s a active portfolio, a very, very active portfolio as it relates to where we can build value.

And then, can I just follow up with that on, as it relates to that portfolio it looks like there’s two assets that are sort below stabilization, Lakewood and Burnt Store. Is there, do you have a sense as to the timeframe it will take you to get to a more mid-90s, more consistent mid-90s occupancy? Is there decent traffic for potential lease-up within those two centers?

Sorry, I think there are two different properties. So in terms of, I wouldn’t put them in the same bucket, Lakewood is a, as Tom just mentioned is one of the redevelopment properties. So that’s probably going to be a longer process where we intentionally hold back on leasing, until we’re clear on what exactly, we’re going to do on the redevelopment side. So, that one is probably a little longer situation because we think we’re going to undertake a fairly significant redevelopment there and that’s an infill spot in Jacksonville. The other deal, Burnt Store is a small grocery anchored center in Punta Gorda. And that’s really more a matter of us stepping in and leasing and just being actively engaged in the leasing process. So that should come overtime. But it’s a very different scenario.

Okay, great. Thanks a lot guys. Appreciate you taking my questions.

Absolutely. Thank you.

(Operator Instructions). Your next question comes from the line of Tammy Feak from Wells Fargo Securities.

Hi. I just had a couple of quick questions. Of course the first one is with the larger base of assets after combining with Inland and your strategy to focus on assets with better growth prospects. Can you discuss the volume of assets that may look to recycle over time as you look to fund additional development or redevelopment brands?

Yes, I mean I don’t know that we can as we said I’ve got to be cautious relative to where we are with the filing of our S4 Tammy. So, it’s difficult to stray from what we’ve disclosed publicly about when we intend to do on Inland. That said if you just look at what we’ve just talked about relative to the (inaudible) portfolio I mean where we’re redeveloping two, three centers out of nine. I think there is two things that are going to happen. There is going to be redevelopment opportunities and there is going to be pruning of the combined portfolio, not just specifically their assets but our combined portfolio which would be approximately a 130 properties. It is not going to be unusual to see us look to prune 10% of that over time. So I think it will be geographically driven it will be driven off of growth, it will be driven off of the non-strategic kind of component. So I think there is no question it gives us a better opportunity to just kind of do it on a bigger scale. And as we said to take whatever money that we’re able to generate there and positively reinvest it. So don’t I want to dig real super specific because I’ll be in trouble for that but in general there is opportunity there.

And we should think about asset sales as the primary source of funding for any additional development redevelopment that you do?

Yes, I mean it’s a recycling process. I mean as you know we’ve said that we believe that the combined entities balance sheet, will be extremely strong and that we are going to generate two times the cash flow that were currently generating or more. So it won’t really be dispositioned it will be free cash flow. And we’re talking about I think we said this fairly publicly that you are talking about significant free cash flow after the combined dividend of $65 million, $70 million range. So there is a lot of things we can do with that cash flow, there is also the asset sales to reinvest in redevelopment and again that’s one of the things that we love about the deal is that this truly is scenario where I don’t think either company going on independently without the other would be able to be in that position to have that flexibility and the strength of that balance sheet while yet that still growing earnings and cash flow so feel very good about that.

Okay. And then maybe just one more question on the credit portfolio specifically and you guys have obviously had some good growth here in the last couple of years on an NOI basis, I guess as you look out to 2015 and we are going to use the guidance for 2015, but do you have some visibility as to whether or not same-store growth will kind of revert back to the longer term mean or is there some additional upside that you can see that gets you on kind of this 3% to 4% growth for mean the next couple of years?

Well, again let’s start macro to that be careful with the macro relative to the deal. So on macro level, my personal believe is the entire shopping center space eventually reverts back, I don’t know that the mean of the right way to look at it, but if you just look at our same-store NOI growth this quarter at 4.7% camping against the 5% previous growth rate, we had a 140 basis point increase in occupancy in the same store pool that’s probably more than some people’s increase in same store occupancy but it’s not a crazy number. So you are not only getting this growth out of that occupancy compression you are also getting it out of rental increases, you are getting it out of, in our case percentage rent which was probably 50 bps of that number. So I think we are in a scenario where over the next few years as the occupancy to leased percentage shrinks that number not going to be 4.7% for us. That said, when I look at 2007 which I refer back to as peak of the previous cycle, our same store NOI growth was under 2%. So a big reason for what is happening with us particularly is how we have actively engaged in the operating portfolio. And that’s one other things I have said that people misunderstand about us is our ability to actively add value in the operating process not just the external process. So that’s a long way of me saying after working on this deal for the last few months, we feel very good about the combined growth prospects of the portfolio and we do not see it materially hurting us at all, we see it helping us. But I think overall as our lease percentage versus occupancy stabilizes that growth profile obviously comes down, but right now we are far exceeding most. So we try this to come down where the other people are which is more normal.

Okay, great. Thank you.

Your next question comes from the line of Nathan Isbee from Stifel. Please proceed.

So after the false alarm this call is not ending huh?

Yes, we talked. I was going to say, thanks to you.

It’s all right. John I don’t want you to get in trouble. So maybe I’ll move it over to Tom.

Well, that’s fine.

But if one of you could just discuss it’s been a passage of time since it was announced if you had anymore thoughts not on the leasing side, maybe on the asset management side operating efficiencies and geographic diversity et cetera. And if your updated thoughts on all those things and how you might approach this portfolio once it’s yours?

No, we’ll both come on it Nate. First of all, again I just said after working on this for a few months. Every surprise we’ve had has been positive. So we feel very good that we underwrote the deal in a conservative way and that we definitely see upside in our ability to step in and very actively manage the portfolio. And with all the respect to the way the portfolio has been managed currently, it’s just a different way I’m going about it, where we are much more actively engaged in what we can do to take the assets to the next level versus just kind of managing it for it’s for current yield. So that’s just a different business approach. Now we’ll obviously invest capital where needed and get good returns on that capital. But if anything over the last few months, we have felt very good about the portfolio, I would tell you that the people at Inland Diversified have been great to work with and have, are very excited quite frankly about the merger and about the prospects of the company going forward. This is not a deal where we do this deal and it’s over. I mean this is definitely a deal, where both sides feel like, there is a lot more here than what’s here today. So, that has not changed and it hasn’t changed from a geography perspective. We will as I mentioned, we will, as a bigger company, we will have more opportunity to recycle assets, that’s exciting, because we’ll reinvest the money at higher yields. But as it relates to the anything that we’ve seen differently it really is, I mean this sounds like it’s just talk in our book, but there is a lot of opportunity here and when you get right down to it and you look at the G&A synergies, you look at our ability to bring, the redevelopment skill to these assets and you just look at our performance. I mean, look at our performance in the company today. Just looking at same-store NOI growth, looking at cash flow growth, looking at revenue growth, we’re doing that with the portfolio we own. And it’s not a bicoastal portfolio that we acquired at 4 and 5 caps this is a portfolio that we actively manage, it’s a portfolio that’s strong and we’re getting great results. So, I think it ought to be a bit of an eye opener in terms of the type of assets that everyone owns and what you can do with them.

And it ties back to the actual merger, ties back to the transition. I really think it’s been a model and we did a great job on asset but with Inland’s help I think this has even got better. We spent an all day session at their office at this went we met peer-to-peer with each division head and since that time there has been weekly meetings whether it be asset management, leasing whatever that is marketing we continue to stay in touch, we continue to build and they have been great in terms of helping us find opportunities. There is a slap rent component that we found the other day for how do we solve them. So it’s been a very cooperative productive process and we will be ready because we’ve been hitting it hard since February and we’re very much upto speed on these assets and we do give credit to Inland their help in that and their ongoing process. So, we do feel good, we feel like there is upside, we’re already identifying it and moving well.

All right thanks. Is there more business to you done with the Inland Group as a whole?

We hope so, I mean it’s been so far it’s been great and then obviously they’re large organization. They’ve got a lot of different pools of assets. So I am sure both of us feel like we’ve got a job to do right now and get this deal done and make it perform, but normally when you’re able to do that other opportunities arise. So we’ll just keep our head down and we’ll find the way and get this thing done and we’ll start to grow it and we’ll see what happens.

All right. Thanks so much.

Thank you very much.

I would now like to turn the call over to John Kite for closing remarks.

Okay, now we’re actually done. So we appreciate everyone’s time coming on. And just to summarize we’ve had a great start to the year. We anticipate that continuing and we look forward to our next call. Thank you.

Thank you very much. This concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.