Hi, everyone. Welcome to the 2:15 session with Acadia Realty. My name is Linda Tsai. I'm from Jefferies. I cover retail and residential, and net lease. Really pleased to have with us today, Ken Bernstein, CEO of Acadia, John Gottfried, CFO, and to my left, Stuart Seeley. So Acadia is a $3 billion retail REIT in the open-air shopping center. In my opinion, they have two differentiating characteristics: They have a dual platform with the vast majority of their value and earnings coming from their core business. This is conducted on balance sheet with public capital, and then also an investment management business that leverages strategic, private, institutional capital.
Within the core portfolio, the company's focus on street retail is unique to the public open-air shopping center sector, and Acadia's core portfolio is currently about 50% weighted to higher growth street retail properties located in residentially dense urban areas and/or highly trafficked destination shopping corridors. I'm just gonna do a quick intro of Ken and John. Ken is the President and CEO. He's a retail real estate industry veteran, having co-founded Acadia in 1998, and was a practicing lawyer prior. Ken sits on the board of trustees of the ICSC, and was a past vice chairman. John Gottfried, CFO, he joined Acadia in 2016, following a successful plus-20-year public accounting career at PwC, where he led the real estate assurance practice and was responsible for advising the firm's largest REITs.
So I'm gonna pass it over to Ken for a couple of opening remarks. We're gonna do some Q&A, and then we're gonna open it up to the audience for any additional questions. Ken?
Great. Thank you, Linda. Welcome, everybody. Welcome, especially to our summer interns. Hopefully, it'll be a good and exciting summer for all of you. Linda touched on a bunch of the aspects of Acadia, and let me just then show you through how we filter thinking about growth, and there's really three key drivers of growth for us. First of all, is maintaining a strong core portfolio. In our case, it's with a concentration on street retail, which has seen a very strong rebound over the last couple years after, frankly, a scary few years. That growth feels strong, and we'll get into it into the Q&A, and I think we have multiple years in front of us of strong, sustained, peak growth. Then the second is maintaining a strong balance sheet.
We think that given where interest rates are, given the higher, longer environment, utilizing less debt and being less exposed to floating rate debt is a positive, and we are in the right range of leverage, liquidity, very limited floating rate debt exposure. And then the third key driver of growth for us will be external growth, and after several years where I think it has been tough in the public markets to create external growth, we're now at a point where we are seeing opportunities, especially in the street retail component of our business, where we can add assets accretively, and we look forward to doing that, along with continuing to execute on our investment management platform.
So those three components, strong internal growth, strong balance sheet, and now adding external growth, puts us in a position where we think we can continue to provide strong top line and bottom line growth, which we have now for the last couple of years, and then see that happen for several years going forward. Linda?
Okay, maybe just leveraging off the topic of growth. So you had a recent announcement of a sale of a grocery-anchored center to a JV with J.P. Morgan. Can you just give us, like, a little bit background on the deal and, you know, why are you doing this?
So about 75% of our portfolio is street and urban, within the REIT, and 25% is more traditional suburban. We think our shareholders are gonna benefit over time if we migrate some of those suburban assets, into either joint ventures or sell them outright and capital recycle. In this case, this is an asset we like just fine, good supermarket-anchored center in a dense location, but we have better uses for the capital in higher growth opportunities. So we entered into this joint venture. We're 5% of the capital, J.P. Morgan is 95% of it, and we get to continue to own, operate, get additional upside, as the value continues to appreciate, but migrate that over into our investment management platform.
I think you will see us continue to do that on a disciplined basis over time, where, again, it's accretive day one, and then as we redeploy that capital, even more accretive.
And then I think a few quarters ago, you mentioned on a call that, you know, Acadia would continue with the private institutional capital business, but it would likely look different from the previous fund vehicles. Was this the type of transaction you were expecting?
Exactly. And that's why I predicted it. So we have historically operated a single fund at a time, one size fits all, really more opportunistic goals, and for a variety of reasons, including some mundane accounting reasons, that feels less optimal for us, given where our focus is going forward. So rather than having a one size fits all, only one kind of cost of capital, if you will, we are targeting select joint ventures with different institutions, some who have Core or Core Plus goals, others who may be more special situation, and we thus won't get pigeonholed into that conundrum. It also will enable us, over time, to simplify that piece of our business, because-...
We could then go on to earnings calls, and what should be 5% or 10% of our conversation sometimes was 50%, and that's not doing any benefit to our shareholders. So again, it will take time, but that simplification process is underway.
So this JV commenced with you selling an asset into the venture. Would you expect to sell more assets into the JPM ventures, or are you gonna be pursuing, you know, more assets for them?
All of the above. It doesn't have to just come from our core portfolio. It doesn't have to just come from assets we own within our funds. There can be new acquisition opportunities. We may take those acquisition opportunities down, wholly owned, day one, and then bring in the right joint venture partner. Really depends on the opportunities, but again, expect that to be 5%-10% of our business and relatively straightforward, and should not have, going forward, as much impact on earnings volatility and otherwise.
For this specific transaction, what's the expected use of the net proceeds?
Yes. So first of all, as I said, bringing our leverage to a level that we're comfortable, paying off our lines so that we have liquidity to grow, all of that makes sense. I don't feel any urgent rush to put that money to work. It was accretive day one. So if all we do is pay off that debt and do nothing, I'll be disappointed, 'cause I see growth opportunities that I want us to execute on, but it's not like it's burning a hole in our pocket. Point number two is, we're gonna see a variety of opportunities. If that money gets redeployed into other investment management acquisitions, fine. If it gets redeployed into core acquisitions, fine. But our leverage is about where we want it. You'll see our ratios get healthier over the upcoming 12-24 months, just because our NOI is growing as well.
But expect us to continue to focus on keeping our leverage at the 30%-35% of GAV, that I think is appropriate in the economic environment we're in.
What does that translate into in terms of, net debt to EBITDA?
John?
I think we're right now at about a 6.61 debt to EBITDA, and goal would be targets to be in the fives by the end of the year, and as Ken mentioned, mid-fives in the next 12-24 months, just through retained cash flow that we're generating through our REIT, as well as the incremental NOI growth from our portfolio.
Does street retail, I don't know, create a need for a different type of leverage structure versus just traditional open-air shopping centers?
No, but I would say a higher interest rate environment, where you're not getting the positive leverage that we saw for 10 or 20 years, or the majority of 10 or 20 years, I think that changes it, and I don't think it's just for street retail. I would argue it is for most real estate. We went through a period where the more debt you used, arguably, the better off your investors and stakeholders were, until they weren't. GFC being an example of that, and then more recently. I think it is fair for us to assume, and our thesis assumes, that we're not gonna be using leverage to engineer the growth. We can do it because of the strong embedded growth that we're seeing in retail, but specifically in street retail. And so I actually prefer this environment.
Sure, I'd love to get past the inverted yield curve, but I feel better about the fundamentals and our ability to drive growth today than in prior periods.
Maybe combining two questions: so, you know, what are the building blocks for that growth, and why... You know, what are the best arguments today for why street retail is a compelling asset class for a public REIT?
Yeah, so there are some distinctions that we see in our street retail portfolio versus our suburban. So no one should go out here and say, "Ken said something negative about someone else's portfolio." This is just ours. In street retail, we get 3% contractual growth, and more often than not, we get fair market value resets. Now, fair market value resets just don't matter during a period where rents are declining. So 2015 to 2020-something, our FMV resets had no value. But we are now in a period where we're seeing sustained growth, and you've already seen us execute on about a half a dozen of those FMV resets.
The reason that those two components are important, strong contractual growth, obviously strong tenant demand, and the ability to capture additional upside as tenant sales, as market rents grow, is if we are in a higher, longer inflationary period, we are gonna wanna make sure that we have a portfolio that can exceed inflation and provide returns on top of that. During a period of disinflation, which arguably was from the global financial crisis through until 2020, that didn't matter. But I would argue for the next foreseeable future, you're gonna wanna have a portfolio that can have that kind of growth, and we're seeing that. It doesn't hurt that we're also seeing secular shifts. We're seeing retailers migrate out of wholesale and into DTC, direct to consumer, meaning into stores, and that migration-...
plus a generally healthy consumer, especially at the affluent levels, plus a recognition by retailers that simply selling online is not a pathway to profitability, that the bricks-and-mortar store is the best channel. You put all of that together, and we have a portfolio that not only has strong tenant demand, not only has strong tenant performance, but also has the ability for us as owners to capture the growth.
Can you talk about the type of tenant demand that you're seeing? What types of retailers, where are they coming from? Are they looking exclusively on the street, or are they coming from different, you know, geographic shopping center type formats?
Yeah. So, in general, tenant demand is strong, and a fun game about a year ago was polling my fellow CEOs, "It hasn't been this good in blank number of years," and the number was 3, 5, perhaps 10 years. So tenant demand is strong. I would argue that it feels like our tenants are being more disciplined this time than perhaps in the 2010 to 2015 run-up. We'll see, but so far, they seem disciplined, but they're recognizing the importance of stores. Now, what about the differences? Well, perhaps you're seeing some shifts in terms of demographics. Lower-income consumer is being stressed, arguably more, given the inflationary period, and maybe there's a slight slowdown on that side. I wouldn't call it meaningful yet.
Sure, there are demographic shifts in terms of geographies, but even there, our strongest rebounds have been New York, Melrose Place in L.A., even Chicago now is bouncing back incredibly well. So I'm not seeing the level of geographic distinction that I thought I might have seen. We own down in Dallas. We love it. It's going to be an exciting project, but we're seeing equally, if not stronger, demand in SoHo or in Williamsburg. So not the level of distinction, not the level of slowdown that I would think. A few minor issues with some retailers, but we should expect that, and nothing that rises to the level of concern from my point of view.
Maybe a question for, John here: Could you comment on the CapEx and net effective rent trends you see across the different buckets in your portfolio?
Yeah. So one of the compelling things about street is, with the street portfolio, oftentimes we don't own the roof. There's not a parking lot, so you don't have the typical CapEx spend that we would have in our suburban, where you do have much more in terms of capital outlay. So general percentage, it's gonna vary year to year, space by space, market by market, but generally speaking, our street, we target about 5%-10% of our NOI is what we're gonna put into CapEx between any improvements, TIs, leasing commission, so about 5%-10%. Grocery-anchored, we're probably in the 12% range, and power centers, and we own each of these three groups, are probably in the 14%-16% range.
So I think that's one of the compelling things we like about the street is just the lower CapEx spend, coupled with the 3% contractual growth, is where we look at pure net effective rent growth, really is what's driving it. And I think, as Ken mentioned, with the fair market value resets and just given where market rents have moved in our markets, we're seeing a good chunk of our growth coming from our streets, and it's hitting our bottom line because we're not having to incur the capital to do it. And last point I'll make is, when we sign a lease, we look at the upfront cost of what does it cost to bring this tenant into a space, and we use a concept payback period.
So the theory is, is how long does it take before all of the outlay that we had to do to get the tenant in the door, when are we in the green, or when have we recovered our capital? So typically, on the streets, and this is just a function of the rents are higher, so think of $100+ per foot, we're typically getting paid back, at worst, a year, but oftentimes it's 6-9 months. So I think we're able to get paid back within, you know, well within a year on, on our street with all of our upfront cost. Contrast that with a one of our suburban assets, where you're doing a junior anchor, and it's a $15 rent. If you're doing any meaningful work there, it could be 5+ years that you're getting your, your capital out of it.
So that's where we see trend-wise and what we think is compelling, and when rates were zero, it was less of an issue, but now interest rates are not zero. It's much more of an economic decision as we think about re-tenanting.
For historical context, how have payback periods changed, you know, pre-GFC, post-GFC, pre-pandemic, now? Has there been much of a change?
Yeah. So I think there was a period, particularly when there were supply chain issues, when there was less tenant demand, that we saw cost really starting to escalate, that we needed to do to incur to get a space activated. You know, what I would say is it feels it's the supply chain issues I think are largely what we're seeing, largely behind us. We are seeing a slight moderation of cost as part of that. Yeah.
So your same-store NOI is above your peer average. I think you talked about street retail being a big part of that, but, you know, how long do you view this as being sustainable, and do you always expect kind of a discernible delta between street retail and shopping, you know, traditional suburban shopping centers?
... Oh, yeah, no, I think just one structural difference why. And again, we'll just talk about our portfolio. So we have suburban, and we have street. Our base case and our thesis, because we don't have to do either of those, we have a choice as to what type of assets that we can buy and to pivot, we could do that. But to us, what we find compelling and what our data shows, both when we look backwards and more importantly, we look forwards, is we see an incremental 200-300 basis points of incremental growth, net effective rental growth, which is slightly different than same store when you factor in cost, coming from our streets. Key difference is the fact that within the streets, we get 3% contractual growth.
So that's just a structural difference, is that every year, our street leases grow 3% contractually, versus in suburbia, a junior anchor is going to grow less than 2% a year. So I think that's one difference. The other difference Ken mentioned was he used the word fair market value resets. So what this means is that in a typical suburban lease, you'll sign a whether it's a 10-year or 15-year term, and the tenant will have options to renew at a fixed price for, depending on the lease, another 15-20 years. So you've really locked up your growth in that asset for an extended period of time.
Differentiation on the street, and we're feeling the benefits of that right now, is that after the initial term, which is somewhere between 5-10 years, a tenant has an option for the space, but their option is to pay the greater of 3% or the fair market value of the space. So given where rents have moved, and they've moved much faster than internally we even expected, we are seeing meaningful increases on, on a mark-to-market basis. So that's where we see that, you know, that's typically been a 200 basis point spread. We see that spread widening, given where our current basis is on the streets and where some of the mark-to-markets are as, as well. And so we think sustainable. Our same-store NOI for the next several years is gonna be higher than trend because we have some lease up.
So we have probably, call it, 200 basis points of lease up in our numbers, but we think we are in a 4%-5% run rate after we get through these next couple of years of lease up on a same-store basis.
Maybe just more near-term, you know, what's the near-term growth potential for Acadia this year, and then kind of like medium-term growth into 2025?
In terms of earnings?
Sure.
That's you. Yeah. So why don't you know, we've put out a number, maybe just to baseline. So right now, our guidance is $1.28 per share. That's our guidance this year. And what we've put out as a metric, and we have about a little over 100 million shares, so every $1 million for us is $0.01 of FFO, just to put in context. What we have put out there is in the near term, and this is, call it, 3 years, $30 million-$40 million, translating that into $0.02 of internal growth. So this is internal growth, the majority of that coming from our street. This year, we are growing, and we've talked about our fund business, which creates transactional profits. Let's strip those out just so you can look apples to apples.
Our FFO this year, adjusting for the transactional profits, is up 7.5% on roughly 5% same-store growth, and we see that trajectory for the next several years as we look forward, given where our growth is. As Ken also mentioned, our balance sheet is fully hedged. Unlike others that have debt rolling, otherwise, whatever top-line growth that's showing up, they may have to pay their lenders additional money as higher interest costs. We're hedged through 2027, which I think sets us up nicely with the internal growth we have, a fully locked-in balance sheet, and hopefully, Linda, we get some of these accretive acquisitions done, and that 5.5% increases even further.
Maybe this is a good segue into external growth, and we'll just touch on this for a little bit before we open it up to the audience for their questions. So just, you know, on the topic of external growth, what is the environment for Acadia, and, you know, what are your kind of target assets, target markets?
Yeah. So, I think the main focus, what you should all expect, is for us to continue to execute on the street retail component. We think that has the highest risk-adjusted returns, that has the highest growth, and it is a less crowded area in terms of competition, compared to some of the other areas of open-air retail. The stars have to align. You need to have the right sellers. You need to have the right locations. We need to have a cost of capital that makes sense. And what I have said on past calls is that bid-and-ask spread is narrowing, and we are getting a heck of a lot closer to seeing executable opportunities.
In terms of product type, if you look at the majority of our street retail, that is performing very well, you should expect to see us add assets that look like that, but they may or may not be in the same markets. I have no problem doubling down on most of our markets. Some of them, we've been clear, we own enough in a given market, we're not in the add. But there's also new markets. When we came down to Henderson Avenue, the Knox-Henderson corridor of Dallas, that was a new market for us, and we're excited, and so far, that thesis has been nicely validated. So you think about fun streets that you enjoy shopping on or areas that are in need of that, and that's likely where we're gonna show up.
How are you gonna fund these investments?
I've been pretty clear that we do not intend to increase our leverage, and that gives us a few choices. We can capital recycle. We touched on one example where we monetized an asset for $50 million, and we redeployed that one way or another. We raised a little bit of equity just in January to de-lever, but also to give us an opportunity as we see new acquisition opportunities. They need to be accretive. They need to be accretive to earnings, they need to be accretive to NAV. So if our stock is not where we want it, then we're more likely to capital recycle, and we need to see where sellers show up.
So when I say stars align, I mean realistic sellers, I mean strong tenant demand, so we can underwrite it, and I mean a cost of capital that makes sense. Feels like we're getting pretty close.
Last question before we open up to Q&A. So who are the sellers, and, do you see more investors coming back into the street retail space?
Yeah, I see more investors coming back because for many years, starting probably 2017, 2018, even pre-COVID, a lot of investors got shook up, first with the retail Armageddon, and certainly then with COVID. So you're seeing some come back, but not nearly as many as in other segments of open-air retail. So we do think that we're gonna have a period where there will be a lack of competition, but we can't keep talking on these panels and then expect not other people to hear about the growth and other things. So they'll start to show up.
In terms of the sellers, it's gonna range from institutional owners, in many cases, finite life funds, they have to liquidate sooner or later. Families, who, for a variety of reasons, may no longer wanna own that kind of real estate, and then a variety of different owners. The landscape is so different than it was 5, 10, 15 years ago in terms of competition and in terms of our ability to execute in these markets, that it makes me very bullish that when the stars align, we're gonna be in a unique position to capitalize on it.
Great. Now we're gonna open it up to any of your questions.
Hello. If you had to mention a few, let's say, downtowns where you think high street is gonna grow the most in, in the coming years, and then a few where it's gonna continue to suffer, can you point to a few of those downtowns?
Yeah, and the easiest way, the leading indicator of recovery that we saw over the last couple of years was watch residential occupancies. And what we saw is, as residential occupancy improved in New York City, for instance, in general, we saw a lift. You're seeing. We were just in a meeting earlier, residential occupancies and rents grow in Chicago, and we're seeing a lift in Chicago. But to be more specific, then, San Francisco seems to be lagging. We still need more people returning to the office in San Francisco, and the Union Square area might take longer than we might like. We don't own in that portion of San Francisco, but that seems to be a slower market that we're rooting for, but we don't see it yet.
Chicago seems to be surprising to the upside, and Melrose Place in L.A. has probably had the strongest growth within our portfolio, followed by Soho. Up-and-coming markets, ranging from Nashville to Dallas in the Knox-Henderson corridor, certainly seem exciting, and there's probably another dozen I could mention. So thankfully, the problem children are fewer, and the hot markets feel pretty good, and I'll, I'll leave it as vague as that.
Thank you. Can you talk a little bit about tenant occupancy cost, urban versus the other portfolio, and also any kind of trends in total occupancy costs as retailers think about digital versus physical store location?
Yeah, and all of that is critical. First of all, while we're all navigating through a period of hyperinflation, and hopefully that is moderating, we're gonna look back on occupancy cost and tenant sales, because the way we think about it is: What is gross sales? What is the rent, so the tenant occupancy cost, but then also, what's their bottom line? And after we get through a period where there will have been, let's say, 30% inflation, that's gonna be good for our rents. It's gonna be good for tenants' top line, and then the question is: How will they manage their bottom line? So far, so good. So the way our retailers are telling us what they see is, quarter-over-quarter, tenant occupancy costs relative to sales fluctuate because their sales fluctuate.
But compared to 2019, tenant sales almost across the board have been substantially stronger. And I'd urge you, when you're kind of thinking about the health of a portfolio, the health of a tenant, how are they doing compared to pre-COVID? In many cases, up 10%, 20%, 30%, 40%, 50%, and that bodes well for how we think about what a tenant can afford to pay us in rent. So that's the, that's the... call it rent-to-sales component of it, and then the other, supply and demand. And there just has been no new supply for retail. So what felt like an oversupplied market 5 or 10 years ago now feels undersupplied.
Hi, Robert. I just wanted to ask about your quarterly dividend. You guys have been posting a fairly hefty quarterly dividend. Can you talk about that in terms of where you're seeing your cost of capital and where your credit lines lay in this current rate environment?
Yeah. So I think in terms of our dividend, I think our target or what we set our dividend as our taxable minimum. So I think our from a payout ratio, we're pretty low, that we're at the lowest amount we can without having to pay a federal income tax. So I think that's what we guide our board when we recommend to our board what our dividend level is. But given where our cost of capital is, given the growth that we see in front of us, we are retaining as much cash flow as we possibly can to stay within the IRS regulations.
What I would say is that with the growth that we've talked about throughout the last few minutes, is that, I mean, our dividend, in order to maintain compliance with the IRS, it will have to adjust to where our taxable income goes, but at this point, we are, and we'll continue to target it to our, our taxable-