Hi, everyone. Thanks for joining us. I'm Caitlin Burrows. I cover REITs at Goldman Sachs. This is the Phillips Edison presentation. So today, we have Jeff Edison, Chairman and CEO. We have Bob Myers, President, and John Caulfield, Chief Financial Officer. So with that, maybe, Jeff or anyone else, do you want to start with just a brief intro to the PECO portfolio and what makes you unique?
Sure. Thank you, Caitlin, and thank you all for being here. Appreciate your time. I'm Jeff Edison, the CEO and founder of Phillips Edison and Company. What Phillips Edison and Company does is a pretty simple strategy. We buy grocery-anchored shopping centers across the country and put the PECO team to work on them to create value in the properties that we buy. We started this business 30 years ago and have built what we think is the strongest team focused on a very specific niche, and that niche is to have the number one or two grocer in a market, which we believe, for the retailers, is a very strong location.
We're the number one location in the markets that we go to for retailers who want the association with that grocery anchor. And the reason they want to be with that grocery anchor is because you shop there 1.7 times a week on average, and that traffic generates the traffic that allows the small stores to be successful. Today, we have 300 properties. We're in 30 states, and we are very focused on making sure that as we operate these 300 different businesses, that we are the best in that market and that we can... Because we don't compete in major MSAs, we compete in a 3-mile radius.
Our centers are located at the corner of Main and Main, so that when you wake up on Saturday morning and you've got necessity things that you've got to do, the best choice for you is to come to one of our centers. And that's what we focus on, and we've built a team that has been able to capitalize on that. And we've been able to successfully do that for a sustained period. You know, we've been doing it for 30 years, so that gives us a team that's stayed together. Bob's been with us 20 years, John-
Ten.
We, you know, we're excited to be here today and hope all of you have had a good NAREIT, and we look forward to your questions as well as any from the audience.
So yeah, with that, recently in May, it was the ICSC conference. Leasing's obviously a big part of what you guys do, so maybe if you guys could talk about kind of the goals going into the event, what were your major takeaways, and perhaps what might have been different in 2024 versus 2023?
Sure. So thank you for the question. Our goal at ICSC is to meet all the retailers, developer, landlords, brokers, and during the course, we sent about 45 of our associates in our booth there, and we'll have between 500 and 650 total meetings. So it really fuels the rest of our performance, the remainder of the year. In talking with the retailers, the retailers are still very active. They're looking for store counts, and with the lack of new supply coming on the market, and our portfolio specifically, they're looking for store openings in 2025, 2026, and 2027. So I'm not seeing any slowdown in demand. As Jeff mentioned, you know, we've been in this business 30 years. We've seen the success of owning the number one, number two grocer.
Our average footprint is 114,000 sq ft, so our average in-line space is 2,500 sq ft. So we continue to see a lot of demand from fast casual restaurants, health and beauty, and MedTail. And when I think about MedTail specifically, it's, it's The Joint Chiropractic, it's Aspen Dental, Pacific Dental, to name a few. A few primary care operators and a few urgent care operators. So the demand coming out of ICSC was very, very strong.
I guess it feels like whether it was this year or last year, that ICSC has been strong for a couple of years now. So is there anything you could point to that might have been different this year, or how we might start to see the strength of multiple years in a row flow through into your results?
You know, the tone at ICSC was kind of interesting. The biggest difference was that everyone was like: "Why are we talking about the exact same things this year that we talked about last year?" which was the strength of the consumer, the acquisition market, the interest rate environment that we're in. Those are all things that were top of mind, and probably the most talked about things at the ICSC. It was, you know, very well attended. We're really in an environment where on the operating side, really things have never been stronger.
You know, we're at the highest occupancy that we've been in our portfolio in our history, and we continue to see really strong neighborhood demand for our small store spaces, and our grocers continue to do very well. So we're in a very strong environment there. The acquisition market, which was more difficult last year, has improved. We're seeing about twice as many acquisition opportunities in our IC meetings this year than we did last year at the same time. So that market, that part of the market is starting to thaw somewhat from a very difficult year last year.
We were still able to buy about $280 million of product last year, that was grocery-anchored, and we've guided the street towards $200 million-$300 million this year, and we were well on our way. We bought about $58 million in the first quarter, and have a strong backlog going into the rest of the year.
... Maybe there, on that acquisition volume, you mentioned that it's volume, it seems like, more is coming to market. Seems like the interest level for the types of properties you guys want to buy is also high. So what do you think sets PECO apart, and what do you think makes you able to complete these acquisitions when there is that competition?
Yeah. The level of—I mean, there are a lot of people who are thinking the grocery-anchored shopping center business is a great business to be in right now. We've been in it for 30 years. We don't like new entrants, but they do come. The advantages we have is that we've been doing this for 30 years. We've been the largest buyer of grocery-anchored shopping centers during that entire period of time, and that gives us relationships. It gives us the ability to see everything that is on the market and to selectively be one of the best, you know, the biggest buyers and as we were last year.
When you guys make these acquisitions, I know you talk a lot about your required IRRs on them. The REIT community likes to talk about cap rates, too. What kind of stats or numbers are you guys underwriting to, and are they accretive necessarily from day one?
Yes. So our biggest focus there is to make sure that we meet our targeted IRRs. Our unlevered IRR target is 9% or better, on the properties that we buy, which in today's higher interest rate environment, translates to about a 10% return on our equity, about 10.3% based on our latest debt offering. And we anticipate to be able to continue to do that, this year and have a good backlog going into the rest of the year.
And you mentioned, maybe last one for now on acquisitions, but the guidance for this year of $200 million-$300 million, I guess, what would it take, do you think, to get above that $300 million? Is it just more properties coming to market, bigger properties? Not that you necessarily want bigger properties, but what would get you above that level?
I think it's gonna be what products are on the market. And the difference in the bid-ask that we had last year, which was quite wide, has narrowed, but is still, there's still some friction there. That's what-- That'll be the thing that really pushes us to be able to buy more. We'd love to... We have the best balance sheet in the shopping center space, which gives us the capacity to go well beyond those targets if the opportunities arise in the acquisition market. We work really hard to make sure there isn't any product that gets sold in our market that we haven't seen and underwritten and looked at as an opportunity.
You know, that's one of the things that having been in the business for a long time gives us those relationships to make sure that we are, you know, top of mind when anyone is gonna be selling a grocery-anchored shopping center.
Maybe moving back over to the non-acquisition side. You mentioned how occupancy is at, I think, all-time highs. Leasing demand's really strong, so everything's chugging along. Maybe on the potential negative side, so in May, Stop & Shop announced it would close a number of underperforming stores. So what's your exposure to Stop & Shop, and do you expect PECO to experience any closures?
So it wasn't a surprise for us when Stop & Shop made this announcement. What we've seen, being in the grocery business for over 30 years, is in the Northeast, health ratios and occupancy costs can be very high. As you know, we own over 300 of these assets, and we've seen a lot of those with health ratios and occupancy costs between 5.5% and 8%. Our exposure, we have 5, and our average occupancy costs are right at 3.2%. We have great relationships with our contacts there at Stop & Shop. The other key thing that we wanted to make sure is, are they performing from a sales per square foot basis?
Ours average right around $580 a sq ft, so the ratio to rent makes sense to generate the health ratios. And then, in addition, we wanted to make sure that they were reinvesting capital into the stores. Are they redoing the freezers and the decor? And, fortunately, in our portfolio, they have. So we, we feel very confident with our exposure to Stop & Shop.
I guess bigger picture, so you are a grocery-anchored shopping center. The grocers matter a lot. To the extent there were to be a grocer move out in the future, kinda, I imagine you would backfill it, aim to backfill it with a grocer. How long do you think that takes, and do you expect that terms of the lease could be any different than they were? I know maybe we could get into talking about leasing spreads after, but you have a lot of options. So would there be any change to lease structure, or do you think that's kinda set?
We don't anticipate being able to push much differently than what is in the traditional leases with our grocers. So we don't think there'll be a big change in that. We also are very focused on making sure that what you're talking about doesn't happen. We do not. You know, we buy properties where the grocers are profitable with very healthy health ratios, which pushes them to being very profitable. So the chances of them closing, we think, are very reduced. And we've seen, you know, we've seen that over 30 years with a very low rate of loss of any of our grocers. Yeah, so-
... I think we receive, especially given the strength of the environment, we do receive this question from time to time. I think a key element of our strategy is that the grocer is about 30% of our rent, and ultimately, what that grocer is doing is providing stability and attractiveness to the center. And so if you think about a portfolio, they're the investment-grade bond that provides a nice base, and then we get all of our growth from the in-line neighbors that we have at the center. And so we believe that our portfolio delivers more alpha with less beta.
With that grocer providing that consistent, constant revenue or contribution at a flat level, we are still able to drive our portfolio with internal growth between 3%-4% every year at the NOI level, which we believe, when combined with our ability to acquire, which we spoke to, that we can deliver mid- to high single-digit FFO growth on an annual basis. So the grocer, the most critical thing to us, is ensuring their stability, their investment in the property, because that will bring foot traffic and customers to the shopping center that will feed our local neighbors.
On the pricing side, total portfolio leasing spreads have been in the low double-digit range for over a year now. How long do you think this strength can continue for? It does seem like the real opportunity is on the new leasing side, so, what potential do you guys have to increase new leasing?
Sure. Well, currently, we have the highest occupancy in the sector at 97.2%, with our inline occupancy at 94.8%. We feel like we can continue to move occupancy another 100-150 basis points on our inline vacancies. That being said, given where demand has been, our leasing spreads in the first quarter were 29.1%, and our renewal spreads were 16.9% in the first quarter. So again, I do have good visibility out the next 6-9 months, and based on our leases out for signature and renewals out for signature, those, those spreads are going to be elevated compared to where we've been in the past.
So the demand is very strong, and given our footprint of 114,000 sq ft, and again, having the number one, number two grocer in the market, we do have somewhat of a monopoly with these retailers that are looking to add new stores. So we do have a waiting list to get into our properties, given our high occupancy.
And part of that is how expensive it is for development. Really, no real development has occurred over the last 15 years, and based on where values are, you know, rent spreads would need to almost double. Rents would need to double in order to actually make development work. So you have a supply constraint, but yet increasing demand because retailers are moving closer to the consumer into the neighborhoods, so that is what is allowing us to push pricing.
I think it is an exciting time for retail because you guys are the sector that doesn't have that construction headwind. Maybe moving over to the bad debt side. So the bad debt for PECO has historically been pretty low, especially compared to peers. A range of 60-80 basis points, I think, was guidance last year and this year. Last year was at the lower end. You mentioned this year could be at the higher end. It feels like that's kind of coming from a point of strength, but you tell us. So as you talk about that high occupancy, the demand there is, like, what could be the reason for it being high this year, and what should we take away from that?
Sure. Maybe I'll start, and then Bob can go. Our first quarter bad debt was elevated, but part of that was because we're taking a more aggressive stance. Because of that positive demand that we have, we're more aggressively taking back space from neighbors that are either slow-paying or not paying, and then that is causing us to reserve more against the amounts that they have due from us. The more important detail is that even though it was elevated in the first quarter, we did guide that we expect to be at the higher end of our guidance range, but we did reaffirm our same-store outlook for the full year of 3.25%-4.25%.
So we feel very good about our neighbors, but that we will have a short-term headwind, but a long-term benefit to our shopping center.
Yeah, and really, what it is, it's a case-by-case situation. So depending on what kind of merchandising strategy you have at the asset level, we're looking for necessity-based goods and services that are... as our, you know, operators are there. And what I would continue to just, you know, say is, you know, we're, we have been more aggressive this first quarter in trying to get spaces back, but the leases that we've received, we've already released them at 40% new leasing spread. So as long as we can continue to see that, to John's point, we're gonna continue to drive same center NOI growth. But it is a case-by-case situation on what spaces we want to get back and where the demand is.
Jeff, before you were talking about some of the unique pieces of the PECO portfolio. I know one of the other things you guys talk about is the local neighbors and how important they are. So I guess they're a little more than a quarter of your rent. They stay for over nine years. They have lower TIs. Those are some of the things you guys have talked about. How do you assess the credit of these businesses before leasing? How does that impact the lease and your desire to have them in the center?
The key to driving value in shopping centers is to have the best merchants and the best merchandising mix in each center, and it's different for every one of the three hundred markets that we're in. And our ability to have the right merchandising mix allows each of those neighbors to be successful and to grow their sales. That allows us to grow our rents, and that's the fundamental thing that we're focused on. The value you create on that, we think, is outsized, and that's why we've had the performance that we've had.
... Yeah, just to add a little more color to those types of neighbors, we do a very thorough underwriting when we evaluate each of those. One, is it the merchant we want to have on our properties? But two, you know, do they have the stability of cash flow? So I'm looking at personal financial statements, bank records to verify that, credit score, and on average, our local neighbors have a credit score of 741. So if you, you know, are familiar with credit, that range can be from 450 to about 825. So at 741, they have the means, so.
Maybe one for John. You guys recently issued $350 million of unsecured bonds. I think you've been talking about doing it for a while, so congrats. But could you discuss the decision to move forward with the offering now? Kind of which pieces were you happy with? Which could have been better? I guess the tenure could have been lower, but yeah, discuss that.
Sure. So I think the important thing that we're looking at is becoming a long-term unsecured issuer in the bond market. We did our inaugural bond issuance in 2021, shortly after our IPO, and our plan was to be that regular issuer. Then 2022 and 2023, the debt markets were a bit more challenged. And so the most important thing that we look at is managing our maturity calendar and giving us flexibility and optionality so that we can be opportunistic in accessing the market and not forced into the market. So we had no meaningful maturities, but we were looking for the right time, and ultimately, yes, you're right, that was the-- what we would have liked, a lower 10-year. But ultimately, we believe our credit spread execution was quite favorable.
We believe we're an underrated credit, so we are an investment-grade credit at triple B minus, Baa3. But our actual credit metrics would support at least a notch higher than that, which the fixed income investors did recognize. And so we priced very efficiently, and we're able to take our weighted average maturity calendar from 3.8 years to 5.1 years. We went from 74% fixed debt percentage to 94% fixed debt percentage and begin building that reputation in the unsecured bond market, which we envision that we will be able to do over an extended period of time. And now we have no real meaningful maturities until 2026.
So, I guess with that complete, what are the balance sheet priorities for the rest of, I guess, this year and next year as you look forward?
So our focus is we replenished our liquidity, so we have an empty $800 million revolver to execute on our growth plans, where we, you know, have a guidance of $200 million-$300 million, which we've spoken of. And so we're looking for those opportunities. We can buy that volume, so we can buy about $250 million a year and remain in the low to mid 5x leverage, which is what our long-term financial leverage is. So I mentioned earlier, that's going to allow us to continue to grow our portfolio and our platform.
From a balance sheet perspective, my job is to make sure that we have the capital that we need as efficiently at the cost of capital as we can to support that growth effort, and I think this was a great step in that direction.
If we were to get to that higher end, then, of the $200 million-$300 million volume, do you think you'd be using equity leverage?
So, I think the key piece for us is, as we've looked at the capital markets, there are times where one is more favorable than the other. So in 2023, we found the equity markets to be in a more favorable position, while the debt markets were a bit more distressed. So we raised almost $150 million of equity last year, which we deployed accretively into acquisitions last year.
This year, unfortunately, the equity markets are in a less favorable position, which isn't great from an issuer standpoint, but I would say for an investor, I think it presents a great opportunity, because if you look at our implied cap rate, you know, let's call it in the low sevens, that is, you know, 75-100 basis points discounted relative to where we actually think our portfolio would be valued. So it does present an attractive opportunity, but not so much from an issuer standpoint. So we saw the debt markets as being a more favorable market at this time, so we used that to extend our duration. And for us, we would look to issue equity if we can invest it accretively.
So the key piece is that we are a cash flow company focused on cash flow growth, and so if we are able to invest it in an accretive way, we would consider issuing equity. At this time, we think, while it's a great investment opportunity, we will most likely, you know, operate it with the leverage that we have and continue our growth from there.
Does anybody in the audience have any questions? No. Okay, I'll keep going. So I guess, as we think about the long-term growth, of the company, you guys have the internal growth from a same-store perspective. There's the acquisitions. From a same-store perspective, what kind of same-store NOI growth do you think the portfolio can support long-term?
So we believe that we can deliver 3%-4% growth over a sustained period of time. We think about 50-100 basis points of that growth will come from occupancy growth. Bob mentioned that we are at a high occupancy level, but we believe we can continue to push our in-line occupancy another 100-150 basis points. But on a same-store level, that'll contribute about 50-100 basis points of growth annually. We can continue to push leasing spreads, which Bob also referenced. That'll be another 100-125 basis points annually. We're pushing rent bumps, so the embedded escalators embedded in the portfolio and our in-line neighbors is a little over 1% today.
Well, we're getting, you know, almost 3% on renewals and between 2% and 3% on new leasing. That'll be another 75 to 100. And then we have a great development portfolio, which is really outparcel builds. Our, our development is, is, really a great return on a risk-adjusted basis. We develop these outparcels to 9%-12% cash-on-cash yields, but we do only about $40 million-$50 million a year of that. That's gonna be another 75 to 125 basis points of growth. So that's on an annual basis, we can deliver 3%-4%. In 2024, we're actually guiding slightly above that, so the midpoint is about 3.75% on a same-store growth.
When you combine that with our acquisitions, we think that will deliver once interest rates stabilize, mid- to high single-digit FFO growth.
Maybe just another question on the outparcel opportunity. So we've seen a number of the REITs getting active with it. It does seem like there's good returns on that. How do you decide which centers can accommodate an added outparcel, and maybe what's the timing of completing one of those projects?
Well, a lot of our outparcels that we've been developing, the $40-$50 million, are actually taking a piece of our parking lot and carving it out, putting somewhere between a 5-8,000 sq ft shopping center on it. Usually 90%-95% pre-leased on those opportunities, and to John's point, delivering somewhere between 9%-12%. The art, in terms of merchandising, is who are you going after? Is it a complement to your overall grocer and the merchants that you have at the shopping center? How does it hinder sight lines and access and stacking? Because if you have a Chick-fil-A or Chipotle or a Starbucks, you could have stacking issues. So you want to make sure that whoever you put there, there's synergies in cross-shopping.
So are you gonna get your coffee at Starbucks, and then are you gonna go to the grocery store and grab a few things, and then walk to the next bakery, maybe get your hair cut while you're there? That's the art of merchandising and what we're trying to do on our particular outparcels.
I think with such high occupancy, one of the other opportunities you guys have is to maybe shrink some in-line space in some locations. So could you talk about how widespread that opportunity is? I imagine it's definitely space by space, but is that something that's significant or is it more one-off?
Sorry, can you repeat that? Did you say shrink?
Shrink.
Shrink, one to then have two stores next to each other.
Oh, oh, okay.
Yeah.
So our average in-line space is already 2,500 sq ft. So for us, part of our strategy is our average center is 114,000 sq ft, and so for us, about half of that is the grocer, and the remainder are the in-line shops. So I would say, for us, we are looking for opportunities to add. Perhaps we're bolting on a few more units, or we're doing an outparcel that could have two or three suites to it, but we don't really have that exposure to that secondary box that would be cut up. So I think that's a little different, but a unique part that we think helps the returns in our model.
One thing I'll mention, we closed on $175 million of shopping centers in the fourth quarter, but, you know, when you look at all 14 assets we acquired last year, we had an average occupancy of 87%. What we closed in the fourth quarter was 84%. So as we're looking to move in-line occupancy 100-150 basis points, I really wanna run a parallel path on the acquisition side that has good vacancy, good upside. So to your point, we may not shrink. We just need to see where demand is in terms of the average 2,500 sq ft. But if we can buy some of that occupancy, you know, upfront, I know we have the demand to lease it.
Just checking, anybody else? No. Okay, another thing that we've heard over the past couple of years is that tenant retention has been really high. I think that speaks to maybe the strength of the tenants and that they like being in PECO centers. So, what are you seeing from a retention side, and how does that—I guess it has an impact on your potential CapEx and downtime, but yeah, how are you considering that retention piece?
Yeah. So in the fourth quarter of last year, our retention rate was 93%. In the first quarter, it was 88%. But that was very intentional in terms of recapturing some of the spaces that we could re-tenant at $40 a foot. Renewals are a key driver, especially when you're generating 16.9% renewal spreads, but the key factor of that is, to your capital question, we only spent $0.54 a foot, so retention's very important in terms of managing cash flow for the long term and FFO and AFFO.
We've gotten through a lot of questions here. Maybe, again, thinking on the local neighbors, I see you have a list here of who's hot. So maybe, Bob, you could talk to us back to the ICSC conference and kind of who you were doing a lot of conversations with, and as you think of that merchandising mix, where you think there's further upside in the portfolio.
Well, we met with a lot of retailers in Vegas, but the Starbucks, Chipotle, Wingstops, as an example, Great Clips. We have 67 Great Clips in our portfolio. They want to have 100. So when you talk about Great Clips, looking through our portfolio for new store sites in 2026, 2027, we had a lot of conversations about that. UPS, Cava, First Watch, Dave's Hot Chicken, all those have been growing. Five Below, a little bit larger tenant that takes between 7,000-10,000 sq ft, a nice junior box tenant. They're growing. T.J. Maxx, we like T.J. Maxx. Our portfolio, I think our ABR is 1.2%. It's our largest, what I would consider junior box. They have incredible credit. They're growing new brands like Sierra, HomeSense, but they're, they're actually going to smaller markets, so they're hot.
The Medtail players, the dentists like Aspen Dental, Heartland Dental, Pacific Dental, are very aggressive. Physical therapy, ATI Therapy, Benchmark, UPS stores, again, Sola Salons, AT&T. There are so many retailers right now that are aggressively growing and need store counts for the next two or three years. So again, the demand is there, and they do want to be aligned with the number one, number two grocer. They want to be closer to the consumer. They want to have the efficiency and convenience of living next door.
Okay, with that, I think we're done.
Can I, can I just do one, one close? Where the PECO stock right now is trading at about a 7.6% cap rate. The market is 6-6.25 for that kind of product. It's a great opportunity, we believe, and if you look at what the results that PECO's put on the board, we're number one in terms of occupancy, we're number one in terms of rent spreads. We have the best balance sheet in the market. We have the largest acquisitions program with the highest targeted unlevered IRR in terms of what we buy. We have the lowest exposure to at-risk tenants of any of our peers. Our CapEx is at the lower end of the peers.
We have the highest level of tenant diversity, the highest retention rates. Our core FFO growth has been market leading, as well as our same center NOI growth. So at this point in time, we see a lot of upside in our stock. We see a great oppor-