Session with Phillips Edison. Thanks for joining us. I see a lot of familiar faces from our other retail meetings we've had so far in this room, but you know, we wanna make this as interactive as possible. So if you do have any questions or topics you wanna discuss that we missed, please raise your hand and let us know. To my left, we have Jeff Edison, CEO. In the middle, we have Bob Myers, President, and then to the left, John Caulfield. Similar to the other roundtables, we give each company an opportunity to discuss themselves, explain who they are, their positioning, differences maybe versus others within their space. So I'll hand it off to the other Jeff, and then we'll ask questions.
Great.
Thank you.
Yeah, great. Thanks. Thanks, Jeff, and thanks all of you for being here. I'm Jeff Edison. I'm the founder of Phillips Edison and Company. We started this business 30 years ago with a focus on buying grocery-anchored shopping centers. Our focus is to buy a grocer with the number one or two grocer by sales in a market. Our average center size is 114,000 sq ft, so these are right-sized grocery-anchored centers, sort of at the corner of Main and Main in cities around the country. We're in 31 states. We are very focused on taking the 300 properties, which are actually really 300 companies, each competing in a very specific market, and that's how we've approached the business over the 30 years, and it's been...
You know, we've had the enjoyment of building a team that's been together for a long time. Bob's been with us for twenty years, John, almost ten. And we are very focused on a very specific niche in the shopping center business. And our drive is to be with that number one or two grocer. We're Kroger's largest landlord. We're Publix's second-largest landlord. And those grocers drive traffic to our centers. They are the best place for someone when they wake up on Saturday morning, and they've got to get their necessity things done for that on Saturday, they come to our centers. And those are the centers that we buy, and you know, we have...
We're at the highest level of occupancy of anyone in the retail business. We have the highest rent spreads, we have the highest retention, and it's all driven by that format that really drives those results. And we're. We appreciate you all being here, and we would, you know, love to take your questions. And, you know, we're. One thing that we are very active on the acquisition market. We buy somewhere between $200 million and $300 million a year in centers. We also have a development program that does development, primarily smaller development, around our existing centers to grow what we have at a specific asset. And that's allowed us to have sort of market-leading growth in our thing.
So we have both this internal engine that drives growth, but we also have an external engine that drives growth and has been able to stay in this business for 30 years and build a great team.
Jeff, over those 30 years, did you ever dabble and try to buy a big box or a mall or an outlet center or anything else? Over the 30 years, you really stuck with this formula.
Yes, and that's the reason that we have stayed very focused. It's, you know, we've redeveloped malls, we've done ground-up development, we've done power centers. We don't do that today, and the reason we don't do it is because we've found a niche that through the cycles performs very well. Just as an example, you know, if you look at the pandemic, it would be like, well, that's a pretty tough time for retail, and you know, we lost 0.6% of our occupancy, and then you go back, and we get questions like: Okay, well, yeah, but that was a weird one, right? That was the pandemic. What about the Great Financial Crisis?
Great Financial Crisis, we lost 1.6% of our occupancy, and we're back at the same occupancy within twelve months. So, this necessity-based nature of what we do is what has allowed us to perform very well during tough times. We believe that with both our internal and our external growth, we can provide more alpha, but we also have a very strong beta protection in the necessity-based nature of our retailers.
And in terms of the strategy of owning one or two in a market, I think one of the big surprises that, you know, we've seen since we've covered you and our former retail guru, Craig Schmidt, you know, observed, was that how sticky that one or two is. I mean, we admit, we thought that maybe it's easy for a competitor to try to steal that one or two, to develop, you know, around the corner or down the street in some of these markets, but it's been fairly sticky.
It has been, and it's actually really driven by the customer. And the reason is that when you shop at a grocery store, it takes you to learn a new grocery store. It takes you 45 minutes to an hour to get the same things that you would have gotten at the one that you knew. And so there is a strong retention of customers, and that has, for us, been the reason that the grocers, when they're there, and they are doing strong sales. So they're the number one or two grocer to start with when we buy them. They have a really good stickiness, and that's been one of the advantages we have.
And then the small stores who feed off of that traffic, they are also sticky. I mean, we get a lot of questions 'cause we have about 27% of our occupancy is local neighbors. We call our tenants our neighbors. Those have been on average with us nine and a half years. So these are not, you know, quick in-and-out, kind of, you know, fly-by-night retailers. These are strong entrepreneurs who have been, on average, with us almost 10 years, and that they're doing that because they're making money at those centers.
By the way, that's a great point on the one or two stay ranked one or two. Well, I was also thinking that, you know, that the one or two stay in your center, that they're not stolen by a new developer or, you know-
Yeah.
they've stayed in your center.
Yeah, and they. I mean, when you look at the cost structure of a grocer, their rents, if their rents are in that lower range, it helps their profitability and their margins, obviously. Our average cost is 2.2% of their sales. And so for them to move, they're gonna move to 5% to 6% at least in terms of their occupancy costs. And so there is also that inertia which keeps them there.
Okay.
And keeps them from somebody coming in and being able to replace them. And then, probably most importantly, is that we're at the corner of Main and Main. I mean, our centers are located where they want to be, and we work with them constantly, and have for a long time, helping them build new stores, like Publix does a tear down, rebuild program that we've been very active with. But also, Kroger's, you know, putting money back into their stores to upgrade them. We're helping them in that process. We're helping them get BOPUS, so that BOPUS is really a BOPUS is buying online and picking up in stores.
We work with them to make sure that they have the right setup for that, and we also do that for our small stores as well. Making sure that it's an omni-channel approach to retail, and in today's market, that's what the consumer demands. They don't. It's not profitable for the grocers. It's not very profitable for the small stores, but retaining their customers is very important, and most customers do not do one thing only. They do BOPUS sometimes, they go into the store and pick up stuff sometimes, and then they want home delivery sometimes.
So it's in order to maintain that, you really do have to have an omni-channel approach, which is very important for us when we're bringing new neighbors into our centers, that they have that approach. And it's one of the things that we do on the leasing side that I think has allowed us to continue to have a very strong position in the markets that we're in.
Let's talk a little bit more about your markets. Again, the strategy is owning the number one or number two grocer in that market. Can you talk a little bit about your, you know, diverse geographic diversity and the decision to be in your markets? We focus a lot as analysts on demographics. I mean, what are some of the lessons you've learned over the years on markets, demographics, versus that number one or number two grocer?
Like, our mantra is, we wanna make money where the grocers make money, and the grocers do not compete on a regional basis or a SMSA basis. They compete on a certain corner, and they have a certain competition among that, and they got a certain customer that they have to attract. And if they do that, they will be successful. We are in thirty-one states, and we're there very intentionally. We're not just coastal, we're not just major city, because that's not where our main tenant is, which is the, you know, is the grocer. They, you know, if you want to go to a Kroger in Manhattan, good luck. Or even a Walmart, I mean, or a Publix. I mean, they aren't there. They're where the customer is.
They've known very early on that the convenience of being close to your customer is what drives their success, and that's why we've kept with that strategy.
I know you already touched on this, but I guess let's talk a little bit further, 'cause it's come up in other retail meetings today, on the demographics and cycles. You know, I guess demographics, cycles, you talked about the world financial crisis and loss in occupancy, and I guess, the risk around the small shop tenants.
Yeah, we get that question a lot, and, I mean, one of the reasons we didn't lose occupancy in both the great financial crisis and the pandemic is because of the necessity-based nature of our product. Our shopping centers provide the best opportunity for the customers, the most convenient place to do their necessity shopping. And as long as we can continue to have that driver, we have less beta, and we, because of our internal and external growth, we have a really strong alpha. So we can actually do both, protect on the downside, but provide strong upside.
And then on, I guess, to just finalize the topic on markets and positioning, you know, I guess thinking about the next five years and some of the trends we've seen with migration, our B of A Institute this morning talked about the continued move to the Sun Belt away from the coast. How are you thinking about, you know, the PECO portfolio and markets over the next five to ten years?
Having done this for a long time, about ten years ago, we put together an algorithm that helps us to determine, as we're buying new properties, as well as managing the properties that we have, the strength of each center. That ability to understand how that drives the results that has pushed us. It tends to push us to more growth markets. So we are, you know, over half of our centers are in the Sun Belt. That's not because we want to be in the Sun Belt, it's because we want to be in that three-mile radius where the growth is and where we can actually really drive our results and be able to drive our rents. So that, that's it. That's sort of the thing.
On the demographic side, you know, our median household income is $87,000, which is about $10,000 higher than the average for Publix and Kroger, but still in a range where the average American shops for their goods, and where the average necessity-based retailer wants to be close to that customer.
And maybe just one more follow-up on the demographics. As you mentioned, you know, household income. Again, we focus a lot on demographics, maybe too much. Of demographics, density, household income, I mean, is there something in particular that you do feel is important? Or again, you know, as long as you're above these out, like you said, Publix, I think, and did you say Kroger?
Kroger, yeah.
Yeah.
Yeah.
Which is strong.
Yeah.
That's the clearing, and that's good enough, and it's again most important is the number one, number two grocer in the market.
Yeah, I mean, demographics are very important, and they're a key part of our, you know, of what we buy. With the right-size center, the demographics that we have have produced market-leading rent spreads, market-leading occupancy, market-leading retention, market-leading retention spreads, because they are the right value for the retailer. And we believe strongly that if you merchandise your center and maximize the sales of your center, we can also maximize the growth of those properties as well.
Just to add on to that, too, I mean, another factor that we enjoy looking at is education. So it's great to have people that are educated and also, you know, population growth. So as you think about 87,000 people in a 3-mile, you know, median incomes, and I believe our three-mile population is 67,000 people, we also heavily look at, you know, education and market growth. And that's what we've done for 30 years, and we see that success. Jeff's touched on it, but, you know, market-leading spreads, I mean, our occupancy is 97.5%, with our anchor occupancy at 88.8% and our-
Ninety-eight.
Yeah, 98.
Sorry. My bad.
It's a little different.
Yeah. No, I'm sorry, 98.8% and our in-line's at 95.1%. Our renewal spreads were 20.5%, with CAGRs of 3%. Our new leasing spreads for the second quarter were 34.4%. So when you think about our necessity-based strategy, we're 70%, the income's coming from necessity-based goods and services. The demand has been awesome. Best operating environment I've seen in thirty years, and you'll continue to see demand from fast casual restaurants, health and beauty, Medtail, a little bit of fitness, as an example. So we want to complement that. To Jeff's point earlier, is it all recession-proof?
It certainly helped us in the Great Financial Crisis and then, you know, COVID, we bounced back very quickly and, you know, to Jeff's point, we do have market-leading spreads, so it's been a great recipe, you know, owning the number one, number two grocer, and being closer to the consumer.
Yeah, and there have been some tailwinds that have been very helpful for us. I mean, when you think about the suburbs, you know, the moves to the suburbs, you think about working from home, all of that, you think about buying local, you think about last-mile delivery, all of those things have been tailwinds. And at the same time, we've had these strong tailwinds from the retailers. There's been basically no new construction in the retail side of the business. And when you put those two together, you know, we're really good at what we do, but we've also been very lucky to have a really strong operating environment. And we don't anticipate new construction in our business until rents almost double and to any significant amount.
If you think about that, that gives us a lot of runway to continue very strong growth.
Can you talk about the acquisition environment and any movement in cap rates and the confidence in where acquisitions are going?
Yeah. The market last year was probably one of the most difficult acquisition markets. We bought about $280 million worth of new centers last year, but it was really hard. There were not that many sellers, and there were no buyers. What's happened as rates have come up, cap rates have spread about 75 basis points. They've probably come back about 25 basis points over that timeframe, and we're in an environment where there is today more product on the market, but there are also more buyers. People are realizing that the grocery-anchored shopping center business that we've been doing for thirty years is the place to be, and it's bringing more buyers into our market.
So we're, you know, underwrite all of our acquisitions to over a nine unlevered IRR, and we think that combination with our cost of capital gives us the ability to have somewhere in the mid- to high single-digit FFO growth, combined with a 3.5% dividend, gives you, you know, low double-digit annual return.
We've also closed-
Does that, does that answer your question? I'm sorry. Just second.
Yeah, in terms of the IRR, what about, like, going in cap rates?
Going in cap rates? As we say, we're really not cap rate buyers, we're IRR buyers, but when you back into it, it's in the sort of six to six and a half range. There have been some more aggressive buys in the mid-fives this year, but that's generally where we see it. I know you were. You had a question. Yeah.
I did. I actually had two questions. The first is, those rents on the new lease rates, is that a form of being in a post-COVID environment now, where you can re-gear more comfortably...?
I would say it's two-fold. I mean, we do have a very high retention rate of 89%, which is certainly helpful. The demand, the lack of supply, also has been... But I think it's just, you know, overall, our occupancy is 97.5%, and, and that the retailers, and I'm talking to the retailers every day, and they're trying to find new locations for 2025, 2026 and 2027. So, you know, as long as we see that, and then, most importantly, you know, it's really the health of, of our neighbors, and occupancy costs for them right now are running around 9.5%, and we think we can, we can grow that over the next, you know, five to eight years to between 11% and 15%.
They all report sales, yeah, so it's nice to have, you know, color when we negotiate the renewals and, yeah, we're seeing the benefit of that.
Thanks.
Yeah. Follow-up question. I believe you mentioned, you know, if you thought we were gonna hit our guidance. We've closed on $180 million so far year to date, and, you know, we have good visibility into our pipeline the remaining of the year, and feel very confident, you know, that we'll be $250 or at the higher end of the range. So we have a very nice pipeline. And to Jeff's point earlier, I mean, the number of deals we're looking at in investment committee and OMs is up about 35% you know, from last year, so feel encouraged by the activity.
In terms of, you mentioned, and again, I know it's been a theme for a long time now, limited, no new construction, but you did mention that you did ground up in the past. You know, as you said, you do development on parcels, et cetera. I mean, would you consider doing ground up again on... I'd say, I think you said it would take two times rents for to increase two times, but-
If we can underwrite it to a reasonable return, yes, but it's gonna be a very small part of the business, and it will be basically grocers who are expanding into new markets. Publix is expanding into some new markets. H-E-B is expanding into some new markets. Hy-Vee is expanding into some new markets, so it'll be someone along those right lines, and it will be a very specific case. We don't see it being a major part of our business, but we've done it a bunch of times, so we know how. I mean, it's a natural part of just 'cause of our relationships with the grocers over thirty years, we have the ability to do that.
Jeff, we get to the double, basically, by saying the acquisitions that we're making, we think are, you know, somewhere between 40% and 50% of replacement cost. And so ultimately, that between that knowledge and the knowledge of when we will execute a tear-down, rebuild for Publix, where we know their rent was to where their rent goes, that's what gives us that knowledge of it's just very expensive in the construction environment. And eventually, they may get to the point, I'm speaking more retailers than the grocers, they will get to that point, but that's a long way to go from a grocer perspective.
Yeah. We have a question over here.
I'm curious to understand, your teams are looking at capital as a percentage of NOI. What are you seeing in the portfolio?
Sure. So if you're looking at maintenance capital, which I would include just general maintenance capital, plus tenant improvements and leasing commissions, and the like, we're around 12 to 13% on a percentage of NOI on a long-term basis, and then we spend a couple points more, and we spend about $40 to $50 million a year on development and redevelopment. That's what Jeff was speaking to, is we're building out parcels. We might build some additional GLA at our centers. Again, we're at 98% occupancy, so to the extent we can, we've got the demand, and those are gonna get the best rents, 'cause typically, they're out on the main drive lane.
But we think that capital is pretty stable. Actually, over time, it actually could decline a little bit, maybe 100 to 200 basis points or so. But it's pretty consistent. I do think one thing that we've hit on here that's important is we talk about format drives results, and ultimately, part of the business model is it's focused on the grocer. But focusing on that neighborhood center minimizes our exposure to those secondary large boxes. That's where the disruption has been. So if you look at a third of our rent comes from the grocer, about 13% comes from non-grocer anchors, and the largest of those is the TJ Maxx brands in total, at 1.3% of our ABR. So ultimately, that has been.
Actually really helped us because when you look at that, that has been where a lot of the disruption has been over the last five to seven years. But then you also look at where the demand is for from national retailers, from regional and local. It's in those smaller spaces. So outside the grocer, our average space is 2,500 sq ft, and I think using CoStar data this year, and this has been true since our IPO, it's about 65% of leasing demand is in that smaller space, that 2,500. So and I, we'll get back to the point, I promise.
Here it is, which is those smaller spaces. There's more demand, and they take less capital than those larger boxes, and I think that's where the capital and our lower capital as a percentage of NOI comes in, is because we're not backfilling, you know, a lot of Bed Bath boxes, where ultimately, if you have to cut the space or cut off the back, I mean, that's a very capital-intensive proposition, so given our leasing and focus on inline and the capital we put to that, allows us to maintain a pretty consistent low CapEx as a percentage of NOI.
Jeff, and obviously, your hunger and then succession and debt, could you talk to that?
To-
Like, like-
Succession planning and-
Oh, yeah.
Yeah.
So, like, it seems that succession, your hunger-
Yeah.
And-
We have, since we started the company, a very strong philosophy, which is hire from within, which we believe is very critical, and that if you want to advance in the company, you have to have a successor for your position, and you have to train them, you have to bring them along, and they have to be ready, you know, battle-ready when they move into that position, and so that has been an important part of our thing. We have a succession plan for every one of our senior people, and there are a few positions that we'll go outside for. General counsel is a good example, where you really can't bring a general counsel along.
But as a whole, we have on the operating side, and it's a good great example is Devin Murphy, who is our president, stepped down. Bob took his position. Bob's been with us 20 years. His successor was Joe Sloss, who had been with us 19 years. This is a very important part of the culture of the company, that we first of all we learn stuff at every property we buy for 30 years, but we want to retain that. And the way you retain that is to keep your people on a long-term basis, and we have a really strong track record of doing that. And it's an important part of sort of who PECO is.
And it's not perfect for everybody, 'cause we're demanding, and we like to win, but it, it's worked really well.
I can assure you, working for this individual for the last twenty-some years, that he has a significant amount of fire still left in the tank. Not resting on your laurels and still. You know, we do see sometimes people, later on, they're too, well, you know, they don't want to take as much risk, but it sounds like in terms of acquisitions, obviously, you're still.
Well, every associate at PECO has stock in the company. We own, the management team owns 8% of the company. I think it's the highest of any of the peers.
When you first come into PECO, you start to think like an owner, because we want everyone totally aligned with our investor base and have, you know, since we really started the company. It's an important part of that, and it's one of the reasons we've been able to keep people on a long-term basis.
Can we talk about, you know, grocer, brick-and-mortar, e-commerce, grocery today in the United States? You know, where do we stand in terms of percentages, and where do you see it going from here? You know, the importance of brick-and-mortar for grocer and what your retailers are saying and doing.
If you step back five years, we had more questions about retail armageddon from the internet taking over all of retail.
What people didn't look at was for the retailer, for every grocer that has to deliver goods to your house, they lose money. The only reason they're doing it is because they want to retain you as a customer, because you will shop in the store if you're a customer of theirs on a, you know, as a certain percentage of your, of your sort. The retailers are pushing towards BOPUS because it is the. It's at least a break-even for them. If you and BOPUS is where you they put everything together, they, and they deliver it to your car, but you pick it up at our shopping center...
great for us because we still get the full traffic, and before they pick up their groceries, they will, you know, go and get their hair done or their nails done or get a workout in, or get a smoothie. Like, that's been an important evolution for us. So it's really important as a retailer to have an Omni-channel approach. If you don't have an Omni-channel approach, you will lose customers, and that's the hardest part. But the online-only problem is it's very expensive to acquire customers, and it's a fraction of the cost if you have a bricks-and-mortar shopping experience versus having to do it online.
It was relatively inexpensive to acquire customers for a long time, and now it's very expensive to acquire online customers, and so that has moved-- that has really changed the perspective. If you look at some of the ICSC research, what they will show you is that the halo effect. When you have bricks and mortar, your online goes up, and when you lose the bricks and mortar, it has a huge negative effect on your online business. So what you're seeing and have now consistently is there's almost nobody who is online only who is not moving to a bricks-and-mortar solution as well. Yep?
So on that, your leases then would have a bonus clause that the sales count for that store, and it's on an online sales only?
We wish we had them 100%. We do on a lot of our neighbors, but not all. We push for that pretty hard, and but, it is 'cause we, as part of most of our leases, we have a percentage rent clause, that we get a percentage of the rent-
Oh, right
... above a certain sales amount, and-
So the sales, the sales would count from that store? I think that was my question.
The answer is sometimes.
Mm-hmm.
And we get in a lot of arguments about that.
Okay.
But we, it, it's
We have seen increases in our overage rent post-COVID because grocery sales have increased 35% over the last five years, so we do get into the overage, and our overage rent is increasing. But even then, it's maybe $3 million a year on $400 million-plus of revenue. The other piece is the grocers don't love that either, so a lot of times they want to get a fixed component. So what will happen is we'll, as part of negotiations for consents, additional term, things like that, a rent increase, they'll want to fix that. And so it ends up becoming back into the base, which is part of why that overage rent number never goes... It's never that large.
A negative effect.
Right.
I know we're running out of time. Can we turn to the balance sheet and your recent unsecured raise?
Yes, so we've been working hard. So earlier this year, we received positive outlooks from Moody's and S&P, which I was disappointed with, but then they came around, and in August and just this past Friday, we are now triple B flat, Baa2, as both S&P and Moody's improved or at least caught up on the credit ratings that our fixed income investors did realize. And yesterday, we successfully raised $350 million. Our second issuance of the year, coupon was 4.95%. This does several things for us. One, it allows us to continue to ladder our maturity.
So this was a long 10 year, so it took our weighted average debt duration from around four point eight, four point nine to six one, including the extension options we have on the few term loans we have left. It continues to build our bond trading history that will allow us more efficiency in that market. It was very successful. We had some new investors, but a lot of investors that have participated in our previous and own our previous bonds, they came into this as well. And at that interest rate, we were very pleased with that because it does allow us to, you know, continue our growth. The purpose, the use of proceeds was we paid down the line. We use...
We paid down the line. We have no meaningful maturities now until almost 2027. So I think that's a key thing from an, a cost of capital and a growth perspective, is maintaining optionality and great flexibility. We have our line, which is $800 million, that we have available to us to continue our growth plans. We're 5.1 times levered on a debt-to-EBITDA basis, and, you know, with a long-term leverage goal of 5.5 times. So the key thing is, is to maintain the liquidity, the balance sheet, you know, optionality, to allow us to execute those growth plans. We've Since the IPO, we've had a target of buying $200 million to $300 million a year in acquisitions, and we can do that while maintaining that 5.1, 5.2, 5.3.
Like, in the low fives, we can continue that growth, and that's something that we have been doing for a really long time, which is continuing to buy through all markets, but matching the capital that we're deploying so that we can, you know, ensure that we're getting the returns that we believe we are.
Great. I know we're out of time, but we are doing three rapid-fire questions.
We love these.
Rapid responses. Please, Andrew.
Sure. Okay, first, do you expect real estate transactions to increase once the Fed starts to cut, yes or no?
Yes, but it'll take a little time.
Okay. Well, the second part of the question is: when do you expect them to pick up between 4Q this year, first half next year, or second half of next year?
How quickly are rates gonna come down and stabilize? That's when they will. The stability of interest rates is what will drive that, so there's an acceptance of where rates are gonna be.
Mm-hmm.
I think the Treasury's already moved. They're pretty close, so I think we're starting to see more volume come right at today.
Okay. Second, how would you characterize demand for space today? A, improving, B, steady, or C, weakening?
I would say steady, if not improving.
Okay, and finally, how would you characterize your AI spending plans over the next year: higher, flat, or lower?
Higher. We have every department in the company has an AI sort of sponsor, and each department is responsible for bringing an AI project by our annual meeting of February next year, that will be happening. And these are not transformative things. These are like HR. HR now has Ask HR?
Yeah, Ask HR.
Ask HR, and you can go on HR and ask any HR questions, so it basically is increasing the efficiency of the HR department. We have that across the board in terms of the teams, but we're using our own information. We're not. We haven't really broadened it widely yet, and we'll see some, maybe some of the departments will.
Great. Thanks so much to the PECO team.
Yeah.
Thank you.
Thanks. Thank you.