Welcome to the Phillips Edison roundtable. Happy to have Jeff Edison, CEO of the company, with us here today. Maybe introduce your team, then opening remarks, please.
John, our CFO, and Kim, our head of IR. In terms of opening remarks, they say it's great to live in interesting times. We don't need things to be this interesting because it's really trying to figure out what's going on. We're in one of the best operating environments we've been in. We saw a little run-up over the last 45 days, then all of a sudden it starts going back, and the operating market is as good as it's ever been in terms of leasing margins, leasing occupancy, all just very strong, like record kind of strong. Not just good, but really as good as they've been. The acquisition market, our volume is going to be as high as it's been, quite a bit higher, actually, than it's been any time since we've been public.
At numbers that we think are very consistent with what we've been targeting. You have 9% unlevered IRRs on what we're buying. We're buying in at about a 6.7% initial yield. So very strong dynamics there. You got great operating environment. You got a great acquisition market where we're seeing stuff. We're selling stuff at basically a 5.9% yield. So we're buying at a 6.7% and we're selling at a 5.9%. We have a really strong ask and buy front on that side. Again, we've increased our disposition numbers as well at those kind of rates. If I woke up and I said, "This is as good of environment as you can get, but the market's not trading great." There are obviously a lot of explanations for that.
What we're focused on is continuing to do the things that we influence, which is put great numbers on the board, which I think we have and will continue to do throughout the year. The market will do what the market does. Over time, what we're committed to is growing our FFO per share mid to high single digits, paying a 3.5%+ dividend, and getting a 10% return for investors year in, year out in a hard asset, low leverage business. We think that's a good return. Our management team owns more of PECO than any other of our peers in terms of percentage of it that's owned by the team that's rep.
We have skin in the game, and we are going to keep skin in the game because we believe in this business, and we think that it is, particularly in environments where there is uncertainty, we have a lot less beta in what we do, but we are convinced that we got a really good alpha, and we are putting scores on the board that would say we got good alpha. That is our opening remarks, what we are feeling. As we said, we are going to keep taking advantage of what is a very strong market and growing the business.
Maybe on the flip side of that, you look at recent news, grocer earnings, right? We have talked about softer consumer spending, some pressure there on the lower end, lower income consumer. I guess, what are you seeing across your portfolio today?
The consumer is actually doing really well. It was two months ago, we were talking about the K and everything is going to be, the lower end of the market is not going to do well. Well, that is sort of gone.
Yeah.
Because the lower end is growing faster. Our market is the top of the K anyway because if you look at our median household income of our centers, it is, whatever, 17%-18% higher than the median. So that is what we service, and that is what, we are in density and incomes that are above what Kroger is and Publix are, which are our two largest tenants. So we are doing well in that. This concept that the consumer is having trouble is one that, the credit card debt and all that, those are actually pretty healthy right now. You are hearing stories like, oh, the consumer is in trouble and having to But you are not seeing it. We are not seeing it.
One of the things that we look at really closely is our local neighbors, those are what would be called mom and pops, but they're really the true entrepreneurs, the people who are counting on that business as what they're going to pay their rent with and what they're going to pay for their house and that's what they live on. Every time when they renew a lease, they come back to us, and they have to make a decision, what are they going to do? They can walk from the deal if it's not profitable, or if they see the future is not profitable. They can extend for a year or two and just kind of see what happens, or they can extend their leases for long-term. They come at us negotiating in, and we keep very close look at that.
Today, that retailer is looking for longer term. They're renewing at 90% of their spaces. So you think about that means the person who knows the consumer the best, which you can have all the talking heads, you can have all the research you want. There's nobody who knows the consumer better than the entrepreneurial local retailer, because they actually know when somebody's husband or wife got laid off. They know why they're buying something and what's too expensive, what's not. That is their job. They're making the bet on a long-term basis. They want to be there. They're trying to tie up the space for as long as they can. That to me is probably, certainly one of the things we watch really closely, and encourages us that we're in a much better position than what you're kind of hearing about from their perception of the consumer.
Maybe taking that, expanding that a little bit.
Yeah
As you think about the shopping center space overall, what are the biggest risks facing the industry or the sector over the next 12 to 24 months, do you think?
Our stuff is right-sized grocer anchor shopping centers with small stores that provide necessity-based goods. My answer to you is based on that. There are a lot of people in the open air space who are doing more discretionary spending and that stuff. That is not where we spend our time. In that particular market, the necessity-based side, it is very strong. We are not seeing the consumer react in any sort of dramatic way. As a matter of fact, they are actually spending more. That would be, we think, a positive.
I think that when we look at, it is a negative sided question where we want to try to be positive, but I think if you look at it from a risk perspective, that is kind of how we conservatively approach the business. When you are focused on necessity based goods and services, you are focused on the best retailers of the grocer. Ultimately, that is why we often talk about we have less beta. When you look at the different things going on, and your first question was talking about, kind of retailer earnings. There is an adjustment, but the large nationals, Jeff highlighted the locals, but nonetheless, they are incredibly adaptable. Kroger same-store sales were a little softer, but they reaffirmed their profit guide. Ultimately as you look at that, they are continuing to grow. They are going to continue to operate.
We actually think that, I think some of the things from the headlines that we are hearing is perhaps it is interest rates or inflation. Well, actually, these retailers, they actually like some inflation. That allows them to pass along price increases more easily. When you look at interest rates, we actually think that is an advantage to us, because when we talk about the acquisition market, that has just made it that much more expensive for the levered buyer. In our space, maintaining the balance sheet that we have and being lowly levered like we are, then those moves give us an opportunity to play a bit more offense in that market.
Ultimately, I think when we have back tested and we look at the GFC and we look at the pandemic and things, our real estate has performed exceptionally well because of the resilience of the local retailer of that grocer and the consumer spending for necessity based goods and services.
Maybe just on the grocers specifically, any concerns about grocer health or M&A potentially leading to closures? We had Kroger, Giant Eagle announced earlier this year. Any updates on divestitures there or closures?
You are going to see any M&A activity is not going to include closures. They cannot get it through the government if that is part of the plan. Now, long term, could that happen? Yes. It is not going to happen in any kind of short term merger conversations. That being said, I do not know if as many people know as there is, Kroger is built on mergers. They have, I think they have close to 19 different brands that they keep. They are going to keep the Giant Eagle brand when that transaction closes because they actually use the brand, and the brands are really important to the local customer that they do not change it. They bring in their product, they bring in a lot of things to change the way the business is run, but they do not change the name.
That so I think the Giant Eagle thing is a good example, and I think you will continue to see, particularly the family owned, the Schnucks of the world, maybe the Cub Foods. You will see potentially some of the Albertsons brands potentially getting sold. You will see some of that. There will be some M&A transactions. But that is actually more normal for the grocery business than not having it, which really has been blocked by the government with the Albertsons thing. Just basically put a stop on any kind of M&A activity until that was resolved. That took two and a half years, three years to get resolved and not happening. I think that is probably a pretty good bow of it.
I think the other piece is that when we look at the PECO portfolio specifically, this really goes to the importance of having the number one or number two grocer in a market, which over 80% of our shopping centers have the number one or number two grocer in the market. Because when these pieces come up and there are those questions, we look at it and we are able to say, "This is a great grocery-anchored location." Ultimately gives us confidence that someone will be there. You go and you say, "Okay, Albertsons did not have the sale. Well, maybe they will separate certain brands." We know the markets that they are actually very successful in and then in other places. That sort of grocery knowledge allows us to curate our portfolio to be quite strong.
It is a critical part of understanding the business. It is not whether you have Albertsons or Kroger, it is what market you have Kroger in. If you have Kroger in Denver, you have the dominant player in Denver. King Soopers just kills it compared to everyone else. If you have the Albertsons there, the Safeways are okay, but they are not great. There will be 50 to 100 basis points difference in cap rate between a Kroger center in Denver and a Safeway center. It is that way in literally every market across the country, which is why it is not whether you have Kroger or Albertsons, but what market you have them in.
I just want to stop there to see if there is any questions from the audience. Okay.
Really good, John.
On non-monetary clauses, as we think about on renewals, the renegotiation of that, whether it is restrictions, can you quantify the incremental NOI that can be there to get unlocked?
It's very complicated to give you a hard number on that because it is things like being able to develop an outlot that you couldn't get the approval before. The controls are almost all at the grocery level. Our small stores have very little control of what we do. We don't give them control, we never have given them control of how we operate the shopping center. Some of the anchors will have visibility things, so the negotiations with them are more about sight lines and the ability to put outlots into spaces. Then probably the most important, and this is particularly important when you're buying a property, is what restrictions they have on what merchandising mix you can put in the center.
Because that can definitely constrain what you can do in terms of turning around a shopping center and getting the right merchandising mix for that shopping center. That's really changed a lot in the last three to five years.
Post-COVID
As they still ask for stuff. The grocer always asks for stuff, and any of the anchors who have some of the exclusives, they ask for stuff in exchange for that. But it used to be no. The answer was no for a long time. Now you're getting the ability to kind of trade certain pieces for that, and it does unlock outlots, it unlocks leasing opportunities. Importantly, it allows you to merchandise your center to the right kind of retailers, which allow you to grow rents more. Those are the pieces that we're seeing in.
More of today.
Today than we have for a long time.
Got it. Then maybe switching to external growth, acquisitions, which is a big part of your strategy. Maybe talk about what you're seeing in the transaction market out there. Clearly, you're seeing from all the meetings we've been in, cap rates continue to compress. Talk about the competition that you're facing today in the market.
Yeah. We started the year targeting $400 million- $500 million of acquisitions this year. We increased that at mid-year to $500 million- $600 million. Currently, what we bought and have under control is at the very high end of that range. So we've had a very strong acquisition activity so far in the year. It's been in a wide variety of markets, but nothing that wasn't sort of where you would think. Florida and Texas being the biggest, California being large, Washington. We bought some stuff in South Carolina, we bought some stuff in Minnesota. So it is, as you'd expect, with PECO, it's spread across the country, which is what our platform is. There are more buyers in the market. Grocery-anchored shopping centers are in favor. They're in favor among institutional buyers, they're in favor in family offices.
There are more buyers in the market, and each segment probably has a little bit more demand than it has historically. Most people were underweight grocery-anchored shopping centers. I'm going to keep focused on grocery-anchored shopping centers, not on power centers and malls and other parts of retail. Because that's the market we know, and we're not in those other markets. But the institutional demand has been high. When there is strong institutional demand, pricing usually gets way beyond something we're willing to get involved in. We've looked at a lot of portfolios this year, and the private equity buyers have been the buyers of that. These are multi-billion dollar portfolios, so they're sizable. But private equity has had the highest bid on literally every single major real estate or retail real estate portfolio that is predominantly grocery anchored.
We have been participants, we have not been winners of any of that because the pricing has gotten to levels that we are not going to go to.
How far off you think you were, percentage-wise?
Yeah. We were probably 15%-20%, so sizable. Not a little. It was not 0.5%.
Right.
But in most cases, it has been a private equity firm that was sort of buying on a thesis as opposed to They were going to buy it. They decided they were going to buy it, and whatever they had to pay for it, they were going to buy it. And that included Blackstone and [inaudible] as the two buying the biggest portfolios. There are a couple of others, the Slate portfolio and one other, where it is going to be sort of private equity, but they are going to be high return private equity. More opportunistic kind of stuff. That is what is playing out in the market. We continue to do what we do really well, which is buy asset by asset, market by market. And our markets are a 3-mi radius around where the center is, with the number one or two grocer.
In that market, we've had tremendous success in performance, and performance better even than what we underwrite to. That's been what we will continue to keep focused on.
If I can, I'd like to tie this question into the kind of the first bit of the questions, because I actually think there's a real opportunity here. Because we review several hundred million dollars worth of properties every week in investment committee. So we have a great pulse on the private market values and where shopping centers are pricing. If we look over the last 45 days, two months, I think the retail stocks in PECO, our stock, has retreated on headline concerns about the consumer. I think the continued strength is a real buying opportunity in the public space because institutions are buying, we're buying, we know where this is valued. I think ultimately, as that consumer remains strong, the hope will be that there will be improvement there.
Yeah, if you think about the stuff we sold this year, I think we've announced it's about $150 million, but we're going to be somewhere between $100 million and $200 million in terms of guidance. That product sold at a 5.9% initial yield. We bought at a 6.6% yield. You can make a lot of money doing that. Then when you add onto that, what we're selling is stuff that these are transactions, so it's not like where we think the market is. It's where the market is. Our ability to sell at that kind of a spread, I think gives us confidence that we're not only going to get spread, but the stuff we're selling is probably, in our mind, a 7% unlevered IRR that the buyer is going to get, and we're buying at a 9%.
We're not only spread investing at the beginning, we're also adding a really strong growth opportunity to the company on a long-term basis. That's a 7-year underwriting for the stuff we're buying, as well as what we're selling. I think it's a great trade, and I think it will provide outsized growth for the company over a long period of time.
With rates, when you look at where 10-year Treasury is above 5%, does that sort of hinder your ability to continue to acquire?
Well, we will see. It is kind of early on the rate changes.
Yeah.
We have not seen any sort of major changes yet, but we would anticipate there being some. I think we kind of got to wait and see if it does have any kind of major impact on volume and what our competitors are going through.
I do think that it brings in a point that we talk about internally a lot, which is match funding.
Ultimately, the ability of where we've been able to sell assets to buy assets on the, as Jeff was talking about, that difference in IRR. We have been the largest individual asset buyer of grocery-anchored shopping centers, the largest one in the country for the past 15 years. We have bought throughout all cycles over 35 years that Jeff's been running this business. There will be opportunities. Interest rates definitely will have an impact, but it takes a little bit longer. That match funding is really important.
We raised equity in the second quarter, and we're able to deploy that accretively and then add to our growth, and that's kind of what we're looking at. The first piece with interest rates going up, it's actually helpful because now the levered buyer, it just got a lot more expensive for them. So ultimately all cash buyers, and when you're 30% levered, those moves have a lesser impact on us.
That said, it should have an impact on cap rates. That actually should improve the yield and the returns, and that will come about. But that's where I think, we're kind of doing both sides. I should say, we have the ability internally to acquire $300 million of asset every year. We're leverage neutral. Our leverage target is less than 5x because we retain over $120 million of cash flow for the dividends, which we just raised 6%. Between the retained cash flow, the growth, and the EBITDA of the overall business, it gives us that capital to deploy. Depending on the environment, it could be more towards development and redevelopment where we're building out parcels.
We have not done it yet, but certainly stock repurchases would be something to consider. But at the same time, we're not going to go back and forth where I just issued it last month and going to buy it back this month. They're disconnected. We're focused on long-term growth. Jeff mentioned being owners and operators. Today's acquisitions are driving NOI growth in 2027, 2028, 2029, and beyond. We're really focused on that long-term growth of the company.
Maybe on the platform, with investors that look at your company, your stock, what would you want investors to better understand about your strategy, the differentiation of your strategy versus other shopping center REITs?
Yeah. One, it is product differentiation. We are grocery anchor shopping center buyers. We buy centers at the corner of Main and Main that deliver necessity-based goods to the consumer. That is what we do. You will see in terms of who our leading neighbors are. We are Kroger’s largest landlord. We are Publix’s second largest landlord. We are one of Sprouts’ top five landlords. We are in the grocery anchor shopping center business.
Our top list is not power center tenants. It is grocers. That, I think, is unique in the business. Part of what we think that, combined with our necessity-based focus on the small store space, provides a really good foundation, which fundamentally has less data than other retail. If you think of in your own life experience, there is stuff you do discretionary-wise and there is stuff you do necessity-based. Food is probably your number one necessity-based thing.
Now, you may buy at a restaurant instead of buying it at the grocery store, but food is not one of the things you say, "Yeah, maybe I will eat next week." But the shirt, you might buy next week, right? You might or buy later. That is the beauty of our product. So there is less data naturally in buying necessity-based things. What we have combined that with is the ability to have two really strong channels of growth. One is internally being able to grow this cash flow from property on a property-by-property basis. Then the second is to use our expansion, both on the development, redevelopment side, but also on the acquisition side to give us more alpha. That is what we love about the business. As a large shareholder, that is what I love about the business. We have been doing it for a long time.
We went back actually and looked at, okay, what returns have we gotten for our investors over 35 years? If you look at it, there are different sort of segments, the first segment did extremely well, like 40% IRR over 35 years. We do not have a lot of those investments in our lives, but that one was great. As you move out, it ends up kind of circling around 12%-13% on levered IRRs, or less on levered IRR. So these are numbers that we have proven we can sustain over extended periods of time. If you think about 35 years, we think everything is happening now. We have had a lot of these experiences over time that this necessity-based retail has actually survived through. Not only survived, but delivered really strong returns to the investors.
Okay, we have got a couple of minutes here. Time for rapid fire questions, Jeff.
Oh, no.
All right. Number one, if long-term rates stay higher for longer, which has the biggest impact on your sector? Is it higher refinancing costs, is it lower transaction activity, or less new supply?
Less new supply.
Okay. Over the next three years, will third-party capital become a more important source of growth for public REITs than balance sheet capital? Yes or no?
Yes.
For your sector, will next year's same-store NOI growth be higher, the same, or lower versus this year?
For what? Is it-
For your sector, same-store NOI growth next year. Is it higher, same, or lower?
I think it'll be similar.
Okay. All right. Thank you, everybody.
Yeah.
Thank you.
Thanks a lot.
Enjoy it.
I was going to do this spot to say higher. What, are you about to say higher?