Thanks. Welcome to the Regency Centers Corporation second quarter 2022 earnings call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note that this conference is being recorded. I will now turn the conference over to Christy McElroy, Senior Vice President, Capital Markets. Thank you. You may begin.
Good morning, and welcome to Regency Centers' second quarter 2022 earnings conference call. Joining me today are Lisa Palmer, President and Chief Executive Officer, Mike Mas, Chief Financial Officer, Jim Thompson, Chief Operating Officer, Chris Leavitt, SVP and Treasurer, Alan Roth, Senior Managing Director of the East region, and Nick Wibbenmeyer, Senior Managing Director of the West region. As a reminder, today's discussion may contain forward-looking statements about the company's views of future business and financial performance, including forward earnings guidance and future market conditions. These are based on management's current beliefs and expectations and are subject to various risks and uncertainties. It's possible that actual results may differ materially from those suggested by the forward-looking statements we may make.
Factors and risks that could cause actual results to differ materially from these statements may be included in our presentation today and are described in more detail in our filings with the SEC, specifically in our most recent Form 10-K and 10-Q filings. In our discussion today, we will also reference certain non-GAAP financial measures. These comparable GAAP financial measures are included in this quarter's earnings materials, which are posted on our investor relations website. Please note that we have also posted a presentation on our website with additional information, including disclosures related to forward earnings guidance. Our caution on forward-looking statements also applies to these presentation materials. Lisa.
Thank you, Christy. Good morning, everyone. Thank you for joining us today. We are pleased to report strong second quarter results reflecting a still healthy operating environment. Leasing demand continues to be strong and tenant move-outs remain light, driving occupancy and rent growth higher. We acknowledge the increasing macroeconomic headwinds, and in our view, that makes our results all the more notable. We know that we're not immune to the adverse impacts of inflation, interest rate increases and recessionary risks, all of which could have implications for us, but we very much believe that we are extremely well-positioned to weather any economic storm. For the remainder of this year, as a result of that, we are very confident in our forecast as reflected in our guidance increase. Looking beyond 2022, Regency's portfolio and balance sheet were built for times of greater uncertainty.
Everything we've done over the last decade and every decision we've made positions the company not only to play offense and drive growth when times are good, but to successfully navigate challenging macroeconomic environments. We are designed to outperform through cycles, evident most recently in the resiliency of our performance through the pandemic, and how quickly we were able to pivot back to offense and return to pre-pandemic levels of NOI, earnings per share, and leverage. Importantly, in the context of the current environment, the demographic profile of our trade areas is supportive of a consumer that has more cushion to absorb pressures from inflation and economic softness. In times when tenant bankruptcies may be elevated, our locations tend to be among the best performing, limiting occupancy decline. Additionally, current positive momentum is a source of tailwinds into 2023 and beyond.
First and foremost is our strong pipeline of leases, both executed and those in negotiation. Also, next year, we will see an even greater benefit from development and redevelopment NOI coming online. Finally, as we've been saying, our dense suburban neighborhoods and communities continue to benefit from structural tailwinds stemming from post-pandemic migration and hybrid work. Where we have begun to see some impact from the current environment is in the capital markets, but again, we are extremely well-positioned. The strength of our balance sheet and our low leverage afford us the luxury of not needing to raise capital when it's not advantageous to do so. Our dry powder and ready access to capital give us a competitive advantage should opportunities arise. A prime example of that was the execution of our share repurchases in the second half of June.
We saw a window of opportunity to essentially buy our own high-quality properties in a mid-6% implied cap rate range, a meaningfully more attractive price than what we would pay for anything comparable in the private market today. We were uniquely positioned to take advantage of that dislocation given our balance sheet strength and liquidity position. We can't control the macro environment, but we can control our response to it. As we sit here today, we remain confident in our operational strategy and our balance sheet strength, regardless of the macro backdrop. Closing out, I'd like to comment briefly on ESG. As many of you know that have been covering Regency for a while, we take pride in having best-in-class, sector leading environmental, social, and governance programs across which we continue to meet or exceed our goals.
We did publish our annual corporate responsibility report in late May and also announced an interim 2030 target for reducing absolute Scope one and two greenhouse gas emissions, which was endorsed by the Science Based Targets initiative. We also set a long-term net zero target of 2050. We don't take these commitments lightly. These targets were established after extensive work by our team to identify and analyze the impact of specific initiatives that will help us reach these goals, which includes further improvements in common area energy efficiency and continued growth in our on-site solar program. Corporate responsibility is a foundational strategy for Regency, and it has been for many years. It's part of our culture and is as fundamental to what we do as is our commitment to portfolio quality and balance sheet strength. Jim?
Thanks, Lisa, and good morning, everyone. While we are keeping a close eye on the increasing economic pressures in the U.S. today, the operating environment for our open air retail centers currently remains healthy and active. We had a great second quarter of operating results, leading us to further increase our 2022 same property NOI guidance by 100 basis points to 5.25% at the midpoint, excluding prior year collections. This confidence in our outlook is driven by continued positive vectors in our key metrics. First, continued robust tenant demand, with new leasing volumes up 20% year to date versus the historical average. Increasing occupancy, both on leased and commenced spaces, especially on shop space, as we backfill space vacated during the pandemic. Our tenants are paying rent, and we're nearly back to more customary levels of current period bad debt.
Retention rates remain above historical average. Cash spreads were nearly 9% in the second quarter, and we're embedding contractual rent steps in close to 90% of our executed leases, especially important in this inflationary environment, contributing to GAAP rent spreads of 17%. Strong tenant sales reports, again contributing to higher % rent, and we're maintaining low levels of leasing CapEx with net effective rent growth also in the mid-teens. Our success and momentum relating to all these key drivers of our business gives us continued confidence in the strength of our core operating outlook. As Lisa discussed, we do acknowledge the heightened risk of softer economic environment, including the potential for an uptick in tenant failures. We're not seeing that yet, as tenant move-out activity has remained light, and we believe that is a result of the purge of weaker operators that occurred during the pandemic.
Our tenants are as healthy as they've ever been, especially our shop tenants, who went through the wringer two years ago and emerged stronger and smarter. If we do see bankruptcies materialize, we feel like we're in a good relative position. Turning to development, we now have nearly $390 million of development and redevelopment projects in process at yields in the 7%-8% range. Despite construction cost increases over the last couple years, we remain on track and on budget with our current in-process projects. Additionally, we continue to source new opportunities supported by strong tenant demand at yields that are holding steady despite cost increases we're seeing in our underwriting. During the second quarter, we started phase II of our ground-up Baybrook development in Houston.
You may recall that we completed phase I of this project late last year, and the H-E-B anchor, which opened in December, is already one of the top-performing grocers in the Houston market. This new phase of the project will include roughly 50,000 sq ft of shops and outparcels adjacent to the new H-E-B store. We have already signed or committed leases on the nearly 75% of the new space and anticipate the first tenants opening in about a year from now. We also started a major redevelopment this quarter at our Buckhead Landing property in Atlanta, formerly known as the Piedmont Peachtree. With total costs of around $25 million, we will redevelop the 150,000 sq ft center and replace the existing grocer with a new Publix anchor.
Our team is really excited to start this much-anticipated transformation of this irreplaceable location in the heart of Buckhead. Our consistent track record and successful execution within our development and redevelopment program is a testament to the depth and perseverance of our experienced teams across the country. This avenue for investment is a core competency for Regency and is where we have the ability to create value and drive incremental growth. In upcoming quarters, we look forward to sharing further details on additional projects as we plan to start over the next 12-18 months. In summary, even in a more volatile macro environment, we remain encouraged by continued strength in tenant sales, foot traffic, and demand for space, supporting continued same-property NOI growth and reflective of the resiliency and quality of our locations and tenant base.
Beyond that, our self-funded value creation pipeline provides an additional layer of accretion and growth. Mike?
Thank you, Jim. Good morning, everyone. I'll start by addressing second quarter results, walk through key changes in our 2022 revised guidance, and touch base on our balance sheet. First, we'd like to point out some new disclosure on page eight of our supplemental, where we now summarize the contributing elements of our same property NOI growth. Last quarter, we spent time describing the noise that exists in the quarterly cadence of our NOI growth rate throughout 2022, driven primarily by the collection of prior reserves as well as an expense recovery adjustment that occurred in the second quarter of last year. Due to the continued significant impacts of these items, we stress that base rent growth is the best indicator of what is truly driving our business and is the best representation of our continued growth trajectory.
You should find that this new disclosure is helpful in making these themes more clear. As you can see in the table, the largest positive contributors to second quarter performance were growth in base rent and improvement in current-year uncollectible lease income, which together added a total of 450 basis points to our NOI growth rate. While the offsetting factors include the tougher year-over-year comparisons relating to prior year reserve collections and expense recoveries, detracting a total of 380 basis points from our results. We've also added GAAP or straight-line rent spreads to our supplemental on page 19 as a complement to our historically reported cash spreads. GAAP spreads have always been an important metric for us internally, given our stro lng focus on embedding contractual rent growth into our leases.
We believe this metric helps provide an even more fulsome picture of the primary drivers of our base rent growth over time. Notably, as of the second quarter, even after removing the positive impact of prior year collections, our core operating earnings per share has returned to pre-pandemic 2019 levels. This achievement is a testament to our portfolio's quality and resiliency. We also converted more cash-basis tenants back to accrual in the second quarter, continuing a trend over the last year following improvement in both collections and underlying tenant credit. The resulting reversal of straight-line rent reserves contributed $3.5 million or $0.02 per share to Nareit FFO, which was not included in prior guidance. We now have about 12% of our ABR remaining on a cash basis of accounting.
Turning to our updated current year guidance, we refer you to page 6 of our second quarter earnings presentation, specifically the column indicating the drivers of the increase in our Nareit FFO range at the midpoint. The biggest change was to our same property NOI growth forecast, up 100 basis points at the midpoint, positively impacting our Nareit FFO per share outlook by about $0.06. All the positive operating trends we are seeing that Jim outlined and that impacted our second quarter results are supportive of the 100 basis point increase for the full year. The primary drivers include higher average commenced occupancy, benefiting both base rent and expense recoveries, and better collections on cash-basis tenants, leading to decreasing levels of uncollectible lease income.
Another driver of the increase is non-cash revenues, up $0.03 per share at the midpoint, primarily driven by the impact on straight-line rent from the conversion of cash-basis tenants back to accrual during the second quarter. Recall that we only include these impacts in resulting guidance on an as converted basis. Our balance sheet remains in excellent condition, ending the quarter with full capacity on our revolver, with total leverage at the bottom end of our targeted range of 5-5.5 times net debt to EBITDA. This strong balance sheet position enabled us to take advantage of an opportunity to repurchase our shares in the second half of June. We bought back 1.3 million shares for about $75 million, representing an average price of $58.25 per share.
As Lisa mentioned, this price implied a cap rate in the mid-sixes, a price at which we would happily buy assets that match Regency's quality and growth profile. Notably, the share repurchase was about a penny accretive to 2022 earnings. The debt markets have remained volatile, and the movement in both Treasuries and spreads has impacted our cost of debt capital. With no unsecured maturities until 2024, we have the luxury to remain patient, waiting for more opportunistic windows. We're also reminded that during periods of dislocation in the capital markets, the importance of our significant level of free cash flow is highlighted, which at north of $130 million annually allows us to continue investing accretively. Looking ahead from an operational perspective, inflationary impacts on the consumer, combined with a softer economic backdrop, introduces some uncertainty into our outlook beyond 2022.
As we reflect on our resiliency throughout the pandemic, the impacts from which could be described as indiscriminate towards property location and tenant quality, we believe Regency's portfolio is well positioned ahead of a more traditional economic recession, with greater bifurcation and performance across the quality spectrums of trade area locations, property formats, and tenant exposures. As Lisa indicated, you won't hear us say we're immune to the impacts of a downturn. The good news is that we are starting from a position of strength. Our leasing pipelines are very active, featuring a healthy mix of tenant demand across all markets, categories and sizes, with retention rates that continue to be above historical averages. One silver lining of the pandemic is that the less resilient operators were culled out during 2020, and our tenant base has emerged even stronger, providing stable footing in our occupancy.
We also have a strong value creation pipeline, fully funded with free cash flow, with visibility to more meaningful NOI contributions in 2023 and 2024. Maybe most importantly, as we consider the rising economic uncertainties, we have one of the strongest balance sheets in the sector, allowing us the ability to remain on offense and create value through investme nt should opportunities arise. With that, we look forward to taking your questions.
Thank you. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate that your line is in the queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing any star keys. One moment please while we poll for any questions. Our first question comes from the line of Greg McGinniss with Scotiabank. Please proceed with your question.
Hey, good morning.
Good morning, Greg.
Leasing GLA was down from prior quarters at 1.3 million sq ft. Is that just a function of more limited anchor leasing? Because obviously the number of leases was quite good, or how should we be interpreting that result?
Greg, this is Jim. Great question, and be happy to kind of explain what's going on there. Basically, the total number of transactions was right in line with trailing twelve months, as were the new leasing volumes, and quite frankly, rent spreads were very solid as well. Overall, the GLA leased was slightly down for the quarter due to the renewals. It's really the mix between anchors and shops. Typically, we're about 50/50 mix. This particular quarter, it was 70/30, heavy on shops, which basically smaller square footage averages. It also relates to that ABR of $34.43, which is a little higher than the average.
I looked at that, and don't tell anybody, but I looked at the July numbers from a renewal standpoint, just to satisfy my own curiosity. July numbers are significantly, on the renewal side, significantly higher than our average monthly rates, and the mix is back where the anchors should be. I think the anomaly will be sorted out prior to year-end, so I'm not too worried about that. In addition, I'd just mention that the overall renewal retention rate is over eight or right at 80%, which is again, higher than our typical average.
Okay. It sounds like it's just a timing issue then.
It really is.
Okay, great. Second question for me is, with the post-pandemic migration to closer suburbs or certain suburbs and hybrid work from home seemingly here to stay, how does that impact the foot traffic you're seeing at the centers and decisions around merchandising?
Greg, I think the foot traffic we're seeing is really back to where we've seen it before. In general, our demand is very strong, really across the board, across regions as well as product type. Categories that are doing exceptionally well, I think are very active or grocery value apparel, the QSRs, restaurants, obviously. We're seeing a lot of good, strong demand in the health fitness medical and also the pet categories. The mix between locals and nationals for the shop space is really relatively the same as what we've seen. Really, from an overall demand standpoint, I'd say, just to give you a flavor on the anchors, we've got 39 available spaces today. Twenty-four of those are either at LOI or at lease.
Again, I think that's with the likes of TJX, Publix, Burlington, Ross, Five Below, Nordstrom Rack. Those are the kind of folks we're talking to, and I think that gives you a sense for not only are we seeing great shop demand, but also the anchor demand is very, very strong.
Great. Thank you.
The only thing I'd add to that, I think, is we remain confident in that suburban market in which we operate, kind of anchored by that dominant grocer, with necessity type of retailers. We believe we're gonna continue to see demand shift towards our product type and our quality.
Greg, I'll just add, really well said. We continue, I think we sound like a broken record, but what the past two and a half years, if that's how long it's been, have really demonstrated and validated is the importance of the neighborhood community shopping center in the retail and service ecosystem. We sound like a broken record. If you went back and you listened to earnings calls prior to the pandemic and then throughout it, we feel really good about the future of our business.
I'm sorry, just, one point of clarification on the foot traffic. Are you seeing any increase in midweek traffic, and do you have the data on length of stay, whether that's changed since pre-pandemic?
Well, it's basically still the same. Remember, we did, as everybody did, dip with the pandemic, and we recovered really quickly and much more quickly in some markets versus others. It was all, as we always say, indiscriminate, but what it was discriminating on was the amount of shutdowns. There have not been significant differences from pre-pandemic to today.
Thank you.
Our next question comes from the line of Michael Goldsmith with UBS. Please proceed with your question.
Good morning. Thanks a lot for taking my question. Maybe to follow up on Greg's question here, you know, can you talk a little bit about the demand from tenants and maybe break it down between discretionary versus essentials? I know you have more exposure to the essential side, but trying to understand if different types of tenants are slowing their demand or if the momentum kind of continues on both sides.
I would tell you that I see the demand basically staying pretty robust across all sectors of the folks that we do business with. Really not seeing a category I can point to to say, this has fallen off.
Thanks for that. As my second question, you know, the lease spreads accelerated on a cash basis on a GAAP basis. Is there kind of a continued upward trend here? I think you also mentioned that you have escalators in 90% of your new leases. Where did it stand before, and how accepting are tenants in taking on these escalators? Thanks.
Sure. Yes, the cash rent spreads, roughly this quarter, right at 9%. Trailing months is right in that neighborhood. That mirrors what we believe long term is our target for the cash rent spreads. Again, when we couple that cash rent spread with the embedded spreads that we're putting in the new leases, the combination of that really is what I think judicious CapEx spend, that kind of gets us that net effective rent and GAAP rent spreads that we're kind of looking at as a real answer to whether or not we're making progress in our business. As far as the embedders, we are in this inflationary area right now. We are taking steps to raise our ask.
We're asking between 3%-4% on deals today, which is higher than we've done in the past, and we're having pretty good success with that. I think everybody recognizes the inflation touches everyone and we're not getting left out of the program. We're actually having pretty good success getting that higher embedded rent step.
Thank you very much. Good luck in the back half.
Thank you.
Thanks, Michael.
Our next question comes from the line of Ki Bin Kim with Truist. Please proceed with your question.
Thanks, and good morning. You have a 240 basis point spread between signed and occupied. Could you just talk about what that ABR looks like and how much of it is actually being accrued in the income statement already?
The pre-lease %, Ki Bin? This is Mike. That's worth about $34 million of rent. We actually added some disclosure to our NAV page. I don't have the page number, but.
Page 33.
Page 33. Thanks, Christy. You'll see that we added some disclosure to get you to the value of that pre-lease pipeline. All of that is, again, it's pre-lease %, so that's embedded into our forward outlook of same property NOI growth. We did, you know, I'll take this opportunity to reconfirm that we've increased our outlook for the balance of the year by 100 basis points. It is largely driven by higher commenced occupancy and lower move-outs and the combination of the two. We'll continue to deliver space. We're doing so quite successfully. It's not easy, but the team's doing a remarkable job bringing that pre-lease pipeline into production. Then lastly, the other huge element from a same property NOI outlook is uncollectible lease income.
We've been just, you know, so surprised this year at how quickly that is healing and returning back to classic levels of 50 basis points. You know, last year was 175 basis points of bad debt. We came out, you know, thinking it'd be in the 100 basis points area. Now, we've lowered our sights again to about 75 basis points for the balance of the year. That implies a back half of the year that's basically on par or getting pretty close to that historical average. We feel, to confirm the points that Jim made earlier, really good about the in-place tenancy and the health of our tenants.
I can't help but just make a quick comment that while we talk about it is extremely important to get the signed but not occupied paying rent and to get you know get back to maybe more stabilized level. I'm very happy if it stays where it is, as long as our percent rent paying is also increasing, 'cause that means we're doing a lot more new leasing. That's a good thing. The fact that that SNO isn't moving much and our percent rent paying is increasing means we're doing more new leasing. That's a really positive sign.
Great. Second question from me. When I look at your tenant list, it's probably one of the healthiest tenant rosters I can see in the strip center space. It shows your top 30 tenants, so I'm assuming the rest is probably equally as healthy. How do you think about your tenant roster today versus pre-COVID? As there are some concerns about a macro slowdown or inflation impacts on different consumer segments, how do you think your portfolio and your tenant roster handles that situation versus what it might have been, you know, three years ago?
Ki Bin Kim, I think I'll be honest with you. I think we're absolutely a stronger in a stronger position today with our tenancy. Obviously, the last couple of years really split the wheat from the chaff. Our survivors are smarter, stronger, just like I said in the opening comments. They're savvy. They're reactive. They know how to get things done with a lot of adversity, and that gives me a lot of comfort. It really much much going into any kind of slowdown, I feel very comfortable with the folks we've got on the roster right now.
Okay. Thank you.
Our next question comes from the line of Craig Schmidt with Bank of America. Please proceed with your question.
Thank you. My question is on the contractual bumps you mentioned in the opening comments. I'm just wondering, what are your annual contractual bumps generally ranging? And do you have any CPI bumps in any of your existing leases?
Annual average is probably somewhere in the 2-4 range. CPI, we've got kind of a mixed bag. We do have some CPI, but generally, I would say, that's a pretty small portion. Most are stated rates. We have, at renewal time, we got some fair market value. We're kind of shifting towards that fair market value window at renewal. I think that gives. It's fair both ways, and it doesn't lock anybody into a predicament, if you will. I think that's-
That 2%-4% sounds like it's a little bit higher than it was. Have you been able to increase that?
I'm sorry, say that again.
The 2%-4% bumps sound a little bit higher than I'm used to hearing. I'm just wondering if you've been able to raise that in the last few years.
The 2-4 is new. In place is probably closer to the.
Yeah, let me. I'll take that one, Jim. What you typically hear us talk about, Craig, is our portfolio-wide impact to growth. If you look through the entirety of the portfolio, we're at 1.3% or so of growth. We're teetering on 1.4%. As the team and Jim articulated, on a deal specific basis, we're getting 2% to sometimes 4% growth on over 90% of our new leasing, and that's what's helping drive that 1.3% up. It's. There's 9,000 tenants that we're working through. We have move-outs that actually, you can have a tenant moving out that was paying 3% contractual increases. That's. It's a mountain to move, but we're making great progress in that regard.
If I could follow up. I mean, I understand your appropriate caution about the macro environment, but there are articles going around saying that 50% of small businesses could go out of business in the months ahead. You know, I just find that I have not heard anyone suggest a recession as bad as the Great Recession, and the Great Recession had nowhere near that number of damage to small shops. Are you seeing anything that would make you unduly worried about your small shops, even given the macro environment?
Craig, I'll take that one. Absolutely not. You know, I'll just reiterate what Jim just talked about with regards to the health of our tenant base. It sounds a little bit contradictory when we say we're coming into this, what may be, what may become a recession, if it's not already, from a position of strength. That meaning that the tenants that we have in place, the merchants that are in our shopping centers really have survived. I love that Jim said, "Separate the wheat from the chaff." Like really have survived a really difficult, challenging time from a demand standpoint, with COVID-19. We have really strong, good operators, and they, even those that may pull back on maybe new store opening plans, we have the best locations.
If they pull back, okay, I'm gonna open two stores in this market to one. I don't see an impact to Regency whatsoever in that scenario. I will go out on a limb and agree with you. I may very well be wrong, but I don't see another GFC in the future, at least not in the next two years.
Okay. Thank you very much.
The next question comes from Craig Mailman with Citigroup. Please proceed with your question.
Hey, good morning. Just quickly following up on the previous question on escalators. You know, you guys are running at above average retention rates, getting better escalators than you have in the past. Are the retailers who, you know, wanna keep the space that they have? Or let me ask, are you giving up anything to get the higher escalators, or are you getting the base rent increases that you would have wanted regardless, along with the better escalators? Can you talk a little about the kind of negotiation there with tenants?
Yeah. I don't think we're giving anything up to negotiate market. We're pretty good negotiators on rents, and that's what we believe market is today. We're seeing other landlords moving that direction, so we're just negotiating what we believe is market today.
As we think about kind of long-term trends in same store with the structural uptick in escalators here, I mean, what do you think your portfolio could, you know, start to post in the next couple of years as you really churn through and reset leases?
Yeah. Hey, Craig, it's Mike. You know, I'll go back to the 1.3% going to 1.4%. That's a big change. It sounds small, but it is a big change. In the overall picture of our forward outlook on same property annualized growth, we're still the two largest contributors in the near term will continue to be occupancy increases and lease spreads. Certainly embedding contractual increases is important to Regency's long-term outlook and our long-term growth. We will not stop embedding those increases into our leases, which we have been doing for a long period of time at this point. Right now, our eyes are on our ability to push commenced occupancy.
We've talked about 2022 achieving ±100 basis points in commencement, and we feel as good as we have six months ago in saying that, and we have good visibility to achieving that objective. To Lisa's point, if we think about even a softer economic backdrop. Given our relative position of strength, we feel like we can grow through a period of disruption and continue to add rent-paying occupancy in 2023. On previous calls, we've talked about another 100 basis points ± of opportunity. More to come on when that will. More to come when we put out formal guidance in our outlook for next year and beyond. There's at least another 100 basis points of commencement there to get back to our peak occupancy levels.
The other major contributor is lease spreads. Jim spent a lot of time, you know, in the 9% range, mid- to high-single digits is where we wanna be, where we need to be to achieve our objectives of averaging, you know, north of 2.5, certainly 2.75, before redevelopment contributions. When you add the investment and the reinvestment into our portfolio, we feel good about averaging 3% or better on a sustained basis going forward.
Okay. You know, maybe on a similar kind of aspect is, you know, right now, AFFO growth. You guys are a little bit impacted by the noise from collections. You know, with the higher retention rate, you guys should theoretically have less CapEx, higher net effectives. I'm just trying to think, as you know, maybe it doesn't fully correct itself by 2023. As you look maybe into the outer years, and not looking for guidance per se, but just a sense of where, you know, that longer term AFFO growth from the portfolio could start to trend and how that could look relative to peers in the sector.
I'll let you handle the peers component. Let's talk about a couple ways to interpret our disclosure first. Core operating earnings, I would point you right to that metric. We are unique in the space, and we use core operating earnings. Obviously, we're stripping out the impacts of anything that's non-cash. The only difference between core operating earnings and AFFO is gonna be capitals. When we think about capitals, we are planning and have been spending about 10%-11% of our NOI every year in maintenance capitals combined with leasing capitals. We don't see that trending materially outside of those bounds. Craig, I would probably point you more towards the upper end of that range at about 11%.
You know, given the amount of space we have left to lease, it's just gonna be a volume business, so we probably will spend a little bit more capital. To your point on prior year collections. You gotta eliminate the impact of prior year collections to get to more of a core AFFO metric. When you do that, as we think about our business going forward, our core operating earnings growth, therefore our AFFO growth, should match together, should move in lockstep with one another, because we just don't see any kinda disproportionate moving parts between those elements.
Okay. Thank you.
Sure.
Our next question comes from the line of Wes Golladay with Baird. Please proceed with your question.
Hi, everyone. Just wanna go back to you, maybe looking at your watch list. At this point in time, is it more skewed towards tenants with capital structure issues? Sounds like everything on the ground level is looking pretty good.
I think generally that's probably, yes, the right answer. There are a couple folks on there that really don't have debt issues as much as they've got operational issues. For the most part, you're exactly correct on that assumption.
Would you typically have a much higher recovery rate when it's just a reorg?
Absolutely. You know, as we look at that watch list and look at the guys that might be towards the top of that list, we do a lot of Placer.ai data and things like that to try to understand, look at sales, where do they fit in the organization. Fortunately for the vast majority of those locations, we sit in the top 60%-70% of their locations, which gives us great leverage when it comes to negotiating in a reorganization BK. In addition to that, we look at existing rents versus what we again believe market rents are, and I think we've got some pretty good opportunity for upside in a lot of those cases.
At this point, we're pretty comfortable where we are in the watch list and our position in that whole arena of where it goes from here.
We have a very detailed investment strategy, but it really comes down to, we like to own, acquire, develop properties where bad news is good news.
I guess maybe with, I mean, it sounds like the anchor space is pretty much spoken for all the vacant space. Would it be fair to say maybe you want some space back at this point? With, I think you mentioned you have some upside in some of these assets.
Yeah, as Lisa said, we like the opportunity too. Bad news becomes good news, and that's a lot of times getting those anchor spaces back can trigger the redevelopment that you're waiting on. Those are the kind of things with watch list tenants are strategic plans that we devise for every one of our assets. Our guys are, "If I get it back, what am I gonna do?" We're not surprised when it happens or if it happens, but we're ready in the event it does happen, that we know where we're headed.
Got it. Then for the redevelopment, I think the comment earlier in the call was the development and redevelopment will be a positive contributor next year. More specifically for the redevelopment, do you expect it to be that net positive contribution that you have in your algorithm? Or is there anything special that's gonna come offline that may be a little bit of a detriment to offset the positive from what's coming online next year?
More to come details, Wes, but on balance, it's gonna be a major contribution on a net basis. We will continue, I hope, to have some opportunities to frankly take some NOI offline to set up new redevelopments. In particular, the Abbot and the Crossing Clarendon are two assets that the teams have been working extraordinarily hard on. We've been from a finance perspective very excited looking out to when those properties start to stabilize, and that time is now. The leases have been executed. Great visibility into when we start. We'll start seeing some income start to come in at the very tail end of even this year, providing from this point forward, there's.
In those two assets, and if you put our 4 in-process ground-up developments into the bucket, by 2024, that's another $15+ million of NOI that we are creating in the portfolio. The short answer, we do anticipate returning to a positive contribution from redevelopments as we look into 2023 and 2024.
Great. Thanks for the time.
Thanks, Wes.
Our next question comes from the line of Ronald Kamdem with Morgan Stanley. Please proceed with your question.
A couple quick ones. Just looking at the shop occupancies. You know, it's been ticking up nicely over the last 12 months. I think I heard you say earlier that there's maybe 100 basis points more to go to get to peak. Just trying to get a sense of just for some context throughout the cycles, you know, how high can that shop occupancy get? Could you get to sort of the 93-plus range, or do you start to run into some structural factors? Thanks.
Yeah. The 100 basis points, by the way, was an all-in commenced rate. That's shops and anchors. We look at 92.5%-93% as a kind of a top end from a shop percent lease perspective. That's where our eyes are. We believe in the quality of the portfolio. We believe we can replicate those ceilings, and the teams are working hard to do that.
Great. Just my next question was just trying to back to sort of the breadcrumbs of the growth algorithm. You have a really great breakdown of sort of the same store NOI and the SUP. I see base rents at 3%. Just trying to get a handle of some of the other two big lines on collectibles, and this is year-to-date numbers. On collectible, adding 4.7%, recoveries, a headwind of 3.9%. As you're thinking about sort of the future and those sort of presumably normalized, is this sort of the right new way to think about it in terms of the long-term growth prospects of the company?
Let's first make some short-term comments, and then we'll get into the long. I appreciate you noting the new disclosure, by the way. I hope everyone takes a look at that. I think it's really helpful. What it first does is highlights that base rent growth, as we've been trying to point people's eyes to, is the best line item to look at for the health and forward quality of our earnings stream in the near term. What you see there is, yes, 3% growth outside of the noise in the first half of this year. We should do better than that to finish out the year on the base rent line item. That will not be a decelerating impact. That will be an accelerating impact.
We will continue to have tailwind, as I mentioned previously, from bad debt expense or uncollectible lease income, as the portfolio very quickly moves back to historical averages. Again, 175 basis points last year, moving to about 75 basis points this year. 50 basis points, Ron, being our long-term sustained average. There is noise in the other line items. We've got just a lot of COVID era type of adjustments still moving through really 2021 that are impacting all of the other components of growth. I think looking forward, our eyes are focused on base rent growth, the amplified impact of recovery income. As you lease up space and raise your commenced occupancy, you're gonna amplify that growth by picking up margin, on your collections.
We add into that the investment and what we just talked about with Wes and the contribution from redevelopments. You put all that into the bucket, and we feel great about achieving our long-term objectives of 3% or better through redevelopments. In the short term, we should do better than that from an occupancy perspective because we have room to grow rent-paying occupancy.
Also, that's certainly the same property NOI growth, kind of long-term growth model, which is a very large component of the going forward growth for the company. But we also have the ability to invest the very high level of free cash flow that we generate, which will also be an important part of our long-term growth of core operating earnings per share. I point you to our investor presentation, not just the disclosure, where we do a very, thank you, team, a very nice job of illustrating our growth model going forward. That's on a stabilized basis, so it's not even actually accounting for the occupancy increases that we are seeing today and we will continue to see in the near future.
Excellent. That's all my questions. Thank you.
The next question comes from the line of Han Jing with JPMorgan. Please proceed with your question.
Yeah. Hi. I think in the past you've talked about potentially reaching back to 96% leased occupancy as early as late next year. I guess given your-
Your commentary about the uncertainty that's in the market right now, has your thinking around that changed at all?
I'm happy to jump in. I will reiterate again that regardless of the macro backdrop, we feel really confident about the quality of our properties and our going forward health of our business. Just repeating really what we said in our prepared remarks. We're entering this with a position of strength, as we have worked through a lot of dislocation and disruption through the past two years. Our operators, our tenants, our merchants are in an extremely healthy position. We believe, and Jim talked about how we've watched them be adaptive and react to and be flexible.
I really believe that even if there is softening consumer demand, which we're not seeing because of, again, our trade areas are supportive of consumers that are able to absorb a little bit more. Even if there is softening demand, we truly believe that they're gonna be able to adapt and be flexible as we've seen them already do. Then with that, retailers and merchants play a long-term game as well. It's not just about the next 12 months, and they're also positioning their companies for future growth. They're gonna need new locations for that future growth, and they're gonna desire to be in the best locations. We feel that we are really well-positioned to be able to work with them and help them meet their goals as well.
Got it. Thank you.
The next question comes from the line of Derek Johnston with Deutsche Bank. Please proceed with your question.
Hi, everyone. Good morning. I'm sorry, I know we spent probably too much time on this, but it's important. I'll try to be pointed because investors definitely seem concerned about the forward outlook over business trends in the second half, much more so than strong results and maybe even pipeline commentary. You know, look, we believe Regency is very well positioned, you know, could you speak to actual conversations with tenants and prospective tenants? I guess the question is, you know, are we sensing or seeing any slowdowns in decision-making right now, or is this exercise really mostly conjecture at this point? That's kind of what I'm trying to figure out.
Derek, I would tell you that we're fresh off ICSC out in Vegas. Trust me, I've been at this game a long time, and I'm looking for smoke more than anybody and just not seeing it today. There's continued positive attitude towards growth. Deals are getting done. Yes, we're looking hard, but you're not seeing any cracks at this point in the armor.
No, thank you. That's helpful, you know, that's also in line with peer commentary. Just, I guess, sticking on leasing, the Abbot in Boston, just wondering if we can just get an update on the early leasing there and tenant interest. I know it stabilizes at 24, right? But you do have some rents commencing, I think, in the back half of this year. Just really any color on the demand, the interest, of this mixed-use asset and really how you feel about the project and how prospective tenants are reacting as well. Thank you.
Sure. The Abbot is nearing construction completion. It looks fantastic. If you get an opportunity up in the Harvard area, please poke your head in. I think you'd be impressed with what we've accomplished up there. Leasing momentum is strong. We're 100% leased on our retail. You know, it was a little slow on the office side coming out of COVID. They were close to go. But we've had great tenant opportunity on the office side, and I believe we just signed it. There we go. Just off the press, just signed a lease on the majority of our office space in the tower. Very positive news. Like I said, the project looks great.
Tenants are under construction, should be opening up. Now that we've got this office lease executed, we'll have a good report for next quarter.
All right, excellent. Congrats. Thank you.
Thank you.
The next question comes from the line of Juan Sanabria with BMO Capital Markets. Please proceed with your question.
Hi, good morning. It's Eric on for Juan. I was just hoping if you could talk about, you know, how your tenant underwriting has changed post-pandemic and, you know, kind of your thoughts today, you know, given the potential slowdown in the economy?
I think our underwriting really has been consistent. We are pretty conservative in underwriting. We embed contingencies. We've increased those contingencies as we saw interest rates increase, as we saw slowdowns from supplies and other things. I think our underwriting has continued to keep up with the moving parts in the economy. From an underwriting standpoint, we still are able to underwrite deals that still meet our threshold from a yield perspective with good visibility towards expectation for cost.
Eric, I'll jump in and add. I don't, the way your question was framed, I think we look at tenant underwriting, whether in the operations side of the business or project underwriting in the investment side of the business for all seasons. We don't necessarily, you know, look at the economic backdrop and change. We have a very focused strategy on our merchandising mix and what types of operators we want to partner with and do business with, and that's been consistent through all seasons and in all economic cycles. We make adjustments on the margins in our investment activity to account for or provide for a changing landscape in cost, as you would expect us to do. Really, we don't, you know, you push the accelerator or push on the brakes materially in any way.
We apply our very long-standing, well-honed strategy on both sides.
Oh, great. Thank you. Just to follow up on foot traffic, you know, given your defensive portfolio, just curious, you know, how are your centers performing in versus the competition in the respective trade markets?
As you would expect them to perform. We are not, you know, we believe we own market dominant centers, trade area dominant centers. That is our objective. We call it our DNA approach to investment. We use, you know, premier high quality as these designations. They. The reason we use those designations is they outperform on several metrics, one of which is tenant demand, consumer demand, and they continue to outperform on consumer demand. Our centers are the preferred centers, generally in those preferred trade areas. Foot traffic levels would support that outperformance. Sales would support that outperformance.
Tenant demand.
Tenant demand and rents.
Yeah. I think the best.
Importantly.
The best scorecard that you can really use for that. Yes, you can look at foot traffic and should, but what are average base rents? Because that's what the market is demanding, so that's what the retailers are using as their basis for the sales that they can produce and sales. In both cases, as we've already talked about, earlier today, as Jim Thompson when we talked about bankruptcies, Regency is in the very top % in both of those categories.
Great. Thank you, guys. Appreciate it.
Our next question comes from the line of Paulina Rojas with Green Street. Please proceed with your question.
Good morning.
Good morning, Paulina.
You talked about the strength of your tenants, but in terms of your small shop cohort, I hear from you and your peers that they are stronger than in the past. Aside from the fact that they are survivors from a period of great disruption, which is, yes, by itself very telling, are you able to track any other hard metric, sales leverage, to substantiate the statement that they are stronger than in the past? I know the access to information is limited, but I was wondering if there is anything at all that is more tangible you can focus on and track over time.
Certainly sales has been a major indicator in the past, and that we continue to use that, which with our small shop tenants, we are able to get that kind of reporting. That's probably our best metric to at least judge historical performance. We obviously look hard at credit going in, but it's also an important factor with small shop tenants is their past performance from an operator standpoint. You can walk in a retailer store and get a pretty good sense whether they're a good retailer or not, and that's what our folks in the field do an excellent job of staying close to our tenants. You can read the tea leaves, and that's.
I mean, it's hard to put it on paper and give you a metric, but that's how we you have to run your business to be able to stay ahead of that. I think that's one of the things we do very, very well at the asset management level is really understand what's going on behind those tenant doors. You mentioned sales. How frequently can you have access to their sales performance? We generally take a deep dive on an annual basis.
I think then we've heard, and I know, Paulina, you've heard us talk about this as well. We have 22, maybe a little bit, say more than 20 offices, across the country with people in the local markets that are working with our tenants really closely. We absolutely look at our reported sales, but also just having good relationships with our tenants, with our customers, is really important to understanding the health of their businesses, the challenges they may be facing. I think it is, we really rose above some of the challenges in the pandemic because of that, and we will continue to do so in good times and in bad times. That's also an important part of it.
It's not a hard and fast metric and nothing that we can actually report, but it's certainly those relationships, those conversations, and understanding, what's important to them.
Thank you. My other question is regarding commenced occupancy. I saw it increased by 10 basis points sequentially, less than 1Q , it's usually affected by seasonality, right? My first question is there any reason behind that softer sequential increment? The second part is, I think you mentioned you were targeting a increment of 100 basis points for this year. Can you please confirm that that refers to same-property in-place occupancy on average for the year, not end-to-end? I want to make sure I am understanding the target of 100 well.
The commenced occupancy increases that we're targeting is a period-based measurement, so it'll be at year-end. We should be 100 basis points up from where we started. I think we're already 40 basis points through the first half of the year. That speaks to the confidence we have in delivering space from that pre-lease pipeline over the balance of this year, Paulina. But that's a spot rate, so what we're excited about is the impact on 2023.
Yeah, occupancy commencement should be stronger in the back half.
Yes. It needs to be to achieve our objectives of 100.
Yes.
You know, it's ±100, but we feel good about delivering the space that's, again, already contracted for. It's just a matter of our tenants building out. This is. I'm not making light of how difficult this can be. The teams are doing, I mean, daily hard work delivering spaces, building out spaces, so we can get to rent commencement.
Clear. Thank you very much.
Sure.
As a reminder, if you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate that your line is in the queue. Our next question comes from the line of Linda Tsai with Jefferies. Please proceed with your question.
Hi. You've got 12% left on cash basis accounting. Last quarter, it was 14%. Just given the trajectory you've been coming out of from the pandemic, how many quarters might it take to get to a normalized level of cash, you know, % of tenants on cash basis accounting?
Hey, Linda, it's Mike. I don't have a discrete answer to your question, but we're making great progress. I do think we do have some visibility to at least another 1%-3%, kinda sticking with our policy of what a tenant needs to do and how they need to behave to for us to convert them back to accrual accounting. We do see another 1%-3%, I think, in our near term impact, which, oh, by the way, would include another, call it $2 million-$5 million of non-cash straight-line rent conversions. We don't guide on that number in the supplement, but we do talk about it on this call. Beyond that, the question becomes, well, what is your normal % of cash basis tenants?
That's a little bit harder to get a gauge on because the leasing standards also changed as we look at our historical averages. We think our number's probably in the mid-single-digit area, the 5%-8% range, somewhere in that area ±. We've got a little bit of room to run, but we're nearing the end. We'll continue to, you know, make progress as we have.
I appreciate the question and the concern for it. It's a metric that we have all begun to report, but the important thing to really focus on is bad debt expense, because a tenant can be a cash basis tenant, but paying rent. As Mike said earlier, we are seeing our bad debt expense return to more typical historical levels. That's the more important thing. That's what we focus on here as well.
Thanks for that. The jobs report came out this morning and was better than expected with decent hiring in retail, including grocery and general merchandise. Are you hearing this as well from your tenants in terms of easing labor shortages?
I think generally speaking, what we have seen, and the same conversations that we're having with our tenants, that we have seen things ease. I think we even said that last quarter, so it's a little more than even a quarter, where we've seen some easing of both labor shortages and also supply chain difficulties, both.
Thanks.
Our next question comes from the line of Michael Gorman with BTIG. Please proceed with your question.
Yeah, thanks. Good morning. I know we're running a little long, so I'll try to be quick. Stepping back for a minute and looking longer term, Lisa, you talked about ESG and some of the targets you've laid out in your new report from the spring. I'm just wondering if you could talk about how we should think about the capital commitment to these initiatives over the next 8-10 years or so, and internally, how Regency is approaching underwriting the different projects and different initiatives that you have on the emissions front.
There will be an additional cost, an incremental cost, but there's also savings, as we do implement some of the energy efficiency things that we've done over the past 13 years, from water conservation, LED lighting, and will continue to do. We'll also continue to perhaps generate some revenues from solar panels. From a material standpoint, it's not material. What's more important is the fact that we are really focused on environmental responsibility and corporate responsibility within our company. It truly is a foundational strategy. As we think about and talk about new investment opportunities, it is part of the conversation. Every acquisition, every development, we will look at the impact, essentially, to our targets and to our goals and objectives.
It's not a material cost.
If I may just add a little bit more detail there for you, Michael. 80% of our objectives can be achieved by really pulling two levers, right, through 2030. It's LED light conversions, and it's the addition of solar panels on property. To Lisa's point, LED light conversion is already part of our plan. That is, in effect, a neutral element of our expense rate. Solar panels, to her point, is where you actually save some money. In fact, you have an ROI. You make money on the solar panel installation. Just for a little bit more added color. The balance, so where's the other 20% gonna come from?
Innovation is gonna play a big role, and then we might have to buy some RECs as well, which they'll be high-quality RECs, and we'll be very smart with that.
That's great color. Thank you. Just maybe following up on that, you know, I understand that it's core to Regency anyway, but I'm wondering as the entire market evolves, as you're having more conversations around developments, redevelopments, maybe even acquisitions and lease discussions, I'm wondering if you're seeing Regency's dedication to ESG come up in those conversations as maybe a competitive advantage, as something that maybe helps in these negotiations and in these discussions, for regular way business.
Let me start on the capital market side. Yes. Whether it's tapping the unsecured bond markets or whether it's our, you know, we have a bit of a financial incentive within our revolver, but we're seeing it permeate through the capital markets. We do believe ultimately, whether it's access or whether it's pricing reductions, there will be some marginal benefit to us. On the operations side?
On the operational side, I would say there are kindred spirits that appreciate what you do, but I don't think it's ingrained at the real estate level as much as it is in capital markets.
We do development.
I was gonna say, since we're tag teaming, and then I'll take the transaction side. On the transaction side, we were part of a bid process, if you will, on a portfolio of properties. Unfortunately, we were not successful in it. It was a major part of the bid as to the efforts that the company is putting into the E in ESG. Yes, it is very important to other stakeholders as well.
That's very helpful. Thanks, everybody.
Thanks, Michael.
Thank you, everyone. At this time, we have reached the end of the question-and-answer session. I will now turn the call back over to Lisa Palmer for any closing remarks.
Thank you all very much. Appreciate your time with us. As some of you may be heading to the shore or the beach or Long Island for the weekend, enjoy your weekend. Thanks, all.
This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.