Start. Alan can color it up when I finish. For as long as I've been at Regency, which is, I will round up, nearing three decades, the grocery business is a really tough business. It's a low-margin business, and our strategy has been consistent over those three decades: partner with the best operators, and the best operators continue to not just survive but thrive. Investing in the store experience, investing in servicing their customer online, buy online, pick up in store, and investing in delivery. Again, though, I will tell you that they understand from the cost structure that it is more profitable for them to bring the customer into the store and let the customer do their own picking and putting in the cart. The physical bricks-and-mortar presence of the grocer is vitally important to their success, and they understand that.
As a result of that, they are continuing to expand nearly every grocer in the U.S.
Yeah. I would just add that I think given that there are so many that are expanding and the intense competition within that space, they are all having to elevate their game to provide a better experience for the consumer, or they will become irrelevant. Specific to Regency, we generally are aligned with a number one or two grocer in a trade area or a specialty grocer that provides a special offering. As we look at year-to-date data from a foot traffic perspective, it is up specific to the grocers as well. For us, within our portfolio, we are proud of the volumes that they generate and the quality of the operators that are within the portfolio, giving us the ability to really merchandise with some exceptional adjacent retailers in that space.
With some of the, you talked about some of the secular drivers or tailwinds that you're seeing to the business, good leasing environment. Sounds like not a lot's changed since April 2nd with regard to tenant demand. I mean, how do you think about the growth algorithm for the portfolio? Mike, maybe this is for you. Can you talk a little bit about some of the drivers of growth and how that's evolved over the last few years to what you're seeing today and what you're expecting for this year?
Sure. Let me start just from a steady-state algorithm basis, then I'll distill it down to this year. Just business model, steady-state. We aspire to grow the same property portfolio by 3% plus or minus every year. That's our objective strategically. I would call that occupancy neutral. You lever that modestly, as we do with our balance sheet, as Lisa alluded to earlier. That's going to get you another point of earnings growth. You add to that this best-in-class development program where you're adding new NOI. You're manufacturing new NOI by reinvesting your free cash flow. You're going to generate another 100 basis points of growth in that area. You're at a 5% kind of algorithmic growth story, plus or minus.
You find yourself when in the business cycle with rising and falling occupancy, which can either detract from, or in this case, as we currently sit in 2025 and looking into 2026, we are adding occupancy. We have hit peak percent leased. We aspire to maybe even blow through that, but we have not hit peak commenced occupancy yet. We still have room to run. We are 300 basis points spread between top-line percent leased and commenced occupancy. Steady-state run rate is 180 basis points plus or minus. That tells us that we have room to continue to commence occupancy while minimizing tenant fallout and tenant risk, which could be another question that we could dive into. To Lisa's point on the strategic initiatives on development, $250 million or more of starts per year, we have achieved that for two consecutive years. That starts in 2023 and 2024.
I like our setup, and I like our prospects to do that again in 2025. That NOI will also begin to come online comparatively. It has in 2025. More importantly, it'll continue to come online in 2026. I think we're set up pretty well here from an earnings growth perspective. Going forward, as we achieve steady-state, I think we're also set up very well to perform on a relative basis.
As a result of that performance and earnings growth, the dividend growth as well.
Yeah. We'll replicate that with dividend growth.
We have the, and I know it's getting to be a little bit more in the distant past, but it's still something that we are very proud of, the fact that through the pandemic, we did not cut our dividend. We maintained our dividend. We paid it every quarter, and then we grew it two years past. As we grow earnings, the dividend growth should match that.
Maybe we can talk real quick about the tenant watch list a little bit. Mike, you mentioned that. We might talk about it, and maybe we can get out of the way real quick. What does the watch list look like? It is retail. The business is always evolving. There is always some tenant churn and turnover. How do you feel about the health of the tenant base today?
We feel great about the health of the tenant base. I think we feel as good as we have felt in a rounded 30-year kind of look-back period. To your point, it's evolutionary. It's going to hover in the 150-200 basis point range, generally speaking. Tenants are going to evolve. Tenants are going to fail. It's part of our business. As far as we look across our watch list, it's the same as it has been. Other factors, post-COVID recovery. COVID isn't that far away. COVID cleared out much of the weaker retailers, so we're growing off of a very strong base. Post-GFC, this company has recycled a tremendous amount of assets. The recycling days are long behind us, but we're very proud of the quality of the shopping centers that we currently own.
That combination of owned assets and hand-selected tenants that are currently occupying our assets gives us the comfort that we will be pretty resilient on the move-out front.
The results speak for themselves. I saw Alan reaching for the microphone, so I'm going to let him.
That's exactly what I'm going to say.
I know exactly what you're going to say. I'm going to let you say it.
I would tell you that durability of occupancy is something we are very proud of. We're very intentional in how we merchandise our assets. When you think about the watch list, look, bankruptcies are a normal part of the industry. It happens. When you look at Q1 results, Regency is the only one in our peer sector that actually grew rent-paying occupancy in the first quarter. That's not an accident. That really is largely driven by the limited exposure that we have had to a lot of the names we all know that are out there that have been filing, have recently filed for bankruptcy, and how we're very intentional in how we qualify our operators. Look, we're not immune, certainly, to bankruptcies. We're not immune to store closures.
I was very proud to see that our rent-paying occupancy actually increased while I think that the sector was facing a little bit of headwinds in the first quarter.
Does anybody have any questions? All right. Maybe we can talk a little bit about the development platform. You talked about targeting $250 million of starts a year. You have a pretty healthy pipeline today. There has not been a lot of new construction, though, across the retail industry for a number of years now. How are you sourcing deals? How are you making deals pencil today?
Development's not easy. There's no question there has been limited new supply. Again, I said over the last 15 years, which is benefiting our operating metrics and fundamentals. Development is not something that you can turn on and off. You can't build something overnight. Regency has always been in the development business beyond my 30 years, going back to, said we've been a company since 1963, public since 1993. It's in the DNA. As a result of that, the experience, the team is who it starts with. The team, the experience of the team, the track record of the team and the company, the reputation matters. The reputation then builds with the relationships. The relationships with the grocers, which you've heard Alan talk about, the relationships with master plan community developers, the relationships with homebuilders.
That same team, again, that is across the country, has relationships with local people in the business, land sellers that really provide that source of opportunities. Again, our cost of capital. It is a recipe of the combination of all. It is not necessarily just one individual thing. You need them all and, again, cannot build it overnight. We have been successful in sourcing those opportunities, as Mike said, $250 million each of the past two years with visibility to doing it again this year. Not easy. Really proud of the team. Because of all of those relationships and the ability to source the land, we target a spread over what we would consider market. It is a minimum threshold market cap rates of 150 basis points for ground-up new development.
There have been times, there have been periods of time during my tenure with the company where that has really expanded. When we were developing to 7% returns on invested capital and market cap rates were 4. Today, for the quality, let's say, of what we would buy and develop, say, 5-5.5, and that 150 basis point, if you take the top end of the 5.5, 7%. That is a threshold, but we have been doing better than that. Again, someone called it today in an earlier meeting our secret sauce. I just gave you the recipe for it. The recipe is really hard to copy.
Why are we not seeing more development really start to pick up in the open-air shopping center space? The grocer demand's pretty healthy. The demand small shops seems pretty healthy. What are the challenges to really getting development off the ground here? Why are others not doing more ground-up development?
Again, I'll just go back to exactly what I just said. Those are things that you can't build overnight. It's what has taken decades of our track record and experience to build. As a result of that, we have been successful. You could say that lower interest rates might drive more people into the business. Higher rents could drive more people into the business. There would be more competition. Even if those things do happen, I would still say we have the best platform in the business, and we will get more than our fair share and continue to be able to achieve our goals.
What about acquisitions? Where do acquisitions stack up today in terms of your capital deployment initiatives, and how do the returns compare to what you're seeing for development?
I'll take it. Yeah. The priority is going to continue to be development and redevelopment. The way we've organized our investment thesis is that the free cash flow on a leveraged neutral basis will be prioritized for our development business. That being said, we will have excess free cash flow, leveraged neutral free cash flow that can be deployed into acquisitions. What we are looking for on acquisitions are definitive, consistent quality, consistent to accretive growth profiles. Thirdly, and most importantly, we want to make sure we're allocating capital on a accretive-to-earnings basis. The third one is where it becomes more difficult.
The third one is the pricing of real estate has become so efficient, commercial real estate, grocery-anchored commercial real estate, that our ability to drive earnings growth there can be more limited, which is why we are so grateful and appreciative of this development business that we've built over many decades of time. We have a prioritized earnings, definitive earnings-accretive place to invest our free cash flow. That being said, our track record would tell you that we will find opportunities in the acquisitions market. We are leveraging the same dispersed platform that we do on development to source acquisitions. We will find the needles in the haystack across the country where we can meet those three objectives, and we can deploy our capital accretively and add high-quality grocery-anchored shopping centers to the portfolio.
I think that clarifying what Mike Mas said, the third only is difficult if you check the first two first. It's easy to go find a six-plus.
Lower quality.
Lower quality shopping center acquisition. Consistent with quality and consistent to accretive to our future growth rate. Once you check those boxes, that's when third becomes a little bit more challenging.
Let me just add some color because I'm sure people are interested. We are often asked, where do we see cap rates today in the private market? Maybe you were alluding to that. We're easily seeing cap rates range from the low fives to the low sixes kind of all day, every day for the quality that Lisa described, and especially if there's a grocery-anchored component there. Making that, it's a highly efficient transactions market right now, private and public. We had a hand up over here.
Yeah, sure.
I think the question was how we value retail investments with this shift to online. The percentage of retail sales for e-commerce has certainly grown. That was happening pre-COVID. There is no question we saw a step up, like an acceleration of the market share of retail sales moving to online. I will go back to what I said earlier. What we also all learned, and I say all, the owners of shopping centers as well as the customers as well as the retailers and service providers, is that renewed appreciation for the physical presence. I said this before, you can buy anything you want from your home. What people learned, what the customer learned during COVID, is they actually like to shop. There is a difference between buying and shopping. That is the renewed appreciation for the customer.
It is why when we talk about how we operate our shopping centers, it is not just leased to anybody that is going to fill the space. We think about merchandising. We think about placemaking. We want to make sure that our shopping centers are an inviting place for people to shop. They want to come there. They have so many choices. That is the consumer. That is the shopper. On the retailer side, again, learned very, very quickly through COVID how expensive it is to fulfill the orders from a distribution center home delivery. Target is the one that is probably most transparent with the percentage of their online sales that they fulfill from their stores. It is north of 95%. There is still an incredible value to being close to the customer and servicing the customer from the four walls of a physical store.
Any other questions?
Do you have any thoughts on the shape that the store industry struggles and how that affects occupancy?
Yeah, that's a great question. Certainly in light of Rite Aid filing for a second time. We have not signed a new drugstore lease in nearly 10 years. There has obviously been some significant consolidation. We had nearly 5% of our ABR in the drugstore sector at one point. We are 2.5% now. Consolidation continues. I think you probably read that CVS, through this bankruptcy, is acquiring 60 stores from Rite Aid in the Pacific Northwest, notably Washington and Oregon, to expand their footprint in that market. Beyond that, I think you are going to start to see further consolidation of closed stores. Those remaining stores, although they still need to go to auction, it will be some grocers that take the larger footprint ones. It is going to be the Five Below, the Ulta, the Sephora.
There's going to be a whole lot of different concepts that are going to step in and take those. I would tell you that consolidation will continue. TBD on Walgreens, right? Sycamore Partners announced that acquisition that will close Q3, Q4. At the end of the day, it's something that you got to keep a watchful eye on as you do sort of a lot of the sectors that seem to be contracting a little bit. We'll see where it takes. At the end of the day, I will also say ours are end caps. They have drive-throughs, and they're highly sought-after real estate. I can speak for the drugstore locations within our portfolio. We feel really good about the backfill prospects of those spaces just given where they're located, both in the trade areas, but also where they're located within our assets.
Any other questions? Time for one more, maybe?
Same with the tenant theme. I guess among your largest tenants are Kroger and Albertsons. Their merger agreement was called off last year based on the resistance by the antitrust regulators. We've got a new administration, new regulators. Recently, we saw Nippon Steel pull their deal with U.S. Steel together. Do you see any likelihood of a reignition of the Albertsons-Kroger deal and what you might be doing to prepare for that if there is?
I don't know that I can predict that. I think it's unlikely. If it were, just as we talked about it while they were in negotiation, there were benefits to both outcomes, either the merged company or two separate companies. That would still be the same. A very similar answer to the drugstore question, the real estate in which we own feels really comfortable. We have the grocery locations of both of those tend to be in the higher, they're in the upper quartile of productivity in their chains. If you hadn't heard my answer before, merged company, more powerful, stronger operator. We would have, they would have become our largest tenant. Feel really good about that. Separately, we have two strong operators that are able to provide even more expansion and competition within the market. I think it's unlikely.
If they were to come back together and try again, we again would be comfortable with either outcome.
Thank you.
All right. I think that concludes the panel. Thank you, everyone, for joining.