Everybody, this is Bank of America's Fireside Chat with Simon Property Group. With us today, we have Brian McDade, Simon's Chief Financial Officer and Executive Vice President. So with that, we will kick it off with some opening remarks from Brian, and then we'll head into a Q&A. And at any point, please feel free to jump in with any questions. So with that, I'll turn it to Brian.
Well, thank you, Lizzie and Jeff. Thank you for the opportunity to meet with everybody today. Really pleased to represent the Simon Property Group here, and would love to, you know, open the floor up to questions to investors or, and/or Jeff or Lizzie for questions.
Great. No, no, no particular opening remarks. Why don't you maybe talk about the, you know, year- to- date, I guess, or maybe over the past year since-
Sure.
... we attended last year, some of the accomplishments, some of the things you've achieved as a company.
Sure. Look, the company continues to prosper and grow. You know, we are really at the forefront and intersection of retail real estate globally. You know, the company is at the forefront. We operate across three different platforms: our mall, our outlet, and our Mills platform here domestically. Certainly, we continue to see opportunity to drive occupancy throughout our portfolio. We have a great opportunity to reinvest and reimagine our real estate and have been doing so for the better part of the past decade, and so really excited about the physical environment. It is, it has been proven here to stay. I think one of the lessons, certainly over the last five or six years, was that e-commerce was going to be the center of strategy.
I think COVID really kinda highlighted the need for the physical store and the merging of both digital and physical into one distribution channel. We sit at the crossroads of that and intersection of that. So the company is in a really good place. It has strong financial footing, and we're really excited about the balance of this year and looking at 2024.
We do have a global audience, and so maybe we could just quickly discuss, you know, U.S. regional malls versus, you know, shopping centers. But obviously, for your portfolio, I'm talking about, you know, regional malls and how the health of regional malls versus you also own, as you said, Premium outlets and then the Mills platform.
Sure, yes. We operate across those three platforms here domestically. You know, as we look at our real estate format, you know, we are seeing a differentiation across the asset base. We find ourselves with incredibly located retail real estate, which allows us to meet the demands of our consumer and our retailers. As we look at the U.S., it has been both the regional mall, the outlet, the Mills, and strip and power centers have been undersupplied for the better part of the past decade. If anything, supply is going away. So the supply-demand imbalance is favoring landlords, certainly here in the United States. Specifically, you know, as we think about our business relative to the strip and power center business, the competitive dynamic looks a bit different for ourselves.
We're relative to the balance of those that operate in our sector, find ourselves in a much stronger financial position, allowing us to reinvest in our assets and really partner with our retailers to help them on their real estate journey. And so it is a competitive advantage that we continue to take advantage of and inures to our shareholders' benefit, and also to the bottom line benefit of the company.
In 2022, it was a record year between opening, store openings and store closings. There was a lot of concern heading into 2023 in terms of openings, and I think the May ICSC conference in Vegas was very helpful. Investors really felt it, right? The vibrancy, the lease discussions, right? I'm not gonna say lease deals 'cause it's no longer a deal-making conference, but this is, again, where the retailers, the tenants, are meeting with the landlords, and it was extremely busy. Can you talk about the, you know, the leasing environment right now as we're heading into the fall? Lots of questions on the consumer, and we get asked a lot, again, like: How does all this impact the retailer decision-making in terms of store openings?
Sure. You know, there is—there was and continues to be great demand from the retailer community for physical real estate, and I think you're hearing that across all public companies that operate in the sector, whether it be on the strip center, the Outlet center, or our own or the Mall business. And so, those conversations at the May ICSC were incredibly dynamic. There was a lot of new business that was done. If you look at ourselves, roughly 30% of the activity that we've seen in the last 12 months was for new deals, not just simply renewals. So retailers are expanding their footprint, they're optimizing their footprint, and they're doing so in the best locations with the best landlords. That has not changed.
Retailers are investing somewhat countercyclically in the sense of they're, they've recognized that the store is the center of their nucleus, and technology and e-commerce are gonna be services that they're gonna provide to their retail customers. But comes down to their store, having that nameplate, having the ability to drive the physical and digital interactions together, and that's really driving the demand from the retail community across all of the asset classes, specifically in the retail world. You know, retailer balance sheets are, at least in with respect to our tenant base, are in as good a shape as they've been in the past decade.
Certainly during COVID, there was a lot of clean-out of those underperforming tenants, and subsequent to then, a lot of retailers have materially i mprove their financial position, given the velocity of sales that they saw for a 36-month period of time. They are all stepping back and now really optimizing that real estate footprint, really looking to take advantage of where the physical and the digital cross-pollinate. And if you look at, you know, a variety of data studies out there, it's apparent that as retailers are opening up new physical stores in certain markets, their digital penetration rate materially increases in those markets, and the inverse is also true. If they are closing stores, their digital penetrations in those markets reduces. So the linkage between physical and digital is here to stay.
Physical is going to lead the narrative now for the next 10 years, and really, the growth of the industry, we would expect over the foreseeable future, will come from the physical expansion.
You know, and Bank of America Institute talked this morning about a resilient consumer.
Mm-hmm.
Consumer continues to spend, but again, there is this concern over the consumer. If we do see a slowing consumer, you know, I don't know, let's say, holiday sales are a bit weaker, does that impact store openings that, you know, your conversations and... You know, as we head into 2024, is this, you know, this is a concern? Is it, you know, should people not be as concerned, or, or what are your thoughts?
It's interesting. I think we had this question last year, and I think the answer was: We think 2023 is gonna be a slowdown, 'cause that's what was predicted. I think, you know, we do expect that we're gonna see a bit of a turndown in 2024, probably what we were expecting to see in 2023, to be candid. You know, the long lags of the Fed are probably longer than anybody was anticipating. But, you know, ultimately, the decision-making of retailers isn't dependent upon one holiday season by and large. You know, the retailers are strategic in nature, and they are looking to secure, at least in our business, those locations that make the most sense for them long term.
So while on the margin, if we do see a softer holiday season, I'm sure there'll be one or two decisions that'll be inconsistent with what was expected. But I do expect that or we do expect that we will continue to see strong demand from the retail community, even if there is a slowdown in the holiday season, because they're looking to secure the most profitable locations for their businesses on a long-term basis.
Brian, how would you characterize luxury demand for space today? Maybe what new trends are the retailers coming up with? And I know Simon did report a decline in sales per sq ft last quarter, so owing to like an easing luxury comp year-over-year.
Sure.
Can you just talk about how luxury demand is trending?
Sure. You know, luxury is certainly one of those tenant categories that thinks long term, and they're looking to... You know, as you think about the broader geography of the world, if you think 5-10 years ago, growth from the luxury segment was coming from APAC and their growth in China. That has certainly changed materially in the last 5-7 years, and growth now is expected to come from the U.S. for a lot of these brands and banners. In addition, the format of luxury retail in the United States is going through a fundamental transformation. Historically, luxury, you know, there was a lot of wholesale distribution through department stores. From the luxury brands, they are now starting to break those bonds and want full-price nameplate stores on their own.
They don't want to be sitting behind someone else's nameplate. They want to control that customer relationship, and so what you've seen is the luxury community is moving out of department stores and into full-price in-line stores within our asset base. Those decisions that are being made there sometimes are done 3-4 years in advance of actually the opportunity to take space because of the competitive nature of that industry as a whole. So we've not seen any material deviation in demand from luxury. It continues to be strong. And what is unique about our own business is that as luxury retail looks to open up their full-price store concepts, they naturally will need a secondary channel of clearance or distribution, which is our Outlet platform.
So we're actually getting the benefit of this underlying trend in the U.S., where luxury retailers are coming out of their historical department store relationships, opening up full-price relationships, and then also getting the benefit of their secondary clearance through our outlet channels. So, you know, the luxury bid for space is unabated at this point, continues to be a strong demand from global operators, not just simply domestic ones. And so we are taking advantage of those tailwinds fully to meet the needs and the demands of our retail customers. I'm sorry, you had a question, sir? Please.
Yes, sir. We've heard a lot last year, especially in terms of how the nature of store changing-
Sure.
... retailers, how many of the country's largest retailers have identified their footprint as, you know, they know where they need to be?
Sure.
they no longer need to be a location. You know, and that store is now becoming a customer touchpoint, not necessarily a point of sale. So maybe we should be less concerned about sales per square foot in your malls. But how would you view this change in store format and customer experience, and in managing the retailer's margin, therefore Simon's ability to raise rents?
Sure. So it's a great question, and I think this is, you know, the traditional tension that's always between landlord and tenant. And, you know, tenants forever have tried new formats in their stores to try and generate sales, and so that's continuing, and we're supportive of that evolution. But we take a more holistic view of our relationship with our tenant, not it's certainly on a store-by-store basis, but also holistically across the portfolio. But as tenants are generating more of that activity in their store base, and as they're we are able to capture through our own lease structures, you know, transactions that are occurring digitally in the store or digitally in the catchment area where that tenant is doing business.
And so we're able to, not simply if their store is the nucleus of their activity, we're able to capture the economic activity, both that occurs in the store, but it occurs tangentially, digitally to that store, and really adjust our pricing to reflect both of those elements of the retailer's evolution. Sure. Yeah, please.
Next question. Unless I misunderstood, David alluded to earlier that FMC monetized new retail, that's the value. What do you anticipate as value on that for?
Sure. So look, I think I didn't get a chance to hear what David said earlier. I wasn't ahead of his panel, but I can guess what he was alluding to. Look, our OPI investments are businesses that we certainly have built for. We bought most of them out of bankruptcy, we've restructured them, we've built them, we've increased their earnings capacity, but these are businesses that we don't need to own long term, but we won't simply sell at fire sale prices. So we have the financial discipline and capacity to hold on to these businesses over the long term. I do expect that you will see us to creatively monetize some of these investments.
You know, a good example is the SHEIN transaction with SPARC, where SHEIN invested and now owns one-third of SPARC, and SPARC took back stock in SHEIN. Now we're gonna form a commercial relationship with SHEIN, where we'll bring together their 150 digital customers with SPARC's 200 more physical customers, get the benefit of the merging of those two businesses. In addition, you will also now have SHEIN likely think about opening up store-in- store concepts or SHEIN nameplates. But as you think about what we did strategically, is we reduced our exposure to SPARC in this transaction. I do expect that we will continue to find ways to creatively monetize, whether it be with equity and/or cash.
And our expectation, looking at where some of these businesses are trading on a multiple basis, a real simple use of those proceeds would be to buy back our own stock and create value for our shareholders there, just given the multiple differentials. This could be something that we do in the next six months, or this could be something that takes the next 36-48 months, just depending upon the market and potential buyers or those that are interested in the business.
On SHEIN specifically, should we expect to see a revaluation gain on Simon's investment in SPARC in the third quarter?
You will. Yes, there will be a revaluation gain relative to dilution of our sale down of our interest, in the third quarter.
The mortgage market, a little flavor on, what mortgage lenders... [audio distortion]
Sure. Given the lack of transactional value out there, most lenders are recording on debt yields today. On a regional model, you're talking probably somewhere between 11%-15% debt yields. I appreciate that's a wide band here. And yeah, obviously, the lower the debt yield, the higher the cost, the ultimate higher lower proceeds levels. And so mortgages today are getting done in the CMBS market, call it 50% LTV, mid-teens debt yields. Five-year SASB executions are somewhere in the tune of 8%. 10-year conduits are cheaper, there's just more demand and diversity there. So those 10-year mortgages today are probably 6.75%-7%. So mortgage market is certainly a bit tighter, but products definitely clearing the market.
We've seen probably the past 30 days, a variety of product has come through the conduit market in the CMBS in total, and it's been well received. So it's a good sign that stuff's clearing the market, but certainly more expensive than it has been in recent times.
Just tying into that question, can you talk about your 2024 maturities and-
Sure.
how you plan to address those?
So, we have approximately $2.5 billion of unsecured debt that matures in 2024. $600 million of it matures in the first quarter, $1.9 billion of it matures in the third quarter. With respect to the first $600 million that matures in the first quarter, we pre-funded that maturity, so we're holding cash on our balance sheet, for that maturity. We did that deal in March of this year, and effectively are earning, in the front end of the curve, break-even rates on the debt. So, we will repay our debt here in February in whole.
The balance of the refinancing, I do expect that we will be active in the back half of this year and early next year, as we typically are in the capital markets. Again, pre-funding maturities, just given the ability to borrow in the 10- and 30-year part of the curve and effectively deposit those funds at a break-even rate and pre-fund our maturity. So I would expect us to do that from the unsecured perspective. On the secured side, you know, we have a variety of pieces of debt that mature in the next 24 months, all have their own kinda unique story. We're proactively addressing those maturities and do expect that we will put five, 10, and five and 10-year mortgages on those assets as they roll.
We have no need to pull out excess proceeds, given that we are a positive cash flow generation business. And so, you know, we ultimately will roll, if not delever some of the balance sheet down over time, just with our free internally generated cash flow.
I think that's a good point, 'cause there was the recent refinancing on Century City, there was, I think, cash out, and I think they paid up to have the flexibility to refinance.
They did. So the Century City was an unencumbered asset. There was a five-year or three plus one plus one mortgage put on, and it was a SASB mortgage for $925 million that priced at north of 8%, which is, you know, obviously implying substantial negative leverage relative to the valuation of the asset. So, you know, those asset values will have to recalibrate to the more higher cost of capital environment at some point.
And then one follow-up on the, you know, discussion around OPI and the retail investments. You said it could take six months, it could be longer, maybe, you know, three years. I guess, what is the appetite today in terms of, you know, investors looking at these type of investments?
Look, it's, it's episodic to some degree. It's got to match, you know, a really big strategic initiative. I think SHEIN is a really good example of that. Here's a, here's an enterprise with 150 global company—global customers, north of $60 billion of annual sales and really had no physical footprint here in the United States. And, you know, they've decided that the way that, that they can get to scale fast is by investing in SPARC, which is, you know... Someone with that type of strategic directive and really desire could be a game changer quickly, versus someone that may be looking at an individual brand. You know, that may be a, a bolt-on and may take a bit longer to monetize.
Really it comes down to, you know, the end user and their desires and where they wanna go with their own business. If someone's looking to get to scale quickly here in the United States, I think our platforms are a unique opportunity that, for them to look at. Or if they're simply looking at peeling off a brand that may match what it is that they're doing overall, there may be an opportunity for us to do that as well. There is certainly desire and interest out there across our brands. It really just gonna come down to a matter of us meeting our objectives and obviously a buyer's objectives over the long term.
Can you remind people about the, you know, Simon stock buyback program?
We have a $2 billion stock buyback authorization, and it was reauthorized earlier this year, and we do actively expect that we will use the stock buyback program over time, with—if we were successful in generating proceeds from some of these monetizations that could possibly occur, or simply with the generation of free cash flow. If you look at the company after paying its dividend, it generates about $1.5 billion of free cash flow, that can be used to reinvest, certainly in our properties, into our development and redevelopment, but could also be used to buy back stock and delever.
You know, one of the nice aspects or the competitive advantages that we have as a company is that we are one of those unique REITs that generate free cash flow above its dividend, and has the ability to invest that back into our business.
When it comes to your redevelopment pipeline, can you just give us an update on, you know, what kind of projects are ongoing and what you expect? I know you all said expecting to reach over $1 billion of investment, so could you kind of talk about that timeline and the opportunities you're assessing today?
Sure. We do expect that our committed pipeline will get back above $1 billion here relatively quickly. As you look across our three domestic platforms anyway, and we think about development and redevelopment, redevelopment really is in our Mall business, which is the recapture of anchor department stores and the land underneath it, and then the reimagination of that real estate. That is still one of the biggest unabated opportunities that the company has in front of us over the next decade or so. And the reimagining about real estate is gonna take on multiple forms and aspects, depending upon the respective need in that market. Certainly, we've talked a lot about adding multifamily and residential and hotels to our properties to add density.
We do expect that we're gonna start several projects here later this year, along those that trajectory or that investment theme. As we think about the outlet product here in the United States, we are actively building a new outlet in Tulsa and do expect that we'll break ground on an outlet in LA here in the next 12 months. Excited about that opportunity. We will add additional phases to some of our larger outlet assets. We're adding a phase at Woodbury Common, one of the most productive retail assets in the world. So, in small ways, we will redevelop or add density where we can to our Outlet business. Mills is somewhere in between. Most of Mills' opportunities is gonna be on the recapture of some boxes and the reimagination of that with new tenants.
As we think about the globe, the vast majority of our development opportunity outside of the United States is in our Outlet business. We opened up an outlet, a brand-new outlet on the west side of Paris in April, which we're really excited about, and there's two other assets that are under development and will open up in 2024 and 2025. And so we are finding good opportunity to develop new properties globally, specifically in the Outlet business. And here domestically, we continue to invest capital into our best assets to add density.
What are the returns on the investments, and are you taking on higher risk with the redevelopment or these mixed-use projects today?
The returns generally span between 7%-9% unlevered. Certainly there are projects that are well in excess of that, but, those are, you know, episodic-type products, projects. We've certainly seen the return hurdle increase a touch, just given the volatility of the world and, you know, and the nature of it. We benefit, as I mentioned, that we do not look for third-party financing to invest in our assets, so the use of our free cash flow is a really durable competitive advantage. We're not out looking at 8% construction financing to build something that to an eight. We are using our costless free cash flow, although today you can actually invest that in the bank and earn 5%, so it's no longer costless.
But, on a relative basis, we will invest over the long term from our free cash flow. You haven't seen the return side of the equation. You know, we... Prior to any project actually starting construction, we reevaluate the market, the demand, and make sure that our underwriting still holds water. To the extent we've seen a change between when we've finished our entitlement work in that process, we simply can hold entitlements and wait for a better day for an economic environment in that market that makes sense for us. So, we are very disciplined. We've controlled our development and redevelopment business. Today, it's at about $1 billion. It is a... All of the projects are within our control.
We can start and stop as necessary, which we demonstrated, quite honestly, during COVID, where we stopped our Phipps Plaza redevelopment, and now it's completed, fully completed and doing better than we anticipated in underwrote.
Sorry, one follow-up, and then we'll get, so for all of the apartments you talked about, hotels, et cetera, that's Simon Property Group?
So it's gonna depend on the asset. If there's an asset that's already in JV format that we have the opportunity to add density to, our partner can certainly participate to the extent they want to. They don't have to. And in certain instances, some of our partners can't because they may have investment mandates that are simply retail, and if we're adding multi or hotel, it violates their investment opportunity. But by and large, the funding of the underlying investment will follow the existing asset joint venture structure for the most part.
Okay. Do you have a question here?
Where do you think- [audio distortion]
10-year money today is probably about 5.75. Yeah.
When you think about lease. [audio distortion]
Mm-hmm.
Levers. [audio distortion]
So I would say we're back to our traditional lease. You know, traditional, you know, annual fixed base rent, lease term between five, seven , or 10 years, natural breakpoints, traditional escalation on base rent, so 3% escalators on base rent. Our fixed CAM escalates between 3% and 5%. So I would tell you that we are in a historical lease environment from that perspective. You know, given the breadth of our company and the importance of that tenant relation to us, you know, it's very unusual that we're pushing for exotic terms and leases or what have you. It's more us trying to manage those relationships holistically at the brand level versus the individual asset or lease level.
As a luxury [audio distortion]
Mm-hmm.
How are you using that?
So you're in certain markets, you're using it in the sense of you're giving them the playbook of, "Here are the full-price opportunities that you have in front of us. Once you get to a critical mass of Y, then we have an opportunity for you to clear your excess inventory in a geographic location that makes sense." When you look at the portfolio, there's a lot of crossover in markets with our full-price assets and our outlet assets, and so we use those two distribution channels together in our conversations with leasing. What's another unique aspect of the company is because we operate across these three different platforms, our leasing people are leasing that way.
So when they sit down with a tenant, they're having a conversation across all three of our distribution channels at once, versus individually, if you would. So it gives us the ability to really kind of harness the power of their desires and growth plans in our own portfolio, with our own portfolio.
I asked about the returns on the investments, maybe just, you know, to highlight the importance that the redevelopment, the densification effort really brings to the asset as a whole. You know, we get questions all the time of, you know, what's happening in the suburbs today. David touched on it this morning.
Sure.
You know, why, why, again, densify? What are the benefits of owning an asset that has all these different, you know, property types?
Well, the way to think about it, first and foremost, is, you know, any investment that we're making on a standalone basis has the pencil. So every investment that we make to add density across our portfolio, on a standalone basis, those projects are penciling out to be positive returns, first and foremost. Second, though, is as you bring unique uses to an asset, it creates energy, it creates bodies, it creates buzz. And so I think the prime example, it is the shining star, which is Phipps Plaza, down in Buckhead. We bought back a former Belk's department store and the land underneath it, and that Belk's department store was adding no value to the overall center.
The customer of Belk was not shopping the balance of the center, and they were paying us roughly $800,000 a year in rent. After recapturing the store, knocking the store down, and reimagining Phipps Plaza, we've subsequently built a Citizens dining hall with a five-story Life Time Fitness Platinum club on top of it. We built a brand-new 14-story office tower with all of the modern amenities. We built a Nobu hotel and restaurant, and we've substantially invigorated the luxury offering for the product. And so what we're gonna see is a piece of land that historically would have contributed about $800,000 of rent to us. Now, in the future, that same piece of land will produce roughly $30 million of NOI.
Phipps Plaza is the crème de la crème example, where we can bring all of the components together of density. We won't probably see that across the portfolio, but do expect that we will bring elements together, some of them in various markets where it makes sense. And so, you know, ultimately, the energy and vibe now of that completely reimagined wing of the project is now driving the performance of the balance of the project, just given the investments that we've made. Please.
How the KKR investment return? How do you think about KKR today? [audio distortion]
Sure. Look, Klépierre has been a great investment. We originally made the investment in 2012. You know, through our strategic direction, they've certainly grown, they've pruned their portfolio. They have now one of the better balance sheets as from a European-listed company. We're very excited about the investment. It produces a sizable return for us. They've got good prospects long term. You know, their competitor set in Europe is also a touch weakened, and so they are taking advantage competitively and using that to their advantage. But this is a business that long term, we're a public company-- we're a shareholder.
We are not in there operating this business every day, and so if over the long term, we were to monetize that investment at a profit and redeploy those proceeds back into our U.S. opportunities or even our outlet opportunities throughout Europe, where we actually can, we're on the ground operating, we think that that could be an interesting redeployment of that capital and profit that we've made within Klépierre over the long term.
I think we have time to touch on maybe one more topic before rapid-fire questions. So-
No, please. I think let's,
Could we characterize the transactions market for A-class malls today, and you know, what are your thoughts on maybe the latest sale by Unibail Westfield Mission Valley? Are there any potential acquisition Simon is looking at today?
So, from an acquisitions market perspective or transaction perspective, I think what we've seen is kinda episodic, unique transactions that all have likely their highest and best use of those assets after the acquisition is gonna be something other than an operating regional mall. They will all be redeveloped, they will add density, they will add a multi to their products. And so they... The assets that have transacted, that have been denoted as A malls, truly are probably not A malls long term. They're all gonna undergo transformation. And if you look at the buyers that have bought the assets, you know, you have some uniqueness there too.
Like Stan Kroenke, in California, is building his real estate empire to support his sports empire, and so he is not necessarily focused on buying a regional mall to keep it a regional mall, he's focused on buying the asset to ultimately redevelop it into what he wants. And I think you've seen that play out, at Mission Valley is a good example. I think the buyer of it has gone on record to say they're gonna redevelop it. So the implied cap rates in these transactions are not really reflective of truly ongoing operations of an A-quality asset. It's more development or redevelopment opportunity priced into that cap rate.
Then we're asking each company just three rapid-fire questions.
Yes.
Lizzie, please.
First question is on the Fed. Do you believe the Fed is done hiking, yes or no? And do you expect the Fed to cut rates in 2024, yes or no?
I do not think they're done hiking. I do expect that by the end of 2024, they will have cut rates.
Okay, and then the second question: Do you believe real estate transactions will meaningfully pick up by, A, the fourth quarter of 2023, B, the first half of 2024, or, C, the second half of 2024?
Oh, boy! I'll go C.
C. Okay, and lastly, are you using AI today to help you run your business, yes or no? Do you plan to ramp up spending on AI initiatives over the next year, yes or no?
We are using AI today in a variety of aspects of our business and do expect that we will continue to invest.
Great. Thank you very much.
Thank you.
Thanks, everyone. Thank you, everybody.