Good day, ladies and gentlemen, and welcome to the second quarter Simon Property Group earnings conference call. My name's Allison, and I'll be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. If at any time during the call you require assistance, please press star zero and an operator will be happy to assist you. As a reminder, this call is being recorded for replay purposes. I'd now like to turn the call over to Ms. Liz Zale, Senior Vice President of Corporate Affairs. Please proceed, ma'am.
Thank you. Good morning, everyone, and welcome to Simon Property Group's second quarter 2013 earnings conference call. I'm Liz Zale, Senior Vice President of Corporate Affairs. Joining me on today's call is David Simon, our Chairman and Chief Executive Officer, Richard Sokolov, our President and Chief Operating Officer, and Stephen Sterrett, our Chief Financial Officer. Before we begin, I would like to remind everyone that statements made during this call may be deemed forward-looking statements within the meaning of the safe harbor of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially due to a variety of risks, uncertainties, and other factors. We refer investors to today's earnings press release and our SEC filings for a detailed discussion of forward-looking statements. Please note that this call does include information that may be accurate only as of today's date, July 29, 2013.
Reconciliations of our non-GAAP financial measures to the most directly comparable GAAP measures are included within the earnings release or the company's supplemental information, including this morning's Form 8-K filing. The supplemental document is available on simon.com in the investors section. With that, I would like to now introduce David Simon.
Good morning. It was another productive quarter. FFO was $2.11 per share, up 11.6% from the second quarter of 2012. Our FFO exceeded the first call consensus by $0.04. For malls and outlets, comparable property NOI growth was 5.9%, driven by occupancy up 90 basis points to 95.1%, a growth in the leasing spread to $7.49 per square foot or 14.1%. Base minimum rent per square foot, 3.6% higher than the year ago period. Our tenant sales were up 4.2% to $577 per square foot. Now, let me turn to just some deal activity. On May 30, we acquired a 390,000 square foot outlet center in Portland, Oregon for $147 million. This is a very productive center with sales in excess of $600 per square foot. It's 99% leased. Has a great tenant lineup, fits terrific with our outlet portfolio, and it's been rebranded Woodburn Premium Outlets.
As you would expect, it's immediately accretive to FFO. On June 3rd, we announced our JV with McArthurGlen to invest in certain of their designer outlets and become a partner in their property management development companies. They have a terrific, and one of the best performing portfolios of high-quality retail real estate in Europe and a good, strong team of professionals. The transaction supports and extends our international premium outlet strategy. We completed the initial phase of this transaction and are now 50/50 partners in the management and development companies. We also will become a partner in their new designer outlet project in Vancouver and are working to close our investment in several of their existing centers. On May 7th, we sold Laguna Hills Mall for $110 million. Now let me turn to new development.
Phoenix and Shisui opened in April, both 100% leased, both strong openings. We're pleased with the performance. This third quarter, we have three new premium outlet centers that will open. Toronto this week, August 1st, you're all welcome. St. Louis, which is 100% leased on August 22nd, you're all welcome. Busan, Korea may be a little bit out of your way, but it is 99% leased and opens on August 29th. Construction started during the second quarter at our premium outlets, Montreal, which is our second premium outlet center in Canada. Vancouver will be our third. Let me just turn to redevelopment activity. A lot going on. I won't go through everything, but some highlights. In April, we completed the redevelopment of an existing limited building at Dadeland Mall. It's great. Go look at it.
The redevelopment of Walt Whitman opens this September with the addition of retailers and restaurants on the exterior of the building. The Shops at Nanuet in suburban New York City opens in October. At this project, we actually demolished the existing mall and created a new open-air center. The redevelopment of Lenox Square continues, as does the transformation of Del Amo Fashion Center, among several other centers that are all listed in the 8-K. On the premium outlet front, we completed expansions at Paju and Seattle during the second quarter. Expansions are underway at Orlando Premium Outlets in Vineland and Johor, Malaysia. Both of these projects will open in the fourth quarter. The significant expansion of Desert Hills continues. We'll open in April of next year. Finally, on that front, we started this quarter, the $170 million redevelopment expansion of Woodbury Commons in New York.
The Mills, Sawgrass Mills, we opened the expansion in the Colonnade Outlets during the second quarter, as well as the redevelopment of the former Wannado space. Macy's opened at Gurnee Mills last week. In addition, we have significant box activity throughout the Mills and Mall portfolio, with numerous stores under construction. Our pipeline of new development, redevelopment projects is significant and growing. Stuff is coming online. We're also under construction with several projects. We expect this to continue at least $1 billion annually through 2016. I'll remind you that we're funding this primarily with $1 billion of our free annual cash flow generated by the company. Just quickly on financing, we're pleased with the Standard & Poor's upgrade in May with our corporate credit rating, and senior unsecured debt ratings were increased to A level.
We believe this reflects our conservative balance sheet strategy, the quality of our portfolio, and the ongoing focus of being a good steward of capital. We'll continue to be active in the debt markets. So far, year to date, we did 17 new loans, approximately $2.4 billion, of which our share is $1.7 billion. The average interest rate on the loans is 2.9%, and the average term is 8.1 years. Klépierre reported solid first-half results. I won't go through them in detail. They're available. Shopping center gross rents, which represent 94.4% of total rents, were up 4.1%, or 2.5% on a like-for-like basis. They increased their 2013 guidance for net current cash flow per share, and they continued to upgrade the portfolio through development, redevelopment, as well as the disposition of non-core assets.
Today, we increased the top and the bottom of our 2013 FFO guidance, once again, to a new range of $8.60 to $8.70 of FFO per share. This is an increase of $0.20 from our initial guidance, or over $70 million. As always, we are extremely focused on the successful execution of our plan for 2013, from the effective leasing and management of our high-quality existing portfolio to the successful delivery of our new and redevelopment pipeline and the achievement of the returns that we have outlined. We're now ready for any questions.
Thank you. Ladies and gentlemen, if you wish to ask a question, please press star followed by one on your touch tone telephone. If your question has been answered or you wish to withdraw your question, press star followed by two. Press star one to begin, and please stand by for your first question.
Hello?
Your first question comes from the line of Craig Schmidt of New York. Please proceed.
Thanks for not reporting on Wednesday afternoon. I look at the supplemental, and it says the opening's projected for 2015 and beyond and lists Del Amo and Roosevelt Field, but it doesn't list Copley Place and Houston Galleria. Is this just because those projects are starting later, or is there a change in plan for those assets?
No change at all. Once they are formally approved within our internal process, they go on the schedule. Copley, we're actually going through just a little bit more permitting approvals, which we expect to have by the end of the year. The Galleria, we have an announcement coming shortly. Stay tuned. We approve it internally. They'll both be on our list. No real change of plans on either one.
Okay. I also noticed in the anchor section, you're adding a Wegmans to the Montgomery Mall. May you be adding supermarkets to other centers? Was there any change that you made in terms of parking or access to make Wegmans work with the rest of the mall?
Hi, Craig. It's Rick. The Wegmans is being built on the site of a former Boscov's, which we demolished. The land was suitable to be able to have all their parking accommodated. We are putting several outside uses in Montgomery just to be accommodant to that, so we're having some uses we think will work well with the supermarket. We're also adding a Fairway Market at Nanuet. These types of high profile, high volume users are, we think, very additive to the properties.
Craig, I remember you used to ask about Nanuet all the time. Now, thankfully.
It's happening.
It's opening in October. We're basically virtually leased. Not everybody will open by this year, but by spring of next year, all 100% will be opened.
I was actually by the site a couple of weeks ago. It looks like it's pretty transformative.
Yeah, it should be. We're excited about it.
One last thing. Are you able to give a cap rate on the Laguna Hills Mall that you sold in May?
Well, I'll let you do the math. The NOI, if I remember correctly, was around six and a half or something in that range. $6.5 million.
Great. Thanks a lot.
Sure.
Thank you. Your next question comes from Quentin Van Leeuwen of Citigroup. Please proceed.
Hey, good morning.
Morning.
Just on the McArthurGlen acquisition, can you just talk broadly about the opportunity in Europe with outlets and how involved Simon senior management will be with the management and growth of that business?
Well, I think there is a significant opportunity both within their existing portfolio and the ability to add extensions to them, as well as continue to upgrade the tenant offerings and add to the footfall of those centers through tourism efforts and the like. In addition, McArthurGlen does have a significant pipeline of additional opportunities in terms of new development. When you couple those, as well as we do think there will be acquisition opportunities within their portfolio and others, we think it is going to end up being a significant platform for our growth over the next several years. It is a complicated deal, not only because it is in Europe and you are in different countries, but also the ownership of the assets are owned, not by just one individual, but by various partners and funds.
I think over time, as we solidify the platform, bring our expertise to the table along with their assets and their people, it should be a very good deal for us. We're excited about it. The sales productivity of these centers is very high. There's not a lot of them, and they're very well accepted. There's not that many players in Europe that do it at such a high level. We think ultimately it's going to be a good transaction for us.
I think you still own a stake in Value Retail, the other outlet developer and owner in Europe. Are you now a seller of that stake?
Do you have an offer for me?
I don't have the money.
Okay. No, we're happy with that stake. We're always interested in whatever we can do to benefit our shareholders. That investment has been good for us. We anticipate continuing in it. As you might know, that was an investment that the former Chelsea made. We've added to it over the years. We've got a significant embedded gain compared to our book value of it. They do a very good job in terms of operating their centers as well. We think we're a long-term owner of it, but I never rule anything out.
Okay. Just lastly, there's been a lot of media speculation on the Colonial investment management platform in Australia. I know you guys are constantly looking at global opportunities. Is the Australian mall industry one that interests you?
Well, maybe. I haven't ruled it out. We'll look at anything. Westfield does such a good job, we've always been a little bit reluctant to enter that market. On the other hand, it's an interesting market. It's very stable. We like the people there, and the malls there do very well. I wouldn't rule anything out, just like we've monitored Brazil for years, haven't found the right transaction. We wouldn't rule any one particular place out. The one place we continue to be the most concerned about as we look internationally is China, just because it's a tough place to figure out who's on first. Australia, to some extent, has a lot of benefits that it's a very transparent market.
Thank you.
Sure.
Thank you. Your next question comes from Christy McElroy of UBS. Please proceed.
Hi, good morning, guys. Just a quick follow-up on McArthurGlen. With regard to the property management development partnership, will there be any immediate impact to cash flows? Just thinking about any fees or is that further down the road?
Well, it's a profitable management company, so our investment will have a return associated with it. Now, that'll just end up flowing through our JV line, so it's not going to be in our management company. It'll be hard for you to see, but they're profitable, and we expect to have a pretty good return on our investment in the management company.
What was the investment?
Well, it's really separated into two pieces, but both for the management and the development was GBP 25 million.
Okay. Are you able to disclose the Q2 2013 only year-over-year change in sales?
Say it again.
Just the quarter change in sales. If I were just to isolate the second quarter sales and look at it on a year-over-year basis.
We don't do that. It was up about 1%.
Okay. Just lastly.
Yeah, go ahead.
Just lastly, regarding some of the new sort of in-store customer tracking technology that some retailers are using today, are you having to do any upgrades to the technological infrastructure of your malls, such as increasing bandwidth or other changes? Are you using any new technologies to sort of collect any of your own data on customers or analyze shopper traffic patterns?
Look, that whole area, we are treading very carefully.
Right.
It is lots of privacy concerns. We've looked at it all. The fact of the matter is, until the folks in Washington feel good about it, we are watching it, and we're not really playing in any of that stuff because we really don't know what kind of privacy violations it may generate. I would tell you that we're treading very carefully and have done nothing along the lines that would be able to track anything like that, period, end of story. With respect to, I think the big effort generally in the mall industry is we're all investing in Wi-Fi networks throughout our malls. We're doing that as well. We're starting at the bigger ones first. That's really primarily for the benefit of our consumer, but to the extent that it can help facilitate our retailers, we're happy for them to participate.
Again, I would tell you, on the privacy front, we're not doing anything. We're treading very carefully.
From a CapEx perspective, what are the sort of per mall costs associated with adding the Wi-Fi?
It depends. I'd say generally it's around 150,000 a mall, but it really depends. Somewhere in that range.
Okay. Thank you.
Sure.
Thank you. Your next question comes from Alexander Goldfarb of Sandler O'Neill. Please proceed.
Hi. Good morning. Steve, you've been a little quiet so far, maybe I'll lead off with you. As far as the A rating, is this a blessing or a bit of a curse in any way? Does it limit your ability, whether it's on the redevelopment front or on the overseas investment front? Does being an A student hinder your guys' flexibility, or would you rather be A-minus?
It does not hinder it at all, Alex. In fact, one of the additions that we made to the 8-K this quarter was to give you some look at some credit metrics over a 5-year look back period, and you can see how the metrics had improved. The coverage has gotten better, leverage went down, debt to EBITDA went down. I think if anything, it's just a reflection of the continued strengthening of the balance sheet. To the extent that we can absolutely borrow at cheaper rates than anyone else in our sector, I think that's absolutely a good thing.
I'll just add that S&P, they're pretty smart folks. They've seen what we've done historically, both in redevelopment and M&A activity. They have every expectation that that will continue, and they don't necessarily just rate you based upon being a status business. They rate you on what you've done and what they expect for you to do going forward. Our redevelopment pipeline of $5 billion thereabouts, as well as our continual activity in finding smart external investments is part of our history of our company, and they actually like that stuff because it's obviously increased our return on equity and increased our cash flow and made us a better company. That's all factored into how they look at us going forward.
Okay. Then the second question is going on to the McArthurGlen and Klépierre. The first part is just when you were talking, David, earlier about buying out in McArthurGlen, presumably that was buying out some of those individual ownership stakes so that it would be JVs, that you would own McArthurGlen assets with McArthurGlen and Simon as the ownership structure.
Correct.
Okay.
That's correct.
Separate is, it's early on, but down the road, do you see synergies between Klépierre and McArthurGlen? In your view, these are two totally separate platforms, they each have to stand on their own?
Well, I think initially, they're definitely two separate platforms and definitely will stand on their own. I mean, they both have very successful operating platforms and they have obviously dedicated management for both and they're both big businesses. I do think with time, there certainly could be cooperation between the two. It's not necessary, but I would expect the two to cooperate over time, especially, in France, where McArthurGlen has at least three in the pipe of new potential developments. Given the history of Klépierre in developing in France, there's no reason why some sort of cooperation wouldn't make sense for both companies. We'll certainly encourage that. I happen to know both guys who run it, so it'll make it a little bit easier.
Okay. Listen, thank you.
Sure.
Thank you. Your next question comes from Cedrik Lachance of Green Street Advisors. Please proceed.
Thank you. David, when I look at some of the recent acquisitions, they always seem to be largely strategic. You think about the big picture, you look at adding outlets to Europe, where you obviously have the full parts presence that has similarities with what you have done in the U.S. The approach always seems to be primarily strategic. Do you also look at plays where you would find more distressed real estate, where you would find big discounts to NAV or asset value? Is this still on the back burner and you keep looking for strategic acquisitions?
I cannot tell you there is nothing more than buying something cheap that excites me and the team here. We love to buy things really cheap. If that can be done on a distressed basis, we like it. Ultimately, we have got to believe in the real estate, because I would not say we are traders. At the end of the day, we have got to have a long-term view that we like the cash flow that is being generated from the real estate. To some extent, if you go back to the Klépierre deal, look, Europe is still squishy, to put it mildly. That was, I would not call it a distressed situation, but it was certainly at a pretty decent discount to NAV and an uncertain future. Not many people are investing in Europe.
When we talk about McArthurGlen, there is not many people that are, at this point, taking the position that Europe is a good place to invest in. To some extent, both of those transactions are somewhat contrarian. If we see those as capital ebbs and flows throughout the world, I would hope that we would be able to take advantage of it. We certainly love to try and do that. It is not what we do every day. We have got to believe in the real estate at the end of the day. I would tell you that we have done it historically, we would hope to continue to find those kind of opportunities.
When you look at it currently, are those investment possibilities primarily outside of the U.S., or do you see potential, either distressed properties or even companies that might be at prices that are of more interest in the United States?
I would say, Cedrik, generally, those kind of opportunities are outside the U.S.
Okay. Would you be able to share the cap rate on Woodburn?
You won't believe it, but it was 10.5%, only because we had a long-term option to buy it at a 10.5% cap rate. It's not a reflection of market value, but it's a long history there. It's a pretty good deal for us.
How did that option, how was it put together?
It was really by the outlet guys with Craig over a number of years, history of kind of that whole relationship. It's not really all that material how it got there, but it's a good deal for us. Importantly, it's a very good center.
Okay. Great. Thank you.
Sure.
Thank you. Your next question comes from Steve Sakwa of ISI Group. Please proceed.
Oh, thanks. Good morning, David.
Hey.
I was hoping that you guys could focus a little bit on the core portfolio since that's the primary driver of, I think, growth here. You guys are now 95% occupied. The business is really kind of hitting on all cylinders. When I look at the re-leasing spreads and look at kind of where ending rents are for next year, they actually are lower in 2014 than they are for the balance of this year. I'm just curious, how are you and Rick thinking about kind of the leasing, the discussions with tenants, and kind of what are you guys doing differently today, given where you're sitting with the portfolio as well leased as it is?
How you doing? Okay, it's Rick. Steve, we are spending a lot of time just focusing on our mix, focusing on getting the right tenants in the right spaces to maximize the productivity, to maximize the rent that they can pay. I will tell you that a lot of the calls that David Simon and I receive are tenants worried about whether they're going to be renewed in their spaces as opposed to having to solicit interest in the spaces. We're still in a pretty dynamic market. All of the improvements we're making to this portfolio in the renovations, the redevelopments, I think over the last 4 years, we've probably added 200 different anchors to these portfolios. We're just taking market share and making them better. I think that the thing you can focus on is the fact that our occupancy cost is 11.3%.
As you see with our spreads and you see with the momentum we have, we're going to be able to continue to grow that NOI because of all those reasons. But Steve, I would just say, look, the fact is supply and demand is a little bit better, but our philosophy on how we operate the business is not all that different. We've seen cycles ebb and flow. At the end of the day, what's best for the business is creating the win-win with the retailer, and we've done that. We don't get to where we are today if we hadn't taken that philosophy over the last 50 years. It's not all that different. Sure, it's better to be in this kind of environment where supply and demand is in the owner's favor, but that changes too.
At the end of the day, it's all about just trying to create a win-win, which I think, the history of our company suggests we know how to do.
Okay, maybe a quick question for Steve. On page 22 of the supplemental, you've obviously got a fairly large decline in the other income, and even if you strip out some of the things like gain on land sales, the other was down about $10 million, and it's down about $12 million for the year. Can you sort of just talk about that, and how do we think about that business in the back half of the year and into next year?
Sure, Steve. There are a couple of things that were in other income in 2012 that aren't there in 2013. If you remember, we talked from time to time, on prior calls that we were owners of some mortgages, so there was some income flowing through from that debt. That debt has all been paid off. Likewise, we were the mezz lender to The Mills. That debt was obviously retired as part of the transaction in 2012. Then we have had, as you mentioned, both lower land sales as well as on a year-to-date basis, much lower lease settlement income.
Just to reinforce. The core business of what's in the other income, sponsorship, all the ancillary things that are generated from the mall business is up this year compared to last year. There's no change there. That category does represent a lot of our other activity, whether it's loaning folks, buying mortgages. Sometimes we loan developers money to where we get an option to buy. As Steve said, we bought mortgages. Last year, we sold our investment in The Domain residential. That also category represents kind of the other activity that the company does that's not its, what I'll call its operating business, and it's a little bit lumpy. No big deal, but the important point is, it is other income, which is good. It's not other losses. That's point one.
Point two is that the core business sponsorship, et cetera, is all trending up this year compared to Q2 of last year and year-to-date. I don't have exactly that number, what it's up, but we can certainly get it to you pretty quick, unless you have it. Or what is it?
I don't know the core number.
I don't know. We don't have the core business number. We can get that for you. No big deal.
Okay, thanks. Lastly, David, just talk maybe a little bit about the Brazil situation, your relationship with BR Malls, and sort of what's going on in terms of looking for deals down there and kind of the weakness in Brazil, and how do you think that sort of plays out over the next year or two?
Well, look, the joint venture that we have with BR, the first deal we were
Looking to build an outlet center in São Paulo, as you know, it ran into right-to-build issues. Those still, to this day, have not been satisfied, at least to our comfort level. At this point, it's a no-go deal until that gets satisfied. If it does get satisfied, then we'll have a decision to make. We'll have to assess the climate, both short-term and medium-term, in deciding whether or not to go forward. The condition precedent to that decision is not yet there, and that's the right-to-build issue. There's a couple of other sites that our team went down to look at that may be in the pipe in the future. Let's put that aside. The macro stuff there is concerning. All of the supply in the market is concerning.
That's why we kind of like the outlet business, because it was different, it was new, it was going to get ahead of a lot of the supply that came on the full price. Obviously, you got to weigh the macro in. Long term, Brazil is a great country with a lot of dynamic growth to it. We're very cautious on a market like that, and we haven't found the right deal, and thankfully, in hindsight, our decision not to invest aggressively there has been the appropriate one. We'll wait to see. I've always worried about the cash flows from the buildings that have been built there and whether that was sustainable with all the new supply, the fact that a lot of the cash flow comes from parking. There's a whole host of things. The cost of the goods down there is significant.
The high-end malls there, whether they're profitable for the retailers or not still is a question mark. There's a lot there to underwrite, and essentially, you should assume that those questions have been factored into the fact that we have not made an investment in Brazil.
Okay, thanks.
Sure.
Thank you. Our next question comes from Caitlin Burrows of Goldman Sachs. Please proceed.
Hi. Just a question on sales growth with regards to the increase from $5.75 a square foot reported in the first quarter to $5.77 reported now. Do you think the sequential increase of 35 basis points is a sign for concern as it's somewhat weaker than the other recent quarters?
No.
No? Okay. Then can you comment on which areas of retail seem to be doing especially well versus the ones that are keeping that number from increasing as much as it had been in the previous few quarters?
Yeah. I'll let Rick talk about that, I will say this. The ups and downs of retailers and retail sales is a historical fact. The increasing of our cash flow year after year is also a historical fact. We don't get overexcited whether sales go up 5% or down 5%, because we know that the cash flow that we generate from our buildings has a long history of increasing, given that we've got tenants in there that are very profitable, and we have leases that are below market. When we give you this information, I have never pulled my hair out based upon or jumped up for joy when sales have increased. We're just giving you the facts.
The fact of the matter is our comp NOI is going to grow because our market rents are well below what leases are rolling over, as someone pointed out earlier. I just want to reinforce that point, and then Rick can go ahead and answer your question.
Just to add a little more color to that. The stronger regions for us were New England, the Mountain States, Southwest, and South Atlantic. A little weaker were the Plains, Mid-Atlantic, Great Lakes. The stronger categories were juniors, women's specialty, accessories, men's shoes, and women's better. The weaker areas were women's popular, home furniture, and women's special size.
Great. Thank you.
Sure.
Thank you. Our next question comes from Ki Bin Kim of SunTrust Robinson Humphrey. Please proceed.
Thanks. Just a couple of quick follow-ups. Could you guys talk about a yield expectation for your investment in McArthurGlen?
Well, when the whole deal closes, we'll give that to you. As we said initially when we announced it in May, that it will be accretive. We believe it's going to be a profitable transaction. Until all the elements of it close, we're not going to get into those details.
Okay. You guys made investments in six interest in their malls. They own about, I think, about 20 or more. Was it just because of the structures in individual malls, or was it more selective bias?
Well, again, we haven't closed on four of the six yet. When those close, some of those interests are held outside of MGE, which again, over time, I think we'll have the opportunity, to the extent that we want to buy interest in some of those assets. They're not really, at this point, owned by MGE other than a couple of which we kind of collectively both agreed that we didn't want to buy at this particular point. Again, this is a long-term transaction that we feel will be able to increase our investment in, but in a methodical, thoughtful way. We're just focused on finishing the first deal, then we'll be able to look at other opportunities going forward, not just with some of the assets that they manage, but don't own or own very little, but also other opportunities out there.
Okay. The 5.9% same property NOI growth, could you-
Yeah
help us? Could you break it out a little bit on just maybe how much of it was on the revenue front versus expenses? It looks like your tenant reimbursements increased pretty significantly. How much of that was driven by that as well?
Ki Bin, this is Steve. You hit the three components. Minimum rent was over half of it. A contributor was also the net increase in recoveries, if you will, and then percentage rents. If you look at our overage rent line on both the consolidated financials, also our share of the JV income, overage rent was a contributor as well.
Is that the increase in recoveries? What brought about that? It seems as if it's higher than it's been before on a year-over-year basis.
Well, I don't think it's higher than it's been year before, but we're 90-plus % converted to fixed CAM. We have annual escalators of that fixed charge, that annual escalator has been at a higher rate than expenses have been growing. In fact, we've done a really good job of holding expenses relatively flat. That's been additive.
Okay, last question, I'll kind of leave it open-ended. Surprised that you guys didn't include the outlet development in Philadelphia with Henri in your, I guess it's too new, in your development pages or disclosures. Like I said, I'll leave it open-ended. Maybe you could comment a little bit about that.
Yeah. Once we approve it internally, it'll go on our schedule. We expect it to go forward. It's still finalizing the permit. We're actually rushing, I hope, to start this year, we could open next year. That's going to be touch and go, just because we have to go through some permitting stuff. Once we do it and approve it'll be there. We expect it to be a good deal. Henri approached us with the site, I don't know, a year and a half, two years ago, Rick, probably.
About a year.
We looked at it. We did a little bit of tentative pre-leasing with the retailers. They expressed an interest. We're going to build it once we get permitted, not overly complicated. Hopefully, if we do jump through the hoops that we need to jump through, we could actually start this year and have the chance of opening next year. Like I said, that's right on the bubble. If not, it'll be a 2015 opening.
Is that a 50/50 JV?
No. We own 75. They own 25, and we have a small partner in our piece. I think our effective, if I remember, is around 65. Our effective ownership is 65%.
Okay. Thank you, guys.
Sure.
Thank you. Your next question comes from Paul Adornato of BMO Capital Markets. Please proceed.
Thanks. Good morning. I guess this morning Hudson's Bay was talking about spinning off their real estate into a Canadian REIT. The question is not on Hudson's Bay or Canadian REITs, but really just the longer-term trend of the anchors trying to capture the real estate value for their own shareholders. Was wondering if you had any thoughts or comments on that dynamic and how you might see it playing out going forward.
Well, I will tell you that the attractiveness of a company like ours versus a captive REIT. A completely different set of institutional investors. What people look to in our investment is the growth, rising dividends, the dynamic nature of our company. By investing with us, they've been well rewarded by our ability to increase our earnings and our dividend, and obviously, resulting stock price increase. In those captive REITs, they're basically a different set of investors. They're bond-like investors. It's a whole different thing, and if a retailer wants to do it, God bless them. If it makes them ultimately a better retailer and they can use that capital to reinvest in their business, it's no big deal from our standpoint. There are some that are also trying to redevelop some of their boxes. I think they have found that to be really difficult.
I think what they'd rather end up doing is trying to figure out what the fair market value is and then look for the developer, i.e., us, to make the profit. That's been the nature of the development business for years, is that the developer tends to get the development profit because they know what they're doing. I don't think any of this is really all that different. I think it's potentially an attractive way for them to raise the capital to fund Saks. If they can do that and make the combination a better, more profitable business, we're all for it.
Okay. Thanks very much.
Sure.
Your next question comes from the line of David Harris of Imperial Capital. Please proceed.
Good morning, all.
Good morning.
Hey, it looks as if we ended the 30-year decline in long-term interest rates in the first half of this year. If rates are going to be going up, what do you think Simon might have to do differently over the next three to five years in order to generate returns as attractive as the returns you've been able to generate over the last couple of decades, David?
Well, look, I think, the plan has been put in place, David, which is for us to generate the kind of returns that we want to generate, that we've done historically. It's really the redevelopment, new development pipe that we've produced, that's bigger than it's ever been. A lot of the returns that we generated historically was because we bought a lot of stuff at good prices and the values went up, we added value through increasing the cash flow. The arbitrage that we have in the redevelopment and new development business, as large as it is actually higher even with higher interest rates.
As long as we can execute, that's assessing retailer demand and making sure the costs are right, I think we can still do what we've done as we've shifted more toward redevelopment and new development as opposed to acquisition in terms of how we look at all the capital that we're plowing back into the business. I don't think we have to do anything extraordinary, it is extraordinary other than execute our pipe, which is huge and complicated. If we can do that, I think we're in good stead.
David, I'd also remind you, as I think David mentioned in his opening remarks, we fund that pipeline with free cash flow. In theory, the cost of that capital is zero, the arbitrage is very good. I'd also remind you, we have $2.9 billion of debt coming due next year. The weighted average interest rate is 6%. We've got $2.9 billion coming due the following year at a weighted average interest rate of about 5.25%. Even with the spike in interest rates that we've seen, today our bonds trade in the 3.75% range for 10-year. There still should be a very positive pickup as we refinance that debt over the next couple of years.
Steve, you read my note that I put out a month ago or so. I made six suggestions that REITs might adopt, by way of strategy and tactics, to generate performance in a rising rate environment. Would you just care to expand on why you think that managing leverage over the cycle would perhaps not be the right way to go?
Well, David, listen, I think one of the things we should have all learned coming out of 2008, 2009 is that the world changes. It's a volatile place. The price we pay for being a REIT is that we don't self-fund our debt from cash flow. We should all run with a fair bit of liquidity. I think we should all run with relatively conservative balance sheets. You and I might disagree on that particular point.
Okay. Just a point of detail on the McArthurGlen deal. If we think about the return expectations you underwrote there, on the existing assets, do you think those assets are going to produce higher returns than dollars invested in the existing outlet centers in the U.S., we're looking really at this transaction as offering the better returns from development as we go forward? Do you think you're going to get attractive returns out of the existing assets as well?
Well, look, I think the returns that we're able to generate out of the U.S. outlet business are pretty damn good. There's not much out there that we're going to do that's going to rival the returns that we get from new development and extending our existing U.S. Premium Outlet business. That doesn't mean that should eliminate us making other good investments. We are as busy as we've ever been in the U.S. Premium Outlet business. We're not doing every deal. There's lots of other outlet developers doing lots of new business in that space, both redevelopment and new development. We're focused on what we can do, and that's great. We're piling a lot of capital on that, as evidenced by the new development and the extensions at Woodbury and Seattle and Desert Hills and Orlando and Vegas, et cetera.
That doesn't mean that the stuff that we're doing in Europe is not going to be attractive over both the medium and the long run.
Having seen a couple of-
It's not quite as good as the U.S.
Right. Having seen a couple of those McArthur assets over the years, I think they've been pretty well managed. I'm not suggesting that you couldn't squeeze some more out of them, but it's not like there's a huge amount being left on the table, I don't think.
Well, people have said that about other stuff that we've bought.
Yep
we figure out how to do that. I'm hopeful we can do the same thing here as well.
Okay. Good luck. Thank you.
Thank you.
Thank you. Your next question comes from John Kim of CLSA. Please proceed.
Thank you and good morning. I wanted to follow up on your potential interest in CFS Retail in Australia. Internationally, your acquisitions have primarily been through joint ventures. Regarding CFS, I was wondering if your preference was again to go this route, or would you entertain the idea of fully owning and managing the assets, given the high quality of the portfolio and given the fact that the management rights are for sale?
Well, we didn't say any of that. I think someone asked a big picture question about Australia, that's all I said was that we haven't ruled it out. I really can't add anything more to that than what I just said.
Okay, maybe I could just clarify. Is the Commonwealth Bank's potential sale of its management rights and interest in CFX, is that something that heightens your interest in Australia than a normal investment?
Well, again, we're looking at opportunities worldwide, and that would, to the extent that surfaces, we'd look at it just like anything else. I can't really expound on it. There's nothing really to add at this point.
Okay. Just turning to another Aussie company. There are market reports that Lend Lease, who you've transacted with in the past, is looking to sell its ownership stake and management rights of Bluewater in the U.K. Would a single acquisition like this be appealing to you in complementing your European investment, or do you still prefer a platform in entering a new market?
I would say This is a generic statement. It would have to be a unique individual asset in a market that we're familiar with for us to do that as opposed to just, I'd prefer a platform. Certainly, an asset like Bluewater is unique, and it's a very good asset. Generally, it would have to just, this is a generic statement. For us to enter into a market that we don't have any presence, it would have to be the best of the best in terms of an asset. I'd prefer a platform, and that's basically a generic statement. Outside of it being kind of the best asset in that market.
Can you comment on whether or not the U.K. is within Klépierre's domain, or is it sort of an open market for either one of you to invest in?
Well, first of all, there are no restrictions that we have vis-à-vis Klépierre. Other than, I'm chairman of the supervisory board, and I've got to obviously act accordingly. They are not in the U.K. There's never been any discussion that they'd have any interest in the U.K. I don't foresee that at all.
Great. Thank you.
Sure.
Your next question comes from Jeff Donnelly of Wells Fargo. Please proceed.
Good morning, guys. Maybe a follow-up to an earlier question for both David and Steve. What sort of interest rate environment are you guys managing the business towards over the next few years? Are you expecting higher rates in, say, the next two to three years?
Well, are we sure? I wish I could tell you what the rate is, then I would also be trading treasuries, I guess. Fact of the matter is, we're being as aggressive on refinancing our business as we can. We're not all that excited doing trading dollars, which essentially is, to some extent, our secured debts, obviously make whole provisions in all of it or most of it. As soon as they are open to prepay, we're refinancing that. We don't necessarily believe in funding the make whole premium. It's basically trading present value dollars, creates lumpiness in the earnings, blah, blah. I'm not a big fan of it. We may do it in one particular context on one deal. We're as active as we can, Steve, on refinancing.
We are. Not only that, Jeff, we have, despite the fact that LIBOR is at 20 basis points and hasn't moved and there would be a temptation to float, the fact is 90%-plus of our debt is fixed rate debt, and we've done the match with long-lived assets and long-term fixed rate debt. Jeff, I think David's right. I think rates are likely to rise. Having said that, they've already moved 75 to 100 basis points, and we don't have a lot of robust economic growth in the economy today. I do think it's probably likely that we'll see a higher rate environment going forward.
Have you guys seen already any demonstrable impact on asset pricing, either deals being retraded, or do you expect a better acquisition environment ahead?
No. I don't think there's been a real reaction on the transaction side because of rising rates at all. I have not seen that at all.
Maybe this one's for Rick, just on occupancy costs. I'm curious. The pace of sales growth is decelerating, releasing spreads have been fairly healthy. Why haven't we seen an increase in occupancy costs, and do you think that's going to ratchet up in the next 12 months?
Well, one of the components of occupancy costs are sales and rents. Frankly, we're only rolling a relatively small percentage of our square footage every year. Our sales have been growing pretty aggressively, and our spreads have been growing right along with that. As we pointed out earlier, given that we're 11.3%, we think we still have considerable room to grow our rents, even in a moderating sales environment.
That's helpful. Just maybe in understanding percentage rents. I know overall, the portfolio does about $577 a square foot. When you guys look at who actually pays percentage rents, does the sales productivity of those tenants vary much from the portfolio average? I'm just curious if the productivity of the percentage rent payers is sort of higher or lower than the portfolio as a whole.
It is all over the block. We've got over 1,200 tenants that pay us percentage rent. We have a very wide and diverse base, and really, there's no particular corollary between how you would say sales productivity and the payment of percentage rent.
To amplify Rick's point about 1,200, a lot of our percentage rent payers are actually department stores that pay 1% or 2% or 3%, depending on the vintage of the original deal. I would tell you that that's a big component of our percentage rent. As you might imagine, it's been kind of static over the last several years, and in some cases down, when you're talking about $0.01.
Just one last question, actually, for you, David. I recall that I think Simon or Chelsea had bought in Craig's interest in their Carlsbad outlets years ago for, I think, around a 10 cap. Are there any more of those purchase options still lingering with Craig?
We're looking. I'd like to find a few more, I don't believe so. If I stumble upon it, I'll let you know.
Thanks. Have a good one.
Sure.
Thank you. Your next question comes from Nathan Isbee of Stifel. Please proceed.
Hi, good afternoon. Just focusing on the same store growth. You're in the mid-fives through the first half of the year, against some pretty tough comps in 2012. You had mentioned earlier in the year that some of the redevelopment might weigh on the 2013 growth. Would you say you've navigated through that better than expected, or should we expect some of that to rear its head in the second half of the year?
Well, I have been very, very pleased. It's above our own internal budgets on our comp NOI growth. The team, the folks, the leasing, the management folks, have done a fantastic job year to date, and beaten my own internal expectations. They've done a great job.
Okay. Looking ahead to the second half of the year, you do have some pretty easy comps from last year. Is there anything out there in the redevelopment that should make us think that you would not continue what you've been doing here in the first half?
Again, redevelopment, we exclude. That's not in that number. Let's put that aside. Look, there are unknowns in the business environment, right? Sales. I hate blaming the weather. I will never blame the weather. Even if we miss one quarter because of the weather, you will not hear the weather excuse here.
Will you take credit for it, though?
We won't take credit. We will not blame an early Easter, a late Easter, early Halloween, or a late Halloween. There are lots of things, Nate, out of our control. Tenant bankruptcies, lousy sales, lousy weather, whatever, international politics, U.S. politics. Whatever changes the consumer mindset. We're still in an uncertain environment. That's why we try to be very cautious in how we look at things. I've been, as I said to you, I wish I could give you a number. I won't. You know we don't, but I've been very happy with the way the team's executed, operationally. They've done a great job thus far.
All right. Thanks.
Sure.
Your next question comes from Vincent Chao, Deutsche Bank. Please proceed.
Hey, everyone. Just wanted to clarify just on the McArthurGlen deal. I know you're going to provide more details when it finally closes. In terms of the guidance update, though, is there anything baked in for accretion for McArthurGlen, and also, any transaction costs baked in?
No, not at all. It's not in our numbers. Correct.
Okay, thanks.
Sure.
Just going back to the interest rate commentary, appreciate the color on not wanting to prepay some of the mortgages. Just curious if you're thinking about pre-funding some of the unsecured debt that's coming due, given where rates are today, how they've backed up, in light of your rating increase or improvement there.
Yeah, that's a distinct possibility as we look out in the third and fourth quarter. Steve can add to this, but we always get ahead of that schedule, so shouldn't surprise you if we do that sometime this year.
Yeah, Vince, the bonds are like mortgages in that there is the equivalent of a yield maintenance. There's a make whole. To some extent, you are trading dollars. Having said that, much like we did in December of 2012, we went to the bond market to pre-fund, if you will, our 2013 maturities because we knew what they were. If you look at our debt maturity schedule, we've got about $900 million of bonds coming due in 2014. As David mentioned, we do look at the market, we monitor the market. One of the great things about the bond market is that you can go relatively quickly. We do have that option to pre-fund that at some point in time.
Okay. Thanks, guys.
Sure.
Your next question comes from Michael Mueller of JPMorgan. Please proceed.
Yeah. Hi. Just two quick ones on McArthurGlen. Sorry about this. The $435 is an equity investment. Can you let us know what the associated debt is that goes along with that?
We will outline all of that when we're closed on the transaction.
Okay.
There's nothing extraordinary about the leverage amount on these assets. We'll lay it all out with all the facts once all of the elements get closed.
Okay. Do you think that's Q3 or is that Q4?
Let's see. I would think that it should be completed by the end of this quarter.
Okay, great. Then, last question. What was the trigger to sell the Laguna Hills Mall?
It's very interesting. We had a redevelopment plan. Even after that redevelopment plan, given all of what the assets are, if you've been to Laguna and you know what we own in Orange County, what the spectrum does, and what the spectrum is, our Mission Viejo and Brea Mall. Even with the redevelopment, even though it's well located, it was never going to be a really good core asset like Brea or Mission, or The Outlets at Orange. We said, you know what? We can take that capital, reinvest it in what we think will be a core opportunity at the end of the day. It was really that kind of thinking.
Got it. Okay, thanks.
Sure.
Thank you. Your next question comes from Ben Yang of Evercore. Please proceed.
Hi, thanks. Dave, you mentioned having no additional purchase options with Craig Realty, but I do recall you did have some prior agreements with Prime when you ended up buying Livermore and Grand Prairie. Maybe based on your comments, is it fair to assume that you have no prior agreements, option or other, with any private outlet owners at this time?
Well, I'm just trying to think. Don't put me on the spot like that. I can't remember everything. We are about to do another deal with Prime that actually we'll probably sign up this week. They've announced, it's no secret, it's in the Minneapolis-St. Paul area, which we think is going to be a terrific investment for us. You're putting me on the spot, we've got a couple other opportunities. I just want to be careful how you characterize that. There's other stuff that we're working on that we'll have options to get in on. I shouldn't unilaterally say, yes, you're right. I think there are other stuff out there.
All right. Sorry for putting you on the spot.
No worries.
Maybe for that deal with Prime in Minneapolis, can you talk about the pricing and the cap rate on that potential deal? Are you going to buy the entire center outright at this point?
In that case, there's no option to buy it, frankly. We're a development partner, so we're just going in it on the development side.
Okay.
The returns are consistent with kind of what we've developed over the years in the outlet business.
Okay, you are going to be an owner of that project, right?
Correct.
Okay. I'm just curious, why is the expansion at Woodbury Premium Outlets so expensive, given the relatively modest expansion of physical space there? Is there anything unusual going on with that would lead to that $170 million investment that you're making?
First of all, parking is really expensive because we have to deck the parking to create the additional space. We have a tight site to start with, and we've got a lot of infrastructure work in terms of the parking, and a lot of it, we're redoing all of the ingress, egress, all the roads around it. Then, as much as we love the center, it is long in the tooth, so we're also keeping it with consistent theming. It does need to be renovated. At the end of the day, even with that said, you have the parking, you've got all the roadwork that's going to make it better for the consumer to get in and out of. We're renovating the mall. We got to demolishing a couple of buildings. You put it all together, New York ain't cheap.
It's not like building in the Midwest. You put it all together, I had the same reaction, frankly. I still like the returns, and it is the world's best outlet center. If we're going to spend money anywhere, it ought to be in the world's best outlet center. You put it all together, it's a good return, and it is what it is. We're actually very excited. It's progressing. We actually originally were going to do it over a 3-year period. I told the guys to go back, figure out how to get it done in 15, and they've come up with a plan. This thing is going to be hot and heavy for a year and a half, but I think afterwards, it will reinforce its position as the world's best outlet center.
We couldn't be more excited about a project other than that one.
Okay. A lot of non-income producing work that you're doing there. A good return to you, but below the 12% that you're getting on some of the other redevelopments in the outlet space?
Correct.
Below? Okay.
Correct.
Just final one. I know it's a small potential investment, but can you maybe comment on your intentions at that land at Oyster Bay that you're trying to buy with some of your partners?
Nothing really to say other than, to the extent it moves forward, us and our partners will look at it and come up with a plan that's subject to zoning. We would expect to come up with a responsible development plan, it's all going to be something that's going to be subject to getting zoning approvals. We hope to benefit the community there and work with the community there to come up with the appropriate plan. It's going to be driven not just by us, but our two highly regarded partners.
Is the goal to build a regional mall at that site longer term?
No, I don't see that at all.
Okay. Thank you.
Sure.
Thank you. Your next question comes from Rich Moore of RBC Capital Markets. Please proceed.
Hi. Good afternoon, guys. Way back to the recovery ratio question, Steve. The JV recovery ratio is up pretty extensively in the first and second quarter of this year. Is that going to continue at that kind of rate, you think? Are we level at 2Q for recovery ratio in the joint venture platform?
Well, Rich, ultimately, it's math. It's a function of where the expenses go relative to the contractual increases that we have built into our leases. Give me your view on where you think inflation is headed and where costs are headed. So far, over a period of several years now, we've been having expenses grow at a slower rate than the escalators and the leases, so it's been additive to the comp NOI growth. In any event, Rich, I would say that the pace of the additiveness will probably slow down.
Okay, good. That's fair. You commented, David, on what's going on in Brazil as far as outlet centers go. What do you think for North America in terms of how many you can build annually or some number that addresses that sort of concept over the next five years?
Well, I can't put a number on them. There's a big pipeline out there. We're going to do a handful. Lots of other guys are involved in trying to do a number of them, and we'll see. Not clear to me that they'll all get built, but obviously, it's the flavor of the month. Any center that's out there that is not meeting its performance expectations turns into an outlet center. They're all harder to do than what people think. There's a lot of obviously very capable, competent developers out there trying to build outlets. The important thing is what we build is good, and I can't worry about what others build. I can only worry about what we build, and it's every intention on our front to only build what we can lease and generate a positive return on.
Thankfully, Rick, we haven't really screwed up yet in the new development side. Hopefully, that will continue.
The only thing that I would emphasize, and David touched on it earlier, is in addition to new development, these expansions that we're doing are at some of the best outlet centers in the world, and they're not small. Desert Hills is 147,000 feet. Las Vegas North is 147,000 feet. Seattle is 90,000 feet. These are big, substantial expansions that we're bringing great retailers, making some of the best in the world even better, and that shouldn't be lost sight of.
Okay. While you're on that, Rick, I have a question for you on Desert Hills. I just was in the area and saw that one, and it's always been a great center, and I'm curious, I didn't quite get exactly what you're doing there. It looks like you might be building a golf course in the middle or something?
Even though Steve wanted us to.
Yeah, exactly.
Yeah, I thought it was finally time to have a golf course at an outlet center.
Just a par three. What's going on now is there's really three things going on simultaneously. We are, as David alluded to at Woodbury, we're building a parking deck behind the existing larger section of Desert Hills, plus we've already built additional grade parking behind the smaller section. Now what you're seeing in the interior of the larger section is the actual development of the retail space that's basically going to be an inner ring. We're going to maintain our racetrack layout, but now instead of being single-sided with parking in the middle, it's going to be double-sided with parking in the decks.
Okay, I got you. How many retailers do you add there, do you think?
Well, we're adding 147,000 feet, and frankly, one of the things we've been able to do to drive our NOI is to try and be a lot more disciplined on the size of the retailers and maximizing our revenues by trying to fit as many new retail concepts into the space as possible. I would hope that it would be several dozen, but it remains to be seen because people want as large a store as they can get there.
Okay, good. Got you. Last thing, guys, do you have any updated thoughts on JCPenney and how they're doing, I guess, over the past quarter?
The only thing that I would comment on is that we're obviously in the stores. The stores look good. We know as much about their sales as you do. I will tell you that through our channel checks, the debt's trading at par. I think this is just a matter of giving the management team time to position it where they want to position it. It's still a formidable retailer with considerable gross sales, and we certainly hope they can recapture market share and resume a growth profile.
Okay, great. Thank you.
Sure.
Thank you. Your next question comes from Omotayo Okusanya of Jefferies. Please proceed.
Hi. Yes, good afternoon. Two quick ones with Steve. First, Steve, the reversal of the provision for credit losses. I'm just wondering how much of that is a signal to The Street about how confident Simon is feeling about tenant credit.
Tayo, it's not really a reversal of a provision. It's just the fact that there were some receivables that we had reserved for, and in essence, written off that in fact were subsequently collected.
Okay.
I will say this, as we look at our credit profile of our tenants and as we look at our receivables every month that we do, number of outstanding receivables, number of tenants on the watch list is pretty muted right now. I would say the overall health of the retailers is pretty strong right now.
Yeah. Other than, there are a few out there that Don't ask me to name names, because I won't. There are a few out there that still have some clouds around them. We're focused on two or three out there.
Decent
decent size for the mall business that we'll have to just monitor how they ultimately turn their business around.
Okay. That's helpful. Just the JV income, Steve. First quarter, that number was about $54 million, I think you mentioned that number was on the high side because of some mark to market on the Klépierre leases. In 2Q, the number comes in at $56.5 million. Just kind of wondering from a run rate perspective, what makes sense for us to be modeling?
I would say, Tayo, the run rate is probably more in line with what we saw in the first quarter, backing out that one-time thing that we talked about. It's in the high forties to about $50 million a quarter, I think.
Okay. What happened this quarter again to make it still elevated?
There was a small gain that flowed through, related to Klépierre's sale of their home office headquarter building.
Okay. Thank you very much.
Sure.
Thank you. We have no further questions at this time. I'd now like to turn the call over to Mr. David Simon for closing remarks.
Thank you very much. Have a great rest of the summer. See you soon.
Ladies and gentlemen, thank you for your participation in today's conference.