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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Greetings, and welcome to the Regency Centers Corporation, Third Quarter 2018 Earnings Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Laura Clark, Vice President, Capital Markets. Thank you. You may begin.
Good morning, and welcome to Regency’s third quarter 2018 earnings conference call. Joining me today are Hap Stein, our Chairman and CEO; Lisa Palmer, our President and CFO; Mac Chandler, EVP of Investments; Jim Thompson, EVP of Operations; Mike Mas, Managing Director of Finance; and Chris Leavitt, SVP and Treasurer.
I would like to begin by stating that we may discuss forward-looking statements on this call. Such statements involve risks and uncertainties. Actual future performance, outcomes and results may differ materially from those expressed in forward-looking statements. Please refer to our filings with the SEC which identify important risk factors that could cause actual results to differ from those contained in forward-looking statements.
On today’s call we will also reference certain non-GAAP financial measures. We provided a reconciliation of these measures to their comparable GAAP measures in our earnings release and financial supplement, which can be found on our Investor Relations website. Before turning the call over to Hap, I would like to thank those of you who participated in our Investor Perception Study. We are grateful for your candor and appreciate the feedback. Hap?
Thanks Laura. Good morning everyone. In our evolving business we continue to see the rise of retailers that have identified what it takes to remain relevant and evolved in the fall of those that have not.
As we all know, Sears was once a successful brand, but in the ebb and flow of the retail industry their declining performance over the last decade, further hindered by excessive debt illustrates how critical it is for retailers to keep the pulse of consumer preferences and expectations.
Sears failure, along with the success of numerous winning retailers also demonstrates the importance of having the capital to invest in the betterment of store, customer service and experience, as well as a technology platform that supports multi-channel retailing.
The best in class retailers including Amazon, Whole Foods, Kroger, Target, Publix and TJX just to name a few continue to make sizeable investments in the bricks and mortar footprints. Based upon our many conversations that we’ve had with key retailers, it is clear the physical stores remain a very critical component of a multi-channel strategy. This is really apparent in how retailers are investing in the physical footprints and providing a seamless and differentiated shopping experience to meet the evolving needs of their customers.
Kroger is not only enhancing their technology and delivery platform, but investing in their store with a restocked Kroger initiative, which focuses on customer experience, value and talent development.
Safeway Albertsons while partnering with Instacart and rolling out Drive-up is also remerchandising 400 of their stores. Publix continues to heavily invest in both new and existing locations with plans to redevelop over 130 stores this year as part of their $1.5 billion capital plan.
Publix has also demonstrated a real point of differentiation with their commitment to exceptional customer service. Going above and beyond offering aid in communities that were impacted by recent catastrophic storms is yet another example of the many ways that grocers are able to effectively connect to their shoppers and communities.
Target has expressed their commitment to bricks and mortar and indicated that the store is the central part of their strategy. They plan to remodel all stores by 2020; continue to open their very successful small format store and are investing in their team, as well as pickup and delivery service.
In addition, Amazon has announced an aggressive rollout of bricks and mortar locations and this is in addition to the large investment in Whole Foods. These and other best-in-class retailers are benefiting from the proactive investments and producing solid results.
Publix reported strong comparable sales and generated an impressive nearly $1 billion in free cash flow in the first half of the year. TJX’s comparable store sales rose 6% last quarter and Target reported their large quarterly sales growth in 13 years.
Our well-conceived and well-merchandised shopping centers located in trade areas with substantial purchasing power appeal to these and other outstanding retailers and restaurants. Regency’s proven strategy which our team has successfully executed with astute capital allocation and intense asset management has been distinguished by sector leading NOI growth over the last six years.
We do spend a significant amount of time ensuring that Regency is staying relevant and employing our unequal strategic advantages to achieve our objectives. First, earning a high quality portfolio that sustains sector leading same property in our growth; second, creating substantial value to our national development and redevelopment platform; third, maintaining a very conservative balance sheet; and fourth, engaging a team that is best in the shopping center business is guided by Regency’s special culture and operators efficiently with industry leading systems.
And finally, earnings and dividend growth and in turn total shareholder return that is consistently at or near the top of the shopping center sector. JT?
Thanks Hap. Core fundamentals within Regency’s premier portfolio remain extremely healthy. As Hap said, retailers continue to see value in locating a higher quality shopping centers and staying close to their customers. This is evident as occupancy climbed to nearly 96% this quarter.
Move-outs were the lowest they've been in two years and bad debt remains very healthy. The strong fundamentals across our portfolio translated into another solid quarter of same property NOI growth, driven by base rent growth of 3.8%.
As I noted on our prior call, rent spreads in any given quarter can vary based on the mix of leasing. This quarter we executed on several opportunities to bring valuable anchor spaces to market resulting in new rent spreads at 35% and total rent spreads of 10%.
I'd like to take a moment and highlight our shop space performance that clearly demonstrates the quality and resilience of our portfolio. Our shop space percent leased has been 92% plus for the last six quarters. We're seeing demand for space across all categories from many thriving tenants.
We've been successful, executing increases in starting rents, and in addition our achieving contractual rent steps for shop space that average 2.5% while judiciously managing capital commitments. All leading to strong, net effective rent growth for the last five years.
I'd like to touch on recent retailer bankruptcies before turning it over to Mac and I’ll start with a Toys "R" Us update. Of the five locations originally in the portfolio, one of the locations was released and the centers been sold. One location was assumed by another retailer at auction where we experienced zero downtime. One has been released as already commenced and the remaining two locations that we most recently acquired at auction, we're in active negotiations with a specialty grocer and a fitness user.
Next, we have 25 mattress firm locations in our portfolio. Only five of these leases have been formally rejected at this time. Most importantly, we are confident that with the quality of our real-estate we will have the opportunity to upgrade merchandising as we back fill any closures.
And finally Sears, where we have two Kmart’s and one Sears location. Two of these locations were included on the initial closure list, both of which are redevelopment opportunities that we are excited to finally unlock. All three are located in grocery anchored shopping centers where grocery sales average over $950 per square foot, demonstrating the draw of our real-estate, as well as the opportunity and our ability to substantially upgrade the anchor. Average rents on these locations are less than $8 per square foot.
While these bankruptcies will certainly impact near term results, more importantly the remerchandising and redevelopment opportunities triggered by recapturing this real-estate will positively impact our shopping centers over the long term. Mac.
Thank you, Jim. The healthy fundamentals we are experiencing in our operating portfolio are also evident in our investment activity. We continue to find compelling ways to astutely investor capital and go book our new development and redevelopment pipeline.
Our in process development and redevelopment projects are performing very well with strong leasing interest and economics in line with underwriting. For example, this quarter our Mellody Farm development in Greater Chicago celebrated its grand opening with all five acres, including Whole Foods, RAI and Nordstrom Max open for business. All have reported impressive sales exceeding expectations.
In regards to our pipeline, we continue to make progress on our development and redevelopment opportunities and are positioned to achieve our five year goal of $1.25 billion to $1.5 billion in starts and deliveries. Our local teams are pursuing new opportunities in our target markets, including L.A., D.C. and Houston.
We are also making meaningful progress on our pipeline at infill redevelopment. We are especially excited to start the redevelopment of the office building at Market Common Clarendon and The Abbot in Cambridge which should start in Q4 and Q1 respectively.
Further, our entitlements are progressing positively in Bethesda, which should allow our Westwood Shopping Center redevelopment to commence next year. And while we are in the early stages from a timing standpoint, we are making great strides to unlock the value creation opportunities at several premiere properties such as Costa Verde in San Diego, Town and Country in Los Angeles and Piedmont Peachtree in Atlanta's preeminent Buckhead market.
These larger scale pipeline opportunities and others, especially those that are mixed use but non-retail components take tremendous discipline, expertise and persistence. Proudly, our platform possesses these qualities and as we’ve said in the past, if we side to co-invest in a compelling non-retail component that will complement our retail, we will only partner with best-in-class world capitalized developers.
Moreover we continue to unlock value through redevelopments that are more technical in nature. This is a focus where we have enjoyed great success over the years and is an integral part of a pro-active asset management and fresh look merchandising and place making philosophy. Current examples include Bloomingdale Square, a $19 million redevelopment started this quarter where we are relocating and expanding the Publix into a former Walmart space and adding Home Centric and LA Fitness to the shopping center.
At Gateway at Aventura, we proactively acquired the former Toys “R” Us box at auction and are now in anchor negotiations to greatly enhance the value and drawing power of this excellent property. Lastly, at Point 50 in Fairfax Virginia, we are completely repositioning the center by building a new Whole Foods 365, as well as several new shop buildings.
Now turning to transactions. Similar to last quarter, there is a limited availability of institutional grade shopping centers on the market. Demand and pricing for these high quality centers continues to be strong.
On the selling side, the momentum we reported last quarter is coming to fruition. The buyers for these centers that we are selling are still discerning. The market has improved as that market debt solidified and deals are getting done. We have more visibility into expected sales volume for late 2018 and early 2019 and have accordingly increased our disposition guidance. The upward revision to our disposition cap rate is a reflection of the pool of properties we expect to close and not a change in pricing expectations.
As a reminder, our strategy is to sell approximately 1% to 2% of our asset base annually. We invest these proceeds along with free cash flow into value add developments and redevelopments, high growth acquisitions or our own stock when pricing is compelling.
This quarter we co-invested in Ridgewood Shopping Center located inside Raleigh’s belt line and anchored by the highly productive Whole Foods. This center had been owned by the same family for nearly 70 years and our local presence and deed market knowledge give us an inside track to acquire our 14th shopping center in the Raleigh market. Lisa?
Thank you Mac and good morning everyone. As Jim stated, we had another solid quarter as our high quality portfolio continues to perform. Year-to-date same property NOI of 3.8% has been driven entirely by very strong growth. But as we mentioned on our prior call and as our full year guidance indicates, while we are still projecting strong baseline growth in the fourth quarter, we do expect a deceleration in overall same property NOI grow, as this strong base line growth will be offset by three main drivers.
First as expected, our real-estate tax reassessments in California triggered by our merger with Equity One has started to come in and are retroactive to the date of acquisition. So essentially this equates, it actually is two years of real-estate tax expense. While the vast majority of real-estate taxes are recoverable from our tenants, we will experience a drag from the non-recoverable portion of these reassessments.
Next, we're are also up against a tough comp in base rent from redevelopments that came online in the fourth quarter of last year, specifically from too much larger projects, Fairmount and Aventura. And lastly as Jim discussed, the recent retailer bankruptcies will create opportunity to remerchandise and reposition our real-estate in the future; these will have near term impacts.
So although the timing related to the Sears bankruptcy could moderately swing us one way or the other, we have incorporated reasonable assumptions on their move out dates into our of revised 2018, same priority NOI growth guidance of plus or minus 3.25%.
Turning to earnings, both NAREIT FFO and operating FFO for the full year were revised upward by a penny at the low end, incorporating slightly better performance in same property NOI.
Before we turn the call over for questions and reminding you that we won't provide formal guidance for 2019 until early next year, I still would like to give you some insight into our same property NOI growth expectations as we do look to next year.
Let me start with a reminder of our road map to our same property NOI growth objective. First, embedded in the portfolio is 1.3% growth coming from contractual rent increases. Then another 1% to 1.2% comes from new and renewal leasing rent spreads. Combined these provide about 2.5% growth.
Finally the contribution from redevelopments is expected to add another 50 to 100 basis points of annual growth. Together, absent any changes in rent paying occupancy, these components equate to our strategic objective of 3% plus, average annual, same property NOI growth.
However our initial look into 2019 includes a couple of short term impacts to this roadmap. First, while timing is still very uncertain, the downtime associated with our three Sears boxes could impact same property NOI growth by up to 50 basis points.
Next, the redevelopment contribution has been and will continue to be uneven at times. Over the past 5 years, including year-to-date 2018, the annual contribution has ranged from 40 basis points to 170 basis points, averaging at 75 basis points positive contributions, thus the 50 to 100 basis points range in our roadmap.
In 2019 the contribution is expected to be minimal as NOI is taken offline at some of our larger, more transformational redevelopment projects. So while the contribution from redevelopments to our NOI growth can be uneven and I want to reiterate that we still remain extremely excited about our expanding pipeline and the contribution to growth that will come in 2020 and beyond.
For the difficult to predict Sears bankruptcy and the atypical contribution for redevelopment is likely to result in a more muted 2019 same property NOI growth in the low to mid 2% range. That said, there is much more to come as we close out the year before issuing formal guidance. But most importantly given our very high quality portfolio and our active REIT development pipeline, we continue to expect our same property NOI growth to return to 3% or greater over the long term.
We're extremely pleased with our results this quarter, and the position of our high quality portfolio and fortress balance sheet, all of which support our ability to grow earnings and dividends, which in turn expect total shareholder return to be consistently at or near the top of the shopping center sector.
That concludes our prepared remarks. We now welcome your questions.
Thank you. [Operator Instructions]. Thank you. Our first question comes from a line of Nick Yulico with Scotiabank. Please proceed with your question.
Hey, good morning. This is Greg McGinniss with Nick. I was just hoping you could provide some details on those new anchor lease signings. I was just trying to understand if this is a repeatable situation. Of those 88 new leases how much were actually above that 35% mark.
Greg, I'm not sure I can bifurcates that 40, but bottom line in that we had strong anchor growth of 85%, really driven by Publix and LA Fitness in our Bloomingdale redevelopment; those where the real leaders. As I said in my opening statement, the mix on a quarter-to-quarter basis is hard to predict and hard to try to analyze or bifurcate, but overall we're really excited. 12.7% of that new growth rent was in shop space, so the combination of 35% is really kind of across the board.
On the renewal side I will say that we were somewhat muted on a very large target at Serramonte renewal which was flat. So overall we are happy with the rent growth and [inaudible].
[Cross Talk]
You know the trial package we’ve indicated in the past, we’re going to have – Greg we’re going to have a number of legacy leases that will repeat the benefit we received from the publics in LA Fitness leases and other leases that JT just mentioned. It won’t be all of the time, but over time we’re going to see more of that than less of that.
Okay great, I appreciate the insight there and then you know I appreciate the details on the same store NOI growth guidance as well, but I’m just trying to understand a bit more here. So 3Q came in stronger than originally expected, so I’m just curious what changed their. You know this was the full reason that guidance was raised and if any of that impact that you were expecting is part of what got pushed into 2019.
Primarily it is the reason why one, that we raised the low end of our earnings guidance and additionally took off the low end of our same property NOI guidance. It's just a matter of – as you know and as we all know, the most difficult thing to predict are move outs and we always incorporate a reason of what we believe it to be, a reasonable assumption and that came in better than expected for the quarter, so we had fewer move outs than we anticipated.
Okay, great. Thank you very much.
Thanks Greg.
Our next question comes from the line of Christy McElroy with Citi. Please proceed with your question.
Hi, good morning everyone. Lisa just following up on the – again the topic of the same store NOI into 2019, just with regards to the California reassessment, the portion of that that's one time, are we looking at another three more quarters of drag there to the recovery rates? And then in terms of the redevelopment just to clarify, are you talking about to inherit in the low to mid 2% range, is that zero contribution or is that a drag from redevelopment?
First, the real estate tax reassessments, we would expect that just the fourth quarter should be the last of the one-time impact and next year as in any typical year, as in other states where properties are reassessed at you know certain intervals, we are expecting potentially up like a 5% increase in real estate taxes next year. But remember that we do recover about 90% of that. So it would be a minimal bleed for that. So the recovery rate going forward for all recoveries we would expect is right about where we are year-to-date assuming no change in occupancy, so in the 82% to 83% range.
And then with regards to redevelopment contribution for next year, again it's pretty early as you know and we need to have a little bit more visibility as to when leases come online and as we finish projects, so I don't know that we can give you any specifics and we will do that in early next year, but would expect it to be you know somewhere in the zero to 50% range of the positive contributions.
Okay, and then just with regards to the accounting change, the $0.06 to $0.07 moving into G&A in 2019, I understand that that also includes the leasing costs that previously would have been capitalized into the basis of your in-process development projects. How much of the estimated $0.06 to $0.07 would have been attributed to sort of normal recurring CapEx versus sort of that development, redevelopment bucket. Just geographically thinking from a modeling perspective you know just where that would have found through.
Christy I’m not sure I understood. So you are asking how much of our internal leasing costs are – because the $0.06 to $0.07 is [Cross Talk]
No, no, no. Just with regard to the $0.06 to $0.07. Yeah, just splitting out the $0.06 to $0.07, what has this gone through, recurring CapEx versus what would have been through development, redevelopment spend, the leasing costs, because it would have been, it would have shown up in your development schedule right, in the total cost attributed to each development project. So I'm wondering if that gets adjusted?
It's still – in our disclosure when we give leasing capitalization costs, it’s still our – we’ll have to get offline on that, we’ll come back to you.
Okay, thanks so much.
Our next question comes from a line of Craig Schmidt with Bank of America Merrill Lynch. Please proceed with your question.
Oh! Thank you. On the three boxes from Sears holding, does Regency have control over these boxes?
Craig, at this point we do not. All we know is we have two boxes that were on the initial 142 store closure list. We've not heard any more than that.
We obviously have been awaiting this day for a long time. Our teams have been focused on redevelopment plans. We feel like we're in great shape and eager to recover our real states, so that we can move forward and enhance our centers by back filling these tired old Sears and Kmart boxes with dynamic retailers today. So we’re – and more to come obviously, but no news other than its showing up on the closure list and we are prepared when it comes back to take those two.
In addition as Jim indicated earlier in the prepared remarks, the inbound comments and interest in the space has been very, very encouraging.
And is there a broader acreage of land that comes with the stores?
In the Sears specific we have a tire, battery, auto and probably some excess parking area that we believe we can probably do some patch / out billings on. So beyond the box we think there's some external redevelopment opportunity as well.
Okay, and was October rent paid on these boxes?
Yes.
Great! Okay, thank you.
Thanks Craig.
Our next question comes from a line of Derek Johnston with Deutsche Bank. Please proceed with your question.
Hi, good morning. We've discussed a real estate tax assessments and how it relates to the EQI portfolio, but in relation to the prop 13 bill in California, can you give us an update on the weighted average age of the Legacy Regency assets there? Have you begun to assess that potential impact?
Yes, and it is just the Legacy Regency obviously as essentially those that are being reassessed at ages zero if you will. So of the remaining which is about 20% of our asset base, its 13 years.
Thanks, and just switching over to the omni-channel repositioning that you discussed at the beginning, what effort and the roles of the local strip banker grocers are you seeing? Which are best positioned to address online delivery, online pick up growth segments and you know what actual investments are you seeing on the ground and what can you guys do to expedite the adoption?
We’re facilitating the adoption of the pick-up and delivery and we're seeing a keen focus on the part of pretty much all of the grocers. I think the key thing, and that's all important; technology is important in the store and we’re all investing heavily in that, but it's also the shopping experience and the service that’s really the point of differentiation and I think that's critically important to remember and keep that in mind, and that's the reason why you know we think that our grocer sales are as high as they are, both on an aggregate basis of $32.5 million and $650 per square foot.
Great, thanks.
Thank you.
Our next question comes from a line of Jeremy Metz with BMO. Please proceed with your question.
Hey, good morning. Going back to the Sears and Kmart topic, assuming you can get control of those boxes, do any of those represent an opportunity to kick off bigger densifications of those sites just given how big this year's in Kmart boxes presumably were and then it sounds like you more or less have been ready for this as most have been. So any rough capital investment that this could potentially represent?
Jeremy, to answer the first question. We studied the densification and believe our best avenue today is to replace with like retail. So the justification, I think we’ll be just higher better use, better quality retail. And I'm sorry, what was the second?
About capital. You certainly [cross talk] …
Capital, it's really too early. We’ve got a lot of – as Hap indicated we got a lot of answers from a lot of different players and until we can spend some more time and really understand when we are going to get back and those kind of things, we're really not positioned today to talk about it. Well, obviously we continue to target the 7% to 9% when we get our hands back on our redevelopment, that's kind of our goal.
Yeah, I think just to add a little bit of color Jim, in two of the three that are Kmart boxes. They're not Sears boxes, so they're just typical legacy Kmart’s and there's a reason they’re still, because it's really strong real estate and we do believe that will be an opportunity to upgrade the merchandising and then potentially also grow NOIs.
The K are extremely excited about the opportunity.
Yeah, I know that's fair. A question for Mac, in terms of acquisitions, the Ridgewood Center that you did enter by Whole Foods, was this sourced by your partner or why not put that one on balance sheet. Just given that it seems like down the fairway for Regency and I guess sticking with acquisitions, one of your peers mentioned the move-in rates causing some sellers to pull back. I know you guys have been active, but maybe you can talk about what you're seeing and hearing out there from an acquisition standpoint.
Sure thing, Jeremy. You're right that Ridgewood is right down the alley for us. It’s a terrific center and we look forward to working with Whole Foods as their lease doesn’t expire sometime in the next 10 years. Our partner was that we acquired the property with actually had some internal recycling, so they were selling a center that we owned with them and this was part of their internal capital recycling. So they were up and the rotation worked within that and that's the reason for that.
In terms of just overall perception, buyers are closing and we mentioned it this last quarter. There's just a firmer fitting underground for sellers; debt markets were cooperating and it seems like the market has come up and we noticed that in the transactions we closed today and we have another $60 million under contract with scheduled closings by year-end and another $65 million where we’re negotiating purchase agreements, but in those cases buyers have already begun their due diligence.
So they may not all close, but we’ll have some to grow to next year and some could drop out, but we are seeing you know buyers feeling you know measurably better about things than they were six months ago and we're seeing that in the transaction market.
Yeah, so I guess I was also trying to wonder just from an acquisition standpoint, as you’re out there your seeing, not you guys, but other sellers in the market pull back a little bit here or has there been any change in the cadence of deals that are out there that you are seeing?
I think what makes it hard to measure is there is very little property of the caliber that we're looking for that's on the market and we’ve seen very, very few transactions out there. So you know there are definitely institutional buyers and advisors who are out there looking for a Class A product that we are a product that has a strong tenure CAGR, but unfortunately there's a pretty select few properties out there that are transacting because buyers – owners are reluctant to put their properties in the market because it's hard to find a replacement property; there's so little Class A in the market.
Okay, fair enough. Last one from me. Hap you mentioned the importance of investing in the store and the customer experience. You know as you think about your increasing role in that, the landlord needing to play a bigger part in creating that overall environment, are you committing more capital are looking to commit more capital along this front which may not necessarily be able to immediately – it should be returned to the longer term, you know it's going to benefit the center and therefore your ability to both retain and source new tenants as you need.
Well, number one, as part of our – obviously our large scale redevelopments and even our tactical redevelopments, there our fresh look philosophy where there's a tremendous emphasis on merchandising and on place making, they're going to distinguish the look of listing the state appeal of those shopping centers to the communities and neighborhoods that they serve, so I think that’s important. But we’ve got an ongoing maintenance program and in that ongoing maintenance program we're very focused on you know place making and ongoing leasing and merchant and merchandising is critical to that.
So that’s a part of the way we do our business each and every day and we feel really good about the way our shopping centers are distinguishing and they are continuing to focus on how to keep them relevant and we are also – I think our view is we spent between 10% and 11% of NOI from a tenant improvement White Box ongoing business, you know building improvement standpoint and think that that number is still good and together with the redevelopments that are tactical in nature will keep our shopping centers looking fresh and relevant to our communities.
Thanks for the time.
Thank you.
Our next question comes from the line of Ki Bin Kim with SunTrust. Please proceed with your question.
Thanks. So you have an interesting dynamic that's going on in your department pipeline. You might have about $280 million of pipeline, but if I look at the percent leased and think about the dollars at risk, there’s really not much because a lot of it has been leased pretty well.
It kind of clears up your pipeline or your development capability for next year. You also mentioned a lot of these other bigger projects in your opening remarks. So I'm just trying to get a sense of how much do you think you will start next year?
Sure, I’m happy to take that. This is Mac. While we haven’t given formal guidance yet on our developments starts for next year, and we will be doing that in the near future, but you are right. The developments that we have that are underway are performing very well. At 80% leased where we are very happy with those and it allows us to use our expertise to work on some of these longer term redevelopments and I touched upon several of those in our opening remarks, I’ll just give an example.
Westwood Shopping Center which is a center they came over with Equity One, in about a year's time we should be ready to start that project and that is very promising. It's a mixed use project, with retail. It's got approximately 200 apartments and some tenants to it and these are complicated projects and not every company is capable of doing this, but we think we have the team and the expertise and the market knowledge to take this on.
So we are bullish about that. We’ll eventually give guidance on where we think we’ll be, but over a long term, which is really the right way to measure our contribution, it’s not a year-to-year business, it’s always going to be lumpy, but we think we are on track to hit our five year target at $1.25 billion to $1.5 billion in starts and then deliveries would come with that two as well. So hopefully that answers your question.
Yeah, I mean it does. I mean I think about Bethesda project. That by itself is probably very sizeable. You guys started about $200 million this year. I mean I guess just directionally it does feel like it could be a lot more in the next year. So is that – am I thinking about it correctly?
Well, I think directionally you will see us doing more of redevelopments as a percentage of our total investment than we have in the years past. In some years it was more ground up as compared to redevelopments and I thinks switching and more agnostic to the two. In fact we like the flexibility optionality that redevelopments give us and so I wouldn’t associate more, but I would say the mix between ground-up and redevelopment is shifting more towards redevelopment and we are very pleased with that.
These are properties that we one and then Town & Country is for the one, new one to that and we are coming into a partnership on that property which is a terrific property located across the street from The Grove and we mentioned that before. But that allows us to bring our expertise to enter into a family partnership and to add some density to that and ultimately that will be one of our more key properties across the country. We are very pleased with that.
Okay and just last question. For the last question, on the Sears, Kmart I realize you don't have much direct exposure, but how do you think about that tangential exposure just from the model shop supply that might hit the market and how that impacts your portfolio?
In general, space is space and it has an impact. But we think and we feel real good about our locations, about our anchor tenants, about the team’s focus and you know we have released virtually all the space that’s coming back to us, the anchor space that has and I think that’s indicative to say it doesn't have any impact. But we believe that as Lisa said that we can generate in fact 2.5% from an underlying NOI growth standpoint before redevelopments and we think over time that redevelopments are going to contribute an additional 50 to 100 basis points.
We've got the team in place, the commitment, only to say in regard to the redevelopments, you know it's kind of become the topic de jure and this has been an integral part of our business historically and we got to the team placed and the markets to markets these projects happen.
As Mac said, they can be complicated, they can be difficult, and we’ve not even viewed the tactical ones. I think as I indicated earlier, it’s just an opportunity to refill a box, etc. It’s an opportunity to further distinguish of our shopping centers for the long term. And just to reiterate what Mac said I think we're very well positioned to achieve the $1.25 billion to $1.5 billion of development starts and to average as Lisa said, 3% same property NOI growth, even in a market where there is going to be additional store closings.
Okay, thank you.
Our next question comes from a line of Rich Hill with Morgan Stanley. Please proceed with your question.
Hey, good morning everyone. I want to maybe just go back to the properties that you're buying and selling. Maybe we can talk about the properties you're selling first. Could you provide any more color as to what’s maybe making those less attractive and trade at lighter cap rates. Is it location, is it you know the type of grocery store there, is there alternative mix. What is making that less attractive to you or maybe you want to work into something that's so called higher quality.
Yeah, sure thing Rich. This is Mac. You know if you just look at page 15 of our supplemental, you can start to pick up some teams here from the set of properties. It’s a [inaudible] anchor. It’s a deals anchored center; it’s a theater anchored center.
There’s two larger projects that are really big box centers. There is one in India, its unanchored, its shadow anchored by Home Depot, so it’s not the typical Class A infill grocery anchored tenants that we own and we feel that these properties were ready to be sold. These were prioritized disposition for us, and ready to solid and were widely marketed and they cleared.
It’s a type of center that I mentioned, sort of the tenants who are there, but it’s also the location. These are smaller markets, and if you plug into the demographics, they are lighter than our typical property. They are on the low end and they are typically lower growth and people are paying for growth. So all those characteristics contribute to the pricing and we feel that the pricing was correct. These are really out buyers in many ways.
Got it, and so it looks your rising sales have been fairly similar this year, at least in terms of number. But you also mentioned it’s hard to find the high quality properties that you want to own. Do you think there is more role quality properties to go for you to sell or as you just mentioned, is it really just an outlier. I guess what I'm asking, do you think there's more opportunities to see more portfolio location at this point in time or is it becoming harder just they may as well be higher quality properties.
Yeah, being able to find good use of the capital is an issue. Being able to do transactions on a tax efficient basis is also important, but the other key thing is we don't have to sell properties. We are in a position where those properties that kind of have the characteristics that Mac just described are the remaining less than 5% of our portfolio, so we are in a position to sell when it makes sense to sell and when we have the appropriate use of funds and we can do it on a tax efficient basis.
Got it, and just one more follow-up question if I will. Are there any examples where you can take out so called 79 property and put money into it and make it a 49 property? I mean does that exist or is that just not a use of your funds in your opinion.
That’s – where we can we have an opportunity to do that, we do that each and every day. That's a key part of our business and we've been doing that for years and these redevelopments represent a lot of those when we are transforming the properties that we have.
Got it, thank you guys. That was really helpful.
Our next question comes from a line of Mike Mueller with JPMorgan. Please proceed with your question.
Hey, good morning, I through I got out of the queue. My question was the prior question on about how much of the 7.5 to 8 cap properties are less in the portfolio. So I think that – I heard you said it was about.
I don’t know that we actually answered the question. So I would point you to our Investor Presentation where we have about 2% that we consider kind of non-core and think about again remind you of our funding strategy. So free cash flow is going to fund our development spend to the extent that we are short, we are going to – and do not have access to the equity market because it's not a compelling price at the time. We will use dispositions for that and it will come from that 2% bucket.
And if you do, to give a little bit more color on page 15 in the supplemental, if you look at those, there is not a single one on here that we went out and bought individually. It either came as in the package of the of the portfolio acquisition and a couple of them were legacy developments when we are building much larger power centers back in the late marching developments, which we do not do today.
So basically if that 2% of the portfolio was gone and we're looking in the supplemental, the disposition cap rates wouldn't be 7.5% or higher.
I think that's a fair assumption.
Got it. Okay, that was it, thank you.
Our next question comes from a line of Chris Lucas with Capital One. Please proceed with tour questions.
Good morning everybody. Hey, just a couple of quick ones. Lisa on the implied guidance for the fourth quarter, you know $0.03 spread between 91 to 94, is there any one item that sort of causes that spread or is it just a myriad of factors that you're unsure about going in.
It’s you know, same priority NOI is a big driver obviously and although our guidance is 3.25 plus or minus, it can be plus or it can be minus, and Sears is a big driver of that as well depending upon when – if we get November and December we are in it and that is one of the largest drivers.
Okay and then just kind of following up on that topic. The Mattress Firms you had rejected, given the likely scenario, the plants they're going to come out. I think they want to get out of bankruptcy this year. You'll get paid what for those rejected leases?
Its still, I’m a little hesitant to say that I'm certain what's going to happen. So our understanding at this point is we are going to get paid for them for up to a year, but again I think its…
A year from when they file.
A year from when they file. But I think that its more to come. But right now that is the assumption.
Bankruptcy is an uncertain process and we’ve incorporated that into our projections.
So just, Hap just so that I’m clear. You are saying that you could get up to a year, but it would be a year from now that you would get paid or when they come out.
I don't know that we really know when it's, and that's part of the uncertainty as well, but the early indication is that we will get up to a year's worth of rent.
Whether that’s from when they filed or it’s from when they come out, we still don’t know.
Okay, and as it relates to Sears in terms of the guidance you provided earlier and the drag to same store NOI from near year, does that matter as to whether that’s a seven or a 11 liquidation or we just a rework and what are you guys assuming?
I mean that won’t matter. What matters is whether or not we actually – whether someone assumes and buys the lease or if we get it back.
Okay, great. Thank you, I appreciate it.
Thank you, Chris.
Our next question comes from the line of Samir Khanal with Evercore. Please proceed with your question.
Yeah, good morning. I just had a question on the leasing spreads for new deals. I mean it was up 35%, but it didn't look like you put in a lot of CapEx. Certainly if you look at the CapEx per term in the quarter versus maybe the trailing 12, it actually fell. So I just want to know what was kind of going on there.
Samir, yeah it was interesting that it fell with the volumes and what that represents is really the driver there was Publix at our Bloomingdale Redevelopment. That particular deal is a tear down and rebuild. So what you had was less, what we call IT and White Box and it's really rebuilding a building. So that artificially dampened that number. If you took Publix out of that, we would normalize it $30, which is right in line.
Okay, got it. And I guess my second question is just regarding your NOI guide post, you know that low to mid 2% range for ‘19. I mean how are you guys thinking about sort of credit loss reserves for ‘19 versus this year.
You know how much cushion do you have sort of built in for maybe other distress retailers besides sort of the Sears and Mattress Firm of about certainly 90 basis points, excuse me a 50 basis points down time.
Again, that's not formal guidance’s, so we will come back to you in early part of next year with more formal guidance. But Sears is obviously incorporated in there as I indicated in my remarks, up to 50 basis points.
So at this point beyond Sears you are not incorporating any other?
Samir yes, of course we always do and even through a bad debt expense, it doesn’t exactly translate to how much we are incorporating into kind of the credit collection loss if you own typical underwriting. We've been kind of around the 45 in the – 40 to 50 basis points range in bad debt expense. I think that that’s a good indication that we’ve had a pretty normal and steady rate of move outs if you will and bankruptcies and store closures and we would expect something similar next year on top of Sears.
We're incorporating – our thinking is incorporating our normal amount of issues, but at the same time we're also incorporating that the underlying business is good, leasing spreads will remain healthy, we're seeing strong demand for space. So we feel good about the underlying fundamentals of the business and our ability to continue. The Sears bankruptcy aside, the 2.5% underlying same property NOI growth that Lisa described earlier.
And I think my prepared remarks directly hit that and also there is even some – it’s also implied, if you go back to the road map again of 1.3% contractual rent steps and then another 1.2% from rent lease spreads, that gets you to 2.5 and I just told you that we’re expecting and incorporating up to 50 basis points at Sears and we're still saying we're going to be in the 2% to 2.5% range.
Okay, thanks.
Our next question comes from a line of Vince Tibone with Green Street. Please proceed with your question.
Good morning. I have a clarification question on the Sears closures. Are you have to bid for the leases, the bankruptcy option?
Jim, [inaudible].
It’s just that we don’t know. We are on a closure list, but there is no telling how Sears will – whether they'll try to sell the leases before they reject, we just don't know at this point. We are – obviously in our planning we're preparing to defend our real estate.
Got it, okay. [Cross Talk] They are still paying rent and the lease is still in place until further notice.
Can you just talk maybe a little more broadly about the pros and cons of buying a lease in bankruptcy option versus letting a new tenant you know purchase a below market lease?
Well obviously we evaluate every aspect, and I would say during the Toys we evaluated a deal in Chicago where it was at auction. We were prepared to be it if needed. We did our homework. Understood who was interested in the space and felt comfortable with that user and felt the economics of no-downtime projecting rent was a good alternative to us jumping in and protecting the real estate. So it's a one off thing we evaluate on every space that’s in play.
And Mac in my just review to kind of what we did with Hagan, because it was a combination of working with replacements to Hagan, buying leases and letting some of them go and coming back to us on that date.
Before Mac does individual examples, I mean the biggest thing is, is the pro is it gives us control of the real estate. It allows us to control the merchandising and in often cases which Mac is going to talk about allow us to unlock a lot of value.
Those are lease closures?
Well, you may change the use Vince, right, upgrade the use, but you also by wiping out that former lease you may get rid of some restrictions that have to do with competing uses, exclusives, co-tenancy parking requirements. Sometimes these older leases are just outdated with how the market works. So you get a fresh start and there's generally at a reasonable price. The pros heavily outweigh the cons and you take some leasing risk, you're not going to have it preleased, but we're in that business anyway and we have a good feel for that and we factor that into our pricing. So net-net its usually advantageous for us to buy a least back.
That's very helpful color. Thank you, that’s all I have.
Thank you, Vince.
[Operator Instructions] Our next question comes from the line of Linda Tsai with Barclays. Please proceed with your question.
Hi, yes. Does having a Kmart box versus having a Sears…
Linda, we can’t hear you.
Sorry about that. Does having a Kmart Box versus have a Sears give you more flexibility given the size and you know maybe in terms of back filling more easily with the tenant versus having to redevelop?
The reason I commented specifically that they were Kmart's versus Sears is to see exactly the size of the box and they're in your typical neighborhood community shopping center, so there's not a whole lot of densification opportunities at those.
Okay, and then in terms of the 35% increase in new leases, can you give us a sense of what percentage of your anchor leases are considered legacy?
Hey Linda, we can’t give you that percentage. This is Mike, but we do have as we indicated at our Investor Day, there are 40 leases that we call “Legacy Leases” that are available to us in the upcoming say five plus years and those will be the leases that are going to really drive the top line rent growth metric.
And even – it’s pretty interesting, even in a portfolio of our size, it doesn't take much for it to really move the needed, because they are such large increases at these legacy anchor leases.
And they control the space for a significant amount of time. The key thing as far as the health of the portfolio and the relative strength and sustainability of the portfolio I think is the same store rent spreads that we are experiencing, 12% on the shop space.
Thanks, and then while your peers are using technology and data to better understand shopping habits and help tenants make location decision, to what extent are you engaging in these initiatives to?
Linda, I’ll answer that. Lisa, do you want to take it?
Go ahead Mac.
This is not a new thing for us. We’ve actually been at the forefront of using technology to help us with merchandising, to target actual customers by using mobile data to track where our customers are coming from and we've actually been piloting probably over a dozen different technologies over the years and actually have helped companies create that technology by working with them closely.
So we're using it for better merchandising, where we've been able to convince tenants that our sites makes sense by showing them what our customers are coming from and using technology that they don't have in house and it's been eye opening for them and that’s really helped us.
And then the future really is using this technology to actually target customers coming on to our property through advertisements, through mobile phones and that’s in the early stages of it, but we are spending a fair bit of time on this and the industry still has years to grow up, but it's not a new thing to us. We’ve been following this for many, many years.
Thanks.
Thanks Linda.
Our next question is from Christy McElroy with Citi. Please proceed with your question.
Hi, thanks for taking the follow-up. Just on mattress firm, I know that there’s the initial closure list. It’s all very fluid. There's more that’s potentially coming. Just that you know you've got five closing, 20 remaining. On the 20, are they – as they sort of work through the process and potentially emerge here, are they trying to negotiate rent release on those 20 remaining or is it still sort of up in the air?
Christy, as any good bankrupter will do, they will absolutely ask on every location which they did here. We’ve been firm in our responses. I think the average AVR is $33 on ours. I think they are located in centers in 96% leased. They generally took very good real estate, high visibility high access. So that’s when we felt over good about being strong and recapture our real estate. When asked we said no, and the five may turn into seven or eight, but at the end of the day we will proactively release those boxes in smaller phase.
Just say no.
Okay, and then just – following up on some of Ki Bin’s questions, you guys were talking about Westwood a bit. Any sort of early estimates you can give us in terms of the potential for a capital commitment on this project? Is there something that you would be maybe working with partners on any non-retail components and would this project stay in the same store pool?
I can touch on the first part of that. Plus or minus $75 million is what we circle for investment in that and we would have all of the retail. We are negotiating with a partner where we would take half of the apartment, 50% interest and that’s included in the $75 million. There is also approximately 75 town homes which are up for sale product and we're going to provide some of the capital for that, although that’s not a long term hold as I mentioned.
So Lisa can talk to you about sort of the big picture, what’s in and out of that. But we are excited about that project. It should have a return of in the high sixes. This is what a stabilized return is and it’s going to be down in the project for us.
And just in both cases, on the town home and multi-family developer they were negotiating with and both are best in class and both will have a meaningful amount of capital invested on this share of – of those portions of the development.
At this point of time with the early head nod of the 2% to 2.5%, we are assuming that Westwood stays in our same property pool. But it’s a great question as we really do have larger projects that we are beginning to work on, beyond – a scale beyond what we have had in the past. We got another one that’s in our pipeline in San Diego in Costa Verde. It’s over $5 million of NOI and we may essentially take that to zero as we redevelop it. So it’s something that we are evaluating and we’ll have more clarity on how we will handle those large projects in the future, but for now Westwood is assumed to be just staying in the same property pool.
Okay, and then is Giant staying at the project, has that been resolved.
Giant is staying. They are going to relocate. Sorry to interrupt. Giant is planning to stay. We are going to relocate them and put them into a brand new store in a podium format with parking below them.
Okay, thank you.
Thank you, Christy.
Thank you. It appears we have no future questions at the time. I would now like to turn the floor back over to management for closing comments.
We really appreciate your time, interest in Regency and wish that you all have a wonderful weekend. Thank you very much.
Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day!