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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day and welcome to Retail Opportunity Investments 2018 Third Quarter conference call. Participants are currently in a listen-only mode. Following the company's prepared comments, the call will be opened up for questions.
Please note that certain matters discussed in this call today constitute forward-looking statements within the meaning of the federal securities laws. Although the company believes that expectations reflected in such forward-looking statements are based upon reasonable assumptions, the company can give no assurance that these expectations will be achieved. Such forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause actual results to differ materially from future results expressed or implied by such forward looking statements and expectations.
Information regarding such risk and factors is described in the company's filings with the Securities and Exchange Commission including its most recent Annual Report on Form 10-K. Participants are encouraged to refer to the company's filings with the SEC regarding such risks and factors as well for more information regarding the company's financial and operational results. The company's filings can be found on its website.
Now I would like to introduce Stuart Tanz, the company's Chief Executive Officer.
Good morning everyone. Here with me today is Michael Haines, our Chief Financial Officer and Rick Schoebel, our Chief Operating Officer.
We are pleased to report that the company posted another active quarter. Capitalizing on the demand for space, we achieved a new record high portfolio lease rate ending the quarter at a very strong 97.8%. We executed over 100 leases during the quarter with a good mix of new and renewed activity while also achieving solid rent growth. As it has shaken up thus far we are on track to lease a record amount of space for the year.
In addition to our success on the leasing front, we also strengthened our balance sheet during the third quarter raising equity and paying down debt. In terms of acquisitions market conditions had begun to show signs of becoming favorable again; however, the recent jump in interest rates has brought back the uncertainty that we saw in the marketplace during the first half of the year. Therefore, we continue to be cautious and patient.
Turning to the redevelopment opportunities that we introduced on our call last quarter, we are continuing to analyze the feasibility of having a mixed use component namely multifamily to a select group of our shopping centers. Our strategy is aimed at furthering the long term competitive position of our shopping centers and enhancing the underlying intrinsic value of our portfolio. Thus far we have identified 20 properties that we think are potentially feasible for adding a multifamily component.
Of those 20, we are currently underway with the entitlement process on three opportunities, specifically at two of our shopping centers in the San Francisco Bay area and one up in Seattle. Based on preliminary analysis, altogether these three opportunities represent about $200 million investment with a projected unlevered yield in the mid 7% range.
One of the two San Francisco opportunities involves redeveloping a Kmart site that is adjacent to our shopping center in Pinole. Kmart had a long term ground lease on this site which we acquired during the third quarter fortunately just ahead of this year's bankruptcy filing where we could have lost control of the site. Very important, this is the only Kmart exposure that we had in our entire portfolio.
As we move forward with these three opportunities our goal is to carefully mitigate the development risk. To that end, we intend to partner with a seasoned multifamily developer that has considerable experience and expertise in building multifamily properties specifically in these markets where we can best capitalize on our combined market knowledge and relationships with the local municipalities.
We are currently in discussions with several key players exploring a variety of partnership arrangements ranging from a simply contributing the land as our equity contribution to taking a larger more equal position. Assuming we do take a more meaningful stake, we would look to potentially fund our capital investment in part through certain noncore asset sales.
Speaking of dispositions, during the third quarter we sold one property for $28 million. It was the lone property that we owned in Nevada on the California border east of Sacramento. Beyond this property we also have a few other potential asset sales that we are contemplating including additional properties in Sacramento. Our long term goal is to exit the Sacramento market in an orderly fashion as we complete certain lease and objectives and then redeploy the capital in other core markets, as well as redevelopment opportunities as they take shape.
Now, I'll turn the call over to Michael Haines to take you through our financial results for the third quarter. Mike?
Thanks Stuart. For the three months ended September 30, 2018 the company has $73.9 million in total revenues and $25.3 million in operating income. GAAP net income attributable to common shareholders for the third quarter of 2018 was $14.2 million equating to $0.12 per diluted share and in terms of funds from operations for the quarter FFO totaled $35.1 million equating to $0.28 per diluted share.
With respect to our financial results for the first nine months of 2018, the company had approximately $221 million in total revenues and $76.4 million in operating income. Net income for the first nine months of 2018 totaled $32.2 million or $0.28 per diluted share. And in terms of FFO the company had approximately $106 million in total FFO or $0.85 per diluted share for the first nine months of 2018.
With respect to property level net operating income, on a same center comparative basis cash NOI increased by 2.5% for the third quarter of 2018 and by 2.6% for the first nine months of the year. Included in the third quarter was a one-time expense totaling roughly $200,000 in connection with an anchor lease that we recaptured. As Rich will discuss we already have a new tenant lined up to take this space at a notable increase in rent. Excluding the expense, the increase in same center NOI would have been closer to 3% for both the quarter and year-to-date.
As Stuart touched on, during the third quarter we raised some equity through our ATM program. In total we issued approximately 1.25 million common shares raising $24.2 million in gross proceeds. Taking the equity proceeds together with the asset sale that Stuart spoke of, during the third quarter we reduced our debt by $64 million including retiring a $9 million mortgage along with reducing our credit line balance. As a result, at September 30, the company had approximately $1.5 billion of debt outstanding a vast majority of which was unsecured.
In fact, our secured debt is now down to less than $90 million encumbering just four properties. In other words, over 95% of our portfolio, 87 out of our 91 shopping centers is currently unencumbered. And with returning that one mortgage we now have zero debt maturing for the next three years when our credit line comes up for renewal.
And with respect to our credit line, during the third quarter we lowered our balance by $55 million down to $137 million outstanding as of September 30. And in step of lowering our debt, our interest coverage increased to 3.3 times for the third quarter.
Finally, in terms of the FASB accounting change requiring internal leasing costs to be expensed rather than capitalized, when the accounting change takes effect next year the impact to our financials will be modest adding only about $1.2 million to $1.3 million annually to our G&A equating to roughly to $0.01 per share which is less than 1% of our annual FFO.
Now, I'll turn the call over to Rich Schoebel, our COO, to discuss property operations. Rich?
Thanks Mike. As Stuart noted, demand for space across our portfolio continues to be strong. national and regional grocers as well as other daily necessity and value oriented retailers continues to seek expansion and relocation opportunities on the West Coast. Notwithstanding our anchor occupancy being at 100% we continue to proactively seek out any underperforming space in order to capitalize on this anchor demand.
As an example, as Mike mentioned, during the third quarter we recaptured an anchor space and are replacing them with a strong value-oriented grocer that is expanding in the marketplace. Not only are we achieving a significant increase in rent, close to three times what the previous tenant was paying, the previous tenant also had an old restriction on the property that’s now been removed enabling us to build an additional 5000 square foot pad at the shopping center.
In terms of smaller format tenants, the demand continues to be driven predominantly by service users including wellness and fitness concepts, organic, health oriented restaurants and a variety of children focused users ranging from learning centers to day care facilities. The common thread with all these small format users is that they are all Internet resilient and they are all looking for shopping centers conveniently located to their target consumers.
From our perspective, these are ideal tenants for us in several key aspects. Given their small format we are able to fill those last bit of remaining hard to lease spaces enabling us to bring certain properties to a full 100% leased which in fact we accomplished at several of our properties during the third quarter. Additionally, these types of users draw consistent foot traffic to our centers, particularly during weekdays and evening which serves to bolster sales and activity at our larger daily necessity anchor tenants.
To take you through our specific leasing results for the third quarter, starting with occupancy, as Stuart noted, we achieved a new record high for the company ending the third quarter at 97.8% leased. Breaking the 97.8% down between anchor and non-anchor space, as I mentioned our anchor space continues to be 100% leased which is now the seventh consecutive quarter at 100% and the 19 consecutive quarter at or above 99%.
In terms of our shop space, we continue to work hard at leasing the available space we have across our portfolio. In fact, during the third quarter we increased our in-line space to a new high of 95.3% leased as of September 30. During the third quarter we executed a total of 106 leases totalling 443,000 square feet achieving a 10.2% increase in same space cash rent on average.
With respect to new leases, during the third quarter we executed 48 leases totalling 139,000 square feet achieving a 17.1% increase in same space comparative cash base rent on average. That increase was largely driven by an anchor lease that we signed during the third quarter where we achieved nearly 100% increase in base rent.
In terms of shop space, during the third quarter the majority of in-line spaces that rolled were essentially close to market so there was only a nominal increase. That is not indicative of a trend. It is simply a function of the specifically leases that rolled and were released during the quarter. Much of the shop space that released during the quarter were small spaces, many less than 1000 square feet, where the releasing rents can vary widely depending upon the specific space and the perspective tenants.
Looking ahead we fully expect to continue achieving solid rent growth going forward. In terms of renewal activity, during the third quarter we executed 58 renewals totalling 304,000 square feet achieving an 8.6% increase in cash base rent on average. And lastly, in terms of the economic spread between build and lease space meaning newly signed tenants that have not yet taken occupancy and commence paying rent, at the start of the third quarter the spread stood at $7.1 million in additional annual rent on a cash basis.
During the third quarter, tenants representing about $3.7 million of that incremental $7 million started paying rent of which $487,000 was received in the third quarter. Taking the remaining $3.4 million together with our leasing activity during the third quarter as of September 30 the spread was about $5.5 million.
Now I'll turn the call back over to Stuart.
Thanks Rich. It is safe to say that this has been an unusual year for us. As it relates to acquisitions, we are accustomed to acquiring 300 million to 400 million each year. However, as I noted in my opening remarks, we continue to be cautious in this current environment. That being said, we are as we always have proactively seeking out off market opportunities and continue to explore a number of interesting transactions.
In terms of our FFO and same center NOI this year, there have been two underlying factors that have impacted our performance. First is the slow permitting process as it relates to both our ability to deliver newly leased space which ties to GAAP when commencement and then once we do deliver the space as it relates to the tenants getting final sign off from the city to open their stores which ties to our cash NOI.
In our 25 years of operating in these markets we've never experienced this type of delay in backlog with the various municipalities, which in turn has made it increasingly challenging in terms of our ability to forecast our results. The second factor which ties to the slow permitting process is the extended downtime between leases. As the year is progressed the downtime is proving to be longer than what we originally projected as it relates to our property level budgeting for 2018.
Notwithstanding being on pace to lease a record amount of space this year and averaging 20% growth thus far in terms of new leasing spreads, unfortunately the record leasing, together with the slow permitting process does mean additional downtime which in the short term impacts both GAAP and cash based rents as well as CAM recoveries.
To be clear though, we are still achieving growth this year in terms of our total GAAP rent, total FFO and same center cash NOI. It is that we had had expected the growth to be a bit higher based on our original budgeting which we would have achieved had it not been for the slower than anticipated permitting process and added downtime. Taking these factors into account together with the equity issuance in the third quarter along with asset sales, our FFO guidance range for the year is now $1.13 to $1.15. In terms of same center NOI we expect the year-over-year increase to be between 2.5% and 3%.
While this has been an unusual year, the fundamentals of our markets, our portfolio and our business remains sound. As Rich highlighted, retailers continue to push forward with expansion plans on the West Coast. In fact, we just met a few weeks ago with many of our key tenants at the Los Angeles ICSC Conference. And I can tell you that they all remain very upbeat about growing their presence on the West Coast.
Additionally, our core metro markets remain among the most highly protected, supply constrained markets in the country. Our portfolio is well situation in these markets. With that as a backdrop we continue to be confident in the future, long term prospects of our portfolio and our business overall. We look forward to completing 2018 and turning our sights to 2019 and beyond.
Now, we'll open up the call for your questions. Operator?
[Operator Instructions] And our first question comes from the line of Collin Mings from Raymond James. Your line is now open.
Good morning, Collin.
Hey, first question from me, just Stuart just as you kind of explore options for the redevelopment opportunities that you outlined the three projects, can you may be just talk a bit about how you're thinking about the trade off between potentially having a larger stake in projects and sharing more on the upside versus complicating what has historically been a pretty straightforward story?
Collin, at the present time we have no intention in getting into the multifamily business. We are very proud of the straightforwardness and transparency and simplicity of the company. So as we move forward we still are a bit – we haven’t yet determined the final structure of these transactions, but right now we're just looking to contributing the land and really that fee roll their plane at this point in terms of moving this process forward.
So I really can't get, there are lots of options, but the key for us is to keeping that decision really on the basis of what we've done in the past which is simplicity, straightforwardness, and transparency.
Okay, so it sounds like may be in the prepared remarks you are just making that as a point, that there are a lot of option now here, but in terms of a go forward strategy the focus is kind of what you've historically done, is that fair?
That is correct.
Okay, and then as far as the guidance reduction, I appreciate the details and some of the moving pieces there, I mean can you just talk a little bit more just two parts in terms of clarifying, so when we think about the $0.04 reduction at the midpoint is that really all just lower NOI that had been previously forecast? And then really the second part of that, how are you working with some of the municipalities and other constituents as it relates to kind of getting this process to move quicker going forward?
Well, I'll let Rich answer the second part of the questions which is the municipalities and then Mike you can jump in and share more detail.
Hey Collin, as far as the components of the guidance lowering, you know there are a couple of different things going on. Obviously you've picked on most of the stuff from the press release. You know we raised some equity in Q3 so that's going to impact Q4 and year-to-date. We had the asset sale for the NOI and so that asset is going to be nonexistent in Q4. You know we're got the anchor revenue coming from one anchor that we did recapture in the third quarter, that's going to impact has well. And then we're also taking into the account the continued downtime due to the permitting delays in getting tenants open. So those four primary factors are what caused us to kind of re-guide to a lower number.
And then in terms of trying to get ahead of the permitting process, we do several different things. One is we use expediters when available. We also require the tenants to hire an expediter for their permitting process. And then in certain municipalities I think like we have touched on before, like the City of Seattle where it takes six months just to get an intake appointment, we are just scheduling those appointments even when we don’t have something to submit so that we're in the queue. So we're trying to be as proactive as we can, looking for every opportunity to shorten that timeframe.
All right and then just one last one from me, just on the, focus on deleveraging Mike, just in the past you guys touched on being below 6 times by year end or I'm sorry, below 7 times by year end, is that still the goal and at this point of the year how should we think about additional asset sales closing before year end?
Asset sales probably you will see more of that before year end and again we've taken that into consideration on our guidance, but Mike's got the first part of the question.
Well, as far as de-levering obviously we would like to do more, actually that's going to be subject to market conditions. We originally communicated $25 million to $50 million before the end of the year, we're halfway there. And we'll see as the market plays out price wise we'll see if we can actually see more before year end.
Alright, I’ll turn it over. Thanks guys.
Thank you.
And the next question comes from the line of Jeremy Metz from BMO Capital Markets. Your line is now open.
Good morning, Jeremy.
Hey guys, good morning. Going back to the identification kind of bigger picture here, you mentioned there are three that are closed already out of the 20 you've initially identified. Just wondering how much more we can expect over the next call it I'd say 12 to 24 months, how realistically close are some of these other projects you're looking at versus the 20 being maybe a bigger 10 year type of plan, how should we think about that?
Well, it's going to vary for each project, but generally speaking, we currently expect that it will take around 12 months give or take to complete the entitlement process on the three that we're working on now. In terms of the balance of these of the 20, and just quickly one thing to mention on the three projects, most of these projects are excess lands, so from an NOI perspective, the only impact in developing these three come from the Kmart that we bought which is of course taken into consideration with the downtime of the other anchor in our guidance in terms of the fourth quarter. But in terms of these projects, the only NOI from these projects that get impacted is the Kmart everything else has no impact going forward in terms of our NOI.
And then in terms of the balance of these opportunities, it's too early to really comment on how fast these opportunities will come and the simple reason why is because we're, there is a number of tenants that we're currently talking to because those tenants' leases will need to be terminated and renegotiated, and that's what makes sort of the balance of this a bit more complicated, so hopefully we'll be able to give you some more detail on that in our next call.
Okay, I appreciate that and then looking at acquisitions, if we go back last quarter you mentioned seeing some increased activity and now it sounds like sellers are hitting the pause button a little bit again. Stuart, can you just give a little more color on what you're seeing out there because it sounded like maybe you are close on a few things at least on the last call?
Sure, I mean the West Coast, grocery, drug anchor assets continue to be the most sought after product or segment of retail with the West Coast certainly being one of the most sought after markets in terms of capital. In terms of what we're seeing, certainly widely marketed, very high quality assets have just continued to trade in the sub five cap range.
Going forward though, what we are continuing to see when interest rates do pop up is the uncertainty of sellers either coming to the market at better pricing or us continuing to work on OP transactions. And that will fluctuate depending on both interest rates, timing and in terms of dealing with these sellers and the market itself.
So it's hard to sit here today and tell you, what we're going to be acquiring. We haven't really taken our foot off the pedal per se. We're just being very focused as it relates to underwriting risk and more importantly we want to continue to use our relationships to buy transactions that will be accretive to our capital.
And have there been any changes in your underwriting here in the past call it 12 months?
We haven't gotten more conservative in our underwriting, but what we have been a lot more conservative at looking at is the - to make sure that if we have more than two anchors in a possible acquisition, we really don't want to be buying something that's more than a drug store and a grocery store. And if we do have to look at a third anchor it's got to be one of the top what I would call value retailers out there from a risk perspective that we believe will continue to do well as we look into the future.
Thanks guys.
Thank you.
And our next question comes from the line of Brian Hawthorne from RBC Capital Markets. Your line is now open.
Good morning Brian.
Good morning. My first question is on the least occupied spread and just kind of how are you guys expecting that to trend in 2019?
As you've seen in the past it's going to it really be dictated by the leasing activity we have. The anchor space is 100% leased but as I think we touched on in the script, we're always looking for opportunities to upgrade that tenancy and in those circumstances it's going to take some NOI offline for a period of time in order to get that upside similar to what we talked about, where we took out the anchor and we're getting three times the rent, but that's going to come with some associated downtime in the NOI. So it's really hard to predict, but I think that it would probably be, consistent with the levels that it has been this year.
Yes, Brian I guess the one point that I'd like to make on this is that when we make decisions at this company we make decisions for shareholders for the long term. And we're still playing offense in some of the West Coast, so once in a while like we saw during the third quarter, you're going to have a situation where an opportunity is going to pop up, where we're going to be able to recapture something very quickly, but at the same time like we did in the third quarter, we're going to find opportunity to lift rents by close to 300% on this particular situation.
Those decisions are being made very quickly for the long term, although it does impact the short term. So the one thing that hit the quarter that we knew would cause a bit of an issue would be the proactive, aggressive way we manage our real estate. But more importantly, we're managing the real estate to create value for shareholders long term. So that's what, that’s why when you've got a portfolio that's as well leased as we have those are really the things that we focus on today in terms of playing offense.
Okay, and then, so on that recapture then, how much did, I mean, can you kind of talk about when that happened and how much NOI we should assume will come out in the fourth quarter?
So it occurred during the third quarter where this prior tenant had been sitting with this location dark, but paying. It was obviously having an impact on the rest of the shopping center. They had proposed bringing in some subpar, subtenants into the property which would have not done well for the property. So we took the opportunity to take them out. The other consideration that we received as part of this transaction at other locations with this particular tenant which include an operating covenant, so there was a lot of incentive for us to do this deal.
As we mentioned the rent was very low, way below market. This lease was about 45 years old and so the impact of the NOI will not be as large as other situations just given the low rent that this tenant was paying.
Sure. And then any more of those that I guess, so you guys kind of see opportunities coming up?
Absolutely, yes. We have a few leases not as large as this particular one, but more in the mid box range that are significantly below market that we are currently working on somewhere the tenant no longer has any options to remain and somewhere we know that they will not likely want to stay, so yes we expect more activity like this in the coming year.
Okay, thank you for taking my questions guys.
Thank you.
And our next question comes from the line of Michael Gorman from BTIG. Your line is now open.
Good morning, Mike.
Good morning guys. Quick question just if I could go back to the recovery ratio Stuart, you mentioned that some of the timing on the leasing was impacting that. Just as I look over the history as that leasing and as that timing kind of resolves should we expect the recovery ratio to move back up kind of towards where it was in 2016 which has kind of averaged over 90% or what's a normalized run rate here for recovery ratio at the portfolio level?
Yes, this is Rich. Yes, you will definitely see that recovery of ratio come up as these new leases come online. I think you know all of our new leasing is done on our lease form which is much broader recovery language in it allowing us to recover many more items including management fees and administrative fees. So we expect that that will continue to go up.
Okay, great and I apologize if I missed it, could you guys mention like the pricing that you achieved on Round Hill and what you're looking at some of the Sacramento assets as we move through the back quarter of the year?
Sub 6 on Lake Tahoe and probably around a 6.5 to 7.5 on the balance of the properties in Sacramento.
Okay, great and then last one from me just kind of from a strategic level Stuart, obviously if the capital markets kind of improve and in that way the acquisition pipeline gets more active again, just curious because you guys have focused a lot in recent years on acquiring assets with upside potential bringing them on to your platform, managing them with your team, if the acquisition environment doesn't kind of free up in the next few quarters what happens in the same store environment then right? Can we get back to some of the same store of numbers we saw in 2015, 2016 or is it more of a stabilized 3% to 4% without the acquisitions feeding into those kind of upside opportunities?
Well, with such a highly occupied portfolio and even continuing to play offence, assuming that the markets stay as good as they've been, the run rate on a same store NOI basis will probably continue to be in the 3% to 4% range.
Okay, great. Thanks guys.
Thank you, Mike.
And our next question comes from the line of RJ Milligan from Baird. Your line is now open.
Good morning, RJ.
Hey, good morning guys. Just one quick question for you Mike on the sort of AFFO deduct, TIS [ph] CapEx obviously up year-over-year this year versus last year and I'm curious where you think that might trend without obviously giving guidance for 2019, given the fact that you guys are 100% occupied in anchor space, so probably not a lot of charges there, but as you think about maybe replacing lower rent paying tenants in 2019, I'm just curious what you anticipate sort of that growth rate being for those TIS [ph] CapEx as we get into the fourth quarter and into 2019?
I guess I'd first like to say is that we’ve been on this anchor repositioning initiative for couple of years now, where on the kind of the tail end of that. But the reinvestment back to tenants for those tier dollars is a lagging thing. So that's the cash payments going out by quarter. So I would expect those to be trailing down. As far as the in line shop space that's going to be a function of what the tenant is, well it's a restaurant user, in terms on the use type that drives that TIS dollar. So I don’t know if Rich you want to jump in on that as far as the - what's basically left to lease, what are average TIS?
Yes, I mean I think you know as Mike touches on one of the biggest categories we have right now are restaurant type tenants and we continue to convert retail space to restaurant because that's where we’re able to achieve the highest rents and the best return. The challenge there is predicting the velocity going forward. So I would expect that that shop space would sort of be in line with what it has been last year going into 2019.
Okay, that’s helpful. That’s all from me guys.
Great, thank you.
Next question comes from the line of Todd Thomas from KeyBanc. Your line is now open.
Good morning Todd.
Good morning Todd.
Hi, good morning. Stuart, just circling back to the transaction market in your prepared remarks you mentioned that you're seeing some impact from the rise in interest rates, can you just discuss that and is there any evidence that rising rates are having an impact on the market today?
Sure, I mean what we've seen is interest rates have gone up quite dramatically, quite quickly is that a number of transactions that were under contract have to fallen out, but those are transactions that are typically in secondary or tertiary markets or transactions on the segment of retailing that continues to be more tougher in nature, power centers, malls, things like that.
As it relates to grocery, drug anchored assets, those continue to be the most sought after product in the market and we haven't really seen any deterioration yet in that segment of the market. So it really is, it really goes to what I would call more of a second tier type of shopping center versus what we typically buy.
Okay, do you expect to see cap rates widen a little bit from here?
Given the demand for our product in the most sought after markets in the country, I think cap rates and valuations are going to stay pretty well in a tight range. I think they could go up and in some cases they could go down depending on how much product comes to the market, but all in all I think that spread will remain pretty tight over the next several months. All of course on the basis that interest rates either stay where they are, but if they continue to go up even further, you could see a change in the market.
Okay and then Stuart I was just wondering if you could comment about the dividend policy a bit, how you and the board are thinking about things here. You raised every year since the IPO, just there is a slowing external growth that you're seeing today, does that suggest that, we might not see an increase this year?
Well of course that policy is driven by the board, but certainly I think as Michael articulated we do believe our cash flow is going to improve as we move our free cash flow as we move through 2019 at this point which will give some emphasis in continuing to raise the dividend. But at this point, again the policy is really driven by the board, so I think that's really all I can comment looking at 2019 at this point.
Okay, thank you.
Thank you.
And our next question comes from the line of Christy McElroy from Citi. Your line is now open.
Good morning Christy.
Good morning. I'm just wondering with regards to the $200 million plan spend on the three projects maybe a little bit more clarity there, in terms of what would be your share and then does that include the land value or is the land value that you would contribute incremental? And similar question around the 7% yield, does that yield include the value of the land you're contributing or that just on incremental spend there?
The yield does include the land and in terms of the contribution that the land is included in the numbers that we threw out. And of course that value was going to be different from property, but our goal there is to contribute the land, so that we have a minimal amount of equity required in terms of moving these transactions forward.
Okay, got it and what’s your estimate of the land value on that $200 million?
I would tell you probably in the $30 million range, but again I can’t give you exact numbers, hopefully by our next call Chris you will have something more definitely something more definite to give you in terms of that number, but that just a guestimate at this point.
Okay and then just as you think about your capital allocation priorities in terms of funding the pipeline with dispositions, non-core dispositions versus your leverage and any sort of debt pay down is deleveraging any more of a priority for you today? And then to Todd's question, how does that play into free cash flow coming back at some point?
Well de-levering is certainly important to us. There is no question about that. We will continue, I think as Mike again mentioned to work on the balance sheet from a de-levering perspective. In terms of capital allocation it’s really going to be, we'll look at capital allocation as it relates to the selling of these assets in terms of the redeploying that capital and depending on our stock price we may even hopefully at some point if not this year next year going in and do a bit more equity. Mike, I don’t know if you want to add to that in terms of capital allocation?
I would just reiterate that obviously my number one focus is to try to de-lever the balance sheet to replace equity that we should have raised last year when we were held up at the [indiscernible] transaction. So given market conditions I'd like to use the ATMs or raise some more equity if it makes sense to do so.
What sort of levels it’s Michael Bellamy speaking, so you raised in the low $19 range during the third quarter. The street NAVs are circuit 20 and I think our estimates are a tad lower, you've obviously been talking about the redevelopment and ability to identify has had an incremental value I guess what level are you comfortable assuming equity at?
Well, Mike in terms of what we did during the third quarter, that number was about, I think it was around 1937 [ph] so or I think around that number. Obviously we would like to raise the equity a lot higher. But we've just felt when that opportunity opened up it was important for us to issue some equity.
Going forward, we are cognizant of how precious that equity is and more importantly that we certainly want to be issuing that equity above our NAV. So NAVs are different obviously with everyone. I mean, but certainly management's current thoughts on NAV is that, that equity was issued really at or at a touch lower than what we think our NAV is. So we will keep monitoring the situation but more importantly we are very cognizant in terms of how and when and how much that equity gets issued.
And then in terms of instead of using equity because you don't know where the equity market is going to be right, and when the stock is down a bunch today on what was very much weaker results than the Street was expecting, so you don't know when it could recover right, and you have additional capital that you want to commit.
I guess how do you think about using your assets? And I recognize you like simplicity so you don't like joint ventures, but would that be an area that you would look towards on liquefying some of your higher quality assets at low cap rates rather than issuing your equity potentially below NAV to be able to de-lever as well fund your incremental capital commitments?
Yes, I mean look, from a capital commitment standpoint in terms of redevelopment, the goal there is really to contribute the land and put in virtually no or very little equity. So in terms of looking at capital allocation as it relates to growing our portfolio it's really a combination of selling and redeploying some of the equity and in terms of selling assets. And then, but at this point we really have no interest in doing joint ventures. We're just going to continue to do what we do best which is manage our real estate and create value for shareholders long term and to take advantage of continuing to play offense on the West Coast, that’s our goal right now, in terms of 2018 and 2019.
And then just in terms of disclosure and I'd like to get your or the management team's thoughts, have you sort of maybe sat back and reevaluated what you're putting out in terms of guidance pieces each quarter the components of guidance number one? Number two given this lag between basically renting economic occupancy and lease rate actually providing those statistics each quarter in your supplemental so the market is not surprised when you put out results that may be different from what the expectations were, I guess have you re-thought disclosure and communication to be more of best of breed in the industry?
Look Mike, we do our best and I think the company and Michael Haines does a great job in terms of disclosure. Can we do better? Sure, but the bottom line is we look at best practices in terms of what we do and what we disclose. Maybe we can give you a call offline and we can talked about some of the more important details from your perspective, but the answer is yes we will continue to look at best practices.
I would respectfully disagree in terms of where your disclosure is relative to the peer set right? The peer set has all of the components of their guidance every quarter. The peer set has got economic occupancy not just leased rates, so that we can really understand that spread in the supplemental.
So there's a lot of different areas, happy to share with you our best practices report to go through that, but I do think that there's certainly some room. Last question just in terms of the interest rate swap that's expiring at the beginning of next year, what are your plans, it's sitting there at a pretty low 2% rate, how should we and the Street think about the role of that and where that goes in early ’19?
Well, as far as the swap that's about $100 million that burns off in end of January. We’ve been talking internally about re-swapping that either for a short period of time or through the end of the maturity of the term loan. [Indiscernible] interest rates are moving around a bit. The swap rates have changed and kind of in relation toward the 10 years and that's been bouncing around a little bit lately. So not committing to anything, but we're looking at the current time of maybe swaping, re-swapping that $100 million on a shorter term basis to see where rates are really going over the next 12 to 24 months.
Is that a dilutive event for that $100 million?
Well, the swap rate currently is going to be higher than where it's currently locked in, yes, so there will be some dilutions in that higher interest expense. Yes.
Okay, thank you.
Thank you.
Thank you.
And our next question comes from the line Jeff Donnelly from Wells Fargo. Your line is now open.
Good morning Jeff.
Good morning Stuart. Just a few follow-ups, I guess may be one for Rich, I guess a two part, curious what do you think is going on with asking rents there in the last few months for small shop space if you really see any kind of discernible trend or change? And then maybe secondarily, I'm curious what’s your gut sense of the market impact if Sears Kmart ultimately decide the chain to close all their stores? I'm curious how significant of an overhang thing that could be on anchor asking rents in the markets you guys operate in?
Yes, I mean I’ll talk about the Sears closure and then let Rich certainly dive in, in terms of the first part of the question. But we don't see a lot of impact in terms of the Sears Kmart issue, very much so, and when I say that I'm really referring to the metro markets on the West Coast. A number of those stores if you look at what has happened over the last several years, most of the strongest assets that Sears owned have already traded into the market and are currently being redeveloped at the present time in the metro markets on the West Coast.
So I really don't see much impact in our markets. Step out of the West Coast, it's a whole different story Jeff. But most of the best assets were traded into the market several years ago and those assets where that shadow supply is currently being redeveloped right now on the West Coast, so again I don't really see much impact.
And then in terms of the shop rents, I mean I think as we touched on in the prepared remarks, just coming out of ICSC in LA that the tenants were all very positive, looking for locations, there's very limited good opportunities available on the West Coast. It is to the point where certain tenants were leaving meetings with our leasing people and then pulling Stuart and I aside to tell us that it was very important that they were going to get an opportunity that hadn't even come available yet. And I'm speaking of a pad where we're taking back the pad and dividing it up into shop space and people are trying to use their relationships to make sure that they're at the top of the list to get that location. So we see still a lot of demand for that space which will support good rents going forward.
And just one more disconcerting the comment about exiting Sacramento, if I'm right or am I right, I should say you just have two to three assets in that area and would you guys also consider exiting Stockton, I think that market is also a little bit of an outpost for you guys too?
Yes, that's correct, two or three assets do include Stockton, so you're absolutely right Jeff. The answer is yes. We're currently negotiating right now on a number of those assets.
Okay, thanks guys.
Thank you.
And our next question comes from the line of Chris Lucas from Capital One. Your line is now open.
Good morning Chris.
Hey good morning guys. Just one detail question that's related to the Kmart at Pinole Vista. Is that store open, is that still paying rent and then sort of when do you expect the impact of the closer to occur?
Well, I mean the store is closing. We anticipated that. We expect the store, I mean we don't know exactly when they're shutting down, but in terms of our agreement they have to be gone by the end of the year.
Correct.
Okay, so rent will cease at that point?
Yes, correct and we may have lost a bit of rent in between the bankruptcy, but just between the time the rent was due and then the company going bankrupt which is standard for companies that are in that position, but we should hopefully be getting rent.
Yes, they actually, the month they filed bankruptcy they actually had paid the rent already which was somewhat unusual for a tenant planning to file. And they are obligated to pay us through the end of the year. And that's really just the base rent because we settled up completely for the taxes and the triple nets as part of the termination, so it's just the rent component through the end of the year.
Okay, great thanks. And then just Mike I appreciate the guidance on the lease accounting change. I guess a bigger picture question on that topic is just simply next year's lease expirations schedule is comparatively light to what we'll see in the following next several years. As we think about how to model out that number in recognizing, in your case it's a relatively small number, but just how impactful is volume whether it's number of leases square footage ABR to that number and how should we be thinking about the drivers to either increasing or decreasing that number over time?
I would expect the number to stay relatively consistent. It's our internal leasing staff and the listing velocity based on the expirations is one of the drivers of things that they work on. A lot of times they work on leases that are not even on the expiration schedule. So it's just I don't expect any real meaningful change in that number going forward.
And I think the reason '19 may look a little tighter we dealt with some of those renewals already this year, so some of them have already come off ahead of year starting, but the compensation isn't necessarily one for one for one in terms of velocity that's way being internally leased we're able to control that cost better than if we had a broker working on a commission.
And then just from a presentation perspective Michael, where should we expect that expense to lineup, is that a G&A or an operating expense line item?
It will be a G&A expense increase versus operating.
Okay, great. Thank you, I appreciate it.
Thanks, Chris.
That’s all I have.
Thank you.
And our next question comes from the line of Michael Muller from JPMorgan. Your line is now open.
Good morning Mike.
Hey good morning. Just a question and going back to the three redevelopment projects, is the scope of all three solely going to be adding multifamily or will there - can there be retail components or other components that you'd more naturally be a direct investor in or is it just picture the existing center where the resi building and you loan a portion of that building by way of either contributing land or deciding to put more capital into it?
Well it depends on the municipality. Some municipalities will want a bit of retail and some won't. On what we're moving forward on right now it's a very small component of retail, so it's primarily going to be multifamily.
Okay and again it sounds like the base case is at a bare minimum of that $200 million on the low end if you just do the contribute land route your investment in it is $30 million at a 7.5% return unless you decide to take a bigger stake in the project, is that the right way to think of it?
Yes, although if you put debt on top of the equity Mike we may have to put a bit of that portion onto our balance sheet, so we think about that as well as it relates to the capital side, so or the balance sheet side, so but yes, you're very close in terms of the numbers.
Got it. Okay, that was it. Thank you very much.
Thank you.
And our last question comes from the line of Craig Schmidt from Bank of America. Your line is now open
Good morning, Craig.
Good morning. I just wondered on the mix used identification [ph] efforts, are you looking exclusively at residential or are you examining office, hospitality or other mix use formats?
Well, Craig we have looked at hospitality because we have offers from hotel operators, but the economics don't line up and when I say that we're looking at hospitality from a land lease perspective. I know it's a lot less capital obviously, but the NOI is in a whole different sort of, the NOI is a lot different.
So we have looked at other alternatives, but certainly as it relates to both timing and NOI growth certainly multifamily is the place to go. And more importantly remember we're building in the most sought after markets in the country where there is very strong rent growth and more importantly that these municipalities really need housing. That's the key here in terms of getting these entitlements.
Because there's a lot of municipalities we went to where they said come in and identify however you'll never get a permit because of how highly constrained and how antidevelopment some of these municipalities on the West Coast are. So that's sort of the overview in terms of how we've gone through this process.
Okay and so at this point the entitlement process is going pretty well.
It is. We are a bit further down the road at crossroads phase two because we started that process almost two years ago. We're getting very close to getting those entitlements. The other two are at the beginning stages, but from our discussions with the municipalities and potential partners we believe that the entitlement process will go pretty quickly.
Ok, thank you.
Thank you.
And at this time there are no further questions.
In closing I would like to thank all of you for joining us today. If you have any additional questions, please contact Mike, Rich, or me directly. Also you can find additional information on the company’s quarterly supplemental package which is posted on our website. Lastly, for those that are attending Navis Annual Conference in San Francisco in a few weeks we look forward to seeing you there. Thanks again and have a great day everyone.
Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.