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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 afternoon, and welcome to DDR Corp's. Fourth Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded.
I'd now like to turn the conference over to Brandon Day-Anderson. Please go ahead.
Good evening and thank you for joining us. On today's call, you will hear from President and Chief Executive Officer, David Lukes; Executive Vice President and Chief Operating Officer, Michael Makinen; and Executive Vice President, Chief Financial Officer, and Treasurer, Matthew Ostrower.
Please be aware that certain of our statements today may be forward-looking. Although we believe such statements are based upon reasonable assumptions, you should understand these statements are subject to risks and uncertainties and actual results may differ materially from forward-looking statements. Additional information about such risks and uncertainties that could cause actual results to differ may be found in the press release issued today and the documents that we filed with the SEC, including our Form 10-K for the year-ended December 31, 2016 and subsequent quarterly reports on Form 10-Q.
In addition, we will be discussing non-GAAP financial measures on today's call, including FFO, operating FFO, and same-store net operating income. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures can be found in our earnings press release issued today. This release and our quarterly financial supplement are available on our Web site at www.ddr.com.
For those of you on the phone, who would like to follow along during today's presentation please visit the Event Section of our Investor Relations page and sign into the earnings call webcast.
At this time, it's my pleasure to introduce our President and Chief Executive Officer, David Lukes.
Thank you, Brandon. Good evening and thank you very much for joining us on our fourth quarter earnings call. I’d like to start by summarizing the three key points I’d like everyone to take away from this call. First, 2018 is the year in which restructuring and dilution from deleveraging will start, replaced by growth and enhanced returns to stakeholders. Second, this shift is possible because of the dramatic changes we made to our balance sheet, which is now among the best in the shopping center space. And third, there are substantial leasing opportunities embedded in the new DDR portfolio, including mark to market of anchor spaces and significant momentum in small shop leasing.
Now onto the quarter. I will review our results and then provide an update on the spin of RVI and recent DDR transaction activity. I will then hand the call over to Mike for comments on Puerto Rico and an in-depth look at the operating environment and we will close with some comments from Matt on the balance sheet and guidance.
Operating FFO per share growth for 2017 in the fourth quarter were negative, largely because of dilution from the deleveraging process. We exceeded our 2017 transaction expectations handily, disposing of over $1.3 billion of assets and bringing pro rata debt to EBITDA down from over 7x at the beginning of the year to 6.4x today. This has been painful for shareholders, but we continue to believe derisking was the right decision given today's operational and capital markets uncertainties.
Decisive actions in 2017 mean that dilution from deleveraging should end in 2018. Operationally, 2017 presented growth headwinds primarily from exposure to several large anchor tenant bankruptcies and the impact of hurricane Maria in Puerto Rico. Despite these headwinds, results exceeded our original budget allowing us to avoid a contraction in Continental U.S NOI.
Looking forward, we still expect at least 1.5% same-store NOI growth in 2018 for new DDR unchanged from December and a product of DDR significantly improved portfolio following the completion of our $900 million disposition program and the spin of slower growth assets in Puerto Rico.
Mike will say more about Toys "R" Us shortly, but the announced closures in new DDR are great examples of embedded opportunities in our restructured portfolio. In fact, many of the assets in new DDR were selected precisely because of anticipated retailer disruption. Toys "R" Us closures at two of our best assets will open-up future redevelopment projects with potential value creation far exceeding lost NOI and downtime at other toys closures. We expect this story to recur at new DDR again and again where incremental closures represent net opportunity for stakeholders.
Turning now to the spin of RVI. We remain on track for midyear 2018 effective date and we closed on the $1.35 billion mortgage just yesterday, a major milestone for the transaction. We expect to provide more details on the loan and it terms in the upcoming months when the loan syndication process is complete.
And as we mentioned at the time of the announcement, we've already commenced the asset sales process with the majority of the Continental U.S assets now formerly listed for sale of brokers. We expect RVI transactions to begin closing in the second quarter with larger volumes in the second half of the year.
Finally, I'd like to comment on our recent transaction activity. We sold nearly $600 million of assets in the fourth quarter at a blended 7.5% cap rate at our share and closed an additional $135 million subsequent to quarter end. For the full-year 2017, we sold over $1.3 billion of assets at a sub 8% cap rate. Asset level debt markets are open, private market buyers are active, and our sheer volume of recent activity gives us great confidence that we have clarity on current pricing.
This last quarter alone we sold 13 assets to 12 different buyers. We have a dedicated and focused transaction team and I’m incredibly pleased with their results. Their better than expected pace allows DDR to pivot to leverage neutral, capital recycling in 2018, something that energizes our entire company.
I’d like to reiterate how proud I’m of our team's accomplishments in 2017 and how excited I’m about new DDR's opportunities in 2018. Over the past 12 months, we streamlined our organization and significantly reduced costs. We fundamentally restructured our balance sheet through deleveraging and over $900 million of securities offerings.
We supported our employees in Puerto Rico and began the recovery process, and of course we announced the final step in our strategic transformation through the spin of RVI, creating two different and focused business plans for two different portfolios. I spend the last month visiting new DDR assets, once again with our outstanding leasing and property management teams and then convinced that we have exciting opportunities embedded in our strong new DDR portfolio.
We expect 2018 to be very different from 2017, especially as we return to a growth posture. But one thing will remain constant is our commitment to act decisively in order to create value for all stakeholders.
And with that, I will turn it over to Mike to review some key operating conclusions.
Thank you, David. Fourth quarter same-store NOI growth for the Continental U.S portfolio was negative .4% in line with our budget. Better than expected occupancy would have resulted in flat NOI growth, if it were not for a 30 basis points negative impact from unbudgeted snow removal costs.
Importantly and as part of the theme you will see with nearly all of our fourth quarter operating metrics, new DDR is roughly 1% same-store growth, was measurably stronger than the combined portfolio. The combined companies lease rate declined 20 basis points sequentially to 93.5%. This was entirely a product of dispositions as the assets we sold in Q4 had weighted average lease rate of 98.9%.
Total NOI growth in our Puerto Rico assets was negative in the quarter, a product of the lingering hurricane impact in the island's weak economy. Electricity from state utility has been restored to all of our assets, and the repairs to damage spaces has begun.
While year-over-year operating comparisons will remain challenging, I am encouraged by our significant positive sequential momentum highlighted by the opening of the first Dave & Buster's on the island mid-January, which has exceeded expectations. From a physical perspective, we reported at 75% of lease space was reopened at the end of October, excluding our badly damaged Palma real estate, and that number rose to 85% at the end of January.
More importantly, 92% of the tenants opened at the end of January were rent paying as cash receipts have rebounded similarly. I couldn't be happier with the progress to date and the current state of the assets which upon visit are in excellent shape with full parking lot, heavy foot traffic, and great sales volume. To show you just how far things have come, we produced a short video tour of footage from two weeks ago, which is available in our earnings call slide deck as well as in the section of our Web site.
I would encourage you to click on the link, you will be amazed at the progress. All of this would not be possible without the herculean efforts by our team on the islands as well as our property and construction management teams. On leasing economics our fourth quarter results were strong with ongoing healthy new lease volumes and better newly spreads been year-to-date trends. Importantly, when combining new and renewal leasing activity, new DDR spreads of 9.5% were measurably above the combined companies by .9%.
We continue to make progress backfilling vacant anchor boxes from 2016 and 2017 bankruptcies. Backfilled tenants include Marshalls, AutoZone, planet business in Burlington. At our Westlake redevelopment project here in Cleveland, we now have signed leases with Fresh Thyme, Ultra, HomeSense, and perhaps supplies plus.
I’ve spoken previously about my view that there was a small shop leasing opportunity at DDR. And we now have two quarters of improving results to back up this thesis. Specifically third quarter's small shop leasing volumes were up 30% compared to those in the first half of the year. And fourth quarter, volumes, were up 48% on the same basis, despite a smaller number of assets we are releasing. And we didn’t achieved these volumes, but sacrificing economics. As the average double-digit spreads we achieved on these spaces in the second half of the year attest.
We see these new, higher, profitable activity levels at sustainable, given the 590,000 square feet of small shop space that is currently vacant in the higher quality new DDR portfolio.
On Toys "R" U.S, the bankruptcy will impact our portfolio in 2018. I will walk through the results of our negotiations thus far. Though I would add that final closures and outcomes remain subject to change as the bankruptcy process continues. As of now we expect eight stores to close and the combined portfolio with portfolio on stores in new DDR, including a previously announced retenanting of a dark but rent paying store in Los Angeles.
The impact of 2018 NOI is expected to be $4.3 million for the combined company and $3.5 million for new DDR, a 73 basis point impact to same-store NOI. We do not expect any of these closures to trigger co-tenancy clauses. This bankruptcy scenario is an important case study for new DDR with an estimated mark to market in new DDR significantly higher than that in the combined portfolio.
I will close with some comments on the operating environment, which I’ve described as generally unchanged from quarter ago. We continue to see healthy demand for spaces, including our vacant anchors. Though the breadth of demand is certainly smaller than it was several years ago.
With that, I will hand the call over to Matt for some comments on our balance sheet and guidance.
Thanks, Mike. As David mentioned, the work we've done this year both in terms of lowering leverage through asset sales as well as significantly extending our maturities, means that DDR is positioned to begin investing capital and growing FFO in 2018.
Pro rata debt to EBITDA declined from roughly 7x at year-end 2016 to 6.4x today. Additionally, repayment of debt when combined with the three debt and preferred offerings completed this year, resulted in a significant lengthening of the combined companies weighted average maturity from 4.2 years at the beginning of the year to 5.4 as of yearend.
New DDR will benefit from all these changes with added derisking through improvement in the overall quality of the unencumbered pool and extension of our weighted average maturity to 6.5 years through the application of proceeds from the $1.35 billion mortgage loan. We expect new DDR to have virtually no unsecured maturities until 2022, which significantly limits refinancing risk. On the spin itself, we expect to confidentially file the Form 10 this quarter and make a public filing sometime late in the second quarter. As David mentioned, we remain on track.
I’d like to now touch on a few fourth quarter financial statement items. First, our plan to sell the 50 spin assets caused the change in our projected holding period, which in turn triggered a $259 million non-cash impairment on these assets, a significant portion of which is from Puerto Rico.
Further impairments are possible if sale prices fall below new book values and/or from the ongoing process of rebuilding assets in Puerto Rico. This impairment does not change the year-end 2018 leverage or covenant forecast that we presented in December.
Second, we received and recorded $8.5 million of business interruption insurance payments in the fourth quarter. These payments represent a partial payment against our claim to take and are thus below the ultimate reimbursement amount we expect to receive for each period. We are working with our insurer to receive regular business interruption payments as we negotiate finalized claim amounts.
Finally, we received repayment of $49 million of the preferred securities associated with our Blackstone joint ventures in the fourth quarter, as well as $36 million subsequent in January as a result of the ongoing liquidation of that fund. Since the third quarter of 2017, we’ve received $91 million in total preferred proceeds. Lastly, we made no significant other adjustment to the carrying value of the preferred securities this quarter.
I will now make a few comments on guidance before turning the call back to the operator for questions. We’ve provided new DDR operating FFO guidance of at least $0.15 per share for the third quarter of 2018, the first quarter post spin. We'd expect to provide further new DDR FFO guidance as the year progress. This is consistent with the dividend rates and AFFO payout ratio, is that we provided for new DDR at the time of the spin announcement in December.
Embedded in this guidance are several assumptions. First, the same-store NOI guidance of at least 1.5% that we provided at the time of the spin announcement remains unchanged and already anticipated significant Toys "R" U.S store closures.
G&A guidance of $70 million represents a run rate based on expenses in place in 4Q '17. This is consistent with our guidance for $10 million of external management fees for RVI that we’ve provided which should self assumes no 2018 asset sales. In actuality as RVI assets are sold RVI fees will fall as well.
Finally, the year-over-year decline and interest income and GVC income is largely a product of the aforementioned ongoing sale of properties within our two remain Blackstone JVs and additional JV asset sales. As mentioned, we received $36 million of preferred equity in January, so please note that you will see a further step down in interest income in the first quarter of '18.
With that, I’d like to turn the call to the operator for your questions.
Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Christy McElroy with Citi. Please go ahead.
Hey, good afternoon, guys. Just on the disposition, just wondering excluding what if you could provide some color around cap rates on the assets that you sold in Q4 and so far in Q1. And understanding that you’ve used on a few so far year-to-date, but just given the active marketing process that you’ve mentioned and others potentially under contract. May be you can give us a sense for disposition, and this is that your volume expected prior to this spin?
Sure, Christy. Happy too. If you look at Page 21 of the stuff you'll see that the pro rata share of ownership of the assets were sold in the fourth quarter. Only 5% comes from what was the relative impact on the cap rates, that we’ve talked about the 7.5% for the fourth quarter. It isn't really going to have a dramatic effect. I think the bigger question is what if we’ve seen sense then, and of the 135 million dollars we’ve closed year-to-date, the blended cap rate at bit lower than the average for fourth quarter. So, it really depends on the inventory.
In general, the longer our disposition process goes, the better the assets are that are being sold. And so, we haven't really seen a whole lot of change in cap rates over the past couple of quarters. Projecting of the future, you got as a mine. I feel very good about our team being able to get such a large quantity of assets into the market in January, I think we’ve got a lot of active buyers that have successfully bought assets from our civil code, the best 12 months and we are feeling pretty good about where the market stands today. I can't iterate as you would heard in that. I think in prepared remarks, we expected the RVI process in those dispositions will accelerate through the year, right. So I would have more modest expectations, especially for the sake of conservatism where more modest expectations for that portfolio in the first half of the year and higher expectations in the second half.
Okay. And then, just bigger picture I realize that you’re just coming off of a very long deleveraging period, but just given where your shares trade today, at just such a massive discount. When do you get to a point in terms of the new DDR and there's a lot of talked about that. When you can start doing share repurchases on a leverage neutral basis, where you can say, okay, we’re going to take more through our free cash flow and sort of limit redevelopment and not by any assets and just buyback your stock.
Well, probably the most important and exciting part of that question is that we’re actually able to discuss it. And I feel great about what’s ahead of us in the next 12 months. I think whether it's an asset purchase externally, whether it's a share repurchase, a fall off to the same thesis which is we’re going to be on our front foot. We have things to do and nothing is off the table, we’re trying to make an accretive purchase.
All right. Thanks.
Our next question comes from Todd Thomas with KeyBanc Capital Markets. Please go ahead,
Hi, thanks. Good afternoon. Just following up on the disposition, so you completed $246 million of assets held at DDR share in the quarter. I think that compares to the $450 million expectation that you laid out at the announcement of the spin, which was to be completed through the year-end -- for 2018. Is there a desire to potentially raise more capital to the extent that that you can through asset sales and that the demand is there and to the extent you do where will incremental proceeds be applied?
Yes, look, I think the message is we move from -- in 2018 we move from outright delevering, which kind of forecloses a lot of options to: a, capital recycling position, right. So as ever and I think you will see that our overall strategy over time is going to be to constantly look at the assets that are at the lower growth rate side of the spectrum that have attracted pricing. And look to recycle those into higher growth assets. so, I think that answers -- I hope that answers your question. I think we really will be selling other things, but it won't be for the sake of delevering.
Okay. And then, the financing $1,35 billion financing that you announced yesterday. I was just curious if you could comment on? How that changed if at all, since the announcement through closing whether there are a structuring changed at all or pricing or anything at all changed since the December announcement?
Yes, Todd. The reality is not much. So the way process worked and what we announced in December was something that we had a commitment on, right so we had signed a term sheet and in those term sheets you commit through all of the major terms of the loan. You have to then paper the loan which I shouldn’t underestimate the importance of and the kind of length stuff. But in reality all the move negotiations, all the key business points should be done by the time you sign that commitment and I would say that was very much the case in this instance. So nothing really changed.
Okay. And I don’t know if I missed this at all anywhere, but can you comment on the pricing?
Yes. It's difficult. So loan provides the lender's the right to syndicate, which would ultimately we think impact the interest rate on the loan. So we'd expect to provide more information on the loans rate and terms once we’ve greater clarity on that process.
Okay. Thank you.
Our next question comes from Alexander Goldfarb with Sandler O'Neill. Please go ahead.
Hey, good afternoon or good evening. I guess, still afternoon. So just a few questions here. First, just given -- actually let me ask this guidance one first. Matt, did you go over how much of the at least 1.5% same-store, how much of an impact toys and any other lease restructurings or closings that you guys maybe budgeting? So is that like -- is there 50 basis of NOI impact or some way to quantify the impact from what you expect from toys and others?
Yes, we said in the prepared remarks that there was a 70 or so basis point impact this year from toys.
Okay. So …
On the new DDR side, which is consistent with that 1.5% guidance.
Okay, great. And then as far as the disposition side, we will talk more about the U.S assets not the Puerto Rico once again you’re trying to sell. Have you noticed any change in the buyer's like, it seems like on this quarter's earnings call, you all the REITs collectively are speaking about a better retail Environment, and sort of people feeling better coming off the sidelines to buy more assets. Are you seeing buyers willing to take on releasing risks or everyone pretty much wants 95% for assets and no one is saying, hey, don't renew that space, so that space we'd like to crack out it.
This is David. It's hard to note changes. And the reason I’d say that is we’re trying to be very careful about talking about what has happened and not projecting what may happen. But what has happened is a fairly consistent pace of dispositions with a pretty wide pool of buyers, most of which are using leverage, And I would say depending on the asset for sale, for instance triple net lease Walmart, there's a certain type of buyer that is not active in releasing. Other properties in secondary market that have some sharp occupancy or a Junior anchor vacancy, there are buyers that would like to have that leasing risk. So I think the pool is widen enough that there' is both types of buyers out there. And to be clear we’re selling an incredibly wide variety of assets, right. We are selling some single tenant Walmart's which is obviously not going to be any lease up opportunity and those buyers want a full bond like asset. And there's others where there is vacancy whether we like it or not. So it really is -- I mean, you could see what these volumes are still wide spectrum of what we’re selling. It's really hard to generalize.
Okay. That’s helpful. Thank you, Matt.
Our next question comes from Richard Hill with Morgan Stanley. Please go ahead.
Hey, this is Ron Kamdem in for Richard Hill. Just a couple of quick questions here. The first one is on RVI. Obviously, looking at the -- that the dispositions that were done in 4Q, just thinking about the assets in the RVI portfolio. But if you could just provide more color of maybe how those compares in terms of size, maybe in terms of anchor mix and so on and so forth. Whether you’re feeling more or less comfortable about the velocity given what you've done in 4Q?
Are you -- I’m sorry, just to be clear, are you asking about RVI assets that we sold in the fourth quarter?
No, I’m asking about RVI assets that you're going to sell potentially …?
Compared with those- -- one that we sold in the fourth quarter.
That’s right.
Okay. I think the message has been pretty consistent on this, which is that we think the RVI assets are actually a good notch higher in quality than what we’ve been. Again, really hard to generalize and just because they’re higher in quality, it doesn’t mean the buyer pool is necessarily more robust. But all else being equal, if you want a generalization, I think we'd say that the cap rates for getting and the volumes we’re seeing should be a very positive indicator for the process we’re going to go through with RVI. The problem is things can change and cap rates can change and debt availability can change and so there is some uncertainty about that. But just comparing apples to apples the RVI stuff we think is better.
Great.
Ron, the other way to add to that is to say that when we started selling assets for the purpose of deleveraging, we tended to choose assets that we thought had some risks. When we talked about splitting the company and have a spin occur, we stated that we were taking the durable assets that were strong, but slower growth because they don't leave enough growth left in new DDR. So I would say if I had to put a title on them, I would say the RVI assets are very durable and safe. They just happen to be slower growing, the one we are left with.
And Ron, if you recall we have a slide in the December presentation. While we walk through the demographics, lease rate and RVI versus what we sold as well.
Great. That’s useful. And then, just on the debt, I was just wondering if guys have any color on investor feedback or reception on the pricing and on TL.
No, no feedback on that at this point.
Great. And then, so my last one would be just looking at the presentation, the monthly cash receipts for Puerto Rico. I just was curious, if there's any color in terms of -- obviously, you had a big bounce back in January. But if I’m looking at this correctly, it looks like it's even back to levels of July 17. I would have thought you will have more deceleration. Is that because of the Dave & Buster's? Just trying to understand what that -- what’s driving?
Add into our reopening and paying rent. I know Mike talked about in his part of the presentation, but I really would encourage you to look at the video. I think we’ve had a variety of people go to Puerto Rico and take a look at the assets and whether they’re self taught analysts or buy siders or other people just with interest the feedback is that my goodness I expected something really, really difficult and what I saw our assets had didn’t obviously had -- obviously had anything happen to them. So I really would encourage you to take a look for yourself. But the -- and the cash receipts show it. There is a rebound taking place on that Island.
Great. Thanks so much for the transparrency at all.
Our next question comes from Steve Sakwa with Evercore ISI. Please go ahead.
Thanks. Good afternoon. I was just wondering if you could speak a little bit about the redevelopment program. I guess the desire to play a little more offense and defense and you talked about some of these boxes that you’re getting back. Can you just remind us what you're planning to spend on the redevelopments and expansions in '18, and how that may unfold into '19?
I don't believe, Steve, and good evening. I don't believe we have guided to a specific dollar amount of redevelopments nor have we really described the breadth of the portfolio. I mean, obviously in the supplemental you’re seeing a fairly small amount of redevelopment activity that’s getting smaller every quarter. As you can probably imagine from our skill sets and interest in redevelopment, we're later focused on building that portfolio and would certainly look forward to describe it in more detail in the near future.
Steve, over the next two years we’ve obligations of about $40 million for the major redevelopment project, but to David's point that really just encompasses what’s in the program today.
Okay. And then maybe just to circle back a little bit on the 1.5% internal growth. I can appreciate the toys impact I think you said was specifically 70 basis points. But just to be clear, are there other just kind of catchall buckets that you’re putting in there for other potential tenants. And if so, was there a range of NOI hit that you are taking above and beyond the toys that’s embedded in the 1.5%?
Yes, so it is less about buckets more we do a kind of space by space analysis, right as one does to understand what you expect in the coming year. We try to be conservative in that forecast and then we obviously try to put some contingency into our expectations to make sure that we're not overpromising anything. So, I think where I could guess, there's a variety of paper cuts out there for us in 2018, but we have -- as I can imagine we’re trying to make sure we’re providing you with some guidance that we know we can hit. So we’re providing for there to be more bankruptcies etcetera, less about a specific tenant. Things like some of the big names are gone for us now right in new DDR, we will have no serious exposure. So, there is not a bucket for sears specifically, but we are thinking there's a variety of other tenants that you can -- you hear about them on a daily basis, that are having some struggles and we’re trying to make sure we account for those.
Okay. I guess just last question, may be to go back to some of the asset sales and kind of the funding and the leverage. I realize each buyers are a little different, but do you have a sense for sort of the type of leverage or the amounts of leverage that you’re average kind of purchaser is using and obviously rates have backed up, maybe 50 basis points since the beginning of the year and how that might impact potential sales going forward?
It's a really good question, Steve. I mean, if we had a tremendous amount of transparency as to exactly what the buyers were doing, it would be an interesting note. The problem of course and even if you look in the supplemental, all the assets that were sold over the course in the last four quarters, there's a pretty wide variety and it's all over the country. And so it's hard to come up with an average of what people are using for leverage. I do think that CMBS marketplace are rolling. And I think if you’re going to see an impact in cap rates due to changes in interest rates, then that’s something that’s probably more on its way as opposed to something in the near distant past.
The only thing I would add is, we certainly learned through our process. You can imagine we have some insights on the CMBS market now. And I know people have concerns about how that market is functioning for certain types of assets like B malls, specifically or C malls, as it were. I would tell you that our experiences with that that market is alive and well. I think if you talk to people who actually do those syndications and those securitizations and/or involves in that market, they will tell you that its functioning very normally for the assets we’re trying to sell as well as the wide variety of other ones.
Okay, great. That’s it for me.
Our next question comes from Vincent Chao with Deutsche Bank. Please go ahead.
Hey, everyone. Just a quick question on -- just on the leasing side of things. It sounds like the conditions have state relatively stable from -- Maybe three months to go, but just curious, given the spin out announcement, I mean, does that change the discussions at all with the tenants as you’re trying to renegotiate. I mean, is there any concern out there from them about the potential for the assets to be moved into the spin out or I guess is the change conversation in anyway?
No. In fact, it haven't changed at all. I mean, we're basically talking to the tenants of our leasing space in both properties and both sets of properties and really feels exactly the same,
Okay. And then just maybe another follow-up on Steve's question about the bankruptcies and then theirs is some level of additional closures expected in the guidance range. But I’m just curious relative to on a year-over-year basis. I mean, is it assuming an improvement in the closure rate, similar to last year or worse?
I would say about the same. I mean, we’re assuming that and I think we believe that the bankruptcy environment is likely to stay challenging for a period of time. So we built our forecast around a pretty tepid environment or pretty tepid level of changes as far as bankruptcies are concerned.
Okay. Thank you.
Our next question comes from Steve Ki Bin with SunTrust. Please go ahead.
Hey, Steven. Good evening, guys. So, just a few follow-ups here. The one thing I get maybe more concerned than just pure bankruptcies is as your tenants expire and as move Staples or Office Depot's come back, how much of the conversation is what we will renew, but only for half the space. And how is that baked into your guidance?
Hi, Kevin. I will take that the theory side and then Mike can add to it and then Matt could talk about the guidance. But that’s the subject matter that we talk about most frequently, particularly when it comes to budgeting because the larger risk in this type of portfolio today is that rents change with the worse as opposed to the positive at renewal. The reality is that reductions inside are somewhat uncommon because it's very expensive for the retailer. It's very hard to rely out of store and once they have a sales in a specific neighborhood, it's very difficult to have that sales volume transition that are taking some risks. And to date, I would say, unless you disagree, Mike, that the amount of risk that our retailers are willing to take to put their sales at risk, it's not just happening.
I think the most important thing, David, said is that from a retailer perspective the inside of the store and the layout of the store is incredibly difficult to change for two reasons. One because it's expensive physically, but two, because from a merchandising standpoint everybody is scraping and crawling for their space. And when you downsize a store something has to give and typically retailers become very reluctant to downsize and historically there's been very few who actually do it. So that conversation doesn't often come into play. Occasionally, it does but for the most part it doesn't represent a major proportion of our conversations.
From a forecasting perspective, it's really not an issue for 2018, right because 2018 is all about rent commencements. So those leases, for it to have any impact on our actual results in '18. You can imagine that we signed these leases some time ago. We do our forecast leads by lease, so we already know and even for leases we haven't signed yet. The leasing team is usually far advance with those expirations or having those conversation, so we have a enormous amount of transparency on that particular issue for the next 12-months at least.
Okay. And are lease modifications or rent lease in your spreads?
In what spread, sorry?
The spreads that you report.
Yes.
Yes.
It's a fully loaded number.
Okay, that’s helpful. And is it too early to give any kind of broad range of FFO for RVI? -- RBD?
Yes. Yes, it is too early -- I’m not actually certain that we’re going to be able to provide that guidance key event. It's really not an FFO story. It's going to be a story about generating proceeds for shareholders as quickly as we possibly can. And so FFO is going to be entirely dependent on transaction volumes which I’m sure you can hear us say already are just very difficult to predict. So recurring FFO is not -- I don’t think the way investors are likely to look at that investment.
All right. Thank you.
Our next question is a follow-up from Christy McElroy with Citi. Please go ahead.
Yes, its Michael Bilerman. I’ve had a number of questions. The first is just relating to release time and hoping this call recognizes there is a lot of stuff going on in the back half of last year. The 20 minutes to review a 50 page stuff is not really that much time. So are you going to think about changing your reporting in conference call schedule in the future.
That’s actually the first time hearing of that. Michael, but as ever we’re always going to take the feedback and consider things.
And 99% of the industry does it different ways. So I think more time would lead to more thoughtful questions to better analysis. The second question is that, Matt, can you walk through, you did $0.28 in operating FFO this quarter, new DDR will be at $0.15 in the third quarter at a minimum. Can you walk through the buckets that get you from $0.28 to $0.15?
I’m sorry, I didn’t hear the last part of your question, that get from what to what?
So taking yourself from today, the $0.28 you reported to new DDR's FFO of $0.15. Can you just walk through the pieces and the components that you get there?
Pardon me, this is the conference operator. We are currently experiencing some technical difficulties with our speaker line. Please give one moment while we reconnect them. Pardon me everyone, I've rejoined our connection with the speaker line. Mr. Bilerman, if you are still online …
I’m still here.
… you can continue with your question.
Can you hear me now?
Yes.
Yes.
Sorry, Michael.
I will start off -- maybe I will start off nicer. Maybe, if you have the call at like 7.30 in the morning, that would be better.
I’m sure that would make all the difference.
Yes. Right, so I was trying to just -- there is a bunch of things in the supplemental of new DDR and RVI in Puerto Rico. What I'd love to be able if you can go through is, you obviously reported $0.28 of operating FFO this quarter. You're presenting a minimum of $0.15 for the third quarter, $62 million of FFO between those two numbers. Can you walk through the building blocks, some positive and some negative of getting from point A to point B?
Yes, Michael. It's Conor. Sorry we got cut off there. So if you look at Page 5 of the slide deck you will see the major sources and uses for the first quarter. Obviously, that will have a fairly negative impact in terms of higher cost of debt or asset sales paying off, some debt with a lower cost as well as Page 13 of the supplement we break out the NOI for DDR and RVI. Those two pieces should get to the majority of the framework. The other three things I would add is we sold quite a few assets at the end of the fourth quarter. Obviously, that NOI would be included in the fourth quarter run rate. Happy to help you there. And then the last thing is Blackstone we’ve had quite a bit of preferred repaid as Matt outlined in his prepared remarks. So you will see a fairly significant decline in interest income starting in the first quarter from the fourth quarter. So, those three pieces of sources and uses for the first quarter as well as the breakout on page 13 of the supplement should get you there/ again, how to spend more times, if you like.
And then how do we think about when you did the announcement of the spin, it was a $0.40 dividend. 75% targeted payout ratio. Historically, you’ve been FFO to AFFO about 80%, low 80s. So the 15 will take you down to $0.12 a share in AFFO. So I’m just not sure how all that sort of ties together with the way you presented your math, whether the $0.15 is an absolute bottom of range and that’s going to grow. And how we should think about the FFO versus AFFO drop.
Yes, I mean, you heard us talk about the fact that the goal for 2018 is to begin to grow. So I think that’s the most important comment. Did you want to add something, Conor?
Yes. I would say, mass prepared remarks, we talked about that, that at least $0.15 is tied to the numbers we provide in December. So the $0.10 dividend, 25% payout ratio, so you could -- there's an implication there in terms of the growth for the fourth quarter, Michael. The other thing I would add is CapEx levels today are going to come down. We provided a break out of CapEx again on Page 13 for new DDR and also as a leasing volume as these leasings come back online or come online in the fourth quarter, you will start to see CapEx come down and NOI come up. So, those factors kind of tied to our $0.75 payout ratio number that we provided in December.
And then just thinking about earnings and cash flow growth over time, because RVI is going to be effectively, a liquidating in its NAV story, Matt, you talked about non-earnings story. How do we think about the $10 million of fee income? Are you going to be able to cut the DDR organization by the same $10 million, so that there's not earnings hit in a year, 18 months or 24 months time that it won't be something else that we'd sort to have to deal at that point.
Michael, I think -- this is David. We’ve thought very carefully about how we structured the fee arrangement between the two companies and have been very careful to make sure that we’re not under a whole lot of pressure with respect to time. Certainly, as time goes on, we have to make some decision just to how much G&A we have in DDR and we will make those decisions. But I can assure you that we haven't structured the fees, so that we are going to get under water or have an earnings risk at some point.
Okay. Last question, just where are you guys currently on the Board, refreshed? Obviously, you’re trying to get two or three new Board Members at DDR. Can you share with us where the Board is in that process of identifying candidates and when those would be announced?
I can tell you that we are at a point where -- at a proxy season here. We’ve got a spin that was announced and so I think there's a lot of movement. The Board has been active in dialogue and thinking about strategically what we need for skill sets for these two different business plans. And we are into the proxy season here pretty soon. So I think we will have more information as we get closer to it.
Great. Thank you.
Thanks, Michael.
Our next question comes from Mike Mueller with J.P. Morgan. Please go ahead.
Thanks. Hi. Just two quick ones here. Mike you were talking about the small shop opportunity. Can you quantify about how much small shop occupancy pickup, you think you could have over the next 12 to 18 months. And then on the dispos, [ph] I just want to make sure I’m thinking about the right way for the $900 million people bogey, that is comparable to the 763 that you -- your pro rata share that you’ve sold year-to-date. So you’re looking for a ballpark and other 150 or so and sales to close that out, is that correct?
Yes, correct.
Okay.
With regard to the shop leasing question, we really initiated our amplified shop leasing efforts in the third quarter. And so far our progress has been very encouraging. I think the most important thing to mention is that shop leasing is really the blocking and tackling of the leasing efforts and it is decidedly unglamorous. And I think the most important thing to do in order to drive that business is to make the team culture built around recognizing that, driving that effort really can drive a lot of NOI growth, and effectively rewarded so that becomes glamorous. And what we're doing here is really no different than what I’ve done in some of my past experiences in former companies, and that is to use that philosophy to drive the growth. Right now we don't really have a specific target as to where we're going to peak as far as the occupancy for shop growth. But the results over the last few quarters are very encouraging and we should add more color on that in the next few quarters.
Got it. Okay. Thank you.
This concludes our question-and-answer session. I would like to turn the conference back over to David Lukes for any closing remarks.
Thank you all very much and we will talk to you next quarter.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.