Federal Realty Investment Trust (NYSE:FRT) Bank of America 2024 Global Real Estate Conference September 10, 2024 12:45 PM ET

Company Participants

Don Wood – CEO
Dan Gee – CFO
Leah Andress Brady – VP, IR

Conference Call Participants

Jeffrey Spector – Bank of America

Jeffrey Spector

Roundtable session with Federal Realty Investment Trust. I hope everyone had a good networking lunch, a little bit of coffee as we emerge for the afternoon sessions. To my right is Don Wood, CEO; and Dan Gee, CFO. And then Leah, IR. Leah is back from maternity leave. So good to see you. Thanks for coming. And it’s Don’s birthday today, so happy birthday.

Don Wood

Thanks [Multiple Speakers].

Jeffrey Spector

There we go.

Unidentified Company Representative

Everybody does need to know that.

Jeffrey Spector

I got to warn people. We got to be nice today. So again, thanks for joining our afternoon session. Kicking off here with Federal Realty. For those in the audience that maybe don’t know the company as well. Don is going to provide some opening remarks on the company where it stands today, and then we want to make this as interactive as possible. So if you have any questions, just raise your hands and we’ll get things started. So I’ll pass it on to Don.

Don Wood

Thanks, Jeff. And really thank you guys for taking time this afternoon to be here. When I look around the audience and again, I don’t know who’s on the webcast, forgive me for going back and giving a little bit of history of the company for those of you who do know us well. But I don’t think everybody does. So Federal is a shopping center REIT. And we’ve been around — one of the oldest REITs in the country, been around since 1962. Pretty interesting in that period of time, which is now, whatever it is, 62 years. So only been three CEOs of this company. And I’m the third. I’ve been at the company since ’98. I’ve been CEO since 2002. And the reason that, to me, it is important is because it does say a lot about the stability of this place. We’re a high quality company. In fact, I would argue we’re the highest quality open air shopping center company out there with respect to not only population around our centers but income around our centers. We are largely on the coasts from Boston to Washington DC, also in Florida, West Coast of Northern California, Southern California, Arizona. It’s a company that was really put together to accomplish one thing. We sat down and said, we know this is a cyclical business. We know that there are highs and lows in the shopping center business. How do you build a growing stream of cash flow that finds its way through the cycles, good times, bad times, whatever they are.

And I think if we all came together and sat back in the early 60s and said, how do you put together a portfolio and grow a portfolio that did that, we probably agree on a few things. One, we want to be in places where people have money to spend, people have money to spend when times are good, people have money to spend when times are not good. We want to be in places with lots of those people from a demographic perspective and importantly, barriers to entry, because it’s really, really hard to get rents to go up to the extent there’s a product that looks very similar to yours, that’s right next door. And so those three facets led us to put together what we think is a really great high quality portfolio. The other thing is you want to diversify that income stream. And certainly, we have our share of grocery anchors, certainly we have our share of box anchors. We also have our share of mixed use properties and that means a residential income stream that makes up 9% of the portfolio. And office stream, the bad word of office but different office that is part of only our mixed use properties, which makes up 9% or so of our income stream. So you’re looking at a way for cash flow to be generated by the company that comes from a really varied type of tenants. Our largest tenant makes up less than 3% of our income stream.

The other thing you’d probably want to do is recognize that in order to create value in real estate or keep cash flow growing through good times and bad, you need as many arrows in your quiver as you possibly can. So we do have a strong — not only strong internal growth through the properties that we have, but we also have the ability to use a very strong balance sheet to acquire. We also have a very strong balance sheet to develop. And when it comes to develop, what we primarily do is add on to our existing shopping centers for whatever the highest and best use of that real estate is. What it’s turned out to be a lot of our residential properties or assets that for people living in those residences they appreciate having the amenities of the shopping center adjacent to them. So that’s another arrow that’s in the quiver. And when you put all those things together, what you found is a company that throughout its 60 year history has been able, remarkably, to increase its dividend to shareholders every single year since 1967. Every single year since 1967. And if you think about what’s happened in this country and you know over that period of time, whether you’re talking about 20% interest rates or whether you’re talking about 9/11 or whether you’re talking about wars and certainly many economic cycles of inflation and recession, it’s pretty, it’s pretty remarkable.

There’s one time that knocked us off our game. One time. It was COVID. And the reason COVID knocked us off our game more than other shopping center companies, still not bad, but more than other shopping center companies is because our markets on the coasts largely closed down and they closed down more than other markets. And so as a result that growing stream of income was interrupted by that and only that over that period of time. It’s pretty remarkable. It’s also been pretty remarkable that since that time we’ve recovered extremely strong. We’re well above where we were in 2019 and look at a very, very bright future. And I’m sorry, Jeff. You know me. I could talk on forever. So just stop me when you want. I got a few more things to say if I keep going, though, if you don’t mind. When you look at our business today, the open air shopping center business today, it is a period which is different than much of the last — much of that history and that it’s really the first time that in open air shopping centers, I can honestly say demand exceeds supply. And for most of that time, some of you gosh, certainly, Steward and Steward certainly know, as investors that I have preached that supply exceeded demand, we built like crazy through the 90s. We built like crazy in the 2000s. And so we were specifically focused on making sure that our product was differentiated, that’s — that it was better, that it was different, that we had to be a choice for a retailer to come to us, because it was not the same thing.

And as a result of the lack of development, really, since the great financial crisis, in the country, there has been very little retail supply added. And when you think about that through the teens and into COVID and now coming out of COVID, it’s really been a benefit to the entire industry. So anywhere that you invested in open air shopping centers post-COVID, it’s worked out pretty darn well. And it’s worked out pretty darn well because a rising tide does lift all boats, and I think that’s great. And that demand supply characteristic really won’t change for the next — for the foreseeable future. It takes time to make the numbers work, to plan, to entitle, to be able to build new product. There’s some of it starting in a couple of places, but very, very small. So that supply demand dynamic, you should expect to continue. Now what probably won’t continue is an economy that was so propped up post-COVID. And lots of money, $5.5 trillion into the economy has a lot to do with consumers being able to consume at their leisure. And obviously, that’s changing. So the notion of, do you expect consumers to continue to consume at the level that they did in ’21, ’22, into 2023? No, I don’t. I expect a more normalized environment in the country overall. Not a bad environment, just not compared to an overstimulated environment of the past 24, 36 months.

And so to me, it’s pretty likely that it’ll become more important, like it did for most of those 60 years, for the high quality stuff, the places where consumers have the means to consume are located with respect to the real estate that you own. So I’m looking for — I’m looking at — we’ve been sector leading growth for the past two years. I would hope that to be able to continue into the foreseeable future. So I think quality matters. And when you look at tenancy that is — that could — has not seen a lot of bad debt, has not seen a lot of failures, you have got Bed, Bath & Beyond. You’ve got some of the retailers that are hitting, that affect lower, income consumers, the Big Lots of the worlds, the JOANNs, if you will, of the worlds. Those notwithstanding, the credit of many of those big boxes is pretty darn strong and should be pretty darn strong for the next few years. Question is, can you make money around those tenants with the small shop? And the places that make that shopping center feel different than every other shopping center that you know in America. I’m going to stop right there because I’m exhausted, and let you ask your question.

Question-and-Answer Session

Q – Jeffrey Spector

All right. That was great. Thanks, Don. I guess on the subject of quality and demographics, it’s something that we’ve been emphasizing. But the last couple of years, year-to-date, it hasn’t mattered as much or it’s not a big part of the conversation, demographics. So I guess first, I mean — and maybe tie into the — we had a consumer panel this morning with the BofA Institute. And through our credit bank data, we have seen some slowing but resiliency across the Board and then in particular, lower income consumers starting to [weaken]. So are you — when you talk to your peers or retailers, I mean, where do you think we are in terms of the state of the consumer, is it just normalizing? Or from your experience, this is typically the start of something that could create some issues or are you hearing any more issues that we should be aware of?

Don Wood

Yes, there’s a couple of things to talk about in there. One is — and what I’m about to say is obvious, but it’s important to keep this in your mind. The landlord, the real estate, is not the retailer. There’s an inherent cushion between a retailer’s performance and whether they’re able to pay the rent in the real estate that they own and what can happen with that. And with respect to that, I can sit here, wherever we are, in September of 2024, and say, I have seen very little, if any, reductions in the appetite of retailers to continue to sign leases and to grow. I do think what’s important in here, and this is something that’s very hard for an investor to get his or her arms around, is the quality of the operator. And this will be part of the normalization, which I think is what’s happening, Jeff, that’s important here. If you think, think about most shopping centers in the United States of America. Wherever you live, wherever you’ve traveled, wherever you go, you’ve certainly seen places where it doesn’t matter, other than the TJX box or the Ross box or the Dick’s box, whatever that’s in the shopping center or the grocer, whoever it is. When you look at the small shop, there’s a propensity to lease to whoever will pay the rent, and that to me is short sighted. Because if you are trying to build a stream of cash flows that gets through highs and lows, what you really need are the best operators in each category. And you’ve all seen it in your towns and the way you’ve grown it. Think about any restaurant that’s part of a shopping center in your town.

When things are great, the mediocre person, they can make it. They do just fine along the way, it’s mediocre but you got money and there’s stuff to do. When things get tighter and the consumer spending, I don’t know, 10% less, your sales are down 10%, 5%, something like that, your margins are squeezed, your costs are up, it gets tougher. The difference between being able to pay your rent and continue to thrive in your business is whether you’re a good operator or not, and there is not enough talk about that. And I say that because what we try to do throughout the portfolio, and albeit it’s a higher quality portfolio, so we have a better chance of doing it, is to find the best operators in each category. When you can do that and you know you’ve got tenants that are not worried about making it through the cycle, they are — they know they are going to make it. They’re operating differently. They’re operating smarter. They’re using technology. They’re the people that can get them the best employees, because they’re known in the industry as being the best operators. All those kind of things that are qualitative, in many respects, are why what happens to us in downturns normally is we are much less impacted by the downturn. And it goes back to where I started from.

That’s kind of the way I see the next couple of years. A good a good economy. I do think we’ll figure out how to how to get to a soft landing. I’m hopeful. But I’m not an economist. So if we don’t, I want to make sure that it’s not what we’re going to do now. If you’re waiting till now to decide how you’re going to — what you’re going to do, it’s too late. You had to build up the company with the right cash flow stream, with the right tenants, with the right balance sheet, historically, to get to where we are today. That’s why I’m hopeful on a relative basis that you’ll start to see some differentiation for — in a prior period that that didn’t matter as much, because it was all — because the rising tide was lifting all boats.

Jeffrey Spector

Does it take a recession to see these differences?

Don Wood

No. It doesn’t. This is not a political comment. This is just fact. Federal Realty made more money for its owners during the Obama administration than anybody else by far. And you know why? Because the economy was so, so. Because two things, interest rates were low and that’s important, but not that important. Interest rates were stable, and that’s important. So whether they’re stable at 2.5% or 4.5% or 5.5%, well, that’s not a number that you can’t make any money with, that’s important. But the thing that’s most important is that the economy is growing slowly. Economy growing slowly, real estate investment trusts like this look great. Economy growing too fast, you got other places to put your money. There’s other opportunities. Economy going poorly, nobody’s interested in anything. So I’m looking for what I think we’re going to see over the next few years and that is a slow growing more normalized economy, which I think should be good in a space where demand exceeds supply.

Jeffrey Spector

And then in terms of the portfolio, you talked about 9% resi and I believe you said you’re also at 9% office?

Don Wood

Yes, 9% or 10%.

Jeffrey Spector

How has that evolved? And how should investors think about that over the next five or 10 years?

Don Wood

For those of you who don’t know us well, we have affectionately known as the big four within federal and that is $4 billion plus of four assets that are large, mixed use, laboratories for us, Santana Row and San Jose, California, our flagship. Pike & Rose in North Bethesda, Maryland. Bethesda Row, Bethesda, Maryland. Assembly Row in, Summerville, Massachusetts. In each of our major markets, we’ve got a big one. And the — what we get out of the big one is the economics of the residential, the economics of the office, the economics of the retail. And the integration of those in the big one, what people don’t get is what we’ve learned by doing those billion dollar projects basically trickles through to our other 102 assets. We’ve learned tons about construction, we’ve learned tons about place making and how to make a place feel special. We’ve created relationships with tenants that aren’t in usual shopping centers, that are in our shopping centers. It’s found its way all the way through the company. And you’ll notice a difference if you go out and look at our assets than at the typical shopping center. And so the notion of having those mixed use properties, the only reason we have them is because we had shopping centers in places that intensified over the years, over those 60 years, such that we were able to make economics worth by going up. Going up, not much of a shopping center demand on the fifth floor of anything.

And so we created communities. The residential at those properties has grown at 3.5% CAGR for 20 years in those properties. It’s been fantastic. Because — and you all know it, you want the convenience of the amenitized base with the restaurants, with the shops, with the services to effectively go along with you. And in any of those markets, those four markets that I’m talking about, and we also have some in Miami too, at CocoWalk, something that we did just in the last couple of years, that those rents are premium. The same applies to the office at those places. And God, the o word, how could, oh my God, how could we have a conversation with the o word and it’s a bad thing here. It’s not a bad thing in these places, particularly when the buildings are new or being built. Now, that’s the only places where we do have office. And that’s the place where we’ve done, heck, 1.2 billion square feet — million square feet or billion. 1.2 million square feet leases over the last four years all at premium rents. It’s good stuff. Now when you put that together and you look forward about that, we acquire — we don’t acquire mixed use, usually we tend to acquire great pieces of great shopping centers or great potential shopping centers with maybe the ability to put mixed use on them, which I love putting residential on properties that we already own. But you should expect that ratio, 9 and 9, 10 and 10, whatever that to be roughly 80 to stay. This is an 80% — this 80% of this income stream is retail all the way through. And I would argue that the residential one and office is so tied to the retail at those places that we’re really — we certainly think of ourselves as a retail company through and through and through.

Jeffrey Spector

And on that residential side. When we saw you in March, I know you said you want to be opportunistic and take advantage of entitled land, wherever it’s appropriate to add resi, you need that cost of capital. Where are you today in terms of your mindset on adding more residential to your properties?

Don Wood

Yes, it’s an important thing to understand. So during any cycle, during any time, there are times when math works better to buy and when math works better to build, and it is clearly heretofore it makes much more sense to buy than to build. Construction costs are high, this, that, and cost of money high, higher. All of those things. What we use periods like that for, exactly like we did in the great financial crisis, is to go through the process of getting ready to be able to build when the market changes. As investors and you look and you see, there’s development. When you think of development, you think of construction generally, building something. The reality is that’s the very last phase of development. The permission to be able to do what you want to do, the entitlement phase, takes years and is upfront before that. The designing of what it is and the pricing of what it is that you’re going to do, it takes a year before something more than that before that. So you take your down periods and you work like that like crazy. That’s what we’ve been doing with respect — over the last couple of years with respect to entitling and designing largely residential adds, apartment adds to our best shopping centers.

We’ve got an opportunity, it looks like to do 12 of them. Do I think we’re going to get to all 12 of them? No. Do I think the math will work on all 12 of them? No. But we got the first one. And it’s under construction in Bala Cynwyd, Pennsylvania, which is on the main line just outside of Philadelphia at Bala Cynwyd Shopping Center, a very good shopping center that we did, where we did an experimental first 90 units a few years back and it killed. So now we’re adding a couple of 100. And we’ve gotten that with more retail on the ground floor to incorporate this piece of land as a mixed use project. The going in yield would be a seven unlevered on residential, which is really — when you can count on 3% CAGR each year from that time, because you get to those leases, it’s not like you’re putting this thing away, you’re getting to that year-after-year. From my perspective makes a ton of sense from a capital allocation perspective. No land costs because you own that land effectively there, which is a huge plus. And often in some of these places, parking is already there partially there, which is a huge — another huge component of costs that is advantageous. We’re real close on adding a smaller project in Hoboken on a piece of land that — on a retail piece of land that that we own that should come up next.

I think you should expect to see more of that over the next few years as the economy changes. And you know this gets down to kind of where we are today. Most retail real estate portfolios are fully occupied. And once you get to 95% or 96%, you got — because now you’re fully occupied generally. We got a little bit more to go than now. We got another 100 basis points or potentially more in ours because we were hit harder by COVID. So we’re behind a little bit in that. So there’s a bit more of a tail that way. But if you say, well, okay, once you’re fully leased, how do you grow? And I am afraid that the investment community, in general, particularly the generalists who don’t know this business well, are being led to think that these properties can grow much faster than they actually can. Because when you think about a shopping center, it’s made up of anchor boxes, which almost universally or universally have a CAGR in their leases of about 1% a year. 1%, maybe 1.2% or about 1.4%, because the way those leases work. So you have to make your money in the shop, small shop, which is very, very important to have distinguishable and not just anybody in the shop.

It gets down to the operators, it gets down to the sales, gets down to the place making all that. When you put all that together, a good same store growth portfolio, a really good one, like, I think ours is, should grow about 3.5% a year at the POI level, at the property operating income and I think most grow at much less than that. So the point is, well, all right, in a more mature market, in a more normalized market, what other arrows do you have back here to be able to create that growth? And that’s why I talk about that residential development, because the more you can think like a real estate person and create value and add cash flow to that income stream through more sources, the better your overall growth is going to be. And so I’d like to have as many arrows in the quiver as possible. We’ve been doing that for 25 years.

Jeffrey Spector

And on the residential development, it’ll be on balance sheet?

Don Wood

Yes, and that’s a big point. Whatever you do, it’s got to matter. We’re a $10 billion equity cap company. The notion of doing all the work to entitle, to design, to get something ready on your property with your land cost, to be able to go do it and have it be a $80 million, $100 million project, something like that and joint venturing that and investing 20 or 30, doesn’t move — it wouldn’t move the needle for us enough. So we would prefer, and we’ve developed the expertise over 25 years, not unimportantly there, we would prefer to put that capital out so that it translates to the bottom line. At the end of the day, it’s got to come through the bottom line.

Jeffrey Spector

I just want to make sure if there’s any questions from the group. If not…

Don Wood

You’re doing a lot of clicking. Are you right in your overboard right now? You know there’s AI now?

Jeffrey Spector

True. I wish they let us use that app, I thought about that. Please…

Unidentified Analyst

Don, you talked about the big four. You talked about developing, especially apartments. So from a funding standpoint, how do you [Technical Difficulty].

Don Wood

Yes, I know where you want me to be on that one, but let me talk about this for a second. So first of all, our job, I think, is to not surprise you. And so the notion of balance and capitalizing your company with balance, capitalizing your company with consistency, making sure that all potential capital streams are available to you, is such a key part of what it is that we do, which is why you’ll see us issue equity, but we issue equity $100 million a year, $150 million a year at a time through the ATM program. We’ve been doing that since 2011 or 2012, something like that, each year. I don’t think there’s an equity investor out there that minds us raising $150 million. If we’re putting it to work above that cost of capital there, which I think we’ve done a good job of doing it. We absolutely recycle assets and sell $100 million, $200 million, $300 million, depending on the marketplace and the opportunistic possibilities we have there in each year about $120 million. So this year so far along the way. And then the third thing, and I’m getting at your question now, the third way to do it, it’s all part of what you own, form of a joint venture, et cetera. I’ve said in the past that we would look to in the future joint venturing those big four assets or a potential part of those big four assets. That is absolutely on the table.

Now what has what has really pushed me to say that is over the past few years, and to some extent still, the public markets are not paying for those assets. Those assets, those are low cap rate assets, man. They’re the best in the country. And if any of you want to really dig into and see and understand a Santana Row or an Assembly Row or one of the big four, I’d be happy to show you. And you will see what I mean. I mean, these are better — these are really good stable income streams with future development opportunities embedded in them. When you look at that stuff, $117 stock price doesn’t catch it — doesn’t cut it. Frankly, it is $100. When it was $195, I was really saying, man, we got to figure out how to exploit that. I mean, we got to get paid for that. If I had my way, the stock price would reflect it. We would not have joint ventures. I personally — I don’t want another — I don’t want another partner and they’re diluting our growth assets there. When — would I do it, when are you going to pay me for it? So there’s a number. There’s a place. There’s a time that, that can happen. It’s not today. Don’t need it today with the other measures that we talked about but it’s something that’s on the screen. Effectively, if you look — if you really think about it, it’s a competitive advantage that nobody else has. There is a big chunk of this company that is undervalued that we can tap at some point in the future, that can’t be a bad thing.

Jeffrey Spector

When we saw you in March at our retail executive event in New York City, I think in all the years I’ve known you, you were the most excited on acquisition opportunities. Where do you stand today on, I guess, the opportunity set?

Don Wood

Let’s talk about how it works, right? There isn’t one of you here that wants to sell anything you own for less than you think it’s worth. Not one. I don’t care if you’re talking about a car, you’re talking about a stock or you’re talking about whatever, unless you have to. And in order for you to be comfortable at a value that you think what it is that you own is worth, you’ve got to be comfortable in real estate with where your cost of money is going to be. And obviously, for the past couple of years, nobody’s been comfortable with where interest rates are going, with what the story was going to be. That changed a bit early this year. And that gave me irrational exuberance, if you will. Because what was happening was the difference — it’s always the difference between bid and ask. But what I’m willing to pay and what you need to deliver something, and that historically had been very, very wide really through COVID, and wasn’t going to happen. As that came down early in this year, we saw a window. And we jumped through that window, in two ways, pinhole, in Northern California. And to me, one of the best things we ever did was Virginia Gateway, in Gainesville, Virginia. So nearly $300 million of assets. Virginia Gateway, we’re going to do a 7.2% yield cash-on-cash to start there. If they had waited four to six months to today, that’d be 75 basis points, 100 basis points inside that because there’s far more clarity on what’s going on with interest rates.

Now that exuberance let us get those done. Do I wish we did more? Sure, we tried. Not a lot that was out there. Now the question is, will we be able to, because once again, a seller is going to have an expectation of falling interest rates, their expectation for what they’re going to get paid is going to go way up or going to go up. Question is, our stock is higher, our cost of capital is lower, we can pay more. If the bid ask before was here and we made it work, is the bid ask here and can we make it work? I’m still encouraged that we can. In fact, I’m going to leave here. I’m going to get on a conference call about a specific asset that we’re looking at right now to be able to do that. So I’ll tell you more at the 3:00, if you’ll wait till then, in terms of what’s happening. I am still optimistic about it. But I do realize, man, that you’re not — we’re not going to put out capital that is not accretive to start value producing from an IRR perspective over time. And we’ve been able to find a couple of those. I’m hopeful that we can find a couple more to go and that will always be a key part of what it is that we’re doing.

Jeffrey Spector

Great. That went by fast. We’re already out of time. We do have three rapid fire — rapid answer…

Don Wood

I didn’t think we’re doing rapid [Multiple Speakers] hear what happened…

Unidentified Analyst

Three quick ones. First, do you expect real estate transactions to increase once the Fed starts to cut? Yes or no?

Don Wood

I don’t know. I don’t. It’s the bid ask thing. Do I expect more properties to be available? Yes, I do. Do I expect there to be able to get to — cover the ask with a bid there? I must say, yes. Just change it to yes. It’s rapid fire. I should just say something…

Unidentified Analyst

Then it’s yes. When do you expect them to pick up fourth quarter this year, first half next year…

Don Wood

Now you see, he suckered me into that question. You see what just happened? Fourth quarter this year.

Unidentified Analyst

Okay. Second, how would you characterize demand for space today? A, improving, B, steady, or C, weakening?

Don Wood

Steady.

Unidentified Analyst

Okay. And finally, how would you characterize your AI spending plans over the next year? Higher, flat or lower?

Don Wood

Boy, that has such an interesting connotation to me. That’s a rapid fire?

Unidentified Analyst

Yes.

Don Wood

All right. Flat.

Unidentified Analyst

Perfect.

Don Wood

Boy listen, I could really talk about that for a while. But anyway…

Jeffrey Spector

All right. Thank you very much to the Federal Realty team. Appreciate that.

Don Wood

Thank you guys for giving us time.