Phillips Edison & Co Inc

NASDAQ:PECO

Earnings Call Transcript 2019-Q2

[Operator]

Good morning, and welcome to Phillips Edison & Company's Second Quarter 2019 Earnings Presentation. My name is Rocco, and I will be your conference operator today.

Before we begin, I would like to remind our listeners that this live presentation is being recorded and simultaneously webcast. The webcast and a copy of the slide presentation can be accessed on the Investors section of the Phillips Edison website at www.phillipsedison.com. A replay will be available later today on the Investors section of the Phillips Edison website at www.phillipsedison.com under the Events and Presentations tab.

I would now like to turn the call over to Michael Koehler with Phillips Edison & Company. Sir, please proceed.

[Michael Koehler, executive]

Good morning, everyone, and thank you for joining us. I'm Michael Koehler, the Director of Investor Relations with Phillips Edison & Company. Joining me on today's call are our Chairman and Chief Executive Officer, Jeff Edison; our Chief Financial Officer, Devin Murphy; and our Executive Vice President, Mark Addy.

During today's presentation, Jeff Edison will touch on our highlights for the quarter and will provide an update on our portfolio. Following Jeff's comments, Devin Murphy will discuss our investment management business and joint ventures, review our financial results and our recent share repurchase program activity and then discuss some important changes to the share repurchase program. Finally, Jeff will speak to our upcoming executive changes and highlight 2 additions to our Board of Directors. Upon the conclusion of our prepared remarks, we will address your questions. [Operator Instructions]

Before we begin, I would like to remind our audience that statements made during our prepared remarks and the question-and-answer session may contain forward-looking statements which are subject to various risks and uncertainties. Please refer to Slide 3 for additional disclosure and direction on where you can find information regarding potential risks. In addition, we will also refer to certain non-GAAP financial measures. Information regarding our use of these measures and reconciliations of these measures to our GAAP results are available in our earnings release issued last -- yesterday afternoon as well as in the slide presentation for this webinar, which is available for download on our website.

I would now like to turn the call over to Jeff Edison, our CEO. Jeff?

[Jeffrey Edison, executive]

Thank you, Michael. Good morning, everyone, and thank you for being on the call today. Before I get into the results for the quarter, I'd like to review with everyone our key initiatives we have been focused on during 2019, as outlined on Slide 4. We believe these initiatives will improve our positioning as we seek a full cycle liquidity event.

Across our organization, we are first and foremost laser-focused on delivering solid operating fundamentals and growing net operating income, or NOI, at our properties. We can do this by improving occupancy, increasing revenues through rent increases and driving foot traffic at our properties by focusing on our centers' merchandising mix. This must be done in concert with the strict commitment to expense management across our platform.

Our second initiative is to increase our active disposition program to fortify the quality of our portfolio and generate proceeds. We will recycle this capital by reinvesting in better-quality, higher-growth assets and investing in development projects at our existing centers with attractive yields or repaying debt.

Our third initiative is to grow our investment management business, which provides recurring income streams and allows us to grow without additional capital investment.

Our focus on reducing leverage is a result of conversations held with investment bankers and our observation that the public peers are targeting lower leverage levels and continue to delever. Therefore, to maximize the outcome of a future liquidity event, we need to have an appropriately structured balance sheet, although these 3 initiatives will allow us to improve our leverage ratios in order to best prepare for a liquidity event.

Now turning to Slide 5. The second quarter of 2019 was the second full quarter since the transformational merger with Phillips Edison Grocery Center REIT II, which closed on November 16, 2018. The $1.9 billion merger added 86 grocery-anchored shopping centers, totaling approximately 10.3 million square feet to our portfolio. The quarter was highlighted by significant leasing activity, which drove improved occupancy at our centers. Our leased occupancy increased to 94.6% at June 30, 2019, which is a meaningful improvement from 93.2% at the beginning of the year. This increased occupancy and our double-digit leasing spreads helped drive the 1.5% same center NOI growth for the quarter and 2% growth year-to-date. In the first half of 2019, we sold 6 smaller centers and recycled that capital into a center in Naperville, Illinois, an affluent neighborhood outside of Chicago. We upgraded the demographics and growth profile of the portfolio through these transactions. These strong operating results continued the momentum we have seen over the past 3 years and reflect sustained, healthy tenant demand for well-located, grocery-anchored real estate.

Slide 6 provides some detail on our national portfolio for -- of grocery-anchored shopping centers. As of June 30, 2019, our portfolio consisted of 298 wholly-owned properties anchored by 36 leading grocers representing multiple banners located in 32 states totaling 33.5 million square feet of gross leasable area, or GLA. This compares to 235 properties as of June 30, 2018, located in 32 states with 34 leading grocers totaling 26.3 million square feet, which was before our merger with REIT II.

As of June 30, 2019, our leased portfolio occupancy was 94.6% and our inline occupancy was 97.9% (sic) [ 87.9% ]. That was compared to 95.7 -- 85.7% a year ago. 76.5% of our total rent came from grocers and national and regional tenants, illustrating an established tenant base; and 77% of our total rent came from necessity-based tenants. The average remaining lease term for our portfolio is 4.8 years.

We also have 2 joint ventures. One joint venture with Northwestern Mutual Life Insurance company, which owns 17 properties; and one with TPG Real Estate, which owns 13 properties for a total of 30 properties in our asset management group. These joint ventures with institutional investors like Northwestern Mutual and TPG Real Estate are a meaningful and positive affirmation of the PECO brand and the quality of our asset management platform. Devin will provide more details on our JVs in a few moments.

Slide 7 provides an overview of our leading grocer anchors. Kroger and its banners are collectively our largest tenant, marking 6.9% of our ABR for the quarter across 69 centers. Today, PECO is Kroger's largest landlord. Publix and Albertsons/Safeway are our second and third largest tenants, marking 5.5% and 4.3% of our ABR for the quarter across 58 and 32 centers, respectively. Today, PECO is Publix's second largest landlord. Ahold Delhaize, our own -- which owns GIANT, Stop & Shop and Food Lion, among others; and Walmart round out our top 5 tenants. We strive to own shopping centers anchored by the #1 or 2 grocers in a given market, and we believe our portfolio enjoys excellent anchor diversification.

The scale of our relationships with our grocery anchors provides us unique advantages that we believe allow us to generate better property level performance. As we look at our leading grocery-anchored tenants, we continue to see brick-and-mortar as the cornerstone of their future growth strategies, and we remain very positive about the long-term prospects of owning and operating grocery-anchored real estate.

Slide 8 provides an overview of our necessity-based tenant base. Our leasing fee is highly focused on leasing out space to tenants that have e-commerce-resistant businesses, strong credit and are part of strong companies operating in growing industries. As a result of this focus, approximately 70% to 80% of our ABR comes from national and regional tenants, which means they are often -- they often have higher credit and financial stability than smaller, single-location tenants. Further, 77% of our ABR comes from convenience and service-based businesses like grocers, restaurants, hair salons, barbershops, health care and fitness centers. Recently, we have seen increasing demand from health care tenants as their preference to be located in neighborhood closer to their patients continues to be an increasingly important business strategy. We believe that these tenants offer goods, services and experiences that are Internet-resistant and will continue to drive recurring foot traffic to our centers on a regular basis.

Additionally, we believe that our neighborhood centers are rightsized for the evolving retail landscape at an average size of approximately 113,000 square feet. We attribute our consistent portfolio results to the smaller footprints of our centers when compared to our publicly-traded REIT peers filled with necessity-based tenants who drive regular foot traffic as they serve a trade area of approximately 3 miles. Further, because of the size of our centers, our exposure to secondary anchors is low, thus limiting our exposure to big-box retailers that are closing their stores and downsizing. Example of these types of stores are Payless Shoes, Sears, Pier 1 Imports and Gymboree. We have no exposure to the retail -- to these retailers.

To summarize, our portfolio consists of rightsized neighborhood centers that have a grocery anchor. These centers are currently viewed as the best type of retail shopping center with the lowest risk to e-commerce disruptions. This is highlighted by research reports from groups such as Green Street Advisors.

Slide 9 outlines our occupancy metrics and in-place rent or ABR. As of June 30, 2019, leased portfolio occupancy totaled 94.6%, which is an increase from 93.8% in June 30, 2018. Anchor occupancy was 98%, which was unchanged from a year ago. And inline occupancy increased to 87.9% from 85.7% last year. This was due to strong leasing activity. Our overall annual ABR was $12.29 per square foot, which was an increase of 7.6% from a year ago. Our inline tenant ABR was $19.44 per square foot, which was an increase of 9.6% from a year over -- from a year ago.

Many have asked what an inline tenant is in our past calls. The graphic on the top right illustrates an example of one of our centers. The anchor is orange and is the grocer, and the other tenants in blue I'll refer to as our inline tenants. The green is an example of an out-parcel. The inline tenants use the foot traffic generated by the grocer to create demand and awareness for their business, and these rents are typically much higher than the rent that the grocer pays.

Slide 10 provides some examples of leases that our first-class leasing team executed during the quarter. We remain focused on leasing our vacant space to tenants that offer necessity-based products, services and experiences as well as high level of convenience, which we believe are and will be Internet-resistant. Chick-fil-A, Wendy's, Publix Liquor and Five Guys Burgers and Fries are a few examples of national tenants that are expanding in our portfolio from the Food & Beverage industry. Other new leases includes Sport Clips and Great Clips, which are national brands in the personal care category. AT&T Wireless and UPS fall in the service category, and Anytime Fitness and Pure Barre are 2 fitness concepts that will also be added to our portfolio in the near future. We are pleased with the leasing activity we executed in the quarter and are optimistic about the future given our current leasing pipeline.

With that, I will now turn it -- the call over to our Chief Financial Officer, Devin Murphy. Devin?

[Devin Murphy, executive]

Thank you, Jeff. Good morning, everyone. As Jeff mentioned earlier, one of our key growth initiatives for 2019 is to further expand our investment management business, which is illustrated on Slide 11. With my upcoming transition to President, I have been tasked with expanding our investment management business by raising additional equity and overseeing our current joint ventures.

As of the end of the second quarter, our investment management business provided asset and real estate management for 38 properties currently owned by 5 different entities, including 3 joint ventures. Together, we currently have $725 million of third-party assets under management.

Our investment management business generates fee income for PECO and provides consistent, recurring income streams for us. It also provides an opportunity to grow and expand our earnings without additional equity investment. The investment management business both leverages and strengthens PECO's operating platform as we deliver property management, leasing, asset management and tenant support services to sophisticated institutional investors.

Finally, we believe this business enhances the PECO brand with key constituencies in both the private and public markets, which has the potential to pay long-term dividends for our shareholders.

If you'll turn to Slide 12, this slide is an overview of our 2 largest joint ventures. Last November, we entered into a joint venture with Northwestern Mutual, one of the largest and most experienced commercial real estate investors in the country. In this JV, Northwestern Mutual acquired an 85% interest in 17 of our grocery-anchored shopping centers valued at $369 million. PECO maintains a 15% ownership interest in these properties and provides asset management leasing and property management services to the JV. We expect this joint venture to generate approximately $4 million of annual fee income for us in 2019. The $161.8 million of cash proceeds generated from this joint venture transaction was used to reduce our leverage, fund redevelopment projects and invest in properties with additional growth opportunities.

We also have a joint venture with TPG Real Estate, another well-regarded institutional real estate investor. In this joint venture, TPG owns an 80% interest in a 13-center portfolio currently valued at approximately $250 million. PECO maintains a 20% interest in the venture and provides asset management, leasing and property management services to the venture. We expect this joint venture to generate $2.5 million in fee income for PECO this year.

Partnerships with well-regarded institutional investors like Northwestern Mutual and TPG Real Estate are a meaningful and positive affirmation of the PECO brand and the quality of our asset management platform.

If you'll turn now to Slide 13, this slide outlines the history of our common stock. From the initial public operating price of $10, we have increase our estimated value per share 4 times, including most recently in May when we increased the estimated net asset value per share to $11.10. Our current distribution rate is $0.67 per share per year. Together with REIT II, we have made distributions of over $1.1 billion to our shareholders, and our distribution on August 1, 2019 marked our 104th consecutive month of distributions. Most recently, our Board has again approved our monthly distribution rate at an annualized rate of $0.67 per share for September, October and November. We are committed to driving shareholder value, and that is illustrated by the returns enjoyed by our investors.

Depending on the timing of your investment and the treatment of your distributions, Phillips Edison & Company common stock has produced a cumulative total return between 48% and 99%, which equates to a 7.5% and 8% compounded annual return.

Gross consideration from our monthly distributions to our original PECO shareholders range from $3.67 to $8.76 per share on the original $10 per share investment. For our former REIT II shareholders, their investment with us has produced a total return to date between 15% and 32%. These results represent a history of delivering shareholder value.

If you'll turn now to Slide 14, we'll review our year-to-date pro forma same-center NOI performance. For the purpose of evaluating same-center NOI on a comparative basis and in light of the merger with REIT II last November, we are presenting pro forma same-center NOI as if the merger with REIT II had occurred on Jan 1, 2018. As such, our pro forma same-center NOI includes 291 properties that were owned and operational as of January 2018.

During the 6 months of 2019, same-center NOI increased by 2% when compared to the first 6 months of 2018. This improvement was the result of a 7.4% improvement in expenses, partially offset by a 80-basis-point decrease in revenue. Our rental income increased by $1.2 million due to a $0.22 increase in average minimum rent per square foot from the beginning of the quarter. Tenant recovery income decreased year-over-year, almost entirely as a result of the change in presentation of real estate taxes directly paid by tenants from the implementation of a new lease accounting standard, which we will discuss further on the next slide.

If you'll turn to Slide 15, Slide 15 outlines our financial results for the 6 months ended June 30, 2019. The company recorded a net loss of $48 million compared to a net loss of $15.9 million for the same period in 2018. This net loss was primarily the result of $38.9 million of noncash real estate impairment charges and additional noncash impairment charges of $9.7 million related to certain intangible assets.

As real estate companies evolve their portfolios and recycle assets, the recognition of impairment charges is a common occurrence. As we are in the process of recycling capital out of noncore assets into assets with higher growth opportunities, we may continue to realize these noncash impairments in coming quarters.

Also contributing to the net loss was $27.7 million of additional depreciation expense, primarily due to the additional properties owned after our merger with REIT II when compared to the year ago period.

When we add back these noncash impairments and other items, the company generated FFO of $104.1 million for the 6 months ended June 30, 2019, which is a 31.7% increase from the $79.1 million for the same period in 2018. This increase in total FFO is attributed to income from the merger, including NOI from its properties and year-over-year property level NOI growth partially offset by the loss of NOI from properties sold.

On a per share basis, FFO decreased by 5.9% to $0.32 per diluted share. The reduction in FFO on a per share basis is the result of our net disposition activity over the last 6 months as our debt to total enterprise value decreased to 40.7% from 42.2% at June 30, 2018. Delevering our balance sheet has a short-term negative impact upon earnings.

During the first 6 months of 2019, the company made gross distributions of $109.6 million, including $35 million reinvested through the dividend reinvestment plan for net cash distributions of $74.6 million, which were fully covered with FFO year-to-date.

For the 6 months ended June 30, 2019, the company generated MFFO of $108.5 million, which is a 30.5% increase from MFFO of $83.1 million for the same period in 2018. On a per share basis, MFFO decreased by 8.3% to $0.33 per diluted share for the first 6 months of 2019. MFFO performance was also impacted by the decrease in leverage through net disposition activity, offset by higher earnings from the larger portfolio resulting from the merger with REIT II.

Slide 16 outlines our debt profile as of June 30, 2019. Our net debt to total enterprise value was 40.7% as of June 30, 2019. Our debt had a weighted average interest rate of 3.5% and a weighted average maturity of 4.7 years. Approximately 86.4% of our debt is fixed rate. This compares to a debt to total enterprise value of 41.1% at December 31, 2018, and weighted average interest rate of 3.5%, a weighted average maturity of 4.9 years and approximately 90.1% of fixed-rate debt.

With the recent decrease in interest rates, we are actively working on opportunities to refinance certain debt in order to strengthen our balance sheet and maintain a cost of capital that is as low as possible and lower our annual interest rate expenses.

As we look at our liquidity, we had $491.4 million of borrowing capacity on our $500 million revolving credit facility as of June 30.

If you turn to Slide 17, this slide provides an update on the activity under our share repurchase program, or SRP. During the 3 months ended June 30, 2019, we repurchased 541,000 common shares totaling $6 million for death, disability and incompetence, or DDI, in accordance with the SRP. We did not have any funding available for standard repurchases under the SRP during the quarter. Subsequent to quarter end, on July 31, 2019, we repurchased 1.2 million shares of common stock under the SRP. We fulfilled all repurchases for DDI, and we executed a standard redemption on a pro rata basis at $11.10 per share under the SRP. Due to the demand for standard repurchases, only 3% of each standard SRP requests was redeemed.

If you'll turn to Slide 19, please. Last week, our Board of Directors decided to suspend the standard repurchase portion of the SRP. We believe these changes are in the best interest of all our long-term stockholders and will generate free cash flow to invest in growth and delever to improve our leverage ratios and maximize the value of our common stock upon a listing event, which will provide liquidity for all of our stockholders.

The current SRP program is no longer an effective tool as it does not provide adequate liquidity to those seeking it. This change will generate approximately $40 million of cash flow that we can use to delever and reinvest in our growth initiatives. All SRP requests currently on file will be canceled. We will provide an update in the second quarter of 2020 regarding the status of the SRP. Please note that we will not accept any paperwork for standard repurchase requests until further notice.

We will continue to execute qualifying DDI redemption requests in full on a monthly basis. Shares will be repurchased at the original Phillips Edison & Company offering price of $10 per share or the most recent estimated value per share, whichever amount is lower. These changes have been approved by our Board of Directors and will be effective September 11, 2019. A letter will be mailed to each financial adviser that has clients affected by the changes this week, which will outline the changes to the plan in detail.

I would now like to turn the call back over to Jeff for an update on our executive changes and Board of Director additions and closing comments. Jeff?

[Jeffrey Edison, executive]

Thanks, Devin. Turning to Slide 19. As we previously announced, we have made 2 important changes to our executive team, and I'm very pleased to announce the addition of 2 new highly qualified members to our Board of Directors, both of which we feel are important steps as we prepare the company for the next step in our strategic plan.

As we announced on our call last time, Devin Murphy will be promoted to President. Devin's responsibilities will include expanding the investment management business and raising new institutional equity. Further, we will -- he will oversee our current joint ventures with TPG Real Estate and Northwestern Mutual. Devin's experience and career in the investment banking world, combined with his intimate knowledge of PECO, give us confidence he will be successful in growing this important business for PECO.

At the same time, John Caulfield, our current Senior Vice President of Finance, will become CFO. Since joining PECO in 2014, John has worked for Devin and has been a critical resource in managing the company's financial operations and reporting processes, as well as providing guidance for our properties and capital markets initiatives. We are highly confident this transition will be a smooth one.

Additionally, we have appointed 2 new independent Board members, Elizabeth Fischer and Jane Silfen, to our Board effective November 1, 2019. With their appointment, our Board will increase from 7 to 9, with 8 Board members serving independently. These talented women bring a breadth of experience in investing and sustainability advisory services. Both are fantastic additions to our team. PECO is committed to environmental, social and governance initiatives, and as we look to the future, we believe Liz and Jane will be key contributors to these efforts.

In summary, please turn to Slide 20. As we have stated on past calls, one of the possible ways we can achieve a full cycle liquidity event is through the listing of our shares on a national stock exchange like the New York Stock Exchange or NASDAQ. In preparation for listing, I discussed 3 important strategies at the beginning of this call that we feel will position the company for a successful listing and long-term growth, and we are committed to these strategies. We must continue to focus on operating fundamentals and growing NOI at the property level. We are actively reviewing the portfolio for disposition candidates to improve the portfolio and to delever. Lastly, we want to grow our investment management business to drive earnings and leverage -- and deleverage our operating platform.

As we have stated previously, we continue to be disappointed by the current discount to net asset value that our public shopping center REIT peers trade at in the equity markets. As of August 1, 2019, our public peers were trading at an average discount to net asset value of 19.4%, which compares to 31.8% at the beginning of the year. Although this has improved throughout the year, the discount is still meaningful. We would like to see the share prices of our public peers and the value of shopping center REITs move closer to NAV, reflecting their true value before we move forward with the liquidity event.

Patient approach to liquidity is necessary. We believe executing on our strategic initiatives will position us to achieve full cycle liquidity event at a more attractive valuation when public equity valuations for shopping center REITs improve and a meaningful discount to NAV is not required in order to achieve liquidity.

In closing, we are pleased with our results for the first 6 months of the year, but we know we have to be laser-focused on execution in order to achieve our goals and successfully provide liquidity for investors.

With that, I would now like to turn the call back over to Michael, our Director of Investor Relations. Michael?

[Michael Koehler, executive]

Thank you, Jeff. This concludes management's prepared remarks.

Please turn to Slide 21. Before we open the call up for questions, we're pleased to inform you that Phillips Edison & Company's adviser services team will begin serving as the main support resource for our financial advisers beginning Tuesday, September 3, 2019.

Financial advisers should make note of our new phone number, [phone]. Our hours will be Monday through Friday, 9 a.m. to 5 p.m. Eastern time.

Phillips Edison adviser services team will serve in conjunction with our Investor Relations efforts currently offered by our transfer agent and record keeper, DST. DST will continue to handle all account maintenance and investor-related inquiries. Their phone number is [phone] and their hours are Monday through Friday, 10 a.m. to 6 p.m. Eastern time.

We're committed to providing our financial advisers information about their clients' investments in an efficient and timely manner while maintaining a high level of customer service. By bringing these initiatives in-house, we have more control over achieving these objectives.

With that, we will begin our question-and-answer session. Our webcast listeners can submit a question via the webcast portal.

[Michael Koehler, executive]

Our first question comes from Nikolas Kane from Citizens Union Bank. His question reads as follows: There was a lot of history whereby foreign entities and pension funds seem to be interested clients of Phillips Edison. Why have there been no offers to sell the shares at NAV to a large pension fund, for example? I don't understand how there's not an interested buyer out there for this.

Devin, do you want to take that one?

[Devin Murphy, executive]

Sure, Michael. Nikolas, thank you for the question. You are correct. We have had a history where we have had investment from large global investors, and we are in constant dialogue with global investors. We have had specific conversations with certain investors to acquire shares in PECO. The issue we face is that our publicly traded peers currently trade at a 19% discount to net asset value, and investors want that discount plus an additional discount for illiquidity.

Remember that we did execute the Northwestern Mutual Life JV in November of 2018, which allowed us to raise $420 million of capital at a sub-6 cap rate. This transaction was one of the largest transactions involving retail real estate in 2018. We used the capital raised from this transaction to delever and invest in growth initiatives. We continue to pursue investors willing to invest at attractive valuations.

[Michael Koehler, executive]

Thanks, Devin. A follow-up question: It's my understanding that the management fee is around 1.5%. Why is it so high? What is the motivation to have a liquidity event if you are receiving 1.5% on a $6 billion portfolio?

Mark, do you want to take that?

[Robert Addy, executive]

Sure. Thanks, Michael, and thanks for the question. We received similar questions like this from many financial advisers because they look back at some of the legacy sponsors that are still externally managed and continue to receive fees. Phillips Edison receives no asset management fees from its wholly-owned properties, so we receive no asset management fees for those properties.

If you look back on Slide 6, there are 298 wholly-owned properties. As Devin also discussed, we do receive fee income which comes to PECO, to all of the shareholders there, from our investment management business, which we continue to try to grow, and that currently is 38 properties.

If you look kind of the history of this, in October of 2017, when REIT I was merged in, the asset management fees ended. And then similar when we brought in REIT II in November 2018, those asset management fees also ended.

So presently, we're not receiving any asset management fees for our wholly-owned properties, and we are very highly incentivized to execute for our full cycle liquidity event. We know that's something that many of you are looking for. We still feel there are many advantages to being a publicly listed company. And for a certain segment of the shareholders, we know the opportunity then to seek liquidity. Thanks for the question.

[Michael Koehler, executive]

Thanks, Mark. Next question comes from a number of our listeners, including [ Matt Wells ], [ Phil Anderson ] and [ John Rath. ] They're asking, when do you expect to have a liquidity event or publicly list Phillips Edison? Even if you don't know the exact quarter, can you give a reasonable range in terms of timing?

Jeff, do you want to take that?

[Jeffrey Edison, executive]

Yes. It's a question we get often and we ask ourselves a lot as well. In the prepared remarks, we provided a lot of detail about liquidity. We continue to be disappointed by the fact that currently the public equity markets are not attractive for shopping center REITs. And as I said in prepared remarks, the market's trading as of August 1 at a 19.4% discount to NAV.

As we said, we're focused on our business to maximize our valuation in the eyes of our institutional investors and the Wall Street research analysts, which we believe will maximize our valuation when the market is appropriate.

When we look at the past 10 years or so, shopping centers have traded at an average premium to NAV of 6.4%. That's right, a premium to NAV of 6.4%. For this reason, we believe the market will adjust. We will be well positioned to list when the time comes. But unfortunately, I don't have a time frame for that. I don't think anyone does. But I can -- all I can guarantee you is that we are preparing ourselves for it, and when the time comes, we will be ready to act.

[Michael Koehler, executive]

Thanks, Jeff. Following question has been asked by [indiscernible] including [ Bill Signs ]. Can you provide some more detail on the impairments? The number is very high this quarter. Should we be concerned? And will it affect liquidity?

Devin, do you want to take that one?

[Devin Murphy, executive]

Sure. Yes. Thank you. In terms of whether or not the impairment charges will impact liquidity, the answer is that they should not impact liquidity. GAAP accounting requires that the valuation of long-lived assets, including goodwill and properties, are appropriately accounted for. This analysis is required on a regular basis, and these charges are common for a real estate company of our size. As real estate companies evolve their portfolios and sell noncore assets, they recognize impairment charges.

The issue with GAAP as it applies to a real estate company is that GAAP allows you to only make adjustments that are negative. And as a asset increases in value, you're not allowed to write up the value of that asset. So this is an indication that we are not concerned about at this point in time.

[Michael Koehler, executive]

Thanks, Devin. Follow-up question related to the net losses. How can the company increase their estimated value per share and continue to make distributions with the net losses?

[Devin Murphy, executive]

Okay. I'll take that as well, Michael. Thank you for the question. Again, the net loss is driven primarily by noncash charges that we have discussed.

Depreciation is typically our largest expense, and it is a noncash expense. For the second quarter of 2019, our depreciation expense was approximately $60 million. This expense is only realized on the income statement and does not impact our cash flow. For this reason, we look to metrics such as MFFO, which, while not a replacement for GAAP metrics, provide more detail into the cash flow performance of the company as this metric excludes noncash and onetime expenses. This is a widely accepted metric used by investors in REITs.

For the first 6 months of 2019, PECO generated $108.5 million of MFFO, which is more indicative of the cash generation enjoyed by the company.

[Michael Koehler, executive]

Thanks, Devin. Another question here. During the first half of the year, there have been a lot of headlines about retail store closings. How well and how has this affected PECO?

Jeff, do you want to take that?

[Jeffrey Edison, executive]

Yes. Thank you again for that question because it is very frustrating to us as operators to read the press and the headlines be as negative as they are when our operating fundamentals are very strong.

As we mentioned in our presentation, our occupancy increased during the first half of this year from 93.8% to 94.6%. Our small store occupancy, which is outside of the grocer, increased to one of the highest -- I think the highest level that we've had in the history of the company at 87.9% at the end of the 6 months.

So we're hearing the news about all the dropouts, and I think what's really happening there is that there's a -- there are 2 different kind of retail markets. There's the grocery-anchored and necessity-based retail, which we do, which is thriving and doing very well in this environment; and then there are the malls and power centers, which are struggling a little bit more.

And really, if you look at the people who are announcing closures like Pier 1 and Bed Bath & Beyond and Payless Shoes and Dress Barn and Gymboree and Gap and Foot Locker and Charlotte Russe and Fred's and [indiscernible], they're just not tenants that are in our centers. So the news seems really bad, and we're sitting here with really good operating fundamentals. It's difficult to explain that to people.

The bottom line is we normally have about 1% bad debt. Year-to-date, we're at about 0.62% bad debt, which to me is the acid test on how our retailers are performing. So that's a tale of 2 cities, and we're fortunately in the right city at this time.

[Michael Koehler, executive]

Thanks, Jeff. Again, we've had a number of our listeners ask questions around the changes in the SRP and the interest in liquidity. Can you provide some comments on that, Jeff?

[Jeffrey Edison, executive]

Sure. The -- first of all, the -- I think our comments in the prepared remarks on the SRP are just our feelings -- I mean we are -- our focus is on creating long-term value for our shareholders, and we don't believe that the SRP will be -- would do that if we continue that in place. So we -- that's our reasoning behind that, and so that's the answer to the SRP.

And the other part of the question, Michael, was with regard to liquidity?

[Michael Koehler, executive]

Yes, that's correct.

[Jeffrey Edison, executive]

Yes. And I think we've answered that every way we can without giving you a date when we're going to be liquid, so we're -- we couldn't be more focused on it. The way you get liquid is you perform really well. We are doing that, and that's what -- where our focus is on. We are working on things like improving the quality of our portfolio by selling some of our lesser-performing assets. We're very focused on getting our leverage to a point that is comparable with our peers.

That's been a frustrating thing for us because when we set up the non-accretive REIT, our peers were trading at about a 40% leverage -- 40% ratio of debt to total enterprise value. Over these last 3 years, while we've been putting together the company, they've been actively deleveraging. And today, that market is closer to 30%. And that is -- becomes another hurdle for the company so that we're ready to do that, and we have a number of ways of doing that, selling assets and paying down debt, doing an IPO where we raise additional equity.

Those are the things that will be the tools we use to get liquidity. But none of them really work until you have a market where demand is strong enough that they're willing to buy our assets at net asset value. We put a bunch of markers in the ground these last 24 months of what our assets are worth when we sell them in the open market, and they coincide with our net asset value. So we're comfortable that we have the right NAV, but the market doesn't -- is not appreciating that.

[Michael Koehler, executive]

Great. Thanks, Jeff. The next question comes from [ Ritchie Hoffman ]. He asked, rent spreads were less than they were last quarter. Can you provide a little bit of commentary on that?

[Devin Murphy, executive]

Sure. Michael, I'll take that question. This is a metric where there will be volatility on a quarter-to-quarter basis, and our leasing spreads in the second quarter were positive at 10.8%. However, that 10.8% is lower than the increase we saw in Q1, which was 13.5%. However, a 10.8% rent spread is a strong number. This 10.8% compares favorably to our public peers that generated a mean leasing spread of 7.7% and a median leasing spread of 8.1%. So our 10.8% spread is a solid number on both an absolute and a relative basis. Given that double-digit rent spread, we continue to be optimistic about the current leasing environment.

[Jeffrey Edison, executive]

Hey, Devin, let me just add in there that -- I think it is a great question because it's something we're very focused on, and it's a matter of trying to figure out trends versus onetime events. We will continue to be focused on that area. The thing that gives me reassurance of that, that we're in a strong demand market, is the increase in occupancy.

You don't have many times to be at the very top of your occupancy number, and we are there today. So we still continue to have strong demand for our space, and that will continue to be a -- but it's a great question because it is one of the things we look at literally every month as we're looking at how the portfolio is progressing.

And it is very bumpy, as Devin mentioned, that it'll go up and down based upon a few leases. But our job is to figure out the trends and where that demand level is from our tenants.

[Michael Koehler, executive]

Thanks, Jeff. And this will be our last question as we're running short on time, but a follow-up question to the liquidity question. You said that you need to delever to best position the company for liquidity, decreasing your debt to TEV. How much debt do you need to pay down? And how long do you anticipate it taking?

[Jeffrey Edison, executive]

Well, as I mentioned, we have 2 ways of doing it -- we actually have 3 ways of doing it. We grow out of it by growing our net operating income and that -- increasing the equity value of the company. That's one way. The other way is to sell properties, and then the third way is to do an IPO where we raise additional equity.

Right now the target number is around $700 million of debt that we need to repay to get to 30% debt to total enterprise value from the 40% that we're at today. And there are a number of other metrics that are becoming common for people to look at. We'll -- we continue to focus on those as well. But that -- this is, I think, a good way to look at where the company needs to be competitively priced with our peers.

[Michael Koehler, executive]

Thanks, Jeff. This now concludes our question-and-answer session. I'd like to turn the call back to Jeff quickly for some closing comments.

[Jeffrey Edison, executive]

Well, I want to thank everyone for being on the call.

As I hope you know from both our prepared remarks and from our answers to your questions, we are laser-focused on the operating side of our business. We will continue to be that way. We do have an eye towards the -- to the liquidity events, and we are preparing ourselves we think the best way so that when that opportunity arises, we will be there.

We had to make difficult decisions this year about the SRP and other things, but we will continue to focus on creating long-term value for our shareholders. And one thing you can be -- know is that we are big shareholders. We are aligned with you as the investor I think as much as any and certainly as more than any of our public companies are. So you can count on us looking at that in a way that is, we believe, in a very consistent between your needs and our needs, and we will continue to do the best we can.

So thanks for being on the call. And if you have any additional questions, obviously call us, and we'll get you the answers.

So have a great day, everybody, and thanks for being on the call.

[Michael Koehler, executive]

Thanks for joining us. You may now disconnect.

[Operator]

And ladies and gentlemen, today's conference has now concluded, and we thank you all for attending today's presentation.

You may now disconnect your lines, and have a wonderful day.