Acadia Realty Trust

NYSE:AKR

Earnings Call Transcript 2022-Q3

[Operator]

Good day and thank you for standing by. Welcome to the Third Quarter 2022 Acadia Realty Trust Earnings Conference Call. [Operator Instructions] Please be advised that your conference is being recorded.

I would now like to hand the conference over to your speaker today, Max Kohl. Please go ahead.

[Max Kohl; Acquisitions Analyst, executive]

Good morning, and thank you for joining us for the Third Quarter 2022 Acadia Realty Trust Earnings Conference Call. My name is Max Kohl and I'm an analyst in our acquisitions department.

Before we begin, please be aware that statements made during the call that are not historical may be deemed forward-looking statements within the meaning of the Securities and Exchange Act of 1934 and actual results may differ materially from those indicated by such forward-looking statements. Due to a variety of risks and uncertainties, including those disclosed in the company's most recent Form 10-K and other periodic filings with the SEC, forward-looking statements speak only as of the date of this call, November 2, 2022, and the company undertakes no duty to update them. During this call, management may refer to certain non-GAAP financial measures, including funds from operations and net operating income. Please see Acadia's earnings press release posted on its website for reconciliations of these non-GAAP financial measures with the most directly comparable GAAP financial measures.

Once the call becomes open for questions, we ask that you limit your first round to 2 questions per caller to give everyone the opportunity to participate. You may ask further questions by reinserting yourself into the queue and we will answer them as time permits.

Now it is my pleasure to turn the call over to Ken Bernstein, President and Chief Executive Officer, who will begin today's management remark.

[Kenneth Bernstein, executive]

Great job, Max. Welcome everyone. As you can see in our quarterly release, we had another strong quarter led by the outperformance of our street retail portfolio, fundamentals remain strong and at the upper end of our forecast. Same-store NOI growth for the quarter came in stronger than forecasted at 5.4%. Leasing activity was robust with both an increase in physical and leased occupancy. Leasing spreads also reflected this momentum with cash leasing spreads in excess of 20%.

Looking forward in our pipeline, we see continued strong leasing momentum. This is true both in our street retail portfolio, which is earlier in its recovery and growth trajectory and that's poised for higher long term growth, but also in our suburban assets, while at a more mature stage of growth, still posting solid performance. This momentum should continue to drive strong NOI growth over the next few years, even after taking into account the potential headwinds from those tenants on our watch-list or in our forecasted tenant role.

Now questions remain, how might macro headwinds from Fed tightening impact this leasing momentum? Well, as we look forward, in our leasing pipeline we are not seeing declining demand for space by tenants. Some of this stability may be due to the quality of our locations or the affluence of our shoppers. But from where we sit, demand seems strong. In the markets we're active in such as SoHo or Gold Coast of Chicago or Melrose Place in LA, we are seeing luxury retailers double down. These luxury retailers are not only experiencing incredibly strong sales, they're also increasingly seeing demand and shopper interest for those retailers that surround them.

We're also seeing increased demand and markets experience strong demographic growth. An example of this is our recent acquisition in Dallas on Henderson Avenue where due to the growth of the residential community surrounding the Knox-Henderson corridor, we're already seeing leasing spreads of about 20%. And this is even before we have executed on the expansion and rejuvenation of our assets on that street.

In conversations with our retailers in relation to new store commitments, they are generally looking past this current period of economic uncertainty and committing to key locations, especially for unique mission-critical locations like we have in our portfolio.

Now we can get into this further during the Q&A, but there are a variety of reasons why this momentum may be continuing. A major contributor is the tailwinds from the ending of the so-called retail Armageddon. Over the past year, our retailers have made it abundantly clear that physical stores are once again the critical driver of their top line and bottom line in an omnichannel world. This is true for a broad selection of retailers from luxury to young brands. And it's true whether it's in Melrose Place in LA where Gucci recently came to the street, or Armitage Avenue where we have a waiting list for tenants to join other young brands. They are in our portfolio.

It's important to note that these shifts are causing our rents on many of our streets to not only recover to pre-COVID levels, but often exceed them. Retailer sales and tenant demand in most of our street retail corridors is stronger today than before COVID. This is partially because of pent up demand or survivor bias, meaning those retailers that made it through the last couple of years are operating from a position of strength.

But one way or another, it's being reflected in tenant sales. For example, M Street in Georgetown, still in the early phase of reopening and our retailer sales there are in excess of 20% higher compared to pre-COVID. Rush Walton in Chicago, our tenant sales are 15% higher and on Greenwich Avenue in Connecticut sales are up 30%.

Additionally, healthy tenant sales are only one part of what ultimately drives rent. Supply/demand dynamics are equally critical. And as we are seeing there is very limited remaining high-quality vacancies in most of the corridors and they are quickly being spoken for. For example, Green Street in SoHo, which faced years of headwinds due first to the retail apocalypse and COVID lockdown, today virtually all of the quality spaces spoken for. Or Bedford Avenue in Williamsburg with retailers ranging from national tenants like Apple to regional superstars like Levain Bakery and local Michelin starred restaurants, all of this is combining to create a dynamic shopping experience and strong tenant demand that is only now getting even stronger now that luxury is also beginning to show up there as well.

Keep in mind, even with the strong rebound and rents over the past year, rents in many markets are still well below prior peaks. And while the gap is closing, given the strong tenant sales performance our retailers tell us, these streets are screening as very attractive. And importantly, as it relates to our portfolio in those markets, our in-place rents compared to today's market rents position us for strong NOI growth over time. So while not overlooking the current economic uncertainties in the marketplace around the Fed tightening, if our operating fundamentals are any indication, this is not stacking up in any way like we had to navigate through in prior cycles during the global pandemic or the global financial crisis or the retail Armageddon. Leasing efforts often felt like pushing on a string, whereas now tenant demand is growing and so are rents.

We are not ignoring headlines or headwinds. And we're certainly preparing for market volatility. But we have been through many cycles before and we have also been in periods where our stock was disconnected from its real estate values. Every cycle brings different conditions. But for us, there are always a few common areas of focus.

First, we're going to continue to lease aggressively and drive internal growth and cash flow from our existing investments. Granted, it's pretty hard to fight the Fed, but it's fairly easy to lease space to tenants who want space. And successful leasing combined with embedded property level growth should mitigate concerns about increased interest rates or longer term inflation. We are slated to add $30 million to $40 million of NOI to our core portfolio over the next 3 to 5 years. This growth is in excess of 25%. And if inflation runs hotter, the growth will probably be stronger.

Second, we are making sure we can self-fund our capital needs and minimize our exposure to rising rates. As John will discuss, we have capital from retained earnings and normal course of business return of capital to fund our relatively modest capital needs.

Third, beyond simply self-funding our internal growth, when there is such a gap between private real estate values and our stock price, we need to look at ways to close that gap on a leverage neutral basis. While the large transaction market has slowed down significantly, one-off deals are still happening. And whether monetizing at the fund level or in our core portfolio, we can likely opportunistically sell some assets with limited impact to earnings growth and use the proceeds for a variety of compelling uses as they might arise.

Finally, beyond having dry powder, we will make sure we're in a position to capitalize on opportunities that might arise as a result of the disruption, whether through remaining capacity and Fund V or by other means. Over the many cycles we've navigated through, we have been able to identify compelling opportunities and dislocations when these disruptions occur and then bring the right capital structure to that deal. This has been the case for us with our Mervyn's and Albertson's investments and our distressed retailer fund or our acquisitions of Lincoln Road in Miami and Cortland Town Center shortly after the global financial crisis. The kind of disruption we are seeing today will create opportunity and we intend to capitalize on that as well.

So to conclude, while the gyrations in the capital markets can be distracting and distressing, we know what we have to do. Our internal growth is continuing to drive strong results and should continue to do so for the foreseeable future. And as it relates to future external growth, today's distractions should be tomorrow's opportunities.

With that, I'd like to thank the team for their hard work this last quarter and turn the call over to John.

[John Gottfried, executive]

Thanks, Ken and good morning. I will start off with some comments on our most recent quarter along with an update on our multiyear core internal growth and then closing with our balance sheet.

Starting with the quarter, we had another strong quarter with earnings of $0.28 coming in ahead of our expectations. And our third quarter results were clean with about a penny of FFO from prior period collections and no promote or fund transactional income. Amy will provide an update on our profitable Albertson's investment in her remarks.

In terms of same-store NOI, our core portfolio grew 5.4% for the quarter and 6.6% year-to-date. And we are on track to exceed our initial 4% to 6% full year same-store guidance. And keep in mind, we are achieving the same-store growth even with the headwinds from prior period cash collections, which would have further increased our reported metrics by another 200 basis points. And driving this strength was a combination of the sheer volume of leases signed, along with signing leases, primarily within our street portfolio at rents in excess of our expectations. And both of these are showing up in our third quarter core leasing metrics.

Starting with occupancy, sequential physical occupancy grew by 70 basis points during the quarter, resulting in rent commencements of approximately $1.2 million of pro rata ABR net of expiring leases. In term of leased occupancy, our leased occupancy increased to 94.3% at September 30, up from 94.1% as of the second quarter. And this positive momentum is being driven by our street leasing with approximately 70% of the leases executed or renewed this quarter coming from our street portfolio, resulting in a 150 basis point increase in sequential leased occupancy to 92% at September 30 with leased occupancy gains of 210 basis points in New York, 190 basis points in Washington, D.C., and 140 basis points in Chicago.

And not only are we filling space in these key markets, we are filling them profitably with cash spreads of 21% during the quarter on new and renewed leases. And it was our street portfolio that drove this growth with 30% spreads this quarter including 40% cash spreads in SoHo followed by 35% spreads across our street and urban portfolio in Chicago.

Now in terms of Chicago, we signed a renewed nearly 80,000 square feet of GLA, which represented more than 10% of our aggregate GLA in Chicago. And it occurred throughout our highly targeted sub markets with leases signed or renewed in the Gold Coast, Lincoln Park, State Street, Armitage Avenue and the South Loop. So as we reflect on our quarterly and year-to-date results, we are excited by not only exceeding our expectations on the sheer volume of leases signed, but we are executing leases particularly on our street assets at rents in excess of what we had initially budgeted.

Now turning to our core signed but not yet open pipeline. As of September 30, the spread between our leased and physical occupancy was 310 basis points. And it's worth noting that given how effective our team has been in getting stores open and rent paying, our leased versus occupied spreads declined 50 basis points during the quarter from the 360 basis points that we reported for the second quarter. However, notwithstanding this decline, given the higher productivity leasing from our streets, we actually increase both our pro rata share of ABR and our NOI to $8 million and $9.4 million respectively from the $6.7 million and $8.3 million that we reported as of the second quarter.

Our signed but not yet opened pipeline represents an excess of 5% of our in-place ABR. And in terms of timing of the anticipated rent commencement, we estimate that approximately 45% of the ABR or about $3.5 million will commence during the fourth quarter of this year with another 25% commencing in the first half of 2023 and the remaining 30% in the second half. And please note that given the timing of commencements, we won't get the full benefit in our reported results until the subsequent full annual or quarterly period.

Now moving on to credit. Our collections remain strong with quarterly cash collections at 98% which is in line with our pre-pandemic levels. As a reminder, we have one high-performing Regal location in our core portfolio. They did not make their September rent following their Chapter 11 filing, but have since resumed making payments in October. And we did not incur any onetime reserves during the quarter as a result of their filing as Regal has been on the cash basis method of accounting.

Additionally, as discussed on our second quarter call, we have 2 Bed Bath locations in our core portfolio, and neither of these locations were included in Bed Bath's initial [indiscernible]. And as a reminder, the majority of Bed Bath's ABR comes from their store at 555 9th in San Francisco with rents that are well below market. And as discussed in our second quarter call, this location has historically been a high performing store, but oversized for its existing needs. And we remain confident that if we are successful in recapturing the space, we should be able to do so very profitably.

In terms of our second location at Wilmington, Delaware, we are in the final stages of lease negotiations with another tenant for a profitable expansion. Therefore, both of these locations should result in incremental NOI upon re-tenanting with the only consideration being the transition period. However, our base case is that we pre-lease the space and thus minimize any downtime.

As highlighted in our release, we increased our 2022 guidance for FFO before special items to $1.28 to $1.30, which at the midpoint represents year-over-year FFO growth of about 17%. This is a third guidance increase in 2022. And consistent with our updated expectation of above 6% same-store NOI growth in 2022, we anticipate that the NOI generated from our core portfolio will exceed the high end of our initial guidance. The upside in this organic growth from our core business was largely offset by higher interest costs in our fund business arising from greater than initially anticipated increases in base rates during the year and in particular the third and fourth quarters with a bottom line net increase in 2022 FFO before special items to reflect our revised expectation of achieving the high end of our guidance for fund promoting transactional income.

And as we start thinking about 2023, we continue to anticipate 5% to 10% pro rata core NOI growth after excluding the nonrecurring impact from 2022 cash recoveries and before factoring in the growth from City Point. We anticipate that City Point will enter our same-store pool in 2024 and will be meaningfully accretive to our 5% to 10% of multiyear annual NOI growth. And as a reminder, our 5% to 10% multiyear growth has always and continues to reflect our rollover assumptions across our portfolio, including our core assets in North Michigan Avenue in Chicago, which given the dynamics and realities of the submarket, our 2 core assets will likely be part of a redevelopment as we explore alternative usages and formats.

In terms of progress on 2023 core NOI, we have already signed or are in the final stages of lease negotiations on approximately 75% of the core ABR necessary to achieve our goals. And to remind everyone, as this cash rent comes online in 2023 and increases our reported AFFO and cash NOI, it is counterbalanced by noncash adjustments for straight line rent and below market leases. Thus, for modeling purposes we anticipate that our pro rata share of noncash GAAP adjustments to be in the $7 million to $9 million range for 2023.

Lastly, given the ongoing and profitable monetization of fund assets, fund fee income is expected to decline slightly in 2023 to $14 million to $16 million from the approximately $18 million that we expect in the current year, which we anticipate will be more than offset by increases in our promote and transactional income in 2023.

As outlined in our release, we took a noncash GAAP impairment charge on 3 investments during the quarter. As we do each quarter, we scrutinize our entire portfolio to assess whether a write-down in value for accounting purposes is appropriate.

The factors leading to these write-downs were very nuanced and isolated to these 3 individual investments. First, and as we've discussed on prior calls, the North Michigan Avenue corridor in Chicago and the Union Square San Francisco submarkets have taken longer to recover as compared to what we are seeing across our other submarkets.

Secondly, the GAAP accounting rules governing impairment require consideration of an individual investment capital structure or more specifically as it relates to these 3 investments. When an investment declines in fair value, a capital structure that involves multiple partners financed with secured debt will often require a noncash write-down in value for accounting purposes that would not have otherwise been required had that same investment been held in a wholly-owned unencumbered capital structure.

Keep in mind that these noncash charges represent a moment in time that the complex accounting rules require us to comply with. But we remain confident with the long-term growth prospects and the ultimate recovery of these iconic corridors.

Lastly, I want to touch on a few items on our balance sheet. We have ample liquidity with no meaningful core maturities over the next several years. In terms of future funding and capital allocation, the projected cost to fund the $30 million to $40 million of projected core NOI growth over the next several years is about $100 million and we expect to self-fund these costs. Furthermore, over the next 18 months or so we anticipate generating $150 million to $200 million of proceeds from a variety of sources, including retained cash flow from the REIT, repayments from our lending book, the continued monetization of fund assets, including all or a portion of our Albertson's investment, along with the possibility for a handful of strategic core asset dispositions. And we intend to use these proceeds to repay debt along with keeping dry powder available for leverage-neutral investment opportunities.

In terms of interest rate exposure, 93% of our core debt is fixed or hedged with long-dated interest rate contracts. At September 30, we have approximately $850 million at our pro rata share of core interest rate swap contracts that expire at various points over the next several years with a weighted average duration of about 5.5 years and fixes our current all-in borrowing costs at about 4%.

In terms of our fund business, given its buy-fix-sell nature, this requires that we maintain financial flexibility. Thus, we appropriately operate this portion of our business with a higher percentage of shorter duration variable rate debt. So on a look-through basis, inclusive of our fund business, our current exposure to variable rate debt is approximately 18%, which has declined by about 1/3 during the quarter due in part to the profitable monetization and repayments of variable rate debt of several fund investments that Amy will discuss.

In summary, while I've thrown out a lot of data, the key takeaway from this update is the continued strength we are seeing in our business along with the opportunity for extraordinary NOI growth over the next 3 to 5 years. So while not being naive to the mixed economic signals and likely headwinds in front of us, our multiyear outlook feels really good given what we are seeing in our results along with the continued extraordinary demand for space and our highly differentiated and targeted portfolio.

I will now turn the call over to Amy to discuss our fund business.

[Amy L. Racanello, executive]

Thanks, John. Today, I'll share updates on the key moving pieces within our profitable fund platform.

Beginning with Fund V. First, we were pleased to receive unanimous support from our investors to extend Fund V's investment period by 1 year to August 2023. We still have about $300 million of buying power. And if the pace of compelling transaction opportunities accelerates because of current market turmoil, then we will look to expand this buying power through co-investment structures.

In the meantime, here's what we're seeing on the ground. Over the past few months, the gap between buyers and sellers has widened due to the uncertain impact of rising base rates and widening spreads on returns and pricing. So far this year, we've been able to shake loose a couple of interesting opportunities where debt maturities were a catalyst or value-add activities are a more meaningful driver of total return, putting our decades of real estate expertise to good use. To that point, in August, we completed the acquisition of the shops at South Hills and Poughkeepsie, New York in partnership with DLC.

This shopping center totals about 0.5 million square feet and was 74% occupied at acquisition. The property was acquired at a 7.5% cap rate. So even in a rising interest rate environment, we're still achieving positive leverage going in before we execute on our value-add activities. These include converting a vacant retail big box representing about 15% of the center's current square footage to self-storage use and monetizing excess land where we think best and highest use is residential.

We're pleased to report that we're making strong progress. With respect to Fund V overall, we're currently at a 13% leverage deal done invested equity and project that the portfolio remains at about 12% over the next several quarters due to increases in NOI. Of our overall approximately $625 million of property level debt, our weighted average term to extended maturity is about 2.5 years.

Next, consistent with our buy-fix-sell mandate over the past few months, we completed $85 million of shopping center sales in Fund IV. Both properties were stable and ripe for disposition. On a blended basis, these sales returned a 16% internal rate of return and a 1.94 multiple on $34 million of invested equity. And overall, we were a net seller so far this year at attractive returns.

Now on to City Point. We're very excited to share our recent progress. As previously discussed, we completed our recapitalization this summer and opportunistically increased Acadia's ownership from 28% at the start of the year to 62% today. This is consistent with our long-stated goal to convert this finite life fund investment to a longer-term hold due to the densifying submarket, solid national and credit tenancy in Target and Trader Joe's, among others and strong embedded growth, not only in the near term as we complete the project's lease-up, but also over the next decade.

To that end, during the third quarter, as previously reported, we executed 2 fourth floor leases totaling 37,000 square feet with Alamo Drafthouse, who will be adding 5 more theaters to their successful City Point location and the indoor tennis club, Court 16, which provides best-in-class instruction-based programming for active New York City families with an emphasis on community. This will be Court 16's fourth New York City location, and we believe their offerings strongly complement the other tenancy within the City Point ecosystem.

Inclusive of these 2 experiential leases, our upper level space is now approximately 60% occupied and nearly 90% leased. The gap between leased and occupied rates on the upper levels will begin to close later this year when Primark is expected to open for business.

In other tenant news, last month, Brooklyn-based brewery Sixpoint opened its first New York City taproom adjacent to decal market on the concourse level. On this level, the pieces are mostly in place, but a lot of embedded NOI growth remains as rents continue to ramp up. And now that the upper and lower levels of our project are, for the most part, substantially complete, our focus is primarily on the retail spaces on City Point street and mezzanine levels. In fact, here, we currently have 2 leases out for execution. Both spaces will overlook the new 1-acre park that's currently under construction on Gold Street. We're pleased that these tenants were able to look past the current construction disruption and envision what a great amenity the screen space will be for our project and for Downtown Brooklyn.

With respect to City Point overall, we remain on track to achieve the 6% unlevered yield to cost that we discussed on our last call upon initial stabilization with significant projected growth beyond that as this market continues to mature. And as John mentioned, we expect City Point will be added to our core same-store pool in 2024.

In other Fund II news, as I'm sure you're aware, Albertson's announced a planned merger with Kroger for an estimated total consideration of $34.10 per share. There are some moving pieces here that are outside our control, but the shares are likely locked up through May of 2023, unless certain conditions are met. Remember, Fund II currently holds about 4 million shares, of which Acadia's pro rata ownership is about $1.5 million. And at $34 per share, we will have achieved an 11x multiple on the fund's initial equity investment of about $24 million.

So in conclusion, our fund platform remains well positioned. Fund V, despite market volatility continues to post strong returns and has dry powder available for growth. City Point is poised for an extended period of strong growth and capital recycling activities. Both profitable dispositions and new investment opportunities should keep this profitable platform on track.

Now we will open the call to your questions.

[Operator]

[Operator Instructions] One moment for our first question. It comes from the line of Todd Thomas with KeyBanc.

[Todd Thomas, analyst]

Ken, first question. I just wanted to ask about the $30 million to $40 million of core NOI that you expect to come online over the next 3 to 5 years. You've outlined future growth previously. I realize it's a little bit of a moving target at times. And I think, John, you outlined that there's a little less than $10 million of NOI currently in the signed-on occupied pipeline today. Can you just provide a little bit of additional color, I guess, around the breakout of that $30 million to $40 million between lease-up of vacant space in the portfolio, sort of mark-to-market and ongoing leasing activity and escalators? Just to give us a sense for what you're sort of expecting around that growth.

[Kenneth Bernstein, executive]

Sure. So let me put some of the parameters and updates on that, and then John, fill in the blanks. But first of all, to be clear, even though the world is evolving, the targets that we forecasted remain absolutely on track, if not stronger. And that $30 million to $40 million is before you add in any additional NOI from our more recent acquisitions investments ranging from City Point to Henderson, et cetera.

So the lease-up is going exactly as we had planned, and John will fill in how much of that $30 million to $40 million is from net lease up. But on top of lease-up, Todd, what we have seen is market rents growing faster than we had originally forecasted. It will take a couple of years for us to get those mark-to-markets, but that piece feels good. And then keep in mind, because of our street retail, where we have generally 3% contractual growth, there is also just simply the contractual growth.

So John, why don't you fill in the different pieces that get us to that 30% to 40% over the next 3 to 5 years?

[John Gottfried, executive]

Yes, absolutely. And Todd, a couple of things to keep in mind. So one, in terms of lease-up, you mentioned that we have just under $10 million in the signed but not open that's already leased. And I think further driving that is going to be what we're going to see on our street portfolio. So we are about 92% leased. Today, 87.5% occupied. So it's going to be the continued leasing of our streets. And over this period, we think our street portfolio grows about 15%, inclusive of everything, [ entire ] streets, North Michigan grows 15%.

So I think the leasing, I would say, is about probably half of that, roughly half of the $30 million to $40 million. And another probably $10 million to $15 million of that is going to be the contractual growth. And as a reminder, we get within our streets 3% contractual growth. So strong contractual growth, so call that another $10 million to $12 million. And the balance of that is going to be on mark-to-market. And I think that's the differential between the $30 million to $40 million is do we continue to see the rent growth that we clearly saw this quarter, and we'll see what's in front of us. But I think that's how we get to the upper end of that is through the continued mark-to-market of our street.

[Todd Thomas, analyst]

That's helpful. And then, Ken, just to clarify. So you mentioned that that does not include recent acquisitions and that does not include any incremental growth from City Point, which should transition into the core in '24. Is that right?

[John Gottfried, executive]

Yes, Todd, I'll clarify that. So it does not include City Point and it does not include any potential future acquisitions, right? So it's what we own today.

[Kenneth Bernstein, executive]

And so as best we can, Todd, we are trying to make sure that we are comparing things on an apples-to-apples basis. And so far, things look very positive on that side. Obviously, in the next year or 2, we will be including -- John mentioned that City Point comes online. It's expected to in '24. But we will try to measure that $30 million to $40 million over time, so we can see what we're seeing and what our tenants are telling them, which is business is good, and they want to be back in SoHo, they desperately want to be on Melrose Place or Armitage, et cetera. And it's showing up in rents, it will show up in NOI.

[Todd Thomas, analyst]

And then, Ken, so you talked about the luxury retailers doubling down and how retailers are looking past the current cycle potentially and what you're seeing in sort of the street retail and some of the retail corridors. There was a little hesitancy by retailers to lock in long-term leases during the pandemic. I think both tenants and landlords were looking for a little bit more flexibility, so not to lock in terms during some of those volatile periods. How are those conversations today around how retailers are thinking about these higher profile, more expensive stores, their commitment to sign long-term leases and invest in the build-out of those stores, how are those conversations evolving?

[Kenneth Bernstein, executive]

Well, so there's a few things playing out. One is the notion and thought that once we get through this current storm, that we may have a higher level of inflation certainly than we've seen over the last 10-20 years. What that generally means is that rents grow faster. And so retailers are more inclined to lock in long term, some mission-critical locations than they were in a period where everything felt deflationary and what the heck, if you wait a few years, everything will be less. That sentiment has shifted. So for those locations, that retailers believe in long term.

And remember, some retailers are buying their locations. So that's about as long-term a commitment as you can measure. And a lot of the corridors we're involved with, that's the case. But where retailers are committing long term to a location, the issue then is much less about the ability to leave in 2 years. Additionally, what we're seeing, especially at the luxury side, but this is true across the board, shoppers are coming back into the stores for a variety of reasons we talked about.

They don't want a pop-up experience. They want a store that speaks to who the retailer is in multiple ways. And so the notion that you can do something inexpensively [Technical Difficulty] and short term, there'll be some of that. But for the type of retailers that show up on Green Street and SoHo, show up in Melrose Place, show up on Armitage Avenue in Chicago or the Gold Coast of Chicago, they're investing heavily into the stores with their money. They want to know they have the lease term for that as well.

[Operator]

And one moment for our next question, please. And it comes from the line of Ki Bin Kim with Truist.

[Ki Bin Kim, analyst]

I guess we can start off with just kind of bigger picture thoughts on longer term how you want to finance some of the fund investments. Obviously, you guys have been using a lot more variable rate debt. Any changes to that going forward?

[Kenneth Bernstein, executive]

Well, in a few different ways, and it's a critical conversation that Amy, John and I have on a constant basis. So first of all, the fund business is, in general, a buy-fix-sell business. And while occasionally one can benefit by putting long-term debt on a long term -- on a short-term asset, more often than not, and we've been at this for a while, that doesn't work. So if we are buying assets with a view that we are going to dispose off, monetize in the next few years, we're somewhat limited on our hedging within that, and that's fine because we better be buying them, right? And Amy walked through for Fund V over the last several years, we've been buying out of favor retail financing it, commensurate with our expected hold, and so far, so good, very good.

But we're at a unique point in time in terms of the debt markets, and we need to think through -- and for reasons I'll get into later -- what's the best way to buy, what's the best way to finance. The debt markets are backed up right now. That's causing the acquisition markets to be backed up right now. And thus, the way we finance our next deal probably will look different than the way we financed a few years ago, but that's very dependent on, in fact, what the kind of opportunities are.

That's a long way of saying we can afford to be flexible in the fund business in terms of floating rate financing. It may cause some headwinds to John's earnings on any one quarter. But as long as we invest profitably, flexibly, successfully, it ultimately comes out in transaction, promotes fees otherwise.

[Ki Bin Kim, analyst]

Okay. And sorry if I missed this, but in your 717 North Michigan Avenue project, it looks like the development project went to TBD. You guys have already spent $116 million on it. I'm just curious from an economic standpoint, so not the write-offs, but from an economic standpoint, how much of that $116 million is still usable for whatever life that project takes and how that all shakes out?

[Kenneth Bernstein, executive]

We are in the middle of a potential transaction. So I'm not going to get into the details right now, but hopefully, over the next quarter, that will become clearer on what our vision and planned execution for that is.

[Operator]

And one moment for our next question. It comes from the line of [ Seth Berger ] with Citi.

[Unknown Analyst]

It's actually [ Craig Newman ] here with Seth. Just kind of curious on the commentary around Bed Bath & Beyond in San Francisco. Just curious how receptive the company has been or the tenant has been to any approaches there to try to get the space back early.

[Kenneth Bernstein, executive]

So I would call the situation fluid defined as for the last 5 years. We have tried with different administrations, different paths to rightsize that store because it -- and hopefully, some of you get a chance to visit it. It's on 2 levels with parking on both levels. It is oversized, but very productive for Bed Bath, and we have tried to convince them to operate out of one level. And historically, they have said interesting idea, but we kind of like the status quo. Their rent is low, and they're the tenants, so they get to make that decision.

Fast forward to the last 6 to 12 months, they've seen more open-minded receptive and we are in the middle of negotiations. So stay tuned. We tend not to like to conduct our negotiations over quarterly conference calls. But I have every reason to think that on the conversations we're having, they're being very rational. There's strong demand there. Even though, again, it's San Francisco, we're signing leases. So I am more confident today. However, I've been confident at different points in the past, then been unable to get the space back.

Again, the marketplaces worry is what if we get the space back. My concern is what if we don't. I've been through this before, you all watched us go through this with Kmart in Westchester. It took us forever to get that back. Thankfully, we did. BJ's just opened last week and they're crushing it. So sometimes it takes a little patience, but this is valuable space and a valuable property. I believe we will get to a profitable and rational conclusion for us and Bed Bath.

[Unknown Analyst]

And then I think -- and I don't want to presume, but clearly, the stock is off a bit here today. I don't know how much the impairments have to do with that. And not necessarily those specific assets, but just kind of concerns about asset values here in the absence of transactions. And if you kind of try to square that with your commentary on rent growth, it seems to be a little bit of a disconnect between where your stock is trading from applied cap rate basis versus where maybe these assets would transact in a more normal time.

I know, again, this is more of an academic exercise at this point. But just from your standpoint, from either an underwriting or any kind of angle you could give us a sense of the kind of movements in cap rates with the underlying rent growth you're seeing and how that compares maybe to where the stock is being valued in the public market?

[Kenneth Bernstein, executive]

Yes. And you're spot on in terms of some of this disconnect. And it is hard, unless you're walking the various different streets and hopefully, many of you have that opportunity to do that to understand the disconnects between certain streets and others. The most glaring contrast is one block away from North Michigan Avenue we own on Rush & Walton, but Rush & Walton is doing better today than pre-COVID, not only in terms of rents and sales, but also in terms of the quality of tenants.

You have luxury doubling down there. For instance, we expanded Saint Laurent a couple of years ago. [ Deor ] just expanded and the list goes on. So it's not like, oh, this is a Chicago problem. This is a North Michigan Avenue micro climate issue, but it's a real issue. And because we have to moment-in-time account for it, that's what we've got to do.

North Michigan Avenue is suffering headwinds that other parts of Chicago are already rebounding from. Why? Well, unique to that major corridor, it is saddled with 3 enclosed malls. Right across the street from us is Water Tower, which was once upon a time an iconic asset and it needs to be reinvented. I am highly confident it will. But that may take some time. And for a moment in time accounting, we need to recognize that shift.

So in the longer run, I am confident that you will see a rebound on North Michigan Avenue. But I don't want to hitch our trailer to count on just a recovery in North Michigan Avenue. What we have said is we've got enough growth, whether it's down the block or across the country to net out the net negatives of North Michigan Avenue for us. So let's move past that. We've got some interesting ideas in terms of how this gets redeveloped, perhaps gets redeveloped by others. But if you walked Rush-Oak Walton and then headed over to North Mish, you'd understand the distinction. If you want to predict that North Mish rebounds quickly, great. If you think it's going to take time, so do we, one way or another, the balance of our portfolio more than counterbalances that.

And that's where the disconnect is, is right now the marketplace has got to figure out where do they see rebound long term and what feels like a melting ice cube. Thankfully, we see this growth on a net basis and that's what we're focused on.

[Unknown Analyst]

Okay. I guess...

[Operator]

Do you have a follow-up?

[Unknown Analyst]

Yes. sorry. My phone just cut out there for a second. I guess I was trying to get more broad thoughts about just investment returns kind of where the market could go versus your implied 773, particularly as you guys are talking about this could spur some opportunities here. So how you're thinking about kind of the values that you think the portfolio is worth, yet you want to be opportunistic on the acquisition side. And so you're going to have to adjust your underwriting for that.

I guess I'm just trying to kind of get a holistic view on in that environment, everyone wants to be opportunistic, but no one wants their assets to be revalued in the interim.

[Kenneth Bernstein, executive]

Yes. So I was talking rents, you were talking values and cap rates. I get it. Here's what I'd say. Right now the dislocation on value, the spread between buyers and sellers and bid and ask is fundamentally debt-driven and it's a double whammy issue. Double whammy meaning that not only are base rates going up, but spreads are gapping out. In order for opportunistic dollars to come in, we need to see some normalization of that. And that could take weeks, it could take months. But my guess is spreads normalize.

You tell me where base rates are and then a normalization of spreads will give opportunistic buyers and opportunities show up. Where and what cap rates do they show up to? A lot of that will depend on one's view of growth and inflation and thus exit caps. And that's what everyone's scratching their head around now.

Right now you've seen a pivot towards everyone still want positive cash flow. And so actually higher cap rate assets are holding up better than the more valuable assets. Over any extended cycle, we've seen it go the other way. Meaning location matters, value matters, and lower cap rates return. What does that mean for North Michigan Avenue? Well, my guess is it remains iconic over an extended period of time and cap rates remain lower there than they do just somewhere in America.

Where do rent settle? That's what we were talking about before. And that could take a year or 2 in terms of value. I wish I could tell you it should be a 5 cap versus a 4 cap versus a 7 cap. It's just not that simple because a lot of what we're talking about is what do these redevelopments look like. And that's where the marketplace is trying to figure all this out.

So that's a long way of saying, I would expect high-quality leased assets in places like SoHo or Melrose Place or Rush & Walton, with strong embedded growth to hold on to much of the cap break valuations that they previously had. And I would expect that heavy lifting redevelopments requiring debt, requiring a lot of uncertainty, probably gap out. It's going to take a while for that to sort through, but that's my best guess.

[Operator]

One moment for our next question, please. It comes from the line of Linda Tsai with Jefferies.

[Linda Yu Tsai, analyst]

Ken, can you discuss luxury retailer store opening plans and maybe how that plays out in your street retail portfolio?

[Kenneth Bernstein, executive]

Sure. And I don't want to make it seem like we are dependent on that one anchor, but luxury retail in SoHo in Rush & Walton, Oak Corridor, in Melrose Place, in the Knox-Henderson corridor longer term, it's pretty clear. I don't have specific names. And if I did, I'm not allowed to say them, and I don't have specific numbers. But you can glance and see it's about twice the square footage that existed there pre-COVID. Why? Because those brands are gravitating towards direct-to-consumer, which a few years ago, we confused to think that meant online. And now what we realize is that direct-to-consumer for a lot of our luxury is their own store.

It doesn't mean that department stores go away, doesn't mean that online disappears, but it's really about the store that they can connect. So what you should expect is about half of our markets are going to have luxury. Williamsburg, Brooklyn is getting luxury. The other half, equally exciting are some of the newer, younger names. Aritzia is crushing it on M Street in Georgetown. M Street in Georgetown is not going to be luxury, but it's got so much more energy today than it did pre-COVID.

So look for luxury to be a piece of this. I don't have specific data, but then expect other exciting shopping experiences. And so far, we're seeing it show up in tenant sales, those [ Carter's ] that have activated are working.

[Linda Yu Tsai, analyst]

And then maybe just as a follow-up. There's a discussion on another earnings call about how a lot of retailers experienced a pandemic-related lift to margins. And now we're seeing greater normalization given cost pressures. Do you think the same dynamic is playing out in luxury retail or are they better protected?

[Kenneth Bernstein, executive]

Well, they're better protected in the sense that their cost of goods relative to what they're selling for, they are -- they have a better margin. But this is going to be an issue that will play through for a variety of our retailers. And what our retailers are telling us when I speak to them is those pressures that feel more short term, more supply chain inventory management oriented, and they're confident they can work through those.

Some that feel like they're longer lasting, wage growth, they're going to have to price in. At the luxury level, you see high levels of pricing elasticity. The consumer is willing to show up. We're seeing that elsewhere as well.

So what our retailers are concluding is, there will be some margin pressure depending on who their shopper is in the short run. But over any extended period of time, it probably will come back to the age-old discussion negotiation, which is top line sales. And most of our retailers are forecasting solid top line sales growth. Perhaps the COVID lift become a flattening, but compared to pre-COVID, we're seeing very encouraging numbers.

It will be about top line once bottom line normalize, and they think they will. They won't normalize for all retailers, all segments. The lower end shopper is perhaps going to feel more headwinds, and thus, their retailer might. But it's going to come back to top line sales growth and supply and demand. And because of the shift from the end of the retail armageddon, the supply and demand metrics on most of the corridors that we're involved with have shifted significantly over the last 12 months, and our retailers are stepping up thinking past any of these short-term margin issues and thinking about what the next 5 or 10 years will look like.

[Operator]

One moment for our next question, please. It comes from the line from Jeff Spector with Bank of America.

[Jeffrey Spector, analyst]

Ken, my first question just ties to the opening remarks. Just I guess the skeptical view on retailers and their historically, I guess, let's say, the lack of discipline in terms of store openings. I know you have a lot of experience. And clearly, you laid out a lot of the reasons why they're still pursuing store openings. Are you saying at this point that you would normally see retailers start to pull back on future concerns? Or is it still too early to say that?

It sounds like you have a lot of confidence in the demand will be resilient over the coming months.

[Kenneth Bernstein, executive]

So the short answer, Jeff, is I would have thought we would have started to see a slowdown if our retailers were hyperventilating over the current economic conditions. So far, they are not. Now that does not -- retailers, by their nature, need to be somewhat optimistic, and the industry is very Darwinian. The difference this time, my sense is talking to our retailers compared to other cycles, call it, before the global financial crisis, there used to be a lot more pressure from Wall Street on our retailers to open stores to meet plan. Period, full stop. And that caused open to buys at time periods where it felt a little more like a head scratcher. So retailers were opening stores in anticipation of population showing up somewhere in America. The housing crisis occurred and they got caught in a bad spot.

We are seeing retailers now again, they're optimists, but they're opening in places where shopping demand exists today. And when you're talking about some of the markets we're involved with like New York City, starting today before international tourism has kicked in, before full return to office, before a whole bunch of other factors. So they're looking at their sales. They're looking at sales 2019, not 2021, and they're saying, how do I forecast over the next several years, and things are screening attractive.

So a hard recession will absolutely have an impact, but it does not feel like this is a bunch of overly optimistic, undisciplined tenants. This feels like software retailers recognizing the shift away from online, the importance of these iconic locations and the attractive rents that they're coming in at.

[Jeffrey Spector, analyst]

Appreciate the comments. And then my second question on opportunities. I guess when you look back through the last, I don't know, call it, a couple of years through the pandemic, as you said, things have really changed for brick-and-mortar. Are there new opportunity sets for Acadia that when you think about the 5-year plan, let's say, a particular product type, I mean is there any change in what you would desire to own versus the current portfolio or regions?

[Kenneth Bernstein, executive]

Yes. So without having our annual strategy session on this quarterly call, I would tell you there are shifts that we are either open minded to or executing on. Think about our recent addition down in Dallas. That would fall into regions or demographic shift. And it's not an either/or or win/lose. SoHo can do great, Williamsburg can do great and so can the Knox-Henderson corridor, and that's how our retailers view it. They're not saying, oh, maybe I should not open in SoHo and instead open in Austin. They're saying we now have other markets that we can serve that extends our brand. And we want to do that with responsible landlords who are capable.

We have a proven track record of that. So there are a host of new regions. If our retailers want to show up, can do the business and pay the rent, then you should expect us to consider that. That's one small piece when we think about things from a region perspective. Then there are pricing dislocations. We touched on our [ Mervin's ] and Albertson's involvement. Times like this will create dislocations and we will spend a certain portion of our time thinking about where those opportunities show up.

But to be crystal clear, that will not be at the cost of us laser-focused on our leasing, laser-focused on getting that $30 million to $40 million plus City Point plus or everything else in online. So we can do both at the same time and it's going to be an interesting 5 years, as you say, in terms of where this shakes out. Bottom line though is retailer strength will get us, I think, through the next 5 years in ways that the retail Armageddon was just headwinds.

[Operator]

[Operator Instructions] Our next question comes from the line of Mike Mueller with JPMorgan.

[Hong Zhang, analyst]

It's Hong on for Mike. I think in the past, you've talked about expecting a certain level of tenant rollover next year. I was wondering if you could give us an update around that. I think you specifically mentioned the H&M lease on Michigan not renewing middle of next year, for example?

[Kenneth Bernstein, executive]

Yes. So Hong, I think as we said, we're on track for the 5% to 10% growth next year, inclusive of with the largest being what you referred to in North Michigan. So on track with that, nothing meaningful beyond those which has and continues to be baked into our expectations for '23.

[Hong Zhang, analyst]

Got it. And could you remind us what your traditional credit reserve is? And where do you think it could trend for next year given where you sit today?

[Kenneth Bernstein, executive]

Yes. I think traditional defined over the last 3 years would be tough, but I think pre-pandemic normal times, we were 50 to 100 basis points. And as I sit here today, our watch-list is pretty nominal. We've talked about the couple of credit issues between Regal and Bed Bath. But we're -- and we think we have those well-controlled. We have a pretty slim watch-list. So I would say, just in light of just the uncertainty in front of us that we may revert back to -- and we've had virtually no credit loss besides cash basis noise throughout the year for the past -- throughout these results.

But I think next year, I would preliminary target maybe a return to normalization in the 50 to 100 basis points, I think, is right. But I'll know more as we get into -- we issue guidance, but not seeing the distress in our quarterly results and our monthly cash collections we don't have a big small shop local tenant exposure, which is where I think there could be fallout.