Whitestone REIT

NYSE:WSR

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Ladies and gentlemen, good morning, and welcome to the Whitestone REIT Second Quarter 2024 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, David Mordy, Director of Investor Relations.

[David Mordy, executive]

Good morning, and thank you for joining Whitestone REIT's second quarter 2024 earnings conference call. Joining me on today's call are Dave Holeman, Chief Executive Officer; Christine Mastandrea, Chief Operating Officer; and Scott Hogan, Chief Financial Officer.

Please note that some statements made during this call are not historical and may be deemed forward-looking statements. Actual results may differ materially from those forward-looking statements due to a number of risks, uncertainties and other factors. Please refer to the company's earnings news release and filings with the SEC, including Whitestone's most recent Form 10-Q and 10-K for a detailed discussion of these factors.

Acknowledging the fact that this call may be webcast for a period of time, it is also important to note that this call includes time-sensitive information that may be accurate only as of today's date, August 1, 2024. The company undertakes no obligation to update this information. Whitestone's second quarter earnings news release and supplemental operating and financial data package have been filed with the SEC and are available on our website in the Investor Relations section. We published second quarter 2024 slides on our website yesterday afternoon, which highlight topics to be discussed today.

I will now turn the call over to Dave Holeman, our Chief Executive Officer.

[David Holeman, executive]

Thank you, David. Good morning, and thank you for joining Whitestone's second quarter 2024 earnings conference call. We had another very strong quarter, extending out to 9 quarters we have now had 17% plus leasing spreads. Beyond the very strong supply and demand fundamentals underpinning our business, our strategy and our focus on operations are driving strong same-store net operating income growth, which is the key to our long-term earnings growth.

We reiterated our 2024 core FFO guidance of $0.98 to $1.04 this morning and delivered $0.24 core FFO per share for the quarter. We remain on track with our internal forecast for the year. In the second quarter, we signed new and renewal leases at a blended 17.5% increase over the prior leases on a straight-line basis and a 7.7% increase on a cash basis. We grew our top-line revenue over 3.3%, producing 6.6% growth in same-store NOI and achieving core FFO per share of $0.24 and we continued to strengthen our balance sheet with debt-to-EBITDAre at 8x. Excluding the proxy contest fees in the quarter, our debt-to-EBITDAre ratio was 7.5x, an improvement of 0.8x from a year ago. Our occupancy was 93.5% at the end of the quarter, up 20 basis points from a year ago. And our net effective annual base rent per square foot was $24, up 5.4% from 2023.

We recently took a harder look at some of our key differentiators in terms of our ability to drive growth and I wanted to share some of those with you this morning. These key differentiators are captured on Slide 3. Strategically, these key differentiators allow us to focus our acquisition efforts where we can drive results quickly once we take possession of a property. We assess demand growth drivers in the neighborhood anchoring the property and determine if our team will be able to improve the alignment of tenants with the surrounding demand. Our leasing team's strength is placing high growth tenants in centers with 1,500 to 3,000 square foot spaces.

We have long believed that neighborhood and community centers correctly configured with the right mix of 1,500 to 3,000 square foot spaces will outperform larger box centers. This belief is being proven by both national data and by Whitestone's numbers, as you can see on our Slide #4. According to our recent Marcus & Millichap report, neighborhood and community centers grew year-over-year asking rents at 4.6% versus 0.1% for power centers. It is no surprise that our higher mix of neighborhood and community centers have allowed us to outperform the peer group's same-store net operating income growth, averaging 65 basis points over the last years of outperformance versus the group.

Turning to Slide 5. You'll see this outperformance is even more impressive given the amount of capital we're required to drive these results. Because we acquire correctly configured centers, our redevelopment capital is generally not spent on reconfiguring a center, but rather on areas that drive income. Another key differentiator in terms of driving results is our tenant base. We have over 1,400 tenants that are selected by a leasing team trained to find tenants capable of growing, driving traffic and allowing us to push our same-store net operating income higher.

Once again, you need a long-term operational mindset plus a really strong leasing team in order to build-up that tenant base as a key differentiator. It is because of these differentiators that we believe we should trade at a more attractive cap rate than most of our peers in the retail sector. We are pleased with the progress we have made in terms of market valuation and we believe there is more runway ahead for us as we continue to drive results via these key differentiators. The differentiators became more and more apparent as we consistently drive results and our success is built on a solid strategy and the ability of our leasing, property management and acquisition teams to execute.

On the governance front, we continue to make improvements as we recently announced our intent to strengthen and refresh our Board of Trustees by adding 2 new experienced and independent board members who will replace David Taylor and Nandita Berry upon appointment to our Board. We will share more with investors as we move through this process. And I'm very thankful to David and Nandita for their efforts in leading the company's leadership changes in early 2022, for their ongoing commitment to do the right thing for shareholders and for their strong support of our Board refreshment initiative. They've served investors well for the last 7 years and we are a much better company as a result of their efforts.

I'd also like to thank Amy Feng for stepping up as our new Independent Chair and for Julia Buthman, assuming the Chair of our Nominating and Governance Committee and leading our Board member search efforts. Both Amy and Julia have a strong commitment to grow shareholder value and bring a wealth of valuable experience to our team. We look forward to attending the Bank of America Conference in September. And for those of you attending the conference, we hope you'll find time to meet with Whitestone there.

And with that, I'll turn the call over to Christine.

[Christine C. Mastandrea, executive]

Good morning, everyone. As Dave mentioned, we remain confident in terms of achieving our 2024 objectives and are on track with our internal monthly and quarterly goals. Occupancy remains high at 93.5%, up 20 basis points from a year ago. Anchor occupancy was 97% and smaller space occupancy was 91.4%. We achieved renewal leasing spreads of 13.9% and new leasing spreads of 33.3% for a combined overall positive leasing spread of 17.5% in the quarter.

Our drive to re-merchandise continues unabated and it's one of the primary reasons behind our delivering 6.6% same-store NOI this quarter. Rather than viewing our record occupancy percentage as simply an indication of the general strength of the business, we view it as an imperative to continue re-merchandising. We are continually advancing our quality of revenue initiative, replacing tenants that are tracking increased demand from the newer younger demographic and properly serving the neighborhood.

The leasing team is continually challenged to understand existing and prospective tenants business plans with a focus on understanding how business makes money and how they plan to capture demand growth in the surrounding neighborhood. This re-merchandising effort extends well beyond larger re-merchandising that we've talked about in the past, such as EoS replacing the [ aging ] grocery store in the neighborhood or the Picklr replacing the Bed Bath & Beyond. The younger demographic is spending far more on their pets and we've matched that offering with City Vet at Quinlan Crossing in Austin, Central Bark at Paradise Plaza and Canine Creek, both in Arizona. As part of our local franchises, Canine Creek was named the Small Business of the Year by the local Chamber of Commerce, opening their second location at the Promenade at Fulton. We celebrate our local entrepreneurs and welcome the opportunity to participate in their success.

We're also seeing the younger generation spend significantly more on healthcare and well-being, massage, yoga, beauty products, pilates and more. One of the reasons these businesses are often well tied in the local demand is that they have a millennial or GenZ operators operating their third, fourth or fifth franchise and bringing in more sophisticated marketing techniques and the ability to meet demand with lower capital outlays. We've recently brought in The NOW Massage at Lakeside Market in Dallas, a perfect example of this. They've done a fantastic job creating a natural Zen environment for their customers. But importantly, they've reduced their cost, and in order to do so, divide the space differently than it used to be done in the past by using curtains rather than walls. They are often more of an example of newer operators with strong long-term business plans that know how to develop and use their capital appropriately to make money.

Week-in and week-out, we are constantly having our leasing team sharing their successes with one another. This is leveraging each other's talents and experiences not confined to how the team finds new prospects. They share their experience and technology and tools they utilize to assess neighborhood demand and how they evaluate businesses and lessons learned from other centers that are evolving. Over the last few years, we've seen a number of competitors brand themselves with the grocery-anchored or Sunbelt sticker.

We believe it's critical for investors to understand that the growth model we've built requires far more than shifting an acquisition strategy to draw investors' attention. The centers we've acquired are well positioned to capture neighborhood demands and they're configured correctly to attract high growth service-oriented businesses. However, leasing team expertise is the reason we're able to properly curate centers and it's critical to understand how interdependent our differentiators are and how that allows us to deliver consistent results.

I'll also expand on our ability to outperform with less capital. The biggest part of the capital difference is the redevelopment capital. Redevelopment capital is often a critical component of driving results. However, the key is to be tuned into the neighborhood demand, allowing that demand to drive the actions you take. We project demand when we acquired the properties and we continually maintain a pulse on that demand in order to ensure the center is keeping up with it. This is a vital for leasing agents to determine the right tenant and for a win to apply redevelopment capital.

We also factor in the timing of lease expirations, both in our acquisition analysis and in our application of redevelopment capital. Investors may have seen recent news on Kroger's proposed acquisition of Albertsons stores that may be divested to CNS. We have 3 Safeway stores on the list; Market Street, Pinnacle of Scottsdale and Anthem Marketplace in our Phoenix market, plus another 2 shadow-anchored centers, Arcadia Towne Center and Fountain Square also in our Phoenix market. These are well-performing stores with an average grocery sales of approximately $500 per square foot and a 3-mile household income of approximately $124,000. If the merger goes through, we believe CNS will be a strong operator. As always, the key is that these centers are well anchored by surrounding neighborhoods. We'll keep investors updated as we learn more.

If we look back over the last 10 years, the strongest quarters in terms of total lease value signed were the fourth quarters of 2021, 2022 and 2023. The most recent quarter was the next highest on the list with nearly $37 million signed in lease value. While this is impressive and certainly a sign that we're on the right track, my biggest reason for wanting to thank the leasing team and the operations team for delivering space to tenants is their ability to learn from one another and continually sweat out the details necessary to ensure the long-term success of this business. We've got a busy second half ahead, but we also have the right environment and the right team to deliver. It's my thanks to that team that we've been able to deliver thus far. Scott?

[J. Scott Hogan, executive]

Thank you, Christine, and good morning. We were pleased to deliver $0.24 of core FFO for the quarter. As Dave and Christine discussed, this was a very strong quarter led by strong leasing efforts. Our original and our current forecast anticipates that we will increase FFO in the second half of the year, especially the fourth quarter with G&A reductions, percent of sales causes kicking in more heavily in the fourth quarter and leasing delivery in the fourth quarter similar to the last 3 years.

Pursuant with our delivery and same-store NOI growth of 6.6% this quarter, we raised the full year same-store NOI guidance range to between 3% and 4.5%, raising at 0.5%, both on the bottom and the top end of the range. On the debt side, we financed $56 million of 6.2% secured debt maturing in 2031. In essence, this was laddering out our secured debt we have coming due in the second half of this year. We will keep an eye on laddering out a bit more of our revolver debt. Currently, we have 13% of our debt on variable rates and the revolver matures in 2026, not including 2 6-month extension options.

Looking at our core FFO walk on Slide 11. We reiterated guidance and updated the forecast in terms of how we get there. Non-same-store NOI growth increased and in conjunction interest expense also increased. We intend to continue balancing out our acquisitions and [Technical Difficulty] and the timing will impact these 2 contributors. But to the extent one increases, we should see the other approximately balance it out. Our goal is to make sure that our underlying growth engine becomes more and more visible to investors. We will do this both by eliminating noise and by continuing to drive same-store NOI growth in order to deliver bottom-line growth.

With that, we will keep our comments brief today, and I will open the line for questions.

[Operator]

[Operator Instructions] Our first question is from the line of Anthony Hau with Truist Securities.

[Anthony Hau, analyst]

So in the rental trend chart on Page 7 in the presentation, rent growth for San Antonio and Austin moderated strongly. And then you see an uptick in -- for Dallas, right? So just curious, what are you guys seeing on the ground today for those markets?

[Christine C. Mastandrea, executive]

We're seeing strength in all of our markets, Anthony, still. It's just a matter of what leases are turning when and the site space. So I don't see a real shift in a negative way. In fact, I'm seeing it still continuing on track with what our expectations are. And that's across all markets. And quite frankly, the difficulty is some of our markets are getting to full occupancy. So that's why we've continued to work our re-merchandising efforts to strengthen the base of the growth.

[Anthony Hau, analyst]

Got you. And then you're hearing news that some restaurant owners like McDonald's are struggling a little bit. Are there any like restaurant tenants that's on your watch list right now?

[Christine C. Mastandrea, executive]

Not on our watch list right now. What we're finding, and I think this has been talked about quite a bit, is that fast food is starting to meet the same pricing as fast casual. And so people are opting for a choice of sitting down and having a good meal versus what would be something that would be less desirable like eating a hamburger in the car.

[Operator]

Our next question is from the line of Mitch Germain with Citizens JMP Securities.

[Mitch Germain, analyst]

So it appears based on your same-store guidance you're kind of looking at a little bit of a deceleration in the back part of the year. Just can you just talk about kind of what the expectation is there?

[J. Scott Hogan, executive]

Mitch, thanks for the question. This is Scott. We're still looking at sequential same-store growth. But I think that if you were to look at the first half of the year, same-store growth and compare that to the second half of the year, compared to 2023, the second half will be a little bit lower than the first half of the year was. You may recall, in the second half of last year, we had a quarter that was a little bit lower. So that's one of the reasons why we -- one reason why the second quarter this year was a little higher.

[David Holeman, executive]

Yes. Mitch, it's Dave. As you saw, we did increase our same-store guidance for the year. So we're -- to Scott's point, I think we're very pleased with the performance, a bit above our original guidance. We moved it up on the bottom and top end, and I think pleased with the performance of the portfolio.

[Mitch Germain, analyst]

Got you. You didn't provide an update on Pillarstone. I know a lot of what's happening there is a little bit out of your control. I know some of this is contemplated in your guidance right now. Anything of note happening there?

[David Holeman, executive]

Mitch, Dave again. A lot happening. I think we mentioned we're really in the collection phase for our redemption, working our way through that and expecting proceeds as we go through that process. I think we communicated earlier on, we had about $13 million of expected proceeds in our guidance this year and that's kind of -- no change to that and we're working to collect those funds through a disciplined organized process.

[Mitch Germain, analyst]

Are assets with from the Pillarstone entity for sale?

[David Holeman, executive]

They are, as part of the BK. Obviously, we're working through a plan of reorganization. Right now, we understand they have about $40 million of contracts in place for 3 of the assets. And we're obviously working to get all of the assets, all or some of the assets liquidated in order to meet Whitestone's redemption.

[Mitch Germain, analyst]

Got you. And then last for me. Christine, fourth quarter last year, obviously, you had a pretty meaningful increase in occupancy quarter-over-quarter from 3Q. You're starting at a little bit of a higher point this year. But obviously, your comments referenced the fact that the back part of the year are the more seasonally active. So where do you think is a comfortable occupancy level for this portfolio to start to kind of perform a little bit more consistently?

[Christine C. Mastandrea, executive]

Well, I mean, I -- like I said, I mean, there's an active re-merchandising effort because I think there is a profitability that can be achieved with that. But we're still looking at 93.8% to 94.8%. But I'm quite confident that we can get this portfolio in a good place at the end of the year.

[Operator]

Our next question is from the line of Gaurav Mehta with Alliance Global Partners.

[Gaurav Mehta, analyst]

I wanted to ask you on your G&A guidance for the second half of '24. Does your guidance include any non-recurring items within the G&A?

[J. Scott Hogan, executive]

No. So in the first half of the year, we had proxy defense cost of around $1.8 million, and that's the majority of the increase in G&A. In the second half, we expect to be a little bit more normal. Some of the legal fees were front-loaded into the first half of the year associated with the bankruptcy and other legal matters. So we do expect a more normalized G&A in the second half of the year.

[Gaurav Mehta, analyst]

Okay. Second question I had was on the real estate property taxes which were lower in the second quarter. How should we expect about real estate property taxes for the second half of '24?

[J. Scott Hogan, executive]

So in the State of Texas, there's a long process to dispute and litigate property taxes and you often get tax refunds. You don't know when you'll get those. So we had a few more tax refunds in the second quarter than we normally would. So I would expect property taxes to normalize and be closer to where we were in the first quarter for the second half of the year. And the reason the second quarter is so much lower is we just -- we've had a number of favorable settlements on properties in Texas.

[Gaurav Mehta, analyst]

Okay. And then maybe lastly on the transactions. I think on the last call, you had talked about maybe selling $25 million of properties in second quarter. Was there any update on those expected dispositions?

[David Holeman, executive]

Gaurav, it's Dave. Yes, our recycling efforts are on track. I think in the second quarter, we closed on a couple of acquisitions. And I think we closed on one disposition right before the second quarter. We do have a couple of assets still on the -- in the pipeline and to close in the balance of the year. I think we've done about $100 million in acquisitions over the last couple of years and $85 million of dispositions. Our plan is to continue to balance those. So we've probably got another $20 million to $30 million of dispositions coming in the balance of the year. And those are going well. We're continuing to be able to buy assets where we think there's significantly more upside and an initial day 1 spread as well.

[Operator]

[Operator Instructions] Our next question is from the line of John Massocca with B. Riley Securities.

[John Massocca, analyst]

So just -- I mean, I'm sorry if I missed this earlier in the call, but I'm splitting hairs a little bit, but the interest expense expectation increased versus kind of prior guidance. What's the driver of that? Is it anything to do with disposition timing versus kind of what your expectations were last quarter or was just execution on the mortgage you recently did? Just trying to get a little color on the change in that guidance outlook.

[J. Scott Hogan, executive]

No, the majority of the increase in the interest expense guidance is just -- we have a recycling plan where we -- the plan is to be capital neutral. But in the first half of the year and a little bit into the second half of the year, the acquisitions are outpacing the dispositions. And so with that, you just have a little bit higher NOI and a little bit higher interest expense. And so the bottom-line impact to FFO is going to be virtually nothing. Maybe $20 million to $25 million would be the amount that we're ahead on acquisitions versus dispositions for the year. Just to give you a sense for this.

[John Massocca, analyst]

In the original -- in the guidance last quarter in 1Q was the anticipation that there would have been earlier timing on dispositions then?

[J. Scott Hogan, executive]

Yes, I predicted the dates of these things.

[John Massocca, analyst]

And I guess, what kind of is being assumed from a variable interest expense perspective just given all the volatility we're seeing? I don't know when that was permanent. It seems like in a given week that can be very different. But just kind of interested in the timeframe of when you set that element of the interest expense expectation?

[J. Scott Hogan, executive]

Well, we're down to 13% variable interest rate as of the end of the quarter, the second quarter. And we look at the -- we take a look at the 1-month SOFR curve going out through the end of the year. And to high-6s, low-7s would be the range that we're looking at for the balance of the year, at least in this quarter's forecast.

[John Massocca, analyst]

[Technical Difficulty] kind of low-income consumers versus high-income consumers. I mean, as you look at your own portfolio to the extent you have exposure to those different kind of income buckets, are you seeing any kind of difference in terms of your ability to push rent at properties that are maybe a little closer to lower-income consumers versus higher-income consumers? And does that shape kind of how you're thinking about your capital recycling plan?

[Christine C. Mastandrea, executive]

Good question. I think a couple of things. That's why we've positioned most of our acquisitions and our properties and high HHIs. And in those higher incomes where we see those growth opportunities really come from job growth. So we've been very fortunate that we've been able to see the upside of that growth as well with those incomes. Truly, this has been a concerning thing to see what's happening with the lower-income consumers. We don't have a lot of exposure there. Where we do on some of those properties, they're still not really on the lower end. They're about mid-range. So again, I haven't seen anything as of yet. But that being said, we feel bad for what's happening, right, to these people and it's very unfortunate. So hopefully, things will balance out towards the end of the year for everybody in a good way. But like I said, we don't have a lot of exposure in that area. In fact, it's very minimal.

[John Massocca, analyst]

So as you look at kind of capital recycle, I mean, is the thought process to continue to move up that HHI curve?

[David Holeman, executive]

John, it's Dave. It is. I mean, we've continued -- part of our recycling is just -- the biggest part is the ability to add value through the new acquisition, but we have recycled with a little bit higher HHIs and also higher ABRs. So continuing to focus on where we think the greatest opportunity is.

[Operator]

As there are no further questions, I would now hand the conference over to Dave Holeman, CEO, for his closing comments.

[David Holeman, executive]

Thank you. Thanks everyone for joining us this morning. At Whitestone, we're pleased with our progress in the second quarter and really look forward to performing for the balance of the year. We will be out among investors in the fall and would love to interact with any of you that would like to. So please reach out to us. Have a great day. Thanks, Dave.

[Operator]

Thank you. The conference of Whitestone REIT has now concluded. Thank you for your participation. You may now disconnect your lines.