Kite Realty Group Trust at REITWeek 2015

Kite Realty Group Trust is a full-service, vertically integrated real estate investment trust engaged in the ownership, operation, management, leasing, acquisition, construction, redevelopment and development of neighborhood and community shopping centers in selected markets in the United States. As of December 31, 2016, the Company owned interests in a portfolio of 121 operating, development and redevelopment properties totaling approximately 24 million total square feet across 20 states. For more information, please visit the Company’s website at http://www.kiterealty.com.

Maggie Daniels, CFA
Kite Realty Group Trust
317-713-7644
mdaniels@kiterealty.com

Christy:  Good morning everyone. I'm Christy McElroy. I'm the retail REIT analyst at Citi. I have the pleasure of introducing Kite Realty Group here at NAREIT. From my immediate right, to my far right, is Tom McGowan President and COO, John Kite Chairman and CEO, and Dan Sink EVP and CFO. With that, I'll turn it over to John for some opening remarks, and then I'll kick off the Q&A.

John:  Great. Thanks Christy. Hi, welcome everyone, and thank you for coming. Again, I'm John Kite, CEO of Kite Realty Group. Kite Realty Group is a shopping center company. We own approximately 120 properties in 22 states, about 25 million square feet of gross leasable area. We operate out of 6 regional offices in United States in the northeast, Florida, the west, central United States, mid-west, and southeast. Two-thirds of our properties, we would consider have a grocery component within them. These are class A properties in higher income areas. Average household income in our properties is about $80,000, and about 70% ABR comes from the top 50 MSAs in the United States.

Our top 3 tenants are Publix, TJ Maxx, and PetSmart, and we currently have about $177 million of development under construction, which would generate an additional $11 million of NOI into the company in the next 18 months. We, in terms of the balance sheet, [have] done a lot of work over the last couple of years. We're now an investment grade credit with a BBB minus and BAA 3 rating. Our net debt to EBITDA is in the low 6 range, and we currently have about $500 million of liquidity of cash and available credit, which actually exceeds our debt maturities through 2018. We feel like we're positioned very well to weather any kind of situation that may be down the road. We've done a lot of work to significantly overhaul the portfolio and have been growing it very well, and have had a strong internal growth of the last few years as well. That's a quick summary, Christy.

Christy:  Great. Maybe I'll kick it off with a question about ICSC, since it was just a few weeks ago. Following the conference, what would you say was the overall message that retailers are giving you in terms of the health of their business?

John:  I think we would all agree that ICSC, for us, was very good. It was similar to the last couple of years, in terms of the retailers are in a situation where there's very little new supply. They're very focused on opportunities. I think their business is quite strong really. I think that most of the traditional bricks and mortar retailers have really adjusted their business model since the downturn, a much leaner, much more efficient at their inventory returns, and much more focused on making sure that they're delivering to the customer. All in all, I would say it was a pretty strong, generally from the retailers. Tom, do you want to add anything?

Tom:  The only thing I would add is it's also great to see the value players doing extremely well, the Ross, TJ Maxx, of the sectorjust performing extremely on that and growing. In addition, people like Dicks are still turning out tremendous amount of stores. We feel very good in terms of our occupancy and the demand that's coming up behind it.

Christy:  Tom, would you say ... Aside from the retailers that you mentioned, are there any others that are meaningfully grown square footage, and then on the other side of the coin, what are the areas of concern, the retailers that are closing stores and the still at risk categories?

Tom:  I would say first of all, the primary at risk category is clearly the office players. We spend a tremendous amount of time with both groups, both Staples, Office Depot, OfficeMax. The way we're looking at it, is we're talking it as an opportunity. We're taking it as an opportunity to improve shopping centers, find tenants that increase traffic. We really feel like we're in a good position. We feel like the more time we spend with each one of these retailers, we can really work out proper timing and ability to take over the space and make meaningful additions to the sum.

John:  I would add just in terms of the new retailers. You're definitely seeing new concepts now, and that's something we haven't seen in a couple of years. Forever 21 is rolling out a concept called F21 Red, which is going to be in power centers. Similar to their Forever 21 brand, but situated in power centers, smaller spaces, but similar product. Nordstrom Rack and Off 5th are both expanding pretty rapidly. Now they're not as worried about being closed to their flagship stores. You've got Macy's with Backstage. There's just a lot happening. As Tom said, really on the negative side, it's the same retailers that it has been for years. Office supply has been weak for years. Electronics was weak and has stabilized, and the book segment is weak, and has been weak for years. Really, there's nothing new on the weak side, but there's a lot new on the positive side.

Christy:  Then maybe in terms of the changes that we're seeing in terms of consumer shopping habits and the impact that that's having on the way that retailers are running their business and operating their stores, what changes are you seeing within the stores, and then what changes are retailers demanding in terms of the shopping centers to accommodate the new ways that they're doing business?

John:  I think first of all, retailers know that ... I don't know where my phone is, but they know everybody has a smart phone. Everybody in this room right now, I guarantee you, has a smart phone, I mean almost everybody. What's our quarterback's name? He has a flip-phone. What's his name again? Andrew Luck has a flip-phone, but everybody has a smart phone. They know everyone has a smart phone. I think they're very focused on ... The right retail segment is very focused on knowing that they have to embrace that, not fight that. I would say, personally, I feel like in the beginning of the internet retail age, the bricks and mortar retailers were fighting it, and now they're embracing it as part of their business strategy. We, as an owner/builder of shopping centers, have to embrace it as well. We're spending a lot of time thinking about what we can do to make it easier for the retailer, our customer, to deliver product.

I think you've heard this before, but the reality is, when you look at what Target is doing, and you look at what Macy's is doing, you look at what Bed Bath is doing, these guys are starting to take advantage of their foot print. You hear about what Amazon is doing, and they're building these ... They're just distribution centers, but they call them fulfillment centers or whatever they call them. These things cost a lot of money, and how many of them can they really actually build. Whereas, Target has a thousand stores today that they can deliver from. This is changing, and it's going to be a great thing I think in the next 5 years. We spend a lot of time trying to help these guys strategize. Tom, you might talk about the-

Tom:  Then from a physical perspective, we're not seeing anything physical, in terms of the change of the store. Internally, as it ties back to their specific build out, they're making modifications, a lot of modifications on technology. In South Naples we have 6 boxes under construction right now, so we have not seen anything specific. As John said, it's just great to see them reacting. It's great to see the change and capitalizing on tremendous amount of real estate from a distribution standpoint.

Christy:  What about in terms of driving traffic to the centers and the changes that are happening at the centers in terms of your merchandise mix? There's a lot of talk about more restaurants coming to centers. You certainly see that on the mall side with malls evolving. It's more experiential versus just shopping places. What's happening on the shopping center side, on the strip center side in terms of those types of changes?

John:  I think this is the coolest thing about our business is that the real estate itself is adaptable. We often talk about how in the end of the day, good real estate wins. If we own good real estate, the retailers will want to use it in adapting their models. The restaurant thing that you're talking about is something that's been going on for quite a while, but it's really just a reflection of our particular country that doesn't eat at home as much as it used to. There's a lot more demand for quick service restaurants, for sit-down, for fast-casual.

In terms of what we do, when we look at building something new like Parkside in Raleigh for example, a big part of what we thought about is where are we going to put the restaurants, and how are we going to make sure that we're integrating it within the whole centers. That's something that if you're building, you can do ahead of time. If you've already got something, then you're adapting. It's more about merchandising mix. It's not just the restaurants, it's a combination. We spend a lot of time. If we have the right merchandising mix, which could take us a little longer to do, then we're going to be much more sustainable. I think people assume we just lease to whoever comes around, but the reality is we spend a hell of a lot of time trying to figure out what the right mix is.

That's the great thing about our properties is the real estate itself, the dirt itself is so finite. The buildings that we have or the tenants that we have are going to transition over time. If we own strong real estate, that's how we'll continue to grow cash flow, no matter what the environment is. It's a big part of our game today, trying to figure out the right merchandising mix.

Christy:  Switching to Kite specifically, I'm wondering if you could talk about what your key priorities are over the next 12 months.

John:  I think our key priorities are ... Right now, we're blocking in tackling in terms of executing. In an environment like today, where it's a little volatile in the outside world, internally, in the company, things are very strong. We have to focus on continuing to execute. We have, as I mentioned, we still have just under $200 million of ongoing projects that we need to finish and deliver. They're 80% leased, combined. We still have a lot of upside just finishing that. I mentioned it's around $11 million of additional NOI. That's first and foremost.

Secondly, we have a real good opportunity to grow same store NOI. This would be the lease up in our operating portfolio. We have our small shop lease percentages is about 86%, which historically is a pretty good number, but in today's world with limited supply, we believe it can be 90%, and we're pushing very hard to get there. That's a big number for a company our size, in terms of ongoing revenue. Then I think also, it's a matter of continuing to have a strong balance sheet and continuing to actually make it better. Our view is right now the world is awash in capital. That will change, and we're going to be in a situation when it does change, it's not a problem for us. While we're being aggressive to continue to grow the company and execute, we're also being conservative with our balance sheet at the same time.

Christy:  You mentioned lease up of the portfolio is a key driver of same store NOI growth, and presumably that over 2015, 2016. Maybe you can talk also about the other levers of same store NOI growth in terms of contractual rent growth, releasing spreads, and operating cost.

John:  Sure. We have several components of our annual NOI growth. First of all, on the external side, there's acquisitions. We're currently engaged in the acquisition market. We initially started off the year with guidance to acquire $85 million, which we've now increased to $125 million. We think we're going to do that. That's obviously some NOI growth. It will have to, as it comes in to the portfolio. Operationally speaking, you mentioned leasing spreads. Leasing spreads have been strong. When we lease from 86 to 90, that's significant, but we're also renewing tenants, and our renewal spreads have been good. In fact, in the last quarter, we're starting to see ourselves, where new tenants on average at 7 to 8% range. That's strong. The development pipeline is definitely going to be bringing in NOI. Then also the redevelopment pipeline will be bringing in additional NOI overtime.

You really have to look at it from a perspective of the things that you could control internally, what we can control internally, and what we can do externally. I think, as we go to the next 2 years, the part of that that's going to ebb and flow the most will be the acquisition side, because the acquisition side is very, very competitive. We have to be weary of our cost of capital and be smart about how we're doing that.

Christy:  Maybe you can touch more broadly on acquisitions, since you brought it up as a key driver for NOI growth. You also mentioned that you increased your expected volume for 2015, from 80 to 125 million. Maybe you can talk about what you're seeing out there in the market, in terms of opportunities.

John:  Yeah. It's tough. The reality of the acquisition market today is that there is just a wall of capital chasing, very limited, high quality opportunities. We have to be very creative in what we do. Our goal is try to acquire stuff off market. Historically, we've acquired the majority of our acquisitions have been off market. We continue to do that. We bought a deal recently in Dallas, which is the Whole Foods anchored center in Colleyville, a high-end suburb of Dallas. That was an off market transaction. That was a great transaction for us.

I would tell you that just from a cap rate perspective, because so many people are talking about cap rates, the dispersion between that and what public company's implied cap rates are, it's wide. It's the widest I've seen in quite a while. If you want to buy a high quality power center in United States in any reasonable market, and if you look at what I said earlier, 70% of our properties are in the top 50 MSA. If you looked at those top MSAs, and you want to buy a high quality asset, it's in the 5s, it's not in the 6s. I think that's just the way it is, and it's, from my personal opinion, not going to change any time soon, just because there is no new supply. Every time something gets bought, you're not back filling it with new product, so there's less and less out there, and it's all cash. These are not leveraged transactions.

The acquisition market is tough. That said, we've been able to find things that make sense for us. We've been able to find things that we think we can grow. Because of our development skill, which not everyone has in our business, we look at things differently. We think about what we can 2, 3, 4 years down the road to an asset. I think it's very difficult, but it shouldn't shock anybody. Real estate is a good place to be. It just really is. We can grow. When you see people growing their NOIs around 3% a year, you see that the cash flow generated from the asset is mostly investment grade credit in these power centers. It makes sense to me, so I'm not surprised by it.

Christy:  Maybe you could talk about your sourcing of acquisitions a little bit. Are you sourcing specific markets in terms of where you'd like to grow your presence, establish a new presence? Is it market specific or is it asset specific? Are you looking in many different markets?

John:  I think when you're in a market, like I just described, you have to be flexible. If you just narrow in and say "I'm only going to buy in this 1 or 2 markets" you're going to have a difficult time achieving what we just talk about, which was trying to find these opportunities that have some growth in them. In our case, we're spread out. We're in 22 states, but we're really regionally set up. We're focusing in the markets where we have regional offices. That would be the Las Vegas offices is the west. We're looking at stuff in the west. In the northeast, we have an office in White Plains. We're looking at stuff in the metro region here in New York. In the southeast, we're looking. In the mid-west and Florida, we have a lot of assets, so we're going to be a lot more cautious around adding to that. We're trying to balance our portfolio out. Again, you have to be opportunistic if you can be.

Tom:  The only other thing I would add is it ties back to sourcing. It's so important for us to get out and nurture relationships with brokers, owners, et cetera. As John said, it's so competitive that we have to be the aggressor. We have to sell Kite Realty Group Trust. We have to be out in front of them. Before we left, we're on a call with a potential seller, and we're going to go out and see him. You have to get out in from of them. You have to make the extra phone call. You have to work the relationships, even as you get down to the final 2 or 3, you still have to continue selling, figuring out a way to make sure they understand you're the right buyer. It's very, very competitive. We have to out work the other groups.

Christy:  Maybe while we're on the subject of external growth, maybe you could talk a little bit about your current approach to development. It seems like a lot of other strip center REITs arenow starting to get back into the new development game. You've continued to do that over the last several years, in terms of having a new development pipeline. Redevelopment is also something that you're newly approaching in volume, given the recent Inland acquisition. Maybe you could talk about your approach and how you're looking at development as a percentage of your gross asset volume.

John:  Sure. I mean maybe the real thing there is maybe we know too much about development. It's really, really hard. To just into development is always a very dangerous thing. We've been doing it for, Tom and my, whole career. Unfortunately, that's getting to be long. The reality is development never occurs the way you anticipate it will occur. There's always forks in the road. It is everywhere. Every step you take, someone is trying to stop you. The reality of that is that the yields get compressed over time. No one brings a pro forma into an office to someone that says, "Hey, let's do this crappy deal." It's a bad return. Returns on pro formas are always good. We are very focused on risk adjusted returns.

Redevelopment is also difficult. Redevelopment sometimes can be more difficult than ground-up development, because you're dealing with an existing building, an existing soil conditions, all these things that you may not know about. I'm really surprised by the number of people that develop that really shouldn't be developing. That said, everyone is trying to find yield. If someone thinks that they can build something at an 8.5% return in today's cap rate environment, maybe that feels good. The reason that we haven't done a lot of ground-up development, other than stuff that's legacy land, is that we're very well aware of the fade that occurs. We're good at it, we know how to do it, we're very disciplined around it, and we will continue to do it, but we're going to do it selectively.

The redevelopment pipeline, now that we're a bigger company, is bigger than it used to be. Our idea of starting a hundred million of redevelopment every 2 years is something we think we can do, and we think we can execute at it, and we think we can get 8 to 10% returns, which again, risk adjusted, is a great number. The ground-up development, I think we're still way off, in my personal opinion, from seeing it anywhere near the 1999 to 2005 phase, which really got to the point where it was out of the control in terms of the amount of construction that was going on. We're just really far away from that. I don't think guys like us, who are experienced at, want to really jump back into it. I think people that are jumping back to it are going to get hurt.

Christy:  John, you mentioned that disconnect between public and private market values when we were talking about acquisitions. I wanted to come back to that, given that the topic of M&A has been prevalent in the shopping center sector, since the take out of AmREIT and Excel recently by Blackstone. There's been a lot of talk about potential M&A in the strip center space, and further potential privatization, not necessarily public to public, but privatizations. I wonder if you could give your thoughts on that. What's your role in the M&A landscape? Are you an acquirer? Are you a seller? Where is Kite?

John:  I'm just going to tell you everything right now. Look, I think it's understandable that people are curious about it. It's ironic, because really the only reason it's so talked about in terms of privatizations right now is that this is one of those periods in times where the public market valuations are pretty far off of what's actually happening every day. I think we all know it. I think anyone that is around the business knows it, but it just is what it is. For this period of time, it will be very likely for ... Everybody talks about Blackstone, they're great, they're smart, but they're not the only ones. There's a lot of capital out there, trying to do this. There's a lot of core plus capital being raised. The only reason that is, is because everyone has adjusted their returns down.

If you get a 10% return today, that's really pretty good, versus trying to get a a teens return 5 years ago or whatever. I think it'll continue. I think it's definitely a factor. In terms of our role in all this, we have just recently done an M&A transaction, it's very, very positive. I think we've shown that we know how to operate a portfolio and squeeze more cash flow out of it than what was being done before. I think if you look at a company that was a small company that's now a medium-sized company in terms of public REITs, we've established, we're capable at it, and not everyone is. If there's an opportunity, we're going to look at. It doesn't matter really what side of the trade it would be on. If there's an opportunity, we're going to look at it. I would expect this to continue as long as the public valuations remain so far off than what's actually happening in the everyday world.

Christy:  Was there a question here? If you wouldn't mind, I'm sorry, stepping on to the mic. Thank you. It's being webcast.

Speaker 4:  Hi. Given that you've been through the OfficeMax and Office Depot merger, you understand a little bit how they've dealt with their space. If Staples goes through, can you give us any insight in terms of how you're positioned, what kind of overlap there is, and how you think they'll be evaluating which properties to keep?

John:  Sure. As Tom said, we've spent the last couple of years working on this. This isn't something we just worked on for a couple of months. We have gone through the entire portfolio of all 3 of our office supply users. Clearly, if they all 3 come together, then there's going to be crossover for sure. That's the beauty of this business though. We have leases and we have term. Just because a company, which is an ongoing enterprise comes to you sand says, "Hey, we want to close a store." "That's fine. You can close the store, but you still have to pay us rent, and we'll go get another tenant, and we'll work out a deal." We're not terribly worried about it, but that demonstrates the power of our platform and the power of having lease term, that we are able to negotiate.

The good thing is we have good relationships with these teams, and we're working hand in hand with them to solve. It's not contentious at all. It's actually more of a partnership situation. They realize that they can't be contentious with us. That's one of the nice things about size. Now that we have 120 properties, instead of 60 properties, we're a little more meaningful to these guys. It's really going to be a positive, and we see upside in the rents, and certainly upside in the merchandising mix.

Tom:  Without question, I think the key is we're being proactive. We'll not allow ourselves to be reactive to the situation. When we meet with the heads of real estate of both of those groups, it's actually what John said, that we're working on a proactive basis to improve our centers. We're looking at buyouts. We're looking at all the different options we have. As well, they're responding, saying "Hey, this could be one, if you could take, that would be great." We're already working with the back fill. It may seem odd, but it's actually a net positive for us to be in this position.

Christy:  Do you have any other questions, from the audience? Go ahead.

Speaker 5:  Yeah. Tom, you guys have done a really good job in increasing your dividend, and you pointed that out in your literature over the last 12 months. Could you speak a little about your dividend policy, if you got any targets for that, the growth? What percentage of your AFFO you make as you make at that happen?

John:  Sure. First of all, the dividend is very important. If you look at total returns of REITs historically, the dividend has been a larger component of that than the actual stock appreciation. That will continue, and it will become more important when REITs get their own classification as an investment vehicle. I think people probably need to pay more attention to this, because ultimately, we're going to have a broader investment community, which is a good thing. Our policy, we don't have a hard policy, as it relates to a payout ratio. One of the balances that you have in a business that's creating value is we throw off ...

In 2015, well throw off about $50 million of free cash flow after the dividend. That's significantly higher than it was the last few years. In 2016, that number will be higher again. Our payout ratio currently is around 60% of our AFFO in that range. That could be considered conservative. I think that we're very interested in having a growing dividend consistently, versus trying to have a dividend that grows 1 year, and then stop, and then 3 years. Again, this team is battle tested. We've been through the deepest of the dark times. Now we know that we're going to always plan for that to be around the corner. We will continually grow the dividend, but we will also throw off a lot of cash. As a team, we want to get this company throwing off $100 million of cash, which is very achievable in the next few years for us, if we continue to do what we're doing, but yet still grow that dividend on a consistent basis, and have a broader base of shareholders. It's very important

Christy:  We have time for one more question. Go ahead.

Speaker 6:  Just curious [inaudible 00:28:24].

John:  Right.

Christy:  The question was about the preferred that becomes callable later this year.

Dan:  On the preferred, it is callable on December of '15, so it's actually this year. You give 30 days’ notice to call the preferred. It is our objective definitely. That's 102 million roughly at 8 and a quarter. You know we do have in our capital plan and in our financing strategy to pay that off. We've been looking at various options, and we've been looking at ... continue to secure the balance sheet, look for the best opportunity for us. When we gave our guidance. We talk about public bond deal, because we've gotten the S&P and Moody's ratings. Right now we're looking at what's the best and secured product to use, whether it's public debt, private placement, term loans.  Then when we look at that, we're going to utilize that, a portion of it, to call the preferred. It is definitely in our guidanceand in our capital plan.

Christy:  Great. Thank you. John, Tom, Dan, appreciate your time.

John:  Okay. Thanks everyone. Have a great day.