Whitestone REIT

Greetings. Welcome to Whitestone REIT's second quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone today should require operator assistance during the conference, please press star zero on your telephone keypad. Please note that this conference is being recorded. At this time, I'll turn the conference over to David Morty, Director of Investor Relations. Mr. Morty, you may now begin.

Good morning and thank you for joining Whitestone REIT's second quarter 2022 earnings conference call. Joining me today on today's call are Dave Holman, 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 3, 2022. 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, www.whitestonereit.com, in the investor relations section. I'd also like to draw investor attention to the fact that we published second quarter 2022 slides on our website yesterday afternoon and will reference page numbers throughout this call. I will now turn the call over to Dave Holman, our Chief Executive Officer.

Thank you, David. Good morning, and thank you for joining Whitestone's second quarter 2022 earnings conference call. I will begin on slide number two. We're pleased to announce another strong quarter of operating and financial results driven by continued demand for spaces in our centers and associated leasing activity. Versus the second quarter of 2021, our revenue grew over 14%, FFO per share is 25 cents per share, up from 24 cents. Same store net operating income increased 8%. Total occupancy is 91.5%, up 150 basis points from Q2 2021, and up 50 basis points from the first quarter. As of the end of the second quarter, our net effective annual base rent per square foot was $21.72, up nearly 9% from a year ago and up over 2% from the first quarter. And our balance sheet continues to strengthen with lower debt leverage as shown by the improvement of our net debt to EBITDA RE ratio to 8.3 times. Total second quarter 2022 leasing spreads were very strong, and I'll have Christine discuss leasing further in her section. Our strategy of designing necessity-based community centers located in high growth, high household income, Sunbelt markets continues to produce strong and improving results. Given another quarter of successful results, I wanted to discuss some of the positive steps we've taken over the last six months. I've shared some of the big focus points over the last several conference calls. We have enhanced our governance, increased our investor outreach and interaction, strengthened our leadership team while reducing overhead expenses, grown FFO per share 25 percent, and meaningfully improved our debt leverage. Our dedicated team of associates share a common purpose to meet the needs of our communities, position our tenants to reach their success, and to create value in commercial real estate better than anyone in our industry. We value hard work, teamwork, integrity, and growth, and I am honored to lead a team dedicated to executing on our business model and delivering long-term shareholder value. Our strategy is clear and consistent. Whitestone has had the right strategy in place for over a decade, and we believe the environment has never been stronger to showcase that strategy. First, in terms of strategic consistency, our focus has been on well-located, necessity-based retail centers located in high household income neighborhoods, in the best submarkets, in the fastest-growing MSAs. and today our portfolio is located 99% in the top markets in the Sun Belt. The importance of geographic focus is something the industry has recently and rightfully placed tremendous value on. Beyond our geographic focus, and even more important, is our strategy of crafting service-oriented centers designed around meeting local needs. This strategy has always been embraced throughout the company, including our acquisitions team where we have utilized local sharpshooters to find centers in high-income neighborhoods capable of morphing into one of our growth centers. This strategy is relentlessly pursued by our in-house leasing agents who are ingrained in the surrounding communities and know how to attract tenants that meet the demands of their communities. This strategy is embedded in the way we write our contracts, opting for shorter leases because of our strong belief in the tenants we choose for our centers, validated by the successful track record of growth of our tenant base. This strategy is understood by our tenants as they grow, strengthening a center's connection with the surrounding neighborhood and benefiting from increased traffic levels. And finally, this strategy is also embraced by our development and redevelopment team eager to find opportunities to build value through improvements to our current properties and through adding additional leasable area. I'll have Christine expand on some of the detail behind our strategy, specifically on leasing and by walking through a property development cycle, but I have a couple new additions to the team I wanted to mention first. Tim Ng recently joined the team as our Vice President of Acquisitions and brings over 20 years of real estate experience, most recently in similar roles with Fifth Corner and Amrete. Tim has great relationships in our markets, knows our product type very well, and we're excited to have him on board. For the balance of 2022, he will be focused on our disposition efforts and sourcing great new acquisitions for the Whitestone portfolio. I also want to welcome our newest board member, Amy Fang, to Whitestone. As part of our continued focus on governance, we are strengthening our board through the addition of Amy and increasing the number of independent trustees on our board. Amy is currently the Director of Investor Relations for Shopify, a leading provider of essential internet infrastructure for many of the same businesses we work with. Amy brings significant depth and experience in providing strategic counsel to hundreds of companies in her time at several leading strategic financial communications firms. She has tremendous capital markets knowledge, having spent her time as an analyst on the sell side, and we're thrilled to have her join our board. And with that, I'll turn things over to Christine.

Thanks, Dave. One of our team's strengths is leveraging our tenant relationships to continue to produce strong results. Since we've made the change, as Dave mentioned earlier, we've continued to grow our occupancy, which is now at 91.5%, 150 basis points higher than the prior year, and a new record for Whitestone. Aggregate leasing spreads were a positive 17.4% the second quarter and are a positive 13.8% over the last 12 months. New leasing spreads were up 15.6% the second quarter and have grown 11.2% over the trailing 12 months. Renewal leasing spreads expanded 17.6% in the second quarter and have increased 14.3% over the trailing 12 months. The qualitative reasons behind these impressive leasing spreads on slide three depict our strategy that we have pursued over the last decade and positions us well to benefit from the trends that have been emerging the last few years primarily. Demand for smaller spaces continues to increase. especially in the 2,000 square foot range. Convenience, necessity, and service are ever more critical to our customers and cannot solely be replaced with an online presence, but are optimized by a combined click and order strategy. Second, we are seeing a strong rebound in the fitness category, which has numerous brands coming in a variety of sizes and are strong and sticky traffic drivers. Demand for restaurant space continues to strengthen. Convenience and casual restaurants are seeing a significant uptick in demand. This may be a part of a post-pandemic trend, but we think the larger influence is a generational shift as demand for millennials and Gen Z strengthens, with both groups spending a higher percentage of their income in this category. Importantly, a number of our centers are reaching higher levels of occupancy, which allows us to optimize tenants and their rents. On slide four, we show that within our specific metros, we are in the best location within each of our metropolitan statistical areas, as evidenced by the premium rents we collect versus the average for each MSA. Looking at the specifics in each metro, in Phoenix, we targeted key neighborhoods in the immediate aftermath of the 2009 financial crisis and acquired the base of our centers at well below replacement costs. Our strategic focus on the East Valley and North Scottsdale has paid off due to the outsized gains in job growth and out-of-state relocations which have driven traffic at our well-located centers. In Houston, a majority of our NOI comes from the main retail district known as the uptown district or Galleria and from the affluent western suburbs. In Dallas, we were early investors in the northern suburbs that have been magnets for corporate relocations and are among the fastest growing zip codes in the country. In Austin and San Antonio, we purchased centers in prime locations in both cities before the migration from coastal cities really gained strength. Often the reason we're able to secure these premier locations within cities is because we're very in tune with where concentrations of educated talent are attracting employers. Looking at the chart in the bottom right, the portfolio average base rent per square foot with the blue bars and the same store straight line basis rent increases with the green line. This takes out some of the variability with different size tenants and shows the overall rent trend in addition to the fact that rents are accelerating as we're coming out of the pandemic. On slide five, we illustrate the general life cycle of our properties, which is the inner ring of the slide. As an example, we use Lakeside Market, a 2021 acquisition, which is rapidly moving through the phases. Add to acquisition in 2021, Lakeside Market had an occupancy of just over 80%. Lakeside was sandwiched between more developed areas and had an unmet demand for young families primed to invest money in their children and need of services designed for hardworking parents with limited time. The same dynamics that attracted us to making this acquisition also attracted HEB as a shadow anchor shortly thereafter closing down the property. Most recently, a new Kohl's across the street is opening as well. In just over a year, we have grown the occupancy to over 90% while increasing renewal rates as we go. In conjunction with adding new tenants, we are rebranding Lakeside with a new identity. The location strongly centers around educational and fitness offerings for kids, as well as affordable casualty dining and dessert offerings that young families seek out as they spend time together. We are in the process of developing the pad sites in order to take advantage of the morning commuters as well. We anticipate that within a short time, Lakeside will join the roughly 40% of our properties in the refining phase with an occupancy over 95%. Once properties reach this level, we heavily monitor the sales reports and further strengthen the center by preferencing thriving businesses that tie strongly with the surrounding neighborhood and are more likely to endure through any economic cycle. Often a property will take two to three years to make the refining part of the cycle, but still has several years of strong improvement within that finding phase. Achieving all this takes a dedicated, well-trained team, and I'd like to thank our team for driving results and for their commitment to our communities, tenants, and customers. And with that, I'll turn things over to Scott to go over the results in detail.

Thank you, Christine. As you can see on slide six, They read funds from operations per diluted share was 25 cents for the quarter versus 24 cents for the same period in 2021. You will notice that we have shared drivers regarding our 2022 FFO. As Dave and Christine have shared, the core business is doing very well, which is driving up our occupancy and base rents. The reduction in management compensation was most impactful in Q1 and will continue to be impactful in future quarters. Development opportunities may be a modest driver late in the year. Our guidance contains an assumption on interest expense increasing versus 2021. We anticipate we will refinance the majority of our 2022 and 2023 maturities within the next few months, which will provide us with greater clarity on our future interest expense. Earnings growth continues to contribute to our strengthening balance sheet. Total net debt was $638 million improving our debt to gross book real estate cost ratio to 51% and improvement from 52% a year ago. We are pleased with the significant progress we have made on strengthening our balance sheet and we remain steadfast in our commitment in this area. Our board approved a quarterly dividend of 12 cents per share for the second quarter representing an annualized dividend amount of 48 cents per share and an 11.6% increase versus the previous level. To wrap up, I would like to reaffirm our previously issued 2022 guidance. FFO, for fully diluted common share and OP unit guidance, is expected to range from $0.98 to $1.02, representing a 14% to 19% increase from 2021. This includes $0.04 of non-recurring stock forfeitures and severance costs from the first quarter. Our key assumptions related to the guidance have not changed. With that, we will now take questions. Operator, please open the lines.

Thank you. We'll now be conducting a question and answer session. If you'd like to ask a question today, please press star 1 from your telephone keypad, and a confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, It may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions.

Thank you. Thank you.

And our first question is from the line of Mitch Germain with J&P Securities. Please proceed with your questions.

Thank you. Is there anything changed with regards to the lease negotiation? I guess I'm curious if you're requiring more security deposit or requirement for... financials, anything different in terms of the discussions you're having with your tenants?

Well, I think, and thanks for your question, but I think what they're looking at, they're starting to see the impact of inflation, and they're also asking for longer lease terms. And so this is something that we're still sticking with, keeping shorter lease terms, because that's benefited us as a company, them as well, because it gives an opportunity to revisit their business when their lease turns. Regarding additional security and those other items, I mean, we have changed our focus to a quality of revenue focus about, oh, two years ago. We did this primarily during COVID, and that's really strengthened, I think, our product line, the stickiness of the kind of client that we have now. That involves a deeper look in their financials, but not just their financials. It's It's a look at what resources they have. It's not just cash. It's how they operate, who their teams are, what's the quality of some of their vendors, looking into their current operations to understand how well they understand the metrics of their business, their commitment to the business as an owner, and how engaged and how involved they are. So those are some of the things that we've refocused the team and their efforts on, and it's paid off.

Hey Mitch, it's Dave. I'll just add a couple things to Christine's comments. As she said, just a continued focus on quality revenue and just to highlight, we have seen obviously that be very successful. If you look at our leasing activity as well as our leasing spreads, they're trending very well with this quarter being 17.5% leasing spreads on a gap basis and and 9% on just a starting point basis. So really pleased with the activity levels we're seeing in our centers, pleased with the leasing activities, and really a focus on continuing to lock in really quality revenue.

Great. Question on same store. Obviously, the results have been significantly above guidance. Are you implying a slowdown potentially in the back part, or are you just taking a conservative view with regards to your guidance?

Thanks for the question. It's Scott.

I think we expected the first part of the year to yield higher same-store results because we were still in a recovery mode from COVID. In the first few quarters and by the time we got to the back half of the year, we started to see improved collections. We ended up with record leasing by the time we got to the end of the year. And so I think it's just – it has more to do with 2021 than it does to do with 2022 results.

Gotcha. And then what should I be thinking about asset sales in the back part of the year? Are there any –

assets on the market and you know what's the status if there are what status of discussions yeah so as we communicated previously we expect to do some recycling this year we do have a handful of assets that are that are hitting the market so I think we've targeted somewhere less than 50 million kind of in and dispositions and acquisitions we are actively in the market on a handful of dispositions that come up to about that amount, and we're sourcing potential recycling deals for those. So I think we're on track and look forward to having more to report potentially in the next couple quarters.

Thank you. Thank you. The next question comes from the line of Gaurav Mehta with EF Hutton. Please receive your question.

Thank you. Good morning. Following up on your comments on sourcing potential transactions, can you maybe provide some color on what you guys are seeing in the acquisition market?

Morning, Garb. This is Dave. Obviously, we are seeing some softening of pricing, but it's a little early. We're still seeing a fairly decent gap between sellers and buyers on cap rate expectations. But Whitestone has always looked for a little different type of asset. Part of our search is our depth in the markets we're in. Through our relationships, we tend to look for assets that aren't widely marketed. So I think we'll have greater visibility into that as we get a little further into the process. But right now, we're tending to look for probably a little smaller asset maybe a type of asset that is in an area of capital where Whitestone could get in at a price that's attractive. So right now, we are seeing opportunities, but probably not a whole lot more to comment until we get further along the line.

Okay. And on the assets that you're trying to sell, can you talk about your expectations for the assets that you have in your CV?

I'm sorry, Garth, could you repeat that question?

I lost you at the end.

Maybe, you know, can you talk about what you guys are expecting for the assets that you hold in the joint venture? Would you be planning to sell those assets as well?

Yeah, I think that's, you're talking about the properties we own in our joint venture, the non-core assets. Whitestone is working toward liquidating that equity investment. We have on our books about $35 million of investment in some assets that are non-retail. And so we are working towards monetizing that. Timing, that's a little hard to predict now, but we are actively working toward recycling those properties as well.

Okay. And then lastly, on the balance sheet, you talked about the potential refinancing of 2022 and 2023. debt expirations in the next few months. Can you maybe provide some color on what you guys are hearing as far as the interest rates? And then the 23 debt expiration, that's the credit line with the floating rate debt. Should we expect you guys to fix, to enter into fixed rate debt as you try to refinance the maturities?

Hi, it's Scott.

We're working on the recast right now. We do expect to fix the interest rates on the $260 million that are fixed now and probably to leave around 20% of our debt variable. But we're assessing that as we go through the process. But those are our current expectations. And Dave, I don't know if you have anything to add there.

Yeah, I might just add, obviously there's been a ton of volatility around rates. But it has come down just a little bit. If you look at the Treasury rates, they're very similar to where they were four years ago when we did our last recast of our credit facility. I think we've looked at the five-year swap rates, and they're somewhere in that 2.5% today. Obviously, a little bit of variability. So... We're in the process. There's a fair amount of activity in the banking world, as you guys know, right now with folks doing refinancing. So we expect to be closed in the third quarter. We've built a little bit of extra interest expense into our guidance for the second half of the year, and we'll have greater visibility on that, obviously, as we close. But I think we're on track with the refinancing, moving out those 2022 and 23 maturities. and then continuing to look at laddering our debt, continuing to look at our fixed rate variable rate, but we do believe having a portion variable right now makes sense about, as Scott said, about 20%.

Okay, thank you.

Thank you.

The next question comes from the line of Greg Cucera with B. Ryan Securities. Let's just see what's your question.

Hey, good morning, guys. You've reported a loss in your joint venture portfolio for the first time, I think, since you've reported it. It looks like occupancy dropped sequentially at some of those properties, but can you give some color going on there? Were there any one-time adjustments, maybe impairments, and kind of what are your expectations for the rest of the year?

No, there weren't any impairments in that portfolio. There's a number of properties that I believe they're trying to cycle the leases out of there to have flexibility there. with purchasers. And so we do see NOI going down in a number of those properties, but I think in several of those cases, they're just getting them ready to sell.

All I might add to that is I do think, Craig, that we clearly would like to exit those assets. So I think there might have been some additional expenses incurred by the general partner this quarter that were charged as well, but... I think we think clearly from a Whitestone perspective, it's in the best interest of our shareholders to exit. We're working toward that and recycling that into the retail assets that we do very well at.

Got it. And I would say for over the last year or so, you've been able to keep a lid on taxes pretty well, but there was a pickup this quarter. Were there any one-time adjustments in there, or is that just a function of the rising value of the assets?

In the Texas market, there's sort of a three-step process in the tax valuations, and that's where a good chunk of our assets are. So there's an initial valuation, then we get a chance to protest, and then we litigate. So oftentimes we see a little bit of a bump until we work our way all the way through that three-step process. And we're conservative in the way that we estimate those taxes and would expect those valuations to get lower as we work through the process this year.

Got it. I appreciate the color. Just one more for me. With the potential for recycling capital, Dave, are you guys looking at maybe getting involved in any sort of development or redevelopment of your existing properties at placing capital there versus maybe making acquisitions, or what are your current thoughts there?

Sure. I'll start with just a couple of comments and have Christine give some more thoughts, but excuse me. Yeah, we're continuing to look at, so just on the dispositions and recycling, obviously focus on 22 to get back into the markets, obviously do some acquisitions, but do it in a capital-neutral way through recycling. We do also have several opportunities within the portfolio that maybe some are small, some are larger through development. You know, we're ramping those up and expect to have that coming. I'll let Christine, if Christine wants to add anything, she may not, but we have, you know, within the portfolio, all I will say is as we've acquired assets over the years, sometimes we've picked up land parcels, sometimes we've picked up a little extra parking field, and we're working internally to look for pad fight opportunities, development opportunities, and really getting those starting to plan up so they can contribute to our earnings over the coming years. So we think we'll have more opportunities more to announce on that, but I think that right now we are, our plan is to extract that value, to start to work toward that, and working through it, we'll find more details later.

Okay, thanks.

Thanks, Greg.

As a reminder, to ask a question today, you may press star one.

Thank you.

At this time, I will turn the floor back to management for further or closing remarks.

Well, thank everyone for joining on today's call. We very much appreciate your interest in Whitestone. Should you have any questions, I encourage you to reach out to David Morty or anyone on our team. And once again, we thank you for your interest and have a great day.

This concludes today's conference. May disconnect your lines at this time. Thank you for your participation.