Phillips Edison & Company Inc. recently announced that COO Bob Myers will move into the role of president in January as Devin Murphy prepares to retire in June. A 20-year veteran of the firm, Myers has played an active role in building the company into what one of the nation’s largest owners and operators of grocery-anchored shopping centers in the U.S. Commerce + Communities Today contributing editor Beth Mattson-Teig talked with Myers about the industry and the firm’s strategy to continue growing its portfolio.
We’re seeing one of the best operating environments in over 30 years. We continue to see a resilient consumer and steady foot traffic to our properties. We see strong demand and pricing power. I’m still really encouraged by our leasing spreads and I expect that to be strong throughout the balance of the year and into 2024, so I don’t see signs of anything slowing down. In addition, we continue to benefit from positive macroeconomic trends that are driving our [tenant] demand and support for our growth: hybrid work, migration to the Sunbelt, population shifts that favor the suburban markets. All of these factors have accelerated, and with the limited new supply delivered in the market since 2008, I still feel very bullish and I just don’t see the near-term challenges.
The majority of our inline space is necessity-based uses. The growth that is happening really lies in fast-casual restaurants, health-and-wellness and medical. We’re great partners with Starbucks, Chipotle, Jersey Mike’s, Dave’s Hot Chicken and First Watch, to name a few on the fast-casual side. In health-and-wellness, Hand & Stone Massage, Orangetheory Fitness, Eos Fitness and several others. On the medtail piece, there is demand from AFC Urgent Care, Humana, BenchMark Physical Therapy, Aspen Dental, Heartland Dental. All of these continue to migrate from urban to suburban, and we’re a lot closer to the consumer, given that we’re on Main and Main at our shopping centers.
The evolution is growth, and I think demand for our quality of assets will continue to grow. The biggest issue that I see is there’s just a lack of development. We’re acquiring shopping centers on average at $250 per foot compared to new construction at $450 to $500 a foot. The lack of development is going to continue to drive demand into our type of shopping centers. New construction would have to charge almost two times as much rent. So retailers want to go into our type of shopping centers where occupancy costs are within 10% of their business models. I’m also excited about the leasing spreads that we’re seeing on new deals and renewals, and we have the highest retention that we’ve seen, around 93%. If I’m going to forecast anything going into the future, I think the lack of new construction will continue to give us pricing power and leverage.
I believe that to be true. We’re seeing some migration, certainly from malls into the neighborhood grocery shopping centers, especially in health-and-wellness and with some of the clothing retailers. Retailers are wanting to find creative ways to move into more not only grocery-anchored property but locations that offer convenience. You really see that where a lot of the medical users that used to be in medical parks have migrated closer to the consumers where grocers are driving foot traffic, and I think you’re going to continue to see that.
Most importantly, we generate a significant amount of pre-cash flow from the portfolio, roughly $100 million a year. We’re only 30% levered today, and our debt-to-[earnings before interest, taxes, depreciation and amortization ratio] is at 4.9x. We certainly have a strong balance sheet, and we have a lot of liquidity. We have a very nice acquisition pipeline in the works, and interest rates impact what we’re trying to buy from an acquisition standpoint. But we’ve moved our unlevered return targets from 8% to 9%, and we continue to creep that up to a 9.5% unlevered [internal rate of return] basis. We’re very well positioned to continue to grow, and what we’ve been telling the Street over the past two or three years is that we want to acquire between $200 and $300 million of acquisitions [annually], and we feel confident that we can execute on that.
The market is really interesting today. With the rising-interest rate environment, pricing is moving all over the place. Our acquisition strategy has always been around finding acquisitions that host the No. 1 or No. 2 grocer in that market with solid demographics and income. We focus primarily in the Sunbelt states, but I am open to looking at all solid markets that are serving the American population with the No. 1 or No. 2 grocer where the sales and the traffic make sense and, most importantly, are generating the returns that we want to see on an unlevered basis between 9 and 10%. I’m excited about the pipeline that we have with a nice diversity of good, solid grocers that are all generating over 9.5% unlevered returns.
Transaction volume is down 50% to 60% this year versus other years, so we’re not quite seeing as many opportunities. There are particular funds or maybe debt maturities that are motivating owners to sell. I’ve seen a lot of sellers test the market by generating [broker opinion of values], but the spread between interest rates and the bid-ask isn’t to the point where it needs to be yet. All that said, we have one of the best acquisition departments in the country with the best REIT broker relationships. We’re seeing everything that hits the market, and we’re identifying first, if it’s the No. 1 or No. 2 grocer in the market, is there an inefficiency? Is there a motivation to sell? And then we price it accordingly. We’ve had to re-trade some deals based on the interest rate environment, but what we’re acquiring is delivering well into our unlevered returns.
In the first quarter, we closed on four Publix-anchored assets, and they’re all in very solid markets. One in Atlanta, as an example, is anchored by a very strong Publix. We had a couple of vacancies in that property, and we’ve already been able to lease both of those vacancies. We closed on another deal in Atlanta on a Kroger-anchored asset that is roughly 85% occupied that still has some really good vacancy left to lease, and we are already in negotiations on two letters of intent. When I think about our acquisition strategy, what we’re really trying to do is find opportunities to grow the same-center [net operating income] between 3% and 4%. That’s the type of [compound annual growth rate] that we’re looking for, and those are two examples that we’ve acquired this year. I’m encouraged by the pipeline that we have, and we should have a strong fourth-quarter closing with returns above 9.5% unlevered and CAGRs above 4%. So, that’s the inefficiency in the market that I’m seeing today that we want to make sure we’re active in.
Phillips Edison & Co. acquired Suwanee, Georgia’s Village Shoppes at Windermere, above, in April and Florida’s Town Center at Jensen Beach, at top, in March.
It is a big focus of ours, and it’s a nice complement to our same-center NOI strategy. We want to do between $30 and $50 million of either ground-up development or redevelopment, and we can generate returns between 9% and 12% on that initiative. We find a lot of opportunities in outparcels. We’ll take, say, an existing parking lot, and we’ll be able to carve out part of the parking lot and construct a 4,000- to 6,000-square-foot building. We’ve done 35 to 40 of these over the last four or five years that are 100% occupied. We’re attracting the interest of a lot of good, solid, national and regional tenants to that strategy. That strategy will generate somewhere between 75 and 125 basis points to our same-center NOI, as we want to be between 3% and 4% year over year. When your occupancy is as high as ours, creating the opportunities to support the demand is [our aim], and it is generating very positive returns for us.
Rising interest rates, construction costs increasing 25% to 40% over the past few years and supply chain issues — all of those factors are going to continue to be an obstacle. What I do think will happen is that you’ll see retailers change their footprint. They’ll get more creative in terms of the size. Orangetheory Fitness used to be in 4,500 square feet and is now going to 2,000 square feet is a great example. Given hybrid work, they don’t need showers and locker rooms anymore in their facility, so I think you’re going to continue to see the retailer be creative to find opportunities to support their growth plans.
When I first started at the company, we had 20 associates and 30 properties. I was hired as a senior leasing agent, and then I moved to a leasing manager where I managed five leasing agents. After that I had the opportunity to take the position of a VP of leasing and then VP of leasing and operations. That all happened over a seven-year period, and then I’ve been chief operating officer over the last 13 years. All that being said, Phillips Edison has been a company about cross-functional training. That’s a culture that I believe in, and I’m an example of the opportunity for growth within the company.
I’ve certainly helped to grow the portfolio as it exists today. We’ve successfully managed operations, development, acquisitions, construction and portfolio management. I was able to hire most of those individuals, and those individuals at the senior vice president level have been with me for 10-plus years. We will continue to focus on executing our simple strategy, which is winning at the property level. I view every asset as its own individual business, and our job at Phillips Edison is to pick up the pennies. I look forward to partnering with [CEO] Jeff Edison and the PECO team in delivering long-term growth and value creation for our shareholders.
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