2023-11-28 04:15:57 ET
Summary
- Kite Realty is experiencing strong growth with multiple guidance increases.
- The three main sources of growth for Kite Realty are leasing of existing real estate, SNO leases, and developments.
- The market's valuation of Kite Realty is relatively cheap, but the forward growth potential suggests it should trade at a higher multiple.
Kite Realty (KRG), a grocery anchored shopping center REIT, is firing on all cylinders with strong growth resulting in multiple guidance increases. In this article, we will examine the 3 sources of its growth with an aim to determine how much runway remains ahead.
We believe the forward growth is significantly greater than what is implied by the relatively cheap valuation at which KRG trades. Over time, as this growth is realized, I think KRG will trade up closer to fair value.
3 sources of growth
In order of magnitude of impact to FFO/share KRG’s 3 largest growth drivers are:
- Leasing of existing real estate
- SNO leases
- Developments
KRG has had multiple bumper quarters in a row with impressive leasing activity with rollups as high as 30% in addition to occupancy gains. The favorable leasing filters directly into same store NOI growth which has been stellar since the pandemic.
Strong leasing has resulted in multiple guidance increases.
It has also helped Kite achieve its highest ever FFO, now well above pre-pandemic levels.
All of the above should be well known by the market as it is historical data. Since valuation should be based on future earnings, it is the forward growth that is of greater interest here.
KRG’s FFO multiple of just over 10X implies that the market believes growth is coming to a close. A 10X multiple is mathematically appropriate in this environment for a steady company with no growth.
However, the 3 drivers we mentioned above are not for historical growth, they are drivers of future growth.
Leasing – mark to market opportunity
Market rates for KRG’s shopping centers are roughly $30 a foot. This can be measured by the actual contracts signed in the last 4 quarters:
- 995K square feet of new leases were signed at a weighted average rent per foot of $29.23.
- 1.16 million square feet of non-option renewals were signed at a weighted average rent per foot of $30.65
KRG’s existing leases are at a weighted average rent per foot of $20.59. That implies roughly 45% upside in rental rates as leases roll over. Below is the schedule at which KRG gets to re-lease their space.
2024-2026 collectively have 34.6% of revenues expiring at current average rates of $18.49 - $21.96.
The total mark to market opportunity once KRG marks its entire portfolio to market rates which I estimate at $30 per foot, would be incremental annual revenue of $250 million.
At pure margin that would be $1.14 per share or about 57% growth.
There are 2 significant caveats to this growth:
- It is over the course of 10 years of lease expiry
- Re-leasing is not free, especially not new leases
KRG needs to capex the properties a bit to pull in rental rates in the $30s. We will discuss leasing expenses in greater detail later.
SNO Leases kicking in
SNO leases refer to those which are signed by not yet operating. So a tenant may sign a rental agreement but perhaps it doesn’t start until March, for example.
While smaller in magnitude than the mark to market, SNO leases, are closer to guaranteed as the contracts are already inked. Per the supplemental:
“Portfolio leased-to-occupied spread at period end of 220 basis points, which represents $27 million of signed-not-open NOI.”
That is $27 million of incremental FFO or about $0.12 per share.
Developments
Developments are by far the smallest contributor to incremental FFO/share growth, but are still worth looking at because they represent a growth avenue that gets around the currently low cap rates of buying stabilized assets.
Below is KRG’s development roster:
While I consider it a positive that they have ample future projects planned, I would still consider the NPV of the future projects to be $0 as we don’t have any numbers with which to discern accretion or dilution.
We can, however, look at the active projects. With respect to future FFO growth the line items that matter most directly are KRG’s remaining spend and the remaining NOI to come online.
$32.6 million of incremental expense comes at a cost of $2.28 million annually assuming a 7% WACC. This expense offsets the incremental NOI resulting in an estimated $1.47 million of accretion to FFO or just under a penny per share.
Tallying the growth drivers
FFO per share growth on the positive side consists of the following:
- $1.14 per share over the next ~10 years from full mark to market
- $0.12 per share from SNO kicking in over the next year
- $0.01 per share from developments
Offsetting these will be the tenant improvement and leasing commissions involved in getting the portfolio into top shape for rental. It is difficult to measure exactly how much this will be as it will depend on the portion of leases that are renewed versus new. It also varies significantly property to property.
My best estimate would just be extrapolating recent TI and LC as leasing has rolled at a fairly steady pace for KRG given their laddered expiries.
Over the last 9 months, leasing expense was $65.399 million annualizing to $87.2 million or about $0.40 per share.
Thus, I would deduct 40 cents from the above which nets a grand total estimate of 87 cents per share of FFO growth over the course of the full period of marking leases to market.
It is not rapid growth in the tech company sense, but growth should always be considered in the context of valuation.
Valuation
Grocery anchored shopping centers in general are trading at fairly cheap multiples with an average 2023 multiple of 11.5X. KRG is cheaper than the peer set in absolute terms with a multiple just over 10X.
It looks even better when converting to a leverage neutral valuation as KRG keeps a low debt balance.
The vertical distance below the line indicates that KRG, ceteris paribus, is leverage neutral cheaper than its peer set.
Overall, I think that sets up for an attractive investment.
A 10X multiple is cheaper than most companies growing at the moderate pace discussed above. I would estimate the fair multiple for KRG is 14X FFO based on the following factors.
- Moderate growth
- Reasonably good visibility to growth
- Conservative leverage
- Stable business model
Risks to investment in KRG
While any company can be subject to idiosyncratic risks, KRG does not have anything that sticks out to me as a yellow flag. Thus, the risk factors would be more at a sector level.
Key factors to watch are:
- Ratio of retail store opening versus store closings (currently 2 openings per closing but could change with recession or other macro shocks).
- Appetite for anchor space and small shop space. KRG does power centers so they are a bit more anchor store heavy than their peers
- Changes to market rental rates of shopping centers could amplify or reduce mark to market growth opportunity
For further details see:
Kite Realty's Mark-To-Market Growth Is Not Priced In