JuSun
It’s no secret that real estate has been pressured this year, with higher interest rates spooking many investors. Perhaps that’s why net lease REIT STORE Capital (STOR) agreed to be acquired at a valuation that would have been seen as below market value in a “normal” economy.
However, not all REIT classes are the same, especially when it comes to shopping center REITs, which are better prepared for a sustained inflationary environment (if that happens) due to shorter duration leases, especially on small shops.
This brings me to Kite Realty Group (NYSE:KRG), which has made significant progress on transitioning its portfolio in recent years. If and when inflation subsides, I believe the market will resume an “asset grab” mode, with KRG positioned to rise.
Why KRG?
Kite Realty Group is an Indianapolis based REIT that has 60 years’ experience in developing, acquiring, and operating retail real estate. It’s been public since 2004, and is one of the Top 5 shopping center REITs in the U.S.
At present, KRG owns 183 open-air shopping centers and mixed-use assets. Its assets primarily centered around the growing Sun Belt region (67% of annual base rent), and strategic gateway markets (23% of ABR).
KRG’s management has adapted the company for an e-commerce environment, by transitioning the portfolio more towards essential services. This is reflected by the fact that 75% of KRG’s ABR now comes from centers with a grocery component.
The portfolio appears to be garnering strong interest from tenants, as same property NOI and ABR per square foot rose by 4.4% and 7% YoY during the third quarter. This was driven by very strong cash leasing spreads of 31% on 22 new leases, and 8.5% on 134 renewal leases, equating to a weighted average 11% blended lease spread. Also encouraging, the portfolio leased rate is high at 94%, reflecting a 20 basis point rise sequentially, and a 120 bps rise over the prior year period.
Looking forward, KRG is very well positioned from a balance sheet standpoint, with investment grade ratings of BBB and BBB- from Fitch and S&P. This is supported by a strong balance sheet with a net debt to EBITDA ratio of 5.4x, below the 6.0x level generally deemed safe by ratings agencies. The strength of KRG’s assets is reflected by the bond market’s willingness to lend it $300 million during the second half of this year at a fixed 3.95% interest rate for 3 years over a 7-year term.
This brings KRG’s total liquidity to $1.2 billion, which could go a long way in funding the development pipeline. This includes 4 active developments with limited future capital commitments of just $59 million.
Moreover, KRG had $38 million of signed and not yet open development in its pipeline, which should further boost its top and bottom line in Q4 and beyond. It’s also making use of its land bank by transitioning some assets into mixed use with a multifamily component, as outlined during the recent conference call:
In addition to our leasing efforts, our development team continues to further enhance the value of our entitled land bank. In fact, we recently took a significant step in establishing our vision for our adjacent land at One Loudoun. We receive rezoning approval to convert 2.9 million square feet of commercial GLA to 1,745 multifamily units and 1.9 million square feet of commercial GLA.
Adding entitled multifamily units at One Loudoun is a huge win for the project, considering the first phase of multifamily materially outperformed the pro forma absorption rates and rents per square foot. As a reminder, we’ll prudently evaluate each parcel in our land bank to determine the highest and best use of the real estate and the best risk adjusted returns for KRG.
While KRG’s 4.6% dividend yield isn’t particularly high, it is very well covered by a 49% payout ratio, based on FFO per share of $0.49 generated during the third quarter. As such, I would expect for meaningful dividend increases down the line, especially considering the development opportunities.
Turning valuation, KRG at the current price of $20.97 and forward P/FFO of 11.2 makes it reasonably attractive. This is considering the sizeable valuation gap from bigger peers Kimco Realty (KIM) and Regency Centers (REG), which have P/FFO of 13.5 and 15.6, respectively.
Analysts have a consensus Buy rating on the stock with an average price target of $25, and Bank of America (BAC) recently upgraded KRG to a Buy from Neutral, citing its leasing strength, merger benefits (from acquiring RPAI), and its high exposure to grocers in the Sunbelt region. All of these factors translates into potentially very strong double-digit total returns in the near term.
Investor Takeaway
KRG is on track to generate potentially strong growth in both the top and bottom line, driven by promising leasing activity, higher rent spreads and prudent capital allocation. The solid balance sheet also provides plenty of dry powder for KRG to pursue development opportunities, which should further boost earnings in the quarters ahead. Finally, KRG’s favorable industry dynamics, development pipeline, and low valuation makes it a buy for potentially strong returns.
Be the first to comment