Retail Opportunity Investments: Banner Operating Performance, But Can It Continue?

Retail Opportunity Investments Corp. (NASDAQ:ROIC) is a West Coast-based real estate investment trust (“REIT”) that has a large interest in grocery/drug-anchored properties.

Since a prior analysis on their Q2FY22 results, shares have returned just under 9.5%. This compares favorably to the broader S&P’s (SPY) 6.7% return over the same period.

Following their run higher, shares were recently downgraded by Raymond James on doubts regarding further runway for growth. While the outlook for the stock is positive, the current downgrade appears justified.

Q3 results did come in hot, with record leasing activity and generally favorable commentary. But an intention to pause investment activity strips the company of an important lever of future growth. While organic opportunities exist, it’s unlikely to be enough to produce outsized returns for investors.

Recent Performance

ROIC logged their strongest quarterly leasing performance of the year in the period ended September 30, 2022. During the quarter, the company leased over 480K square feet (“SF”) of space. This represents about 40% of their total YTD leasing volume through Q3 of +$1.2M. This is a new record for the company.

The record leasing volumes have contributed to continual gains in occupancy through the year. At the end of the first quarter, portfolio occupancy stood at 97.2%. That then increased to 97.6% in the second quarter, and it now stands at 97.8%. This is 10 basis points (“bps”) short of their record achieved in 2019.

In addition to occupancy gains, the company is also benefitting from significant rate growth on both new and renewed signings. Impressively, cash base rents on new leases were up 48%. This was complemented by 6.8% growth on renewals for a combined blended growth rate of 13.6%.

And despite significant rate growth, the company has yet to experience meaningful tenant pushback. On the contrary, management cited continuing demand, especially from their long-standing anchor tenants, who are increasingly seeking early renewals. In some cases, these negotiations are occurring 9 months to a year in advance of their expirations.

YTD, the company has completed 884K SF of renewals. And about 40% of this total was completed in Q3. In addition, during the quarter, ROIC renewed 182K of anchor space. And of the total anchor space renewed, three quarters of the space was not due for renewal until next year.

The strong demand for space is a testament to the positive fundamentals in the West Coast markets, the strongest being the significantly constrained supply dynamics. This not only supports current occupancy levels, but in ROIC’s case, it is resulting in tenants accelerating negotiations on existing leases and providing pricing power to the company.

Looking ahead, ROIC expects continuing strength in rental rate and same-center growth in net operating income (“NOI”). Accordingly, full-year guidance for funds from operations (“FFO”) for the remainder of 2022 was narrowed to a range of $1.09 to $1.11/share from a previous range of $1.08 to $1.12/share. The lowered top end reflects expectations of higher interest on their current debt holdings.

Liquidity And Debt Profile

ROIC has sufficient liquidity to meet their short and long-term obligations. In addition to cash on hand and their positive reoccurring operating cash flows, the company has access to a +$600M credit facility, to which +$52M is outstanding.

Their overall debt load stood at 43% of total capitalization at quarter end. And as a multiple of EBITDA, net debt declined slightly to 6.6x in the third quarter from 6.7x in the second.

This is despite additional acquisitions during the quarter totaling +$60M. Overall, their total gross assets grew by +$42M yet their total principal debt increased by less than +$6M.

Nevertheless, interest expense still tracked higher during the period. In total, interest was up +$300K during the period. Contributing to the increase is their higher exposure to floating rate date, at 26% of their total stack.

Interest, however, was still adequately covered by earnings. Currently, interest coverage stands at 3.5x, and this is consistent with historical averages.

Down the pike, the company does have near-term maturities of about +$580M, +$250M of which is due in late 2023. Though management has yet to provide plans on how the 2023 maturity will be addressed, it’s likely to be a topic of discussion on releases in the first half of 2023.

Dividend Safety

ROIC currently provides a quarterly payout of $0.15/share. At current pricing, this represents an annualized yield of about 4%.

The payout is still 33% below their payout they provided just prior to the start of the COVID-19 pandemic. It was, however, recently increased by 15% earlier this year.

The increase did result in a higher payout ratio in relation to FFO, but coverage remains adequate. At current levels, the payout stands at 55.6% of FFO. While this is up from the 44% payout level in Q3 of 2021, it is still less than the sector median of 65%.

Main Takeaway

ROIC is having a banner year in 2022. YTD leasing volumes through Q3 have surpassed records and occupancy levels are hovering just shy of records achieved in 2019. In addition, rents are still growing at double-digit rates, with rates on new cash signings on same-center space up a whopping 48% during Q3.

An increasing share of their tenant pool initiating negotiations well in advance of expirations is another indication of the positive fundamentals in their West Coast operating markets. Part of this is due to the significantly supply constrained nature of the region, in combination with the favorable demand drivers of their grocery/drug-anchored properties. This is resulting in enormous pricing power that continues to show very little signs of abatement.

While the year has certainly progressed better than expected, one could be forgiven for expressing skepticism on an encore performance in 2023. As it is, there is quite a bit uncertainty in transactional markets. This has led to a notable intention to pause investment activity moving forward. This closes a significant driver of growth.

And with occupancy nearly at records levels, the organic opportunities don’t appear lucrative enough. The pending merger between Kroger (KR) and Albertsons (ACI) also creates additional uncertainties, especially since they are the two largest tenants served by ROIC. While shares can certainly track higher in the coming periods, investors seeking outsized returns would likely be better off deploying capital elsewhere.