Simon Property Group's Earnings Calls: Contradictions Emerge in Capital Allocation, Transaction Strategy, and TRG Portfolio Cap Rate Guidance

Financials Results

• Revenue: Not explicitly provided; FFO per share $3.20
• EPS: Not explicitly provided; FFO per share $3.20

Guidance:

• Increased full-year 2023 FFO per share guidance from $11.85-$12.25 to $12.15-$12.25, an increase of $0.30 at the midpoint.
• Expects $0.05 lower FFO contribution from SPARC in Q4 2023.
• Q4 2023 OPI contribution lowered by roughly $0.20; full-year OPI lowered by about $0.15 (excluding the $0.05 SPARC impact).
• Expects strong tenant demand and increased occupancy, with leasing momentum continuing.

Business Commentary:

• Strong Financial Performance:
• Simon Property Group reported third quarter funds from operations of $1.2 billion or $3.20 per share. Real estate FFO was $2.91 per share, up from $2.83 in the prior year.

• The increase was driven by higher rental income and noncash after-tax gains from partial sales of SPARC and ABG, despite higher interest expenses.

• Leasing Activity and Occupancy Levels:

• The company signed over 970 leases for approximately 4.3 million square feet in Q3, with more than 3,500 leases signed for 15 million square feet in the first 9 months of 2023.

• Leasing momentum is strong due to broad-based retail demand, leading to increased occupancy levels, which reached 95.2% for malls and outlets, up 70 basis points from the previous year.

• Dividend Increase and Share Buybacks:

• Simon Property Group announced a dividend increase of 5.6% to $1.90 per share for Q4 and purchased 1.27 million shares for $140 million.

• The dividend increase and share buybacks reflect the company's strong financial position and strategy to return capital to shareholders, especially given the undervalued stock price.

• Guidance Increase:

• The company increased its full-year 2023 FFO guidance from $11.85 to $11.95 to $12.15 to $12.25 per share, an increase of $0.30 at the midpoint.

• This adjustment was due to gains from the SPARC Shein deal and improved performance in the real estate business, despite some headwinds like lower contributions from SPARC post-deal.

• Development and Refinancing Efforts:

• Simon Property Group completed refinancing for 11 properties totaling $960 million at an average rate of 6%.
• The company is focused on redevelopment and new development projects, such as Brea Mall and a new outlet in Jakarta, driven by strong tenant demand and strategic growth plans.

Sentiment Analysis:

Overall Tone: Positive

• Management expressed being 'pleased with our third quarter results,' noted the business is 'performing well and is ahead of our plan,' highlighted 'strong broad-based demand,' 'record levels' for base minimum rent, and increased guidance. They stated 'Tenant demand is strong, occupancy is increasing' and 'we are very experienced at managing our business through volatile periods.'

Q&A:

• Question from Ronald Kamdem (Morgan Stanley): Just one on some of the guideposts you've given in the past, as we're flipping the calendar to 2024, you talked about sort of 3% organic growth as achievable. Just wondering how you're thinking about that and how we should think about potential interest cost headwinds as that sort of roles?
  Response: Feels good about comparable NOI growth; debt is reasonably laddered, so some interest expense headwinds expected but business growth anticipated for next year.

• Question from Ronald Kamdem (Morgan Stanley): I was just going to say if I can ask a follow-up just on the $0.30 guidance raise. I think you talked about $0.32 gain and then $0.05 lower from the retailers. Just wondering, is there any other sort of puts and takes that we should be mindful of?
  Response: The raise is due to the $0.05 lower from the SPARC Shein deal, a couple of cents loss from mark-to-market of securities, and the real estate business significantly outperforming budget.

• Question from Caitlin Burrows (Goldman Sachs): David, I know you gave some numbers on recent leasing activity, which sounds really strong. I was wondering if you could give some additional context maybe to how that leasing activity compares to recent and pre-pandemic years. Maybe what that means for pricing and how that could impact permanent occupancy?
  Response: Occupancy expected to be very high by year-end; demand is strong across categories, pricing is comparable to the 2015-17 era, and about 30% of deals are new, driving rent increases.

• Question from Samir Khanal (Evercore ISI): David, maybe provide color on how your malls are performing versus outlets. Maybe from a regional standpoint, coastal non-coastal Sunbelt, just trying to see if there's any differences from a leasing standpoint.
  Response: Tourist properties (mostly outlets) are seeing good growth; Sunbelt performing well; no significant bifurcation between malls and outlets; luxury sales flattened in Q3 but was retailer-specific.

• Question from Alexander Goldfarb (Piper Sandler): On -- as you guys gain leverage with the tenants, are you seeing tangible ability to get more favorable terms. One of the issues with retail over time has been the tenants, especially the larger tenants or the more anchor-ish or more fashion -- like the hot tenants of the day are driving lease terms traditionally. Curious if you're seeing a change in that, which would translate to an ability to accelerate rent growth, NOI growth, et cetera?
  Response: Attributes success to a diverse, high-quality portfolio and scale, not leverage over tenants; strong retailer demand and market rents; retailers know Simon Property Group is reliable and will stick to deals.

• Question from Jeffrey Spector (Bank of America): Great. David, just want to tie in some of the leasing comments, the momentum you're seeing, the deals in the pipeline, the high occupancy levels to the redevelopment pipeline. And just, I guess, how are you thinking about that pipeline and the ability to increase that? Like how are you going to satisfy some of the needs out there and continue to capture that market share, maybe even more.
  Response: Has the ability to invest in redevelopment but faces higher hurdles due to increased cost of capital; will maintain leadership while ensuring economic returns are competitive with buying back stock.

• Question from Michael Goldsmith (UBS): David, you specifically mentioned the performance of the real estate business on this call several times [indiscernible] just been strong. At the same time, this quarter, you sold off some of SPARC. So how can you continue to refine some of the ancillary parts of the business so that the strength that we're seeing and that you're talking about on the core business can continue to show it through?
  Response: Ancillary investments (under 5% of earnings) are volatile; strategy is to monetize them over time and use proceeds to buy back stock, as they are accretive and provide value despite low GAAP earnings.

• Question from Floris Gerbrand van Dijkum (Compass Point): David, so I was curious on TRG. So I noticed the occupancy gets a little bit -- you essentially -- you want increasing your ownership by 4% by issuing some of OPUs. What price was the stock issued at? And what yields are you buying? What's the implied cap rate on the TRG business? And how should we think about that also as it relates to other potential opportunities in the market. And how much flexibility was there? And then maybe, I guess, in terms of the timing of the next sort of puts or hurdles that you have for increasing your interest in that business going forward?
  Response: The exchange was at appraised value, roughly equivalent to pre-COVID deal levels; TRG NOI is higher than in 2019; plans to use capital to buy back Simon stock to offset dilution; the Taubman family has 16% remaining, with potential for further puts next year.

• Question from Vince Tibone (Green Street): So minimum base rents were about 3% year-over-year, which is about the same level as contractual bumps. So I'm just trying to get a sense of leasing spread economics here. Like does that mean leasing spreads are also in the low single-digit range? Are there other factors influencing this metric one way or another?
  Response: The overall portfolio average is influenced by new leases driving rent higher; renewal spreads must be higher than the 3% contractual bumps to achieve the portfolio increase, but specific renewal spread details not provided.

• Question from Greg McGinniss (Scotiabank): David and Brian. I'll keep this to 1.5 questions for you. So last quarter, you spoke about potentially being more active with asset recycling or reallocating real estate capital. Have the challenges facing the financing market changed those expectations at all? Or how are you thinking about that today? And how are higher interest rates impacting your customers and tenants?
  Response: Higher interest rates affect consumer affordability (more for moderate-income), but demand remains strong; cost of capital is up, so development/acquisition activity is measured against stock buybacks; asset sales to create liquidity for buybacks are favorable.

• Question from Michael Mueller (JPMorgan): Just a quick one here. I know this is a bit of a hypothetical. But do you think you would have bought stock back if you didn't issue the shares to Taubman?
  Response: Would buy back stock given any liquidity event or dilution (like TRG issuance); development/redevelopment projects are measured against buyback returns; may sell assets to buy back stock if math works.

• Question from Nicholas Joseph (Citigroup): Nick Joseph here with Craig. David, you've talked a lot on the share buybacks, it sounds like in your answer to the last question, you're open to asset sales and other monetization opportunities. What are you seeing in the transaction markets today in terms of those asset sales? Where are cap rates? What's the buyer pool like? And are you seeing an opportunity to try to crystallize some of that disconnect between the stock price and where you would hope to sell an asset?
  Response: Domestic retail transaction market is not active; few opportunities in residential or hotels; not expecting significant activity to drive strategy currently.

• Question from Linda Yu Tsai (Jefferies): About 6% of ABRs on month-to-month leasing and then 12% expiring for '24. How much of the month-to-month is getting converted to permanent or should that number grow? And then in terms of the 12% expiring in '24, what's been addressed from a renewal standpoint from where you stand today?
  Response: Most 2023 leases are agreed; negotiations for 2024 leases are more than halfway done; processing lag is clearing about 2.2 million square feet per quarter.

• Question from Haendel St. Juste (Mizuho): Dave, I just had a quick follow-up on the consumer retail sales line of question from earlier. I think you noted your portfolio sales were flattish during the quarter. We've heard from other sectors, storage apartments, which seemed like the consumer hit a bit of a wall during the third quarter in September. I'm curious if you saw anything within the quarter, maybe in September of that sort and then perhaps what's your expectations in the near-term outlook for retail sales for your portfolio and the consumer as we head into the holiday season of next year.
  Response: Expects retail sales to be relatively flat in Q4; cautious due to inflation and rates affecting moderate-income consumers, but no downturn anticipated; higher-income consumer remains strong.

• Question from Haendel St. Juste (Mizuho): Got it. I appreciate that. If I could squeeze in a follow-up. I think you mentioned earlier as well that you started, I think it was $960 million of new redevelopment at 6% yields and you talked about a higher hurdle rate. Maybe some color on perhaps what that hurdle rate today is and where the next batch of redevelopment yields or projects would need to be and where we continue to migrate soon?
  Response: Hurdle rates vary by project and purpose; must be higher due to increased cost of capital; will only proceed if creating value and not dilutive; thresholds have been raised but specific rates not quantified.

• Question from Juan Sanabria (BMO Capital Markets): Saving the best for last, I love it. Just curious if you could comment on kind of the watch list you've commented about the consumer, but maybe what the bad debt has been year-to-date with the historical levels is in your perspective as you think about '24?
  Response: Watch list is relatively low, expanded by only 2-3 retailers this year; none are in top 10/20 tenants; exposure is minimal, and debt levels are at a low point historically.

Contradiction Point 1

Capital Allocation Priority: Stock Buybacks vs. Redevelopment Investment

This represents a significant shift in corporate financial strategy and capital deployment priority. The stated hierarchy moves from a balanced approach between property investment and shareholder returns to a rigid, three-tiered priority system where dilution reversal is paramount, dividends follow, and new capital deployment is a residual option. This change directly impacts expectations for shareholder returns, portfolio growth, and the company's cost of capital.

How do strong leasing and high occupancy relate to the redevelopment pipeline, and how do you plan to expand it to gain market share? - Jeffrey Spector (Bank of America)

2023Q3: The strategy is to find the right balance between investing in properties and returning capital to shareholders. - David Simon(CEO)

How do you prioritize capital allocation: dividend buybacks, development, redevelopment, etc.? - Adam Kramer (Morgan Stanley)

2025Q3: Priorities are: 1) Quarterizing the 5 million OP units issued for the TRG deal to return share count to pre-issuance levels (subject to market conditions), 2) Growing the dividend, and 3) Capital redeployment where it is accretive... - David Simon(CEO)

Contradiction Point 2

Transaction Market Activity and Domestic Asset Sales Strategy

This indicates a material change in the company's operational and portfolio management strategy. The shift from downplaying domestic asset sales as a primary driver to actively planning to "unlock and re-encumber" assets for portfolio optimization represents a significant pivot towards a more aggressive and active role in the asset transaction market. This alters the expected capital deployment profile and portfolio composition.

What's the current state of asset sales in transaction markets, where are cap rates, and is there an opportunity to capitalize on the gap between stock prices and asset sale prices? - Nicholas Joseph (Citigroup, for Craig Mailman)

2023Q3: Domestic retail transaction volume is low. The company has assets globally... but domestic asset sales are not the primary driver of expected activity. - David Simon(CEO)

Will you unencumber the TRG assets and consider selling parts of the portfolio? - Michael Mueller (JPMorgan)

2025Q3: The company expects to over time unlock and re-encumber assets using unsecured capital to improve the overall unencumbered asset base. - Brian McDade(CFO)

Contradiction Point 3

Retail Sales Outlook and Consumer Behavior

This reflects a notable shift in market and tenant performance outlook. The change from expressing strong confidence in tenant demand and pricing power ("comparable to the 2015-2017 era") to a more cautious characterization of sales as stabilized but not fully robust ("not yet hitting 'on all cylinders'") indicates a potential reassessment of market conditions or internal performance metrics. This affects expectations for future leasing velocity, occupancy, and portfolio value.

How does recent leasing activity compare to pre-pandemic levels and current trends, and what impact does this have on pricing and permanent occupancy rates? - Caitlin Burrows (Goldman Sachs)

2023Q3: Tenant demand remains strong across categories... Pricing power is favorable, comparable to the 2015-2017 era... - David Simon(CEO) & Brian McDade(CFO)

Was the sales increase widespread? Did a few tenants drive the sales increase? Are tenant base upgrades showing impact yet? - Caitlin Burrows (Goldman Sachs)

2025Q3: **Sales are not yet hitting 'on all cylinders,' but they are stabilized. Higher-income centers performed better, while value-oriented centers were more flat.** - David Simon(CEO)

Contradiction Point 4

Cap Rate Expectations for TRG Portfolio

This involves a clear change in financial guidance and transaction valuation. Providing a specific, elevated target cap rate (north of 8%) for a major portfolio acquisition, including synergies, in 2025 Q3 directly contradicts the earlier non-committal response in 2023 Q3 that the transaction was immaterial and similar to pre-COVID deals. This represents a material shift in how the company communicates the expected returns and value of its largest deal.

What was the issuance price and implied cap rate for the TRG transaction (4% OPU issuance ownership increase)? How should we assess future opportunities and the timing for the next put right? - Floris Van Dijkum (Compass Point)

2023Q3: The transaction is not material (~under $200M) and is similar to pre-COVID deal values. - David Simon(CEO) & Brian McDade(CFO)

Could you clarify the final 12% pricing and how it compares to the initial 7.25%? Will the cap rate exceed 8% in the coming years? - Alexander Goldfarb (Piper Sandler)

2025Q3: The overall transaction for the TRG portfolio results in a cap rate of a little over 7.25% on today’s numbers. Adding operational synergies and efficiencies will increase this to north of 8%. - David Simon(CEO)

Contradiction Point 5

Strategic Capital Allocation and Investment Criteria

This shows a shift in the company's investment thesis and growth strategy. The move from actively seeking accretive acquisitions and internal development opportunities to a stance where such investments are deprioritized in favor of share buybacks, due to higher hurdle rates, indicates a significant change in risk appetite and growth expectations. This alters the long-term growth trajectory and return profile for investors.

How does strong leasing and high occupancy affect the redevelopment pipeline, and how will you expand it to gain market share? - Jeffrey Spector (Bank of America)

2023Q3: The company has significant capital... but faces higher required returns... The strategy is to find the right balance between investing in properties and returning capital to shareholders. - David Simon(CEO)

Can you discuss the upside at Brickell City Centre and potential for additional acquisitions? - Caitlin Burrows (Goldman Sachs)

2025Q2: The company is able to do acquisitions because it doesn't need to sell assets or downsize, and hopes to announce a couple of more accretive deals this year. - David Simon(CEO)