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Retail Opportunity Investments Corp. (NASDAQ:ROIC)
Q3 2018 Earnings Conference Call
Oct. 24, 2018, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to Retail Opportunity Investments 2018 third quarter conference call. Participants are currently in a listen-only mode. Following the company's prepared comments, the call will be opened up for questions.

Please note that certain matters discussed in this call today constitute forward-looking statements within the meaning of federal securities laws. Although the company believes that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, the company can give no assurance that these expectations will be achieved. Such forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause actual results to differ materially from future results expressed or implied by such forward-looking statements and expectations.

Information regarding such risks and factors is described in the company's filings with the Securities and Exchange Commission, including its most recent Annual Report on Form 10-K. Participants are encouraged to refer to the company's filings with the SEC regarding such risks and factors, as well as more information regarding the company's financial and operational results. The company's filings can be found on its website. Now I would like to introduce Stuart Tanz, the company's Chief Executive Officer.

Stuart A. Tanz -- President and Chief Executive Officer

Good morning, everyone. Here with me today is Michael Haines, our Chief Financial Officer, and Rich Schoebel, our Chief Operating Officer. We are pleased to report that the company posted another active quarter. Capitalizing on the demand for space, we achieved a new record high portfolio lease rate, ending the quarter at a very strong 97.8%.

We executed over 100 leases during the quarter with a good mix of new and renewed activity, while also achieving solid rent growth. As it is shaping up thus far, we are on track to lease a record amount of space for the year. In addition to our success on the leasing front, we also strengthened our balance sheet during the third quarter, raising equity and paying down debt. In terms of acquisitions, market conditions had begun to show signs of becoming favorable again; however, the record jump in interest rates has brought back the uncertainty that we saw in the marketplace during the first half of the year. Therefore, we continue to be cautious and patient.

Turning to the redevelopment opportunities that we introduced on our call last quarter, we are continuing to analyze the feasibility of adding a mixed-use component, namely multi-family, to a select group of our shopping centers. Our strategy is aimed at furthering the long-term competitive position of our shopping centers, and enhancing the underlying intrinsic value of our portfolio. Thus far, we have identified 20 properties that we think are potentially feasible for adding a multi-family component. Of those 20, we are currently under way with the entitlement process on three opportunities, specifically at two of our shopping centers in the San Francisco Bay Area and one up in Seattle.

Based on our preliminary analysis, all together these three opportunities represent about a $200 million investment, with a projected unlevered yield in the mid-7% range. One of the two San Francisco opportunities involves redeveloping a Kmart site that is adjacent to our shopping center in Knoll. Kmart had a long-term ground lease on the site, which we acquired during the third quarter, fortunately just ahead of the Sears bankruptcy filing, where we could have lost control of the site. Very importantly, this is the only Kmart exposure that we had in our entire portfolio.

As we move forward with these three opportunities, our goal is to carefully mitigate the development risk. To that end, we intend to partner with a seasoned multi-family developer that has considerable expert experience and expertise in building multi-family properties specifically in these markets, where we can best capitalize on our combined market knowledge and relationships with the local municipalities.

We are currently in discussions with several key players, exploring a variety of partnership arrangements, ranging from us simply contributing the land as our equity contribution, to taking a larger, more equal position. Assuming we do take a more meaningful stake, we would look to potentially fund our capital investment in part through certain non-core asset sales.

Speaking of dispositions, during the third quarter, we sold one property for $28 million. It was the lone property that we owned in Nevada on the California border east of Sacramento. Beyond this property, we also have a few other potential asset sales that we are contemplating, including additional properties in Sacramento. Our long-term goal is to exit the Sacramento market in an orderly fashion as we complete certain leasing objectives and then redeploy the capital in other core markets, as well as redevelopment opportunities as they take shape.

Now I'll turn the call over to Michael Haines to take you through our financial results for the third quarter. Mike?

Michael B. Haines -- Chief Financial Officer

Thanks, Stuart. For the three months ended September 30, 2018, the company had $73.9 million in total revenues, and $25.3 million in operating income. GAAP net income attributable to common shareholders for the third quarter of 2018 was $14.2 million, equating to $0.12 per diluted share. In terms of funds from operations, for the third quarter, FFO totaled $35.1 million, equating to $0.28 per diluted share.

With respect to our financial results for the first nine months of 2018, the company had approximately $221 million in total revenues, and $76.4 million in operating income. Net income for the first nine months of 2018 totaled $32.2 million, or $0.28 per diluted share. In terms of FFO, the company had approximately $106 million total FFO, or $0.85 per diluted share for the first nine months of 2018.

With respect to property level net operating income, on a same-center comparative basis, cash NOI increased by 2.5% for the third quarter of 2018, and by 2.6% for the first nine months of the year. Included in the third quarter was a one-time expense totaling roughly $200,000 in connection with an anchor lease that we recaptured. As Rich will discuss, we already have a new tenant lined up to take the space, at a notable increase in the rent. Excluding the expense, the increase in same-center NOI would have been closer to 3% for both the quarter and year-to-date.

As Stuart touched on, during the third quarter, we raised some equity through our ATM program. In total, we issued approximately $1.25 million common shares, raising $24.2 million in gross proceeds. Taking the equity proceeds together with the asset sale that Stuart spoke of, during the third quarter we reduced our debt by $64 million, including retiring a $9 million mortgage, along with reducing our credit line balance. As a result, at September 30th, the company had approximately $1.5 billion of debt outstanding, the vast majority of which was unsecured. In fact, our secured debt is now down to less than $90 million, encumbering just four properties. In other words, over 95% of our portfolio, 87 out of our 91 shopping centers is currently unencumbered.

With retiring that one mortgage, we now have 0 debt maturing for the next three years, when our credit line comes up for renewal. With respect to our credit line, during the third quarter, we lowered our balance by $55 million, down to $137 million outstanding as of September 30th. In step with lower our debt, our interest coverage increased to 3.3x for the third quarter.

Finally, in terms of the FASB accounting change requiring internal leasing cost to be expensed rather that capitalized, when the accounting change takes effect next year, the impact to our financials will be modest, adding only about $1.2 to $1.3 million annually to our G&A, equating to roughly $0.01 per share, which is less than 1% of our annual FFO. Now I'll turn the call over to Rich Schoebel, our COO, to discuss property operations. Rich?

Richard K. Schoebel -- Chief Operating Officer

Thanks, Mike. As Stuart noted, demand for space across our portfolio continues to be strong. National and regional grocers, as well as other daily necessity and value-oriented retailers continue to seek expansion and relocation opportunities on the West Coast. Notwithstanding our anchor occupancy being at 100%, we continue to proactively seek out any underperforming space in order to capitalize on this anchor demand.

As an example, as Mike mentioned, during the third quarter we recaptured an anchor space, replacing them with a strong, value-oriented grocer that is expanding in the marketplace. Not only are we achieving a significant increase in rent, close to 3x what the previous tenant was paying, the previous tenant also had an old restriction on the property that's now been removed, enabling us to build an additional 5,000-square-foot pad at the shopping center.

In terms of smaller format tenants, the demand continues to be driven predominantly by service users, including wellness and fitness concepts, organic, health-oriented restaurants, and a variety of children-focused users, ranging from learning centers to day care facilities. The common thread with all of these small-format users is that they are all internet resilient, and they are all looking for shopping centers conveniently located to their target consumers. From our perspective, these are ideal tenants for us in several key aspects.

Given their small format, we are able to fill those last bit of remaining, hard-to-lease spaces, enabling us to bring certain properties to a full 100% lease, which in fact we accomplished at several of our properties during the third quarter. Additionally, these types of users draw consistent foot traffic to our centers, particularly during weekdays and evenings, which serves to bolster sales and activity at our larger, daily necessity anchor tenants.

To take you through our specific leasing results for the third quarter, starting with occupancy, as Stuart noted, we achieved a new record high for the company, ending the third quarter at 97.8% leased. Breaking the 97.8% down between anchor and non-anchor space, as I mentioned, our anchor space continues to be 100% leased, which is now the seventh conservative quarter at 100%, and the 19th conservative quarter at or above 99%. In terms of our shop space, we continue to work hard at leasing the available space we have across our portfolio. In fact, during the third quarter, we increased our inline space to a new high of 95.3% leased as of September 30th.

During the third quarter, we executed a total of 106 leases, totaling 443,000 square feet, achieving a 10.2% increase in same-space cash rent on average. With respect to new leases, during the third quarter we executed 48 leases, totaling 139,000 square feet, achieving a 17.1% increase in same-space comparative cash-based rent on average. That increase was largely driven by an anchor lease that we signed during the third quarter, where we achieved a nearly 100% increase in base rent.

In terms of shop space, during the third quarter the majority of inline spaces that rolled were essentially close to market, so there was only a nominal increase. That's not indicative of a trend. It's simply a function of the specific leases that rolled and were released during the quarter. Much of the shop space that we leased during the quarter were small spaces. Many less than 1,000 square feet, where the releasing rents can vary widely depending upon the specific space and the prospective tenants.

Looking ahead, we fully expect to continue achieving solid rent growth going forward. In terms of renewal activity, during the third quarter, we executed 58 renewals, totaling 304,000 square feet, achieving an 8.6% increase in cash base rent on average. Lastly, in terms of the economic spread between billed and leased space, meaning newly signed tenants that have not yet taken occupancy and commenced paying rent, at the start of the third quarter, the spread stood at $7.1 million in additional annual rent on a cash basis.

During the third quarter, tenants representing about $3.7 million of that incremental $7 million starting paying rent, of which $487,000 was received in the third quarter. Taking the remaining $3.4 million together with our leasing activity during the third quarter, as of September 30th, the spread was about $5.5 million. Now I'll turn the call back over to Stuart.

Stuart A. Tanz -- President and Chief Executive Officer

Thanks, Rich. It's safe to say that this has been an unusual year for us. As it relates to acquisitions, we are accustomed to acquiring $300 to $400 million each year. However, as I noted in my opening remarks, we continue to be cautious in this current environment. That being said, we are, as we always have, proactively seeking out off-market opportunities and continue to explore a number of interesting transactions.

In terms of our FFO and same-center NOI this year, there have been two underlying factors that have impacted our performance. First is the slow permitting process as it relates to both our ability to deliver newly leased space which ties to GAAP rent commencement. And then once we do deliver the space as it relates to the tenants getting final signoff from the city to open their stores, which ties to our cash NOI. In our 25 years of operating in these markets, we've never experienced this type of delay and backlog with the various municipalities, which in turn has made it increasingly challenging in terms of our ability to forecast our results.

The second factor which ties to the slow permitting process is the extended downtime between leases. As the year has progressed, the downtime is proving to be longer than what we originally projected, as it relates to our property level budgeting for 2018. Notwithstanding being on pace to lease a record amount of space this year and averaging 20% growth thus far in terms of new leasing spreads, unfortunately the record leasing together with the slow permitting process does mean additional downtime, which in the short term impacts both GAAP and cash-based rents, as well as [CAM] recoveries.

To be clear though, we are still achieving growth this year in terms of our total GAAP rent, total FFO, and same-center cash NOI. It's that we had expected the growth to be a bit higher based on our original budgeting, which we would've achieved had it not been for the slower-than-anticipated permitting process and added downtime.

Taking these factors into account together with the equity issuance in the third quarter, along with assets sales, our FFO guidance range for the year is now $1.13 to $1.15. In terms of same-center NOI, we expect the year-over-year increase to be between 2.5% and 3%. While this has been an unusual year, the fundamentals of our markets, our portfolio, and our business remain sound. As Rich highlighted, retailers continue to push forward with expansion plans on the West Coast.

In fact, we just met a few weeks ago with many of our key tenants at the Los Angeles ICSC Conference. I can tell you that they all remain very upbeat about growing their presence on the West Coast. Additionally, our core metro markets remain among the most highly protected, supply constrained markets in the country. Our portfolio is well situated in these markets. With that as a backdrop, we continue to be confident in the future long-term prospects of our portfolio and our business overall. We look forward to completing 2018 and turning our sights to 2019 and beyond. Now we'll open up the call for your questions. Operator?

Questions and Answers:

Operator

Ladies and gentlemen, at this time, if you have a question please press the * then the number 1 key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the # key. Once again, to ask a question at this time, please press * then 1. Our first question comes from the line of Collin Mings from Raymond James. Your line is now open.

Stuart A. Tanz -- President and Chief Executive Officer

Good morning, Collin.

Collin Mings -- Raymond James & Associates -- Analyst

Hey. First question from me. Just Stuart, as you explore options for the redevelopment opportunities that you outlined, the three projects. Can you maybe just talk a bit about how you're thinking about the trade-off between potentially having a larger stake in projects and sharing more on the upside, versus complicating what has historically been a pretty straightforward story?

Stuart A. Tanz -- President and Chief Executive Officer

Collin, at the present time, we have no intention in getting into the multi-family business. We are very proud of the straightforwardness and transparency and simplicity of the company. So as we move forward, we still are a bit -- we haven't yet determined the final structure of these transactions. But right now, we're just looking at contributing the land, and really that's the role we're playing at this point in terms of moving this process forward. So I really can't get -- there are lots of options, but the key for us is to keeping that decision really on the basis of what we've done in the past, which is simplicity, straightforwardness, and transparency.

Collin Mings -- Raymond James & Associates -- Analyst

Okay. So it sounds like maybe in the prepared remarks, you're just making a point that there's a lot optionality here, but in terms of a go-forward strategy, the focus is what you've historically done. Is that fair?

Stuart A. Tanz -- President and Chief Executive Officer

That is correct.

Collin Mings -- Raymond James & Associates -- Analyst

Okay. Then as far as the guidance reduction, appreciate the details on some of the moving pieces there. Can you just talk a little bit more, two parts, in terms of clarifying. When we think about the $0.04 reduction at the midpoint, is that really all just lower NOI than have been previously forecast? Then really the second part of that, how are you working with some of the municipalities and other constituents as it relates to getting this process to move quicker going forward?

Stuart A. Tanz -- President and Chief Executive Officer

I'll let Rich answer the second part of the question, which is the municipalities. Then Mike, you can jump in and take the mortgage detail.

Michael B. Haines -- Chief Financial Officer

Hey, Collin. It's Mike. As far as the components of the guidance lowering, there's a couple different things. Obviously, you picked out most of the stuff from the press release. We raised some equity in Q3, so that's going to impact Q4 and the year-to-date. We had the asset sale, so the NOI off of that asset is going to be nonexistent in Q4. We've got anchor revenue coming from the one anchor that we did recapture in the third quarter. That's going to impact it as well. Then we're also taking into account the continued downtime due to the permitting delays in getting tenants open. So those four primary factors are what caused us to reguide to a lower number.

Richard K. Schoebel -- Chief Operating Officer

Then in terms of trying to get ahead of the permitting process, we do several different things. One is we use expediters when available. We also require the tenants to hire an expediter for their permitting process. Then in certain municipalities, like we've touched on before, like the City of Seattle, where it takes six months just to get an intake appointment, we are just scheduling those appointments even when we don't have something to submit, so that we're in the queue. So we're trying to be as proactive as we can, looking for every opportunity to shorten that timeframe.

Collin Mings -- Raymond James & Associates -- Analyst

All right. Then just one last one for me. Just on the focus on de-leveraging, Mike, just in the past you guys touched on being below 6x by year end. I'm sorry, below 7x by year end. Is that still the goal? At this point of the year, how should we think about additional asset sales closing before year end?

Stuart A. Tanz -- President and Chief Executive Officer

Asset sales, probably you will see more of that before year end. Again, we've taken that into consideration on our guidance. But Mike, the first part of the question?

Michael B. Haines -- Chief Financial Officer

Well, as far as de-levering, obviously we would like to do more acquisitions, but that's going to be subject to market conditions. We originally communicated $25 to $50 million before the end of the year. We're halfway there. We'll just see as the market plays out. Price-wise, we'll see if we can execute some more before year end.

Collin Mings -- Raymond James & Associates -- Analyst

All right. I'll turn it over. Thanks, guys.

Stuart A. Tanz -- President and Chief Executive Officer

Thank you.

Operator

Our next question comes from the line of Jeremy Metz from BMO Capital Markets. Your line is now open.

Stuart A. Tanz -- President and Chief Executive Officer

Good morning, Jeremy.

Jeremy Metz -- BMO Capital Markets -- Analyst

Hey, guys. Good morning. Going back to the densification, kind of bigger picture here. You mentioned the three that are close to ready out of the 20 you've initially identified. Just wondering how much more we can expect over the next call it say 12 to 24 months. How realistically close are some of these other projects you're looking at versus the 20 being maybe a bigger, 10-year type of plan? How should we think about that?

Stuart A. Tanz -- President and Chief Executive Officer

Well, it's going to vary for each project. But generally speaking, we currently expect that it will take around 12 months, give or take, to complete the entitlement process on the three that we're working on now. In terms of the balance of the 20 -- and just quickly, one thing to mention on the three projects -- most of these projects are access land. So from an NOI perspective, the only impact in developing these three come from the Kmart that we bought, which is of course taken into consideration with the downtime of the other anchor in our guidance in terms of the fourth quarter. But in terms of these projects, the only NOI from these projects that get impacted in the Kmart. Everything else has no impact going forward in terms of our NOI.

Then in terms of the balance of these opportunities, it's too early to really comment on how fast these opportunities will come. The simple reason why is because there is a number of a tenant that we're currently talking to, because those tenants' leases will need to be terminated and renegotiated. That's what makes sort of the balance of this a bit more complicated. Hopefully we'll be able to give you some more detail on that in our next call.

Jeremy Metz -- BMO Capital Markets -- Analyst

Okay. Appreciate that. Then looking at acquisitions, if we go back last quarter, you mentioned seeing some increased activity. Now it sounds like sellers are hitting the pause button a little bit again. Stuart, can you just give a little more color on what you're seeing out there? Because it sounded like maybe you were close on a few things, at least on the last call.

Stuart A. Tanz -- President and Chief Executive Officer

Sure. I mean, the West Coast, grocery, drug anchor assets continue to be the most sought-after product or segment of retail. With the West Coast certainly being one of the most sought-after markets in terms of capital. In terms of what we're seeing, certainly widely marketed, very high-quality assets have continued to trade in the sub-5 cap range. Going forward though, what we are continuing to see when it rates do pop up is the uncertainty of sellers either coming to the market at better pricing, or us continuing to work on OP transactions. That will fluctuate depending on both interest rates, timing in terms of dealing with these sellers, and the market itself.

So it's hard to sit here today and tell you what we're going to be acquiring. We haven't really taken our foot off the pedal per se. We're just being very focused as it relates to underwriting risk and, more importantly, we want to continue to use our relationships to buy transactions that will be accretive to our capital.

Jeremy Metz -- BMO Capital Markets -- Analyst

Have there been any changes in your underwriting here in the past, call it 12 months?

Stuart A. Tanz -- President and Chief Executive Officer

We haven't gotten more conservative in our underwriting, but what we have been a lot more conservative at looking at is to make sure that if we have more than two anchors in a possible acquisition, we really don't want to be buying something with more than a drugstore added to a grocery store. And if we do have to look at a third anchor, it's got to be one of the top, what I would call value retailers out there from a risk perspective that we believe will continue to do well as we look into the future.

Jeremy Metz -- BMO Capital Markets -- Analyst

Thanks, guys.

Stuart A. Tanz -- President and Chief Executive Officer

Thank you.

Operator

Our next question comes from the line of Brian Hawthorn from RBC Capital Markets. Your line is now open.

Stuart A. Tanz -- President and Chief Executive Officer

Good morning, Brian.

Brian Hawthorne -- RBC Capital Markets -- Analyst

Good morning. My first question is on the lease to occupied spread, and just how are you guys expecting that trend in 2019?

Richard K. Schoebel -- Chief Operating Officer

As you've seen in the past, it's going to really be dictated by the leasing activity we have. The anchor space is 100% leased, but as I think we touched on in the script, we're always looking for opportunities to upgrade that tenancy. In those circumstances, it's going to take some NOI offline for a period of time in order to get that upside, similar to what we talked about where we took out the anchor and we're getting 3x the rent. But that's going to come with some associated downtime in the NOI. So it's really hard to predict. I think that it would probably be consistent with the levels that it has been this year.

Stuart A. Tanz -- President and Chief Executive Officer

Brian, I guess the one point that I'd like to make on this is that when we make decisions at this company, we make decisions for shareholders for the long term. We're still playing offense on the West Coast. Once in a while, like we saw during the third quarter, you're going to have a situation where an opportunity is going to pop up where we're going to be able to recapture something very quickly, but at the time same, like we did in the third quarter, we're going to find an opportunity to lift rents by close to 300% on this particular situation. Those decisions are being made very quickly for the long term, although it does impact the short term.

So the one thing that hit the quarter that we knew would cause a bit of an issue would be the proactive, aggressive way we manage our real estate. But more importantly, we're managing the real estate to create value for shareholders long term. That's why when you've got a portfolio that's as well leased as we have, those are really the things that we focus on today in terms of playing offense.

Brian Hawthorne -- RBC Capital Markets -- Analyst

Okay. Then so on that recapture then, how much, can you talk about when that happened and how much NOI we should assume will come out in the fourth quarter?

Richard K. Schoebel -- Chief Operating Officer

It occurred during the third quarter, where this prior tenant had been sitting with this location dark but paying. It was obviously having an impact on the rest of the shopping center. They had proposed bringing in some sub-par subtenants into the property, which would've not done well for the property, so we took the opportunity to take them out. There's other consideration that we received as part of this transaction at other locations with this particular tenant, which include an operating covenant. So there was a lot of incentive for us to do this deal.

As we mentioned, the rent was very low, way below market. This lease was about 45 years old. The impact to the NOI will not be as large as other situations, just given the low rent that this tenant was paying.

Brian Hawthorne -- RBC Capital Markets -- Analyst

Sure. Then anymore of those that I guess you guys see opportunities coming up?

Richard K. Schoebel -- Chief Operating Officer

Absolutely.

Stuart A. Tanz -- President and Chief Executive Officer

Yes. We have a few leases, not as large as this particular one, but more in the mid-box range that are significantly below market that we are currently working on. Some where the tenant no longer has any options to remain. Some where we know they will not likely want to stay. So, yes, we expect more activity like this in the coming year.

Brian Hawthorne -- RBC Capital Markets -- Analyst

Okay. Thank you for taking my questions, guys.

Stuart A. Tanz -- President and Chief Executive Officer

Thank you.

Operator

Our next question comes from the line of Michael Gorman from BTIG. Your line is now open.

Stuart A. Tanz -- President and Chief Executive Officer

Good morning, Mike.

Michael Gorman -- BTIG -- Analyst

Good morning, guys. Quick question. Just if I could go back to the recovery ratio. Stuart, you mentioned that some of the timing on the leasing was impacting that. Just as I look over the history, as that leasing and that timing resolves, should we expect the recovery ratio to move back up toward where it was in 2016? Which is averaged over 90%. Or what's a normalized run rate here for a recovery ratio at the portfolio level?

Richard K. Schoebel -- Chief Operating Officer

Yeah, this is Rich. Yes, you will definitely see that recovery ratio come up, as these new leases come online. I think all of our new leasing is done on our lease form, which has much broader recovery language in it, allowing us to recover many more items, including management fees and administrative fees. So we expect that will continue to go up.

Michael Gorman -- BTIG -- Analyst

Okay, great. I apologize if I missed it. Did you guys mention the pricing that you achieved on Round Hill and what you're looking at some of the Sacramento assets as we move through the back quarter of the year?

Richard K. Schoebel -- Chief Operating Officer

Sub-6 on Lake Tahoe, and probably around a 6.5 to 7.5 on the balance of the properties in Sacramento.

Michael Gorman -- BTIG -- Analyst

Great. Then last one for me, kind of from a strategic level, Stuart, obviously if the capital markets improve and in that way the acquisition pipeline gets more active again, I'm just curious because you guys have focused a lot in recent years on acquiring assets with upside potential, bringing them onto your platform, managing them with your team. If the acquisition environment doesn't free up in the next few quarters, what happens in the same-store environment? Can we get back to some of the same-store numbers we saw in '15, '16? Or is more of a stabilized 3% to 4% without the acquisitions feeding into those upside opportunities?

Stuart A. Tanz -- President and Chief Executive Officer

With such a highly occupied portfolio, and even continuing to play offense, assuming that the markets stay as good as they've been, the run rate on a same-store NOI basis will probably continue to be in the 3% to 4% range.

Michael Gorman -- BTIG -- Analyst

Okay, great. Thanks, guys.

Richard K. Schoebel -- Chief Operating Officer

Thank you.

Operator

Our next question comes from the line of R.J. Milligan from Baird. Your line is now open.

Stuart A. Tanz -- President and Chief Executive Officer

Good morning, R.J.

R J. Milligan -- Robert W. Baird & Co. -- Analyst

Good morning, guys. Just one quick question for you, Mike on the AFFOD docs, TI, LCs, capex. Obviously up year-over-year this year versus last year. I'm curious where you think that might trend without obviously giving guidance for 2019, given the fact that you guys are 100% occupied in anchor space, so probably not a lot of charges there. But as you think about maybe replacing low-rent-paying tenants in '19, I'm just curious what you anticipate that growth being for those TIs, LCs, capex as we get into the fourth quarter and into 2019?

Michael B. Haines -- Chief Financial Officer

I guess first I would like to say we've been on this anchor repositioning initiative for a couple years now. We're on kind of the tail end of that. But the reimbursements [inaudible] for those TI dollars is lagging this. So that's the cash payments going up by quarter. I would expect those to be trailing down. As far as the inline shop space, that's going to be a function of what the tenant is, whether it's a restaurant user. It depends on the use type that drives that TI dollar. I don't know if, Rich, you want to jump in on that as far as what space is left to lease, what our average TI is?

Richard K. Schoebel -- Chief Operating Officer

I think as Mike touches on, one of the biggest categories we have right now are restaurant-type tenants. We continue to convert retail space to restaurant because that's where we're able to achieve the highest rents and the best return. The challenge there is predicting the velocity going forward. I would expect that shop space would be in line with what it has been last year going into '19.

R J. Milligan -- Robert W. Baird & Co. -- Analyst

Okay. That's helpful. That's all for me, guys.

Stuart A. Tanz -- President and Chief Executive Officer

Great. Thank you.

Operator

Our next question comes from the line of Todd Thomas from KeyBanc. Your line is now open.

Stuart A. Tanz -- President and Chief Executive Officer

Good morning, Todd.

Richard K. Schoebel -- Chief Operating Officer

Good morning, Todd.

Todd Thomas -- KeyBanc Capital Markets -- Analyst

Hi, good morning. Stuart, just circling back to the transaction market. In your prepared remarks, you mentioned that you're seeing some impact from the rise in interest rates. Can you just discuss that? Is there any evidence that rising rates are having an impact on the market today?

Stuart A. Tanz -- President and Chief Executive Officer

Sure. I mean, what we've seen is interest rates have gone up quite dramatically quite quickly, is that a number of transactions that were under contract have fallen out. But those are transactions that are typically in secondary or tertiary markets or transactions on the segment of retailing that continues to be more tougher in nature -- power centers, malls, things like that. As it relates to grocery and drug anchored assets, those continue to be the most sought-after product in the market. We haven't really seen any deterioration yet in that segment of the market. So it really goes to what I would call more of a second-tier type of shopping center, versus what we typically buy.

Todd Thomas -- KeyBanc Capital Markets -- Analyst

Okay. Do you expect to see cap rates widen a little bit from here?

Stuart A. Tanz -- President and Chief Executive Officer

Given the demand for our product in the most sought-after markets in the country, I think cap rates and valuations are going to stay pretty well in a tight range. I think they could go up. In some cases, they could go down, depending on how much product comes to the market. But all in all, I think that spread will remain pretty tight over the next several months. All, of course, on the basis that interest rates either stay where they are. But if they continue to go up even further, you could see a change in the market.

Todd Thomas -- KeyBanc Capital Markets -- Analyst

Okay. Then, Stuart, I was just wondering if you could comment about the dividend policy a bit. How you and the Board are thinking about things here. You've raised every year since the IPO. Does the slowing external growth that you're seeing today, does that suggest that we might not see an increase this year?

Stuart A. Tanz -- President and Chief Executive Officer

Well, of course, that policy is driven by the Board. But certainly I think as Michael articulated, we do believe our cash flow is going to improve, or free cash flow as we move through '19 at this point, which will give some emphasis on continuing to raise the dividend. But at this point, again, the policy is really driven by the Board. I think that's really all I can comment looking at '19 at this point.

Todd Thomas -- KeyBanc Capital Markets -- Analyst

Okay. Thank you.

Stuart A. Tanz -- President and Chief Executive Officer

Thank you.

Operator

Our next question comes from the line of Christie McElroy from Citi. Your line is now open.

Stuart A. Tanz -- President and Chief Executive Officer

Good morning, Christie.

Christine McElroy -- Citigroup Global Markets -- Analyst

Good morning. Just wondering with regard to the $200 million planned spend on the three projects, maybe a bit more clarity there in terms of what would be your share. Does that include the land value or is the land value that you would contribute incremental? Similar question around the 7% yield. Does that yield include the value of the land you're contributing or is that just on incremental spend there?

Stuart A. Tanz -- President and Chief Executive Officer

The yield does include the land. And in terms of the distribution, the land is included in the numbers that we threw out. Of course, that value is going to be different from property to property, but our goal there is to contribute the land so that we have a minimal amount of equity required in terms of moving these transactions forward.

Christine McElroy -- Citigroup Global Markets -- Analyst

Okay, gotcha. What's your estimate of the land value on that $200 million?

Stuart A. Tanz -- President and Chief Executive Officer

I would tell you probably in the $30 million range. But again, I can't give you exact numbers. Hopefully by our next call, Christie, we'll have something more, definitely something more definite to give you in terms of that number. But that's just a estimate at this point.

Christine McElroy -- Citigroup Global Markets -- Analyst

Okay. Then just as you think about your capital allocation priorities in terms of funding the pipeline with dispositions, non-core dispositions versus your leverage and any sort of debt pay-down, is de-leveraging any more of a priority for you today? To Todd's question, how does that play into free cash flow coming back at some point?

Stuart A. Tanz -- President and Chief Executive Officer

Well, de-levering is certainly important to us. There's no question about that. We will continue, as Mike mentioned, to work on the balance sheet from a de-levering perspective. In terms of capital allocation, it's really going to be we'll look at capital allocation as it relates to the selling of these assets in terms of redeploying that capital and depending on our stock price, we may even, hopefully at some point, if not this year, next year go in and do a bit more equity. Mike, I don't know if you want to add to that in terms of capital allocation?

Michael B. Haines -- Chief Financial Officer

I would just reiterate that obviously my No. 1 focus is to try to de-lever the balance sheet to replace the equity that we should have raised last year when we were held up by the [inaudible] transaction. Given market conditions, we'd like to use the ATM to raise some more equity if it makes sense to do so.

Michael Bilerman -- Citigroup Global Markets -- Analyst

What's your levels -- it's Michael Bilerman speaking. You raised in the low $19-range during the third quarter. Street NAVs are circa $20. I think our estimate is a tad lower. You've obviously been talking about development, an ability to densify is at an incremental value. I guess what level are you comfortable shooting equity at?

Stuart A. Tanz -- President and Chief Executive Officer

Mike, in terms of what we did during the third quarter, that number, I think it was around $19.37. I think around that number. Obviously, we'd like to have raised the equity a lot higher. But we just felt when that opportunity opened up, it was important for us to issue some equity. Going forward, we are cognizant of how precious that equity is. More importantly, that we certainly want to be issuing that equity above our NAV. So NAVs are different, obviously, with everyone. But certainly management's current thoughts on NAV is that that equity was issued really at or a touch lower than what we think our NAV is. So we will keep monitoring the situation, but more importantly, we are very cognizant in terms of how and when and how much that equity gets issued.

Michael Bilerman -- Citigroup Global Markets -- Analyst

Then in terms of instead of using equity, because you don't know where the equity market is going to be, right, I mean, your stock is down a bunch today on what was very much weaker results that the Street was expecting, so you don't know when it could recover, right? And you have additional capital that you want to commit. How do you think about using your assets? I recognize you like simplicity, so you don't like joint ventures. But would that be an area that you would look toward on liquifying some of your higher-quality assets at low cap rates, rather than issuing your equity potentially below NAV to be able to de-lever, as well as fund your incremental capital commitments?

Stuart A. Tanz -- President and Chief Executive Officer

I mean, look, from a capital commitment standpoint, in terms of redevelopment, the goal there is really to contribute the land and put in virtually no or very little equity. In terms of looking at capital allocation as it relates to growing our portfolio, it's really a combination of selling and redeploying some of the equity in terms of selling assets, but at this point, we really have no interest in doing joint ventures. We're just going to continue to do what we do best, which is manage our real estate and create value for shareholders long term, and to take advantage of continuing to play offense on the West Coast. That's our goal right now in terms of '18 and '19.

Michael Bilerman -- Citigroup Global Markets -- Analyst

Then just in terms of disclosure, I'd like to get your and the management team's thoughts. Have you maybe sat back and reevaluated what you're putting out in terms of guidance pieces each quarter, the components of guidance, No. 1. And No. 2, given this lag between basically rent paying economic occupancy and lease rate actually providing those statistics each quarter in your supplemental, so the market is not surprised when you put out results that may be different from what the expectations were? I guess have you rethought disclosure and communication to be more best of breed in the industry?

Stuart A. Tanz -- President and Chief Executive Officer

Look, Mike, we do our best, and I think the company and Michael Haines does a great job in terms of disclosure. Can we do better? Sure. But the bottom line is we look at best practices in terms of what we do and what we disclose. Maybe we can give you a call offline and we can talk about some of the more important details from your perspective. But the answer is yes, we will continue to look at best practices.

Michael Bilerman -- Citigroup Global Markets -- Analyst

I would respectfully disagree in terms of where your disclosure is relative to the peer set, right? The peer set has all of the components of their guidance every quarter. The peer set has got economic occupancy, not just lease rates, so that we can really understand that spread in the supplemental. So there's a lot of different areas. Happy to share with you our best practices report to go through that. But I do think that there's certainly some room. Last question, just in terms of the interest rate swap that's expiring the beginning of next year. What are your plans? It's sitting there at a pretty low 2% rate. How should we in the Street think about the role of that and where that goes in early '19?

Michael B. Haines -- Chief Financial Officer  

Well, as far as the swap that burns off, it's about $100 million that burns off at the end of January. We've been talking internally about reswapping that either for a short period of time, or through the end of the maturity of the term loan. Obviously sensitive to where interest rates are moving around a bit. The swap rates have changed in relation to where the 10-year is. That's been bouncing around a little bit lately. So not committing to anything, but we're looking at the current time of maybe reswapping that $100 million on a shorter-term basis. See where rates really go over the next 12 to 24 months.

Michael Bilerman -- Citigroup Global Markets -- Analyst

Is that dilutive event for that $100 million?

Michael B. Haines -- Chief Financial Officer

Well, the swap rate currently is going to be higher than where it's currently locked in, yes. So there will be some dilution from that higher interest expense, yes.

Michael Bilerman -- Citigroup Global Markets -- Analyst

Okay, thank you.

Stuart A. Tanz -- President and Chief Executive Officer

Thank you.

Operator

Our next question comes from the line of Jeff Donnelly from Wells Fargo. Your line is now open.

Jeff Donnelly -- Wells Fargo Securities -- Analyst

Good morning, guys.

Stuart A. Tanz -- President and Chief Executive Officer

Good morning, Jeff.

Jeff Donnelly -- Wells Fargo Securities -- Analyst

Good morning, Stuart. Just a few follow-ups. I guess maybe one for Rich, I guess a two-parter. I'm curious what you think is going on with asking rents out there in the last few months for small shop space. Have you really seen any kind of discernible trend or change? Then maybe secondarily, I'm curious, what's your gut sense of the market impact if Sears Kmart ultimately decides the chain to close all their stores. I'm curious how significant of an overhang you think that could be on anchor-asking rents in the markets you guys operate in?

Stuart A. Tanz -- President and Chief Executive Officer

I'll talk about the Sears closure and then let Rich certainly dive in in terms of the first part of the question. But we don't see a lot of impact in terms of the Sears Kmart issue. Very much so and when I say that, I'm really referring to the metro markets on the West Coast. A number of those stores, if you look at what has happened over the last several years, most of the strongest assets that Sears owned have already traded into the market, and they're currently being redeveloped at the present time in the metro markets on the West Coast. So I really don't see much impact in our markets. Step out of the West Coast, it's a whole different story, Jeff. But most of the best assets were traded into the market several years ago, and those assets or that shadow supply is currently being redeveloped right now on the West Coast. So again, I don't really see much impact.

Richard K. Schoebel -- Chief Operating Officer

Then in terms of the shop rents, I think as we touched on the prepared remarks, just coming out of ICSC in L.A., the tenants were all very positive, looking for locations. There's very limited good opportunities available on the West Coast. It is the point where certain tenants were leaving meetings with our leasing people and the pulling Stuart and I aside to tell us that it was very important that they were going to get an opportunity that hasn't even come available yet. I'm speaking of a pad where we're taking back a pad and dividing it up into shop space. People trying to use their relationships to make sure that they're at the top of the list to get that location. We see still a lot of demand for that space, which will support good rents going forward.

Jeff Donnelly -- Wells Fargo Securities -- Analyst

Just one more concerning the comment about exiting Sacramento. If I'm right, or am I right I guess I should say, you just have two to three assets in that area? Would you guys also consider exiting Stockton. I think that market is also a little bit of an outpost for you guys, too.

Stuart A. Tanz -- President and Chief Executive Officer

Yes, that's correct. Two or three assets and do include Stockton. You're absolutely right, Jeff. The answer is yes. We're currently negotiating right now on a number of those assets.

Jeff Donnelly -- Wells Fargo Securities -- Analyst

Okay. Thanks, guys.

Stuart A. Tanz -- President and Chief Executive Officer

Thank you.

Operator

Our next question comes from the line of Chris Lucas from Capital One. Your line is now open.

Stuart A. Tanz -- President and Chief Executive Officer

Good morning, Chris.

Christopher Lucas -- Capital One Securities -- Analyst

Good morning, guys. Just one detail questions related to the Kmart at [inaudible] Vista. Is that store open? Is that still paying rent? When do you expect the impact of a closure to occur?

Stuart A. Tanz -- President and Chief Executive Officer

Well, I mean, the store is closing. We anticipated that. We expect the store -- we don't know exactly when they're shutting down, but in terms of our agreement, they have to be gone by the end of the year.

Christopher Lucas -- Capital One Securities -- Analyst

Okay. So rent will cease at that point?

Stuart A. Tanz -- President and Chief Executive Officer

Yeah, correct. We may have lost a bit of rent between the bankruptcy, but just between the time the rent was due and then the company going bankrupt, which is standard for companies that are in that position. But we should hopefully be getting rent.

Richard K. Schoebel -- Chief Operating Officer

No, they actually, the month they filed bankruptcy, they actually had paid the rent already, which was somewhat unusual for a tenant planning to file. They are obligated to pay us through the end of the year. That's really just the base rent, because we settled up completely for the taxes and the triple-net as part of the termination. So it's just the rent component through the end of the year.

Christopher Lucas -- Capital One Securities -- Analyst

Okay, great. Thanks. Then, Mike, I appreciate the guidance on the lease accounting change. I guess a bigger picture question on that topic is just simply next year's lease expiration schedule is comparative light to what we'll see the following next several years. As we think about how to model out that number, and recognizing in your case it's a relatively small number, but just how impactful is the volume of whether it's number of leases, square footage, ADR to that number? How should we be thinking about the drivers, either increasing or decreasing that number over time?

Michael B. Haines -- Chief Financial Officer  

I would expect the number to stay relatively consistent. It's our internal leasing staff the leasing velocity based on the expiration is just one of the drivers of things that they work on. A lot of times they work on leases that are not even on the expiration schedule. I don't expect any real meaningful change in that number going forward.

Richard K. Schoebel -- Chief Operating Officer

I think the reason '19 may look a little lighter is we've dealt with some of those renewals already this year. So some of them have already come off ahead of the year starting. But the compensation isn't necessarily one for one in terms of velocity. That's why being internally leased, we're able to control that cost better than if we had a broker working on a commission.

Christopher Lucas -- Capital One Securities -- Analyst

Then just from a presentation perspective, Michael, where should we expect that expense to line up? Is that a G&A or an operating expense line item?

Michael B. Haines -- Chief Financial Officer

That's going to be a G&A expense increase versus operating.

Christopher Lucas -- Capital One Securities -- Analyst

Okay, great. Thank you. Appreciate it. That's all I have.

Michael B. Haines -- Chief Financial Officer

Thank you.

Operator

Our next question comes from the line of Michael Mueller with J.P. Morgan. Your line is now open.

Stuart A. Tanz -- President and Chief Executive Officer

Good morning, Mike.

Michael Mueller -- J.P. Morgan Securities -- Analyst

Good morning. Just a question going back to the three redevelopment projects. Is the scope of all three solely going to be adding multi-family or can there be retail components or other components that you'd more naturally be a direct investor in? Or is it just picture the existing center with a rezi building and you'll own a portion of that building, by way of either contributing land or deciding to put more capital into it?

Richard K. Schoebel -- Chief Operating Officer

Well, it depends on the municipality. Some municipalities will want a bit of retail, and some won't. On what we're moving forward on right now, it's a very small component of retail. It's primarily going to be multi-family.

Michael Mueller -- J.P. Morgan Securities -- Analyst

Okay. And again, is sounds like the base case is at a bare minimum of that $200 million on the low end if you just do the contribute the land route, your investment in it is $30 million at a 7.5% return, unless you decide to take a bigger stake in the project. Is that the right way to think of it?

Stuart A. Tanz -- President and Chief Executive Officer

Yeah, although you know, if you put debt on top of the equity, Mike, we may have to put a bit of that portion onto our balance sheet, so we think about that as well as it relates to the capital side, or the balance sheet side. So but yeah, you're very close in terms of the numbers.

Michael Mueller -- J.P. Morgan Securities -- Analyst

Got it. Okay. That was it. Thank you very much.

Stuart A. Tanz -- President and Chief Executive Officer

Thank you.

Operator

Our last question comes from the line of Greg Smith from Bank of America. Your line is now open.

Stuart A. Tanz -- President and Chief Executive Officer

Good morning, Greg.

Gregory Smith -- Bank of America Merrill Lynch -- Analyst

Good morning. I just wondered, on the mixed-use densification efforts. Are you looking exclusively as residential or are you examining office, hospitality, or other mixed-use formats?

Stuart A. Tanz -- President and Chief Executive Officer

Well, Greg, we have looked at hospitality because we have offers from hotel operators, but the economics don't line up. When I say that, we're looking as hospitality from a land lease perspective. I know it's a lot less capital, obviously, but the NOI is in a whole different sort of -- the NOI is a lot different. So we have looked at other alternatives, but certainly as it relates to both timing and NOI growth, certainly multi-family is the place to go. More importantly, remember, we're building in the most sought-after markets in the country, where there is very strong rent growth. And more importantly, that these municipalities really need housing. That's the key here in terms of getting these entitlements. Because there's a lot of municipalities we went to where they said come in and densify; however, you'll never get a permit because of how highly constrained and how anti-development some of these municipalities on the West Coast are. So that's sort of the overview in terms of how we've gone through this process.

Gregory Smith -- Bank of America Merrill Lynch -- Analyst

Okay, so at this point, the entitlement process is going pretty well?

Stuart A. Tanz -- President and Chief Executive Officer

We are a bit further down the road at the Crossroads Phase 2. Because we started that process almost two years ago. We're getting very close to getting those entitlements. The other two are at the beginning stages. But from our discussions with the municipalities and potential partners, we believe that the entitlement process will go pretty quickly.

Gregory Smith -- Bank of America Merrill Lynch -- Analyst

Okay. Thank you.

Stuart A. Tanz -- President and Chief Executive Officer

Thank you.

Operator

At this time, there are no further questions.

Stuart A. Tanz -- President and Chief Executive Officer

In closing, we would like to thank all of you for joining us today. If you have any additional questions, please contact Mike, Rich, or me directly. Also, you can find additional information on the company's quarterly supplemental package, which is posed on our website. Lastly, for those that are attending [inaudible] annual conference in San Francisco in a few weeks, we look forward to seeing you there. Thanks again, and have a great day, everyone.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude your program, and you may all disconnect. Everyone, have a great day.

Duration: 57 minutes

Call participants:

Stuart A. Tanz -- President and Chief Executive Officer

Michael B. Haines -- Chief Financial Officer

Richard K. Schoebel -- Chief Operating Officer

Collin Mings -- Raymond James & Associates -- Analyst

Jeremy Metz -- BMO Capital Markets -- Analyst

Brian Hawthorne -- RBC Capital Markets -- Analyst

Michael Gorman -- BTIG -- Analyst

Todd Thomas -- KeyBanc Capital Markets -- Analyst

Christine McElroy -- Citigroup Global Markets -- Analyst

Michael Bilerman -- Citigroup Global Markets -- Analyst

Jeff Donnelly -- Wells Fargo Securities -- Analyst

Christopher Lucas -- Capital One Securities -- Analyst

Michael Mueller -- J.P. Morgan Securities -- Analyst

Gregory Smith -- Bank of America Merrill Lynch -- Analyst

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