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Edited Transcript of WSR earnings conference call or presentation 1-Aug-19 3:00pm GMT

Q2 2019 Whitestone REIT Earnings Call

HOUSTON Aug 4, 2019 (Thomson StreetEvents) -- Edited Transcript of Whitestone REIT earnings conference call or presentation Thursday, August 1, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David K. Holeman

Whitestone REIT - CFO

* James C. Mastandrea

Whitestone REIT - Chairman & CEO

* Kevin Reed

Whitestone REIT - Director of IR

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Conference Call Participants

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* Craig Gerald Kucera

B. Riley FBR, Inc., Research Division - Analyst

* Mitchell Bradley Germain

JMP Securities LLC, Research Division - MD and Senior Research Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Whitestone REIT Second Quarter 2019 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Kevin Reed, Director of Investor Relations. Please go ahead, sir.

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Kevin Reed, Whitestone REIT - Director of IR [2]

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Thank you, Eduardo. Good morning, and thank you for joining Whitestone REIT's Second Quarter 2019 Earnings Conference Call. Joining me today on today's call are Jim Mastandrea, our Chairman and Chief Executive Officer; and Dave Holeman, our Chief Financial Officer.

Please note that some statements made during this call are not historical and may be deemed forward-looking statements. Actual results may differ materially from those forward-looking statements due to a number of risks, uncertainties and other factors. Please refer to the company's earnings press release and filings with the SEC, including Whitestone's most recent Form 10-Q, for a detailed discussion of these factors. Acknowledging the fact that this call may be webcast for a period of time, it is also important to note that this call includes time-sensitive information that may be accurate only as of today's date, August 1, 2019. The company undertakes no obligation to update this information.

Whitestone's second quarter earnings press release and supplemental operating and financial data package has been filed with the SEC and are available on our website www.whitestonereit.com in the Investor Relations section. During this presentation, we may reference certain non-GAAP financial measures which we believe allow investors to better understand the financial position and performance of the company. Included in the earnings press release and supplemental data package are the reconciliations of non-GAAP measures to GAAP financial measures.

With that, let me pass the call to Jim.

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James C. Mastandrea, Whitestone REIT - Chairman & CEO [3]

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Thank you, Kevin, and thank you all for joining us on our Second Quarter 2019 Earnings Conference Call. I would like to highlight 4 areas in my remarks today: First, our continued strong leasing activity related to our value-add properties; second, our development pad opportunities that we continue to capitalize on; third, our predictable and sustainable cash flows; and fourth, our progress towards achieving our long-term goals.

My first point is our strong leasing. We continue to focus and execute on our proven and resilient commercial retail real estate e-commerce-resistant business model and have posted strong leasing activity in the second quarter. Once again, we continue to build on our solid and predictable cash flow.

Our leasing is the result of mixing a well-crafted tenant base developed through our extensive research and analysis, including the demographics and psychographics of the potential consumers in the surrounding neighborhoods of our properties; controlling our real estate through disciplined leasing and leased underwriting that avoids restrictive co-tenancy clauses; and employing triple-net structures, percentage rent clauses, shorter-term lease durations, and annual base rent increases of 2% to 3% in our leases. This provides us an inflation hedge and participation in the success of our tenants' businesses.

Our approach avoids the retail disruption that the Internet continues to cause. We focus on the consumer and the entrepreneurial service-oriented tenant to drive high-volume traffic to our centers. Our proactive leasing allows us to transfer properties market-by-market to create value. We lease to tenants that are financially sound and primarily entrepreneurial. Ultimately, their success is our success.

We have redefined the retail real estate industry by the way we repositioned our real estate portfolio. Our approach of leasing to tenants focused on the new e-commerce-resistant, service-based economy produces consistent leasing results. Our end goal is to create value for all of our Whitestone REIT stakeholders.

Let me now take a moment to highlight some additional detail in our leasing results. During the quarter, we executed 57 leases, and 35 -- the 57 renewed leases and 35 new leases for a total of 284,000 square feet, representing $26.1 million of lease value. That's incredible.

Looking deeper into our leasing results, our same-store occupancy rate was down 190 basis points from a year ago and 67 basis points from the first quarter of 2019. These percentages represent a decrease of leased square footage of approximately 90,000 square feet from a year ago and 30,000 square feet from the first quarter.

However, this change in occupancy year-over-year is largely the result of the move out of only 5 of our 1,350 tenants. These tenants are unique in that they occupy large spaces in our portfolio and they are more representative of the older, traditional retail tenants. Specifically, 4 of the tenant move outs were in our Houston market, creating approximately 50,000 square feet of vacancy, and one was 47,000 square foot grocer -- grocery store closed in our Phoenix market. We have previously spoken of this grocery closure at a property of non Phoenix market, which does represent about half of the occupancy decline.

In 2018, we received a 47,000 square-foot building as part of a lease settlement termination. Interestingly enough, our original interest in the property was only a leasehold interest. So we received the building back and we received a cash settlement. Now it's our opportunity to break this down into smaller spaces, which we've already planned, and put it into our production model. Given our favorable cost basis in this asset, we will continue to work to maximize the long-term value of this asset.

The balance, approximately 90,000 square feet of vacancies, are as of the end of the quarter, approximately 14,000 square feet are currently under lease and expected to be included in occupancy over the balance of the year. The remaining vacancies are being actively marketed potential replacement tenants.

As we always do, we are evaluating breaking these larger vacant spaces into smaller spaces that demand higher rental rates per square foot and are more attractive with e-commerce-resistant tenant mix that will -- that Whitestone properties attract. We believe we have great opportunities to reposition these properties and add value with each as we move ahead.

The second point is related to our development pad opportunity. This value-add component of our strategy includes the development of residual land that we acquire with many of the initial acquisitions at little or no cost when we purchase a property. We are now feeding these parcels of land into our production pipeline to expand leasable square footage and cash flows.

This quarter, we completed a multi-tenant 7,000 square-foot pad at our Anthem Marketplace property in Arizona at a project-stabilized early ROI yield of 10.5%, and leases -- lease terms that are averaging 7.5 years. This successful pad development exemplifies the opportunities we continue to extract from our portfolio to add value to our properties and for our shareholders.

My third point is that our strategy continues to produce predictable, reliable and sustainable cash flows. Our unique value proposition is owning prime community center properties and capturing tenants who provide for the needs of the consumers in the surrounding neighborhoods through -- where they live, work and play. Environment's created in our properties, our communities are our anchors, not any of the specific tenants. Consumers is in our properties 18 hours a day, 7 days a week.

Whitestone's strategy focuses on highly attractive growth markets of Houston, Dallas, Fort Worth, Austin, San Antonio, Phoenix, Mesa, Gilbert, Chandler and Scottsdale, which all sit atop of most every list of the fastest-growing cities in the country.

With such a diverse stream of cash flows where no one tenant accounts were more than 3% of our ABR and locations in such desirable markets, we have built a portfolio over the past 9 years to produce cash flows that are predictable, sustainable and continue to increase as further evidence Whitestone has through solid fundamentals that continue to increase, such as average base rent that has grown from 4% a year ago to $19.53, primarily as a result of rental rate growth of 7.5% on new and renewed leases signed.

Our balance sheet and capital structure support our business model and growth strategy and provide us stability, flexibility, and by all means, simplicity. We have only one class of stock, which is common stock, no joint ventures, no partnerships. What you buy is what you own.

Let me now discuss our continued progress towards our long-term goals. We continue to work to reduce overhead and to scale our overhead by creating efficiencies in our operations to drive increasing sustainable cash flow. Our long-term goals include: Reducing leverage, improving general and administrative expense to revenue ratio, making accretive acquisitions and dispositions and redeveloping and developing our out parcels and land parcels.

Our accomplishments at Whitestone are a result of an exceptional leadership team and extraordinary people. We have a strong belief employee development is fundamental to our business. We hire talented people and remain dedicated to further developing our employees to become our future leaders through our real estate executive development program, which we titled REED; and our first scholar program in conjunction with the Jones Graduate School of Business at Rice University.

From time to time, people believe Whitestone, and when they do, we want you, our investors, to know that we have a deep bench and others in training to replace it. This helps us in many ways, including when we expand our business. But it also helps us to create a workforce who's talented, with diverse backgrounds and perspectives and a cultured that is performance based and dedicated to achieving our goals.

And with that, I would like to turn the call over to Dave Holeman. David?

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David K. Holeman, Whitestone REIT - CFO [4]

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Thanks, Jim. I am happy to provide a few more details on our second quarter and year-to-date operating and financial results. At the start of 2019, we adopted the new lease accounting standards, and as such, all income related to tenant leases is reflected in a single rental line on the operating statement. The impact of bad debt is now a component of the single rental line item and is no longer a component of operating and maintenance expenses. And real estate taxes paid by certain major tenants directly to the taxing authorities are no longer reflected in rental income and real estate tax expense. These bad debt and tax changes are reflected in the 2019 reporting periods but have not been made to the company's 2018 historical results. The company's net income, net operating income and funds from operations were not impacted by these presentation changes.

We continued to build on our positive start to the year in the second quarter of 2019, we further enhanced the overall quality of assets and our tenant mix continues to improve, as evidenced by increases in our composite average annual base rent per leased square foot.

Net income attributable to Whitestone REIT for the second quarter was $3.3 million or $0.08 per share compared to $2 million or $0.05 per share in 2018. Net income attributable to Whitestone REIT for the 6 months was $6.1 million or $0.15 per share compared to $5.1 million or $0.12 per share for the 6-month period in 2018.

NAREIT funds from operations for the quarter was $10 million or $0.24 per share compared to $9 million or $0.21 per share in 2018. For the 6 months, NAREIT funds from operations was $19.8 million or $0.47 per share compared to $19.1 million or $0.46 per share in 2018.

Funds from operations core, which we adjust NAREIT FFO for non cash stock compensation and proxy cost professional fees, for the quarter was $11.1 million or $0.27 per share. This compares to $12.4 million or $0.30 per share in 2018. For the 6 months, our funds from operations core was $22.9 million or $0.55 per share compared to $25.1 million or $0.60 per share in 2018. The decrease in funds from operations core was primarily the result of: Wholly owned and equity investment property disposition of $26 million; higher interest cost, driven by fixing the interest on a greater percentage of our debt and extending maturities; and higher professional fees in 2019.

Our property net operating income was $22 million for the second quarter of '19 as compared to $22.5 million for the same period in 2018. This change was the result of property dispositions in both our wholly-owned portfolio and in our equity investment in real estate partnerships. Our same-store net operating income for the quarter was flat with the prior year largely as a result of the 190 basis point year-over-year reduction in occupancy.

For the 6 months, our net operating income was $45 million compared to $45.4 million a year ago. This decrease is primarily due to lower same-store occupancy and property dispositions, offset by positive same-store rental rate growth producing a year-to-date $460,000 increase in same-store NOIs or a 1.1% same-store NOI growth on a 6-month basis.

Adjusting for $1.9 million of proxy contest professional fees incurred in 2018, general and administrative expenses for the 2019 second quarter were flat with the prior year quarter. As a percentage of revenue, including our pro-rata share of revenue from our real estate partnerships, general and administrative expenses, excluding 2018 proxy contest professional fees, were 16.7% for the 2019 6-month period, an improvement of 20 basis points from 16.9% in the 2018 6-month period. Included in our second quarter 2019 general and administrative expense was $1.1 million for the amortization of stock-based compensation. We expect the amortization of stock compensation to be approximately $3.5 million for the balance of 2019.

Interest expense was $6.5 million for the quarter or $200,000 higher than the prior year as a result of higher interest cost from fixing interest rate and extending maturities. As of the end of the quarter, 87% of our debt is subject to fixed rates. This is up from 64% a year ago. Our weighted average interest rate is 4.1%, which is up from 3.9% a year ago, and our average remaining term on our debt is approximately 5.5 years, which is an improvement from 3.5 years a year ago.

Now turning to our balance sheet. At the end of the quarter, our ratio of net debt to undepreciated total real estate assets was 57.9%, which is an improvement of 40 basis points from a year ago. As I mentioned last quarter, we significantly improved our underlying debt structure through the amendment, extension and expansion of our credit facility and the inaugural issuance of corporate bonds. The result of these actions was a greater percent of our debt is subject to fixed rates, we now have a well-laddered debt maturity schedule with minimal near-term debt maturities and extension of the average debt tenure and a largely unsecured debt structure.

Let me now discuss in greater details our leasing. Second quarter leasing activity represents a 42% increase in leased square footage and a 65% increase in total lease value compared to the first quarter of 2019, and a 58% increase in leased square footage and a 57% increase in total lease value compared to the second quarter of 2018. Consistent with our focused tenant mix strategy, our leases signed for the year have an average lease size of 2,800 square feet and an average lease term of approximately 4 years. Our GAAP leasing spreads on a trailing 12-month basis are 8% increase for renewals and a positive 5% for new leases.

Lastly, turning to our outlook for 2019, we are reaffirming our previously issued guidance.

And Jim and I would now be happy to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll now take our first question from Mr. Germain from JMP Securities.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [2]

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On your renewal leases, I saw -- on the renewals, I saw term came down a bit. I think term -- lease term overall for the quarter was a little bit lower than the last couple. Is that by design? Or is this a trend that is in the market right now?

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David K. Holeman, Whitestone REIT - CFO [3]

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I could start out and Jim will probably add. Mitch, thanks for the question. I think as we've communicated, we really do enjoy the shorter-term leases because it gives us the ability just to be more proactive in our ownership of real estate to move the rates. As we've always said, obviously, on point in a quarter is not a trend. We continue to focus on leases kind of in that 3- to 5-year range with 2% to 3% annual bumps. And we're very comfortable with that. And that gives us the ability, as we improve the quality of real estate, to move the rental rates.

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James C. Mastandrea, Whitestone REIT - Chairman & CEO [4]

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Yes. And Mitch, I'd like to add that tenants who are the entrepreneurial, smaller-type tenants, they're not thinking in terms of what's the square foot rent, they're thinking in terms of absolute numbers. So they're paying $2,500 a month and you say that -- or -- and you say their increase is been absolute number which is maybe $300 a month. They don't think in terms of what's the percentage of that, and we are able to charge them appropriately.

Also, we're able to adjust the rents to avoid the NAV increases that we might find in some of the cost for operations. But finally, is that when you have really great properties in strong neighborhoods, and you've seen many of them, that their businesses do so well because we attract a lot of people, that they don't want to lose that advantage they have in the marketplace. And so they're usually willing to go along. We just want to be careful that we're always fair in terms of what we charge, what we charge and what the market will bear. And there's -- it's about a 2- to 3-year period, sometimes 4 years, when you buy a value-add property, to adjust it to get it up to market rents. And then often, if you have the short-term leases, you can quickly -- you can get it more quickly up to what the market rents are in the surrounding 5-mile radius.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [5]

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Great. The Anthem land, I know it's about 60% occupied. Maybe one, what's the plan to stabilize that parcel or that development? And then two, what other projects are underway in the portfolio of similar to that one?

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David K. Holeman, Whitestone REIT - CFO [6]

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Mitch, it's Dave. I'll start out and we'll once again go back and forth. So we did complete Anthem's 7,000 square feet pad in Arizona. It's going to have 3 tenants. One of those tenants is currently occupying 58% of the space. The balance of the space is going to be split between 2 tenants. Half of that space is currently leased and expected to move in probably in the balance of the year. And then the other tenant, we're marketing. So we're very confident with about plus 70% leased and just one space to fill up. And I think, as we communicated, the returns on that are very good with a kind of plus 10% cash of return on our investments.

In the portfolio, we have a number of pad sites, and I'm going to kick it over to Jim to talk about that.

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James C. Mastandrea, Whitestone REIT - Chairman & CEO [7]

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Yes, we do. In fact, some of those pad sites are very, very large. They're actively in the planning stage right now. For example, Ahwatukee, we're in discussions with a major coffee company for a pad that was covered up with asphalt. So that's in progress. In Fulton Ranch, down in there -- in the technology sector of Phoenix, we've got several pads that we're looking to develop down there. Market Street, which is located in DC Ranch, we have a pad that's -- it can accommodate about 50,000 square feet more of buildings. And we're in the discussions and in some design discussions.

BLVD Place in Houston is really, really hot right now. And since we bought that property where the Whole Foods is located, as you know, there were 2 apartment buildings build behind it, one was 350 units, another one was 240 units. They're both up and operating now. Right across the street, I mean literally across the street is another 340-unit building, and it happens to be main and main, which is the best location for some office space and some mixed space more. And so we have about 140,000 square feet of space we can build there.

We have -- Memphis is open, it's a Mexican restaurant. We've had meetings with the Rooftop theater operator. They're now asking us if they can put a second screen on top of the roof. So we have some development plans there.

And then not finally, but the ones I care to mention today, is Dana Park, which is down in Mesa. Mesa is now in the top 50 cities in the country. It's just growing very, very fast again. And we have plans laid out for about 200,000 square feet of additional retail. There is also a multi-family plans there 340 units, and then plans for a hotel.

So we've got a lot of things on the drawing board. It keeps a team of a few people very, very active.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [8]

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Great. Last one for me. Do you have any additional asset sales that you're planning in the back part of the year?

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David K. Holeman, Whitestone REIT - CFO [9]

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We have -- we'll continue to look at our portfolio. There are -- in our equity investment in our real estate partnership, I think there are currently 3 assets that are for sale there, that the proceeds would be some portion of those would come to Whitestone business to pay us down. So nothing currently active in our wholly owned portfolio. In the equity investments, there are 3 properties. And we're going to continue to look at our capital sources, which involve selling properties when we feel like we've added all the value we can.

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James C. Mastandrea, Whitestone REIT - Chairman & CEO [10]

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Yes. And Mitch, I can say that, just to follow on Dave's comment on the equity investment we have in the company called Pillarstone, which you're well aware of. In fact, when we were talking to you and others who said, "We think that Whitestone should become a pure real estate retail play." As when we develop that business model, we're now in the process of selling off. We have LOI, not a contract, for 3 properties that once sold, it will pay off all the debt owed to Whitestone and the debt owed to one of the insurance company banks.

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Operator [11]

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(Operator Instructions) We'll now take the next question from Craig Kucera.

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Craig Gerald Kucera, B. Riley FBR, Inc., Research Division - Analyst [12]

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And I apologize if you addressed this earlier. But you had a pretty sizable decline in your G&A expense both year-over-year and sequentially, both cash and noncash. Was this a light order? Or how should we think about sort of a run rate for G&A on both a cash a noncash basis for the rest of the year?

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David K. Holeman, Whitestone REIT - CFO [13]

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Craig. So let me just, per your question, included in our G&A, as you said, is both a cash portion and then the amortization of our stock compensation. In the second quarter of '19, that amortization of stock compensation was a little lower than some of the other quarters. It was $1.1 million. For the balance of the year, we expect that noncash G&A portion to be about $3.5 million for the next 2 quarters in total. And then the cash portion of G&A was relatively flat with the first quarter. And I think the cash portion of the G&A for the second quarter is a pretty good run rate. And then the noncash portion, which is just the amortization of stock compensation, should be about $3.5 million for the balance of '19.

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Craig Gerald Kucera, B. Riley FBR, Inc., Research Division - Analyst [14]

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Okay. Great. And just circling back to some of your leasing activity. I think the cash leasing spreads have been sort of trending down the last few quarters. Occupancy's, I think, sort of peaked maybe in third quarter at 92% and has softened a bit. I think last quarter, you mentioned that you thought you needed to shuffle some things internally, there was maybe a bottleneck. Do you think you've taken care of kind of those things internally? Or are we sort of still midstream in that activity?

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David K. Holeman, Whitestone REIT - CFO [15]

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Yes, I think we'll both comment as well. I think, obviously, we feel like we got a really good team in place to drive occupancy. I think we talked about on the call that the decline in year-over-year occupancy is largely the result of kind of 5 larger-space tenant boxes in our portfolio. I think we're obviously working through those. But we got -- we have really good lease activity so far this year. The second quarter lease activity from a volume standpoint was very strong.

On the spreads, you're right. The cash spreads over the last 3 quarters have been a little lower. Our GAAP spreads have been in that kind of 7.5% range. We're continuing to watch those. We're continuing to be focused on pushing our occupancy as well as pushing the rates.

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James C. Mastandrea, Whitestone REIT - Chairman & CEO [16]

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Yes. And Craig, one -- this is Jim. And one of the things that changed, it's -- to us, it's all about the people. And what we did is we switched around a process in terms of meeting and discussing leases, where now, we do it once a week for 2 hours at the beginning of the week. And it's really all the regions calling in on a conference call, going through their activity lease by -- believe it or not, lease by lease by lease. And we have someone who leads that process who's very, very good at it.

The change was -- the difference is we were doing it on a regional level and expecting a person to bring that together for the senior management team. Now what we've done is we've changed it to have all of the leasing people. So the underwriting is the same. And we have a senior manager, management person, namely (inaudible), at those meetings. So that when there's decisions made that deviate from a policy or a process that we might have, it's made right away.

An example would be we don't subordinate leases. We don't subordinate our leases to any loans from banks, answer that question by the way. We don't permit any cotenancy provisions. That's answered, it's off the table right away. We must have personal guarantees, answered right away. So the whole process of filtering is the same.

And then on Saturdays, we pick a different person, and they usually take us out and show us what they're doing in one of the marketplaces. Little boring to tell you that, but that's what we do.

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David K. Holeman, Whitestone REIT - CFO [17]

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Craig, I might just add one thing as well, Jim. I touched on this, the leasing activity. I think one of the things that are -- that's really positive so far this year that potentially you don't see is, if you look for instance, at our renewal volume, we've renewed almost 50% more square feet this year than we did in the 6-month period last year. Ultimately, what that results in is -- in some of those leases that are not coming in due for 6 months or something. But ultimately, that results in a greater retention rate and higher occupancy levels. So that lease activity, we think, is a really good leading indicator of our future results.

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Operator [18]

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It appears there are no further questions at this time. I'd like to turn the conference back to Mr. Mastandrea for any closing remarks.

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James C. Mastandrea, Whitestone REIT - Chairman & CEO [19]

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Yes, thank you all. Thank you very much. Just in closing, I'd like to say that from our perspective, we continue to believe that our strategy is proving it's predictable and it's reliable and it's sustainable cash flows. I believe I commented the last call that we had, that if you take from the time we did our IPO through the time at 12/31/18, we have paid out approximately $260 million in dividend. And I say that only because it's a stat that you don't really hear in place or look at anyplace. But the meaningful that's behind that is the level of very close tolerances where we run our business, and we feel very confident we can continue to run that and maybe even see it get better in the shorter-term and even longer-term future. All the results can be seen in our leasing success. We have achieved year-to-date incredible results, and we continue to ring true as our -- as we progress towards our long-term goals.

So I'd like to thank you all for joining us on our call today and look forward to our call the next quarter. Thank you all.

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Operator [20]

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Now concludes today's call. Thank you for your participation. You may now disconnect.