First Industrial Realty Trust - Earnings Call - Q1 2016

Transcript

Speaker 0

Good morning. My name is Nicole and I will be your conference operator. At this time, would like to welcome everyone to the First Industrial First Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.

I would now like to hand the conference over to Mr. Art Harman, Vice President of Investor Relations. Please go ahead, sir.

Speaker 1

Thanks, Nicole. Hello, everybody, and welcome to our call. Before we discuss our first quarter twenty sixteen results, let me remind everyone that our call may include forward looking statements as defined by federal securities laws. These are based on management's expectations, plans, and estimates of our prospects. Today's statements may be time sensitive and accurate only as of today's date, Thursday, April 2836.

We assume no obligation to update our statements or the other information we provide. Actual results may differ materially from our forward looking statements, and factors which could cause this are described in our 10 ks and other SEC filings. You can find a reconciliation of non GAAP financial measures discussed in today's call in our supplemental report and our earnings release. The supplemental report, earnings release and our SEC filings are available at firstindustrial.com under the Investors tab. Our call will begin with remarks by Bruce Duncan, our Chairman, President and CEO as well as Scott Musil, our CFO, after which we will open it up for your questions.

Also on the call today are Jojo Yap, our Chief Investment Officer Peter Schultz, Executive Vice President Chris Schneider, Senior Vice President of Operations and Bob Walters, Senior Vice President of Capital Markets and Asset Management. Now let me turn the call over to Bruce.

Speaker 2

Thanks, Art, and thanks to all of you for joining us today on our call. Overall, 2016 is off to a great start as we continue to execute on our plan to drive current and long term cash flow growth. We ended the first quarter with occupancy at 94.8, reflecting the typical first quarter depth plus the impact of the 400,000 square foot move out in our Memphis asset we discussed on our fourth quarter call. Rest assured, we are focused on the work to be done to achieve our occupancy objectives for the year. We delivered strong cash same store NOI growth of 9.6%.

This is primarily driven by a decrease in free rent, higher average occupancy, rental rate bumps and rental rate growth. Based on the strength of our first quarter, we increased our cash same store guidance, which Scott will walk through shortly. Cash rental rates were up 6.9% overall, our ninth consecutive positive quarter. GAAP rents were up 15.2%, making it 17 positive quarters in a row. Moving on to development, I refer you to Page 20 of our supplemental.

We have had some very good development leasing wins thus far this year. In the first quarter, we successfully leased and placed in service the final building of our 237,000 square foot $28,000,000 First Park at Ocean Ranch in Southern California. We also leased 341,000 square feet at our 585,000 square foot First 33 Commerce Center in the Lehigh Valley where our total investment is approximately $44,000,000 In the second quarter, we are also pleased to report that we are 100% leased at our 188,000 square foot First San Michele Logistics Center in the Inland Empire At the end of the first quarter, we had 1,100,000 square feet of completed development not placed in service comprised of the aforementioned projects in the Lehigh Valley plus buildings in Dallas and Phoenix. Our combined estimated investment on these projects is $75,000,000 and they have a targeted initial GAAP yield of 7%.

They were 67% leased as of the end of the first quarter and as of today. We had 1,500,000 square feet under construction at March 31, which includes San Michele and our spec projects in Dallas and Chicago plus build to suits in Atlanta and Southern California. Our total investment for these developments is $94,000,000 They were 31% leased at quarter end and 44% leased today. And they have a targeted GAAP yield of 7.3%. So in total, at quarter end, our development pipeline was 2,600,000 square feet with a total estimated investment of $169,000,000 and a combined targeted initial GAAP yield of 7.2%.

That pipeline is 54% leased today. With industrial fundamentals continuing to be strong, we identified and closed on several attractive investment opportunities that were the primary driver of our decision to raise $125,000,000 of equity. Scott will discuss the offering in more detail in a moment. Let me walk you through some of these projects which are squarely aligned with our cash flow growth and portfolio objectives. Just last week, we closed on the acquisition of a site in Southern New Jersey for $9,200,000 There, we started development of the first Florence Logistics Center, a 577,000 square foot state of the art facility.

Total investment is estimated to be $39,000,000 with a targeted GAAP yield of 6.9%. We expect First Florence to be completed in the first quarter of twenty seventeen. In the Inland Empire West submarket of Chino Eastvale, we acquired a 50 acre site for $22,800,000 This site will be the home of the Ranch by First Industrial, a six building, 936,000 square foot park with buildings ranging in size from 50,000 to 300,000 square feet. Total investment is expected to be approximately $90,000,000 with a targeted gap yield in the low sixes. We plan to start this park later this year and we will build all six buildings at one time with an expected completion in the third quarter of twenty seventeen.

Also in the Inland Empire, in the Riverside submarket, we acquired a 13 acre site for $4,800,000 There, we plan to build a 243,000 square foot First Sycamore two fifteen logistics center. We will break ground in the second half of the year with expected completion in the first quarter of twenty seventeen. Total investment will be approximately $18,000,000 with a targeted GAAP yield of around 6%. Moving to Phoenix, we acquired a development site in the West Valley submarket for 12,900,000.0 where we can build a total of 1,100,000 square feet. We will kick off this project called First Park at PV 303 by building a 600,000 square foot facility with a total investment of approximately $33,000,000 and a targeted GAAP yield in the mid to high sevens.

We anticipate starting it in the third quarter with completion in the first quarter of twenty seventeen. We also have an option to acquire additional land at this site that could accommodate another 1,500,000 square feet. These four projects will have a total investment of approximately $180,000,000 with an estimated combined GAAP yield in the mid-6s. One final note on development. We also added an 11 acre site for $1,700,000 in the Inland Empire close to our Moreno Valley holdings.

We expect to be able to build a 236,000 square foot facility on the site after we complete some entitlement work. As we have commented on previous calls, the acquisition market is challenging. That said, year to date we've successfully closed two acquisitions in the Orlando market. As previously disclosed, in the first quarter, we acquired a 126,000 square foot building in Orlando that was 100% leased. The purchase price was $9,300,000 and the in place yield was 7.8% reflecting above market rental rates.

In the second quarter, we acquired a recently completed 199,000 square foot facility for $14,000,000 The building is 100% leased on a long term basis with an in place yield of 6.6%. Regarding dispositions, in the first quarter, we sold five properties totaling 420,000 square feet for $16,300,000 with a weighted average in place cap rate of 8.6%. These include properties in Indianapolis, Detroit and Chicago as well as our sole asset in Des Moines. Thus far in the second quarter to date, we have sold five buildings comprised of 406,000 square feet for $15,400,000 with properties in Detroit, Dallas and Chicago. As we discussed last call, we expect to sell $150,000,000 to $200,000,000 of properties in total in 2016 with sales weighted to the second half of the year.

Now let me give you a quick update on our CEO search. The process is moving forward according to plan. We are pleased to have talented internal and external candidates that we are vetting and we will let you know when we have a decision. We have no specific timetable other than I plan to retire by year end. In closing, the year is off to a great start.

Our team's focus is squarely on driving cash flow growth now and in the future. Cash flow in turn drives our dividend which as you know we increased 49% from our prior rate to $0.19 per share in the first quarter. We are excited about the opportunities we have to deliver value for our shareholders throughout our business, including the new investments I discussed. With that, let me turn it over to Scott. Scott?

Speaker 3

Thanks, Bruce. Let me start with the overall results for the quarter. Funds from operations were $0.35 per fully diluted share compared to $0.20 per share in 1Q twenty fifteen. Funds from operations before one time items, namely our acquisition costs in 1Q twenty sixteen and hedge costs in 1Q twenty fifteen were $0.35 and $0.31 per share respectively. EPS for the quarter was $0.14 versus $02 one year ago.

As Bruce noted, we finished the quarter with occupancy at 94.8%, which was down 130 basis points from the fourth quarter, but up 50 basis points year over year. Regarding leasing volume, we commenced approximately 3,800,000 square feet of long term leases in the first quarter. Of these, a half a million square feet were new, 3,100,000 were renewals, and 200,000 were development leases. Tenant retention by square footage was 70.6%. Same store NOI growth on a cash basis, excluding termination fees, was 9.6%.

This was primarily driven by a decrease in free rent, higher average occupancy, rental rate bumps, and rental rate growth. Other items such as tax refunds and lower landlord expense contributed 110 basis points to our same store growth. Lease termination fees totaled $128,000 in the quarter and same store cash NOI growth including termination fees was 9.8%. For the quarter, cash rental rates were up 6.9% overall. Breaking it down, renewals increased 7.1% and new leases were up 5.8%.

On a GAAP basis, the overall rental rates were up 15.2% with renewals increasing 14.9% and new leasing up 17.2%. As we previously disclosed, we issued 5,600,000.0 common shares on April 5. As Bruce discussed, we have been pretty active on the investment side and we thought it was prudent to raise additional capital to fund our strong development pipeline. I will discuss the impact of the equity offering on our 2016 FFO guidance shortly. Other first quarter capital market actions were the planned payoffs of our 160,000,000 5.75% unsecured notes and $58,000,000 of secured debt with an interest rate of 7.75%.

Recall that these payoffs were effectively pre funded with the 3.39%, $260,000,000 seven year term loan that we closed in the third quarter of last year. Moving on to our balance sheet metrics. At the end of 1Q, our net debt plus preferred stock to EBITDA is 6.3 times, adjusting EBITDA by normalizing G and A and excluding acquisition costs, and adjusting debt by adding back loan fees. This is toward the low end of our target range of six to seven times. If you included the impact of the proceeds of the equity offering, we would have been at 5.8 times.

At March 31, the weighted average maturity of our unsecured notes, term loans, and secured financings is four point seven years with a weighted average interest rate of 5.1%. These figures exclude our credit facility. Our credit line balance today is $242,000,000 and our cash position is approximately $15,000,000 Now reviewing our 2016 guidance for our press release last evening. Our NAREIT FFO guidance range remains unchanged at $1.41 to $1.51 per share even after the impact of the equity offering. The dilution from the equity offering would have been approximately $0.35 per share.

This was primarily offset by the lease up of developments ahead of pro form a, higher capitalized interest due to the new planned construction starts, as Bruce discussed, our strong first quarter same store performance, offset by sales dilution net of acquisitions. The key assumptions are as follows: average in service occupancy remains 95% to 96% based on quarter end results as we expect occupancy to increase throughout the balance of the year Average quarterly same store NOI on a cash basis before termination fees is expected to be 3.5 to 5.5%, an increase of 50 basis points at both ends of the range, reflecting our first quarter performance. Our G and A guidance range is $25,000,000 to $26,000,000 As a reminder, our G and A guidance reflects the costs related to our CEO search, but does not reflect any potential changes in CEO related compensation. Note that guidance includes the costs related to our developments under construction at March 31, as well as planned development starts in Southern California, New Jersey and Phoenix. In total, for the full year 2016, we expect to capitalize about $03 per share of interest related to these developments, which is $02 higher than the guidance we provided on our fourth quarter call.

Guidance also includes the impact from the acquisition and sales completed in the second quarter to date. Our guidance does not reflect the impact of any future sales nor any acquisitions or developments other than those we discussed nor the impact of any future debt issuances, debt repurchases or repayments. Guidance also excludes any future NAREIT compliant gains or losses or the impact of impairments or the potential issuance of equity. With that, let me turn it back over to Bruce.

Speaker 2

Thanks, Scott. Before we open it up to questions, I will wrap up our comments by saying that the industrial real estate sector remains healthy and continues to benefit from broad based demand helped by the secular growth arising from e commerce activity. We need to capitalize on this favorable backdrop by continuing to execute on the opportunities within our portfolio and from our new investments. We are delighted that business remains good as evidenced by the development leasing wins I highlighted that have helped us to maintain our FFO guidance range for the year despite the impact of our equity offering. Driving cash flow for investors is what our business is all about, and our team embraces that mission.

We look forward to keeping you apprised of our progress throughout the year. We will now open it up for your questions. As a courtesy to other callers, we ask that you limit your questions to one plus a follow-up in order to give the other participants a chance to get their questions answered. You are, of course, welcome to get back in the queue. So operator, should we open it up for questions?

Speaker 0

Your first question comes from the line of Craig Mailman with KeyBanc Capital.

Speaker 4

Hey guys. Just on the development, know you guys on the 180, it's about a mid-six yield, but I'm just curious with at least on my numbers, the stock trading kind of that low to mid-six percent implied cap rate range, how you guys think about starting new projects and what yields you kind of need for a threshold perspective apart from just kind of spread versus acquisition cap rates, especially on an individual basis, some of the Inland Empire projects coming in kind of that low six cap rate range. I'm just curious kind of how you guys think about that from an NAV perspective.

Speaker 2

All right. Well, let me have Jojo answer, but let me just give you just the highlights, which is as we look at it, again, we like development for two reasons. We think on a risk adjusted return, we're getting good value for it. And again, we know we own it. We've got to deliver.

We've got a great team. Our team has executed. We've shown great progress in terms of what we've done to date and we're very excited about these new developments that Jojo can talk about. But I would also say that it also helps upgrade the portfolio. Again, when we're building these projects, we're putting in extra bells and whistles.

We're really focusing on making sure we've a lot of parking, trailer parking and we're very excited about them. To us, that also helps just to the overall portfolio valuation. But Jojo, you want to talk add about?

Speaker 5

Yes. Thanks, Bruce. I mean, and these developments will give us superior cash flow growth, superior cash flow profile. And so we're very excited about these investments. When we look at these investments, we're trying to achieve 100 to 150 basis points spread over acquisition.

That's kind of how we look at it. In addition to that, we look at the sub market level and we really try to build product that we think is in demand and work in, the demand will exceed supply. In terms of spreads, as you know, the two projects are basically what we spoke about are in California and today California is in the low force. And then we also spoke about the, you know, the in South Jersey. That's low in the low five to low fives.

So, you know, there is obviously a spread. And in And in Phoenix, you know, we're talking about the mid to high fives. So again, overall weighted average basis, it's clearly within the range that what we're trying to do.

Speaker 2

And Craig, we're very excited about these developments.

Speaker 4

Okay. And then just on First Florence, I'd read that Amazon was looking for a 600,000 square foot warehouse in Florence. Is that related to this project? Do you guys have any leasing on this?

Speaker 2

Let me ask Peter to answer that.

Speaker 6

Sure. So Craig, this project, again, as Bruce said, we just closed on the land. It's right at the intersection of the New Jersey Turnpike and the Pennsylvania Turnpike at Exit 6A, so about 13 miles south of 7A. We can't comment specifically on activity in the market, but certainly Amazon is looking at a lot of requirements around the country. We just broke ground last week, we expect to deliver the building in the first quarter of twenty seventeen.

And we'll be sure to keep everybody updated on our progress, but no leasing activity reported today. As I said, we just started construction, but we're excited about the project.

Speaker 4

Great. Thank you.

Speaker 0

Your next question comes from the line of Dave Rodgers with Baird.

Speaker 7

Yes. Good morning, guys. Maybe a follow-up on Craig's first question. I guess what I want to try to understand is with the amount of acceleration and development that you talked about, how close you're going to be, maybe run through some of the math in terms of kind of getting to your capital at risk targets with the speculative construction, etcetera. Will you be able to stay within those targets?

And how close to that limit do you expect to be?

Speaker 2

Good, Aya. It's a good question. Jojo, you want to answer that?

Speaker 5

Sure, Dave. So our speculative development cap is $325,000,000 If you put into assume that you put in the leasing that we've had in First Park Ocean Ranch in Southern California, First San Michele, and First thirty three Commerce Center, and you include all of the $180,000,000 of development, our total number within the cap is $286,000,000 So that imputes to a $39,000,000 capacity under the cap.

Speaker 2

After taking into effect all these new investments.

Speaker 7

Okay. That's really helpful. And then maybe the second part of it is can you talk a little bit more about what you're seeing in Houston and Dallas and some of the markets where new supply seems to be creeping up a little bit on you and how new supply might be factoring into some of these decisions?

Speaker 2

Sure. Let me ask Joe to handle that.

Speaker 5

Sure. Overall, in terms of Houston, the demand has leveled off in the Northwest submarket. Basically, in the Southeast market, the market is still driven by downstream related activity, primarily refining and petroleum. As you know, we have two newer assets. Basically, first North Commerce Center in Northwest Dallas.

We've got about a 40,000 oh, in Houston, that's about 40,000 square foot remaining vacancy there, and we're focused on getting that done. That's 88% leased. And late last year, we acquired two building new developments that at the time of acquisition, it's about 13% leased and now it's 41% leased. This is the Southeast market right on the Beltway. So as you can see, there's been leasing activity there.

But our job is to get that all leased. Overall, in terms of our Houston portfolio, we're 98.5% leased today. And year to date, in terms of our leasing, we've achieved slightly over 6% cash and cash flow rate increase. And you mentioned, Dave, Dallas. Dallas, yes, we do not have a big box development right now as we sit.

What we have is a 50,000 square foot remaining vacancy at First Arlington Commerce Center. That's 67% leased, and we're focused to get that done. We already leased to two tenants, and that's a multi tenant building. And we're still under construction with First Arlington Commerce Center II, which is a 231,000 square foot multi tenant building, that's mid sized. The target there is the mid sized tenants in the great Southwest market of Dallas, which we believe is under built today and where demand will continue to exceed supply.

Speaker 2

Great, thanks.

Speaker 0

The next question comes from the line of Eric Frankel with Green Street Advisors.

Speaker 8

Thank you. I was hoping you could touch upon your same store NOI growth forecast. So if you just look at your first quarter results and you look at your revised forecast, it looks like second quarter to fourth quarter same store NOI growth should be just over 2.5% per year. That seems a little bit conservative. Can you touch upon that, Scott?

Speaker 2

Well, sometimes we call them sandbags, Scott. But let me I would say you have to look at it the first quarter in terms of as we look at as we go through the rest of the year, we'll update that what we just did in the first quarter.

Speaker 3

Yes. And Eric, think we always on same store, you got to look at the year because there's going to be some lumpiness in there. So if you look at our midpoint same store guidance of 4.5%, you get to about an average of 2.8%, say 3% for the rest of the on average for 2Q through 4Q. Some of the items that could maybe possibly surprise in the upside as we give a range of occupancy, that might be able to help that out if we're able to achieve on that. The other thing is bad debt expense.

Eric, we've modeled in $750,000 per quarter 2Q through 4Q. We came in first quarter at $265,000 our bad debt's been coming in well. So if we're able to do better on that as well, I think you might be able to get some upside there. But any follow-up?

Speaker 8

Yes. Are there any expense growth increases related to that? I mean, so if you had a tax refund in the first quarter, are there potential for real estate tax increases just because property values are rising throughout the country and

Speaker 3

throughout I the rest of the would say we probably have more of a surprise possibly for tax refunds as opposed to tax increases. I mean, we build in tax increases if we know of that in the same store numbers. Eric, on tax refunds, we had some of that in the first quarter. It's hard to determine if or when you're going to get those. So there may be some of those in the second quarter to fourth quarter as well.

Speaker 8

Okay. And can you just remind me what forecast in terms of rent upon lease rollover in your same store forecast?

Speaker 2

Overall on the rollover, Eric, we're looking for the year about between 57%

Speaker 6

on a cash basis, rents to increase.

Speaker 8

Okay, thanks. Do I have time for one more question or is that

Speaker 2

of a please. No, keep going. You're on a roll. I appreciate that. Peter, I

Speaker 8

was hoping you could touch on the first Florence project. So I just note that your cost base on the development is $16 per billable square foot, but your overall base is going be about $70 So that's a pretty hefty construction cost number. So I was hoping you'd touch upon construction cost trends and whether that's just a unique project, whether there's some unique costs in there.

Speaker 6

Sure, Eric. There's nothing that's that unique. We have some site work on the property, which, as you know, is always the biggest variable. But this will be a tilt wall concrete building and relatively straightforward. So we certainly like the basis we're at, particularly when you look where things have traded in New Jersey.

In this submarket, which is really benefiting, as you probably know, from the widening of the New Jersey Turnpike all the way down South Pax Exit 6 And 6A, it's helping to drive demand further down the Turnpike where Exits 7A And 8A remain pretty tight. But no, we're happy with the basis. We certainly have seen some costs increase and some capacity issues on things like precast, But nothing else that would really be unusual here.

Speaker 8

Okay, I'll jump back in the queue. Thank you.

Speaker 0

Your next question comes from the line of John Peterson with Jefferies.

Speaker 9

Great, thank you. I just had more of a high level question, maybe just a little bit for my curiosity. But over the last few quarters, a lot of economic indicators have been trending fairly negative, the ones that are typically good indicators for general industrial demand. But demand from you guys, from all your peers tends to be really strong right now. It's almost obvious that e commerce is what's driving that.

So I'm just curious if you could kind of walk us through like maybe the last few years. Like what percent of leasing are you doing now that you would classify as e commerce related relative to a year ago, two years ago, three years ago? Like how much of the incremental demand is driven by that?

Speaker 2

That's a hard one. But Peter, you want to address that?

Speaker 6

Sure, John. It's Peter. It's difficult to quantify exactly how much of the demand in leasing is e commerce. It's easy to see the pure play e commerce companies like Amazon, for example, that was mentioned earlier. But there are a lot of companies that are engaged in this, whether it's logistics companies and transportation firms or third party companies providing these services or even package delivery companies.

And part of the occupancy may be e commerce and part of it may be more traditional warehousing. But there's no doubt that we've been the benefit in the industrial business of e commerce and the secular change. And we continue to see it as a significant driver. But it's not the only driver. As we've talked about before, there's pretty broad based demand across a number of industries.

But clearly, e commerce is helping.

Speaker 9

Okay. And is there a certain type of business, whether it's an e commerce customer or otherwise, where you're seeing more incremental demand? I know it's probably more market specific, but different clear heights or different sized buildings or closer to kind of CBD areas of market?

Speaker 2

Do you want to try that?

Speaker 5

Yes, the demand has been broad based, you know, On the immediate delivery or last mile, we're seeing in our infill portfolio that some tenants are looking to do omnichannel, which is both bricks and mortar and direct fulfillment. But also not everybody needs a same day delivery item, so you see the Inland Empire benefiting from large boxes because again or other parts of the country too because in some deliveries, customers find it acceptable to get it received in two to three days. So the demand is broad based, John. Got it.

Speaker 9

All right. Good quarter. Thanks for the color.

Speaker 0

And you do have a follow-up question from the line of Eric Frankel with Green Street Advisors.

Speaker 8

Thank you. Quick questions on Orlando. Why are you looking to expand there?

Speaker 2

Again, know, we've been in Orlando before, but Jojo, you want to talk about Orlando?

Speaker 5

Sure, Eric. We're familiar with Orlando. We've been in Orlando. That market, vacancy rate continues to decline. Now they're at about 6% and there continues to be net absorption.

Orlando is the primary distribution market for Central Florida. So we think it's going to be staying that way for a long time. It's a decent sized market, 158,000,000 square And we found really two good acquisitions we're very happy about. We'll continue to expand there, but we'll maintain our discipline because acquisitions are pretty competitive. Okay.

That's it for me. Thank you.

Speaker 0

And I show no further questions at this time. Bruce, I'll hand it back to you.

Speaker 2

Great. Thanks, operator. And thank you all for joining us. If you have any questions, please feel free to call Art or Scott or myself, and we look forward to seeing some of you in June and NAREIT. And we appreciate your support.

Thank you.

Speaker 0

This concludes today's conference call. We thank you for your participation and ask that you please disconnect your line.