First Industrial Realty Trust - Q2 2023

Transcript

Operator (participant)

Good morning, welcome to the First Industrial Realty Trust, Inc. second quarter results call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Art Harmon, Vice President of Investor Relations and Marketing. Please go ahead.

Art Harmon (VP of Investor Relations and Marketing)

Thank you, Jason. Hello, everybody, welcome to our call. Before we discuss our second quarter results and our updated 2023 guidance, let me remind everyone that our call may include forward-looking statements as defined by federal securities laws. These statements 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, July 20, 2023. We assume no obligation to update our statements or the other information we provide. Actual results may differ materially from our forward-looking statements, factors which could cause this are described in our 10-K 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 Peter Baccile, our President and Chief Executive Officer, and Scott Musil, our Chief Financial Officer, after which we'll open it up for your questions. Also with us today are Johannson Yap, Chief Investment Officer, Peter Schultz, Executive Vice President, Chris Schneider, Senior Vice President of Operations, and Bob Walter, Senior Vice President of Capital Markets and Asset Management. Now, let me hand the call over to Peter.

Peter Baccile (President and CEO)

Thank you, Art. Thank you all for joining us today. Our team delivered an excellent quarter, highlighted by an FR record-setting increase in cash rental rates on new and renewal leasing. We also achieved some leasing wins at some of our developments and began construction of two new buildings in coastal markets. As a result of our performance and updated outlook, we raised our estimates for our 2023 cash rental rate growth and full-year FFO per share guidance, which Scott will discuss shortly. Before we get deeper into our results, let me spend a moment discussing the broader U.S. industrial market. Overall fundamentals remain good. National vacancy today is low at around 3.7%. In our 15 target markets, vacancy is 3.3%.

As we discussed on our last call, there's a fair amount of new supply expected to be delivered nationally in roughly the next 12-18 months. Based on CBRE EA's analysis, there is 540 million sq ft under construction across the U.S., 31% of which is pre-leased. Focusing on our 15 target markets, completions are expected to be approximately 400 million sq ft, with 30% currently pre-leased. Nationally, new starts in the first half of 2023 are down approximately 40% compared to the same period a year ago, as sponsors continue to evaluate the economic landscape and the revised economics of new projects due to meaningful increases in the cost of capital. With respect to demand, the pace of leasing activity in our in-service portfolio continues to be strong.

Tenants are making leasing decisions many months in advance of their lease expirations, and we are achieving very healthy rental rate increases. I will touch on these two points later in my remarks. For the unleased portion of our 1.8 million sq ft of completed developments that is slated to be placed in service in the third and fourth quarters, we have interest from prospective tenants for many of the spaces. However, tenants' decision-making time frames have elongated compared to a year ago. Customers are dealing with uncertainty in the overall economy, and the Fed's decision to delay future rate hikes likely didn't provide any comfort. As a result, we adjusted the lease-up assumptions for some of these developments, which impacted our average occupancy guidance midpoint by 75 basis points for the year.

Scott will walk you through the details, importantly, we have offset the FFO impact with the help of leasing at other developments. Returning now to our performance. We finished the second quarter with an occupancy rate of 97.7%. Our cash rental rate increase for leases commencing in the second quarter was 74.1%, exceeding the FR record we established just last quarter. As of yesterday, approximately 81% of our 2023 lease expirations are in the books at a cash rental rate increase of 63%. We now anticipate that our cash increase on rental rates on new and renewal leasing for 2023 commenced leases will be in the range of 55%-60%.

This is an increase of 7.5 percentage points at the midpoint compared to what we mentioned on our April call, and 12.5 percentage points higher than our original guidance. As we've highlighted previously, one of the drivers of our record-setting rental rate increases is the contribution from our Southern California lease signings. For 2023, of the 2.1 million sq ft expiring in Southern California, we already have signed leases for 72% of that space at a cash rental rate increase of 156%. Looking ahead, we're already seeing renewal activity on our 2024 lease expirations. Of note, we have taken care of next year's largest lease expiration by square footage, with the renewal of a 700,000 sq ft tenant in Nashville at a 40% cash rental rate increase.

We've also inked a 213,000 sq ft renewal in Central New Jersey for a 128% cash rental rate increase. We're off to a good start addressing our 2024 lease expirations, and we will provide you with an update on our leasing progress on our third quarter call. I'd like to provide you with a leasing update on our 644,000 sq ft Old Post Road building in Baltimore. Our prospective 3PL tenant continues to await the final decision from the government regarding the contract award. We continue to assume lease up of the full building in the third quarter, as this is the start date of the contract award. We also continue to market the building to new potential tenants. Moving on to development activity.

Since our last earnings call, we signed full building leases for the 56,000 sq ft First Park Miami, Building 13, and the 132,000 sq ft First Gate Commerce Center, both in South Florida. At our three-building project in our Phoenix JV, we pre-leased the 420,000 sq ft building to a restaurant supply business. Given our success in South Florida at our First Park Miami project in the infill market of Medley, we broke ground on the 136,000 sq ft Building 12. Total estimated investment is $34 million, and the projected cash yield is 6.9%. This will be our seventh building at this multi-phase park. The previous six were leased at or shortly after completion. Beyond this new start, we look forward to further growth at First Park Miami.

We just closed on another phase of land at the park, which is buildable to approximately 430,000 sq ft. We expect delivery of the last parcel from the seller per our option agreement in mid-2024, which would accommodate another 430,000 sq ft. When fully built out, the park will total 2.5 million sq ft. On the West Coast, we broke ground at First Harley Knox Logistics Center in the Inland Empire. First Harley Knox will be a 159,000 sq ft facility with a total estimated investment of $31 million and a healthy projected cash yield of 8.4%. Including these second quarter development starts, our developments in process total 2.7 million sq ft with an investment of $441 million.

The projected cash yield of these investments is 7.9%, which represents an expected overall development margin of approximately 75%. In addition to the First Park Miami land, we also closed on 3 more new development sites since our last call. In the Lehigh Valley in Pennsylvania, we acquired 66 acres for $24 million. This site can support a four-building park totaling 762,000 sq ft. In the Inland Empire East, we added a four-acre site in Perris for $13 million that is next to a site we already own. Combining these sites will allow us to build a single 550,000 sq ft building at a higher yield and margin. We also acquired five parcels totaling 101 acres from four sellers in North Palm Springs on the I-10 corridor for a total of $21 million.

This assemblage will position us to build up to three buildings, totaling 1.9 million sq ft, with a very competitive land basis. In total, our balance sheet land today can support an additional 16.8 million sq ft. This represents approximately $2.6 billion of potential new investment based on today's estimated construction costs and the land at our book basis. These figures exclude our remaining share of the land in our Phoenix joint venture. Since our last call, we completed the sale of two buildings in Houston and Detroit, totaling 190,000 sq ft, plus a small land parcel in Minneapolis, for a total of $18 million. Our sales guidance for the year remains $50 million-$150 million. With that, I'll turn it over to Scott for some additional commentary and updated guidance.

Scott Musil (CFO)

Thanks, Peter. Let me recap our results for the quarter. NAREIT funds from operations were $0.61 per fully diluted share, compared to $0.56 per share in 2Q 2022. Our cash same-store NOI growth for the quarter, excluding termination fees, was 10.8%. The results in the quarter were driven by increases in rental rates on new and renewal leasing and rental rate bumps embedded in our leases, partially offset by slightly lower average occupancy, higher free rent, and an increase in real estate taxes. As Peter noted, we finished the quarter with in-service occupancy of 97.7%, down 70 basis points compared to 2Q 2022, primarily due to anticipated move-outs. Summarizing our leasing activity during the quarter, approximately 1.7 million sq ft of leases commenced.

Of these, 200,000 were new, 900,000 were renewals, and 500,000 were for developments and acquisitions with lease-up. As a reminder, we are strongly positioned with no debt maturities until 2026, assuming the exercise of extension options in two of our bank loans, which puts us in an advantageous position, given the volatility and higher interest rates in the financing markets. Moving on to our updated 2023 guidance per our earnings release last evening. Our guidance range for NAREIT FFO is now $2.37-$2.45 per share. Excluding the $0.02 per share income item discussed on our first quarter call, our guidance range is now $2.35-$2.43 per share.

Our new midpoint of $2.39 per share is a penny increase at the midpoint, primarily due to higher capitalized interest from our two newly announced development starts. Key assumptions for guidance are as follows: quarter-end average in-service occupancy of 97%-98%. As Peter mentioned, this is a 75 basis point decrease at the midpoint, given the lengthened decision-making time frames we're experiencing from some of our prospective tenants. In particular, we have adjusted the lease-up assumptions for the available space at the 1.2 million sq ft of developments that will be placed in service in the third quarter. We are now projecting that approximately 860,000 sq ft of that space will be leased up in the fourth quarter of this year, with the remainder to be leased in 2024.

We also adjusted some of the lease-up assumptions for the development scheduled to be placed in service in the fourth quarter. Of the 650,000 sq ft, half is still anticipated to be leased in the fourth quarter, and the other half is now slated to be leased up in 2024. Moving on to our other guidance components. Same-store NOI growth on a cash basis before termination fees of 7.75%-8.75%. Note that the same-store calculation excludes $1.4 million of income related to insurance claim settlements recognized in the fourth quarter of 2022. Guidance includes $0.02 per share of JV FFO related to our share of the ground rent from our joint venture discussed on our first quarter call.

Guidance includes the anticipated 2023 costs related to our completed and under construction developments at June 30th. For the full year 2023, we expect to capitalize about $0.10 per share of interest. Our G&A expense guidance range is unchanged at $34 million-$35 million. Guidance does not reflect the impact of any future sales, acquisitions, development starts, debt issuances, debt repurchases or repayments, nor the potential issuance of equity after this call. Let me turn it back over to Peter.

Peter Baccile (President and CEO)

Thanks, Scott, thank you to all of my teammates for another excellent quarter. We're delivering strong cash flow from our portfolio as we capture our cash rental rate growth opportunities and maintain high levels of occupancy. Our regional teams are laser-focused on the lease-up of our pipeline as we build upon our track record of development, execution, and value creation. Operator, with that, we're ready to open it up for questions.

Operator (participant)

Thank you. We will now begin the question-and-answer session. To ask a question, you may press star, then one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. At this time, we'll pause momentarily to assemble our roster. Our first question comes from Rob Stevenson from Janney. Please go ahead.

Rob Stevenson (Analyst)

Good morning, guys. Peter, you sold the Houston asset in the quarter. What's the market like for asset dispositions today, given where rates are and the availability of debt for private buyers? I guess the other thing is that how much are you guys able to rely on dispositions as a funding source today, given those factors?

Peter Baccile (President and CEO)

The disposition market is open, the transaction market is open, albeit at lower volumes than you've seen in the past. As we've always said, most of our sales end up going to users, or high-net-worth family offices or smaller regional funds. We're having quite active dialogue on some deals with that kind of a buyer group. In terms of financing, their financing is available, it's expensive, so you're seeing a lot of these deals happen with all equity right now.

Rob Stevenson (Analyst)

Okay. Then the $145 million of developments you're expected to complete in the second half of this year, how are you thinking about starts behind those over the next six to nine months? Are you waiting and letting some of that 400 million sq ft of development that you talked about in your markets clear? Do you just keep your head down and start your projects when they're ready? How are you guys thinking about starts over the next six to nine months?

Peter Baccile (President and CEO)

Sure. Obviously, development leasing is going to dictate, to a large degree, the opportunity to have starts, but also so are the markets. We're gonna continue to evaluate the fundamentals in the market, leasing velocity, et cetera. You know, we do have a number of very good projects lined up that we can bring, but we're a profit shop and not a value shop, and if the market and the risk-adjusted returns aren't there, we'll just hold off

Rob Stevenson (Analyst)

Okay. Last one for me, Scott. 9.4 same store NOI year to date, guidance at the midpoint is like 8.25, which implies about 7% in the back half of the year. Is it just tougher comps, or is there something else that slows you down, you know, 250 basis points versus what you've seen year-to-date in the back half of this year?

Chris Schneider (SVP of Operations)

Yeah, this is Chris. You know, the decline is primarily due to the year-over-year drop in average occupancy. Our average occupancy in the first half of 2023 versus the first half of 2022 is up slightly. You know, in the back half of 2023 versus comparable 2022, the average occupancy is down slightly. You know, the balance of that decline is really just due to a little bit lower cash rent increases in the second half, and then our real estate taxes and bad debt are negatively impacting that a little bit.

Rob Stevenson (Analyst)

Okay. Very helpful. Thanks, guys.

Operator (participant)

Our next question comes from Michael Carroll from RBC Capital Markets. Please go ahead.

Michael Carroll (Managing Director)

Yep, thank you. Can you guys provide some color on your Baltimore portfolio? I mean, what drove the overall occupancy within that portfolio lower? I mean, just kind of looking at the comps, it looks like it's a property that's near your Old Post Road. I mean, is that correct?

Peter Schultz (EVP)

Good morning, Mike, it's Peter Schultz. Yes, it's one building of 350,000 sq ft that was a known move-out. The tenant moved to a consolidation into almost 2 million sq ft in a build-to-suit. The building is being marketed. We're seeing activity from full and partial users. The amount of supply in that submarket continues to be very limited, and in fact, there's a limitation on new industrial development imposed at the moment by the municipality. We'll keep up to date on our progress on releasing that, but that's the one building that impacted the occupancy.

Michael Carroll (Managing Director)

Okay, great. What is the I guess, I know you kind of talked about that there's interest in that asset, and I'm assuming the 3PL tenant that might take the building next door, they wouldn't be interested in it. Is this an expectation of another elongated leasing process, or is that interest level strong enough that there could be a quicker lease-up?

Peter Schultz (EVP)

In general, I would tell you that smaller mid-size tenants are more active in making decisions quicker than larger tenants. We would anticipate the lease-up of this asset, certainly to be faster than 500 Old Post Road, and we'll keep you posted. As I said, we are seeing activity from full and partial tenants now, and they don't have a lot of choices.

Michael Carroll (Managing Director)

Okay. On the completed developments, the ones that are gonna go into service in the back half of this year, I mean, how strong are those markets? I mean, it looks like Denver is one of the markets that where a couple assets are in. I mean, is there a lot of interest in those assets? I mean, how many tenants are specifically looking at those properties in general?

Peter Schultz (EVP)

Yeah. In Denver, we have two buildings, a 588,000 sq ft building and a 200,000 sq ft building. Generally speaking, we're seeing activity from partial building users, for the most part, a couple of full building users on the smaller building. As I just said, in answer to your other question, activity levels and interest levels are better, in the smaller midsize, and those decisions are being made faster, as opposed to tenants, the larger-sized tenants, where they continue to be slow-playing those discussions. Both of these buildings were designed, and built with the expectation that we would multi-tenant, both of them. It's really a matter of when the deals get done, but we have multiple prospects on both buildings.We just would like to see the decision-making proceed a little bit faster.

Michael Carroll (Managing Director)

Yeah, understood. I mean, just last question for me is, like, what is the reasons for the delayed decision-making? Is it just the current disruption in the capital markets? Are you surprised that it's taking them this long to make those decisions?

Peter Baccile (President and CEO)

The decision to lease a 600,000 or 700,000 sq ft facility, it's a big financial commitment. Not only do you have the rent, but you've got to equip the building and put inventory in the building and hire people, and it's tens of millions of dollars. Some of the larger users are trying to decide when is the right time to fund their growth. This is all new growth. The need is there, but the need may not be today, it may be three months from now or a bit later than that. That's really the decision they're tossing around as they look at what's happening with rates and the impact on the economy and whether we're gonna have a recession, et cetera.

It's really just trying to make the right decision about when they invest pretty big dollars, into their business.

Michael Carroll (Managing Director)

Okay. Are you surprised that it's taking them this long to make these decisions?

Peter Baccile (President and CEO)

Not really. I mean, I think every business is trying to figure out what the go forward looks like, just like we are. It's not surprising given all of the uncertainty in the market.

Michael Carroll (Managing Director)

Okay, great. Thank you.

Operator (participant)

Our next question comes from Craig Mailman from Citi. Please go ahead.

Craig Mailman (Director and Equity Research Analyst)

Guys. Peter, on the development pipeline, not to harp on this, but as I'm just going through it, you guys, you know, haven't done a lot of build-to-suit, and it just feels like with a pullback in your competitors really being able to secure financing, is this an area that you guys could, you know, start to gain some market share and to maybe de-risk the pipeline a little bit on incremental starts?

Peter Schultz (EVP)

Good question, Craig. We are in the build-to-suit business. As you know, we don't do a lot. I will offer that we are having some conversations on that front now.

Peter Baccile (President and CEO)

We'll see where they go.

Craig Mailman (Director and Equity Research Analyst)

I mean, is it a return issue where you guys don't want to give up the profit margin, or is it just you don't have the landslide where the RFPs are at this point?

Peter Baccile (President and CEO)

I would say that it's both. The returns on speculative development are obviously, and in many cases, significantly higher. Then, you know, we target land that it is in pockets of unmet demand, and we don't have as many alternatives in some markets as maybe some of the other competitors would have. That limits the number of build-to-suits that we're positioned to do.

Craig Mailman (Director and Equity Research Analyst)

Then, you know, just going through, where you guys have the availability, there's clearly a fair bit of square footage in California, that's obviously ground zero for a lot of concerns right now in the investor community. I mean, could you talk about what you're seeing in different size ranges and different submarkets, vis-a-vis where you guys have availability?

Peter Baccile (President and CEO)

Specific to SoCal?

Craig Mailman (Director and Equity Research Analyst)

Yeah.

Peter Baccile (President and CEO)

Johannson, you wanna provide your thoughts on that?

Johannson Yap (First Industrial Realty Trust)

Sure. In terms of availability, our existing portfolio is basically on, you know, close to 100% lease. Very, very few spaces available. We have one space in the Inland Empire East that we're trying to lease. Very, very good product. Well, well below market. In terms of our speculative developments, we have four ongoing right now. Nothing is completed right now, you know, they're scheduled to be completed closer to Q4, and we're getting inquiries and tours. If you look at the four developments that are under construction, they range from 83,000 sq ft-460,000 sq ft. They're spread over Inland Empire, West Moreno Valley, into Inland Empire East, the submarket of Redlands, and the 215 corridor. We're getting tours and looks at every building.

We haven't announced a lease yet because we don't have a lease yet, but we're working hard to get this, all those pre-leased. Today, users are more inclined to seriously engage in leasing when the building is close to getting built. As you may have heard, there have been some delays due to supply chain and municipal approvals in California, and then a lot of tenants has been a little bit concerned that, you know, buildings be delivered exactly on time. That's affected a little bit of leasing. By and large, again, you know, the prospect activity has been active.

Art Harmon (VP of Investor Relations and Marketing)

Just because there's a fifth building that we just started, Craig, in the Harley Knox deal we talked about earlier.

Johannson Yap (First Industrial Realty Trust)

Yeah, that's not gonna be, completed until Q, until 2024.

Craig Mailman (Director and Equity Research Analyst)

You know, Carvana put out some news yesterday about restructuring. It looked like some of the ADESA assets were put up as collateral. I mean, from your standpoint, is that just improved the credit for you? Is there, you know, any insight you guys have on that transaction and, you know, how you guys feel incrementally about that credit?

Peter Baccile (President and CEO)

I mean, we don't have any particular insights that you already haven't read about in the newspaper. It certainly looks like they're doing their best to right the ship. It's interesting to us that the founders have put in some substantial cash into this new deal. At the end of the day, these ADESA sites are owned by us, leased to them. As we've said on prior calls, if we get that back, yes, we'll have a short-term hit to FFO, but the long-term value creation is significant. We'll take the cash flow while they're paying rent, and they are current, and if they stop paying rent, we'll take the assets back and redevelop them and make a heck of a lot of money.

Craig Mailman (Director and Equity Research Analyst)

Okay, great. That's it for me.

Operator (participant)

The next question comes from Ki Bin Kim from Truist. Please go ahead.

Ki Bin Kim (Managing Director of US REIT Equity Research)

Thanks. Good morning. Just to go back to the Inland Empire topic. Given that you have a few projects that you're developing there, you know, how do you just view the supply-demand dynamics in that market and how it might impact the lease-up timing for your projects?

Peter Baccile (President and CEO)

Jojo?

Johannson Yap (First Industrial Realty Trust)

Okay. Again, you know, the buildings are still under construction. As we've always said, our underwriting always has a one-year downtime. In the past, there's been pre-leasing in that market. I think today we're more of a normalized, you know, we lease it within our underwriting period. In terms of activity, again, we've seen a better activity in Q2, even over Q1. If you look at even the containers cargo flow of inbound containers only, in June, almost to this year, almost matched June of 2022, wherein the Q1 of 2023 lagged Q1 2022 TEU traffic. I mean, you know, we see a little bit improvement.

I think overall, this agreement between the unions and the owners, it hasn't been ratified yet, but they reached agreement on a labor agreement. I think that will give more visibility to shippers and all that, and I think that'll reduce any concern. You know, it all depends on how the economy moves. Bear in mind, overall, that LA is still sub 2% vacancy at 1.7%, and basically, IE is sub 3% at 2.7%. It's the hardest place to entitle land today in the U.S. You know, long term, supply should be continued to be constrained.

Nicholas Yulico (Managing Director)

You know, your retention rate was 60% this quarter. Obviously, the Baltimore lease probably made a big impact. Just overall, when you look at the reasons why tenants don't renew, have the different reasons or categories shifted at all? I'm just curious if, you know, tenants are becoming increasingly more price sensitive.

Peter Baccile (President and CEO)

In our portfolio, when tenants leave, have left, and this continues to be true, they've left because we can't accommodate their need to grow. The tenant, in fact, in Baltimore, that moved out, consolidated into a nearly 2 million sq ft facility. We obviously couldn't provide that growth room for them. That is really the reason people leave. When we're discussing potential tenants for lease up of new developments, once in a while, a tenant will come around and say, "Gee, I'm gonna move," you know, let's say, if it's California, east, to pay a little bit lower rent. That's not, that's not a trend, and that doesn't represent the bulk of any of those conversations.

Nicholas Yulico (Managing Director)

Okay, thank you.

Scott Musil (CFO)

Kevin, this is Chris too. The majority of the time, we're releasing those at significantly higher rents, you know, when they move out. Yeah.

Nicholas Yulico (Managing Director)

Okay, thank you.

Operator (participant)

Our next question comes from Nick Thillman from Baird. Please go ahead.

Nick Thillman (Senior Research Analyst)

Hey, guys. Maybe just going on development. On, like, the market rent growth, sort of, for new development, have you seen market rents for new development in your markets? Have they peaked, or are you kind of seeing any retreating there?

Peter Baccile (President and CEO)

We Market rents are growing. I think in earlier in the year, we thought it would be in the kind of 5%-10% range. We still have a view that when you get to the end of this year and look back, you'll see that rents grew, you know, mid- to high-single digits for the year nationally, obviously, at the higher end of that range in the higher barrier markets. In some places, there may be interest in racing to lease, like South Dallas, so maybe rents there aren't growing, in fact, may be sagging a tiny bit in the million-foot category, where there are quite a few large-format buildings available. Generally speaking, across the markets, we do continue to see decent rent growth.

Nick Thillman (Senior Research Analyst)

Okay. Maybe on another way of asking the Southern California development question, but just what are you guys tracking for, like, on a square footage basis of demand in SoCal? How has that changed over the last, like, 3 to 6 months?

Peter Baccile (President and CEO)

You have a view on that, Giorgio?

Johannson Yap (First Industrial Realty Trust)

There's no exact square footage because there's no data exactly, you know, and it continues to shift quarter by quarter and by week by week. I think the way I would characterize this is that Q4 2022, Q3 to Q4 2022, I would say for every vacant space you have, you might have 3 to 4 prospects. Today, you would have 1 to 2, looking at your building at any given point in time.

Nick Thillman (Senior Research Analyst)

That's helpful. Maybe last one for me, for Scott. Any shift in the tenant watch list or bad debt expectations for the remainder of the year?

Scott Musil (CFO)

No, Nick, nothing. Our bad debt expense continues to trend low. It's under $100,000 in 2Q. Year to date, our total is $180,000, so very low. Again, no material tenants on the watch list, and Peter spoke about ADESA.

Peter Baccile (President and CEO)

Yeah, let me add one more thing to what Giorgio just said. You know, the tenant velocity or tenant interest reflects more of the demand that we had in 2019. Obviously, you know, we've been around a while. 2018, 2019, were, at the time, the best markets we'd ever seen. This is, again, why at the beginning of the year, we discussed normalization of demand. It's really going from multiple, you know, four or five prospects per space down to two or three prospects per space.

Nick Thillman (Senior Research Analyst)

Very helpful, and thanks for the time.

Operator (participant)

The next question comes from Nicholas Yulico from Scotiabank. Please go ahead.

Nicholas Yulico (Managing Director)

Thanks. I just wanted to, you know, follow up back on the Old Post Road, you know, potential tenant there or releasing. It sounds like it. I think you said you're still including this in the guidance for third quarter leasing. Yeah, so you're assuming even if the one tenant with the government contract, you know, doesn't work out, that you have a backup tenant there for that asset?

Peter Schultz (EVP)

Nick, it's Peter Schultz. The assumption is that the 3PL that we've been working with for some time, as you know, for the government contract, that that gets released by the government sometime in the near future, and the lease-up remains in our third quarter guidance. I'm not prepared to tell you that we have somebody else today behind that. What I would say is, we continue to market the building, and we continue to see prospects. We had a fresh tour this week for both buildings, we'll see how it goes. You know, the government wants to get this done, it's taken an awfully long time, as everybody on this call knows from our prior calls. Hopefully we'll have some news to report on that sometime soon.

Peter Baccile (President and CEO)

Our assumption of a third quarter lease-up reflects our expectation, and the probability that our tenant wins this contract.

Nicholas Yulico (Managing Director)

Okay. Thank you. Appreciate that. Just going back to Southern California, I know there's already been some questions on this, but, you know, if you look at the occupancy at quarter end,... in the sup, I mean, it was down, you know, 100 basis points or so versus the average number. Can you just talk about what, you know, drove that in particular, and how we should think about maybe a trending occupancy for the market for the rest of the year?

Chris Schneider (SVP of Operations)

Yeah, Nick, this is Chris. Jojo had mentioned that, you know, we had one space that was available in the Empire. That was a 225 sq ft move-out. That the rent is very, very significantly below market rent. We have a opportunity to re-lease it at a much higher rent. That's really what was driving that occupancy drop.

Nicholas Yulico (Managing Director)

Okay, got it. Just last one on, you know, the land inventory. You know, the number that's on the NAV page, I mean, it says it's a fair value number. Can you just give some perspective on, you know, how you may have adjusted, you know, the land values? You know, we have heard some level of correction in land values in the market, realizing that, you know, in many cases, you guys still have a good basis in land. How we should think about, you know, fair value of the land today?

Johannson Yap (First Industrial Realty Trust)

Sure. This is Jojo. We look at the schedule quarter by quarter. We adjust it to what we believe are fair market values. I mean, from Q1 to Q2, I would say the big change would be, not a big change, but some of the changes were North Palm Springs. We acquired that, and we think we're clearly in the money on that already because that's an off-market deal with a assemblage. Over time, we've adjusted this, especially on the entitlement basis. You know, when I say entitlement basis, SoCal, when it's acquired, it's unentitled, and as we go through successful entitlement, and we've been successful 100% of the time with all of this, our SoCal land acquisitions, we've adjusted that over time.

That's, we do this a fair market value basis every quarter.

Nicholas Yulico (Managing Director)

is there just any rough % you're able to share about how much, you know, you've adjusted your land values down, you know, versus a peak value?

Johannson Yap (First Industrial Realty Trust)

Well, what we've actually done is we've actually not adjusted it up when it was due to be adjusted up, and until we complete entitlement. It's more of meeting the market.

Nicholas Yulico (Managing Director)

Okay, thanks.

Operator (participant)

If you have a question, please press star, then one. Our next question comes from Anthony Powell from Barclays. Please go ahead.

Anthony Powell (Director of Equity Research)

Hi, good morning. 1 follow-up on Old Post Road, I guess. How much FFO or occupancy is in the guidance, assuming that the contract is done in the third quarter?

Scott Musil (CFO)

Sure. This is Scott. It's about $0.01 per share in FFO related to that lease-up. The occupancy impact, this is the impact on our quarterly weighted average occupancy, is about 50 basis points.

Anthony Powell (Director of Equity Research)

Thanks. Maybe one on market rent growth. You know, I think in prior quarters, there's a lot of optimism about the Southern California and coastal markets doing very well. In recent calls, I've heard just increasing strength in more interior markets. Maybe if you talk about coastal versus non-coastal rent growth trends you've seen recently?

Chris Schneider (SVP of Operations)

Peter, you want to talk about what you're seeing, and then Jojo, you talk about the SoCal, et cetera, and Phoenix?

Scott Musil (CFO)

Sure.

Johannson Yap (First Industrial Realty Trust)

In general, the best markets are Southern Florida and New Jersey, where rents continue to really grow. As we mentioned in the script, we just leased or announced a lease-up of 2 more buildings in South Florida that we'll occupy in the 3rd quarter. And the rent growth there has substantially outpaced our pro forma. Jojo? Yes. If you look at, I'll go with basically in the Southwest interior market and then basically go west. If you look at Dallas and Phoenix, for example, you know, due to increase in consumption zone, due to the increase in migration of population and businesses, they really experience a good amount of rent growth, and we proceed to continue to experience that.

In fact, Dallas and Phoenix has been a big contributor, along with South Florida, big contributor for our quarterly cash rent growth. When you move out to the west, in the west, as you all know, I mean, in SoCal, primarily LAIE, rents have increased about 100% over the last 2 years. Over the 3 years, they've increased anywhere from 125%-150% over 3 years. Significant rent growth. Every portfolio owner and every development has enjoyed that, and that's the reason why we've been able to continue to develop at higher yields.

Going forward, we think rent growth will be in the 5 to, you know, 5% to high single digits in SoCal due to just a little bit of a, of companies taking a breather. Again, you know what, a lot of owners have achieved significant return and yields on their investments. Also, it's due to the fact that it's a little bit reduced port traffic, although I mentioned to you earlier that June, the June number is closer to the June 2022 number, maybe that's a little bit of a turnaround. You know, that's what we're looking at.

Anthony Powell (Director of Equity Research)

Thank you.

Operator (participant)

The next question comes from Caitlin Burrows from Goldman Sachs. Please go ahead.

Caitlin Burrows (VP)

Hi, good morning. Maybe going back to development, lease-up, it sounds like you're still generally assuming 12-month lease-up time frames for the development project. I was just wondering what it could take for that assumption to change, recognizing that right now you still seem to feel good about 12 months on in general?

Peter Baccile (President and CEO)

... I suppose, experience of it not being long enough to change our view. I think right now, we think that we're in a period of adjustment as we digest. If you look at net absorption over the last several years, it was enormous in '21 and '22. It actually started in the fourth quarter of 2020, that fueled a lot more construction, a lot more capital coming into the business. you have this way above trend construction pipeline. now, as we've said earlier, starts are off 40%. I think the market is going to take a bit of some time to digest that larger development pipeline, but at the same time, as we get into the second half of next year, we think there's gonna be a shortage of space.

That's really what we're dealing with right now, and we look at our assumption for downtime, and we think that given that picture, that scenario, 12 months is still the right, the right number.

Caitlin Burrows (VP)

Got it. Thanks for that commentary. Maybe also, just subleasing as a topic that's been coming up some, I think not because it's significant, but just because it's up off a low base. Just wondering if you could comment on if you're seeing subleasing activity happen, if so, where, and at what point it could potentially be a concern or not?

Peter Schultz (EVP)

Caitlin, it's Peter Schultz. You're right, sublet space is up a little bit, but I would probably put it in two different buckets. There are a handful or some sublet spaces, portions of buildings that occupiers are trying to sublet, or tenants that are trying to limit, a sublet term to only a year or two. We don't really consider that, you know, legitimate sublet space. The other bucket is, spaces that are on the market for sublet, and in general, we've seen those get absorbed pretty quickly, in the higher barrier markets. Jojo, anything you want to add?

Johannson Yap (First Industrial Realty Trust)

That's good, Peter. The only thing I'd like to add, there are some sublet sublease spaces that actually the lessee took back because now their plans have changed, and they figured out that they actually need it long term. A number of these large subleases, they've actually wanted to do only a couple of years of term, and that's actually not very favorable for the new tenant that's coming in because, you know, a lot of tenants don't want to move in and be forced to move out in the short term.

Caitlin Burrows (VP)

Yeah, no, that makes sense. Thank you.

Operator (participant)

The next question comes from Todd Thomas, from KeyBanc Capital Markets. Please go ahead.

Todd Thomas (Managing Director and Equity Research Analyst)

Hi, thanks. Good morning. First question, in terms of occupancy, just stepping back a little bit more broadly, you know, you mentioned the decrease in Baltimore in the quarter and discussed Southern California. Can you provide some thoughts around whether you anticipate occupancy stabilizing by year-end or in early 2024, or whether you see potential for occupancy to continue normalizing, you know, as you move forward throughout 2024, as the 400 million sq ft is delivered in the pipeline that you discussed?

Chris Schneider (SVP of Operations)

Yeah, this is Chris. I mean, the drop in occupancy is all related to the, you know, the new developments coming online. If you look at our, you know, same store portfolio, you know, that's very stable. We're expecting the average for the entire year to be about 98%. Still very, you know, healthy, strong numbers on the, you know, the existing portfolio.

Todd Thomas (Managing Director and Equity Research Analyst)

Okay. Then, just, I guess, a follow-up on Baltimore and Old Post Road, maybe a point of clarification around something that you said earlier. You know, the recent Baltimore vacancy that occurred this quarter, that's adjacent to the 644,000 square facility, you know, does that vacancy at all impact your efforts or the outcome potentially at, you know, the Old Post Road facility? Would the government tenant at all have interest in taking, you know, the additional square footage that's available now?

Peter Schultz (EVP)

The new vacancy doesn't impact or influence the outcome at the larger building. We want to get the deal done with the government contractor at 500. Certainly, they could have interest, as most tenants have interest in expansion capabilities. As I said earlier in response to another question, you know, the level of activity for full or partial buildings in 350 is pretty good. We're optimistic that we'll make some headway there. As Peter said earlier, you know, our plan is based on the government contract being finalized and awarded for the larger building here, yet in the 3rd quarter.

Todd Thomas (Managing Director and Equity Research Analyst)

Okay. Just last one from me. You know, the dispositions, you maintained, that $50 million-$100 million guidance, and, you know, you've sold one asset so far, for $15 million, this year. Can you just talk about demand for asset sales and whether, you know, there's anything, you know, sort of progressing at this point that's in the pipeline that you're seeing?

Peter Baccile (President and CEO)

Sure. Just to correct, it's $50 million-$150 million, not $50 million-$100 million, the guidance. There is a market, and the pricing isn't bad. You know, we've always intended our closings to be back-end loaded, so that's why you haven't seen much volume. You know, we maintain the guidance range, and that's kind of reflective of our expectations of how the market's going to end up.

Operator (participant)

Okay. All right. Got it. Thank you. The next question comes from Michael Mueller from JP Morgan. Please go ahead.

Michael Mueller (Analyst)

I guess if you look at your in-process development, all but two of the projects are in California, where if you look at what's been delivered in 23 to date, in 22, I think there was just one California development. I know California is a big state, but do you see the geographic mix of the starts over the next couple of years as being as concentrated in California as what the current pipeline is?

Peter Baccile (President and CEO)

The projects that we are evaluating for future starts are almost solely on the coasts, which would include California, obviously, South Florida, you know, New Jersey, PA, et cetera. That's where the focus is going to be. Does that answer your question?

Michael Mueller (Analyst)

Yep. Yep. I think that was it. Thanks.

Operator (participant)

The next question comes from Jessica Zheng from Green Street. Please go ahead.

Jessica Zheng (Senior Associate)

Good morning. Just wondering, for some of your large box developments where, you know, additional tenant demand is slowing down currently, do you have any optionality to divide those up into smaller suite sizes, and do you think that could help with the lease-up time at all?

Peter Baccile (President and CEO)

Yeah, our projects are designed with that in mind, so that we can demise and still provide all the functionality that the tenants require. We're in a pretty good position with respect to that.

Jessica Zheng (Senior Associate)

Have you tried that option for some of the large boxes, where you?

Peter Baccile (President and CEO)

Well-

Jessica Zheng (Senior Associate)

-changed your lease-up assumptions?

Peter Baccile (President and CEO)

As Peter mentioned, for example, in Denver, with our 588,000 sq ft building, that was designed to either be single or multi-tenant. Obviously, we do a few things differently to make sure we can multi-tenant it, we do that. There's no change in direction. It was just maintaining our optionality and creating a building that is functional under both scenarios.

Peter Schultz (EVP)

Jessica, it's Peter Schultz. The other thing I'd add to that is that when we deliver buildings, they're move-in ready, so they already have spec office. We've permitted demising walls and so forth. To Peter's point, we're already way ahead of that curve. Nothing else that we would do differently, because that is part of the strategy.

Johannson Yap (First Industrial Realty Trust)

Just to add on, our design of multi-tenant not only is on the large buildings, but in the midsize to smaller buildings. Case in point, First Steele in Seattle, that's a 129,000 footer, but we designed that building to basically be accessed on both ends of the building, with docks available to the length of the building. There, we were able to successfully lease, at completion, half of the building, a 64,000 footer.

Jessica Zheng (Senior Associate)

Okay, great. Thank you. Just a second question. Curious for your Carvana sites. If they do go out of business, per your lease agreement with them, are you going to be getting back all the land at once, or is there going to be a separate process on each parcel?

Peter Baccile (President and CEO)

If they default on those leases, there would likely be a legal process that we would go through. I can't predict how long that would take, but the outcome eventually would be that we have the ability to develop or sell. Some of the sites we would probably sell because there's a higher and better use now, after all these years. We would have the right to develop or sell those sites after the legal process that we'd have to go through to take back the. To kick them out. Essentially, to kick them out.

Jessica Zheng (Senior Associate)

Okay, great. Thanks for those comments.

Operator (participant)

The next question comes from Vikram Malhotra from Mizuho. Please go ahead.

Vikram Malhotra (Managing Director)

Thanks for taking the question. Just following up on that development question around can you slice up the properties if demand is more sluggish? I'm just wondering more tactically, let's just say lease-up is a little longer than the 12 months you've baked in. What do you do in terms of or what's the thought process around gaining more share? Is it, you know, rents? Is it more incentives? Do you sort of, you know, what would you do to try to gain share in that environment, just given the macro, if things slow down from here on?

Peter Baccile (President and CEO)

Well, historically, when markets soften, concessions go up, whether it's free rent or additional above standard TIs or lower rents. We're not anywhere near that. I mean, Free rent today it continues to be a third or a half a month per year of the lease term. It's standard TI packages today. We're still getting higher rents than had existed previously. You got a long way to go before you get to what you're talking about.

Vikram Malhotra (Managing Director)

Okay, makes sense. Just on SoCal, you talked about market rent growth now being, you know, 5, mid-single digits to high single digits. You know, one of your peers sort of articulated there's a, there's actually pushback on the rent level in itself. Just like you highlighted, rents up 150% over three years. Are you actually seeing incentives, also go up specifically in SoCal, as you, as a landlord try to attract new tenants?

Peter Baccile (President and CEO)

Jojo, you want to cover that?

Johannson Yap (First Industrial Realty Trust)

Sure. No, no, we're not seeing any increased incentive. Like Peter mentioned, free rent, for, term of year has been pretty sticky. TI has been pretty sticky, meaning it's been pretty standard. A TI per square foot, or TI allowance, and improvement allowance, I mean. In terms of, just pushback, I mean, if you look, like I've mentioned earlier, if you look at there are some tenants who are looking for a, you know, little bit of relief on rent because of that 100% appreciation. You know, in IE West, that actually a market that had a little bit of, less absorption of our rents, you know, gave a little bit, maybe 1%-2%. In IE East, we're in, again, there's cheaper rent. Actually, the rent went up.

I mean, and that was from a Q2 situation. I think that's the kind of situation is more short term and may, you know, just be a quarter or two.

Vikram Malhotra (Managing Director)

Got it. Then just, you know, last one, again, one of your peers sort of outlined, over the next several years, 3-5 years, even if, you know, there's no rent growth, more limited demand, there's still a scenario where same store NOI growth, you know, can, I believe the word was, you know, average 7%-ish. I may be wrong on that. If you look out sort of three years, not looking for next year's guide, but just on a longer-term basis, three, five years, assuming market conditions exist as they are today, where do you see sort of the structural same store NOI growth of your platform?

Peter Baccile (President and CEO)

A couple things. One, obviously, all of us have significant upside as our leases continue to roll, as you've heard us today, talk about what's going on in some of these markets, and it's in a pretty broad basis. The second thing is, annual rent escalations have gone up pretty significantly, our portfolio rent escalation average is gonna go north of 3% next year. Those are both gonna contribute to pretty significant growth, as you say, even if rents stay flat for the next 3 to 5 years. I don't think we have a number to put on that right now. I know one of our peers did, but we are very optimistic about the future growth opportunity, again, even if rents don't grow.

Vikram Malhotra (Managing Director)

Fair enough. Thanks.

Operator (participant)

This concludes our question and answer session. I would like to turn the conference back over to Peter Baccile for any closing remarks.

Peter Baccile (President and CEO)

Thank you, operator, and thanks to everyone for participating on our call today. If you have any follow-up questions, please reach out to Art, Scott, or me. I wish everyone a happy, healthy, and productive summer.

Operator (participant)

This concludes the conference. Thank you for attending today.