Industrial Logistics Properties Trust - Q2 2024

Transcript

Operator (participant)

Good morning, and welcome to the Industrial Logistics Properties Trust Q2 2024 Financial Results Conference Call. All participants will be in a 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. To ask a question, you may press star, then one on a touchtone phone. To withdraw your question, please press star, then two. Please note, this event is being recorded. I would now like to turn the conference over to Kevin Brady, Director of Investor Relations. Please go ahead.

Kevin Brady (Head of Investor Relations)

Thanks, Nick. Good morning. Joining me on today's call are ILPT's President and Chief Operating Officer, Yael Duffy, Chief Financial Officer and Treasurer, Tiffany Sy, and Vice President, Marc Krohn. Today's call includes a presentation by management, followed by a question-and-answer session with analysts. Please note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company. Also, please note that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on ILPT's beliefs and expectations as of today, July 31, 2024, and actual results may differ materially from those that we project. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call.

Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission or SEC, which can be accessed from our website, ilptreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements. In addition, we will be discussing non-GAAP financial measures during this call, including normalized funds from operations or normalized FFO, adjusted EBITDAre, and cash basis net operating income or cash basis NOI. A reconciliation of these non-GAAP measures to net income is available in our earnings presentation, which can be found on our website. With that, I will turn the call over to Yael.

Yael Duffy (President and COO)

Thank you, Kevin, and good morning. Before we start, I would like to welcome Marc Krohn, who joined ILPT as our Vice President on June 1. On today's call, I will start with an overview of our portfolio, review Q2 leasing results and upcoming lease expirations before turning the call over to Tiffany to review our financial results. As we enter the second half of the year, we remain encouraged by the continued demand for ILPT's high-quality portfolio, which has benefited from solid leasing activity and organic cash flow growth. Compared to the same period last year, cash basis NOI increased 2.6% and normalized FFO increased 18.1%.

In the first half of 2024, we signed 26 leases totaling 2.6 million sq ft at weighted average rental rates that were 30.5% higher than prior rental rates for the same space. The impact of this activity is an increase of $4.2 million in annualized rental revenue, of which more than $3.4 million has yet to be realized, given the effective dates are in the second half of 2024 or in 2025. As of June 30, 2024, ILPT's portfolio consisted of 411 warehouse and distribution properties in 39 states, totaling approximately 60 million sq ft, which includes 16.7 million sq ft of industrial land and properties in Hawaii.

ILPT's portfolio has a weighted average remaining lease term of 7.9 years, anchored by tenants with strong business profiles and stable cash flows. ILPT's top tenants account for nearly half of our total annualized rental revenues, and 77% of our revenues come from investment grade-rated tenants or from our secure Hawaii land leases. During the quarter, we entered 15 new and renewal leases for approximately 628,000 sq ft at a weighted average lease term of 6.8 years. This activity resulted in GAAP and cash leasing spreads of 15.8% and 7.8%, respectively. Leasing in our wholly owned mainland portfolio was strong, with total renewal leasing of approximately 432,000 sq ft at weighted average roll-ups and rent of 9.6%.

We continue to benefit from mark-to-market opportunities within our Hawaii portfolio, where market vacancy is 1% and there has been minimal new construction. We executed 11 leases at weighted average rental rates that were 23.8% higher than prior rents, including 2 new leases totaling 73,000 sq ft, increases in rent of 43.5%. As we have long telegraphed, this quarter, we saw the impact of the 2.2 million sq ft land parcel in Hawaii that became vacant on April 1 as occupancy declined to 95.4%. While the property accounted for 3.7% of total occupancy, it represents less than 1% of ILPT's annualized rental revenues. We are actively marketing the site for lease. Looking ahead to ILPT's upcoming lease expirations.

For the remainder of 2024, 1.3 million sq ft, or 3.1% of ILPT's annualized revenue, is set to expire. In July, a 535,000 sq ft property in the East Submarket of Indianapolis, previously leased to a beverage distributor, became vacant. This tenant accounted for approximately 90 basis points of ILPT's occupancy and 1% of ILPT's annualized revenue, or $4 million. Accordingly, this move-out will impact our results in the second half of the year. As we look ahead to 2025 and 2026, 8.4 million sq ft, or 12.8% of ILPT's total annualized revenue, is set to expire. Our leasing and asset management teams are proactively engaging in renewal discussions with these tenants.

As conversations progress, we expect to benefit from our proven track record of strong tenant retention and reputation as a landlord of choice. Our leasing pipeline remains active. We are tracking 36 deals for over 7 million sq ft, of which 2.5 million sq ft, or 35%, is in advanced stages of negotiation or lease documentation. Included in our pipeline are proposals for the Hawaii land parcel and the Indianapolis property that I mentioned earlier, and we will update you on our progress as discussions evolve. Before I turn the call over to Tiffany, I would like to reiterate that we believe there is continued opportunity to generate organic cash flow growth and reduce leverage, which has declined from 12.7x to 11.9x over the last year.

As such, we remain focused on tenant retention, maximizing mark-to-market rent growth, and continuing to evaluate opportunities to reduce operating expenses. Tiffany?

Tiffany Sy (CFO)

Thank you, Yael, and good morning, everyone. Yesterday, we reported Q2 Normalized FFO of $9 million, or $0.14 per share, representing an increase of 18.1% compared to the same quarter in 2023. GAAP and cash basis NOI were $86.3 million and $82.9 million, increasing by 2.2% and 2.6% year-over-year, while Adjusted EBITDAre of $85.1 million increased 4.6% compared to the same quarter a year ago. As we look towards the Q3, it's worth noting that approximately $1 million of non-recurring GAAP and cash basis revenues related to one-time fees and bad debt recoveries were included in our Q2 results.

Interest expense of $73.6 million increased by $1.8 million compared to the same period a year ago, and approximately $400,000 on a sequential quarter basis. During the Q2, we paid $58.3 million of cash interest expense, net of the cash we received from our interest rate cap, and recognized $15.3 million of non-cash amortization of financing and interest rate cap costs. We expect our Q3 interest expense to remain in line with the Q2. Turning to our balance sheet.

As of June 30th, our net debt to total assets ratio was 68.2%, an improvement of 60 basis points compared to a year ago, while our net debt coverage ratio improved by 80 basis points to 11.9 times, driven by an increase in Adjusted EBITDAre and the paydown of our amortizing debt. All of our debt is currently carried at a fixed rate or a fixed-rate interest rate cap, with a weighted average rate of 5.35%. As of today, we intend to exercise the first of our three one-year extension options on our $1.2 billion loan maturing in October 2024. Including extension options, ILPT has no debt maturities until 2027.

As of June 30th, total cash was approximately $260 million, including $112 million of restricted cash, representing total cash growth of approximately $50 million over the past year. We expect to use this cash to pay for a replacement interest rate cap on our $1.2 billion loan and to fund future leasing obligations. In closing, ILPT's portfolio continues to benefit from rising rental rates, overall high tenant retention, and an investment grade-rated tenant profile, and is well positioned to support our strategic objectives. That concludes our prepared remarks. Operator, please open the line for questions.

Operator (participant)

We'll now begin the question-and-answer session. To ask a question, you may press star, then one on your touch tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Bryan Maher with B. Riley FBR. Please go ahead.

Bryan Maher (Analyst)

Thank you, and good morning. Just a couple from me today. On the Home Depot and Indianapolis properties, that was some helpful information on your leasing pipeline, and I understand both are in the advanced stages. But from a modeling standpoint, you know, where would you advise, you know, that we, we possibly slot that in? Could, could it be as early as the Q4, or is it, you know, more like first half of 2025?

Yael Duffy (President and COO)

I would conservatively model the second half of 2025.

Bryan Maher (Analyst)

And why would it take so long?

Yael Duffy (President and COO)

While we have proposals out for both sites, we aren't in advanced negotiations with any one tenant quite yet, and by the time we negotiate a lease and document it, it'll probably take some time.

Bryan Maher (Analyst)

Okay. And then maybe for Tiffany, when you have this, you know, the upcoming extension in October, has there been any changes, you know, given the interest rates have declined since we last spoke on an earnings call, to your thoughts on what the cap cost might be?

Tiffany Sy (CFO)

Right now, we're expecting the cost to be between $25 million and $30 million.

Bryan Maher (Analyst)

And when might that actually be executed?

Tiffany Sy (CFO)

I would say very close to September 30th.

Bryan Maher (Analyst)

Okay. And then, given your current progression on leverage, and that's at the EBITDA, assuming there's not some deleveraging transaction, you know, via adding a JV partner or some asset sales, you know, what should we think about the pace of deleveraging? Should it be similar over the upcoming 12 months to what we saw over the past 12 months?

Tiffany Sy (CFO)

I think that's a fair estimate. Yes.

Bryan Maher (Analyst)

Okay. And then just last for me, and I don't know if, Yael, you're gonna be able to answer this or not, but, I mean, your cash position is decent, especially when you think about, you know, paying for the cap at $25 million-$30 million. You know, I know you have some, you know, tenant stuff that you have to do. But has the board given any thought to ratcheting up the dividend even a little? I mean, the dividend payout ratio when we look at CAD and CAD payout ratio, you know, is really conservative. You know, is the board giving any consideration to that at all at this time?

Yael Duffy (President and COO)

We do discuss it at each of the board meetings, and currently, the plan is just to continue to preserve cash to run the business.

Bryan Maher (Analyst)

Okay. Thank you. That's all for me.

Yael Duffy (President and COO)

Thanks, Brian.

Operator (participant)

Again, if you have a question, please press Star, then 1. The next question comes from Mitch Germain, private investor. Please go ahead.

Mitch Germain (Managing Director and Equity Research Analyst)

Oh, interesting. I got a new job. So, Yael, I wanted to talk about the leasing pipeline and just some of the, you know, kind of ins and outs. You were at 7.5 million sq ft last quarter. Seems like it's down a bit. Is that the way to think about it? It's at 7 million sq ft, or did I mistake what you said?

Yael Duffy (President and COO)

So it was 7.5 million sq ft last quarter, but we also did execute 628,000 sq ft of new leasing this quarter, so that gets backed out. So there is some ins and outs as we execute leasing.

Mitch Germain (Managing Director and Equity Research Analyst)

Right. That's kind of what I was asking in terms of, you know, kind of, what's the kind of execution rate on that, on the pipeline historically?

Yael Duffy (President and COO)

So we executed what was in the 7.5, so it's a net positive of 150,000 sq ft of new pipeline from one quarter-

Mitch Germain (Managing Director and Equity Research Analyst)

Got you.

Yael Duffy (President and COO)

to the next.

Mitch Germain (Managing Director and Equity Research Analyst)

Okay, great. And then, I guess your commentary suggested you had a proposal out last quarter on, the Hawaii space. Is it safe to say that that kind of fell through and now it's kind of back out there? Or are you still under negotiations with, you know, that customer and maybe even others as well?

Yael Duffy (President and COO)

Yep. So we only consider, we only account for the square footage one time. So we do have multiple proposals out for the Hawaii land parcel, one for the entire site and then a couple for half the site. And so we're kind of negotiating, but not far enough to say that we have an LOI yet.

Mitch Germain (Managing Director and Equity Research Analyst)

Right. And-

Yael Duffy (President and COO)

Part of the reason it's gonna take a little while, there's just a lot of diligence to do for any tenant who's gonna take that Hawaii parcel. It's, you know, a big piece of land, and I think for a tenant to undertake it, they have a lot of homework to do before they commit.

Mitch Germain (Managing Director and Equity Research Analyst)

Walking 2 million sq ft is not an easy task. And then Indy went dark on July 1 or was it July 31st? I just can't remember.

Yael Duffy (President and COO)

The Indianapolis property?

Mitch Germain (Managing Director and Equity Research Analyst)

Yes.

Yael Duffy (President and COO)

It was, they actually held over for a couple of days, so in early July.

Mitch Germain (Managing Director and Equity Research Analyst)

So basically, July 1 is the safest way to think about it, right?

Yael Duffy (President and COO)

Correct. Yep.

Mitch Germain (Managing Director and Equity Research Analyst)

Okay, great. And then last one for me. You know, obviously, we're in this period where, you know, the discussion around rates cuts is gaining momentum, call it. How is your team viewing the potential to possibly refinance some of the existing debt? Is it something where you're just gonna kind of let the market settle and see kind of where things go? Or do you look to maybe take an advantageous view toward potentially locking in more favorable rates, you know, kind of nearer term? How do you kind of see the playbook there?

Yael Duffy (President and COO)

So we are evaluating. Before we would ever exercise a cap, we're evaluating if it's beneficial to refinance instead. So that analysis is ongoing.

Mitch Germain (Managing Director and Equity Research Analyst)

Great. Thank you.

Yael Duffy (President and COO)

Thanks, Mitch.

Operator (participant)

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

Yael Duffy (President and COO)

Thank you, everyone, for joining us on the call today.

Operator (participant)

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.