Industrial Logistics Properties Trust - Q3 2024

Transcript

Operator (participant)

Good morning and welcome to the Industrial Logistics Properties Trust third quarter 2024 financial results conference call. All participants will be in the 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 your telephone keypad. To withdraw your question, please press star, then two. Please note, this event is being recorded. I will now call over to Melissa McCarthy, Manager of Investor Relations. Please go ahead.

Melissa McCarthy (Manager of Investor Relations)

Thank you, Dorman. Good morning. Joining me on today's call are ILPT 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, October 30th, 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 funds from operations, or 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 financial results package, which can be found on our website. With that, I will now turn the call over to Yael.

Yael Duffy (President and COO)

Thank you, Melissa, and good morning. On today's call, I will start with a high-level update on our portfolio and third quarter operating performance before handing it over to Marc to discuss our leasing achievements. From there, Tiffany will review our financial results. We remain encouraged by the continued demand for ILPT's high-quality portfolio and the strength in industrial real estate fundamentals. We delivered strong results in the third quarter with year-over-year growth in key metrics, including FFO and cash basis NOI. Given many of our leases have contractual escalations and we have illustrated a track record of capturing rent growth through our leasing efforts, we believe there is embedded opportunity to drive organic cash flow growth. As of September 30th, 2024, ILPT's portfolio consisted of 411 distribution and logistics properties in 39 states, totaling approximately 60 million sq ft.

Our strategically diversified portfolio is highlighted by our unique Hawaii footprint consisting of 226 properties totaling more than 16.7 million sq ft. Our portfolio carries a weighted average lease term of eight years and is anchored by tenants with strong business profiles and stable cash flows. ILPT's top 10 tenants account for nearly half of our total annualized rental revenues, and 77% of our annualized revenues come from investment-grade rated tenants or from our secure Hawaii land leases. Last week, American Tire Distributors, our fourth-largest tenant, representing 1.6% of ILPT's annualized revenues, filed voluntary Chapter 11 proceedings as it contemplates a restructuring agreement with an ad hoc group of its lenders. American Tire has publicly indicated that it will continue to operate across its nationwide distribution network. Within our portfolio, all rent obligations have been paid and the five properties they leased from us are being fully utilized.

At quarter end, our consolidated occupancy was 94.4%, a slight decrease from the second quarter, primarily due to the previously disclosed 535,000 sq ft property located in the east submarket of Indianapolis that became vacant in July. Leasing this vacancy, along with the 2.2 million sq ft parcel in Hawaii that became vacant on April 1st, are among our top priorities. Tour and proposal activity for the sites has increased, and we are optimistic that both will be leased in 2025. Also impacting our GAAP NOI results this quarter is a $1.3 million non-cash charge resulting from the early termination of one tenant which leased two parcels within our Hawaii portfolio. After the end of the quarter, we were able to execute a new lease with a replacement tenant for one parcel and are negotiating a lease for the other parcel, both at average roll-ups in rent of 48%.

These results continue to highlight the scarcity of land, persistent demand, and value of our Hawaii real estate. In the third quarter, strong relationships with key tenants such as FedEx drove much of our leasing momentum as we executed over 2.7 million sq ft of leasing at weighted average rates that were 7% higher than prior leases, with a weighted average lease term of five and a half years, which Marc will provide more detail on momentarily. We intend to continue capitalizing on the attractive operating environment to deliver favorable leasing outcomes. While near-term expirations are minimal, with approximately 4.5% of total annualized revenues scheduled to expire through 2025, we plan to address expirations in a way that will maximize mark-to-market rent growth while minimizing potential downtime and capital costs. Lastly, earlier this month, ILPT announced that it would maintain its quarterly cash dividend at $0.01 per share.

In recent months, we have been frequently asked when we expect to increase our dividend. We recognize the value of the dividend to our investors, and it is a topic that we discuss regularly at both the management and board level. However, as ILPT does not have a credit facility, we feel it is important that we have ample liquidity and financial flexibility to address future leasing costs, capital expenditures, and obligations under our debt agreements before increasing the dividend level. With that, I'll turn the call over to Marc.

Marc Krohn (VP)

Thank you and good morning, everyone. As Yael mentioned, our third quarter leasing activity totaled more than 2.7 million sq ft, which was highlighted by 13 renewals with our largest tenant, FedEx, encompassing over 2 million sq ft across eight states at average lease term of 5.1 years and a GAAP roll-up in rent of 4.5%. This mutually beneficial renewal provided ILPT with cash flow security with no leasing concessions in form of free rent or tenant improvement in return FedEX will be able to secure strategic locations within its network as it continues to execute on its optimization plan it announced in April of 2023. Since we acquired Monmouth Real Estate Investment Corporation in February 2022, we have executed 33 leases with FedEx totaling nearly 3.8 million sq ft.

Furthermore, over 94% of our FedEx portfolio and the associated $121 million in annualized revenue is secure given it is long-term leased with expirations in 2027 and beyond. We believe this reinforces ILPT and our core commitment to fostering strong tenant relationships, addressing our tenants' needs, and being a landlord of choice. We also executed renewals with tenants in key markets, including a 302,000 sq ft early renewal in Charleston, South Carolina, and a 125,000 sq ft renewal in Columbus, Ohio. In aggregate, these two renewals represent an average GAAP rent increase of 18% with a weighted average lease term of 6.4 years. Nearly all of our remaining 2024 expirations have been addressed with only 79,000 sq ft set to expire. As we look ahead to 2025 and 2026, 6.9 million sq ft, or 9.5% of ILPT's total annualized revenue, is set to expire.

We are currently tracking 39 deals for over 8.3 million sq ft, of which 3.2 million sq ft, or 38%, is in advanced stages of negotiation or lease documentation. Now, I'll turn the call over to Tiffany.

Tiffany Sy (CFO and Treasurer)

Thank you, Marc. Good morning, everyone. Yesterday, we reported third quarter FFO of $8.1 million, or $0.12 per share, representing an increase of 1.5% compared to the same quarter in 2023. Third quarter NOI decreased by 0.7% to $84.7 million, and cash basis NOI increased by 1.1% to $82.5 million compared to the same quarter in 2023, while Adjusted EBITDAre increased by 0.9% to $83.9 million. In October 2024, we exercised the first of our three one-year extension options for a $1.2 billion floating rate loan. As part of the extension, we purchased a one-year interest rate cap for $17 million with a SOFR strike rate of 2.78%, replacing our previous cap with a rate of 2.25%. The cost of this cap was less than previously expected as a result of the Fed's interest rate cut in September.

Additionally, the lender allowed for the higher strike rate based on the strong performance of the property securing the loan. We expect that further interest rate cuts will lower the cost of any caps that we may purchase in the future and provide us more flexibility as we evaluate opportunities to reduce leverage. During the third quarter, we paid $58.8 million of cash interest expense, net of the cash we received from our interest rate caps, and recognized $15.1 million of non-cash amortization of financing and interest rate cap costs. We expect our fourth quarter interest expense to decline from $73.9 million to approximately $72 million, reflecting the impact of the new interest rate cap.

Turning to our balance sheet, as of September 30th, our net debt to total assets ratio was 68.1%, an improvement of 40 basis points compared to a year ago, while our net debt coverage ratio declined to 12.1 times from 12.3 times in the third quarter of 2023. Total cash, excluding $101 million of restricted cash, was approximately $154 million. We expect to use this cash to fund future leasing obligations and provide us with greater flexibility when evaluating our financing options, which may include purchasing interest rate caps in the future. As a reminder, including extension options, ILPT has no debt maturities until 2027. Looking ahead, we expect that our strategic leasing approach will continue to result in strong tenant retention and generate stable cash flows that support our operations and deleveraging efforts. That concludes our prepared remarks. Operator, please open the line 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 telephone keypad. If you are using a computer, please pick up your handset before pressing any keys. If at any time your question has been answered and you would like to withdraw your question, please press star and 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 (Managing Director)

Great. Thank you. And good morning. Just a few for me today. Just wanted to drill down a little bit more on the interest rate cap cost. So with $17 million, I think we had been modeling for like $27.5 million just to be conservative. But you're going to pay a higher interest rate and rough calculations, maybe $6 million on that $1.2 billion, whatever. So kind of 17 plus six is 23. So still below what we were thinking. But can you talk about how you were thinking about the trade-off in pricing versus interest rate?

Tiffany Sy (CFO and Treasurer)

Sure. Also, good morning. So our interest rate for this particular loan is going to increase to 6.71%, and our weighted average for ILPT overall will be around 5.5%. Our lender determines the strike rate on our cap based on required debt service coverage ratio. And so, as I said in the prepared remarks, based on the performance of the properties that secure the loan, they allowed for a higher strike rate of 2.78%. So we were actually pretty pleased to be able to save some upfront costs with that $17 million price tag. Effectively, we are able to defer interest rate payments. And so we will pay interest as it comes due, but that's how we thought about that. We were pleased to save upfront costs.

Bryan Maher (Managing Director)

Okay. That's kind of what I thought. Moving on to leasing Hawaii and Indianapolis, Yael, I think you said, or maybe Marc, 2025. Can you be a little bit more granular there? Is it second quarter? Is it third quarter? I know you want to be conservative, but it's a pretty wide gap for modeling purposes.

Yael Duffy (President and COO)

Yeah. Hi, Brian. I think the reality is, especially for the Hawaii land parcel, there's just a lot of diligence that any prospective tenant will have to do to evaluate what it's going to cost them to execute on their business plan for that parcel. So while we're having discussions, a lot of it depends on the timeline for the tenants. So I would say the second half of the year for 2025 would be probably most realistic for Hawaii. And then for Indianapolis, I think we could be able to be in a position probably in the first half of 2025.

Bryan Maher (Managing Director)

Okay. And so the American Tire commentary that you made, I'm assuming based upon what you said that there are no expected vacates there. Correct me if I'm wrong. And are there any known vacates that we should know about over the next 12 months?

Yael Duffy (President and COO)

From what we know today on American Tire, we expect them to, I mean, they're utilizing the properties, and we expect that they won't reject the leases, but again, it's very early. They just made the announcement last week, and then there's nothing else material from a known vacate perspective.

Bryan Maher (Managing Director)

Do they have the ability in the bankruptcy process to, I'm sure they probably do to some degree, to request a lower rent rate? And if they did, could you tell them to go pound sand and vacate?

Yael Duffy (President and COO)

Yeah. I mean, as part of their bankruptcy proceedings, I think they can come and try to negotiate with the landlord, and it would be our decision if we want to do that. I guess I would just note American Tire has been in this position before. They filed for bankruptcy in 2018 and actually leased these same properties from us, and they didn't reject the leases at that time and have since renewed all of them. So we take some comfort in that as well.

Bryan Maher (Managing Director)

Okay. Just two more quick ones for me. As it relates to the Mountain JV, I know there's a 39% JV partner. And if you were to get another partner to onboard, so you're north of 50%, you can deconsolidate that. Maybe for Tiffany, have you guys run the numbers as it stands now? And I'm sure we could probably back into them roughly. But do you have the numbers on what net debt to EBITDA would move to should you be able to deconsolidate that JV?

Tiffany Sy (CFO and Treasurer)

There are a lot of factors that we would have to consider. So we don't have exact numbers that we would share at this point.

Bryan Maher (Managing Director)

Okay. And then just last for me, Yael, I know you talked a little bit about the dividend. We also get a lot of questions on your dividend with CAD running at $0.70 on a trailing four-quarter basis. I don't know that anybody that I've spoken to on the buy side is looking for any whopper of a dividend, but to simply take it up from $0.04 to $0.10 or something around there is maybe $6 million a year of dividend payments when you're sitting on, whatever, $154 million of cash and CAD expected to be roughly $0.70 on a go-forward basis. So if I could just throw that out there, we do get a lot of questions on that.

I don't think anybody's asking for some big whopper of a dividend pre-Monmouth, but something to reflect the improving overall positioning of ILPT, I think, would be really welcome by the investment community. That's all for me.

Yael Duffy (President and COO)

All right. Thanks, Brian.

Operator (participant)

Thank you. Again, ladies and gentlemen, if you have a question, please press star, then one. The next question is from Mitch Germain with Citizens JMP. Please go ahead.

Mitch Germain (Managing Director of Real Estate Research)

Good morning. Thanks. Tiffany, I just want to understand the interest expense forecast. The change quarter over quarter, is that entirely non-cash? Is that the way to think about it?

Tiffany Sy (CFO and Treasurer)

It's not entirely non-cash. So I guess to give a little bit more perspective or a little bit more transparency, so we're expecting our cash interest expense to be $60 million and then the non-cash to be $12 million. So what will happen is our cash interest expense will increase some to cover the differences between the 2.25% and the 2.78% strike rate, but then our non-cash amortization will decrease. And that is twofold. That's based on the cap amortization, but that's also we have some deferred financing costs that are running off. They've fully amortized as of September 30th. So we get a benefit from that. Hopefully, that's helpful.

Mitch Germain (Managing Director of Real Estate Research)

That's helpful. The lower cap has nothing to do with a higher swap rate, correct? You said that swap rate is determined by the lender. It's not like you traded a lower cap for a higher amount. Is that the way to think about it?

Tiffany Sy (CFO and Treasurer)

That's correct. I want to make sure I'm understanding your question. It's the same notional amount.

Mitch Germain (Managing Director of Real Estate Research)

The swap cap was $17 million, but it was at 278. Replacing something was at 225, which was at a higher amount that you paid for the rate cap. So I didn't know if there was a reflection of a lower amount being that it rose. Okay.

Tiffany Sy (CFO and Treasurer)

You're right. There's a piece of that as well.

Mitch Germain (Managing Director of Real Estate Research)

Yeah. Okay. Great. And then I think Marc talked about what, 8 million or so sq ft under consideration right now. Assuming that only includes Hawaii once. And then if so, I'm just curious about kind of how many users are circling the wagon, and is it all full site, or is there a discussion around breaking it up?

Yael Duffy (President and COO)

Hi, Mitch. You're right. So we only include within the 8.8 million, we only include the 2.2 once. And so far, the conversations we've been having have been with tenants for the entire parcel.

Mitch Germain (Managing Director of Real Estate Research)

Okay. Great. And then last one for me, I mean, it looks like the rate environment to become a bit more accommodating on a forward basis, which obviously helps your balance sheet, but is it a time for the firm to start considering asset sales again? And kind of where does that potentially sit?

Yael Duffy (President and COO)

So we do get a lot of inbound unsolicited offers, and we are evaluating all of them as they come in. We have found that there's still been a little bit of a disconnect between what we think the properties are worth and what somebody is willing to pay for. But it is something we are constantly evaluating. But I guess I will just remind, and I feel like I'm a broken record about this, but to release properties from our debt, we have several different covenants that we need to look at to make it accretive. So that is also something we're up against.

Mitch Germain (Managing Director of Real Estate Research)

Understood. Does that suggest that one-off sales are more difficult, or does that suggest that portfolio sales are more difficult as you look to unwind some of those covenants?

Yael Duffy (President and COO)

I don't think one is more difficult than the other. I think it really depends on the assets and in which loan pool they sit.

Mitch Germain (Managing Director of Real Estate Research)

Thank you.

Operator (participant)

Thank you. This concludes our question and answer session. I would like to turn the conference back over to Yael Duffy, Chief Operating Officer and President, for any closing remarks.

Yael Duffy (President and COO)

Thank you for joining us today. Have a good day.

Operator (participant)

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