Duke Realty Corp (DRE) 2018 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Duke Realty Quarterly Earnings Conference Call. (Operator Instructions) And as a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Mr. Ron Hubbard. Please go ahead, sir.

Thanks, Greg. Good afternoon, everyone, and welcome to our first quarter earnings call. Joining me today are Jim Connor, Chairman and CEO; Mark Denien, Chief Financial Officer; and Nick Anthony, Chief Investment Officer.

Before we make our prepared remarks, let me remind you that statements we make today are subject to certain risks and uncertainties that could cause actual results to differ materially from expectations. For more information about those risk factors, we would refer you to our December 31, 2017, 10-K that we have on file with the SEC.

Now for our prepared statement, I'll turn it over to Jim Connor.

Thanks, Ron, and good afternoon, everyone. We followed up a very strong 2017 with a fantastic start to 2018. We had a big quarter of leasing, maintained our high occupancy levels, we grew rents at an all-time record high, and we also had a big quarter of development starts.

During the quarter, we increased our in-service occupancy by 130 basis points to 97%. This was driven primarily by strong leasing of recently delivered speculative projects and recently acquired facilities. Our stabilized in-service portfolio occupancy held firm at 98.5%. Our total portfolio occupancy, including projects under development, increased by 50 basis points to 94.4%. Nationally, net absorption numbers for the quarter are coming in at a very solid 41 million square feet, which is up about 8 million square feet compared to the first quarter a year ago. New supply in the first quarter was 35 million square feet, which is down from 45 to 50 million square feet range for the first quarters of 2016 and 2017. On a trailing 4 quarter basis, the overall spread between net absorption and supply remains in the 25 -- 20 to 25 million square foot range. With these favorable supply demand metrics and nationwide vacancies in the 4.5% range, the logistics real estate business remains in the sweet spot. Leading economic indicators has also been very good for the last few months with the GDP outlook for 2018 remaining in that 2.5% to 3% range. All of these drivers indicate continued strong demand for our product and our ability to maintain our high occupancies and continued rent growth.

Turning to our own portfolio. As evidenced by our occupancy levels, our team continued its great execution with the completion of over 6.9 million square feet of leasing for the quarter. With this strong leasing, our high occupancy, we continue to be able to improve rents. Rent growth for second-generation leases averaged 26% on a GAAP basis and 12% on a cash basis. We are seeing this rent increased growth all across markets. We renewed 68% of expiring leases during the quarter, yet after considering immediate backfills, we effectively released 94% of our expirations. We had an exceptional activity in the southeastern part of the country, including a 760,000 square foot lease signed with a 3PL in Atlanta which was an immediate backfill of a large expiring space. In Savannah, we signed 6 new leases totaling 1.1 million square feet, a majority of which represented immediate backfills from expiring tenants and reflective of the very strong fundamentals of the Port of Savannah. All of these deals resulted in substantial rent growth over the previous leases. We also executed notable leases on 2 vacant facilities that were part of the Bridge Portfolio acquisition. Overall, the 10 acquired Bridge assets are now 90% leased, with the commitments for 2 of the last 3 spaces. We would expect these assets to be 97% leased next month, several months ahead of our original underwriting. This increased occupancy taking place earlier in the year was the basis for increasing our full year occupancy and earnings expectations. Mark will discuss this in just a moment. Leasing momentum is strong and our speculative development pipeline as well, which is expected to contribute significant earnings growth and cash flow growth as we close out 2018 and head into 2019. We've had a great start to the year in new development starts with $226 million of projects in 6 markets totaling 2.5 million square feet that were 45% preleased in aggregate. Our overall development pipeline at quarter-end had 18 projects under construction, totaling 9.6 million square feet at a projected $808 million in stabilized costs for our share. These projects are 57% preleased, and our margins on the pipeline our continued to -- are expected to continue in the 20-plus percent range. Our development opportunities continue to be very strong. In fact, we've started 3 more developments earlier this month, totaling an additional 2 million square feet and $111 million in projected costs that are 91% preleased. And our pipeline for prospects for the remainder of the year is strong as well, which has led us to increase our development expectations for the year.

Now let me turn it over to Nick Anthony to cover our acquisition and disposition activity for the quarter.

Thank you, Jim. We had an active quarter on the disposition front. Building dispositions totaled $170 million and included the 3 data centers in the Washington, D.C. market totaling 447,000 square feet. This project was developed on land we had owned for quite a while, part of which included a demolition of an obsolete office building for one of the sites. This project represented a creative land redevelopment by our DC team and generating significant value creation for our shareholders.

We also disposed of a property in Nashville totaling 160,000 square feet. This transaction represented a part of a property swap whereby we acquired 2 facilities in Southern California as part of a tax-deferred exchange by the other party. These Southern California projects were acquired -- we acquired were located in the Orange County submarket and totaled about 120,000 square feet.

Regarding the broader acquisition market, we continue to look at many opportunities. And as you're aware, the market is extremely competitive, and thus, making it difficult to find appropriate risk-adjusted returns.

As Jim has noted a few times recently, it will be extremely difficult to replicate an investment like the Bridge Portfolio transaction we did last year. We have experienced 40 to 50 basis points of cap rate compression in the Northern New Jersey markets as these types of high-quality assets are now selling at sub-4% cap rates. Even so, our team is continuing to seek out opportunities that may make economic sense today.

On the positive side, we originally [entered under] stabilized yields in the mid-4% range for the Bridge transaction, and we expect to outperform those levels through higher rents and quicker lease up. Through our outperformance of lease-up timing and run rate increases, along with the cap rate compression, we believe we have already realized 60 to 70 basis points of value creation on that transaction.

I would also like to revisit our prospective Columbus portfolio disposition discussed in the last earnings call. We are in negotiations with prospective buyers and anticipate it closing late in the second quarter. Also, as you'll recall from our January call, 1 of the 4 buildings is leased to Bon-Ton, representing about 20% of the NOI of the portfolio for sale. While Bon-Ton is in bankruptcy protection, they're still current on monthly rent to us. The bankruptcy proceedings are expected to result in a liquidation of the company. The prospective buyers are well aware of the situation, and we do not expect the Bon-Ton liquidation to be any surprise to the expected closing of this transaction.

I will now turn our call over to Mark to discuss our financial results and guidance update.

Thanks, Nick. Good afternoon, everyone. I'm pleased to report that core FFO for the quarter was $0.30 per share, consistent with core FFO of $0.30 per share in the fourth quarter of 2017. Growth in core FFO from newly acquired or developed properties during the first quarter compared to the fourth quarter of 2017 was offset by increased noncash G&A expense triggered by the accounting requirements to immediately expense a significant portion of our annual stock-based compensation grant. This higher level of G&A expense in the first quarter is consistent with past years due to this accounting treatment.

We reported FFO as defined by NAREIT of $0.31 per share for the quarter compared to $0.33 per share for the fourth quarter of 2017, with the decrease largely pertaining to changes to deferred tax assets and higher gains on land sales during the fourth quarter of 2017 compared to the first quarter of 2018. AFFO totaled $108 million for the current quarter compared to $84 million for the fourth quarter of 2017. This increase was attributable to significant lease-related costs, reducing AFFO in the fourth quarter of 2017, as well as overall improved operating results and the positive impact of new acquisitions and developments in the first quarter of 2018.

Same-property NOI growth was 3.4% on a cash basis. It was about 160 basis points higher than that on a GAAP basis. The 2 biggest factors causing our GAAP number to be higher than cash is free rent that we had in quarter 1 of 2018 from all the leases we have signed over the last 2 quarters, along with some bad debt expense on a straight-line basis that we had in quarter 1 of 2017 related to last year's hhgregg bankruptcy. We expect our cash to same-property numbers to accelerate over the next couple of quarters as this free rent burns off and the significant increase in rental rates on these recently signed deals kick in.

We continue to operate with our balance sheet at A level metrics. We have plenty of leverage capacity and liquidity to fund our business well into 2019 without any equity needs, and we'll have the opportunity to lower our overall borrowing cost later this year when $227 million of secured loans earning interest at 7.6% are prepayable. From a financial and capital standpoint, we're progressing according to plan and we are well positioned to continue to grow our portfolio.

Let me now address revisions to our 2018 expected range of estimates, which is an exhibit at the back of our quarter's -- quarterly supplement and on our website.

In reflection of better-than-expected rent growth and lease up of vacant space and speculative development completions and recent acquisitions at a faster pace than anticipated, we raised guidance for core FFO to a range of $1.26 to $1.32 per share, or a $0.02 per share increase at the midpoint. Similarly, we increased the range of growth in adjusted funds from operations on a share adjusted basis to a range of 4.5% to 10% from the previous range of 2.7% to 8.2%. We increased the range for stabilized portfolio average percentage leased to 97.5% to 98.5%, up 40 basis points from the previous midpoint. We increased the range for our total in-service percentage lease to 96% to 97%, up 50 basis points from the previous midpoint. We did not make any changes to our same-property NOI guidance as we're still comfortable with our original range. As we've been saying for several quarters and have disclosed in our investors slide deck, we have opportunities in our portfolio to grow overall NOI and earnings by a substantial amount, but much of this growth would come from properties that are not currently part of our same-property pool. Our current quarter results in these guidance changes reflect this.

The estimate for building dispositions was also increased to a range of $350 million to $550 million, up $50 million from the previous midpoint, reflecting our ability to take further advantage of the overall significant demand for Class A properties across the U.S. and record-low cap rates and to use these proceeds to fund our growing development pipeline.

Regarding development expectations, given the strong start in Q1 and the 3 additional starts thus far in April and along with strong prospects for the remainder of the year, we increased guidance for development starts to a range of $650 million to $850 million, up $150 million at the midpoint. This should support incremental earnings growth as we get into next year, and generally speaking, we expect to continue to drive strong preleasing levels in this pipeline to maintain a strong risk-adjusted return profile on our growth plans. Revisions to certain other guidance factors can also be found in the Investor Relations section of our website.

Now I will turn the call back over to Jim.

Thanks, Mark. In closing, the real estate -- the logistics real estate demand drivers remain very strong in both traditional distribution and e-commerce fulfillment. In particular, the e-commerce sector is creating new customers for us and forcing players to modernize their supply chain strategies for delivering goods faster and more efficiently. We're very pleased with our team's execution through the first quarter on leasing performance, capital redeployment and development starts, and we're optimistic about our strong performance for the remainder of the year.

(Operator Instructions) We'll now turn it back to the operator, Greg, for the first call.

(Operator Instructions) And our first question comes from the line of Manny Korchman.

Jim, when you spoke about the increased development pipeline or that the rent in development pipeline, you spoke about an increase in prospects. I was wondering if those are tenant prospects in terms of build-to-suits? Or is that land that has either come to entitlement faster or have you found new land opportunities that you can development on?

Well, Manny, I would tell you it's a little bit of both. Obviously, we've committed to keep our preleasing percentage at or above that 50% range. So we're finding more build-to-suits, and we're filling the pipeline with additional build-to-suit opportunities that, we think, look pretty good for the second half of the year. And then secondarily, based on our occupancies and the leasing that we've done, we've got ample opportunities to start additional spec projects. All of that requires the land that you referenced. So we're -- we've either got land that we can put in service or we've acquired land recently that's now entitled and ready to go. It's all driving the development machine right now pretty well.

Got it. And a quick one for Nick. You talked about the lack of acquisition opportunities out there, mentioning that Bridge would've been hard to find today. What do you have to do to get sort of acquisitions done? Is it look for bigger portfolios, smaller portfolios, development assets? How do you sort of solve for that lack of acquisitions today?

Well, I guess the best example was our Southern California acquisition. We were able to provide and exchange property in Nashville that some of our competitors were not able to provide, which allowed us to acquire that property, we think, at below-market pricing. So it's just getting creative and that sort of thing. But I'm not going to kid you. It is very competitive out there right now and even with the recent rise in interest rates, cap rates have compressed.

And next, we turn to the line of Jamie Feldman.

Jim, you had commented that the Southeast is particularly strong. Can you give some more color about what you're seeing in that region specifically? And then are there any other regional differences that stand out?

Yes, I would -- I think our guys, our teams in the Southeast, particularly Atlanta and Savannah, had a great quarter. Backfilling that 760,000-foot vacancy right away was really key for us and got us off to a strong performance. And then there's just incredible demand going down at the Port of Savannah. We actually met with the port leadership just literally a couple of days ago. And it's the fastest growing port on the eastern seaboard, and it's clearly seeing the benefit of the expansion of the Panama Canal, which opened up a couple of years ago. So that's obviously helping us drive business down there. So as all of our peers have reported in the last week or 10 days, most all of the markets are really pretty good. That team down there for us had a really good -- did a really good job in the first quarter.

And we have a question from the line of Jeremy Metz.

Jim, in your opening remarks, you mentioned the national supply and demand numbers, and you talked a supply of -- I think it was 35 million square feet being down on a relative basis so far this year. Just wondering, given the strength in this sector, the attractive development spreads, were you surprised at all by this -- by that number? And I mean, if we just look at your own portfolio, your ramp starts, your peers are doing it, so should we expect to see that supply figure really ramp back up here throughout the year?

Yes, Jeremy, I would agree with you. I think we're all very pleasantly surprised by that. I wouldn't read too much into that, that's just a quarter number. I think most of us are expecting pretty close to equilibrium this year being plus or minus 200 million square feet of demand and plus or minus 200 million square feet of supply. So we keep pretty close tabs on all the markets and the submarkets within there. And while there's a little softness in a couple of submarkets that we've all talked about from time to time, when you're at 4.5% vacancy across the entire country, we're in a really good spot right now, and I'm not particularly worried about supply, at least for the foreseeable future.

And no real change in your forecast at this point, right?

No, I think we could see those absorption and supply numbers flip-flop next quarter. I mean, I'm not making a projection, but you could. Again, at the end of the year, I think most of us are pretty much consensus at or about equilibrium. But as I've been saying for quite some time, equilibrium at 4.5% vacancy nationwide is a pretty good place to reach equilibrium.

Appreciate that. And just as a follow-up question, in terms of the Bridge portfolio, it sounds like both the timing and the achieved rents there have been ahead of schedule. I think when you originally announced that you talked about underwriting it to just under 5% stabilized yields. So wondering where did that yield pencil out today on a stabilized basis?

Hey, Jeremy, it's Mark. We -- I think when we originally underwrote it, we were talking mid-4s, 4, 5 or 6, something like that. Based on what Nick said earlier, with the cap rate compression and our better performance that we had underwritten, we think we've got 60 to 70 basis points of value creation, so you could add another 20 basis points on that original underwriting and that's probably where it's going to stabilize at.

And we have a question from the line of Ki Bin Kim.

Could you talk about the lease spreads and if there's any trends in -- whether certain markets are driving it? Or was it kind of broad-based?

Ki Bin, it was really across the board. I guess probably our best-performing markets were the ones Jim already commented on. Savannah was very, very strong on the rent growth, but it was really broad-based across the board. There weren't a lot of trough leases that rolled either, so it's just substantive rent growth. The one benefit when you've got longer-term leases in an environment like this, the rents that you had in place are a little bit lower, but it was pretty much across the country.

Yes, I think the only color I would add, Ki Bin, would be if you discount the immediate backfills, I think we renewed 65%, 68%, which is down a little bit for us. And when we're as highly occupied, it really gives our leasing and development professionals the ability to go out and push rents because they just don't have that much occupancy. So that's what they've been doing. And consequently, when you're not renewing a tenant and you're immediately backfilling space to the tune of 98% of everything that's expiring, it's a pretty good place to be for a landlord right now.

Okay. And you have a couple larger asset -- development assets in -- I think, in Allentown still on lease. I mean, given your track record, I'm not too worried about it, but any kind of color on momentum you're seeing there from tenants?

Yes, we've got a lot of activity. I can't tell you that any of our exposure that we've either got in the portfolio today or that we're -- that's in the development pipeline coming at us in the next 6 months worries me at all. There's a lot of activity in the Greater Lehigh Valley right now, shortlisted on a bunch of deals. So I think we'll continue to see pretty consistent performance as we did the last quarter of us ability -- our ability to lease this space as it comes online.

And next, we turn to the line of Dick Schiller.

Two quick ones for me. First of all, could you guys clarify the impact on the change in the same-store methodology and the detriment to 2018, the hit you'll see there? And then secondly, the Bon-Ton assets, I understand one of the assets is set for sale in Columbus. Was the asset in Chicago released?

I'll cover the same-property, and I'll let Nick or Jim cover the second question, Dick. The -- our same-property number for the current quarter under the new methodology was 3.4. If you look at the prior quarter -- I'm sorry, the sequential prior quarter, so the fourth quarter of 2017, we reported 3.2. If you would've used our current methodology back in that prior quarter, that 3.2 would've been 2.5. So a 70 basis point reduction, if you will, under the new methodology. So the way we look at it, quarter-over-quarter, we grew from 2.5 in the fourth quarter to 3.4 this quarter. So it was about a 70 basis point difference. And then I'll let Jim or Nick address your second question.

Yes, Dick, Nick addressed Bon-Ton in Columbus, so we think we're in a pretty good place there. Bon-Ton, as has been publicly reported, is now in the liquidation phase. Our expectation is that they will likely be in through most of the summer. The liquidator that was selected is now in the process of breaking up the building. The business is selling the assets. There are several potential buyers of the business that occupies the space in Chicago, which, for us, is 270,000 square feet. It's a 40-foot clear building, so it's a really nice asset. In addition, we've actually got two inquiries from our own portfolio in Chicago looking at the building. So I think in short order, this will be a little bit like the hhgregg. I think it'll be a short-term pain and long-term gain because I think we'll backfill that space in fairly short order and we'll improve the NOI from the space and obviously get a better quality tenant.

Yes. And I would just clarify on the Columbus facility, it's 1 of 4 assets that are -- we have for sale right now, and that asset only represents 20% of the overall portfolio.

And we have a question next from the line of Blaine Heck.

Next is John Guinee.

I'll ask the question that Blaine was going to ask. So Nick, you're selling 4 out of 15 assets in Columbus, can you sort of talk about why those 4 relative to the other 11 and how you're thinking about tightening up various portfolios in places like Columbus?

Yes, we're constantly trying to diversify our portfolio from a geographic perspective. The 4 assets that we're selling are in West Jefferson, which is the west submarket of Columbus along Interstate 70. Those are -- that's a park that we've -- optioned land over the years and done a lot of build-to-suits on that. And so as we're trying to rightsize portfolios, it was -- it made logical sense to go ahead and monetize those assets and redeploy them to other geographies.

Okay. And then that was a softball. Then the other question Blaine was going to ask is if you look at industrial product, it's maybe 30% to 40% leased to traditional retailers. And when, Jim, you brought up the Bon-Ton situation, it reminded me of this, does the other shoe drop anytime soon where e-commerce gets so strong that the traditional retailers need less space?

Well, John, I think you've got to step back and look at it. E-commerce represents about 9% or 10% of sales in the U.S. And while everybody expects it to grow, bricks-and-mortar sales are still the vast majority of the sales, I think $3.6 trillion. And we spend a lot of time in meetings and on conversations like this talking about good retailers and bad retailers. And unfortunately, there's a few of them like Bon-Ton and hhgregg that tend to get a lot of the headlines and are in tough shape. And they -- whether they're overleveraged or they haven't been able to invest in their business or they haven't embraced e-commerce, they're not doing too well and many of them will not survive. But a lot of retailers have, in fact, made those investments. They've kept their stores up, they've been smart about opening new facilities, they've invested in their supply chain and they've embraced e-commerce, and they continue to grow sales and they continue to grow it through the use of e-commerce. So I think it's a case of the glass half full or the glass half empty. We tend to focus on the strong guys that are doing well, and we tend to try to stay away from the guys that aren't doing so well. And Bon-Ton is unfortunately one of those, but I think we've mitigated that risk with the sale of the Columbus portfolio. And hopefully, we'll be able to have the Chicago assets backfilled by the end of the year. And as we've discussed, we just -- we don't have that much tough retail exposure out there in our portfolio, so it's not one of the things that keeps me awake at night.

Now that I asked Blaine's question, can I ask my question?

Sure.

We turn to the line of Blaine Heck.

But a couple of more for me. In the guidance, I think it shows that you guys are focused on acquisitions in Tier 1 markets. Can you get any more specific on where those markets are and maybe what the cap rate on the acquisitions may be?

So on the acquisition side, we're focused on a high barrier Tier 1, so Southern California, South Florida and the Northeast, primarily Northern New Jersey, and then we'll also look to some transaction in the East Bay. Right now, most -- in those markets, trades are going off in the -- breaking a 4.00% cap now in a lot of those markets or very low 4.00% cap numbers. Fortunately for us, there's been more development opportunities to make up for the lack of acquisition opportunities for us.

Okay, that's fair. And then just a quick one on the data center sales. Do you guys have any other opportunities to do similar deals? I think -- and a lot of it has to do with the location of the land and infrastructure around it, but I wanted to get some color on whether we'll be seeing any more of that.

Yes, Blaine, we actually do have opportunities. I can't tell you that we have a great deal of expertise there and we're out trying to find data center land. Sometimes it's just better to be lucky than good. But we've done a number of those, as Nick referenced, the ones we just sold in D.C. and some of the land that we've got there has the potential to go that way. We've also done a number in Chicago, in and around the O'Hare market. Again, where we bought really good industrial land and it happened to be viable for data centers. So it's not business that we're trying to find, but every now and again, we've got a good piece of land that makes a lot of sense for the data center guys. And if the pricing is right, we can develop it, then we're more than happy to do that.

Next, we turn to the line of Eric Frankel.

I just wanted to quickly focus on same-store results. The operating expense increase, can I assume that, that increase has been passed on through tenants?

It has, Eric. And the recent expenses were up so high this quarter over last year was snow. Snow removal expenses were quite high this quarter over last year and it was all pass-through.

Okay. And your acquisition and disposition activity this quarter was quite interesting actually, that property swap is a pretty good case study. Nick, I wanted to get your sense, what do you think is the right cap rate spread for buying in Tier 1 markets and maybe selling a little bit more assets in the Midwest or more inland markets?

Well, for that particular swap, we looked at more on the IRR basis, on an IRR basis, but I would tell you that we talked about the cap rates in the high barrier Tier 1s a lot and how low they are, but the Midwest cap rates are at record levels, too, in numbers we have not seen before. So they're getting very low as well. I think the spread, just take 2 markets between SoCal and Indianapolis is as low as 100 to 125 bps right now.

Very interesting. So it would be fair to say that you'd be pretty willing to both increase your acquisition and disposition guidance, if you found pricing similar to today and assuming cap rates don't move?

No, I think that -- first of all, our disposition -- our portfolio, we're pretty happy with it right now, so all we're doing is the last little bit of repositioning around the system, and we'll continue to that from year-to-year. But I think to redeploy -- I'd rather redeploy -- I think we'd rather redeploy that into development right now because we think that's much more accretive going forward for us.

The other thing I would mention, Eric, is we raised our guidance on development. We just still think that's the best place to put new capital out right now and raised our guidance on dispositions to pay for some of that. We did not touch our acquisitions guidance. And I think as we sit here today, we would think that, that's probably going to trend more towards the lower end on the acquisition side.

And next, we turn to the line of Michael Carroll.

Jim, I know you've touched on this earlier in the call, but can you add some color on what you're seeing in the market today with regards to new development starts? Where are these opportunities? And similar to the acquisition strategy, are these focused on the Tier 1 markets?

Well, Mike, I would tell you, clearly, we're doing more development activity in the Tier 1 markets. Trying to remember the exact number, we had a board meeting yesterday, and I think it's 65% of the development activity is in the Tier 1 markets. So that's South Florida, Atlanta, New Jersey, the Lehigh Valley, Chicago, Dallas or Southern California. For us, that would be how we would define that. And that's really where we're trying to really grow our portfolios. I think you'll continue to see us develop in all the other markets that we're in. But there, I think, you'll see us, as Nick explained in the Columbus portfolio, continue to, every now and again, harvest some gains and rightsize some of those portfolios, and we would expect some pretty healthy gains coming out of the Columbus sale. As we've done, I think, that's for build-to-suits that we've done over the last 6 or 7 years, and we think we'll get some really good pricing out of that. I think you'll continue to see us do that.

And what type of deals are you willing to pursue outside of those Tier 1 markets? Are those mostly build-to-suits with existing relationships?

No, it's both build-to-suit and spec, but it's on land that we own that we've got a fairly attractive basis. So we're making really good, stabilized returns in those projects. So it's -- we continue to do development in Indianapolis. In St. Louis, you saw us do a build-to-suit and a spec building in Minneapolis. I think that business will continue for us.

And next, we turn to the line of Michael Mueller.

In terms of development leasing, I'm just thinking about activity levels. Can you give us some sense as to how many serious proposals, tours, looks are you getting from tenants on kind of a typical building that now is shell complete that you're trying to lease up? And how is that level compared to, say, a year or so ago?

Well, let me answer the second question first. It's pretty consistent in -- when we talk about having good activity across the board, we review every month with our leadership team all the major vacancies. We review all the build-to-suit prospects that we've got. And activity level, I would tell you, has been consistently good month-to-month and quarter-to-quarter for the last several years. In terms of the individual spaces, our leasing guys have an expression, "It only takes one." So you can have 4 or 5 different proposals out on the space or you can have one, and it just takes the one guy that's willing to step up and sign for the right terms. So sitting here today, as I answered one of the earlier questions, we've got really good activity across the board. We start following spec developments the moment we approve them internally, so even when they're in just coming out of the ground. And some of those, the activity is modest or nonexistent at that point, but some of them already have great activity because they're in established parks and it's really good land and in a very competitive environment. So that's a long way of telling you it's kind of all over the board, but month in and month out, we've got pretty good activity everywhere.

(Operator Instructions) Next, we turn to the line of Jamie Feldman.

I guess just sticking with the land, can you talk about the land bank and how it lines up with your development opportunities and maybe Tier 1 versus Tier 2 markets?

Yes, sure, Jamie. Our land bank at the end of the quarter was up to about $270 million. Ours had gotten down into the low 200s, might even touch $200 million, which was really low for us. And we acquired about -- oh, I want to say...

$60 million.

$60 million of land in the quarter, and we monetized about the same amount through either minimal land sales, but monetized it through development. So over the years, we've told people that we're comfortable as long as we think we're in a healthy economy and a healthy market with the land portfolio or land holdings of $300 million to $400 million, so we're currently well below that. Some of the plays that we're making and some of the higher barrier Tier 1 markets are bigger and more expensive, so I would anticipate that, that land bank for us is going to kind of stay between the $250 million and $300 million mark for the balance of the year. We've talked in past calls about the pricing on land and the difficulty, the challenges that we face every day to get good sites at reasonable prices and then be able to get it entitled. And I have spoken before that I think that's one of the governors that is keeping supply in check in the U.S. industrial market because land is not as plentiful us a lot of people would think, and it's very expensive today, and the entitlement process is expensive and lengthy and that's keeping the amount of spec development across the country to a reasonable level.

So how does it line up with your development opportunities in terms of -- help me out, the $270 million, what's Tier 1, what's Tier 2?

Jamie, I don't have a breakdown in front of me. I would tell you that -- and this is a problem that I have every year, I have too much land in some markets and not enough land in other markets, and it changes year-over-year. So we're actively looking for land in markets like New Jersey, where we have no vacant land in our inventory because we put the last 2 sites into production. We're looking for land in the Lehigh Valley because I think we've only got a site for one more development right now. Other places, we've got more than ample land for the next 5 or 6 projects, like a market like Atlanta. So there's a good, healthy mix. We don't have that much, what we would call, surplus land anymore. I think our surplus landholdings are down under $20 million of land that's held for sale right now. So over the last few years, we've really been able to prune that portfolio, get it down to a very nice healthy level and get rid of all the nonstrategic land. And you've got to remember, we own residual retail land and residual office land from when we were in those businesses. And now all that's gone and we're really focused on the core industrial.

Okay. And then you mentioned governors -- our land as a governor. Are you seeing any change in appetite for spec development or from the merchant builders for -- due to higher construction costs or higher interest rates?

Well, I think construction costs is another one of the governors that keeping things in place. And as we've talked before, financing. Financing levels are much more reasonable compared to previous cycles. So you're still looking at most of the merchant builders having to have institutional equity in order to get financing and move ahead on spec projects even as good as the market is today. So I think the combination of those things has kept spec development at a very reasonable level.

So would you say there's been a change recently or not really in terms of their appetite?

No, no. I think there's a lot of people in the world that would build more spec today if they could, if they had land at a better price or they could get it entitled sooner, or they could get it financed or construction costs were a little more reasonable. But the combination of all of those things right now makes it a little bit more challenging. It puts spec developing out into the marketplace. And I think the market's been at this kind of level, sub-5% vacancy for a couple of years now, so I don't think you're seeing any increased demand to do more spec. I think that's been there pretty consistently throughout the last few years.

And we do have a follow-up from the line of Dick Schiller.

I'm good. I don't have a follow-up, guys.

And our final question comes from the line of Eric Frankel.

I do have a follow-up question. Can you describe in your recent leasing activity, given that labor is becoming more expensive and less plentiful, whether there's more CapEx incurred by the tenants to install more automated operations in the spaces and maybe in your new development projects?

Sure, Eric. Well, let me give you 2 answers to that question. One of the things that we do, and I can't speak to my peers, but one of the things that we do is before we buy a major piece of land, we do a labor study. So we're not investing however many million dollars in a land site if we don't have the answers on the labor study beforehand because we know that's such a key criteria for many of our big logistics and fulfillment clients. So that's answer #1. We're comfortable with the labor for every one of the sites that we own and anything that we're pursuing. In terms of your second question about CapEx, yes, I think a lot of retailers and e-commerce companies are looking to put more automation and more material handling into the buildings to get faster and more efficient. That's not part of the CapEx for us. So our CapEx is listed to docks and lights and a little bit of office, shipping warehouses, things like that. So those dollars are going up, but that's not part of the TI package that we're putting into any of our deals.

Right, understood. But do you have a sense of how much more the tenants are putting in, just get a sense of how their operations are evolving?

I think at the high end, Eric, I think it is a -- like 10 multiple of our cost of the building for some of these highly sophisticated fulfillment centers with material handling, robotics, multiple levels. And that's the investment a company makes before they put $1 of inventory or they hire one person. And they're hugely, hugely sophisticated buildings that have the big capability to run 24/7. And these are the companies that are making this kind of investment that are getting much more efficient, that are in a position to get product to the consumers, whether that's the store or the consumer's house, faster and more efficiently, and those are the guys that are going to survive.

Okay. One final question, I know you just spoke quite extensively on the land and entitlement process and why development volumes are probably a little bit less, lower than people would normally expect in this part of the cycle. I don't think it's a secret that it's particularly hard to build in the Tier 1 markets you're describing. Can you talk about how the entitlement and development process though has changed in some of your more traditional markets, in more inland -- in more of the inland part of the U.S?

Yes, I'll give you a great example, this is very timely, and it's Houston, Texas. So in Houston, they have just passed ordinances that have made it particularly restrictive and difficult to develop industrial on a site that is in the 500 year floodplain, and there's a lot of industrial that is in the 500 year floodplain in Houston. And we're not talking about 100 year floodplain, we're talking about the 500 year floodplain. I was with the leader of our Houston office, David Hudson, on Tuesday and Wednesday, and he believes that's going to take the normal entitlement process for a piece of raw land in Houston from, what would normally have been probably 9 to maybe 10 or 11 months, to somewhere between 12 and 18 months.

Okay. And you think that's -- is that probably applicable to other similar markets?

Yes, I think that's an extreme, but I think even some of the most business-friendly Midwestern markets that we've operated in for a long time are continuing to make the entitlement process and the approval processes that much more challenging. They're sensitive to cars on the road, they're sensitive to trucks, incentives are getting harder and harder to get. And it's just a result of the strength of the economy and the strength of the markets.

I'd like to thank everyone for joining the call today. We look forward to seeing many of you at the NAREIT Conference in New York in early June. Operator, you may disconnect the line.

Thank you, sir. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive TeleConference Service. You may now disconnect.