Eastgroup Properties Inc (EGP) 2010 Q2 法說會逐字稿

Good day, everyone, and welcome to EastGroup's second-quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. Please note this call is being recorded and I will be standing by should you need any assistance. It is now my pleasure to turn the conference over to Mr. David Hoster, President and CEO. Please go ahead, sir.

Good morning, and thanks for calling in for our second-quarter 2010 conference call. We appreciate your interest in EastGroup. Keith Mackey, our CFO, will also be participating in the call.

Since we will be making forward-looking statements today, we ask that you listen to the following disclaimer covering these statements.

The discussion today involves forward-looking statements. Please refer to the Safe Harbor language included in the Company's news release announcing results for this quarter that describe certain risk factors and uncertainties that may impact the Company's future results and may cause the actual results to differ materially from those projected. Also, the content of this conference call contains time-sensitive information that's subject to the Safe Harbor statement including in this release is accurate only as of the date of this call.

Thank you. Operating results for the second quarter exceeded the midpoint of our guidance range. The increase was due primarily to achieving higher than projected property occupancies and termination fees and experiencing lower bad debt.

Funds from operations were $0.71 per share as compared to $0.80 per share for the second quarter of last year, a decrease of 11.3%.

The $0.09 per share decline was in part the result of our lower property occupancies, and less capitalized interest in development fees during the second quarter of this year.

For the six months, FFO was $1.45 per share, as compared to $1.63 per share for the first half of last year, a decrease of 11.0%.

Same property net operating income for the second quarter declined 3.8% with straight-line rent adjustments, and 4.7% without. These figures are approximately what we experienced in the first quarter.

In the second quarter on a GAAP basis, our best major markets after the elimination of termination fees were San Francisco, which was up 30%; Houston up 3.1%; and El Paso up 2.2%.

The trailing same-property markets were Los Angeles, down 28%; New Orleans, down 23%; and Tampa, down 11.3%.

Although average rents were declining, the difference between quarters is still basically due to changes in property occupancies in the individual markets.

EastGroup's occupancy at June 30 was 87.2%, an increase of 100 basis points over our March 31 occupancy. This improvement exceeded our expectations, and we've primarily achieved in the month June.

Looking forward, we project occupancy to continue to increase to approximately 89% by the end of the year. Please note that our occupancy statistics include our development properties that were moved to the portfolio at the earlier of 80% occupancy, or one year after [shelf] completion.

Our Texas markets were the best, at 94.2% leased and 92.8% occupied at the end of the quarter. Houston, our largest market, with over 4.7 million square feet, was 94.7% occupied.

Our most challenging major market continues to be Phoenix at 75.8% occupied, which experienced a small improvement over the first-quarter results.

Looking at second-quarter leasing statistics, we renewed 66% of the 1.0 million square feet that expired in the quarter, and leased another 1.1 million that had either terminated or expired during the quarter or was vacant at the beginning of the quarter.

In total, we signed 131 leases in the second quarter, which was the highest quarterly number of leases ever, exceeding the previous high in the first quarter of this year, clearly a positive sign. In addition, this was the first time since the second quarter of '08 that our leased percentage increased.

As shown by our occupancy results, leasing activity has improved. We cannot call it good yet, but at least it is better, and we expect to achieve increased occupancy over the next two quarters.

There is leasing activity in all of our markets, but prospects continue to expect cheap rent with significant concessions and feel little sense of urgency since they have so many lease alternatives.

As you can see in our supplemental information, GAAP rents in the second quarter decreased 16.1%, and cash rents declined 18.9%, a greater decline than last quarter. Our Arizona and Florida markets continue to have the largest decreases after having achieved the largest increases several years ago.

We expect to experience negative rent growth until occupancies recover to the 93% to 94% level. This was the case coming out of the last recession. Average lease length was 4.0 years, which is about our average for the last year.

Tennant improvements were $2.41 per square foot of the life of the lease, or $0.60 per square per year of the lease, which is well above our usual averages and was the result of a renewal lease at our LA corporate center office building, Los Angeles, and the modernization of a number of orders for [bases].

Our efforts to acquire properties have been frustrating. There have been several opportunities that have fit our business distribution criteria, but we have lost out on pricing.

As a result, we have reduced our acquisition guidance in half to $20 million in the fourth quarter of this year, dropping out the $20 million that we've projected for the third quarter.

In the second quarter, we did acquire a small asset, East University III, in the central Phoenix sub market for $1.3 million. The 100% leased single-tenant building contains 32,000 square feet. It is projected to generate a yield of approximately 9.5%. We currently do not have any properties under contract to either purchase or sell.

During the quarter, we transferred Blue Heron III, with 20,000 square feet, to the portfolio from the development program. It is a 42% leased service center property in Palm Beach County.

At June 30, our development program consisted of World Houston 30 and a pre-leased expansion of Arion 8 in San Antonio. Together, they represent 108,000 square feet and a total projected investment of $8.5 million, of which only $2.1 million remains to be spent.

We do not have any development starts planned for 2010, but are continuing to look at several potential build-to-suit opportunities.

Keith will now review a number of financial topics.

Good morning. FFO per share for the quarter was $0.71 per share compared to $0.80 per share for the same quarter last year.

Lease termination fee income was $1,025,000 for the quarter compared to $210,000 for the second quarter of 2009. Bad debt expense was $126,000 for the second quarter of 2010 compared to $639,000 in the same quarter last year.

The net effect of these items increased FFO by $1,328,000 or $0.05 per share. We have now re-leased 53% of the space given back to us from the terminations, and are hopeful that the reduced level of bad debts will continue.

FFO per share for the six months was $1.45 per share as compared to $1.63 per share for last year.

Lease termination fee income was $2,438,000 for the six months in 2010 compared to $442,000 for the same period last year.

Bad debt expense was $742,000 for the six months of 2010, compared to $1,417,000 for last year.

Debt to total market capitalization was 43% at June 30, 2010. And for the quarter, the interest and fixed charge coverage ratio was 3.2 times, and debt to EBITDA was 6.4 times.

Our floating-rate bank debt amounted to 7.8% of total market capitalization at quarter end, and we have no mortgages that mature in 2010.

In June, we paid our 122nd consecutive quarterly cash distribution to common stockholders. This dividend of $0.52 per share equates to an annualized dividend of $2.08 per share. And our FFO payout ratio was 73% for the quarter.

And rental income from properties amounts to almost all of our revenue so our dividend is 100% covered by property net operating income. And again, we believe this revenue stream gives stability to the dividend.

FFO guidance for 2010 has been narrowed to a range of $2.81 to $2.89 per share with the same midpoint of $2.85 per share.

Earnings per share is estimated to be in the range of $0.62 to $0.69. The major changes to the assumptions were to remove the proposed acquisition of $20 million on July 1, and reduce the amount and rate of the proposed mortgage on October 1 from $75 million at 6.25% to $55 million of 5.25%. We also project that termination fees and bad debts for the second half of 2010 will offset each other.

These changes, along with other revisions, reduced projected FFO per share for the second half of the year by $0.01 a share. Since we were $0.01 a share better for the second quarter, the midpoint FFO per share projection did not change. Now, David will make some final comments.

We are pleased with our leasing results for the second quarter and expect slow, but continued improvement in occupancy for the balance of the year. We will experience negative same-property operating results over this period, but believe this statistic will come positive in the first quarter of next year.

With our strong balance sheet, we are continuing to seek attractive new investments and build-to-suit opportunities. We believe we are well positioned for future growth. Keith and I will now take your questions.

Jamie Feldman, Bank of America.

Thank you. I was hoping you could give a little bit more color on activities since the end of the quarter, just kind of what kind of tenants are still active in the market? And then also, we're seeing a lot of mixed economic data out there, including today's durable goods report. So I'm just wondering, how are tenants reacting to this data, and are you seeing any kind of change?

Take a step back on leasing activity. There's been a real swing. We would agree with most of what's been written about really the first three or four months of the year, where there appeared to be I guess you would call it pent-up demand since companies did so little leasing in '09 and late '08. And then, I guess maybe starting in May through June and maybe into early July, there seemed to be a real slowdown, and we were spending time finally getting leases signed from that early activity, and went through a slow period of three to six weeks where we started to get worried about what was going to happen the rest of the year.

And then most of our markets we've seen at least a tick back up. It's not back up to where it was during the first quarter, but the phones started to ring again. We're putting out proposals again. And that has allowed us to have the optimism to continue to project that we will increase occupancy over the balance of the year.

Our activity seems to be spread over a whole lot of different categories. We're seeing a pretty good pickup in what we call commercial construction and products. And maybe it's not so much new construction, but retrofitting of buildings, everything from building supplies to air-conditioning, wire and cable. We're starting to see a little bit of a pickup in apparel, and continued activity in food-related things, food services, food wholesaling. So, it hasn't changed much. As I say, it slowed and has picked up a tad, so that at least we have the sense that we can continue to improve the occupancy through the end of the year.

Okay, thanks. And then you had mentioned you think same-store NOI could turn positive by the first quarter. When you think about your rollover schedule for next year, where would you put the mark to market currently? And then where do you think it would be by then in terms of the rents?

We've never done a very good job at determining marked to market when rents were going up. All our office brethren talked about embedded rent growth. We never thought we had any, but our rents kept going up. So, we spend our time trying to figure out how to lease space, get leases executed rather than worrying about that role.

I think what's going to happen to market rent is certainly going to be determined by what happens with economic activity, nationally and in our individual markets. If activity picks up, you'll start to see an uptick of it in local market rents. So -- and I say we've not gotten into our 2011 projections yet. But, one of the reasons we think the first quarter is going to be positive next year is because the first quarter of this year was so bad. And we're, from an occupancy standpoint, above it now and expect to end the year well above it, so that having a low baseline helps reporting same store when you look at future years.

Okay, thank you.

Michael Bilerman, Citi.

Good morning, guys. This is David Shamis here with Michael. So, just looking at your FFO from the second quarter, if we add back the lease termination fees, we get to a quarter of about $0.68. So I'm just wondering if you could walk us through the ramp to the midpoint of $0.70 in the third quarter and then $0.71 in the fourth quarter.

We come at that several different ways, but the most important one is that every quarter, we revise our budgets on occupancy by suite, at every property. And, so that -- the numbers that we are showing, we call rev 3 budget for the third and fourth quarters, and it's on a suite by suite projection.

Secondly, I think it's important to note that the occupancy increase of 100 basis points that we achieved at June 30 compared to March 31 was an end of the quarter number, not an average for the quarter in the comparison. And basically, all of that increase of 100 basis points occurred during the month of June. Some of it, June 1, some of it the middle of the month, some of it at the end of the month. So that you can't look just at what the run rate was because the average occupancy will be let's say at least 100 basis points higher in the third quarter versus the second quarter.

Thanks. And then the $20 million of acquisitions that you are forecasting for October 1, are those actually targeted acquisitions or just a goal that you have set? And then what's the probability of that not happening?

It's a target goal. Probability, since we didn't -- we did $1.3 million instead of $20 million for the second quarter, beginning in the third, we can have a couple pop up in the next 30 days or not do any of them. But in terms of how it affects our guidance because it's projected for just one quarter, I mean it will be a negative, but not a significant negative.

Great, thank you.

Paul Morgan, Morgan Stanley.

Hi, good morning. David, you mentioned that pricing kept you out of the deals that you've bid on. Could you just talk about kind of what cap rates those assets did ended up transacting at?

Well the biggest one that's gotten a lot of publicity through the brokerage community is a 880,000 square foot complex in -- north of Miami airport. I -- the brokers state that I think they got 30 offers on, and AMD supposedly has it under contract, at a sub 6. That's what the brokers have reported, and only time will tell whether that's a cap rate. It -- going-in cap rate.

When we looked at it, we thought that cash flow, it's at about a 95% occupancy now, which is probably going to dip before coming back up. We view ourselves as a cash flow buyer, not an IRR buyer. And I think looking down the road five, six years is going to be heck of an investment from an IRR standpoint. But we look at things on what we can do with that cash flow going forward from the day we close on it.

There was an offering in Dallas, four properties. One of them is -- we thought was very attractive. The other three, we didn't like at all. So we just bid -- tried to bid aggressively on the one we liked. And as often happens in that situation, we don't know yet what the cap rate was, but that a local buyer has tied up all four. We generally aren't going to let the tail wag the dog in order to get one property out of four that we would like.

Earlier, I think we reported we bid on a two-building complex in San Antonio, and a single building in Denver. Both those, we thought we had, but for various circumstances, another buyer ended up talking directly to the seller and we lost out. Both of those had vacancy, and so it was hard to put a cap rate going in, but it would have been probably stabilized at a high 7 or a low 8, once you lease 25% to 30% vacancy. Those are the projects that we have looked at recently.

There are a lot of others that are more buildings, larger tenants which just don't fit our criteria. There have been a number sold in South Florida to both -- fund advisors and pension advisors at fairly rich per square foot prices, but I can't tell you what the cap rates are because we didn't bid on those because they didn't fit us.

It's been some -- somewhat -- it's been disappointing that we had hoped that as cap rates came down and the threat of capital gains taxes going up next year, that that would shake more properties loose, make them available to the marketplace. But right now, there is a whole lot more capital seeking out industrial assets than good properties available at least in our Sunbelt markets. And it's real hard to tell what's going to happen between now and the end of the year, but so far, as I say, it's been very frustrating.

And you say that you are -- think of yourself as a cash flow buyer. Does that -- so are you less inclined to -- it doesn't mean you're less inclined to buy vacancy, or does it?

That all depends on the market and the amount of vacancy. If it's a vacant building that's been vacant for two years, and -- or three years and it's in a very soft market, and we don't see how we can do better with it for a period of time, is one thing. If we can buy something with a 20%, 30%, even 40% vacancy factor, and we see that we have the capital and the expertise to lease that up and achieve a yield that reflects that lease-up risk, we'll definitely jump into it.

It's the ones that get more difficult where there's a number of leases turning in the first two years of ownership, the rents are currently well above market and you are going to have a significant dip in the NOI of the property, due both to vacancy and lease rate roll-down before you can start to bring it back up three or four years out. So, it depends on each of the assets.

When we look at a building with a lot of vacancy, sometimes we look at it from the standpoint of achieving development-type yields or looking at it from a redevelopment standpoint where we can go in and do things to the complex that make it more attractive that the seller has not done for one reason or another.

Okay. My other question, just on the oil spill, how has that impacted your markets, generally, I guess Houston, New Orleans, any others?

So far, nobody can -- in any of our markets can put it a finger on it and say here is a deal that didn't happen or here is bad news that has come out of it. New Orleans so far, we've not gotten any feedback one way or another on the activities not gone up or down as a result of the oil spill.

In Houston, the press has given it obviously a lot of coverage, and most people believe it's -- it will be detrimental in the short run, but in the long run, will probably help Houston because one, there's still going to be drilling in the Gulf in some form or another. And anytime the government increases rules, that usually means jobs, whether it's more safety features, more inspections, more whatever else it is on the Gulf rigs, and all of that is done out of Houston.

I think also we've gotten the feedback from Houston that where there have been loss of jobs so far is more on the coast of Louisiana, where you've got the offshore workers who are now sitting at home. But so far it's not any dramatic effects in Houston that we can point a finger at and say woops, we lost this deal for one reason or another, related to the spill.

Okay, thanks.

Thank you.

James Milam, Sandler O'Neill.

Good morning, guys. I just wanted to come back to the build-to-suits. You mentioned that you're still seeing a little bit of activity there. But I was curious if that slowed down, given just sort of the economic uncertainty if people are still a little concerned about making those commitments, and what they need to see in terms of given what rents are doing to make the commitment to potentially do a little bit more expensive of a transaction.

We have a number of proposals out that have been out for a while. We're still having slow discussions with the companies that have asked for the proposals. We're optimistic that we, over the next six months, will at least nail one, if not two or more down. Some of our people in the field have described -- it's just like the leasing of vacant space; nobody feels any urgency. You've got the unknowns with the economy and the unknowns with what's going to happen with tax rates, the unknown with all sorts of different rules and regulations.

And so, we can't really put a finger on it; is it the economy that's causing people not to actually jump into it? Or, is it just an overall no sense of urgency, they know the deal is going to be there going forward? And we've learned over the years that when people do a build-to-suit, it's usually -- and end up paying more rent than if they leased a vacant building -- it's for usually a whole group of reasons.

Generally, there's not a vacant building that's right where they want it to be or exactly the right size with all the specs they need. Or, what they're going to do on the inside of that building is so much more capital-intensive, expensive than the rent, that having the shape, design of the building perfect to allow them to do what they need to do on the inside, saves them more money than having a lower rent. But that's -- it's just been discouraging.

We hoped to have something done by now, but nobody said that they are killing the deals yet. It's just they are still talking, looking for approvals and that sort of thing. But, the one positive that I think most industrial [owners] are seeing is after a bunker mentality of tenants who look for just the cheapest rent, we're now seeing the more sophisticated users start to see this as an opportunity to the same or less rent, end up with a better building and a better location, higher-quality, and instead of one year lease, looking for five or seven-year leases. And that's just one of the steps in a recovery.

Okay, thanks. And then my second question, you know the term fee guidance is up again. Is that just from having a little bit higher term fees in the second quarter? And can you just give us a little color on what the tenants are doing that are leaving? Are they downsizing and consolidating space? Or are they -- is the business contracting? Or are they just finding a better deal somewhere else and trying to move to a different location?

I don't think any of them that I know of have been a better deal. It's been a contraction, a pulling out of the market. The economic reasons, consolidation, the bigger the corporation sometimes the stranger things they do with leases in terms of what they will pay on a termination fee, and to get it off their books.

And, so our bigger ones are generally where there's not been an option, but where we've negotiated it. For example, in the second quarter, almost $600,000 of that total is a single tenant in Hayward, California that was a supplier of auto parts to the NUMI plant, the Toyota, GM joint venture. We cut a very attractive lease termination with them, re-leased the space within one month or had one month of downtime and got over a 9% rate increase.

So, like I say, the bigger ones we take back where we're getting a huge percentage of the obligation and where we think we have above-average odds to re-lease the space. But, you generally don't lose a tenant over somebody giving them a better deal because you get real flexible in those circumstances.

Okay. That makes sense. Thank you.

Mitch Germain, JMP Securities.

Good morning, Keith and David; how are you? Just curious about traffic trends, call it the start of the second quarter versus end of the second quarter or today. A couple of your competitors have talked about a bit of a pullback in leasing and I'm just wanting to see if you've experienced something similar.

Yes, as I mentioned, we saw a pullback. I don't know maybe starting mid-to-late May that went into early I guess -- I'm overgeneralizing through the Fourth of July that started to get us worried. And then we've seen a pickup. It hasn't gone back to where it was in the first quarter, but there seems to be a pickup in calls. I mean even in Phoenix, everybody in Phoenix uses the heat as an excuse when there's not leasing in the summer, but after a lull there, we're starting to see some new activity in our Sky Harbor development and some other spaces that have been vacant for a long time.

So, it's -- and it's certainly not consistent, and there's still absolutely no sense of urgency on prospects' parts. But, we're getting some more phone calls. Only time will tell whether we're too optimistic or not in projecting increased occupancy over the balance of the year, but right now we're real comfortable with that projection.

Great. All my other questions were answered. Be well.

Thank you.

(Operator Instructions). Sri Nagarajan, FBR Capital Markets.

Thank you. Good morning. I think the question that I had was on the 87.2% occupancy was 89.1 leased. Now, what is the ramp-up in terms of actual occupancy that you guys will be having over the next couple of quarters? And related to that, the leasing, was it more on a new development? Or was it on older properties as well across the board on all markets?

To answer your first part first, it was pretty much across the board. And actually, probably less on new development or development that rolled into the portfolio with vacancy. We are projecting that we will be 89% occupied by 12/31.

Okay, so pretty much the next couple of quarters.

Yes; we -- you know, continued growth and, I -- I'd like to have more of it in the third quarter, but it's hard to project that when somebody wants to move in on a certain date. But we think we have the -- are starting at a good level and have the amount of activity out there.

One of the numbers -- spreads that we look at is what's the difference between occupancy and leased? And, if leased space -- I mean that space is leased that somebody hadn't moved in yet, if that's -- if you're only 10 or 20 or 30 basis points spread there, you know you're going to have move-outs, so occupancy is going down. So if that spread increases, which it has for us, it doesn't guarantee anything, but it's an encouraging sign that you should be able to increase occupancy over time.

And as I mentioned in my comments, the second quarter was the first time in two years that the amount of space leased showed an increase over the previous quarter.

I see. Now, in terms of your commentary on acquisitions, obviously, disappointing is what you're characterizing it as. But, the question is, why not get a little bit more aggressive than your usual conservative selves? Look beyond the Sunbelt perhaps in markets, and look beyond your light distribution facilities, focused on the [Belt] distribution. What's preventing you from doing that?

Well, over 15 plus years, we've refined our strategy of the business distribution, and it's worked. And when we look back at what our vacancies today, which properties that if you had to do over again, you might not have bought, it's in the bulk distribution area. Our occupancy is lower in bulk distribution than it is in either our business service center or our main thrust in business distribution.

With our focus on infill markets, you're generally not going to be building -- there isn't enough land to build big boxes and big-box users are generally looking for the lowest rent possible, so you find them on the fringes of development. Again, over generalization, but this is how we look at it. There's more competition out there, and when you're in those big bulk buildings on whether it's the far west side of Phoenix or how far east side of Los Angeles, out east of Ontario, areas like that, and somebody puts up a big fancy new building next to you, the only way you compete is on rent. And then you become a commodity. We think we've shown over time that our business distribution buildings have outperformed because of the location, so we are trying to compete on those locations.

Perhaps then the last question, for me -- the light distribution leasing versus again, the bulk distribution you describe was a little bit better. Perhaps in terms of fundamentals, again, not necessarily going market by market but with a broad brush stroke on the Sunbelt, what are you seeing in terms of rent roll-downs in your bulk versus the light distribution?

They're all rolling down, but the bulk is rolling down more. It becomes more competitive. People get much more aggressive for a 300,000 square foot user than they do for a 10,000 square foot user.

And, coming out of the last recession, and we're seeing it now, that the activity, each market has sort of a different sweet spot today. But it's generally in below 50,000 square feet. In some cases it's 5,000 to 10,000. In some others it's 20 to 30, where if you look in a lot of markets, the number of leases executed on spaces over 100,000 or over 200,000 square feet is pretty small. So, it's those smaller users that start to come out and start to grow first has been our experience and it continues to be today.

Thanks. Fair enough.

Brendan Maiorana, Wells Fargo.

Thanks. Good morning. I just wanted to follow up on Sri's question regarding the difference between the occupancy rate and the lease percentage. Is the outlook for the second half of the year the optimism regarding the increase in occupancy expectations due to a narrowing of the leased rate versus the occupied rate? Or is it driven by just a level of activity that you are seeing today that you expect to have that that spread, if you will, kind of remain the same, but the occupancy level will move up because there's better activity?

Well, because the spread between leased and occupied is higher today than it has been for a while, that gives us optimism that those people who have signed leases will, in fact, move in and that they will outstrip what we lose to new vacancy, plus, and we will continue to be doing leasing.

But it really gets back to what we project on a suite by suite basis for the activity that's there today, and what we expect through the balance of the year. We don't make broad generalizations about certain markets should pick up 1% or 2%. It's what's going on on the ground with each building when we do our budget revisions, so that's more what the optimism is based on. Something can go real wrong with the economy in the next couple of weeks, next month, you know, that's going to be tough to reach. On the other hand, we see a pickup, maybe we can outperform it.

Okay. Okay, that's helpful. And then, David, you mentioned that rent levels, you don't expect to have improved rent levels until you get to 93% to 94% occupancy or leased rate. I forget what you said. Now, I just want to clarify, are you talking about having re-leasing spreads turn positive at that point? Or are you saying that you don't expect your spot rent levels to move up until your portfolio reaches that level?

Well, it's a combination of factors. It's one, -- one of the -- well, our negative spreads are higher in this quarter compared to the last couple quarters for two reasons. One is that we are comparing to a higher point in the good days; and secondly, there is still some drop in market rents for individual size spaces. So that those spreads are going to stay negative until one of two things -- probably both things happen.

One is that we've come away from the peak of where we were signing leases in the really strong economic times; and secondly, it's a very practical thing. When a prospect it out looking for space and they have a dozen alternatives, you don't push rents, and the rents don't move in the market because there are usually one or two [owners] who will keep rents down in order to get a deal. So, what it takes is an increase in occupancy in individual markets and sub markets, so that a prospect has less alternatives. And that's when the whole psychology of the leasing game changes with brokers and users.

And, it goes from 10 to 12 good alternatives to half a dozen down to two or three. And then when they're still being slow and one of those two or three get leased out from under them, then they start to feel a sense of urgency and then we have pricing power. So it really -- before there be any big movement in rents in any one market, there's going to be -- there is happening a stabilization and it will start to inch up. But you don't get any real jumps until the number of alternatives and the desperate [owners] start to get reduced, and everybody's psychology of what's going to happen in the future changes.

So, if I look at where your re-leasing spreads have been over the past few quarters, I think the average is around negative 14% or 15% on a cash basis. And you've got -- I don't know there's a little bit of a mix issue -- but you've got the average rent per square foot on the expirations for next year, which appears to be moving up a little bit.

So even though you've kind of talked about how occupancy really drives your same-store numbers much more so than what re-leasing spreads are, if you are in the environment of kind of call it negative 15-ish% re-leasing spreads for the foreseeable future, are you going to be able to turn same-store NOI positive at least in a meaningful way if you are still rolling down rents 15%?

We think so. Occupancy still seems to have a much more important factor than a roll-down in rents. And I think that roll-down in rents is going to mitigate from the standpoint that we are starting to see stabilization in markets. And there will be some bounce off the bottom, but there's not going to be any big movement up until occupancy goes up.

And the second factor, when you look at leases rolling, and we get into next year, and then we're three years -- 2.5 years, three years from when rents started to go down initially, and so, we're not going to be comparing to such high numbers.

Sure. So is it fair to say -- if I look at your average rent roll, it moves up next year, but then it moves down in '12. Do you think that that's fairly representative of the movement of rents that are like on a same space kind of basis? There's not a major mix issue as you kind of look at '11 rolled versus '12?

I'd have to look at more detail on that, Brendan, to answer that without guessing on it. That's not something that we worry about a lot because the market is going to be the market. And, we can outperform that by a little bit, but you never do by a lot. And it's much more approachable to deal with it when the time comes.

Okay. Fair enough. And then just in terms of the capital recycling outlook, if acquisitions are more challenging, just given where pricing is today, where do you think that -- how far are rents below where they need to be to do -- to make a development deal work today if you had just, let's say, kind of market-level rents, outside of kind of the risk of starting a spec development project?

Every market is different. We don't even talk about future development in a market like Phoenix right now. But, Houston and San Antonio, because the rents never shot up as much, they haven't come down as much. We're probably -- maybe 8% to 10% away there, maybe a little closer because of our World Houston location that always has -- generates a premium rent.

So, I -- with maybe a little bit of luck we can do something in Texas next year. Florida is somewhere in between Arizona and Texas. But, I would expect that in terms of development that it is going to happen in Texas first, probably Houston and San Antonio. And, in the strong times, we were building buildings 100% spec, I would guess our first couple of buildings that we would start would have some form of pre-leasing just so that we could prove to ourselves and to our investment community that those pro forma rents are achievable.

And do you -- have you ratcheted back or would you consider ratcheting back the return, the yield expectations, just given that financing costs are down a little bit?

That all goes into the picture. But what we've talked about is, we've, at least historically have felt that we needed at least 150 basis points spread in yield over what an acquisition would cost or what we could sell the finished development for to take that construction and lease up risk. So that's a factor.

Cost of capital, obviously, is another factor. And then, just our gut feel on the riskiness of individual markets, would be a final factor. So, it's hard to say that it would exactly be a 9 or a 9.5 or a 8.5 pro forma yield going in. The level of pre-leasing would affect that.

Sure. Okay, thank you.

Dan Donlan, Janney Montgomery.

Thanks. Just one question for me. Just curious, of the new leases you signed this quarter, how much of that was tenants coming into the market versus just a little bit of musical chairs going on and maybe some people upgrading their space needs to your product?

Good question. I would say -- most of it was musical chairs of one sort or another. And some of that is where somebody is downsizing or consolidating, and they are willing to pay for a little more quality, and so they are leaving one or more other buildings for the same reasons that that other landlord can't meet their needs or the rent is not attractive or they have the opportunity to upgrade. There's very little at this point of new users moving into the marketplace.

Okay. And then, just on the NOI margins, if I back out the bad debt and the lease termination fees, it looks like you guys are at about 69.5%. Granted, your occupancy is low. Would you expect it to move back to the 72% level once your occupancy gets back to about 92%, 93%, as it has done historically? Or is there anything else that may affect that one way or the other?

No, it's -- when -- almost all of our leases are triple net or double net leases in one form or another where the customer is paying the operating expenses of the building, that occupancy directly -- I mean there's always some aberration one way or another at different times. But, the more space we have in our hands, the more expenses we pay from a real estate operating standpoint. So that goes up and down. A very high percentage of our leases are triple net. And almost all the others have at least a breakpoint where the customer pays everything above that stated amount, so that as we go back up, the expense percentage changes.

Okay. Thank you.

Thanks.

(Operator Instructions). Bill Crow, Raymond James.

Good morning, guys. I guess my question is kind of a combination of things that have been asked before, but maybe put a different way. David, if you could just talk about how your risk philosophy changes during the course of the cycle? Whether you might be more aggressive at the bottom of a cycle than a top? And, as you were losing these acquisitions, how the spread on your cost of capital differs from when you were succeeding with acquisitions in '06, '07?

Well, if you go back to that point in time, we really -- we had trouble competing, so we didn't buy much. We were putting our capital into new development because we were getting so much better yields there.

In '09, and two of the deals closed in January of this year -- but in '09, the pricing was very attractive, and -- but that pricing almost changed overnight. And, interest rates were higher, but our stock price was higher too and how we at different times had taken a rifle approach at what cost of capital is.

But, the cut -- a couple of the deals that we lost this year, the seller would come back and said to do this deal, you've got to pay a little bit more, we would have jumped on it. We thought we had a deal I guess in both cases and were surprised when we didn't have them.

So we would have bought those at a lower yield and been happy with them if we had had that opportunity. But, what we look at is a whole series of different things, but going-in cash flow, where that cash flow is going to go in the first couple of years related to potential roll-down of rents; lease-up of vacancy; our estimation of what's happening in that individual market; location of the product; is a complement of what other assets we own in that market or sub market.

So it's all those factors going in. We would certainly today be more aggressive on yield, look at a lower yield than we would have a year ago, and I would say six months ago. But, it would have to have a heck of a lot of upside for us to be in a sub 6 going-in yield and 95% occupancy. That just doesn't work for us. As a cash flow buyer, we've got to answer you all quarterly on a conference call.

Okay. Thank you.

I'm showing no further questions in queue at this time. Mr. Hoster, I'll turn it back over to you.

Thank you very much. We appreciate everyone's interest in EastGroup. And as always, please don't hesitate to call Keith or me about anything that we didn't clarify on the call or any other questions that come up about what we are doing. Again, thank you and talk to you next quarter.

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