Eastgroup Properties Inc (EGP) 2016 Q2 法說會逐字稿

Good morning and welcome to the EastGroup Properties second quarter 2016 earnings conference call.

(Operator Instructions)

Please note this call is being recorded. It is now my pleasure to introduce Marshall Loeb, President and CEO.

Good morning, and thanks for calling in for our second quarter 2016 conference call. As always, we appreciate your interest in EastGroup. Keith McKey, our CFO; and Brent Wood, Senior Vice President, are also joining me on today's call. Since we will make forward-looking statements we ask that you listen to the following disclaimer.

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 describes 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 is subject to the safe harbor statement included in the news release, is accurate only as of the date of this call. The Company has disclosed reconciliations of GAAP to non-GAAP measures in its quarterly supplemental information, which can be found on the Company's website at www.EastGroup.net.

Thanks, Keena. Second quarter saw a continuation of EastGroup's positive trends. Funds from operations exceeded our guidance achieving a 7.6% increase compared to second quarter last year. This marks 13 consecutive quarters of higher FFO per share as compared to prior year's quarter.

The strength of the industrial market can be seen through another solid quarter of occupancy, leasing volumes, re-leasing spreads, and positive same-store NOI up for both cash and GAAP. The depth of private market capital looking to invest in quality industrial assets was demonstrated by the pricing and volume we've seen in our dispositions which we'll elaborate on later.

At quarter-end we were 97.2% leased and 95.7% occupancy. Occupancy has exceeded 95% each quarter for the past three years, a trend we project maintaining through year end. This basically represents full occupancy for a multi-tenant portfolio, and as we've said before and as market commentary, we have never achieved this level of occupancy for this long.

Drilling down into specific markets at June 30, our major markets of Dallas, Orlando, Charlotte, San Francisco, and Los Angeles were each 98% leased or better. Houston, our largest market with over 5.9 million square feet, which is down from 6.5 million square feet last quarter, was 94.4% leased.

Supply remains largely in check in our markets, and sifting through the figures you'd see supply is largely comprised of big-box deliveries being 250,000 square feet and above, so by design, we simply aren't competing for the same prospects. In fact, the figures we've read state that 75% to 85% of the new deliveries of big-box markets. In our markets where the fear of overbuilding is the greatest, such as Dallas and Houston, we are seeing declines in construction with deliveries being absorbed.

To date, market discipline has been institutionally controlled and remains strong. Rent spreads continued their positive trend for the 13th consecutive quarter on a GAAP basis. And while we experienced negative quarterly cash releasing spreads, it was driven primarily by three leases, the largest being an 82,000 square foot R&D tenant renewal in Santa Barbara, rather than a reflection on the industrial market. In other words, with a portfolio of our size, we may experience quarterly anomalies. Overall, with 95% occupancy, strengthening markets and disciplined new supply we continue to see upward pressure on rents.

Second quarter same property NOI rose on a cash and GAAP basis. This quarter was unusual as the growth was due to rising rents as average quarterly occupancy fell 50 basis points as compared to second quarter 2015 to 95.7%. We expect same property results to remain positive going forward, though increases will continue to reflect rent growth, as at 95% to 96% we view ourselves as fully occupied.

The price of oil and its impact on Houston industrial real estate market remains a major topic of discussion. We thought it appropriate for Brent to again join today's call. Brent is one of our three regional Senior Vice Presidents and is based in our Houston office with responsibility for EastGroup's Texas operations. Brent?

Good morning. Our Texas markets finished the second quarter at a combined 96.4% leased, while our Houston operating portfolio finished the quarter at 94.4% leased, down from 96% last quarter. The Houston industrial market continues to exhibit solid fundamentals. Despite the overall decrease in prospect volume, builds continue to be made across the market in a broad range of sizes.

The market vacancy rate finished the quarter at 5%, which is just 30 basis points above its record-low mark of 4.7% set third quarter last year. However, we have seen an increase in sublease space this year. For numerous reasons, this often does not compete with existing vacancies, but it could lead to a gradual increase in the vacancy rate over time. During the quarter we experienced our first tenant default of the year, and only the second in two years.

Across the Houston market there was 1.8 million square feet of positive net absorption for the second quarter, which marked the 21st consecutive quarter of positive net absorption, and raised the year-to-date total to 3.8 million square feet. Meanwhile, developers continue to show restraint, with the construction pipeline containing just 2.8 million square feet of speculative space, which represents about 0.5% of the total market.

Looking ahead to the remainder of 2016, we have further reduced our Houston scheduled expirations from 15.8% a year ago to 5.8% of the operating portfolio. However, we have a number of known move-outs later in the year, primarily the result of tenants either downsizing or consolidating locations. As a result, we continue to be cautious with our Houston budget assumptions included in our guidance. Our leasing assumptions produce an average occupancy of 93% for the year, unchanged from guidance last quarter, with the anticipated low point being third quarter, at 90%.

From a development perspective we transferred our last two buildings that were in the development pipeline at a combined 87% leased. We remain pleased that the diversification of our development platform within Texas is replacing the volume we enjoyed during Houston's most recent growth cycle. Our projected 2016 development starts for the Company include five buildings in Dallas and San Antonio for an estimated total investment of $33 million, two of which broke ground in the second quarter. The fundamentals remain strong for the Texas markets outside of Houston, and they remain unaffected by the impact of lower oil prices.

Marshall will discuss dispositions in more detail in a moment, but I will mention that regarding Houston, we remain pleased with the quality and depth of the buyer pool and the cap rates we're achieving, which has ranged from a low 5% to a mid-6% depending on asset age and characteristics. Our Houston portfolio now consists exclusively of 100% class-A properties, with 95% of the square footage contained in one of our five master plan business parks spread across three sub markets.

For the remainder of 2016, I anticipate that the core Texas markets of Dallas, San Antonio and Austin will present growth opportunities while we continue to take a conservative approach to our Houston operations. Marshall?

Thanks, Brent. Given the intensely competitive and expensive acquisition market, we view our development program as an attractive risk-adjusted path to create value. We believe we effectively manage development risk as the majority of our developments are additional phases within an existing park. The average investment for one of our business distribution buildings is below $10 million. We develop in numerous states, cities, and sub markets, and finally, we target 150 basis point minimum projected investment return premium over market cap rates.

At June 30, the projected investment return of our development pipeline was 8%, whereas we estimate the market cap rate for completed properties to be in the low to mid 5%s. During second quarter we began construction on three projects, two in San Antonio and one in Orlando. These developments contain three buildings totaling 265,000 square feet, for a projected combined investment of $18.6 million.

Meanwhile, we transferred two properties totaling 132,000 square feet at 87% leased into the portfolio. At June 30, our development pipeline consists of 14 projects containing 1.9 million square feet, with projected costs of $133.6 million, and of that amount, we have already invested $81 million or roughly 61% of projected total investment. For 2016 we project development starts of approximately $90 million.

What is gratifying about these starts is we can reach this level with no Houston starts, whereas in 2012, for example, Houston accounted for almost 90% of our starts. This demonstrates the value of a diversified, fund-built market strategy.

As Brent discussed, with the industrial property sales market remaining strong we're actively reducing the size of our Houston portfolio and raising capital through the disposition of nonstrategic land parcels. Year-to-date we sold eight properties totaling 1.164 million square feet for proceeds of approximately $74 million. Four of these sales were in Houston which represented 906,000 square feet and $51.6 million in sales proceeds. Through June 30 we closed two land parcels generating $1.3 million. Since quarter-end we closed two more parcels for $2.6 million and we have two additional sales, one with funds at risk, in the pipeline. While these aren't material to our balance sheet, I love raising capital through the disposition of non-strategic, non-income producing land parcels.

The second quarter dispositions outside of Houston were 140,000 square foot condemnation of Interstate Commons by the Arizona DOT, our user sell of our 30,000 square foot Castilian Center, an R&D project in Santa Barbara, and Stemmons II, an older 26,000 square foot Dallas distribution building. Our asset recycling is an ongoing process. We are pleased with the year-to-date progress and are continually evaluating our options, especially further Houston sales. As we recycle capital and diversify, the portion of our NOI from Houston will continue to decline while the quality of our Houston portfolio continues to rise. We view dispositions as an attractive capital source to help fund the development pipeline.

Additionally, we are pleased with the match funding achieved within our 1031 tax gain deferrals. In fact, we successfully sheltered the gains generated by the $74 million-plus in dispositions year to date. And while most of our activity has been dispositions, we were pleased to acquire, for $32 million, the 446,000 square foot Park North development in Fort Worth. The four Park North buildings were completed earlier this year and are 37% leased. We are excited about the lease-up and long-term opportunities the asset presents.

By acquiring at this stage, we are able to generate returns which, while below full development yields, are materially above core stabilized acquisition yields. Keith will now review a variety of financial topics including our updated 2016 guidance.

Good morning. FFO per share for the quarter was $0.99 compared to $0.92 for the same quarter last year, an increase of 7.6%. Operations have benefited from an increase in property net operating income related to same properties, developments, acquisitions, lower interest rates, and a reduction in G&A costs. FFO per share for the six months was $1.90 as compared to $1.79 for last year, an increase of 6.1%. Debt to total market capitalization was 30% at June 30, 2016.

For the quarter, the interest and fixed charge coverage ratios rose to 4.5 times and debt to EBITDA was 5.8. The adjusted debt to adjusted EBITDA ratio declined to 5.4 for the quarter. Floating-rate bank debt amounted to only 1.1% of total market capitalization at quarter end.

During the second quarter we took advantage of market conditions to provide for our capital needs and strengthen our balance sheet. We closed the previously announced $65 million unsecured term loan on April 1, 2016. In June, we executed a commitment letter for a $40 million unsecured term loan. The five-year term has an effective fixed interest rate of 2.335%. Also, we sold $30 million of common stock under our continuous equity program.

For the remainder of 2016 we are projecting no additional debt or sales of common stock. We do have two mortgages coming due in the second half of the year. We plan to pay off a $25 million mortgage on August 5, 2016 and a $52 million mortgage on September 6, 2016. In June we paid our 146th consecutive quarterly cash distribution to common stockholders. This dividend of $0.60 per share equates to an annualized dividend of $2.40 per share. Our FFO payout ratio was 61% for the quarter and rental income from properties amounts to almost all of our revenues, so our dividend is 100% covered by property net operating income. We believe this revenue stream gives stability to the dividend.

Earnings per share for 2016 is estimated to be in the range of $2.90 to $2.98. FFO guidance for 2016 has been narrowed to a range of $3.96 to $4.04 per share, and the midpoint was increased from $3.99 to $4.00 per share. At the midpoint we are projecting a 9% increase in FFO per share compared to last year. Now Marshall will make some final comments.

Thanks, Keith. Industrial property fundamentals are solid and continue improving in the vast majority of our markets. Based on this strength, we continue investing in and diversifying our development pipeline. We remain committed to maintaining a strong healthy balance sheet and have taken a number of recent steps towards improving it. Maintaining our balance sheet is important not only on a day-to-day basis, but as a critical resource coming out of the next recession when opportunities are more plentiful. Please note we do not see signs of a downturn, but rather stay ready when there is one.

In sum, we like where we are, where our industrial markets are, what we're doing and the results it's created for our shareholders. We'll now open it up and take your questions.

(Operator Instructions)

We will take our first question from Alexander Goldfarb from Sandler O'Neill. Your line is open.

Hello. Good morning down there. Marshall, just some quick questions. First on the guidance.

Can you just walk through the drivers of the reduction in the same-store, how much of that was impacted by dispositions and then also on the lease term fees, how much of that was sort of unexpected changes in what you guys originally thought, maybe kind of decided to stay or not stay versus had an ability to pay, versus no longer have an ability to pay the term fees.

Sure. A couple of questions I'll reverse, or -- maybe on the lease term fees, usually what happens is a tenant will tell us they would like to leave and we'll start marketing their space. So one of the ones -- we have had two main drivers this quarter, one happened in one of Brent's properties in Houston, the tenant terminated early. That was a payment and not unexpected.

Then in Florida we had a tenant who had approached us, we were able to locate another -- a new tenant for the space. That one we didn't -- you don't budget for until you really have the deal with the next tenant, but we were able to negotiate a nice buyout with the tenant and immediately backfill the space at a higher rent in that case. So that was really where the majority of the pickup was on that.

On the same-store NOI there were a couple of drivers. As you said we have more dispositions, we raised our disposition guidance $20 million and we've sold 1.1 million, over 1.1 million square feet year to date, so obviously the portfolio mix affects our same-store NOI.

And then another driver of that was simply we've tracked thankfully year to date a little ahead on a monthly basis where we thought our occupancy was budgeted to be, and remind people, these are our projections, we are projecting a little more vacancy that we make up towards the end of the year. So there is a little bit of a lag the next couple of three months.

As Brent mentioned we have a lot of leases rolling in Houston and some known move-outs there. Probably that combination were the biggest drivers of our same-store NOI. We typically focus on a GAAP basis, so on a GAAP we are down 10 basis points. That's a lease here or there on our projections, and we hope trends hold up and we do a little better than we are projecting right now and that's our task between now and December 31.

Okay, and you guys increased the disposition goals, so now $110 million. Is the revised same-store guidance reflect the planned $110 million or are we going to see further adjustments to same-store as you guys achieve your goal of $110 million of sales this year?

Good question. The $110 million reflects -- the same-store guidance reflects $110 million of dispositions. As we talked as the year has played out we started at $85 million so we're up $25 million on our dispositions year to date. Guidance today reflects $110 million. We like where cap rates are holding in there.

Our fear early in the year was always that the private market got as nervous about Houston as the public market was, so it's probably 50-50. There's a chance we could break the $110 million and if we do, that's not in our same-store numbers. But we think we are taking the right steps to exit older assets in Houston and cap rates are at historic highs -- or historic lows, high pricing.

Just to be clear, the original same-store guidance that you provided, did that factor the old $90 million of dispositions or it did not?

Yes, originally we were projecting $90 million in dispositions, so obviously as we bumped it to -- well, maybe not obviously -- obviously as we bumped it to $110 million we took other assets out of our same-store pool.

Okay, the final question. Brent, in Houston, as things have calmed down a bit -- or maybe they haven't, but it seems based on the stock's performance that they have -- are you thinking differently about development in Houston, or should we read your sort of retrench comment that you're just going to focus on operating in those five parks but not looking for any new investments?

Yes, I would say, yes, that is the feeling that things seem to have flattened out, or bottomed out in moving sideways which is good. You don't feel like there is still overly downward movement in the market, or at least the sentiment is getting slightly more positive. Not nearly to the point though I don't think for development for us.

There is a little bit of spec development still occurring around the city. It is primarily though out on the East side with all the port-related and petrochemical-driven type properties, and in southwest Houston there's been some new projects.

A lot of our land inventory, for example, in Houston is up north, and that is the one submarket that did get the softest because it fell victim to its own desirability, it's where most of the development was happening so when the music slowed down there was a little more vacancy there. We keep an eye on it and looking at numbers we're chasing build-to-suits and would certainly do a build-to-suit given the opportunity, but on a spec basis we are not projecting anything this year, and we will just see when it comes to next year.

Okay. Thank you.

Thank you.

Will take our next question from Jamie Feldman Bank of America. Your line is open.

Thank you. Two questions on the guidance, I think you took up your bad debt expense and land sale gains, so can you maybe talk about the changes there and the impact on earnings? And then I guess for the bad debt, where is that and is that a sign of anything where we are in the cycle?

Sure. Hey, Jamie. Good morning. It is Marshall. On bad debts, we have budgeted $280,000 per quarter, so we have maintained that for the balance of the year. No known bad debt. It was really in second quarter we got ahead of what we budgeted, it's up $54,000 for the year based really on what happened in second quarter and what happened there we had our first bankruptcy for the year in Houston and really only second, thankfully, since the downturn.

Then we had some bad debt in Los Angeles. We had a tenant go bankrupt and one that is in arrears that we are still hopeful will catch up and collect there. Nothing systemic so much as three tenants affected that. The second part of your question, in terms of guidance, go ahead Keith.

$280,000 each quarter.

And the land sales. That was your other -- I'm sorry -- your other question.

Land sales were $0.02 per share that we projected

An incremental $0.02 from the last guidance?

Yes, roughly. Those are hard to project, really, until you get funds at risk, you never know what someone's planning to do. One has been a retail site in Orlando and then we've had two smaller parcels up at World Houston, one closed where it will be a hotel development.

Okay. And then I guess going back to the bad debt, has your watch list changed? It sounds like Houston is just starting to happen, or maybe that was just a one-off event, but as you look forward do you think you will see more of this?

It is hard to predict. I don't think our watch list has changed. We really took it -- the reserve early in the year to be conservative and hope, best case we don't need it and so we've still got $560,000 in margin there. I would say particularly in Houston -- or Brent, chime in -- as this old drag lasts you hope people's balance sheets are strong enough, and so you always hear rumblings. Houston is a market we are concerned about, but I would also say if you look, to date to only have two bankruptcies in 20 months since the oil and gas downturn, I am pleasantly surprised we have only had two bankruptcies.

Okay. And then thinking about your expirations, it looks like on your top tenants list you have a couple in the third quarter of 2016 and then a big one with Kuehne and Nagel in 2017 in Houston. Any early thoughts there?

I will jump in on the Kuehne and Nagel next year in Houston. They are a good customer of ours. They are in two different locations and we are in discussions with them. As you might expect this far out, they are weighing what their business looks like and what they think their needs will be. We always have close communication with them, but at this point nothing one way or the other.

The other two maybe you're looking at, we have Mattress Firm --

Yes, Mattress Firm.

They were not -- that is an interesting, maybe, trend. I'll take you slightly off-topic. They were not a top tenant several years ago, but as their retail model shifts, and we've seen with other tenants where smaller retail footprint but use our type building for that last mile of distribution, and so we have them in a number of markets, we really have renewal proposals.

Jacksonville should have them renewed there and a proposal out in Fort Myers where we are looking at breaking ground for another project in Fort Myers, so they will either renew or we are hopeful they may anchor our new project. They could use some expansion space in Fort Myers. We feel pretty good about both of the Mattress Firm renewals, that we will hang onto those two spaces.

Great. Thank you.

Sure.

We will go now to Manny Korchman from Citi. Your line is now open.

Hey, good morning, guys. Maybe given the volatility of the scene in rent spreads or cash rent spreads at least, can you give us what you think the outlook is for the rest of the year for cash re-leasing spreads?

Sure, Manny. I guess I would back up and maybe overview say, we had on a GAAP basis, five quarters in a row of double-digit growth. We dropped down this quarter, I think that trend is still there although I will say -- as we would say, mention in my remarks where in Santa Barbara we can have a lease or two that will throw us off that trend line, and this time it was really three main leases that drove it, if it's helpful.

We had a R&D, as is, meaning no TI renewal in Santa Barbara, so 82,000 square feet for us is a large tenant. Our average is 25,000 square feet and on a net basis we went from in the 20s down to the high teens. That is a big swing on a cash basis for us on a tenant. Again, there I think we did the right thing not offering -- they didn't meet the tenant improvements and we didn't offer it, so that was reflected on our cash renewal.

And then there were two leases in Florida. One in Tampa, where it was a build-to-suit for a manufacturing tenant that moved out and we had amortized some of the TI in and had rent bumps, so when they vacated it went from a manufacturing building to a more typical distribution building, and that was a roll down on a new lease and then had -- I am walking through the granular, I apologize -- but then a renewal and expansion in South Florida where we had done a good job on our last lease, and with the bumps when the lease expired the renewal was a slight negative and on the expansion space, similar to Tampa, it was an aerospace manufacturing space they expanded into, but we got a new seven-year lease in place.

So, three leases really drove down our re-leasing spreads this quarter. I would say if it's helpful to the listeners, we don't think three trees make a forest, and with a company our size we can get anomalies in our reporting. I'll still full comfortable that the double-digit type GAAP releasing spreads are the trend, although I am aware of a lease or two that we've got in the pipeline between now and year-end where Houston, I would say, is a market where cash and GAAP are down in the single digits, so I hope we are planning to lease space in Houston.

So those will have some negative effects and then there's one I'm thinking of, we have a large renewal that we've worked out within our portfolio. It's not signed so it may not -- you never know until it's signed, but that will be positive GAAP, negative cash. This isn't the only anomaly quarter, but I will stick by the trends if that's helpful.

We're not concerned about the market or the state of the market. It's really a case-by-case, and in any quarter we can get an odd mix. Unfortunately this was one of those quarters.

Great. If we think about the Parc North acquisition, what's your sort of expected stabilized yield there and also coming-in yields?

This is Brent. Parc North we are excited about. We bought that project 37% leased, four buildings, it's a submarket that we've looked at for well over a year now, and we kept driving around figuring out what we wanted to do and we kept saying we wanted to do this. So we finally approached the merchant developer and bought it.

Upon 100% stabilization it's a mid 6%, so at 95% it's a low 6%. In the open market if it were stabilized we think it would trade at a low 5%.

We think it's a way to create value beyond just a straight-up acquisition were you are buying at a 5% cap. So we were willing to take on the leasing risk, stabilize it, then we've got equity built in day one and a great asset where we want to be. There is an adjacent 15 acres that we have under contract that we are in our inspection period, so if everything checks out there it also gives us the ability to add a couple of buildings in the future. We are really excited about the acquisition.

If we look at the brokerage reports there, it looks like the vacancy in the North Fort Worth market is pretty high compared to markets around it. How do you get comfortable with the leasing risk in this asset?

Brent, chime in. I think North Fort Worth you have Alliance, is really where they have their space. It's about 12 miles north of our project. We are really -- what I like about this one, we are at the intersection of two freeways where we are at the southeast corner of I-35 and the 820 Loop, so we have great visibility, great access, and where I was going with -- Hillwood, which is up north, probably their smallest building they develop is 500,000 square feet.

It is the big-box, million square foot Amazon-type warehouses, and they may build a smaller building really for a supplier or related entity to that. There is vacancy there and it will probably bounce around north just given the size of the buildings they build.

I would add to that the North Fort Worth submarket, 7.9% the overall market, 6.2% which is a record low for Dallas Metro area, by the way, but that little bit of higher vacancy that Marshall alluded to is driven by major, big-box distribution centers primarily being built by Heinz there. Our multi-tenant like Parc North is a lot less percentage of that, and is an underserved portion of that submarket. So we feel like we're going to fit in real well.

All right, thanks, guys.

Sure.

Thank you. Take our next question from Eric Frankel with Green Street Advisors. Your line is open.

Thank you. The question on the dispositions, can you comment on what the overall occupancy rate was for all your dispositions and a rough cap rate, if that's relevant given the occupancy rate?

Sure, I'll take the first part. Good morning. They were all full, so that is part of what we talk about what has impacted this year as we've moved our disposition guidance out. They were all 100 -- you know, we purposely picked 100% leased buildings to maximize the value as we exited those assets.

In terms of cap rates, the range is probably from the low 5% to the highest would be approaching probably about, northwest was our first disposition this year which included some service center buildings and a 30-year-old project on the northwest side of Houston was about 6.5% cap.

That includes the Phoenix building with the combination?

Yes. The way we looked at it was -- that was an atypical disposition, and the state had started the condemnation process. So the state pays rent until they close on the condemnation so every tenant but one had vacated. And the way we started kind of underwriting it was if we aren't able to reach an agreement with the state, and we were acquiring this building, the cost it would take to re-tenant, re-tenant improvement and release that space, plus we had stopped putting money into the project, so because we though the state was taking it. If you underwrote it that way, it was about a 5% cap or slightly below a 5% cap sale. I think if we went back to where it started, it still was a sub 6% cap rate.

Okay. That's helpful. Can you comment on the disposition guidance? Where are the additional properties you intend to sell? Did that occur -- already occur for this quarter or is it something you are adding to your plate towards the end of the year?

It has not happened yet. We've added to our plate, and we still like the ability to reduce our Houston exposure so we're still eyeing a couple of Houston assets between now and year end.

Okay. I'll queue back in. Thank you.

Okay.

Thank you. We'll go down to John Guinee with Stifel. Your line is open.

Thank you. Decent quarter, guys. One thing you mentioned is that you were able to achieve an 8% yield on cost and it was a 250, 275 basis point spread on for-value creation, is that 8% yield on cost attainable at fair market rent for the land or your basis for the land? Because 8% is a pretty big number in this day and age.

Thanks. I guess I will take it. I will choose to take it as a compliment, and we agree. 8% is, we've said -- going forward it's hard to maintain 8% yields on our development pipeline, and we have a good spread. It is underwritten using our cost. We don't mark land to fair market value. It's based on what we purchased it as we put it into production. So it's historic cost and current construction costs, and current rents to get to that 8%.

Got you, and then obviously lease-up for your development pipe, plus under construction is maybe 35% or so. Can you kind of talk through how you decide to start a building? When you are deciding to start a building, are you pretty sure from talking to your tenant reps out there in the marketplace that there is someone who will be in the market to sell it at that time? Is this very much a bottom-up, there is an existing tenant in your space or an existing tenant nearby who you are pretty sure is going to take it eventually?

Great question, and it's really driven in the field which I like, rather than out of corporate. Most of our developments are additional phases within in a park, and we've used kind of the description to investors, think of us as a homebuilder, as a subdivision, as one or two homes are sold and one is under contract we will break ground on the next one. So it really bubbles up, and based on the leasing velocity of the last building we built, and sometimes we have prospects in hand or proposals outstanding, as that building starts to fill we will go ahead and have permits and we'll break ground on that next building.

So that is really where we believe we are managing risk rather than building -- again, a lot of different ways to do it -- but building a large building on the outskirts of town, we like making smaller bets on infill sites, and really we can deliver in five to six months, and if the last building worked well we'll build another one. That has served us well in Houston and markets when we cut the spigot off, we can cut it off pretty quickly and keep moving pretty quickly. Brent, you are living it day-to-day.

I would just say John, as an anecdotal example, to that our Eisenhauer Point 1 and 2, you see it is still under construction and we have moved up to 74% leased. We have had really good activity there. We moved out very quickly with Eisenhauer Point 3 and 4. Eisenhauer Point 3 is a front park, rear-load multi-tenant building, Eisenhauer Point 4 is a front load building, so those two buildings cater to different tenant types. Just based on that direct feedback at 1 and 2, we were comfortable moving forward.

Another example is Parkview has moved up to 82% leased, Creekview which is basically that same submarket, we moved forward with it. Even before we began to scrape ground there we signed a lease that moved us from 0% to 18%. Yes, as we go into these multiple phases of development, you are looking at the macro but then we are drilling down ultimately to what are the proposals we are putting out. When we move forward we have obviously a high degree of confidence when we do that.

I'll add, if it helps people, kind with that velocity of what we are feeling in the market is you see us, like this year, we bought additional land in San Antonio and at Eisenhauer, Brent was doing well. We'll start looking for contiguous land, and we have done a nice job of that at World Houston, where it was multiple parcels and then Charlotte, John Coleman, it was eight different sellers to acquire 50 acres earlier this year that we were quickly running through our land at Steele Creek, and thought what is available that is contiguous? And find ways to keep expanding the subdivision.

Great, thank you.

Thank you. Will move now to Blaine Hecht from Wells Fargo. Your line is open.

Thanks, good morning. Just a follow-up on Jamie's earlier question, maybe for Marshall and Brent. Despite the occupancy decline you saw in Houston, it looked like you guys might have had decent retention on your expirations during the quarter. Can you talk about whether that was expected this quarter.

Then obviously you guys have some move-outs coming up, but what are your retention expectations for the remainder of 2016. And maybe how do you feel about 2017 retention, if you can comment on that?

Okay. See if I can get all that there. The second quarter, you are right, it was higher, and that went about the way we expected. We have known, because of the advanced notice at third quarter, we had two or three particular known vacates that are coming and so the retention rate, we only have 5.8% remaining for the year in terms of rollover. Over 4% of that is in third quarter. By the time we get the fourth quarter I think we have a little over 1% left.

The rest of this is going to happen third quarter, and the retention is going to be low just because, again, driven by specifically two known vacates that will be forthcoming. I just want to point out we've had some vacancy coming our way, but we have continued to sign leases year-to-date, or as of like today we signed 604,000 square feet of leases, and of that amount was 450,000 square feet of new leases meaning it filled either a vacancy or a development space, so meaning it's going to begin to produce income on a space that wasn't.

So, we are getting space coming back to us. We are working our way through it as we have been saying since the original guidance back in February, we knew all this was coming and very pleased so far. I will say that in the third quarter with some of the transactions were doing and Marshall alluded to it, for various reasons the rent comps will probably show some downward pressure, but net-net, we are pushing to get the vacancy taken care of and get our occupancy back in that range, plus were selling these 100% leased assets so that's pushing the occupancy a bit too.

Okay, and any sense at this point on how you think retention might trend in 2017?

I really don't. There is one particular large tenant that we are talking to about a potential build-to-suit, but it is so early in you don't know what is going to happen with them. At 17% it will be, and you can see the years after that it drops down quite a bit. We're going to have, from now through 2017 we're going to have some leasing to get done in Houston, but no early good or bad news in 2017.

Okay, and there was a pretty significant decrease in the Houston expiration schedule for 2020. Was that related to the dispositions you had in the quarter, or were there any move-outs that might've changed those numbers?

There was no move out that changed that number. I would look back. I think, you'll notice our sales caused two of our top five on the Houston summary page, our sales caused two tenants to drop off and it was just because of the sale, not because they had left us. I'm just looking now, and one of those, that is what I thought, Palmer Logistics which was 238,000 feet, they were a 2020 expiration. They were in Lockwood, so that went down because we sold those tenants with that property.

Okay, that's helpful. Lastly, in addition to the building sales you are doing in Houston, looks like you are also making a little bit of a push to sell land. Can you give us any color on changes in land prices in that market and maybe how you think current pricing compares to your basis in the roughly 100 acres you own?

Sure. Land prices are -- Mitchell, one of your peers earlier, asked us about development yields. Land prices are maybe surprisingly sticky. With Houston's disruption in oil and gas, land prices have not moved much. We think we've got good basis in our Houston land, and would probably be hard to replace today. What we have sold has been really land we picked up in bigger acquisitions in terms of parcels and really trending here and there.

It started earlier in the year, we didn't like where our stock price was, we wanted to help keep funding the development pipeline, so we took a hard look at what non-earning assets can we shift on our balance sheet, and I'm happy, proud of the team for the results we've gotten. It hasn't been huge dollars, but say we get $6 million or $7 million by the end of the year, that is the equity for one of our developments in our pipeline. So that is what it looked like. I'd say land prices probably are rising across our portfolio and are flat in Houston.

I just want to point out too, to everyone that the two land sales in World Houston are smaller parcels that we bought as part of a larger land transaction many years ago, I think even over 10 years ago. We've increased our position there with the golf course expansion, and over time we've just evaluated that these wouldn't in the near-term or even long-term industrial sites. They had a higher and better use, so in both cases with the World Houston land sites we're selling to hotel developers, so we are recording great games on very small land transactions, which we are very pleased with.

We're not selling what I would say industrial sites, they are sites that are going to be used for something different. And then the one site we sold in Flower Mound was just an offshoot from the main parcel we had bought where we built Parkview, and we sold that at about a breakeven which reflected market. We had not held that track of land very long so we were just moving that, bring the cash in and put it somewhere else.

Interesting. Thanks, guys.

Thank you. Will take a follow-up from Eric Frankel of Green Street Advisors. Your line is open.

Thank you. Brent, can you comment on the supply picture in Houston in a little bit more detail? I think we heard from prolaw just last quarter there is a large amount of supply generally in the market. Obviously a lot of that is built-to-suit or its a combination of build-to-suit and all the inventory being built in Eastside. But how much of it is deemed built in close proximity to your portfolio?

I'm not sure, I would not agree with the sentiment that the market is over built when you have a 5% vacancy factor and only 0.5% of spec space in the development pipeline, the two combined are 5.5%. That just doesn't strike me as over built at all.

The north submarket has the softest vacancy rate. Again, as I mentioned earlier, that's where the last cycle, for all intents and purposes spec development on any large scale has ceased. There is just say two million square feet of projects.

It is more of a demand issue, just slow demands versus overzealous developers. The north probably has more heavy lifting to do than the other submarkets, but it does not strike me as over built at all. We'd like to see demand pick up a little bit more. You would like to see companies moving into the market that are new companies, which we were seeing before. Those things would be better drivers then even if you cut off the spigot on the two million feet that are going now it's not very large in scale to the market.

Right, but where is that two million square feet of spec located?

It is spread out across several submarkets, which dilutes it even further. You have southwest, two or three developers over there, you've got some projects going out on the east side near the port. The only thing going up north, there is a developer that has a parcel they are building a 500,000 square foot spec building, which is a very big bet. So that pretty much represents the spec development in the north submarket in that one building, and that is certainly not something we compete with.

Okay. Thanks for the additional color. Marshall, can you comment on just additional development projects in other markets? Maybe I think Brent commented pretty thoroughly about what they are hoping to do in Dallas and San Antonio and Austin, but maybe the prospect of doing more developments in additional markets would be helpful to understand.

Sure. We are actively developing in Tampa, which is a market we have seen kind of pick up the last 12 months, probably. We are certainly active in Orlando, and if John Coleman and the team there would tell you, Florida is stronger today than it's been at any point since the downturn.

We are looking to break ground in Fort Myers, which would be the first spec development down there. We are full, we have seen rents rise from around $4 a foot to $7 a foot. I was in Fort Myers recently, and the only development that has been there has been build-to-suit because there has been no spec developers. That is maybe an atypical case for us. It is within our park, but it would be starting back up again.

So we're optimistic about Fort Myers doing well, and Tampa doing well and Charlotte as well is another market, with our Steele Creel. We think will be ground there, knock on wood, between now and year end. That is dialed in there. We have some good activity lead with a build-to-suit and out in Arizona, that we need to get the lease signed, but that is hopefully something we could -- our goal would be if we can talk about that next quarter.

That's helpful. Two final questions. Apologies for the long list, but can you just talk about, I know we've discussed in the past several years is hard to track how market rents have trended or grown, but do you have a sense of year to date whether market rents in your respective portfolios or respective markets, have they grown more, has the prospect of some new supply tempered that in any shape or form?

I think outside of Houston, so I said painting with the roller brush, they are off this year. I hate to be specific, but it feels like rents are growing and demand is rising faster than supply for our type product. The exception, which is again what helps -- we like about reducing our footprint -- because every market will cycle. Houston is cycling down, so that one is down single digits. Probably people expected worse than that a year ago or 18 months ago, and otherwise they continue to rise.

It's always a little bit space by space, and where does that tenant roll, and that is what hit us this quarter. Not really anything systemic, but it does feel like we think that trend of double-digit GAAP releasing spreads, I think our chart will look similar in the next year to what it looked like over the past year, which is double digits.

Okay. Final question is actually for Keith. I was hoping you comment on the debt capital markets.

We certainly noticed with the equity issues and some of dispositions that your leverage, the balance sheet leverage has decreased, but can you talk about term of debt? Obviously some of the debt you procured this quarter was five to seven years and I was wondering, are tenure terms doable, and can you tap the unsecured market to accomplish that?

We have good quotes on 10-year, 7-year, and 5-year. The way we look at it is, get a 10-year quote and then get the 5-year quote and after the 5-year rate is up, what do you have to get the remaining 5-year to equal that 10-year rate? It was still a pretty good gap between the 5 and the 10 where we thought that the 5-year was the best rate.

Okay. That's all I've got. Thank you very much.

Sure.

We'll move now to Brad Burke from Goldman Sachs. Your line is open.

Hey, guys. Just a couple of questions on capital allocation. First, the thoughts on pulling back with incremental ATM issuance for the remainder of the year, considering where the shares are at.

Then second, Keith, we appreciate the comments on the debt capital markets but how you're thinking about total leverage. I know you indicated you were going to get down below 6x by the end of the year. I guess I didn't expect you to get there by the second quarter, and it looks like you are going to be a net debt reducer for the balance of the year. So just once you get through that, how you are thinking about the appropriate level of leverage?

With leverage, I guess we are down some of the best debt metrics that we've ever had, and so things are looking good. Then we've got multiple ways we can increase capital for either issuing stock, and as things get better and we will continue to look at opportunities and see where we are, but we are in pretty good shape right now.

I guess with the share prices where they are at, and also having what looks like ample capacity to layer in some of the additional debt, can you help us think about how you would think about incremental capital between equity and debt?

Sure. I will take a little bit of a stab, and Keith, chime in. We assume no new equity in our assumptions for the balance of the year, and it really will be driven by acquisitions. It is awfully tough, we are mindful of what year in this cycle we are and we're mindful of, as the brokers would call it, the wall of capital.

We've bid on the number of acquisitions and really have had a poor batting average. So we like that we have a stock price that gives us the availability to issue equity and make acquisitions. It's easy to spend money, its hard to find value. We're going to keep looking for value and if we find that we might issue equity. We are thankful that the equity and the debt markets are available. But based on what we see, and the best news is we think we can keep funding our development pipeline at the pace it's running without needing to go for external sources of capital.

I appreciate the comments.

Thank you, we'll go now to Craig Mailman with KeyBanc Capital. Your line is now open.

Hey, guys. Most of my questions have been answered here, but just curious on your thoughts on how far you think you want to push Houston exposure down from current levels?

Sure. We are around 18.5%, our thinking without a specific number, we have still earmarked another Houston asset or two that we would like to exit kind of the next six to nine months, so that will push us further down. We have hesitated on saying a number, as Brent mentioned. We've got land in Houston, land at World Houston. If we can find the right build-to-suit opportunity and the right yield, we would build -- and their credits there, and term -- we would build today. That has made us a little bit hesitant.

The other thing, we really like our Houston team. They have done a nice job creating value over time, so in backing down we realize when Houston stabilizes, don't be surprised, or I hope you see us announce a land acquisition.

Again, this is down the road, but we've acquired 50 acres for the next part Brent and his team dream up for us to build. So we like having that runway for when there is an inflection point in the market. At 18.5%, it feels like we're not quite there, and so we'll keep backing down a little bit in Houston and more importantly growing elsewhere, but we would like to have that runway when the market allows us to create more value there.

That's helpful. I guess without trying to pin you down exact numbers, you guys, got caught a little over-exposed in Houston on this down cycle. As you think about going forward and just risk mitigation and asset allocation to different markets, how comfortable, or what comfort level are you with having your top market be x percent higher than the next biggest market in terms of just trying to spread things out a little bit more evenly?

Good question. We have kind of looked at not so much in relation to the number two market, but it is a topic of conversation and something that we discuss with our Board being how large, how comfortable are you seeing any one market be? That is probably reflective of what you are seeing in Houston today. I would say 20% is really a lot in any one market, because every market has its day, type thing. If you could switch it from Houston to San Francisco to Orlando and 20% is a lot in any one market because they'll all roll.

And then we do talk too, there are certain markets that kind of trend in pairs. San Francisco and Austin are those driven a lot by technology. Dallas and Charlotte are kind of Fortune 100, Fortune 1000-type markets, so there are markets where we think there is a higher level of correlation and we think about that, but we have really thought more about what is our ceiling, which is probably in the higher teens on our largest markets and something we talk about with our Board, and we kind of hit the warning track I would call it, is what we'd like to do on a go forward basis.

Great. Thank you.

Sure.

Thank you. We'll move next to Ki Bin Kim with SunTrust. Your line is open.

Just one quick follow-up. When you look at the tenant roll in Houston for the next year, any pockets of weakness that you can see already?

As I have mentioned earlier Ki Bin at this point, we are in dialogue with a couple of the larger rollovers, but nothing good, bad or indifferent really to report. The 17% figure is certainly, that's not really above average, but it is a full number for any given year. We've got some leasing work to do be it renewal or leasing vacant space, so our team is on it and focused, but really no specific news one way or the other to give you at this moment.

Okay. Thank you.

Thank you.

Thank you. We'll take our final question from Casey Martin with CenterPoint Properties. Your line is open.

Thanks for taking my call. Most of my questions have been answered, specifically on the San Antonio development pipeline. Just a follow-up question maybe on the acquisition piece. Maybe, you said you guys have been striking out a little, or have low batting average. Where are you guys looking and then maybe where do you see the last $15 million that you're projecting for 2016 coming from? And what markets?

Sure. We're looking within our existing markets, for the most part. Sunbelt markets, I think all of them have been in existing markets. Really just it's what bubbles up through the, I call it the CBRE, Cushman & Wakefield, typically someone has a listing.

We called on assets that weren't actively being marketed to find them and that's really -- especially once an asset gets listed -- I just talked to the CBRE, and I know Brent talks to them regularly, but our dispositions national guys and what they have seen this year is cap rates continuing to come down across the country, and really even spread to, it was the top five markets where cap rates were falling, now it is within the top 15 as capital is having a hard time being placed.

We've got $25 million, which we started the year with $50 million in acquisitions projected. We lowered it to $25 million again, mindful of where we are in the cycle and how competitive that world is. And our goal would be to place that between now and year end and most likely within one of our existing Sunbelt markets. Never say never, but it will probably be in a Texas, a Florida, a California market.

Okay. Thanks, guys. I appreciate it.

We have no further questions at this time. I would like to turn the call back to our presenters for any closing remarks today.

I appreciate your interest again in EastGroup. Thank you for your time and please feel free to call any of us post call if you have any questions. Thank you.

This does conclude today's program. Thank you for your participation.