First Industrial Realty Trust Inc (FR) 2003 Q2 法說會逐字稿

Good morning ladies and gentlemen and welcome to the First Industrial Realty Trust Second Quarter 2003 Results Conference Call. At this time all participants have been placed on listen-only mode, and the floor will be open for your questions following the presentation. It is now my pleasure to turn the floor over to First Industrial. You may begin.

Good morning everyone, and thank you for joining us today. Before we review the quarter, let me remind you that this conference call contains forward-looking information about First Industrial. A number of factors could cause the Company's actual results to differ materially from those anticipated, including changes in economic conditions generally in the real estate markets specifically. Legislative and regulatory changes including changes to laws governing the taxation of real estate investment trusts, availability of financing, interest rate levels, competition, supply and demand for industrial properties in the company's current and proposed market areas, potential environmental liabilities, slippage in development or lease of schedules, tenant credit risks, higher-than-expected costs and changes in general accounting principles, policies and guidelines applicable to real estate investment trusts. For further information on these and other factors that could impact the company and the statements contained herein, reference should be made to the company's filings with the Securities and Exchange Commission. I will now turn the call over to Michael Brennan, President, and CEO. Mike?

Thank you Mike, and welcome everybody to our second quarter earnings conference call. I'd like to, before we begin, introduce the members of management that are here with me today. Johannson Yap, Our Chief Investment Officer; and Michael Havala, our Chief Financial Officer; and you just heard from Michael Damone, Director Of Investor Relations. Today I am going to start the discussion with an overview of our strategy, and then follow-up with the discussion of our operating environment result. Jojo, will follow with the discussion of our portfolio performance and investment performance, and Mike will finish up with the discussion of our balance sheet, capital market's activity, and the details of our guidance for 2003. On June 2, we, as many of you know we were in New York, and we gave our annual analyst and investor day, and one of the things that we thought was very important was to ground everybody again in, why we have the strategy that we do, and the way we did that was to first discuss what are the industrial - industry characteristics, And I would like to repeat those again, because they are very significant for the formulation and execution of our strategy. And we identified three important things. Number one was the big and large size of our industry, 26b square feet in the continental United States. Number two is the unique ownership characteristics of the industrial market place, in which corporations own 65% of all the industrial properties, private investors own 30%, REITs only owning 3% and pension funds owning 2%. And the last characteristic of the industrial marketplace was characterized by low rent growth, about 3% over the last 20 years. And so, these characteristics have strategic implications for us and again they set the - they set really the direction for our strategy. With respect to the strategic implications of size, it's very important that we set a national network up to catch the large net to give us as many opportunities as we see that mere investment criteria. Our size obviously results from [Inaudible] so that we could reduce dependency and risk on any one region and size meant for us, based on the way we operate our business that there was no need for us to take international risk, we do not think in our model, the risk award is compelling for us.

The strategic implications of market ownership meant that if we were going to penetrate as the largest owner of industrial properties be in Corporate America, we need a national organization with diverse capabilities to serve their needs. In order to compete against that owner that owns 30% of the market, a private investor, we also needed to set up local market experts that were capable of competing, people that were experienced, incredible local market experts. With respect to the final strategic implications of the market economics of lower rent growth, for us it meant that value was going to be created on the front end and we couldn't count on inflation to make our investments better. It meant that the passive rent collector model probably was not going to optimize returns and we took very seriously the NCREIF index return which is the - the composite index of industrial returns that are owned mainly by pension funds, that had a 20-year return of 8.4%, significantly below what we think our cost of capital was in. So it meant for us that profit maximization required capital recycling and not an indiscriminate policy of just simply buying a holding. So therefore, we hold to our conviction that it's important for us to state a course with our mission, which is to be of course a national provider of diversified industrial facilities of serving the needs of Corporate America through our INDL platform. A couple of words about today's environment. Since we spoke with you in April, there has been modest improvements that are evident in the economy but obviously that movement up is small and that movement up is still gradual. Corporate America's capital spending is still constrained and capital spending for us is one of the main drivers of absorption. There still a significant over-capacity in the industry, plant utilization is about 74.8% and there's also over-capacity in our own industry in the form of 11.5% vacancy. Second characteristic of the market that still remains is the robust disposition activity. For low interest rates, although they have moved up a little bit, have kept above investor demand. There's still low default rate, so that's kept up vendor supply. So while it's a good market in which to sell things, it has made that a tough acquisition environment. So, when we talk about this, you probably sort of want to know, do we think this is a good thing or do we think is a bad thing. Well, clearly having a robust disposition market that we like, we like the fact that we are getting healthy prices of our properties that we are selling becomes problematic in investing those properties because you want to make down sure that you are not buying the same thing that you just sold.

So for us, the answer to that, in the third characteristics of today's environment is that, we are finding our opportunities in Corporate America. Corporate America is the big owner that's having the big problems today, whether it's sagging profits, or whether it's finding ways to fund, pension fund liabilities, or whether it's trying to find ways to improve their supply chain efficiency, or unwind out of synthetic leases, or reduce high leverage. Companies have one, or host of all those problems today and there are solutions inside their industrial real estate holdings that they have. So, this is where, we think the opportunities are, and this is where we are going to dedicate a significant portion of our energies as we already have. With that let me just lead in to the second quarter performance, and all aspects of the strategy that I have just mentioned and the environment which we operate in, the good and the challenging, were in full view in the second quarter. Let me go over a few specifics, with respect to our portfolio, the big question and then it was a fair one, was how we were going to do with our lease roll overs in '03. Well, I am pleased to state, as you can see it in the press release that we have done actually quite well and we fully expect our occupancy to be at or above 89%, the forecast that we gave to you about three months ago. On the acquisition side, what's apparent is that, what Roger will soon make apparent to you is that our two largest acquisitions that we did, are resultant corporations, supporting our view that the best opportunities are in serving the requirements of Corporate America and it also bolsters our confidence that we will continue to find value added opportunities in a tough acquisition market. On the disposition side, our track record of recycling capitals, add returns that are significantly above our cost of the capital, continues. This again was detailed in the press release. Our only disappointment was that one transaction did not close at the quarter, but that transaction is under agreement and it is scheduled to close in the third quarter. But despite that, our net economic gain activity in the second quarter was the second highest quarterly level that we have achieved thus far. So the economic gain number certainly didn't, although we expected more, it did not drop-off. On the development side, we had a good quarter in development but here two trends are apparent also. The first was delayed decision making but corporation, which led the slow release of our merchant project. The second trends that we are seeing is pan-up demand, where some corporations no longer able to delay; and so as a result of that during the quarter, we were awarded some new built-to-suits that again Roger will talk about, bringing the total number of built-to-suits under construction or in final documentation to 12 - to a total number of 12.

Last, I would like to end my comments by speaking to you about the safety of our dividend and I would like to just cover three points on that. Number one, at $3.35, which is the low end of our guidance, our FAD payout ratio is less than a 100%, and therefore it fully covers the dividend. Point number two is that, as we go in to 2004, as we round the corner, and if we hold everything constant, we assume that there is no deterioration in other aspects of our business, we would expect the dividend coverage to improve, solely as the result after moving almost all of our development gains from both our merchant pipeline and our built-to-suits from our '03 guidance, are now proposed in '04, and will now recognize those profits in '04. Last, the company has two significant growth drivers that should manifest themselves as the economy improves. The first is what we have referred to in the past is our low-income producing asset. At the end of the first quarter, we held over $300m in land, [Inaudible] cash and mortgages that were yielding in the aggregate about 2%. Our plan is to reduce this to no more than $150m and invest the difference in income-producing assets and Michael Havala will discuss the progress we've made on that in just a second. The second of course is our vacancy. For every 1% rise in our occupancy that's equal to $0.08 share. For seven years, we operated between 95% and 97%. So I have no doubt that will move our occupancy up as market conditions improve. And thus improving not only our dividend coverage but our overall valuation as well. And so with that, I would like to pass the discussion over to Daluga.

Thanks Mike. I'll first discuss the portfolio and then discuss our value equation result in the reinvestment activity. I'll then conclude with the discussion of our pipeline. Overall, we [Inaudible] in the markets in which we operate have stabilized. The two reasons for this are occupancy and leasing activity. As Mike has mentioned, our occupancy today is 87.4%, up slightly from the last quarter. Including the occupancy by Tyco of the former Amazon state, it's 88.4%. And it includes all our joint venture occupancies with 89.1%. By the way, the last method including joint ventures is the common way our peer group report their occupancies. In terms of leased activity in the second quarter, we leased 4.7m square feet across our whole portfolio including development. Year-to-date, we've released 10.4m square feet. The economic of such leasing activity however continue to be challenging. In most of our markets, both perspective and renewing tenants are seeking concession in the form of free rent and other concession. For the balance of the year, we currently anticipate that occupancy will remain stable just slightly increasing. Rental rates and renewals will be flat to 2% lower and manual rates of new leasing will be plus or minus 10% lower. Regarding CAPEX, we incurred $20m year-to-date. For the rest of the year, we expect that number to be in the $50m range. Our costs were higher in the first half than they will be in the second half for three reasons. First, we front-end loaded our [Inaudible] cost in Q2 to get both volume discount and seasonal discount. Second, Q2 cost included leasing cost incurred in connection with releasing the Amazon [Inaudible] Tyco. Third, in the second quarter, a higher amount of leasing was concentrated in smaller tenant, higher finished markets of Denver and Minneapolis. Going forward in the second half, CAPEX, which includes leasing cost will be similar to other recent quarters. Let me now give you some color on the major markets, in which we operate. [Inaudible] market occupancy is at 88.4%, down 20 basis points as well. Our occupancy is up 90 basis to 90.1.

Development activity in Chicago has started to slow but remains active in the Southwest suburbs namely the I-55 sub market. This sub market scaled the best, up until this year with net absorption turns slightly negative. The more stable sub market in Chicago are [Inaudible] , with all vacancies around 8%. The [Inaudible] market are up 83.8%, down 10 basis points versus our occupancy of 79.7%, which is up 280 basis or a 90.6% including the space that is leased to Tyco, which will take possession on August activities [Inaudible] in Northeast and South Atlanta sub market, as they had growth absorption of over 7m square feet. 44% of our Atlanta portfolio is located in this sub markets. The worst sub market in Atlanta is the I20 West Colton district. It a predominantly ware-off sub market, only 3.5% of our Atlanta portfolio is in the sub markets. We expect in general, the Atlanta market to remain soft although new construction is virtually coming to a halt. The Dallas-Fort Worth markets occupancy is at 86.2%, down 80 basis points versus our occupancy of 94%. We just obtained 380 basis points. Brookhollow and Forth Worth are the best performing markets, all with occupancies about 90%. In terms of lease activity, Northwest Dallas has started to see improvements. 30% of our Dallas portfolio is in the sub markets. Lets now turn into the Denver sub market. Occupancy is 87.5%, down 40 basis points versus our occupancy at 90%, which is up 340 basis points. The majority of leasing activity in the Denver markets in the Southwest area and the East I70 Montebello sub-markets. 25% of our Denver portfolio is located in these two sub markets. Moving on to New Jersey, the Middlesex Somerset sub market is the strongest in terms of tenant activity. 31% of our Northern New Jersey portfolio is in this sub market. Morris is our largest sub market with 43% of our Northern New Jersey portfolio. Tenant activity here is starting to pickup and we expect the sub market to improve in a faster rate than the Northern New Jersey market as a whole.

Lastly, in terms of our major markets, our occupancy in Los Angeles is 94.5% beating the market by a 100 basis point. LA County is clearly the best market in the country, showing both very strong construction and tenant activity. This market is going to continue to benefit from the International trade economy. That completes the portfolio sections, but before I move to re-investment activity, I want to comment briefly on sales. In the second quarter, we sold a total of $78.2m as of assets, achieving an un-leveraged IRR of 30%. That obviously continues to reflect a strong market. We see that market continuing to be strong, as private investors, users, and institutions remain active, due to an availability of capital, the desirability of Industrial product and investments, and continuing low interest rates. This is driving Cap rates to record lows in the 7.5%, to 8.5% Cap rate range. In terms of investment profits, our sales contributed $11.5m. Again as Mike has mentioned, this is the second highest quarterly economic gain in a company's history. We believe these results are a function of a number of things; our sound asset management plans we put in place for each of our assets, our expensive merchant development and re-development capabilities, and our broad reach of our IS corporate service program. I will now turn to our re-investment activity. While the overall re-investment market remains highly competitive, we manage the second quarter to the net investors acquiring a $110m of property, or $32m net of dispositions, while maintaining our selective investment criteria. As we said in investor day, we only focused on transactions that have favorable seller transaction and probably circumstances or FTPS because - because this is what leads us to profitable opportunities. Several transactions we closed in the second quarter highlights the benefit of focusing on opportunities, that had favorable [Inaudible] circumstances, transactional complexity, and property asset dues. For example, we closed on a 724,000 square foot portfolio, along with additional land in San Diego. In this transaction, Mitsui, a Japanese conglomerate, was disposing off assets nationally at a motivated seller, we saw a safe potential due to below market trends and additional leash of opportunities through more proactive management. We also saw the opportunity to sell single tenant buildings to users at a higher prices, and to sell the additional land pursued for builders' use. In fact, we already sold- 111,000 square foot building out of the portfolio in the same quarter at a 16% profit. In the Baltimore area we bought a 100% leased, 520,000 square foot portfolio in the active year ending quarter. As part of this transaction, we obtained at no additional cost, marketing license control of 600 acres purchase plan. The reason of seller grabbed these rights in control over to land was to benefit from our national infrastructure and corporate relationship. Of course this arrangement will also allow him to sell more quickly out of this land holdings. Underestimated arrangement towards what I have just described, we currently can sell ex-site totaling 550 acres across Baltimore, Chicago, Chile Pennsylvania, Indianapolis with Kansas. All of these sellers granted us the control for the same reasons I just stated.

In the Atlanta market, we purchased a 650,000 square foot building in a $60m sale lease-back transaction Whirlpool. Whirlpool an investment company, one to close by the end of the quarter, which acquired quick to [Inaudible] Whirlpool worked with us because of our understanding with the stock market and in our ability to gross quickly. In fact we closed within two weeks of the achieve at 10% cap rate that are very good basis. Under 25,000 square foot in a very functional building in a good market of Atlanta. In terms of other signed contractors, one that I wanted to mention, as the- another good example of FBP working on favor. The has evolved a company which look (Audio break) if they quickly sell members' property and all the transaction to raise capitals to fund identified investment including (Audio break) especially in multiple market. This only increases our competitive advantage in these types of transaction. We expect to achieve a stabilized deal in excess of 11% and IRR an excess of 13% on this $32.5 m investment. By the way this month in July, we closed up the first phase of this investments. And in summary, these are good examples of our INDR infrastructure and our transactional capabilities utilizing FBP can produce solid result. Moving on to the pipeline. With respect to our pipeline of properties that we expect to sell within the next 18 months, it currently stays at 689m, this is comprised of 383m of existing buildings that we own, on which 143m of merchant development 56m of redevelopment, $97m of build-to-suit in process are under final negotiation and $10m of land. I'll now give you some detail on business pipeline, which has never been larger. This just reflects our continuing expansion of relationships with Corporate America. We have two key developments. First a 92000 square foot facility for [Inaudible] corporation a gaming device company, German gaming device company with it's American headquarters at Phoenix and second under 124,000 square-foot, food processing facility in Chicago for Wendy Foods . Both projects are on budget and scheduled for completion in 2003. Among our on balance sheet built-to-suits, we are nearing completion on a 318000 square foot facility for Tractor Supply, one of the nations largest retail supplier of tractor and car parts .

This is our second transaction with Tractor supply. We've also commenced construction on a second high velocity distribution center for Ford Motor Company in Atlanta. Other examples of built-to-suits includes an 88,000 square-foot distribution building for Mary Kay Cosmetics in New Jersey and 144,000 square-foot corporate head quarters and warehouse discussed in Arizona for a private company engaged in a whole sale distribution of consumer and electronic accessories. We've also been awarded by Caterpillar logistics to build a 252,000 square-foot distribution center to serve their eastern seaboard operation. They chose [Inaudible] our site in the IIE 1 corridor as it's strategically located and provided and also provided them with expansion capability to, up to 450,000 square-feet in addition to the 252. We're also able to arrange for them very competitive municipal tax incentives on that site. In summary, in terms of our occupancy of all the development in process including signed leases, it stands at 59% today. So, in summary we believe our markets have stabilized and should remain stable for the balance of the year all though leasing activity just like we've mentioned will continue to see pressure in terms of economics. Our evacuation strategy continues to show results and we believe we will continue to generate profits for the company. While the reinvestment market remains competitive we continue to spread invest and select opportunities and maintain a pipeline of reinvestment prospects. In addition, we continue to search opportunities from Corporate America as it needs for Realty solutions all we increased it. Lastly our profit pipeline remains strong and is broad based, across development, redevelopment, corporate service activities in our existing portfolio. With that I'd like to turn the presentation to Michael Havala.

Well thanks, Jojo. I want to go through a couple of things with you here today. But first, I want to remind you about the strength of our balance sheet. As of June 30, our debt asset value is 42%. Our interest coverage for the second quarter was 2.6 times and our fixed charge coverage was 2.2 times. These are very solid ratios especially, considering this part of the business cycle that we're in now. Before we step to our debt, let me go through some qualitative features with you. First of all, we have one of the longest statutory schedules in the entire REIT industry at 11.1 years. Secondly, 100% of our permanent debt is fixed rate and then we have very little secured debt in fact 98% of our assets are unencumbered by mortgages. Next, let me talk about the capital market activities. In the second quarter, the first Kuwait Finance House fund required an additional $20m of properties bringing the total net fund to just over $230m, and remember this one is anticipated to grow to close to $300m. In the second quarter, as you previously saw, we announced a second fund with KFH, which is a net lease fund. The purpose of this net lease fund really is to help us serve our corporate customers better. We believe that good service is full service and this new fund allows us to do more business in the way of sale lease packs, etc with our corporate customers. And as you know, in the ordinary course in dealing with our growing list of corporate customers, we already see a large number of long-term net lease opportunities for industrial properties. Let me just clarify what will go into this fund. First of all, it is not assets of our balance sheet. What will go into this fund are newly created sale lease packs, and then existing net lease product that we see in the marketplace. And then with respect to this new fund, let me just conclude and talk about the economics. We anticipate that the fund will go up to 425m in total capitalization. We expect public capitalization, that will be about 70%, debt and then First Industrial will be 15% of the equity, [Inaudible] will be 85% of the equity and the remaining economic structure of this new fund should be and will be the same as the first fund with KFH.

Next let me talk about our guidance for 2003. As you saw earlier in July, we revised our guidance. We expect our GAAP EPS to be $2.15 to $2.35 and then we expect FFO per share to be $3.35 to $3.55. Let me talk about the assumptions that we changed in revising our guidance earlier in July and these changes by the way are all related to development. First of all, we reduced our 2003 expectations, total monetization of merchant development, which of course we think is prudent when you consider the tough leasing environment. And then secondly, we deferred the timing of the profit recognition for new build-to-suit activity. So simply said, in total, we pushed out the majority of the monetization of development into 2004 from 2003. Regarding the property sale volume, again I just want to clarify that we simply reduced our expectations of sales of development projects and we did not change our expectations of sales of existing properties. So our assumption for sales of existing properties remained unchanged. On an unrelated matter but still related to guidance, as you would have noticed, that we increased our booking assumptions to account for the higher accumulated depreciation on assets already sold in the second quarter as well as those expected to be sold in the remaining part of the year. And remember as we go into each year, we have identified the properties we expect to sell and while we are likely to sell the majority of these, certainly property circumstances may change and our population may change somewhat. Thus in projecting the accumulated depreciation on sales, which of course is needed to calculate the booking on sales for the EPS calculation, we tend to make conservative estimates. So, it's not uncommon for us to underestimate slow gains, and this is the sole reason we increased our EPS guidance for 2003. And then just to reemphasize, the volume of sales of existing assets was not changed. With respect to our 2004 guidance, we will provide this on our next quarterly call in October. And the last thing I wanted to talk about was two significant opportunities that we have and Mike Brennan mentioned to us earlier and these two significant opportunities can result in as much as $45m increase in annual.

Let me talk about the first of these two opportunities. As we laid out in our Investor Day in New York on June 2, we have assets on our balance sheet which are earning a below normalized return, and we refer to these as low income producing assets. Specifically, these are cash, which includes 1031accounts, land, construction in progress and then mortgage notes receivable. And at June 30, in total, we had about $254m of these assets, and if you look at what we earned in the second quarter on these assets, we earned an annualized return of about 2%. And if you assume at some point we can earn 10% then the 8% incremental return on $254m is about $20m. Now, what I want to tell you is that we will probably always have some cash on our balance sheet, and some land, construction, so forth, but certainly we are looking to monetize at least half of this balance. So the opportunity, which is half of the $20m, is a $10m opportunity here, that's the first opportunity. Second opportunity lies within our occupancy, as you know in the second quarter we were 87.4% occupied and for seven years running, we were over 95%, in fact we were between 95% and 97% occupied. So if you take and do the math, if you take 87.4% and calculate the NOI incremental getting up to 95% occupancy, that's about $35m, so that's the second opportunity. So we combine these two opportunities, the low income producing assets at $10m and the occupancy potential at, say $35m, that's a $45m potential that we have. Now, let me make a couple of comments about this. First of all, with respect to the low income producing assets, the good news is that we started off with about $300m in the beginning of the quarter and we have lowered that down about $254m at the end of the quarter, so we are making progress on that. And with respect to occupancy, this certainly the economy at some point in time will pick up, certainly at some point in time the supply demand characteristics in our industry will get better and so occupancy will go up. So, we think it's more of a matter of when and not if our occupancy gets back up to a more normalized level. So I just wanted to share these two opportunities with you because it is significant to the future potential performance. So with that let me just conclude and say that the economic environment has been challenging for almost everyone. For First Industrial, our financial position still remains strong, and we have a solid balance sheet, and strong and diverse sources of cash flow. And with that let me turn it over to Mick Brennan.

Thanks, Mike. And before we take your questions, I just wanted to offer few takeaway points for today. I think the first is that the economy does seem to be stabilizing and it may even about to show some sustained improvements but we will obviously have to take a wait and see, but our second quarter performance would seem to indicate this. Second point is that we want our strategy to follow the real industry characteristics both to find ways to meet those opportunities and also find a way to meet the challenges inherent in the industrial property market. And I think we have done that, we intend to stay the course with our strategy. For one of the things that our industry - industrial marketplace clearly shows us is that we need to be more than one-dimensional. We need to understand that there will be different capital market cycles, that there will be different business cycles, that there is a way to prosper in each one of them if we have the right organization and the right infrastructure. So, as we said in the Investor Day, not only did we want to a good running game, which is analogous to our portfolio NOI and the profits that generates, but we need a good cashing game as well. We need to be able to find in our organization, in our industry, ways to create value, whether it's in development or redevelopment, whether it's in our corporate services business, there are ways in which we can make some of the parts greater, and that's what we are attempting to do - to fill the two strong sustainable value streams so that we can create something which hasn't existed before, and we are about the business in trying to do that. So with that, moderator, please open it up for questions.

Thank you. The floor is now open for questions. If you do have a question, please press one followed by four on your touchtone telephone at this time. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. We do ask that while you pose your question to please pick up your handset to provide optimum sound quality. Once again that's one followed by four on your touchtone telephone at this time. Please hold while we poll for questions. Once again that's one, followed by four on your touchtone telephone at this time.

Your first question is coming from James Sullivan of Prudential Securities. Please state your question.

Good morning. Couple of questions. First of all, in the guidance for 2003, can you clarify what your assumptions are regarding same store in NOI growth for the full year?

Unidentified Company Representative Company Representative: Yes Jim, we expect same store NOI growth for the full year to be in a negative 4% to 5% range.

And in terms of, I'm sure you look at what your peer group has been reporting, your metric or your result for the second quarter is certainly a good deal weaker than the peer group, what do you attribute that to?

I don't have all the handy statistics available Jim. This is Mike Brennan. You know, as we move on throughout the rest of the year, we expect that to improve just slightly from a comparison basis, but I guess I can't answer your question, because I really don't know exactly what their statistics were. But I really don't think they will rise to a level that's in any way materially different from ours, and we are pleased with the progress that we've been making. And it's [Inaudible] is there anything you would like to add on that?

Basically our guidance is at a similar level of the negative same store performance that we've expected in the second quarter. So, we are guiding you to just a flat to slightly higher occupancy, but basically a similar same-store performance from the prior quarter.

Unidentified Company Representative Company Representative: And Jim as you know, most of the peer group has shown negative same-store by a couple of percent and that's what we are showing and expect to show for the year as well.

The shifting focus from in it to the investment activity and the assumptions and the yield. Your investment assumptions are pretty much the same as they were at the end of the first quarter in terms of volume and amount. If I look at what you have completed your acquisitions at year-to-date in terms of average cap rate as well as your projected cap rate for developments that have been completed and in the pipeline, the weighted average cap rate on those two sources of activity is down below 10% with the development in the pipeline having a slightly lower cap rate than what you've completed so far. Yet your guidance is from ten to eleven. Should we be assuming significantly higher yields on incremental acquisition activity in the second half?

Hi Jim, this is Mike. Regarding our volume, just to clarify, our sales volume assumption did in fact change from -

I am talking about the investment volume, not the, I am talking about the acquisitions and development activity.

Yeah and that did change as well. We changed our guidance in early July. We reduced both our sales volume expectations by about a 100m as well as our investment assumptions by about a 100m.

Jim, in terms of just the yields, we've been beating our guidance assumptions from selling. We've guided that we've been selling 9% to 10% cap rates. We have been definitely beating that. And you are right. The overall weighted average yields of acquisition development, if your mathematics has fallen below 10, but it is still close to 10. So the point I want to make is that there is still significant spread between what we invest in and on what we sell properties at, which is more of what we track and what we train them in [Inaudible] .

And Jim, just that clarifies well. You know, as you know we took out most of our assumptions with respect to development for the rest of the year. And that means that our investments for the rest of the year will find lot of the acquisitions. And if you saw what got on acquisitions, year-to-date, as well as in the second quarter, we are in that 10 to 11 range.

Well let me just go back and look at this. I accept the point that the investment volume assumptions, yes have reduced by a 100m both of the upper and lower end of the range. The cap rates remained in the 10 to 11. The development is under construction at the end of the quarter, we're a 150m at a 9.5 or 9.4 cap rate and the average cap rate on acquisitions completed so far, as far as I can read it is 10.1. And we have been hearing off course from your peer group again this quarter that acquisition activity and we've been hearing all year, that's become a very difficult market. Acquisition cap rates have declined to a point where in many cases your peers are saying, you know, they are stepping back from the market, it's a seller's market and they don't want to play in this market and your cap rates overall have remained the same, your home for assumption purposes. It appears in consistent with what we are seeing and hearing from the peer group and that's why I put the question. And from modeling purposes it would seem to be probably safer to be assuming something fairly less than 10% as supposed to say the mid point in your guidance, which would be 10.5 for the mid-point in your assumptions. So that's why I asked the question. And then the final question regarding SG&A, can you give us the full year guidance for the SG&A line, Mike?

Okay, for our run rate as far as our G&A costs, we expect that to be somewhere to the second quarter which was about $7m, So, you are in the mid-20's, I'll call about 26m actually the overall expectations for G&A for calendar 2003.

And if you could just remind me the year-over-year increase we saw in the second quarter and that line item was attributable to what?

Yes, it was mostly attributable to the fact that we internalized our due diligence function. Something that we previously talked about, just because of the accounting and the way that works, we internalize the function that was previously outsourced and so that cost now goes down in our G&A line where before it was the cost of sales and so forth or acquisitions. So, we are actually receiving cash by internalizing that function, but because of the accounting it hits on the G&A line. That's bets the primary differential.

Okay, very good thanks.

You know Jim. This is Michael, just wanted to go back and answer your question. Why do we think, well we should keep our range of 10 to 11% when clearly the peer group, as you properly have identified as having difficulty finding investments at all. But alone in that range. We obviously took a lot of time at Investor Day to take investors one by one through the transactions that we have closed and as Jo mentioned a few of those today. They have these characteristics. Number one is that we don't spend our time or too much of our time trying to buy properties from the professional real estate investor. So the company's efforts are focusing on that 65% that is owned by corporations. People that have a far different motivations, they are running businesses; they are not running real estate businesses and they have many different concerns, the monolithic concerns of a private professional investor, who looks through one and only one thing and that is to get the highest price. The second thing that we pointed out to investors was that we look for those properties with transactional complexity, because obviously the more complicated the transaction, the more the flame field thins. So, if you had one property in Chicago, it's a long-term net lease to have it laps, a 100 people can buy it, when you introduce five different properties in different locations with different property types with different types of leasing involved, that field begins to thin very very rapidly. So, we look for those things. And in the final characteristic we look for those property attributes with the proceed risk is greater than the actual risk. Now so that's really what we're looking for and we spent a lot of - a good deal of time and money with a marketing effort to stand at really identifying the right seller and having a full service organization to financially deliver on the promise, secure transactional complexity of property attributes would have moved quickly with seller circumstances, with the transaction of Jojo recently described that we closed the [Inaudible] was one such transaction. We will buy that property at about 75% lease at 10.3% cap and growing in number at 75% lease. The reason we are able to do that is because we are moving very quickly to close the transaction. We've got five different - four different markets, it's got three different industrial property types and that just makes it a much more complicated transaction. You got a right picture, you got to go it quickly, you got to move in four different markets and you've got to be able to do in on three different industrial property types. So that - having said all that, that's really what we're trying to do. Don't say it's easy to do, but we've been successful doing it in the past and then that's really the formula we've tried here. It's very important that people understand that what we're trying to do.

Great, thank you.

Thank you. Your next question is coming from Don Fandett of Wachovia.

My question has been answered. Thank you.

Thank you. Your next question is coming from Gary Freeman of Gem Investors. Please state your question.

Good morning guys. Two questions, the first is, in terms of base rent about a third of your portfolio rolls over the next 18 months and I know it's tough to look out that far, but hopefully you have a sense for, where the risks and opportunities are in the portfolio. Can you give us a sense for that?

The rollovers, Gary, is within the historical norm in terms of property types and in terms of finish and in terms of the sizes. I mean our tendency is so broad based and it's not particularly waded to each market. Except for the second quarter, wherein we had a fairly high leasing expiration and rollover in the markets of Minneapolis and Denver and happened to be more focused to small tenants and it happened to be a slightly higher finish than what we expected in the past. But going forward, we do, you are right about a third - 10% left over this year and about in the 20% range next year.

Okay, fair enough. Second question. I was just - I'm just trying to get a little better sense for your FAD payout on a comparative basis with last year and my question is, I think I'm right in saying that last year you were excluding games from FAD. Can you give us a sense what your FAD payout ratio would be for the first six months of this year and what your outlook is for the remainder if you were to compute that on a sort of apples to apples basis with last year.

Sure. Just to clarify, we did include games in both FFO and FAD both last year and this year and then when you look at for 2003 as Mike Brennan mentioned, even at the low end of our guidance, we'd expect our FAD payout ratio to be below 100% for the full year 2003.

So that's assuming some material pickup for the remainder of this year?

That's correct. Remember in the second quarter, we had a sale which did not close, which will close in the third quarter, which impacted our second quarter numbers.

Okay, got it. All right, thank you guys.

Thank you. Your next question is coming from Jeff Kelly Lowenstein of Meadow News Service. Please state your question.

Yeah. on the press release and in the comments you said that you saw 78.2m

For the quarter and then the press release site of was 144m for the year. By then your supplemental information on page 33, you have figures of 74.5m for the second quarter, then 138.9m for the year. So [Inaudible] understand what the discrepancy is?

Unidentified Company Representative Company Representative: The difference there is because in the press release that includes sales of properties, in our lease properties as well as sales of raw land . In the supplemental, we just missed out sales of properties and not the land. That's the difference.

Thanks.

Once again, if you do have a question, you may press one followed by four on your touchtone telephone at this time. Your next question is coming from Don Vendetti of Wachovia. Mr. Vendetti, your line is live. Please proceed with your question Mr. Vendetti.

Yes. Hi, can you hear me. This is Chris Haley .

Unidentified Company Representative Company Representative: Yeah, Chris we sure can.

Thanks, sorry about that. Is there interest in the re-do of probably the new [Inaudible] venture. I'd like to get your perspective, first industrials perspective on what type of return expectations on an unlevered and levered basis this capital is looking for any industrial market here in the US based on the investors that you're looking at?

I'm not going to disclose their precise total, because they would not want me to do that, but what I can say is it's very well priced and attractive capital for us, and it's certainly something that will help make this venture very profitable.

If you're looking at first, maybe to dig in a little bit. Putting new money to work for First Industrial shareholders. What is the incremental cash yield and IRR that you're looking at today?

Okay. I can't give you the [Inaudible] , but I can give you the balance sheet, because that is First Industrial. It's a minimum of a 12% IRR. I mean we are a total return investor and that's what we shoot for. Of course, there are various assumptions that goes in a model, but we all look. Our investment criteria, all mandates a five-year hold on a base case underwriting scenario and if it passes our unleveraged tests, what we do now is go through on aggressive asset management scenario in order to beat those hurdles. That's the one, two step that we take.

Okay, in some of the markets, the larger markets in the US where pricing is aggressive, aggressively in some cases below seven and half initial cash yields. How can one, may be not First Industrial, but how does one justify competing in that market trying to generate a 12 yield.

You don't?

Yeah, you should, in those situations we don't try to buy from the professional real estate owner. I think you have to keep the bat on your shoulder and decide that, probably it's not worth selling, because you just find the same thing you sold and look for other venues and other value added things which you can do with different types of owners. If those are our options and only once we wouldn't recycle capital, because we wouldn't be doing any better than what we sold.

So on your underwriting, what kind of cap rates are you assuming on the exit, or at least to the terminal relativity initially, are you assuming? Have you changed that at all?

No, we've assumed a 100 before when cap rates were higher, we would assume a 50 basis points increase on the terminal cap rate versus the in place market cap rates. Now we've assumed 100 basis points, because we just feel that, on cap rate today maybe [Inaudible] .

And on an unlevered basis, what do you expect your capital returns to be on your ventures?

Again we're not going to comment specifically on our returns and our ventures...

Or when you're adding the fees and so forth. What kind of returns are they generating?

Very significant returns, let us just leave it at that.

Okay. Bye, thanks very much.

Okay.

You know one thing I want to make it clear is, as Jojo said, we underwrite to a 12 IRR, we are not cap rate arbitrage players. We are not going to - we are not going to buy it at 9, what we are used to buy it is 10, because we can sell it at an 8, unless somebody standing there is ready to our contract position over. We are underwriting, we are underwriting again to a 12 IRR, and that's playing the Cap rate arbitrage model, that's not something we do, if we can benefit from it, we will. But we are not basically going to lower our underwriting standards to what might be something that might be temporal.

I guess the question is - looking at buying something at a 10 and selling it at 9, has a 10% unlevered spread to it, yet selling, buying something at a 9 and re-selling it at 8 in this market actually has a higher, it probably can actually even be higher if you apply leverage. So, what is....

Nothing wrong with that, it's just that, there is nothing wrong with it at all, you can pull it off constantly, it's just that you might find yourself. If you are going to play the cap rate arbitrage game, you might find yourself someday holding a property that you wouldn't otherwise want to hold, because you bought it on the basis of cap rates staying down for a long period of time, and that wouldn't be good. So we have nothing against buying at 9 and selling it at 8. We just, you know, that's fine, but we are not going to, we are not going to buy a property simply in hopes that we can flip it, so.

Right. Again, going to replacement costs, are there any markets that, forget about Cap rates, look at replacement costs. Are there any markets that you feel pricing is at or above or substantially above replacement costs today?

I cannot point to our market worth, and currently that on a general basis is priced significantly above replacement costs. There's two caveats to that though. There are some long-term net lease products because of the investment-free nature of the tenancies and the length of lease term that it is being traded at above replacement costs. So that's a long caveat. The other caveat is that there are some areas, especially in filled areas for smaller type buildings for users end up buying above replacement costs, because they have significant investmental space, and the moving cost and relocation cost - it's just cost prohibitive for them. And those are situations where you do see assets trading at above replacement costs.

Okay, that's great. I appreciate your inputs.

Thank you.

Thank you. Your question is coming from Jonathan Lid of Smith Barney. Please state your question.

Good morning. It's Gary Boston here with John Lid. I wondered if I was on these, the low income producing assets in the strategy there. You mentioned several sources of funds, one of which was construction progress assuming that obviously that - the way you are going to monetize that would be to - to sell it, at some point. Should we then expect the development pipeline will continue to be shrinking over time?

Well I think, you can assume that what's on our balance sheet at this given point in time will probably be less. We are at a point in time now where we really do have more on balance sheet than we want on development, especially development which is not completely leased. Certainly, as we do more and more and exclusively [Inaudible] , we are fine with that. But with the spec pipeline, which is obviously somewhat unleased right now, we do expect to reduce that significantly on our balance sheet.

So I guess, as a core [Inaudible] of that, in the net economic gain bucket, should we then be focusing on the existing property gains, [Inaudible] land sales as a bigger piece of that pie?

Well one way Gary that we get the number down to the $150m target is to monetize or build [Inaudible] earlier, you know some become fee developments, others become pre-sales. We are not having as much capital invested into it as we have had before, that's one of our plans, so I wouldn't conclude from that given our desire to move it down to $150m, there will therefore be less development. We simply want to have less of our own money in not low income producing assets, to which we will find a number of different strategies to win that business and monetize it early, either in a form of turning it into a fee development for someone else or turning in into a pre-sale to someone else.

Okay, I guess, coming at this may be a different way. As you look forward on the net economic gain wind, do you have any sense on how the break down is going to look between those three [Inaudible] that you use?

Gary Hi! This is Jojo . Year-to-date, you can do the numbers but you would have seen about 55% of the economic gain has come from the existing portfolio, and the rest has been from land and redevelopment. Overall, we think that it is going to be in that range, again its coming from a lot of sources but as we are sparsely considerate now by the 60% coming from the existing portfolio is a good enough guess as any guess. In addition to that, I want to just address quickly the land component. In terms of land, land gains have never been a big part of economic gain and we don't see it as big part of economic gain. But it is over the last, I would say 10 quarters, we have been strategically selling land to higher and better users. So I want to tell you that as Mike Havala Mentioned that we would lower our net income producing assets, it is not going to be a significant contributor, it will be a consistent small contributor over time.

Okay. I guess as a final question. In terms of just that business in general, economic gain. I know you haven't given gross forecast past '03. But, just as you look at that long-term, what sort of annual growth in that business are you looking the target?

Well, I would say, this is Mike. I would say it would be probably in the 5% to 10% range. Some of us feel that we could do better than that. Doing better than that depends upon real penetration into the corporate initiatives that we are working on. They are certainly an awful lot of opportunity there. So but I still feel, that just based upon what we have done today, that 5% to 10%, its probably a reasonable number. As the economy, gets better how ever the amount of our assets held attributable to the economic gain component will decrease, so the make up will be little bit different. But again I think 5% to 10% is probably pretty good number.

And you are saying that the composition will change because of the occupancy pick-ups?

That's correct.

Yes.

Great thank you.

Thank you. Your next question is from Stephanie Krewson of BB&T Capital Markets. Please state your question.

Hi guys, how are you.

Fine Stephanie.

I have a two unrelated questions. As you know, I've spent; I was the initial non-believer in your capital re-cycling program because I questioned whether or not you had the infrastructure in place to make it a sustainable and consistently profitable business. As you know all too well I have spent years traveling each of your major markets with your people on the ground there, and I am very comfortable with your ability to have that as repeatable very profitable business. So I know that its sustainable and that it is real, because I have had the privilege of driving those markets and seen a lot of your deals. A question that gets put to me frequently, which I can hope you can answer is, assuming that you don't formally, just theoretically if you don't formally pursue your capital recycling business, how much of that economic gain would still be there? What sort of dollar volume with sales would you get?

May be, Mike could judge our financial question. I just want to ask a clarifying question. Did you mean that if we, I don't know what you mean, if you stop selling properties or stop.

Oh sure. I'll clarify, I apologize. A lot of people asked me, okay maybe it is sustainable. What happens if the people at First Industrial stop focusing on generating these buy low sell high opportunities, what if they just focus on leasing. How much of that is recycling dollar volume is capital there because I know that this business comes to you. But, I just want your take on that?

As Yap said, that and this is a guess, because you really have to go back and look at every transaction but we were garden variety, [Inaudible] run collector model, that's what we adopted. You know clearly gains would have [Inaudible] to us simply from market gains, which I would probably say about half of that might come to us anyway. Again that's a guess, it could be less then that. But I thought people stopped, working the network is vital, going out there everyday and working and trying to find these opportunities and trying to sell the value proposition to the customer is something that we work very hard on every day to do. I will tell you some people, in the real estate business find that a little bit foreign, but people in other businesses know they have to go out and you know might get a new order for life policy or cars or pretty fast on what ever you have to go after and sell the customer everyday. We're just beginning in this, still our network cannot be, active calling on customers is vitally important. I think without that and without that push, you see it drop significantly, so I know many of our regional directors are out there listening today and couple of weeks ago, we had a new and increased emphasis on being a full service company. Because I know that our organization is capable of doing that, so we do expect, you know, we've actually expect more from that on these initiatives.

Thanks, great. And another completely unrelated question, but - is there any movement of foot through the SEC or a REIT to compel other REIT's to begin disclosing not just their bookings but their economic gains on the sales of assets. Because you or Stone Smiths and Prologists appear to be only one pioneering this effort, and I don't understand why there's not more pressure brought to their own companies to show that they're really making money on assets sales.

Well, if the rolls were reverse, if I was the investor and somebody else was management, I wouldn’t give anybody money and my stake told me exactly what they made or lost on an investment. That to me is inconceivable, I don't know the SEC is beginning to involve in or isn’t leading or anything else but certainly, investors should say, in the real estates business it's always been cash flow and capital gain. You know if you keep the man behind the curtain and you don't show in fact you're losing or making, especially when making on, your achieving a return for investors in excess of your cost of capital, duly depends upon that residual and then not for show it. Not to say what the gains are, and that's to provide the IRR's. I don't think you can make a really good you know estimations to whether at the end of the day this company or any other company is going to pay its bills to the capital markets, to provide the kind of returns share holders want. So I - I mean obviously I think it's a very vital component, I don't know who needs to get involved in it, may be investors know that you know when the day of reckoning comes that the IRR's have to be there, as the property goes so do these stock prices.

Great, excellent quarter gentlemen keep up the great work.

Okay, thank you.

Thank you. Your next question is coming from Kenny Wallace of Raymond James. Please state your question.

All question has been answered. Thanks.

Thank you. Your final question is coming from David O'Connor of High Rise Partners, please state your question.

Hi it's actually Charles Fitzgerald. I have just a question about the transaction at Santiago that Jojo had talked about. You guys can you just clarify for me that you bought the property and then you're in the process of selling some of the assets to the users, is that correct?

Yeah, we actually sold already 111,000 square foot in the same quarter. And that's a building there that goes empty, and we sold it to a user already.

That will be in the third quarter - the sale?

No, it happened already in the same quarter.

Oh it did, okay.

Yes. We executed - we tied it up, we found a buyer, well you know we sold it at 16% margin.

Okay, I didn't see that on the supplementary page on page 33. Is it somewhere else?

Yeah. Let me - Customhouse Plaza - we're looking for it now.

Yeah, no problem.

Yeah it's under Customhouse Plaza, I know I'd right [Inaudible]

So you-

We'll get back to you offline, we think it's under the Customhouse plot but we'll -

Okay but you booked a gain an economic gain in the quarter on that sale, is that correct?

Yes.

Yes? How does that work if you sell an asset that's part of a portfolio, isn't there a reallocation of basis that you have to do or can you rush a book a gain on that?

That is there is no reallocation of basis, I mean, you bought a property and if buy a portfolio of five properties, five properties are worth what they are. Have you paid for them, and then as you buy, actually sell those properties, you have gained the losses and depending on the economics and how much you've sold those for.

Okay.

If it is the question is proper allocation of basis, which I think it is -

Right.

On every single property that we buy, every single one of it is soft back for the IRR consistent with the economics in the market for the sale. There is no - you know this is not sell a good one and don't the sell the bad one, they all have given it a proper allocation that is open for anyone to look at to establish the appropriate value for that particular property. So that's what we do. And by the way just a little more color on that thing you know, it was a great acquisition that the West Coast region did along with Jojo it's properties that we bought at about a 7.5% cap rate at 68% lease. And we know that there are properties that sell it to 7.5 cap rate that are 98% leased or 95% leased with a hell of a lot more downside in them. So it was really a remarkable acquisition, I think we'll stabilize there and about 11% some people say 10.5 I'd like to push him to 11, could be one of the reasons we sold that building, though was because that was the worst building in that particular complex, that was a manufacturing building, a big building and a small market with low ceiling heights and we said you know if we could lease it would be great, if we could sell it will be great, if we get rid of it, it will be great. So that by the way was one of the transactional complexities associated with it, was that you know we had to take on a number of different types of building from Midstu and Midstu wanted out, they wanted to - this is one of their lasts sales so that's really why we sold the building that it was going to be a tough job of getting it leased up, but we knew that we had it properly underwritten and we knew we could find some way out of it.

And we are already at 86% occupancy.

So that would imply that the other $69m, $70m that you bought in the quarter you averaged sort of 11.9%, 12% [Inaudible] something like that if you bought that if you bought that one at 75. Is that about right?

I don't have those numbers. It is not my finger tips.

Okay, you just guessed. Thanks a lot.

Yeah.

There are no further questions at this time.

Well thanks everybody for calling in and expressing your interests, appreciated. We look forward to talk in with you on next quarter. Thank you.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.