First Industrial Realty Trust Inc (FR) 2005 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the First Industrial Realty Trust conference call on its first quarter results. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. It is now my pleasure to introduce First Industrial. Please go ahead.

Good morning everyone. This is Sean O'Neill, Senior Vice President of Investor Relations and Corporate Communications. Before we discuss results for the quarter, let me remind everyone that this call contains forward-looking statements about First Industrial. A number of factors could cause the company's actual results to differ materially from those anticipated. These factors can be found in our earnings release that is available on our website at www.firstindustrial.com. Now, let me turn the call over to Mike Brennan, President and CEO.

Thank you very much, Sean, and welcome, everybody, to our first quarter 2005 earnings conference call. Before we begin, I would like to introduce the members of management that are here today. JoJo Yap, Chief Investment Officer, who will go through our first quarter investment performance and the pipeline, David Draft, our Executive Vice President of Operations, who will detail our portfolio performance and the outlook for the markets for the balance of '05, and Mike Havala, our Chief Financial Officer, who will discuss our new joint venture, our balance sheet and our guidance for the balance of '05. And you just heard, of course, from Sean O'Neill, our Senior Vice President of Investor Relations.

Let me begin with just a little discussion on our new joint venture. With the completion of our venture with California State Teachers’ Retirement System, it might be helpful just to step back and give you a perspective on the overarching objective of our company. Number one, as I said before, the mission of First Industrial has been to be a provider of industrial solutions. And we believe that the stronger your geographic coverage, the skill sets of your personnel and the range of your capital sources all determine the degree to which you can provide solutions. So, our aim has always been, with our corporate real estate customers, to be able to say yes more often. To be able to say, yes, we can purchase land. Yes, we can purchase your surplus buildings. Yes, we can do the long-term net leases. Or yes, we can do it in any combination.

And what we found out over the years, is that the better solution, the better the margin and that's why the mantra for our transaction officers has always been to compete on solutions and not on price. So, the CalSTRS venture, by expanding our ability to offer solutions, expands our ability to secure the higher margin business. Some specifics on the fund. It's approximately $950 million and, of course, you've seen that it's for the purchase of land, the development of buildings and the redevelopment of assets within the United States.

Some other points of significance I want to bring to everybody's attention are that, obviously, it provides ample capital for us to finance every component of our business plan. And you'll recall that at one end of the spectrum is our fund with the Kuwait Finance House, which funds our long-term net lease acquisitions. And now, at the other end of the spectrum, CalSTRS fund will finance our development and redevelopment opportunities.

Secondly, it strengthens our competitive advantage. With the combination of the infrastructure we have and the capital that allows us to work the infrastructure to its maximum advantage, this gives us the broadest possible spectrum of opportunities that we can look at.

And third, it squarely puts in place another engine of growth, that of fees and promotes from the joint ventures. So, together with the earnings streams that we already have from net operating income, we already have from capital recycling gains, we possess three significant sources for recurring earnings growth.

Finally, what was equally gratifying to all of us here was the value that CalSTRS placed on local management, what they placed on our skills of development and redevelopment and on the vast corporate real estate market. In short, the value they placed on the platform and our proven strategies to create value.

Getting into the first quarter results, they were at the high end of our expectations and they demonstrate both the solid execution of a plan and the overall economic strength of the market. Our FFO was $0.80 per share and exceeded the midpoint of our guidance by $0.05. Contributing to that was our occupancy, which rose to 90.8% and that's the eighth consecutive quarter that we've had of increasing occupancy, also, of course, driven by economic gains of $20.1 million.

The economic environment by all accounts is still very strong. I especially want to point out to the - point out the increases in inventory levels and capital spending. The forecasts are still for double-digit growth and, as I've mentioned there, capital spending is a significant driver of absorption. And we think these levels reflect both a need to meet the current demand and also to correct for a prolonged period of underinvestment.

So, with that, I'd like to pass the discussion over to JoJo, who will discuss our investment performance.

Thanks, Mike. Let me start by discussing our on-balance sheet performance. We put in a solid investment performance for the quarter. We invested a total of $110 million in acquisitions and developments placed in service, excluding land. We continue to be an accretive investor as our projected yields of 9.6% exceeded the yield on sales by 150 basis points. This yield spread compares favorably to our five-year average of 136 basis points between investments and sales.

In terms of economic gain, we achieved $20.1 million for the quarter. I would note that a substantial portion of these profits came from our merchant activities, namely development, redevelopment and land sales. We also achieved a significant value creation by our unleveraged internal rate of return of 51.7%. Now, this is high compared to our historical average of 17.8%. But we achieved these high returns by the quick recycling of the assets. For example, the average holding period of our sales for the first quarter was less than two years. This execution is possible if one has the local infrastructure on the ground that can buy, redevelop, lease and sell.

In terms of our balance sheet investment pipeline, it continues to grow and stands at $450 million that are either closed, under construction or under agreement. The breakdown is as follows. Acquisitions closed and under agreement are at $208 million. Developments under construction are at $176 million, which is 63% leased. Build-to-suits under agreement are at $66 million. Now, switching over to our joint venture pipeline. We have $132 million of acquisitions and developments under agreement. I just want to note that this is in addition to the $171 million of land and buildings that we invested in the first quarter in our joint ventures with CalSTRS and the Kuwait Finance House.

We believe this on-balance sheet and joint venture investment activity that I just discussed, positions us well to meet our investment and profit objectives in 2005 and beyond. There are a number of reasons why our pipeline is strong. First, we owe it to the national infrastructure. For example, the current on balance sheet and joint venture pipeline comes from 47 separate transactions across 20 of our markets. Second, is the growth that we experience and continue to see in the corporate business.

For example, 70% of our acquisitions in the first quarter were corporate transactions. In addition, we're coming into the year at a pretty good pace. Year-to-date, we're already about 37% of all of last year's corporate business volume. We owe this growth to our increasing market share of this type of business and the positive industry trends.

Another reason for our strong investment pipeline is the investment we've made and continue to make in our human infrastructure. For example, in the first quarter, we added a development officer in Los Angeles and added a veteran investment professional in Miami. These are in addition to the investment professionals we had in the second half of last year in the Baltimore-Washington area and San Francisco. We believe they will provide us with more ways to invest capital profitably and serve our customers better than any point in our company's history.

The final reason we're optimistic about our investment pipeline is from the increased capacity and competitiveness we've obtained from our joint ventures. As we've told you in the past, these ventures will give us added opportunities to invest and it will also complement our business, since we'll be able to leverage our national infrastructure and deepen our relationship with corporate America.

With that, I'll turn it over to David.

Okay. Thank you very much, JoJo. On a national basis, the industrial real estate sector remained solid in the quarter, as a number of fundamentals showed sequential improvement or remained at a relatively sound level. Net absorption in the quarter totaled about 41 million square feet, extending the trend of positive tenant demand into the seventh consecutive quarter and exceeding the historical absorption average of 31 million square feet by a notable margin.

And the outlook is favorable as well. Absorption is expected to remain positive on a quarter-to-quarter basis throughout the remainder of 2005. Absorption was strong enough to outpace new deliveries, which totaled 27 million square feet in the quarter. This level of deliveries is markedly less than the long-term delivery average of 39 million square feet. And importantly, it was the fourth consecutive quarter in which demand has exceeded supply.

And just to provide some context here, prior to these four quarters, just the opposite was true - supply exceeded demand and did so for a long time - 14 straight quarters. The national availability rate in the quarter improved 20 basis points from the prior quarter and now stands at 10.8%. Those, by the way, are updated figures just from within the last couple of days.

With industrial space fundamentals moving in an overall positive direction, First Industrial's portfolio posted very solid results in the quarter, with all of our statistics either in line with or ahead of expectations. Occupancy for our in-service portfolio, at the end of the quarter, increased to 90.8% and that is a 70 basis point increase over the fourth quarter and notably marks the eighth consecutive quarterly increase. The improvement continues to be broad based across all of our regional portfolios and is also consistent with our projection last quarter, wherein we said we expect occupancy to move to or above 92% in the second half of this year.

Looking at the markets overall, the combination of the growth in international trade and the ongoing domestic economic expansion continues to drive demand in the coastal areas. Southern California, specifically Los Angeles, Riverside and Orange County, all are in the top four markets in the country as measured by occupancy. Northern New Jersey is also one of the strongest markets in the country and Houston is improving on both the occupancy and rental rate fronts as well.

Other markets where we see continued improvement are Northern California, Phoenix and Philadelphia. Markets where we see a more moderate pace in the rental rate growth include Denver and Indianapolis, though even in those markets we expect positive net absorption to keep occupancy and rental rates moving in a positive direction as we move along in the year.

Overall, we saw a wide ranging improvement in demand for industrial space in the first quarter. And that's clearly borne out by the exceptionally high leasing volume we posted in the quarter. That was close to 8 million square feet and that represents a significant increase over the 5 to 6 million square feet leased in each quarter of the last couple of years. And it also, importantly, sets a record for the most square footage leased by the company in any one quarter. Industries that were particularly active included distributors of consumer products and building materials, as well as electronic parts and packaging solution providers.

Turning to same store NOI. That was up 90 basis points in the first quarter '05 as compared to the first quarter 2004. This is the second sequential increase in same store NOI and keeps us solidly on track to deliver same store growth of positive 1-3% for the year, which is in line with our previous estimate. Retention was exceptionally strong in the quarter, as we renewed 85.8% of our square footage and 81.3% of our leases. The strength of the leasing environment is surely providing a welcome assist there as is our continued emphasis on customer service.

We're also making very, very good progress on our 2005 rollover. We have, to date, successfully addressed approximately 40% of our 2005 expirations. Not only does that compare favorably with the last several years, but, of course, we now have the added benefit and an important one, of being in a stronger business environment.

Looking at rental rate changes. Cash-on-cash rental rates declined in the quarter by 6.3%. That is consistent with what we expected at this point in the year. The outlook for rental rates continues to be encouraging. And we site two reasons for that. First of all, overall economic growth. That, of course, drives net absorption, which in turn has a favorable impact on occupancy, thereby strengthening the landlord's negotiating position. That's one reason.

A second reason is we will see increasing benefits as our average five-year lease terms expire, because leases originated four to five years ago were, of course, done in a higher rental rate environment than what exists today. Now, we can see the evidence of this benefit already by the fact that our rental rate decline for leases originated in the last three years was only 1%.

Leasing costs for the quarter improved as well, came in at $2.16 per square feet - foot. That's well below the 2004 average of $2.30 and right about in the middle of our estimated range for 2005. Now, while come of this improvement is related to individual deal circumstances, which perhaps could be outside of directional type change, we feel that TI incentives are gradually moderating as time goes on.

In summary, our quarterly results reflected the improvement we saw in just about all areas of the business. We anticipate that that positive direction will continue over the remainder of 2005. Our field personnel are seeing a healthy level of interest in renewals and, importantly, we're also seeing a reduction in the time it takes for tenant leasing decisions to be made. And that was quite a long time coming. All of this means that we look forward to more good news in terms of future increases in NOI coming from increasing occupancy levels and, of course, the positive net effect of the investment activity JoJo spoke about just a few minutes ago.

So, at this point, I'd like to turn the call over to Mike Havala.

Well, thanks, David. First, I'd like to talk about our new $950 million joint venture with CalSTRS. As we said on our last few earnings calls, we expected to close this joint venture by the end of the first quarter and I'm happy to say that we, in fact, did, closing the venture in March. Note that, also in March, the venture invested in $86 million of land and repositioning assets as we seeded the venture with these assets.

Just as a reminder, the purpose of this venture is to invest in land to be developed and that will be either on a build-to-suit basis or a spec basis and also to invest in repositioning properties. The venture intends to create value and then harvest that value through property sales. Note that the investments in the venture will be additive to the investment levels that we're already doing on the balance sheet, as we no longer will have to turn away business in this area due to our own balance sheet constraints. So we are very excited about being able to do substantially more investments in this area. Also, we'd expect this venture to help add some more certainty and visibility to this part of our business.

The economic benefits of this venture to First Industrial are several. First, we'll have a higher return on invested capital. Second, we'll receive fees in fives areas, and those areas are property management, leasing, development, portfolio management and sales. Third, with respect to the economic benefits, we expect to receive promotes as we sell assets and, as we know from past experience, these have the potential to be significant. And then fourth, the venture will help us, in fact already has, lower our low income-producing assets, such as land, on our balance sheet.

So, the last comment I want to make about the joint venture is that we're especially pleased to be partnering with CalSTRS, which, as many of you know, is one of the largest public pension funds in the United States with over $125 billion in assets. We've developed a great relationship with the people at CalSTRS, including their advisors, CBRE investors, and certainly we hope to enjoy additional opportunities with them as part of this overall relationship.

Next, I'd like to make a few comments on the strength of our balance sheet and our ratios. For the quarter, our interest coverage was 3.0 times. Our fixed charge coverage was 2.7 times. And these are very solid ratios, which, by the way, should continue to improve throughout 2005. With respect to the qualitative features of our debt, we have one of the longest debt maturities, at nearly 9.1 years, in the entire industry. And 100% of our permanent debt is fixed rate. Also, we have very little secured debt as over 96% of our assets are unencumbered by mortgages, which, of course, by the way, is very important for a capital recycling business model.

Next, let me talk about earnings and our guidance. For the first quarter you saw our FFO per share at $0.80 and this exceeded the midpoint of our guidance range by $0.05. Then let me make a few comments about G&A. Our G&A has been in the 11 to $12 million range in each of the past three quarters. And we expect to be -- that to be our going forward run rate for 2005. The other comment I'd like to make about G&A is remember that GAAP accounting requires us to classify in G&A the incentive compensation that we pay to our transaction officers for directly producing the investment gains. Thus, part of what's in the G&A line is really a direct cost of the investment gains that we produce.

Moving over to guidance, as you saw, we reaffirmed our guidance for 2005 with FFO per share of $3.40 to $3.60 and then GAAP EPS of $1.60 to $1.80. And then we initiated our guidance for the second quarter of 2005 with an FFO per share of $0.80 to $0.90 and GAAP EPS of $0.35 to $0.45.

Before I conclude, I just wanted to point out something I think is very important. We've worked hard over the last number of years to put all the parts of our revenue stream in a position to not only be recurring, but also to grow. You heard JoJo talk about new investments in our corporate real estate efforts. And you heard David talk about the portfolio and the improvements that we started to see there. And then I talked about our new opportunities that we have with our newest joint venture. And when you put it all together, what you see is that we expect growth in all parts of our income stream, those parts being NOI, fees and promotes from joint ventures, and then recurring investment gains. So while we've had to make a meaningful investment in our company, this is directly translating into growth in the company.

And one thing I would also like to point out is that we're very focused on growing the company. And interestingly, what is often overlooked in, say a simple year over year FFO comparison is that we are growing meaningfully. For example, for 2004 if you were to remove the $32 million gain on our sale of the KFH joint venture, our expected growth rate in 2005 would be substantial. So that all the things that we're doing and working towards expanding the company are, in fact, working to help achieve our growth.

So with that, the last comment I want to make is that while we haven't provided specific guidance for 2006 and beyond, we would expect that based on what we're seeing here today, that is improving NOI, our new joint venture and our increase in the corporate real estate business, these should benefit us even more in 2006 than in 2005, because of what will already be in place as we start 2006. So again, while we're pleased with what we're seeing in 2005, we're even more excited about our prospects for 2006 and beyond.

And with that, let me turn it back over to Mike Brennan.

Thank you very much, Mike. Before we open it up for questions, I'd like to make one closing remark. As Mike Havala said, over the course of the last two years we've made investments to advance our overall competitiveness. We added people, we entered new markets and we obviously brought in new capital partners. And that's very important because what has permitted us to make good real estate investments over the years relates to two simple ideas and the first is to cast a wide net and to see as many opportunities as we can. And the second is to do what is difficult for others to do, and at no time have we been better prepared to do both.

So with that, I'd like to open it up for questions. Moderator?

Thank you. (operator instructions)

Thank you. Our first question is coming from Ross Nussbaum from Banc of America Securities.

It's Christie McElroy here with Ross. Your FAD payout ratio is pretty high relative to your goal level at 117%. Given that you're expecting pretty -- little earnings growth this year, can you talk about when you expect to start covering your dividend?

Sure. As you know, we already cover our dividend when you look at things from an annual basis. In 2004 our FAD payout ratio was below 100%, as it was actually every year for the last 10 years since our IPO. So when you look at this year's numbers based on our guidance, again, we expect that our FAD will exceed our dividend. So in other words, our cash flow will exceed our dividend so we already are covering and have our dividend.

Do you expect your FAD to be below 100%?

Yes, we do.

Okay. Can you provide the initial cap rate on your acquisitions in the quarter?

Sure. The projected overall yield is 9.9%. The initial cap rate is 8.9%.

Thank you. Your next question is coming from Stephanie Krewson from BB&T Capital Markets.

Hey guys, great quarter. One of the things that I think might be helpful for people to understand -- because I don't know if a lot of your investors have the time to go out and really walk markets and understand what's going on -- there is a lot of talk about cap rate compression, but the fact of the matter is it has not been linear across the asset classes and that varies by facility type. But more importantly, it varies by what segment you're going after. And I really think that a lot of people don't understand that, much like CenterPoint , which is pursuing capital recycling in a different segment of industrial assets, you all are doing something similar and that is why your cap rates on what you're buying have not compressed like they have for a bulk distribution facility at Exit 8A in New Jersey, for example. Could you address that just to help clarify things for people?

Stephanie, hi. This is JoJo. A couple of things. The reason that we've really been able to find these opportunities, again it's the wide net that we have. We invest over 25 markets, we invest in diversified property types and that's bulk and regional warehouse, light industrial and R&D/flex. And that gives us a lot of opportunities to invest in and we can select over those opportunities. In addition to that, our corporate business has increased and will continue to increase. Our market share of the business has continued to increase. There are industry trends in that arena that points to us and we believe that will continue to drive repeat corporate business.

One thing I'd like to note is that a lot of people out there hear only about those large transactions and large net lease transactions that are being quoted at a low cap rate when indeed, the national average for cap rates for industrial is about 8.3% based on Real Capital Analytics. Now, the last thing I do want to point out to everyone is that as a value creator, what we need to focus on is the spread that we invest our capital in. Whether cap rates go down or up, what's important for a value creator is to invest in spreads. So if you go back in First Industrial since 1999, our average spread between investment and sales has been at about 136 basis points. Overall, those are the reasons why we continue to create value.

Stephanie, I can't say it any better, I just would add a couple of things, that people comment on how we're able to be successful in buying at those kind of spreads. And I mentioned that in my last comment, cast a wide net, do what's difficult for others to do. But remember that when we sell properties at 7 or 8 cap rates, we're selling those largely to passive investors, okay. So we're selling to passive investors who are obviously less capable of dealing with leasing issues or construction issues. So I find it sort of interesting that people would say not that we can do it, but of course we ought to be able to do it because we're obviously much more skilled in being able to do that than other people and we have a wide -- we have a very wide pipeline in which to source opportunities.

So the other thing, too, that I would add that I don't think -- unless you're sort of working the corporate transactions like we do, is that transactional difficulty drives away competition. So if you've got a sale in multiple markets or properties that consist of multiple property types or things that require leasing or construction expertise, again, that doesn't fall easily into the competency of most real estate investors. So of course it would stand to reason that we should do better. So that's a long answer to your question. I hope we've answered it.

You absolutely did. Keep up the great work guys.

Our next question is coming from Todd Voigt from Cliffwood Partners.

I was just wondering if you could quantity any lease termination fees for the quarter.

Yes, they were about $500,000 for the first quarter of '05.

Thank you. At this time there appears to be no further questions. I would like to turn the floor back over to management for any closing remarks.

Okay, you let us off easy this quarter. If anybody has questions, I guess we'll talk to you next quarter or see you in the next industry event. Thank you.

Thank you. And thank you, callers. That does conclude today's conference. You may disconnect your lines at this time and have a wonderful day.