First Industrial Realty Trust Inc (FR) 2006 Q2 法說會逐字稿

At this time, I would like to welcome everyone to the First Industrial second quarter earnings conference call. [OPERATOR INSTRUCTIONS] It is now my pleasure to turn the floor over to First Industrial.

Good afternoon, everyone, this is Sean O'Neill, Senior Vice President of Investor Relations and Corporate Communications. Before we discuss our results for the quarter, let me remind everyone that this call contains forward-looking statements about First Industrial. A number of factors may 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.

Okay. Well, thank you very much, Sean, and welcome, everybody, to our second quarter 2006 earnings conference call. Before we begin, let me introduce the members of senior management who are here today. JoJo Yap our Chief Investment Officer who will discuss our investment performance and pipeline. David Draft, Executive Vice President of Operations, who will cover our portfolio results. Mike Havala, Chief Financial Officer who will go through our capital markets activity, our balance sheet and the guidance for 2006. And you have just heard from Sean O'Neill, our Senior Vice President of Investor Relations and Corporate Communications.

We are very pleased with our performance for the second quarter. Funds from operation grew 30% from last year to $1.12 per share and funds available for distribution were likewise up by 35% to $0.92 per share. Given these strong results, we are increasing our FFO guidance range for the full year 2006 by $0.10 a share, based on the midpoint of our guidance of 4.10 per share, this represents a 14% growth in annual FFO. The acceleration in our FFO has come from all three revenue sources, it came from our net operating income, from economic gain and from joint venture income and was driven by the growth of our platform, our capital sources and most importantly, our people. Therefore, we are now beginning to realize the economic benefits of a platform that is dedicated to offering comprehensive supply chain solutions to our corporate customers, ranging from light industrial to bulk warehouses and from single asset requirements to multiproduct, multilocation requirements.

As you know, attracting the right capital to undertake broad and/or complex industrial real estate needs is a key ingredient of our strategy. Last quarter, as you'll recall, to accentuate our ability to invest in long-term critical facilities, we announced the formation of a new co-investment with UBS and this program is off to a strong start. Yesterday, we announced the creation of another new JV, our second joint venture this year and our fourth since March of last year. Our new venture is a 950 million strategic land and development venture that will invest in land parcels and vertical development in growth market that we believe will benefit most from several important trends.

The first is the continued rise in international trade that we see driving increased investments in major coastal and inland ports. The second is accelerating demographic changes that are rapidly increasing the population of certain markets. For example, in Arizona and in Florida. And third, is the increased supply chain activity by our corporate customers who are realigning their operations to optimize both production and distribution and, of course, to be prepared for just in case scenarios. These three trends have and they will continue to increase the demand for industrial properties in targeted coastal and inland ports and in those markets that are experiencing large population increases.

The new strategic land and development fund will augment both the build to suit and the spec projects that we are already doing on balance sheet and the in-fill development projects of our first Cal One joint venture and later on, Mike will provide further specifics on our new venture. In anticipation of greater development volume, you now perhaps have a better understanding of why we recruited new development officers in those growth markets such as south Florida and the inland empire and why, in January, we hired Gerry Pientka as our new Executive Vice President of Development. So while we were already a significant developer across the United States, we wanted to expand this business even further based on the trends that I've just mentioned. We now have the necessary capital and human resources to make development a key contributor to future FFO growth.

While I touched on the growth in resources on our development side, I would also like to highlight for everyone that First Industrial is a much larger organization today overall than just one year ago. We have increased our personnel by 30%. The sole purpose of that expansion was to capture the opportunities in our industry. But more importantly we've not yet seen the full benefits of our expanded personnel and the reason is straight-forward, there is a lag time between when we hire someone and when their pipelines grow to their full potential. So in summary, the quarter was strong, the outlook is favorable, and now JoJo will tell you that we have a lot of opportunities that will keep us busy. JoJo?

Thank you, Mike. I'll begin by discussing our on balance sheet activities. Then I'll provide you with an update on our joint venture activities. And I'll close by reviewing our investment pipeline. For our balance sheet we acquired 29 properties in 11 separate transactions for a total of $94 million. On the development side, we placed in service two developments totaling $22 million for corporate customers Walgreens and Atlas Storage. In total, balance sheet investment during the quarter was $116 million.

In the second quarter again, we continued to bring real estate solutions to our corporate customers. And 46% of our total investments were within this target customer segment. Year to date, 66% of our total investments were with Corporate America. For the quarter, our investment yield exceeded the yield on dispositions by 145 basis points. Maintaining this yield spread is a key goal of our investment underwriting and by doing so, we will continue to generate profits from sales.

Moving on to sales during the quarter. We sold 44 properties in 27 separate transactions for a total of $201 million by the weighted average cap rate of 7.3%. I'd like now to move on to our joint venture activities. In our JVs we invested $292 million during the quarter, the majority of which was in our net leased co-investment program with UBS. The largest investment was a 900,000 square foot warehouse distribution facility in New Jersey in a foreign trade zone at exit 88. During the quarter, we also sold $203 million in our JVs, the majority which was in our First Cal 2 fund, as we execute our strategy to unlock value from that portfolio. As in prior quarters, we exceeded the leverage returns we projected at the time of acquisition.

I will now turn to a discussion of net economic gain. In a quarter, net economic gain was $31.1 million. On our sales, we achieved an unleveraged IRR of 15%. The average hold period for all properties sold in the first half on balance sheet and in our JVs was 2.4 years. This is a result of our active investment process borne out of our ability to uncover and create value quickly.

I would now like to briefly highlight three example that give us a good sense of our corporate focus strategy at work. The first one is a 376,000 square foot redevelopment at Halls Ferry Road in Washington, D.C. In December of '04, we acquired this well located property [Inaudible] from a corporate owner who needed only partial use of the property and was not capable or willing to redevelop. We executed our asset management plan and sold the excess land at a profit in April of '05 and later on sold the redeveloped property at profit to a user in the second quarter of '06. The second example is [Osprin Hefe]. This logistics customer owned 13 buildings in multiple markets and wanted to raise capital to expand their business yet also retain operational flexibility. We offered them a solution in varying lease terms and acquired all 13 buildings from them in the fourth quarter of '05. We sold a portion of the property in the first quarter of this year and the balance in the second quarter of this year. This is an example of a transaction wherein we generated profits through providing a customized solution and acquiring the investment in full and selling it in pieces.

The third example is the 19 users sale in the quarter. These sales reflect the benefits of our strategy to focus on corporate customers as the vast majority of these property sales were to customers who planned to grow their businessing and control their own facilities. Our corporate relationships and ownership of five different facility types make us able to arrange these sales to our customers. We've now generated economic gains for 27 consecutive quarters. For the full year, we expect the composition of our gains to be approximately 60 to 65% from land and merchant activity on our balance sheet.

Now to our pipeline. We define our pipeline as all acquisitions and developments under agreement as well as acquisitions already closed since the end of last quarter. Our overall investment pipeline for balance sheet and joint ventures is nearly $1.7 billion. Of that amount, acquisitions currently under agreement total $880 million and we've already closed $208 million in new investments since June 30. Together, these total about 1.1 billion or about two-thirds of the pipeline. Developments currently under construction and under agreement total $605 million.

Like in the past, let me now break it down by entity. This break down, by the way, also appears in your press release. Out of the $605 million of development, $246 million is for our JVs and the remainder for our balance sheet. Of the $1.1 billion acquisition pipeline, 677 million is for our JVs and the rest is for our balance sheet. Additionally our land holdings, which will be important for future development pipeline, total approximately about 1400-acres on balance sheet and in our JVs. These land holdings can accommodate approximately 24 million square feet or more than $960 million of additional development.

As Mike Brennan has discussed, our new land and development venture and our First Cal 1 JV gives us additional capacity to expand our land inventory and position us well for future development in strategic markets. With regard to the new land and redevelopment venture, we expect to invest the initial 950 million over the next three years.

Let me now distinguish the investment focus for the three sources of development capital. Our new strategic land and development JV will focus on coastal inland ports that will benefit most from international trade and supply chain reconfigurations. It will also focus on markets that will grow from increasing populations. Our First Cal 1 JV, which we started last year, invest in all of our markets across the U.S. to satisfy existing customer demand. Predominantly for in-fill projects. In our on balance sheet, invest in build to suit projects and as you recall, we have a sizable land inventory on our balance sheet that we can use for further development.

So in closing, we continue to deliver strong gains and our pipeline of investment opportunities remains strong for our balance sheet and our ventures. And with that, I'd like to turn it over to David Draft.

Okay, well, thanks, JoJo. As I usually do, I would like to start with some brief comments on the market industrials fundamentals the industrial real estate sector. After which I will review our own portfolio results.

Nationwide occupancy was even at 90.1% versus the first quarter of 2006 and that's as recorded by [Inaudible] Also of note and I'm sure you saw last week, many of the key macro economic statistics important to the industrial sector showed better than expected strength. Industrial capacity utilization was 82% for the quarter, which was the highest in six years. Industrial production rose at an annual rate of 6.6%, which was the largest quarterly rise since the fourth quarter of 1999. Net absorption in the quarter was approximately 55 million square feet, which was more than double the previous quarter and deliveries were about 42 million square feet. So, overall, business activity remains strong and the need for industrial space should continue to rise. So against the backdrop of those positive fundamentals, I'd like to just now turn to First Industrial's on balance sheet portfolio results.

Turning first to occupancy. Occupancy increased 150 basis points in the quarter. Going from 90.7% in the first quarter to 92.2% in the second. This increase resulted from a combination of several factors. First, we saw a strong level of new leasing. Second, retention in the quarter was strong at 87.2%. And, third, we successfully completed a number of asset management plans through the sale of buildings to user buyers. Occupancy increased in a majority of our markets during the quarter. We continue to see good activity in markets near to the coast and where demographic and logistics trends are increasing the demand for space. Examples of these markets include northern New Jersey, central PA, Houston and Phoenix. Specific industries that were most active in the quarter included packagers and distributors of food products, general warehousing and logistics companies and wholesale medical equipment suppliers. Now, based on what we see for the remainder of the year, we maintain our previous guidance of occupancy coming in at about 92% average for the full year 2006.

Turning now to NOI. Total NOI in the quarter was 65.3 million, that's an increase of 6.3% from the previous quarter. This increase was primarily due to higher occupancy, contractual rent increases built into existing leases, and a reduction in some of our property operating expenses. As well as an overall increase in the size of the portfolio. Of course, this also had a favorable impact on same-store NOI, which is positive 1% on a quarter over quarter basis. And on a cash basis, excluding lease termination fees, same store would be 2.2% positive.

Looking ahead, we expect same-store NOI to average 2 to 4% positive in the second half and that would result in a full-year same-store being positive. Rental rates also improved in the quarter, declining just 0.5% as compared to the negative 2.3% in the first quarter and negative 4.4% for the full year 2005. Looking at the second half of this year, we expect continued improvement in rental rates with a good chance they will turn positive by year-end. Now, one factor in this outlook is that we're getting close to the end of renewing leases originated in the higher rate environment of some years ago.

Lease costs in the quarter were $2.35 per square foot and that's essentially even with 2005. And then finally, with respect to lease expirations remaining in 2006, we're in good shape there, ahead of where we usually are at this point and looking further out, our rollover in 2007 is on a percentage basis, less than it has been in recent past years. So we like that, too. So in sum, we had a very strong set of operating results in the quarter. We are also confident that we will see more good results as we go forward. So with that I'd like to now turn the call over to Mike Havala.

Well, thanks, David. First, let me provide you with an update on our capital markets activities. Yesterday, we announced a significant new joint venture. This new joint venture is a 950 million venture which is focused on investments in strategic land parcels and the associated vertical development. As our other ventures, this is additive to what we already do, not just in terms of capital capacity, but also in our ability to serve our customers. So here, let me give you a few specifics on the new venture.

Our partner is CalSTRS, so this is now our third venture with them and of course we're very pleased to be furthering our relationship with them and their adviser, who is CBRE Investors. The expected capitalization is 35% equity and 65% debt. CalSTRS will initially contribute up to 300 million in equity and then First Industrial will initially contribute up to $33 million in equity. So that equates to a 90% and 10% interest respectively. Something that's very important to note is that the capacity of this venture could greatly exceed 950 million in activity for two reasons.

The first reason is that both the debt and the equity are revolving. So that means we can invest a lot more than the stated 950 million if we develop and sell assets which of course is exactly the plan for the venture. Second, if the initial $950 million investment is reached at any one point in time, we've already agreed and provided that the venture can be expanded up to 1.6 billion total through additional capital contributions and debt financing. And then the last point I wanted to make regarding this new venture is that we'll receive fees for development, property management, leasing, dispositions, and portfolio administration. And then importantly, we also have the opportunity to earn performance-based incentives, also promotes.

We've been busy raising private capital since the beginning of last year so I thought it might be helpful if I summarize exactly what we've done. The four new ventures that we've created since the beginning of last year are first, a $950 million joint venture that focuses on infill development and redevelopment. Second, a $1 billion venture that has already invested in a $1 billion core portfolio. Third, a $900 million venture which acquires net lease properties and enters into sale leaseback transactions. And then fourth, as we just announced, our new $950 million joint venture that focuses on strategically located land and development of that land. So in total, through these four new ventures, we've added nearly $4 billion in additional capital capacity since early last year.

Next, let me talk about the balance sheet. As we have for many years, we continue to maintain our financial strength. We have a weighted average debt maturity of 8.5 years, 100% of our permanent debt is fixed rate and we have a strong and improving fixed charge coverage ratio of 2.9 times. Moving to the results for the quarter, FFO per share was $1.12 and this was up 30% from the second quarter 2005. And note that this exceeded the high end of our guidance by $0.11. This outperformance against our guidance by $0.11 was driven by these factors.

First of all, NOI was higher than expected by $0.05. Economic gains also were higher by $0.05. And then the remaining $0.01 was just due to some miscellaneous items including JV FFO being higher. So essentially higher NOI and higher economic gains were the reasons for the FFO coming in above our guidance range in the second quarter.

The last comment I wanted to make about the quarter is note that our FFO payout ratio has improved to 62% and our FAD payout ratio has improved to 75%. Next, let me talk about our guidance. As noted in our press release, we increased our 2006 FFO per share guidance to a range of $4 to $4.20. At the midpoint of our guidance range, our FFO growth would be nearly 14% in 2006. And please note that we expect to provide our guidance for 2007 at our investor day, which has been scheduled for October 4.

So with that, let me conclude and say that 2006 is going very well. The investments in our platform and people and having significantly more capital sources are really starting to pay off. We're seeing higher growth this year and we're positioned for growth in the years ahead. With that, let me turn it back over to Mike Brennan.

Okay, thank you, Mike. As we mentioned earlier, we've seen positive momentum in our business in the first half of 2006 and that I can tell you was the product of a lot of hard work and planning on the part of the team. Our business model is built to serve Corporate America. And as such we've identified the growth trends in international trade, in the demographic changes, in supply chain reconfiguration and, of course, in the ongoing acquisition of redundant assets from Corporate America. To meet those needs, we expanded the platform and we added human resources. And then, we attracted nearly $4 billion in new capital to support our strategy including a value-added redevelopment joint venture, a core JV, a net lease JV, and now a strategic land and development venture. And the early results are showing momentum within all parts of our business from our portfolio, from our capital recycling and our joint venture activities. So we feel good about our performance in the first half of '06 and we feel even better about the future. We've got a strong pipeline, we have ample capital, and we have a talented group of people who have executed well for all of us. With that, moderator, we'd like to open it up for any questions.

Thank you. [OPERATOR INSTRUCTIONS] Your first question comes from John Stewart of Credit Suisse. Please go ahead.

Quick question for Mike Havala on the guidance. So it looks like you're raising the FFO per share guidance by $0.10, but if you look at the increase in net economic gains, midpoint to midpoint that's up about $0.20. In anything, it seems like the core is improving a bit. So I assume that's not the offset. Can you help us understand what the offset may be, whether it's higher G&A related to those net economic gains or interest rates?

Sure. Let me walk through our guidance increase of $0.10 for the year, John. Basically, it's composed of three main components. We saw a JV FFOs being higher so we raised that an effective $0.10. Likewise with economic gains, that being higher, that contributed another $0.10. So that's $0.20 total. So there's a $0.10 offset, of course, and that is just -- lies in higher interest expense and G&A. So those are the three components that net to a $0.10 per share increase in our guidance for 2006. Does that answer your question, John?

Yes, that's very helpful, thank you.

Thank you.

I also wanted to ask about the breakdown of JV FFO, if you look at footnote 8k in the quarter, it looks like 13 million was from inventive fees and 1.4 was your pro rata share of operations. Is that 90/10 breakdown a good run rate for what you're expecting for the rest of the year?

Not necessarily. Again, it's going to vary a little bit, quarter to quarter, depending on the incentive payments. The pro rata share of operations, John, should be relatively consistent and the fees will probably be increasing, again, incentive payments will vary a little bit quarter to quarter. But certainly order of magnitude the fees and incentive payments will be significantly higher than the pro rata share of operations.

Okay, got it. And then with the new land and development JV, I assume that any -- there probably won't be any near-term contribution from that. Is that fair?

Yes, John. For 2006. We really don't anticipate that new venture having any meaningful impact on the numbers for a couple of reasons. Number one, it's halfway through the year already. And, two, when you look at the investments in the -- inside the venture in land and development, that really shouldn't have any near-term effect for us.

Okay. Last question. I understand that you've generated net economic gains 27-quarters in a row and obviously some of those have been on deals that you bought very recently. So while you've benefited from cap rate compression, that's not necessarily been the entire driver for those, for generating those gains. But in the event that cap rates do move against you at some point, can you, how would you quantify your exposure to a backup in cap rates?

Okay, John, hi, this is JoJo. A couple things. Actually cap rates have come down since the start of the year. And--.

Right, but they can't come down forever.

That's correct, John. What I was going to add was that cap rates, we do see some stabilization and we don't see meaningful moves. A couple of things. If cap rates do go up, it will not have a material impact on our business. And I wanted to give you a couple of reasons. One is that, as you know, the no NOI portfolio on our corporate portfolio has gone up. So, if cap rates do go up, our NOI -- the value of our portfolio continues to go up.

The other reason is that even in the past, for the last, for since we've been public company and inception we have been focused on spread investing. One of the things we do in our investment is that we always try to see where cap rates are going and we try to invest at a spread. You can do that if you're an active investor or an active developer. You can't do that if you're passive because that really dictates that you either develop or buy below market. And because of our wide platform, we're able to do that. If you look at over about 5 to 6 years ago, where we've been giving you the spread, our investment yield, which is a combination of acquisition and development yields, have consistently had a spread over exit yields. For example, this quarter, it's over 140 basis points. So as long as we continue to do that, we think we will continue to generate economic profit. Does that answer your question, John?

Yes. Thank you.

John, this is Mike Brennan. Just, I agree with what JoJo said. Just to add to that as the summary, for us, margins, the greater our margins, really the greater our solution, the greater our margins. That's really been the secret of our success. So and the ability to generate solutions means to see a lot of things and be capable of doing a lot with what you've seen. So that's why we've been able to maintain the spread. That's why when you look at the average transaction we sold in as much as it is a very short life in terms of holding it, it wasn't as you said, due to cap rate contraction.

So it really lies in the business model of seeing more things and doing what's difficult for others to do. And then taking those capabilities and focusing it on the biggest market that we can find. And that's the Corporate market. And also, as I mentioned, we also have more people on the ground doing that. We've got a 30% increase in the amount transaction officers that are are applying their craft throughout the nation. Higher than we had last year.

Okay. Thank you.

Thank you. Your next question comes from Paul Adornato from BMO Capital. Please go ahead.

Thanks, good morning. With respect to the new joint venture, was wondering if you could talk about the risk tolerance of that venture in terms -- or perhaps tell us a little bit about the criteria for acquiring land, how long would you expect to hold it? And what might be the criteria for starting new developments? Will they be build to suits or will there be a speculative component to it?

Paul, hi, this is JoJo Yap. Let me address all your questions. One is that like we said, we are going to target a location that will benefit from supply chain reconfiguration, really the increased level of containerized cargo due to the increase of international trade and really the positive above average growth of demographic changes in the market. So where are those markets? You look at those markets, port markets are certainly within our target, within our range. New Jersey, the Southern California area, which really includes South Bay and the inland empire. Of course we also have to focus on inland ports, but what are those? Those are Dallas, I would say Chicago, Harrisburg, and Columbus.

One of the -- a couple of markets, too, that will benefit from all this is the hub market. Again, there's Chicago, Dallas, Atlanta, New Jersey markets as you know. The -- when we find these opportunities in these markets, we will go in with a long-term view, again, and look at how these investments would fit the trends that we've mentioned. Now, in terms of investment, initially you can expect most of the investment will be in land. Of course, we believe that the most valued creation and most profits we can generate will come from vertical development of these land acquisitions. But at that point in time, you expect us to make the most optimum investment decision, whether value creation is optimized by either vertical construction or land sale. So, those are the things you should expect us to do. And I just like I mentioned, we expect to invest the 950 million over the next three years.

Paul, does that answer your question?

Yes, yes, it does. I guess the next question related to that is now with this new JV with which FR has a piece, I was wondering if you could talk about FR's overall risk profile and how does this development in land JV fit into the FR equation in terms of the Company's risk profile?

Okay, Paul. Yes. Well, basically, this actually completes, it's really the last piece of the puzzle of our development strategy. As we mentioned to you on our balance sheet, we primarily built build to suit for customized solutions of our customers and on the land that we own. Our FirstCal 1 JV really develops in all our current markets. And in all product types, in all of the industrial product types to meet immediate customer demand. And this one really positions First Industrial to capture the future demands. So we're very, very pleased now that heretofore, now we really have the complete puzzle for the development effort.

In terms of the risk profile, the way we look at it is that we really following our customers, really from start to finish. And there's for us, there's no better way to provide a solution to customer other than really being able to provide a development solution if that's what they need over the whole life cycle. So in terms of risk, the only thing I would mention to you is that we have adjusted our returns to basically arrive at a risk adjusted return for every joint venture.

Okay. So is it safe to say that it's not likely that we'll see a new development joint venture beyond, from this point forward?

As far as we can tell right now, we're not working on any current development joint venture. Of course, things might change. But at this point, no. We are not currently working on another development joint venture, Paul.

Okay. And just with respect to the incentive fees and management fees, I think you listed a total in the footnote of 13.101 million combined incentive fees and management fees. That's FFO from those two sources. I was wondering if you could break up that 13.101 into those two pieces.

Paul, yes, that's something that we don't provide just because again, we need to respect our partners' request for confidentiality and so forth. And so that's just something that we don't break down between the different types of fees and so forth?

That includes all of the JVs, is that correct?

Correct.

Great. Thank you.

Thank you. The next question comes from Stephanie Krewson of BB&T.

Good afternoon, guys, great quarter.

Thank you, Stephanie.

Two quick questions. Just to clarify on the new JV, the ability to win build to suit mandates I think everybody knows is highly dependent upon having land ready to go in key markets. More so than any other thing. So this JV basically is a land bank short term that positions you through it to win more build to suit activity; is that correct?

Stephanie, this is Mike Brennan. As -- really the new joint venture is positioned as JoJo mentioned in the path of growth. It contains larger parcels in contrast of to FirstCal 1, which is more in-fill in contrast to our balance sheet, which is more in-fill and more focused on build to suits. So this new joint venture has a longer investment period, but you can start build to suits or spec immediately, but there's more land involved. So it can do build to suits and it will do spec as well. It has a longer horizon and its placement is, as JoJo mentioned, in the demographic areas. In the areas that can benefit the supply chain, which is a hub market. And then those areas benefiting from international trade or from inland ports. So all three of our land holdings on balance sheet in FirstCal 1 and in FirstCal 3 can do build to suits. They're just set up to do different things and focus on different aspects of our customers' needs.

Thank you, that's helpful. By extension, then, am I correct in reading into this that the value creation event for the REIT will not be contingent upon stabilization of a developed property? In other words, you make money through the the process and you don't have to wait for an asset to be stabilized for the JV and, therefore, you will pro rate a share of the economics to start flowing through; is that correct?

Yes. Although FirstCal 4, although larger in its scope in terms of what it takes down, will operate similarly. So you have fees and promotes coming off of individual buildings, whether build to suit or spec. We also do land sales, the lot sales as well when we buy large parcel. So as Mike said, Mike Havala, we have assumed no earnings contribution in '06, but we would likely begin to see that in '07 in the combination of things that normally come off of a land and development undertaking.

That's a very fantastic and savvy structure. Congratulations on that. One other quick note. And this is more of a broad-based question. Have you considered the weaker than expected UPS outlook into your forecast? Or have you considered that specifically as sort of a macro commentary on demand for industrial space?

Well, no, not specifically. What we have, I think Dave made a great case of some of the signs of health we've seen in the capacity utilization, in the absorption, in the industrial production, in the business spending. But we've also, so while we've seen good things, we've also tried to be very, very conservative in our outlook or what we project in terms of leasing. So we try to take as much input as we can and then come back and try to make a reasonable and conservative decision as to our prospects.

Great. Thank you very much. Once again, congratulations, gentlemen.

Thanks, Stephanie.

Your next question comes from Ross Nussbaum of Banc of America Securities.

Most of my questions have been asked. I just had a nitpicky one on the income statement that I don't think you addressed. Maybe I missed it. Can you discuss the tenant recoveries other income line that came in meaningfully higher than we expected? What was the driver behind the growth there?

Just on the tenant recoveries, this is Dave, by the way, Ross.

Hi, Dave.

Tenant recoveries increased primarily for two reasons. One is an increase in occupancy. 110 basis points over the prior year, and 150 basis points over the prior quarter. And owning a larger portfolio. Our portfolio was about 3.9 million square feet larger on a year-over-year basis.

Okay. So it's really the recovery is not the -- there wasn't anything sort of one-time in nature that drove that?

Not so much. It was more of a result of the size in the occupancy.

Okay. And then the other question I have for you is just sort of some macro commentary on the supply demand/outlook in the U.S. You had talked about industry occupancy being flat from Q1 to Q2. I'm just curious, where do you guys see industry occupancy going in the second half of the year? And it sounds like, at least it looked from us anyway in the second quarter that the spread between new supply and space absorbed has narrowed from where it was at the end of 2005. Where do you sort of see that trend going?

Well, it has narrowed somewhat, you're right. We see an increase in demand, Ross, but not an extreme increase. And let me just kind of bring it down into our own portfolio, which I think will probably play out fairly close on the national scene as well, although as you know, we're ahead of the national occupancy. But in our own portfolio, we're looking for about a 90 -- between 92 and 93% average in the second half of the year. Whereas we averaged 91.5 in the first half. So yes, we see an increase in the second half, but it's as I mentioned a moment ago, it's not an extreme increase.

I think as we look around at the opportunities that we're working on today, we look at our retention rate. We look at the RFPs that we have out there for new space. We look at a number of the macroeconomic fundamentals that I referred to in my presentation and you kind of add it all together, and I think it's good news, it's a positive outlook. And we -- we're looking forward to increased results over the second half.

Thank you.

You're welcome.

Thank you. Your necessity question comes from Jim Sullivan of Green Street Advisors.

Thanks, a couple of questions, Mike Havala, I understand there's a lot of things in your business that are difficult to predict. But I think I heard you say that one of the positive surprises in FFO was that NOI was $0.05 higher than you expected? It would seem like NOI would be one of the factors you could predict with some certainty, why was it so much higher than you expected?

Sure. Thank you. Jim, as far as NOI being a little higher than expected in the second quarter, that was a result of occupancy going higher as well as our tenant retention was very high during the quarter at 87%. Another way to say that is our downtime was very little. Because we had so much retention during the second quarter. That really has a positive impact on your NOI. And of course the last thing always is, is the timing of your buys and your sells of assets during the quarter -- I can't expect that number. But those are the primary reasons why our NOI went up in our second quarter a little higher than we had originally projected.

All right, got it. Okay. With respect to the guidance, you increased the guidance for sales volume from I guess 750 at the midpoint to something like 900 million. Yet the economic gain outlook at the midpoint went from 110 to 115. Why wouldn't the incremental $150 million of sales generate more than a $5 million growth in economic gain?

Jim, hi, this is JoJo. When you look at the year, where we started the year, our after-tax margin was about close to 13%. If you look at, now, at the forecast, it's closer to about 12.5%. And I wouldn't look at it from an incremental point of view but really the rest of the half. And let me give you reasons why that after tax margin notched down a little bit.

One is that we have had a significant increase on our corporate business and an increase on the immediate sales as part of our value creation strategy. What's interesting in these corporate deals is that we do have a lot of cash flow when we acquire these leasebacks. And so when we sell it, despite the fact that we might have a lower than, a slightly lower after-tax margin, the IRR is significant and well over above our cost of capital and we make a good profit there. So in the year, we expect significant amounts of these corporate acquisitions with immediate fee sales. The next reason or the other reason is that we have sold some underperforming assets in the first half of the year. And Jim, we'll also expect to sell some underperforming assets in the second half of the year. So by and large, the margins have been really significantly changed from a whole year point of view. But because of these situations, we expect it to notch down a bit.

Is G&A a factor there? It seems like the G&A associated with the economic gains is creeping up as a percentage of the gain.

That's not really a factor there as far as from a margin analysis point of view. Generally, as you see, Jim, we split out the G&A associated with economic gain in our supplemental. That number is going to range anywhere from, say, 7 to 15% of the economic gains in any one given quarter. And again, that's just because of the mix of the gains and how the compensation plan works. So that really shouldn't be a factor.

Mike, a question on depreciation, when I look at the balance sheet and I look at June 30. '06 versus June 30, '05, the buildings and improvement line increased something like 5 or 6%. Yet when I look at depreciation in the second quarter of '05 versus the second quarter of '06, depreciation went up over 50%. Why would depreciation go up 50% plus if the portfolio didn't really grow very much?

Jim, that has -- the reason that has done that, I think you'll see this similar in other REITs as well is because of the effects of 141, FAS 141 where you are allocating a lot, or part of your purchase costs, to things like the value of leases. So you have a shorter period for what you're depreciating, what we would all consider real estate. But under FAS 141, part of that purchase price gets allocated to things, again, like the value of in-place leases. So that's the reason why you'll see depreciation increasing from periods past. And again I think that's something you'd see from other companies as well.

So effectively depreciation is being accelerated versus--?

Exactly, exactly.

And naturally that's interesting from an FFO standpoint in how much is being added back? With so much development capital available to you, what do you think you can get your annualized pace up to, given what is not a shortage of capital, but given the infrastructure that you have, how much volume can you guys do?

Jim, I don't want to -- this is Mike Brennan. I don't want to venture a guess right now on that. But we are optimistic that it's going to rise and rise significantly. Obviously, we have more land. Obviously, we have -- we have more opportunity to see things. But I think the personnel will be the big story. And, of course, what we buy, but the personnel is huge to us. I mentioned to you that we hired Gerry Pientka to be our Executive Vice President of Development. So we've got a person with great ability and great contacts. All of our managing directors, you know our structure, Jim.

Our recent hire was Bob Carlett, he came from Duke. And Weeks, and High Woods. He's got -- now all of our managing directors have a development background and Bob our latest hire does, too, and he's the President of National Association of Office and Industrial Properties, that's our -- that's the nations largest development organization. So we expect big things from him. You are, of course, familiar with the new hires that we did in Miami and in the inland empire and maybe several others that you may not be aware of.

So what we try to do when we hire somebody is we want them knowledgeable about both properties and people and come with a book of business. So I think in October, at investor day, we can give you a much better answer. So if you don't mind me holding off until then, I will. And then I think we can give you an answer that is based on a lot of research and increasing pipeline.

And my last question is for JoJo. JoJo, if I heard you right, you said the average holding period on the assets that were sold during the quarter was 2.4 years. Give that the sales were split evenly between joint ventures and the wholly owned portfolio, and given that the joint venture sales pretty much came out of the development joint venture, whereas the holding period was pretty short. Is it fair to conclude on the wholly owned stuff that the holding period was something like 4 or 5 years?

No, they were fairly similar, Jim. Because we are conducting a significant amount of merchant activity also in our taxable REIT subsidiary. And so there was a lot of sales that came through that. But you're right, that the FirstCal 1 JV, there's a lot of development there. But also there's a lot of redevelopment there. So there's not a major difference between the holding periods for this quarter.

Okay. I was looking at page 14, it looked like a lot of your economic gains came out of the development JV. But, okay. Do you guys do an attribution analysis when you sell an asset that you've owned for a while to see how much of the gain was generated by improvements that were brought to that asset by you through lease out et cetera and how much was attributable to simply the declining cap rates over time?

Well, the way, the way we -- well, the analysis that we do to measure our performance really is not doing that, Jim, but to compare our actual performance versus the projected performance at a time of development commencement or acquisition or presentation or approval of a transaction. And what we do is that we do a debriefing here in the Company where what went right, what went wrong, what could we have done better? And as you know, we do a lot. So what we do, we do that to try to improve our investment and development process.

But we don't really dissect the gains that profits that came from either lease-up or vacancy or cap rate or from the strong initial yield, for example. There are so many factors, I don't, as an investor and developer, you can spend a lot of time there, but I don't know what the meaningful trend we can get. But when we monetize a transaction the first thing we ask ourselves, did we do what we said we were going to do at the time of investment? It is not why not, if we did better, how can we do -- how did we do better? How did we -- you know. If it's worse, what can we learn from the transaction? I hope that helps you kind of.

Jim, just to add to that more globally, we sold about $3 billion. There's very, very little things that we sell that come from 94 to 99. Again, we have recycled out through those. So most of the stuff that we're selling right now was bought in a low cap rate environment. And is being sold in a low cap rate environment.

We do do an analysis on and I think everybody that's sold properties will appreciate this, what did we say we were going to get in terms of net operating income, and what did we get? Now, net operating incomes were down in most of the things that we bought in 2000 and 2001 and 2002. We didn't predict where the market would go and also cap rates are down. So while it was true we didn't predict a cap rate decline on some of those assets like we saw, we didn't also predict a net operating income decline to the degree that we saw. So now, if we lose something on cap rates going up further, if we lose -- if whatever margin we might lose on cap rates going up, we hope that with the increase in fundamentals, we'll gain it back on the net operating income side. So hope that gives you a little bit more clarity, Jim.

Yes, it's very helpful. Thank you.

Thank you, your next question comes from Sri Nagarajan from RBC Cap Markets, please go ahead.

Thank you, I'll try and be quick. With respect to the $0.10 offset due to interest expense in G&A, Mike, can you break it out as to how much was interest and how much was G&A in your projections? And within G&A is it because of increase in personnel or compensation expense?

Sure. I don't have the exact breakdown here, but it was weighted a also bit more towards G&A than it was interest expense. And again, that's just in -- G&A's increasing a little bit. We're not talking a big number here, but it's increasing a little bit, partly due to some additional investments in the development infrastructure and so forth.

Okay. A couple of questions in the fund just continuing and that strain. The new land and JV fund, why not go international from your comments it appears to be a pure U.S. domestic fund at this point?

Mike, you want to answer that?

Yes. Yes. It is designed to be a U.S. venture because that's our focus for First Industrial yes, exactly.

Is there a specific minimum holding fee for the property before you can dispose of in the fund itself?

No, there's not.

Okay. Thank you.

You're welcome.

Thank you. Your next question comes from John Litt of Citigroup, please go ahead.

Hi, it's Craig Melcher here with John.

Hi, guys.

Your acquisition cap rates so far this year have been around 8.5, which is right around where your development yield are expected to be on your current pipeline. What are you expecting in terms of a spread between acquisition cap rates and development yield? What level do you look for in order to go forward with a deal? What should we expect in terms of yields for the new fund venture?

Okay. Your question was -- what I understand your question to be is what yields do we expect to commence in the development? Well, first of all, we're a total return investor. So the main determinant of any of our investments, whether on balance sheet or off balance sheet is internal rate of return. And then the only difference between on balance sheet is we apply an unleveraged criteria and on a joint venture basis, we apply a leveraged criteria. Okay.

Having said that, the next growth that we apply is spread. Now, so in the whole country, there is a spread between markets from the lows, for example, of a 5 to 6% cap rate to maybe a 6.5 to 7.5 cap rate depending on location. Now, so depending on what location the property is, we adjust for that spread. So that's the second component. IRR first, spread next. And lastly is the risk and investment. If you're doing a build to suit, of course, you're going to accept a lower spread, everything else being the same on a speculative development. You're, of course, going to require a higher spread. Vis-a-vis the projected returns or -- yields between acquisitions and development, overall, we don't expect that to be significantly different. As we mentioned to you before, that we're active investors so most of our investments are value-added. And our developments, of course, are primarily born of our solutions we provide to corporate customers that allows us to get those kind of yields.

So again, the other thing I want to mention is quarter by quarter. It will vary and it's pretty volatile. I don't want to predict quarter by quarter. Trends between acquisitions and development. But we look at it more from a -- I suggest we look at it more from a long term point of view, maybe year-over-year. If you look at year-over-year changes, our investment cap rates don't really, has not really changed that much. If anything, they've actually moved quite consistently with the market cap rate. Does that help you?

Yes, would 100 basis points if you have a deal that you could say buy an asset for 6% cap rate, you could develop to a 7, would you be okay with 100 basis points? Is that a good number to think about?

Again, -- what -- if it's within the range, we just have to make sure the IRR, of course, also works. So, yes. The answer is that we invest -- there is an investment profile that allows us to do that. Yes.

And just looking at your lease expiration schedule, about 10% of your portfolio is rolling in the second half. What are you expecting in your guidance in terms of a renewal rate for that space?

Sure, this is Dave. I think our renewal rate is going to run more along the lines of the historical average, call it in the 70% area. We had a little lower first quarter, a also higher second quarter here. But probably even out in that 70% area.

Thank you.

Thank you. Your next question comes from Chris Haley of Wachovia, please go ahead.

Good afternoon.

Hi, Chris.

Hi. Congratulation on the venture creation on FirstCal 3.

Thank you.

I was really interested in the formation, the steps in which this was created and the interest from the institution, your partner, of buying into a land portfolio versus buying into an income portfolio. Just from reading the press release and hearing what you're saying, it sounds like it's going to have a carry period to it before there's an income period to it. I'd just like to get a little color on that creation process, and how they looked at the land, at Land Adventure.

All right. Well, I think one of the good things about our co-investor, our partner in this case is they really are looking out to the future as are we, about some of the things that are impacting the demand for industrial space. Things like international trade and supply chain reconfigurations and population growth. They're very much in sync with what our thoughts are on those factors. And that's what got us together so to speak with respect to our venture. Certainly, again, you need to have somewhat of a longer-term view of where things are going to be an investor in this and obviously we're very much in favor of that and think it's a fantastic thing that we have set up here. And even a little unique, I would say, as well. I think Chris, as you were alluding to. So I don't know if--.

Was the -- is there -- your FirstCal 1 is quote unquote an opportunistic venture. Which this appears to be an opportunistic venture as well. But it has a, obviously the words you're using are a land bias initially which would carry a much lower rate of return initially with hopefully a higher as you say total return, keeping all things constant which rarely is. So I'm interested in understanding what CaLSTRS sees in buying dirt, large chunks of dirt that have a longer duration to them, that have a 3 to 5-year-plus buildout period versus what you said before regarding First Cal 1 which can do quick turnaround, build to suits, in-fill, and what First Industrial will do on their balance sheet, which is quick turnaround in-fill deals.

Chris, this is Mike. Maybe I can kind of give you a historical viewpoint and how it maybe fits into our strategy. The -- when we look historically at our land investments, properly done, properly underwritten, some of your land investments are really your most powerful in terms of overall return. So when we looked at the intelligence that we had in the field, we knew that there were a number of parcels that could be purchased at a bulk discount if we had a competitive advantage of a partner that had a longer-term horizon. So, FirstCal 1 does in-fill parcels that are ready to go for immediate demand. FirstCal 3 identifies parcel, larger parcels and that's a distinct competitive advantage. Because we won't pay nearly the price for the large land tracts that we pay in our in-fill parcels.

So one -- so again as we look at that, as we look at what we've been able to do in the large parcels, the discounts we're getting, and then if those parcels are close to really the paths of growth, we think that that represents for us and our partners substantial capital appreciation. Now, the returns as I mentioned, will come over a longer period of time. But that should start right in '07. It's just that these parcels are larger.

You mean the return to you or the return to the partnership?

Return to both us and the partnership. There will be an unrealized portion of the gain in the partnership over a period of time. But the cash flows and promotes will come off as we begin to develop out these parcels in the path of growth.

Is this structure the same in terms of you received disposition fees from FirstCal 1 and development fees, but you do not receive acquisition fees?

That is correct.

Okay. Not entirely -- okay. On the return thresholds, how would you characterize FirstCal 1's return thresholds during a discussion or the formation periods versus the return thresholds to CaLSTRS on FirstCal 3?

Okay. This is JoJo, basically we've set the leverage returns threshold for FirstCal 3 higher than the FirstCal 1 joint venture. And for basically the reason it carries a higher risk. So, when we look at our historical performance, within First Industrial and we actually have a pretty good track record in terms of returns coming from land investments and ultimately vertical and immediate redevelopment. So we adjusted those. And those are things that are -- our partner and our -- feel appropriate in adjusting these returns.

I just want to add, too, that our partner here, it was also their missing piece of the puzzle as I mentioned before. As our missing piece of the puzzle is that when you really look long-term what you want to be is within all parts of the development cycle. Having all the tools and capital to participate in all the development strategy. And heretofore, CaLSTRS does not have a platform to effectuate that. And heretofore, First Industrial does not have the capital to basically benefit from these long-term trends. That was the wonder -- number 1 impetus for this new joint venture. It really filled both companies' objective.

CaLSTRS look at the land, the land market as you're saying that -- they are underexposed to the industrial land market. Did they look at any other institutions or did you speak to any other institutions that had a desire to be in this asset segment?

Chris, this is Mike. We did speak to some others with respect to this idea and concept. But as I said, the deal that we struck again, especially with our partner, who really could see things and visualize things as we did, and then economically of course, that was the best execution for us. One thing I also want to mention that -- just to make sure that it doesn't get lost in some of the questions and so forth, is that what this venture really helps us accomplish, I hope, is give you a lot more visibility with respect to our earnings from development. Because what we may do in this venture as an example is buy larger tracts of land and those land tracts will have multiphases to the development. So phase one maybe is 2007. Phase 2 is 2008. Phase 3 is 2009. Phase 4 is 2010. And so forth. So hopefully, just to maybe clarify and I'm not sure if you were ask some of this, is that while we could see some early returns from this in '07, that this venture will have a nice long lasting positive impact on our earnings going out a number of years.

Okay. Great. That's very good input. Thanks much.

Thanks, Chris.

Thank you. Your next question comes from Richard Paoli from ABP Investment. Please go ahead.

Hey, guys. I just have one follow-up question and I hope it's not too banal, I guess. But early you referenced the 141 adjustments that make you allocate some of the purchase price to, I guess, below market releases and maybe everybody else on the call kind of gets this. But could you walk through how that either benefits or hurts your FFO accretion or I guess gains, compared to how it was previously calculated before?

Sure.

141?

Sure. It has no impact on that. The only impact it has is with respect to depreciation which, of course, is adjusted for when you calculate FFO. So it really doesn't have any impact on FFO. And just to clarify, most of what gets allocated in the FAS 141 is not, in our case not above or below market leases but it's the value of in place leases. So, anyway, no impact on FFO. Does that help?

I guess so. What you're saying is it's a different depreciation schedule, that's all basically or period?

Yes.

So you'd look at the total price regardless of whether it was a premark, a below market lease or not?

It's total cost that we have into a project regardless of the 141 adjustment.

Okay. Thank you for clearing that up for me. Thanks.

You're welcome.

Thank you. [OPERATOR INSTRUCTIONS] Your next question comes from John Stewart of Credit Suisse. Please go ahead.

Just one quick follow-up. Mike, can you give us a sense for what total G&A will be for the year?

Yes. Hey, John. If you look at the first 6 months, the second 6 months will be in that range, but I will say probably a little bit higher, but fairly close to where you saw it in the first and second quarter.

So, including G&A from economic gains, we're looking at 75 million?

I'm not going to provide you specific number on a line item as far as guidance goes, John. But again, if you look at the first two quarters, you'll see that the run rate was pretty similar in those quarters. And I think that's a reasonable way to look at the second half of the year.

All right. I guess I was just trying to zero in on it since you had kind of indicated that was one of the offsets for--.

Understood.

Okay. Thanks.

Okay. Thanks, John.

Okay.

Well, I think moderator unless there are any questions, that concludes our call. We hope to talk to everybody soon and remember to save the date October 4, is our investor day. Thanks.

Thank you. This concludes First Industrial conference call. You may now disconnect. Thank you. [OPERATOR INSTRUCTIONS] Your first question comes from John Stewart of Credit Suisse. Please go ahead.

Quick question for Mike Havala on the guidance. So it looks like you're raising the FFO per share guidance by $0.10, but if you look at the increase in net economic gains, midpoint to midpoint that's up about $0.20. In anything, it seems like the core is improving a bit. So I assume that's not the offset. Can you help us understand what the offset may be, whether it's higher G&A related to those net economic gains or interest rates?

Sure. Let me walk through our guidance increase of $0.10 for the year, John. Basically, it's composed of three main components. We saw a JV FFOs being higher so we raised that an effective $0.10. Likewise with economic gains, that being higher, that contributed another $0.10. So that's $0.20 total. So there's a $0.10 offset, of course, and that is just -- lies in higher interest expense and G&A. So those are the three components that net to a $0.10 per share increase in our guidance for 2006. Does that answer your question, John?

Yes, that's very helpful, thank you.

Thank you.