First Industrial Realty Trust Inc (FR) 2017 Q1 法說會逐字稿

Good morning, my name is Holly, and I'll be your conference operator today. At this time, I'd like to welcome, everyone, to the First Industrial First Quarter Results Conference Call. (Operator Instructions) I'd now like to turn today's call over to Art Harmon, Vice President of Investor Relations and Marketing. Sir, please begin.

Thanks, Holly. Hello, everyone, and welcome to our call.

Before we discuss our first quarter 2017 results, let me remind everyone that our call may include forward-looking statements as defined by federal securities laws. These statements are based on management's expectations, plans and estimates of our prospects.

Today's statements may be time sensitive and accurate only as of today's date, Wednesday, April 26, 2017. We assume no obligation to update our statements or the other information we provide. Actual results may differ materially from our forward-looking statements, and factors which could cause this are described in our 10-K and other SEC filings.

You can find a reconciliation of non-GAAP financial measures discussed in today's call in our supplemental report and our earnings release. The supplemental report, earnings release and our SEC filings are available at firstindustrial.com, under the Investors tab.

Our call will begin with remarks by Peter Baccile, our President and CEO; and Scott Musil, our CFO, after which, we will open it up for your questions. Also on the call today are Jojo Yap, our Chief Investment Officer; Peter Schultz, Executive Vice President; Chris Schneider, Senior Vice President of Operations; and Bob Walter, Senior Vice President of Capital Markets and Asset Management.

Now let me turn the call over to Peter.

Thanks, Art, and thank you all for joining us today. As you saw in our press release last night, we're off to a good start in 2017 as we continue to execute on our plan to drive current and long-term cash flow growth.

We finished the quarter 95.8% occupied, which is 100 basis points higher than a year ago. Our cash same-store NOI growth was 5.9% and cash rental rate change on new and renewal leasing was 6%. These results reflect the overall health of the leasing market, the strength of our portfolio and the great work of our team.

On the strength of our same-store NOI performance and leasing at one of our developments, we increased the midpoint of our FFO per share guidance by $0.02. Scott will walk you through the details on guidance later in his remarks.

We continue to be encouraged by the depth and breadth of the leasing market, which is supporting our efforts to grow rents. Given the strong demand and the high occupancy levels in virtually all of our major markets, new supply continues to increase, but still at a measured pace.

On the investment front, we continue to focus on development, where we've been able to earn better risk adjusted returns than the acquisition market generally affords. In addition, we are building the right buildings to meet a variety of tenant needs today and for the long term.

We're pleased to tell you that we leased approximately 50% of our 602,000 square foot second building at First Park 94 in the Chicago market on a long-term basis. The building will be completed and the lease will commence in the second quarter. This new lease was one of the drivers of the increase in FFO per share guidance.

Regarding our other development projects, we completed our 618,000-square-footer in Phoenix in the first quarter. We've seen good interest in this property, and we'll keep you posted as our leasing progresses there.

In Southern California, First Sycamore 215 and The Ranch remain on schedule for completion in the second quarter and fourth quarter, respectively. At the end of the first quarter, our completed and in-process speculative developments totaled $169 million, comprising 2.4 million square feet, with a targeted weighted average GAAP yield of 6.9%. As of March 31, these projects were 13% leased. As a reminder, when we say GAAP yield, that's our first year cash NOI divided by our GAAP investment basis. I refer you to Page 19 of our supplemental for details on our developments.

We continued expanding our footprint in Southern California with our first quarter acquisition of a 19 acre development site in the Inland Empire West submarket of Fontana. We have some entitlement work to do there before we're ready to go. We're excited about this opportunity due to its great location in a market where vacancy is around 2%. The purchase price was $15 million and the site can accommodate two buildings, totaling 400,000 square feet.

Thus far in the second quarter, we acquired a 181,000-square-foot facility in Denver's I-70 East submarket for $11.2 million. The building is leased on a long-term basis to a leading provider of products for home improvement. Our yield on our total investment is expected to be approximately 5.9%.

As part of our portfolio management efforts, we sold 12 buildings totaling 258,000 square feet for $20.5 million comprised of two small portfolios of light industrial and flex buildings in Salt Lake City and Philadelphia. These sales were at a weighted average in-place cap rate of 7.3% and a stabilized cap rate of 7.7%.

For 2017, you'll remember that our goal for sales is $150 million to $200 million, which we expect to be back-end loaded similar to prior years. I would like to call out some good news that we received the past several weeks from two of the credit rating agencies. Fitch upgraded our unsecured debt rating to BBB, and Moody's revised our ratings outlook to positive from stable. So we're very pleased with this traction.

In conclusion, we're off to a good start to the year and we look forward to keeping you updated on our progress.

Now let me turn it over to Scott for further discussion of our results and guidance. Scott?

Thanks, Peter. Let me start with the overall results for the quarter.

EPS was $0.19 versus $0.14 one year ago. Funds from operations were $0.36 per fully diluted share, compared to $0.35 per share in 1Q 2016. Excluding the loss from retirement of debt in the first quarter of 2017 related to the early payoff of a mortgage loan, our funds from operations were $0.37 per share. As Peter noted, we finished the quarter with occupancy at 95.8%, down 20 basis points from the fourth quarter. This was better than we expected when we rolled out guidance in February as we were able to offset a good portion of the typical first quarter seasonal roll down. Note that sales had no impact as compared to 4Q '16, and year-over-year occupancy was up 100 basis points.

Regarding leasing volume, we commenced approximately 4.1 million square feet of long-term leases. Of these, 588,000 square feet were new, 3.4 million were renewals and 47,000 square feet were at vacant acquisitions. Tenant retention by square footage was 84.7%. Same-store NOI growth on a cash basis, excluding termination fees was 5.9%, primarily reflecting in-place rental rate bumps, rental rate growth on leasing and a decrease in free rent. Lease termination fees totaled $278,000, and including termination fees, cash same-store NOI growth was 6.1%. Cash rental rates were up 6% overall, with renewals up 4.8% and new leasing up 11.9%. On a GAAP basis, overall rental rates were up 14.3%, with renewals increasing 13.3% and new leasing up 19.4%.

Moving now to the capital side of the business. On April 20, we closed our private placement of $200 million of fixed rate senior unsecured notes. As a reminder, the notes are comprised of two tranches: $125 million with a 10-year term; and $75 million with a 12-year term. We pay interest semiannually and the weighted average interest rate of the notes is 4.34%. Initially, we used the proceeds to pay down our line of credit, and we will draw down on the line of credit later in the year to pay off our 2017 unsecured note maturities that totaled $157 million at a weighted average interest rate of 6.5%. $102 million will be paid off in mid-May and the remaining $55 million will be paid off in early December. As we discussed on our fourth quarter call, we also pre-paid $35 million of secured debt in the first quarter with an interest rate of 5.55%.

So to quickly summarize, the $200 million we raised was at a rate of 4.34%, and in 2017, we will pay off a total of $192 million of debt at a weighted average interest rate of 6.3%.

Regarding the dividend, we just paid it for the first quarter at $0.21 per share, which represented an increase of 10.5% compared to the fourth quarter's rate of $0.19 per share.

Recapping our balance sheet metrics for you. At the end of 1Q, our net debt plus preferred stock to EBITDA is 5.4x, adjusting EBITDA by normalizing G&A, and debt was also adjusted by adding back loan fees. As a reminder, as we telegraphed on our last earnings call, our first quarter G&A costs were higher than the quarterly average implied in our full year guidance due to early vesting of incentive compensation for our former CEO.

In March 31, the weighted average maturity of our unsecured notes, term loans and secured financings was 3.7 years, with a weighted average interest rate of 5.02%. These figures exclude our credit facility. Our credit line balance today is $92 million, and our cash position is approximately $30 million.

Now moving on to our guidance for our press release last evening. Our NAREIT FFO guidance is $1.48 to $1.58 per share, which is an increase at the midpoint of $0.02 per share compared to the guidance issued on our fourth quarter call. The increase is primarily due to our first quarter same-store outperformance and the new lease at First Park 94, as Peter discussed.

Before the loss related to the early prepayment of secured debt we discussed on our fourth quarter call, our FFO guidance range is $1.49 to $1.59 per share, which is again a $0.02 increase at the midpoint. The key assumptions for guidance are as follows: Average in-service occupancy of 95.5% to 96.5% based on quarter end results. Our new cash, same-store NOI growth range is now 3% to 5%, which is a 25 basis point increase at the midpoint, reflecting our first quarter performance. Our G&A guidance range is $26 million to $27 million. And note that guidance includes the anticipated 2017 costs related to our completed and under-construction developments at March 31.

In total, for the full year 2017, we expect to capitalize about $0.03 per share of interest related to our developments. Our guidance does not reflect the impact of any future sales, nor any acquisitions or developments other than those previously discussed, which includes the Denver acquisition we closed in April. The impact of any future debt issuances, debt repurchases or repayments other than those previously discussed. The guidance also excludes any future NAREIT compliant gains or losses, the impact of impairments and the potential issuance of equity.

With that, let me turn it back over to Peter.

Thanks, Scott. The industrial real estate environment continues to be favorable today and we expect our sector to benefit from the long-term trends of e-commerce expansion, supply chain reconfigurations and population growth.

Our job is to use our platform to capitalize on the opportunities arising from these trends by continuing operational excellence, making targeted new investments in a disciplined fashion and by further enhancing our portfolio through our active management discipline. We are always mindful of risk and strive to remain well positioned for new opportunities, which is why we maintain our strong and flexible balance sheet. By doing so, we can continue to grow cash flow and deliver value for our shareholders and that is our mission.

Thank you. Now, operator, can we please open it up for questions?

(Operator Instructions) Our first question is going to come from the line of Anthony Hau with Suntrust.

One of your peers talked about supply outpacing demand by 2018. Just curious, what's the internal view on that? Are there any markets that you're concerned about?

So, it's Peter. So as we mentioned in the last call, we are under the -- we're operating under the assumption that we're a lot closer to equilibrium than not, which generally means, we're probably there by the end of this year. As you know, much of the building around the country is big-box and lease-up there tends to be pretty binary. Demand is good. We are seeing a lot of requirements around the country, but several markets do have a lot of supply as much as they've also seen strong absorption. Two markets that we are keeping our eye on for supply would be Indianapolis and North Houston. But it's also critical to remember that when we develop, we're not making big macro bets. We certainly are mindful of the overall supply and demand trends. And before we go ahead with any development or land acquisition, we conduct a thorough bottoms-up analysis to make sure we're bringing the right product at the right time in the market to serve the existing demand.

Our next question is going to come from the line of Craig Mailman with KeyBanc Capital Markets.

Just curious. You were able to push rents pretty nicely here in the quarter, but retention was also 84%. I guess I'm just trying to see what you guys think is how aggressively you should be pushing rents at this point versus keeping that retention level at a good level?

Well, I'll start this off, and then Jojo and Peter can jump in with their views. Every time we approach a new discussion about a lease, whether it's a new lease or a renewal, we're trying to maximize the economics, maximize the outcome across a number of variables. Rents are certainly one, term and cost. So we're pushing, as you can imagine, as much as we think we can reasonably push on all of those factors to maximize the value of the lease. The retention number for us is high, and that's good. It means we've got a lot lower cost going into those leases than if they turned over. So we'd say, we're pretty pleased with the outcome. We think that with the high retention, we still achieve pretty strong growth and pretty good increases in rents. So we're definitely mindful of all of the inputs. I don't know, Jojo or Peter, if you have anything to add.

Sure, Craig, it's Peter Schultz. Certainly, the population varies quarter-to-quarter, but, as Peter said, we were pleased with the combination this quarter of retention rent -- of retention rate, our releasing spreads and our lower TI costs. And certainly it varies on a space-by-space basis around the country. But we've taken the opportunity to push rents and terms and we're willing to take vacancy in some situations if we think that our releasing opportunities are better, and we've seen some success there. So hopefully, that's helpful.

And, Craig, this is Chris. I would just add too that on the -- a quarter-by-quarter doesn't necessarily make a trend. Our renewal rates were down a little bit consecutive quarters, 4.8%. But if you look going forward, all the renewals that we've signed for 2017, those were actually up 6%.

And, Scott, if you look at kind of the 25 basis point bump here in same-store, was that more on the occupancy side coming to bear in expectations or more on the rent side? I guess I'm just trying to figure out where there is more juice in just keeping occupancy where it is or trying to push rents harder?

Craig, it's Scott. The majority of it had to do with our bad debt expense assumption. We had $625,000 budgeted for the first quarter of bad debt expense that came in at $75,000. So that was a big driver in the first quarter outperformance of same-store and was a big driver in causing us to increase our same-store guidance on an annual basis by 25 basis points at the midpoint.

How much you have baked in for the full year?

We have $625,000 per quarter in the second quarter, third quarter and fourth quarter. And I'm not saying that we're going to have $75,000 of bad debt expense in each of those quarters, but if we did have consistent bad debt expense, Craig, our same-store growth on an annual basis would be about 60 basis points higher than our midpoint guidance now, with everything else remaining consistent.

(Operator Instructions) Our next question will come from the line of Eric Frankel with Green Street Advisors.

So Amazon announced, I think, a few weeks ago that they're going to be shutting down one of their subsidiaries, Quidsi, which operates the Diapers.com brands. And that's -- they are on your rent roll, as I recall, their building is in northeastern Pennsylvania. Can you just remind us, I think their lease expires next year. What are the renewal prospects for the company? And would Amazon just keep the building as part of their supply chain in general?

Sure, Eric. It's Peter Schultz. You're right, that lease is in our 1.3 million square foot building in Northeast PA. The lease expires March 31, 2018. Amazon, since buying Quidsi a number of years ago, has been using the building for a variety of operations in addition to the Quidsi operations. And certainly, we're all aware of them shutting down the Quidsi platform, but they have other uses for the building. And as you probably saw in some of the press, the distribution needs are not going to go away. Obviously, we can't comment on any discussions we're having them -- with them at the moment, but we certainly think that's a building that's well suited for what they do and others in that location.

Okay. That's helpful. Peter, as you continue to get more experience in your role there, any thoughts on portfolio -- on how the -- what you want your portfolio size to look like over a long period of time? Do you think, as a company, your portfolio size, let's call it $4 billion to 5 billion in assets. Is that big enough? Do you think you want to scale more significantly in the next year too, especially as I think all industry REIT's cost of capital a little bit better?

Well, certainly, we like the markets that we're in. We do feel like we have good assets and we're competing well in these markets. Certainly, we are looking to grow over time. But the game plan isn't going to change. We're going to continue to seek out profitable opportunities on the development side. We will continue to make acquisitions, again, where we think we can make money and where it improves the overall portfolio. And we're going to keep a close eye on our leverage. We like the way our balance sheet looks today. So no big changes in the game plan really.

Our next question will come from the line of Dave Rodgers with Baird.

Just a follow-up on an earlier question, the higher retention that you have, obviously, good to see occupancy remaining high. Is that a function of the smaller footprint that you have and then kind of maybe a different tenant base than you're traditionally dealing with at the upper sizes of buildings? Or was there not really a big difference that you're seeing between those two?

Yes, this is Chris. As far as -- actually, typically with the larger tenants and you're probably going to get a higher retention rate, overall. So I would say, it's not really driven by the size of the tenant, but we're happy with that number, that first quarter number, and for the entire year, which should be right in the mid-70% or 75% range.

Okay, that's helpful. And then, Peter, maybe a bigger question for you. Just in terms of when you look at the preleasing percentage in the development pipeline, and I think we've chatted about this before but I don't know whether I've been able to ask you directly. So you look at your preleasing developments kind of lower end of the peer average, what continues to kind of give you the confidence that you're seeing to go out buy the land that you did in the quarter and continue to kind of pursue this level of development? Just kind of given that prelease percentage?

So you'll recall that in the recent past, we've delivered our spec developments, largely leased or within 6 months we've leased them. We build in a 12-month downtime into our pro formas on those. So we've been outperforming our pro formas. Today, we have $169 million under construction. Only -- we're only about 20% complete in terms of investment dollars. And so we're really right on track with the leasing conversations that we're having. I'd also point out that half of that pipeline isn't going to be completed until the fourth quarter. That's The Ranch. And so we feel pretty good about where we are and the markets are coming to meet the supply that we're delivering.

And I just like to add that we're very pleased about that land acquisition in the Fontana submarket of Inland Empire West. That market is approximately 2% vacant. There's a lot of activity there and that site, that still needs entitlement, but we look forward to doing something with that site when we get entitled.

And Jojo, with I guess some of the speculative land that you've bought recently and what's under construction, where do you stand against your development cap?

Right now, David, we're at $128 million of capacity in our speculative development cap.

All right. And then I guess maybe last question for Scott, when you look at your same-store NOI guidance for the year, I did see you increased it and notwithstanding the bad debt comments that you made earlier. You started the year at about 6%, which was a great start. What kind of gets you to the low end of that range? Do we see a natural slowing in free rents as the year progresses? Because it sounds like your renewals are already up 6% or so on a cash basis for the remainder of the year. So it sounds like you've got good traction there. What's going to get you down into the lower end of that range?

Dave, this is Scott. We look at same-store more on an annual basis, not on a quarterly. There could be some bumps there. But one of the benefits we did have in the first quarter is we had higher free rent burn-off in that quarter than what we're going to have in the second, third and fourth quarters of 2017. And as I mentioned earlier to Craig, the other thing that's impacting it as well is we have $625,000 per quarter in bad debt expense in the second, third and fourth quarter. And our first quarter came in at $75,000. So if we -- again, I'm not saying we're going to achieve this, but you had the same results in the second through fourth quarter on bad debt expense, that would lift same-store about 60 bps. So really it's the bad debt expense assumption and some burn-off in free rents in the first quarter of '17 that's causing that.

And sorry, one more last question for me, maybe for the guys in the region. Can you talk about kind of what industries you're seeing improving in activity and where you might be seeing any potential slowdown just in terms of demand activity, leaving out the supply side out of the equation for now?

Sure, Dave, it's Peter. I would say the activity has been pretty consistent with what we've talked about now for several quarters. Third-party logistics and transportation providers continue to be very active, as are the parcel carriers. E-commerce continues to be very active. We're seeing a lot of food and beverage requirements. We're seeing some home improvement requirements. So it continues to be pretty broad-based across the country in size ranges. In terms of any fall off, no specific industry that we've seen and I would say, we haven't really seen any reversal in direction of any prospective tenants or our existing tenants in terms of pulling back. So the confidence level, I would say, generally among occupiers continues to be pretty good.

(Operator Instructions) Our next question is a follow-up from the line of Eric Frankel from Green Street Advisors.

Could you clarify your supply concerns in some of the highlighted markets in the Indianapolis and in North Houston. From what I understand specifically in Houston, that supply has actually come down a little bit, as demand has obviously -- hasn't been quite as robust the last couple of years.

In terms of -- Eric, it's Jojo. Let me clarify in terms of supply concerns in Houston. Houston in the North submarket has had negative absorption, recently. In addition to that, add more color, rents in North Houston submarket have flattened out. Conversely, the Southeast market has garnered more and most of the net absorption, and then that's driven by really the downstream market as we've experienced in the last 18 months to two years. Let me turn it over to Peter for Indy.

Sure, Eric, Peter Schultz here. In Indy, we've talked about that periodically over the last couple of years, where that market has seen a fair amount of new product. Last year was a pretty good year in Indy from an absorption standpoint, which triggered a next round of new speculative construction. As you know, we're certainly not developing there, but it's a market that we're in and we keep our eye on. But in general, as Peter said, in response to an earlier question, we feel pretty good about demand around the country even though supply is increasing, certainly in the larger markets. And there could be pockets of supply that are a little bit ahead. I might say Central PA, where you're seeing less new construction in Central PA, you're seeing a little bit elevated vacancy rates there compared to the Lehigh Valley, which continues to be very tight and you're seeing new supply there, but the demand is strong and the buildings are leasing at or near completion.

Okay. And just to clarify in Houston. Just to jive with what I'm seeing and hearing is that the supply issue is actually in Southeast Houston. There is a demand issue in North Houston, but the supply there is essentially tapered. That was my understanding.

Yes, you're correct, Eric, this is Jojo. The supply has tapered in North Houston, but the demand has not kept up. And due to the strong demand, the Southeast, there's more construction now in the Southeast.

Okay. Just moving to Southern California, what exactly -- do you have a vision, Peter, of what -- how large you want Southern California to be as a proportion of your portfolio. Obviously, this -- the last two deals that all of your -- most of your recent capital allocation activity has been there. You obviously have been a little bit more aggressive on the development end. And then as a follow-up to that, how much more entitlement work do you have to do on the First Fontana site? That land value seems that -- it's certain -- obviously the land value is going to increase, but that's certainly of a bit higher than what we've seen everywhere else -- we see in terms of recent land comps there.

Sure, I'll cover the first part. Jojo can cover the second part. We're very pleased with this supply demand dynamics in Southern California. Rent increases there are significant, as you heard us and others talk about over the last several quarters. We think that growth is going to continue there. It's a very, very densely populated, high-consumption area. And we'd be quite pleased to see the proportion of our portfolio in Southern California grow from the current 14.5%. So we are looking for opportunities there. Again, everything we do is focused on profitability, but again, we think that notwithstanding some of the little bit higher costs of land that the rent opportunity and the opportunity to push those rents is going to be around for some time. So hopefully that covers the first part. Jojo, you can talk about Fontana.

Yes, Peter. So, Eric, we really like this parcel that we bought. You -- we bought for $18 per land foot, which is about $38 per FAR. Land prices have increased in that market and that's due to the significant absorption that the market is experiencing. Right now, it's about 2% vacant for that pocket. This is right off really 10th and Cherry, really, really great access. We think we can create value based on our price and what constructions are. And based on what the rents are we can create a lot of value for FR here. Existing products are selling at 4. Class A like this would be 4, sub 4. Rents right now are in the mid-50s to high 50s for this product. And so our initial math -- of course, we're going to have to do entitlements here -- would be in the low -- to the mid-5s to the high-5s. In terms of entitlement, Eric, this could go either way, 6 months to 12 months in terms of timing. And that's because it's either is going to be a mitigated negative declaration or a full environmental impact report. So if it's EIR, then it's about 12 months. If it's mitigated negative declaration, it's going to be 6 months, Eric.

Our next question is a follow-up from the line of Craig Mailman with KeyBanc Capital Markets.

Scott, just a quick follow-up on the bad debt. Do you guys have any tenants on the watchlist that you're worried about at this point? And maybe just give us a sense of the -- this cycle kind of how bad debt has come in versus budgeting?

Craig, this is Scott. Bad debt has been very low for us, I'd say the past 3 years. When we come up with our assumption, we look at the whole 20-plus year history of the company to come up with how we model that. As far as the watchlist is concerned, we have a very granular portfolio. Largest tenant is around plus/minus 2.5%. As we sit today, there are no tenants on the watchlist, but we conduct our calls on a monthly basis, we haven't conducted our April call, but we're not aware of anything at this point in time, Craig.

Okay, that's helpful. And then just curious separately on the disposition front, one of your peers is talking about the continued demand for B's and kind of their view that maybe cap rates could fall. Just curious what you guys are seeing out in the market, kind of what demand has been for your product, maybe where cap rates are coming in relative to your initial expectations, and the ability to maybe ramp that a little bit quicker. And then just kind of what you may have left in that noncore kind of higher cap rate bucket?

In terms of demand, Craig, the demand -- the buyer demand continues and so nothing has really changed from the recent past, the private investors, pension fund advisers, plus users are all active in the market. There seems like buyers are very underallocated to Industrial. So we have the same amount of demand. In terms of our portfolio, that's part of our ongoing portfolio management strategy. You'll see us continue to push out the low cash flow growth, high CapEx properties and reinvest that in what we believe is higher rent growth and low CapEx properties. That's our job, and we'll continue to do that.

On the cap rates side, what's your view and kind of what's been your recent experience? I think you guys said kind of high 7s on the stuff you did this quarter kind of versus your expectations going in?

Sure, sure. In terms of the overall market cap rates have remained steady. There's a little bit of compression in Class A and the spread between Class A and Class B has narrowed a bit.

(Operator Instructions) And at this time, we have no further questions. I'll turn the call over to Peter Baccile for closing comments.

Well, thank you, operator and thank you all for participating on our call today. As always, please feel free to reach out to Scott, Art or me with any follow-up questions and we look forward to seeing many of you in New York at NAREIT in early June. Thanks again.

Once again if -- we'd like to thank you for your presentation on today's conference call. You may now disconnect.