Industrial Logistics Properties Trust (ILPT) 2018 Q1 法說會逐字稿

Good morning, and welcome to Industrial Logistics Properties Trust First Quarter 2018 Financial Results Conference Call. Please note, this event is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Olivia Snyder, Manager of Investor Relations.

Thank you, and good morning, everyone. Thanks for joining us today. With me on the call, our President and Chief Operating Officer John Popeo; and Chief Financial Officer Rich Siedel. In just a moment, they will provide details of our business and our performance for the first quarter of 2018. We will then open the call to your questions.

First, I would like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company. Also note that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on ILPT's beliefs and expectations as of today Friday, April 27, 2018, and actual results may differ materially from those that we project. The company undertakes no obligation to revise or publicly release the results for the new revision to the forward-looking statements made in today's conference call. Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission, or SEC, which can be accessed from our website, ilptreit.com or the SEC's website. Investors are cautioned not to place undue reliance upon any forward-looking statements.

In addition, we will be discussing non-GAAP numbers during this call, including normalized funds from operations or normalized FFO and cash-based net operating income or cash basis NOI. A reconciliation of these non-GAAP figures to net income and the components to calculate cash available for distributions or CAD are available in our supplemental operating and financial data package, which also can be found on our website.

And now, I will turn the call over to John.

Thank you, Olivia. Good morning, everyone, and welcome to the first earnings call for Industrial Logistics Properties Trust or ILPT. ILPT is an industrial REIT that owns 266, primarily warehouse and distribution properties, with 28.5 million square feet located in 25 U.S. states and leased to 243 separate tenants.

ILPT became a separate public company when it completed its initial public offering in January 2018, raising $480 million gross proceeds. Prior to its IPO, ILPT was a wholly owned subsidiary of Select Income REIT or SIR. SIR continues to own approximately 70% of ILPT post-IPO.

Around 60% of ILPT's annualized revenues come from properties located on the island of Oahu in Hawaii. ILPT's Hawaii portfolio includes 16.8 million square feet that are 99.9% leased as of quarter end. The majority of ILPT's Hawaii properties are owned lands that are leased to 223 separate tenants for an average lease term of around 13 years. Most are currently used for warehouse and light industrial uses, not necessarily tied to e-commerce.

However, occupancy at our Hawaii properties has remained above 98% since 2003, when our predecessor first entered the market. And since 2003, our properties have achieved rent growth over prior in place rents of around 33% as leases have either expired or rents have reset to market. In addition, around 50% of our Hawaii rents have contractual rent steps that amount to around 2% per year.

Our historical rent growth in occupancy rates reflect a strong demand for our properties, particularly our Hawaii, Honolulu properties, which are located near the Honolulu seaport, airport and CBD, and represent over 80% of our Hawaii annualized rents. The scarcity of flat developable land on the island of Oahu helps keep new development in check, which also supports strong demand for our Hawaii properties.

We'd love to grow our Hawaii portfolio, but fee interest buying opportunities are rare. In fact, since the initial land purchases in 2003 and 2005, we've acquired only one property in 2012 in the Mapunapuna submarket of Honolulu for $126 per land square foot or around 150% higher than our initial purchase price of comparable lease land back in 2003.

We're optimistic about our future rent growth prospects in Hawaii, but most of ILPT's external growth will more likely come from acquisitions on the Mainland. ILPT's mainland portfolio includes 40 buildings with 11.7 million square feet, located in 24 states, that are 100% leased to 20 tenants, with an average lease term of around 8 years as of quarter end.

The average age of our Mainland portfolio is around 9 years. The majority of our Mainland rents are from investment-grade rated tenants or tenants that are subsidiaries of investment-grade rated companies. We have no material near-term lease expirations on the Mainland, and most of our leases include annual rent steps that average around 1.5% per year.

Examples of our buildings that are linked to e-commerce activities are 3 buildings leased to Amazon, our 13 buildings leased to FedEx and an online sales facility leased to Net-A-Porter. The balance of ILPT's Mainland portfolio includes, warehouse and distribution facilities leased to RH, formerly known as Restoration Hardware; Toro; American Tire Distributors; a cold storage facility leased to General Mills; and properties leased to various other tenants as fulfillment and distribution facilities located throughout the U.S. We also own 6 Mainland buildings that serve as light manufacturing facilities.

Mainland industrial property values have risen dramatically in recent years, due in no small part to growth and e-commerce. Industrial property net absorption has outpaced deliveries since the first quarter of 2011, contributing to the steady rise in occupancy rates to around 95% today.

Based on recent reports, e-commerce sales have increased from approximately $200 billion in 2011 to around $400 billion, and e-commerce sales represents only 8% of total retail sales with many predicting continued growth in market share. We think these industrial market dynamics will translate to continued demand and increases in rents for our existing portfolio of industrial properties when leases rollover in the future.

Current market dynamics also continue to drive cap rates lower, especially in some of the top-tier markets around the U.S. Despite the competitive environment we're working in today, we're confident we'll be successful in acquiring quality industrial properties on the Mainland. We have a robust pipeline of potential acquisitions, but nothing under purchase and sale agreement as of today. We have $458 million of availability on our $750 million revolving credit facility and a relatively low debt-to-EBITDA ratio of only 2.9x that provides us with a solid runway to acquire quality assets with relatively low cost capital.

Of all the industrial REIT, ILPT seems to be trading at the largest discount to analyst NAV estimates. This is perplexing for us, and we're doing everything we can to educate the market about the quality of our portfolio and our growth prospects. In addition, there are recently published market value benchmarks that apply directly to our Hawaii properties that are included in our IPO registration statement that warrant some attention.

Also, the majority of our Mainland industrial buildings were acquired from Cole Corporate Income Trust, or CCIT, in January 2015. With cap rate compression taking place in the industrial space since those properties were acquired, one could argue the right cap rates to apply to our Mainland industrial properties should be lower than the approximately 6% blended acquisition cap rate from back in 2015.

We'll continue to drive the value proposition of ILPT in future earnings calls and at investor conferences. Our hope is to reduce our current trading discount and increase our trading multiples to level some more in line with our industrial REIT peers.

I'll now hand the call over to Rick Siedel to provide details on this quarter's earnings. Rick?

Thanks, John, and good morning, everyone. Revenues for the first quarter of 2018 increased by $1.2 million to $40.6 million, representing a 3% increase over prior year results. The increase primarily reflects lease renewals and rent resets at our Hawaii properties.

Our cash basis NOI increased by approximately $500,000, representing a 1.7% increase over the prior year. Hawaii cash basis NOI increased by 2.9% over the prior year, reflecting the exceptionally strong market dynamics John discussed earlier and the resulting increases in rents from renewal and re-leasing, along with resets. Excluding rent reserves and temporary increases in security cost at some of our Hawaii properties, the increase in Hawaii cash basis NOI for the current quarter would have been 5.4%.

Mainland cash NOI was relatively unchanged, but excluding property insurance proceeds received in the prior year and to a lesser extent, the timing of other non-recoverable expenses recognized in the current period, Mainland cash basis NOI would have increased by 1.7%.

Portfolio occupancy as of the end of the first quarter remained at 99.9%, representing a 30 basis point increase from the prior year and unchanged from last quarter. During the quarter, we executed 8 new and renewal leases, totaling 296,000 square feet, all at our Hawaii properties, at rents that were 46% higher than previous rents for the same space. The average lease term is over 30 years, and leasing capital per square foot per lease year was just $0.01.

We are encouraged by these leasing results and the potential growth we may achieve when over 50% of our Hawaii leases mark-to-market, either through rent resets or as leases rollover over the next 5 years. As John mentioned earlier, over 50% of our Mainland revenues are from investment grade-rated tenants or tenants that are subsidiaries of investment grade-rated companies. And for our combined portfolio, over 76% of our revenue comes from our Hawaii tenants and Mainland investment grade or subsidiaries of investment grade-rated entity.

Our top 3 tenants are Amazon, representing 10.2% of annualized revenues, followed by RH at 3.8% and FedEx at 3.6%. We have no significant near-term lease expirations on the Mainland, and 314,000 square feet of lease is scheduled to expire during 2018 in Hawaii. Our hope is that rents will continue to increase in Hawaii at the same average rate as our historical performance and generate meaningful internal growth for ILPT.

Operating income increased by $2.1 million or 10.1%, reflecting leasing activity mentioned earlier and the allocation of a portion of SIR's general and administrative expenses required under GAAP in the prior year when ILPT was a wholly owned subsidiary of SIR. The increase in interest expense reflects average borrowings on our revolving credit facility, which we successfully syndicated during the quarter, expanding the size of the bank group for this new company to 22 financial institutions.

The average interest rate on our revolver is based on LIBOR plus a spread, which amounted to around 3.2% at quarter end. As John mentioned earlier, this low initial cost of debt capital and $458 million of drawing capacity gives us a strong footing to acquire new industrial and logistics properties and meaningfully enhance future earnings.

Normalized FFO for the first quarter was $26.1 million or $0.42 per share, calculated using $61.4 million average shares outstanding during the quarter. Adjusted EBITDA for the quarter was $30 million. Both normalized FFO and adjusted EBITDA include $941,000 of annual percentage rent recognized in the first quarter of 2018 related to 2017.

We ended the quarter with $19.8 million cash on hand and just $302 million outstanding on our $750 million unsecured revolving credit facility. We have just one property encumbered by secured debt, and we believe our balance sheet is very well-positioned for growth. Debt to adjusted EBITDA was just 2.9x and adjusted EBITDA to interest expense was 7.9x.

Lastly, I wanted to mention that, subsequent to quarter end, we declared a prorated first dividend of $0.27 per share, which is based on our expected normal quarterly dividend of $0.33 per share or $1.32 per year.

That concludes our prepared remarks. Operator, we are now ready to take questions.

(Operator Instructions) Your first question comes from Mitch Germain with JMP Securities.

John, I think you referenced a robust pipeline of deals. I'm curious what sort of characteristics are you looking for in acquisition candidates?

Sure. Thanks for the question, Mitch. So we're seeing a lot of products since our IPO. A lot of that -- newer products coming online. We're seeing from merchant builders and developers. We reviewed at least 2 to 3 dozen listings, and we've been on several. And we, unfortunately, have not won any deals to date. But we're seeing cap rates pretty much all over the place as low as -- high 3s in Northern New Jersey and Inland Empire to maybe 5.5% in some of the markets in Ohio, Columbus. We're taking a very disciplined approach to acquisitions right now. We clearly think there's many markets out there that are overheating, but we're very encouraged at the same time. Some of the things we're looking for is -- very interested in the newer buildings, lease to strong credit tenants under long-term leases. In a perfect world, you get all 3. Realistically, you're not. And so we are underwriting properties in pretty much every market throughout the country. As you know, RMR's acquisitions group sources a large amount of acquisitions each year, and RMR probably closes about $1 billion each year. But we're targeting -- our interest in underwriting pretty much in every market. It looks like markets like Northern New Jersey, parts of Dallas, parts of Chicago, clearly, Inland Empire are just really, really smoking hot, overheating. Nonetheless, we do feel optimistic that we will be successful in acquiring some properties in these prime markets, but also we're focused on some markets -- submarkets in Ohio, maybe Columbus, Cincinnati, maybe some properties in Indianapolis. We have a pipeline of around 14 buildings, close to $800 million in value, 6 million square feet. We're looking at properties down in southern Florida, parts of Texas, parts of New Jersey, I think it's a little cost prohibitive for us to think we'll land a quality property in the Teterboro area but maybe a little further off Route 95, looking at properties in Minnesota. When we -- we're out on the road with the IPO, we were thinking cap rates that we would pull properties in at would be, maybe, 5% to 7%. Now we're thinking it's -- more likely it will be 5% to 6%. So we're bidding as we speak. Unfortunately, nothing under contract today. But we're still confident that over, say, the next 1.5 years, maybe 2 years, we'll have $400 million of acquisitions under our belt.

I guess, my follow-up to that is, if the pricing dynamic is as competitive as it is today, why not just delay and operate the existing portfolio which -- and try to create value just through the assets rather than look to buy?

It's a great question. I mean, clearly, we're hyper focused on maximizing internal growth prospects in the existing portfolio. I mean, we had a good solid quarter in Hawaii, again, with a significant rent growth from renewing leases on the U.S. -- on the Mainland. We just don't have a whole lot expiring over the next couple of years. I mean, we have, maybe, one small property that we expect to renew in 2019. Again, we're writing up a lot of deals. We're being very disciplined in our underwriting and our bidding. The other thing to consider is, we're more focused on smaller deals, Mitch, in the $30 million to $60 million price range. We're not looking for a blockbuster, $2 billion to $3 billion deal like the 2 Blackstone deals in late 2017 and early '18. We're taking a slower, more deliberate pace with our acquisitions program. It allows us to keep an eye on interest rates and also market dynamics.

Great. Last one for me. Can you pull some of the resets forward into 2018?

Yes. I mean, we're constantly in contact with our tenants. That would be our preference. Historically, we probably landed or negotiated early deals on resets for a handful. I don't expect it will be a large percentage of early resets, but we usually get them done 2 months before the scheduled date.

Our next question comes from Bryan Maher with B. Riley FBR.

Mitch got a good chunk of mine, but kind of elaborating on that a little bit -- and you kind of touched upon some of the markets you're looking at. Given that the kind of hot markets like northern New Jersey are really well known, are there any emerging markets that you've been looking at that people who kind of play in the industrial space might not be thinking about, but that's on your radar screen? Or do you not want to share that?

No. No, I'm happy to share it. I mean, like I said, we -- we're looking at pretty much everything that comes to market. We do recognize that various markets seemed to be in different phases. For example, we're looking at some properties in some of the Florida markets today at Miami and Tampa. We're looking at properties in Phoenix, Nashville, where we already have a presence. These are markets where we think rents are rising and vacancy is declining maybe a little more opportunity than some of the more saturated markets. We're also interested in Atlanta, Memphis. I mentioned Cincinnati and Indianapolis, where supply seems to be slowing the pace of rising rents. But nonetheless, they're still strong and attractive markets for us. And then you have the more mature markets like Houston, Milwaukee, Pittsburgh, Minneapolis, where rents are still increasing, but at a lower pace and -- but [vacancy's] still stable. It's an interesting time that we live in right now, and it's very competitive, and it's very interesting to see what's going on. Industrial demand, I guess, has historically been directly correlated with economic growth, but e-commerce has dramatically shifted the delivery of consumable goods from stores to warehouses. So we think, even if there's a market that looks like it's saturated or peaking right now, with e-commerce -- I mentioned in the prepared remarks, it represents around 8% of total retail sales, it's really -- that's from our IPO registration statement today, I believe, it's more like 10%. And the expectation is that's just going to keep rising, which should maintain the health of the markets and demand for industrial properties for the foreseeable future.

Okay. And just a point of clarification on the earnings release and the supplemental. The 296,000 square feet that you released at the 46% or so GAAP rent increase, that -- those renewals were on Hawaii. Is that correct?

That's correct.

And is it correct that there's still one more set for this year, or was that the one?

No. There's still one more reset scheduled for 2018. And then, separately, we've got about 314,000 square feet expiring in Hawaii in 2018 that we'll be looking to renew. There's a small amount of asset that may not renew and may vacate. But historically, we've been able to get a retenant.

And our next question will come from Brian Hawthorne with RBC Capital Markets.

Can you remind us, what is the mark-to-market on the Mainland portfolio and the Hawaiian portfolio?

Mainland portfolio, like I mentioned in the prepared remarks -- I'm sorry, the Hawaii portfolio, we've achieved rent growth of around 33% over the years, and our expectation -- our hope, I should say, is for the -- around 50% of rent that are set to expire or reset over the next 5 years. We're hoping for a repeat performance on rent growth. So right around 30%. On the Mainland, rents generally are right around -- based on our latest estimates, right around 1% below market. If you strip out 3 or 4 buildings that are, sort of, skewing the numbers. One is the cold storage facility that just has high tenant sit outs. If we're able to relet that space -- I mean, we take a conservative approach to estimating in-place rents. So that -- if we replace that tenant with a traditional warehouse distribution tenant, yes, there might be a roll down. But if we can get a comparable tenant, I think that lease is probably at market. I think, previously, and maybe during the IPO, I may have mentioned that our Mainland portfolio was slightly above market. I think that warrants some clarification that I just mentioned about the 3 or 4 buildings that are skewing that number. Those buildings also happen to have longer-term lease expiration, so I don't see any impact in the near term.

Okay. And then -- so on the resets in 2019, when do you start discussing the release or the reset, and what are your expectations for those? The 2019 ones, not the 2018 ones.

I think the team is pretty strategic about which tenants they approach. Obviously, trying to maximize value and make sure we're positioned well for the more difficult resets that will happen in '19. So I think we have a great team in Hawaii and a strong asset management team here in Newton that will be working together to come up with a plan and start going through them in 2018. So when the deal is actually getting to -- it's still up in the air, but we'll be pretty strategic about it and make progress over the next 1.5 years.

Okay. And then is there any plan to term out the credit facility?

Not at this point. It's only $300 million out. I mean, as we start drawing to buy acquisitions, we'll look at our options and opportunities to term out a portion. But that's probably not going to be for another 6 months or so.

And our next question comes from Jamie Feldman with Bank of America Merrill Lynch.

I just want to focus on the floating rate debt. Can you talk about -- do you have any plans to maybe put on some hedges or just help us think through how to think about the floating rate debt balance and potential risk to earnings, especially as you do more acquisitions?

Okay. Well, I guess the way I look at our overall capital stack and really cost of capital is until debt to EBITDA reaches our internal target and also, sort of, the peer group average of 5.5x, our current cost of capital is our current cost of debt capital. And as you point out, it's all floating rate debt right now. So I mean, we have $415 million of capacity on the revolver. Current rate at LIBOR plus 130 is only around 3.3%. And even with a hypothetical, say, 75 to 80 basis point interest rate increase between now and year-end, our cost would still be less than around 4.25%. So we think we can be competitive. We can get out there and acquire quality properties in good locations for more than our 4.25% -- well above our 4.25% midterm, not short-term, but midterm cost capital target acquisitions between, say, 5%, 5.5% cap rate, which is what we're seeing right now. To some extent, we're hoping our rent steps on new acquisitions will keep pace with any additional interest rate increases on the floating rate debt. So we've decided to term it out. And in addition, as I think you know, Jamie, we don't have any big plans for development. So we do have some free cash flow that will reduce the amounts we draw on the revolver for acquisitions. And we could further preserve, I guess, this is really what you're getting at or going in investment spreads, we can further preserve them by walking into, say, mortgage debt on some of our properties, but it's not something we're considering in the near term. We'll consider it later on as our floating rate debt exposure increases. On the mortgage side, we're hearing from some of the brokerage firms that we deal with on the acquisition side that you might be able to get 5-year fixed rate debt, mortgage debt from a life company at 3.25%, I mean, that's today. Like I said earlier, we just really need to keep an eye on the interest rate environment as we're executing on our acquisition program. So again, over the next couple of years, we're hoping we'll acquire $400 million. And in all likelihood, at least initially, we'll fund that from drawing some of the revolving credit facility. And even if we drop $400 million, we're still below our target debt-to-EBITDA ratio of 5.5x. So I hope that answered part of your question.

Yes. So where would that take you if you did the $400 million based on the deals you're seeing? What would your leverage be?

It would be probably 5.3x. It'd be right there.

Okay. And then -- well, I mean, it's clearly a more competitive environment even -- it sounds like even when you guys launched the IPO, releasing your perspective. Do you have any -- I mean, do you think at all about getting into other types of assets here? Anything that could be considered industrial, but isn't truly just like distribution or storage. I mean, how are you guys thinking about playing around the edges?

We're pretty much primarily focused on warehouse and distribution right now. We have looked at a couple of cold storage facilities. But to be honest with you, those aren't the projects that really excite us. It's primarily warehouse and distribution.

Okay. And then anything internationally you'd look at?

No. No, we're focused on our own backyard for now.

Our next question comes from Nick Yulico with UBS.

Just a question on the releasing spreads. I know you give it on a GAAP basis, can we get a feel for what they are on a cash basis?

These are Hawaii deals, and most of them are subject to rent resets. I think the largest deal we just did will have either 1 or 2 more resets. It really is driving the majority of the performance of reporting this quarter and the GAAP yield is the cash yield.

Okay. That's helpful. And then, I guess, in terms of just thoughts -- I don't think you specifically address this, but do you just have a feel for underlying rent growth assumptions? How you're thinking about rent growth for your markets in the Mainland, U.S. this year versus Hawaii?

Well, fortunately and unfortunately, we don't have really anything -- any leases maturing on the U.S. Mainland this year. We have one small deal, and I think I mentioned this a few minutes ago, but we have one -- I think, maybe 60,000 or 70,000 square foot deal that is due to renew. We're already in discussions with tenants. We think we'll see a small rent increase. But again, it's only 62,000 square feet. It's not going to move the needle. Looking out into 2020, again, it was just not a whole lot expiring on the Mainland, but we do have a tenant in one of our distribution facilities in Denver that we expect a roll up. At this point, it's just really too early to tell what that number's going to be, but it is a roll up. I mean, the Hawaii portfolio, again, our expectation and hope is that we'll see a repeat performance and see maybe 25% to 30% rent growth as leases expire or reset. And then on the Mainland, generally speaking, we think the portfolio is probably 1% below market if you strip out maybe 3 or 4 outliers, like the cold storage facility example I mentioned a minute ago.

Okay. That's helpful. I guess just following up in terms of putting aside the mark-to-market opportunity. Just thinking about your markets in the Mainland U.S. in terms of what market rent growth could be this year, do you have any forecast for that?

I -- Rick, go ahead.

No, I was just going to say, I think we're pretty encouraged. I mean, if you actually look at the locations of our properties, they're generally right along the interstate. Seeing what people are bidding for these properties, you have to believe the market is really pushing rent. So we'll work with our asset management team to try to put a number on it that we can maybe mention in the next call. But I think we're encouraged by the strength of all of our markets.

And the next question is a follow-up from Mitch Germain with JMP Securities.

Rick, anything in the operating expense number for 1Q that was, kind of, onetime in nature?

Yes. We had a couple of things. In the Mainland portfolio, we had a little over $215,000 of some prior year insurance proceeds and things that kind of didn't recur, which is a little bit of a drag on our growth number. And then in Hawaii, we actually took some rent reserves and incurred some security costs related to a tenant that will be going through the process of evicting and getting released. So there's a little bit of noise there. I think I mentioned in prepared remarks that Hawaii's growth without that stuff would have been about 5.4% year-over-year and the Mainland would have been 1.7 versus flat. So looking forward, I think we're encouraged. Even the rent reserves and security costs incurred in Hawaii -- if we look back at history, the silver lining has generally been that we've been able to retenant the properties with a rollover rent. And from time to time, a few quarter later, it's not unlikely to recover some of that stuff that we've reserved. So again, trying to just move forward and make sure we're maximizing value in the portfolio. But overall, we're pretty (technical difficulty).

And the next question is a follow-up from Jamie Feldman of Bank of America Merrill Lynch.

Sorry if I missed this, but are there any known move-outs? I know you just mentioned the Hawaii credit issue, but are there any known move outs we should be thinking about going forward?

Again, I mean, I just mentioned that the tenant that we've kind of worked through, that kind of was a drag on the overall portfolio. It's a difference between us being at 1.7 consolidated NOI growth versus like 3.9. But that particular tenant, aside from the reserves that we have to take, isn't particularly material. It's somewhere around $70,000 a quarter or so. So it doesn't really move the needle one way or the other. I think our internal growth from the rest of the portfolio will more than make up for it, even if we do have a little bit of frictional vacancy along the way.

Okay. And are there any other tenants that you are expecting to move out maybe this year or next?

Again, just the normal frictional process. But no, nothing notable.

Nothing chunky?

Yes. Nothing material, no.

And this concludes our question-and-answer session. I would like to turn the conference back over to John Popeo for any closing remarks.

Thank you, everyone, for joining today's call. We look forward to seeing some of you at the upcoming UBS industrial REIT summit in May and the NAREIT conference in June. Thank you.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.