First Industrial Realty Trust, Inc. (FR) Q2 2015 Earnings Report, Transcript and Summary

Good afternoon. My name is Tabitha and I will be your conference operator today. At this time, I’d like to welcome everyone to the First Industrial Second Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session [Operator Instructions]. Thank you. I will now turn the call over to Mr. Art Harmon, Vice President of Investor Relations. Please go ahead.

Thanks Tabitha. Hello and welcome to our call. Before we discuss our second quarter 2015 results, let me remind everyone that our call may include forward-looking statements as defined by Federal Securities Laws. These are based on management's expectations, plans and estimation of our prospects. Today's statements may be time sensitive and accurate only as of today's date, July 31, 2015. 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 Investor Relations tab. Our call will begin with remarks by Bruce Duncan, our President and CEO; as well as 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 for our east region; 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 Bruce.

Thanks, Art. And thanks to everyone for joining us on our call today. Our team delivered an excellent second quarter. I am particularly proud of the fact that we hit our year end occupancy target of 95% ahead of schedule. We finished the second quarter at 95.1%, up 80 basis points from the end of the first quarter. You will recall that we established the goal of achieving occupancy of 95% by year end 2015. At our Investor Day, back in November of 2013, when our occupancy was at 91.2%. This achievement is a function of the focused leasing execution by our team around the country as well as contributions from our continuing portfolio of management efforts. I congratulate all of my teammates for making this goal a reality. Our second quarter same store cash NOI was up 4.7%, primarily as a result of our occupancy increase, rental rate bumps and continuing low bad debt expense. As a result of our performance to-date, we have raised the midpoint of our average quarterly same store NOI guidance by 50 basis points to 4.5%. Scott will walk you through the increase in our FFO per share guidance and other changes shortly. Cash flow rates on new and renewal leasing were up and have now been positive six quarters in a row. On a GAAP basis, rental rates were up 11.9% and we have now been positive on this metric for 14 consecutive quarters. These results reflect the underlying strong sector fundamentals as tenant demand continues to be healthy and outpace new supply. Moving on to investments. During the second quarter, we placed in service two developments. The first was the 377,000 square foot property at our two buildings First Pinnacle Industrial Center development in Dallas. As previously reported, this building is 100% leased on a long term basis to a beverage company. Our GAAP yield based on the first year cash NOI over the GAAP investment basis was 7.6%. Our total estimated investment is $15.9 million. The second development placed in service was our 556,000 square foot First 36 Logistics Center in the Inland Empire for which we signed a long-term, full-building lease with an auto manufacturer in the second quarter. Our GAAP yield on this facility was 7% and our total estimated investment is $33.1 million. At June 30th, we had three additional completed developments that have not yet in service located in Houston, Dallas and Minneapolis. These total 716,000 square feet and are combined 79% leased. Let me quickly walk you through these projects. The first is our 352,000 square foot First Northwest Commerce Center in Houston that is 78% leased. Second is our 222,000 square-foot First Pinnacle II building in Dallas that is now at 100% as we successfully leased up the remaining 80,000 square foot space. Lastly, our 142,000 square foot development in Minneapolis remains 50% leased; our total investments for these three completed developments is $40.2 million and our projected first year GAAP yield is 7.9%. As of June 30th, we have four projects under construction, comprise of seven buildings totaling 1.4 million square feet that are 17% preleased. This figure includes our second quarter start of First Park Tolleson on a 21 acre site in Phoenix we recently acquired. First Park Tolleson is 386,000 square foot multitenant project which is 44% preleased. Recall that our tenants from one of our nearby properties required additional space, growing from 80,000 to 170,000 square feet. We expect to complete this facility by the end of the first quarter of 2016. Total investment is expected to be $21.5 million and our targeted stabilized GAAP yield is 7.8%. For these four projects under construction our estimated investment is $102.3 million and our targeted first year GAAP yield is 6.8%. I refer you to Page 20 in our supplemental for details on all of our developments. As part of our ongoing efforts to replenish our development pipeline, during the second quarter we also added a 24 acre development site in the Great Southwest submarket in Dallas where we can build up to approximately 300,000 square feet in a two building configuration. Regarding future capital deployments, given our increased portfolio occupancy, strengthened balance sheet and successful development execution, our south imposed revolving spec cap is now $325 million. We believe development and value add acquisitions continue to provide superior risk adjusted returns while enhancing our portfolio. We’re always mindful of the supply demand equation we’re doing so. But again the market remains in balance so we are actively using our platform to identify new opportunities. Regarding acquisitions, at previously disclosed, we were successful in adding to our portfolio of Southern California by acquiring two 100% leased properties during the second quarter; one was a 172,000 square foot Distribution Center for $14.8 million in Riverside in the Inland Empire; the other was a 45,000 square foot in the South Bay of Los Angeles for $5.4 million. The weighted average in place cap rates for these properties was approximately 5%. Moving on to dispositions. In the second quarter, we completed $16 million of sales comprise of three buildings totaling 384,000 square feet in Detroit, Southern New Jersey and Atlanta and one small land parcel. In the first quarter to-date we’ve completed the sale of a small building in Tampa and a land parcel in the Milwaukee market for a total of $1.3 million. Year-to-date we have closed $43.9 million of sales on pace for our full year target of $75 million to $100 million. To wrap it up before I turn it over to Scott. Our team delivered an excellent quarter and I look forward to what we can accomplish in the second half of this year in capitalizing on our opportunities to grow cash flow and further enhancing our portfolio for the benefit of our shareholders. With that, Scott?

Thanks, Bruce. Starting with the overall results for the quarter. Funds from operations were $0.35 per fully diluted share compared to $0.28 per share in 2Q 2014. Results include a $0.01 per share gain from the Interest Rate Protection Agreement we sell during the quarter. Before this charge and acquisition costs, as well as losses from the retirement of debt and a portion of a 1 time restoration fee in the year ago quarter, funds from operations were $0.34 per fully diluted share versus $0.28 in the year ago quarter. EPS for the quarter was $0.13 versus $0.04 one year ago. As Bruce noted, we finished the quarter with occupancy at 95.1% which was up 80 basis points from the first quarter and up 210 basis points year-over-year. Sales had a 5 basis point impact on our second quarter occupancy results. Regarding leasing volume, we commenced approximately 3.5 million square feet of long term leases in the second quarter. Of these, 0.9 million square feet were new, 1.5 million were renewals and 1.1 million square feet were development leases; tenant retention by square footage by 83.4%. Same store NOI growth on a cash basis excluding termination fees and a 1 time restoration fee we recognized in 2Q14 was 4.7%. Same store growth was primarily the result of our increase in occupancy, rental rate bumps and bad debt expense coming in below plan. Lease termination fees totaled $620,000 in the quarter and same store cash NOI growth, including termination fees but excluding the 1 time restoration fee in the year ago quarter was 5.3%. Cash rental rates in the quarter were up 4% overall. Breaking it down, renewals increased 6% and new leases were up 0.7%. On a GAAP basis, the overall rental rate change was a positive 11.9%. Moving on to our balance sheet metrics. At the end of 2Q, our net debt plus preferred stock to EBITDA is six times excluding the impact of the interest rate hedge settlement and acquisition costs. This is at the low end of our target range of 6 to 7 times. At June 30th, the weighted average maturity of our unsecured notes, term loan and secured financing is 4.1 years with a weighted average interest rate of 5.6%. These figures exclude our credit facility. Credit line balance today is $217 million and our cash position is approximately $9 million. Now, reviewing our updated 2015 guidance through our press release last evening. Our NAREIT FFO guidance range is $1.21 to $1.29 per share with a midpoint of $1.25 per share, which is a $0.04 per share increase from the prior midpoint. And we also narrowed the range $0.01 at both ends. The $0.04 per share increase is primarily attributable to; an increase in our occupancy expectations for 2015; lower bad debt expense in the second quarter compared to prior guidance; as well as a $0.01 per share pick up due to the settlement of our interest rate protection agreement in the second quarter. Excluding the impact of the settlement of the interest rate hedge, our FFO guidance is $1.31 to $1.39 per share, which is a $0.03 per share increase compared to this guidance. The key assumptions are as follows; average in service occupancy of 94.5% to 95.5% based on quarter end results, an increase of 100 basis points at the midpoint; average quarterly same store NOI on a cash basis before termination fees of 4% to 5%, an increase of 50 basis points at the midpoint and a narrowing of the range. Note that this excludes the 1 time restoration fee in the comparative period of 2014. Our G&A range remains the same at $24 million to $25 million. Guidance reflects the anticipate fourth quarter 2015 no cost prepayment of approximately $23 million of secured debt at 5.58%. This loan is scheduled to mature in the first quarter of 2016. Guidance includes the costs related to our developments and process in Dallas, Pennsylvania, Southern California and Phoenix. We totally expect to capitalize about $0.02 per share of interest related to our developments in 2015. Other than what I’ve noted; our guidance does not reflect the impact of any future debt issuances; the impact of any future debt repurchases or repayments; any additional property sales, acquisitions of further developments; any future NAREIT compliant gains or losses or the impact of impairments; nor the potential issuance of equity. With that, let me turn it back over to Bruce.

Thanks, Scott. Before I open it up for questions, I want to make a few final points. Achieving our 95% occupancy goal for the year ahead of schedule demonstrate the strength of our portfolio and our platform, as does our solid same store and rental rate performance. Fundamentals in the industrial real estate market is strong as is our position as a landlord. This is reflected in our occupancy and our sixth consecutive quarter of positive cash rental rate growth on new and renewable leasing. While we are pleased with our results, we are not satisfied. We have the opportunity to continue to grow cash flow by driving up average occupancy in our existing portfolio, leasing up our developments, pushing rental rates and further reducing capital cost. Our platform also continues to make an impact by enhancing our portfolio and value for shareholders through our developments, acquisitions and disposition efforts. To further showcase these strengths to you and the opportunities we see ahead, we ask you to mark your calendar to join us Thursday, November 12 in New York City for our Investor Day. Additional details will be forthcoming. So with that, we’ll now open up for your questions. As a curtsey to other callers, we ask you limit your questions to one plus a follow-up in order to give other participants a chance to get their questions answered. You are of course welcome to get back into the queue. Tabitha, may we now open up for questions?

[Operator Instructions] Your first question comes from the line of Ki Bin Kim with SunTrust Robinson Humphrey.

Thank you. As one month into the third quarter just curious -- and you hit manufacturers and occupancy already, if you look at what’s in that visible path line going forward. Any known material move outs or move in that might change your occupancy in the near term?

Ki Bin, this is Chris, if you look at our lease exploration for the rest of the year, it’s only 3.6% of the portfolio, so a pretty small number. So, we should be in pretty good shape.

And looking ahead a little more forward and maybe 18 months or a couple of years, if I look at the average for rent start expiring in your portfolio, it’s pretty static, I mean. In 2015 before you started rolling, 2015 average rent was 443, the average rent per square foot in 2016 437. So it seems I mean I am sure the mix could be different, but from a rent perspective pretty static. How should we think about this? And give what’s been your 2015 leases are, I am not sure they’re more favorable or less favorable. Should the lease spreads get better than what we’ve seen, or similar?

Ki Bin, again, we’re not going to talk about 2016 guide, but we welcome, we encourage you to show up for our Investor Day because we’ll go through a lot of details. But the general thing is the world is getting better, rents are stronger and we’re very encouraged by what we’re seeing. So again we have a lot more detail when we get together on our Investor Day in New York City on the 12.

Your next question comes from the line of Dave Rodgers with Baird.

First, maybe on acquisitions, I know you’ve done a small amount in the quarter on acquisitions, but you’ve continued to buy the cap rates for right around 5%. But based on your kind of spec development cap, sounds like you really expect development to ramp up. So I guess; one, on the acquisition, what get you excited about buying in the five, and can you get that number up quicker in the near term; and two, how do you look at allocating additional capital through acquisition here in the near term?

Well, again, I think we’re very excited about the acquisitions we did in Southern California. We like that. It’s our largest market. If you look at the one property in South Bay, in terms 98% of market and some occupancy, so we really like that. The other was in the Inland Empire. Other properties we have new building right off the highway and we think it’s a very good piece of real estate. So we think you’re going to have substantial rent growth out there and we’re very encouraged by those assets. That being said, we are focused more on development because we think this development opportunity we continue to be able to execute using our platform and we’re very excited about the opportunities we’re seeing. And so that’s -- given that given the strength of our balance sheet that’s why we’ve increased our spec cap rate. And again the spec cap rates also includes when we buy buildings that have vacancy. So, again, the Company both buying buildings that maybe not fully leased as well as doing new developments. But we’re pretty encouraged by what we’re seeing.

And then, maybe a follow-up for Scott. Scott I was going to ask you about the lower expenses in the quarter, and then I think in your prepared comments you made a comment about bad debt. So, maybe could you recap the bad debt comment for us and how you see kind of OpEx running for the rest of the year?

Bad debt was very low in the quarter, it was $100,000 and we modeling about $750,000 in the quarter, so that did come in a little bit lower. I’ll turn it over to Chris on operating expenses for 3Q and 4Q and what we’re seeing.

As far as what we’re seeing, we’re not seeing in past few years and quarters, we had impact from the weather related, but we’re not really seeing that. we’re not really expecting that going forward. So it’s just pretty flat going forward.

Your next question comes from the line of Eric Frankel with Green Street.

So obviously you plan to increase your development start I am sure over the next few quarters. I was hoping if you can share some color on the financing strategy?

As we mentioned in our prepared comments, we’ve got sales guidance this year of $75 million to $100 million, so we’re going to have some money coming in the last six months from sales. Also based upon our AFFO payout ratio between 50% and 60%, we’re low 50s for the first six months. We’re going to have excess cash flow coming in from that. So, I would assume that the two major sources of funding development are going to be property sales in that excess cash flow.

Given that asset pricing was so high, and obviously you guys haven’t been acquiring as much properties as you were several years ago. I was wondering why you guys are taking your disposition pipeline pretty steady. I would have perhaps thought that disposition proceeds would increase over the next couple of quarters.

That could be -- again we’re at $44 million now, our goal is $75 million to $100 million. We’ll be disappointed if we don’t come in at the high end of that range or exceed it. So, we’ll see how we do on that. But we’re focused. Again I think our disposition team is doing a great job maximizing the value of the assets and we’re selling and we’re very pleased with the pricing. But we’re continuing on our strategy of continuing to enhance the portfolio through selective dispositions.

[Operator Instructions] Your next question comes from the line of Michael Mueller with J.P. Morgan.

I was wondering for the 80 basis point sequential occupancy gain, were there any geographies or assets that really help to contribute to that stood out?

Not really, it was really a broad bush in terms of seeing everything. Peter do you have any thoughts?

Michael, there is one building in Baltimore that accounted for little bit more than 10 percentage points of occupancy in that market that we released, so that certain helped as well as some improvement in Atlanta.

And Scott, I think I missed it. Did you say about 5 basis points of it was -- that was tied to the occupancy just from moving stuff in and out of the portfolios, just 5, is that correct?

5 basis points was sales related to second quarter, that was the impact in occupancy with 5 bps Mike.

So, of the 80 basis point increase in occupancy, 75% was leasing and 5% was from dispositions.

Your next question comes from the line of [indiscernible] with Stifel.

Quick questions for you on -- what's the current mark to market on your 17% of ADR that’s expiring in 2016?

We’re not giving guidance on 2016 at this point of time. We’ll do that in our fourth quarter call. But I think what we can say is what we’re seeing in the markets are very good things, it’s turning more into a landlord market. And we’re hoping to continue to see positive increases in leasing spreads in 2016. But again, we’ll give you more color on that in our fourth quarter call.

And then just in regard to the land that was purchased, looks like 5 million an acre in Phoenix but 11 million an acre in Dallas. What does that imply about Dallas, is Dallas in your opinion or is that submarket becoming land constrained, seem like a high number.

Jojo, do you want to talk about that…

In terms of this we’re very excited about that acquisition. Dallas, that’s a site that we acquired for GSW. And basically that’s a very large submarket in Dallas where absorption is very strong. Again, we have success there as well. And so, our plan there is to build two buildings and expect us to build some there in term. In terms of Phoenix, again, we’re very pleased with that basis there. As we mentioned to you it’s about 7.8% yield. Again, Dallas also helped by the preleasing, 44% preleasing we achieved in our project. So, we look forward to announce further leasing in that project to achieve our target.

And you have a follow up from the line of Ki Bin Kim, SunTrust Robinson Humphrey.

Sorry about [indiscernible] the queue, all my questions have been answered.

[Operator Instructions] You have a follow-up is from the line of Dave Rodgers with Baird.

I guess new questions about some of the markets, I’ve been looking through and it looks like Indiana and Minneapolis are still lagging in terms of occupancy, and I think your Minneapolis development is still leasing up a little slower. So I guess I’d love the comment on kind of competition there or asset quality the reason that those might be lagging? And then second part to that question would. Looks like your land in Miami and Tampa in the same pool have rents down year-over-year. And so I am just wondering again if that’s a mix shift an asset issue competition or what. So I guess the comments in those five markets might be helpful from the team. Thanks.

On Minneapolis as we talked about last call, we had a large move out in the fourth quarter of about 312,000 square feet one tenant in a couple of buildings. We have released a portion of that and are certainly seeing interest. It’s not an asset quality issue. It’s really just finding the rightsize tenants to fit the spaces. There certainly is more new supply in Minneapolis and in Northwest market. As to Indianapolis -- you asked about the development in Minneapolis as well. Remember that was a two building development, the first building was fully leased to completion and the second building is half leased. We are seeing interest there and the balance of the space could accommodate either one or two tenants. And we’ll certainly keep you updated on our progress there. In Indianapolis we had a first quarter move out of 311,000 square feet in a portion of a larger multitenant building. This space divides for one or two tenants. And we have seen some interest yet, but nothing there to report. And that is a large space for us in that market. It’s little bit over 10 percentage point of occupancy there. So certainly we have work to do and that will be a significant improvement there. And again we’ll keep you up to date on our progress. I’ll turn it over to Chris for your other question.

Overall in the same store rental rates, as far as the couple of markets, really it’s just not that – you’ve seen the trend overall, it’s going up. You do lease different mix of the property types if you have a lower rent of higher finished rents. So certainly kind of the mix in those markets, so there is a slight drop.

And Dave you specifically asked about Atlanta, this is Art. We had some sales of some flex properties over the past couple of quarters. So, you’ve got change in the mix there.

You have a follow up from the line of Eric Frankel of Green Street.

Just very quickly, on your new leasing for the quarter, I know the leasing cost was fairly high. So, want to understand that number little bit better. Thank you.

Really the function of the cost per square of the leasing is really a function of the lease turn, the lease turn overall were about 4.9 years, so that’s higher that’s been in last quarters. If you add in the development next year, we’re about seven years on the average lease term, so more a function of that.

You have a follow up from the line of Aaron [indiscernible] with Stifel.

Two quick ones, term fees in second quarter of ’15?

Little over $600,000, Aaron.

And then can you just remind us of your plans for the $160 million bond coming due in January ’16?

We continually look at the model of the capital markets in our sources and uses to the extent that something changes on our timing, we’ll report it at that point of time, Aaron.

Do you plan to refi…

We got capacity currently in our line here, we have $217 million outstanding in our $625 million line, so we’re in pretty good shape.

[Operator Instructions] You do have a follow up from the line of Ki Bin Kim, SunTrust Robinson Humphrey.

What is your average rent escalation for portfolio now?

Chris, do you want to talk?

Ki Bin, if you look at the commencements that we had in 2015. Our bumps will annualize about 2.6% and that was on 87% of all our leases greater than 12 months.

But that’s for what you signed, right, but on a portfolio level?

The entire portfolio is very similar to those numbers.

At this time, there are no further questions. I’ll turn the call back over to Bruce Duncan. Please go ahead.

Thank you. And thank you all for participating on our call today. As always please feel free to reach out to Scott, Art or myself with any follow up questions and we appreciate your interest in First Industrial. Thanks a lot.

Thank you. That does conclude today’s First Industrial second quarter results. You may now disconnect.