First Industrial Realty Trust, Inc. (FR) Q1 2017 Earnings Report, Transcript and Summary

Good morning. My name is Halle, and I'll be conference operator today. At this time, I would like to welcome everyone to the First Industrial First 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] I would like to turn today call over to Art Harmon, Vice President of Investor Relations and Marketing. Sir, please begin.

Thanks, Halle. 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 are 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 a 100 basis points higher than a year ago. Our cash same store NOI growth was 5.9% and cash rental rate change our 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 development, we increased the midpoint of our FFO per share guidance by $0.02. Scott will walk you through the details and guidance later in his remarks. We continue to be encouraged by the depths and breadths of the leasing market which is supporting our efforts to grow rents. Given this 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 verity of tenants' 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 foot in Phoenix in the first quarter. We've seen good interest in this property and will keep you posted as our leasing progresses there. In Southern California, First Sycamore 215 and the Ranch remained unscheduled for completion in the second quarter and fourth quarter respectively. At the end of the first quarter, our completed and end process speculative developments totaled a $169 million comprising 2.4 million square feet with a targeted weighted average GAAP yield of 6.9%. As of March 31st, 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 footprints in Southern California with our first acquisition - our first quarter acquisition of 19 acre development site in the Inland Empire West submarket of Fontana. We have some entitlement work to do there before ready to go. We're excited about this opportunity due to its great location and 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 yields on our total investment is expected to be approximately 5.9%. As part of 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 stabilize cap rate of 7.7%. For 2017, you'll remember that our goal for sales is $150 million to $200 million, which we in fact to be back end loaded similar to prior years. I would like to call out some good news that we received in the past 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 are very pleased with this traction. In conclusion, we are 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 95.5% 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 a typical first quarter seasonal roll down. Note that sales had no impact as compared to 4Q 2016. 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 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 and leasing had 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 20th, we closed our private placement of $200 million of fixed rate senior unsecured notes. As a reminder, the notes comprised of two tranches: $125 million with a 10-year term and $75 million with the 12 year term. We pay interest semiannually and the weighted average interest rate of the notes is 4.34%. Initially we use 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 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've discussed in our fourth quarter call, we also prepaid $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 $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 5.4 times, adjusting EBITDA by normalizing G&A and that 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 investing of incentive compensation for our former CEO. In March 31st, the weighted average maturity of 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. 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 issues on our fourth quarter call. The increase was 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% and 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 the guidance includes the anticipated 2017 costs related to our completed and under construction developments in March 31st. 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 or 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 and 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 ecommerce expansion, supply chain reconfiguration 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 position 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.

Absolutely. [Operator Instructions] Our first question is going to come from the line of Anthony Howe with SunTrust.

Thanks guys. Thanks for taking my question. 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 are concerned about?

So - hi, it's Peter. So as we mentioned in the last call, we are under the - we are operating under the assumptions that were lot closer to equilibrium than that which generally means we are 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 have also seen strong absorption. Two markets that we are keeping an eye on for supply would be Indianapolis and North Houston, but also a critical to remember that when we develop or not making big macro bets, we certainly are mindful the overall supplying demand fronts. And before we go ahead with any development or land acquisition, we conduct a thorough bottoms up analysis to make sure we are bringing the right product at the right time in the market to serve the existing demand.

Okay, thank you.

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

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

I'll start this off and then Jojo and Peter can jump in with their views. Every time we approach a new discussion about lease whether these are renewal. We are trying to maximize the economics, maximize the outcome across the number of variables, that is certainly one term and cost. So we are 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. Their retention number for us is high and that's good, it means we've got a lot of our costs going into leases then if they turned over. So we think we are pretty pleased with the outcome. We think that with a high retention, we still achieve pretty strong growth and pretty that increases the rent. So we are definitely mindful of all the inputs. I don't know Jojo or Peter if you have any?

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

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

And Scott, if you look at kind of the 25 basis point from peer and same store, was that more on the occupancy side coming in better than expectations or more on the rent side? Okay, I guess I am just trying to figure out where there is more juice and just keeping the occupancy where it is or trying to push rents further?

Hey 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, bad debt expense that came it at 75,000. So that was a big driver in the first quarter outperformance the same store and was a big driver and causing us to increase our same store guidance on an annual basis by 25 basis points at the midpoint.

How much you've backed in for the full year?

We have $625,000 per quarter in the second quarter, third quarter and fourth quarter. And I am not saying that we're going to have $75,000 of bad debt expansion 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.

Great, thanks guys.

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

Thank you. So Amazon announced I think a few weeks ago that they are going to shut it down one of their subsidiaries at Quidsi which operates Diapers.com bands, and that's - all your rental whatever call there located in North Eastern Pennsylvania. Can you just remind us, I think their lease expired next year, what are the renewal prospects for the company and would Amazon just keep the building, inform their supply chain in general?

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

Okay, that's helpful, thanks. Peter, as you continue to get more experience in your roll there, any thoughts on portfolio and which you're watching portfolio size to look like over a long period of time, do you think as a company your portfolio size what called $4 billion to $5 billion in assets, that's picking up, do you think you want to scale more significantly in the next or two especially it's I think all industry would cost the capital a little bit better?

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

Okay, thank you. I'll jump back in the queue.

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

Yeah, good morning, guys. 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 any kind of maybe a different tenant base and then you traditionally dealing with at the upper sizes of building or is there not really a big difference that you are seeing between those two?

Yeah, this is Chris. As far as - it's actually typically with the larger tenants, you are probably going to get higher retention rates overall. So I would say it's not really driven by the size of the tenant but we are happy with the number that first quarter number. For the entire year, we 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 chat about this before but I don't know that 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 are seeing to go out by 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 six months we lease them. We built then a 12 month down time into our pro forma on those. So we've been outperforming our pro forma. Today we have $169 million under construction. We are only about 20% complete in terms of investment dollars. And so we are really right on track with the leasing conversations that we are having. I would also point out that you know 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 are delivering.

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

And Jojo, I guess some of the speculative land that you bought recently and what's under construction, where do you standing into development cap?

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

And then I guess maybe last question for Scott. You know when you look at your guidance for the year, I did see you've increased notwithstanding the bad debt comments that you made earlier, you started the year about 6% which was a great start, what kind of get you to the low end of that range, do we see a natural slowing in free rent as the year progresses because it sounds like your renewals are already up 6% or so on a cash basis for the reminder of the years. So it sounds like you've got good traction there, what's going to get you down into the lower end of that range?

Hey Dave, this is Scott. We look at same store more than 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 quarters and what we are 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 is as well that 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 - that saying we are going to achieve this but if you have the same results in the second through fourth quarter on bad debt expense that will leave same store about 60 bps. So really it's the bad debt expense assumption and some burn off in free rent in the first quarter 2017. That's causing that.

Sorry, one more last question maybe for the guys in the region, can you talk about kind of what industries you are seeing improving in activity and where you might be seeing any potential slowdown just in terms of demand activity leaving out the supplies out of the equation for now?

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

Great, thanks everyone.

[Operator Instruction] Our next question is a follow-up from the like of Eric Frankel with Green Street Advisors.

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

In terms of - Eric, hi it's Jojo. Let me clarify in terms supply concerns in Houston. Houston in the north submarket has had negative absorption recently. In addition to that add more color you know 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 Indi.

Sure. Eric, Peter Schultz here. In Indi, we've talked about that periodically over the last couple of year where that market has seen a pure amount of new product. Last year was a pretty good year in Indi. 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 are 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 large markets. And there could be pockets of supply that are a little bit ahead. I might say central PA where you are seeing less new construction. In central PA, you are seeing a little bit elevated vacancy rates there compared to the Lehigh Valley, which continues to be very tight and you are seeing new supply there, but the demand is strong and the buildings are leasing at or near completion.

Okay, thanks. Just to clarify Houston, just to jive with what I am singing hearing is that the supply issue is actually in Southeast Houston, there is a demand in North Houston but the supply there is essentially tapered, that's was my understanding.

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

Okay, thanks. Just moving to southern California, what exactly - do you have a vision Peter of what, how large you want something be a proportion of portfolio is obviously this lots you deal is that all of your - most of your recent cap allocation activity has been there, obviously been little more aggressive on the development? And then as a follow-up to that, how much more entitlement work you have to do in the first tenant site, that lands - you know obviously land values have increased about certainly higher than we've seen ever now, we've seen in terms of recent land caps there? Thank you.

Sure. I'll cover the first part. Jojo can cover the second part. Look we are very pleased with this supply demand dynamics in California. Rent increases there are significant as you have heard as we've talked 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 cost of land there that the rent opportunity and the opportunity to push those rents that will be around for some time. So I think hopefully that covers the first part. Jojo, you can talk about Montana.

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

Okay, thank you very much.

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

Hey Scott, just a quick follow-up on the bad debt, do you guys have any tenants on the watches that you are worried about at this point and maybe just give us a sense of you know this cycle kind of how bad debt is coming versus budgeting?

Craig, this is Scott. The bad debt has been very low for us I would say in the past three 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 watch list is concerned, we have a very granular portfolio, largest tenant is around plus or minus 2.5%. As we sit today, there are no tenants on the watch list but we conduct our calls on a monthly basis. We haven't conducted our April call but we are not aware of anything at this point in time Craig.

Okay, that's helpful. Then just curious separately on the disposition font, one of your peers is talking about the continued demand for these and kind of their view that maybe cap rates could fall. Just curious what your 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 maybe ramped at a little bit quicker and then just kind of what you may have left in that non-core kind of higher cap rate bucket?

In terms of Demand Craig, the demand - the buyer demand continues. That seems to be really changed from the recent past the private investors, advisors plus users are all active in the market. This seems like buyers are very under allocated to industrial, so we have the same amount demand. You know in terms of our portfolio that's part of our ongoing portfolio management strategy. You will see us continue to push out the low cash flow growth, high CapEx, you know properties and reinvest that and what we really with higher rent growth, higher rent growth and lower CapEx properties. That's our job and we'll continue to do that.

On the cap rate side, you know what's your view and kind of what's been your recent experience that you guys are at kind of high 7s on that as you did this quarter kind of versus your expectations going in?

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

Great, thank you.

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

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

Once again, we would like to thank you for your participation on today's conference call. You may now disconnect.