Eastgroup Properties Inc Q3 FY2020 Earnings Call

Good morning, and welcome to the EastGroup Properties Third Quarter 2020 Earnings Call. Now it is my pleasure to introduce Marshall Loeb, President and CEO.

Good morning, and thanks for calling in for our third quarter 2020 conference call. As always, we appreciate your interest. Brent Wood, our CFO, is also participating in the call. And since we'll make forward-looking statements, we ask that you listen to the following disclaimer.

Please note that our conference call today will contain financial measures such as PNOI and FFO that are non-GAAP measures as defined in Regulation G. Please refer to our most recent financial supplement and to our earnings press release, both available on the Investor page of our website and to our periodic reports furnished or filed with the SEC for definitions and further information regarding our use of these non-GAAP financial measures and a reconciliation of them to our GAAP results. Please also note that some statements during this call are forward-looking statements as defined in and within the safe harbors under the Securities Act of 1933, the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995. Forward-looking statements in the earnings press release, along with our remarks, are made as of today, and we undertake no duty to update them, whether as a result of new information, future or actual events or otherwise. Such statements involve known and unknown risks, uncertainties and other factors, including those directly and indirectly related to the outbreak of the ongoing coronavirus pandemic that may cause actual results to differ materially. We refer to certain of these risks in our SEC filings.

Thank you, Keena. Good morning, and I appreciate your time. I hope everyone and their families are well and safe. I'd like to begin by expressing my gratitude to our team for their high performance in a challenging work environment. Our results for the third quarter were strong and highlighted the resilience of our portfolio and the industrial market. The team delivered another solid quarter, with funds from operations exceeding guidance, up 6.3% compared to the last quarter and the third quarter of last year. This marks 30 consecutive quarters of increased FFO per share compared to the same quarter from the previous year, showcasing a long-term trend. Year-to-date, FFO per share has risen 7.8%. Although our quarterly occupancy was lower than the previous year, it was still high, averaging 96.6%, and at the end of the quarter, we exceeded projections at 97.8% leased and 96.4% occupied. Our occupancy benefited from a healthy market with growing e-commerce and last-mile delivery trends, as well as a strong retention rate of 83% year-to-date. Re-leasing spreads achieved a quarterly record of 28% for GAAP and 16.1% for cash, while year-to-date leasing spreads were solid at 23.1% for GAAP and 13.3% for cash. Additionally, same-store NOI increased by 3% for the quarter and 3.6% year-to-date. In summary, during this uncertain environment, I am proud of our team's performance. Our strategy is evolving to include not just maintaining occupancy, cash flow, and liquidity, which has been our focus since March. We are now responding to the market's strength by restarting development. I'm thankful we ended the quarter nearly full at 97.8% leased, marking our second-highest quarter on record. In Houston, our largest market which accounts for 13.5% of rents, we achieved 96.2% leasing, with an average collection rate over the past eight months exceeding 99%. Our company's rent collections remain strong, with 97.6% collected for October so far. There are still many unknowns regarding the pace and timing of the economy's recovery, leading to less clarity than usual. Brent will discuss our budget assumptions, but I'm pleased to report that despite the uncertainty, we are on track for $5.35 per share in FFO, which represents a $0.07 increase from our July forecast and $0.05 above our pre-pandemic expectations. We are fortunate to have the most diversified rent roll in our sector, with our top 10 tenants accounting for only 8.1% of rents. As previously mentioned, our development starts are driven by market demand. Thus, we halted new starts during the shutdown. However, given the strength in certain submarkets, we plan to initiate a few projects in the fourth quarter, and pending permitting, we will continue into the first quarter of 2021. To better position ourselves post-pandemic, we have also been developing several new land sites and expanding parks. More updates will be provided as we finalize these investments. Furthermore, we are working on strategic transactions, including a 162,000 square foot value-add acquisition in Rancho Cucamonga, near the Ontario airport, as well as dispositions expected to close in Houston and on our last property in Santa Barbara. Now, Brent will cover a range of financial topics, including our updated 2020 guidance.

Thanks, Marshall. Good morning. Our third quarter results reflect the resiliency of our team and strong overall performance of our portfolio amidst a very challenging year. FFO per share for the third quarter exceeded our guidance range at $1.36 per share and compared to third quarter 2019 of $1.28 represented an increase of 6.3%. The outperformance continues to be driven by our operating portfolio performing better-than-anticipated, namely higher occupancy and strong rent collections. From a capital perspective, during the third quarter, we issued $32 million of equity at an average price of $133 per share and earlier this month we closed on 2 senior unsecured private placement notes totaling $175 million. The $100 million note has a 10-year term with a fixed interest rate of 2.61%. The second note is $75 million with a 12-year term and a fixed interest rate of 2.71%. That activity, combined with our already strong and conservative balance sheet, has kept us in a position of financial strength and flexibility, including the complete availability of our $395 million revolver as of today. Our debt to total market capitalization is 19%, debt-to-EBITDA ratio is 4.9x, and our interest and fixed charge coverage ratios are over 7.4x. Our rent collections have been equally strong. We have collected 99% of our third quarter revenue and entered into deferral agreements for an additional 0.5%, bringing our total collected and deferred to 99.5% for the third quarter. Last April, we reported that 26% of our tenants have requested some form of rent deferment. In the 6 subsequent months, that only rose to 28% and deferral requests have basically ceased. The agreed-upon rent deferrals thus far totaled $1.7 million, an increase of only $200,000 since our report in July. That represents just 0.5% of our estimated 2020 revenues. We have consistently stated the depth and duration of the pandemic and its impact on the economy is undeterminable. However, the immediacy and degree of potential tenant financial stress and loss of occupancy we had budgeted for has not materialized. As a result, our actual performance and revised assumptions for the fourth quarter increased our FFO earnings guidance from a midpoint of $5.28 per share to $5.35 per share or a 7.4% increase over 2019. The revised midpoint exceeds our original pre-COVID guidance at the beginning of the year. Among the budget changes were an increase in average occupancy from 96% to 96.5% and a decrease in reserves for uncollectible rent from $3.6 million to $2.3 million. Note that the reserve for potential bad debt for fourth quarter of $600,000 is not attributable to specific tenants. Our continued earnings growth directly contributed to increasing our quarterly dividend by 5.3% to $0.79 per share. Our third quarter dividend was the 163rd consecutive quarterly distribution to EastGroup shareholders and represents an annualized dividend rate of $3.16 per share. In summary, we were very pleased with our third quarter results. We will continue to rely on our financial strength, the experience of our team, and the quality and location of our portfolio to carry our momentum into next year. Now Marshall will make some final comments.

Thanks, Brent. In closing, I'm also proud of our third quarter results. Our company and our team has worked through numerous downturns and, while different, will work through this one too. As the economy stabilizes, it's the future that makes me the most excited for EastGroup. Our strategy has worked well the past few years. And coming out of this pandemic, we foresee an acceleration of a number of positive trends for our properties and within our markets. Meanwhile, our bread-and-butter traditional tenants remain and will continue needing last-mile distribution space in fast-growing Sun Belt markets. These, along with the mix of our team, our operating strategy and our markets, have us optimistic about the future. And we'll now open up the call for your questions.

And we will take our first question today from James Feldman with Bank of America Securities.

This is Elvis Rodriguez for Jamie. Great quarter, everyone. I have a couple of questions. The occupancy and lease percentage in Houston dropped 150 basis points from the previous quarter. Was that expected? Are there any specific leases you can discuss?

Elvis, it's Marshall. In Houston, I wanted to provide a brief update. While we anticipated some fluctuations, we thought our occupancy would drop more than it has over the last couple of quarters. We've had some expected move-outs and various factors to consider. Interestingly, there hasn’t been much impact from the oil and gas sector. We did face one issue with a tenant in the airline industry, which is specifically related to the slowdown in airlines and their refurbishing efforts. Overall, this was somewhat expected but not tied to any specific tenants. Since the end of the quarter, we've improved by 50 basis points, bringing Houston's occupancy back to 96.7%, which is just under our portfolio average at nearly 97% leased. We feel positive about Houston. Throughout the pandemic, we’ve been pleased to collect around 99% of rent, with Houston performing slightly better at about 99.5% since March. We believe Houston is steady, as our team has indicated. While it's not our strongest market, the pace of new supply has thankfully slowed, with most new constructions being larger spaces that don’t directly compete with us. We are confident about our position in Houston, and while market expectations may have been concerning, our reality has proven more stable. We expect to be around 95% to 97% leased depending on the developments before year-end.

Great. And then just 1 follow-up. So your development starts, I know you said you're going to continue or increase developments going forward, but it went from 1 million square feet to 825 million square feet of starts for the year. And I know you mentioned some delays from COVID, but maybe can you give us an outlook on what you're thinking for '21 and supply versus demand in your markets for next year?

Sure. Good question. At the beginning, like many of our peers, we decided to finish what's in our pipeline and hold off on starting anything new to assess how things would unfold. Fortunately, the situation has been much better than we expected, especially in March and again when we reported in July. As of the end of the quarter, our leasing rate is at 97.8%, and we are maintaining that rate. October seems to mirror the third quarter, which was our second-highest quarter on record. I want to acknowledge our brokers who have indicated that some of our existing tenants are looking for additional space, and those in the market are asking for inventory. We plan to start development in several areas, including Charlotte, Phoenix, and parts of the Northeast and Dallas/Fort Worth, where we see potential. We are still finalizing our budget for 2021, but I believe that as long as conditions don’t worsen—considering the current COVID case headlines and barring any further shutdowns—the timing of when we commence new projects will be key, from permitting to getting our construction crews ready. We are optimistic about our 2021 starts aligning more closely with a typical year. If we continue to maintain a leasing rate above 97% and start to see demand from new tenants, I think our tenants are becoming comfortable enough to initiate discussions about expansion plans that were previously on hold. Therefore, without going into too much detail, I’m hopeful that 2021 will turn out to be a strong year for development starts for us.

We will take our next question today from Daniel Santos with Piper Sandler.

Congratulations also on the quarter. Just continuing with the development theme, I was wondering if you could walk us through just what you're seeing as far as development costs and yields at cost at different markets. That would be helpful.

Sure. Dan, the good news is that on a macro level, as we finalize some construction bids, we've noticed that build and shell costs have decreased, particularly in Charlotte, which is further along than a couple of other projects. While land prices have remained relatively stable, we’ve successfully acquired some land, including in Fort Myers, and have secured contracts for more land near existing parks to support the next phase of development. Although land prices have been consistent, shell costs have reduced, perhaps by about 5% to 7%. Fortunately, our yields have remained strong in our product type. Most of our competitors are larger boxes located further from town, while we focus on business parks and last-mile locations. It’s encouraging to see our yields stay steady, around 7% to 7.3%, based on our development and deliveries. Recently, we’ve observed a decrease in cap rates, which is likely due to lower interest costs and investors moving away from office, retail, and hotel sectors toward industrial properties. Consequently, our development profits have increased. If we can maintain our yields and our rents remain stable while our costs slightly decline, we are optimistic about the value creation, which has likely improved by about 25 basis points or more in the past 90 days.

Got it. That's helpful. And then second, I mean, based on your rent collections and your occupancy, it's safe to say your portfolio has been fairly well insulated from COVID impact. But in places of the markets where there has been at least a spike could you walk us through maybe some changes in economic activity or tenant behavior that you're seeing in those markets?

There hasn't been much recently to note. One market that comes to mind is Florida, which has been good overall. However, speaking with our team there, occupancy in South Florida seems fine, but our Gateway project near Hard Rock Stadium has experienced some challenges. We constructed two buildings that were fully leased before completion by companies like Lowe's, Peloton, and Best Buy, which fit well for last-mile delivery. We then delivered the third building, which is leasing more slowly. The local economy in Miami has faced more restrictions than in other Florida markets like Tampa, Jacksonville, Fort Myers, and Orlando. Las Vegas is another market where we recently acquired three new buildings; two were leased before we finished, but the third is taking a bit longer to lease, despite some interest. This delay seems to be driven by the local economy also experiencing shutdowns in recent months. Interestingly, I would have expected our third building in Miami to lease up more easily than the first in a new development, but it has proven more difficult due to the ongoing effects of COVID and the significant market closures.

And we will go next to Emmanuel Korchman with Citi.

This is Chris McCurry in for Manny. Quick question from us. What are you seeing in the transaction markets now that is giving you confidence in raising guidance for these volumes? And how do you think pricing has changed since pre-COVID levels?

I'm trying to understand the question. The pricing for finished products is likely 25 to 40 basis points lower, particularly in major markets. Recently, even within the top 20 markets, there are some we are actively pursuing, like a portfolio in Atlanta with a cap rate in the low 4s, and we are in discussions with CBRE. They had three projects under contract waiting to close, all below the lowest cap rate in Atlanta, typically around 4.25% to 4.5%. In Austin, we're observing cap rates around 4.5% and prices per square foot nearing $200 in certain areas. As we became accustomed to these trends in Los Angeles, San Francisco, and Miami, we are starting to notice a similar pattern in other cities. Charlotte has a portfolio in the market, and while I aim to respect confidentiality agreements, we expect to see a low cap rate there, likely a record. In those markets ranked 6 to 25, cap rates are declining. What we've been told is that investors feel confident about industrial rent growth going forward and there's a diminished interest in other asset classes outside of multifamily and industrial, which are currently the most favored.

Yes. I think, too, then you may be referencing to our increase in our value-add property acquisitions from none to $30 million, and Marshall might touch on those. Those are a couple of deals that we had planned to close last year and they've leased a little quicker. And so I mean, those are both under contract and going to close before the end of the year. So those are deals in hand.

Yes. To elaborate further, one of our acquisitions turned out to be a value-add, thanks to John Coleman and his team in the Eastern region, who secured a tenant before the building was completed. What was initially anticipated as a value-add opportunity is now officially considered an acquisition. Additionally, referring to the Rancho Distribution Center in Rancho Cucamonga, we purchased it with an owner user leasing it back for about six months. We believe this leasing arrangement, combined with its strategic location near two major freeways and the Ontario, California airport, provides us with better pricing as we take on the leasing risk. This also boosts our confidence when discussing with brokers in Southern California, who describe their market as fluctuating, with strong activity in the first quarter, a slowdown afterward, but a significant rebound in business and interest in the Inland Empire, particularly in the Inland Empire West, where this property is situated.

Got it. Yes. That's helpful color. Just a quick follow-up. How do you think about using asset sales versus equity issuance as a source of funds?

Yes, we are very pleased with our stock price and noted that we issued some debt this quarter. We were happy that the markets were open to us and offered attractive conditions. We are not lacking in capital; those will be our main sources. However, we have been good stewards of recycling through some of our lesser assets, which aligns with our approach rather than doing it solely for capital. You will see us continue to make progress in Houston, and we are pleased to reduce it to the 13% area and keep it declining. We have a property there that we expect to close before the year-end. Our focus is more on navigating these aspects rather than capital. Fortunately, our situation presents more opportunities than bottlenecks, which is a positive issue to have.

And we will go next to Eric Frankel from Green Street.

I was hoping if you can give us a little more color on how market rents are generally trending. So just looking at your rental changes by market, it looks like a few markets, understandably California, but even parts of Texas can be doing really well, while other markets have decelerated a little bit. Maybe you could provide a little more color.

Sure, Eric. It's Marshall. You are correct that the California markets remain strong, which positively impacted our re-leasing spreads this quarter. Interestingly, this has even surpassed records set during the pandemic. It’s a situation where the headlines do not align with our daily observations. While California markets are performing well, Fresno might be a bit slower compared to the Bay Area, Los Angeles, and San Diego. Our larger markets like Houston have stabilized and flattened out. As we look at year-to-date performance, there can be anomalies based on our lease batches, especially in smaller markets like Atlanta where we have seen some negative numbers, but that largely depends on which leases have rolled. Houston was initially slower, and rents had decreased earlier in the year, but there are signs of improvement as activity is picking up. Overall, other markets are starting to stabilize and recover. The pause in construction is noticeable, and as we analyze the charts, we see it beginning to resume. However, much of the new construction is focused on big box properties. We are optimistic about restarting our development pipeline, especially since there isn’t much activity in shallow bay development right now. With our delivery timeline anticipated for around the second quarter of 2021, we typically plan to lease back up within a year, positioning ourselves to stay ahead of the market.

Right. It makes sense. One of your peers kind of mentioned earlier this earnings season that leasing volume might slow up a little bit next year just as the economy opens up, and maybe folks change their consuming habits and spend a little bit less on amazon.com and more on vacations or concerts or whatever services. Do you have any views on what the economic recovery would look like and how that might shape demand?

I'll start by saying that we're not economists. As we've exceeded our guidance a few times, Brent and I clearly aren't great economists, which is part of that preface. I think we can expect questions about whether Amazon is creating a misleading demand in the market. I would argue that's not true, particularly not in the shallow bay sector where we operate. I've heard one broker describe Amazon more as a disruptor, and it's clear that other companies will need to adapt to Amazon's model, increasingly focusing on e-commerce and delivery rather than traditional storefronts. I do believe that while e-commerce won't sustain its current growth rate of 80%, it will continue to expand. With each passing quarter, even in this unusual economy, our tenants, including our own team, are starting to find their footing. The first quarter was typical, and the second was highly disruptive. Some tenants have even told us they faced inventory shortages at various times. Initially, we focused on safety stock, but now we're observing a growing trend in that direction. I believe the industry that will benefit EastGroup includes Ferguson plumbing and Delta, with Kohler seeing an uptick in homebuilding. We're noticing some activity in home renovation and homebuilding within our portfolio, and I expect that to increase as homebuilders seem to be ramping up due to population shifts. I'm more optimistic about 2021 compared to 2020. I'm thankful that our team has managed to navigate this better than expected, but I am hopeful for 2021, assuming we don't encounter any significant setbacks.

And we will go next to Craig Mailman with KeyBanc Capital.

Maybe I just want to circle back to the balance sheet and maybe from a higher level. Clearly, your cost of equity has made it very conducive to use the ATM to help fund, but the cost of debt is also extremely low for you guys now. But just in the context of lower cap rates for industrial assets, by nature, raise debt to EBITDA, just the way the math works. And just kind of curious, as you guys think about the optimal capital structure to maximize earnings, kind of minimize risk, what are talks internally? Kind of how do you guys balance those 2 things? And does there need to be some upward trend in debt-to-EBITDA just to be able to kind of maximize everything?

Yes, Craig, we often discuss this topic. Fortunately, we've seen two positive trends: an attractive cost of equity and a similarly appealing cost of debt. This year, we are approaching things with a somewhat conservative mindset, as reflected in our recent release. Currently, we don’t have any balance on our nearly $400 million revolver, which is unprecedented for me during my time with the company. Our discussion is ongoing. There are moments when we consider becoming slightly more leveraged, but then you encounter situations like earlier this year when our stock price reached around $88 or $90 a share, which makes us feel more confident about our conservative stance. The situation fluctuates, but it's worth noting that our debt-to-EBITDA ratio has decreased over time. However, as you pointed out, it can be challenging to manage growth, especially when we are consistently incurring development costs that have not yet started generating net operating income. We did achieve a sub 5% debt-to-EBITDA ratio last quarter, which is a target for us, but it won't prevent us from continuing our development efforts. If that means a slight increase in our debt-to-EBITDA ratio, that’s just part of the nature of our business. Overall, our balance sheet is in good shape, and our main focus is on finding the right opportunities. Our team does an excellent job seeking out advantageous situations for us, and this remains our priority.

I agree with Brent and Craig. I would add that a few years ago, our debt to market cap was around the mid-30s, and our debt-to-EBITDA ratios were a bit higher. Generally, we target a 150 basis point spread over market cap rates, but currently, we are closer to 300 basis points. This means if we can aim for a 7.2, it’s probably about a 4 to account. As we discuss our strategy and position ourselves, we want to ensure we don’t flood the market with too much product. We’re focused on seeing the market absorb what we have as we continue to reload our development inventory. The potential for value creation is compelling, and we’re prepared for some disruption. We decided to be operationally aggressive to take advantage of the current environment while maintaining a safe balance sheet. This strategy allowed us to improve our balance sheet significantly. I don’t feel a pressing need to continue reducing debt; we might if a good opportunity arises, but we believe we can comfortably pursue development opportunities where there is market demand. The spreads we’re seeing are the widest in our company’s history, and having a solid balance sheet provides security in case leasing takes longer than expected for some projects.

That's helpful. I appreciate the thoughts there. And then just, Brent, relative to the same-store guidance, you guys are at 3.6% year-to-date. Midpoint is 3%. Is this just conservatism? Or it's late in the year, so it's harder to move the numbers. But I mean, does this imply sort of a deceleration from 3Q levels in 4Q to get to that midpoint? Or should we think more you guys could be at the higher end of that 2.5% to 3.5% range?

As we traditionally do, the information we put in that guidance table is just transparency on what equates to that midpoint of FFO. So in that case, it does dial up to that 3.0%. And as you basically are backing into, that does imply a bit slower fourth quarter than the earlier quarters. And as of right now, from a budget perspective, that is what we've got dialed in now as to what happens there. Each quarter here through the year, we have been ahead of where we've anticipated. So my hope would be that that proves to err a little bit on the conservative side and improves yet again. But just a reminder, last year, third and fourth quarter were some of our, I think, the highest percentage lease marks we've had in the history of the company. So I don't know so much of the deceleration in markets as much as the measuring stick that you're going up against there is pretty darn strong. And you compare that to just, again, budget assumptions that aren't our goal or is an objective every day, so you hope you'd beat that. So we'll see. Like I say, it's just a quarter to go there, and we're only two months to go there. So we like where we are at this point in the fourth quarter, and our focus would pretty quickly here turn to kind of see how that stacks up for next year.

Right. And then if I could slip one more in. Marshall, the Rancho Cucamonga deal, is that the $28 million, i.e., West deal that you guys did in the quarter?

You're correct. Yes.

Can you just talk about what kind of initial yield is versus what it could be stabilized when the tenant in place kind of moves out and you guys either put capital in or roll the rent up or down?

Yes. The owner leased the building back, so the rents are likely at market value now, which I would estimate to be in the mid- to high-4% range. While we are not planning to flip the asset immediately, if we secure a tenant that is not a Fortune 1000 company for a 5 to 7-year lease, we could likely sell it today for a market value in the high 3% range based on current cap rates. I believe we will stabilize and maintain the yield as we underwrote it. I remain cautiously optimistic that by the time the tenant moves out, considering the constraints in the Inland Empire West area, the rents we previously projected will likely be below market rates 6 months from now. However, I anticipate that we will finish slightly under 5%. Ideally, if we can secure a tenant with a term around 4.75%, we will achieve a premium of over 75 basis points compared to the current market cap rate.

Nice job. I appreciate it.

No, I would like to provide some additional insight. None of these moves are significant, and we still have a couple to finalize. However, they reflect our strategic desire to expand in Southern California. It is challenging to be patient in the LA market, but I am pleased with how we are aligning our efforts. We hope to sell our last R&D building in Santa Barbara and close on another asset in Houston. Currently, Houston represents a 30 basis point decrease in our portfolio compared to the second quarter. We aim to complete another sale in the fourth quarter, continually adjusting our strategy in a positive direction. These are not major changes, but they are incremental steps toward our goals across all three areas.

So we will go next to Bill Crow with Raymond James.

Marshall, you've referenced a couple of times today the inflow of capital into the sector from other places. And I guess that leads to kind of a 3-part question. Are you seeing new competitors on acquisitions? Is there an erosion in development discipline, which might be evidenced in extended lease-up periods and new construction? And three, how do you think this thing ends?

We are noticing new entrants into the industrial sector, which is surprising given the pandemic. This trend seems to be more related to acquisitions and development, particularly in areas like Dallas. While we aren’t observing an oversupply right now, that doesn’t mean it won’t happen in the future. To date, development activity has been moderate. In Dallas, for instance, new projects tend to be located at the edges of town where larger investments can be made. I’ve had conversations with colleagues who are outside the industrial sector about how they perceive it, and I can understand why they might feel uneasy. However, we advise them against entering this sector, as many believe it is suffering from oversupply; yet, we see evidence to the contrary. My perspective remains optimistic. Historically, after downturns like in late 2015 and 2016 when development in Houston rapidly diminished due to slumping oil prices, the fundamentals in the industrial sector have remained strong during this pandemic. It’s worth noting that our industry has become more disciplined and is now largely institutionally owned. Conditions could tighten as they did in the past, but I maintain a positive outlook. Moreover, the influence of companies like Amazon is reshaping retail and advancing e-commerce growth, particularly with curbside pickup and delivery options. I believe we are at the beginning of significant changes in shopping behavior, which will benefit our operations over the next few years. We are already experiencing an increase in repeat business from our customers, revealing that our strategic location choices are paying off.

And we will move next to Michael Carroll from RBC Capital Markets.

I wanted to talk a little bit about your guidance occupancy trend. Obviously, it's held up fairly well over the past 3 quarters, better than, I guess, expectations. I guess what's driving that? Is it due to the strong leasing volumes that you guys have been able to deliver over the past few quarters? Is it just less tenant issues that you thought possibly could have happened? Or is it a little bit of both?

I'll take this out and Brent will jump in. Looking back, I felt confident about each group considering our balance sheet, but with 1,600 tenants, I was concerned that some might not survive the downturn and economic shutdown. Fortunately, the attrition has been much lower than we anticipated, which has improved our occupancy. Typically, our retention rates average in the low 70% to 75%, but year-to-date, it’s at 83%. With the uncertainty, tenants have postponed their growth plans from late 2019 and early 2020, allowing us to retain many of them. There were tenants earlier this year that we expected would vacate, but instead, they chose to renew their leases due to uncertainty about the future. These have been the two main factors. As markets reopened, particularly in places like Atlanta, the Carolinas, Texas, and Florida, we've experienced an increase in activity. In fact, some have noted that we're back to pre-COVID levels in leasing velocity.

Okay. Have you assessed how many tenants are in sectors that are highly exposed, such as leisure or event planning, that might need to give back space, potentially causing some short-term disruptions? Or do you believe the risk is minor enough that it's not a significant concern?

We certainly monitor those sectors. I'm pleased to note that our top 10 tenants contribute just over 8% of our revenues, which is the lowest we've observed in the industrial sector. We appreciate geographic diversity and are actively working on it, as well as having landfall diversity. We keep those tenants on our radar, particularly in Orlando and Las Vegas, where surprisingly, we have retained our tenants and faced fewer issues than anticipated just a few months ago. Although we remain vigilant, those markets have remained stable. Thankfully, our requests for rent relief surfaced in April, and tenant movements have been positive since then. Our rents have actually been coming in earlier, with improvements noted over the past three months—September showed better results than August, and October is also looking stronger. It seems to be an overall improvement. Although our rent relief requests haven't vanished, they've significantly decreased. Interestingly, just 50 basis points of our revenue was related to previously deferred rent, and we've managed to collect a substantial portion of it. This gives us confidence in our portfolio, allowing us to raise our guidance last quarter and again this quarter. We were anxiously waiting for any negative developments as things progressed, but fortunately, the impact on any of the industrial REITs has not been as severe as we all initially anticipated.

Okay. Great. I guess last question, and I'll jump off is, I guess, you did talk a little bit about your watch list. I mean, how big is that watch list right now? And how did it compare, I guess, to what, 3, 6 months ago?

It's probably been less than 3 or 6 months since we last assessed this. It's not really about the market; it's more about specific tenants. For example, we had one tenant in Houston involved in airplane refurbishments whose entire industry faced challenges. Additionally, we had a tenant in the dental supply business in Atlanta, and when the situation arose, people temporarily stopped visiting the dentist. Those tenants encountered difficulties. With 1,600 tenants in total, we do keep a watch list, but thankfully, the number is probably in line with what is considered normal right now.

Yes, I would agree. Our bad debt continues to be less than we initially expected. The watch list and receivable ledger have been well maintained and quite clear. We remain impressed with our collections, particularly in Houston. Kevin and his team have done an excellent job, as Marshall noted. For the third quarter, between collections and rent deferral, we collected 100% of our rents in Houston, which is a testament to the team and our tenant base. Overall, the watch list is very manageable at this time.

We'll go next to Ki Bin Kim with Truist Securities.

When you look into your tenant rolls for the next 12 months or so, any pockets of concern that we should be aware of? And also, how do you think about your Mattress Firm tenant today?

There's always movement among our tenants. For instance, one tenant is consolidating their multiple locations, so we expect to reclaim that space. Fortunately, we have another tenant in L.A. where the current rents have potential for increase, and we plan to refurbish that building and lease it out again. I don't see any major concerns right now. As the economy stabilizes, I anticipate our retention rate will likely drop from the low 80s back to the lower 70s, which is where we've typically been. Nevertheless, there are more opportunities emerging. In some cases, we are considering upgrading our tenants and making adjustments. I'm pleased that we've maintained a 99% collection rate throughout the pandemic, so it wouldn't be fair for me to complain about our tenants overall. However, from time to time, we have chances to enhance our tenant mix. Mattress Firm has navigated through their challenges, including bankruptcy. Over the next few years, we will likely be reviewing several of their leases. I recall that at the time of their bankruptcy, the average age of their buildings was about six years, and they have locations in new developments in markets like Houston, Fort Myers, and Tampa, which have healthy tenant movement. While they are in a difficult industry, they are current on their obligations, and we'll keep an eye on them due to market demand. We are likely closer to the end of some of their leases than to the beginning, so we'll monitor those spaces and understand their future plans.

Okay. And do you have any early estimates for Prop 15 and what that can do to your tax base in California?

I believe that almost all of our California leases are triple net, so any changes won't be passed on to our tenants. The latest information suggests that there isn't much expectation for it to pass, but it's uncertain. If it does pass, it would take about 2 to 3 years for tax assessors to fully reassess the buildings. Fortunately, most of the costs will likely be transferred to our tenants, which would affect our rent growth in California, a market we consider strong. This concern makes us value our diversified portfolio that we are expanding in California. However, it is difficult to overlook the negative news coming out of California regarding its long-term economy. This situation increases my appreciation for Texas, Florida, and the Carolinas. If it passes, the impact will be delayed, and it will hinder our ability to increase rents because, as Ki Bin has mentioned, it's all part of the same budget. Regardless of whether we call it property tax reimbursements, rent, or insurance reimbursements, there is a limit to the gross rent dollars available. Therefore, some of the funds that could have been allocated to rents will instead go towards taxes if that occurs. We’ll manage our size in California just as we have been doing in Houston over the past couple of years.

Could you provide an estimate of the impact? I understand it might be challenging, but can you share a couple of details, such as the average vintage of your properties in California and the total current tax bill for the state if you have that information?

There’s quite a bit of uncertainty regarding our situation in San Diego. We've acquired several assets, including one in Rancho Cucamonga, which has not been impacted since we just purchased it, and we are actively working in San Diego. However, in L.A. and San Francisco, some of our assets are from the 1990s. While we have seen about a 2% increase year-over-year, these older assets are experiencing more significant challenges. We plan to exit Santa Barbara, and quite a few properties in the Bay Area are older. The same goes for some in L.A. and a project in Fresno that dates back to the late '90s. These older assets may face greater exposure depending on their assessments, which can be hard to predict due to the varying aggressiveness of assessors and our deal structures. I don’t have a precise figure for you at this moment, but many of our properties in San Diego are likely already at market rates.

And we will take our final question today as a follow-up from James Feldman with Bank of America Securities.

Just one more quick one. Brent, you mentioned $200,000 increases in deferrals from July to now. Anything from those tenants? Are they more tourism related in Houston? Or anything else that you can share from that?

No, it has remained quite diverse with many tenants, which is fortunate, rather than relying on a single tenant to significantly impact the numbers. There isn't anything concerning about the $200,000. We're pleased that the total amount, as Marshall previously mentioned, appears to have stabilized at 1.7 million. We have already collected $200,000 of that through September. All deferred payments that were due have been collected by the end of the third quarter, reducing the outstanding figure as of September 30 to $1.5 million. Nearly all of that, except for about $100,000, is scheduled to be repaid by December 2021. Our team effectively minimized the duration of the deferrals, giving tenants some leeway to make payments later without any significant issues related to the $200,000 or the overall total. It reflects a diverse mix of assistance to a wide array of customers.

And this does conclude our Q&A. I'll turn the call back to our presenters for any additional or closing remarks today.

Okay. Thanks, Brucella. Thanks, everyone, for your time this morning and your interest in EastGroup. We are certainly available. I know we limited everyone on their questions, on their Q&A, but Brent and I are both available. If you have any follow-up, please give us a call, shoot us an e-mail, whatever is easiest, and look forward to seeing you virtually at NAREIT, I guess, next. Thanks.

Thanks.

This does conclude today's program. Thank you for your participation. You may disconnect at any time.