Eastgroup Properties Inc Q3 FY2022 Earnings Call

Good day, and welcome to the EastGroup Properties Third Quarter 2022 Conference Call and Webcast. Please note this event is being recorded. I would now like to turn the conference over to Marshall Loeb. Please go ahead.

Good morning, and thanks for calling in for our third quarter 2022 conference call. As always, we appreciate your interest. Brent Wood, our CFO, is also on the call this morning. 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 and 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 reflect our current views about the company's plans, intentions, expectations, strategies and prospects based on the information currently available to the company and on assumptions it has made. We undertake no duty to update such statements or remarks, whether as a result of new information, future or actual events or otherwise. Such statements involve known and unknown risks, uncertainties and other factors that may cause actual results to differ materially. Please see our SEC filings, including in our most recent annual report on Form 10-K for more detail about these risks.

Thanks, Keena. Good morning, and thank you for your time. I'll start by thanking our team for another strong quarter. They continue performing at a high level and capitalizing on opportunities in a fluid environment. Our third quarter results were strong and demonstrate the quality of our portfolio and the resiliency of the industrial market. Some of the results produced include funds from operations coming in above guidance, up over 14% for the quarter, ahead of our initial forecast. This marks the 38th consecutive quarters of higher FFO per share as compared to the prior year quarter, truly a long-term trend. Our quarterly occupancy averaged 98.3%, which was up 120 basis points from the third quarter of 2021. At quarter end, we're ahead of projections at 99% leased and 98.5% occupied, matching our company record occupancy. Similarly, quarterly re-leasing spreads were strong, both above 39% GAAP and 23% cash. Year-to-date re-leasing spreads are similar at 36% and 22% GAAP and cash, respectively. Finally, cash same-store NOI reached 8.7% for the quarter and stands at 8.9% year-to-date. In summary, I'm proud of our year-to-date results and the positioning this gives us to finish the year. Currently, we're responding to strength in the market and user demand for industrial products by focusing on value creation via raising rents and new development. I'm grateful we ended the quarter 99% leased. To demonstrate the market strength, over the past 2 years, we have produced a number of quarterly records for the company. Another trend we're seeing is more widespread rent growth. Re-leasing spreads have trended higher than in 2021 and, more importantly, across a broader geography. I'm happy to finish the quarter at $1.77 per share in FFO and raise annual guidance to $6.93 per share, up 13.8% from the 2021 record. Helping us achieve these results is thankfully having the most diversified rent roll in our sector, with our top 10 tenants only accounting for 8.9% of rents. As we've stated before, our development starts are pulled by market demand within our parks. Based on our read-through, we're adjusting forecast for 2022 starts to $375 million. Through September 30, we've completed 11 development and value-add projects, with 10 of those rolling into the operating portfolio fully leased at an average yield of 6.6%. In addition to these, we have another 8 projects, which are 100% leased prior to construction completion. We're happy with the consistent value creation these represent, and we'll continue to closely monitor development progress given heightened economic uncertainty. Given the shift in capital markets early in the second quarter, we're taking a measured approach on new core investments. We're also carefully evaluating each new development site given the level of demand and longer time frame often required to put these sites into production. Brent will now speak on several topics, including our updated projections within the 2022 guidance.

Good morning. Our third quarter results reflect the terrific execution of our team, strong overall performance of our portfolio, and the continued success of our time-tested strategy. FFO per share for the third quarter was on the high end of our guidance range at $1.77 per share and compared to the third quarter of 2021 of $1.55, represented an increase of 14.2%. The outperformance continues to be driven by our operating portfolio performing better than anticipated, particularly occupancy and rental rate growth. From a capital perspective, macroeconomic concerns have caused the stock market to further decline, including our share price. As a result, we only issued $1 million of equity. We have been intentionally deleveraging the balance sheet over the past several years, placing ourselves in an advantageous position to pivot to debt proceeds for capital sourcing. During the third quarter, we closed on $125 million of senior unsecured notes with a weighted average fixed interest rate of 4.04%. This issuance included 2 tranches, one for $75 million with a 5-year term and another for $50 million with a 2-year term. We also agreed to terms on the private placement of 2 senior unsecured notes totaling $150 million. One note for $75 million has an 11-year term and an interest rate of 4.9%, and the other $75 million note has a 12-year term and an interest rate of 4.95%. The notes were issued and funded after the quarter end. As a reminder, the company does not have any variable rate debt besides the revolver facilities, and our near-term maturity schedule is light with only $115 million scheduled to mature through August of 2024. Although capital markets are fluid and have risen in costs, our balance sheet remains flexible and strong with healthy financial metrics. Our debt to total market capitalization was 21.3%, unadjusted debt-to-EBITDA ratio is down to 4.88x, and our interest and fixed charge coverage ratio is at 8.9x. Looking forward, FFO guidance for the fourth quarter of 2022 is estimated to be in the range of $1.73 to $1.77 per share and $6.91 to $6.95 for the year, a $0.03 per share increase over our prior guidance. The 2022 FFO per share midpoint represents a 13.8% increase over 2021. In closing, we were pleased with our third quarter results. And as we have in both good and challenging times in the past, we will allow our financial strength, the experience of our team, and the quality and location of our portfolio to lead us into the future. Before I turn it back over to Marshall, I want to note that, fortunately, our Florida portfolio sustained minimum damage as the result of Hurricane Ian in September. With the aid of insurance proceeds, we will replace 2 older roofs on buildings in Fort Myers. We do not anticipate any meaningful financial impact to the operating portfolio because of the storm. Now Marshall will make final comments.

Thanks, Brent. I'm proud of the results our team created year-to-date and the position it leaves us in for the balance. Internally, operations remained historically strong as our results indicate. That said, the capital markets and overall environment are volatile. While never fun to live through, a couple of thoughts that may prove helpful. First, our team has worked together through several downturns and forecast downturns before. Our strategy shifts, but it's not uncharted waters. Secondly, the industrial market has been red hot the past few years, so some level of market concern we view longer-term as healthy for a sustained positive environment. Meanwhile, our buildings are as full as they've ever been, and rents are rising throughout our portfolio. We'll work to keep occupancy high, continue pushing rents and listen to tenants and prospects to accommodate their demand in the market as we've always done in good and bad markets. And longer-term, I remain excited for EastGroup's future. There are several, long-term positive secular trends occurring within the last mile shallow bay distribution space and Sunbelt markets that will play out over years, such as population shifts, evolving logistics changes, etc., which we are well positioned for. And we'd now like to open up the call to take your questions.

Thank you, Mr. Marshall Loeb, President and CEO. Our first question comes from Craig Mailman from Citi.

I know, Brent, you said there is no real impact from the hurricane, but anything on just development timelines or impact on fourth-quarter recognition that we should be aware of?

This is Marshall. I'll provide some comments and then let Brent add to it. We were fortunate with Hurricane Ian as we didn't incur significant damage. We have a few roofs that we'll be addressing, which were already planned for next year's budget. The main impact was some revenue loss in the fourth quarter. If you check our development schedule, there are three buildings in Central Florida now set to be delivered in January. Two of these in Fort Myers are fully leased, along with one in Orlando. We had anticipated partial revenue from these in the fourth quarter, but we have now pushed that back to early next year. As a result of Hurricane Ian, utility companies and inspections are prioritizing residential areas over commercial ones, causing us to fall behind. We hope to have those buildings operational this quarter, but we have removed their contributions from our budget. This has impacted us, as we were aiming to deliver fully leased buildings. Long-term, this is not a concern, but in the fourth quarter, we did experience a revenue shortfall of a few cents that we expected to earn due to the timing related to Hurricane Ian.

Okay. That's helpful. So no anticipated kind of impact to the '23 run rate. It's just a shift from 4Q to 1Q. That's how we should think about?

Yes, the yields on the assets are fine and they're leased; it's more timing, and we will have maybe some number. We had some cleanup and things. We will have $100,000 in expenses, maybe in the fourth quarter from Ian, but that's more gutters and cleanup, and some of that will get capitalized as well. But in terms of run rate, your short answer is no.

Perfect. Moving on to the development pipeline, which has been quite significant for your team over the past few years. I'm curious because your yields have remained in the high 6% range, but your cost of capital is gradually increasing, which is narrowing that gap. Historically, there has been a strong demand from the ground. Is there any consideration to potentially pause developments until yields increase, allowing for a more comfortable spread between financing costs and returns?

Good question. We are still seeing a pull in demand, but unfortunately, the cost of equity, the cost of debt, and the availability of debt have become tighter this year. Earlier in the year, we might have developed into the low 5s in certain markets, where cap rates were in the 3s, but thankfully we did not need to. Currently, our projected returns from the pipeline are at 6.8%, and what we've delivered out of the pipeline is at 6.6%. We are looking more closely at our development pipeline to push those returns higher. Another positive aspect is that we use current construction pricing and rents in our pro forma, and rents have been declining in our markets recently. With the ongoing volatility, many local and regional developers have exited the market, which leads us to anticipate a significant decline in construction and supply starting in the second half of next year. This gives me hope. We are noticing a slight improvement in delivery times. I believe that construction pricing and deliveries will take time to stabilize, but they will eventually work in our favor as construction activity across various sectors, such as industrial, hotel, and office, is expected to slow down into 2023.

You mentioned that there is significant concern regarding current industrial supply, indicating that your company may reduce output soon, which is a trend among some competitors and most builders. This situation is resulting in increased pressure on market rents due to the lack of availability in many markets. Based on your discussions with brokers and tenants, do they recognize that rent growth might need to accelerate from this point to make development feasible in order to support the supply chains they require? I understand it's a bit of a circular argument, but I'm interested to know if market participants are beginning to discuss this as a potential outcome.

I understand your point. It seems that people have definitely taken a step back from what used to be a common practice for us, where Brent and I could acquire a site and, after securing zoning and plans, flip it or move forward with construction. Since about May, we've significantly reduced our engagement in acquisitions and bidding on new properties. Historically, people weren’t worried about vacancy, and we lost several bids because it’s easy to project favorable rents for a property set to be completed in 8 months to a year, but that has changed. I believe we will observe a reduction in supply once the current construction projects are completed. Additionally, due to rising costs, especially land prices, which peaked around the time of price discovery in the second quarter, I anticipate higher rents. However, I hesitate to be too certain about this because of the uncertainty around demand. Currently, our leasing status is about where we finished the third quarter, with a 99% lease rate and 98% occupancy. While we have remained full, all tenants must be paying attention to the news, which may lead to some uncertainty. We have been anticipating a slowdown in demand since April, following Amazon's announcement, but fortunately, we have not yet seen that slowdown. If demand can remain steady despite the limited supply, I am optimistic that 2024 will shape up to be a favorable market.

Our next question comes from Camille Bonnel from Bank of America.

I wanted to follow up on the comments you made regarding the development pipeline in markets like Phoenix and Dallas that are not directly competing with your assets. Can you comment more specifically if you're seeing any change in appetite for location where tenants are basing their operations, given the tightness of the market? And are you seeing them move out further to the suburbs or relocate to other markets with better pricing?

We have two main types of tenants. The larger box buildings tend to remain in markets like Atlanta or Phoenix, conducting market-wide searches, which often leads them to locations further out in the suburbs where land is more affordable and they are more price sensitive. This can turn the business into more of a commodity situation, with multiple companies offering big-box deliveries targeting price-conscious tenants. We prefer tenants that need to be close to their customers. Despite discussions around supply in markets like Phoenix or Atlanta, it’s worth noting that we are fully leased in both locations. We do expand a bit away from the city center in areas like Phoenix and Atlanta, capitalizing on the population growth. In Atlanta, particularly between 10:00 and 2:00, and in Phoenix, many new deliveries are occurring in the Southwest where land is cheaper. We favor the Southeast Valley of Phoenix where residential growth is happening. Tenants here, while certainly aware of rent prices, focus more on workforce availability and transportation costs. Recently, we’ve seen tenants like Train and Red Bull sign leases in different parts of Dallas because they needed to be close to their customers, wanting to minimize the time their drivers spend on the road. In some of these larger cities, even a low-cost location can result in high transportation costs that can negate any rent savings.

For my second question, could we please discuss Houston? Your portfolio occupancy has been very strong in recent quarters, but it looks like some space was given back this quarter. Just given that this market represents 14% of leases expiring in 2023, can you update us on how the demand pipeline is looking here?

Yes, you're correct about Houston. It has experienced a decent amount of roll. By year-end, Kevin and the team will likely finalize things, and we're looking at an average year for us at 14%. Currently, our occupancy in Houston is slightly higher than where we ended the third quarter, and the team has done well to fill some of that space. This market has always caused some concern due to oil price fluctuations, but we have historically maintained occupancy rates between 94% and 97%. While I wouldn't classify Houston as one of our top markets, it remains stable as the fifth largest city in the country and is more diversified than many outside of Texas might realize. We feel confident operating here. Our revenue in Houston has decreased from over 20% to below 11%. The team effectively generates value through development, and we are looking to divest a couple of Houston assets. We plan to continue developing, ideally reaching buildings in the high 6s. In the past, we've managed to sell assets in the low to mid-4s, and even the 5s today if necessary. We'll keep monitoring the growth of our overall portfolio while managing our presence in Houston, feeling reassured that it remains a solid and stable market despite current national concerns.

Our next question comes from Alexander Goldfarb from Piper Sandler.

So I have two questions. First, Marshall, I appreciate your insights on the overall demand being over 98% occupied, which is clearly an impressive statistic. Other REITs are mentioning slowdowns, but it seems like nothing is affecting you at all. I assume you are closely monitoring for any signs of weakness, but it doesn’t appear that anything is happening. As you evaluate your tenants, whether they are in homebuilding or perhaps technology, or those sectors that might be influenced by rising rates or reduced corporate spending, are you not noticing any impact whatsoever? Or has any reduction in certain areas been more than compensated for by other tenants?

Good question. It's probably a little more of the latter in that we're concerned about homebuilding, especially in the Sunbelt. There are markets seeing significant population movement, which drives homebuilding activity, so we’re monitoring those closely. However, I can't list the homebuilder bankruptcies we've faced. Earlier in the year, we hadn't pursued Amazon for new leases for several quarters, and FedEx has recently made headlines. Both are in our top 10 customers, but together they account for about 3% of our revenue, so any slowdown from them is manageable as other tenants are taking that space. Our bad debt this quarter came from a tenant in the pharmaceutical sector who lost a lawsuit and filed Chapter 11, contributing to our losses in the fourth quarter. We're working to recover the rent from that tenant, which amounts to a little over a penny loss for the quarter. The positive aspect is that if we regain that space, the current rent levels are about 50% below market rates, allowing us to increase rents. This tenant was responsible for 95% of our bad debt in the third quarter, and while we’re remaining vigilant, historically our bad debt has been about 20 to 25 basis points of revenue. I believe concerns from the Street about smaller spaces leading to smaller tenants aren't supported by our history. With 1,600 tenants, our top 10 account for under 9% of our revenue, and many have multiple locations. If we were to lose a tenant like FedEx, Amazon, or Lowe's, it wouldn't be at every location.

Can you discuss cap rates overall? You mentioned that Houston is now in the 5s. You also bought a significant amount of land in the third quarter, and while development yields seem to have decreased slightly, I'm curious about the current situation regarding cap rates.

Yes, we're launching it. I wouldn’t say that Houston is in the 5s right now. We've been in a phase of price discovery for several months, and back in May, we decided to step back from actively bidding on acquisitions, including value-add acquisitions. Most of my information is anecdotal; we frequently communicate with brokers, but we’re not actively bidding where cap rates have changed the most significantly. For single-tenant long-term leases, it makes sense to consider them like bonds, and those cap rates have increased. However, for multi-tenant projects with shorter-term leases, they are likely to be below market given the trends of the last couple of years. Those cap rates have been more resilient; they've gone up but remained stable. We have a few smaller assets available, and there are definitely fewer buyers. There's ongoing price discovery. We’re hearing there’s strong institutional demand for industrial properties, which are appealing compared to other types of properties for various reasons, but there’s not much trading activity. The lack of debt and very few portfolios for sale means that this situation will likely continue for a while. This caution has influenced our development strategy, especially since we are looking at returns on each new project. Our company is 99% leased overall, and about 100% leased in several of our active development markets. If an existing tenant requires space, we prefer to move them within our park and backfill their previous space, especially with the market being so tight and rental prices higher than what we currently collect. We have been careful and even more so now, keeping an eye out for potential slowdowns, but as of October 25, we haven’t noticed any significant impact.

Our next question comes from John Nickodemus from BTIG.

Just a quick question regarding sort of return hurdles you're looking at when making acquisitions or any of your developments. Just was curious if there are any changes for your team there given the current market conditions, and you said you haven't been impacted as much. But just anything you're monitoring there, any changes you've made sort of in the past few months?

Good question. Earlier this year, if you had reached out regarding a new development in the right market and submarket, we would have considered it in the 5s due to its long-term growth potential. Now, we would likely be looking at the 6s because our cost of capital has increased. We haven’t needed to venture into that territory for our development pipeline. We had considered a few value-add projects, which allow us to sidestep construction risk but take on leasing risk. We evaluated those in the 5s and even completed one last year in California in the 4s. Now, we're being more cautious and have halted value-add projects altogether, raising our development hurdle rates by 75 to 100 basis points due to the higher value of our capital given current pricing. We want to maintain some flexibility because we anticipate opportunities arising from smaller local and regional developers. While I don’t expect a lot of distress, some opportunities may come through land acquisitions. We’ve managed to acquire a couple of land sites, one of which we closed, where the previous buyer couldn’t complete the contract, allowing us to renegotiate the price. We’re being careful with our capital and have increased our development yield expectations this year. We’ll monitor how things unfold, but I don't foresee interest rates decreasing anytime soon, especially with the Fed's stance. My main concern is the impact on our existing tenants as these situations develop.

Great. That is super helpful. And then just a second one for me. I know we've seen sort of more macro headlines about a shift from port activity sort of from the West Coast over to the East Coast, Houston would be a notable example of that just due to several different reasons. But I was just curious if this is something that you've seen impacting your business? If so, how? New your business and your tenants, I guess?

Yes. It's interesting to observe the developments at the ports, and I think there is a good opportunity for industrial growth or ownership at the port. For instance, the Port of Savannah, Georgia, has been successful, as has the Port of Houston, and we likely benefit from that indirectly. However, we have steered clear of directly developing or acquiring properties related to the port. My concern is that it’s not a sector we have engaged with much. The logistics side is different, and I remember seeing a video showcasing the improvements at the Port of Jacksonville, which excited me. It made me realize there are probably similar videos for Virginia Beach, Savannah, and Miami, and I always assume that someone in Bentonville, Arkansas, or somewhere decides where to ship their products. In terms of our strategy, we've avoided port submarkets. Instead, we believe we will benefit more from onshoring or near-shoring of manufacturing. In South San Diego, we’ve seen advantages, which isn’t directly related to ports, but it could be considered a port of entry due to our Amazon delivery operations earlier this year. We acquired several buildings that were 50% leased from an institution late last year. El Paso has proven to be a strong market, as have Phoenix and Tucson. While we think about ports, our position is more aligned with the border and the shift in manufacturing, especially in technology. We're optimistic about Austin long-term, particularly with companies like Tesla moving there and Samsung's presence. We've seen benefits not just from manufacturers, but also from their suppliers in Austin and San Antonio. So, we’re focusing on ports of entry, rather than seaports, and I hope this information is helpful.

And our next question comes from Jason Belcher from Wells Fargo.

I just wanted to ask about the Horizon West II and III developments. I noticed you transferred those into the operating portfolio in Q3 upon reaching the 1 year post completion threshold ahead of that, otherwise 90% occupancy threshold trigger. But all the other developments that went into the portfolio in Q3 are fully leased. Just wondering if you could give us an update on the Horizon West developments and maybe comment on any drags on occupancy there that you can share?

Yes, we're pleased with the Orlando market, and we like the park, which spans about 50,000 square feet. I tend to have mixed feelings about this; we've transferred 11 buildings this year, some of which are fully leased. The timing has been an issue with Horizon II and III. We anticipate that Horizon West will perform well, and Horizon West IV is a large building that we'll deliver in January, and it is 100% leased. The park is thriving, and as long as demand remains strong, we'll continue our development efforts. I recognize that this particular project took longer to lease compared to others in the park. Looking at the bigger picture, while I'm conflicted, I believe that if we are succeeding with 10 out of 11 projects and seeing profits, we should consider whether we could improve our results further. Even with the uncertainty around timing, any delays in leasing could affect our return on a solid asset by a small percentage. We're comfortable with Horizon West II and III and the park in Orlando.

Understood. And then I guess, for my second one, I know you're not giving guidance yet for '23, but just given the rising rate environment and its impact on the investment sales market. Maybe if you could just talk maybe big picture how you're thinking about acquisitions versus development going forward? To what extent do you anticipate the pipeline for acquisitions, at least at attractive pricing, could expand over the next year?

In recent months, we haven't pursued acquisitions actively. However, should an opportunity arise, it would have to be a unique situation, such as a property very close to our current projects. If the market remains volatile and we identify the right acquisition—especially if our development yields around 6.8%—we might consider it, though it would likely need to be a core property. We have already entered into a couple of advantageous land deals, responding to local developers who needed capital quickly. Some have profited, although not as much as expected, and we have been renegotiating several land purchases. We are cautious with land acquisitions, having eliminated some less strategic and more costly sites. If a valuable infill site becomes available, I would prefer not to hold onto it unnecessarily, but if it comes to that during a mild downturn, it has been a challenge for us to secure good land sites over the past few years. Based on feedback from brokers, we anticipate that contracts may be extended or discarded. We've let go of a few ourselves, which can be tough, but these opportunities will still be there, and we can revisit them at the right time.

We have a question from Dave Rodgers from Baird.

It's Nick filling in for Dave. I wanted to ask about the rent growth mentioned in the prepared remarks. Which markets have surprised you with their rent growth numbers when looking at the entire portfolio?

Good question. I'm looking at our portfolio year-to-date because, with our size, any quarter can present an unusual mix. Overall, Tampa, Florida, has been a strong market, performing above 40%, with Tampa hitting 50%. Our new Las Vegas market has also shown strength, and while our GAAP numbers are at 66%, reporting 39% for the quarter and 36% for the year is impressive for us across these markets. We are pleased with Austin as well, which is not surprising since it's the capital and a university town. There are geographical constraints in Austin, particularly on the west side due to aquifers and topography, which we believe will keep it a strong market. Last year, we operated in the low 30s on a GAAP basis, which was a record, aided by some large leases in California. This year has seen improvement without that support, which feels more sustainable and reflective of the market. There's a general awareness on Wall Street regarding land scarcity in coastal cities, but in places like Dallas, although there is supply, a significant portion—73%—of the new supply is in areas classified as outliers, where we are not active. It highlights the limited availability of land even in expansive cities like Dallas, Phoenix, and Atlanta. If opportunities arise, we're satisfied with our rent growth. Looking ahead, bandwidth for growth could slow due to economic conditions, but I’m encouraged by our existing rent growth. I read that rents in Atlanta have increased by 18% year-over-year. If that growth decelerates or pauses, we still have room to increase rents until we navigate any potential recession and can continue to show growth during that period.

That's helpful, Marshall. And then maybe a question for Brent. With the current stock price, you guys said you're probably not going to be issuing equity. But you did mention incremental debt and kind of flexing the balance sheet. So for leverage parameters, like, were you flexible taking leverage at this point, just looking at development opportunities and future acquisitions?

Yes, we are flexible in that regard. We have positioned our team to add debt. Six months ago, we did not anticipate that debt costs would double over the year, which has presented challenges. However, we acted proactively early in the year, issuing $525 million of debt so far at a rate of 3.8%. This approach has provided us with considerable runway. Currently, our draw on the revolver is low, and we are in a strong position going into next year. As Marshall mentioned, we'll assess how things unfold from both a leasing and capital access perspective. We're also exploring more affordable options, including potentially exercising part of our accordion on the revolver. Our total revolver capacity is $425 million, which is fairly limited for our size, but it has been cost-effective for us historically. We might consider expanding that to improve our liquidity and flexibility as well as adjust some shorter-term gaps in our financial strategy. We are trying to utilize all available options early on to ensure the best cost-effective access to capital, and we are well-positioned for the upcoming year. We'll see how market conditions develop, especially with a slight decrease in pricing around the low 150s. In terms of NAVs, there is a range from 136 to 216, with the consensus averaging uncertain figures. We still hold on to the possibility of accessing equity next year, depending on Federal Reserve actions, the company's performance, share prices, and cap rates. We are generally in a good position to make measured decisions moving forward. Additionally, regarding our development pipeline, we have a total of $600 million in projects with only $190 million remaining to fully fund that amount. The overall value is likely closer to $1 billion, and we only need to invest the remaining funds to unlock that value. As we progress through 2023, we'll adapt to market demands accordingly without resistance.

We now have a question from Bill Crow from Raymond James.

Marshall, as you think about what's happened to rent growth over the last, I don't know, 10 years, and you think about the mark-to-market that you're reporting this year, and I assume next year. At what point do we hit really tough comps? In other words, when did the real acceleration take place? Was that kind of an '18 event, '17 event? I'm just trying to think your average 6- or 7-year lease term. When do we start to see those more difficult comparisons?

Good question, and I'm thinking as I respond. I believe this is our eighth year of double-digit rent increases. Typically, we have 4- or 5-year leases, and it hasn’t always been in the 30s; it started in the low teens and high teens. That said, and this is anecdotal, regarding the spaces we re-leased in California last year, we had about a 2/3 rent increase on a large space near the port. Last week, I was in California with a couple of our team, and they believe our rents are 50% below market. Despite raising rents by 2/3, we wish we had signed a 1-year lease instead of a 5-year lease since the market rent has doubled since we signed it. Personally, and perhaps Brent and I have been in the industrial market longer than we care to calculate, I never anticipated industrial rents would rise as they have in recent years. We will start to face higher comparisons, but given the demand for quicker delivery and the growth in Sunbelt cities, traffic has become so congested that multiple sites are necessary in various parts of the city. Fortunately, our rents constitute a small part of the cost structure, which is reassuring. I empathize with our tenants considering the increases in employee wages and transportation costs; this situation gives us room to raise rents. While we will push rents, we cannot set market rents; we follow market trends. However, the performance has been widely varied. If you have well-located, well-designed properties, there are many ways for our tenants to utilize our buildings. I am optimistic about our ability to achieve rent growth, even if the market needs to take a moment to pause due to economic conditions. We are likely already encountering some of the tough comparisons, having now been in a phase of double-digit rent growth for eight years.

I would just add to that, Bill. If you consider any given market, it typically grows year-over-year by 5% to 8% over a 5-year lease, resulting in a potential increase of 25% to 40%. Coming out of the Great Recession, the comparables may have been different. If the market can maintain that growth, it seems there's nothing significant that was overlooked, unlike the Great Recession. It really comes down to demand and the market's health, determining its sustainability. As Marshall mentioned, the comparables have consistently improved without a clear soft spot to reference. If supply decreases next year, as Marshall suggested, due to developers having better access to capital, and if demand remains steady, those factors could positively influence rent stability.

Yes, no, I appreciate it. I want to ask a follow-up question. A 2-parter hopefully, short answers here. On the construction environment, any change, and I know you addressed this a little bit on the horizon lease-up, but any change in the lease-up duration on average of your new development pipeline? And then second of all, I'm assuming the costs overall to build are at least starting to come down if they haven't already come down when you think about land and you think about some of the construction materials; how far are we off of peak if we are off of peak pricing?

I believe we might be addressing this in reverse. We may be slightly past peak, as we're noticing quicker delivery times, which is encouraging. This will help reduce the supply pool, though it still takes time for everyone to complete construction. Supply has risen due to the time it takes to deliver buildings, but we're seeing some decreases in pricing. Some materials, like roofing, are becoming less expensive, while concrete prices have increased. We're likely around 5% to 10% below peak pricing, and I expect it will take another quarter or two for this to fully reflect in the market. However, we're still optimistic about our development demand. We did have a missed opportunity in Horizon West, but that reflects just one tenant. Overall, we would have achieved a 100% success rate if we look at it broadly. Our 99% lease rate provides a better perspective on the market across our larger asset pool than just one building with that one tenant. We're still doing well, having leased over half a million square feet this quarter from our development pipeline, and we have other pre-leasing opportunities. Given the tight market, it's an interesting situation. A tenant representative shared with me that they find it challenging to show options to their clients since there are fewer available spaces, and everything presented comes with competition. However, tenants seem to be taking longer to make decisions. While leases are still being signed, decision-making is slower due to the current economic conditions. We'll continue to monitor our development pipeline closely, as it has been an effective way to generate earnings and build NAV over the years. We'll adjust our strategy based on market signals moving forward. We've developed more buildings than I initially projected this year, and if the market slows down, we’ll adjust our development plans accordingly. We've already reached our yield expectations considering the shifts in our cost of capital throughout the year.

We have a question from Ki Bin Kim from Truist.

Marshall, I wanted to revisit your comments about smaller spaces possibly not being linked to higher risk or more fallout during a recession. Could you elaborate on that? Additionally, how has your portfolio evolved over the years, and how has it performed during a moderate recession?

Yes, good question. When we look at our top 10 tenants, some names come to mind. Recently, we signed leases with tenants like Ki Bin, Brent, and Marshall, and we just left our garage to open a new space. In our development pipeline, I've mentioned tenants like Train, Red Bull, HD Supply, Frito-Lay, and Walmart, all of whom have signed leases in the last month or two. Historically, we quoted bad debt at around 40 basis points of revenue two or three years ago, but that's dropped over the past decade to about 20 basis points. With the current tight market, when some tenants face challenges, we’ve been able to backfill their spaces at higher rents, allowing us to generate turn fees, and our team has managed this well. Looking back at our bad debt during 2008 and 2009, it averaged around 100 basis points, but that dropped significantly since then. During the financial crisis, we were a different company in terms of size and tenant quality. We removed many tenants who deferred rent during the COVID period, and thankfully, we've managed to replace them in a strong market, which has helped improve our credit. In 2020, during COVID, we reported about 75 basis points of bad debt, but last year, we even saw negative bad debt as we recovered many of the tenants we had reserved. In this quarter, the bad debt came from just one tenant, and it was a straight-line write-off, not related to cash or back rents. I know it’s a lot of information in a brief amount of time, but I hope this helps clarify things.

Yes. If I think about the financial crisis, you're not alone in this, but you did experience a drop in occupancy. While it may not be classified as bad debt, there were several issues regarding tenant renewals, leading to a decline in occupancy by several hundred basis points. I'm curious, when you compare your current portfolio composition to that of the financial crisis, is there anything structurally different? Do you have fewer housing-related tenants? Any additional insights you could share on this?

I think some of our markets have developed significantly over the years, such as Dallas, Phoenix, and Orlando. When we entered these areas, they were growing, and now, 14 to 15 years later, they have expanded even more. I believe we will perform slightly better because the cities have grown that much larger. We previously discussed Fort Myers, where homebuilding accounted for 105% of the GDP during the last downturn, and this region continues to be a fast-growing area. Therefore, I have more confidence in the cities we are operating in. In the past, we were more concentrated in specific markets, but we have worked on diversifying our geographic presence in recent years. I was speaking with a peer, who mentioned that during the global financial crisis, occupancy dropped significantly. The difference today is that current market-wide occupancy is approximately 500 to 600 basis points higher than it was before the financial crisis. This situation appears to be more influenced by government actions than by homebuilding, primarily due to raised interest rates aimed at managing inflation. I'm reassured that our portfolio is at 99% occupancy while our markets range from 95% to 99% leased. I feel more optimistic that the downturn may not be as severe as during the financial crisis. Additionally, supply in these markets is more institutionally owned now compared to before, and even local developers tend to have institutional partners, which may have already halted merchant development. I believe the supply will likely reduce more quickly than it did in 2007 or 2008.

Our next question comes from Michael Carroll from RBC Capital Markets.

Marshall, I wanted to touch on your current market rents today. Given that your portfolio is a little unique with the infill shallow bay type exposure, I mean how different is rent growth within your portfolio versus the rest of the market? I know you said earlier that Atlanta rent growth was up, I think it was 18%. What was your portfolio's market ramps up compared to that in Atlanta compared to that 18% number that you highlighted?

Looking back, the 18% figure I mentioned was from CBRE, and I can assure you we didn't rehearse this. We are just above 25% cash in Atlanta year-to-date, with over 31% GAAP. Additionally, according to that same CBRE report, the market vacancy in Atlanta is at 4.2% and the shallow base is at 3.4%. It's beneficial that our peers are larger, mostly private entities like pension fund advisers who have significant capital to invest. Building is easier due to land availability and zoning on the outskirts of the city compared to infill sites, which is where the big box segments are. The average building size in Atlanta is about 325,000 square feet, while most of our spaces range from 90,000 to 150,000 square feet, reflecting a different product offering. This distinction helps us avoid being seen as a commodity and allows us to increase rents. We've also observed demand for smaller spaces, with one of our private peers highlighting interest in 15,000 to 25,000 square foot units. Our average tenant size is in the low 30s, which is slightly larger, yet we've seen rents double, largely due to the costs associated with building out these spaces. The tenant improvement allowance combined with construction expenses necessitates higher rents. It's unaffordable to build out a 20,000-square-foot space, considering the costs for offices, restrooms, and warehouse lining. This dynamic supports our ability to raise rents and tends to deter many of our peers, as it requires nearly as much effort to construct an 80,000 to 90,000 square foot building as it does a 600,000 square foot building on the city's outskirts, with zoning complexities adding to the challenge.

Okay, great. And then you mentioned earlier in your prepared remarks that your underwriting for development has changed. I think you touched on a longer time frame. Did I hear that correctly? Were you referring to the construction time frame or the lease-up of developments that you've been changing?

I apologize if I misspoke. We previously looked at the yield hurdle for new developments in the 5% range, but now it's in the 6% range. Our lease-up of development will still bring buildings into the portfolio when we reach either 90% occupancy or one year after obtaining the certificate of occupancy. Thankfully, those buildings have been coming in. Currently, we are 100% leased, except for one that we had some issues with this quarter. We haven't made any changes other than to adjust our yield requirements based on our cost of capital and the market cap rates, even though it's still unclear where cap rates will ultimately land. We're continuing to underwrite based on current market rents, construction costs, and all the factors we've historically considered.

We now have a follow-up question from Craig Mailman from Citi.

Just quickly, Marshall, I apologize if I missed this. Did you provide an embedded mark-to-market for the portfolio, either for the 2023 roll or in general, that you can share?

Yes. I know a couple of our peers do that, and we've looked at it, but we haven't been that great. In our portfolio, we've stated that we haven't done this for 2023. So the short answer is no, we haven't taken that approach. We've always hesitated to invest the time, especially if a lease doesn't roll for three, four, or five years and market rents are changing significantly. It's something we've discussed, but I don't see the market changing much from its current state unless demand really unwinds. However, we have not formally disclosed a mark-to-market.

Okay. And then just second, I know we've talked a little bit about the development pipeline and maybe some slowing here. Just, Brent, as you look out at kind of what's delivering, what maybe starting, I know maybe early for that budgeting process. But do you feel like cap interest burn off is going to be material at any point? Or because since you're coming on so well leased from an earnings impact, it's not something to be that concerned about yet.

It wouldn't really be a major concern unless the market changed, whether due to a slowdown in leasing or increased cost of capital. Our projected development starts this year are at 3.75%. If that number decreases next year, it would affect our capitalized costs since we would be working with a smaller figure, impacting both capital interest and the capitalized costs that offset overhead and G&A. Right now, it doesn't seem likely, but that's something to keep an eye on. We recently finalized those capitalized figures, and if that amount were to be $275 million instead of $375 million, the capitalized numbers would also decrease proportionally. That's something to watch. Ultimately, our decision-making will depend on the strength of the market and our access to capital. We're in a good position at the start of '23, maintaining our current state, but we need to closely monitor both the strength in leasing and our access to capital and its cost. We will make decisions as we approach that time. If the figures end up being lower, it will certainly impact our bottom line. However, it's still too early to determine how this will unfold.

We have a question from Ronald Kamdem from Morgan Stanley.

It's Damien calling in for Ron. I wanted to follow up on some earlier questions about the cost of capital. I understand you recently conducted some debt offerings that were priced in the second quarter. If you were to offer the same type of debt today, how would that compare to the previous blended cost of under 5%?

Yes, it would definitely be higher. The cost would indeed change. We've been somewhat aggressive in the early part of the year, anticipating a rise in cap rates. If we were to examine long-term debt today, it would likely be around 6% for us on 10-year or longer fixed-rate debt. However, we're considering some shorter-term options for flexibility, like possibly expanding our revolver balance and addressing some gaps in our laddering with shorter-term debt that might be priced more favorably. We still have several strategies that we are exploring. Long-term debt has increased and continues to rise, which is something we need to keep an eye on as we head into next year, especially regarding costs compared to our investment opportunities.

Makes sense. On internal growth. I think some of your peers have talked about there's a big spread between leasing spreads on commenced leases versus signed leases. Are you guys seeing that within your own portfolio as well? Just on a cash basis and on a GAAP basis?

I'm not sure I follow that. I mean our numbers have been pretty consistent for a number of quarters now in terms of cash rents being strong and still slightly inclining or increasing and GAAP numbers increasing from signing to commencement generally. For development, there could be a few months for a vacant space; it's generally a pretty quick turn. I don't know that we've seen any big change from signing to commencement. I'm not sure if I totally follow the question.

Yes, that answered my question, just if there was kind of a big jump in market rental rates over the past couple of months, given there is kind of, like you said, a 3-, 6-month lag between when you commence on a rent versus when you sign the rent.

Some of our peers have traditionally waited until they have completed buildings before they start leasing, which has worked well over the past few years. Ideally, if a tenant is prepared to lease, we need to act quickly, especially if market conditions worsen. If a tenant is ready to sign a lease, we negotiate the rent in a firm yet fair manner and proceed with the lease when they are ready to move forward or renew, effectively averaging the costs over time. With a portfolio of 3 million or 4 million square feet in a market, we will have leases expire at both advantageous and less favorable times. I agree with Brent and the earlier comment that rental rates have been on the rise in recent years and continue to experience upward pressure today.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Loeb for any closing remarks.

Thanks, everyone, for your time. If there are any questions or follow-up questions, certainly, Brent, Staci Tyler, and myself are available. If not, we look forward to seeing an awful lot of you at NAREIT in just a couple of weeks in San Francisco. Thanks for everyone's time.

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