First Industrial Realty Trust Inc Q3 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to the First Industrial 3Q ‘21 Results Conference Call. I would now like to hand the conference over to Art Harmon, Vice President of Investor Relations and Marketing. Thank you. Please go ahead.

Thank you, Shelby. Hello, everybody and welcome to our call. Before we discuss our third quarter 2021 results as well as updated guidance, let me remind everyone that our call may include forward-looking statements as defined by federal securities laws. These statements are based on management’s expectations, plans and estimates of our prospects. Today’s statements may be time-sensitive and accurate only as of today’s date, Thursday, October 21, 2021. We assume no obligation to update our statements or the other information we provide. Actual results may differ materially from our forward-looking statements and factors which could cause this are described in our 10-K and other SEC filings. You can find a reconciliation of non-GAAP financial measures discussed in today’s call in our supplemental report and our earnings release. The supplemental report, earnings release and our SEC filings are available at firstindustrial.com under the Investors tab. Our call will begin with remarks by Peter Baccile, our President and Chief Executive Officer and Scott Musil, our Chief Financial Officer. After which, we will open it up for your questions. Also on the call today are Jojo Yap, our Chief Investment Officer; Peter Schultz, Executive Vice President; Chris Schneider, Senior Vice President of Operations; and Bob Walter, Senior Vice President of Capital Markets and Asset Management. Now let me turn the call over to Peter.

Thanks, Art, and thank you all for joining us. Our team continued its strong performance in 2021 by delivering another great quarter, highlighted by increased in-service occupancy, new development leasing, and continued strong growth in rental rates on new and renewal leasing. As importantly, we were also successful in readying land for new development starts and replenishing our pipeline with strategic land acquisitions. I will discuss those successes in more detail shortly, but let me first update you on the overall strength of the U.S. industrial market. Per CBRE EA, net absorption was a healthy 120 million square feet in the third quarter, while completions came in at 79 million square feet. Through the first three quarters of this year, net absorption was 292 million square feet, significantly outpacing new supply of 193 million. In our portfolio, we grew occupancy by 50 basis points to finish the third quarter at 97.1%. Cash same-store NOI increased 6.9% and cash rental rates for new and renewal leases were up 22.8%. Looking at rental rate growth for the full year, as of today, we have signed roughly 98% of the 2021 expirations and including new leasing, our overall cash rental rate increase is 15.3%, which puts us on pace to top our previous company record of 13.9% in 2019. With respect to 2022 expirations, we are off to a great start, with 29% of renewals signed at a cash rental rate increase of 19%. Let me move now to the primary driver of our external growth, our development program. As most of you know, as part of our underwriting process and risk management discipline, we operate with a self-imposed speculative leasing cap. Due to continued robust fundamentals in the industrial market, the strength of our balance sheet, growth in our portfolio, and the significant opportunities we have to create shareholder value through new investments, we have increased our speculative leasing cap by $175 million, bringing the total to $800 million. Now, let me walk you through our recent land acquisitions as well as three exciting new development starts that will put some of the incremental cap capacity to good use. During the third quarter, we closed on 3 development sites totaling 122 acres for $59 million; 2 are in the Inland Empire East, and the third is in Denver. In total, these sites can accommodate up to 2.1 million square feet of new development. At one of the new Inland Empire East sites, we are starting our first Pioneer Logistics Center, a 461,000 square foot cross-dock facility. Our total projected investment is $73 million, with a targeted cash yield of 6.8%. The Inland Empire continues to be one of the strongest logistics real estate markets in the U.S., helped by significant net absorption from activity related to the two largest ports in North America. Market vacancy in the Inland Empire is sub-2% and market rents have grown more than 80% since we went under contract on this site in early 2020. We look forward to adding this prime asset to our Southern California portfolio, which represents approximately 23% of our rental income as of the end of the third quarter. Moving to the East Coast, we are starting another development in South Florida to serve the strong tenant demand we have experienced there with our recent leasing successes at First Park Miami and First 95 Distribution Center. First Gate Commerce Center will be a 132,000 square foot Class A distribution facility in the infill Coral Springs submarket. Market rents in Broward County have grown 15% to 20% since the end of 2019. Our total estimated investment is $24 million, and our targeted cash yield is 5.5%. In the fourth quarter, we acquired a site in Bordentown, New Jersey just off of Exit 7 on the Jersey Turnpike for $8 million. We immediately started construction of the first Bordentown Logistics Center, a 208,000 square foot facility. We look to build upon our past successes in this location, where our two prior developments were leased near construction completion. The Central New Jersey market has been exceptionally strong with asking rents up 34% versus last year, according to a recent market report from CBRE. Our total projected investment is $33 million, with an estimated cash yield of 5.8%. In summary, these three planned fourth quarter starts totaled approximately 800,000 square feet, with an estimated investment of $130 million and a cash yield of 6.3%. Including these planned starts, our developments in process totaled 6.4 million square feet with a total investment of approximately $725 million. At a cash yield of 6%, our expected overall development margin on these projects is approximately 65%. With development as our primary driver of external growth, we are also focused on replenishing our land holdings. In the fourth quarter to-date, in addition to the New Jersey site I just discussed, we also acquired a total of 10 acres in the Inland Empire and Northern California for a total of $10 million. As of today, adjusted for our planned fourth quarter starts and the aforementioned land acquisitions, our balance sheet land can support approximately 12.5 million square feet of new development. Our share of the Phoenix Camelback joint venture is an additional 3.8 million square feet. In total, that’s north of 16 million square feet and represents approximately $1.7 billion of potential new investment activity. Now let me update you on our recent development leasing successes. We just leased the entire 548,000 square footer at First Park at PV303 in Phoenix upon completion to a leading omni-channel retailer. As part of this lease, we are also expanding the building another 254,000 square feet for a total of 802,000 square feet. The total estimated investment for the project, including the expansion is $72 million and the estimated cash yield is 6%. The tenant is expected to take occupancy of the just completed space by year-end, with the expansion ready for use in the second quarter of 2022. We also leased 100% of our 303,000 square foot first Wilson Logistics Center in the Inland Empire that will be completed in the first quarter of 2022. With a cash yield of 8.7%, we substantially outperformed our underwritten yield. This lease further showcases the rapid rental rate growth in the Inland Empire that I discussed earlier. We are pleased that we have land sites in this high-growth market that can support another 2.8 million square feet of development. As another example of the strength of the Southern California market and our platform, we just leased our Laurel Park redevelopment project in the South Bay. This property is very well suited for port-centric warehouse distribution users given its great location and highly sought after yard for surface use. Our first-year yield is 7.5% on our $21 million investment, which represents a margin of around 150%. Moving on to sales, during the quarter, we sold 6 properties and 4 units for $14 million. In the fourth quarter, we have sold 4 additional buildings in Detroit totaling $7 million, bringing our year-to-date total to $126 million. Given current visibility on our disposition pipeline, we now expect sales for the year to total $175 million to $225 million, a $75 million increase from the prior midpoint of $125 million.

Thanks, Peter. Let me start by summarizing our results and leasing stats for the third quarter. NAREIT funds from operations were $0.51 per fully diluted share compared to $0.49 per share in 3Q 2020. Excluding approximately $0.04 per share of income related to the final settlement of an insurance claim, 3Q 2020 FFO was $0.45 per share. Our cash basis same-store NOI growth for the quarter, excluding termination fees, was 6.9%, primarily due to higher average occupancy and an increase in rental rates on new and renewal leasing, rental rate bumps, and lower bad debt expense, slightly offset by an increase in free rent. We commenced approximately 2.4 million square feet of leases. Of these, 500,000 were new, 1.4 million were renewals, and 500,000 were for developments and acquisitions with lease-up. Tenant retention by square footage was 85%. Cash rental rates for the quarter were up 22.8% overall, with renewals up 21% and new leasing up 27.5%. And on a straight-line basis, overall rental rates were up 36.2% with renewals increasing 34.9% and new leasing up 39.5%. Moving on to some capital markets activity. As previously announced in early July, we closed on two financing transactions. First, we expanded our line of credit to $750 million and improved our pricing to LIBOR plus 775 basis points, a reduction of 32.5 basis points compared to our prior facility. The maturity is now pushed out five years, including our two 6-month extension options. We also refinanced our $200 million term loan. The new term loan matures in July 2026 and has an interest rate of LIBOR plus 85 basis points, a reduction of 65 basis points in the spread compared to our prior facility. With our interest rate swaps in place, the new fixed interest rate on the term loan is 1.84%. On the equity side, through our ATM, we issued 1.1 million common shares at a weighted average price of $55.35 per share for total net proceeds of $59 million to help fund the new investments Peter spoke about. Moving on to our updated 2021 guidance per our earnings release last evening, our guidance range for NAREIT FFO is now $1.93 to $1.97 per share, which is a $0.02 per share increase at the midpoint, reflecting our third quarter performance and an increase in capitalized interest due to our announced development starts. Key assumptions for guidance are as follows: in-service occupancy at year-end of 96.75% to 97.75%. This implies a full year quarter-end average in-service occupancy of 96.5% to 96.8%, an increase of 15 basis points at the midpoint. Fourth quarter same-store NOI growth on a cash basis before termination fees of 6% to 7.5%. This implies a quarterly average same-store NOI growth for the full year 2021 of 4.3% to 4.7%, an increase of 25 basis points at the midpoint due to our third quarter performance.

Thanks, Scott. Before we take your questions, let me thank our team for another great quarter. We’re excited about our growth prospects as we continue to put into production our landholdings that can currently support more than 16 million square feet of value-creating developments. We are also focused on replenishing our pipeline with new sites in higher barrier markets. We continue to benefit from robust sector fundamentals that are reflected in strong net absorption, high occupancy levels, and increasing rents. With that operator, would you please open it up for questions?

Your first question is from Craig Mailman of KeyBanc Capital Markets.

Hey, good morning guys. Scott, maybe this one’s for you. Just looking at the year-to-date FFO kind of implies a deceleration in the fourth quarter to get to the midpoint of your range, could you just walk through that?

Sure, Craig. I would say the two drivers there are: one, is we forecasted $500,000 of bad debt expense in the fourth quarter. Our actual in the third quarter was $25,000. Hopefully, we can do better in the fourth quarter than our $500,000. And also the fourth quarter is being hit with a full quarter dilution related to the equity issuance, where the third quarter was only partial. So I would say those are the two drivers.

Okay. And did you say that there is equities – more equity included in the guidance going forward? Or did I mishear you?

No, no future equity, but what I’m saying is that the equity issued in the third quarter was more back end in the third quarter. So the fourth quarter, it’s in for the entire quarter. So you have a higher share count in the fourth quarter compared to the third quarter.

Got it. And then just separately, Peter, you noted your spec cap is up $175 million. Kind of what – could you just walk through, as you – the balance sheet gets bigger over time, how we can kind of maybe track the upside to this? Like what’s the most important metric you guys use to set that cap?

Sure. So we put the cap in place back in 2012 and a little history here will give more context to the answer, because the answer is pretty straightforward. We put it in place in 2012. Obviously, we had a very, very different portfolio and a very different balance sheet. And back then, the formula was 9% of the total market cap of the company. As time has passed, we have adjusted the cap based on that formula. So we adjusted it in ‘15 and ‘18 and then again at the beginning of this year. We have not changed the multiplier. It’s still 9%, notwithstanding the dramatically improved portfolio and balance sheet. So you can say it’s even more conservative today than it was back in 2012. So it’s pretty simple, Craig, it’s just 9% of the total traded value plus debt of the company.

Got it. Thank you.

Your next question is from Ki Bin Kim of Truist.

Thanks. Good morning. Sticking with the same line of questioning, I wasn’t sure how you calculated how much you’ve eaten into that speculative cap because you also consider the vacancy in your existing portfolio. So I guess, first question, how much have you eaten into the cap? And do you – I can’t remember that you use like book value for your assets or market value to get to that speculation?

So committed dollars. So any new development that we start that has less than 90% leasing those dollars go in on a pro rata basis. If we were to do a forward with no tenant, those dollars go in. And that’s how we – the cap works. We have $279 million of capacity today largely due to the great leasing on our new developments that we’ve just completed. So of the $800 million, $279 million is available. Does that answer your question, Ki Bin?

Yes.

Yes, it’s based on book value too Ki Bin.

Also, Ki Bin, as acquisition vacancy, so if we acquire an empty building, it goes into the spec cap. We treat that risk the same as development. And so when we lease any acquisition vacancy, it comes off; it comes off the list. And finally, once an asset is 90% leased, it all comes off.

Got it. So when you think about that and the amount of good leasing that you’ve done in your portfolio. What is a practical range for development starts on an ongoing annual basis? I know you guys don’t typically provide guidance, just looking for some type of ballpark figure.

Right. So given the strength and scale of our current land position, the spec cap and the pace at which we lease new developments ultimately are going to determine the development volume going forward, of course, subject to profitability, as we always say, we’re a profit shop, not a volume shop. So you should see development levels going forward at higher levels than in the past several years, again, assuming fundamentals hold.

Okay. And as you think about funding that development pipeline that’s growing, should we expect a kind of a steady-state contribution from dispositions, so like $200 million that should ratchet up as the pipeline grows or different sources?

With respect to dispositions, I think the volumes that we’ve guided to the last few years are going to be similar going forward. Obviously, we just increased, and that has a lot to do with quite often we will get unsolicited offers on assets that are in markets where we want to dispose of more assets and we will take those offers. That’s really what you see when we pop up from our original guidance. So I think the guidance lines going forward will be similar keep into what we’ve been giving.

Okay. That’s it for me. Thank you.

And obviously, as we get bigger, that’s a much lower percentage – dwindling percentage of the overall size of the company.

Your next question is from Rob Stevenson of Janney.

Good morning guys. Just a follow-up on Ki Bin’s question. The fourth quarter disposition guidance is now roughly, I guess, $60 million to $100 million given the full year guidance. Are you seeing any meaningful change in the asset pricing there? Or is that increase more of a reflection of the increases to the development pipeline and the need to fund that and the attractiveness of dispositions as a funding source?

No. I mean I think the bottom line is we’re getting really good pricing. And again, in these markets, and you all know that the markets that are outside our 15 target markets are the markets where we find lower growth, and we’re going to be disposing of more of those assets. And the market for assets – the market for assets in those submarkets is very, very strong. That’s really what drives it. We’re really not looking to sell real estate to fund development. That’s not the key driver. Obviously, it’s a benefit, but it’s not the key driver.

And will you be – with these $60 million to $100 million in the fourth quarter, are you going to be exiting any markets as a result of that?

Wholesale exit, I don’t think so.

Okay. And then, Peter, there has been a lot of press on the continued supply chain issues and the cargo ships sitting off the coast. What impact is that having on your tenants and then their incremental demand for industrial space these days? And if this continues through 2022 as many expect, what’s the impact down to your business, you think?

I’m going to give that to Jojo and Peter to give their thoughts on that.

Sure, sure. Basically, the net impact is that a lot of the tenants in our business who need imported products are really having a hard time getting product, and they cannot ascertain the availability nor the timing. So the net effect is that they order more. They have to stock more; they have to put more inventory because it’s so hard. The bigger loss is to sell that product. And if they don’t really know the timing based on our issues certainly. So they are going out. The net effect is they are getting – wanting to take more space. And what’s been happening is that we now have less space than the start of the year. And so what happens is that now rents have been rising because of that. And in terms of 2022, we don’t know. There are so many issues in the supply chain right now and there is strong demand. So we hope that this levels off for our tenants, but the reality is that I don’t think it will level off. I think it looks – the supply chain issues will continue, and the rent pressure will continue because of the lack of space and increased demand.

Hey, Rob, it’s Peter Schultz. The other thing I’d add to that is we’re seeing a marked increase of activity from the third-party logistics companies looking for space to help with the capacity constraints that a lot of our tenants and companies have. So they are very, very active looking for, as Jojo just said, a finite and declining amount of space today.

Should we be thinking about this time period of elevated rental rates and increased demand as a pull forward? And then at some point, whether it’s 2023, 2024, who knows that there will be some sort of lull as the catch-up actually happens? Or do you think that this sort of elevated level winds up sticking around for a prolonged period of time as people are reluctant to go back to previous inventory procedures?

That’s a very, very good question. In order to answer that question, we have to predict where e-commerce as a percentage of total sales will be in the market. And in e-commerce in the next 5 to 6 years, I don’t know if it goes to 50%, then that’s even going to be a bigger driver than the supply chain issues. So the supply chain issues will be very, very minimal compared to that long-term driver. So now that’s the first thing. The second thing is that in terms of supply chain, it’s hard to predict really when it’s going to be fixed because you have offshore issues, you have inshore issues, you have shipper issues, you have labor issues. You have a multitude of issues you have COVID still a little bit. It’s lessening related efficiency issues in the ports. So we don’t know when that’s all going to get fixed.

Don’t forget the primary catalyst to these supply chain issues was COVID where everything was shut down and then it opened up all at once. And so if anything, you’re catching up more than you’re selling forward if you follow me.

Okay.

The primary driver is just good, solid demand. The consumption that is happening in this country is higher than it’s ever been, largely due to COVID. Household savings are the highest they have been, and household debt levels are low. And so you have got all the right fundamentals for people to go out and of course try to celebrate life after a year off, but also they have the capital to do it. So, that’s what you’re seeing. It’s flat-out strong demand and all of the wrinkles in the supply chain have a lot to do with that exploding demand when we aren’t fully back to work in a lot of these delivery chains.

And also just to finish up with what Peter said, we expect our customers to be fairly capitalized and really well-funded in the industry because we have got very good customers. We expect them to be marginally more competitive with the small users in getting supplied because they have got capital to spend, they have got big relationships. And you will notice that the larger suppliers out there are getting you goods. To give an example, Amazon. If you order from Amazon today, you will probably get it quicker than from a small shipment company. So, having good customers and tenants like ours is boding well in the industry today.

And as far as you are concerned as whether people have inventory or not, we can tell you just from our portfolio that all of our spaces are fully being utilized.

Yes. Good morning everyone. Great solid quarter. Questions still around the supply chain issues. Again, still not 100% clear to me exactly how that’s impacting the demand curve for industrial real estate. I mean it sounds like a lot of the occupancy increases you guys have seen has just really been driven by not a lot of development in the past year or so and still pretty good demand and maybe to an extent there is some formal out there from all these companies saying, I need space because everyone is running out. Is that really the way we should kind of think about it versus the whole kind of collapse of the supply chain actually did, is causing some type of increased demand that probably could still be around until supply chain issues are fixed?

So, I guess for me, the simplest way to think about it is that companies do try to best operate just in time, meaning they get the product and they have an order; they ship the product to minimize warehouse inventory because warehouse inventory has capital carrying costs. And today, we can’t operate that way. So, everybody is operating on adjusting case. Why just in case, and basically they don’t know when the product is coming, and they are not sure the product is coming. And in some, they don’t know what cost is coming. So, they rather front load and order more because also remember, due to the increased demand, the inventory to sales ratio has dropped. So, now they are just trying to go back to inventory. They call now just in case to basically increase their inventory. And in the simplest impact, that requires more space when you are carrying more inventory. So, that is the simplest way of looking at what’s happening in the industry in the U.S. today, and that’s creating demand for more warehouse space.

I would add to Jojo’s point, though, we are seeing a lot of demand, not only for just in case, but just net growth across a variety of industries around the country. Demand is really good particularly from the larger companies in food and beverage and the transportation logistics field, as we have said earlier; consumer product companies, traditional retailers. They are all growing in addition to trying to increase their inventories, as Jojo said.

In summary, these three planned fourth quarter starts totaled approximately 800,000 square feet, with an estimated investment of $130 million and a cash yield of 6.3%. Including these planned starts, our developments in process totaled 6.4 million square feet with a total investment of approximately $725 million.

There are no other questions in queue. I would like to turn the call back over to Peter Baccile for any closing comments.

Thank you, operator, and thank you all for joining us today. As always, please feel free to reach out to me, Scott, or Art with any follow-up questions. We look forward to talking with many of you during the NAREIT’s Virtual Conference in a few weeks. Be well.

Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.