First Industrial Realty Trust Inc Q3 FY2023 Earnings Call

Good day and welcome to the First Industrial Realty Trust, Inc. Third Quarter Results Call. Please note, this event is being recorded. I would now like to turn the conference over to Art Harmon, Vice President of Investor Relations and Marketing. Please go ahead.

Thank you, Dave. Hello, everybody and welcome to our call. Before we discuss our third quarter results and our updated 2023 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 are accurate only as of today's date, October 19, 2023. 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 that 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'll open it up for your questions. Also with us today are Jojo Yap, 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 hand the call over to Peter.

Thank you, Art and thank you all for joining us today. We continued to deliver strong cash rental rate growth on new and renewal leasing and we're making good progress on our 2024 expirations which I will touch upon shortly. We also achieved some leasing wins at our developments in Pennsylvania, Northern California and Orlando. And we're capturing significant value from the sale and ground lease of our on-balance sheet land sites in Phoenix. As expected, our quarter-end occupancy metric was impacted by a few recently placed in-service developments that remain in lease-up. As we noted on our last call, prospective tenants continue to be deliberate in making significant commitments for new space in the face of the uncertain interest rate, economic and geopolitical environment. This is being reflected broadly in the national vacancy figures as new supply continues to come online. National vacancy was up 50 basis points in the third quarter but still at an overall low of 4.2%. In our 15 target markets, vacancy is 4%. As we discussed on our last call, there is a fair amount of new supply expected to be delivered nationally over roughly the next 12 months. Based on CBRE's analysis, there is approximately 475 million square feet under construction across the U.S., 30% of which is preleased. Focusing on our 15 target markets, completions are expected to be approximately 325 million square feet. New starts naturally have trended downward, with third quarter 2023 starts down more than 60% compared to third quarter 2022. This market response is being driven by the rapid increase in the cost of capital and the uncertain economic environment. In our portfolio, we're capturing strong rental rate increases on our renewals, realizing the benefit of the healthy market rent growth we've seen for the past several years. Tenants continue to renew well in advance of their lease expiration dates, reflecting continued confidence in their core business. Overall, leasing market dynamics continue to favor the landlord, particularly with renewals, given the low vacancy levels I discussed earlier. Through yesterday, with 97% of our 2023 lease expirations in the books, our cash rental rate increase is 60%, with average annual rental rate escalators of 3.8%. A big driver of our cash rental rate increases has been the outperformance of our Southern California assets, where we've achieved a cash rental rate increase of 151%. Looking ahead to 2024, we've taken care of 40% of next year's lease expirations and achieved a cash rental rate increase of 38%, which is similar to our pace of progress at this time last year. Our 2023 rental rate increase has benefited from slightly more than 25% of rental income coming from leases signed in Southern California. Due to a few Southern California leases that expired in 2023 that are assumed to lease up in 2024, we expect the Southern California portion of lease signing by rental income in 2024 will be roughly the same as 2023 at a little over 25%. We will give you a refined view of our thoughts on our 2024 cash run rate increase on our fourth quarter call with the benefit of our budget reviews. We anticipate our cash rental rate increase on new and renewal leasing will be in excess of the 38% we currently achieved on lease signings related to 2024 expirations. Moving on to development leasing. Since our last earnings call, we leased half of our 699,000 square foot First Logistics Center at 283 Building B in Central Pennsylvania. We also leased our 37,000 square footer in Northern California and our 17,000 square feet at our First Loop Park in Orlando. With these lease signings, the capacity on our self-imposed $800 million speculative leasing cap today stands at $108 million. We continue to monitor tenant demand for new growth to determine the appropriate time to start new developments. As I discussed earlier, tenants' decision-making on space for new growth continues to be deliberate. When we do decide on new starts, we're well positioned with our existing coastally oriented land bank that can accommodate 15.2 million square feet. This represents approximately $2.4 billion of potential new investments based on today's estimated construction cost in the land or book basis. Moving now to dispositions. Since our last call, we completed a significant sale of 39 acres of land at our PV-303 project in Phoenix for $41 million to a data center user. We also entered into a ground lease with that buyer for the remaining 100 acres of land at this project. The ground lease is for 5 years and includes a purchase option exercisable beginning in year 3. Our year-to-date sales totaled $61 million. We now expect sales for the full year to be $75 million to $150 million. With that, I'll turn it over to Scott for some additional commentary and updated guidance.

Thanks, Peter. Let me recap our results for the quarter. NAREIT funds from operations were $0.62 per fully diluted share compared to $0.60 per share in 3Q 2022. Our cash same-store NOI growth for the quarter, excluding termination fees, was 7.4%. The results in the quarter were driven by increases in rental rates on new and renewal leasing, rental rate bumps embedded in our leases and lower free rent, partially offset by slightly lower average occupancy and an increase in real estate taxes. We finished the quarter with in-service occupancy of 95.4%, down 230 basis points compared to 2Q 2023 and primarily due to completed developments placed in service in the third quarter. Summarizing our building leasing activity during the quarter, approximately 1.4 million square feet of leases commenced. Of these, 300,000 were new, 500,000 were renewals, and 500,000 were for developments and acquisitions with lease-up. As a reminder, we are strongly positioned with no debt maturities until 2026, assuming the exercise of extension options in 2 of our bank loans. Moving on to our updated 2023 guidance per our earnings release last evening. Our guidance range for NAREIT FFO is now $2.40 to $2.44 per share. Excluding the $0.02 per share income item discussed in our first-quarter call, our guidance range is now $2.38 to $2.42 per share, which is a $0.01 increase at the midpoint. Key assumptions for guidance are as follows: we are projecting year-end occupancy of 94.25% to 94.75%. This range assumes that the 644,000 square foot Old Post Road asset is leased up in 2024. We have made this assumption based upon our experience with the asset and the delays in the final governmental award process experienced by our prospective 3PL tenant. Year-end occupancy guidance also assumes the lease-up of our developments placed in service in the third and fourth quarters will now occur in 2024 due to prospective tenants' measured pace in making significant commitments. I would note that if you excluded the impact of these developments being placed in service, our midpoint for year-end occupancy would be approximately 97%. Our 4Q occupancy assumption implies a quarter and full year average of 96.5% to 96.6%. Moving on to other guidance components. Fourth quarter same-store NOI growth on a cash basis before termination fees of 6% to 7.5%. This implies a full year quarterly average growth for this metric of 8% to 8.5%. Note that the same-store calculation excludes $1.4 million of income related to insurance claim settlements recognized in the fourth quarter of 2022. Guidance includes the anticipated 2023 costs related to our completed and under-construction developments at September 30 for the full year 2023 and we expect to capitalize about $0.10 per share of interest. Our G&A expense guidance range is $34.5 million to $35.5 million, an increase of $0.5 million at the midpoint. And guidance does not reflect the impact of any future sales, acquisitions, development starts, debt issuances, debt repurchases or repayments, nor the potential issuance of equity after this call. Let me turn it back over to Peter.

Thanks, Scott, and thank you to all my teammates for all that you have accomplished thus far this year. Together, we're focused on delivering strong cash flow by pushing rental rates on new and renewal leasing and the continued lease-up of our development pipeline. Operator, with that, we're ready to open it up for questions.

We will now begin the question-and-answer session. Our first question comes from Rob Stevenson with Janney.

A couple of questions on development. Are you expecting to start any new developments in the fourth quarter or early first quarter at this point? And then first state, move from a first-quarter completion to a fourth-quarter completion? Can you update us what's going on there?

Yes, I'll take the first part of that, Rob. Look, development starts are going to be a function of market strength, tenant velocity, the economic outlook and, of course, lease-up of our completed developments. Given our desire to operate with additional capacity under our self-imposed cap so that we can take advantage of potential stress in the market, it's unlikely we're going to have any additional starts this year. And as you know, we don't give guidance on starts, so I won't comment on 2024.

Rob, it's Peter Schultz. To your question on first-date crossing, our construction schedule has gone well. We've had great weather. So the building is a little bit ahead of schedule and that's what's allowed us to move it from a first-quarter 2024 completion to a fourth-quarter 2023 completion.

Okay. Peter discussed the overall supply situation in the core market. In which of your core markets are you observing the least amount of new supply in relation to their size?

Yes, there are a number of markets that didn't have any starts in the third quarter. Starts are down pretty significantly across the country, in some markets, 100%, in the 90% range. I'm not going to go market by market, but many markets have seen little to no starts. A couple of markets, starts went up in Q3: Orlando and Denver would be two markets where that happened. But by and large, the vast majority of the markets are down significantly.

Our next question comes from Ki Bin Kim with Truist.

Can you help us understand your comments about new leasing demand being intentional? Perhaps you could compare it to 2019 in terms of the feedback you are receiving or the number of prospects you are encountering. I'm trying to grasp how things might be evolving.

I'll take the front end of that and Jojo and Peter should chime in too. I think when we talk about 2018, 2019, when we had a perspective when we had a space available, we were usually talking to 1 or 2, maybe 3 tenants in '21 and '22. Maybe it was 5 or 6. So we're back down to a smaller number of prospects. Obviously, with the increase in development deliveries, we also have a little bit more competition than we had in '21 and '22 for new space. Peter, do you want to talk about your regions?

Sure. Ki Bin, Peter Schultz here. I would say a couple of things. The overall level of activity, to Peter's point, has been generally consistent. But what we are seeing is tenants being cautious and really delaying their decision-making. We've seen a number of deals where they had a targeted commencement date, only to see those push back as tenants are hesitant to make those commitments given some of the macroeconomic and geopolitical issues that Peter touched on in the script. We have seen a little bit of increase in activity coming out of the summer. Activity levels are better in the smaller and midsize spaces than they are in the biggest spaces, for the most part. But the primary headwind is just the lack of and the slower cadence of decision-making by tenants. Jojo, anything else you want to add?

Yes. So for me, kind of bottom line is like in 2019, businesses are focusing more on growth. And their focus on where the expansion is because of new business coming in. Today, they're more securing their current commitment and wanting to make sure they've got good enough space to run their business and let's focus on growth. In '19, there was a little bit more of a fear of missing out on space because they're being gobbled up quickly. Today, tenants have a little bit more choices, so they're more deliberate and they're shopping around a little bit more.

How does this affect your strategy regarding leasing your development space or any other space? Is reducing rents a viable option? If the customer base is smaller, perhaps lowering rents won't be effective. Maybe increasing leasing commissions is a better approach. How are you addressing this?

Currently, concessions are not significantly increasing. I use the term significantly because we are seeing some sponsors slightly increase free rent. Typically, we offer about half a month of free rent per lease year, and in some cases, it's up to a month. Other than that, there hasn't been much change. As for tenant improvements or standard packages, we have developed properties that are very competitive compared to those primarily built by merchants. From a functionality standpoint, we are superior. When we mention more competition, we are not referring to 6 or 8 other options; it could be 2 or 3. The market is not saturated. At the moment, the market remains steady. Occasionally, someone may receive a bit more free rent, but overall, things are holding steady.

Ki Bin, I’d like to add that over the past few years, many of our developments have been leased to single tenants. We invest significant time in designing these spaces to ensure they are functional and can be divided for multiple tenants. As I mentioned earlier, we are witnessing increased demand from smaller midsize tenants, and our buildings are equipped and ready to accommodate multiple office spaces, stock packages, and in some instances, separate divisions. Given the quality we provide, we have the flexibility to meet this demand. Therefore, you may observe us taking on more multiple tenant arrangements than we have in recent years, which has largely been influenced by the market conditions.

The next question comes from Nicholas Yulico with Scotiabank.

First, I just wanted to ask about the development projects that, I guess, already delivered this quarter and still will come in the next couple of quarters in the Inland Empire. If you could just talk a little bit more about what sort of competitive level of supply you're dealing with there relative to those projects, we do see just stats in your commentary that Inland Empire East is where there is more of that supply impact but just wanted to hear your thoughts on that.

Sure. I'll discuss the Inland Empire. The vacancy rate in the Inland Empire remains historically low at 3.5%. We anticipate that there will be positive rent growth in the long term. Regarding our developments, we have five ongoing projects with two recently completed and a total of 300 under construction. These projects vary in size and are located in different submarkets, primarily Montana, the 250 corridor, and Redlands. We believe we are not overinvested or overbuilt in any area. Each of these properties has no more than two competing properties of similar quality in their locations, and there are even two properties for which we couldn't find any comparable. We are very optimistic about these projects, which amount to approximately $200 million, and we are currently projecting a 9.3% yield, slightly under a 90% margin. While it is our responsibility to lease these properties, we feel confident about creating value for shareholders moving forward.

That's helpful. The second question is about how we should consider the pace of leasing development projects over the next year, specifically regarding the timeframe from delivery to achieving a stable occupancy level. The other question pertains to capitalized interest and potential sensitivity in the coming year based on the leasing duration of projects. Can you share your thoughts or reminders on how to approach the impact of capitalized interest in relation to the development pipeline and how long buildings can remain under capitalized interest after delivery?

I will address the first part of your question, and then Scott will discuss capitalized interest. Regarding lease-up timing for next year, we will dedicate significant attention to this topic as we prepare our budgets. Currently, we do not plan to alter our 12-month downtime assumption for new developments. However, for the projects that have been completed and are now in service, we will concentrate on when we anticipate they will lease next year, based on our current discussions with potential tenants. Unfortunately, I can't provide more details on that matter. Scott, would you like to discuss capitalized interest?

Sure, Nick. So we stop capitalization of interest once the development is completed. So we've got a handful of developments that are scheduled to be completed up until the second quarter of 2024. So we will have capitalized interest for the first 6 months of that period. For the back half or the last 6 months of the period, that will be dependent upon new starts.

The next question comes from Craig Mailman with Citi.

Just wanted to hit on the data center ground lease in Phoenix here. Just had a couple of quick questions on this. Just first, from a run rate perspective, is the full run rate in the 3Q number? Or do we need to think about additional revenue coming in the fourth quarter to annualize it?

Yes, Craig. So there's a little bit of lease income in the third quarter. I think it might be just half of a month. And then obviously, we're going to get a full quarter in the fourth quarter of 2023. Take a look at our NAV footnote, Craig. We have some more information on the ground lease that you can get some of the economics.

Okay. And sorry, I apologize, I didn't see that footnote. Did you guys put in what the purchase option is in there in terms of pricing and how that compares to what the value would have been if you had just kept this as industrial ads?

We have a strict confidentiality agreement with this counterparty. So we can't discuss the terms and values in detail. Generally, the value of data center land is significantly higher than that of industrial land. However, that's about all we can disclose. To put it simply, we are very satisfied with the economics, or else we wouldn't have proceeded with the deal.

Was that your way of indicating concern about overbuilding in Phoenix? It seems like this deal is preferable to expanding the industrial side, especially since the market has been favorable for you since you entered a few years ago.

This in no way is an indication of our confidence in that market. We spent a lot of time deliberating whether we wanted to do this. At the end of the day, the economics of this trade pretty much equal the economics of building that site up.

I have a quick follow-up question for Scott regarding the mark-to-market. You mentioned that you’re not providing guidance on spreads yet, but you expect that next year it won’t exceed 38%. Is the 40% leased this year mainly due to a mix issue outside of L.A. or other markets with smaller mark-to-market? Could you clarify what comprises the net 40% versus what makes up the remaining 60% in terms of market exposure?

Chris, do you want to take that?

Yes, Craig, this is Chris. Yes, it is definitely a mix issue. So if you look at what's been taken care of, it's only 6% from Southern California. If you look at the rest of the 2024 rollovers, that mix is 56% coming from Southern California.

Our next question comes from Vikram Malhotra with Mizuho.

I want to follow up on development. Some of your peers might be concerned that if development starts are very low, by the end of 2024, there won't be much product available. If demand is increasing, there could be opportunities to gain market share. I'm curious about how you manage between the specific markets where you may consider pausing in the fourth quarter, as you mentioned, but then increase activity again, given that there will generally be a shortage of quality product.

Yes. I mean 1 of the big indicators for all of us is going to be development lease-up, and we have product in the market now. We're having good conversations. As we've said in various in many different ways, tenants are taking a while. To lease a 500,000-square-foot building, that's about a $50 million decision. And the current economic outlook and what's going on around the world, that causes people to pause before they put down that $50 million. So yes, it's possible that toward the end of next year, there's not enough supply. That would be fine by us, obviously. And we really think that the market will be particularly strong in 2025. So with respect to us looking at what we're going to start to potentially start next year, it really is going to depend upon how we feel about lease-up.

Okay, that makes sense. And just following up on the Inland Empire comments you made around the competitive set being small in terms of your project. Maybe just help us think about how you're seeing what you've seen in terms of market rent growth in SoCal in general, what the variability in that region looks like quarter-over-quarter? Any numbers you can share would be helpful.

Jojo?

Yes. So kind of address it a little bit because of the low vacancy. L.A. is at a sub-2, and then i.e. at about 3.5. Long term, we would think that it would be a minimum mid-single digits going forward. But today, as you may recall, SoCal has had the highest rent growth of any market in the U.S. for the last 3 years straight. So right now, what the market is doing is digesting the supply in the marketplace, along with a little bit of a decline on the inbound TEUs that affected the demand. And I'm not going to be surprised. We're not going to be surprised. In the very near term, the rent is flat through the end of the year and maybe the first quarter next year to maybe slightly negative. But that doesn't mean that we can't create value because I'd point out to you, our developments, for example, just as a subset, it's about a 93, based on current market trends, rent to yield.

Our next question comes from Caitlin Burrows with Goldman Sachs.

Maybe somewhat related to the last question. But on the development yields, it looks like today, they're expected to be 7.2% for the under-construction set of properties which is up from like 6.5% a year ago. So how are you thinking about your cost of capital today and what yields are required to make development attractive? And I guess to what extent is that impacting your activity?

Yes, thank you, Caitlin. The cost of capital has definitely increased. However, when we evaluate it in relation to the margins and profits we aim for, the yields on new developments need to exceed 6.5%, with expected internal rates of return above 8.5%, ideally closer to 9%. On a weighted average basis, our pipeline projects meet those return thresholds. We are optimistic about the opportunities ahead. Once we have a better understanding of the additional supply coming into the market nationally, we have many promising projects ready to proceed in the top markets across the country.

Got it. Okay. And then maybe on the acquisition side. I know it's historically not been as much of a driver for you guys and transaction volumes are down significantly this year across CRE. But are you seeing any attractive acquisition opportunities come to market? Or do you expect attractive opportunities to come up, either of stabilized properties or even lease-up properties?

I mean, economics certainly make a difference in terms of what's attractive. But Joe, do you want to talk about some of the things you've seen and the reasons we've taken in the past?

We are monitoring the market for potential stress among merchant developers or property owners, especially those in the midst of projects or looking for capital, as well as sellers of real estate. However, there aren't many opportunities that align with our standards for quality and location. In instances where properties do match our geographical criteria but not our financial benchmarks, we notice some buyers are purchasing real estate at prices that seem unreasonable to us. Yet, we have identified a few smaller opportunities. For example, we are stepping in to assist a developer who lacked funding for a build-to-suit project, which we believe is a good deal. Additionally, there’s another smaller project where a developer requires funding for their speculative project, and they are seeking to secure equity swiftly, prompting us to buy one of their properties at a significantly lower price. These are the types of opportunities we are currently pursuing.

Got it. And just to clarify, those are things that you're looking for or have already been decided on and are moving forward?

I can't really give you much more specifics as those are...

We're pursuing. We're pursuing.

We're chasing it.

The next question comes from Todd Thomas with KeyBanc Capital Markets.

This is A.J. on for Todd. Just going real quick back to the capitalized interest discussion. You said that you stopped capitalizing interest when development is completed. As you look at your construction pipeline today and everything under construction, do you see any potential delays or anticipate any delays for what's currently supposed to be delivered over the next few quarters?

I would say that's our best thinking as of this point in time. So if you're asking about developments under construction, we've got estimated building completion in our supplemental. That's our best thinking at this point in time that that's when those developments will be completed.

Okay, perfect. And then, just one question regarding Old Post Road. Is the 3PL tenant still engaging, or is there any update about that contract that was supposed to be awarded? Or are you planning to market the asset to a new tenant altogether?

So A.J., it's Peter Schultz. We continue to market the asset. In terms of the 3PL group, we continue to talk with them. The government continues, for whatever reason, to postpone the final decision on that contract award. The latest information is that they're supposed to issue that award sometime later this quarter. Given our experience with this process over the last year, our confidence level, I would say, is not high, which is why, as you heard from us earlier, we decided to push the lease-up into 2024. It's certainly possible that this could get done this quarter, but our probability is that it's less likely just given the way this process has gone.

The next question comes from Michael Carroll with RBC Capital Markets.

Just following up on Old Post Road. I know this has been taking a couple of years to get done. I mean at what point do you just decide to kind of go multi-tenant and try to lease it to some smaller tenants that might want that space?

Mike, that's a good question. It's Peter Schultz again. We have been and are open to that. As we've discussed in previous calls, demand from larger users in this submarket and others has slowed down, whereas historically, that size range was very active during that quarter. We're receptive to exploring that option. Ultimately, it depends on the timing of market demand and how tenants make their decisions.

Okay. And then just real quick on your comments on the smaller blocks of space. I know for the past few quarters, you've highlighted the tenant activity for those small to midsized blocks as being still pretty healthy. Is that still a fair comment today? Or has that changed over the past 3-plus months, given kind of the slowdown that you've seen in demand?

I would say it's consistent. Our in-service portfolio has very high occupancy, and we're still seeing strong demand and quickly filling spaces. For the Old Post Road building and some of our larger developments, demand remains very active. Tenants in these situations operate with greater urgency and diligence, taking larger commitments into account. However, they are not rushing to make decisions and commitments at this time due to broader macro factors affecting everyone.

The next question comes from Nick Thillman with Baird.

Question on the land bank. It looks like the fair value of the land bank was marked down like 10% quarter-over-quarter. Some of that could be related to some land sales but just curious if you did make some changes in your estimates for fair value to land and maybe which markets in particular saw the biggest haircuts.

Do you want to take that?

Yes, Nick, it's Scott. We removed the land in Phoenix associated with the land sale and the land that’s being ground leased from the land bank. This will lead to a noticeable drop in fair value in the third quarter compared to the second quarter due to the longer-term impacts. I'll have Jojo discuss the adjustments we made regarding what remains.

Sure. In addition to the Nashville land acquisition, we adjusted our land values in Chicago and Florida and made slight adjustments to other lands. This was done on an asset-by-asset basis. For some land, we initiated off-site improvements, which increased their value. We accounted for these costs in our additional land investments, resulting in the overall difference.

Was there any specific markets that were haircut like significantly in this process or not really?

No, I would say that we didn't do it market by market. We did it property by property. I would say the change was anywhere from 5% to 15%. And then Chicago, we, for example, took down Orlando. We took down in terms of value, we adjusted it. So yes. So I mean we did it property by property.

Sure. Bad debt's very low. For the third quarter, it's about $100,000 and that's compared to our guidance assumption of $250,000. So still in very good shape. If you look year-to-date third quarter, we've expensed about $275,000 compared to our original guidance for those first 3 quarters of $750,000. So doing very well against our forecast. As far as tenants on the watch list, no material tenants are on the watch list at this point in time.

Our next question comes from Rich Anderson with Wedbush.

So when I was kind of looking back in time, Peter, back in 2019, I asked a question of you, what trigger points are you looking for as it relates to build-to-suit versus spec development. You talked a lot about it here on this call. One of the things you said then, not to put you on the spot, is the so-called musical chairs phenomenon where tenants have the ability to move around from 1 asset to another because they can. And that, to you, would be an indication of market weakness. You talked about the hesitancy of tenants and so on that's going on today. But are you also seeing that with the elevated level of deliveries is creating optionality? Is that another sort of dynamic that you're seeing happen in your space?

Kudos to you, Rich, for remembering that and bringing that up. Good question. No, we're not seeing that. What we're seeing is a current example in the portfolio, where a tenant moved out to consolidate into a bigger space. And that's still the theme. If we lose a tenant, it's because we can't accommodate their additional growth needs. In terms of people leaving buildings, it's very expensive to move. So the deal they can achieve somewhere else has to be pretty outstanding, and that is not reflective at all of where we are right now, even with the additional supply coming to the market. As we've pointed out, vacancy rates at 4% in our markets are still very low. That's not going to generate the kind of financial arbitrage that would cause a tenant to leave for another building. So, good question, but we're not seeing that phenomenon right now.

Yes, it's definitely significantly higher. Our policy states that we place properties in service 12 months after completion. Generally, looking back to year 3, five years ago, we have leased everything within that 12-month period. So that spread is indeed higher. We experienced a bit of this dynamic during COVID with a few of our developments, so I would say it's higher at this point in time. Moving forward, it really depends on each asset when we get them leased up, and we will go through our budgeting process at the end of the year and provide more details during our fourth-quarter call.

Our next question comes from Vince Tibone with Green Street Advisors.

Could you discuss how 3PL tenants are performing in your portfolio? And do you have a sense of where their current volumes are relative to peak activity 12, 18 months ago? I'm just trying to understand how much kind of excess capacity there may be among 3PLs and how that dynamic could potentially impact near-term demand?

First, I would say that our teams report high utilization of all of our spaces around the country. 3PLs continue to be the top most active prospect that we're seeing for new buildings and existing availability. And in general, they're all looking for more space, not less space. So I would simply tell you that we're not seeing really any stress there. To Scott's question, nobody on the watch list and no bad debt, but they continue to be an important and active component of demand. Jojo, anything you want to add to that?

Yes. Our experience shows that the 3PL business is not immune to recessions, but when companies that are not in the fulfillment sector face slowdowns, they tend to turn to 3PLs because these providers offer greater efficiency and cost savings compared to handling fulfillment internally.

That's really helpful. I have one more general question about the industry. Could you discuss the trends in sublease space within your markets? Are there any notable changes? This is a complex topic because not all sublease space is the same. Peter and Jojo, would you like to add anything?

Sure. So Peter Schultz. I would first say that sublet space at the headline is certainly up a little bit, but I think you have to break it down and it's a couple of different buckets. One is a corporate occupier saying a 700,000 square foot building gets an edict from their corporate to sublet 200,000 or 300,000 square feet. That's a hard deal to make for tenants and generally doesn't happen. We don't really view that as competitive sublet space. Some of the sublet space has a time or term limit of only a couple of years and most tenants are not going to take advantage of that. We've also seen some sublet space come on the market and be pulled back by the prime tenant because they need the space again. So yes, there is some sublet space. We don't view it as a high concern today. And then I would just end with, as I said a couple of minutes ago, the space utilization in our portfolio is very high. We're not really seeing any change in sublet space across our portfolio. Jojo?

Yes, I just want to just add to Peter, when we surveyed really our teams is that we haven't really lost anything close to anything significant to subleased space, just like Peter said. And if we did, these are the subleases that are long-term subleases that would be very good for a long-term user. But the problem is that most leases don't fit that. Most of the leases are short term. And therefore, frankly speaking, we would like to cope with sublease because a lot of times, the tenants that we're pursuing can really operate out of a short-term lease. It's like Peter Baccile said, it's constantly moving.

Our next question comes from Mike Mueller with JPMorgan.

So for the two questions. The first one is, for the development leases you signed in 3Q and 4Q, how did the rents compare to the original underwriting? And the second question is a little bit more of a clarification. When you were talking about '24 leasing, did you say 56% of the remaining expirations were in Southern California? And if so, how does that compare to what the mix was of what you signed already?

Chris, take the first part.

Yes. So correct. The remaining 2024 lease expirations at 56%. And again, the ones that have been signed already, the mix with Southern California was only 5%. So obviously, it's going up quite a bit.

Significantly ahead of what we underwrote.

Our next question comes from Anthony Powell with Barclays.

Just a question on data centers. And as you look at your land bank, are there any obvious opportunities for you to do additional joint ventures or development deals in the space?

So we are land positions and...

We are very pleased to have achieved the highest and best use for our piece of land in Phoenix, and we are excited about that. Across all aspects of our operations, we consistently aim for higher and better use. If we encounter a scenario where an offer for a price does not justify constructing an industrial building or exceeds our profit potential, we would consider selling. This is a principle we follow at FR. As for potential candidates for future data centers, I can say that we currently do not have any pending offers or pursuits related to additional data center opportunities.

Sorry, just 1 follow-up which is similar to the question that was just asked. But in terms of the mix of expirations in '24, I think you had previously said on other calls that 2024 would have less SoCal than 2023. So I'm wondering, as you compare '24 to '23, if that changed or just that kind of exposure that you were talking about that might be confusing. I'm just wondering how the '24 SoCal exposure compares to '23.

Yes, Caitlin, this is Chris. A few leases that were set to expire in 2023 will not be renewed in 2024, and the allocation between the two years is both around 25% or more.

Yes. We're talking about a couple of month’s difference. So...

Right. So very similar between the 2 years.

Our final question comes from Craig Mailman with Citi.

I'm not trying to prolong the call unnecessarily, but there's considerable attention on market rent growth right now. It seems that many of the statistics shared by brokers are mainly focused on asking rents, which in some markets are influenced by new properties entering the market rather than the actual taking rates. I'm curious, as you assess your market exposure, whether there is a more optimistic view on taking rates compared to the trend in asking rates that you could share.

Yes. It's a complicated subject because market rent growth, that's tracked differently by a lot of different brokers. Taking rents right now, they report are more like 15%. We don't quote that. We think the asking rent number is more accurate. Our expectation for rent growth for 2023 was mid- to high-single digits. That was with asking rents in mind. So far, year-over-year, CBRE reports for the third quarter, that number is 7.5%. So it's right in the middle of what we expected. So yes, we're looking more at a 7.5% rental rate increase across the markets that we're active in. We don't look at the taking rents are higher because, by definition, they have to include some amount of mark-to-market as opposed to just what's happened in that quarter or that year. So we don't pay attention to that.

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

Thank you, operator, and thanks to everyone for participating on our call today. If you have any follow-ups from our call, please reach out to Art, Scott or me. We hope to connect with many of you in person in the coming months. Be well.

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