Earnings Call
First Industrial Realty Trust Inc (FR)
Earnings Call Transcript - FR Q2 2023
Operator, Operator
Good morning and welcome to the First Industrial Realty Trust, Inc. Second Quarter Results Call. All participants will be in listen-only mode. After today's presentation, there'll be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Art Harman, Vice President of Investor Relations and Marketing. Please go ahead.
Art Harman, Vice President of Investor Relations and Marketing
Thank you, Jason. Hello everybody and welcome to our call. Before we discuss our second 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 accurate only as of today's date, July 20th, 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 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'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.
Peter Baccile, President and Chief Executive Officer
Thank you, Art and thank you all for joining us today. Our team delivered an excellent quarter, highlighted by a record-setting increase in cash rental rates on new and renewal leasing. We also achieved some leasing wins at some of our developments and began construction of two new buildings in coastal markets. As a result of our performance and updated outlook, we raised our estimate for our 2023 cash rental rate growth and full year FFO per share guidance, which Scott will discuss shortly. Before we go deeper into our results, let me spend a moment discussing the broader US industrial market. Overall fundamentals remain good. National vacancy today is low at around 3.7%. In our 15 target markets, vacancy is 3.3%. As we discussed on our last call, there's a fair amount of new supply expected to be delivered nationally in roughly the next 12 to 18 months. Based on CBRE EA's analysis, there is 540 million square feet under construction across the US, 31% of which is pre-leased. Focusing on our 15 target markets, completions are expected to be approximately 400 million square feet with 30% currently pre-leased. Nationally, new starts in the first half of 2023 are down approximately 40% compared to the same period a year ago as sponsors continue to evaluate the economic landscape and the revised economics of new projects due to meaningful increases in the cost of capital. With respect to demand, the pace of leasing activity in our in-service portfolio continues to be strong. Tenants are making leasing decisions many months in advance of their lease expirations, and we are achieving very healthy rental rate increases. I will touch on these two points later in my remarks. For the unleased portion of our 1.8 million square feet of completed developments that is slated to be placed in service in the third and fourth quarters, we have interest from prospective tenants for many of the spaces. However, tenant decision-making time frames have elongated compared to a year ago. Customers are dealing with uncertainty in the overall economy and the Fed's decision to delay future rate hikes likely didn't provide any comfort. As a result, we adjusted the lease-up assumptions for some of these developments, which impacted our average occupancy guidance midpoint by 75 basis points for the year. Scott will walk you through the details, but importantly, we have offset the FFO impact with the help of leasing at other developments. Returning now to our performance. We finished the second quarter with an occupancy rate of 97.7%. Our cash rental rate increase for leases commencing in the second quarter was 74.1%, exceeding the record we established just last quarter. As of yesterday, approximately 81% of our 2023 lease expirations are in the books at a cash run rate increase of 63%. We now anticipate that our cash increase on rental rates on new and renewal leasing for 2023 commenced leases will be in the range of 55% to 60%. This is an increase of 7.5 percentage points at the midpoint compared to what we mentioned on our April call and 12.5 percentage points higher than our original guidance. As we've highlighted previously, one of the drivers of our record-setting rental rate increases is the contribution from our Southern California lease signings. For 2023, of the 2.1 million square feet expiring in Southern California, we already have signed leases for 72% of that space and a cash rental rate increase of 156%. Looking ahead, we're already seeing renewal activity on our 2024 lease expirations. Of note, we have taken care of next year's largest lease expiration by square footage with the renewal of a 700,000 square foot tenant in Nashville and a 40% cash rental rate increase. We've also inked a 213,000 square foot renewal in Central New Jersey for a 128% cash rental rate increase. So we're off to a good start addressing our 2024 lease expirations, and we will provide you with an update on our leasing progress on our third quarter call. Now I'd like to provide you with a leasing update on our 644,000 square foot Old Post Road building in Baltimore. Our prospective 3PL tenant continues to await the final decision from the government regarding the contract awards. We continue to assume lease-up of the full building in the third quarter, which is the start date of the contract award. We also continue to market the building to new potential tenants. Moving on to development activity. Since our last earnings call, we signed full building leases for the 56,000 square foot First Park Miami building 13 and a 132,000 square foot First Gate Commerce Center, both in South Florida. At our three-building project in our Phoenix joint venture, we pre-leased the 420,000 square foot building to a restaurant supply business. Given our success in South Florida at our First Park Miami project in the infill market of Medley, we broke ground on the 136,000 square foot building 12. Total estimated investment is $34 million, and the projected cash yield is 6.9%. This will be our seventh building at this multi-phased park, the previous six leased at or shortly after completion. Beyond this new start, we look forward to further growth at First Park Miami. We just closed on another phase of land at the park, which is buildable to approximately 430,000 square feet. We expect delivery of the last parcel from the seller per our option agreement in mid-2024, which would accommodate another 430,000 square feet. When fully built out, the park will total 2.5 million square feet. On the West Coast, we broke ground at the First Harley Knox Logistics Center in the Inland Empire. First Harley Knox will be a 159,000 square foot facility with a total estimated investment of $31 million and a healthy projected cash yield of 8.4%. Including the second quarter development starts, our developments in process totaled 2.7 million square feet with an investment of $441 million. The projected cash yield of these investments is 7.9%, which represents an expected overall development margin of approximately 75%. In addition to the First Park Miami land, we also closed on three more new development sites since our last call. In the Lehigh Valley in Pennsylvania, we acquired 66 acres for $24 million. This site can support a four-building park totaling 762,000 square feet. In the Inland Empire East, we added a four-acre site in Paris for $13 million, that is next to a site we already own. Combining these sites will allow us to build a single 550,000 square foot building at a higher yield and margin. We also acquired five parcels totaling 101 acres from four sellers in North Palm Springs on the I-10 corridor for a total of $21 million. This assemblage will position us to build up to three buildings totaling 1.9 million square feet with a very competitive land basis. In total, our balance sheet land today can support an additional 16.8 million square feet. This represents approximately $2.6 billion of potential new investment based on today's estimated construction costs and the land at our book basis. These figures exclude our remaining share of the land in our Phoenix joint venture. Since our last call, we completed the sale of two buildings in Houston and Detroit, totaling 190,000 square feet plus a small land parcel in Minneapolis for a total of $18 million. Our sales guidance for the year remains $50 million to $150 million. With that, I'll turn it over to Scott for some additional commentary and updated guidance.
Scott Musil, Chief Financial Officer
Thanks, Peter. Let me recap our results for the quarter. NAREIT funds from operations were $0.61 per fully diluted share compared to $0.56 per share in 2Q 2022. Our cash same-store NOI growth for the quarter, excluding termination fees was 10.8%. The results in the quarter were driven by increases in rental rates on new and renewal leasing and rental rate bumps embedded in our leases, partially offset by slightly lower average occupancy, higher free rent and an increase in real estate taxes. As Peter noted, we finished the quarter with in-service occupancy of 97.7%, down 70 basis points compared to 2Q 2022, primarily due to anticipated move-outs. Summarizing our leasing activity during the quarter, approximately 1.7 million square feet of leases commenced. Of these, 200,000 were new, 900,000 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 and assuming the exercise of extension options in two of our bank loans, which puts us in an advantageous position given the volatility and higher interest rates in the financing markets. Moving on to our updated 2023 guidance per our earnings release last evening. Our guidance range for NAREIT FFO is now at $2.37 to $2.45 per share. Excluding the $0.02 per share income item discussed on our first quarter call, our guidance range is now $2.35 to $2.43 per share. Our new midpoint of $2.39 per share is a $0.01 increase at the midpoint primarily due to higher capitalized interest from our two newly announced development starts. Key assumptions for guidance are as follows: quarter end average in-service occupancy of 97% to 98%. As Peter mentioned, this is a 75 basis point decrease at the midpoint given the length and decision-making timeframes we're experiencing from some of our prospective tenants. In particular, we have adjusted the lease-up assumptions for the available space at the 1.2 million square feet of developments that will be placed in service in the third quarter. We are now projecting that approximately 860,000 square feet of that space will be leased up in the fourth quarter of this year with the remainder to be leased in 2024. We also adjusted some of the lease-up assumptions for the development scheduled to be placed in service in the fourth quarter. Of the 650,000 square feet, half is still anticipated to be leased in the fourth quarter and the other half is now slated to be leased up in 2024. Moving on to our other guidance components. Same-store NOI growth on a cash basis before termination fees of 7.75% to 8.75%. 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 $0.02 per share of JV FFO related to our share of the ground rent from our joint venture discussed on our first quarter call. Guidance includes the anticipated 2023 costs related to our completed and under construction developments at June 30. For the full year 2023, we expect to capitalize about $0.10 per share of interest. And our G&A expense guidance range is unchanged at $34 million to $35 million. 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.
Peter Baccile, President and Chief Executive Officer
Thanks, Scott, and thank you to all of my teammates for another excellent quarter. We're delivering strong cash flow from our portfolio as we capture our cash rental rate growth opportunities and maintain a high level of our occupancy. Our regional teams are laser-focused on the lease-up of our pipeline as we build upon our track record of development execution and value creation. Operator, with that, we're ready to open it up for questions.
Operator, Operator
Thank you. We will now begin the question-and-answer session. Our first question comes from Rob Stevenson from Janney. Please go ahead.
Rob Stevenson, Analyst
Good morning, guys. Peter, you sold the Houston asset in the quarter. What's the market like for asset dispositions today given where rates are and the availability of debt for private buyers? And I guess the other thing is, how much are you guys able to rely on dispositions as a funding source today given those factors?
Peter Baccile, President and Chief Executive Officer
So the disposition market is open, the transaction market is open, albeit at lower volumes than you've seen in the past. And as we've always said, most of our sales end up going to users or high net worth family offices or smaller regional funds and we're having quite active dialogue on some deals with that kind of buyer group. In terms of financing, their financing is available, it's expensive, so you're seeing a lot of these deals happen with all equity right now.
Rob Stevenson, Analyst
Okay. And then the $145 million of derailment you're expecting to complete in the second half of this year, how are you thinking about starts behind those over the next six to nine months? Are you waiting and letting some of that 400 million square feet of development that you talked about in your markets clear? Do you just keep your head down and start your projects when they're ready here you guys thinking about starts over the next six to nine months?
Peter Baccile, President and Chief Executive Officer
Sure. Obviously, development leasing is going to dictate to a large degree the opportunity to have starts, but also so are the markets. We're going to continue to evaluate the fundamentals in the market, leasing velocity, et cetera. And we do have a number of very good projects lined up that we can bring but we're a profit shop and not a volume shop. If the market and the risk-adjusted returns are there, we’ll just hold up.
Rob Stevenson, Analyst
Okay. And last one for me, Scott. So 9.4% same-store NOI year-to-date guidance at the midpoint is like 8.25%, which implies about 7% in the back half of the year. Is it just tougher comps, or is there something else that slows you down 200, 250 basis points versus what you've seen year-to-date in the back half of this year?
Chris Schneider, Senior Vice President of Operations
Yes, this is Chris. The decline in spend rate due to the year-over-year drop in average occupancy are – average occupancy in the first half of 2023 versus the first half of 2022 is up slightly. The back half of 2023 versus comparable 2022, the average occupancy is down slightly. The balance of that decline is really just due to a little bit lower cash rent increases in the second half, and then our real estate taxes and bad debt are negatively impacting that a little bit.
Rob Stevenson, Analyst
Okay. Very helpful. Thanks, guys.
Operator, Operator
Our next question comes from Michael Carroll from RBC Capital Markets. Please go ahead.
Michael Carroll, Analyst
Yes, thank you. Can you guys provide some color on your Baltimore portfolio? I mean, what drove the overall occupancy within that portfolio lower? I mean just kind of looking at the comps, it looks like it's a property that's near your Old Post Road. I mean, is that correct?
Peter Schultz, Executive Vice President
Good morning, Mike, it's Peter Schultz. Yes, it's one building of 350,000 square feet that was a known move-out. The tenant moved to a consolidation into almost 2 million square feet in a build-to-suit. The building is being marketed. We're seeing activity from full and partial users. The amount of supply in that submarket continues to be very limited. And in fact, there's a limitation on new industrial development imposed at the moment by the municipalities. So, we'll keep up to date on our progress on re-leasing that. But that's the one building that impacted the occupancy.
Michael Carroll, Analyst
Okay, great. What is the level of interest in that asset? I assume the 3PL tenant considering the adjacent building wouldn't be interested in it. Is there an expectation for another lengthy leasing process, or is the interest strong enough for a quicker lease-up?
Peter Schultz, Executive Vice President
So in general, I would tell you that smaller mid-sized tenants are more active in making decisions quicker than larger tenants. So we would anticipate the lease-up of this asset to be faster than 500 Old Post Road, and we'll keep you posted. But as I said, we are seeing activity from full and partial tenants now and they don't have a lot of choices.
Michael Carroll, Analyst
Okay. And then on the completed developments, the ones that are going to go into service in the back half of this year. I mean how strong are those markets? I mean, it looks like Denver is one of the markets that a couple of assets are in. I mean, is there a lot of interest in those assets? I mean, how many tenants are specifically looking at those properties in general?
Peter Schultz, Executive Vice President
Yes. So in Denver, we have two buildings: a 588,000 square foot building and a 200,000 square foot building. Generally speaking, we're seeing activity from partial building users for the most part, a couple of full-building users on the smaller building. And as I just said in answer to your other question, activity levels and interest levels are better in the smaller or midsized segment, and those decisions are being made faster as opposed to tenants in the larger size categories where they continue to slow play those discussions.
Michael Carroll, Analyst
Yes, understood. I mean, just last question for me is like what are the reasons for the delayed decision-making? Is it just the current disruption in the capital markets? And are you surprised that it's taking them this long to make those decisions?
Peter Baccile, President and Chief Executive Officer
So the decision to lease a 600,000 or 700,000 square foot facility is a big financial commitment. Not only do you have the rent, but you've got to equip the building and put inventory in the building and hire people, and it's tens of millions of dollars. So some of the larger users are trying to decide when is the right time to fund their growth. This is all new growth. The need is there, but the need may not be today; maybe three months from now or a bit later than that. So, that's really the decision they're tossing around as they look at what's happening with rates and the impact on the economy and whether we're going to have a recession, et cetera. It's really just trying to make the right decision about when they invest pretty big dollars into their business.
Michael Carroll, Analyst
Okay. Are you surprised that it's taking them this long to make these decisions?
Peter Baccile, President and Chief Executive Officer
Not really. I mean I think every business is trying to figure out what the go-forward looks like just like we are, and it's not surprising given all of the uncertainty in the market.
Operator, Operator
Okay, great. Thank you. Our next question comes from Craig Mailman from Citi. Please go ahead.
Craig Mailman, Analyst
Hey, guys. Peter, on the development pipeline, not to harp on this, but as I'm just going through it, you guys haven't done a lot of build-to-suit, and it just feels like with a pullback in your competitors really being able to secure financing. Is this an area that you guys could start to gain some market share in to maybe de-risk the pipeline a little bit on incremental starts?
Peter Baccile, President and Chief Executive Officer
Good question, Craig. We are in the build-to-suit business. As you know, we don't do a lot. We'll offer that we are having some conversations on that front now. So we'll see where they go.
Craig Mailman, Analyst
Are you facing a return issue where you don't want to sacrifice profit margin, or is it simply that you lack available land sites for the current RFPs?
Peter Baccile, President and Chief Executive Officer
I would say that it's both. The returns on speculative development are obviously, and in many cases significantly higher. And we target land that is in pockets of unmet demand. And we don't have as many alternatives in some markets as maybe some of the other competitors would have. So that limits the number of build-to-suits that we're positioned to do.
Craig Mailman, Analyst
Okay. And then just going through where you guys have the availability, there's clearly a fair bit of square footage in California, and that's obviously ground zero for a lot of concerns right now among the investor community. I mean, could you talk about what you're seeing in different size ranges and different submarkets vis-à-vis where you guys have availability?
Peter Baccile, President and Chief Executive Officer
Specific to SoCal?
Craig Mailman, Analyst
Yes.
Jojo Yap, Chief Investment Officer
Sure. In terms of availability, our existing portfolio is basically close to 100% leased, with very few spaces available. We have one space in the Empire East that we're leasing at very good product, well, well below market. In terms of our spray of developments, we have four ongoing right now. Nothing is completed right now, and they're scheduled to be completed closer to Q4, and we're getting inquiries and tours. If you look at the four developments that are under construction, they range from 83,000 square feet to 460,000 square feet. They're spread over Inland Empire West into Inland Empire East, the submarket of Redlands in the 250 corridor. We're getting tours and looks at every building; well we haven't announced a set, because we don't have to lease yet, but we're working hard to get all those pre-leased. Today, users are more inclined to seriously engage in leasing when the building is close to getting built. As you may have heard, there have been some delays due to supply chain and municipal approvals in California. A lot of tenants have been a little bit concerned that buildings are not being delivered exactly on time. So that's affected a little bit of leasing. But by and large, again, the prospect activity has been active.
Art Harman, Vice President of Investor Relations and Marketing
And just to be clear, there's a fifth building that we just started, Craig, so.
Jojo Yap, Chief Investment Officer
Yes, that's not going to be completed until 2024.
Craig Mailman, Analyst
Okay. And then Carvana put out some news yesterday about restructuring. It looked like some of the ADESA assets were put up as collateral. I mean, from your standpoint, is that just improved the credit for you? Is there any insight you guys have on that transaction and how you guys feel incrementally about that credit?
Peter Baccile, President and Chief Executive Officer
I mean we don't have any particular insights that you already haven't read about in the newspaper. It certainly looks like they're doing their best to right the ship. It's interesting to us that the founders have put in some substantial cash into this new deal. And at the end of the day, these ADESA sites are owned by us, leased to them. As we said on prior calls, if we get that back, yes, we'll have a short-term hit to FFO. But the long-term value creation is significant. So we'll take the cash flow while they're paying rent, and they are current. If they stop paying rent, we'll take the assets back and redevelop them and make a significant profit.
Craig Mailman, Analyst
Okay, great. That's it for me.
Operator, Operator
The next question comes from Ki Bin Kim from Truist. Please go ahead.
Ki Bin Kim, Analyst
Thanks. Good morning. Just to go back to the Inland Empire topic. Given that you have a few projects that you're developing there, how do you view the supply-demand dynamics in that market and how it might impact the lease-up timing for your projects?
Peter Baccile, President and Chief Executive Officer
Jojo?
Jojo Yap, Chief Investment Officer
The buildings are still under reconstruction. As we've mentioned before, our underwriting includes a one-year downtime. Historically, there has been pre-leasing in that market, but currently, we are operating more on a normalized basis, leasing within our underwriting period. Activity has improved in Q2 compared to Q1. In June, the inbound container cargo flow nearly matched that of June 2022, while Q1 2023 showed slower TEU traffic compared to Q2. We see some improvement. The agreement between the unions and the owners has been ratified, which I believe will provide greater visibility for shippers and alleviate concerns. Overall, Los Angeles continues to have a vacancy rate below 2%, sitting at 1.7%, and the Inland Empire is below 3% at 2.7%. This region has the most challenging land entitlement process in the US, meaning that supply should remain constrained in the long term.
Ki Bin Kim, Analyst
And your retention rate was 60% this quarter. Obviously, the Baltimore lease probably made a big impact. But just overall, when you look at the reasons why tenants don't renew, have the different reasons or categories shifted at all? And I'm just curious if tenants are becoming increasingly more price-sensitive.
Peter Baccile, President and Chief Executive Officer
In our portfolio, when tenants leave, it's often because we cannot meet their need for expansion. For example, a tenant in Baltimore moved to a nearly 2 million square foot facility, which we couldn't accommodate. That's essentially why tenants exit. When we discuss potential tenants for new developments, there are occasionally inquiries about relocations, such as moving from California to pay lower rent. However, that isn’t a widespread trend and doesn’t reflect the majority of our conversations.
Chris Schneider, Senior Vice President of Operations
And Kevin, this is Chris, too. In a majority of cases, we're releasing those at significantly higher rents when they move out, so yes.
Ki Bin Kim, Analyst
Okay.
Chris Schneider, Senior Vice President of Operations
And in a majority of cases, we're releasing those at significantly higher rents when they move out, so yes.
Ki Bin Kim, Analyst
Okay. Thank you.
Operator, Operator
Our next question comes from Nick Thillman from Baird. Please go ahead.
Nick Thillman, Analyst
Hey, guys. Maybe just going on development. Unlike the market rent growth sort of new development. Have you seen market rents for new development in your markets? Have they peaked, or are you kind of seeing any retreating there?
Peter Baccile, President and Chief Executive Officer
Market rents are increasing. Earlier this year, we anticipated growth in the 5% to 10% range. We still believe that by the end of the year, when we assess the situation, we will observe that rents have grown in the mid- to high single digits nationally, particularly at the higher end of that range in markets with more barriers to entry. In certain areas, such as South Dallas, there may be a rush to lease; however, rents there may not be increasing and could be declining slightly in the large-format buildings available in the 1 million-foot category. Overall, we continue to witness respectable rent growth across various markets.
Nick Thillman, Analyst
Okay. And then maybe another way of asking the Southern California development question, but just what are you guys tracking for like on a square footage basis of demand in SoCal? And maybe how has that changed over the last three to six months?
Peter Baccile, President and Chief Executive Officer
You have a view on that?
Jojo Yap, Chief Investment Officer
There's no precise square footage due to the lack of specific data, and this continues to evolve from quarter to quarter and even week to week. However, I would describe the situation from Q3 to Q4 of 2022 as having three to four prospects for every vacant space, compared to one to two potential tenants looking at your building at any given time.
Nick Thillman, Analyst
That's helpful. And then maybe last one for me for Scott. Any shift in the tenant watch list or bad debt expectations for the remainder of the year?
Scott Musil, Chief Financial Officer
No, Nick, nothing. Our bad debt expense continues to trend low. It was under $100,000 in 2Q. So year-to-date, our total is $180,000, so very low. Again, no material tenants on the watch list and Peter spoke about ADESA.
Peter Baccile, President and Chief Executive Officer
Let me add one more thing to what Jojo just said. The tenant interest reflects the demand we had in 2019. As we all know, 2018 and 2019 were the best markets we've ever experienced. This is why we discussed the normalization of demand at the beginning of the year. We're seeing a shift from having four or five prospects per space down to two or three prospects per space.
Nick Thillman, Analyst
Very helpful, and thanks for the time.
Operator, Operator
The next question comes from Nicholas Yulico from Scotiabank. Please go ahead.
Nicholas Yulico, Analyst
Thanks. I just want to follow up on the potential tenant for Old Post Road or re-leasing. It sounds like you mentioned that you're still factoring this into the guidance for third quarter leasing. So you're assuming that even if the one tenant with the government contract doesn't work out, you have a backup tenant for that asset?
Peter Schultz, Executive Vice President
Nick, it's Peter Schultz. So the assumption is that the 3PL that we've been working with for some time, as you know, for the government contract, that gets released by the government sometime in the near future and the lease-up remains in our third quarter guidance. I'm not prepared to tell you that we have somebody else today behind that. What I would say is, we continue to market the building and we continue to see prospects. We had a fresh tour this week in both buildings, but we'll see how it goes. The government wants to get this done and it's taken an awfully long time as everybody on this call knows from our prior calls. So hopefully, we'll have some news to report on that sometime soon.
Peter Baccile, President and Chief Executive Officer
Our assumption of a third-quarter lease-up reflects our expectation and the probability that our tenant wins this contract.
Nicholas Yulico, Analyst
Okay, thank you. Appreciate that. And then just going back to Southern California. I know there's already been some questions on this. But if you look at the occupancy at quarter end, in the SOP. I mean it was down 100 basis points or so versus the average number. Can you just talk about what drove that in particular and how we should think about maybe trending occupancy for the market for the rest of the year?
Chris Schneider, Senior Vice President of Operations
Yeah. Nick, this is Chris. George had mentioned that we had one space that was available in Empire. That was a 225 square foot move-out. The rent is very significantly below market rent. So we have an opportunity to release it at a much higher end. So that's really what is driving that occupancy drop.
Nicholas Yulico, Analyst
Okay, got it. And one last question about the land inventory. The number listed on the NAV page is labeled as a fair value number. Can you provide some insight into how you might have adjusted the land values? We've heard about some corrections in land values in the market, and while you still have a strong basis in land, how should we evaluate the fair value of the land today?
Unidentified Company Representative, Unidentified Company Representative
Sure. This is Giorgio. We review the schedule on a quarterly basis and update our assessment of fair market value accordingly. Between the first and second quarters, there has been a significant change. In North Palm Springs, for instance, we made an acquisition that we believe is already proving beneficial for us due to its off-market nature and the assemblage involved. Over time, we have made adjustments, particularly regarding entitlements. Typically, when we acquire land in Southern California, it is unentitled. However, as we successfully navigate the entitlement process—something we have achieved with 100% success across all our SoCal land acquisitions—we have updated our evaluations. We conduct this assessment of fair market value every quarter.
Nicholas Yulico, Analyst
And is there just any rough percentage you're able to share about how much you've adjusted your land values down versus a peak value?
Unidentified Company Representative, Unidentified Company Representative
What we've actually done is not adjusted the values upward until we complete the entitlement process. It's more about aligning with the market.
Nicholas Yulico, Analyst
Okay, thanks.
Operator, Operator
Our next question comes from Anthony Powell from Barclays. Please go ahead.
Anthony Powell, Analyst
Hi, good morning. One follow-up on Old Post Road. I guess, how much FFO or occupancy is in the guidance, assuming that the contract is done in the third quarter?
Scott Musil, Chief Financial Officer
Sure. This is Scott. It's about $0.01 per share in FFO related to that lease-up and the occupancy impact, this is the impact on our quarterly weighted average occupancy is about 50 basis points.
Anthony Powell, Analyst
Okay, thanks. And maybe one on market rent growth. I think in prior quarters, there's a lot of optimism about just Southern California and coastal markets doing very well. And recent calls I've heard just increasing strength in more interior markets. So, maybe you could talk about coastal versus non-coastal rent growth trends seen recently?
Peter Baccile, President and Chief Executive Officer
Peter, do you want to talk about what you're seeing? And then Jojo, you talk about the SoCal?
Peter Schultz, Executive Vice President
Sure. In general, the best markets are Southern Florida and New Jersey, where rents continue to really grow. As we mentioned in the script, we just leased or announced the lease-up of two more buildings in South Florida that will occupy in the third quarter and the rent growth there has substantially outpaced our pro forma. Jojo?
Jojo Yap, Chief Investment Officer
Yes. So, if you look at the outlook, we basically in the Southwest and Jersey market and go West. If you look at Dallas and Phoenix, for example, due to increase in the consumption zone due to the increase in migration of population and businesses, they really experience a good amount of rent growth, and we foresee to continue to experience that. In fact, Dallas and Phoenix have been big contributors, along with South Florida, to our quarterly cash rent growth. When you move on to the West, in the West, as you all know, in SoCal, primarily LAIE, rents have increased about 100% over the last two years. And over the three years, they've increased anywhere from 125% to 150% over three years. So, significant, significant rent growth. Every portfolio owner and developer has enjoyed that and that's the reason why we've been able to continue to develop on higher yields. So going forward, we think rent growth will be in the 5% to high single digits in SoCal due to just a little bit of companies taking a breather. Again, once a lot of owners have achieved significant returns and yields on their investments. It is also due to the fact there's a little bit of reduced core traffic, although I mentioned to you earlier that the June number is closer to the June 2022 number. So, maybe that's a little bit of a turnaround. So that's what we're looking at.
Anthony Powell, Analyst
Thank you.
Operator, Operator
The next question comes from Caitlin Burrows from Goldman Sachs. Please go ahead.
Caitlin Burrows, Analyst
Hi, good morning. Maybe going back to development lease-up, it sounds like you're still generally assuming 12-month lease-up timeframes for the development projects. So, I was just wondering what it could take for that assumption to change, recognizing that right now, you still seem to feel good about 12 months in general?
Peter Baccile, President and Chief Executive Officer
I suppose experience of not being long enough to change our view. I think right now, we think that we're in a period of adjustment as we digest. If you look at net absorption over the last several years, it was enormous in 2021 and 2022. It actually started in the fourth quarter of 2020. And that fueled a lot more construction, a lot more capital coming into the business. So you have this way above-trend construction pipeline. And now, as we've said earlier, starts are down 40%. I think the market will take a bit of time to digest that larger development pipeline. But at the same time, as we get into the second half of next year, we think there's going to be a shortage of space. So, that's really what we're dealing with right now, and we look at our assumption for downtime, and we think that given that picture or that scenario, 12 months is still the right number.
Caitlin Burrows, Analyst
Got it. Thanks for that commentary. And then maybe also just subleasing as a topic that's been coming up some, I think not because it's significant, but just because it's off a low base. So just wondering if you could comment on, if you're seeing subleasing activity happen? If so, where and at what point it could potentially be a concern or not?
Peter Schultz, Executive Vice President
Yeah, Caitlin, it's Peter Schultz. So you're right, sublet space is up a little bit, but I would probably put it in two different buckets. There are a handful or some sublet spaces, portions of buildings that occupiers are trying to sublet or tenants that are trying to limit a sublet term to only a year or two. So we don't really consider that legitimate sublet space. The other bucket is spaces that are on the market for sublet. In general, we've seen those get absorbed pretty quickly in the higher-barrier markets. Jojo, anything you want to add?
Jojo Yap, Chief Investment Officer
No, that's good, Peter. The only thing I'd like to add, there are some sublease spaces that are actually the seat taken back because now their plans have changed, and they figured out that they actually need it long term. A number of these large subleases they've actually wanted to do only a couple of years of the term, and that's actually not very favorable for the new tenant that's coming in because a lot of tenants don't want to move in and be forced to move out in the short-term.
Caitlin Burrows, Analyst
Yeah. No, that makes sense. Thank you.
Operator, Operator
The next question comes from Todd Thomas from KeyBanc Capital Markets. Please go ahead.
Todd Thomas, Analyst
Hi. Thanks. Good morning. First question in terms of occupancy, just stepping back a little bit more broadly, you mentioned the decrease in Baltimore in the quarter and discussed Southern California. Can you provide some thoughts around whether you anticipate occupancy stabilizing by year-end or in early 2024, or whether you see potential for occupancy to continue normalizing as you move forward throughout 2024 as the 400 million square feet delivered in the pipeline that you discussed?
Chris Schneider, Senior Vice President of Operations
Yeah, this is Chris. The decline in occupancy is primarily due to the new developments being introduced. When we examine our same-store portfolio, it remains very stable. We anticipate the average occupancy for the entire year to be around 98%, indicating that the existing portfolio continues to perform well.
Todd Thomas, Analyst
Okay. And then just, I guess, a follow-up on Baltimore and Old Post Road maybe a point of clarification around something that you said earlier. The recent Baltimore vacancy that occurred this quarter, that's adjacent to the 644,000 square foot facility. Does that vacancy at all impact your efforts or the outcome potentially at the Old Post Road facility? And would the government tenant at all have interest or in taking the additional square footage that's available now?
Peter Schultz, Executive Vice President
No. The new vacancy doesn't impact or influence the outcome at the larger building. We want to get the deal done with the government contractor at 500. Certainly, they could have interest as most tenants have interest in expansion capabilities. But as I said earlier in response to another question, the level of activity for full or partial buildings in 350 is pretty good. So we're optimistic that we'll make some headway there. And as Peter said earlier, our plan is based on the government contract being finalized and awarded for the larger building yet in the third quarter.
Todd Thomas, Analyst
Okay. And just last one for me. The dispositions, you maintained that $50 million to $100 million guidance, and you've sold one asset so far for $15 million this year. Can you just talk about the demand for asset sales and whether there's anything progressing at this point that's in the pipeline that you're seeing?
Peter Baccile, President and Chief Executive Officer
Sure, just to correct, it's $50 million to $150 million, not $50 million to $100 million of the guidance. But there is a market and the pricing isn't bad. And we've always intended our closings to be back-end loaded. So that's why you haven't seen much volume. And we maintain the guidance range, and that's kind of reflective of our expectations of how the market is going to end up.
Operator, Operator
The next question comes from Michael Mueller from JPMorgan. Please go ahead.
Michael Mueller, Analyst
Yeah. Hi, I guess if you look at your in-process development, all but two of the projects are in California, or if you look at what's been delivered in 2023 to date to 2022, I think there was just one California development, now California is a big state. But do you see the geographic mix of the starts over the next couple of years being as concentrated in California as what the current pipeline is?
Peter Baccile, President and Chief Executive Officer
The projects that we are evaluating for future starts are almost solely on the coasts, which would include California, obviously, South Florida, New Jersey, PA, et cetera. So that's where the focus is going to be. Does that answer your question?
Michael Mueller, Analyst
Yeah. And I think that is it. Thanks.
Operator, Operator
The next question comes from Jessica Zheng from Green Street. Please go ahead.
Jessica Zheng, Analyst
Good morning. Just wondering for some of your large box developments where additional tenant demand is slowing down currently. Do you have any optionality to divide those up into smaller suite sizes? And do think that could help with lease-up time at all?
Peter Baccile, President and Chief Executive Officer
Yeah. Our projects are designed with that in mind, so that we can demise and still provide all the functionality that the tenants require. So we're in a pretty good position with respect to that.
Jessica Zheng, Analyst
And have you tried that option for some of the large boxes where you changed your lease-up assumption?
Peter Baccile, President and Chief Executive Officer
As Peter mentioned, in Denver, we have a 588,000 square foot building that was designed to accommodate both single and multi-tenant use. We implement certain strategies to ensure it can be multi-tenant, but we are simply maintaining our flexibility and creating a building that functions well in either layout.
Peter Schultz, Executive Vice President
Jessica, it's Peter Schultz. The other thing I'd add to that is when we deliver buildings, they're move-in ready. So they already have back offices, we've permitted demising walls and so forth. So to Peter's point, we're already way ahead of that curve. Nothing else that we would do differently because that is part of the strategy.
Jojo Yap, Chief Investment Officer
And just to add on. Our design of multi-tenant not only is on the large buildings, but in the midsized to smaller buildings. Case in point: first deal in Seattle that's 129,000 footer, but we designed that building to basically be accessed on both ends as a building with docks available to the length of the building. Therefore, we were able to successfully lease at completion half of the building at 64,000 square feet.
Jessica Zheng, Analyst
Okay, great. Thank you. And then just a second question. Curious for your Havana site. So if they do go out of business, per your lease agreement with them? Are you going to be getting back all the land at once, or is there going to be a separate process?
Peter Baccile, President and Chief Executive Officer
If they default on those leases, there would likely be a legal process that we would go through. I can't predict how long that would take. But the outcome eventually would be that we have the ability to develop or sell, and some of the sites we would probably sell because there's a higher and better use now after all these years. We would have the right to develop or sell those sites after the legal process that we don't have to go through to take them out, essentially, they kick them out.
Jessica Zheng, Analyst
Okay, great. Thanks for your comments.
Operator, Operator
The next question comes from Vikram Malhotra from Mizuho. Please go ahead.
Vikram Malhotra, Analyst
Thank you for the question. Following up on the development topic, can you discuss how you might adjust the properties if demand slows? Specifically, if lease-up takes longer than the 12 months you've anticipated, what strategies would you consider for gaining market share? Would you focus on lowering rents, offering additional incentives, or take another approach to enhance your position in a potentially slowing market?
Peter Baccile, President and Chief Executive Officer
Well, historically, when markets soften, concessions go up, whether it's free rent or additional above-standard TIs or lower rents. We're not anywhere near that. I mean that's free rent today continues to be one-third or half a month per year of the lease term. It's standard TI packages today. We're still getting higher rents than had pre-existed previously. So you've got a long way to go before you get to what you're talking about.
Vikram Malhotra, Analyst
Okay, makes sense. And then just on SoCal, you talked about market rent growth now being mid single digits to high single digits. One of your peers articulated there's actually push back on the rent level itself, just like you highlighted, rents up 150% over three years. Are you actually seeing incentives also go up specifically in SoCal as landlords try to attract new tenants?
Peter Baccile, President and Chief Executive Officer
Jojo, do you want to cover that?
Jojo Yap, Chief Investment Officer
We are not experiencing any increase in incentives. As Peter mentioned, free rent over the term of the year has been fairly consistent, and tenant improvement allowances remain standard per square foot. Regarding pushback, some tenants are seeking a bit of relief on rent due to the 100% appreciation. This has led to a slight decrease in rental absorption in the US, around 1% to 2%. However, in the Inland Empire East, rents actually increased, which was evident from the Q2 situation. This trend appears to be more short-term and may only last a quarter or two.
Vikram Malhotra, Analyst
Got it. And then just one last question, one of your peers outlined that over the next several years, three to five years, even if there's no rent growth and demand is limited, there's still a scenario where same-store NOI growth could average around 7 percent. If you look out over three years, not focusing on next year's guidance, but on a longer-term basis, three to five years, assuming market conditions remain as they are today, where do you see the structural same-store NOI growth of your platform?
Peter Baccile, President and Chief Executive Officer
There are a couple of important points to mention. First, we all have considerable potential for growth as our leases continue to renew, and we've discussed the dynamics in several markets today, which are quite varied. Secondly, annual rent increases have risen significantly. Our portfolio's average rent escalation is expected to exceed 3% next year. Both of these factors will lead to substantial growth, even if rents remain flat for the next three to five years. While we don't have a specific number to share at this moment, we remain very optimistic about our future growth opportunities, even in a scenario where rents do not increase.
Vikram Malhotra, Analyst
Fair enough. Thanks.
Operator, Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Peter Baccile for any closing remarks.
Peter Baccile, President and Chief Executive Officer
Thank you, operator, and thanks to everyone for participating in our call today. If you have any follow-up questions, please reach out to Art, Scott or me. I wish everyone a happy, healthy and productive summer.
Operator, Operator
This concludes the conference. Thank you for attending today's presentation. You may now disconnect.