Industrial Logistics Properties Trust Q1 FY2021 Earnings Call

Good morning. And welcome to Industrial Logistics Properties Trust First Quarter 2021 Financial Results Conference call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Kevin Barry, Manager of Investor Relations. Please go ahead.

Good morning, everyone and thank you for joining us today. With me on the call are ILPT's Chief Executive Officer, John Murray; Chief Financial Officer, Rick Seidel; and Chief Operating Officer, Yael Duffy. In just a moment they will provide details about our business and our performance for the first quarter of 2021 followed by a question-and-answer session with sell-side analysts.

Thank you, Kevin. Good morning, everyone, and thank you for joining us. I'll provide a quick overview of first quarter performance and then Yael and Rick will run through the details, our portfolio statistics, leasing activity and financial results. We began 2021 with earnings growth, solid leasing activity and a commitment to acquire high-quality distribution property. First quarter normalized FFO per share increased to $0.47 from $0.46 in the prior year quarter or 2.2% growth. We executed new and renewal leases for 620,000 square feet achieving 16% growth. And portfolio occupancy remained healthy at 98.6%. Also, earlier this month, our board decided to maintain our regular quarterly distribution to shareholders at $0.33 per share. Our acquisition strategies are to invest in modern high-quality diversified assets with stable cash flows and strong rental growth margins. We are primarily focused on well-located properties in the top 30 industrial markets as well as properties that offer expansion opportunities with access to develop land.

Thanks John, and good morning everyone. I'll begin with an overview of ILPT's portfolio and then summarize our leasing activity for the first quarter. As of March 31, 2021, ILPT's portfolio consisted of 289 warehouse and distribution properties in 31 states totaling approximately 35 million square feet that were 98.6% leased. Our mainland portfolio includes 63 properties and 30 states totaling 18 million square feet. Mainland occupancy improved to a 100% at quarter end. The balance of the portfolio is comprised of 17 million square feet of industrial land and properties in Hawaii that were 97% leased. ILPT's top 20 tenants represent 46% of total annualized rental revenue with Amazon, FedEx and Restoration Hardware representing approximately 10%, 5% and 3% of total annualized rental revenues respectively. Investment grade rated tenants or subsidiaries of investment grade rated parent entities make up more than half of our mainland revenues. Looking at the total portfolio, more than 70% of revenue comes from those investment grade rated tenants and subsidiaries from our secured Hawaii land leases. The total portfolio has a weighted average remaining lease term of approximately nine years. During the first quarter, we achieved strong leasing results which reflect our proactive approach of engaging in early renewal discussions, 18 to 24 months ahead of lease expiration. First quarter leasing activity included 23 new and renewal leases for 620,000 square feet, of which 18% were for leases scheduled to expire in 2022 and 2023.

Thanks, Yael. And good morning, everyone. Our rental income and substantially all of our expenses decreased year-over-year following the deconsolidation of the 12 properties in our joint venture during the fourth quarter of 2020. Total portfolio same property cash basis NOI for the first quarter decreased less than 1% year-over-year excluding the $507,000 of lease termination income we recognized during the quarter that Yael discussed a moment ago. From a property side perspective, we reported modest growth in our mainland properties as occupancy returned to a 100% and a 2.2% decrease in same property cash NOI in Hawaii due to slightly lower occupancy year-over-year combined with one lease we amended in order to give the tenants additional free rent as they were delayed getting the permits required to improve the land due to COVID-19.

Our first question is from Bryan Maher with B. Riley Securities. Please go ahead.

Good morning, everyone. Just a couple of questions from me. Well, when you look at the EBITDA and FFO generated from the JV in the first quarter, would you consider that to be a decent run rate for our modeling going forward?

Thanks, Bryan. That's a good question. Yes, I mean this is the fourth quarter of JV activity and I don’t think there is anything particularly unique or interesting in the JV this quarter. So I think that that’s fair from an FFO and EBITDA perspective.

Great. And Rick, while I got you, do you guys have an outlook for CapEx for 2021?

Well, we typically don’t provide guidance but I would tell you that for Q2 we expect it to be a tick higher than Q1. Just from a seasonal perspective, there are some parking lot improvements, some concrete works and rooftop units that we'll likely replace. So Q2 is probably in the $2 million to $3 million range; I would expect it on the higher end.

Okay. And maybe for Yael. How do all the discussions going? And first of all, congratulations on getting ahead of the lease expirations and renewals. But how are the discussions going with tenants particularly in Hawaii as you try and drive rate higher particularly in light of what they've experienced as a market in 2020?

That's a good question. We've actually not gotten any pushback on the rents because I think the tenants know that this is market, and there really is such a scarcity of available land that if they want to continue operating on these parcels, they need to pay the market rent. So I think with some of the renewals the tenants might be asking for maybe a month or two of free rent which we might not have previously granted, but besides the concessions, they have been minimal and the tenants are agreeing to the increased rents.

Okay. And maybe for John or Yael, when you guys look at acquisitions, what's going on with construction in the new industrial assets with kind of the crescendo of e-commerce in industrial uplift in 2020? Not that it's going to go down, but we certainly saw much more demand in 2020. What are you guys seeing with cap rates? I think you mentioned maybe the low 5% and I was a little surprised with the 4.6% cap rate on the Columbus property, my guess is that you probably got a little bit lower of the cap rate because of the land that came with it. But how are you thinking about the market and putting in so many bids and coming away with just one asset for $30 million? Can you shed a little light on that?

Sure. Thanks, Bryan. There continues to be development of new properties, but generally the absorption has been healthy as well. And it’s a very desirable real estate form today not just in the typical industrial players chasing transactions; net lease rates that traditional investors in industrial properties or high net worth individuals are investing. All the traditional players are still after transaction. So we've seen a number of transactions where the properties have traded below a four cap, and there’s no point in investing in properties where you're going to be running in place or going backwards. We had a number of transactions this quarter where we’ve bid in the first round and then just not chased the transaction into the second round even though we were invited by the brokers because the price expectations were just too aggressive. The property that we did agree to buy in Columbus was attractive to us because it’s a solid credit for the tenant. Its development potential, the market map of growth in that southeast section of Columbus has been in excess of 5% for all these five years now. And so, it's got great access to one of the most active cargo airports in the country and great access to Norfolk Southern intermodal center that can take double stacked trailers from the Port of Norfolk in less than a day.

Okay, thanks. That's all from me.

The next question is from Jamie Feldman with Bank of America Merrill Lynch. Please go ahead.

Thank you. Sticking with CapEx, I was just hoping you could provide a little more color on the elevated leasing costs in the quarter. And then also, can you just talk about what your cash leasing spreads are? I'm just trying to better understand like deal economics, I think you provide GAAP only.

Hi, Jamie. So the CapEx this quarter we had done as you know typically the leasing on the mainland includes tenant improvements and leasing commissions, which we usually don’t have in Hawaii. So we did that one deal in Minnesota where we back sold the expiring lease. And so that deal had a $1.50 per square foot per lease year. So that was kind of the driver of the elevated $0.45 per square foot this quarter. And then, as you've said, we usually just disclose really our spreads based on GAAP I guess for your modeling purposes you could model high single digits for cash price would be appropriate.

That's what they were in the first quarter or that's what you're thinking for the rest of the year?

That's what they were. That's what they were for the first quarter. Most of our leases that we're doing on the mainland have between 2.0% and 2.5% rent growth and in Hawaii 2.5% to 3.0%. That's what we've typically seen.

Okay, all right, that's helpful. And then, I guess just it's kind of following up to a prior question but just thinking about how you get deals done, I mean are you willing to get a little more creative here in terms of whether it's new markets or different property types or just the kind of to keep growing the business and growing the platform? I mean, any thoughts about potential style drift to find opportunities given cap rates are so low and competition so high for the core assets you're looking at?

That's a good question, Jamie. We talk about that and consider that topic a lot internally. And we have been willing to look at properties that maybe aren’t in top 25 markets, but because it's a good newly built property or because the rent growth is strong in those markets. We have been looking a little bit outside of our box. We could go into tertiary markets and Class B and C buildings, but at the end of the day getting a high yield today on lesser quality real estate isn’t a good long-term strategy. So we are looking at where we may have excess land where we could develop properties not just within ILPT's existing relationships but even across beyond more platforms whether maybe excess land. So you may see over time a little bit more development from us than has been seen historically. But our focus is going to remain on quality real estate first, as we look at what different ways to achieve higher yields. But it is something that we are looking at trying to figure out new ways to subpar cap rates as they are tough to make work.

Okay, that's helpful. And so just to confirm, the development you're talking about, is that warehouse development or could that be other property types?

Yes, industrial warehouse properties.

It's all industrial warehouse. Hey, what about other stuff that's tangential, I mean I saw this morning I think TPG is putting up its port business, kind of port operating business, I know like RMR got into the truck side business years ago. And you guys think about other types of platforms that could still be kind of industrial focused under this entity?

I'd say at the present time we're not considering the type of modification to our business plan.

Okay.

I say never. You're right, we have diversified over time in the RMR group and that's likely to continue but within ILPT I don’t see anything on the horizon.

Okay, all right, thank you.

Next question is from Tom Catherwood with BTIG. Please go ahead.

Excellent. Thank you so much for taking the questions and good morning. John, a question for you on the joint venture portfolio. Obviously, it's been up and running for a couple of months here. But you had mentioned during past calls that there is the opportunity to put some assets into that joint venture going forward. How do you think of that as a source of capital as you're kind of looking at more deals or even buying within that portfolio especially at the lower cap rates and being able to kind of juicy returns with some fees there?

Well, we do think that the joint venture is a useful potential source of equity capital for our growth. From time to time we do evaluate properties that are in the portfolio that might be a good fit for our joint venture partners. We are in regular discussions with the joint venture partners about our existing properties as well as potential acquisitions. Although our share price has improved, we're still quite a ways from where it makes sense to issue common equity. So it's still much more attractively priced equity to use from the joint venture. For equity capital, we can get that essentially at net asset value. In the near term, I would expect that we would consider some sales contributions of properties that we currently own to the joint venture. We could also close and acquire properties and close into the joint venture if we do enough homework upfront. So I would not rule that out, although we're not working on anything like that currently.

That's right. I appreciate that, John. And then a question on assets in the joint venture portfolio. It looks like you extended a lease from maybe 2024 expiration out to 2030. Didn’t see any leasing mentioned there. Was that just kind of picking up the Amazon renewal in Indiana from the prior quarter or is that something new?

Yes, we did a 10-year renewal with Proctor & Gamble in Ohio, which extended the lease. Since it's deconsolidated, we don’t discuss the leasing in the joint venture.

Got it, understood. Thank you for that, Yael. And kind of one follow-up on kind of leasing. I know last quarter you mentioned that of the two leases to expire in 2021, you were in active negotiations with the tenants. Any kind of updated thoughts on that or any progress on that front?

Yes, both of them are actually in LoI status right now. So we're working through the lease amendments.

Excellent, that's it from me. Thanks, everyone.

Thank you.

The next question is from Jason Idoine with RBC Capital Markets. Please go ahead.

Hey, good morning guys. I was wondering if you could touch on maybe where some of those potential development opportunities are located and how those opportunities will compare with kind of the core markets that you're targeting with acquisitions?

We have excess land on properties in a variety of different markets. There's excess land on the property that we're presently pursuing in Columbus. The property we acquired in Kansas City late last year has access to develop land. We have other properties around the country that do as well. And we're currently looking at a parcel that had formerly been a travel center in the Dallas industrial market for possible development as well. So they are all over.

Got it, and I was just going to follow up. Do you have any idea of what type of yield would be reasonable to expect from rental in this market?

I think it's market by market, and then it depends on the size of the building that can be developed or in some cases that may be expanding an existing building. So I'd be reluctant to give you a specific rate other than to say would be better than buying.

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

Thank you very much for joining us today.

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