Industrial Logistics Properties Trust Q4 FY2022 Earnings Call

Good morning, and welcome to the Industrial Logistics Properties Trust Fourth Quarter 2022 Financial Results Conference Call. All participants will be in listen-only mode. Please note this event is being recorded. I would now like to turn the conference over to Kevin Barry, Director of Investor Relations. Please go ahead, sir.

Good morning, everyone, and thank you for joining us today. With me on the call are ILPT's President and Chief Operating Officer, Yael Duffy, and Chief Financial Officer and Treasurer, Brian Donley. In just a moment, they will provide details about our business and our performance for the fourth quarter of 2022, followed by a question-and-answer session with sell-side analysts. First, I would like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company. Also note that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on ILPT's beliefs and expectations as of today, Wednesday, February 15th, 2023, and actual results may differ materially from those that we project. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call. Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission, or SEC, which can be accessed from our website, ilptreit.com, or the SEC's website. Investors are cautioned not to place undue reliance upon any forward-looking statements. In addition, we will be discussing non-GAAP numbers during this call, including normalized funds from operations or normalized FFO, adjusted EBITDA, and cash-based net operating income or cash basis NOI. A reconciliation of these non-GAAP figures to net income and the components to calculate cash available for distribution are available in our supplemental operating and financial data package, which also can also be found on our website. I will now turn the call over to Yael.

Thank you, Kevin, and good morning. I will begin with a review of ILPT's portfolio and operating performance and then turn the call over to Brian to provide an update on our financial results. ILPT's consolidated portfolio includes 413 warehouse and distribution properties in 39 states, totaling 60 million square feet with a weighted average remaining lease term of approximately nine years. Occupancy at year-end was 99.1%. FedEx, Amazon, and Home Depot, represent approximately 40% of our annualized rental revenues, and 78% of our revenues come from investment-grade-rated tenants or their subsidiaries or from our secure Hawaii land leases. We finished the year with strong demand for our high-quality portfolio, consistent with the trends we saw throughout 2022. For the full year, we achieved record annual leasing activity of 7.8 million square feet at weighted average rental rates that were 47.3% higher than prior rental rates for the same space. The impact of this activity is an increase of $17.1 million in annualized rental revenue, of which more than two-thirds will take effect in 2023 or 2024. These results showcase our ability to generate organic cash flow while maintaining portfolio stability. During the fourth quarter, we entered 17 new and renewal leases and one rent reset for a total of 1.4 million square feet at a weighted average lease term of eight years. This activity resulted in GAAP and cash leasing spreads of 18.7% and 6.7% respectively. Renewals on the Mainland drove most of our leasing activity. Our leasing spreads include a 338,000 square foot renewal in a tertiary market in Iowa, where we were only able to achieve a 4.5% roll-up in rent. Excluding this renewal, GAAP and cash leasing spreads were 25.7% and 14.1% respectively. Looking ahead, approximately 12 million square feet or 18% of ILPT's portfolio is scheduled to roll by the end of 2025, primarily driven by our Mainland properties. We are currently tracking 28 deals in our pipeline for 2.8 million square feet. Once executed, we expect these leases will yield average roll-ups in rent of 20% on the Mainland and 30% in Hawaii, further illustrating the strength of our portfolio. Lastly, as we have communicated in the past, we are focused on improving ILPT's leverage. However, given the ongoing uncertainty in the capital markets, our timeline for addressing these priorities is unknown. With no near-term debt maturities and a cash-flowing portfolio, ILPT will continue to be patient as we evaluate opportunities. I will now turn the call over to Brian.

Thank you, Yael. Good morning, everyone. Starting with our consolidated financial results for the fourth quarter of 2022, normalized funds from operations were $5.4 million or $0.08 per share, a decline of $26.3 million compared to the prior year quarter. The major drivers impacting normalized FFO over the prior year quarter were higher interest expense, partially offset by a $40 million increase in NOI. Adjusted EBITDA increased 88% year-over-year to $79.2 million. These changes were a result of our acquisition of Monmouth and the related financing activities earlier in 2022. Total portfolio same-property cash basis NOI for the fourth quarter increased 30 basis points year-over-year. The prior year included a reduction to reserves for uncollectible rents of approximately $0.5 million, negatively impacting comparisons. Excluding these charges, consolidated same-property cash-based NOI increased 1.3%, primarily due to our leasing activity and contractual rent steps. Interest expense increased $62.6 million over the prior year quarter. The interest rate cap we have for our $1.2 billion floating rate CMBS loan exceeded the strike rate for the entire fourth quarter, and a cap to the $1.4 billion floating rate loan in our consolidated joint venture crossed the strike rate in mid-November. Assuming short-term interest rates remain at current levels or continue to rise, our current estimated quarterly interest expense run rate will remain fixed at approximately $72 million. This consists of $59 million of cash interest expense and $13 million of non-cash amortization of financing costs, including the interest rate caps. Turning to our balance sheet, including extension options ILPT's weighted average debt maturity is six years with no maturities until 2027. As of December 31, our total debt either carried a fixed rate or was fixed through interest rate caps with a total weighted average interest rate of 5.4%. We currently have $48 million of cash on hand, excluding the cash held by our consolidated joint venture and amounts escrowed under our debt agreements. Capital expenditures for the fourth quarter were $7.9 million, including $4.4 million of tenant improvements and leasing costs, $2.2 million of building improvements, and $1.3 million of development costs. In closing, our operations remain strong with an exceptional tenant roster, near full occupancy, and rising rents across our portfolio, and we expect that ILPT will continue to benefit from industry demand for high-quality industrial real estate. Before we turn the call over to Q&A, I'd like to point out that we've included additional disclosures in our supplemental operating and financial data package this quarter that provides additional details and insight into the different components of our portfolio, as well as our joint ventures that we believe may be helpful to stakeholders. That concludes our prepared remarks. Operator, please open the line for questions.

Thank you. We will now begin the question-and-answer session. The first question comes from Bryan Maher with B. Riley FBR. Please go ahead.

Yes. Good morning, Yael and Brian. A couple of questions for me; when it comes to the re-engagement of a dialogue, let's say, with potential JV partners for the Monmouth JV and asset sales. I know, Yael you touched upon this briefly in your opening comments, but do you have any thoughts on when that might heat up? Are there any discussions currently? How should we be thinking about that?

Good morning Bryan. For the property sales, I think we really haven't seen much in the form of the transaction market. It's been pretty quiet as you would expect with the rising interest rates and the availability for financing. So, I think we're really looking to see more data to turn to, to kind of see what the cap rates look like. So, I think that's the answer to that. In terms of discussions with potential joint venture partners for the Mountain, we're not having any conversations currently. Brian alluded to in his prepared remarks that we've put in additional data in our supplemental. If you look to that, you'll see that we're currently not cash flowing in that joint venture, so it would be very hard for us to find the second joint venture partner until interest rates decrease.

Okay. Thanks. And then maybe for Brian, we noticed that leverage went from the third quarter from 13.7. I think it went down to like 13.1. Assuming you don't have asset sales or deconsolidate the Mountain JV, is that a good run rate, maybe give or take a basis point or two?

Yes, Bryan, great question, and good morning. I think as time passes and we continue to see the effect of rent roll-ups, it will come down marginally, but the high 12 low 13 range. That's sort of where we expect things to be throughout 2023.

And you touched upon the leasing activity for 2023. It seemed like a pretty solid 2022 and a very strong full year, and the fourth quarter was pretty decent. But where are you seeing any potential strengths or weaknesses over the next two years in lease renewals, or should we just continue to expect that this portfolio runs at roughly 99% occupancy? And are there any known vacancies?

So, I think this year was an exceptional year for us. We had a lot of leasing in Hawaii. So, I think as we go into 2023 and 2024, a lot of the leasing will be focused on the Mainland. And so I'm not sure we're going to see a 47% roll-up for the year in 2023. But I think a 20% roll-up is a good estimate. In terms of known vacancies, we have a couple that we know about in Hawaii. Generally, we've been able to re-lease those within a quarter or two. So, there's no concerns there. And I think the 99% to 98% range is a good estimate for where we think occupancy will turn out.

Okay. And then just last for me, maybe for Brian on the extensions for the two MNR-related debt financings out to 2027 from 2024. Is there anything in the covenants or anything that you could foresee that would prohibit you from exercising any of those extensions?

No, the only requirement is that we replace or add a new interest rate cap upon expiration of the current maturity. So in 2024, we'll have to get a new interest rate cap for the extension period for each of those debt instruments, which we don't foresee a problem.

Okay, great. Thank you. That’s all for me.

Thank you.

Our next question comes from Mitch Germain with JMP Securities. Please go ahead.

Good morning. When does the same-store pool change? Will it be next quarter, or do we wait until the new calendar year?

Same-store meaning to include the Monmouth acquisition, that would be in Q2.

Okay. Okay. And just talking a little bit about that performance in the same-store pool, occupancy is sort of flat, rents higher, not a lot of growth. Is there anything specific that you guys want to point out there?

We reported 7.8 million square feet of leasing this year, but 66% of it won’t take effect until 2023 or 2024. Earlier this year, we mentioned two significant leases with Home Depot that will result in increased rent. However, we won’t see the positive impact on cash net operating income until 2024. So, some of this activity hasn't reflected in 2022 yet. As we start the year, we expect to see some growth.

For my final question, when considering potential asset sales, is everything still up for discussion, or are we limited to the original pool of Monmouth assets that were previously considered, or has that been abandoned altogether with a more opportunistic approach based on market conditions?

We're really looking at everything within our portfolio to see what opportunities we have. So we're not by any means married to the 30 properties we originally brought out to the market. I think if it makes sense, we would consider a potential disposition of any property in our portfolio.

Got you. Thank you.

Thank you.

Our next question comes from Michael Carroll with RBC Capital Markets. Please go ahead.

Yes. Thanks. Did you indicate that you're currently not marketing any portfolios for sale right now?

Correct.

Now at what point in time do you start thinking about marketing properties for sale? I mean, do you need to see interest rates move lower? Is there a point in time when you're ready to bring something to the market?

I don’t think we have a specific set of criteria. What we really need to see is more transaction volume. We are currently in discussions with brokers from various major broker groups, and there is a general consensus that it’s still too early to bring something to market in 2023. As we move through the year, I hope there will be an increase in transaction activity, leading to closed transactions that will give us confidence to return to the market. We also want to avoid repeating the same process for the properties we’ve already started with.

Okay. And then when you're thinking about some bigger sales, I mean, is it fair to assume that you're more looking at outright asset sales that could generate better valuations versus the traditional JVs that you have been doing?

I think we're open to either of those options. Again, I think whatever brings us the highest proceeds, we'd be willing to evaluate.

Are you willing to sell some Hawaiian assets at this point?

We know that that's a lever we can pull. So and there's incredible value in Hawaii. So we would consider it.

Okay. Great. Thank you.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Yael Duffy for any closing remarks. Please go ahead.

Okay. Thanks everyone for joining us today. We look forward to speaking with you again soon.

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