LXP Industrial Trust Q2 FY2020 Earnings Call

Good morning. And welcome to the Lexington Realty Trust Second Quarter 2020 Earnings Conference Call and Webcast. All participants will be in listen-only mode. Please note this event is being recorded. I would now like to turn the call over to Heather Gentry, Investor Relations. Please go ahead.

Thank you, operator. Welcome to Lexington Realty Trust's second quarter 2020 conference call and webcast. The earnings release was distributed this morning and both the release and quarterly supplemental are available on our website at www.lxp.com in the Investors section, and will be furnished to the SEC on a Form 8-K. Certain statements made during this conference call regarding future events and expected results may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Lexington believes that these statements are based on reasonable assumptions. However, certain factors and risks, including those included in today’s earnings press release and those described in reports that Lexington filed with the SEC from time to time, could cause Lexington’s actual results to differ materially from those expressed or implied by such statements. Except as required by law, Lexington does not undertake a duty to update any forward-looking statements. In the earnings press release and quarterly supplemental disclosure package, Lexington has reconciled all non-GAAP financial measures to the most directly comparable GAAP measure. Any references in these documents to adjusted company FFO refer to adjusted company funds from operations available to all equity holders and unit holders on a fully diluted basis. Operating performance measures of an individual investment are not intended to be viewed as presenting a numerical measure of Lexington’s historical or future financial performance, financial position or cash flows. On today’s call, Wil Eglin, Chairman and CEO; and Beth Boulerice, CFO; and Brendan Mullinix, Chief Investment Officer will provide a recent business update and commentary on second quarter results. Executive Vice Presidents; Lara Johnson and James Dudley will be available during the question-and-answer portion of our call. I will now turn the call over to Wil.

Thanks, Heather, and good morning, everyone. We had a strong second quarter and have performed very well despite the challenges created for many by COVID-19. Our focus remains on completing our transition to an industrial REIT, working to mitigate any potential impacts of the pandemic on our business, and taking advantage of external growth opportunities. The safety and health of our employees continues to be a top priority. And we have continued to successfully execute our business plan in a virtual working environment. Our portfolio operations have fared well with monthly rent collections very strong from the start of the pandemic. Second quarter cash base rent collections is over 99.5% and approximately 99.4% of July collections have been received to date. We leased over 3 million square feet during the quarter, raising industrial renewal cash base rents nearly 22%. Our overall portfolio leased was 97.3% at quarter end, up slightly compared to last quarter. We have continued to stay active on the acquisition front and act as a capital provider to our merchant builder partners during a time of market uncertainty. As a result, we were able to capitalize on a narrow window of favorable pricing during the quarter. In the second quarter, we closed on $164 million of new warehouse distribution purchases in select target markets of Savannah and Dallas among others at average GAAP and cash cap rates of 5.6% and 5.3%, respectively. These acquisitions brought the first half of the year volume to $360 million and increased our overall average GAAP and cash cap rates to 5.4% and 5%, respectively. More recently, cap rates for quality industrial assets have compressed and appear to be back to pre-pandemic pricing in most cases. That said, there continues to be ample opportunity on the investment front. And we are currently reviewing a considerable amount of existing and build-to-suit transactions in the marketplace with one property under contract for approximately $29 million. To support our growth initiatives during the quarter, we raised over $201 million through an equity offering and strategic use of our ATM program. Additionally, we disposed of approximately $45 million of assets. This capital was mainly used to fund acquisition activity with the remainder used to pay down most of our revolving credit facility, reducing leverage from 5.5x to 5.2x net debt to adjusted EBITDA. We expect to continue to access capital markets when appropriate while augmenting our investment initiatives with retained cash flow, disposition proceeds, and access to credit. Our disposition plan was somewhat impacted by COVID-19 over the past several months, primarily as a result of uncertainty in the debt markets, which has caused a slowdown in the transactions market. We are making good progress under the circumstances and have disposed of $141 million of consolidated properties year-to-date, which includes $67 million in July. These assets generated a combined annualized NOI of $5.4 million. Additionally, we have disposed of approximately $50 million in joint venture assets year-to-date. We remain optimistic that we will make meaningful progress through the remainder of the year. Our 2020 disposition plan continues to consider disposing of or marketing for sale up to $500 million of primarily office properties, but some closings are likely to push into 2021. The most significant sale would involve our Dow Chemical Office property in Lake Jackson, Texas. In addition to office sales, we expect to opportunistically harvest value in our industrial portfolio from time to time, similar to the two industrial assets we sold during and subsequent to the quarter in Oak Creek, Wisconsin and Moody, Alabama, and redeploy capital into more modern warehouse distribution product. Our second quarter activities improved our portfolio mix increasing our industrial exposure to almost 85% of our gross real estate assets. We continue to be well positioned in the current environment with our strong balance sheet, favorable liquidity position, robust investment pipeline, healthy weighted average lease term, and conservative payout ratio. While market factors could affect certain aspects of our 2020 initiatives, we have made exceptional progress on our long-term business plan and remain focused on completing our transition to an industrial REIT. As announced this morning, we are tightening our 2020 adjusted company FFO guidance to a range of $0.74 to $0.76 per common share, mainly due to the deleveraging of our balance sheet. This is subject to change depending on portfolio performance over the balance of the year. With that, I'll turn the call over to Brendan, who will provide detailed commentary on our acquisition activity.

Dallas Fort Worth: This is a port logistics market we have been adding to in recent months due to its high absorption rate and low market vacancy. Two of the properties were acquired as a portfolio comprised of a 356,000 square foot facility and an 89,000 square foot facility, each leased to a logistics company. The average lease term for the properties is approximately five years, and both are brand new Class A warehouses with attractive annual bumps of 3%. Separately, we purchased a newly completed 500,000 square foot facility leased to Unis, a third-party logistics provider for approximately seven years. In addition, we agreed to purchase a two-property portfolio of which one of the properties closed during the second quarter. This 248,000 square foot property is leased to units in the southeast submarket of Houston. While Houston has seen some market weakness recently, our property is in a park located just three and a half miles from the Bayport Container Terminal at Port Houston and is the right size for the market. This acquisition represents our second investment in the Bayport South Industrial Park. The second property, a 325,000 square foot facility leased to Mercury Paper in Winchester, Virginia is scheduled to close in the third quarter. Positioned along the I-81 bulk industrial corridor, the Winchester logistics market has experienced positive rental growth with large corporate tenants relocating there in recent years. We currently own two other distribution facilities within the park. Both the Houston and Winchester properties are brand new Class A facilities leased on average for 4.5 years. Our most recent purchase was a newly developed Class A 617,000 square foot facility leased to Amazon for 10 years. The property is in Ocala, Florida with frontage on I-75, offering easy access to Tampa and Orlando and supports our strategy of increasing our e-commerce exposure. Amazon now accounts for over 3% of our overall portfolio revenue. As Wil mentioned, we are actively reviewing a number of existing and build-to-suit opportunities and continue to work on spec development projects to add to our development pipeline. I'll turn the call over to Beth now to discuss financial results.

Thanks, Brendan. Adjusted company FFO for the quarter was approximately $51 million or $0.19 per diluted common share and in line with our expectations. We continue to maintain a very conservative adjusted company FFO payout ratio of 55.3%. Revenues for the second quarter were approximately $82 million, up 2% when compared to the same time period in 2019. This increase was after we offset rental revenues with $157,000 bad debt expense related to a tenant accounts receivable and the write-off of a deferred rent receivable. Property operating expenses were about $10 million during the quarter, of which approximately 81% were attributable to tenant reimbursement. General and administrative expenses were $7.6 million in the quarter, and our estimated total 2020 G&A is expected to be within a range of $30 million to $32 million. Year-over-year same-store occupancy was down 1.6%, although same-store NOI was down just 0.6%. As Wil mentioned, our consolidated cash-based rental collections have been strong throughout the pandemic. Specifically to the second quarter, we received 99.9% of April rent, 99.1% of May rent, and 99.6% of June rent. Additionally, as of today, we have received 99.4% of July rent. While our collections have remained solid with minimal impact from COVID-19, historical rent collection should not be considered an indication of expected future rent collections. Rent relief requests continue to be minimal, and currently, we are evaluating a request from one small retail tenant in our Philadelphia office building. To date, we have granted only two tenant rent relief requests in our consolidated portfolio, which were immaterial, and we obtained either an extension or favorable renewal terms. Turning to the balance sheet; our financial position remains strong, and we continue to have ample liquidity and borrowing capacity. At quarter end, we had approximately $84 million of cash, including restricted cash, with approximately $560 million available on our unsecured revolving credit facility. The capital raised during the quarter contributed to paying down our revolving credit facility and supported the decrease in leverage to 5.2x net debt to adjusted EBITDA. Our unsecured debt to unencumbered NOI is 4.5x, and unencumbered NOI represented about 85% of our portfolio at quarter end. We have no significant debt maturities before 2023. At quarter end, our consolidated debt outstanding was approximately $1.3 billion with a weighted average interest rate of approximately 3.7% and a weighted average term of seven years. With that, I'll turn the call back over to Wil.

Thanks, Beth. I will now turn the call over to the operator, who will conduct the question-and-answer portion of the call.

Our first question comes from Craig Mailman with KeyBanc. Please go ahead.

Good morning, everyone. This is Artie Cameron on for Craig. Just a quick one regarding acquisitions kind of going forward. Is the $164 million per quarter pace kind of something we can expect for the remainder of the year?

Well, the market of opportunity is large, but our existing pipeline right now just has the $29 million asset under contract. So we think that we can be quite active in the market over the balance of the year. But as I said, there's only $29 million under contract at the moment.

Got it. Thank you. And just one more on bad debt. I remember the last call you guys mentioned you had 150 basis points of bad debt baked into the guidance. I'm sorry if I missed it, but did you guys update that here today?

Hey, Artie. Yes, we did not put that in our prepared remarks. But, yes, we do have 150 basis points of bad debt baked into our guidance.

Our next question comes from Jamie Feldman with Bank of America Merrill Lynch. Please go ahead.

Thank you. Good morning. I guess just can you help us understand or just kind of think through your sources of capital just going forward? Let's say you were to find larger deals than $29 million, how do we think about the next time you need to raise capital or just how you're thinking about the sources and uses going forward?

Well quite a bit will be derivative of how well we can do on the disposition front, Jamie. We think that we've had quite a bit of success in July, and we think we can do well over the balance of the year. So disposition proceeds will be an important use of capital from a redeployment standpoint. And obviously, our credit line is available to us. We may use our ATM program a little bit, but unless we have a large specified pipeline that we have visibility on; we wouldn't expect to use any equity in size.

Okay and then you had mentioned the $500 million of office sales some may get pushed out till next year. Can you just give an update on what's in discussions? What gives you confidence saying that? And why next year? How do we think about that?

Yes. Lara Johnson runs our disposition plan. So, Lara, you may be best suited to answer that one.

Good morning. Currently, we have around $55 million in assets with an accepted offer or contract, which represents our pipeline at this time. We also have several assets that are on the market or are planned to be listed, with our Gadal asset being a primary focus. While we cannot provide any definitive updates on that asset yet, we are actively in discussions about it. Additionally, there are various other office assets either on the market or set to be listed, but the timing for these is uncertain due to COVID. Therefore, we indicated that some of these closings may extend into 2021.

Okay and do you have like a general sense of any moves in pricing so far especially on the office side for what you're trying to sell? Does anyone rethought their underwriting?

It's clear that this is an issue facing all sellers. In the first half of 2020, net lease office sales are down about 44% compared to the same period in 2019. The specifics can vary based on the type of asset; investors are being more discerning regarding the credit quality of tenants, lease terms, and the quality of the real estate. Our lenders are also aligning with this approach. There's more selectivity among investors at the moment. However, we are noticing renewed interest from both institutional and private investors eager to make moves in 2020, and the lending community is starting to return as well. Their underwriting criteria are stricter, and having strong sponsorship is more crucial than ever. This is the current landscape we are experiencing.

Okay and you're seeing points on the board even on suburban office or office campus acquisitions?

Yes, we don't have any campuses in the market. But, yes, we are seeing renewed interest in the assets we're out with.

Okay and then how do you think about your current cost of capital versus the yields? I think you had talked about mid-5s, low to mid-5s on the acquisitions.

Yes. I mean we see the market opportunity sort of ranging between 4.5 and 5.5 depending on credit lease characteristics, location and market. So what's going to drive acquisitions for the most part is 1031 exchange needs from sales. But our cost of capital has improved a lot and made external growth easier.

Our next question comes from Jon Petersen with Jefferies. Please go ahead.

Great. Thanks. In terms of your acquisition pipeline, I'm just curious over the last three to four months, a lot of things in the world have changed. If you guys have changed any of your approach to where you're trying to acquire properties? There's been a lot of talk about re-shoring a supply chain and businesses holding more inventory. I just wonder how that works into the types of properties and the locations where you're trying to acquire.

Yes. I think Brendan, do you want to take a shot at that one?

Yes, sure. Hi, good morning. Well, our investment focus, our logistics-oriented focus I think is an excellent strategy in the current environment. We do expect to benefit from the structural demand drivers of accelerated adoption of e-commerce moved by companies to have increased business inventories for their supply chain resiliency. And also that potential that you referenced for on-shoring or near-shoring, and when we think about the geographies in the country that are most likely to benefit from those trends; we believe that we're very well positioned to benefit. We think our focus in the southeast to the Sunbelt and in the lower Midwest logistics-oriented markets will benefit disproportionately from that demand because those markets offer very favorable access to strong demographics, excellent infrastructure; and are also very attractive from a cost perspective; and are in generally business-friendly environments. So to summarize; we expect to continue to invest in the markets that we've been active.

Okay. All right. That makes sense. And I mean maybe the same question but in terms of the development pipeline; I'm curious if you guys have seen any or the merchant builders that you deal with; have you seen any increase in RFPs in the market recently? And I guess if you have, kind of what geographies are you seeing those in?

So we have, if you look at the leasing activity; the leasing activity for modern bulk distribution has been quite strong across our market. And that has absorbed a lot of the large bulk distribution space. So there has been, I would say, more build-to-suit inquiries than we were seeing at this point last year. And that's also partly on the demand side, as well as on the supply side what you saw in most markets has been a pause in speculative development. So as those spec buildings have been absorbed; some of these larger companies or larger space needs companies, we anticipate they'll need to look to build-to-suit in order to satisfy that space demand.

Okay, yes, that makes sense. I'm sorry if I missed this, but looking at your upcoming lease maturity schedule for industrial in 2020, you only have one left, and then there are several in 2021. Are you expecting any significant move-outs from that list, and is the same true for the office portfolio?

I'm sure Jon, I might ask James Dudley, our Head of Asset Management to give his view on that.

Yes. So, we are aware of a few upcoming move outs. Geotis will be vacating the property in Statesville, which is a functional space that we plan to backfill. Additionally, we have another known move out in our industrial pipeline for 2021, which is with Dana. This is a mixed-use property featuring a significant office area alongside industrial space. We are working on securing a sub-tenant rental that has already been established for that space. On the office side, the only near-term known move out is Schwab in Westlake, Texas. This property is well-situated in a prime area of the DFW market, which is affluent, and it has historically been leased to multiple tenants quickly due to its ample parking and overall quality as an asset. For everything else, we are currently in discussions with the tenants and remain hopeful that we can retain them.

At this time, there are no additional questions. I would like to turn the conference back over to Wil Eglin for any closing remarks.

Yes. Thanks again for joining us this morning. Please visit our website or contact Heather Gentry, if you would like to receive our quarterly materials. In addition, as always you may contact me or the other members of senior management with any questions. Thanks again and have a great day.

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