Earnings Call Transcript - LXP Q4 2020

Operator, Operator

Good day and welcome to the Lexington Realty Trust Fourth Quarter 2020 Earnings Call and Webcast. All participants are 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 Heather Gentry. Please go ahead.

Heather Gentry, IR

Thank you, operator. Welcome to Lexington Realty Trust fourth 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 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 files 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, Will Eglin, Chairman and CEO; Beth Boulerice, CFO; and Brendan Mullinix, CIO, will provide a recent business update and commentary on fourth quarter results. Executive Vice Presidents, Lara Johnson and James Dudley will be available during the Q&A portion of our call. I will now turn the call over to Will.

Will Eglin, CEO

Thanks, Heather. Good morning, everyone. 2020 was an outstanding year for Lexington. And our fourth quarter results were excellent across all our business lines. In the fourth quarter, we generated adjusted company funds from operations of $0.19 per diluted common share to end the year at $0.76 per diluted common share, the high end of our guidance range. Following a robust quarter of $182 million of industrial purchases and $292 million of sales, our industrial exposure increased to 91% of our gross real estate assets, excluding held for sale assets. Portfolio operations have been very strong during the pandemic with fourth quarter cash base rent collections averaging 99.8%. Also, during the quarter, leasing volume was healthy at 1.7 million square feet, consolidated same-store NOI was up 1.6%, and industrial cash renewal rents increased 3.4%, with overall fourth quarter cash renewal rents down roughly 2.5%, due to office lease renewal roll-downs. We recently announced a dividend increase of 2.4%, supported by our positive results throughout the year, which equates to an annualized dividend of $0.43 per common share. Our plan is to continue growing our dividend annually. Our Company has evolved considerably over the last five years, and we have mostly transitioned out of the office sector into the industrial sector, an asset class that we believe continues to have strong fundamentals and an expanding opportunity set. Along the way, we disposed of 127 consolidated non-industrial assets for $2.5 billion and purchased 60 industrial assets for approximately the same amount. Throughout this transition, our investment strategy has targeted purchases, build-to-suits, and select development opportunities in primarily warehouse and distribution assets in markets across the Sunbelt and lower Midwest. We had an active year on the investment side, purchasing $612 million for primarily Class A industrial assets and investing $60 million into development projects. As we near completion of our portfolio transition, we will continue to focus on acquiring and developing primarily single tenant Class A warehouse distribution properties in our target markets. While we expect to be active in the purchase market, we intend to allocate more capital to development opportunities in 2021 relative to 2020. In our view, this is the best way to achieve higher returns without compromising on quality when it comes to building characteristics, markets and locations. Just to highlight a couple of recent successes on the development side. During the fourth quarter, we had value creation events in our first two development projects located in the Columbus, Ohio market. These included selling a land position in one of our ETNA parcels to Kohl’s department stores and executing a full building lease on our Rickenbacker project. These are two great outcomes for us. And we’re excited about the opportunities in our development pipeline going forward, which Brendan will discuss in more detail later in the call. Moving to sales, 2020 volume totaled $433 million of predominantly non-core assets at average GAAP and cash cap rates of 5.8% and 5%, respectively, an excellent result that was consistent with our prior disposition plan forecast. We were particularly pleased with the sale outcome of our Dow Chemical office building in the fourth quarter as we retired a substantial amount of secured debt, and deleveraged the balance sheet. Additionally, we sold two office properties in January for approximately $20 million. While the office sales market continues to be impacted by the pandemic, we remain committed to selling our remaining office properties in an orderly manner, and will continue to give regular updates on our progress and the forecasted sales results. The remaining office and other asset portfolio consists of 18 properties, which generated 2020 NOI of approximately $33.5 million. We expect to market for sale most of this portfolio in 2021, which we currently value at around $300 million. Turning to leasing, we leased over 5.2 million square feet during 2020. And at year-end, our portfolio was 98.3% leased, representing a slight decline compared to the previous quarter, primarily as a result of a year-end lease expiration in our Statesville North Carolina industrial facility. We were very pleased with industrial cash base renewal rents in 2020, which increased 17.5%. At year-end, we had 3.7 million square feet of space expiring in our single tenant industrial portfolio in 2021, of which we expect at least a third to be renewed with the expiring rents below market on average. Of the remaining leases, the two most significant expirations are our Olive Branch, Mississippi facility, occupied by Hamilton Beach through June 2021; and our Laurens, South Carolina facility, occupied by Michelin, through November 2021. The Laurens location has multiple prospects interested in the property for either lease or sale, including the potential for further extension with Michelin. Additionally, the Olive Branch location is experiencing significant leasing interest from full building users, which could result in minimal downtime. Our balance sheet remains in excellent shape, with leverage at 4.8 times net debt to adjusted EBITDA at year-end. Our strong cash position, forward ATM contracts, retained cash flow and proceeds from dispositions provide us considerable capacity to fund future growth initiatives. In 2020, we began building out an ESG platform for our operations. We understand the importance in doing so and have begun to establish a program that is appropriate for our portfolio given the limited control we have over many of our properties due to their net lease single tenant nature. Our 10-K and website will contain a summary of our initiatives, goals and performance, and we expect to report on ESG matters going forward as our platform evolves. To conclude, we were very pleased with our fourth quarter and 2020 results. We have succeeded in monetizing much of our office portfolio, while constructing a high quality industrial platform. Our focus remains on acquiring and developing well-located warehouse and distribution assets, and disposing of our remaining non-core assets. While we will continue to experience some near-term dilution as we sell these assets, we believe that industrial property is demonstrably superior in terms of long-term cash flow growth. With that, I’ll turn the call over to Brendan to discuss recent investments and our forward pipeline.

Brendan Mullinix, CIO

Thanks Will. We had another active year on the investment front, acquiring 16 industrial properties, totaling 6.6 million square feet for $612 million at average GAAP and cash cap rates of 5.4% and 5%, respectively. These assets have an average age of two years and an attractive weighted average lease term of 8.3 years, with average annual rental escalations of 2.3%. Our overall industrial portfolio continues to be shaped with a focus on building quality, age and user versatility and targeting a growing industrial logistics market in the Sunbelt and lower Midwest. Fourth quarter purchase activity was consistent with these attributes and markets, and comprised four warehouse distribution properties, totaling 1.4 million square feet in two Dallas-Fort Worth logistics submarkets, as well as some markets in Phoenix and Greenville/Spartanburg. These properties all featured modern specs, good highway access, and ample trailer parking with an average lease term of 9.4 years and annual rental escalations of 2% or higher. During the quarter, we also closed on and began funding a build-to-suit industrial project in Phoenix, which we expect to be completed in the third quarter of 2021. Subsequent to year-end, we purchased three recently constructed Class A warehouse distribution facilities for approximately $51 million, totaling 520,000 square feet, further adding to our holdings in the Indianapolis and Central Florida markets. We are currently reviewing over $600 million of existing deals in the market. Pricing continues to be very competitive. And as evidenced by our 2020 purchases, cap rates have compressed from a year ago. While the industrial market opportunity is there, we are unlikely to compromise on asset quality to save our current return. Our increased development focus with longstanding development partners will allow for potentially greater value creation compared to purchases and complements our existing investor portfolio. Will mentioned earlier that we secured a full building lease at our 320,000 square-foot Rickenbacker project in Columbus late in the fourth quarter, with a subsidiary of PepsiCo for three years. The base building was essentially completed this quarter. Our expected development cost basis in the fully completed project is estimated to be about $20 million. We were pleased to have preleased the full building prior to completion at an attractive development yield, with anticipated stabilized GAAP and cash cap rates of 7.8% and 7.6%, respectively. Also in the fourth quarter at our Etna West development site in Columbus, we sold the ground position under the 1.2 million square-foot e-commerce distribution center lease to Kohl's department stores, which exercised its two-year purchase option for $10.6 million. This transaction resulted in a gain on sale of $5.9 million. Our Shugart Farms development project, a Class A 910,000 square-foot distribution center in the I-85 South club market of Atlanta, is slated for substantial completion around the end of the first quarter of 2021 and is currently available for lease. Market absorption in the Atlanta industrial market in 2020 exceeded total absorption in both 2018 and 2019 and remains marked with high user demand. Lastly, our future pipeline includes three development projects in which we are in late stage negotiations and due diligence. These projects are in Indianapolis, Central Florida and Phoenix, target markets where we intend to continue building a larger presence.

Beth Boulerice, CFO

Thanks, Brendan. Adjusted company FFO for the fourth quarter was approximately $55 million, or $0.19 per diluted common share. We achieved the high-end range of our 2020 adjusted company FFO guidance at $0.76 per diluted common share. Our 2020 adjusted company FFO payout ratio was 55.6% and continues to provide us ample retained cash flow. This morning, we announced 2021 adjusted company FFO guidance in the range of $0.72 to $0.76 per diluted common share. This range incorporates our commentary on distributions, investments and leasing, we have made on this call. We generated revenues of approximately $83.3 million in the fourth quarter, which represented a slight increase compared to the same time period in 2019. Overall, in 2020, gross revenues increased $4.5 million year-over-year. This increase was primarily attributable to new acquisitions, partially offset by sales. Property operating expenses were relatively flat year-over-year. However, tenant reimbursement increased to 84% for 2020, compared to 72% for 2019. Our 2020 G&A of $30.4 million was in line with our revised target range of $30 million to $31 million. And we expect 2021 G&A to be within a range of $31 million to $33 million. Same-store NOI increased 1.6%, primarily as a result of a 2% increase in same-store industrial NOI. Year-over-year our consolidated same-store lease portfolio decreased 140 basis points to 97.6%, primarily due to the year-end lease expiration of our Statesville, North Carolina property. At year-end, approximately 86% of our industrial portfolio had escalations with an average rate of 2.1%. Our 2020 rent collections were among the best in the REIT sector. We collected 99.8% of cash base rent throughout the year. And as of the end of 2020, we had only granted two rent relief requests in our consolidated portfolio, which we have discussed in the previous call. Bad debt expense was minimal during the fourth quarter with only $212,000 of bad debt expense incurred. Capital markets activity during the quarter included the sale of an additional 1.1 million common shares under the forward delivery feature of our ATM program. These shares increased our forward sales contracts to 5 million common shares for the year with an aggregate settlement price of $55 million as of year-end 2020. Our balance sheet remains exceptionally strong with leverage at a low 4.8 times net debt to adjusted EBITDA at year-end. We had substantial cash of $179 million on the balance sheet at year-end and nothing outstanding on our unsecured revolving credit facility. In connection with the sale of the Dow Chemical office building, we satisfied $178.7 million of secured debt with an interest rate of 4%. This contributed to an increase to our unencumbered NOI to over 89% at year-end. At year-end, our consolidated debt outstanding was approximately $1.4 billion with a weighted average interest rate of approximately 3.3% and a weighted average term of 6.9 years.

Will Eglin, CEO

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

Operator, Operator

Thank you. We will now begin the question-and-answer session. Our first question comes from Anthony Paolone with JP Morgan. Please go ahead.

Anthony Paolone, Analyst

Yes. Thanks. Good morning. First question is on the development activity that you expect for '21. I think, you’d mentioned either in the release or in your comments about spending more on development versus acquisitions. Can you just maybe be a bit more specific on what you think the activity will amount to this year?

Will Eglin, CEO

Sure, Tony. Brendan mentioned, there's a few projects that we're working on. And if those come to fruition, we could have roughly $200 million of funding for development activities, in addition to whatever we're purchasing in the acquisition market.

Anthony Paolone, Analyst

And, you'd mentioned I think the yield on Columbus was up in the high-7s. What do you think the pipeline that you're teeing up now looks like?

Will Eglin, CEO

Brendan, do you have any thoughts on that?

Brendan Mullinix, CIO

Yes, sir. The yields vary depending on the project, but generally, targeting development yields in the range of between 5.25% and 6%. And hopefully, there's some conservatism there. Our base underwriting includes 12 months in downtime, which can really enhance yields when you lease more quickly, as we did, and the Columbus development projects were leased immediately.

Anthony Paolone, Analyst

Okay. So, I mean, if we step back, if you spend a couple of hundred million on development in terms like that might be a bit more than what you think you'll do on the acquisition side. But then, you talked about these other assets that could be pretty high cap rate sales. I mean, how should we think about that as you look out over the next couple of years? Is that going to be a pressure point? Do you think there's enough on the development and acquisition side to offset sort of the remaining dilution to clean out the non-core stuff, or what happens there?

Will Eglin, CEO

Well, implied in our comments is that what's left to sell in the office and other asset portfolio is likely a low-double-digit cap rate outcome. So, we won't offset that entirely in a leverage-neutral context. But, our leverage is low. We would be comfortable with it going up a little bit, if there's good opportunity in the acquisition market. From our perspective, we need to execute on the sale plan this year, but we’re comfortable with a $500 million or $600 million investment plan. We can still keep our leverage sort of in the midpoint of what we've indicated is a comfortable range. So, we do have a fair amount of balance sheet capacity to take advantage of opportunities. But, at the same time, it's a competitive marketplace. So, we want to be careful and pick our spots versus being predictive about acquisition volume.

Anthony Paolone, Analyst

Okay. And Brendan mentioned just the competitiveness in the market and cap rate compression. Is there any sort of premium to the gains going either shorter duration or anything like that at this point?

Brendan Mullinix, CIO

Yes. I mean, I would say that certainly the most aggressive cap rates that you're seeing would be attributable to longer leases in the more primary markets, so 10-year Amazon and in a more primary market, for example. So, being able to underwrite a range of lease durations, including some sort of expirations is helpful to take advantage of the opportunity, get slightly more yield when you can appropriately underwrite the leasing outcomes.

Anthony Paolone, Analyst

Okay. Just one final detail item, I just want to make sure, I think the $50 million in forward equity that's still out there, that's not been brought in yet. Is that right?

Brendan Mullinix, CIO

Correct.

Beth Boulerice, CFO

Yes. That's right.

Anthony Paolone, Analyst

Okay, great. Thank you.

Will Eglin, CEO

Thanks, Tony.

Operator, Operator

Our next question comes from Sheila McGrath with Evercore. Please go ahead.

Sheila McGrath, Analyst

Yes. Good morning. On the Ohio Rickenbacker development, the yields are much higher than you’re targeting on other projects. If you could just talk about what's driving that. Was that low land basis or doing better on rent? And, can you remind us if there - I think, there were other development opportunities at that site.

Brendan Mullinix, CIO

Hi. It's Brendan again. Yes. There were a couple aspects to the Rickenbacker leasing outcome. One is, we did have an interactive basis in that property for sure. And in addition, we were able to lease the property prior to completion, or just around substantial completion. So, we were able to take out a year of carry, which is built into our forward underwriting. So, there's a good yield benefit there. In addition, and then this project, the PepsiCo lease is actually a little bit shorter. It's a three-year lease. But, that was offset by having - we had PepsiCo fund the bulk of the tenant group and build out, which also clearly enhanced our yields there. We have that Rickenbacker project with a single building project. We additionally have two land parcels across from each other and ETNA, and those are multi-building sites that we've been building out infrastructure at for the last couple of years. That project at the outset was set up to focus primarily on build-to-suit opportunities, as the market over the - particularly last couple of years has shifted away from build-to-suit. And it's really been dominated by spec development. And when you're talking about generic bulk distribution product, we're valuing centrally moving forward the spec projects on either our East or West sites there and ETNA. We have already developed a pad on the West site for an 800,000 square-foot building.

Sheila McGrath, Analyst

Okay great. And then in, I think, either Will's remarks or yours, Brendan, I'm not sure who mentioned that you have a stable of development partners. Can you just explain to us how deals are structured with these development partners, do they get a fee, or just explain to us how it works?

Brendan Mullinix, CIO

Yes, we appreciate your interest. Lexington has a strong history of engaging in build-to-suit projects, often collaborating with merchants and builders. Our recent activities in the purchase market for existing facilities are mostly influenced by these merchant builder sellers. We maintain excellent, often long-standing relationships with merchant builders nationwide. Our future partnerships will focus on developing project structures. Generally, I can't share specific details about these structures due to competitive reasons, but they usually involve a joint venture with about a 90-10 split between capital partners and operating partners. Typically, there’s a base development fee around 4%, plus an incentive structure based on performance. These structures are common in the merchant building sector, enabling Lexington to access development yields much more closely than through our previous purchasing strategy.

Sheila McGrath, Analyst

And last question from me, just on the part of the appeal, I think going forward is lowering your capital expenditure outlook by shifting to industrial. If you could just give us some insight on how much capital expenditures you're budgeting this year, either how that compared to the recent past or going forward how much you expect that to ramp lower?

Beth Boulerice, CFO

Hey, Sheila. It's Beth. Good morning. It’s a function of course of the potential leasing outcomes for the year and the timing of the TI work that's being done, of course. We are going to be coming down as we transition away from the office product into the industrial product. So, now, at the beginning of the year, I would say, somewhere between $15 million and $25 million for 2021. We'll have a better handle on the exact amount as we go through the year. And, in general, on the CapEx, we look at $0.10 to $0.11 per square foot on average. But, if you look back in our history, you'll see that we were spending $50 million a year on TIs and CapEx and LCs. So, we're looking forward to a new era of lower CapEx.

Operator, Operator

Our next question comes from Craig Mailman with KeyBanc Capital Markets. Please go ahead.

Craig Mailman, Analyst

Hey, good morning. Will, just on the '21 expirations, the bigger ones in Mississippi and South Carolina. I mean, what are the potential mark-to-markets there?

Will Eglin, CEO

Good morning, Craig. James wanted to jump in and give you a perspective. Thanks.

James Dudley, EVP

Sure. So, on the - we're in a pretty competitive situation right now on the one in Memphis. I don't want to get into too much detail as to where we're at. But, there should not be a negative mark-to-market there. Our expectation is, depending on the outcome, that those should go up. And then, the Laurens facility is also kind of dependent on the outcome as well. We've got a couple of different opportunities there that we're pursuing, including a potential renewal with the incumbent tenant. If it's a renewal, it should be flat, a little bit of an increase; if it ends up being multitenant, it could be flat to a minor decrease. And if we replaced them with a large single tenant, then, it probably is a slight decrease to what they're currently paying.

Craig Mailman, Analyst

That's helpful. For Brendan, you're projecting development yields of 5.25%-6%. There could be potential upside based on downtime and other factors in your underwriting. As you expand into markets with increased construction activity, do you believe that return is appropriate considering your equity is slightly above a 6 cap? Do you feel adequately compensated for the associated risk?

Will Eglin, CEO

We do, Craig, as an alternative to being in the purchase market, it's in our mind a much better capital allocation. So, we're allocating more capital to development than we did last year. But, we're being very patient as we accumulate success in that space. Our first two projects worked out very well. We're very optimistic about the Atlanta project, and then, there's a few more. Whether we commit more capital to development, beyond that pipeline, remains to be seen. But, to us, it's an important part of our business. It's an opportunity to enhance our returns without chasing either weaker credits or older real estate with obsolescence risk.

Craig Mailman, Analyst

I have a broader question that connects to my previous one. As I examine your execution, it appears you have achieved your goals, particularly with industrial reaching 91%. This has positively impacted the stock. From a valuation standpoint, your multiples align with those of other focused industrial companies. However, when I review your AFFO growth and same-store growth, they seem to trade at a discount compared to peers. I'm curious about your plans moving forward to reduce your equity cost relative to those peers. Specifically, what strategies do you have in mind for investments to enhance your growth profile and justify continued multiple expansion, enabling you to better compete for capital with your peers?

Will Eglin, CEO

Well, I think there's several things that we're focused on. We still view it as a priority to finish the transition to write a 100% industrial and trade out of what's left of the office portfolio. I think that's a key factor for us. We want to add selectively to our investment pipeline in the development because we think that there's a better chance for us to capture value there versus purchases, in many cases. And then, the other big thing is, we have to prove the point about having the opportunity to mark our rents to market better than we have historically. And that will prove the shift in our underwriting over the last few years toward modern Class A warehouse and distribution properties in our target markets. We know we have to prove that. We've made good progress in terms of positioning the portfolio, so that it has good organic growth as reflected by the amount of revenue that we have, subject to lease escalations. But we have to prove the point, where our leasing spreads are positive when we come off lease. And I think we're very optimistic on how well we can do in 2021, we did very well last year. But, we understand that given that a portion of our portfolio is older and is in manufacturing assets that some of our mark-to-market opportunities over the next few years won't be as robust as some of the peer companies.

Craig Mailman, Analyst

Regarding your comments on the spreads like those with Hamilton Beach and Michelin, you might see a slight increase there, representing about 3% of your overall industrial rents. Is there any conversation about possibly reducing the size of assets in terms of square footage or considering a mix of assets with shorter lease durations than usual? This could allow you to take advantage of rent increases while potentially lowering the risk associated with larger, million-square-foot properties. Would this approach help you better compete with peers and enhance your internal growth?

Will Eglin, CEO

Yes, absolutely, Craig. We've been adding smaller facilities to the portfolio. And, we would add assets with two or three tenants in them. So, there isn't a multitenant opportunity in our target markets that we're aware of that could make sense for us. And we're not averse to buying buildings that aren't fully leased either, if there's an opportunity to capture greater yield from leasing and otherwise working an asset.

Operator, Operator

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

Jamie Feldman, Analyst

Great. Thank you, and good morning. I was hoping to just get some more color around the guidance assumptions. So, I apologize if I missed it? Did you say what your equity acquisition and disposition volumes were included in your outlook?

Will Eglin, CEO

We didn't. We try not to be predictive about acquisition volume. But, I think, on the disposition side, if you were modeling $200 million to $300 billion of completed sales, that would be a number that we were comfortable with. And if we can execute on those sales, given the way our balance sheet is positioned, we certainly have the capacity to invest sort of $500 million to $600 million and still stay within a comfortable range from a leverage standpoint.

Jamie Feldman, Analyst

Okay. Thank you. The correct way to consider the sales is low-double-digit cap rates versus high-single-digit.

Will Eglin, CEO

Yes, overall, as the outcomes are lumpy though in that portfolio. So, it won't be the same cap rate on everything obviously.

Jamie Feldman, Analyst

Okay. And then, on the investment side, it sounds like kind of 6ish percent yields make sense.

Will Eglin, CEO

That would be high on development initiatives that could be achievable. But, in the purchase market, most of the things that we see that are of interest are more in the 4.5 to 5 area on a cash basis. And obviously, the GAAP cap rate would be higher.

Jamie Feldman, Analyst

How much higher?

Will Eglin, CEO

It depends on term and escalations.

Jamie Feldman, Analyst

So, of the 5 to 6, how much of that do you think could be development versus acquisitions?

Will Eglin, CEO

Well, we could see, at the moment, committing as much as $200 million to development projects this year with the balance of activity in the purchase market.

Jamie Feldman, Analyst

Okay. That's helpful. And then, you had mentioned third of the expirations you think will be renewals and then you mentioned two big leases. But, it looks like there's actually 43 expirations and '21, if you add up the office and industrial. I mean, how do we think about the rest of that group, or are they so small that they're actually included in the one-third and the two you mentioned are two-thirds? I just want to make sure kind of see the full picture here?

Will Eglin, CEO

I think the majority of those are in Hawaii. Beth, do you want to take it, or I can?

Beth Boulerice, CFO

Yes. I was just going to say, there's small tenants in mainly our Hawaii property. And then, some smaller tenants in Antioch too.

Will Eglin, CEO

So, there are six primary industrial leases that are rolling in '21. And then, there's really only one of any size left on the office side. There are a couple of small ones, one retail tenant in the Philadelphia office building and then one small tenant in Arlington office building, but primarily six industrial leases.

Jamie Feldman, Analyst

Okay. That's helpful. And then, you had mentioned 2.4% distribution growth in '20. It sounds like with portfolio repositioning, maybe there's a little bit of a drag in '21. How do you think about the potential for growth? Especially given your comments before on CapEx, I mean less CapEx this year. Is 2.4% something that seems high or low, do you think about kind of annual dividend growth going forward?

Will Eglin, CEO

Yes. I mean, our thought is to increase the dividend a penny a year, until taxable income gets to the point where it's pushing against that in favor of more growth. So, we're very comfortable with continuing to grow the dividend at that rate for the foreseeable future. We think the dividend will be among the best covered in the space. And, if you think about it, if the model is retaining $50 million or $60 million a year of free cash flow, just from reinvesting that capital, that in and of itself drives dividend growth.

Jamie Feldman, Analyst

You mentioned Sunbelt and lower Midwest states; what is restricting you to those areas? As you consider these regions, are you observing an increase from re-shoring that might be a focus for growth?

Will Eglin, CEO

I think, generally speaking, we want to be more targeted in our market focus, so that we get more concentrated positions. We think that helps us both in terms of accessing and underwriting new investments and enhancing our opportunities in those places versus being much more broadly geographically diversified. And with respect to onshoring, I’ll see whether maybe Brendan or James, you have a perspective on that in terms of what you're seeing?

Brendan Mullinix, CIO

This is Brendan. I'll begin. One key dynamic we've observed in the market since 2020, particularly in the fourth quarter, is the rise of bulk leasing. Amazon has been a major player in this area, but if we examine the bulk leasing sector, we can see that it's distributed across various industries. This indicates that companies are prioritizing the resilience of their supply chains. The trends of onshoring and nearshoring may take time to manifest, as they will require additional manufacturing facilities to be established in the U.S., which is not yet a significant factor. However, there are compelling reasons for this shift to occur. Our geographic regions are well-positioned for manufacturing due to a combination of affordable and skilled labor, particularly in the Midwest and the Sunbelt, creating favorable business conditions. Therefore, our geographic strategy aligns well with potential increases in manufacturing. James, do you want to add anything to that?

James Dudley, EVP

No. I think you covered it.

Jamie Feldman, Analyst

Okay. Thank you. I appreciate your thoughts.

Operator, Operator

Our next question comes from John Massocca with Ladenburg Thalmann. Please go ahead.

John Massocca, Analyst

Good morning. Will, I know there's still some work to do on the office disposition side of things. But, as I think longer term about the next leg of the capital recycling strategy, is it view to sell assets out of the heavy and light manufacturing bucket? And I guess, if that's the case, how much cleaning is there to selling those assets? What kind of sizable term left on the lease?

Will Eglin, CEO

I think, it would be opportunistic about that harvesting value there, if we're shrinking that portfolio. I'm not saying that there wouldn't be some disposition activity. But, those assets have long lease durations, they throw off a lot of free cash flow. And that's, right, providing an opportunity for us to reinvest a lot of that cash flow just for the growth plan. So, we're not interested in parting with them at anything that's not a very full valuation.

John Massocca, Analyst

But, I guess, as you kind of talk about that being potentially the area where you have risk of a kind of mark-to-market down. And there's kind of a bit out there in the market for things that just kind of headline industrial. I mean, is there any kind of incentive to kind of clear that out of the portfolios that people have real confidence for kind of the run rate NOI in the portfolio today, or that we really want to this cash flow to also kind of help support the dividend and other kind of positive things, leverage-wise and stuff like that?

Will Eglin, CEO

I think either way, it's fine for us. We understand that industrial as an asset class is extremely hot. And we're not averse to doing something more significant in that space, if it's good for the Company. So, there's nothing imminent, but I do think the value there is probably underappreciated in the context of our current share price. Often tenant retention is extremely high there for long periods of time. It's very difficult to move manufacturing facilities and often occupancy, as I said is sticking for a long period of time. And a rent negotiation with a tenant that doesn't have great options, that's often a good outcome for landlord. So, I don't want to sort of overemphasize the risk around leasing outcomes. It's been a very, very good business for us.

John Massocca, Analyst

Okay. And then, you’re talking about the office itself, and understanding why the kind of move in interest rates has happened very recently. Have you seen any change in demand from potential office buyers, given some of the interest rate volatility? And is it boxing some people out of the market, or maybe pulling them into the market if they get worried the window for attractive funding is potentially closing?

Lara Johnson, EVP

Hi. This is Lara. I think the latter is certainly true, when you have a high quality tenancy, long duration lease and fairly strong market. So, the activity for assets with those characteristics has been intense. And buyers seem as eager as ever to put capital out for assets like that. It continues to be kind of a Tale of Two Worlds and that buyers continue to struggle to underwrite impending vacancy and rollover. So, for assets that have that profile, the market is more challenging.

John Massocca, Analyst

And then, one last one, maybe kind of repainting outlook for Statesville. Sorry, if I missed that earlier in the call. And then, any changes in some of the other lease expirations that weren't talked about, some of the smaller ones like Kalamazoo and Millington, et cetera?

Will Eglin, CEO

Sure. So, on Statesville, we've had some activity, both from full building users and from multitenant prospects, but there's nothing imminent at this point. It's been off of expiration for less than two months. It's a functional building in Charlotte and we expect to have a positive leasing outcome, and they just take a little bit of time. So, Kalamazoo, Dana is moving out. We're in the process of returning to get with the sub tenants that they put in place. It's still kind of up in the air right now. We haven't solidified the terms on those yet, because there's still quite a bit of term left with the Dana lease. Millington, we're right at the finish line to try to get a renewal done with them, which will be an increase in rent. Let's see. And then, the other, 2021 is a smaller building in Rockford, which is a suburb of Chicago. And it's too soon to tell there, but the tenant is fully utilizing the facility and our expectation is they’ll renew.

Operator, Operator

Our next question comes from Todd Stender with Wells Fargo. Please go ahead.

Todd Stender, Analyst

Just back to the PepsiCo lease at Rickenbacker project. Is there anything you can share about what they do with the facility, how they're utilizing it? Is it bottling or manufacturing? I know they put some TI dollars in, but just kind of maybe some color to hear why they only signed a three-year lease?

Brendan Mullinix, CIO

It's a fairly generic distribution unit for Gatorade. There is no specialized bottling or anything like that. I think that the shorter lease is just, I guess, a strategy that PepsiCo is using across their markets where they're trying to match up lease expirations with other lease expirations they're having in given markets, which gives them more flexibility. From our perspective, in this case, we were comfortable mitigating that risk by having them fund the bulk of the TI package. And obviously, the development yields were very attractive as well.

Todd Stender, Analyst

That’s helpful. Thanks, Brendan. Maybe just to stick with you, just looking at the 10-year treasury yield moving higher as of late, is that impacting, have you seen any impact in market pricing, both on acquisitions and also dispositions of office?

Brendan Mullinix, CIO

So, why don't I start with acquisitions, and I think Lara sort of spoke to it on the disposition side, I'll go. But, in terms of investments, typically when you see moves in interest rates, moves on the acquisition side tend to lag. We haven't seen any noticeable change in cap rates yet corresponding to those losing interest rates. I think that for those leveraged buyers, they're also benefiting from some spread compression on the lending side too. That's offsetting some of the base rate changes. I think that will remain to be seen how that may play out.

Todd Stender, Analyst

Got it? And then, maybe for Beth. Just looking at from a modeling perspective, is it fair to assume that the forward equity contracts are settled in the back half of the year? You still have some disposition proceeds to redeploy, maybe just a timing comment on that.

Beth Boulerice, CFO

Sure, Todd. Yes. We do have some cash NAV. So, it will - it'll be later, and we do have to settle the contract between August and November. So, it'll be by then.

Todd Stender, Analyst

Got it. Thank you.

Operator, Operator

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

Will Eglin, CEO

Thanks, operator. We appreciate everyone joining us this morning. And I hope you'll visit our website or contact Heather Gentry if you would like to receive our quarterly materials. And in addition, as always, you may contact me or the other members of our senior management team with any questions. Thanks again for joining the call today.

Operator, Operator

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