STAG Industrial, Inc. Q3 FY2020 Earnings Call

Good morning and thank you for standing by. Welcome to STAG Industrial Inc. Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note this conference is being recorded. I would now like to turn the conference over to your host Matts Pinard, Senior Vice President Investor Relations for STAG Industrial. Thank you. You may begin.

Thank you. Welcome to STAG Industrial's conference call covering the third quarter 2020 results. In addition to the press release distributed yesterday, we have posted an unaudited quarterly supplemental information presentation to the company's website at stagindustrial.com under the Investor Relations section. On today's call, the company's prepared remarks and answers to your questions will contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ from those discussed today. Examples of forward-looking statements include forecasts of core FFO, same-store NOI, G&A, acquisition and disposition volumes, retention rates, and other guidance, leasing prospects, rent collections, industry and economic trends, and other matters. We encourage our listeners to review the more detailed discussion related to these forward-looking statements contained in the company's filings with the SEC and the definitions and reconciliations of non-GAAP measures contained in the supplemental informational package available on the company's website. As a reminder, forward-looking statements represent management's estimates as of today. STAG Industrial assumes no obligation to update any forward-looking statements. On today's call, you will hear from Ben Butcher, our Chief Executive Officer; and Bill Crooker, our Chief Financial Officer. I will now turn the call over to Ben.

Thank you, Matts. Good morning everybody and welcome to the third quarter earnings call for STAG Industrial. We're pleased to have you join us and look forward to telling you about our third quarter results. Presenting today in addition to myself will be Bill Crooker our Chief Financial Officer; who will discuss the bulk of the financial and operational data. Also with me today are Steve Mecke, our Chief Operating Officer; and Dave King our Director of Real Estate Operations. They will be available to answer questions specific to their areas of focus. A phrase that I've heard frequently over the past few months has been it's good to be in industrial and that is certainly true. Industrial management of a few favorite asset classes in commercial real estate fundamentals are strong. Tenant leasing demand slowed only briefly at the outset of the pandemic. It resumed quickly and has continued to be strong throughout the quarter. This resilience has been seen across virtually all markets with e-commerce supply chain build out leading the way. Supply remains a concern but most markets are at or near equilibrium and/or operating at occupancy levels where the levels of incremental supply are not unwelcome. Capital is readily available and acquisition opportunities abound. Not surprisingly, our portfolio continues to perform well despite somewhat uncertain economic conditions. The demand for our space is broad-based. The 5.6 million square feet leased in the third quarter represents the largest total square footage leased during a single quarter in STAG's history. Our occupancy level remains high at 96.3% at quarter end, a reflection of solid retention and shorter downtime experienced. Included in this quarter's leasing activity was the successful backfill of our one million square-foot building located in Hampstead, Maryland. One of the two million square foot facilities with tenant non-renewal expected to occur in 2020. We budgeted between 12 and 18 months of downtime prior to retenanting this facility given its size and location. Thanks to the efforts of our asset management team, we significantly outperformed our budget and successfully released the building to a single user while incurring no downtime. The building was leased to a substantial credit for over five years with minimal tenant improvement work and 3% annual rental escalators. The second one million square-foot building we have discussed is our GSA building located at Exit 6A of the New Jersey Turnpike in Burlington, New Jersey. This is one of the premier submarkets on the East Coast and a version of an e-commerce hub. Our current budgets reflect the midpoint of nine months of downtime for this asset. We continue to receive interest from both potential buyers and potential users for this building and it's included 500,000 square feet of potential additional development. Our guidance assumes we hold this asset for the foreseeable future. However, given the attractive returns of a potential sale, we believe there is an increased likelihood that we monetize this asset. As expected the acquisition market has returned to pre-pandemic levels, both in terms of investment opportunity and pricing. The fundamental strength of the industrial real estate sector going forward has not been lost on investors. As a result, investor appetite for industrial real estate continues to grow. However, our acquisition platform is well-established across many markets in which we operate. Our ability to identify relative value investment opportunities is reflected in our acquisition pipeline amounting to over $2.8 billion today. We recently completed our fourth annual tenant survey. Not surprisingly, there are more and less fortunate industries during the pandemic. The more fortunate include third-party logistics providers and the home improvement industry and of course anything e-commerce related. Less fortunate include tenants in the trade show industry and certain small automobile tenants. E-commerce remains a dominant theme. Approximately 40% of our respondents across our portfolio utilize a portion of their space to conduct e-commerce activity and approximately 15% of our buildings are solely dedicated to e-commerce. Our tenants reported an increase in the percentage of their warehouse footprint focused on e-commerce activity, an increase from 30% in 2018 to almost 40% in 2020. STAG is in an enviable position as we approach the end of the year. Our balance sheet is defensively positioned and our liquidity is high. The STAG team is working effectively and efficiently in the current work-from-home environment with strong engagement across the organization and a resilient culture. With that, I'll turn it over to Bill who will discuss our third quarter operational results and updates to our 2020 guidance.

Thank you, Ben. Good morning everyone. Core FFO was $0.46 for the quarter and leverage remains at the low end of our guidance range. Net debt to run rate adjusted EBITDA was 4.4 times prior to factoring in the outstanding forward equity proceeds related to our January equity offering and 4.0 times when those proceeds are included. Acquisition volume for the third quarter totaled $64.7 million with stabilized cash and straight-line cap rates of 6.3% and 6.8% respectively. Subsequent to quarter end, we've acquired an additional nine buildings for $258 million. This brings 2020 closed acquisition volume to $454 million through today. Additionally, we have acquisitions totaling $216 million currently under contract or subject to a letter of intent scheduled to close by year-end bringing 2020 total acquisition volume to $670 million as of today. For the quarter, 5.6 million square feet of leases were executed with cash and straight-line leasing spreads of 1.3% and 4.7% respectively. New leasing spreads were negative 4.7% this quarter, which was driven by two leases. The new lease related to the one million square foot asset located in Hinton, Maryland as discussed by Ben resulted in a roll down of 2.2%. Note that this lease was an as-is transaction and required minimal tenant improvement or other capital work. The second lease reflects the phased negotiation of a long-term lease with the tenant initially agreeing to a one-year lease at below market rent while simultaneously negotiating a market rate long-term lease. Excluding these two leases, new leasing spreads increased to 12.4% on a cash basis and 21.5% on a straight-line basis for the quarter. Additionally, we leased 82,000 square feet of value-add buildings during the quarter. Retention was 72.1% for the quarter and is 81.4% for the year, both of which include the impact of the one million square foot Solo Cup non-renewal, which was backfilled with zero downtime. Retention was equal to 88.6% for the quarter and 91.5% for the year when excluding the impact of the Solo Cup non-retention. Same-store cash NOI increased 0.8% for the quarter and 1.8% year-to-date. For the third quarter, we collected 98.2% of our base rental billings. Of the remaining 1.8%, 60 basis points has been deferred with prepayment generally expected by year-end. As of November 5, we have collected 96.9% of our October base rental billings. An additional 60 basis points of October base rental billings remain to be collected leading to investment-grade tenants and tenants who pay in arrears. We expect these tenants to remit payment within the next two weeks bringing the total to 97.5%. The timing of these expected payments is consistent with past practices. Of the remaining 2.5% of uncollected base rental billings, 1% has been deferred and 1.5% is associated with smaller tenants that have been impacted by the pandemic. We have not received any new rent deferral increases in the third quarter. We incurred a total of $1.8 million of credit loss in the third quarter. Approximately $850,000 of that loss related to the write-off of straight-line rent and approximately $950,000 of that loss related to cash credit loss. We have updated guidance for the remainder of 2020. We acknowledge the continued uncertainty related to the health of the economy and we will continue to update the market as warranted. Components of our updated 2020 guidance are as follows: we have increased our expected acquisition volume range, now projecting between $650 million and $750 million with an expected cash cap rate range of 6% to 6.25% and expected straight-line cap rate range of 6.5% to 6.75%. We have increased our 2020 disposition volume range, now projecting between $150 million and $200 million. We have increased our expected retention range, now projected between 70% and 75% for the year, which includes 2 million square feet of non-retention associated with the Solo Cup and GSA facilities. We have increased our expected annual cash same-store range, now projecting 2020 annual same-store cash NOI growth to be between 75 and 125 basis points for the year. This range includes a reduction in our annual credit loss guidance to a range of 75 basis points to 125 basis points. We continue to expect G&A to be between $39 million and $41 million for the year. We expect to run leverage between 4.5 times and 5.25 times for the year. Capital expenditures per average square foot is still expected to be between $0.27 and $0.31 for the year. We have increased the expected range of core flow per share to be between $1.86 and $1.88 for the year representing a midpoint increase of $0.03. With that, I will now turn it back over to Ben.

Thanks, Bill. These remain challenging times as we head towards the end of an unprecedented year, challenging but not unworkable. After a pause for most of the second quarter, the industrial acquisition market has found firmer footing. Tenant demand for industrial space is broadly healthy and appears to have substantial legs. We are bullish on the opportunities for STAG that lie ahead. As a reminder, we will provide granular 2021 guidance during our fourth quarter call. In closing, let me mention that as part of our continuing focus on various ESG initiatives, we have recently set up the STAG Industrial Charitable Actions Fund. The fund is a way to formalize and channel our corporate giving. This was done in recognition of and in concert with our augmented commitment to providing substantial financial support to causes and organizations we believe in. Thank you for your time this morning. I'll now turn it back to the operator for questions.

Thank you. Our first question is from Manny Korchman with Citi.

Hey, guys. Good morning.

Good morning, Manny.

Maybe just moving back to your disposition plans. Have you changed the composition of what you might sell or where you might sell, given the way that the market has shifted?

I want to clarify that it's Manny, not Danny. We continue to follow our general philosophy of selling assets when someone believes they are worth more than we do as part of our portfolio. That being said, we're receiving inquiries from individuals interested in acquiring specific assets. We do not plan to sell our entire portfolio. When we sign new leases on buildings that extend the term, they might become more appealing to potential buyers. We may consider selling some assets. The GSA asset, in particular, is something we constantly evaluate for both buying and selling due to its attractiveness and the interest it garners. We remain focused on what's best for our shareholders regarding this asset.

Hey, Manny, it's Bill. We also increased our disposition guidance going into the fourth quarter primarily related to an asset that we had to reverse inquiry on. And we expect strong results from that transaction.

And just could you give us an idea of what you think the spread difference might be in cap rates between what you're selling and what you're buying?

I think it varies depending on the asset and the market. We have seen double-digit IRR to unlevered IRR returns on these arbitrage investments. This means we tend to compare the return on the assets where we are redeploying the equity. Additionally, the asset Bill mentioned will allow us to redeploy those proceeds in a beneficial way. And just a reminder the assets that we sold in the first quarter were also sub five cap. So those proceeds were redeployed accretively as well.

Right. And then thinking about your acquisition pipeline that increased meaningfully in the quarter. Have you changed anything there in terms of the types of assets in the markets you're looking at and sort of maybe widened the target a little?

No. We've discussed this previously, and it met our expectations. One impact of a downturn, like the significant decline we experienced with the onset of COVID, is that people are hesitant to bring assets to market until they have a clearer understanding of where the market might stabilize. During the second quarter, there was a noticeable pullback from sellers and brokers advising them. The expectation, based on anecdotal evidence from brokers and some sellers, was that towards the end of summer and into fall, there would be a release of pent-up supply of assets coming to market. That has indeed occurred. Conversations with the broker community indicate that this trend will continue. While some urgency to sell assets before year-end due to potential tax law changes may have decreased with the election results, our pipeline still reflects the same criteria we have always employed, and it has expanded due to an increase in available assets in the market.

Right. Thanks everyone.

Thank you, Manny.

Thanks, Manny.

Our next question is from Sheila McGrath with Evercore.

Yes. Good morning. Ben, the new acquisition guidance implies a very active fourth quarter. Maybe even a record for STAG. Can you give us some insights? Do you have additional assets under contract right now? And then also you guided on the cap rate a little lower. And I'm wondering if that's cap rate compression in the market, or is that the mix of assets you're acquiring?

So as Bill alluded to during our prepared remarks, we have over $200 million under contract right now, and we're still evaluating assets that might close this year reflective of the increased pipeline number of assets that came to market, etc. So we indeed are looking at a fourth quarter that could be the same as last year's fourth quarter, even larger. It depends on how assets shake out in terms of whether things close; not every contract always closes. Certainly, a letter of intent doesn't always close, but we have a high degree of probability that we'll get into those kinds of volumes. The cap rates have moved south a little bit. But they move south because of mix change: longer leases, less CapEx, in particular when we buy build-to-suit transactions. These are very clean from a capital-required perspective, the longer lease terms, etc. So the one thing I will say is that we've maintained our goal on buying accretive transactions and indeed these transactions are mostly accretive on both core FFO and CAD basis.

Okay. And sorry if I missed this, but you did increase your disposition guidance. What kind of assets are you selling? And what's the motivation for increasing sales right now?

I'm going to let Bill handle this.

Hey, Sheila. Yeah, the increase in disposition guidance relates to one asset that we were not expecting to sell, but we got a reverse inquiry on. And that asset will be an accretive redeployment of proceeds once we sell that and redeploy it. So it's an attractive return for us, and that's the primary reason why we increased disposition proceeds for the fourth quarter.

Yeah. Sheila, as you know, we have three reasons to sell assets. One is opportunistically, which this is reflective of what Bill just referred to. Two is to manage the overall health of our ongoing sale of a relatively de minimis office flex portfolio. I don't believe we have any assets that will be in the remainder of 2020 that will fall into that bucket. And the last bucket is when we aren't happy with our cost of capital from regular common or preferred equity issuance, we would sell assets. None of that is planned. Obviously, capital is attractive. The other sources of capital are attractive today.

Okay. Great. Thank you.

Thank you, Sheila.

Our next question is from James Feldman with Bank of America.

Hi. Good morning. This is Elvis Rodriguez on for Jamie. Just as we think about funding the acquisition pipeline and some of the equity forward you have, your stock today is trading about $1 above where you did the deal in January. How are you thinking about pulling down that equity this year versus potentially doing another equity deal to fund the $2.8 billion pipeline that you have laid out for us?

Yeah. Elvis, obviously, the pipeline historically we've bought something relatively small portion of what's on that pipeline actually gets closed. The pipeline is dynamic. So assets come on and off all the time. But we're certainly not expecting to close anything like that large number. I'm sorry I just lost my way.

Yeah. Hey, Elvis, it's Bill. And in terms of where we are from a leverage standpoint, as I noted with our forward equity proceeds we're at four times leveraged, so sufficient runway there to get to our 5.25% leverage range this year. As we noted in our investor presentation, our long-term leverage range is 4.75 to six times. So if you were to look at where we are today, including subsequent acquisitions and the forward equity, we could acquire $850 million with all debt to get to the upper end of that long-term leverage range. So we have sufficient capacity here.

In terms of reducing the forward equity component, we have until about mid-January to do that. Given the number of acquisitions, it's reasonable to assume that we will be utilizing that equity.

That's right.

Okay. Well, my question was, would you do another deal in lieu of that deal given your stock is $1 higher today?

I apologize if we didn't address that question. I believe the two are not necessarily connected. We have attractive capital available to us, and our capital needs can be met in a beneficial way, so it’s not an either/or situation. As I mentioned, it is very likely we will utilize that equity, but that doesn't mean we won't have other equity needs that we will seek in the market.

Appreciate that. And then just one more question. 2021 expirations you have about nine million square feet of leases expiring next year. Any chance you can share what the mark-to-market on those leases are?

I think that what we've stated previously is our belief that our assets are at or slightly below market. After examining the details for 2021, we believe this still holds true. Specifically for those assets, I would also mention that there isn't anything significant in 2021. The two million square feet we had roll this year is not something we have in 2021.

Okay. That’s very helpful. Thanks guys. Great quarter.

Thanks, Elvis.

Our next question is from Brendan Finn with Wells Fargo.

Hey guys, good morning.

Good morning.

The term on new leasing this quarter was only like 10 years, which looked like it was the lowest since 2017. Was that impacted by the same leases you guys mentioned in the prepared remarks that had an impact on the spreads, or are you guys seeing shorter lease terms just across the board?

Well, I'm going to give this to Bill to answer. But I mean, generally speaking lease renewals tend to be three to five years. So in the long run trends that's not an unusual number, but I'll turn it to Bill.

Yeah. Hey, Brendan, that was driven by really one lease and that was one of the leases that rolled down. This was a lease that we signed for a little over one year with the expectation that we can negotiate with the tenant for a longer term lease. And the first year lease was called as a teaser rate; it rolled down 18% but we expect markets to roll back up about 12% in a year. So it's a little nuance with the way it gets accounted for, but it was a little over a one-year lease, which drove the weighted average lease term on new leases down a bit.

And I'll get to use one of my favorite terms: a small sample anomaly.

Sounds good guys. And then I just wanted to clarify your comments on your plan for the GSA facility. So are you planning to lease that first and then sell it, or would you be open to selling it before signing a lease there? And then similarly, are you looking to potentially sell the 48 adjacent land once you get the entitlements for development there, or are you only going to sell the building and then just continue with developing on those adjacent parcels?

I think the answer is that we're moving forward on all fronts. We're moving forward to permit the development. We continue to talk to people who are interested in portions or all of the building. And at the same time, we're talking to people that are interested in buying any, or all in any mix as we move forward. Dave, do you have anything?

No. That's accurate.

Thanks guys.

It's an attractive collection of opportunities between the existing building and the potential for development. There are even potential buyers interested in acquiring the existing buildings, demolishing them, and constructing new ones. We believe there is the potential to add nearly 1.5 million square feet with a new building. Even though we purchased an existing structure, the value of the land in this desirable sub-market has reached a point where the land value may equal that of the existing building and the development potential. Thus, it presents a number of very appealing opportunities.

Our next question is from John Massocca with Ladenburg Thalmann.

Good morning.

Good morning.

So if we look at the transactions that closed kind of subsequent to quarter end, they seem to me, if you kind of just divide the gross numbers by the amount of assets you closed on. I think a little bit larger in both, in terms of square footage and then kind of cost per asset. I mean is there some larger assets in there that are maybe skewing that, or is it just slightly larger assets all around, as you're buying in October and in November?

Yeah, John I'm going to give that to Bill to answer. The answer is yes, larger assets but Bill will give you some details.

Yeah, that's right. I mean, John, it’s simple math there. But there's a mix. And these are assets that meet our long-term investment thresholds. As with every year, there's smaller assets and larger assets that we acquire. I mean, even looking at this quarter we acquired a small asset of 50,000 square feet and as large as 276,000. But subsequent to quarter end, there certainly are some larger assets in there.

I mean, I guess, it's kind of an arbitrary number. But I guess there's one million square footers that are skewing those numbers in there?

Not one million square footers, but big buildings.

Okay. Understood. As we consider the deferrals and non-cash payments, can you break down the 1.5% among the tenants? We're currently negotiating, or having challenges negotiating, with tenants who are in default or in bankruptcy.

Yes, tenants that have been impacted by the pandemic. I mean, they're not in bankruptcy. But we're having discussions with them. Some of them we're having discussions about potentially a deferment or payment schedule. Others, we were just working with them, to understand their situation. So it's just a mix of assets. I will say, and as we've said before, all of this is reflected in our credit loss guidance for the year. So I think when you take a step back, that's the area we focus on: what's in our same store, what's our credit loss guidance? What's our FFO guidance, all factored into that? And given call it six, seven weeks left in the year, we feel really confident with our guidance we put forth.

I know, I'm asking a bit for kind of early 2021 guidance, but do you think that kind of credit loss outlook flows into next year, or do you think you can get some recovery on those smaller amounts?

Yes. As Ben said, we'll give our guidance in February for 2021. I will say the stimulus has been probably the biggest thing we struggle to estimate and how that impacts our tenants. And thus far, it's been outperforming our estimates in terms of the recovery. As you can see with the guidance this year, our credit loss guidance has continued to come down as we move through the year.

Okay. Understood. And then on the investment front, how do you think maybe a potential kind of surge here in pandemic could impact the ability to close deals either in 4Q or maybe even 1Q 2021, just given what happened earlier in the year in terms of deal volume with kind of the first phase of the pandemic?

So the impact on deal volume earlier was not maybe for a very short period of time, was reflective of the fact that we couldn't get people out to see buildings or people weren't working or anything. The closing process was impacted by that. We have been able to utilize, through third parties, some level of travel, Google Maps, whatever else, and third party consultants, obviously, to get a closing process that is, I believe, is pretty resilient to whatever happens with the pandemic. Sort of a total lockdown, which I don't think anybody really expects at this point. So we're feeling very good about our ability to transact. Again, people have gotten used to operating – and particularly, we have been used to operating in this environment. So we're feeling pretty good about our ability to transact going forward. And the sellers are – the initial drawback from offering assets to the market, certainly has disappeared completely.

Understood. That’s it for me. Thank you all very much.

Thank you, John.

Thanks, John.

Ladies and gentlemen, we have reached the end of the question-and-answer session. I would like to turn the call back to Ben Butcher for closing remarks.

Thank you all for joining us this morning. The word unprecedented gets used a lot. But certainly, we are in unprecedented times, generally. I think that the – as I just stated, our ability to operate here has been demonstrated. The opportunities abound. The short-term malaise that may affect the country as we work through the end of this election, I believe it will be just that: short-term. We don't expect that to have any long-term impact on our business and hopefully no long-term impact on our country. Again, we thank you for your time this morning and look forward to continuing to provide good results for our shareholders.

This concludes today's conference of STAG Industrial. Thank you for your participation. You may disconnect your lines at this time.