EastGroup Properties, Inc. (EGP) Earnings Call Transcript & Summary

Thanks for joining us to talk about EastGroup Properties. I'm Bill Crow. I cover real estate investment trust for Raymond James and have a long-standing relationship with EastGroup and with Marshall. I'm really pleased when he called me up and said, "Do you mind doing this for me?" And I never turn you down for those opportunities to spend time with you. So Marshall Loeb is the CEO of EastGroup. He's got 3 of his executive team members here, who may come up and fire off an answer if need be to a question. But I always find it helpful, especially if we have new prospective investors here to just give us a couple of minutes about how EastGroup is differentiated from the peer set.

Okay. Sure. Well, thank you, Bill. I guess, first, I'll personally thank you. I appreciate the long-term relationship with you. I appreciate -- I know you've got a busy schedule agreeing to moderate and with your firm as well. For those who may not know, and I'd rather make this as informal as possible, so stop Bill and I along the way. We're long-standing and we've been public about 40 years, industrial REIT, we're through what people call the Smile State, really Sunbelt, kind of running California, Arizona, Texas, Florida, up and through the Carolinas. So that's our footprint. We're about 54 million square feet. We're an active developer, which has been a very attractive growth model or portion of our business the last decade plus. And then within the kind of -- so that's how we're in industrial, but within the industrial REITs, we tend to -- our preference is we'll build out business parks. We'll build shallow bay, ideally infill locations. Our typical building is probably average building 120,000 square feet. Now pending the land configuration, maybe 80,000 to 180,000 square feet. We'll design the building for multitenant. And that's really our niche. We're not -- nothing wrong with it, but we're not the million-square-foot buildings south of Atlanta, south of Dallas, Inland Empire East and L.A. So that's -- we're kind of stuck to that. And if you had been in our audience 10, 15 years ago, you would have -- our geographic allocation may have changed a little bit within those markets, but it would have -- our footprint would have looked very similar to that, to what it does today. A little bit -- I mentioned that we're a long-standing REIT. And if you look back, and these numbers are as of March 31. But pending as an investor, whether your investment period is 1, we kind of broke it down, and it's in our -- it's on our website and our slide deck, 1, 3, 5, 10, 15 or 20-year period. Pick your -- basically pick your whole period, our lowest return of any of those was a little over 13%. So we're proud of our return. We think we've been able to do that in good and bad markets when you go back to 2002, I guess, within that 20-year time horizon. So there's been a lot of tech bubbles, I guess, at the start of that financial crisis, this, that, COVID, Brexit, Greece debt, name whatever has been dark clouds like again today is on the horizon, economic downturn, and we've been able to produce a pretty safe, steady earnings per share FFO growth, safe, steady dividend growth throughout that time period. So I think we're probably one of the more long-standing REITs when we're pretty proud of our -- very proud of our track record and how stable that's been over the time.

Stable, yes, but growth has been pretty spectacular as well over the last 6, 7, 8 years. So it's a nice package, a nice combination to have. I want to just get -- we'll address some of the e-commerce issues and maybe some of the recession clouds that you referenced.

But as you sit here today, can you paint a picture of industrial fundamentals, at least in your portfolio?

And what's -- and Bill, you're right. It's interesting where the -- maybe the angst is and our stock price in the last month, I guess, really post Amazon's quarterly earnings result, when they said -- so Amazon grew about 180 million square feet in 2019 and 2021, and so that's really unprecedented and nobody else has come close to that type of growth. And then in their press release, which really didn't strike me as alarming anyway, said we overdid it. So I've read anywhere from maybe -- we take on 180 million square feet that you may not need 180 million square feet. 10 million to 30 million square feet that they didn't need. And if you spoke to us or one of our peers in the industrial space, we would say Amazon had really pulled back on taking new space probably as long ago as a year. So there, the fact that Amazon was slowing down wasn't really news to anyone in the industrial space, but the result was -- and look, I totally get concerns about the economy, whether it's inflation or energy prices or Ukraine or you name it, but the Amazon news, our stock went from about 205 down to about as low as 155, and we're in the 160s today. And then Amazon specifically, and I'll throw you up the handful of EastGroup stats, but they're our largest tenant. But that said, they're only 2.4% of our rents. 95% of our Amazon rents expire at the fourth quarter of 2033 and beyond. So we really -- I mean, if Amazon stops growing, we won't lease new space to them, but we've got them locked in as a tenant. We've got 2 other leases with them. So that's -- we have 4 leases, 2 in Southern California, San Diego that Ryan here, who's with me, got signed with them. And the earliest of those expires fourth quarter 2033. One new 15-year lease that just started in first quarter of this year and one that's 12 years at the end of last year. And then 2 other leases, 10,000 feet in Tucson, actually under 10,000 feet, and we're 100% leased in Tucson and a 55,000 square foot lease in San Antonio, where we're also 100% leased. So we're fine, and those leases have a couple of years left, but they're about 25% below market. So I don't want to get them back. But if they did, out of 54 million square feet, that's a normal day of business. Somebody is always coming and going when you have that many. We have about 1,600, 1,700 tenants. So just capitalism. Someone's coming and going out -- outgrowing their space, shrinking their space, leaving the market. As a company, really, our last -- the strength, as Bill mentioned, our growth, the industrial market has been on a -- as you all are probably familiar with an unprecedented run really the last 5 or 6 years. And as what I would describe as kind of a measured developer within our parks, what we'll do is build a building or 2 and as those lease up, almost like you would stack items on a retail store shelves, we'll build the next building or 2. And that's, what I view, is the advantage of not building a big building on the edge of town. It is really -- our development starts to get pulled by the market. I'll get a phone call from Ryan or one of his peers saying phase 2 just leased up or it's about to lease up. I need to build another building or 2 to have that inventory. And really -- so that's allowed us to grow our market count. We're down a little bit today. But if I use year-end or maybe first quarter numbers, we went from a little bit under $3 billion market cap to north of $10 billion total market cap, and we're probably back around $9 billion today. But it was really 1 or 2, as our CFO Brent will say, it's kind of been one brick at a time in the wall and eventually, you kind of step back. And you've built a lot. We're 98.7% leased at the end of May, which is probably within 10, 20 basis points of our record. And our record maybe last quarter or the quarter before, it's been -- it's all been fairly recent the last handful of quarters. We're 98.2% occupied. And literally, long term, if you went back on that 20-year horizon, we would tell you for multitenant industrial, much like you maybe think about multifamily or hotel, 95% leased is about as good as it gets. We've been 95% leased since second -- or greater since the second quarter of 2013. We're in, I believe, it's our ninth year of double-digit rent increases. Last year, our average [ gap ] rent increase was a little north of 30%. In 2020, it was north of 20%, and then it kind of was in the high teens. It's picked up from the lower double digits, 12%, 13% to high teens to the 20s to 30%. First quarter, it was 33%. And to date, in spite of the stock price news, the economic -- I think it feels -- I'm hoping our second quarter, it'll be in the same ZIP code, more or less. It's not -- our business has not changed much. If anything, I would say if I didn't read the newspaper and didn't have a television, I would tell you 2022 is better leasing environment than 2021, even with Amazon out of the market. Again, we have 1,700 spaces, and 4 of those are with Amazon. So it wasn't like they were our -- we were a preferred developer for them or anything like that for a 25% haircut on our stock price. Another -- if it's helpful for you as a potential investor, watch our development pipeline and that we pull buildings into our portfolio, either when they reach 90% occupied or 1 year after completion. And going back to last year, our last 19 of 20 buildings have rolled into the portfolio 100% leased. So if you see us rolling in buildings that have vacancy, I would use that as your canary in a coal mine. And on the flip of this, I would argue -- and look, again, I get calls from the field. If you're batting 19 of 20, you should go to bat more often. And the average return on those 20 buildings was 7%, and mainly because I can do the math more easily. If you assumed if we were a merchant developer, they would probably trade around a 3.5% yield. So you've got about 100% profit margin. So there's room for that. Even if market cap rates come down and our yields come down slightly, there's room of, okay, we earn 70%, not 100%. It's still an attractive business. And we've had the model the last few years of let's go as fast as the market allows us and then let the market tell us where to stop. And that's where we sit today. And within our development pipeline, if you looked at the end of first quarter, I think I may have one building in this number that's post that. We've got 12 projects that are still either in construction, and then we'll usually keep them there for, I guess, I mentioned a year or until they lease up, 12 buildings that are 100% leased are full on that. Only one of those was a pre-lease. Most everything we built is a build or develop as a spec lease. So 11 of those 12, and only 3 of those 12 are complete buildings. Two of them we bought, which we call value-add, which means someone else built the building and we'll buy them at certificate of occupancy. So of the 3 that are completed, 2 we bought at completion, 1 we developed. And then there's another 9 buildings that really we're telling our construction guys to go as fast as they can because they're already 100% leased. And the other buildings that aren't 100%, there is -- you'll see it on our schedule. There's activity in with multitenants. It's a varying range. The ones that are 0 are typically the ones we just started this last quarter, maybe we're pouring the slab and things like that. So the market day-to-day is as strong as it's ever been. It's just that Wall Street got spooked. And I would tell you, you hate to say always or never. I'd say don't get spooked about the Amazon news. We're pretty safe with Amazon. We'll worry about them in the fourth quarter of 2033 or later after that. But then the economy, yes, that does worry us. But that's why we have a very safe balance sheet. Our debt-to-EBITDA is low 5s. Our adjusted debt to EBITDA, if you give us credit for some of these developments, we've got the debt, and that debt-to-EBITDA number, it actually drops below 5x. So as we've grown our company, Brent and Staci and their team have purposely taken our leverage lower because we said if we're going to lean into that demand, let's have a safer balance sheet. So at the end of first quarter, our total market cap was about 85% equity, 15% debt. And again, we'll look at our debt-to-EBITDA as well.

Yes, go ahead.

Can you talk about the recent transactions?

Sure. Probably one in particular, I'm guessing. And then late last week, a good question. We -- unique transaction. We bought it, I guess, we call it the Tulloch portfolio or Project Gold Rush was the brokerage name. It was 14 buildings, 1.7 million square feet in the San Francisco Bay Area. And maybe I'll dive into specifics on that. But at a high level, what we liked about it, San Francisco has been one of our best-performing markets. We look back at our same-store NOI growth over kind of a 5- to 7-year period. About 3% of our NOI was in San Francisco prior to this transaction. So one of our arguably best market, right at our best market, went from 3% to 7% of our NOI. So a little bit like your portfolio. We would have said we're under-allocated to the Bay Area. It's been a strong market. We were under-allocated to California. We opened an office in L.A. a few years ago. Ryan joined us then. That goes from 17% to 21%. So that feels good. Houston has been a market, if you followed EastGroup over the years, makes -- and it's been a solid market for us and we're committed to Houston, but we were over -- a little north of 20% in Houston a handful of years ago. That will drop it down to 10.3%. And then on an accretion basis, it will add and it's 37 tenants. So as you -- any given time, somebody is renewing a lot of moving parts, but it will be based on current rental rates, which are below market, current occupancy anywhere from $0.04 to $0.06 accretive on an annualized basis to our FFO. So we like the capital allocation, like the accretion for it, why we were able to get that portfolio, we've gotten that question, and I would argue if it were a cash sale, we probably wouldn't. We bid on those tight portfolios and lose often, as I kidded yesterday. Look, I've asked the homecoming queen out any number of times, and I know the usual results of that from my days in junior high and high school. But in this case, it was third-generation member of the family selling it, Brian Tulloch, who I've spoken to and met a few times. He's late 70s. His kids aren't in real estate. So he -- and he's been in a 1031 exchange on any number of these properties. So one of them is literally next door to us in Silicon Valley, right -- one building between us, a couple more that are in Union City or where we are in Hayward that East Bay, and then up at market San Francisco, Benicia, which is North-based market. So it's 100% leased. He wanted stock rather than cash because his basis was so -- and I'm putting words in his mouth, more or less what he said, so it was a stock-driven or tax-deferred step-up in basis transaction. He was thankfully a shareholder in EastGroup prior to putting this on the market. So he knew the company, was familiar with us, and it was a bidding process, but it was a typical bidding process and that it's -- usually, what I would tell you, it's a first-round bids, second-round bids, buyer interview. And in each of those instances, you're bidding against yourself and raising your offer. But here, it was a first-round bid, quasi second round bid. And then because we acquired and merged with this company, it was a little bit of a different animal and used the phrase with him, which is so like I don't want to overpromise underdeliver because we're acquiring your existing company. I don't know at this point their employees, what properties have you sold, what liabilities may we be stepping into. And so we're able with our attorneys and he has worked through all those issues, Ryan and his team did, and we're able to get comfortable with it. So we're excited. To us, it's a -- we issued the equity at $190 a share, which was kind of the structure we had agreed to entering into the transaction in the market. Obviously, came down during that. But if you use that, and there's a couple of parcels of land, I've seen some of Bill's peers have written it's kind of a low 4 spending on how we price the land type yield. And I'd argue these were mid-3s or lower cap rate type buildings. They're a little bit older, but irreplaceable locations, business park. There's no land in Hayward and Milpitas. As you'd imagine, in Silicon Valley, it's more tearing down industrial buildings and repurposing the site for technology or creative office, things like that. So it's been -- it's a fun transaction and one I thought was going to die in a dozen times during it. And thankfully, he hung in there with us, too, I guess I kidded Brian, welcome to the public markets. Our stock goes from 205 to 155, right, as you're the grandson that sells the company business. I empathize. We very much have enjoyed getting knowing him, and he just got caught in a perfect storm as we said for him.

[indiscernible]?

I think it's -- Ryan I think it’ a – Brian -- Ryan, help me. I think it's 1/3 in the first couple of 3 years. So we're already actively working. We've gotten a few renewals done, kind of in the joint ownership process until it closes. So it's fairly stable, but maybe about 1/3 of it rolls. And what we're seeing is pretty good upside in our rents. One, this helps. And again, this is a sample of one, which is dangerous, but just renewed a tenant that market has been moving pretty quickly within our Hayward portfolio about a 40,000-foot tenant. This will show up in our second quarter stats, but we were able to really get a 200% re-leasing spread. So we're able to double and move the rents that much. Yes. I mean again, that was a lower rent, and I'll compliment Ryan and John Travis, who got that done. And that's not the -- don't put that in your model as the run rate. But yes, but rents have moved pretty quickly really -- I'm jumping away from Tulloch. What I would say, last year we raised rents by a little over 30%. We had some bigger rents, bigger spaces in Southern California that helped drive this number. This year, we don't. But our run rate is the same. And what we've seen is the rental rate growth and maybe, look, none of us have lived through inflation earlier when we did, it didn't -- I didn't have any bills to pay, so it didn't matter. But with inflation, we've seen rents grow more rapidly. It's more broad-based in our portfolio than it was 1 year ago. Not that they were bad last year. It's just that rent growth has picked up in Florida and Texas and Atlanta.

Sorry, not that [indiscernible]. You guys said that prior said the accretion, but what I'm curious is there's a 30% roll on the next couple of years and there's an upside to that. Can you give us either a pro forma accretion or pro forma cap rate...

Yes. We really, and maybe we should. We didn't -- we look at this. We'll certainly look at that. I mean, I guess maybe compared to some other buyers or other type REITs, I would say we used to run ARGUS runs, and we kind of stopped. And in part, I'll say as our founder used to say, and kid, I never met a pro forma I didn't like because no one has a downturn in your 10-year ARGUS run model and you're 5 through 7. And I would agree, having worked in other sectors in office, one of the things I love about industrial and office and maybe in retail, you can have those big CapEx sets. Our leasing costs, and this is commissions in TI, is probably averages about $0.70, $0.80 per square foot per lease term. And so we looked at how accretive is it year 1 -- and we did pencil out where is the return at market rents as a portfolio, but then we really didn't -- we didn't pick a stop date, meaning and maybe we could like where is that in 3 years because we said if it works, as again, you just don't know -- look, I guess we were -- we knew we liked the transaction at that point. And so we had 37 tenants to interview, 37 environmental reports that we didn't keep parsing it beyond that. And actually, if we did it, the tenant I just mentioned in Hayward, I don't know our budget numbers, but my guess is we missed it, even though that was measured in a handful of months maybe between our initial 2022 budgets or when we renewed that tenant, I would have missed it, too, because the rents have moved that fast. So -- but yes, there's probably -- again, what I hope is that 20% or 30% by the time those roll, if the economy can just stay okay for industrial or our product type, it doesn't have to be great with inflation. I hope that's understated today by the time we actually have those conversations with our tenants.

On deal pricing, we're hearing that especially if the wallet is more than, call it, 6 or 7 years, the pricing has gone up maybe 50 basis points. Is that similar to what you're hearing out there?

Yes. And probably with emphasis a little bit on hearing because we typically don't buy those large single-tenant longer-term assets. But with the rise in interest rates, what we heard it is more bond-like assets that those cap rates have maybe come up 50, 75 basis points, which makes sense because you -- and what we're hearing as well, and again, maybe 2 part our type buildings, multitenant with the role that there's probably some upward pressure on cap rates with interest rates going up, but when rents are going up 20% to 30%, that helps offset that. So there's been a little more stickiness. And I've heard the phrase, Again, I think with Amazon news, the market's been a little bit disrupted of price discovery, where we would buy vacant buildings and underwrite those, we really -- that train had passed us by a few months ago because we felt like the market was underwriting rents that were too aggressive and the returns weren't there for the risk you were taking for leasing up these buildings. So we've got one more project that's a value-add that we tied up literally over 1 year ago with a developer we had worked with before, and this will be our fourth building that we acquired from him. But the value-add, as we bid on those, we realized, okay, there's other people out there that there wasn't enough fear in the market. It was, okay, I'm going to underwrite where rents are going to be when this is delivered in December and we'll look at kind of, as I mentioned maybe on the toll, look at where rents are today. And that's -- if it helps us when you say why do you develop, our thoughts when you look at that type of capital and aggressiveness in the market a few years ago, CBRE, one of the brokers we work with a fair amount there. [ Phrase ] was there's a global wall of capital that wants to own U.S. industrial, and that's why you've seen cap rates come down and whether that's e-commerce or anybody's working their logistics chains, delivery, all the things like that, we said, having a checkbook isn't a competitive advantage for EastGroup. If everybody wants to own it, we're better off finding the sites and developing it and building it to create value. And that's, again, the 20 buildings that I mentioned that we've delivered over the last 5 quarters, if you can develop to a 7% return, and we'll see if we can hang on to that with rising construction costs and things like that. And then if you could sell those, not that we're a merchant developer, but at 3.5%. And that total, I'm doing this in my head, which is dangerous, is I would say around $400 million. That was $280 million, and then we probably added $100 million to that number in first quarter that we rolled in. So call that $400 million that we can put into development. We're creating another $400 million in value as we finish those projects, assuming that the 3.5 cap rate sticks, and that equates to about $10 a share in NAV besides the earnings growth, that with 40 million shares outstanding roughly. So we like that model. And again, what I feel like is by building 120,000-foot building or maybe 2 of them with a shared truck court that we lease up. And really, again, we'll get a call from the field saying, 50% lease. I've got a lease out. I've got 3 prospects. Let me get going because by the time I deliver these buildings, I'll need more inventory. It's a lot of kind of baby steps. And then you look up -- you look back and you've delivered 400 million square feet of development. And most days, we don't really sit around and think about until global numbers because it would probably scare me if I thought of it in those big numbers. But it's like, did you get 40,000 feet leased? Did you get that? Did you get that? And it's just one step at a time. But I like -- I'd say I won't say maybe one thing Wall Street doesn't understand or maybe Marshall doesn't articulate well enough, but I think our development model has materially less risk than a number of our -- most of our peers do, whether that -- sometimes that's private, public or private, by really just restocking the shelves a little bit at a time.

Yes, sir.

Maybe [indiscernible] we know their supply chain values, right. [indiscernible] I look at something like the [indiscernible] supply chain, part of the supply chain. So when I look to your company, it doesn't seem like it's very much part of the supply chain, it's much more local individual in its current business. To what extent is that true?

Let's just repeat the question for the folks in the back. But I think the question is that a lot of focus on the supply chain and some of the challenges and Prologis, for example, is right in the midst of the supply chain. But when he looks at the EastGroup portfolio, it does not seem to be as focused on, and I would throw e-commerce in there as a representative of kind of the supply chain.

And I would say that's maybe accurate with an [ asterisk ] in a sense that a lot of times, and this happened during COVID, people think we're smaller tenant spaces, you're mom and pop tenants, you're going to have credit issues. And our rent collections, really, if you stacked up all the REITs and took the names off, you'd have a hard time matching it. We have national companies, but it may be Home Depot delivering washers and dryers within Atlanta because you're not leaving because they got their white goods -- you're not leaving the store with those items. It's train air conditioning servicing Dallas or serving Fort Worth, or Phoenix or Las Vegas. So it's -- our bet is you're a long-term shareholder is really, and that's why we like the Sunbelt 10 years from now because that's our capital structure is thankfully to be a long-term owner, there's going to be 0.5 million more people in Orlando or Tampa or Phoenix or Austin, Texas. And it's -- it can be national companies or regional companies, and they're typically serving their local market. And we like being near that consumer because I think that's stickier than it is. We've worried and we were getting questions about yesterday, for example, Target saying they were going to rely more heavily, and I'm probably misquoting which I am misquoting what Target said on the ports, we've said there's probably someone in Minneapolis, in their case, or Bentonville, Arkansas deciding whether that comes to the Port of Seattle or L.A. or Savannah or Houston, that can vary. But if you're delivering into the golden triangle, call it that 10:00 to 2:00 of Atlanta, or within North Dallas, and that's where it's more location-sensitive than price sensitive, and our customers serve that local market. There's some exceptions to that. And that can be, as I mentioned, we have Amazon in 10,000 feet in Tucson. It can be large companies, and it can be Best Buy or Home Depot or any number of national companies. They need -- they may need 1 million square feet in the Inland Empire, but Best Buy or 1-800 Contacts also needs 40,000 square feet in Charlotte, that type of thing.

And maybe you're not the right person to ask on this, but I'm going to ask you anyhow. But there's a lot of talk about moving some of the production of things like shoes and furniture and other items from China and Asia over to, say, Brazil. And I'm just wondering whether that would have any impact as you think about ports and...

Yes, you're right on that. They probably on ports or maybe where we've looked at or experienced it, we -- for example, we think onshoring or nearshore is coming, that's a longer-term decision, longer-term implementation. So we bought land in El Paso. We've been in El Paso probably 20 years, Brent, because they're years ago. And we're building a building and it's 100% leased, but that's 1 of the 12 before we could complete it. We bought land in San Diego because we said -- I think in our belief is near-shoring is probably going to do more. Look, we'd love to have the on-shoring and that could happen. But it may be since you can't find the workers or people struggle to find the workers in the U.S., it could be Tijuana and Juarez, in Nogales, Mexico, which is right just South of Tucson and Phoenix. That's kind of been our play on that, and you've seen we've grown a fair amount in San Diego. We had room for park and Amazon really took our park was what we delivered. We got a 15-year lease with them, deliver that. You may have seen us, we bought 4 buildings in December of last year that were 50% leased, early right on the Mexican border. And I think that's a good long-term hold. They're building a new border crossing, we're between those and Ryan's got those 100% leased. We're doing the tenant build-out now for that. So that's where we think it may come from. Again, if it goes to Brazil, it potentially could come to -- and I guess my fear is, and we're not -- maybe I'm not smart enough to figure out does that person ship it into the port of New Orleans or Houston or Jacksonville or Miami, and that would probably be a pretty easy thing to change, where the consumer base in Orlando or Atlanta or Dallas or San Antonio isn't going to change. And that's why we like the person that needs to make quick deliveries or quick repairs, or it can be home building, things like that. We think the population base is sticky and the port traffic could ebb and flow, I guess, based on union strikes and everything else or all the different animals like that. So again, not that you can't make money in that, and there's developers that do that. We've just said as a long-term owner, maybe if we're a merchant builder, and that was our capital source, you could go build at the Port of Houston, lease it up and flip it and then have a great business. We'd rather be up North by the Woodlands and near the George Bush Airport and things like that, kind of in the center of the city we can distribute in and around Metro Houston.

We are a few minutes out of time, past time, but there's so much to unpack here in industrial and in your company and everything else, but it just flies by. But Marshall and team, thank you all for doing this and thanks for asking me to participate.

Thank you, Bill. Thanks, everybody in the office. I know we're running out of time.