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

Welcome to the 2:20 p.m. session at Citi's 2023 Global Property CEO Conference. I'm Craig Mailman with Citi Research, and we're pleased to have with us EastGroup Properties and CEO Marshall Loeb. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. For those in the room or the webcast, you can sign on to liveqa.com and enter code citi2023 to submit any questions if you do not want to raise your hand. Marshall, we'll turn over to you to introduce your company, any members of management that are with you today, provide any opening remarks. And then we'll get to Q&A.

Thank you, Craig. Good to see you. I appreciate everyone's time and interest in EastGroup. I'd rather in our 33 minutes and 43 seconds -- I'd love to have this be as helpful and as informative. So stop me along the way. Please raise your hands with questions, things like that. Joining me today is John Coleman. John's been with EastGroup 20 plus years now, handles all of our operations and development really here from -- I'll say here from South Florida, Miami up to -- based out of Atlanta to our Charlotte office. So as Craig mentioned, I don't know how much you may or may not know about EastGroup. We're a 40-plus year old REIT, industrial, shallow bay, smaller markets, typically build -- or smaller projects, buildings, kind of 122,000, 100,000 plus square foot buildings. We'll build out a park. And we're in Sunbelt market. So people will say smile states, California, Arizona, Texas, through Florida and up through the Carolinas. So that's kind of our footprint and the niche where we fit, if that's helpful.

Great. So we'll start with our opening question. Marshall, what are the top 3 reasons that investors should buy your stock today?

Okay, my top 3 -- and I was able to narrow it down. I'm a kid with that joke. I would say if you win -- as I mentioned, we're one of the older REITs here, have been around for a while now. If you picked -- pinning your investment time horizon, 3, 5, 7, 10, 15, 20 years, pick your time horizon, and each of those time periods we've averaged double digit shareholder returns, even including last year's kind of weaker year for the whole sector and the overall market. So we have a time-tested strategy. And that -- and if you go back especially 20 years, that includes any numbers of great financial crisis, COVID, this, that, you name it, rising interest rates. So that's one I would point to our long-term track record. Our model evolves, but we really haven't changed it all that much. And I've been with EastGroup a number of years as well. So kind of tying in to that with John. It's the same management team. Again, we've added members. We've added depth. We've got about 80 employees -- 85 employees in total. I like that our team has been through any number of those hot markets. So even in a hot market, you can get yourself in trouble -- which industrials, thankfully, had the last few years -- and down market. So I think we've got a time and market tested model, a time and market tested management team. And so those would be at the high level. And then my last reason more a little bit on the short term nature, just kind of looking at the market today, we -- last year, we averaged 98% occupied as a company and our average GAAP rent increase was 40% -- 49% for fourth quarter. So it's a good market. We're fully developed. We really brought into our pipeline 19 different projects last year and we'll bring them the earlier of 1 year after completion or when they reach 90% occupied. So judging those 19, 18 of them rolled into the portfolio 100% leased. So really strong year last year. And then we just put out our -- heading into Citi, we put out a press release. Today -- this year, 2 months in, we're still staying in that range. We're over 98% leased, just over 98% occupied. And 2 months in, our average rent increase has been 50% as a company. So the fundamentals. Knock on wood, in spite of the headlines really since second quarter, our team continues to keep our buildings full. And where we get chances to push rents, we were able to do 40% last year and 2 months in. Last 10 months of the year always the trickiest. But we're at 50% year to date. So those would be my 3.

Well, that's a perfect transition to my first question, which is going to be about your operating update. I mean, things still seem very, very strong here. And could you just talk a little about some of the tenant conversations you're having, the flow of deals maybe you're seeing come through, community from a leasing perspective. Like is it some deals that didn't get done in '22 in time that are kind of rolling into '23? Or is this just a continuation of that strong demand?

And I'll let maybe John chime in, because he's been active on the leasing front and closer to where the rubber meets the road. It's not that '22 carried into '23, other than I will say usually the larger the tenant, meaning -- John signed a full building lease with Walmart recently and some things like that. Using them -- those leases always take a little bit longer than a smaller, more regional typically do. Just the attorneys things like that, those take a little bit longer to get through the gestation period. We saw a little bit of slowdown in December, which had me for the moment concerned and talking to our brokers and our team. And it makes sense. The reason -- and in hindsight, they turned out they were right, was that this was really the first year -- industrial, thankfully, had been so hot through COVID with the rapid adoption of e-commerce. And then you think where our properties are located. People moving out of East Coast cities down to Florida, companies relocating to Texas, Arizona. We really hadn't had a break it felt like. And this was the first year where either people were off with traveling with their families or either the tenants were out and the brokers -- their brokers were out. Their attorneys were out. We were out and our brokers were out. So December was a little slow. But I don't think those deals stopped. And then the brokers were right. Usually, by mid January, the market picked back up. And in some instances, we're hearing them say there's more. I'm just talking to our person that runs Texas. We have more activity year to date in Texas than we did a year ago. We got get that across the finish line and things like that. And then, John, you may want to talk about some of your recent leases.

Sure. Good afternoon. Yes, the momentum has been strong carrying into 2023. The market fundamentals for my markets in the Eastern region remain strong. What's driving that is really the record low vacancy, and that has maintained into this year. So that has allowed rent rates to continue to press higher. And that -- we're seeing that upward trend with rentals rates into this year. Another trend we're seeing with our development pipeline is substantial leasing activity during construction. Our pro forma always has a construction period and then a 12 month lease up period after that building is complete. And now we're seeing a trend last year and this year more of leasing during the construction period for occupancy, certificate of occupancy. So that's a nice trend. Not all buildings are delivering at 100% lease, but either all or substantial leasing during construction. The other thing that we're seeing is a higher trend or move to full building users. We build our buildings with maximum flexibility for multi-tenant configuration. So that means we could have one tenant in the whole building or multiple tenants. But a trend we've seen last year and then into this year has been more full building leases being executed.

So guys are running about 100 basis points ahead of your full year occupancy on guidance. Is this a timing issue that you guys know there's some pending move outs, right? It doesn't feel like we're seeing the seasonality that we normally see in the first quarter with what you guys put in the operating update? I mean, is it retention coming in better? Could you just kind of go through maybe some of the drivers relative to what's in your guidance? Or guidance was just struck before the New Year and things are just running hotter and you guys will just need to reevaluate?

We'll do kind of a -- a good question. We'll do a kind of a preliminary budget. And really the way we do it, it's -- corporate will certainly work on it, but it really goes to the field and they'll go space by space on every tenant, every lease that's rolling, kind of put their projections in. And then we roll that forward, probably mid to late January. Kind of go through our process, where the Board signs off right before our earnings call and roll that out. And there's no specific vacancies. Again, we're probably down to, call it, 8% of our remaining leases. If you ask me estimate today, I think we were 8.5% a few weeks ago. We probably brought that down. In a typical environment, we'll renew 70% to 75% of that. So most of those tenants are not aware of, knock on wood, any material bankruptcies. But what we really did in our budget -- and again, you could say maybe we're too conservative in this -- is that 98% -- if we weren't public, I would call last year the best year in our company's history. Your 98% and you raise rents 40%. Your developments roll in full. And when I say weren't public because it's to empathize with our shareholders, of which we are them too. When the Fed started raising interest rates, as you know everybody got clobbered, especially the REITs got clobbered too. And then this year, budgeting off a record 30 year high, it was hard to say reading the headlines there may not be some choppy waters. So we pulled our occupancy down to 97.2%, which is still a good year. And knock on wood, we haven't seen that yet. It was maybe -- again, I hope we're being too conservative last year. We'll get often, because our buildings are a little bit smaller than some -- we're not the 800,000 foot building on the edge of town. We may be 650,000 feet building around -- ideally around the corner from your house, that we're Home Depot, FedEx, Amazon, all those packages, Trane Air Conditioning, all that originates from. So we kind of said, "All right, there" -- last year, we had 140,000 square feet of -- $140,000 of bad debt. Okay, thank you. [indiscernible]. Anybody else could hear that for a moment? I was just entering the twilight zone. So we had $140,000 worth of bad debt, it was all as a company. Last year, we ramped that up to more recessionary rate, and then dropped our occupancy, not down, but just more -- down to just above 97% down from 98%. Is that better?

No, I don't think it's your mic on this feedback. I think we're -- what? Oh, it's outside. Okay. So there's nothing we can do. That's what he's saying. But you talked a little bit about bad debt. You guys obviously layer some in every year to be prudent, right? You guys are -- we're now almost all the way through the first quarter, 2 thirds of the way. I know you didn't talk about the operating update. But if there's anything you can give us from a tenant credit perspective, how that's kind of trending relative to expectations. And clearly, we hear a lot on the retail side, watch list tenants. I mean, I know your portfolio's well diversified. But is there any uptick or changes to that watch list?

I mean, I -- if there is, it has been, knock on wood, positive. And that I'll -- our -- a couple of 3 thoughts. Our top 10 tenants were about 8.5% of our revenues. And that's about half the industrial average if you took, call it, our 7, 8 peers and what their top 10 is. And ours -- and theirs would be as well. We got them in 30 locations. So I'm trying to think of some of the names of Home Depot closes in Miami. They're probably not going to close at the -- unless they go bankrupt, they're not going to close in Phoenix and Las Vegas at the same time. So our -- and our watch list -- our team has done a good job -- again markets, full kind of coming out of COVID. A lot of the tenants that we needed to work with and give rent deferrals to as those leases rolled. The benefit of a strong market is it's a great time to weed through some of your weaker credit tenants. So they've done a nice job of getting through some of those tenants, a number of those. Our watch list is probably about at a historical low or close to that right now. And then some of the -- I will get a call typically when it's good in a rising market. Someone wants out of their space. We can work out -- I think we avoid the bad debt. That way, we'll let someone out of a 60,000 foot lease. They'll pay whatever, call it $0.50, $0.70 on the dollar to terminate. Our term fees were up last year. So again, we have that budgeted a little bit lower this year. But we've let people out of the lease because -- as tight as the market is, as John mentioned. Then we usually have that tenant that will backfill it pretty quickly and at a higher rent. So that's the benefit of rising rates. If someone wants out, we can grab what cash we can negotiate with them and have someone backfilling it usually pretty quickly. And our average re-rental cost is under $1 a foot, which, again, compared to some of the other type [ REIT ] groups, office and retail and things, that's -- it's under $1 per square foot for a term of year of lease. Most of that's commission. And then -- and what I love about industrials are tenant improvements are so generic. It may be new lighting, paint, carpet, things like that. It's really not a big number where office buildings and things like that you're getting $30, $40 or more. I guess it's been a while since I've studied an office building supplement. But I like that our costs are so low to re-tenant it. And I think that's how we've really managed our credit cost. We've averaged about 20 basis points of bad debt a year kind of if you look at the last 3, 5, 7 years. We've got more of that dialed into the $2 million number this year, but that's not a reflection of our views on our portfolio so much as the headlines. We've been reading and watching the news of, if we go into recession, how bad is that going to be and how long lasting. And that's -- and as an aside, I would say I worry much more about demand than I do supply. Supply is shutting off pretty rapidly in industrial, especially in shallow bay kind of beginning midyear last year while the markets are tight. But I worry much more, even though we're diversified tenant base, about what happens to the consumer and do we have tenant bankruptcies. But to date, we're not seeing that.

And I want to follow up on your development topic, because I think that's one thing we're starting to see in the starts numbers, that they're coming down pretty noticeably, right, which is going to impact deliveries in the back half of this year into '24. But you put that against the fact that you guys have already started 35% of your targeted starts for the year, right? Can you just talk about your overall view of your development opportunity relative to the market and maybe the relative advantage that you have and some of your peers have from a capital availability? Kind of how you're differentiated as well versus some of your peers in terms of building out existing parks versus greenfield development? And kind of walk through some of the puts and takes of that?

Can John chime in here? But a really good point. I think one big difference -- it's really helped us and a lot of our peers, especially for that shallow bay last mile product is local regional developers maybe with friends and family, maybe with institutional money, that the debt market is much more difficult than I think people realize today. And the equity markets have been hard. And with those merchant developers, the tricky part is if they build and we say -- we came to you and said, "John and I, we're going to" -- "you give us the capital, we're going to build this building, lease it and flip it in 15, 18 months," it's hard to know where cap rates are going to be, that exit cap rate. While we had falling exit cap rates and the merchant developers that all worked like clockwork, but then it stops. So many merchant developers are on the sideline. When we announced in our update, we expanded our line by 200 million. Again, our balance is low. But we wanted to give ourselves that flexibility. So we went from 475 to 675. But we had several banks not participate in that. And when I say -- and I don't -- it wasn't EastGroup so much. It's that they have a drop in deposits, as I'm learning about the banking industry, and they didn't have the roll off. So a number of banks were pencils down. So it was -- it's hard for them. So that stopped a lot of that dry powder for them. And you saw us in our announcement we've raised about 90 million in equity today because we're 98% leased, using just -- and the other regions would be similar. But I just heard this number. Our Texas developments, the last couple of years -- what we like about parks is about a third of that leasing in our developments was existing tenants really moving from, say, building 2 to building 7 as we kicked off in a park. And then with rising rents, we can go backfill building 2 at a higher rent. So that's -- and our -- what I like about our model too is we'll build a park out in phases. So we won't go build the entire park. We'll usually build a building or 2. And typically, Craig, it would be John and I who would call you and say in Phase 3 we're 50% leased. I've got a lease or 2 out and I've got 3 or more proposals. And we've used the phrase restocking the shelves. "Hey, I'm calling back to corporate to say I'm about out of inventory. I need to send some more." So then we'll build the next phase. And that's a double-edged sword. As fast as we need to, we'll build buildings and we'll run through the park. With the same token, Phase 3 isn't leasing -- where we underwrote it, we're leasing slowly. I know the cure to that isn't to build Phase 4 just because we have it on the calendar. So I like that our development starts, I think, within an existing park, and having that demand pulled from the field rather than, "Hey, we're going to go build an 800,000 foot building on the edge of town and we think the market supports it." That's a lot different risk model. Last year, our developments and our value adds that I mentioned that rolled in were just north of a 7 yield. This year, our blended starts, we announced 330. That's probably somewhere in the 6.6, 6.7 type yield. And that's probably 70, 80 basis points above our peers based on what we're building. It's a lot harder to get the zoning and entitlements and it's a lot less capital than if we built that 800 million square foot building. But we kind of take -- our development is really a sum of a lot of small calculated risks. And thankfully, that's -- look -- and if we need to drop the number this year or we need to raise it, I think I'll just follow the calls from John and his peers in the field. And if the markets there, we'll try and restock the shelves as fast as we can. But if the inventory is not selling, then we should be lowering our guidance starts. And I -- look, we'll build it later. The land is not -- the shelf life of land is pretty good. We'll have some carry. But if we need to sit on it for a little bit -- and thankfully, the good side today and -- I want to get too cute because the demands there. But with the stop and slow down in construction starts, we're starting to see a drop in construction pricing on some of the components. The delivery times has gotten faster, construction pricing. So we probably get paid to wait a quarter or 2 as well in terms of construction pricing. I'd say I don't want to get too cute because I don't want to miss the demand, especially if it's one of our existing tenants that wants it, because if we can't accommodate their needs, someone else in the market will.

And as Marshall mentioned, the parks setting is our preference. We don't have a lot of single building sites. So we focus on multi-building parks. And the land inventory is a key part to that. So in addition to having our ongoing development program, we're always looking back, saying, "Okay, when is the next site going to be needed?" And with the entitlement process, wetlands, brownfields, now we're looking more at 2 to 3 years for some of these sites to be put into production. So I like where we are now. We have those -- the inventory to maintain our development program moving forward. And then just to give you a sense on the success of that program even into this year, on new development leasing this year, I can think of 600,000 square feet -- 500,000 to 600,000 that's been leased in new developments. Just more recently, in Florida, we had -- in Orlando, Tampa and Fort Myers, 470,000 square feet that was leased. And then also in Charlotte and Atlanta new developments to bring us up to that 500,000 to 600,000. So very strong performances. And as Marshall said, we're able to accommodate expansion of existing customers. So these leases haven't been companies that are downsizing, moving into smaller spaces. They're actually upsizing or expanding in certain situations where they're taking more space. And again, with a multi-tenant park configuration, we're able to accommodate that growth and then keep them in our EastGroup portfolio.

And as you think about the inputs to the development yields, right, construction costs have been a pressure for people. Rent growth has been the offset. Land prices have been the plug, right? What's happening to land? You guys have been acquiring some stuff lately. You did a project in Austin that I believe was fully entitled that you guys stepped into. And so, as some of these developers have gone down the process so that we can't get that ultimate financing, I mean, what do you guys think is going to happen to land values for industrial sites? And what does that mean for -- maybe for some of these projects that you're going to build out in this newly acquired land? Could we see development yields actually tick up above that 6.5% to 7% range over time? Or is that sort of a longer-term sticky kind of line for you?

There's probably, yes, a -- a good question. But a lot to that and a good memory in Austin. And we've seen this play out. It was more local, regional group. They had the land tied up. They've gone through, gotten it zoned, entitled. And really, the last several years, you could be a developer, a successful developer without breaking ground under that model because then you could turn around and sell it to someone else and just move to the next site. And that's really the value. But here, they got caught in the sense that -- as I mentioned, it's so hard to get debt and equity. They couldn't do a joint venture. The clock with the seller was running out. So we were able to step in. And we're -- early last year, it would have been X. But luckily, they had added the value. Their basis was, "Here" -- it's like, "We're the certain buyer. We're in the market. We've got the balance sheet. We can use our line of credit to close. And you can make a little bit of money or let the clock burn off and have a loss, basically have that all returned back to the seller." So we've seen some of that. I think on the land pricing -- and it certainly has been a run-up in industrial. And John chime in if you see it differently. You probably have 2 camps. You have the long term kind of the farmer, the rancher depending which part of the country. And those land -- they've owned it for a while and those land prices are probably pretty sticky as they go up, because they don't need to sell it. Where we're seeing some of these analogies, wreck cars on the side of the road will be people that may be similar to Austin in a couple of cases where it's a local, regional developer. And we've pursued some of those in cases where I've heard where the lead times were so long. I heard one where they had ordered the electrical equipment, one where they had ordered the steel already and things like that, and they can't get their capital. Or the building is built, it's not leased. There was one where the construction loan was coming due. Actually, they had built the park out all at once, which isn't our model. So we're seeing maybe -- we're not so big that we need a lot of it. But if we could pick up some financial distress, I think that could be some opportunities for us this year similar to the one we closed in Austin last year. And construction pricing, it's interest -- or development yields, it could because rents are still climbing, maybe not quite as high a rate as a year ago, but again, their rents are still going up. And with construction pricing coming down -- what we delivered last year and we'll underwrite and approve it at current market rents, I'll say when it rolled into the portfolio, we were probably 30 basis points above our underwritten goals where we approved it. And so I could see that model continue. I like our model, because if you let John and I underwrite future rents, we'll meet your investment horizon, so what your hurdle rate is. So we've stuck with current market rents. But that makes it awfully hard for us in an up market to buy land or buy those value-add vacant buildings because someone else is willing to extrapolate 10% rent growth out for a decade, and that's just not reality. So it's been nice to maybe have a little bit of a dose of reality starting midyear last year. And maybe -- it was great when it was that hot, but it also felt unsustainable and it made you worry you don't want the market to be that hot where -- I have kidded the analogy: it's like your Uber driver giving you stock tips, where everybody was becoming an industrial developer. We may need a little bit of pause in the market. And this is usually when we find our best opportunities too. It has been every -- the downturns aren't fine, but the best times to find land and new investments has been if we can have capital and not that many people in the market have it. And right now, it's -- given where our line of credit costs are, it's accretive to our earnings to actually issue the equity with the uses, kind of at or around consensus NAV, pay down the line of credit and have that dry powder and take some risk down. Although it's a safe balance sheet. You always want to -- if I could have it a little bit less safe, sure, why not. I think we can do that.

And maybe to take it back to leasing for a second, because you guys are one of the few that's maybe positioned a little bit more for onshoring or near-shoring given some of your Texas exposure. Could you just talk about kind of what you see as the real opportunity there? What time frame for something like that could be? And maybe how big of a demand driver it could ultimately get versus maybe some of the rhetoric?

I think it's there. And I think -- look, we -- 2 or 3 where we'll benefit as kind of -- as you mentioned, we're in El Paso. We're in Arizona. We're in Phoenix and Tucson, even closer to the border. And then in San Diego. And San Diego is interesting in that where it benefits, you've got the city pushing industrial south towards the border. That's the last -- the city has become so much life science, biotech. Industrial is getting pushed south. And then you've got Tijuana pushing it up north. And they're about to finish a new border crossing. So last year -- it was right out a year ago, we bought 4 buildings over 600,000 feet that was 50% leased that CalSTRS was exiting, was the capital behind it. We were able to get that leased, and we actually beat our pro forma there because market rents were rising. And one of the big leases we signed was a medical device company that manufactures in Tijuana and then they ship across the border. One of our larger tenants is Chamberlain, which is a Blackstone entity that got acquired, and they make garage door openers. If you have a Craftsman or Chamberlain or Liftmaster garage door. So vend the [indiscernible] toward the plant, and then they ship it across. And then El Paso. And maybe we -- I'll mention, one of our -- we just had our Board meeting last week. One of our Board members has just retired at the end of the year, was the former CEO of FedEx Express, which is their largest division. And so he had global sales for FedEx. He's convinced that the China Plus One that you hear about, that you can't shut everything down in China. But people got so burned during COVID that whether it goes to India or Vietnam -- and then we're still seeing within Texas probably the higher price of the good, that Texas is -- we've seen a pickup in manufacturing -- no, it's a Texas market. Some of that may be Tesla related. We picked up a number of Tesla suppliers in Austin and San Antonio in the last year. So we do see a -- which has been interesting. We usually get the light manufacturing or the supplier. We don't get the plant itself, but the people that need to be near that. So I do think -- look, I'm excited. I don't know the scale of it other than it could probably be pretty material. We'll stay on this side of the border with it. But we built a building for the first time in probably 15-plus years in El Paso and leased up before we could complete it. And so now we're looking for more land in El Paso. In San Diego, I mentioned the 4 buildings we bought, those leased up within about 4 months. We got those leased above pro forma. We had a land site that we were going to build a park on. And then Amazon came and said, "We'll take the entire site and we'll take it for 15 years." So our park quickly became an Amazon building. But we've got a couple of other sites we're noodling our way through. So we need -- again, what we'll typically do is take on a little bit of inventory, and then as we work our way through it, rather than take a lot on in a market, let us work through it methodically and then get back in line as quickly as we can. I thought we had a long-term site in San Diego. And the good news is Amazon took all of it. So now all of a sudden, the coverage -- Bay area in San Diego, we're 100% leased there. We need to go find that next opportunity. And in the meantime, we just needed to get the capital lined up for that, which has been more worrisome in the last 8, 9 months than it was the prior 3, 4 years, we had that luxury.

Great. So we'll move on to some rapid fires here. So what do you think same-store NOI growth will be for the Industrial Group, not necessarily EastGroup in 2024?

2024, 7.5%.

What's the best real estate decision for EastGroup today, buy, sell, hold, develop, redevelop?

Develop for us.

And then do you think that there are more, less or the same amount of industrial companies in a year, public industrial companies?

Less. Less I can say for the last few years.

How is your change of control?

But we have an industrial dinner Tuesday night, every night of this. And every year, I've kidded we need a smaller reservation at the tables, I guess, for all the guys put together.

Well, thank you, guys, and enjoy the rest of the conference, Mike.

Thank you, Craig. Thanks, everyone.