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

Good morning. I'm Camille Bonnel, a senior REIT analyst at Bank of America. And I'm excited to be here with EastGroup's President and CEO, Marshall Loeb, to my right. And to his right, we also have Brent Wood, the CFO. For many of you who are joining us for the first time, EastGroup is a $7 billion REIT market cap rate, operating primarily multi-tenanted industrial buildings in infill Sunbelt markets. Marshall, I'll hand it to you to go over the company's strategy and any opening remarks before we go into Q&A.

Okay. Thank you, Camille, and thank you, everyone, for your time and interest in EastGroup. Camille's description was accurate. We've been around about 40 years. I hope this audio is okay or -- okay. And we're Sunbelt industrial. Our properties kind of -- some investors will say smile states, California, Arizona, Texas, Florida up through the Carolinas. And then we're last-mile shallow bay industrial, awfully multi-tenant, as Camille said. And with that -- and there's a lot of difference as like any sector, sectors within or segments within industrial. But our strategy really going back a few decades now has been, it's really a bet on the -- say if you pick Orlando, Phoenix, Dallas, Austin, we have some of our other team members here, it's about that Austin, Texas. If you get an infill shallow bay industrial or we build one in Austin, Texas, the population is going to be greater in 5, 10, 15 years. So we're a long-term holder. We build out parks and have a long-term track record. So that's kind of where we fit. We're not so much a play on the port -- or the Port of Savannah or Port of Charleston is going to pick up market share versus the Port of Houston, L.A., Long Beach. It's really about that Orlando is going to have more people. And as a result of having more people, you're going to have more e-commerce deliveries, more goods and services delivered, things like that. So that's where we kind of fit in versus some of our other industrial peers, public and private.

Thank you for the introduction, Marshall. And yes, we'd love to make this an interactive session, so if anyone in the audience has any questions, please feel free to raise your hand at any time.

But I think a great place to start, there's been a lot of concern around REITs this year, but one sector that has been performing well is the industrial sector. Even as of last week, your portfolio is essentially fully leased and 98% occupied. But when we look at logistics data points like freight and ISM, it seems to indicate that the volume of goods moving through warehouses are slowing. Can you help us understand what you're seeing in the market and how that's affecting tenant demand?

Sure. Good question. And we do watch kind of that flow of goods, whether it's from Europe to the U.S. or China, and we'll see those articles of where it slowed. And it really -- it's almost affirming to us. And again, as we mentioned, last week, we put out a press release in advance of NAREIT. And if I round, we're -- mentioned, 99% leased, 98% occupied on a GAAP or, in other words, an accounting basis. Our average rent increase this year has been high 40s, 50%. We were 50% quarter-to-date. We were 48%, 49% first quarter. So good solid growth in rents. And last year, we averaged about -- I'm doing this from memory, but about a 40% average rent increase in our portfolio on a GAAP or accounting basis. So the demand is strong, and again, it's why I mentioned it's affirming to us. What we like is -- we'll say we don't need a great economy. We just need a good economy. And then as you think about it, we're not so much the flow of goods from China to Midtown Manhattan. It's more goods and services being delivered in Orlando or Dallas or Phoenix or Las Vegas. And when you think within our markets, we picked the Sunbelt markets. California is a little bit of an outlier. It's so infill, it works for us. But all of our other markets, if we would say, if you pick just population growth in the U.S., they're all about close to 2x or more. Florida was the fastest-growing state last year in terms of population. Phoenix is fast growing. Texas has great population growth. And we're in the major markets in those cities. So if you need train air conditioning to your house or Amazon last-mile delivery or Best Buy or whatever it is or the pool supply person, it's really a bet. And so we just need the GDP, whether that's population growth or in a number of our markets, when you think of Orlando or Phoenix or different ones, it's -- tourism is a big component as well. And so as long as the tourist markets come back -- and it actually -- those are the markets, so sideline, we were worried about during COVID that's held up surprisingly well even without conventions and conferences in Orlando, Las Vegas, Phoenix. But now it's back, and those markets are still growing pretty rapidly. So it keeps us insulated really from kind of global trade and more with population growth, e-commerce penetration. And then we benefit within our markets on the Sunbelt when you think of onshoring in a lot of cases and nearshoring. Also we're in San Diego. We're in Phoenix, Tucson. We're in El Paso. So a lot of that is where we -- there's -- what I love about our model is there's a handful of secular tailwinds, whether it's safety stock for inventory coming out of COVID where everybody ran out of everything. So again, we just need a decent economy and avoid a bad one. And our model has worked well over the years that way.

And just following up on your comments around e-commerce, we've seen a lot of investment into their supply chains over the last 2 years and the demand not really continue because of the concerns around the macro environment. So how are tenants feeling about their supply chains today, whether it be investing in these omnichannel platforms or bringing production closer to the U.S.?

We certainly see, and I think -- and you all read the same articles we do, there's a large amount -- 60%, 70% of companies here, we talk of China Plus One manufacturing and things like that. We see it, again, being in Austin, and we won't pick up the manufacturer. Our buildings are -- again, I mentioned, we'll build out a business park. They're typically, call it, 80,000 to maybe 180,000 square feet. And we may build them out 1 or 2 at a time and get up to 8, 10 buildings in a park. But what we'll pick up is like with Tesla going to Austin that we've read about, we pick up Tesla suppliers in Austin and even in San Antonio. I know Tesla supplier and kind of in between Austin, San Antonio, and these are not EastGroup buildings, but there's 1 million square feet, kind of last month, 6 weeks absorbed by Tesla suppliers and San Marcos kind of along the way. So we'll pick up, and it was a TSMC building, a big chip plant in Phoenix. We've got land. We've built in Mesa, Chandler. That Southeast Valley, we prefer Phoenix versus the West Valley where land is more plentiful. It takes longer to put our sites into production because the zoning is harder. And that actually continues to get harder, things like that with neighborhoods. But that consumer demand is much, much stickier and it's harder to find those sites. So we have been picking up. I think our tenants -- we thought it's just human nature to carry a little more inventory. Everyone got so burned. And our -- and maybe another example of a way how it's affected us, when we build out our parks -- we've got Staci Tyler and Reid Dunbar here. Reid runs Texas for us. We would say we have the permits in hand for the next couple of buildings in a park, and that historically would take us 6 months to deliver. And again, what we like compared to office and retail, you can stop and start as you feel the economy turning much faster than a CBD office building or different types of product like that. But that 6 months has really grown to, call it, 10, 11 months because it's hard to get the electrical equipment. It was hard to get steel. That seems to be softening, but it's just our own ability to deliver buildings has extended. It's coming back. It's reverting to the norm slowly. And I know our tenants -- when you read about Home Depot, we have Home Depot, Lowe's, Best Buy, all the ones like that. They've all struggled to get inventory. So that's where we think people will carry a little more inventory. And we also see an investing kind of in their own modernization technology within their spaces. And then if you really go longer term with a lot of those tenants will carry their white goods, it's the things you're not leaving Home Depot or Lowe's with, a washer, dryer, range, appliances. Our pitch -- and we hope to make more traction with that, when you think within the industrial space, the big-box space, if it's a 1 million square foot building south of Dallas and we're a 90,000-foot building near the DFW cargo airport, we really don't compete. Our tenants -- our average tenant sizes are in the 30,000 square feet, multi-tenant. We've said sometimes buy online, pick up in store is as much a competition to us. And we'd like to think longer term the retail model, just because we're more cost-effective, if you have certainly delivery but maybe even pickup in a nice business park setting, then why don't you carry -- our pitch to them is carry more SKUs in an EastGroup building than in -- as you rationalize your store count at Home Depot, carry some more of that inventory that people are typically comfortable ordering online and having it delivered to their house. So I think longer term, we'll pick up even more of the kind of the retail as people go to -- keep your A stores and let your C stores close. And our goal would be to pick up more and more of that inventory. Certainly, you want to go see it, touch it if it's a larger white good item, but we already are -- as Home Depot, for example, move to market-level inventory rather than store-level inventory. And that's why all of a sudden, we picked up several Home Depot. And then Best Buy, the same thing with exercise equipment, a big-screen TV, things like that. Our buildings, you can get it delivered. You want to buy it and have it delivered to your home that afternoon. And that's really where we fit in within the supply chain.

And that comment you made earlier around retailers potentially using their stores to service e-commerce, I guess from where you sit in the conversations you're having, how has that model worked out for them having a few years...

I think it's working out -- and I'm biased, so I admit that. I think it's working out well for them. I think it's been a slow adoption. Usually, as we've approached any number of the retailers and you -- it's an education process. And usually, we end up in the real estate department, and it's someone that's spent their life doing brick-and-mortar. The head of real estate is usually used to opening stores and doing a brick-and-mortar retail store. And so it's -- we think it's been more of an education, and it's an -- I think the adoption is coming, just naturally slower than we'd like it, but I think our model makes a lot more sense. You need fewer salespeople. Our buildings are much more efficient for storage and delivery and things like that. But I think some of that's happening today. And more of that, I think, is out there in the future. And we'll keep trying to convince them to -- if you're getting 3 cans of paint and an air filter and some light bulbs, why do you need to have it on expensive high-visibility retail location? Our buildings will be 1 mile behind it typically in a major market. Let it get delivered from that rather than the back of much higher-priced retail space. And with salespeople, we'll have warehouse workers rather than salespeople. So just a different cost model for them.

And so there's been a lot of focus on how market rent growth will trend this year as demand ultimately normalizes. With EastGroup's portfolio mark-to-market being so wide, maybe you can talk a bit about that. And how do you think about rents in your markets if they grew no further or started to turn negative? How do you think about that ability to continue achieving the leasing spreads you're signing today?

Sure. We've been fortunate in that market rents have risen. In a typical year, maybe 15% of our portfolio will roll. So it takes a while -- the good news is we're raising rents high 40s, 50%. Maybe the bad news, unlike multifamily or some other sectors, it's measured in years before you can really get a bite at the apple with every tenant. So if rents flattened, thankfully, we probably have 5% to 6% of our portfolio rolling the balance of this year. We'll start working on 24 expirations as we get closer to year-end. If they flatten, the good news is we've got a few years of rent growth still embedded within our portfolio. If they come back slightly, that statement holds true. If you said, what keeps you up at night, for us, it's not -- we get a lot of questions about supply, but most people don't build the shallow bay last mile. It's more if the U.S. consumer really struggles, then our tenants are going to struggle. If there was negative rent growth, we're all affected. As we think about it, we try to mitigate our risk. The consumer demand is much stickier than port demand, for example. And if rents flatten -- they've been growing. And really, what we've seen, probably, call it, late '21, early '22, it felt like the market -- we'll use the phrase parabolic. It was just rents were growing so fast, tenants were grabbing space. It was great, it was fun, but we've also done this long enough that it felt unsustainable. It makes you a little nervous. Just anything that takes off like a rocket usually lands about as gracefully type thing. And we've seen more normalization. So rather than having a handful of tenants for every space -- our tenants are still expanding. And that's what helps within our parks, too. If it helps you kind of understand our model, where we'll build 8, 10 buildings in a park, usually the lead tenant for building 7, 8, 9 is a tenant that might be in the second or third building, and they've outgrown their space. So we kind of pre-seed our own development that way. And that's really one of our sales pitches today. Because everybody thinks they're going to outgrow their space before their lease is up. So if rents flatten, we'll be okay for a while just because we can only get to about 15% of them for a time period. And then the flip of that, which will benefit -- makes me more excited about the end of this year going into next year, with interest rates going up, the new construction starts are off dramatically in industrial. That third quarter last year and looking at 2 sources, CBRE's research that new starts were at the peak last year, right as things slowed down or started to turn maybe in third quarter, I want to say they draw -- new starts were down about 25% compared to that in fourth quarter. And then compared to third quarter, they were down 45%, almost 50% in first quarter. And I expect this quarter, by the time second quarter, especially with kind of the shakeups in the banks and all the credit tightening and things like that, that new starts have really dropped off. The other stat I recently read from Avison Young out of the -- and there's a lot that's still being delivered in the pipeline. Most of that, again, is big box, but within the pipeline, only 10% of it started in first quarter. And again, I think that will come down. So if we can -- the optimist in me would say, if we can stay 99% leased, hang on to our tenants, push rents when we can -- but it could get interesting or fun in 2024 because there's going to be no new product. So if we can have the dry powder to take advantage of some of those situations because even if rents flatten, as long as our tenants can hang in there, and hopefully, some of them keep growing with -- whether it's -- just when you think about Austin, Texas, there's just going to be more people there and more e-commerce penetration. So there will be demand for industrial even if rents flatten. Our own tenants will keep growing. There'll be more space demands. And right now, the merchant builders -- for the last few years, you could build a building and flip it before you even got it leased up. And that was a way to make money. But with interest rates rising and cap rate kind of uncertainty, it's usually 3 or 4 of us. With a financial partner, you could go build that building and sell it. But now you don't really know at that end of that development lease-up program 18 months what you can sell the building for. So that stopped dramatically. And that's really who most of our competition has been, a local regional developer with Clarion, Heitman, AEW, Nuveen, some type partner like that. And those merchant developers are in a tight spot because you don't -- you can't build it and know until the Fed says they're through raising interest rates or where cap rates ultimately settle, how that shakes out. So we like being -- if we can stay full and play offense on a tenant-by-tenant basis where the market allows us to, which the team has done a nice job, we like that supply is really falling rapidly through this. And it could be -- turn the corner. There's still supply coming. But again, it's -- usually when you see supply numbers, I'd say 15% of what the Atlanta supply is, is comparable product, and the other 85% is big-box buildings. And when you think of just the physical constraints, if you're a 50,000-foot tenant, you'll end up with a long narrow space, a bowling alley with one dot door. And that landlord can't build out that space. So it may as well be a hotel down the street. And typically, they're more outskirts of town. That's where the land is more available. It's cheaper. And the tenants that take the 800,000 feet are really driven more by cost where we've tried to not be a cost provider but a location provider.

Yes. We have a question from the audience?

Yes. You talked about [indiscernible]. I'm just wondering, going forward, the next couple of years, what are your priorities for cash flow? Where do you see the best opportunities? Is it buying more land, developing, redeveloping [indiscernible]? Where do you see some of the...

Yes, yes. I think the answer is yes to those. With certainly development, we've been developing to -- typically average about a 7% return on cost. It's in our supplement. You'll see it's kind of high 6s or 7s. There for a while, the market cap rate was in the mid-3s. So we had a great return. And again, that's when things were -- in last year -- I'll be close. I may not be exactly right. We'll pull buildings out of our development pipeline a year after construction completion or upon 90% occupancy. And 18 of those 19 rolled in at 100% lease. So if you're making those kind of spreads, in hindsight, I wish we had done 24 of 30 rather than 18 of 19. You should have gotten back -- more of that to create that value. But development still, as long as the market is there and we're kind of -- we took a lot of small calculated bets. Our average buildings are 15 million. Maybe if we build 2 buildings, it's 22 million, 25 million. So it's a lot of small bets spread out throughout the Sunbelt. And then dividends, I can -- look, I've talked the entire time. Brent, speak a little bit. It's really driven by our taxable income, which has been thankfully going up the last several years. So it will be -- we address it each August. And...

Yes. I mean basically, dividend's a function of growth. So ideally, we're growing the dividend because we're growing earnings. Just the REIT status, we have to pay out that 90% of taxable income. So we have a good, strong, solid balance sheet. Our -- thankfully, our guys in the field are continuing to find good opportunities to invest capital primarily via development in this environment. And so our goal is to continue to provide that capital for them to put to work. And so we continue to do that. And as Marshall said, we've been a bigger issuer of equity recently versus debt. That for us, it depends how you want to look at it, but call it a cost of a mid-4 to [ 4 75 ], something like that. And if you're still issuing money at that cost and you can still make a 7% return, then we feel like a, give or take, 200 basis point spread on that money as a risk-reward positive for our shareholders. We've got a very long track record of building our product type via development. So you've got it at cost in the markets in the locations you want it. And so again, from the balance sheet perspective, just continue to provide that runway. We've done it very prudently, oftentimes viewed as conservative, but that's paid off good in times like now. But even as a developer, we have a debt-to-EBITDA just sub-5. So again, a very solid balance sheet, a debt-to-total market cap around 20%, sub-20%, fixed charge coverage in the mid-7s. So again, very, very strong balance sheet position.

Yes, sir.

How much of a risk is obsolescence of your portfolio? So obviously, you're developing and [ doing these things with offers and others ]. But you have a sale leaseback. And so just wondering kind of in terms of construction of your projects, how much of that risk exists over the next few years? And how much capital do you have to put into buildings [indiscernible]?

Okay. Good. The question, if you -- hopefully everybody could hear, it was just obsolescent risk within our portfolio. And one of the things -- and again, I'm biased -- I love about industrial is it -- we've kidded, a nice way to say it, ages gracefully. If you have a good location as one guy, older guy starting out, they haven't changed the recipe for concrete in a long time. So unlike office and multifamily and retail where there's -- in retail, there's -- we say the new shiny penny that gets built around the corner, and all the retailers follow that. Really, we're responsible -- the tenants are responsible within the 4 walls where are the roofs, walls, parking lots. So our CapEx is pretty low. We do -- I think we should always be pruning a little bit of our assets. We usually sell $50 million to $70 million, $80 million worth of assets a year, kind of pruning from the bottom. And typically, it's not always the oldest assets we'll sell. If it's really older building and infill -- we've got some in Phoenix and things like that. I think in some of the markets, Dallas, others and within -- certainly within Los Angeles and San Francisco, where our founder used to say their older buildings are not the most attractive, but they're the crown jewels just because there's no land. And typically, a lot of times in those markets, there's negative supply because someone will tear down industrial -- and I know the office market is pretty choppy now, but they would build -- you can go vertical with other product types where ours in the U.S., it's 99.9% all one story. So there's a little bit of obsolescence, but we'll look at it. But even a couple of cases I can think of, and both of those were in California, we were looking at large redevelopments, but the demand has been so strong, we got the rents we needed. We found a tenant without needing to do the -- sometimes we'll put in upgrade to sprinkler system, different LED lights, things like that. But thankfully, the CapEx for our product type is so much less than others kind of around us here at NAREIT that makes me appreciate industrial.

Yes. I would just add that, too, the -- you maybe see a little more obsolescence in what you'd say bulk distribution, which we don't do, say, those 700,000, 1 million, 1.5 million square foot where super flat floors, higher -- clear heights, more sophisticated forklift equipment or maybe nonhuman-oriented traffic going through and picking things. And again, whereas we're more multi-tenant, average tenant size in that 30,000 to 40,000 square foot range. For those type tenants, they're not racking that high. So when Marshall and I both got in the industry 30-plus years ago, 24 clear in a nice truck court and a secure nice environment, worked then, it still works today. It's those really bulk buildings, the Amazon-ish type buildings that you might envision where technology and that type thing could get a little more obsolescent. But that's, again, really not in our product type with the multi-tenant.

And can you touch a little bit on the transaction market and what you're seeing there? Last year was one of your biggest years for acquisition. So do you still see opportunities to put capital in today's market?

Yes. We're still looking -- and last year, you're right, it was a large year for us a little bit. There was one anomaly in the Bay Area. There was an older gentleman who was selling his portfolio, and it was really tax-driven. So we were able to issue -- we were out -- we would have gotten -- or we were outbid on a cash basis, but we could offer equity at a price range. So that worked out well for both sides, but we'll do another one of those in 15 years type thing. It's usually a cash process, and we bid. And we look at assets. I'm looking at Reid. We bet on some things. I've been a little bit -- I have been surprised we keep waiting for acquisition opportunities. The market's certainly not as frothy as it was a couple of years ago, and cap rates have come up but not nearly what interest rates and cost of equity. So we've made a number of opportunistic offers. And we've only -- we've had a few what -- we opportunistically bought a couple of land sites for development here and there. We bought a project in Las Vegas. I think it was early second quarter, and that felt like an opportunity where we got a mid-6 type yield. It was a sale leaseback, kind of lightly marketed opportunity in a market we were underallocated to, things like that. So we got development-like yields on an acquisition. And we've made a number of offers, but we've been outbid still. And I don't know, we'll see if it turns later in the year. I keep thinking where the -- credit tightening and things like that and uncertainty. But I think it's -- there's, I guess, what we hear, there's so much capital allocated to real estate and the other sectors outside of maybe multifamily. Retail is harder to underwrite, hotels pending the economy. Office is tricky right now that people still like industrial. So we've -- and if everybody wants that -- we kind of thought several years ago, if there's this, CBRE would say, global wall of demand for U.S. industrial, we said we're better off building it than outbidding people for it. So that's kind of where we -- did anyone other than me hear that? I hope so.

Yes. So I think we are coming up to time. Just want to check that -- if there are any other questions on the floor. Otherwise, to close, how do you think about the questions facing the economy and risks here? And how do you see EGP positioned in this environment?

Yes. We certainly worry about the market and the U.S. consumer. And I guess as we think about it, and Brent, jump in, I think as a public company or as an operating company, you can't avoid all the risks, but you can mitigate them. So as Brent said, we have a low leverage, our only floating rate debt as our line, which has a pretty low balance on it. Brent and his team expand -- use the accordion feature to expand our line by a couple of hundred million. So our utilization on it is low. Our developments, we certainly watch carefully, and we build in phases rather than -- and really a Phase 2 work, we'll move on to Phase 3 and Phase 4, so we can stop the pipeline that way, and we're full. So I certainly don't want to -- if we don't accommodate our tenants' growth needs, somebody in Orlando or Tampa will. So we kind of work that way. So we think we're trying to position the company as best we can to mitigate our risk without calling a recession too early. This one does feel like -- and I had breakfast this morning with some of our bankers. We've been waiting almost a year for this recession since Amazon said, "Hey, we may have overdone real estate." And that's when people seem to get nervous, but it hasn't hit yet. But we try to keep a safe balance sheet and be as flexible as we can and stay full. Thanks, everyone, for your time. I know we're out, but feel free. We're available. Appreciate your interest in EastGroup. E-mail us, call us if you have any follow-up questions. And thank you, Camille. Appreciate your time.

Thank you.