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

All right. We'll go ahead and get started and I'll introduce myself. I'm Bill Crow. I'm part of the real estate research team at Raymond James, and I cover industrial, office and lodging sectors. Fortunate enough to have covered EastGroup for 27 years or something like that. It's been a long time. And with us today, we obviously have the whole team. I'll introduce Marshall Loeb, I'll let him introduce the rest of the team members for you. And Marshall Loeb, if you could maybe go into an overview, I want to drill down into some of the supply-demand trends that we're seeing, but maybe an over view on what makes EastGroup, EastGroup.

Okay. Thank you. Good afternoon, and thank you, Bill. Thanks for agreeing to host. I know you -- I was curious, I know you had covered EastGroup for a long time, I didn't realize your career has done 27 years covering us and I'm surprised. So thank you. With me are Brent Wood, our CFO; Staci Tyler, our Chief Administrative and Chief Accounting Officer; Reid Dunbar, who runs our Central region, which is mostly Texas, the major Texas markets, along with Tennessee and we threw New Orleans in as well under that. So it's great to be here at the -- I felt like I'm at the first at this church of Manhattan with everybody sitting in back. I felt like the back row is sitting more crowded than the front row, but glad you're here wherever you're sitting. In terms of EastGroup, overall, maybe there's a 2-part answer, if I may, I want to eat up all the Bill's time, kind of longer-term answer, I would say, and go to our website, if you click on our road show, our investor presentation. If you look pending what your hold period is, if you go 1 year, 3 year, 5 year, 10, 15, 20 years, I think it's this far back, the lowest return we have in that is about 11%. So we feel like our strategy is where it has been. We've been through about every economic up lag, down lag, GFC over that time period. And if you said, what we're doing isn't that much different than we did 20 years, it's evolved but we are shallow bay, multi-tenant industrial buildings and fast-growing markets. Our footprint really runs as people say the Smile States, California, Las Vegas, Arizona, Texas, up through Atlanta and up to the Florida and the Carolinas. So our -- as you look at that, what we like about our product, we are shallow bay, which is maybe another way of saying last mile. We're not the goods that come through the ports of LA and Long Beach and get to New York or Chicago. It is more delivery and parts and repair around North Atlanta, around South Jacksonville, Northeast Dallas, Austin. So we're really where people need -- as the way they compete more and more with that last mile delivery. That's where we fit in and we'll touch on that later. That's why there's so much less supply. So overall, we like about being in those growth market, our GDP, if you market weight it, over 5 or 10 years, it's roughly 70% faster than the U.S. average. So I think that makes our job easier. It's not a zero-sum game. There's tenants moving there. Our balance sheet, our leverage level is low. We're a little below 4x debt to EBITDA. Fixed charges, debt to market cap is probably around 18% today, pending stock price. We have no floating rate debt and our debt that we do have is all fixed rate, thanks to this team here. We'll build a product that if you go back what we do with shallow bay, if you look back going all the way to '06, and you'll see this in our road show, the availability has never been as great as the big box in any point in time going back over that 18-year period. You can probably continue to go back, but that's where we kind of started our measures. So we like building. What we build is different than our peers. Lands harder to come by and then the way we develop it. So we try to take that risk out, whether it's being in fast-growing markets, we're geographically diversified across a number of markets. Our top 10 tenants account for a little bit less than 8% of our NOI, and that's about half our sector average. Some of our peers have had -- and Amazon is a great company, more Amazon exposure than our entire top 10 tenants that are in multiple locations. So along the way, what we've tried to do is take that risk away without reducing your return. When we build a park, the majority of our properties ideally are in a park setting, and we'll build as many buildings there as we can kind of squeeze in the park and then buy the contiguous land if we can. But we'll build it 1, 2, 3 buildings at a time. And as those lease-up, we'll build the next building where some of our peers will either build the entire part or build out 800,000, 900,000 foot or greater building on the edge of town. We're a couple of buildings and we've used the retail analogy as Blue Sweaters, as we sell Blue Sweaters, we'll add 1 or 2 more. And so we'll go as fast and awful lot of our leasing is existing tenants outgrowing their space, and we can move you from building 2 to building 6. And in the meantime, industrial REITs thankfully have been rising the last several years, a little bit of an update, the last 6 quarters on a GAAP, so kind of net effective rents. Our average rent increased over that period. We're in the seventh quarter that, knock on which should be north of 50%. The last 6 have all been over 50% rental rate growth. This -- 2 months into the quarter, we were at 70%. The release we put out last week, I think that will moderate somewhat by the time we get to the end of the quarter, but we've had this, thankfully, this great tailwind, whether it's population growth, e-commerce, you all have read about nearshoring, onshoring and we kind of run from San Diego through Tucson, Phoenix, El Paso and benefiting from that into San Antonio and Austin and Dallas, kind of the green belt for energy as they call it, it runs through the Carolinas to Georgia. So I'm grateful for all the tailwinds we have. And if we can just be prudent about finding those opportunities and not go kind of that happy medium too fast or too slow and maintain a safe balance sheet. It's a pretty safe, stable model that over 20 years has produced at least an average of 11% return and pending what your time frame is, a lot of cases much better than that. So I've probably rambled enough and I'll let you guys speak.

You're not using my time. The objective here is to let you speak. I think that's a great answer and I like the comparison to others in the sector. So if we could think about that mindset going forward, I know there's a lot of concern right now about both supply and demand. And we got a little bit skewed or we're in some unusual circumstances the last few years. What are you seeing out there compared to what we saw in the last few years to what you're seeing today from a demand perspective. We will start there.

Okay. I'll start, and then I may pull you in. What we've seen is kind of coming out of COVID, we had -- unlike any time we've seen just this frenzy for industrial space, which is great. And that's some of those embedded rent growth that we're still working through the 50% to 70% rent increases. It moderated as you would imagine, when interest rates started going up, and now we're in our second year of that moderated, it went from great to good. But -- and you've seen it in our release last week, where we ended May were 97.7% leased, 97% occupied. So I'm an optimist, but what I like about that, if you kind of think in my mind, it's almost a 3-legged stool and that we're full as interest rates went up, the other benefit of that is industrial starts went down. So starting in fourth quarter of '22, starts went down nationally, starts are about down probably 30% from where they were at the peak, so that -- and it will take a while for what we build and so much of our competition is local regional developers, and they don't have the balance sheet to carry the land. We bought a good half dozen of those type sites last year or so where they had everything done and due diligence, it was time to close and they couldn't close. So we were able to step in, read was a couple of sites in Austin, Atlanta, Tampa, Denver, a number of sites like that. So with starts down and we're full what -- if you'd say what we need, we don't need -- with the tailwinds, I've always said, we don't need a good economy, we just don't need a bad one. I'd love to have a little bit of an [indiscernible] of business confidence. Renewals have been running higher than historically averaged the last year. And my amateur read in that is that there's hopefully pent-up demand when renewals have run higher as a percent, it was during COVID. And it usually works the way that Brent and I say we need more space, we call you at corporate, you'll say, make do for a little bit. And then at some point, they finally relent. So I think we're hopefully in that make do period before I thought it's when interest rates come down or maybe now it's post-election or every headline seems to be bad and every time a Fed governor speaks somewhere, our stock price drops $3. It feels like over nothing internally related to us. So we just need a little bit of business confidence because there's no supply. And when it does come back, we've got the team. We picked up the land sites. We've got the permits in hand, and we have the balance sheet. So I think we'll have a couple of year head start on our peers, which everyone will be able to push rents, but we'll be able to accommodate that pent-up demand, we just need -- and it is leasing and maybe that's we'll turn it over to Reid. We feel a little better each month this year about the leasing environment.

Yes. So from a demand perspective, I would say that Q4 was slower period for us, especially as we came down off the highs of 2022. But incrementally, every quarter, we've seen an improvement. So Q1 was a little bit better than Q4 and Q2 has been better than Q1. And I would say in the last 30 to 45 days, the team overall in the field seeing definitely an uptick in prospects and demand as well as if you heard us speak earlier in the year about tenant and their decision processes that was getting lengthened out. Now it feels like tenants are stepping up and making decisions a little bit quicker and see a little bit more need to take down space. So we're pleased where we sit now, and we have probably more prospects for space where before maybe we had 1 prospect for space. We're now seeing multiple prospects for 1 space. So that gives us the ability to either maintain or even push rents in what some people believe is a slower environment. But for our multi-tenant smaller bay product, we feel pretty good about where demand stands today.

And it's interesting because we've heard from others that maybe March was a little bit of slower period. And of course, that was used in many cases to provide the commentary on the first quarter earnings calls, and things have actually improved so on.

I kind of heard that too, which is saying it's like, yes, we did -- March was an especially good or bad. It was -- with Reid, it was kind of late last year where prospect activity felt lower and then it's been a little better and a little better. And maybe if this is helpful, I mean, one analogy we've said like during the GFC, one of our guys said, we're getting lease -- space lease, just like, look, I would offer more free rent if I just had someone to offer it, too, that no one was out looking for space at that point. The e-mails I get or if we run through our development pipeline, as Reid said, we've got names and full building users and activity and leases out letters of intent, it's just getting them -- I'll stick with retail, getting them to the cash register, getting people to have a little bit of a sense of urgency about it. And it feels like it's getting slowly better and maybe for a couple of people where we've got a lot of hearing that we've got multi prospects. Because when someone misses out on a space, all of our customers come to us through tenant rep brokers then that word will spread pretty quickly, and that may also help -- where before people were in the -- run-up people were afraid of missing out on space, now it feels like we'll evaluate it and the other comment which makes sense is we've raised rents over time, and we still see that upward pressure is that you went from being a real estate director decision to a CFO decision because the dollar commitment has gotten greater. So it takes longer for our tenants to commit to that space. So that part I get, and it makes sense. And the other side, where you hear about the industrial markets that this is helpful, I would say kind of 2020 to maybe mid, early part of '23, you could buy any industrial REIT, and we're all doing well, thankfully. The supply that came out -- and again, this -- I'll keep referencing our website. We worked with one of the research firms and the square footage that was delivered in buildings that were 140,000 feet, so not that great and above over the last 5 years, grew by 32% and our average building is 95,000 feet. Our average tenant is 35,000 feet and buildings are 140,000 feet and below, the square footage growth was under 6%. So it's -- and it makes sense. If you think it's easier to go south of Dallas, Inland Empire East, South of Atlanta and find a big site of land that you can get more zone, there's less neighbors to protest your permitting change, get it zoned entitled, and so many of our peers are so much larger on the institutional scale, they can put so much more capital to work on an 800,000 foot building than our $120 million or maybe $220 million, $114 million building, we just need to do it in scale to kind of keep moving it. And we've -- that said, we've always had earnings growth and NAV creation as goals, but not -- we've never said, look, we can grow. That's easy. You just outbid everybody else, but we'd rather create -- we need to create that value over time. So we've never had growth for growth as a goal or we've never had capital that we needed to place maybe some of the funds that have raised and they have to go put it to work now.

Well, Marshall, REIT investors are selfish. They want not only that 50% or 70% -- I should say greedy, 50% or 70% mark-to-market on lease roll over, they want to know that market rents continue to grow higher. And I like your perspective on what you're seeing in market rents broadly in the U.S. in your markets, I should say. And then maybe Southern California dive in there a little bit.

We would say -- as I mentioned, we had that great spike in rents, I mean there's bit better. This is not to scale as I draw in the air with my finger, especially for those of you who are listening on the webcast, but we had pretty vertical rent growth there coming out of COVID. It's still growing absent -- and it's interesting and inputs will come. I'd say our 2 of our best historic markets have been L.A. and San Francisco, where they've really been 2 of our tougher markets the last year or 2? And if you read any brokerage group's report, it would absent those 2 markets, it would say absorption was here, deliveries were here, kind of big box included. And the good news is construction stock, so it's going to normalize. If you read those 2 markets -- it's not the new deliveries, it's absorption has been negative. So that has us being -- we like the California markets, we like diversity, but those have behaved differently than they have historically, the last couple of years, and I'm not quite sure if I can explain why, but we've watched those. And as I was drawing our rent growth had this great run up, it's still growing absent those 2 markets, but we've still got embedded growth because it had such a great run. And then I think when you take our markets or maybe 4% bake-out, we're 98 leased and you take new supply out because it takes 10 months and that's once you break ground. But if you go through the permitting and the zoning lot of cases, that's -- most of that's probably 2 years, depending which area, it will take a while for new inventory to catch up. So I'm expecting/hoping there'll be this next squeeze on rents because when people are ready to move again, and I don't see e-commerce going away or all the different drivers near-shoring in our markets where -- are just population growth, people moving to Texas and Florida, so I think we had a rent kind of squeeze. It's still going forward absent 2 markets albeit at a slower rate. And then I think it's going to get another squeezed for a few years, and that's really what will pull our development starts forward too, because there's just that lack of available space.

So we've gone up and just to draw that same chart, you've got up and then now we're at a much slower -- almost horizontal line.

Kind of single digits, double digits to single digits.

Okay. And you anticipate potential acceleration next year?

Yes, I think it's -- look, I've been waiting for an interest rate like all of us. It's going to come in March. It's going to be -- it's 90 days just on the 90 days from when no one's told us, but I don't know if it's after the election. I think -- I'd like to continue late this year to into '25 is when we'll feel it. Whenever people feel a little better about things or when corporate finally relents and says, we'll let you have more space. And we're seeing that on the margins. I think today, and maybe when people miss out on some space, when does it get better? When does everybody -- the pendulum always swings too far one way the other, when does it start moving back and that's where -- again, look I would say, from a high and a low our earnings have gone up, maybe one other reason to own us, our fundamentals are really solid, 98% leased, raising rents 50%, lack of new supply, we're in our seventh quarter of shrinking supply, and I don't see that turning given capital markets anytime soon. And then I'll layer in on that, and we're at our lowest stock multiple that we've been in about the last 5 years. So I think that's what I felt like sentiments swung when some of our peers cut guidance. We felt like, we got -- we maintained our guidance, but we got caught up in the wake of just -- it felt like the world was saying industrial has been so great. We will go to these conferences the last few years, and it's -- when does it finally drop and it's hard -- just as hard for us to predict it. We would just say, watch our occupancy and watch our rent spreads and our development pipeline, how that's leasing. And it's still moving forward. It's just a matter of how fast is it going. Our bad debt, I'll let Staci and Brent still feels manageable. Our term fees are low, which is kind of another red flag or maybe yellow flag.

Sure. So I'll just speak to our tenant credit, and that is really looking good. In first quarter, we had a couple of tenants that surface that we recorded bad debt on, and we we're wondering with all the news and we'll just keep waiting for the ball to drop. Is this the beginning of a larger problem and thus far this quarter, we have not seen any indication of that thus far. So -- we have about 1,400 tenants in 1,600 spaces and we keep a very close eye on timing of rent collections and our AR aging and really keep a good pulse on that and things are looking good thus far. And we are hopeful that, that will continue. It's just as Marshall alluded to, when the interest rates be cut and what type of impact will that have on our tenants over time, time will tell, but thus far, we are continuing to see strength in our tenants and their ability to pay rent.

If you could talk about the -- if you could dissect the tenant base a little bit. Where is the strongest demand coming from? How is that housing renovation -- just where are you seeing strength and weakness?

It's pretty broad-based, thankfully. And Reid, maybe chime on rent lift -- food and beverage, we've got questions about 3PLs, and we haven't seen them pull back maybe the way the big box has. That's been still pretty solid for us in terms of no lease buyout, sublease, anything like that. We picked up more green energy users as kind of as that's bubbled up. And then I think the other thing about our markets will have -- with the manufacturing, we've done very well in those -- so last year, our average rent growth was 50% as a company rounding. And if you look at San Diego, Arizona as a state and then El Paso, those averaged to 100%. So really strong in those markets and friend shoring is the phrase I've heard this week. We think China plus 1 manufacturing is a positive trend. I know that they just had the election in Mexico, and there are some questions. But I do think there's -- that is a long-term tailwind, we can hopefully benefit on part of our portfolio, not all it won't affect Charlotte or Florida. And then of late, it's just [indiscernible] there's an aside, tire guys. I'm not sure I can explain that. But when we looked on our prospect list, we had several tire distributors. So it's a broad mix of -- if you're out and you want to take a tour of an EastGroup building, let us know if -- there's a million ways to make a living out there. We like infill, functional, inexpensive compared to other alternatives. There's a million ways to use our buildings medical, pharmaceutical fulfillment. If you're on a recurring prescription, we've got several in Florida and Arizona seem to be where they locate where Blue Cross or UnitedHealthcare will push you to order online. It's cheaper than go to Duane Reade, CVS, Walgreens, and so we've got some of that used in the back of our warehouse where it is a pharmaceutical fulfillment one, where they'll deliver to your dialysis center, one delivers to nursing home. So it's a little bit of everything, which I think is good. And when I think of our tenant base, I think as Brent has said, some of our old line tenants when you first started the full supply, HVAC, home building, we have the Budweiser distributor in Jacksonville, all those tenants are still there. And every few years, it seems like I will get a call from the field, and it's e-commerce and then it's green energy. And then it's this or that, there's some new use -- those old tenants aren't going away, but there's a new use. It's Home Depot, Best Buy, Lowe's carrying their white goods on a market level rather than a store level inventory. And with kind of their thinking, as Andre said, you're not leaving a Lowe's with a refrigerator or a washer dryer, but if you have an EastGroup building that's an infill location, we can get it to your home this afternoon. So come to the store, pick it out and rather than have that housed in the back of the store, they started carrying more and more white goods with us. And so that is the different use in the last 2 to 4 years.

Let's look at the balance sheet for a second. I'd argue that you're underlevered. But I would also recognize that the times that the companies need capital is the most expensive. So you get them and you can get it more off than that, but kind of give us your philosophy on raising capital, using the equity to drive your growth.

Sure. Yes, I'll jump in, Bill, thanks. I've heard the phrase underlevered, even our Board said, "Hey, how low do we want to go with our leverage in it." We haven't had specific goals about trying to get low. It's just for us for the last pretty much 24 months running now, our most attractively priced source of capital has been our equity. So we've been in a position thankfully to very accretively issue that equity and put it to work. And so by doing that, we have significantly delevered the balance sheet where we've gone under 4 on our debt-to-EBITDA, our fixed charge interest ratio. We've gone north of 11x, which is really high. And so it's really been by default that we've delivered as much as we have. We've been able to issue equity previously, say in the mid-4 that with some price get back as Marshall alluded to, we were now probably at 5, 5.1 or so cost of equity. But when you compare that to long-term debt, be it private placement or 10-year type term, you're still looking for us at our rating at somewhere around 6. So it still is an attractive source. We certainly have cleared the path for a lot of runway to where when rates at whatever point they do come down, we're going to have a lot of capacity, which will be exciting if opportunities are there to lean into that. The other thing I would point out is we've been issuing capital because Reid and his counterparts in the field have been finding very attractive opportunistic places to put this cap. We have been raising capital for just the sake of doing it. We've been putting it to work via opportunistic acquisitions. Our development pipeline is averaging about a 7% return. So even still issuing equity at 5% and bringing back 6.5% to 7% yields, it's still been attractive to look the pendulum will swing. And when it does, we've got plenty of runway for debt. So we're in a good -- we're in a very good balance sheet position to be able to just continue to navigate whatever direction we want to go.

I should have asked this question earlier, apologize we only have about 2.5 minutes left. Are there any questions out in the audience?

It's obviously been a muted transaction environment, but would be curious to hear what you are seeing in terms of trades in your markets where your guys' cost of capital is for acquisitions, and then technology development is challenged as well. What do we need to solve for in development today?

Yes. Good question, and I'll repeat it real quick and get someone -- what are we seeing in the acquisitions environment in terms of cap rates and then our development yields. Our development yields kind of what's in place is we're trending at a 7 type development yield. Cap rates had gotten as low. It's kind of at the peak, we were developing to a 7 and they were maybe 3.5, 3.75, that come up some. But -- and then on the acquisitions, it's almost -- I thought like there's 2 buckets. If it's a portfolio of any size, 3 or 4 buildings, it's still trading sub-5, and we've gotten clobbered. And we're usually -- we'll make offers, and we usually have during the peak, when there's a -- some of the brokers with a global wall of capital that wants U.S. industrial. So we've said we're better off making it than bidding against the world. Where we found opportunities, and it's been 7 buildings. We've sold some of our weaker portfolios you all sold us. They've been leased to a couple of projects in Jackson, Mississippi. They were leased, but that's -- the rents are going to grow faster in Nashville, where rent found an opportunity. We entered Raleigh. We sold our only office building. It was a 2-year process with probably 3 different buyers in suburban L.A. We sold some R&D land. We picked up in a portfolio. We can move your capital where it's going to grow faster. And on the acquisitions, we still get clobbered on the portfolios, but where we've -- the 7 projects we've bought, our ability to say we have capital in this last environment, and we can close in 30 to 40 days has been a point of differentiation where it wasn't. And if you went through the 7, a couple of those where they had been to market, someone had tied it up, they didn't close. We probably most -- we bid on it. But we weren't the high bid. It comes back. It's got a little bit of a stigma. So what do I not know? Why didn't it close? And we -- and they've averaged. So of those 7, the average age has been just over a year old. We're a little north of a 6% yield on those. But -- in 1 case, it was -- so it's been the market didn't close. Pension fund needed liquidity, and this is what we were told by the brokers, they couldn't sell their office building, and they needed liquidity and a quicker close by quarter end. And we were able to step into that. One, a group that tied up a vacant building, had gotten at least so they created the value, but then they weren't able to close. So we assume that contract. So we've kidded at the conference. It's kind of been the Statute of Liberty acquisition. Give us your tired, your pour, your huddle masses, give us some things that's got something is gone wrong capital markets and we can step in. So we've managed 6.1, 6.2 cash, maybe 6.5 GAAP, call it, 6.6 to 6.7 as people say stabilized or mark-to-market rents have been a little below. And then our flip as we think of these, they've added a dime. So we spent $280 million. It adds a dime to our FFO, if you match it up to the equity we raised that quarter. But I would put all 7 of those in the top 1/3 of our portfolio or more there Southwest Las Vegas servicing the strip, where there's land constraints and the airport, Northeast Dallas, a tenant servicing the TI project -- or not TI, but semiconductor plant in Sherman, Texas. Nashville, we're right at the entrants or near the Research Triangle Park in Raleigh, where they've got several billion, multimillion-dollar projects going on, and there's no industrial allowed in the RTP or the Research Triangle as they call it. So I like that we're creating long-term value, but we're getting you -- we're buying state-of-the-art buildings that something happened in the transaction market, and we're able to step in and I'm out of time. And I think that will last very -- I think that window is going to slam shut and we'll be back to being a developer again as soon as interest rates move. But while it's there, we'll take advantage of it.

All right. Thank you all for joining me.