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

All right. Good afternoon, everyone. I'm Jonathan Hughes, one of the real estate analysts at Raymond James. Thank you for joining this discussion to hear more about the EastGroup story. Joining me on stage is President and CEO, Marshall Loeb and CFO, Brent Wood. First, Marshall is going to give an overview of the company. Then I will ask some questions addressing key topics and issues, and then we can open it up to questions from the audience. So with that, Marshall?

Okay. Thank you, Jonathan. Thank you for moderating our panel. Thank you for everybody in the audience that's here. We'll run through our presentation, but please stop, Brent and I along the way if you have any questions and things like that. Happy to help. As Jonathan mentioned, we're one of the industrial REITs here at NAREIT. Kind of differentiate us from our peers, where we fit or shallow bay. Our average building size is 95,000 square feet, our average tenant size is 35,000 square feet. So when you think of last-mile deliveries, that's really the niche where we're targeting. It's not so much getting goods from 1 port, the West Coast to Chicago or New York. It's moving goods around the ZIP code within Atlanta or across Dallas in markets like that. Our markets are primarily the Sunbelt markets, California, Las Vegas, Arizona, Texas, Florida up through the Carolinas, Georgia. It's really where the population where we're going -- it's mostly Sunbelt, but where we're going is where the population growth is where we want to catch those trends for you as last mile delivery, which is where the world is going to, whether it's goods or services or population growth because finding industrial land gets increasingly harder and harder every year. Especially in a city that's growing rapidly. So we're a long-standing REIT. We've been around probably 20 years plus years. Our returns have been very attractive. I'd say we've evolved our strategy, but not really changed it. Thank you. And so that's really where we kind of fit in within our peers. We're primarily a developer, although depending where the market is, we'll end up owning the same type product, and we try to be indifferent whether we buy it, build it or buy it vacant really depending on where that risk reward is at any point in the cycle. But at the end of the day, we'll get to the same place. So we just finished series of buying properties. We feel like the market is going to shift back or it was shifting back earlier this year to the development side and happy to kind of talk more, I won't take all of Jonathan's questions quite yet, but that's a little bit of a summary on EastGroup.

Maybe we can talk about the macro environment. Obviously, there's a lot of uncertainty out there and tariffs have a lot of impact to some industrial properties more so than others. But maybe talk about what you're seeing in terms of that impact on your business?

Sure. I'll talk -- maybe if I -- thank you. If I go back maybe to last fall. And really, last year, you heard us and our peers say, companies or corporations are being deliberate or methodical in their decision-making. So it wasn't -- we were full. We were 96%, 97% leased, which is we put out a press release ahead of NAREIT. We're still roughly rounding a 97% leased. I kept hearing that tenants are waiting on the election and I'm kidded, brokers always have a reason why things aren't happening. And then I heard about 3 times, and it was explained, you have 2 candidates with widely different policies. And for better or worse, after the election, in fourth quarter, we signed and again, we've been around probably 40 years, 30 years as an industrial REIT, a record number of square footage for our company. We put out our earnings and so we had a record quarter in fourth quarter in terms of just square footage lease. ProLogis said the same thing. So that was a little bit eye raising. And then we finished up first quarter, and it was our third most square footage. So it felt like we kind of claim out of a cloudy environment to a blue sky, sunny day, we had 2 of our 3 best quarters in our history in a row. Our developments were leasing, and you felt like, okay, here's this inflection point that Marshall keeps predicting every year is coming in industrial. And then really, we had Liberation Day. And so we signed a fair amount of leases, what I would say, it's not like things stopped, but it feels like we've gone from a little bit yellow light to greenlight back to maybe yellow light again. It's in the last 30 days, it feels like tenants are a little more hesitant. The smaller of the space. Again, our average suite is 35,000 square feet. So I'd say tenants 50,000 feet and below. That activity is still really good. The larger the space and maybe my logic is it's the larger rent commitment by the tenant. Those deals are still happening. We've signed leases as recently as last week. We closed on a small property on a disposition Monday. So there's still transaction activity, but we went from what felt like record pace to a little bit of a slowdown. And then we'll see. I think this is unlike the GFC or COVID or other things we've been through, this one feels more artificial to me or man-made. Everything was fine April 1, April 2, the world changed a little bit. And I think in time that I'm putting myself things will even out, and we'll again, I'm thankful we're 97% leased. If you look at our product type, our market is about 4% vacant. So shallow bay, when you hear about industrial overbuilding or if you won't hear that, it's usually large buildings on the edge of town. That's not what we are. We're infill sites, smaller buildings. So we're, call it, 3% vacant. Our product type is maybe 4% to 5% vacant nationally and supply, what I get excited about is, supply is at a record low. I was just reading for example, Atlanta, construction is at its lowest point since 2014. If you look at markets like Dallas and Houston, absorption last year was $20 million. The construction pipeline is around $10 million. So those markets, I keep waiting for will snap back fairly quickly. And what we've seen I'll blame it on -- pick on Amazon. For us to go through zoning and approvals and entitlement, once everybody wants to go to service quickly, as soon as you hit click or hang up the phone, but no one wanted to originate from their neighborhood or around the corner, you don't want all the trucks on the street. So it's always been a little bit harder. That's why most of the buildings are bigger and on the edge of town for us to get zoning approval, I'd say it's gone up fairly significantly in the last 2 to 4 years post-COVID. So that's going to -- and we've got the land sites, that's going to slow down so many developers as they get back in the market when things do turn. We feel pretty good about our runway given our balance sheet and our land holdings that are all zoned and permitted that will be able to move much more quickly than our private peers will.

Okay. That's maybe a good -- we can continue talking about the shallow bay product type. Historically, it's a less supply impacted segment of the industrial warehouse market. And talk about the cost to build, why you don't see more people doing it, just the economics of it and...

Well, typically, what's interesting, and we'll get the question if what you're doing, if you're building buildings to low 7s today, and they're worth as we complete probably in the mid-4s to maybe up to 5%, that profit margin is attractive. But as I mentioned, it's maybe 2 or 3 things. Land is harder to come by. When you think of industrial, every other property type can go vertical. So we're the first guys to get outbid for land. We need a lot of land and a lot of flat land or at least land, you can make flat, which is expensive. And it's just harder to find those infill sites. So that's why it takes time to get through zoning, it takes time and so many of our peers, not that we're a small company, but are so much larger, the pension funds, a typical building for us is maybe 120,000 feet. So you may spend $12 million, $15 million and we may build then we'll typically build them in 1 or 2 at a time, you're not putting enough capital to work so they can stay very busy but not put the capital to work. Well, we'll try to do that and do it in multiple cities, multiple submarkets and it adds up that people typically shy away from shallow bay just because of the hurdles, but one of the analysts. Jonathan's peers was we have the highest development returns in the industrial space. It's just it would be minimum wage for a number of them for the amount of dollars they could put to work. So even the private guys kind of shy away. There's lands more readily able to find on the edge of town, it's cheaper and it's easier to get through zoning. So thankfully, I've always said I like where we fit on the playground. We're kind of not much competition or our competition is usually local regional players, not that none of the other REITs do it, but it's hard to put the capital to work on our size product that you can on big box development.

And in addition to the smaller size, the shallow base, you have a park strategy, so to speak, so clustering of assets, but talk about what that means in terms of margins, efficiencies for operating these buildings?

Sure. So we'll ideally good -- thank you for the question. We'll build a campus setting. And what we like about that maybe a couple of examples is I think our peers, I'll keep picking on the big box or maybe just a difference. If we went and built a big box, usually, we might go build 700,000 feet on the edge of town. Your tenant is pretty indifferent if you're on the east side of town or the west side, they may be moving goods through Phoenix or Las Vegas or there's no -- the distribution range is much, much larger. So it's more of a commodity business, and it's all about access and employment availability and low rents, where you're trying to service where we are like the golden triangle, as they call it, in North Atlanta or the East Valley within Phoenix or markets like that. And when we build a campus, we'll build it rather than build it all at once. We'll build 1 or 2 buildings at a time, and it gives us kind of a test case rather than building 800,000 feet on the edge of town. Because what happens within those 2 buildings it makes my job much easier, I'll admit. And I hope our comp committee is not listening, but what I would say is that as they lease up, I'll get an inbound call from the field saying, I'm 50% leased. I've got 3 proposals out, and I've got a couple of tenants that are saying they need to expand elsewhere within that market. So then we'll start the next 2 buildings. So it's really maybe my 2 analogies almost like a homebuilder building out a subdivision. As one home sells, you build the next one. So our -- the size of our investment are at risk is smaller than our peers. And then we do it very incrementally. And then the flip side, we know if Phase 3 in our part isn't working that Phase 4 is not leasing as quickly as we'd like. Phase 4 is in a way to solve the challenges for Phase 3. So we can tap the brakes. And really, it will go -- development starts as fast or as slow as really the market dictates. I've said our peers, it's more of a maybe a push strategy, you're pushing product out in the market and you hope the market is there when your product gets delivered. We're pull, and we know, I guess, the other fears in cases. If we don't have those buildings going and we've got tenants that need to expand, someone's going to get that space. So we'd rather cannibalize our own current inventory. But the way it's worked about 1/3 of our development leasing has been existing tenant expansions over the last several years. So we're accommodating their growth and then where industrial rents have gone and are still moving is then we can go back and refill your space in Building 3 at a higher rent midterm. Your midterm, we can kick off Building 7, that failure space at a higher rent and just kind of keep working our way through a park. And then ideally, if we like the park, we'll try to find as much contiguous land or land around the corner to keep going as we can. And that also helps us market the suites because every tenant thinks their goals or they want to outgrow their space, but we can say, look, we've got room for 8 or 9 Buildings even if the park is built, we can get you space ideally under the same roof, we'll move tenants around for you if you give us enough notice or we can put you in Buildings 3 and 4 and you'll be across the truck court from each other for efficiency. So rather than have -- we do have one-off buildings, but ideally, we like that campus setting. And it also allows us to control the tenants that are in there, the landscaping, all the things like that, the amenities package, you can really create a nice sense. I'm biased. I know I'm thinking I'm talking about different product type than industrial, but you can create a great sense of place with the right tenancy and the right landscaping. And I think that as a long-term owner versus a merchant developer who's going to flip those investments for us really start to pay off when you're a 10, 20-year holder of those type parks.

There's a lot of great charts and slides on this in your presentation that would be lovely to show. Maybe we could try that next year. Maybe let's go to an ideal year in terms of acquisitions and development starts. What does that look like?

Again, I try say, we try to end up in the same spot and how we get there. We would say -- if we went back maybe 8 years, our development starts were $100 million a year. And again, at the peak, we probably hit $400 million in development starts. Some of that is construction costs going up, land cost, maybe, but it was really just the market pulling those next wave of buildings. Acquisitions it will really go as we think about it, how many tenants and where across the country we've bought as much as, I think, $500 million and the year was probably our peak year. We don't want to -- look, we've got -- we've built our company for scale. We've grown from a sub $3 billion market cap to, call it, $10 billion to $11 billion market cap, depending where the stock market is in any given time. But we also want to be mindful of that our property managers and our accounting team and things like that. So where are the properties, how many tenancies are there, but I think we could certainly grow. We've done it $0.5 billion a year and start $300 million in starts or when our leasing starts are going well, that was because we -- the benefit we have of an operator, we felt like we were able to see the leasing velocity we had -- and so we in cases where we had those local regional developers around the corner bought their vacant buildings because they're working off an IRR promote and that risk return, we were -- we would say acquisitions at the point were maybe at a 5, development was at a 7. We could buy buildings that had been built but not least at a 6. So it was really a shadow development if we could find those opportunities. And then that window closed. So what we kind of see is for a minute, the acquisition window will be attractive, and then the development window will be open, and then we remind ourselves it's okay to just simply be patient. We've got organic growth. We've been growing our rents at a net effect at 50% -- north of 50% in the last 2 years. The last few quarters, it's been north of 40%. So we like that organic growth that we've got internally. And look, if the external opportunities are there, we're not going to do -- we're not going to buy a hotel with your investment. But if we can find the right risk/reward and sometimes it finds us in the downturn, we had developers who tied up land sites but couldn't close and we bought about half dozen of those where they had done all the kind of -- not all the legal work on the land to have it ready and then they lost their funding, and we were able to step in and that accelerated our ability to start those sites. And then it went from that to the inbound calls became the brokers saying we took this to market, it didn't close, our buyer backed out, and we were able to say, thankfully, Brent and the team had our balance sheet in a good enough shape to say, look, if you were -- I know you're awarded at this price. We're here but we can close in about 30 days. And that worked for a while, and then I think the investment markets come back, so that acquisition window, if you follow, you saw us close a few opportunities in fourth quarter last year. We'll find some strategic opportunities this year, but we were able to buy new buildings that were leased at 6% return. So that was something we had in that acquisition window was open for about maybe 24 months. And you'll just -- the hope is we're nimble enough and you know when that -- which window is open to kind of work through.

Yes. Maybe that's a good lead into just the balance sheet and the flexibility that, that affords you. Maybe for Brent take that one. But that's one thing that certainly is also, I think, differentiating relative to your peers is your balance sheet.

Yes. No, it's interesting. And as we've grown, we're very pleased we've grown earnings for an extended period of time, as Marshall said. And at the same time, we've done it by deleveraging or getting a more conservative balance sheet. Our debt to EBITDA now is trending into 3 and probably going below 3, fixed charge coverage ratios north of 15. So just a historically strong balance sheet for us. We've been the benefactor since interest rates began their quick rise, 2.5 years or so ago, our shareholders, I'm going to say rewarded us with a good share price that we've had good equity access over that period of time. So we predominantly have been sourcing capital via new equity raises. And it's been good to have that access. By doing that, we've delevered the balance sheet. We have a lot of capacity to add more debt down the road. We would like to see rates come down a little bit more. They're headed slowly in the right direction, but we've been patient. And I think the important thing to note and the exciting thing is we have that capital available as we've been raising capital. Our team has continued to find opportunities to invest capital. So we haven't been raising capital as a means to put out a fire here, do something there. It's been continually growing the company via the acquisitions, development and the other things Marshall talked about. So a very conservative balance sheet. I think the people that maybe haven't paid close attention, especially to the top-tier REITs over the last handful of years, it's a much different sector, much more delevered sector, a much more safe haven like a rising interest rate environment. And so again, we're in a good spot. We're looking forward to having a little more sunnier skies here in the future. We can put all that capital to work. But as Marshall said, we'll be patient and the team in the field. We'll do it at the pace that the market allows us. And -- but yes, we look forward to unleashing some of that dry powder we have stored up there.

We're about 20 minutes in. I'll give an opportunity to the audience if there's any questions, please raise your hand. Go ahead.

Can you talk about Southern California [indiscernible] and what you all stress that might be happening in Middle East, but -- to what extent do you see opportunities there?

The question -- I can hear you. Thank you. I'm not sure if everybody could. It was really about Southern California, how do we view that market and maybe inland Empire East a little bit or, i.e., East, as they call it, that maybe perspective, we're about 5% of our NOI comes from L.A. about 5%, we're about 17% California, and that's really spread predominantly the Bay Area, L.A., San Diego. Maybe your question, San Diego and L.A. feel or San Diego and San Francisco feel pretty stable. They've had -- we get spoiled and that we've had positive net demand in our markets. Dallas is one I'm looking at REIT, who runs Texas for us something like 60 consecutive quarters of positive demand. So it's just where is supply at any given point relative to that demand. Atlanta is something like 40 -- 50 quarters in a row. So most of our markets where California has thrown us a little bit was San Diego and the Bay Area would have 1 positive quarter, 1 negative quarter, that type thing. L.A., unfortunately, has had 9 consecutive quarters of negative absorption. First quarter was negative 2 million square feet. So it's -- it's been a harder market for us. We thankfully only have -- I'm aware of 1 vacancy there. We had -- it's in Carson. So we're down by, if you all know, LA, Port of L.A. Port of Long Beach. We have good activity. We've been leased out a couple of times, I think, at least once post April 2, but those tenants have put things on hold. The tenancy there is very port-driven and what's thrown us a little bit, I would argue that was traditionally probably our best market in the country of our markets, and it's probably been arguably the worst for the last 18 months. And unfortunately, we just haven't -- I'd love to tell you I think it's turning around or stabilized, but until they can have at least a positive quarter or a flat quarter of absorption, it still feels like. And what's interesting to me, usually, if you said historically [indiscernible] what ruins a real estate market is it's all supply and demand. But in L.A., they never had the supply because there was already no land. It was really -- as the best I can tell coming out of COVID, all the logistics companies raced to take space. They have more space than they wanted. And Inland Empire East, so our portfolio is predominantly mid-county City of Industry and West. And so we feel good long term about consumption. It's what, 17 million people, maybe off slightly on how many people are in the metro area. So that's a lot of consumption. Even if you're near the port, that's also happens to be south of downtown. You're not that far from Santa Monica and the beach communities. Inland Empire East, if you get more towards San Bernardino, Redlands, those areas of L.A., it's really very port-driven where goods come in from the port, get unloaded there and then they make their way to New York, Boston, Chicago, Philadelphia, that's a trickier. Maybe I'll use it a question not asked, but if you say why do we like being near the consumer? We think it's a lot more predictable, stickier demand. We do have 3 Buildings kind of in that South Bay area of L.A., again, the overall market is 5%, but I've used examples in an earlier meeting. We've been in markets like Houston, which Brent ran for us for years. And we've been -- since the '90s, we've been in Jacksonville, Florida since the '90s, but we're nowhere near the ports in those markets because ports are to me are harder to predict. If you can invest and own our stock. I hope you will, I would say, to me, it's a lot easier prediction to say more people are going to be living in Nashville, Tennessee or Austin, Texas or Tampa, Florida in 5 to 10 years, than the port of Houston is going to gain market share from Savannah versus Miami versus Jacksonville L.A. Long Beach. So we are not really port driven. At times, we've probably maybe missed some opportunities certainly as Houston's port has done well the last decade, it feels like what we like being, we want to be in a low visibility, great access, low visible retail location. We want to be as near your homes as we can. And that's why we see tenancies like Amazon is our largest Senate, but we also have Best Buy, Home Depot, Lowe's, the goods that you probably can't fit, you can't fit in your car, they're white goods. So if you buy a refrigerator, you're not leaving the store, but it can come from one of our properties and be at your house later that day. So again, that's how they've used us as they talk about going from store-level inventory to market level inventory, we get the big bulky items from Amazon and some of them. And so we'll -- L.A. has us a little bit concerned. It's still not -- I'm glad it's 5%. At times, we wished we were a lot larger than 5%, but it's also a reminder of us, we like tenant diversification. Our top 10 tenants are about 7%. And of our revenue stream, and that's about half the industry average, and we like geographic diversification because every market that seems red hot suddenly can turn. Rents doubled in L.A. really rapidly and then they've come down like a rocket as well, unfortunately.

Maybe talk about 5, 6 weeks ago, you were the only industrial player to adjust guidance upward, raising occupancy and NOI growth guidance, what gave you the confidence to do that in this macro uncertainty that we've heard about for the past 25 minutes or so.

Yes, I'll jump in there. We -- part of it is the team -- we had a strong first quarter. I think we're about $0.03 above our midpoint in the guide. So it gave us some flexibility in the latter part of the year. And just strong performance, we continue -- even though things, as Marshall said, coming into April 2, at the time we did the call, you weren't exactly sure how that was going to play out. But we've seen continued strength in rental rates. We've maintained a very strong occupancy and lease percentage, probably where that little bit of slower activities shown itself more as maybe in our development leasing, just trying to get those deals over the hump has been a little bit slower. But really, we build our budget and our guidance from the ground up, meaning all our asset team is not at the corporate level us making global assumptions. We build it from the bottom-up individual leases that are either vacant or rolling for that year. We rolled that up. We had our corporate expense and that type of thing to it then measure. And thankfully, as we rolled out, we were just in a good position early into the year and we put out a release a couple of days ago, which is sort of a market update. We're trending at or maybe slightly ahead on an occupancy level where we've projected. So it was just a good strong quarter, as Marshall talked about, and then we're just trying to sustain that momentum into the year and trying to be patient and wait this out here if there is some clarity, you feel like there's the opportunity for some uptick given supply being tight in some of those other factors, but it was really just a strong -- it always helps to have a strong quarter and the quarterly reporting gives you a little more runway to kind of push the rest of the year. And so we're glad the team afforded us that opportunity.

All right. There's no other questions from the audience, maybe Marshall, you want to leave us with kind of a summary of what the investors in the room should know about the EastGroup story over the next few years?

Sure. And maybe with the preface that takes this I'm an optimist, but here's with that in mind. I really like our positioning better than I have. And I would have told you I'm an optimist the last 4 or 5 years, but I like it better today than I would have in any given point before, even with the tariff news and things. But -- and my reasoning is we're -- if I round, we're 3% vacant, our property type is 4% vacant. Our balance sheet is literally as strong as it's ever been. So we have that dry powder to take advantage and supply is ar -- it was low a year ago, I said a year or 2 ago. But with the downturn in the run-up in interest rates or really capital markets downturn, it wasn't a occupancy downturn or anything like that. So many of our private peers have been pushed out of the market. They didn't have the balance sheet because they were entrepreneur to carry land, carry a construction team. So many of our peers have been sidelined that it's going to take them a while to catch up when things do turn. So I feel like with a little bit of business confidence, which we saw -- I wouldn't call the economy great in fourth quarter or first quarter of this year, but just better or consistent that I feel like there could be a pretty sharp turn, and it's going to be a while before our people can -- our peers can catch up on development and then the other thing I like, if you look back for what it's worth, our average FFO multiple, probably our 5-year average is around 25x. We've gotten as high as in the call it, mid-30s FFO multiple today, we're a little below 19. So I think the fundamental setup is better than it's been the last handful of years, and yet our FFO multiple is 5 or 6 turns below where it's been over that time period. I don't know that 25 is the right number, not but for what it's worth, that's roughly the average. So it feels like our stock price doesn't really reflect what we feel like is this inflection point coming. I'm convinced it's coming. I just keep getting wrong when that is. It's like I keep saying June, I just thought it was going to be June of '24 now I'll say, June of '25. But at some point, when business confidence comes back, we feel like there's pent-up demand, and that will affect us. And I'm seeing zero. So thank you all.

Yes. Thank you, Marshall. Thank you, Brent. Thanks, everyone, for joining.