First Industrial Realty Trust, Inc. (FR) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to Citi's 2021 Virtual Global Property CEO conference. I'm Manny Korchman with Citi Research, and we're pleased to have with us First Industrial's CEO, Peter Baccile. 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. For those joining us here today, if you want to add some questions to the conversation, drop them in the box on the screen. I will see them on this end and weave them into the conversation we're having with management. Peter, I'll turn it over to you to introduce everyone in the room there with you today, and then we'll get going with Q&A.

Great. Thanks. Good morning, and thank you all for joining our session today. Thank you also to Manny, Michael Bilerman and the whole Citi team for the opportunity to participate again in the conference this year. We appreciate all the work it takes to make a conference like this happen, whether it's live or it's virtual, and we look forward to seeing you all in person next year. With me today are Jojo Yap, our Chief Investment Officer; Scott Musil, our Chief Financial Officer; and Art Harmon, Vice President of Investor Relations and Marketing. For those that don't know us well, here are some quick facts. We're a U.S.-only industrial REIT, total market cap today is north of $7 billion, and we're focused on 15 of the nation's top logistics markets. Our team and our infill portfolio performed very well through the worst of the pandemic, which we discussed in great detail at our Virtual Investor Day in November. Our portfolio remains highly occupied, and we ended the year at 95.7%. We also delivered the second highest cash rental rate growth in our history at 13.5%, second only to the 13.9% growth we produced in 2019. Our outlook for 2021, again, calls for double-digit rental rate growth. The strength of our tenant base drove strong collection results. We were at the top of our peer group collecting virtually all cash billings in 2020. E-commerce remains a driving force of demand for logistics real estate. Tenant requirements driven by accelerated e-commerce adoption, helped our sector perform very well through a volatile 2020, and we expect further strength from continued growth in e-commerce sales in the coming years. Overall, tenant demand rebounded substantially in the fourth quarter, driving 110 million square feet of net absorption according to CBRE's latest figures. Given the long runway for e-commerce and the economic recovery that is underway, we're very excited about the growth opportunities ahead. After taking a brief pause from new speculative development for several months last year during the height of the pandemic, we've now fully reengaged our development efforts and have the strongest pipeline we've had since before the global financial crisis. We recently started several new developments, including 2 projects in South Florida, along with new buildings in the Inland Empire, Phoenix and Nashville. Our development margins have been industry-leading, averaging over 60% when comparing our realized development yields with prevailing market cap rates. These high-quality new developments will contribute to strong portfolio cash flow growth for many years to come. At our Investor Day, we highlighted our opportunity to grow AFFO by an average of 9-plus percent from 2021 through 2023. This growth in cash flow supports strong dividend growth, and we just announced an 8% increase for Q1 '21 versus the prior period. With that, I'll turn it back to you, Manny.

Thank you, Peter. You might have touched on these a little bit in that opening, but I'm going to ask the question the way we've written it up anyway. Coming out of the pandemic, if an investor were to own one real estate stock, what are the 3 reasons they should invest in First Industrial?

Well, first of all, we've had best-in-class margins now for several years, leveraging the platform to create great value. Secondly, our expected AFFO growth of 9% per annum through 2023 is very strong. And I'd say, lastly, Manny, pretty strong relative value opportunity play in our stock.

Great. The industrial space overall has certainly seen a lot of benefit over the last few years, COVID notwithstanding. And if we look at any of the broker stats, if we look at your presentation or your peers' presentations, there are just these massive demand numbers that are getting thrown out there, whether it be for warehouse space, industrial space, return logistics, whatever those numbers are. How do you think that the ecosystem sort of works through that demand and the supply that's needed for it in terms of land limitations in the markets where everyone wants to be? So are you going to see new sort of markets need to pop up to satisfy the demand? Are those forecasts just wrong? Is there something that we're missing, sort of the way that we're thinking about that forecast, whether it be on that -- on the initial or return logistics, like something doesn't really make sense if we have to have this 200 million square feet, 250 million square feet, 300 million square feet of new supply every year. And we've heard nothing but the fact that, that's going to be hard to create the last 3 years, how do we bridge that gap?

Yes. I mean, you're right, we've got generally a strong economy and the economic growth that looks like we're going to be driving that for the next 4, 5 years. And you've got the economy within the economy in our space with e-commerce, and the share of retail sales that goes through e-commerce, which today is about 14%, that's up significantly from the prior year, but that could grow into the 22%, 23%, 24%, 25% range in the coming 4 or 5 years and that's going to create a lot of demand for space. You're right in the higher barrier markets. They are called high barrier because there's not a lot of land. You do see some projects where people are going vertical with 7 or 8 stories, with mezzanines and a lot of robotics and technology, multistory industrial properties, and you're going to see secondary markets be buoyed by this. There's -- as you say, there's land there, but the strongest rent growth and the strongest value creation and the way we see it is still going to take place in those higher barrier markets. So the outlook looks pretty strong. Jojo, I don't know if you have any other thoughts on that?

No. Just to add, we don't expect major consumption zones to change a lot. So I mean, where the pressure is, it's the high barrier markets. We expect to face more pressure in terms of working hard to find land, and we know the municipalities are going to have to staff up to meet the supply. The entitlement periods are not getting any shorter. So more work has to be done there. So, Manny, I think you painted the picture right. There's going to be pressure. The ecosystem -- everybody just has to kind of be more efficient. But yes, there are more pressures than last year in terms of just finding good land and being able to develop the good land.

And then if we think about the positive repercussions of all that on rents, are there other limiters there in the conversations you're having with tenants? Yes, there've been very healthy rent rollovers from the group, right, everyone has seen that phenomenon. Is there some other type of bottleneck or limiter or something that's not allowing those rents to go up even more?

Well, I suppose it's lucky for us that right now, the rent -- the cost of renting space is a pretty low contributor to the overall overhead. So it's still transportation and labor, the major expenses rents paid approximately 5% or 6% of the overall overhead. So we don't have the same affordability limiters that you might see in other property types, for example, multifamily, where people earn -- they earn and they can only afford to pay so much, and then they have to move. So I don't -- we haven't really seen any limiters on the upside. As long as they don't -- as tenants have limited alternatives, they have to have a place to operate. You might see more tenants grow in terms of their interest in owning their space. Certainly, you might see lease terms extend as a way to avoid getting caught in the spiral of these very, very large rent increases. Of course, as a landlord, we're going the other way. But so far, we haven't seen any limiters, Manny. And there's certainly no pressure on concessions, et cetera. I mean, we look at the overall package. And obviously, we're looking to maximize the present value of every lease and right now, we're able to get tremendous increases in rent.

And just to add to that, too, if I may. If you look at -- if a company wants to be more efficient, I mean if you look at the technological advances, we don't think it's going to happen in real estate. It's probably going to happen in transportation or labor, robotics or cost of capital or inventory management. Real estate is kind of very hard to make more efficient. You need a piece there -- you need piece of land and how do you technologically advance real estate, not really -- you can only add as much ceiling height or add as much dock doors. The rest, I think, is going to come from more of the warehouse management systems. So if you want to be more efficient, you want to lower your cost, it's going to be warehouse management systems and maybe transportation and how you supply those goods.

Making full use of the space you do rent, if you're renting a building this 36-foot clear and you're not fully utilizing the vertical space, that's obviously less-efficient. You may see taller buildings, although at some point, that becomes inefficient when they're too tall. But we're seeing some 44, 45-foot clear high buildings now, but as Jojo said, it's all about efficiency.

Right. And then cost structure being at the 5% to 7%, 8% cost structure, you can see the company is trying to efficient -- make more efficiencies on other parts of the cost structure less than a real estate.

I guess the question though, there becomes, isn't there a byproduct, whether willful or accidental, of those innovations? So you mentioned transportation, right, that could mean anything from putting more in a truck to more turns per day to autonomous trucking, whatever that is. Don't those lend themselves then to a different real estate decision? So if you can have a truck that runs 24 hours a day instead of 18 hours a day, that's 1 more turn. And so you can now be 3 hours further away? Or is that do you think that those things don't necessarily come to your business because it is much easier just to sign a lease in that market today and have one less issue to deal with from that transportation decision?

Yes. So far, when you look at that, it's logical to think that. And I think as real estate investors, I think we need to think that. But so far demand. The pace of innovation in whether it's transportation, warehouse management systems or labor have been so far -- so behind absorption in demand.

Maybe turning to First Industrial specifically, what is your development plan or pipeline for the year?

So as you know, we don't guide on development, but you -- we did announce $112 million starts in Q4 and another $100 million on our last call. We have spent -- we spent the downtime last year. So during the pandemic, as I mentioned, we discontinued new developments. We really focused all of our resources on looking at new opportunities to buy land and also get the land that we owned in title. So we have significant opportunity in the portfolio. We can build about 15 million square feet on land that we currently own. The vast majority of that is entitled and ready to go. So once we ramp up, you should see our volumes, generally speaking, to be similar, if not exceed what you saw us build pre-pandemic.

And we continue to look for more opportunities as Peter mentioned.

And we're constantly in the market making unsolicited offers, pestering people to sell that don't have their assets on the market, and it's proven to be a very, very good approach to the market, yielding us these great development margins that I talked about.

When you say assets in that sentence that you just said, is that land or is that operating assets as well?

Yes. Most of our effort is around acquiring new land. We do buy existing buildings from time to time. You've seen us do that. The volume, the dollar volumes have never been really high. First of all, in the markets we want to be in, there's just not a lot for sale in terms of Class A space. Secondly, when a Class A asset in the higher barrier markets does come out, it's typically auctioned. We're not going to participate in that because at the end of the day, that's going to end up -- the pricing is going to end up in a place where we probably can't add value for our shareholders. So our acquisition volume is pretty low. And again, when we do buy, it is often because of an extended effort making unsolicited offers, getting to know the owner, sticking with it for a year or 2 years or more until finally, they decide to sell and we're the guys there and they know us and they're comfortable with us and they sell to us.

One of the markets where you've made a push more recently is South Florida. I would say a lot of your peers are targeting South Florida as well. Just wondering what competition in that market looks like, and how you're finding deals to do there?

Sure. So we've been in Florida long time. Our original focus in Florida was central and the Tampa area. A few years ago, we decided to change our focus and move our focus down to South Florida. We exited Tampa from a real estate standpoint, although we still have some people there. But we have some pretty long-standing relationships in that market. We've now got one of our most senior market leaders down there. He's been there now a few years. And the pipeline down there now for us is tremendous. It's a tough market. It's very, very competitive, but the relationships that we have on the ground there are yielding -- are bearing a lot of fruit, especially the First Park Miami project that we have underway, where we're now underway of 3 buildings, totaling just under 600,000 square feet. That is a site that is extremely infill because it was a lake. And before anybody worries about us filing in lakes, it was a rock quarry that filled in with drain water and we're now reclaiming that and filling it in. So at the end of the day, we'll have 2.5 million feet there. The yields there we expect are in the mid-5s or higher and about $400 million of total investment. So that's an enormous project for us going to pay great dividends going forward. And the tenant inquiries already, and we're just underway in the ground are pretty significant. So we feel pretty good about that. We've got another half dozen-or-so projects underway also in South and Central Florida. It's going to be a great market. The demographics in that market are tremendous. A lot of people are moving to Florida. It seems to be a pretty well-run state, and that matters these days, and so we're excited about the future there.

And you talk about development in the mid-5s. What kind of margins are you seeing on sort of that new intends to come?

Yes. So let's take first part, Miami, for example, I think our actual number there is about 5.6%, and that is a 4-cap-or-less asset at the end of the day. I think if we probably put the whole thing on the market to go in the high 3s, it's not that we're ever going to put it on the market, but that's where -- that gives you a sense of the margin opportunity there.

Just coming off of that, are there pieces or markets in your portfolio that do make sense to sell, especially given where pricing is in industrial?

Well, we focus pretty heavily on the growth opportunity and making sure that all of our investor capital is invested in high-growth assets and where it's not, those are the assets that we're selling. Most recently, that has been largely in Midwest assets. Of course, those go for a little bit higher cap rate, but we'll continue to monetize assets where we've completed our lease-up opportunity because that's important. And then where we think we can get very strong bids for those assets. And the assets that we are selling are typically acquired by 1031 buyers. Users buy about 30% of our assets. If we get local family offices, high net worth individuals also acquiring, and we've been able to achieve pretty strong cap rates. Again, they're higher than the 4s that we're talking about or 5s that we're talking about on development yields, but we hit the cash flow from those assets. So the cap rates are a little higher, but the actual cash flow from those assets, because they tend to be labor and capital-intensive, is low. And so we're taking that low cash flow, and we're reinvesting with some lag in new developments, timing lag at 5.5%, 6% yields, so we're creating value through the yield there and creating long-term value just amounting an asset in the market where the rent growth is going to be so much better. So that's been the focus that's worked pretty well.

So we have a question here from the live QA. What percentage of existing inventory is 2021 and 2022 new supply in the current -- sorry, I'm trying to read and digest at the same time, give me a second. Harder one if it's not your own question. How -- so what percentage of your current pipeline is in high-barrier coastal markets versus remaining markets that are not high-barrier coastal markets?

When you look at 2020, it is about 80%. When you look at all the acquisitions, all the acquisitions and all the developments placed in service plus under construction, it's about 80% in high barrier.

Keep those live QA questions coming if you have them. How are your customers thinking about build-to-suits in the current environment as a way to avoid competition for space once it's a developed spec?

Sure. Right now, yes, there is demand for build-to-suits. And these are companies, the way we're thinking about them is that they have a longer-term plan. They usually plan for about a year, a little bit over a year to occupy the space. And there's a lot of places they do want to build because of the demand. The problem, a number of the customers trying to want build-to-suits is that the availability of product and a lot of the supply there is being built for spec because the market demands it, right? So what happens is that -- what we've been finding is that some of the build-to-suit customers are actually occupying existing space because rather than a developer or owner waiting to do a build-to-suit, in a number of cases, especially in the higher barrier markets, the owner, like First Industrial, would want to build spec immediately or rather than wait for the build-to-suit customer to make their decision. And therefore, bottom line is that they lose that opportunity. And I've seen a number of these build-to-suit assignments become quicker assignments wherein they now are starting more than ever before that they're considering buildings under construction versus the traditional build-to-suit where I want to start from scratch, I want to know exactly what my configuration is in the building, how many dock doors, ceiling heights. Now they're saying, bring the spec product in because we might not have a choice. So call it spec-to-suit.

Right. And Jojo, when you're having that negotiation with that potential build-to-suit customer, how do you, as a company, view it? Is it lower risk because you've got certainty of lease and so your yield is going to be lower on that project? Or are you giving up the opportunity to ride this upturning rental rate wave, and so that yield actually needs to be higher because there's sort of a favor involved?

Sure, sure. It depends, Manny, project by project. When a build-to-suit proposal comes in or RFP, we compare it to what we can do in terms of spec. And in some markets that we have with some of the position that we have, we'll be patient. We want to get our return, and we will design to their specs and then bid. In some markets, what has happened is that we -- there's an RFP that comes in. We'd want to respond, but we will go ahead and build our building. And it comes to a point -- I'm giving you the book ends. The other bookend would be, "hey, if you want our building, that's great, but we'll design it based on our market standard, which we think is most in demand of market." And if they happen to be there, and they want the space, we'll give them our specs. In fact, we've done deals over the last 2 years wherein the initial assignment of the build-to-suit customer has changed because there's not enough product in the market and they either expanded or contracted the requirement to fit into our building, spec building.

One more your way, Jojo, and then I want to get some to Scott, too. I had a second ago, where is my question. All right. We'll skip to Scott, and then we'll come back to you if we need to. Scott, you've got a $200 million term loan due in July. What are your plans to refinance that? And what kind of savings would...

Right. Actually, it's a 1 plus 1 plus 1 deal. So we could extend it for 2 more years if we wanted to, but this was a instrument that we renewed last July. We did it during COVID, so spreads popped out. So on the menu this year, it's probably renewing that. We think we can knock spreads down 50 basis points on that. So that's about $1 million a year of savings compared to the old spread. And if we decide to go that route, we've got a line of credit that's coming due in October of this year. We'll roll both together and renew that as well.

Right. And then given all the development spend that we've talked about on the call so far, how do you look at your capital plan for this year and into next?

Yes. We're in very good shape from a liquidity point of view, Manny. We've got about $100 million of cash on the balance sheet now. We'll retain about $60 million to $70 million of excess cash flow after CapEx and dividend. And then our midpoint sales is about $125 million. That's $300 million we could use to fund new investment. Our leverage is at 4.8x. We have 0 drawn on the line of credits, so we can increase leverage a little bit, draw on the line. And to the extent we need more dollars to fund investment, we may look at equity. And if we like the stock price, and if you looked at what we've done in the last 5 years when we raised equity, it's always been for new investments, primarily spec developments, and the margins earned on those were about 60%. So I think we've been a pretty good user of equity when we've raised it in the past.

Turning to operations. Are there any large move-outs on your radar or watch list of tenants that may not make it through all this?

Well, the 1 large move out we have is a 4,000 square foot tenant in Kansas City. They're moving out at the end of May. They gave us notice for marketing that space. The lease-up time is leasing it up within a year or so, so May of next year. So to the extent that we do better than that in 2021, our metrics could be better such as same-store and occupancy. The watch list, Manny, is very clean. We had one tenant from last year that was on the watch list that is current, smaller type tenant. I would say the watch list now is what it was pre-COVID. So it's looking very clean.

And what is your bad debt assumption in 2021 versus 2020?

Yes. It's $2 million, and that's a macro assumption that's based upon the 26-year history of bad debt results. It's not a specific analysis of what we think is going to happen this year. That's always difficult to do because you have to look out 12 months. I can tell you that if you look back from 2015 to 2019 pre-COVID years, the average bad debt expense was about $0.5 million per year. So if we get back to that level, we'll pick up about $1.5 million compared to that assumption. That's about $0.01 accretive to FFO, and that would be about 50 basis points accretive to same store.

Peter, we're asking everyone here as investors focus more and more on ESG. What are your company's top 3 priorities to improve your ESG score going into next year?

Sure. Very important topic, of course. So I guess, our 3 priorities are as follows: one is expand our energy-efficient systems in the portfolio. We've got some work to do there; we're also going to begin, we haven't done this, but we're going to begin to build lead certified standards in our higher barrier market projects; and then the third would be just better and more extensive disclosure of what we already do across the ESG spectrum. We came out with our initial report in '19, and we can do a better job there. So that would be our third priority.

If we just focus on the first one for a second, the energy efficiency. A lot of the companies I've spoken to through the conference struggle with that one because the tenant is usually one that bears the brunt of the energy. And depending on what their use case is, it's very hard for you to tell them how to do their job. So as an industrial landlord in that sort of tight situation, how do you get that energy efficiency to a place where the metrics are coming in, in your favor?

Right. Well, there are certain things we can do for starters in the property, energy-efficient lighting, perhaps using solar for energy insulation, irrigation, et cetera. So there are things that we can do to make sure those assets are as efficient as they possibly can be. But you're right, our tenants, our leases of the tenants are largely triple net leases. We not only don't have the right to tell them how to manage their energy use, we don't have necessarily the right to know what their energy use is. So we've talked a lot about potential areas of opportunity there and to begin to try to establish a dialogue, maybe amend some leases over time. That's a very, very long-term effort to try to get in and understand the energy use and make suggestions on how they can reduce energy use. So that's not something that's going to happen overnight. And we certainly -- there's a value proposition there for them and for us. And our job is to maximize the value of our assets. And obviously, the tenancy is the key driver of the value of the asset. So we have to be a little bit careful about there. But it doesn't mean that we can't begin to try to have that dialogue.

There is another question here from the queue. As you evaluate the backdrop, particularly as it pertains to migration out, you're already in markets such as Florida and Texas. How are you thinking about other areas of the country that are seeing significant relative growth such as Upper Rockies? For example, Idaho, Montana, Utah, could there be a first-mover opportunity there?

Yes. So consumption zones really drive our focus. And we have taken a look at in migration, out migration. We're looking at whether these consumption zones are moving or changing. And you look at California, for example, and obviously, a lot of people have moved out of California, but you also have seen a lot of people move in. And now the net-net of that is a negative or a reduction in population, but it's the fifth largest economy in the world. And so we really have to stick to following the consumptions zones. We're starting a project in Nashville, okay. Tennessee has seen a lot of in-migration. Nashville is the biggest city in Tennessee. I think Tennessee was the #5 fastest-growing state in 2020. They happen to be a tax-free state as well, and that will also impact the demographic opportunity that they have. So we're starting a new building there on land that we've owned for quite a while, but we like the demographics there. So I'm not sure yet that we'll be focusing on the Rockies and the markets that you just mentioned because it's a little bit of a chicken and egg thing. The consumption zones there are not as substantial as they are where we're currently focused.

Right. To wrap it up with our rapid-fire questions here. When we're all sitting physically together in Florida a year from today, what will be the one thing that will have surprised people most about your business over the prior 12 months?

Cash rental rate growth on new and renewal leasing of 15%.

You keep telling them they shouldn't be surprised, right?

Well, our forecast is forwarded to be less. So we're stretching there. Therefore, it would be a surprise.

What do you think your corporate travel budget will be in 2022 as a rough percentage of where you were in 2019?

About 75%, and that has a lot to do with people being comfortable or not traveling. We're looking forward to getting back to 2019 levels, but I would project 75% this year.

That's '21 or '22?

For '21. Did you ask about '22?

I did. Maybe the question I gave, art and prep, for this was less clear. So if you thought about '22, I'll put you on the spot without commenting about...

No, '22, we ought to be back to 2019 levels.

You think flat to '19?

Flat to up. I mean, we're not -- look, we're -- we've made it clear we're a work from the office company, and we can get into that if you want to, but that means going and seeing your colleagues and doing all the things that we did in 2019. So we think we'll slowly grow into that. That's why I said 75% for '21, but in '22, I'd be very surprised if we weren't even or higher than 2019.

All right. What will same-store NOI growth be for the industrial sector overall, not your company, in 2022?

Plus or minus 4.5%.

And where will the 10-year treasury yield be 1 year from today?

Plus or minus 2%.

Thank you very much.

All right, Manny. Thank you.

Good seeing you.

Thank you, Manny.