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

Good afternoon, and welcome to Citi's 2024 Global Property CEO Conference. I'm Craig Mailman with Citi Research. We're pleased to have with us First Industrial, and CEO, Peter Bacilli. This session is for Citi clients only. If media other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. [Operator Instructions] Peter, I'll turn it over to you to introduce your company and team, providing the opening remarks and just tell the audience some top reasons you think investors should buy your stock, and then we can move on to Q&A.

Thanks, Craig, and thanks to Citi for the opportunity to participate in your conference again this year. With me today are Scott Musil, our Chief Financial Officer; and Art Harmon, Senior Vice President of Investor Relations and Marketing. Our team again delivered strong results in 2023 as we, along with everyone else, navigated our way through highly volatile and more costly capital markets and significant uncertainty with respect to the strength of the overall economy. All of this against the backdrop of an ever more dangerous geopolitical environment. A major highlight for us was achieving a new record for cash rental rate growth on new and renewal leasing of 58%. We also drove some key leasing wins in our in-service portfolio and in our new developments. As an industry, we continue to work through the overhang of what were record development completions in 2022 and 2023. However, if you tally the last 5 years of completions and net absorption, you'll find that completions outstripped net absorption nationally by only 187 million square feet, that's about 1% of the existing base. The pipeline at the end of 2023 was approximately 347 million square feet, and that was 29% pre-leased. This new supply will be delivered over the next 12 to 15 months into a market where national vacancy is approximately 5% and is likely to push closer to 6% before that number begins to drop as this new space is absorbed. The market has responded appropriately to this new supply with development starts down approximately 60% from the peak in the third quarter of 2022. Tenants looking at space today may have a few more choices in the submarkets where these developments are being delivered, but overall, the fundamentals are still supportive of rent growth in our submarkets. We've observed some encouraging positive indicators for tenant demand as we progress into 2024. The burdensome Fed rate hikes from the previous year are not expected to recur. Inventory levels have stabilized, potentially paving the way for gradual acceleration in inventory builds in the latter half of the year, especially into the holiday season. Importantly, activity on the West Coast ports have shown some promising signs with growth turning positive in the latter part of '23. In this or any environment, conversion of leasing prospects into tenants is the focal point of our teams across the country as leasing drives cash flow growth and informs our plans for potential new development starts. We're well positioned to capture further rental growth embedded in our portfolio. We're making good progress thus far in our 2024 lease expirations, which once again speaks to the quality of our assets and the strength of our submarkets. Through our earnings call in February, we had taken care of 53% of our 2024 lease expirations by rental income at a cash rental rate change of 39%. We have a few leasing opportunities within our Southern California portfolio, which if we're successful, will improve this rental income growth metric from that level. Overall, for 2024 for our fourth quarter call, we're forecasting cash rental rate growth on new and renewal leasing of 40% to 52%. We continue to shape our portfolio through our successful development program as well as select acquisitions and targeted sales. An important fact about our portfolio, we think people may overlook is that we've developed approximately 27 million square feet since 2012, representing 41% of our in-service portfolio. In addition, our efforts over the past 3 years resulted in our achievement of 2 important portfolio goals we laid out at our Investor Day in November of 2020. As of year-end, 57% of our rental revenue is generated by our coastal markets, exceeding the 55% top end of our target range, and we finished the year with 95% of our rental income in our 15 target markets. Another important asset allocation decision we made in 2020 was investing more capital right here in South Florida. We currently view this as the strongest market in the country. As of the third quarter of 2020, our South Florida market contributed about 2% of our rental income. Through new investments, primarily development, we've grown our allocation to South Florida to 7% of our rental revenue and giving us credit for the development of our current land bank and land under option in South Florida on a steady-state basis, we have the opportunity to grow this market to approximately 12% of rental revenue. And at that level, it would be our second largest market. Our focus on driving cash flow growth in the portfolio is also reflected in our dividend growth. In our last earnings release, we announced that our Board increased our first quarter dividend to $0.37 a share, which is $1.48 annualized, representing a 15.6% growth rate. Importantly, that dividend rate represents a fairly low payout ratio of 70% based on our anticipated '24 AFFO as defined in our supplemental. On the capital side, Scott would probably kick me under the table if I didn't remind you that we do not have any debt maturing until 2026, assuming we exercise our extension options. We're also well positioned to fund the projected cost of our developments in process with our expected retained cash flow and $125 million of anticipated sales proceeds based on the midpoint of our sales guidance range. In conclusion, we're optimistic about our ability to capture future cash flow in the form of rent growth opportunities in our portfolio, the impact of the lease-up of our completed and in-process developments and rental rate escalators embedded in our leases. With that, Craig, I'll turn it back over to you.

Perfect. So maybe if you could distill a couple of reasons why someone should buy the stock today.

Sure. So sector-leading cash rental rate growth on new and renewal leases, which drives really strong portfolio cash flow growth. Number two, the large embedded opportunity to generate new NOI with our existing and largely funded developments. And thirdly, future growth and value creation from land positions that hurdle today's cost of capital at a healthy spread and are located primarily in the higher-barrier markets.

Perfect. So you guys got the long-awaited Baltimore lease done. And as we look through, there's a couple of leases that -- or a couple of vacancies that kind of are outsized relative to your portfolio. Could you walk through maybe what some of the activity is on Denver, on the Aurora asset, on Rockdale. The under-construction stuff, maybe give us a little bit of insight into what tenants in the market look like? Just to give us a sense on kind of overall activity going on and maybe we've heard bigger tenants are starting to at least think about getting back into the market. And so curious if that is what you're hearing and maybe rolling into maybe what could drive some of these -- some leases at some of these assets?

Sure. So the number of tours, RFPs, the number of tenants generally that we are fielding in our projects that are available for lease-up, continues to grow. That started in the fourth quarter of last year, and it's continued into this year. So that traffic is good. From a leasing standpoint, it's still the case. That say, $200,000 and down is where the ink is happening. It's also happening at 1 million feet. But in between, it's still a little bit slower. This is generally speaking. You asked about our Denver property. It's 588,000 square feet. In the last couple of weeks, we've had a couple of prospects come through tour the building and want to have a discussion about both of them full building use. That building -- we design all of our buildings to demise them. We're having a number of conversations with other tenants for that space that would be smaller, so it make it a multi-tenant building. So the traffic there is good, but we need to turn that traffic into leases. We have 1 more building there. It's 199,000 square feet. We just signed a 40,000-foot lease for that building. That building wound up with 4 or 5 tenants. But again, there's decent traffic. And of all the markets that we're in, I would say that Denver is the one that has more space than it needs.

And what about down in Tennessee? How has the traffic down there?

So yes, traffic in Nashville is doing very well. In fact, I think this year, you're going to see rent growth in Nashville, probably a top 5 market in the country. The traffic around our asset in Nashville has been great. We feel very good about the leasing prospects for that building. And it's possible as the year goes on, depending on leasing, et cetera, as you know, we feel strong enough about Nashville, we could have another start in Nashville.

And in Denver, you said maybe that is a little bit more space than they need market-wide. As these tenants are coming through, do you feel like underwritten rents can hold there? And what's kind of the feel right now on concessions?

The rents that we're talking about are above our original pro forma. Now don't forget that building has been finished for over a year. So that we did have some rent growth in the interim. But yes, the rent that we're looking at there is above our original pro forma. It's a solid rent, and it will throw off a good yield, assuming we can sign the leases where we currently have the ask.

And we'd like to thank you guys again for showing First Park Miami yesterday.

Thank you for going.

It's a great tour. And it feels like my South Florida, in general, still has very good demand, rising rents. What's the prospect or at least a thought process on sequencing the rest of that park down here? I know you guys need to do some more leasing to kind of unlock some more speculative cap space to think about doing some dual starts, but what's your viewpoint on First Park?

So buildings 3 through 8 would be the final building, the 6 buildings we have left. The other 6 are up and leased and you saw the one that we're about to finish that lease, I'm sure fairly soon after that. Should we initiate new starts? There's a high probability the first start or 2 will be at that project, buildings 3 and 4. We don't own the land under 7 and 8 yet. We have an option, and we just fully intend to exercise that option once that part of the -- I'll call it quarry. I hate to call it a lake that gets people thinking we're filling in environmentally sensitive areas. But once that part of the swimming hole gets filled in, then we'll exercise our option to buy that. And as you saw when you were there yesterday, we surcharge those sites to make sure they're settled because there's a very, very heavy silt layer down at the bottom, and we need to make sure that's compacted. So I can't tell you exactly timing-wise when the rest of those buildings will roll out, but the market is certainly strong enough to warrant developing those sites when we can, physically when we can.

And I kind of hold Scott aside asked this yesterday, so we'll get Peter's answer without biasing you. But you mentioned the South Florida look forward is going to be probably your second largest market. Southern California is your largest market. It's also the largest source of consternation right now in the industrial world. Long term, do you keep that exposure to the IE East? Do you lower it? Is there going to be sort of a balancing out of the portfolio from a plus 20% concentration long term?

So we like California. We like Southern California. We like Northern California. I think one of the things that may get lost in addition to the 27 million feet I mentioned earlier that we've built since 2012 is how we own in Southern California. So of that 24%, up 8 points, 8 of the 24 is in L.A. South Bay. Rents are growing there this year. Now they are going down in Inland Empire, I'll come to that. 3.3 points of that are in San Diego, 6.9 in Inland Empire East and 6.2 in Inland Empire West, which is a tighter, more expensive market. So it's actually spread out pretty decently in that geographic area, and we've done that on purpose. So we like that market, 39 million people living in the state of California. Yes, we have what I'll call governance risk. But then again, the more regulatory overlay we get, the more valuable what we already have. Okay? So we have about 263 acres there beyond what we've already started that we can build on, and we love that pipeline. And over time, it will probably balance out normally as our investment in South Florida grows, our investment in the East Coast, New Jersey, down the East Coast grows, but we're not going to run or sell or take off high [indiscernible] chunk of Southern California.

I'm just curious, I think the bull argument on the recovery is deliveries kind of peak by midyear as you get to the back end of the year, delivery is slow, '25 and '26 demand steady, we start to see a reacceleration. Fares, I think the argument there would be timing is a little bit less near term than the bulls thing, and maybe there's risk to demand in the near term. I'm just kind of curious, as you think about '25 and '26 from your seat, from what you're seeing on the ground, what camp you're more leaning towards at this point?

Yes. I think maybe we're in the middle, and I'll give you some math as to why. So if you add up the last 5 years of net absorption, so that goes back to '19. So we get a less insane data point there than '21 and '22. Last 5 years of net absorption, the last 5 years of completions. Completions outstripped net absorption by only 187 million square feet. That's 1% of the existing base. And that's why national vacancy is 5%, up from about 4%. That makes sense. The pipeline that used to be 670 million is now 347 million, and about 30% of that is preleased. Starts in the fourth quarter were 46 million square feet. Who knows what they're going to be this year, but I don't see a catalyst for the cost of construction debt coming down to a level anytime soon that makes a lot of the projects that are uneconomic now economic. So let's just say that's the number, and it's 170 million or 180 million square feet of new starts this year. Net absorption was 240 last year. You can make a bet pretty easily that if confidence is higher in the economy, soft landing, all that and the Fed, whether it's this year or next year, is going to bring some rates down at some point you could see net absorption at $250 million. So right there, you're eating up about 80 million of that 347 million gross, right? Some of it is pre-leased. When we look at our portfolio and we apply those assumptions in the markets that we're in, we see equilibrium in 12 or 13 months. So not the fourth quarter of this year, like the bull case, but not next summer or later is the bare case, we're about 12 or 13 months.

That makes sense. And so in that -- in that backdrop, you guys are not overly concerned. You will start selective projects where it makes sense, parks where you could build next building. Does greenfield make as much sense in a de novo park or a stand-alone building?

Yes. I mean we're still in the market. Look, there are no land trades. The cost of capital went up significantly. But for some reason, the people that own land that would normally be for sale, I think the values haven't come down. So you don't see any trades, but it doesn't mean we're not looking and knocking on doors. You can imagine we're pounding a lot of doors in the state of Florida. So yes, they make sense. We think we can generate decent development spreads and yields that justify the risk of those projects. And with the land that we own, it's about -- we can build about 15 million feet. That's about $2 billion and the pro forma yield on that is 7. So we are in the fortunate position of having a pipeline that hurdles, as I said earlier, I just didn't put the math to it, but it hurdles today's cost of capital a good spread.

We've got some questions coming in. So where would you peg market cap rates for your portfolio?

Yes, that's tough. Not a lot is trading. Not a lot is trading. And the stuff that we're selling wouldn't be representative of that.

If you had to go back to like a historical relationship on a stabilized basis, inclusive of mark-to-market because we've never been at this level before, where...

I didn't hear that, speak up a little bit?

I was saying that if you try to think of it on a stabilized basis, inclusive of your mark-to-market, so if I'm thinking about a past relationship, industrial hasn't had this level of mark-to-market in history, right? So that's why I said on a stabilized basis, what's a good spread relative to a treasury for industrial, just to generalize for people.

Spread for what cap rates?

Yes.

I don't think it's uniform. I think it depends on the submarket you're in and the type of -- and the functionality of the asset that you're delivering or that you own?

I tried to ever asked the question. So another question what does nearshoring mean for the Inland Empire in your view?

That was my question. Can I expand on that a little bit?

Sure.

To the extent you have some intermediary manufacturing moving to Mexico. Port flows from China to L.A. should be lower, IE is a port-centric market. And so therefore, does that on the margin erode the demand case for IE?

So that's something that's going to play itself out over a long time. I think when you think about moving supply chains that have been in place for decades, that's not an overnight thing. And it's costly and it takes a focus and commitment to do it because it takes a long time. And if it all starts from the route of, hey, it's better for national security, and it may be, not making a judgment on that. But if things get better and everybody is happy and feeling safe, will that still be there. So we'll see. Now China has been making investments in Mexico and Vietnam and other Southeast Asian countries for manufacturing purposes since 2006. And when we saw the tariffs come in '18, we did not see a significant drop off in the port traffic nor did we see a softening of tenant demand in the Inland Empire. So I guess I'll have to say that the jury is out. Whatever happens is going to take a long time. We'll all have the opportunity to observe and make our judgments and make our bets. And it's still unknown where the manufacturing for the onshoring, obviously, the nearshoring Mexico that makes sense. And a lot of the stuff that's made in Mexico, we don't have manufacturing tenants, and we don't really want to. But when that product comes across the border, it has to go somewhere to get on a truck driven by somebody else that can't go into the country -- further into the country. So that's going to help Dallas, Houston, Phoenix. And I'm not getting away with Inland Empire. I'm just making a general comment on this. And Laredo and El Paso will do well. But that's for manufacturing, and that's just not our game. When it comes to onshoring, you would think that if you're leaving a low-cost labor environment, you want to go to a low-cost labor environment and they might be relative different. But you might think that the lowest cost labor environment here is in the Rust Belt, Middletown, Ohio, whatever you pick your favorite forgotten town. So we'll see what that -- what happens there. I think that the inflows from other Asian countries of things manufactured by China will still be coming into the Port of L.A. And we'll just see over time where that goes. I don't have a crystal ball that's any better than yours.

So we have a couple of questions coming in the same spirit of you guys trade at a discount, whether you want to look at it on a multiple or NAV basis relative to some peers or your intrinsic value. What are the steps that you guys think you can take to address that?

Well, today, I'd look at a couple of things that I think probably impact where we trade. One is, in an environment that people view as a little bit softening, a speculative development business plan probably looks a little risky. Number one. Number two, we have a handful of projects in the Inland Empire that we need to lease up. I think you saw what leasing does when we leased old post and did some of the other leasing that we did, the whole market went up that day when we had that call. So I think that it would be very helpful also when we sign some leases in Inland Empire and show that our business plan isn't so risky.

And to bring up the perpetual or perennial question, would you be open sellers as a way to narrow the gap if you were to get an offer?

That we have said perennially, we're always going to do best, what's best for shareholders.

I guess the other question earlier on one of the panels to go back to the market cap rate question, they're going to come out from a different angle. [ Linked ] kind of said in the panel high 4, low 5 for industrial assets on a stabilized basis. Is that what you would consider to be in the ballpark for market?

Yes.

And by the way, that was not for you guys specifically.

I understand.

That was in general, just for the audiences benefit.

Class A, highly functional, good market, yes.

Can I follow up on that? Sorry, you said high 4s stabilized?

High 4s to low 5s on in-place rent. So stabilized -- sorry, stabilized at 6 to 6.5. [indiscernible] the question.

Follow-up is you've been hearing the tolerance for negative leverage, negative investment spread is not a lot 2, 3 years or whatever. So unless the horizon to achieve your stabilized yield of 6 is less like -- let me rephrase it. If you have a portfolio with 5 years of Walt and a 30% mark-to-market [ deed ], would you go in at a high 4s? Because that would imply more than 2 to 3 years of negative investment spread.

No.

You were priced closer to debt.

Yes, correct.

So why are we talking about for high-4s?

Because there's money out there that will.

Is that a market cap rate if you're levered buyers on the sidelines?

This is the problem. That's why I said at the beginning, there's been no trades. Show me the profile of the buyer. Would a sovereign wealth fund do that? Just flat out wants to put money in industrial in this country? They would. I didn't say we would.

What percentage of buyers are that profile?

No, no, not a lot right now.

Right now, or in any period of time, right? Those buyers are a minority of the...

They are the minority.

From a rent spread perspective, you guys don't put out your mark-to-market like a couple of peers in your sector do, but...

Well, one doesn't anymore. So I hear.

Looking at your rent spreads, though, for '23 and now 24, you've kind of been in that 40% to 50% range, plus or minus a bit.

58% last year.

Yes. So 40% to 60%. Cut it that to 50%. We'll settle there. As we think about your lease roll though for '25, '26 and think about the vintages you're getting into COVID at that point assuming a 5-year lease. How should we think about that trend given that outside of L.A., some markets are still putting up 1% a quarter rent growth, from what we're hearing. Is it going to -- how does the math work in terms of that second derivative decel?

Yes. You'd be surprised, actually, there's some resiliency to the higher rent growth over time. And of course, it matters tremendously what happens with current rent growth. And if you have negative rent growth for the next 2 years, that number comes down, absolutely. We've been generating substantial cash rent increases in our portfolio. And again, this year, I would say 40% to 52% is substantial, especially relative to the peer group.

And so the argument by some that industrial is expensive because same-store NOI growth is more than baked in, but at the same time, I think there's an expectation that spreads will decelerate for people, not insignificantly in '25 into '26, but it sounds like there's a case we made that the same-store NOI growth that the group is putting up, may mean that mid- to upper single-digit range is not necessarily as fragile maybe as some people think.

That depends a lot. The conversation we had a minute ago about bulls and bears and we were in the middle. That depends a lot on that scenario. When will the excess supply be absorbed? And if it's absorbed over the next 12 or 13 months, then '25 and '26, you ought to see better rent growth, which would support that.

Perfect. Any other questions from the audience? All right. I think maybe we'll wrap it up with our rapid-fire questions. Same-store NOI growth for the Industrial Group in 2025, not FR specifically.

What's that?

Just the group, not FR specifically.

8%.

Well, industrial have more or fewer the same amount of public companies a year from now?

More.

What is the best real estate decision today, buy, sell, build, redevelop or repurchase stock?

Build, we hope soon.

Perfect. Well, thank you guys so much, and everyone, enjoy the rest of the conference.

Thank you, guys. Thank you.