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

So good afternoon, everybody. I'm Mike Carroll. I lead the U.S. Real Estate Research at RBC Capital Markets. I'm pleased to moderate this presentation with First Industrial. So I'll flip it over to Peter to introduce the team and provide some prepared remarks and then we can go into Q&A. Peter?

Thanks, Mike, and thank you to everyone joining us here in the room and on the webcast. With me today are Scott Musil, our Chief Financial Officer; and Art Harmon, SVP of Investor Relations and Marketing. Let me offer a few brief comments before we move to Q&A. Starting with the leasing environment, renewal leasing continues to be strong. Tenants in general are making renewal decisions many months in advance of their lease expiration dates. That indicates to us they're confident in their core businesses. When it comes to investing in space for new growth for most of 2023, tenant activity slowed down compared to 2022. Even where tenants were actively looking at space, decisions were being delayed or shelved indefinitely. The uncertainty around inflation and the Fed's policy on interest rates certainly didn't help. In late 2023, the general business sentiment was that inflation was being tamed, interest rate hikes were ending and a soft economic landing was likely. We started to see quicker decision-making from prospective tenants. Examples are our 1 million square foot lease signing in Stockton and the 500,000 square footer in Nashville that we discussed on our first quarter earnings call. As we rolled into late March, the optimism was tempered a bit due to muddy messaging again from the Fed. We saw evidence of more hesitancy in decision-making, but still better decisiveness than in most of 2023. As we stand today, as new tenant demand materializes, we're in a good position to deliver strong growth looking ahead post 2024. We have potential to drive incremental cash flow by about $34 million or roughly $0.25 a share by leasing up our completed developments and developments under construction. This is in addition to the growth we're generating from our portfolio in the form of higher rents and contractual rental rate escalations. On the capital side, we're in a strong position with low leverage and no debt maturities until 2026, assuming the exercise of extension options on our bank debt. And when prospective tenants become more comfortable with adding new space for growth, we're well positioned with land holdings that can accommodate nearly 16 million square feet, 65% of which is in coastal markets. Our most likely next up development projects would be in the South Florida markets, which are the top performing markets in the country, likely in the form of another building at our First Park Miami project. We've grown our position in the Miami, Fort Lauderdale market from 2% of rental income in 2020 to 7% today. With land we currently own and have under option, we can build another 1.7 million square feet, which would grow our position there on a steady-state basis to 12% of rental income that would make it our second largest market. With that, let me turn it back over to you, Mike.

Yes. Thanks, Peter. So I have a few questions here that I'm going to present to the team. And obviously, if anybody in the audience has some questions, raise your hand, and then we can address those too. But first, Peter, how is leasing activity in the marketplace right now? And I know you have some completed development projects that still need to be leased up. So how is leasing activity at those spots specifically? And does this differ across the specific regions that those assets are located in?

So as I mentioned, the attitude or the theme has improved a little since 2023. Foot traffic is up. We're responding to more RFPs. We are not turning those RFPs into ink yet. The response time is a little bit slow on the part of the tenant base. So there's some hesitancy. And you can clearly see the attitude change based on the news that's coming out, both economically and interest rate-wise, it absolutely impacts the pace of those discussions. As I mentioned, South Florida is a great market. Nashville is a good market. Central Valley PA and the Lehigh Valley are very strong. And Southern California leasing is lagging a bit from other markets and -- but we have seen some new requirements lately. So look, this activity that's taking place, we believe is short term, it's going to pick up when the interest rate outlook solidifies and the tenants have more confidence in investing in new growth.

Great. And then who are the tenants that are currently actively looking for space? And how does that differ from maybe at the prior year?

So 3PLs continue to take a large amount of space. Their market share, if you want to call it that, is down from about 33% to 30% that has largely to do with a drop in some of the requirements from their traditional client base, if you will. E-commerce is still strong, food and beverage is strong, multichannel retailers one of the sectors that has dropped off some won't surprise is home improvement, Home Depot, Lowe's, those types of tenants as the housing market has gotten pretty expensive.

Okay. Great. And then if you're looking at concession packages like free rent and TIs. What does that look like right now, especially for new leasing? I mean, have those ticked higher at all?

So free rent during the peak was about half a month per year of term. So a 10-year lease, you had about 5 months of free rent. That number is maybe 3/4 of a month to a month now. So on a 10-year lease, you're maybe at 7 or 8 or 9 months or 10 months of free rent. As far as TIs are concerned, we're not offering anything but standard TIs, if somebody wants a larger investment in their space, we're willing to provide it to them and amortize that cost above the standard TI over the term of the lease at about a 9% interest rate, so it's a good investment of our dollars. And of course, the tenant credit plays into that decision as well. But as far as TIs are concerned, we really aren't giving any concessions there. And of course, rollovers, there are really no concessions at all.

Okay. And then if you look at contractual escalators, I know, especially during '21, '22, you were able to push those pretty aggressively, specifically in some of the stronger markets. I mean, how have those negotiations worked on the contractual escalators. Are those still at similar levels?

So we still ask for somewhere between 4% and 5%. Yes, we definitely get more pushback now than we did say, 1 year or 1.5 years ago. Portfolio wide, we're at about 3.2% contractual escalations on average. For our 2024 rollovers that we've taken care of to date, we're up to about 3.7% and that excludes 1 lease that we renewed several years ago with a tenant that wanted to expand the building. So if you take that out, we're at about 3.7% on the 2024. I expect we'll continue to get more pushback, especially and if inflation continues to tick down.

Okay. Great. Now I'll flip it over. Is anybody in the audience has any questions that they want to ask or -- all right. I can continue to go then. So can we talk a little bit about your view on market rents in 2024? I guess, where have they trended recently? And what's your forecast for the rest of the year?

There's a big difference between markets on market rent. And in some places, market rents are still ticking up. South Florida, Nashville, would be 2 good examples. Certainly, in Southern California, rents are coming down. I would say that from the peak, so L.A., you got L.A., Inland Empire West, Inland Empire East, working from West to East L.A. rents from the peak are down about 5% to 7%. Remember that rents grew in these markets anywhere from double to triple what they were 3 or 4 years ago. So dramatically higher rents. So to be down 5% or 7% is not that big a decrease. Inland Empire West, rents are probably off 10% to 12%. And in the East, maybe 15% to 20%, maybe a little more, in some cases, in the East. So you've got a lot of different rent numbers flowing through on a national basis. Overall, we think there will be positive rent growth this year nationwide in the neighborhood of inflation plus 1 point or so.

Okay. And then the midpoint of your 2024 guidance range kind of implies a 46% cash lease spread. I guess what are the biggest swing factors between the high and the low end of that range that you guys have provided?

Scott, do you want to take that?

Sure, Mike. I would say we've got 2 leases that are maturing in Southern California that have big embedded mark-to-markets. We're assuming one of those leases get renewed. If we're able to sign one of those leases, we should be above that midpoint 46% that you talked about, Mike.

Okay. And how is the activity on those discussions between those 2 tenants.

Sure. We're having discussion with both tenants at this point of time. We do have a couple of months, tough to handicap which one we think we will sign, but more to come on that in our second quarter call.

Now turning to kind of the growth within the company that you guys can deliver on the development side. I mean, how do you think about timing of new development starts, just kind of given the supply-demand dynamics that we're currently tracking right now?

So we've got some good developments, meaning developments in the market starts are way off down about 70%. That's obviously a positive. We don't mind so much that the cost of construction debt is really high, because we don't use it. And it definitely contributes to keeping that start number down. But there's new space coming online in virtually all of our markets. So we are going to want to see some more leasing and more importantly, not just one-off deals, but a more consistent drumbeat to leasing in these markets in order to move ahead where obviously looking in every submarket where we have an opportunity and evaluating whether -- when the time is going to be right to go ahead. You have to think ahead, you have to think 12-plus months away to when you're going to be delivering the asset and making an estimation about the kind of market that we'll be delivering that asset in. We noted on our call that new starts are likely this year and most likely to be in South Florida, probably at our First Park Miami development, which -- where we can build another 1 million, 2 million square feet or so.

Okay. And are you seeing any attractive acquisition opportunities in the marketplace that you're trying to pursue right now?

So we're always in the market to buy, not just land, but cash flowing real estate. We've seen a couple of trades happen at kind of silly math. I won't get too much into the detail, but one is in the Northeast, where the first round bids on that empty brand-new building or based on our estimated market rents about a 5.25% return. . And then we saw a deal recently on the West Coast, where the cap rate was a 4 handle -- so -- low 4 handle. So there is money and again, looking for a home in the space. We continue to evaluate opportunities. We're a little bit picky, I guess, you could say when it comes to geographic location and functionality. As you most of you probably know, we have spent the better part of the last dozen years or so, completely transforming our portfolio. So we're not going to go buy something that doesn't meet all of our criteria. But we're interested and we just need to find the right opportunity.

Okay. Great. Is there any questions in the audience that they want to present to the team? All right. Peter, can you talk a little bit about, I guess, asset sales, I think you're targeting about $100 million to $150 million this year. I guess, how is the appetite for those assets and what does the buyer pool look like for those specific properties?

So consistent with most of our recent sales, the buyer profile is [10 31] buyers. Users buy a lot of these properties, small local investor or investor groups buy these properties. And these properties have been -- largely, as you know, been in the Midwest markets. There is significant activity, significant interest. We have some assets that are on offer where we have literally dozens and dozens of investors taking a look that will result in maybe 10 or 12 offers. So there's money out there, and it's reasonably aggressive considering all the other factors that one needs to think about in terms of the cost of money and the volatility in the marketplace. So we're pretty pleased with what we're seeing. We feel good about that guidance range on sales, and we'll see where we end up.

Okay. And then, I guess, any capital needs that does the company have here in the near term to kind of start funding some of these development projects that you have in process?

Sure. Peter talked about the debt maturity schedule in very good shape there. The developments, the required amount to be funded is about $120 million. Most of that will be spent this year. With excess cash flow after dividends and CapEx of about $60 million in property sales, we think for the rest of the year of about $75 million, we easily cover that. I also want to take the opportunity just to let folks know, it just came out last week that one of the rating agencies upgraded our outlook from stable to positive. So we think that's a good point of view from our credit as well, Mike.

Okay. Great. And then I kind of wanted to flip back on to some of the development projects that you guys have and you're looking at. I guess when you're looking at new development starts, I guess, what's some of the factors to kind of to pull the trigger to start those projects. I mean is it leasing up some of your in-process projects that you have right now? Is it just trying to progress through some of your South Florida markets because that seems to have the best opportunity. I guess, what's some of the gives and takes that would get you to want to break ground on some new projects right now?

So on the back of COVID, as you know, we were -- we have a self-imposed development cap. Today, it stands at $800 million. It's a formula. I won't get into that now. But off the back of COVID, we were right up against that cap. So we couldn't initiate new starts without signing leases. We've now signed a bunch of leases. As you've seen, we have significant capacity to move ahead now under that cap. By the way, we very much like that cap. It eliminates human judgment from the equation and even though we have a tremendous development pipeline, the timing is everything and that cap comes in handy. As you can't lease space, the cap remains full and you can't build more, and that's a very logical outcome. Certainly leasing, and as I mentioned earlier, we're going to want to see more consistency in development -- new development leasing. It's a totally different look from rollover discussions. Those are happening early. Those are happening quickly. Again, that's, we believe, a very solid sign for the market. But we want to see new development lease-up begin to happen on a more regular basis as opposed to the one-offs that we're currently seeing. It really depends on the fundamentals and the availabilities in the submarkets where we have opportunities. In South Florida, there aren't a lot of -- there are no competing buildings for what we can bring to the market. Rents are still growing nicely. Vacancy is low. And that market is incredibly geographically constrained if you were to look at a map from Jupiter to Homestead, so north to south is only 115 miles and from east to west. So the water to the Everglades is 21 miles. So that's obviously a permanent barrier to entry. And we're looking obviously for more opportunity there. But that's why we would initiate new starts in that market probably beyond -- ahead of any other market.

Okay. And then I know you did adjust your development margins, the in-process projects recently this quarter and obviously, you did a little bit last year to get a little bit more conservative. Can you talk a little bit about how you view the value creation from your in process or your completed development projects? And what kind of drove some of those changes in the development margins?

It's really just our estimate of residual cap rates. The development yields that we're achieving are about on a portfolio basis, not every project. Some are higher, some are lower. But about 7%, that's a very nice yield. The land holdings that we have generate a very similar return, again, pro forma, some of it we wouldn't build on for a long time. So we believe we're in a really good place with new growth opportunity because all of our holdings, the raw material we need to generate growth will generate really nice returns at this current cost of capital. So the developments that we have that are completed and the ones that are underway, we lease those up. We have invested nearly all of the money in those assets that requires all but like $130 million. So we've paid for it, and it's going to generate about $34 million of NOI when we're finished or when we lease it. That just goes right to the bottom line.

Okay. Great. I know we still have some few minutes here. Does anybody else have questions in the audience?

What markets are seeing the most oversupply and how long the [indiscernible] do start some kind of stuff?

Yes. I think -- are you from Denver?

Yes.

You look familiar. Denver is one of those markets that has too much space. And it is one of the -- so we track starts within the markets where we're active. Denver is the only market where starts have been above 0 every quarter. We have a 588,000 square foot building there to lease brand new. And we have about a 200,000 square foot building there to lease. And those are going a little bit slowly. We are seeing some decent traffic there, but it's surprising to us that more space continues to start, not come deliver. Of course, the projects underway will be delivered. But -- so hard to estimate how long that will be, but certainly 12 months to 18 months before you see a change there. Every other market starts have been not every quarter, but pretty close to 0. And that's obviously a really good sign because we do have new spaces being leased. And if you make certain assumptions about the pace of net absorption, the pace of new starts and therefore, deliveries, we ought to see vacancies, maybe they go up a little bit from here. Maybe we're not at the bottom of the trough just yet. But going into next year, middle of next year, we ought to see vacancy start to come back down. That's just math based on the current trends. And if those trends change, then that outcome changes. That's one of the reasons we think we're in a kind of a temporary period here. It is helpful that Amazon has taken -- will take this first half of this year, almost 14 million square feet. That's more than they leased all of last year. In 2020, they leased 30 million square feet, more than the next 30 most active tenants combined. Why do I mention it? It was 4 years ago, who cares? Will that served as a catalyst in '21 and '22 for everybody else who competes with them to come out and lease new space. So we'll see if their current activity serves as a catalyst, we don't know, but it's not a bad sign.

So, Peter, can you talk a little bit about Southern California, your views on that market? I know you have some completed development projects or in process development projects. Maybe talk a little bit about the leasing activity or interest level that you're seeing in some of those specific properties.

Yes. So just big picture, and this happened especially in SoCal, you remember when the tankers couldn't dock for 10 days or 2 weeks, because it was too busy and -- there was no space to offload the containers, et cetera, et cetera. So that -- and that was driven largely by demand from COVID, online e-commerce demand. That generated 1 billion square feet of net absorption in 2 years. And that, of course, generated great interest in investing in our space. All kinds of money came in, and we built -- I think the national development pipeline was something like 620 million square feet at its peak. It's down to about 317 now. So we are digesting that period of time where we did overbuild and over lease space. There was a huge sense of urgency on the part of the other tenants who didn't lease back in 2020. Remember, there was no space to begin with. So if you got a space or you could, you took it. And rents were going up 10% a quarter. So again, if you could get a space, you took it. Maybe you weren't sure you were going to need it, but you took it. And that's what we're digesting now, especially in SoCal and that's a 7 Inland Empire, in particular, is a 700 plus or minus 1 million square foot market. I think there's 20 million square feet under construction. So we're getting there. We're getting to the end of that delivery of new space and port traffic is up 20% year-over-year. We're about to have a negotiation on the East Coast with the labor at the docks and as you remember, when that happened in SoCal, a lot of that shipping went to other ports. So we'll see. I mean, we're bullish. We think, again, it's a matter of time before that space gets taken up. It is the one time in the last 4 years that tenants have a little bit more say and can play a little more hard ball and their brokers are definitely telling them to do that. But it will eventually wash through and that market will again begin to grow.

And how quickly does those discussions shift? So if there's a group of tenants, they make a decision and take down some of these or availability within, let's say, Southern California, do you think that could change people's mindset and it's kind of create like a waterfall event where more tenants are willing to make decisions? I guess, how long does that take before we get to that point?

So this is at the peak. So ['21 2-ish], we had 4 to 6 prospects for each space that we had available in SoCal and maybe we had 2 or 3 competing buildings. So everyone was going to lease up their space. Today, I'd say we have 1 to 3 prospects per space and 2 to 4 competing buildings. So somebody is not going to lease and they're building in that equation. It's when that changes, you tell me, but it's not that far away when you consider we're talking about a couple of competing properties in 2 or 3 prospects is making the difference. So if you look at it all and you run through again, we think second half of '25, vacancies will start coming down, perhaps rapidly and the dynamic will change.

Okay. Great. And I know that you had some -- I guess, what type of opportunity set are you seeing from like data center of tenants within some of your land parcel. I know you had a couple of announcements a couple of quarters ago of taking down some of your land parcels. Do you see a lot of those opportunities within your portfolio where there might be a higher, better use for data center?

We like to have more. So we bought over 1,000 acres in Phoenix in a JV in 2 transactions, about 500 acres each. And on the Northern parcel, what we call Camelback, we struck an arrangement with a data center business to buy a 100 acres, they closed on 30 acres, at a price that's probably 4x what industrial land goes for. We're going to make more on selling the land than we would have made developing the building. Power is a big question now. So one of the inputs to due diligence and considerations is not only the availability of power, but who gets it. And if you are a big player like a Microsoft, you're probably going to find a way to get it. You probably have friends in high places. On our Southern parcel called PV303, we did a similar transaction with a very large tech company for a 100 acres. And they're leasing it from us in the interim at a pretty nice yield. We're not going to be involved in the development of data centers. But when the opportunities come up to take land that we own or go ahead and buy land that might fall into this category and put together transactions where we can make as much money on trading the land as we kind of building a building, then we'll do more of that. Unfortunately, we don't have a lot of that in the current land holdings.

Great. Looks like we're almost out of time. If there's one quick question in the audience, we can address it. If not, we can close the session.

Really quickly. Thank you for coming today. My buddy wasn't able to make it, but he was curious how [indiscernible]?

Well, they haven't changed. So I would say they haven't. Now there's a discussion that maybe they go much, much, much higher. We'll see. China has invested a lot for the last 10 years in Mexico to get around the tariffs that come in that way. That's a TBD, but right now, it hasn't really affected it. And some of the share, if you will, from China that's gone into Mexico, has been taken up by other Southeast Asian countries shipping goods. So it hasn't really impacted. But we'll see. I mean, it's a topic to think about for sure.

I guess that's perfect timing. It looks like we're going to end right on time right now. So thanks everybody for coming.

Thanks, everybody.