First Industrial Realty Trust, Inc. ($FR)

Welcome, everyone, to the first industrial session. I'm Nick Thillman, Senior Analyst at Baird covering office and industrial REITs. And today, I'm joined by Peter Baccile, President and CEO of FR, along with Scott Musil, CFO; and Peter Schultz, EVP of the East region. I'm going to hand it over to Peter for some remarks, and then we can proceed with the Q&A after.

Okay. Thanks. For those of you who aren't familiar with us, we're a U.S.-only-focused industrial developer, owner and manager. We've got about 70 million square feet, plus or minus $12 billion or $13 billion of total value. Our primary growth engine is speculative development. We do acquire as well, but not on a volume basis, not as much. Over the last 10 years, we've created $1.3 billion in value through our development pipeline, generating 7% cash yields and about 50% margins. I'll turn it back over to you, Nick.

Yes. So feel free to come up to the mics if you have, like, specific questions, but I'll kick off with a couple of them for you, Peter. Has there been any noticeable impact on tenant activity due to the recent conflict in Iran and/or rise in oil prices or interest rates?

So we -- when we first saw that at the end of February, we thought, here we go again. Last year, it was tariffs and that cooled demand for our space and now this. But I have to say that we've seen no discernible impact on tenant activity or tenant demand since the beginning of the war back in the end of February. Maybe the input prices for most of our customers, transportation and labor are the highest, and those have grown the most over the last 20 years or so. Interestingly enough, I did a little math this morning. A gallon of gas 20 years ago on average was $2.63. Today, it's $4.31. I know it's much higher in some places. But that's about a 2.5% CAGR on gas prices, which is exactly equal to inflation over that same time period. So that might explain why it's kind of been a yawner for all of the tenants that are prospects for our space.

And then maybe dovetailing that a little bit to the leasing demand for some of your developments and your larger vacancies, including the 700,000 square foot vacancy in Pennsylvania, I guess demand seems as though it have to be a little bit of stop start post Liberation Day, and it started to pick up some volume and some -- we saw some momentum in the fourth quarter into the first quarter. But maybe what you're seeing from that element on those.

The last 6 months, we've seen a big pickup in tenant activity and traffic. In fact, the last 6 to 8 weeks, it's gotten even better. That traffic is around much larger spaces as well as the smaller spaces. In many markets, there are still, let's just say, several alternatives for tenants in the kind of 250 to 750 range. Activity. Peter Schultz is our East region head and is responsible for our 708,000-foot in PA. Why don't you talk about what's going on there?

Sure. Pennsylvania is probably the most active market we have in the country today, together with our Texas markets. But Nick, to your question on our largest vacancy, the 708,000 square foot building in Central PA, we have a couple of active prospects we're in discussions with for the full building as well as some interest from a couple of other tenants. Our recently completed project, our first 33 project in Lehigh Valley, just in the first quarter, which is 2 buildings of 150,000 and 211,000 square feet, we've seen really great demand for that 50 to 200 range. And in fact, we already signed a lease for 54,000 square feet in that building within just a couple of months of completion. But activity, as Peter said, is good across the country and a lot of the prospects we're seeing today, including the couple that we're actively working with, weren't even on our radar screen at the beginning of the year. So that's giving us some more encouragement about the pace and cadence of demand and some tenants making decisions with more urgency.

And you maybe just touched a little bit on it from Pennsylvania standpoint, but from overall best markets today and most challenged as you look at the portfolio?

So look, best markets in Nashville is still one of the best markets. Certain submarkets in Dallas, Houston, South Florida. SoCal, we would say, is stable -- stabilized. So rents will be flattish, we think, this year there. Again, there are still some alternatives in terms of lease up there, more alternatives than we'd like to see. Denver remains a market that's behind in this recovery. It is the one market in our 15 markets where new starts didn't stop -- starts didn't stop for probably 3 or 4 quarters behind when the rest of the markets around the country did. So there's a little bit more alternative there for tenants as well. So weaker, call it, Denver, stable SoCal and then those bigger Eastern markets are doing pretty well, including, as Peter said, Central PA very well.

Maybe outlining some of the embedded growth within the portfolio and cash leasing spreads overall. You guys are guiding to 30% to 40% for 2026. And what are your thoughts on 2027 and beyond just for rental spreads given the embedded run-up we've had since COVID?

Sure. So we don't forecast the leasing spreads. What I can say is a couple of things. First, we've got a lot of development leases that we signed pre the peak. That's one of the good things about our strategy through this cycle as we have assets that we leased pre-peak because we built them new. And so you can see that rent growth should have some legs at least for a while. Secondly, our mix for rollovers in 2027 is approximately the same as the representation of those markets in our portfolio with a slight overweight in Dallas and Atlanta, and those 2 markets have done very well, did not have quite the same amount of rent run-up and therefore, rent fall or rent decline as, say, the West Coast markets did. So again, that's another tailwind, if you will, to our cash rents in the future.

That's helpful. And then maybe on the capital deployment and priorities today, you guys put in the buyback recently. Just ranking and what you're seeing between new development starts, acquisitions and repurchases today?

So it's all about economics. As I've said in the past, we're a profit shop and not a volume shop. So we take the precious capital that we do have and consistently evaluate where best to use it. Our growth engine, as you know, over the last decade or more has been through speculative development. That will still be the case. We have land holdings today that are about 75% entitled where we can invest about $2 billion at about a 6.9% yield. So very, very healthy yields and returns. Of course, we're not going to build into markets where there are already too many alternatives. So we need to see some sustained leasing for developments in these markets before we're going to get going in some of them. We have had new starts, as you've seen in Pennsylvania, in South Florida. We've built out our land in Nashville. We're looking for more land in Nashville. We continue to love that market. And as far as the -- you mentioned the stock buyback. So over time, our Board has considered that topic many times. We have always had great opportunity and continue to invest dollars in high-growing real estate assets, but as we looked at some of the market dislocations over time, and we thought, well, gee, we have a very strong conviction on our stock over the long term. When the markets swoon by 10%, 25%, maybe we should think about taking some shares off the table. So that's what we're going to do with that allocation, that $250 million to be very opportunistic. We don't really have a target. It's just about when we see an inflection point that we think just ignores the value of our long-term portfolio.

And as a reminder, if anyone has any questions, feel free. There's a mic over there. But maybe touching on rents a little bit. And just you talked a little bit on Denver and the starts there. As you look at the competitive landscape for starts today, are you seeing any markets where you're starting to see ramping up starts? And I guess from a just overall bet standpoint, like where you've mentioned Nashville, where do you feel like you have the land to develop in today's market?

So in terms of starts, there will be more starts for us this year. We're not going to quantify that. It will be in some of the stronger markets that I highlighted earlier. We are looking for land, as I said, in Nashville, hopefully, we will tie some down soon. It's a very, very, very competitive market. We compete not really necessarily with the other public industrial REITs. It's more with private capital, where the capital is priced very -- in our opinion, very thinly. So what we do is we leverage our platform. We have about a dozen offices around the country. We have people in these offices that have been around for 15, 20 years or even 30 years in these markets and have great relationships. They're making hundreds of unsolicited offers a quarter. We have to have a lot of balls in the air because by definition, the success rate is not super high. We're trying to find those opportunities that come few and far between where we can make a lot of money for shareholders and not get caught up in any kind of broadly distributed bid process. And that process can take a while. But once we get to know those landowners who might be reluctant sellers at the beginning and they get to know us, they have a level of comfort with us, and therefore, we're able to tie up those deals perhaps with minimal competition, there's always some competition, but perhaps with minimal competition. In many occasions, our teams are able to tie up land and have it get entitled while the seller still owns it. So that means we're not -- our capital is not burning while that process is going on. So it's a pretty involved process. It allows us to have a very, very low basis relative to most of our peers. We also build a different product than the private market tends to build. We don't overbuild the sites, maybe we cover 36% or 37% or 38%, whereas others are in the high 40s. We make sure we have ring roads, our ability to secure truck courts, 180-foot truck courts we go. We spend the extra $1.5 and build taller buildings. So not only is our basis in a very good place, that allows us to offer the best product, the most competitive product in the marketplace. And that's really why we benefited during this cycle, 10 years ago, we said we're going to build a portfolio that outperformed through the cycle. You've probably seen if you paid attention, our cash rental rate growth for the last few years has been really large, 58%, 50%, 35%. So that we attribute to the way we do business and that portfolio that we wanted to build that would outperform through the cycle.

Maybe touching a little bit on market cap rates. What are you seeing for market cap rates in your markets today?

So cap rates vary. For Class A space, new space, 5 to 5.5 would be the range. It doesn't mean you won't see some transactions take place in the 4s, you will, but the bulk of the capital is in that 5 to 5.5 range.

And I know you guys have been evaluating some of your land purposes and even some of your operating portfolio for data center-related uses. You completed a large data center sale this quarter. Are there -- are there any other opportunities you've identified in the portfolio or seeking out on your land bank today?

So we've been very pleased with what we've been able to do in Phoenix. We had 2 joint ventures there. We bought, combined between the 2 JVs, about 1,100 acres. We ended up -- it wasn't part of the initial plan, but those -- both of those JVs are wrapped -- now wrapped up. We ended up selling 500 acres for data center use. And we got 3x industrial value. So not 3x our cost, 3x industrial value for those sites. We could have developed those sites, lease the buildings and not made as much money as we did selling the land for data center use. So we're -- we've taken a very detailed look at the rest of our portfolio, land and cash flowing properties. We boiled it down to -- as you can imagine, it's not an easy process. First and foremost, power. If you're in jurisdictions where power is not available, those assets aren't going to work. So you got to -- you have to be able to get power. Number two, you have to be able to get power in a reasonable period of time. 2030 is reasonable. Beyond that, it's not so reasonable. Number three, if the building or the land is tied up by tenant for the next 10, 15, 20 years, take that off the list. So we've narrowed it down to about a handful of potential opportunities on one in particular, we're going to put a full court press on trying to get power soon. Probably if something happens, you're not going to see that happen between -- before 2027 in terms of monetizing those opportunities. The upside, you already heard on the land is kind of 3x industrial value. With cash flowing buildings, it can be -- it's a very wide range for a lot of different reasons. It can be 50% to 100% higher than industrial value. So that's a process that we're going through, and we're hopeful that we're able to monetize some of those assets that way.

Scott, maybe touch on a little bit on what you're seeing on the overall tenant credit and the health of just overall tenant base today, you did have something with a 3PL tenant. But overall, credit within the portfolio, what are you seeing there?

Very healthy. Our bad debt expense in the first quarter was only $100,000. That's about 10 basis points of total revenues, lowest in our sector. As far as tenants on the watch list, these are the couple of tenants we've been discussing over the last year, a tenant called Boohoo. They leased 1 million square feet. They're paying timely. We also have a letter of credit that covers about a year's worth of rent. The 3PL tenant, we entered into an agreement right before our first quarter earnings call, they paid back 60% of their arrearage. They're required to pay the rest back by the end of the year and they're current on their plan as well. Nothing else material on the watch list. So from a credit point of view, looking pretty good in it.

And one more thing to add on the data center opportunity. So the data center business, which we are not in and don't want to be is also providing a bit of a tailwind for demand for our space. So the entity that we sold 300 acres to in Phoenix ended up leasing half of a 940,000 square foot building we have there because they intend to build 14 data centers over time. That's a very -- going to be a very long-term tenant. They use that space for staging and storage of equipment. And so the more manufacturing that happens in the data center business, the power business, as you know, everyone is trying to figure out how to generate more power. That is also a tailwind for demand in our space. Together, these aren't as strong as e-commerce as we know, e-commerce has been a huge tailwind for our space for a long time and will be for a long time to come. But for now and probably for the next 10 years or so, it will be a nice tailwind.

And then for some that aren't as familiar with the story, the broader rotation from the Midwest markets to the coast and these core population hubs from a distribution side, you're mostly wound down with that. But what percentage of the portfolio do you view as somewhat non-core in the recycling of that capital? And is that program mostly complete? And where do we go? What's the next 5 to 10 years look like?

So over the last dozen years or so, we have sold about $2.5 billion. Now remember, 10 years ago, our total market cap was about $4 billion. So we sold 2/3s of what we had at the time. Today, 2/3s of what we have is new, newish since 2010, and then the other 1/3 is what I call legacy. So we're -- and that's the best of the best of what we had. So we're pretty much through that -- we are through that transformation. And again, you've seen the results in our great cash leasing spreads and our growth trajectory, same-store, et cetera. We will continue and we'll always be looking to maximize the value of our dollar invested. And if we see an asset or certain assets in a certain market that aren't going to -- that don't have the growth future that we want to see, we will continue to, of course, to pair off that bottom of the portfolio. But the transformation was completed really at the end of '23, and it's been quite dramatic.

And you'd say growth into other markets. As you look at the portfolio today, do you feel that you've got enough capacity to develop and/or acquire in your existing footprint? Or do you think there's new markets that you look to evaluate longer term?

Nashville is a market that I would say is "new". Now we've always had space there, but very, very small percentage of the portfolio. And about 10 years ago, we said, "Hey, let's go bigger in Nashville. The demographics look really good, and it's been a great move." We did the same thing in South Florida. We had 1.2% of our portfolio there. It's up to a little over 6% today and maybe heading to a top 3 or 4 market for us soon. That's been a great move. You talk about high barriers. It's 21 miles from the Atlantic Ocean to the Everglades and about 115 miles from Homestead to Jupiter. So not a lot of room there. And it's very, very tough to buy land there, and that's a market we continue to love. So that will be the focus going forward.

Peter, how much of -- of that is your responsibility then going forward?

Most of that.

Joe is not here to defend himself. So I figured I'd have to chime in. Scott, maybe going back to -- you guys did your first bond issuance last year a while back. As we look at like funding needs and going forward, I guess, what are your preferred sources of capital to fund the continued development.

The next 3 quarters of remainder of the year development expenditures projected are about $90 million. We generate about $85 million of excess cash flow a year. So that's number one on the list. We also disclosed in our first quarter call a sale -- land sale in Phoenix, which actually closed, I think, last week. So that's a source. And if we need other funds, we can obviously tap the bond market as well.

And what's pricing today for?

I would say it's about probably about 100 basis points for a 5-year and around 120 basis points for a 10-year. Those are the spreads, yes.

And then as we're just thinking about the balance of the year, I guess, what keeps you up at night, Peter, from a demand standpoint? It seems as though conditions are still humming along despite some geopolitical uncertainty and some macro headlines and maybe a potential weakening consumer. I guess what are you monitoring most straight right now to see?

It's always leasing. That's our lifeblood. In good times and in bad, you lose sleep over that. Everything else creates volatility. We're in the forever ownership business. That's why we pursue the business the way we do, why we're focused on the 15 high barrier markets where it's more difficult to build rents are going to grow the fastest. Doesn't mean you can't make money in other markets in other ways. But in our view, they require market timing. And we think over the long term, you're probably going to lose if maybe come out 50-50 at best. So we like to be in the forever market, and we think that's going to lead to the greatest appreciation in the share price.

And maybe just lastly, on just upside you think on rents here relative to maybe when you're rolling your second-gen leases relative to where replacement rents are for new deals, I guess, how much room is there on that?

So there's -- I mean, we can build in a lot of markets, I would say, even some of our land in SoCal pencils today, but if there are already alternatives, they're not going to build. Rent growth, we think, is going to be 0% to 5%. SoCal probably flat. You could have markets like Nashville and Dallas grow higher than that, maybe as much as 8%. So these markets are beginning to get better. That loss to lease factor is going to go to 0 in a lot of places where it isn't right now. I can't really project when you're going to get there for SoCal.

Not for you guys? Not you or the market? Like do you have -- it seems like '27 is still a pretty good setup?

'27 is a good setup. I think. Here's the thing. I think I said this earlier, we're now in a more predictable, stable growth trajectory in this sector, one that goes back to pre-2000 -- pre the Great Recession. Since then, I mean, it's 20 years. But you've had the Great Recession. Nothing was built in this space for 3 years. You had a big run-up to '19 and then when COVID, everybody brought out the hockey sticks, everything grew like crazy. Now we've come down the back side of that. So we've had these big volatility creating events for 20 years. But if you go back to the 2002 to '06 period, this business grew at a pretty steady decent rate and a reliable rate. And I think we're about to enter into that part of the cycle again and that's good for business.

Any questions from the audience?

[indiscernible] What you're seeing in construction across the any impacts from [indiscernible].

Construction costs and impacts from what else?

[indiscernible].

Yes. So construction costs -- okay. Sorry, construction costs since -- from the peak have come down, at the peak, we like to bid to 3 GC -- potential GC and we got to the point at the peak where they would refuse. They wouldn't do it. That's changed 180 degrees now. So people are asking for business, costs have come down. There's been no real impact from the conflict in the Middle East. We haven't seen a rise in the cost of anything really, steel, concrete, nothing. So it's been pretty stable, though the last couple of years. So that drop happened. That drop in expenses -- cost happened '24, '25.

The other thing I'd add to that is with less development and construction underway. Subcontractors and labor has gotten a lot more competitive because they're chasing work now compared to what Peter said where they were refused to bid previously.

Maybe a follow-up on that. Just are you guys seeing competition when it comes to just data center development, like bidding for a new start?

We're not having any difficulty getting multiple general contractors in highly qualified subs to bid our projects. Certainly, data centers are absorbing more land, which is reducing the supply of land available for industrial development as good as an owner of assets. But we've not had any difficulty at all getting people to bid our projects competitively.

[indiscernible] South or this year prediction was for maybe looking out how you make prediction to [indiscernible].

Yes. So that completely depends on the pace of take-up of the existing inventory. We said a couple of years ago that decision-making was taking a long time. And everybody wants to know why it takes a long time. It continues to be somewhat slow in that market because there's no cost to waiting. What's the cost to waiting? Cost of waiting is you can't get the building you want or you can't get it at the rent that you want or competitively, you're not investing in growth like your peers are and you're going to fall behind. Those dynamics need to be in place for rents to start to really grow. And in particular size range in SoCal, there are 80 buildings available. Now it's a 2 billion square foot market. So it's not -- it sounds like more than it is. But 80 is still 80. And we need those buildings absorbed. And it's happening. That number was a lot higher a couple of years ago. And the new starts in that market are literally, so the Inland Empire is about a 700 million square foot market. New starts are in the single-digit millions. So there's almost no new starts. So I can't put a time frame on when you're going to see real rent growth there, but it's certainly not that far away.

I'll conclude. Thanks, everyone, for showing up. And feel free to reach out if you have any follow-ups with the team.

Thank you, everyone. Thank you.