Peakstone Realty Trust (PKST) Earnings Call Transcript & Summary

Good day, and welcome to the Peakstone Realty Trust's Acquisition of Industrial Outdoor Storage Portfolio Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Steve Swett, Investor Relations.

Good morning, and welcome to our call to discuss the company's acquisition of a premier Industrial Outdoor Storage Portfolio. Please note that an investor presentation with additional details and information related to the acquisition has been posted to the Investors page of our website at www.pkst.com and is available through the EDGAR database on the SEC's website at www.sec.gov. Please reach out to our Investor Relations team at [email protected] with any questions. Please note the use of forward-looking statements by the company on this webcast. Statements made on this call may include statements which are not historical facts and are considered forward-looking. The company intends for all forward-looking statements to be covered by the applicable safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Exchange Act of 1934 as amended and is making these statements for purposes of complying with those safe harbor provisions. Furthermore, the forward-looking statements reflect our current views about future events and are subject to numerous known and unknown risks, uncertainties, assumptions and changes in circumstances that may cause actual results to differ significantly than those expressed in any forward-looking statements and could be affected by a variety of risks and factors that are beyond the company's control, including without limitation, those contained in our most recent annual report on Form 10-K and any subsequent quarterly reports on Form 10-Q filed with the SEC. We disclaim any obligation to publicly update or revise any forward-looking statements to reflect changes in underlying assumptions or factors, new information, data or methods, future events or other changes after the date of this call, except as required by applicable law. Additionally, on this call, the company may refer to certain non-GAAP financial measures such as normalized EBITDAre and net debt. You can find a tabular reconciliation of these non-GAAP financial measures to the most currently comparable GAAP numbers in the company's investor presentation that has been posted to the Investors page of our website and furnished to the SEC. On the call today are Mike Escalante, CEO and President; and Javier Bitar, CFO. And with that, I'll hand the call over to Mike.

Good morning, and thank you for joining our call today. We are excited to announce the company's acquisition of 51 premium infill industrial outdoor storage assets in an off-market transaction valued at $490 million. The portfolio comprises 45 operating assets and 6 redevelopment sites. The assets are situated on 440 usable acres across 14 states and are strategically located near major supply chains and population centers. We are thrilled to establish a significant presence in the emerging, high-growth industrial outdoor storage sector, which is characterized by fragmented ownership, significant supply constraints, compelling operating fundamentals and minimal CapEx requirements. We believe that this sector provides considerable opportunities to achieve persistent growth, which will drive long-term shareholder value. In that regard, the portfolio significantly enhances the company's growth profile with a potential 70% mark-to-market opportunity and the ability to achieve incremental yield through the redevelopment properties. Also, the transaction increases our Industrial portfolio concentration in key Sunbelt and Coastal markets and further evolves our portfolio towards industrial, with our Industrial segment ABR now accounting for approximately 40% of our combined Industrial and Office segment ABR. Industrial outdoor storage assets are very complementary to our existing industrial business. The tenant base, lease structures and market dynamics are comparable to our more traditional industrial assets. Further, our existing team has differentiated industrial outdoor storage expertise, which will drive long-term value creation. I will spend a few minutes walking through industrial outdoor storage fundamentals, the acquired portfolio highlights and Peakstone's go-forward strategy. Industrial outdoor storage, also known as IOS, presents a compelling investment opportunity. As I previously mentioned, the IOS sector is highly fragmented with few institutional owners and limited coverage from major research firms and brokerages. Industrial outdoor storage properties serve as a critical connection point for the flow of goods and services and play a pivotal role in the supply chain. These sites are typically designed as low coverage, meaning that they have a building-to-land ratio which is usually less than 20%. The properties have significant improved yard space to facilitate the display, movement and storage of goods and are often improved with a smaller industrial building to support the tenant's on-site operations. The sector has numerous supply constraints. Existing infill land zoned for IOS is limited and is further reduced each year as IOS sites are developed into different uses. Many municipalities restrict new IOS zoning for reasons, including increased traffic and relatively lower tax revenues, which creates a high barriers to entry for the sector. On the demand side, there is a broad universe of tenant industries, including transportation and logistics, equipment rental and building materials. We believe this creates an attractive supply-demand imbalance that will generate strong rental rate growth over time. Industrial outdoor storage assets are typically net leased, tenant managed and have ongoing CapEx requirements that are among the lowest of all real estate asset classes. The improvements are usually not tenant-specific and are designed to accommodate a broad user base with limited risk of functional obsolescence, limiting exposure to re-tenanting costs and downtime. Furthermore, tenancy tends to be sticky as it is difficult to find alternative well-located infill sites that permit broad IOS uses. Moving on to some of the highlights of the IOS portfolio we acquired. As I mentioned earlier, the portfolio comprises 45 operating assets and 6 redevelopment sites. The operating assets are approximately 100% leased to diversified high-quality national and regional tenants with 47% investment-grade tenancy and an average WALT of 4.5 years. The tenants operate in the transportation and logistics, e-commerce, equipment rental and building materials sectors. The redevelopment sites encompass 82 usable acres in 4 states. This portfolio significantly enhances our growth profile, driven by a potential 70% mark-to-market opportunity on the operating portfolio, additional upside through 6 redevelopment assets and contractual rent escalations averaging 2.6% annually. We anticipate the redevelopment sites will take 12 to 36 months to stabilize and we are targeting stabilized yields in the 7.5% to 8% range for these assets. Our Industrial segment now consists of 71 properties spanning 19 states and 32 markets with a 58% concentration in Coastal and Sunbelt markets. I will now discuss the capitalization of this transaction. As reported in an 8-K filed earlier today, we closed on $285 million of additional financing. With the support of our line lenders, we added a $175 million unsecured term loan to our credit facility. We also closed on 3 separate financings totaling $110 million, each secured by one of our existing industrial properties. As a result of these financings, we have temporarily increased our leverage in order to acquire this premier portfolio. In doing so, we have diversified our sources of capital, added debt duration and maintain limited exposure to floating rate debt, while continuing to have flexibility to pay down our revolver with asset sales. Slide 17 of our investor presentation for this transaction shows our pro forma capitalization, and Javier is on this call with me today to answer any questions you may have in this regard. Pro forma liquidity post-close includes $51 million of undrawn revolver capacity and $128 million of cash on hand. Our pro forma leverage is 7.9x our net debt to normalized EBITDAre. As we move forward, we will continue to be strategic about balancing industrial investments, while reducing leverage. We believe this IOS acquisition will drive future growth and create meaningful long-term value for our shareholders. With that, we will open it up to questions from our analysts.

[Operator Instructions] The first question comes from Anthony Hau with Truist Securities.

Congrats. Just curious, like how did this deal come about? Why was the seller selling? And why do you guys think it's a great opportunity today given the soft backdrop for it after TL and construction?

Appreciate the support. And as you can well understand, we've been running hard the last couple of days. So the brain is a little foggy this morning. We are very, very excited about this particular portfolio. It is a phenomenal premier quality portfolio and we think that it will stand out as being superior in many ways when compared to the various portfolios that we expect to see trade in the coming weeks. We've been tracking the IOS sort of business, if you will, dating back to the beginning of this year. We bolstered our team in terms of our expertise in this area and have been specifically studying it for quite some time. We're looking at some things pretty actively through the middle and end of the summer. And then this portfolio came to our attention as a result of relationships really up and down the ladder of the organization all the way into our Board and through our key executives on the ground. I think really when you look at it fundamentally, it came to us largely because it was a large portfolio. They needed someone who had access to capital. We had significant support from our line lenders. And then fundamentally, we had the expertise in-house and demonstrated that to the seller that we could underwrite this, we could underwrite the complexity of the transaction and that we had the funds to close it. So all of that played into our ability to do it on an off-market transaction. We're very happy really with the, I guess, the metrics associated with, the marginal debt that we had to take on and the very little impact that it had to our overall cost of capital. As you know, most of our debt is largely fixed in nature. And when you look at it on an overall basis, the sort of the marginal cost to our overall cost of debt capital really didn't increase all that much. We still have an opportunity to provide some hedging. And as you know, we have the flexibility in our revolver to continue to pay down our leverage as and when we execute on some further office sales. As you know, we've been doing that on a select basis going forward. So in essence, all of that played very well. There was a big crossover for us in terms of the portfolio, in terms of the locations. If you look at our presentation, you'll see on Page 15 a map that overlays our current industrial portfolio on a post-transaction basis. And by and large, our industrial portfolio and our now new acquisition overlay on the interstate's infrastructure in the country. So we feel that on many, many levels, this particular property type plays extremely well into what we're doing as an organization. In terms of being highly complementary to what we're doing, it's consistent with our management style of our traditional industrial. It leverages our existing team. We have a similar credit underwriting. Almost 50% of this portfolio is investment-grade. 73% of the portfolio is made up of national players. We like the repeat business that we think we can do and follow the tenants across the country. The market dynamics are good. I think the better part of this portfolio is the fact that the supply side is very much under control. There's barriers to entry to new development. There's very low rate -- relative -- very low vacancy rates relative to other real estate classes. And the demand is still driven by the same people; it's e-commerce, transportation, logistics and things of that nature. So it's a net lease structure. There's not a lot of CAM. Many of the properties are tenant managed. And again, we had high support and conviction from our lenders. We love that this is a highly fragmented sector or subsector, if you will. It's not new, it's been around since the beginning of time. There are many players in the market in the industrial side of this that already have exposure to this. There's just a new label being attached to it. We even called it industrial adjacent if you look at the vast majority of the properties in this portfolio. We are dramatically infill. We are surrounded by other industrial uses. If we have to go vertical, most of our properties will allow us to do that. But as you know, there's a NIMBYism. The municipalities don't want to create more of this zoning. And so there's -- and actually a more crimped nature of supply happening on this. So you don't have the ups and downs and the vagaries of the rest of the market. So we liken this to sort of the manufactured housing concept in terms of that concept. I've said it's like a beachfront property in California. We're not making any more of it in the major cities around the country. We have a high concentration in Philadelphia, Atlanta, New Jersey, Dallas, for example. So we like the locations. We've got some Florida overlap with what we've already got in our portfolio and then Jacksonville and Savannah and Newport News, so those sorts of areas. So all of this I think plays really well to us. We like the fact that we've got a 70% mark-to-market opportunity as you measure it today. Obviously, that will happen over time with 4.5 years of WALT. We've got the redevelopment properties that give us the potential for additional upside as we lease into the marketplace. We view ourselves as -- it also provides annual increases. I think the portfolio is 2.6%. So fundamentally, we like all of those aspects. It's not going to be linear. In terms of what it means to us is growth, but we do view ourselves now as pushing very much forward as an industrial growth company. We'll play not only in IOS, but we will play in traditional industrial. We will sell office going forward. That will create some lumpiness relative to a straight line up growth. But over time, and we're hoping to be dramatically more industrial right now, this tips the scale to put us at -- as you look at it, roughly 40% concentration in our industrial relative to ABR. So I've filibustered you there a little bit in that question. I thank you for it. But that's how we got into it. That's why we're excited about it. All of these elements are frankly things that just really play well into what we think is a bright future for Peakstone. We've set ourselves up to do this the last 2 years before listing. And since listing, we've done a lot to delever the organization. We anticipate effectuating that. We're going to have our eye on the ball relative to leverage and making sure that we are looking to reduce that again just like we did over the last 1.5 years since we've been listed in 2 years, really since we started putting this all together strategically. So anyway, I think the team has the capability and we're very, very excited and energized to move forward and add value to our shareholders.

Great. Yes, that's great color. Since it's mostly land and it needs minimum CapEx, how does the CapEx compare to traditional warehouses? Like, what are the big ticket items? And what is the typical CapEx reserve you assume for -- underwriting for IOS?

Yes. So I think there's only been one really -- I mean, the other part about this space is that because it's in the process of being institutionalized, we've got a lot of data that we've had to build up really from scratch. The seller was very helpful in giving us sort of an eye into a lot of their data. And we literally, as you would expect, we went literally property by property, property by property and spent a significant amount of time. It seems -- this market tends to be very dominated by sharpshooter brokers in local markets. Rich Hoopis, who is in our group, has been a user in this space and brings a very, very unique perspective to us. But the low CapEx, I mean, it's definitely lower than other real estate classes. I think Green Street published a piece where they estimated that CapEx is in the neighborhood of 5% to 8% of NOI, which would be at the low end of many other asset classes. The structures on site are typically very small to the size of the lot. They're typically very reusable. There's not a lot of -- there's a limited risk for functional obsolescence, although we do see opportunities to build a new building here and there and change the rent structure as a result of that. I would say that we're probably looking at a little bit more conservative number, probably 8% to 10% on a go-forward basis. And we'll see what actually comes out in the wash. In large part, we're talking about the surface of the property. We're talking about fencing, lighting and minimal building and some upkeep on that. And then there's certainly less exposure to re-tenanting costs and downtime. The spaces are in high demand because of the zoning. There's -- in many of the infill locations, there's a lot of infighting going on. Tenants of this nature tend to hunker down into a site and spend many, many years on property. In fact, our portfolio has many of those types of tenancies in place. If you look at the building materials and sort of the equipment rental side of the business, if you've ever been really in the construction business, I think back to my hometown in Los Angeles, the major places that have had those types of uses have been there for the entirety of my 64 years, and they haven't moved and they're not likely to move anytime soon. So we like that kind of stuff.

I know that you have limited data. Do you know what the average tenure is for this type of property?

The average tenure?

Yes, like tenant tenure? Yes.

Yes. Well, like I said, in our -- in this portfolio, the tenure has been quite extensive.

Got you. And like what percentage of the portfolio is truck terminals and container storage? And what percentage of the portfolio is leased to 3PL tenants?

I think very, very few, if any, really. I think we're very heavily weighted towards transportation and logistics, 61% is FedEx, Maersk, Penske and Amazon, so e-commerce. Building equipment rentals are 25%, so United Rentals, Maxim Crane, Sunbelt Rentals, Sunstate Equipment. And then you wouldn't know the building materials people necessarily, but Beacon, Builders FirstSource, Mid-Atlantic Roofing Supply. And a large percentage of our tenants are actually publicly-traded.

Okay. And is IOS the highest and best used for these land sites? Because you mentioned that like historically, these sites have been redeveloped for like other property types. Just curious like what other property types could use these sites?

We're right in the middle of industrial. So industrial is a very significant element of what we're talking about here. I mean, the majority of our properties have as of right for IOS zoning and IOS zoning is sort of dear. It's really important that you're familiar with the zoning regulations and what's going on. But key to our underwriting of the property is that if the zoning were to change through some master plan differential, we are infill, we're near key logistics hubs and we have an ability to leverage our existing platform to maximize the value of these properties.

Okay. And just last question for me. How much does it cost to redevelop those 6 sites? And when do you think the projects will start?

So it's an array. Some of them are going to start today, quite frankly. The prior owner was in a situation where their -- in essence, their fund life was coming to an end. So they put quite a few projects on hold. They set them up, if you will, teed them up. And so now we're just going to be in an execution mode to get some of that done. So we anticipate some of that to happen fairly quickly. We -- I would say, I don't know, we put some reserves together. Fundamentally, we are -- I would say about half of the investment is going -- sort of be in the short run. And one of them is going to be a little bit longer because really it's a ground-up industrial development vertical opportunity. So we're targeting a 7.5% to an 8% return on cost as a result of the money that we're going to spend. We got roughly 82 acres situated for this. And we're anticipating -- we've said in the deck that we're anticipating an additional $9 million to $10 million of uplift in terms of NOI. We've got great markets in terms of where we are situated and we've got active tenant demand, so Seattle, Philadelphia, Atlanta and Savannah.

So I just want to clarify. So does the $63 million just -- that's just the land or does that include the cost of redevelopment as well?

That is -- that's just the purchase price.

Okay. So how much is the cost to kind of redevelop it? Is it another like $100 million?

Yes. So it's lower than that. I mean, we have had a period of time to set our numbers together, but we're in the process of rebidding out some of these things. So over time, I'll let you know what that's going to be.

This concludes our question and answer session. I would now like to turn the conference back over to Mr. Escalante for any closing remarks.

Thank you. We're really excited about this. As I said earlier, this is a premier portfolio. Again, it's going to stand out in many superior -- as superior in many different ways as you start to see some of the larger portfolios trade in the coming months. This is going to become an increasingly institutionalized and more commonly referred to subsector, if you will, within the industrial business. And we believe that we're perfectly placed to take advantage of what's going on. And we've set ourselves up since listing to be able to take advantage of this. We thank all of you for your support and following us. Please read through our materials and let us know if you have any questions. We will be present at NAREIT in Las Vegas and happy to discuss this in more detail on an individual basis. Thank you for your time today.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.