Good morning, and welcome to the EastGroup Properties First Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen only mode. Later, you will have the opportunity to ask questions during the question and answer Please note this call may be recorded. It is now my pleasure to turn the conference over to Marshall Loeb, President and CEO. Please go ahead.
Thank you. Good morning and thanks for calling in for our Q1 2019 conference call. As always, we appreciate your interest. Brent Wood, our CFO is also participating on the call. And since we'll make forward looking statements, we ask that you listen to the following disclaimer.
The discussion today involves forward looking statements. Please refer to the Safe Harbor language included in the company's news release announcing results for this quarter that describes certain risk factors and uncertainties that may impact the company's future results and may cause the actual results differ materially from those projected. Also, the content of this conference call contains time sensitive information that's subject to the Safe Harbor statement included in the news release is accurate only as of the date of this call. The company has disclosed reconciliations of GAAP to non GAAP measures in its quarterly supplemental information, which can be found on the company's website at www.eastgroup.net.
Thanks, Kina. Our team performed well this quarter, starting the year off with a strong ton. Some of the positive trends we saw were funds from operations coming in above guidance, achieving a 5.3% increase compared to Q1 last year. This marks 24th consecutive quarters of higher FFO per share as compared to the prior year quarter. Based on the quarter and the market strength, we further raised our annual FFO guidance by $0.05 a share.
The vitality of the industrial market is further demonstrated through a number of metrics, such as another solid quarter of occupancy, strong same store NOI results and positive re leasing spreads. As the statistics bear out, the current operating environment is allowing us to steadily increase rents and create value through ground up development and value add acquisitions. At quarter end, we were 97.7 percent leased and 96.9% occupied. This marks 23 consecutive quarters where occupancy has been roughly 95% or better, truly a long term trend. And in short, demand continues growing for our infill location, small bay buildings.
Silver markets exceeded 98% leased and Houston, our largest market, was over 97% leased. And while still our largest market, Houston has fallen from roughly 21% of NOI to slightly below 14% for 2019. Supply and specifically shallow bay industrial supply remains in check-in our markets. In this cycle, the supply is predominantly institutionally controlled and as a result, deliveries remain disciplined and as a byproduct of the institutional control, it's largely focused on big box construction. Our same property NOI growth was 4.5% cash and 3.7% GAAP.
We're also pleased with an average quarterly occupancy of 96.9%, up 60 basis points from Q1 2018. Rent spreads continued their positive trend, rising 5.3% cash and 14.2% GAAP, respectively. Further, the quarterly results were materially impacted by 125,000 Square Foot Houston lease where the rents declined. Pulling that one lease out of our pool, our cash and GAAP numbers rise to 10.6% 20.2% respectively. Given the intensely competitive and expensive acquisition market, we view our development program as an attractive risk adjusted path to create value.
We effectively manage development risk as the majority of our developments are additional phases within an existing park, The average investment for our Shallow Bay Business Distribution buildings is $12,000,000 And while our threshold is 150 basis point projected investment return premium over market cap rates, we've been averaging 200 basis point to 300 basis point premiums. At quarter end, the development pipeline projected return was 7.3%, whereas we estimate an upper 4s market cap rate. During the Q1, we began construction on 5 buildings in 5 different cities totaling 650,000 square feet. While coming out of the pipeline, we transferred 300 percent leased projects totaling 421,000 square feet into the portfolio with an average yield of 7.4%. At quarter end, our development pipeline consisted of 19 projects in 10 cities containing 2,500,000 square feet with a projected cost of 230,000,000 For 2019, we're raising our projected starts to $160,000,000 And as color commentary, the $148,000,000 in starts we had last year were a record.
So we're excited to raise this year's forecast. And as further color on our 2019 starts, we project starting over 70% of those by mid year. So as the year progresses, we'll continue to revisit projected starts. And finally, our activity is spread over 9 different cities. This geographic diversity reduces risk while enhancing our ability to grow the development pipeline.
First quarter was relatively quiet for acquisitions, but our pipeline was active. We're committed to acquire 3 separate off market properties. We expect to close soon on a 2 building, 142,000 square foot new development at the DFW Airport, which is currently 19% leased for total investment of $15,000,000 Next, we have a 7 acre site in the Miramar area of San Diego under contract for $13,000,000 which will accommodate 125,000 square foot building. And finally, we're reacquiring 2 buildings totaling 142,000 square feet in Phoenix. We sold the buildings to the Arizona Department of Transportation in 2016, but they were not torn down during freeway construction.
And as a result, we'll re reacquire the buildings for just over $9,000,000 and invest an additional $2,600,000 to redevelopment. On the disposition side, we sold World Houston 5, a 51,000 square foot building for $3,800,000 in Q1. Brent will now review a variety of financial topics included in our 2019 guidance.
Good morning. We continue to experience positive results due to superior execution by our team in the field and the strong overall performance of our portfolio. FFO per share for the Q1 exceeded the upper end of our guidance range at 1 point to Q1 2018 of $1.14 an increase of 5.3%. As noted in the earnings release, we reported FFO of $1.16 per share during the Q1 of 2018. In connection with our adoption of the NAREIT Funds from Operations white paper titled 2018 Restatement, we now exclude gains and losses on sales of non operating real estate from FFO.
For comparison purposes, we adjusted the prior year results to exclude the gain on a land sale and the gain on the sale of a partial interest in a private plane. As tradition for EastGroup, we will continue our standard of reporting FFO as defined by NAREIT. Our protracted strong performance, both operationally and in share price, has continued to allow us to strengthen our balance sheet. While this is demonstrated in metrics, in the earnings release and supplemental information, what is less obvious and perhaps sometimes overlooked is the diversity in our revenue stream. Our 39,600,000 square foot operating portfolio consists of an average tenant size of 28,000 square feet and our average building size is 100,000 square feet.
Accordingly, 58% of our rental revenue sourced from tenants smaller than 50,000 square feet, and 84% of our rents are from tenants smaller than 100,000 square feet. We're benefiting from both our tenant and geographic diversity, where we have a presence in 13 of the 15 fastest growing metropolitan areas in the U. S, mitigating concentration risk for our shareholders. Looking forward, FFO guidance for the Q2 2019 is estimated to be in the range of $1.17 to $1.21 per share and $4.84 to $4.94 for the year. Those midpoints represent an increase of 2.6% and 4.9% compared to the prior year restated, respectively, and an increase of $0.05 per share in the midpoint of our guidance for the year.
You may recall that in Q2 2018, we had a $1,200,000 involuntary conversion gain that is included in FFO. Excluding that gain, the midpoint of 2nd quarter FFO guidance represents a 5.3% increase over prior year. Our first quarter results, combined with the leasing assumptions that comprise updated guidance, produced an increase in both average occupancy for the year from 96.2 percent to 96.4 percent and an increase in cash same property range of 30 basis points to 3.8% to 4.8%. Other notable assumption guidance revisions include increasing development starts by 19,000,000 dollars increasing value add property acquisitions by $55,000,000 increasing termination fee income by $315,000 due to known upcoming fees and increasing our estimated common stock issuance by $85,000,000 as a direct result of finding more opportunities to invest In summary, our financial metrics and operating results continue to be some of the best we have experienced, and we anticipate that momentum continuing throughout 2019. Now, Marsh will make some final comments.
Thanks, Brent. Industrial property fundamentals are solid and continue improving in the vast majority of our markets. Based on the strength we're seeing, we continue investing in, upgrading and geographically diversifying our portfolio. As we pursue opportunities, we're also committed to maintaining a strong healthy balance sheet with improving metrics as demonstrated by the equity we raised the past few years. We view this combination of pursuing opportunities while continually improving our balance sheet as an effective strategy to manage risk while capitalizing on the strong current operating environment.
The mix of our team, our operating strategy and our markets has us optimistic about our future. And we'll now take your questions.
And our first question comes from Jamie Feldman from BAML. Please go ahead. Great. Thank you. Good morning.
Good morning.
So I was hoping you
could talk a little bit more about the supply picture. And we have seen stats showing it is creeping in, in some Just I mean, can you just give more color around your building size and where you may be seeing some supply and maybe what gives you some comfort that this can continue for some time where your product takes a little bit more protected than some of the others?
Jamie, good morning. It's Marshall. Thanks and good question. You'll see some large supply numbers, especially in the major markets, at least in our markets, we'll see it in Dallas, Atlanta, certainly Inland Empire. And then really what we do or have our teams do a good job of really digging into it.
I'd say long term, if you said what keeps you guys up at night, we would say finding infill, good infill sites that are that we can get zoned industrial that we can develop in the parks. So we know how hard it is to find land for that next park. I'll give our team credit that they keep seem to keep coming up with the next site, but we struggle and the brokers we work with struggle. A couple of stats to throw at you that will kind of demonstrate it. In Dallas, for example, there's and these are CBRE stats that I'm quoting.
There's 22,700,000 square feet under construction, but 10 buildings count for over 45 percent of that 22,000,000 So really it gives you an idea of and our average building size is 100,000 square feet. What we develop may get up to 120,000,000, 130,000 square feet. So if you think of the depth of those buildings and our average tenant size being around 28,000, 30,000 feet, they just aren't configured that you could not divide even a 400000 or 500000 square foot building to accommodate that. So I was surprised that only 10 buildings account for moving towards half of that supply in Dallas. And then in Atlanta, for example, the market is 6% vacant, but shallow bay and I don't know CBRE's definition.
It's probably a little bit larger than our average building. It's only 3.7%. So the vacancy rate drops pretty dramatically. And in Atlanta, there's 19,300,000 square feet under construction. Last year, they absorbed a little over 18,000,000.
So it's pretty much in parity even in the big box. But there's 8 buildings that are over 900,000 square feet under construction. So both in Dallas and Atlanta and maybe those are extreme in terms of larger markets. Most of what's being delivered is big box and we seem to see that pattern whether we're in Denver, Dallas, Atlanta, Houston where our peers are it's nice where our smaller size helps us. We're so much larger.
So for them, Clarion, Heitman, AEW, whoever to put the capital out, they need to, they need to go to the edge of town and build a 600,000 foot building. And by design, our tenants can't make those spaces work. They can't get the loading doors. The buildings are too deep. Hopefully, that answers your question.
Okay. Yes, that's great. That's helpful. And then I guess for branches, sticking with or moving to the guidance. So you lowered your bad debt expense outlook by $100,000 and you increased your termination fees.
Can you just talk about the moving pieces and then maybe also just address your credit watch list and anything we might need to think about here?
Sure, Jamie. On term fees, we did up guidance 315,000 2nd quarter termination fee of $525,000 It's a 50,000 square foot space in Tampa. The company was closing their North American location. We were able to negotiate what we felt was an attractive termination fee. It represented just in excess of 16 months of rent.
We feel confident backfilling the space timely. So we felt like net net would come out ahead. And so that was the primary single driver and there wasn't any kind of rash of people wanting out of their spaces per se, which is really driven by that one particular transaction. Bad debt, we continue to be very pleased. 1st quarter just $129,000 which was about $100,000 less than we had budgeted.
Just looking at our AR, the good news is just a potpourri of just miscellaneous here and there, pretty standard items.
Last time we reported, Baxter's firm had affirmed the
bulk of all the releases with us. They remain current. We've had no issue there. So bad debt, AR, term fees, all of that feels good. This early end of the year, it feels good.
I'll add to that. And Jamie, I'll give you and Josh credit. You had pulled a report together showing tenant concentration and happy to see our top 10 tenants have drifted down. We were 8 0.3% at the end of the year. We're 8.1% this quarter.
So our largest customers, some of them are in multiple locations, multiple buildings is I believe per your report, it's the lowest concentration within the industrial sector. And then even when I look through our top 10 tenants, there's a couple of things going on where I think that percentage is one is the company grows and then specifically within those tenants where that number should keep drifting down the next 2 to 3 quarters.
All right. Thanks. And keep promoting our research. We appreciate it.
Yes. You're welcome.
And our next question comes from Alexander Goldfarb with Sandler O'Neill. Please go ahead.
Hey, good morning. So just a few questions for you guys. On the guidance, Marshall, you guys on the Q4 call granted the year ended definitely a low point as far as the capital markets were concerned, but you guys still spoke about your portfolio being strong and tenant demand healthy, and yet pretty strong improvement in the guidance from the initial just a few months ago to now. So is this just that you guys were just too overly cautious when you laid out your initial numbers or has something really fundamentally changed in the portfolio operations that's led to this improvement? Because it doesn't sound like it's anything really one time apart from that penny of lease term.
It sounds like it's just core operations driving it, which $0.05 jumped this early in the year. Look, it bodes well for shareholders, but it seems pretty dramatic in just a few months' time.
That's a fair question. And my answer is, which was it is almost a yes. And that it was a little bit of both and that we were pleasantly surprised. This was a record quarter for us to average 96.9% occupied. Last year, we averaged our companywide 96.1%, and typically, we would say a building is full at 95%.
So the occupancy surprised us to the upside. I don't think we were overly we did see a little bit of a pause in the world within our tenants, not all of them, but a fair number, especially the larger the tenant, probably the more they hit the pause button. A little bit, it's hard to tell over the holidays, but a little bit the world was pretty nervous in December and probably the first half of January and that feels now like it was 2 years ago that the tenant demand has picked back up and people seem to have kind of moving beyond that time with the government shutdown and trade wars and things like that. So I think it's our job. We care about being paranoidly optimistic.
So we were worried about where things were going to head back in January and a little bit cautious, although things were still moving and then they have improved since then. So I don't like to think we weren't overly cautious based on what we heard. And really in the economy, things feel better than they did a couple of years ago based on everything we read and certainly even more so what we see on the ground. And Alex, this is Brent.
I would just add to that. You mentioned moving that much earlier in the year. I would contend that moving early in the year by a fair amount is a little easier to do and then we beat by $0.02 then we raised by an additional $0.03 which at this time of the year basically essentially comes out to about $0.01 a quarter. As you get later in the year, obviously, it's harder to move that delta as much. And as Marsh said, the good news is being and to your point, that's not really no one time items.
It's being driven by property net operating income and especially just want to point out from our development pipeline, not included in same store, all the developments that have rolled in since January 1, 2018 and those properties are contributing more and faster than we're guiding to quarterly. They continue to outperform, which we'll take that as long as it can happen.
Okay. And then, Brent, that leads me to the second. Part of that $0.05 in total increase, you guys also increased your ATM activity for increased investments. So maybe you could just provide a little bit more color on the acquisition yields? And then 2, given how quickly you were able to match whether it's chicken and the egg, whether it's better ATM, So, hey, guys, go out and get more acquisitions or hey, we have acquisitions if we have better ATM, whichever.
It sounds like between the acquisition front and the fact that Marshall, I think you said 70% of the starts are going to be by mid year. It sounds like investment activity in the back half of the year could ramp up even more, which I'm guessing would benefit on the earnings front given that you wouldn't do one without the other. So maybe you can just talk a little bit about the interplay between the cost of the ATM versus the cost and the accretion of the acquisitions?
Yes. I'll start and then let Marshall talk more specific about the assets. But I would be clear to say that acquisitions are driving our capital at being at 21%. I think we ended the quarter at debt to market cap. We obviously have a very strong balance sheet.
So we're not issuing an effort to continue to lower that. And as we stated last call, we'll be a little more conscious of trying to line up ATM issuance with opportunity. And so opportunity will drive what we do or don't do on the ATM and that's assuming that the price is there and we like it. But right now, we view it as readily available. So let Marshall touch on it.
But as long as each whether it's development value add or an acquisition, as long as they stand on their own merit and make good what we feel like are good long term sense, then we certainly are apt to do it.
Thanks, Brent. And really in terms of color, probably 2 buckets. We feel some visibility on the $50,000,000 in acquisitions this year, although that's the most that's the hardest bucket to fill given the competition and everybody's got a checkbook. So we really aren't different from the other bidders. But feel comfortable more comfortable today on that front than we would have, say, 60, 90 days ago at our last call.
And then the value add, we like long term. They're probably or they are they're better benefits for 2020 than 2019. And kind of just walking through them, the 2 interstate common buildings that we're buying back in Phoenix, we had a 4 building complex. We knew Arizona DOT was going to acquire them. So we kind of stopped spending money for obviously a couple of years before they acquired them.
It's been a couple of years since they've had them. So those will take a little bit to redevelop and re lease. We like it long term, and we think we'll be just north of a 7% in terms of once it's redeveloped. So development type yield on a value add. There in DFW, they're brand new buildings, 18%, 19% leased with good activity.
But by the time we get the leases signed, the TI is done and the tenant's in. And that's in the high 6s type yield. And then the San Diego land that we disclosed, it's what I like about it, it's right just east, if you know San Diego of the 805 Freeway, which in Miramar, so we're just north of Miramar Naval Air Station. It's a former card lot. So it's really a better lot than we typically see for industrial land and it's really a last mile location right on the other side of the 805 is La Jolla.
So if you want to get products delivered quickly into La Jolla, we think it's a great site. I said the biggest problem is I wish it was a bigger site. We have a ground lease on it, so we'll get a return until they decide when their lease expires really and then we'll develop it. So we like all three acquisitions. It'll just take a minute before we can really get them stable on us and end the portfolio.
And so it's probably more of 2020, but Brent will raise the capital
for us to close this year. Okay. Thank you.
Sure. You're welcome.
And our next question comes from John Guinee with Stifel. Please go ahead.
Great. Thanks. Hey, just sort of curiosity questions, I'll let off and then you could address them. I noticed somewhere that you bought a property with a 40 year ground lease, which seems a little bit unusual. Can you talk about maybe some options you have on background lease at the end of the 40th year?
2nd, in your infill development strategy, how often are you actually buying greenfield dirt versus 2nd generation development where an existing asset's being demolished? And then 3rd, when you're leasing up your development, how much of the lease up is basically moving existing tenants of yours into a new building? And how much is filling up those buildings with new non EastGroup tenants?
Thanks, Alta. I'll try to answer those and Brent chime in. John, put all you have. Tell me what I'm asking.
That was just one question.
On the ground lease, good observation and good observation. And if you study DFW, I think the number is 18,000 acres that that airport has and their typical lease is a 40 year ground lease. So that's there's all types of industrial. It's really a who's who in terms of national developers that are there on those ground leases as well as hotel, retail office. So the first we have, call it, 39 years left on our 40 year ground lease.
Some of the older ones, they'll be precedent set well before we roll and go back into DFW to renew. So we looked at it in terms of pricing, kind of maybe walking you through the weeds, but if it were fee simple and it is right at the exit, just off one of the tarmacs at DFW, it's probably a 4.75 yield and in the market. And then in talking to some of the brokers, probably 50 basis point premium to get go from fee sample to a ground lease. So that's probably around 5.25. And as we underwrote market rents and carry and things like that, we're 6.5% to 7% type yield.
So we feel like we're getting paid for the premium of the ground lease there. And it really ties into your second question. Most of what we're looking at, as I mentioned earlier, we struggle to find good sites. We'd rather it be fee simple, but there's simply nothing left at the airport. And in talking to our guys, the good problem, they had one vacancy in our Dallas portfolio and tenants that wanted to expand.
So buying these buildings at DFW, we prefer them to be fee simple, but we'd like this location, especially given the prominence of DFW Airport over the next 40 years and how that continues to grow. Most of what we did, Bill, is still greenfield, but all of it seems to have a story where we're relocating someone or like Churchill Downs, it was semi green. We toured the stables down in Miami and we do things. We're looking at a site in Texas that a church would relocate off of or hear a ground lease. They all we kind of apologize to our investment committee.
We promise we're not trying to make things complicated, but infill sites get harder and harder to find and we'll certainly do more and more redevelopment. And then what's nice about having the parks where I'd probably call it moving towards 50% of our development leasing is we have someone in I'll pick Charlotte and Steele Creek 3 and they need more space. So they'll either do a renewal early renewal and expansion in Steele Creek 9 or they'll relocate them if they really want to be in one location into the new building. So that's part of our pitch in the market to tenants. If you're in World Houston or Steele Creek or Kyrene, we can accommodate your growth.
And every tenant usually probably overestimates. Most people are optimists a move down the street that we can accommodate your growth and fill up our parks. So it's probably approaching half of our development leasing as the economy is good and tenants are expanding. And then the good news about a good economy, the spaces we're getting back are typically below market. They'll be vacant a little bit, but typically they're both the leases are a couple of 3 years old and so those are below market.
So we get an early at bat to go back to fill those spaces as well.
Great. Thank you.
Sure. You're welcome.
And our next question comes from Ki Bin Kim with SunTrust. Please go ahead.
Thanks. Your tenant retention ratio dropped a little bit this quarter. I mean, it's just 1 quarter in a long history of really high retention, but anything noteworthy there?
This is Brent. We had yes, Kimo, we had a tenant in California, one of our larger tenants that sublet 135,000 square feet to 3 tenants. Their lease still runs for a number of years. And basically those sub tenants, we signed leases with them to then lease behind that tenant out into the future and just trying to stick to the way we've always done things we thought the fairest way to treat that. We basically treated that square footage during the quarter as a non renewal, which technically it won't be at that point, it will not be renewable.
We've leased the space behind that. So I would definitely call the quarter a little bit that skewed the retention percentage. But again, just in being comparison friendly to how we've handled that type situation in the past, we treated it the same. So I think you'll definitely see that click back upward in absence of not having another anomaly like that.
And is there any maybe besides this quarter, any kind of discernible trends on why tenants choose not to renew?
Usually, if we can't renew on the I think the biggest problem that we run into in some cases is we don't have the space for them and they're growing. I would think that typically we average over time around 70% or a little over 70% is kind of our historical average. But in Tampa, where we had the termination, it was a European company and their business model just did not work in the U. S. So they closed or a bankruptcy or probably what we see more and more is they're growing and we try to have that next development ready.
But if we don't have the space, that's probably where we lose. That's probably our biggest reason right now is not able to accommodate growth. But that said, I still think by the end of the year, we'll average 70% or low 70s tenant retention.
So some high class problems?
Knock on wood, I hope so, yes.
All right. Thank you.
Thank you.
And our next question comes from Manny Korchman with Citi. Please go ahead.
Hey, guys. It's Jill Sawyer here with Manny. Marshall, given your earlier comments on the oversupply in Atlanta market and also at the same store results in the quarter, Have your perceptions of that market or desire to grow in that market changed?
In Atlanta, Jill? I'm sorry, is that your thinking? Yes, Atlanta. Okay. Yes.
No, we like Atlanta and we'd like to grow there. We're just adding in the last week, have hired someone kind of at the Vice President level. It's a backfill of a spot, but they'll be based in Atlanta. And John Coleman, our regional moved to Atlanta. So we like the market a lot with our product type being under 4% vacant.
As I mentioned, there's over, I guess if it helps, 19,000,000 square feet under construction, but absorption last year was over 18,000,000 square feet. So the market is a little Dallas and Atlanta are a little bit and you read the supply and it kind of takes your breath away, but then you look at the absorption over the last few years and what's being delivered keeps getting absorbed. And thankfully, where the numbers get a little bit shocking, it is because of those 600,000 square foot buildings and up that most of our peers gravitate to. So we're pursuing growth, but trying to be disciplined in Atlanta. And we just came in 2nd unfortunately on the building in the last week trying to acquire it.
So we'll kind of keep picking our battles and trying to stay disciplined. But we like the market long term and it's right in our backyard and kind of identified that call it 10 o'clock to 2 o'clock on the map. Right now we're kind of 12 to 2 what they call the Golden Triangle of Atlanta seems to be a good fit for our tight building and our where the path of growth is also in Atlanta up north in terms of residential higher end residential. So hopefully that's helpful.
Okay, great. And any interest in looking at bigger acquisitions or maybe bigger portfolios just given where your stock price is trading?
We look at those. Yes, interest, the bigger the usually, we'll get the bigger the portfolio and the better the sales package, the more intense that competition is. And it just gets priced to perfection really where we would we our acquisitions will look maybe 2 to 4 years in the future and not a 10 year August run like a lot of our peers and that typically no one underwrites a downturn in years 5 through 7 type thing. So we try to not go too far out there and assume too in terms of rent growth. And maybe as a result of that, it makes it awfully hard.
We like them. We certainly have picked up the value add acquisitions this quarter. We like those as almost a shadow development pipeline in terms of getting a good attractive return and managing the risk for our shareholders. And we feel more comfortable on our acquisition assumptions. So we'll stay at it.
It's just it's hard. I mean in Atlanta, there was a package we looked at in the last year, and we were one of 24, 25 bids in the initial round. And it's just hard to if you're the winner of it, I'm not it's hard to believe you're the winner of it almost for time will tell. It'll take a few years on just how competitive the wall of global capital for industrial as the brokers talk about is real and we lose a lot of bids each month on those. But we'll keep trying and I hope we can surprise you with 1 at some point.
Great. Thanks, Marshall.
You're welcome.
And our next question comes from Craig Mailman with KeyBanc Capital. Please go ahead.
Hey, good morning guys. Marshall, just maybe follow-up on your competition talk you guys. It sounds like the yields on some of these value add plays is pretty close to development without the construction risk. Can you just kind of talk about what the competition was for these and how you source them?
Good question. And each of these was off market in no particular order. In Dallas, our guys there called on the developer. It's a local regional developer and kind of developed a relationship. And I think it was going on a year activity.
So far, interstate commons in Phoenix was an anomaly a little bit and that we had sold the buildings to ADOT and had a right to repurchase if they didn't tear them down. And now the freeway work is done, so our visibility and access is even better. And thankfully, they didn't tear our buildings down in the process. So there we had a right to repurchase at appraised value. So again, off market there.
And then the Miramar land, it's a little bit the same. It's a 20 year relationship that we've had with a group out of Southern California based in LA and they had tied up this land thinking it was a letting us participate in it and doing a 95.5 JV. So, letting us participate in it and doing a 95.5 JV. So we're excited about the site and it's turning over a lot of stones to maybe find a small deal here or there, but hopefully they add up over the course of the year for us. So when it goes to market, we'll bid on it, but it's awfully hard to be the winning bidder in that case.
And it's really driving around in a car with a broker and they'll say, if you lob in an offer on this, this seller may be willing to sell. And that's a all of them are long shots, but that's almost a better path to buy things for us or find value adds than to wait and get the e mail blast that everybody gets.
That's helpful. And unlike the DFW deal, it sounds like developers got sort of a construction fee. I mean is there anything on the back end that they try to negotiate with you?
Yes. Thankfully not on that. It was they were and on those a lot of times and I don't know on this case, I know who the developer is, but I don't know how his financing is arranged. Usually, it's they've got a financial partner and we'll get you into your IRR promote and you can go down the road and build your next building, which is really what they typically want to do. And so they'll make some money and take some chips off the table and he'll probably move on to his next development, but no promote down the road for him.
And he was doing the leasing in house, which is good for him, but we like having a 3rd party broker that's really fully focused on leasing. And so we think hopefully we can pick up some leasing velocity by stepping in. He did a nice job finding the side and designing the buildings and hopefully we'll take the back half of it from here.
That's helpful. And then just separately, you guys have a little bit of a different product mix than some of your peers have. I'm just curious how the we all know demand is good, but you guys have had sort of a presence in some of your legacy EastGroup markets for a long time. I mean, how have your guys on the ground seen the demand composition change? Has there been a change?
Or is it sort of evolving as e commerce and those type of tenants evolve?
We would say and Brent chime in, our traditional tenants are still there And typically, almost all of it's about 1500, 1600 tenants doing well and kind of if you almost call it old economy, the floor supply guy, the granite tile, the HVAC contractor, different industries like that, all want to be closer to their customer and they typically are doing well. And as that evolves, also in our legacy markets, the traffic gets worse in Tampa and in Dallas and in Houston. So we'll see them like in Dallas, that's what we liked about Fort Worth is you may need Goodman HEAC, who is a tenant in Dallas, also needed a facility in Fort Worth because it's you could spend all day in traffic. And when your air conditioner is out in Dallas in July, you want someone there immediately. So we see a little bit of that evolution.
And then each quarter, there's more and more e commerce tenants. So people change their model like Lowe's is a tenant we've worked with recently, the retailer where no one drives home with a washer, dryer, refrigerator, but they've leased space with us a couple of spaces from us as they roll out their strategy. So you buy it in the store or buy it online and it gets delivered from an EastGroup facility and that's been a new change. So some e commerce, some just people closing physical brick and mortar and we're lower rents. But if it's lower rents and close to the consumer, we can be that last touch and get it to your house fairly quickly.
Yes.
And the only thing I would add to that, Craig, is a lot of times, I think it just a lot of it is dictated on tenant psychology. And I think across the board in all our markets, the tenant psychology, how they feel about their business and overall economy is good. And so anytime you have that kind of underlying the current is a positive. And then also I think we have enough depth and activity in most of our markets where there's competition for spaces can always equate us a lot to residential because people relate to that better. But if you're looking at a home and there's very little activity, you don't feel that pressure to get that offer out very quickly.
But if you're looking at a residential market where it goes on market, if you don't put the offer in, in 24 hours, it's going to be gone. So there is that sense of urgency, which are all signs of a landlord market, but there is that bit more sense of urgency in our markets too, which all that adds up. And like Marshall said, with the varying type tenants that are out there, it's all stacking up to just be solid, deep activity.
And our next question comes from Jason Green with Evercore.
Please go ahead.
Good morning. Given a good portion of
the guidance increase was due to better than expected impact from development, is there any additional upside that development impact for fiscal year 2019? Or is everything more or less baked into guidance at this point?
I hope I guess I'll preface it by saying I'm an optimist. But we did move it this quarter by, call it, the $19,000,000 And 70%, a little north of that are starts in the first half of the year. So we have our development starts and really our leasing, what I love about our model is rather than at corporate, we decide, hey, we're going to go build an 800,000 foot building south of Atlanta or on the southwest side of Phoenix. It's really almost like a retail store where they're out of inventory and we deliver the next building to put on the shelves. So we keep a shadow development pipeline and that's still a pretty good material size out there.
So I'm hopeful there could be upside to our $160,000,000 Although I'm also, thanks to the guys in the field, appreciative that $160,000,000 would be a record this year in terms of start for us. So we used to say $100,000,000 in starts and have worked our way up to $140,000,000 $160,000,000 And so we'll push it as much as the market allows us to. And Brent and the team have done a nice job of deleveraging the balance sheet, which I like having them more as we stretch on some operational risk in a good market, let's also keep our balance sheet almost as a hedge safer and safer. So with luck, I'd love to bump the $160,000,000 up another one of these quarters and have that news for you, and it will really depend on what our tenants want to do.
And I would just add to that, Jason. We are a little more back end weighted in the year with our FFO growth, especially 3rd and 4th quarters. And that is being driven pretty heavily by what we're factoring in for developments and value add. And when I say developments and value add, I'm talking about properties that have been added into the portfolio since Oneoneeighteen. In other words, they're not same store properties, so outside of same store increase.
So we have a fair factored in Q1. I think we have about $3,300,000 of property net operating income from that development pot. And we're looking by Q4 of that growing to $5,700,000 So it is playing a large and significant role and we're counting on it continuing to push through the rest of the year.
All right.
Thank you. And then maybe we could just touch on development costs and how those are impacting your yields and how development costs have been trending over the last 12 months?
Yes. Good question. We think rents will keep following. And I guess as an aside, it's easy to say, if we pulled the one lease out in Houston, we would have had record GAAP releasing spreads at over 20%. So you're seeing a tight market in construction costs, rising construction costs push rents, we feel like.
But concrete prices, steel prices have gone up. And then underlying all that, it's a good economy. So all of the GCs and all of the subs are busy and we've even heard stories of competition at one of our sites trying to hire the workers away during construction. Just the labor shortage is also pushing rents up. So it's probably moved our yields are 7.3, 7.4.
I think what we're doing from memory, what we rolled into the portfolio was a 7.4. What's in the portfolio is a 7.3. Miami is a little bit lower yield, but lower cap rates. So it should come down, but those probably would have been about 7.5% to years ago. It's just construction prices continue to creep up in a good economy.
So that's certainly something we launch and talk about a fair amount.
Okay. Thank you. Sure.
And our next question comes from Bill Crow with Raymond James. Please go ahead.
Thanks. Good morning, Marshall. I'm just curious with your infill portfolio, are you seeing increased demand from grocers? I mean, that's one of the retail areas that seems to be growing. And what is your thought about getting into at least partially, if not fully refrigerated space on new developments?
Good question and we've read about that and that certainly seems to be the trend where things are going. And I know there's even a cold storage REIT that's come public within the last year, year and change. We and Brent chime in because he's had direct experience with it. We like keeping our buildings fairly generic that when you get into that freezer cooler space, sometimes you can have issues. 1, the equipment gets dated fairly quickly, and then sometimes too, it can damage the slab and some issues like that.
So we and some of the tenants are also start ups. So we steered away from a start up in the Bay Area just because the TIs were heavy. It was an online grocery delivery and just thought in a tight market, we had better options and we could thinking about if something happened in the next tenant down the road. So we may be missing it and it seems to be a growing area, but we really haven't pursued it or focused on it because I like having about $0.40 per square foot per year of TI when our tenants move out is what our average is. Brent, you've lived with it until you've had a bad experience or 2.
Yes. I think, Bill, and good morning, it's the challenge with freezer cooler space, as Marshall said, ideally, you know on the front end going into it, that's what you're building for because they're design specific things you would do to protect your slab, protect your sub slab, meaning the dirt underneath the concrete to keep it from not freezing and then unfreezing and then structural issues. And so there would be some commitment of TI or building specific improvements that you would ideally want to do on the front end. And then your very small percentage chance for us that we would lease to an actual grocer, then you sunk that money into the building and it doesn't actually get utilized. So in a build to suit situation, we would definitely be a little deeper and you want plenty of term, but then you could design it more specifically.
But on a day in, day out basis, it's just not something prevalent enough that we've seen to warrant changing and taking on that additional capital risk on the front end.
So within your markets, you're not seeing Publix or Kroger clamoring to get direct to consumer space or anything like that?
What levering from the store, where you buy click it online, pull up and they bring it out and pick it up, certainly that. But we've not seen a lot of grocers yet out in the market. And it's something that's been tried for a long, long time. We signed a lease with a group called groceryworks.com back in like 2000, about 18 years ago. And that didn't work at that time.
And here we are 18 years later and still people are trying to figure out how to make groceries online work. So it will get there in some of the heavy metropolitan areas, really densely populated. But I don't see that in the near term being a big catalyst to industrial lease up, not traditional space.
I guess I've seen Walmart out looking. And again, if we could do dry goods, we certainly would. But I wouldn't say a good question. I've read more about it than we've seen it in terms of people clamoring, whether, as you say, Publix, Kroger, HEB in Texas, people like that, we just haven't seen it.
And one last one for me, and this may be premature, but certainly there's talk in California about the Prop 13 changes. Have you done a preliminary assessment of what that might mean to you?
Thankfully, we've owned some buildings for a fair amount of time in California, so we would have some tax jobs. But everything, almost all of our leases, knock on wood, not 100%, but the high 90% are going to be triple net. So we can pass it through and all of our peers would have it, I guess, depending on how recently they acquired their building. It could hinder rental rate growth in California. In short term, it would have minimal effect, but because we passed it through to our tenants and it would be an impact on them.
It would be when those leases rolled, our ability to push those rents to market that everything's knock on wood, generally well below market in California if it's just a few years old and some of that may end up being CAM rather than rent is what would happen under Prop 13. So we're watching it and have read about it and just know there will be I can't imagine Irvine Company, Watson Land, Carson Land, there will be some huge players that get involved in the lobbying for this that would be pretty heavily impacted, I would imagine, and how this plays out.
Yes. Okay. Thanks. That's it for me. Appreciate it.
Thanks, Phil.
And our next question comes from Eric Frankel with Green Street Advisors. Please go ahead.
Thank you. Can we just talk about Houston and that big lease roll down? Our obviously fundamentals in the market are better there, but there seems be a fair amount of supply in the market. I'm just wondering if that lease roll was an anomaly?
I would call it a good fair question, an anomaly in the sense that it was a single I guess what rolled in Houston, what
kind of the details of it, it was a
single tenant pre leased or slash build to suit, 125,000 foot leased up at World Houston. And that tenant, it was about a quarter office within the 125,000 feet and a fair amount of that was fifty-fifty mezzanine office. So, 2nd story office and that tenant also had as a 3PL, they were able to use an outside yard storage. So they consolidated, moved out during the downturn. We sat on the space for a couple of years with it vacant and then decided this is a little bit of a unique animal.
And we had a similar situation in Phoenix a couple of years ago, where you end up with a building, I'll tie it to freezer cooler. When a tenant when a building becomes pretty specific for a tenant's use, it makes it harder to re lease it. So after a 10 year lease with annual bumps and it's out there vacant, we decided to stretch and just make the deal we could. So without that, again, our GAAP numbers would have been as a company over just over 20%. And even in Houston, our GAAP re leasing spreads would have been 19 4 of the 85 leases we signed this quarter, all looked you kind of nod your head and nod along.
Here we had a pretty tenant specific building that rolled, sat vacant for a while and we finally just said, all right. And then my fingerprints are on the gun, whether we should have done it or not. Hey, let's just take the tenant in hand. And I'm partially guilty to Brent's giving me a look. My fingerprints are on it.
Let's do this deal and move on. And Brent's only defense has been, hey, I wasn't there to do the renewal as well, I would have gotten a better rate. So it was his original deal. Any color, Brian, or did
I cover it? Yes. I think that covers it. I think the bigger point is that the 19% gap is what it would have been absent that one lease. And talking to the guys in the field, we don't anticipate we do think that's a one off situation, not a we've got 4 more of these coming over the next couple of quarters.
So fully expect that to bump back up. And we'll just point out too that Texas that pulled Texas down and just again without that one lease would go from 3% to 16% as a GAAP increase, which is really where we've been as a run rate as a company for the past, when we were there 2017, 2018 and really minus that lease, we're slightly better than that Q1 2019.
I'll go back a couple of other just kind of Houston stats I was glancing at that the overall market's 5.4% vacant and the North market where our World Houston Park is, is 6.2% at the end of Q1, which is the lowest it's been since 2012. So we were encouraged by that. And then Houston is a little bit of an anomaly market for us as well and the rents in the North market are pretty much back to peak. And usually when we say that, people will refer to the downturn, but in North 2015. So as Brent said, we think this was an anomaly and it's glad to see the market recover back to where we were in 2015.
So that was a more much more recent downturn than the balance of our markets.
Okay. I appreciate the additional color. Just a follow-up question on external growth and acquisitions and asset pricing. I think you've alluded to a pretty competitive environment, but maybe you could quantify where you think stabilized cap rates have trended for some of the markets you're targeting? Are cap rates down 10, 20, 30 basis points since say 6 months ago?
Yes. I would say broad brush kind of the major markets is kind of what we hear and see, L. A, Dallas, Atlanta, maybe Miami, they're high 3s, maybe to 4. And you can get prices per square foot that are pushing $150, $200 per square foot land approaching $60 a square foot in LA, which is and in San Diego in the 40s, are we seeing a $70 per square foot land in San Diego and these are all industrial sites. And then what we've heard, again, I'll quote CBRE.
They said they've been predicting cap rates would compress in the secondary markets, meaning Charlotte, Denver, Phoenix, Tampa, those type markets. And last year, they did compress there. So now you're in the 5% to 5.5% in most of those markets. And it is a long laundry list of international capital that we've seen coming into U. S.
Industrial. We've been the favorite asset class. We met with Brett and I met with HFF recently and their comment was there's a bid ask spread in about every product type right now that there's more dry powder on the sidelines than they've ever kind of as they measure kept track of. And there's a bid ask spread in all product types but for industrial and that there's such demand, it's the most efficient product when they bring properties to market.
That's interesting. Thanks. And just Barry, one quick follow-up question. It's related to, I guess, the grocery question you that was mentioned earlier. Are tenants investing at all more in some sort of equipment handling budgets just to move product more quickly through your facility?
So more robotics? Or is there more just general automation that's occurring in some of the new leases that have been signed?
I would say generally yes. Usually the larger the tenant and probably the better capitalized the company, certainly like we have FedEx in a number of locations, they're cutting edge on that. And tenants do do that. Certainly, all of them are doing it a little more. It's just a matter of what their product is and how fast and what their balance sheet looks like.
But we think with the labor shortage, I think it will keep trending that way and they'll get more efficient and how they're moving product through the warehouse and probably and again, we think we're early on smaller spaces closer to the consumer so they can get that quick deliver.
Okay. Thank you.
Sure.
And our next question comes from Rich Anderson
with SMBC Nikko. Please go ahead. Thanks. Good morning. Hey, Brent, did you mention the rise in the G and A guidance from
a couple
of months ago in your prepared remarks? I don't think I heard it, but if you didn't, I'd love to know what the nature of it is.
Yes, Rick, it's good to speak with you. Good to hear you. Yes, G and A was up a bit and a little bit of its comp and restricted stock oriented, but there is some component of it that relates to a South Florida lawsuit that we've been involved with that that was discussed in the notes to the 10 ks. It will be discussed very summarily in the 10 Q that will be out in the next day or 2. We incurred, I think, $320,000 of that cost related to defending ourselves in that suit, which we feel is without merit, but yet you have to defend yourself.
And then we have some costs dialed in into the year to deal with that. So there are a few moving pieces up and down, but I would say that was the new piece that primarily drove the increase that you see there in the guidance.
Okay, good enough. And then for Marshall or anyone, I'd like to sort of ask a question about risk management. There's nothing wrong with your balance sheet, of course, but you're increasing your development spend, you're going after value add acquisitions and given the demand that's out there for your product. But what are you looking for to not go forward, but just take a step backwards? You're getting 200 to 300 basis point premium spreads versus acquisitions and development.
If that number starts trending down, is that a sort of a foreshadow that maybe we got to take our foot off the accelerator? Or is it maybe the spread between leased and occupancy which is only 80 basis points now? What are some of the things that you're looking for to manage not this year, but 2 or 3 years from now?
Fair question. And you're right. Usually, we'll target our kind of our internal rule of thumb is 150 basis point premium kind of we do a development over market cap rates. And again, thankfully, we've been north of that. And then typically, when we do our underwriting, we'll use the yields we project on current market rents.
So we won't put an inflation factor on rents, albeit we've benefited from those over the past few years. So if that number gets closer to $150,000,000 we certainly would take our foot off the accelerator or alike as our model work where I compared us to retail earlier, if we're delivering buildings and they're not leasing up and during the downturn in Houston, we were able to stop with stop development. I'll give our model credit for working. And same time in Phoenix, we a couple of years ago, we had vacancy and some fairly within our portfolio and in some new developments, and we really stopped development and really stopped looking at acquisitions until we kind of caught up and digested what was on our plate. We've done a little bit.
We're about there in Atlanta, But even more recently, we had added some value add product in Atlanta, had vacancy. And so we had there we've said, all right, let's kind of finish and catch up to what our own internal supply is in that market before we really pursue new acquisitions or new land sites. So we try to almost market by market and if what's on the shelves isn't moving, we won't add to the shelves there unless it's in a compelling reason. And if we've developed vacancy, I don't want to go to our investment committee and say the 3rd or 4th vacant building is the charm, let us build another We'll really get our 1st buildings leased up and then go back to committee. But when things are good, we'll I kind of view it, if we can build to those yields, we'll try to make hay while the sun shines where it's been the last couple of years and keep a safe balance sheet because when things do slow down, they may slow down quickly.
So I like that we're trying to be more geographically diversified in case it slows down in one market and not another. And then just kind of watch each development, knock on wood, our last, what, 16 developments that we've started and we'll miss 1 or 2 here probably coming up that have all rolled into the portfolio. We'll roll them in the earlier of when they get 90% leased or 1 year past completion, but our last 16 have all rolled in at 100%, which that's an anomaly. But that to me feels like, okay, the market is telling you to kind of keep doing that and keep creating that value for our shareholder until you see it start to slip and then we'll play defense again.
All right, fair enough. And just one comment, I mean, if you're making churches move to accommodate your industrial buildings, I just perhaps not walking outside during a lightning storm. And that's all I have. Thank
you. Very much. Bless you. Thank you.
And it does appear that there are no further questions over the phone at this time.
Thank you. Thanks everyone for your time. Appreciate your interest in EastGroup and we're certainly available for any follow-up questions you may have.
Take care.