Good morning, welcome to the EastGroup Properties second quarter 2018 earnings conference call. All participants are in a listen-only mode at this time. Later, you will have the opportunity to ask questions during the question and answer session. Now it is my pleasure to introduce Marshall Loeb, President and CEO.
Thank you. Good morning, thanks for calling in for our second quarter 2018 conference call. As always, we appreciate your interest. Brent Wood, our CFO, is also participating in the call. 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 to differ materially from those projected. Also, the content of this conference call contains time-sensitive information that, 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, Keena. The second quarter saw a continuation of EastGroup's positive trends. Funds from operations came in above guidance, achieving a 7.6% increase compared to second quarter last year, excluding insurance proceeds. This marks 21 consecutive quarters of higher FFO per share as compared to the prior year. We're especially pleased with second quarter FFO, given our equity raise. The strength of the industrial market is further demonstrated through a number of our metrics, such as another solid quarter of occupancy, strong same-store NOI results, 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 along with value-add acquisitions. On leasing, we were 97% leased and 96.4% occupied. This marks 20 consecutive quarters, or since second quarter 2013, where occupancy has been approximately 95% or better, truly a long-term trend.
Drilling into specific markets at quarter end, a number of our major markets, including Orlando, Jacksonville, Charlotte, Phoenix, San Antonio, San Francisco, and L.A. were each 98% leased or better. In Houston, our largest market was 95.8% leased. While still our largest market, Houston has fallen from roughly 21% of our NOI to a projected 14% at year-end. Supply, specifically shallow bay industrial supply, remains in check in our markets. In this cycle, supply is predominantly institutionally controlled, as a result, the deliveries remain disciplined, as a byproduct of this institutional control, it's largely focused on big box construction. Our quarterly same property NOI growth was strong at 6.5% GAAP and 6.4% cash. We're also pleased with average quarterly occupancy at 96%, up 110 basis points from second quarter 2017. Rent spreads continued their positive trend, albeit at a slower pace this quarter.
Rents rose 2.7% cash and 11.9% GAAP. After removing an R&D property in Santa Barbara, these figures rise to 4.9% and 13.5% respectively. Further, our year-to-date GAAP re-leasing spreads, omitting this R&D space, are 16.1%. The takeaway being that the industrial market remains solid with rising rents. We simply had an unusual mix this quarter versus our prior several quarters. Given the intensely competitive and expensive acquisition market, we view our development program as an attractive, risk-adjusted path to create value. We believe we effectively manage the risk as the majority of our developments are additional phases within an existing park. The average investment for our business distribution buildings was below $12 million. We target 150 basis point minimum projected investment return premium over market cap rates.
At June 30, the projected return on our development pipeline was 7.7%, whereas we estimate the market cap rate in the upper fours. Further, we're continuing to see cap rate compression in our markets. During second quarter, we had a fluid development pipeline as we began construction on five properties totaling 719,000 sq ft with a total projected investment of $65 million. Coming out of our pipeline, we transferred six buildings totaling 705,000 sq ft for an investment of approximately $57 million. Four of our five completions rolled into the portfolio at 100%. The one exception was Progress Center in Atlanta, which we anticipated, as it was a December 2017 value add acquisition. In sum, we removed about 35% of the previous quarter's pipeline and added the same into the current pipeline.
This high volume transition dropped our percent lease from 51% to 27%. As context, this change is reflective of the volume of early-stage projects rather than the state of the market. At June 30, our development pipeline consisted of 17 projects in 10 cities containing 2 million sq ft with a projected cost of $171 million. For 2018, we're raising our projected development starts to $140 million and 1.7 million sq ft. One of the things I'm excited about this year is a greater number of development markets. This diversity reduces our risk and is enhancing our ability to grow the development pipeline. I'm also excited about where we stand in terms of our projected starts.
As a reminder, our leasing results are what drive our starts. The $140 million in projected starts consists of 12 separate projects, and I'm pleased that we've either already begun or have approval for 10 of these 12 starts. We're continuing revisiting our forecast as the year progresses. In terms of acquisitions, in late April, we acquired Gwinnett 316, a 65,000 sq ft, 100% leased building in Atlanta for $4.4 million. Later in June, we closed on the 182,000 sq ft Eucalyptus Distribution Center in Chino, California for $23.3 million. This property is also 100% leased. Finally, after quarter end, we acquired the 115,000 sq ft Siempre Viva Distribution Center in San Diego for $14 million. Each of these was an off-market transaction. Now Brent will review a variety of financial topics, including our updated guidance.
Good morning. We continue to see positive results due to the strong overall performance of our portfolio. FFO per share for the quarter exceeded the upper end of our guidance range at $1.16 compared to $1.05 for the same quarter last year. $0.03 of second quarter FFO was attributable to an involuntary conversion gain recognized as the result of roof damage from a hail storm. Excluding the involuntary conversion gain, FFO per share was at the upper end of our guidance range at $1.13 per share, an increase of 7.6% over the same quarter last year. Operations have benefited from the continual conversion of well-leased development properties into the operating portfolio, an increase in same property NOI, and value-add acquisitions. Our balance sheet is strong and flexible. Our financial ratios continue to trend in a positive direction. From a capital perspective, we had an active quarter.
We issued $68 million of common stock under our continuous equity program at an average price of $91.01 per share. In April, we closed on $60 million of 10-year senior unsecured private placement notes at a fixed rate of 3.93%. In June, we extended the maturity date and expanded our borrowing capacity on our revolver facilities. They were scheduled to mature in July 2019 and now mature in July 2022. The total capacity was increased from $335 million to $395 million. The interest rate remained at LIBOR plus 100 basis points. We were pleased that the same group of nine banks not only remained in the revolver, but also increased their participation levels. FFO guidance for the third quarter of 2018 is estimated to be in the range of $1.12-$1.14 per share and $4.57-$4.65 for the year.
Those midpoints represent an increase of 4.6% and 7.5% compared to the prior year, respectively, excluding the involuntary conversion accounting gain. Our first two-quarter results, combined with the leasing assumptions that comprise guidance, produce an average quarterly same store growth of 4.2% for the year, an increase of 20 basis points from last quarter's guidance. This is the result of outperforming our budget expectations in the second quarter, along with continued optimism for the remainder of the year. Other notable guidance assumption revisions for 2018 include increasing our projected development starts by $20 million-$140 million, increasing projected property acquisitions by $40 million-$80 million, and increasing our estimated common stock issuance by $60 million-$110 million, of which $85 million has already been executed.
In summary, our financial metrics and operating results continue to be some of the best we have experienced. We anticipate that momentum continuing throughout 2018. Marshall will make some final comments.
Okay, thanks, Brent. Industrial property fundamentals are solid and continue improving in the vast majority of our markets. Based on this strength, we continue investing in, operating, and geographically diversifying our portfolio. As we pursue opportunities, we're also committed to maintaining a strong, healthy balance sheet with improving metrics that's demonstrated by our year-to-date equity issuance. 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 operating strategy, our team, and our markets have us optimistic about the future. We'll now open it up for questions.
At this time, if you would like to ask a question, please press the star and one on your touchtone telephone. You may withdraw your question at any time by pressing the pound key. Once again, to ask a question, please press star and one on your touchtone telephone. We will pause for a moment to allow questions to queue. We do appreciate your patience, and we will take our first question momentarily. At this time, we will go ahead and take our first question from Jamie Feldman with Bank of America Merrill Lynch. Your line is now open.
Thank you and good morning.
Morning.
Marshall, I want to go back to your comment about a very aggressive acquisition market or pricey acquisition market, and then the deals you guys did in the quarter, some larger than your typical size and in expansion markets for you. Can you just help us understand, I guess the yields on those acquisitions and the returns and just the thought process of doing acquisitions when it does seem like it's a pretty competitive market for you?
Good morning, and thanks. Good question, I'm trying to answer all three acquisitions at once a little bit. What we liked or appealed to us about all three were, one, we found them really through leasing brokers. None were fully brokered transactions. The acquisition in Atlanta, it's a single-tenant building with about 11 years left on the lease, and it's kind of in the low to mid sixes in terms of yield. Given our cost of capital at the time, it's in that Northeast Atlanta I-85 sub-market. It was near our Broadmoor property. It kind of fit our targeted sub-market in Atlanta. If it helps, that one is kind of that acquisition.
Then the next one was a building, we were looking at a different property, you're riding with the broker, they pointed out Eucalyptus and that it was a family-owned building and business where the seller sold it, they kind of said, "We think you can acquire that one." We have acquired Eucalyptus, signed a three-year lease with the seller. Really, it'll be in the low to mid fours. We saw an asset trade in Chino just prior to this in the high threes, we liked our pricing per square foot. There's a chance the tenant, if they own the business and the building, could exit the lease prior to the expiration. If you marked it to market today, which we would view as a good opportunity, it would trade in the low fives.
It's a good current return and really a better long-term investment when we get another at-bat. That West Inland Empire vacancy sub 2%. We like the yield today. We think the tenant will either serve through their term or vacate early. If the market holds, we have good upside on it. Then the Siempre Viva is in South San Diego. This building is literally on the border. It was off-market. We have two tenants at our Ocean View project that's nearby that actually need expansion space. We liked this building. We found that the seller is going to vacate the building. They've signed a short-term lease, we're leased out to backfill the majority of this building and have other prospects that we're talking to, that would get us into the kind of low, probably low to kind of medium distance sixes.
The market, we think there's certainly a little bit of uncertainty with trade and tariffs and things like that, but Southern California and San Diego is probably a high 4s at this point, cap rate. We like all three, have some moving parts before we really get to the full value, but we like the returns on each. I would sum up our California strategy as we've talked of, we like the market, we want to grow there, but we're going to be patient and disciplined and probably do more value add things in California like these two rather than, I agree with you, CBRE and the other groups do a great job of marketing them, and anything that's fully marketed and stable is hard to find value or create value at this point in the cycle on those.
Thanks. How do you think about your stabilized yields versus your cost of capital?
We look at our cost of capital. We're below it today versus, I'll let Brent jump in if he'd like to. Usually call it rounding two-thirds equity, one-third debt. That, if you run through the math on what we can place tenor debt for today on our debt, that gets you, I'm rounding into the higher 4s, call it a four and three quarters range. In two of these three, we're above it, and in Southern California, it's really a bet on the Eucalyptus long term that it may take as much as long as two years, but we'll get above our cost of capital there.
Long term, we really like that Southern California, like the rest of the world, we like the Southern California market because of the growth and just simply lack of land there for industrial space.
Okay. A question for Brent, just thinking about your top tenants and just credit watch. Can you just talk about the, I think you were reserving, but you haven't really taken any, or I don't see any reason to have taken any so far. Can you just talk about how we should think about that?
Yeah. We remain real pleased with where our bad debts are, really lack thereof. We basically had no bad debt this quarter net. We actually had a recovery of a prior balance in Houston that effectively caused bad debt to be zero for the quarter. The one tenant that we have fielded questions on over the past six to nine months or a year is Mattress Firm, which is third on our top 10 list. Again, reminder, their facilities with us are obviously their distribution centers in any particular market, and they're current, and they're still What we hear more is a retail consolidation where they bought a lot of other chains, and then they're diminishing their retail footprint. From a distribution standpoint, we've looked in the warehouses they're in with us. They're very active, very busy. There's nothing reserved there because they're current.
Knock on wood, our tenant collections have continued to be very good.
You're welcome.
Once again, if you would like to ask a question, please press the star and one on your touchtone telephone. We also request that you limit your questions to two, and we will take our next question from Manny Korchman with Citi. Your line is now open.
Good morning, everyone.
Good morning.
Marshall, you touched on global trade. Could you just give us your thoughts more generally or anything you're hearing from your tenants, either positive or negative, as to how it might affect their businesses?
Sure. Good question. With our tenants and kind of internally, knock on wood, it's all been discussion at this point. No one's really felt any impact, and we're not seeing it affect our leasing. We've got one lease out on an expansion and a renewal that's overseas, and that has us, admittedly, a little bit nervous about it. To date, it's been much more smoke than fire. I guess it's all relative, any kind of trade tariffs and slowdown isn't good for anyone or any of the industrial REITs. I'd like to think we believe we're a little more protected and that our buildings are where the consumers are and really not so much along the logistics chain from China to Chicago or northern New Jersey, for example. We're really based, we'd be much more last mile and where the end products are going.
We think we're relatively more insulated than some of our peers, but we're certainly watching it. To date, have really not felt the impact, but we're certainly talking about it. From the leasing perspective, the brokers that we're working with, Brent and I were in several Texas markets last week, and those guys, it never came up in our discussions at all.
Great. Thanks. Maybe turning back a year, a favorite topic was Houston. You mentioned that things were doing reasonably well and that your exposure's going down. If we hadn't pushed so hard, if the market hadn't sort of focused on Houston as much as it had, would your exposure still be going to 14%? Or do you think that was more of a reaction, and where would you like that exposure sort of to be, notwithstanding all the comments you made a year ago?
I guess it's hard to dissect it exactly. I don't disagree with the market that 21% was a lot. I think the pushback was probably justified. I think, and I hope we would all agree, Houston actually performed. I'm surprised how well Houston did through the downturn and never get to 6% vacant. I think we would've gone down in terms of Houston as a percent regardless of the market, but the market, certainly that was a topic we had in, as you said, a year ago, in every one of our meetings. I like that we sold our older buildings in Houston in a good market to sell assets in. We didn't sell things purposefully that we thought we would regret long-term.
Really, I'm excited that our denominator in terms of that calculation, we're growing in Miami and in Dallas and Charlotte and any number of California, a number of markets. There'll be twists and turns along the way as we projected out even beyond 2018. Houston got into the mid to lower 13%. I think as a percent, you'd love for no market to be maybe more than a couple hundred basis points ahead of your number two or three market. Long-term, as I mentioned, we were in Texas last week and talking with our team there. We've been in Houston 20-plus years. Brent lived there for a long time. We're good at creating value. We just needed to kind of back up to create runway, which we have now. I feel like we can grow in Houston.
At 21%, it was hard to keep growing and finding new opportunities. Now, I feel like ideally, you'd have runway in every one of your major markets to go create value. I think we're there now, and as we ran the projections, I was pleased to see how it continues to drift down. We're looking for opportunities in Houston still, I think it'll keep drifting down as we develop out Miami and a number of our other projects.
Thanks, Marshall.
Sure. You're welcome.
We will take our next question from Thomas Catherwood with BTIG. Your line is now open.
A question for Brent. You mentioned same-store wide growth in your prepared remarks on the cash side. If we look at the straight-line side, you're still guiding to 3% full-year growth. So far this year, you've done about 4.6%. It suggests a pretty market slowdown on the straight-line side to the back half of the year. That would imply less than 2% same-store growth. Are we missing something here, or are there some kind of one-time item that could drag down second half internal growth?
That's a good question. It's a bit of a frustrating question for us internally because the annual same-store pool, as you look at our guidance of 2.5%-3.5%. Just a reminder, that particular pool is a static pool, meaning that it's for properties held January 1, 2017, all the way through December 31, 2018. It has to be in that two-year period. That's one reason we've begun to show our average quarterly same store, where from quarter to quarter, it's more current. We show that being an average for the year of 4.2% and actually increasing in our guidance. I would point out to that annual pool, Tom, is for example, there's over $400 million now of our operating assets that aren't picked up in that particular same-store pool.
A lot of those assets are value-add oriented, like Park North or Jones or Weston or some of the other value-add projects that we've added, and they're just not included there. Our internal assumptions do show a fourth quarter slowdown within that static pool.
Part of it is we had a $270,000 termination fee last year that's not included this year. That's a small part of it. I would just point out that's our budget, and we're just disclosing what we have in our assumptions, but we certainly hope to outperform it and beat it, and so far, we've been fortunate enough to do that. I would just say we get accused, and maybe rightly so, of being very conservative, but it's more challenging than you might expect to budget and analyze everything and to come away and try to budget at a 97% lease or occupancy is just very difficult to do. It just puts yourself, I guess we view, as in an unneeded corner. Maybe a little bit of a slowdown in our underwriting, but it's nothing that we're feeling.
Hopefully, we'll continue to outperform through the year as we have.
Got it. I appreciate that. Marshall, you mentioned that you're continuing to see cap rate compression. Kind of a multi-part question here, but how much cap rate compression are you seeing? Is it across all your markets? Has the bidder pool shifted at all for most deals?
I don't know that the bidder pool is shifting a lot. I guess there's a couple of portfolios we're looking at now and then some one-off acquisitions. The quantity of bidders has been surprising to us and to the listing brokers, and that you're getting into the 20s Well over a dozen to 20-something bidders, there is a lot of global capital chasing constructed, leased industrial product. The cap rates continue to compress, probably slightly in the major markets. Our great thought, which probably wasn't so unique, was we looked at more at some, wouldn't call maybe not the top five markets, but it's markets number 6 through 30, like a Charlotte, like Phoenix, Denver. That's where we've seen the compression. Tampa, even Houston, cap rates have been in the upper fours in Houston, 4.75, that they continue to come down.
We're seeing 4.5% in Denver with a large bidder pool on a couple portfolios, but it is awfully hard to find value as, again, we could be wrong, but at this point, what we're guessing is probably later than early in the cycle. What we're hearing is people are underwriting within that bidder pool, and they may be right, higher rent growth going forward than typically. Usually, people underwrite, say, 3% rent growth in a 10-year ARGUS. The listing brokers, people are getting to the same IRRs, but underwriting higher rent growth going forward.
The other feedback, which we feel like we're seeing too, it's potentially late in the real estate cycle, but still pretty early in the logistics shift within retail to e-commerce, and especially within the last mile, which is really the type of buildings that fit our portfolio that we're chasing. That demand for our type assets, the good news is we make it. The bad news is when we try to buy it, there's a large pool of people out there chasing things. One comment we had from one of our brokers, they'll usually give us thresholds, target, and stretch pricing. About the last half dozen sales they had, they all went above what they had considered their stretch pricing.
Got it. Thanks, everyone.
Sure. You're welcome.
We will take our next question from Craig Mailman with KeyBanc Capital Markets. Your line is now open.
Hey, guys. Marshall, just going back to your commentary that there's kind of an unusual mix of leasing in 2Q that kind of drove the rent spreads there. Even if you stripped out Santa Barbara, the lease spreads on new leases were a little bit softer than what we would have thought, given what peers have been doing. Was that kind of contemplated in your budget or how did that come in relative to expectations? As you guys look at the back half of the year, how do you see that trending?
Good question. You're right on Santa Barbara, and it's probably a little bit of a perfect storm in a good way, a perfect storm that we would do again. In Q2, and that I would describe almost all of our market rents at peak, and the two exceptions would be Santa Barbara, where we have There are four two-story buildings in suburban Santa Barbara. We had a 51,000-foot building. The tenant vacated last year. The good news is we're 95% leased now in Santa Barbara, but by the time that tenant finished construction of their new building, we had pushed rents pretty hard. It was a big rent. It was in the low 20s, and current rents are probably 18 net. The square footages get amplified within our portfolio.
50,000 feet doesn't sound like that much, but when the rents are three to four times greater than average industrial rents, it amplifies it. The other market that I'd say rents are not at peak is Houston. It hit its peak when you're looking at, and I'm kind of looking at the CBRE stats. During 2015, they dropped, and they're climbing back, but they're not back where they were. We had a few leases in Houston that we did. We're 96% leased there without a lot rolling. One of the ones that hit us, especially this quarter, was a rural Houston single-tenant building, 107,000 square feet. It was a little bit larger building than our prospect wanted. We all talked about it and stretched and made the deal also.
I say perfect storm, and the good news is we did a lot of leasing in Santa Barbara, and that hurt our re-leasing spreads. The good news is we got leasing done in Houston, and it's pretty full without much roll. Balance of the year, we won't have the exposure to those two markets that we did in second quarter. I think, knock on wood, I think you'll see it rebound more to normal rates. We're not seeing a slowdown in our markets. We had an unusual mix this quarter of a lot of Houston and a lot of Santa Barbara, and that's where our Achilles' heels are in our portfolio.
Gotcha. That's helpful. Just circling back to Chino. It sounds like you guys struck a deal with the seller for a rent that's 10%-20% below market. Does that sound about right?
Yes. It steps up each year. It's a three-year lease, chance they could exit early, and that was part of our deal with the family that owned the building, was that we kind of stepped their rent up. It's below market. It starts in the fours and will end in the low fives.
Did you say how much you're going to have to spend on San Diego? Because you guys are classified as a value add.
Yes. I don't know that I did, but I can tell you, we bought the building for just under $14 million, probably all in, we'll spend about another $600,000 to $700,000 between the TI and commissions.
I know I'm going over my two-question limit, it just relates to kind of what you guys have talked in the West Coast and maybe Jamie's kind of question about cost of capital.
I'm just curious, as you guys think big picture, you want to get more into L.A., which is just a lower cap rate market as we've seen here, kind of how you think about that cost of capital, also how you think about the ability to get assets with maybe better growth potential in some of the other markets, the kind of cushion you get from developing almost close to 8% on new builds and kind of how you look at the overall blend and how much of a cushion you think that gives you to take some shots here and there for some lower than maybe what the market would expect from you to cap rate acquisitions.
Yeah, I think that's a good enough question that I'm glad you went over the limit. How about that? You're right. We look at it as a mix. It's a portfolio of assets. We like the current yield. I guess kind of for next quarter, we like the yields we're getting in North Carolina and in Florida and in Texas. At the same time, we like the insulation, the diversity it gives our portfolio, going back to Manny's question earlier on Houston, to mix in with California, and we're just going to be patient. We've done more this year than we've done in the prior several years combined in California. We've certainly chased a lot and lost and tried to find value add, we realize it always won't be peak pricing in California.
We'll add in a few assets that are value add today. At some point, we like where our balance sheet is today, that we're well below our debt targets long term, that eventually all cycles turn, and when that cycle does turn, we'll hopefully have the dry powder and maybe load up a little more heavily in California, too. You can't wait for that point in time and hire someone, open an office, get to know the markets better, get to know all the brokers and things like that. We'll continue to mix in California knowing it's going to be at or slightly below our cost of capital. As you said, I think the other parts of our portfolio allow us that cushion, and we're 20 years down the road on some of these assets.
I'm really glad we own the buildings we do in Southern California and in the Bay Area. It's great when the leases roll there the last couple of years. They really helped, and I wish we were bigger there. That's kind of how we're thinking about is long term. I hope Ryan's with us, who runs California for us for 20 years. There'll be years he buys a whole lot more than others. We're excited about these, too, looking at a few more right now, and we'll just be patient.
Great. Thanks.
You're welcome.
We will take our next question from Ki Bin Kim with SunTrust.
Thanks.
Please go ahead.
Thanks. Good morning, everyone.
Morning.
Just one quick question on development yields. What are you guys developing to versus exit values today, and how has that kind of trended over the past year or so?
Yeah. Kind of the blended average today is a 7.7 between lease off and under construction. As you can see, under construction is a little bit lower. Some of that's probably driven by two parts. One, construction costs are up, so that's put some pressure, and then some of it is just the mix that we added in our Gateway project in Miami, where we've been saying we're developing to an eight and the market cap rates are five, call it. With Miami, it's probably a four or upper threes if that part were built and fully marketed today. We're building in the mid-sixes and call it still 250 to 275 basis points above market cap rates there. A little bit mix in composition.
Our rule of thumb is 150 basis point premium over market cap rates, and thankfully, we've been closer to 250 to 300 basis points. The other thing we're seeing are all here from our team. We'll use today's construction prices, but we don't project rents forward. We'll look back within our Usually, say, it's building five within a park. We'll look at the leases we signed in building four. Typically, our rents have, the past few years in a rising rent market, have proven to be conservative. I hope we're conservative with our rent projections because we're looking back, not forward too. That's the other thing that's probably pushed us a little bit. Our denominator has picked up with construction pricing, and we haven't pushed rents where I think they'll ultimately come out. That's how we underwrite them.
Okay. Given your land bank, do you think that above normal spread probably lasts for a little bit longer?
Yeah. It should. It's always a tricky balance where our land bank, where we've got it, I've always said, ideally, you would have room for four more buildings, whatever the market. In some markets where we're getting a little bit thinner on our land banks than we would like. If you said long term, what worries us is keeping that land bank where we need it to be. I love that we have a kind of proven long-term way to create NAV, create value for our shareholders, is just that manufacturing process to kind of keep churning out buildings, 250, 300 basis points in value as we finish them. We need that land bank.
By the same token, you don't want it to be too big, because at some point the music stops, and then it goes from being a land bank to carry at that point.
Okay. Thanks again.
You're welcome.
We will take our next question from Eric Frankel with Green Street Advisors. Your line is now open.
Thank you. Brent, I have a quick question about your same-store calculations. It's a little bit confusing. You didn't really change your cash same-store guidance this year, obviously, your second quarter numbers were quite strong. Your year-to-date same-store NOI growth of about 4.5% would imply that your NOI growth for the first quarter was 2.5%, yet your first quarter release said that your same-store growth was actually 4.5%. Can you clarify how you calculate your same-store numbers?
Sure. I'll try to follow you on that. I guess, Eric, what I look at or maybe refer to the most is in our release and also in our supplemental, we put our guidance assumptions in that chart. We basically give a guidance for a quarterly same store, which in this case for third quarter guidance, the cash guidance of 5.2%-5.6%, for example, are for properties that would be held July 1, 2017, also July 1, 2018 through the third quarter. The year-to-date for 2018 would be at the footnote, it says there footnote one. Those are properties held for the entire 2017 physical calendar year compared to 2018. The quarterly pools are different than the annual pools. As I mentioned, the annual pools just get very dated because 1/1/2017 is virtually the cutoff.
Again, we raised our guidance 20 basis points on our average quarterly for the year, which we're excited about. We continue to see good operations across the board from a same-store perspective. I hope that clarifies it. If not, we can talk offline and get in the weeds as much as you would like.
I guess that's fine, I thought the agreement that everybody made in terms of that all the companies in the industrial sector made in terms of calculating same-store pools was just to keep the pool consistent starting at the beginning of the year, just so that you can compare same-store numbers across REITs reasonably well, it makes it a little bit tougher to do that when the pool changes every quarter. I'm not sure if any other REITs are now changing their pool every quarter. I think that's a challenge.
Well, we're all still absolutely under the same way that we compute same-store. Obviously, within that same definition, there's different periods that you can grab. It's ranging from people disclosing three to one, and we do two.
Right. You added in properties into your same-store pool for the second quarter, correct?
For the second quarter same-store pool, yes.
Yeah. I thought that the pool kind of set, as you stated, at the beginning of the year.
That's
you kind of
That's the annual same-store pool. Again, it's all computed. What's included in the pool is the same. Again, we can talk offline. I can walk you through that.
Okay. Then just to clarify, or just to expand on some of the trade arguments. Marshall, I'm sure you probably read the headlines this morning that our president would consider putting a tariff on all Chinese goods, not just probably, what, 5% or 6% of goods that's getting a full tariff now. It certainly seems like they're taking a pretty tough negotiating stance on NAFTA and Mexico. It seems like your portfolio is, I understand that there's a last-mile component to it, and it's based on local consumption. Aren't a lot of your markets and their economies somewhat are pretty heavily dependent on trade with Mexico, at the least? Wouldn't those markets and leasing activities suffer pretty greatly if NAFTA was repealed and nothing comparable could be put in place?
It won't be good for us or anybody, really, if you shut down global trade. You're right, whether it's China or Mexico. Yes, a number of our markets, certainly parts in Texas, parts in Arizona and Southern California will slow down in some to greater or lesser degrees. A number of those markets are all driven. I'll pick one, Tucson, for example, where we do have long-term leases in place in all of these markets. Even if trade gets bad, unless our tenants go bankrupt, we can weather the storm more than maybe the manufacturers or different people like that that may not be as focused on the consumer. Where I was going on, at least using Tucson as an example, you do have a major university, and you have tourism, and in some cases, a state capital here or there.
At the margins, it will hurt. I'm hopeful that they resolve it quickly. I can't imagine the worst thing Trump can do for re-election would be to throw the economy into a recession. I won't speculate on the wild card of a negotiator. We'll see how it plays out. To date, our leasing is not slowing down, thankfully, because of the discussions. You're right. We did read the headlines, and we're watching it and nervous like everyone else. I'm glad our portfolio is more positioned on the end consumer, but we do have some markets. That's one of the reasons why we like being so well geographically diversified. We're not all on the border, but we do have some assets that are closer to the border than others.
Okay. Thank you for taking my questions.
Sure. You're welcome.
We will take our next question from John Guinee with Stifel. Your line is now open.
Yes. Thank you. Two quick questions. First, how did you ever buy four two-story buildings outside of Santa Barbara?
We didn't, I guess, in that sense. We merged, this goes back to 1996. We acquired Copley REIT, which I believe is part of AEW now. They had a mortgage REIT, and within those kind of dozen properties that we acquired a lot in of our L.A. or parts of our L.A. and Northern California, South Florida assets. They had four R&D buildings in Santa Barbara within their REIT. It's been there for 20-plus years.
Interesting. Okay.
Yeah. That's the history, anyway.
Got you. Okay, second question. The end result is between 2019, 2020, and 2021, over half your leases expire. Just ballpark, do you think those leases are, is 5% below market on a cash basis and 15% below market on a GAAP basis a reasonable number, or do you think that's off appreciably?
We're not good at projecting embedded growth. Just as we typically have shied away from that. Maybe another way of trying to answer it, when we look back, we, from a GAAP perspective, which we like because you capture free rent and all the other metrics in there. If I can do this from memory, we were up 12% in 2015 and 2016. Last year, we were up 17%, and this year, absent the four buildings in Santa Barbara we just discussed, we're up 16%. We do feel that there's continued embedded rent growth, and this is more Marshall speculation than fact, but with rising construction costs and the scarcity of land, I am more bullish, absent a trade war, more bullish about rent growth over the next 12 to 18 months than I was probably the past year.
If anything, we thought rent growth should be picking up going forward based on where construction pricing is and where the economy is.
Are those numbers GAAP or cash?
GAAP.
GAAP. Okay. Wonderful.
Yeah, we like.
Thanks.
Yeah, you're welcome. Thank you.
Thank you.
Our next question is from William Crow with Raymond James. Please go ahead.
Hey, good morning, guys. Marshall, I'm trying to put all your comments together, it sounds like you're a little more cautious on where we are in the cycle. There's some economic or political headwinds out there, rising construction costs. Are you underwriting your new developments any differently? Is there a little bit more of a yellow light out there from a new construction perspective?
No, I'm glad you asked. I really don't mean to sound cautious. That may be the recovering CPA within me that I am. We upped our starts this year, I'm excited about that, going from $120 million-$140 million. We've stepped on the equity pedal fairly heavily year to date. I guess comparing to our original budget, we thought we would've raised $25 million year to date, we're at $85 million. We're seeing the opportunities out there, we like deleveraging the balance sheet while we're pursuing those opportunities. We're underwriting them the same way. Probably our projected yield, I saw you mentioned this in your piece, it's the same way we always underwrite them. Now with construction costs going, I'd call it 10%-20% in the last 12 months, it's compressed the yields a little bit.
I'm also optimistic by the time the buildings get delivered and we get leased, that rents will keep pace or close to keep pace. At the same time, cap rates continue to either stay where they are to fall, we have a much greater spread over cap rates than our 150 basis point kind of internal policy. We're bullish. On another side, and I'm just pointing at the facts, I'm pleased that when we quoted our 97% leased and 96.4% occupied, oddly enough, it's the third quarter in a row that we've had those exact same numbers. I've accused our accounting team of having that hard-coded in and not calculating it. Usually, we drift down in second, during the summer months.
That's partially how we got ahead, especially with the equity raise, is that our occupancy has stayed flat from year-end, which that's pretty atypical if we went back the past several years. We're bullish and maybe, I think it's probably good. You always want a little bit of fear out there in the economy. Otherwise, all the developers would just go crazy, I suppose. We're watching those, and we'll watch the news, and I'll get pessimistic, and then I'll get a call from our team, and they've got a tenant that wants to expand. I hope that balance stays in there.
Yeah. I would just add to that, Bill. This is Brent. I tagged along with Marshall last week to Texas, and I've not been back in the markets in a while. It was fun to go back and see the team. I was really impressed with the activity in all of our Texas markets, Dallas, Austin, San Antonio, even Houston. The level of activity, the proposals, the deals they're working, I was quite impressed and came away feeling very, very positive about that. As Marshall mentioned in his written remarks at the beginning, we've 12 projected starts this year, and we've already commenced 10 of them. Now, some of them are very early on. We've been very pleased with the leasing velocity we're seeing across the board, but especially in the development portfolio.
Yeah. Thanks for those comments. One follow-up on construction costs that you noted were up 10%-20% over the past year. Has that been a steady push higher, or has it changed at all on the margin, the rate of increase as we've progressed?
It's been fairly steady, maybe a little more over the last handful of months. In talking to our team, I guess, whether it's industrial or any property type, all the subs are busy, and everyone can pick and choose their jobs. Sometimes it's materials. I ran into a friend that's a multifamily developer, and I guess hardwoods are at their historic high price. Between that and the labor pricing, and the people are just bidding and picking the jobs where they make money. It seems a little more in the back half of the year that it's gotten to 10%-20%. We don't really, unfortunately, I don't see that slowing down unless the economy slows down. That should help us push rents.
Okay. All right. Thank you. That's it for me.
You're welcome. Thank you.
Our next question is from Blaine Heck with Wells Fargo. Your line is now open.
Thanks. Good morning. To follow up on the land topic, can you just comment on which markets you guys are targeting at this point to grow the land bank? Whether there are any specific markets where land costs are becoming an issue when you look at replenishing the development pipeline and getting to an acceptable kind of pro forma yield?
Sure. A couple that are near, and we're still active there, but a good problem to have. We love our Horizon Commerce Park in Orlando, for example, but we're down to the last few buildings. We're looking in Orlando and Tampa, are two that come to mind. We're glad we have the land in Miami and Fort Myers. Florida, we've got one way, but Central Florida, we could use a little bit more land there. We haven't closed. We would be out in Phoenix. We've developed our last building there. It's great that we're running through our land. We have some land tied up there that we think will close this quarter that will give us that next path. Kind of same thing in Dallas and San Antonio. On the flip side, where it is awfully hard is parts of L.A.
Land probably starts in the mid-30s per square foot, and we've seen as high as $60, not per under the building, but just gross per pricing per square foot. In Orange County, I've seen where they've repurposed buildings, and they actually had negative supply. The same thing in Hayward and that East Bay area of San Francisco. The good news about industrial in terms of oversupply is almost everything. I guess there's one in Seattle and a little bit in New York. Almost everything, 99+% of the supply is single story, so industrial can get priced out of the market, and you can get pushed pretty far inland in L.A. and in the Bay Area now because it's hard to underwrite. The good news is we own some assets there, and that's putting a lot of upward pressure. We try to have a balance.
Again, perfect world, you always have room for those next five buildings in our major markets, and it doesn't always come in sizes for those next five buildings. We also, as we think about our land bank, and we thought the cycle was a little bit long for probably three years now. Anything we acquire, our goal, we're not stealing land at this point. We try to put it into production and run through it as quickly as leasing allows us to. We're not buying anything and saying, "Hey, we'll start on this down the road." It's usually immediately in production, or always immediately in production.
Okay. That makes sense. Marshall, you touched on this a little bit, and maybe Brent wants to chime in, too, but the balance sheet is in great shape. You guys are around five times right now, and it looks like your guidance for asset recycling and an assumption for NOI growth could result in a little reduction throughout the rest of the year. I guess, how do you think about the balance between having the safety of a strong balance sheet versus possibly higher earnings growth with a little more leverage at this point in the cycle?
Yeah, I'll jump in. Marshall's touched on that some, I'm glad you picked up on that. We were very excited to have issued the amount of equity we did and still come in at the high end of guidance. I think that may have been lost on some folks. From what we have projected to what we've actually done has put about a $0.02-$0.03 decrease or drag on our 2018 projections. Again, we're still projecting to the high end, which is very nice. Blaine, to answer your question, when you're at the pricing, we talk about this almost daily because you're staring at the market and the price, we're keeping a pulse on when we have good opportunities to put the capital out. It's just right now, we're taking advantage of what we feel is a very good price relative to NAV.
You grab it while you can. It's not really an objective to continue to go to a certain number in terms of Right now, we're 24% debt to market cap. That equity's available. Sometimes it's not, when the market were to turn, if that doesn't look as attractive, then we've given ourselves a lot of runway to go get debt, we have room to do it, we can continue to grow the pipeline. We're just looking at it as opportunity. When one good opportunity presents itself, you act on it, that's really what's freed us up to do all three of our primary growths, which is development, value add acquisition, then a few select strategic acquisitions like we recently did in California.
If we continue to see the opportunities, the price stays there, I think you'll see us remain fairly active on the ATM.
Very helpful. Thanks, guys.
Sure.
Our final question today is from Zachary Silverberg with Mizuho Securities. Your line is now open.
Hi. Thanks, guys. Putting aside the same-store pool definition, what is the assumption for occupancy change sequentially for 3Q18 and the remainder of the year? Is it flat or down a bit for now or with some conservatism dialed in?
Well, as we show in the assumptions, we're projecting 3Q being at 94.8 average for the quarter, and then I think up a little bit in fourth quarter from there. Again, I would just stress we're just being very transparent in showing what is in, basically our guidance assumptions. The guidance range that we're giving for FFO, we're showing what that consists of, and then from there, anyone can add or subtract to that as they might want. That's what's in the budget assumptions. On the ground, what we're feeling is a pretty comparable back end of the year, I feel like, to what we've seen in the first half of the year. We like the activity. We like what the guys in the field or the feedback we're getting.
Our tenant at an average 25,000 or so average tenant size, we're not seeing any impact from all the trade talk rhetoric. We still feel very upbeat about the back half of the year.
Okay. Thank you. Have you seen any instances of construction costs outpacing rents at all?
Probably short term, yes. Long term, we still think, and maybe I'm now thinking out loud, which is dangerous on a call. Maybe construction prices can move pretty quickly and rents, it takes a bit. Construction, it's depending on how many subs are out there at any given moment in Charlotte, for example, or San Antonio, so it can escalate pretty quickly. Where on rents, which is true, there's very limited shallow bay supply industrial being delivered, but with that said, there's always competition. In a given instance, construction can outpace rents, but I think rents will, over time, catch up if the economy stays where it is. Especially given the pricing up on construction and the lack of available infill land, that makes me more bullish about rents than construction pricing over a longer period of time.
All right. Thanks, guys. That's it for me.
Okay. You're welcome.
We have no further questions at this time, so I will turn the call back to Mr. Loeb for any closing remarks.
Okay. Thank you, Catherine. Thanks everyone for your time. We appreciate your interest in EastGroup. Brent and I are certainly available for any follow-up questions or clarifications you may have, and have a good weekend. Thanks, everyone.
Thank you.
This does conclude today's program. Thank you for your participation. You may disconnect at any time, and have a wonderful day.