Good morning, and welcome to the EastGroup Properties second quarter 2017 earnings conference call. At this time, all participants are in listen-only mode. Later, you will have the opportunity to ask questions during the question and answer session. You may register to ask a question at any time by pressing star and one on your touchtone phone. We ask that you ask one question and one follow-up. Please note this call is being recorded, and it's my pleasure to introduce Marshall Loeb, President and CEO. Please go ahead.
Thank you. Good morning and thanks for calling in for our second quarter 2017 conference call. As always, we appreciate your interest. Keith McKey, our CFO, and Brent Wood, Senior Vice President and CFO in waiting, are also participating on 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'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, Gina. The second quarter saw a continuation of EastGroup's positive trends. Funds from operations came in at the high end of our guidance, achieving a 6.1% increase compared to second quarter last year. This marks 17 consecutive quarters of higher FFO per share as compared to the prior year's quarter. The strength of the industrial market is demonstrated through a number of our metrics, such as another solid quarter of occupancy, record leasing volumes for the first half of the year, positive same-store NOI results, and double-digit positive re-leasing spreads. In summary, our increasing FFO and dividend prove the success we're seeing in all three prongs of our long-term strategy. At quarter end, we were 96.8% leased and 94.9% occupied. As market commentary, we've never achieved this level of occupancy for this long.
Drilling into specific markets at June 30, a number of our major markets, including Orlando, Jacksonville, Charlotte, Phoenix, San Francisco, and Los Angeles, were each 98% leased or better. Houston, our largest market, with over five and a half million square feet, down from over 6.8 million square feet in first quarter 2016, was 95.6% leased. Supply, and specifically shallow bay industrial supply, remains in check in our markets. In this cycle, supply is predominantly institutionally controlled. As a result, deliveries remain disciplined. Also as a byproduct of that institutional control, it's largely focused on big box construction. In fact, a recent CBRE study showed shallow bay deliveries still below pre-recession levels. Rent spreads continued their positive trend for the 17th consecutive quarter on a GAAP basis, rising 14%.
Overall, with 95% occupancy, strengthening markets, and disciplined new supply, we continue seeing upward pressure on rents. Second quarter same-property NOI rose on a GAAP and cash basis by 2.5% and 2.4% respectively. Average quarterly occupancy was 94.9%, which is down 60 basis points from second quarter 2016. A material portion of our occupancy decline came via acquired vacancy and value add acquisitions, which impacted average occupancy 110 basis points. Of note in our June 30th results is the 190 basis point margin between % leased to occupied. This is an atypically large margin, and it's being driven by several larger second-quarter lease signs where build-out and permitting are underway.
It will take a couple of quarters to begin seeing the full impact in our results. The other benefit lies in lower risk shifting from projected leases to actual signed leases. We expect same-property results to remain positive going forward, though increases will likely to continue to reflect rent growth, as with mid-'90s occupancy, we view ourselves as fully occupied. The price of oil and its impact on Houston's industrial real estate market remains a topic of discussion. We thought it appropriate for Brent to again join today's call. Brent, until next Tuesday, has run our Houston office with responsibility for EastGroup's Texas operations. Brent?
Good morning. Our Texas properties finished the second quarter at a combined 95% leased. Our Houston portfolio finished the quarter at 95.6% leased, up slightly from last quarter and ahead of projections. The Houston industrial market exhibited solid fundamentals at quarter end. The market vacancy rate was 5.5%, extending the consecutive quarters that the rate has been below 6%, coupled with positive net absorption to 24. Developers continue to show restraint with the construction pipeline containing only 2.2 million square feet of speculative space, which is down to a level not seen since 2011. The overall Houston industrial market remains stable, there is an undercurrent of tenants downsizing upon their lease expiration, which is producing a lot of movement within the market. We have not been immune to this trend and have incurred vacancy as a result.
However, there continues to be prospect activity in the market. In 2016, we signed 30 leases totaling 836,000 sq ft. By comparison, through the first six months of 2017, we have already signed our 30th lease for virtually the same amount of square footage. Our leasing efforts have reduced our scheduled expirations for 2017 from its peak of 17.7% down to 5.1% as of June 30. We have also reduced our 2018 exposure to just 5.4%. This is a welcome reprieve after the past two years, which were in the 17%-18% rollover range. Although we still have some known move-outs throughout the remainder of the year, our leasing results to date have been better than our projections.
Due to that activity and the sale of Techway Southwest, our leasing assumptions for the remainder of 2017 now reflect occupancy reaching a low of 90% in the third quarter versus the prior expectation of 87%. Marshall will go into more detail regarding the Techway Southwest sale in a moment, but I am pleased that over the past 18 months, we have sold over 1.3 million sq ft of buildings and 12 acres of land for gross proceeds of $88 million with book gains of $53 million. This significantly reduced our Houston footprint, and we've now successfully deferred all of the material gains via 1031 exchange transactions. Our development platform within Texas continues to produce positive results and further portfolio diversity. Our 2017 development starts include additional phases to existing parks in Dallas and San Antonio, and our first Austin land acquisition, where we plan to start construction before year-end.
In summary, the fundamentals remain strong for the Texas markets outside of Houston. Marshall?
Thanks, Brent. 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 development risk, as the majority of our developments are additional phases within an existing park. The average investment for our business distribution buildings is below $10 million. We develop in numerous states, cities, and submarkets. Finally, we target 150 basis point minimum projected investment return over market cap rates. As of June 30, the projected return on our development pipeline was 8%, whereas we estimate the market cap rate for completed properties to be in the low to mid 5s. Further, we're continuing to see cap rate compression in the majority of our markets.
During second quarter, in our development pipeline, we began construction in three existing parks on seven buildings totaling 507,000 square feet, with a total investment of $41 million. Those starts were in Dallas, Phoenix, and San Antonio. On the other end of the pipeline, we transferred five properties totaling 867,000 square feet into the portfolio at 86% leased. As of June 30, our development pipeline consists of 14 projects containing 1.9 million square feet with a projected cost of $150 million, which is 47% leased. During the quarter, we acquired two new development sites. The first being 30 acres in Round Rock, Texas, which is just north of Austin, with plans to develop four buildings totaling approximately 340,000 square feet. The second site came via part of our Broadmoor acquisition in Atlanta, where we acquired adjacent land to develop a building slightly in excess of 100,000 square feet.
Our goal is to break ground on both late this year or first quarter 2018. For 2017, we project development starts of approximately 100 million and 1.3 million square feet. What's gratifying about these starts is we can reach this level again in 2017 with no Houston starts, demonstrating the value of our diversified Sun Belt market strategy. Our asset recycling is an ongoing process, year to date, we've sold $39 million in assets with a couple of other opportunities we're evaluating pending pricing. Including in this figure was the $33 million disposition of Techway Southwest, a four-building, 415,000 square foot EastGroup development in Houston. In addition to Techway, we sold a 99,000 square foot Stemmons Circle in Dallas for $5.1 million.
Over the past 18 months, as we've recycled capital, the portion of our NOI coming from Houston declined while the quality of that portfolio has risen. Specifically, at the beginning of 2016, Houston represented over 20% of our NOI, with three properties in under development. Today, Houston represents 15% of our 2017 projections, and following the Techway sale in fourth quarter 2017, Houston falls under 14% of our projected NOI. Our second quarter acquisitions included a $5.8 million investment in the 84,000 square foot multi-tenant Broadmoor Commerce Park in Atlanta and the 99,000 square foot SouthPark Buildings 5 through 7 in Austin, Texas, for $10.3 million. These buildings are immediately adjacent to our SouthPark 3 and 4 properties, and both the Atlanta and Austin properties are 100% leased. Keith will now review a variety of financial topics, including our updated 2017 guidance.
Good morning. FFO per share for the quarter was $1.05 compared to $0.99 for the same quarter last year, an increase of 6.1%. Operations have benefited from an increase in property net operating income related to same properties, developments, and acquisitions.
We had lower interest rates on replacing maturing debt. FFO per share for the six months was $2.04 as compared to $1.90 for last year, an increase of 7.4%. Debt to total market capitalization was 27.2% at June 30. For the quarter, the interest and fixed charge coverage ratios rose to five times, the debt to adjusted EBITDA was 5.9. The adjusted debt to pro forma EBITDA ratio was 5.5 for the quarter. Floating rate bank debt amounted to only 2.2% of total market capitalization at quarter end. These stats are some of the best we have had. In the second quarter, we sold $30 million of common stock under our continuous equity program at an average price of $79.59 per share. For the remainder of 2017, we are projecting new debt of $60 million and no sales of common stock.
We do have one mortgage coming due in the second half of the year. We plan to pay off the $45 million mortgage on August 5th, 2017. It has an interest rate of 5.57%. In June, we paid our 150th consecutive quarterly cash distribution to common stockholders. The dividend of $0.62 per share equates to an annualized dividend of $2.48 per share. Our FFO payout ratio is 59% for the quarter. Rental income provides almost all of our revenues, so our dividend is 100% covered by property Net Operating Income. Earnings per share for 2017 is estimated to be in the range of $2.41-$2.49. FFO guidance for 2017 is estimated to be in the range of $4.19-$4.27 per share, and the midpoint stayed the same as previous guidance of $4.23 per share.
Guidance changes from previous estimates include an increase in same-store NOI, effect of dispositions, an increase in stock sales, and the timing of leasing on new developments. At the midpoint, we are projecting a 5.2% increase in FFO per share compared to last year. Marshall will make some final comments.
Thanks. Thank you, Keith. Industry property fundamentals are solid and continue improving in the vast majority of our markets. Based on this strength, we continue investing in and geographically diversifying our portfolio. We're also committed to maintaining a strong, healthy balance sheet with improving metrics, as evidenced by our equity issuance year-to-date. Overall, we're excited about our 2017 opportunities. From a holistic standpoint, our expectations are for another solid year. I use holistically, as I mean it, in two ways. First, I like the current industrial market, I like where we fit in the food chain, the consistent, steady value per share we're creating each quarter. Secondly, I'm using it in terms of people. We're excited to have Reid Dunbar as Senior Vice President for Texas, as well as Ryan Collins, our Senior Vice President for the Western Region.
They brought with them years of industrial real estate experience, excellent reputations, and are solid additions to EastGroup's culture and team. I'm excited to welcome Brent Wood, who I've known for over 20 years, as our new CFO. I worked with Brent when he transitioned from accounting to our operations side, it seems fitting to work with him on the transition back. As excited as I am about these moves, it's truly bittersweet to see Keith retire. Keith has been with us over 37 years, I've known him since my first day in the office. We're in sound hands, we'll miss him, I'm simply not articulate enough to adequately thank him for all he's done for EastGroup and for me personally. With that said, I'm excited he's off to enjoy himself, he's agreed to our if-we'll-buy-lunch consulting arrangement.
We'll now take your questions.
At this time, if you'd like to ask a question, please press star and 1 on your touch-tone phone. As a reminder, we ask that you limit your questions to 1 and 1 follow-up. Thank you. We'll take our first question from Manny Korchman with Citi. Please go ahead. Your line's open.
Hey, guys. This is Jill Sawyer here with Manny. My question is regarding the Techway Southwest disposition. Who is the buyer for that position, what does the buyer pool look like overall in the Houston market?
Yes. I don't think we're under any sort of non-disclosure with the sale, but it was purchased by Cabot. The buyer pool, we had entertained selling this property 12 to 18 months back when we began our disposition program. It did have some leasing risks, so we decided to hold it and just stabilize the rent roll and move forward. There's so many people looking for investments and just nowhere to put the money. We were approached by different groups over time, but in this case, the price was attractive. They were willing to price it and take on the leasing risk. At that point, we were willing to sell, so we're excited about the timing and the price. Like I say, it was on our disposition list, and it was a good property we developed.
I think it's the first time we've sold a property that we've developed. That sub-market we viewed as that we likely wouldn't add to that cluster over time, maybe even a declining sub-market in our view over time. We were happy to sell.
Okay. Staying on the buyer pool in Houston, do you find that pool any different or more active or less active now than, say, six months ago?
It's probably been a little more active. I think we're the majority of the way through our dispositions in Houston. We'll sell maybe a few more. There's a property, Central Green, that we signed a lease on, thankfully, in second quarter. We're doing the build-out now. We may bring that to market once that tenant's in. We saw the buyer pool contract the second half of 2016, and it feels like there's still demand, and it's picked back up. In fact, someone was just recently telling us about a barely north of a five cap sale transaction in Houston that traded. I think if it's solid, these are newer assets, kind of middle of the fairway. There's certainly a buyer pool, and it does feel like it's maybe opening up a little bit more in Houston. As Brent said, this was an asset we had on our list.
We really had pulled it off. Through a broker, both entities knew we got approached. They were able to hit kind of within our target pricing range.
Okay. Thanks, guys. Congrats, Keith, on your retirement.
Thank you very much.
Take our next question from Blaine Heck with Wells Fargo. Please go ahead.
Thanks. Good morning. Recent commentary from some peers has suggested that merchant builders have come back and are increasing supply in some markets. Are you guys seeing any increase on the supply side in your markets from merchant builders? I guess just more generally, can you talk a little bit more about your expectations for supply as we head into the end of this year and into 2018?
Good question. Good morning. We are seeing a little more supply out there, overall. I would bifurcate it in that where we like, Marshall mentioned where we like where we fit in the food chain. Recently, say, in Atlanta, I was in San Antonio, looking at a project we're considering there, some land. So much of the new supply is all big box. It's simply not designed with our average tenant size of about 26,000 square feet, probably a little bit larger than that in our new developments. The vast majority of the new supply is non-competitive. If you and I were on the ground and we drove around Broadmoor in Atlanta, you'd see new buildings, but they'd be 250,000 square feet and up that are around us.
Supply has picked up a little bit, maybe in an Orlando and things like that. The merchant builders are typically not working with debt, but really with a way for institutional capital to acquire industrial. They're really, I won't call it a fee developer, but close to that, maybe a 10% partner with institutional capital as the investor. We're seeing a little bit of that. If you said what keeps us up at night, one of our main answers would be finding next land sites. Probably the biggest hurdle we've got to new supply is we simply struggle to find new land sites, as do our peers. It keeps getting pushed further and further out of town. Usually once you're there, they're building something that's non-competitive to our design projects.
Yeah, that's very helpful. Then, maybe for Keith or Brent, G&A came in lower than the original guidance for this quarter, which was good. Can you touch on what caused it to come in lower and whether there's any chance of that happening again?
We've had a lot of noise in G&A this year. We're changing our plans. We put out a press release the first of the year, said that that was causing $0.03 a share. We've had some terminations over the time and my vesting accelerating. We do expect G&A to be down next year. I have not come up with the final numbers. It should be less than this year.
All right. Great. Keith, thanks again for everything. Good luck.
Thank you.
Take our next question from Alexander Goldfarb with Sandler O'Neill. Please go ahead.
Good morning. First, Keith, congrats. Hopefully we'll see that handicap continue to come down. Two questions here. The first one is, now that you have some new folks in Texas and out west in the managerial roles, I realize it's only been a little bit, but already we've seen some improvement out of Arizona. Can you just talk a little bit about, they're coming into a firmly entrenched culture where you guys obviously have a formula that works, but at the same time, you went outside the company to get new blood. Just trying to balance what new ideas the new folks will have coming in versus them just operating under the EastGroup MO. Again, I just point to the pickup in lease rate in Arizona. Obviously, it seems like some things are changing.
Thanks. Good morning, good question. Maybe a little bit. Both are a little bit different. In Texas, we've got both places, we have good teams. We have two seasoned Vice Presidents in Texas that are continuing to perform well. We had known Reid Dunbar really from when he came from Charlotte, when he was with Prologis in Charlotte. Followed him. Certainly has a lot of good ideas and a lot of good experience, but stepped into an ongoing situation and is really continuing our development program in Dallas and San Antonio, really with the next phases of buildings. It's thankfully been a nice seamless transaction. Reid was just here in Jackson last week, so got to meet more of our team and has kind of hit the ground running and had a set runway in front of him.
Out west, we opened an office in Los Angeles for Ryan, so it's really been a way to be. We've used the phrase patiently optimistic. He is from Texas, had moved to Los Angeles a few years ago with Clarion, has a great kind of Rolodex of contacts and experiences in Southern California, growing Clarion's portfolio. Has hit the ground running. We've turned down any number of projects that just didn't quite fit us. Seeing such a large market in California, turned down opportunities. A couple that are on the radar that may come in yet that we're still evaluating. Again, he's just finishing his second month there. Then really, Mike Sacco has come into his own, as you mentioned, in Phoenix, where we're 90%, 90.5% occupied at June 30, but 98% leased.
He has stepped in and done a ton of development leasing and been a big driver of that delta that I mentioned, 190 basis points between percent leased and percent occupied, of a lot of first-generation space that he stepped in and has really, kind of with opening a California office, has let the Arizona office more or less be his office to run and do as he wants to. Honestly, I'm happy for Mike, and I'm pleasantly surprised that he got as much done as he did, as quickly as he has. I guess the other side of that, I'll just add what's nice is, an aside, is we had shut down our Phoenix development program because of the vacancy we had in first quarter of 2016. Now that we're 98% leased, Mike even got a nice pre-lease on some land that we have.
Part of our pickup, or really our timing of development, has been stabilizing the Phoenix market. It's let us really move from playing defense to playing offense this past quarter in that market.
Okay. It sounds like you may ramp up some development there.
Yeah. He got some space pre-leased. We're 36% leased on a new building, so we're going to finish out our Kyrene Park, and as soon as our earnings call is over and settles down, I've promised him to come out to Phoenix. He's got another new land site that we'll drive around, while it's 115 degrees still out there, and see what we think of that site, if it's our next park or not.
Great.
We're excited and yeah, he's doing a great job.
Okay. Second question is just on the external side, the acquisition market sounds like it's still pretty tough. Dispositions, it almost sounds like you're fine with where Houston is, like it's settling out. The big rush that you guys have had on the disposition side over the past year or so, is that sort of coming to an end? Do you think that even if you can't find acquisitions, you would still continue to do dispositions to fund development?
I think we would, even if we couldn't find the acquisitions, we're probably looking more towards value add acquisitions these days. I liked the two or three assets we bought at the end of last year, where you're achieving yields that are higher than core markets, but maybe a little bit below what if we had built it ourselves are coming in. I guess to answer your question, the pace will probably slow down a little bit, I think we should always be pruning our portfolio. We still have some service center buildings in Florida and things like that I think for our shareholders, while it's a good market to sell into, we should continue to sell and move assets out.
I'm happy the team's done a great job managing through the 1031 process these last year and a half, we'll probably keep that process going and match it as best we can.
Okay. Thanks, Marshall.
Sure. You're welcome.
We'll take our next question from Richard Anderson with Mizuho Securities.
Thanks. Good morning. Good luck to you, Keith. I understand Ole Miss needs a new football coach, just saying.
Coincidence.
Just going through the math on the guidance. I understand same-store up, dispositions up, stock up. Keith, you mentioned timing of leasing of new development. Has there been a slowdown there? Is that the message you're sending?
No. I'll let Keith chime in. The other one, we did bump our interest rate assumption a little bit this quarter. That was the other thing that we debated and kind of went through internally, updating our guidance. Happy with development leasing. It's moving ahead. With our size, especially with development, if a space or 2 gets pushed off versus an assumption, a month or 2, it's zero or $100,000 maybe within that space. A couple of those, and all of a sudden we're at $200,000, and that's the difference between raising guidance a penny or holding it steady.
We're not saying the development market slowed, but versus assumptions, and what we're happy with is we're able to shift some of those assumptions to actual signed leases and scrambling to get permits and subcontractors and things like that to get the space built.
Okay. You mentioned the 100 basis point spread between leased and occupied. What should we think of as typical?
We've averaged about, if we went back to 2014, maybe 170 to 100 basis points has been probably typical. First quarter, it jumped up to 150 basis points, this quarter, it's all the way up to 190.
Okay.
A lot of that is that development leasing where the build-out takes a little longer. As Brent mentioned, the Houston retention ratio has really inverted these past two years. More new leasing in Houston. That's some of what's caused the delta between those two numbers to grow, but it's about twice our normal run rate at the end of this quarter.
Okay. If you just allow me, did you give a cap rate on the Houston sale?
We didn't. Probably if we were underwriting it to acquire it, as Brent mentioned, it had some vacancy, it would be a low six kind of cap rate.
Low six, fully occupied?
Yeah. If we stabilized it at market rents and some of the things, that's kind of how we underwrote it, is what are we selling, then if we were the buyer, what would we be looking at? That got us to the low sixes.
Richard, it was at that six or low six. It was fully occupied, we had a tenant that was about 20% of the project that we knew was going to vacate July 1. We knew that that was going to go down from there. The buyer was willing to price through that and take that lower yield for however long it takes them to restabilize the property.
Okay, got it. Thank you, and thanks, Keith. Good luck.
Thanks.
We'll take our next question from William Crow with Raymond James.
Keith, God bless. Enjoy. Look forward to seeing you on the golf course at some point. Marshall.
I agree.
Marshall, a question for you. In talking with one of your peers back in May, they suggested that World Houston was perhaps the best industrial park in the country, which you probably would agree with. They suggested it's simply located in the wrong part of Houston. I was just wondering if you could address that part of it, and how transitory that statement might be. In other words.
I'll take the
How big of a gap when we come out the other side?
I'll take a stab, Brent chime in maybe between us, Brent's really seen World Houston grow up. Not unexpectedly, we agree with the first half of your statement. We think it's the best industrial park, arguably, in the country. What I love about it, you're really shoehorned in between Beltway 8 and George Bush Airport in a fast-growing fourth largest city in the country. I think our location and the access is really strong, and it's proven itself out over the years with the demand there. I think the north sub-market has had more available land, had more development heading into this kind of oil price shock.
The other thing that makes it maybe where you're I'm picking up on your word, Bill, transitory, of what we've seen, we have more, because of its location near the airport and near the freeway, there's been more 3PLs and freight forwarders. Those guys may have five or six locations, and my mental image is almost like an accordion. As they lose contracts, it's easy for them to contract organically versus if you and I owned a manufacturing business. We felt that on the contraction. By the same token, this may be the optimist in me, as they pick up new contracts, they will expand much faster than a typical, say, closely held or wholly owned 3PL would be. We probably do have more transitory freight forwarders because of the location adjacent to the airport.
Long term, I love being next to George Bush Airport. Brent, contradict me or-
Yeah. No, I would agree with that. We love the location, love the sub-market. The north became softer than the other sub-markets just because of its desirability. It became a victim of its own success when, as Marshall mentioned, there was more land opportunity there initially. As the market continued to grow and to be hot, more developers entered into that sub-market. When the music stopped, everything began to slow down. Again, it had more space and it was softer. Down the road, whether that's a year or two years, whatever, when things pick back up and spec development picks back up, you're absolutely going to see that occur in the north sub-market. There's no doubt about it.
Thank you. We'll take our next question from Rob Simone with Evercore ISI.
Hey, guys. Morning. Thanks for taking the question. On Houston, could you guys just break down how much of that spread narrowing on your same-store guidance, both with and without Houston, is attributable to the sale? I know that it's some combination of sale plus improving market, just trying to disaggregate that a little bit.
Yes, we looked at that. Two things that are helping us there, that incrementally we're doing better on leasing, and then certainly the sale of Techway, as I mentioned, we had that large tenant, right around 100,000 sq ft tenant that was originally budgeted to vacate, would've been empty the rest of the year had we continued to hold the project. Houston specifically, the improvement there in the same-store forecast, I would say a lot of it was related to Techway, and then some portion to better leasing. It was probably, with two quarters to go, a little more related to the Techway disposition, which again, we were very pleased with the timing.
We were able to operate at 100% for six months, right as the vacancy is impending and approaching, we were able to sell an asset that we had already desired to sell for probably going on 24 months now.
The other nice driver in our same-store results kind of for the balance of the year is that lease up in Phoenix, as I mentioned. We had projected leasing in the balance of the year, but not getting to 98%. In a couple of cases within that, one of them would definitely fall into same-store. It was a development that had sat vacant for a while. That will roll into our same-store pool later this year, and that project's at 100% now. That's kind of the other pickup of really just exceeding what our assumptions were 90 days ago.
Great. Thanks, guys.
You're welcome.
Our next question comes from Eric Frankel with Green Street Advisors. Please go ahead.
Thank you. Keith, I'm going to miss our spirited discussions that we always have. Best of luck in retirement, and hopefully I will see you at some point in my life in Mississippi.
Thank you.
Thank you.
Maybe just to quickly follow up on Houston. It seems like fundamentals are improving a little bit there, certainly better investment sentiment. Do you have a new target of where you want to get Houston to in terms of the % of the portfolio on a square footage or rent basis?
We've talked about that. I think we'll be below 14% in fourth quarter, really with no new developments planned. We might, maybe, pending the market, at least we could think about it maybe in 2018, where we didn't really think about it this year. I think if we stay 12%, 13%, 14%, that's probably towards the high end of it, and really more of that will be driven by how fast we can build out, say, Miami. How fast we can get up and running. I realize it's incredibly competitive in California, but that's certainly an under-allocation within our, if you look, kind of our investment spectrum.
What I would hope is each of our major markets, we have runway when we find the right opportunities to step forward, and hopefully that lets Houston, in the near term, drift or settle back to that 13, 12 type % within our portfolio.
Okay. Helpful. Thank you. I dialed into the call a bit late, so maybe you addressed this a little bit earlier. Brent, now that you've firmly taken the controls of the balance sheet, what are your observations, kind of stepping into the CFO role, and do you see the balance sheet structure differing at all going forward?
Yeah. Keith's looking at me like, "You took control of what?" No, much like Marshall said when he took over for David, me taking over for Keith, I very much just view it as putting hands on the steering wheel. We have a great accounting team. I have great support. No, our conservative balance sheet, keeping 65/35, 70/30 debt to market cap, being very judicious with issuing new equity. My primary goal is to try to do my first loan at just even one basis point lower than what Keith did, just so I can needle him with that. It'll be very similar. Our structure is very simple and straightforward, and we'll continue. My goal is just to continue to implement it.
I hope Marshall and the guys in the field are finding lots of great opportunities, so I hope we're making decisions about equity versus debt and those type things going forward.
Okay, great. A final question. You might have addressed this earlier as well. Are there any particular industries that are doing particularly well or you're seeing an increased leasing activity? Obviously, the term last mile may be a little bit overused, but certainly there's a little more, there's certainly good e-commerce demand. Have you seen any other particular industry or segments that are doing well and leasing well in your markets?
You mentioned e-commerce, so that, probably steady growing demand quarter after quarter. One we mentioned, we just signed a lease with Wayfair, for example, in Florida, and they've popped up on our radar as a growing e-commerce tenant that surfaced in other markets as well. That segment, which is maybe an easy one. Home building is another one that feels like it's picked up. Some more people related into the home building industry, and that probably fits our type size buildings. Those tenants have picked up a little bit. Thankfully, it's been very broad-based and a little bit of everything, so it's hard to pick any one sector. It feels like the home building industry is doing well these days, and that said, some of I'm thinking like a tenant that's expanded.
If you talk to Nick Jones, who runs Charlotte for us, a couple of examples of his comment was, "All of my leasing of late has been expansions." We've expanded Hearth & Home as a tenant, one tenant into another tenant space. What organically we like is seeing that much more expansion. Charlotte, that's really driven a lot of our leasing. Then in Tucson, we have a tenant, basically it's a garage door opener company that outgrew their building. One of our developments is a 300,000-foot building. For them, we were worried previously about getting their little over 150,000 sq ft back. An existing tenant grew and has taken 80% of that building when they vacate next spring.
It's one of those kind of a seamless transition that outside of EastGroup, people wouldn't notice, but we were concerned about getting 150,000-something sq ft back in a market that's not huge like Tucson, but it was nice to see a public company auto parts supplier take 80% of their space. When they're out, we're working on an existing tenant with an LOI moving the lease to take the balance of their space. We had a leasing call just recently, and we continue to hear more and more about expanding tenants really across a broad spectrum, which I like better than us taking a tenant from one of our other industrial REIT peers where it's a zero-sum game.
Okay. Helpful. Once again, Keith, congratulations on your really successful career, and best of luck with your, hopefully, lighter schedule.
Okay. Please come to Jackson.
I'll try. Thanks.
Thank you. We'll take our next question from Joshua Dennerlein with Bank of America.
Hey, good morning, guys. Just wanted to get back to Houston. One thing you said in the past is that I guess some of the lingering drag in Houston is from 3PL leases where the customer shut down a few years ago, but the 3PL lease with the landlord is only just expiring now. How much longer do you expect that overhang will last?
Well, it's hard to tell for us. Just internally within our portfolio, as I mentioned, we're excited that we only have 5% rollover for the remainder of this year and just a little over 5% for all of next year. We're looking at just around 10% rollover for the next 18 months. That just by default Insulate us from that activity. Within our own portfolio, that's mitigating. I think for the most part, within the Houston market, most of that has shuffled and played itself out as tenants have rolled and had the opportunity to resize. As I mentioned, these tenants aren't leaving, they're just readjusting. We've signed 30 leases in the first six months of this year. That equaled what we did all of last year, and we were excited about what we did last year.
I would like to think that things are getting incrementally better as opposed to going the other way.
Got it. Thank you. Why do you think there's less development in the shallow bay market versus big box? Is it just big box is sexier, or?
It's a good answer. Sexier, probably a little bit of it. It's always more fun to build bigger things than smaller. A lot of it is the dollars you can place. We're an institutional investor, but so many of our peers are larger than us, especially when you get to the pension funds, and they have dollars to place, and it's, call it, in our average building maybe $9 million to $10 million. It's minimum wage or manual labor for them to put the dollars out. They've got to keep pace and go. If you go buy a 600,000 foot or 700,000-foot building on the edge of town, you can place dollars so much more efficiently than putting it out.
I've described our development program as a subdivision, but a $10 million home after another, and we add one when the next one gets leased up, when the last one gets leased up. I think it's an inefficient way for them to place the size capital they have to invest. For the merchant developers, the absolute fees are bigger on a larger building than a smaller building. We're happy with the assets long term, but what we saw in Fort Worth, where a good market, a growing market long term, but where they built four buildings at once, where we would've built probably one to two buildings at a time. I'm thankful for it. It's just an interesting fact in our market.
Okay, thanks.
You're welcome.
We'll take our next question from Craig Mailman with KeyBanc Capital.
Thanks, guys. Marshall, just curious, a follow-up on the fact that shallow bay is less development than big box here. Just thinking the tenant profile is different than what you see in big box. I'm just curious, with more limited development, you think you'd be able to push rents even harder than you would in larger distribution facilities? I'm just curious if that's what you're seeing on the ground or if cost structures for the supply chain differ that much between the two tenant bases that it becomes harder.
A good question. Our rent spreads are up. One thing that's been nice this year, our leasing volume is higher through the first half of the year. Also our rent spreads are up. We were about 12% and 15%, I'm doing this from memory, 15% and 16%, We're 16% year-to-date. Our rent spreads are up, Really, I say there's less supply, but there's always competition, and there's usually always pretty good competition. When we're out with space, especially, you have a little more leverage on a renewal than you do a vacant new space, They always have options, We are pushing rents, We don't see a trend of it turning down. I always thought the best brokers really know what your competition is.
Here's the 2 or 3 spaces they're looking at, Here's the pros and cons of each of those spaces. I like that everyone is full for the most part, but there's always still seems to be every tenant has an option or two, The tenants are usually can be a little bit flexible in their racking or what size square footages they can use, things like that. Brent, anything?
Yeah, I have to say, there's still strong demand in the big box, It's not as though they don't have the power to push their rents as well. Part of that factors into it, You push a couple of big 500,000 sq ft leases on a rental rate. That'll move the needle quicker than, say, if we move a handful of small tenants' rental rates. The good news, we're both in a position to lever. Just following up on that in terms of small box, our peer group, the idea of building a 100,000 sq ft building and leasing it to four, five, or six tenants, it just doesn't move it fast enough.
Even from an institutional buyer standpoint or development standpoint, they don't like the intense rent rolls where you have maybe a portfolio where you've got 20, 30 tenants versus where you might have two or three tenants in large bulk buildings for the same amount of square footage. Sometimes, thankfully, they just shy away from that type administrative work.
Helpful. Marshall, you indicated that you're still seeing cap rate compression across almost all of your markets. Just curious where you're seeing the biggest moves lower, kind of which market you're seeing the lowest cap rate in across your portfolio as well.
Kind of the feedback we get, we talked to a couple of the different national brokers, their commentary was along the lines of, say, the top five markets, maybe I'll use Inland Empire in California, where it was already four or really a little bit below four. Those have pretty much stabilized, what we're hearing, industrial is a safe haven, certainly, we are enjoying that from the equity side. For institutional capital, they started under-allocated to industrial, now compared to retail or maybe some other sectors. We're seeing really those markets that maybe one through five have held steady. Maybe, markets five through 15 are really probably up, even into the low 30s, where it would be a San Antonio, a Charlotte, a Tampa, some of those markets where it's probably come down 25 basis points, is what the brokers are saying nationally.
Their transaction volume is pretty consistent with 2016, because people are underwriting higher rent growth, their comments were more total return expectations are about the same. Because everyone's seeing rent growth, are willing to probably more importantly underwrite more rent growth, it's pushed cap rates down maybe another 20-25 basis points this year. Really, you said kind of how do we think about it? It's a good time to continue selling assets where we can. It makes our development program all that more attractive and really pushes us more towards a value add type acquisition. If it's a building that's been built and vacant that we can step in and continue spending capital on, like we did in South Florida and Las Vegas and some others, that's probably where our strategy will take us.
That just to go head to head with an institution on a Class A project with credit tenants is just a tough fight, I'm not sure anybody wins that right now.
Great. Hey, Keith, congrats again. Enjoy, and thanks for all the help over the years.
Thank you very much, Craig.
We'll take our next question from Ki Bin Kim with SunTrust.
Thanks, and congrats, Keith and Brent.
Thanks.
Yeah. Just a broad question on Houston. Do you think we've reached a bottom in the north sub-market fundamentals? Maybe you could tie that in with any kind of commentary on what you're seeing in market rents in that market.
Yeah. It's hard to say it's hit a bottom when the vacancy rate for the market's stayed under six the entire time. For the north specifically, I would think so. Certainly, there is no and has been no spec development, that alone is allowing it to get more stable. In terms of rental rates, we've been very pleased and satisfied with rental rates. All in all, as you can see, our spreads have tightened some. I was just looking back, World Houston, for example, in the second quarter alone, we signed five leases, and those leases were signed at an average rental rate of $0.53 a foot. I've seen a lot of press about rates being well below that. I guess I would just say I'm glad those brokers aren't doing our leasing. They've held in there well.
When we leased our Central Green building, 80,000 sq ft, it had been vacant for a while. We were able to get a really good rental rate there, that's really what drove our positive this time. We had two prospects that got into a hotly contested desire to have the building, one of them ramped up and went through the leasing process very quickly, and signed the lease for it. Again, incrementally better. Not like a deflection straight up, we're feeling positive, feel good about the rates we achieved for the quarter. Again, the low rollover going forward, we're looking forward to that.
All right. A quick one on maybe what you're seeing in terms of any large, known tenant move-outs in the foreseeable future. I'm just looking at your top 10 tenant page. I know you guys don't show the expiration date there, if I look at your older ones, it seems like Mattress Firm or Essent, Iron Mountain, maybe a few of those that might be popping up in the next year. Any sense today on what's happening with those?
Good question. Nothing within our top 10 tenants, thankfully. Essent, we actually did a long-term renewal with last year, so they should be put to bed. Iron Mountain, again, knock on wood, we've had a good portfolio-wide retention rate with them. I know Conn's, they're a tenant we get questions about because they're a retailer, and they've got term left on their lease and are actually in the market looking for additional space for distribution in Charlotte. Thankfully, there. We've got a couple of move-outs in Houston, then the other move-out that we're working our way through. I would describe our 240,000 feet in Santa Barbara is, it's four buildings. Three of them are full, we had one tenant that had been there 20 years that grew and grew and really took the entire building at just over 50,000 feet, and they vacated during second quarter.
The tricky part in Santa Barbara, the good news is it's a high-rent market. The bad news is when it's vacant, it's an expensive vacancy, and it's more of a, as you'd expect for Santa Barbara, smaller tenant, R&D project. As you said, one of our challenges this year, right after Houston, is probably re-leasing that square footage in Santa Barbara. We have prospects, it's a thinner market, we'll work our way through it. If you said overall, where have our move-outs been? It's a couple more coming still in Houston, probably between now, or will between now and year-end, and we got hit with one, a tenant move-out in Santa Barbara that we're working to re-tenant.
Anything notable on Mattress Firm, or is that kind of steady?
They have term on the Houston lease. Yeah, there's nothing really there.
No, I know they were acquired by a South African firm. I may be off on that, but I believe. I think nothing that I'm aware of. They seem to be fine, and no news one way or the other. We get questions about retailers within our portfolio, and thankfully don't have that many. I know we've got Nordstrom is in Southern California, but they've been there 20 years in our Walnut project. Not that many retailers.
Okay. Thank you.
Sure. Thank you.
We'll take a follow-up from Eric Frankel with Green Street Advisors.
Yes. Just commenting on the acquisitions market, you think it's pretty, certainly competitive. We certainly see that as well. It's worth understanding, though, I think, obviously, your share price is up a pretty good bit over the last year or so. Have you thought about taking a plunge in terms of more acquisitions, just as a result of your cost of capital being a little bit lower? Maybe you can also talk about how acquisitions compare to development, and what do you think your competitors are underwriting in terms of development profit margins and what you're underwriting as well?
Okay. Our development yields this quarter, we're at 8%. We keep thinking it will come down, and it will trend down just because we've worked our way through most of our inexpensive land. We've put it into service, everything we're acquiring land-wise. Our development yields could come down, but we've been thankfully able to stay well above that, our 150 kind of basis points over what a fully valued, what we think we could exit it for to kind of justify the development risk. In terms of acquisitions, I know we mentally try to decouple. It's almost like on or off. Maybe when we were in the early 50s or low 50s a little over a year ago, thankfully, on the stock price, we weren't very active or looking for acquisitions.
As our stock price moved up and our cost of capital came down, we started looking more and more for acquisitions, and were active in that market at the end of last year and have been this year. Try to decouple those as much mentally. If we don't like it, I don't think we should buy something just because we have capital. I'd rather you not be grilling us. Thankfully, Keith will retire, but you'll be grilling Brent and I about it two years from now if we buy it simply because we have the capital. Try to mentally decouple it. We are active and looking, and it's kind of one of those, you know it when you see it, probably in an Atlanta or in Southern California or Northern.
It probably steers us more towards value add again, because if there's nothing wrong with it, people are willing to pay such great prices for it. I also like the fact that we're a long-term holder. It helps us kind of underwrite and look further down the road. I think our, I won't say our peers within the REIT so much, but again, what we were hearing is people are willing to underwrite more rent growth, and so that's what's driving the compression in cap rates and the under-allocation. Probably if you can't get into Dallas, Chicago, Southern California, Northern New Jersey, then Tampa, Phoenix, Orlando, any number of our other markets just get that much more attractive. It probably helps from an NAV perspective or where we're looking at it.
The acquisitions won't be our primary path to growth and probably shouldn't be right now, unless it's buying vacancy where we can take on some risk that others are uncomfortable with.
Okay. Just to comment, obviously, your development yields are, obviously, on legacy land, certainly good. If you had to buy land at a pseudo market value today, do you think cap rate, what do you think your spread would be relative to prevailing cap rates on stabilized assets?
A couple that we're looking, like Austin, when we're not finished there, but we'll probably be mid-7s in Austin, and probably if we sold them, mid 5.5%-5.75%. I'm estimating a brand-new product in Austin and Atlanta. It's an allocation with the building, but we'll be at a high 7%, different when we finish it, and that's probably a easy 5.5. Brand-new building along I-85 in Atlanta would be a low 5 cap rate. The spreads are hanging in there. We're looking at something else that's about a 7.5 that's going to investment committee this week elsewhere in the country, and probably, again, easy 150 basis point spread.
That, Eric, will vary by market. When we get active with our Dade County development project where we bought the land last quarter, that spread will be tighter. Again, that's different market dynamics and has different long-term growth. Certainly, if Ryan earned something in California from a development standpoint, again, that spread would look different just because of the market dynamics. It's not a one-size-fits-all necessarily, but for most of our markets, it's along the lines of what Marshall described.
Okay. Thanks for the color.
Sure.
It appears we have no further questions. I will return the floor to Marshall Loeb for closing comments.
Thank you, everyone, for your time this morning. Appreciate your interest in EastGroup, and I will join the chorus of wishing Keith well on the golf course. Thanks, everyone.
This will conclude today's program. Thanks for your participation. You may now disconnect.