The 2018 Citi Global Property CEO Conference

Mar 7, 2018

Welcome to the 8:50 A.M. session at day three of Citi 2018 Global Property CEO Conference. This session's for investing clients only, if media or other individuals are online, please disconnect now. Disclosures are available here and on the webcast on the Disclosures tab. For those in the room or the webcast, you can sign on to veracast.com/ask, enter code CITI18 to submit any questions. Given the storm in the Northeast, we made some changes to the schedule, as you all know. We have the very special privilege here of hosting 3 companies at once. I'm going to turn it over to each of them. We'll start with Marshall Loeb from EastGroup. Maybe each of you can give 3 reasons why investors should buy your stock today. If the reasons line up, maybe that's a triple reason why people should buy them. Marshall, we'll start with you, and then we'll work to my left. I'll take it today and even longer term. Thanks, Manny, for the introduction. EastGroup, we're a shallow bay industrial, shallow bay meaning a little bit shallower, obviously, depths of our buildings, Sun Belt developer. Our properties run from California, Arizona, Texas, Florida, up through the Carolinas. What I like, the 3 reasons I would say buy our stock, I think we are biased, but we think we have the best properties. We have infill sites in fast-growing Sun Belt cities. Of the 10 fastest-growing cities last year, we were in 8 of them. We build infill, meaning kind of that last mile is where we would fit in. Last mile can mean e-commerce or many things. Really like our team. We made some moves on our team, opened new offices last year. Besides the properties, you have to have the people. We have a very strong balance sheet. That's one of the things we've always had. It's important to us. We actually de-levered the company last year. If you look at debt to market cap, fixed charges, depending on whichever metric, debt to EBITDA, we stack up well. Maybe using kind of Manny's opening comments of where do you take those and why today, we're in one of the older REITs here at Citi, and I would say pick your time period. If you want to look at our track record, 1 year, 3 year, 5 year, 10 year, 15 year, or 20 year time period. I'll let you pick the time period, but our lowest average annual return over that time was 12.5%. We like our strategy. It's worked through different economic cycles, and we're proud of our return over a long period of time. It's market-tested. Good. Thanks, Marshall. Bill Crooker, CFO of STAG Industrial. STAG is owner and operator of single-tenant industrial properties across the U.S. We operate in 60+ markets. We have 350 properties. Our strategy really is to identify and acquire single-tenant properties, and by doing that, our vertical integration stops at asset management because in those situations, the tenant is generally the property manager. When an asset does go vacant, we're able to hire the best-in-class property manager in that market. That strategy has worked well since our IPO in 2011. Three reasons to buy our stock, like these two gentlemen up here, industrial fundamentals are just really strong right now. Demand on our markets is as strong as we've ever seen it. Because of that, we're able to sign longer-term leases with contractual rent bumps between 2.5% and 3%. Supply in our markets has been really limited. I think, this part of the cycle, typically, you see more supply coming online, and we're just not seeing that, and maybe that's because the merchant developer, there's not as many of those around as there was before, and some of the lending restrictions as well. There's a persisting opportunity, really second reason, there's persisting opportunity, investment opportunity for STAG. Because of our 3,000+ broker network, we're able to continually identify and acquire relative value acquisitions across the U.S. The ownership of industrial real estate is highly fragmented. The top 20 industrial owners, including the three of us, as well as the private owners, only own 15% of the stock. Because of that highly fragmented ownership, there's uncorrelated reasons to why assets are coming to market, and therefore, an opportunity for us to acquire assets. We generally acquire between 10% and 12% of the assets we underwrite. A very low hit rate in terms of acquisitions, and that's because we're very disciplined and selective on pricing. From the last point of why we're an attractive opportunity for investors today is really just the valuation. Our valuation as compared to our peers is, from a multiple standpoint, significantly lower. I feel like that's unwarranted, given the strength of our portfolio and the stability of our cash flows. Our cash flows are as stable as our peers', and we've demonstrated that over the life cycle of our company. Those are the three reasons. Pass it over. Sure. Good morning, everyone. I'm Peter Baccile, President and Chief Executive Officer. This is my second time here at the Citi conference, thank you, Manny, to you and your colleagues for the opportunity to participate. First Industrial's a U.S.-only focused REIT operating in the nation's top markets. We own primarily bulk and regional distribution facilities. Our largest market is Southern California, where we generate approximately 15% of our rental income, and we expect that number to go up as we complete our current development pipeline through this year. Our total capitalization is about $5 billion. The reasons that we think you should buy our stock. As we reported in our investor day back in November, we have the opportunity to grow cash flow at a 9% per annum rate through 2020. This cash flow growth is based only on internal drivers, so lower CapEx, developments in process, and interest savings, as well as rent bumps. 97% of our leases longer than 12 months have an average annual rent increase of 2.74%. This cash flow growth doesn't factor in any rental rate growth, but certainly, the current environment continues to support strong rental rate growth. As of our February earnings call, we had signed 65% of our 2018 rollovers at an average cash rental rate change of 5.9%. This brings me to the second reason we think you should own our stock. Our ability to create value through development while enhancing our portfolio and earning outsized margins. We currently have a pipeline of $322 million of completed or in-process developments comprising 4.8 million sq ft. This development pipeline has a targeted first-year yield of 7.3%. More than half of that sq ft is in Southern California. We think the weighted average cap rate for the assets that we're currently building would be approximately 4.5%. That implies a profit margin on those developments of nearly 60%, value creation of $190 million. That's roughly a buck and a half a share. Obviously, we need to continue our track record of leasing those developments on a timely basis. Lastly, we've undergone a significant transformation in the portfolio over the past several years, reinvesting $2.5 billion and turning over approximately 70% of the assets of the company. We think that our portfolio is underappreciated at the current trading level. Our portfolio metrics are comparable to those of our peers. For 2017, we ended the year at 97.3% occupancy, generated 4.4% NOI growth. Our rental rate growth of 8.6% on a cash basis and 20.8% on a straight line basis. Our implied cap rate's about 5.9%, while some of our peers are in the low fives and high fours. We think that that gap is unwarranted. Great. Maybe we can switch to sort of the tenant approach to leasing space. Given how good things are, both from limited supply and good demand, how much do you think you can push rents before tenants push back too hard? Maybe Marshall, we'll start with you again. Sure. Our portfolio is similar, listening to STAG. We ended the year, and we're about there today, roughly 97% leased and about 96% occupied. It's too big of a group to share, but we have a quarterly chart going back. We've been 95% occupied for about 13 or 14 quarters, which for our type property, that's full. We typically will look at straight line or GAAP rents because that captures the rent bumps that my peers mentioned, as well as any free rent, which in some markets, depending on where you are in the cycle, the tenants get a free rent. Last year, we averaged about a 17% GAAP increase, 12%, 16%, 15%. I don't sense that changing. In fact, you could argue it will go higher with land costs rising and construction costs rising over the last year. We're full. As you've heard, most of our peers are full. We continue to see. Our mix could change a little bit this year. Certainly, the West Coast, we're pushing rents harder than we are in some other markets. In Florida, we were up. We've got 11 million sq ft, which is a large portion of our portfolio. It was up 20% last year there. I would think rents should be in the mid-teens again this year, as best as our crystal ball, at least in terms of as we're rolling tenants. Usually it's not. When you think of our tenants, the other things we're seeing are a lot more expansions, which to me is the best type of growth we can see. We're not pulling a tenant out of a STAG building and losing one to a First Industrial building. We've seen, in Charlotte alone, 11 expansions in the last year. It's a strong market, and that's almost an under the radar. In Tucson, we're building a building for a tenant. Again, smaller market, but we've backfilled. We called it the trifecta, both of those tenant spaces. I'm happy to see the expansion. When you get into that, our rents, industrial rents, aren't that high for our tenants. A lot of times what we like about being infill, we can maybe push our rents a little bit harder. We should be able to because your option is maybe go to the edge of town and your rents, the land cost is going to be less. You'll pay less in rent, your trucking cost is going to be higher. You're still driving trucks back into the teeth of traffic in Dallas or Atlanta or Tampa. Yeah. Pushing rents is an interesting concept because as a landlord, the worst thing you can have is really a vacant property. On average, our rents are $4 per sq ft. Our vacancy costs are about $1.50. It's an interesting dynamic between the tenant and landlord on what situation you can really push rents. With that being said, we're in a strong part of the cycle. We had four opportunities last year where tenants were willing to renew their leases. They weren't willing to roll all the way up to market. In our experience, tenants are Generally anchored somewhat to what their existing rent is. Their perception of market rent is maybe a little different than landlord. They weren't willing to roll all the way up to market. We had backup tenants in the queue. In those four instances, we allowed the tenants to roll out, and we backfilled the space within a month, and rolling up, on average, across those four spaces, 15.5% on a cash basis. In certain situations, we certainly will drive our rents and push rents. Sorry to interrupt you, where would it have been, to retain the tenants? How much was the tenant sort of thinking, upon renewal- It was- Before the new tenant came in, if you had to do the same math. Yeah, it was around high single digits. They were certainly below market. That was because those particular leases had lower contractual rent bumps and weren't growing as fast as market rents were growing. For us, that difference was significant enough to absorb the one-month downtime in those situations. It did hit our headline retention number. Our headline retention number in 2017 was 59%, but when you factor in those situations, it was around 73%, which is on par with our historical average. Pushing rents. In certain situations when you don't have those backup tenants, we'll sign a lease that if it was below market, may be still slightly below market, because we want to retain the tenant. It really is a building-by-building basis, and because we operate in so many different markets, it really is sub-market, and building specific. On the leasing standpoint, as these guys have said as well, just the contractual rent bumps have been great the past few years. We're signing 2.5, as I said previously, 2.5%-3% on average contractual rent bumps, when historically, those rent bumps were 1%-2%. We look at it on a market-by-market basis and an asset-by-asset basis with the overall objective just to maximize the NPV of the lease. Certainly, because it's such a strong landlord's market, we're pushing rents hard. We're also very focused on term. We're a little bit late in the business cycle, the more term we can get, we think the better. We'll have tenants in California where we bought a building recently. We knew the tenant wasn't going to pay the rent that we wanted, and we let them leave, and we raised the rent 30%. It does cost 4-5 times more to bring in a new tenant than to renew an existing tenant, we certainly keep that in mind. We're looking at all the inputs into the lease equation, driving hard in a landlord's market, like I said, on rents and term. If a tenant doesn't see the market the way we see the market, we're also not afraid to let them go. Peter, in your opening remarks, you mentioned 60% margins on developments, which are certainly above peers. What allows you to hit those types of margins, when the guys sitting next to you are a bit lower? It falls into two broad categories. One is that the sites that we're buying, we're putting to work really quickly, number one. Number two, those sites are generally off-market deals, where our team in the regions has been hanging around the hoop, bothering people to sell property until they finally cry uncle and sell the property. Our current project, Nandina in California, we assembled 13 different parcels from 12 different owners. Took about nine months, and we're into that for about $5.65 a land foot. Competitors are buying land nearby at over $17 a foot. Right off the bat, we start out with a lower basis because of the way we're acquiring land. We also bring these properties to development and then lease them up well within our 12-month downtime assumption. Thus far, we've been able to deliver assets quick. We bought an asset in New Jersey. We closed on the land in April, the tenant was in the building in December. When you can move that quickly, obviously carry costs are lower, and we can generate pretty solid margins. Marshall, can you hit 60% development margins on your new developments? Yes, my short answer, really, I guess it's helpful. I guess I'm glad we did the panel in some ways. I know the weather shifted. We kind of have our metrics, and it was listening to Peter, I was actually running through our own math in my head, just trying to see how we're doing. If you take our last quarter, end of the year, we had $185 million. Again, a little bit smaller buildings, we'll build a park. Our projected return, we'll assume a year of lease-up afterwards. It's usually about six months for us to build a building, and we'll assume one year of lease-up. Hopefully, it goes faster than that, sometimes longer. The average return on what's either under construction or in lease-up was 8%. If you said, all right, when we finish those buildings, and we look at it as really, to me, as we finish each building, here's another $0.10 of NAV, another $0.10, another $0.10. Probably the market cap rate's about 5% for what we've got under construction. That's kind of running through the math. I promise I was listening, Peter Baccile, but I was also running the math. That's about a 60% return on our development pipeline. Bill Crooker was wondering where you can get $5 a foot land. Bill Crooker, you guys traditionally have not developed, preferring sort of the acquisition market. That's right. Does that stay that way going forward? That is our stance going forward. By the time it takes to develop a building, we can buy 10 to 15 buildings, so we dedicate our resources in that direction. With that being said, we've got a fully built-out capital team that we've done a handful of expansions last year for our tenants. When we acquire an asset, excess land on the parcel is important to us because the number one reason why a tenant leaves our building is because the building's too small. Generally, it's not because the building's too big. They just won't rack all the way up to the ceiling. The excess land and expanding buildings is certainly a part of our strategy, but not spec development like these two gentlemen. Questions in the room? Talk about expansions to new markets. Marshall, you mentioned a couple new ones over the last couple of years. What gives you comfort on the new markets you're going into? A couple of them. I think I'm guessing the same two you are, Manny. We have a site we're excited about just south of here in Miami. We bought, it's right on the Turnpike in County Line Road, if you're familiar with South Florida. Churchill Downs has a horse track and a casino there. We bought the hard corner, 61 acres, which was the stables. There along the Turnpike. What we like about it, at least in terms of a new market, we've been in Broward County for 20 years. Literally, we're across the street from Broward County. It is a new market, then we're in Dade County. We love the site, the visibility, the access, the development opportunity there. In studying that site, specifically, the operating costs are about $0.50 per square foot lower in Dade County than they are in Broward County. Our prospect pool is Dade County, it's also that there's a couple of nicer parks just to the west of us in Broward County. Our daydream, we're about to start construction on our first building there. It'll be a five-building park, ultimately a little over 800,000 sq ft. We're excited about entering Dade County. The other market we entered about a year ago, we just completed our third acquisition there, was Atlanta. We're based in Jackson, Mississippi, if my accent hasn't given me away by now. It's a little bit in our backyard. We're constantly in and out through Hartsfield International, we knew Atlanta just intuitively. John Coleman, who heads our eastern region, kind of Charlotte to Miami, had spent 14 years with an industrial developer in Atlanta. He is relocating. He'll keep a home in Florida. More details than you all want to know, but John will have a place, a residential house in Atlanta as well. We like that market, and really what probably swayed me, because we had always heard, Atlanta's so spread out, rents never go up, never rise in Atlanta. Kind of two anecdotal stories, and I won't use all of their time, but Atlanta, I was having lunch with one of the CBRE national partners broker. He said, "When I first started work, it was two million people. Now it's six million people." When we went from broker's office to broker's office saying, "Where's there a 30 or 40-acre site for us to build a park?" You're in their office, they've got Google Earth on a map, and they were struggling to find us a site. We were basically to Athens, Georgia, before they could find a site, and you go realize, okay, these markets really have become infill markets. When I had Southern California for EastGroup, I avoided the Inland Empire because I thought there was land to Arizona. 20 years later, it's become an infill market, and I would compare that to Atlanta now. From a market perspective, we're somewhat agnostic to markets. As I said earlier, we operate in 60-plus markets. We will operate in Charlotte as one of our larger markets. We love that market. You mentioned population growth in Atlanta, and Charlotte has been growing by 250 people per day. That's a great market for us. We have penetrated the West Coast a little bit recently. Last year, we acquired our first building in San Diego, and that was an opportunity that we likely would not have been able to acquire had we not transacted with an OP unit transaction. The seller there really wanted to defer their taxes, and we provide an opportunity for them to do that. We try to be thoughtful and creative when trying to enter new markets and achieve the same risk-adjusted long-term returns. New markets. I wouldn't call them necessarily new markets, we have invested in resources to double down in a couple of places. We hired a senior market leader for San Francisco and Seattle mid last year, and we're really encouraged by the activity that he's drumming up. We also moved one of our most senior 20-year veterans from Minneapolis, where we thought his skill set was being underutilized, down here to South Florida. He moved down here later last year. Again, we're excited about the opportunities. Generally speaking, we're proportionately going to invest the bulk of our capital along the coastal markets. We'll continue to invest in markets like Denver and Phoenix and Dallas and Houston as well, and Chicago and Atlanta. You mentioned staffing within the markets. How important is it to have someone on the ground in each of these, especially larger markets you operate in? Just each of you quickly run through that. I think it's incredibly important. It's extremely competitive. If you don't have relationships in the market, both with the principals and the brokerage community, it's going to be very difficult to compete. There's no substitute for time in. You have to have people that have been in those markets for a long Moving someone, now, we moved our guy from Minneapolis to South Florida, but we've also had an effort down here to begin with. He was plug and play and brought a skill set here that we didn't have. We think you have to have people on the ground. Our properties are single tenant, as I mentioned, and they're generally managed by the tenant themselves. From a property management perspective, we don't view that as necessary. With that being said, our acquisition folks are just road warriors. All based in the corporate office, but they're in the markets all the time. Our broker network is 3,000-plus brokers, and that continues to expand as we continue to grow. In a lot of the markets we operate in and invest in, we're the biggest player there. The brokers know us, and it really comes down to relationships with the brokers. We see, I would say, 90% of the deals in the markets we operate in. I'm sure there's a select number of deals that we may miss out on. For us, the return perspective of not having boots on the ground is worth it and having everybody in one office. We view it, to me, I think it's very important. We have three regions within EastGroup, and last year we split people in, is the really the way it worked out, in each of our regions. We think it's very important for our type product to have people on the ground. I guess maybe on a personal note, this goes back years, I was in our corporate office as we grew out west. I moved to open our Phoenix office, having the Western Region, and it really struck me, again, speaking just for myself, what a night and day difference. When you're living in Phoenix and you're watching the news and you're reading the newspaper and you're meeting the brokers for lunch or grabbing a beer after work or just the ease for me to get to L.A. and the Bay Area and other markets versus missing connecting flights and trying to get home for dinner. It was a night and day difference and really reinforced to me, for what we do, it's important to have those boots on the ground. Can we switch to funding for a second? Maybe, Bill, we'll start with you as the CFO on the panel. How do you think about your funding plan going forward? Our equity pricing right now isn't where we want it to be. We're obviously more external growth focused than maybe the guys up here. We've laid out a disposition plan that's greater than what we have done in the past. Right now, our dispositions are projected to be between $100 million and $200 million in 2018, which is the highest we've done, and that really is more of the opportunistic dispositions. Unidentified assets that we are anticipating we'll be able to sell for values of those assets to where they're worth more, in the context of our portfolio, to somebody else than to us. We executed one of those dispositions already in Q1. We sold an asset in the Charlotte area. It was a long-term lease. We bought the asset for a 9.2 cap rate. We renewed the tenant for long-term lease. A little bit of a shaky credit. We thought the asset was a little bit big for the market, but with all that being said, we were getting paid with a 9.2 going in cap rate, and we just transacted at 6.2. We created 300 basis points of value through our asset management function. Those are going to be opportunities that we see in 2018 as part of our funding source. In addition, our balance sheet is at one of the strongest levels it's ever been. We're at 4.9 debt to EBITDA at year-end, with a leverage target band of five to six times debt to EBITDA. We've got plenty of runway there. Medium term, we'll either use common equity if our equity is priced appropriately, or we'll start to recycle portfolios similar to what we did in 2016. We sold a portfolio of six assets. We acquired those assets for a 9.2. We sold the portfolio for a 6.9. There was some market cap rate compression there. We were buying assets contemporaneously, very similar, same market for an 8.4. Truly 150 basis points of cap rate compression on that portfolio sale in 2016. The recycling of assets via portfolios will be part of our capital plan if our equity price stays where it is. After we sold the portfolio, we actually sold it to Pure Industrial. As many in the room know, they were acquired for a 4.8, so they created a lot of value on that 6.9 acquisition as well. Marshall? Sure. A couple of those on ours. Our target is $50 million of dispositions. To us, we view it as just we should always be pruning our portfolio. We've sold a couple of assets. Another one's scheduled, knock on wood, to close this month, an older service center project. Last year when we were here, we would've told you our target equity, we were targeting $40 million in equity issuance. We issued ultimately $111 million. Maybe the two takeaways from that are we're not very good at projections. Two, as our stock price moved up, we were opportunistic. Citi had put out a piece, the market shifted early in the year of REITs and their premium to NAV, and this was across the REIT space, and it was interesting to us. We were number four, that's part of what drove that equity issuance. We see the uses in our development pipeline, we issued equity. We've moved down from call it mid-90s to we're about 81, 82 today, which is a little above consensus NAV. We're probably not the number four premium to NAV unfortunately anymore with the rise in interest rates. We like our stock price okay today. We liked it better in the 90s. We're working on a renewing our line of credit. We've got a bank group meeting next month. They pull over a year in advance. We have one debt maturity, so our balance sheet's in great shape. You would probably see us issue equity just opportunistically. Our development starts are up. Our target's 20% higher this year, I hope, knock on wood, if this environment lasts, I hope we're conservative on that. I'll just go very quickly. We've guided to $100 million-$150 million in sales, midpoint $125 million. Our debt is at an all-time low for the company at 4.9 times. We were recently upgraded by S&P to BBB flat. We certainly intend to maintain a strong balance sheet, we do have some debt capacity there, we have some retained cash flow, we expect to retain cash flow in 2018. We have several hundred million dollars of capacity right now without issuing equity. As you've seen us in the past, we have been very opportunistic in issuing equity, we'll continue to do that. I'm going to give you each 30 seconds to answer a question. Sorry, wrong question. What is the single most important thing investors get wrong about your company? Marshall, we'll go to you. What gets under my skin, I'll say. I'll give them 30 seconds. Sometimes you may see one of Manny and Jill Spear's describe EastGroup as slow growth, and what they're looking at is annual same-store NOI. We have a different pool annually and each quarter. To me, it's capturing a fraction of the manufacturing floor as a developer, and we think G&A matters. We're earning 60%, as I just calculated today, on our development pipeline. We like FFO. If you take our FFO versus our peers, it's above our peers' growth. If you take adjusted FFOs, some people say, "Well, everybody's got this and that," and we've run it on an adjusted basis, and I can give you a sheet after this, it's still above our peers. Slow growth gets under my skin. Ours is really asset quality. We have a little over 40% of our assets in primary markets, which is markets greater than 200 million sq ft as defined by CBRE. Another 50% of our assets, 52% of our assets are in secondary markets. The perception that we own in secondary markets is a knock on our asset quality. It's just not true. We have underwritten 360 assets last year. We closed on 11.5% of those. We're very selective and disciplined on what assets we acquire and what markets we acquire in. That obviously gets under my skin. Additionally, there's a perception that we can't lease these assets once they go vacant. We've leased over 33 million sq ft since our IPO, 11 million sq ft last year, with healthy rollover rents. As I said earlier, our contractual rent bumps we're signing at 2.5%-3%. We're signing longer-term leases in our markets, tenant confidence is up. These are fungible and functional real estate assets that we own. Just because they're in secondary markets, it doesn't mean they're secondary demand. We own markets in Columbus, Ohio. There's population in Columbus, Ohio. Goods need to get to consumers in Columbus, Ohio. There's e-commerce that happens there. It really is perception of our asset quality. Peter, what gets under your skin? Ticks. Look, we have a pretty straightforward story. Clearly we don't think that our stock price reflects the transformation that we've undertaken in the portfolio over the last six or seven years. Again, turning over 70% of the assets. Approximately 40% of our rental income comes from coastal markets. Again, a big change for us that we don't think is reflected in our share price. I talked about development margins earlier for 2018, 60%. Well, that's not a new thing. In 2015, our development margins were 44%, in 2016 they were 51%, and pro forma 2017, 50%. It's something that we've done for a long time, and that generates tremendous shareholder value and cash flow growth. Perfect. We've got our rapid-fire survey that we're going to really try to rapidly fire through. Do you expect public to public or public to private M&A in the industrial sector in 2018? The demand for high-end quality industrial remains very high, and it's impossible to create new platforms, so I'm going to say public to private. I agree with that. Sure. I'll- Sure. I'll go with the investment banker. We've got consensus, folks. What will same-store NOI growth be for the industrial sector overall in 2019? ±4%. I think a little over 3%. Three to four. Where will the 10-year Treasury yield be one year from today? Three to three and a quarter. I was going to say three and a quarter. Three and a quarter. Wow. Look at us. Thank you, guys. Thank you.