Good morning. My name is Krista, and I will be your conference operator today. At this time, I would like to welcome everyone to the First Industrial second quarter results call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during that time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Mr. Art Harmon, Vice President of Investor Relations, you may begin.
Thanks, Krista. Hello, everybody, welcome to our call. Before we discuss our second quarter 2017 results, let me remind everyone that our call may include forward-looking statements as defined by federal securities laws. These statements are based on management's expectations, plans, and estimates of our prospects. Today's statements may be time sensitive and accurate only as of today's date, Thursday, July 27th, 2017. We assume no obligation to update our statements or the other information we provide. Actual results may differ materially from our forward-looking statements, and factors which could cause this are described in our 10-K and other SEC filings. You can find a reconciliation of non-GAAP financial measures discussed in today's call in our supplemental report and our earnings release. The supplemental report, earnings release, and our SEC filings are available at firstindustrial.com under the Investors tab.
Our call will begin with remarks by Peter Baccile, our President and CEO, and Scott Musil, our CFO. After which, we'll open it up for your questions. Also on the call today are Johannson Yap, our Chief Investment Officer, Peter Schultz, Executive Vice President, Chris Schneider, Senior Vice President of Operations, and Robert Walter, Senior Vice President of Capital Markets and Asset Management. Let me turn the call over to Peter.
Thanks, Art, thank you all for joining us today. Our team delivered another excellent quarter throughout our business. At June 30th, occupancy was 95.7%, cash same store NOI growth for the quarter was 4.2%, and cash rental rate change was 9.2% on new and renewal leasing. Our results continue to reflect the strength of the industrial real estate marketplace and the strong operational focus of our people and platform. Our team continues to see demand for space across all of our markets with new requirements driven by growth in the economy, e-commerce expansion, and supply chain optimization. A great example that illustrates many of these themes is our lease involving UPS at First Park at PV 303 in Phoenix.
Recall that we were successful in leasing the full 618,000 sq ft building as well as a 66 acre parcel that we purchased in a separate transaction for $11.6 million. Our total investment for the building and the leased land was $45.4 million, with a GAAP yield of 7.2%. When we talk about GAAP yield, we're referring to our first-year cash NOI divided by our GAAP investment basis. We remind you that UPS has a purchase option 39 months into the lease. We were willing to provide the option because of the additional value creation opportunities we now have at that park. In a separate transaction, we acquired an additional 97 acre development parcel for $14.7 million, along with an option to acquire another 75 acres in the park.
From a strategic standpoint, the proximity to UPS will be a benefit for future tenants, especially e-commerce related users. We are well-positioned to meet their needs. Moving now to the topic of new supply. While new deliveries are rising, overall, development remains disciplined. As we and others have noted before, we generally expect the overall market to be at equilibrium for 2017. That's been the case for the first half. It's important to note that individual markets are at different points in the cycle. Right now, there are some sub-markets that have inventory to work through, along with pockets where buildings in certain size ranges are too plentiful. We will continue to be disciplined when deploying capital. Regarding investments, we were successful in acquiring 4 high-quality buildings in the second quarter, 2 of which were in Southern California, our largest market.
We added a 123,000 sq ft property in San Diego for $21.5 million at a 5% going-in yield. We also acquired a 106,000 sq ft building in the Inland Empire West for $12.5 million with a projected stabilized yield of 5.4%. We believe the leases at both of these Southern California buildings are substantially below market. Our other 2 acquisitions were a 103,000 sq ft in Orlando for $8 million with a 6.1% yield. As discussed on our last earnings call, a 181,000 sq ft building in the I-70 East submarket of Denver for $11.2 million with a 5.9% yield on our total investment.
On the development front, we recently completed our First Park 94 Building II in Chicago, which is 50% leased. We also wrapped up construction of our First Sycamore 215 project in the Inland Empire East. Our 6th building project, The Ranch, in the Inland Empire West submarket of Chino, is on schedule for completion by year-end. At the end of the second quarter, our completed and in-process speculative developments totaled $136 million, comprising 1.8 million sq ft, with a targeted weighted average GAAP yield of 7%. As of June 30th, these projects were 17% leased. Given these recent investments and what we see in our investment pipeline, we thought it prudent to raise $75 million of equity via an underwritten offering in June. Sales continue to be a critical part of our portfolio management efforts. A significant source of capital for reinvestment.
In the second quarter, we sold eight buildings totaling 717,000 square feet for $38.6 million. The largest sale was of a vacant 222,000 square foot distribution facility in Minneapolis to a user. These sales were at a weighted average in-place cap rate of 4.7% and a stabilized cap rate of 6.6%. Third quarter to date, we have sold three buildings for $18.3 million, totaling 389,000 square feet. These buildings were located in Detroit, Atlanta, and Phoenix and were 100% occupied at sale. Year to date, we've completed $77.4 million of sales on our way to our goal of $150 million-$200 million for the year. With more than half of 2017 in the books, we're pleased with the activity we are seeing and the strong market occupancy that is enabling us to drive rent growth. Let me turn it over to Scott for some additional details on the quarter.
Scott?
Thanks, Peter. Let me start with the overall results for the quarter. EPS was $0.32 versus $0.43 one year ago. Funds from operations were $0.38 per fully diluted share, compared to $0.36 per share in 2Q 2016. FFO before the $0.01 per share tax impact related to a property sale from our taxable REIT subsidiary was $0.39 per share. As Peter noted, we finished the quarter with occupancy at 95.7%, down 10 basis points from the prior quarter and a year ago. Sales helped occupancy by 30 basis points compared to 1Q 2017. Regarding leasing volume, we commenced approximately 3.1 million square feet of long-term leases. Of these, 732,000 square feet were new, 1.5 million were renewals, and 920,000 square feet were developments. Tenant retention by square footage was 79.5%.
Same-store NOI growth on a cash basis, excluding termination fees, was 4.2%, primarily reflecting in-place rental rate bumps, rental rate growth on leasing, and a decrease in free rent. This was slightly offset by lower average occupancy. Lease termination fees totaled $178,000. Including termination fees, cash same-store NOI growth was 4.3%. Cash rental rates were up 9.2% overall, with renewals up 9.5% and new leasing up 8.6%. On a GAAP basis, overall rental rates were up 19.7%, with renewals increasing 19% and new leasing up 21.2%. Moving now to the capital side. As Peter noted, in June we issued 2.56 million common shares to raise approximately $75 million in an underwritten equity offering to support our investment activity. On the debt side, as a reminder, on April 20th, we closed on our $200 million private placement of fixed-rate unsecured notes with a weighted average interest rate of 4.34%.
As planned, we paid off a $102 million 5.95% note maturity in mid-May and have another $55 million 7.5% note maturity to pay off in early December. Recapping our balance sheet metrics. At the end of 2Q, our net debt plus preferred stock to adjusted EBITDA is 5.2 times. At June 30th, the weighted average maturity of our unsecured notes, term loans, and secured financings was five years, with a weighted average interest rate of 4.83%. These figures exclude our credit facility. Our credit line balance today is $162 million, and our cash position is approximately $22 million. Moving on to our updated guidance per our press release last evening. We narrowed our NAREIT FFO guidance range to $1.49 per share-$1.57 per share, with the midpoint remaining the same as our first quarter call.
Before the loss related to the early prepayment of secured debt and the tax expense related to a property sale from our taxable REIT subsidiary, our FFO guidance range is $1.51 to $1.59 per share, which is a penny per share increase at the midpoint. This increase is primarily due to the lease to UPS at our PV 303 development in Phoenix and lower bad debt expense. This was partially offset by sales dilution, net of the impact of acquisitions, and short-term debt dilution from the equity offering. The key assumptions for guidance are as follows: average in-service occupancy of 95.5%-96.5% based on quarter-end results. Our new cash same-store NOI growth range is now 3.5%-5%, which is a 25-basis point increase at the midpoint, reflecting our second quarter performance. Our G&A guidance range is $26 million-$27 million.
Note that guidance includes the anticipated 2017 costs related to our completed and under-construction developments at June 30th. In total, for the full year of 2017, we expect to capitalize about $0.03 per share of interest related to our developments. Our guidance does not reflect the impact of any future sales after this earnings call, nor any acquisitions or developments other than those previously discussed, the impact of any future debt issuances, debt repurchases, or repayments other than those previously discussed. Guidance also excludes any future NAREIT-compliant gains or losses, the impact of impairments, and the potential issuance of equity. With that, let me turn it back over to Peter.
Thanks, Scott. Our focus remains on executing our plan to drive long-term cash flow and create value through our platform via development and select acquisitions, while continually refining our portfolio and maximizing value in our disposition efforts. The results of these efforts are reflected in our strong operating metrics and the evolution of our portfolio. Lastly, as we did in the fall of 2015, we will be hosting an investor day in New York on November 8th. We ask you to save the date. Further information will be forthcoming later this summer, and we hope many of you will make plans to join us. Thank you. Now, operator, please open it up for questions.
If you would like to ask a question, please press star and the number one on your telephone keypad. Your first question comes from the line of Craig Mailman from KeyBanc Capital Markets. Please go ahead. Your line is open.
Good morning, guys. Scott, on the same-store NOI increase, could you give us a sense of how much of that was maybe related to bad debt? Also, the low end's been coming up a bit. What could happen between now and year-end that could get you above the 5% of the high end of the range?
Craig, this is Chris speaking now. Actually on the same store, the benefit on the bad debt from the first quarter was about 20 basis points that we picked up. If you look at the back end of the year as far as where we could pick up some additional, you look at kind of the second half of the year, we're looking at a same-store increase of about 3.4%. Kind of the construct of that is that 2% is from the bumps, about 1.5% is from rental rate increases, and another 70 basis points is from other miscellaneous items. In that number, we're also assuming that bad debt will increase in the second half of the year, offset by about 90 basis points.
If you assume that we get the bad debt from the first half of the year similar in the second half of the year, that would increase our same store for the second half of the year would be 4.3%. That'd bring our 2017 midpoint to about 4.7%. There is some potential pickup there.
Hey, Craig. It's Scott, that increase in our annual guidance by 25 basis points, the vast majority of that had to do with lower bad debt expense in the second quarter. That was the vast majority of the cause of the increase in our same-store guidance range for the year.
Okay. All right. Just separately, Peter, maybe a little bit more color on the UPS purchase option. It sounds like it was negotiated at the time of the lease. What kind of, I guess, margin is baked into that? Kind of what could the IRR look like if they do execute that?
Jojo, why don't you take that?
Yes. Craig, we can't disclose the economics. I can tell you that it will be a profitable transaction, but can't disclose either the margin or the IRR. Just like Peter mentioned in his prepared remarks, we feel really very good because it's going to be a major amenity in the Phoenix area.
I guess maybe another way to ask it, kind of what was the yield on that project and maybe what are market cap rates in Phoenix in that sub-market?
The GAAP yield, which is our first-year cash NOI over a GAAP investment basis for the whole parcel, which includes our building plus the recently acquired 66 acres, is 7.2%. It has bumps. The lease has bumps. Market cap rate, I would say, in Phoenix would be in the range of high fives, low sixes.
Great. Thank you.
Thank you.
Your next question comes from the line of Dave Rodgers from Baird. Please go ahead. Your line is open.
Yeah. Good morning, guys. Maybe stick a little bit with the development pipeline. Jojo, can you talk a little bit about the activity maybe that you're seeing at Park 94 and Sycamore and any early activity out at The Ranch?
Sure. We recently completed First Park 94 and First 215. In First Park 94, as you know, we're already 50% leased. We continue to get inquiries there and tours, but no other lease to report at this time. We're encouraged with the recent announcement of this major manufacturer in the market called Foxconn, and that will add significant amount of economic vibrance in the southeast part of Wisconsin, which really serves the Chicago market. We don't really know what is going to be funded and the timing, but we do know that we've a Class A park there to service whatever happens to that huge investment. With in terms of 215, we just completed the 242,000 sq ft. It has frontage on 215 and between two interchanges. We like that asset a lot.
There's few competitive buildings in that size range, and we've had inquiries, and we've also had tours, but no lease to announce at this time. In terms of The Ranch, that is the six-building development, a total of 336,000 sq ft. We're on track to complete that project by the end of this year. We're very excited about that project. As most of you know, that's in the sub-market of Chino, and Chino today, for high-quality product, has a sub 1% vacancy. In that project, despite not finishing the project yet, we've had inquiries and tours as well. Again, like the other projects, nothing more in terms of leasing to report at this date.
I captured about $120 million of capital at risk against your $375. There could be other things that I'm not aware of in that number. I guess, update that number for us if you could, Jojo. For Peter, maybe a broader question too, just on development, is it sounds like you're bullish. You raised $75 million in June, clearly for some value creation. You've been accelerating asset sales, but the development pipeline's kind of at a lower point right now. I guess, is that just a lull in the pipeline? Is it timing issue? Give us the sense of kind of your confidence and kind of really growing that pipeline in the second half.
I think your question about the cap, there is $152 million of capacity on the 325, not 375. It is 325. We have $152 million in capacity there. With respect to the question about development, look, we expect demand to continue to outstrip supply in several markets that we are active in, and we continue to evaluate new development opportunities. I suppose in the development game, a quarter does not a trend make. Year-to-date, we have also acquired additional parcels that are in good markets where we have had success in the past. We are pretty optimistic about several of the opportunities that we are looking at, and we will let you know when we get started there.
Dave, just to add a little bit more color to the spec, what's used the spec and provide a capacity of $152 million, 70% of what's in that spec cap is the projects we just talked about, the 215, The Ranch, and the First Park 94, of which two projects we just completed recently. The rest is spread around five other projects, which is mostly partially leased.
Okay, got you. Thanks for the color, guys.
As a reminder, if you'd like to ask a question, please press star one on your telephone keypad. Your next question comes from the line of Eric Frankel from Green Street Advisors. Please go ahead. Your line is open.
Thank you. Can you maybe update us on what determines your pace of dispositions in your portfolio?
Can you ask that question again? I couldn't-
I'm sorry. Yeah. Can you just help to explain what determines the pace of dispositions in your portfolio?
Sure. It's pretty straightforward. The pace of our dispositions is dictated by our ability to maximize value. Right now we're continuing to see very good value on the assets that we want to sell. The buyer base consists largely of local investors, 1031 buyers, and users. Yeah, the pace and the reason that we picked the goal that we have of $150 million-$200 million is determined by value maximization on the sales.
I know you don't really set capital allocation guidance, but do you have any goal in store for what you plan this year, and maybe going forward on an annual basis based on your feel today?
Well, on sales, Eric, it's Scott. We gave guidance of $150 million-$200 million for 2017. That number this year is probably a little bit higher than average than it's been over the last six or seven years. When we go through the budget process later half of the year, we'll make a determination on what 2018 will be.
Yeah. Our investment pace depends on the opportunities that we see and the profitability of those opportunities. On the sales side, if we continue to see great pricing on the sales and we end up exceeding our goals, that would be fine, too.
Are there any thoughts in maybe trying to cobble together a portfolio that might appeal to investors, given that there seems to be growing investor demand even for smallish assets in a variety of different markets?
Right now, we're not having any issues selling the assets that we want to sell on a one-off basis. We're able to maximize price that way. If we had the opportunity to do better on a smaller portfolio, sure, we'd look at that. Right now, we haven't needed to do that.
Okay. I'll jump back in the queue, but a final question. Peter, maybe you can just remark on which markets or sub-markets where you're seeing supply starting to peak a little bit.
Sure. Jojo, you want to-
Sure
take on that?
Sure. Basically, most markets, as we see it, they're still solid in terms of demand exceeding supply. Eric, we see that to continue. There are some pockets we know where tenants have more options. What are those? North Houston, I would say a tenant has more options there, and therefore, you will have a more difficult time pushing rent if you have a portfolio in North Houston. The I-55 corridor in Chicago, tenants are starting to have more options there, too. I would say, if you're a prospective tenant, you would have some choices in South Dallas for big box, and that's specifically in the 35 East and 45 corridor. That would be 5:00 to 6:00 o'clock in your dial. If you're a tenant which requires about 200,000 sq ft or less in Phoenix, you would have a bit more choices than last year.
Okay, thanks. I'll jump back in.
Your next question comes from the line of John Guinee from Stifel. Please go ahead. Your line is open.
Great. Couple of questions. First, your Chino deal, six buildings. Can you talk a little bit about the size and scope and what's right for that market? Looks like you built Chino for about $93 a foot, which is probably spread out over the very different between the large buildings and the small buildings. What's your investment basis per buildable foot in the land, Jojo?
Sure. Couple of things. One is that first, the size range, 49,000 sq ft up to 330,000 sq ft. A number of buildings in between that. We designed it that way because we saw that the size range within those that I specified to you was clearly underserved. If you're a tenant really needing anything, just say 50 to 330 today, and you wanted to be in Chino in a Class A property, there's virtually no supply. In terms of a basis, we came into the basis we felt very attractive because we came in, I can't give you the exact number, but under $20 a foot. I will tell you that smaller buildings are more expensive to build. I think everybody knows that. Today, if you can find entitled land sites in Chino, they are approaching $30 per sq ft.
Okay? In terms of the market and yield, so far, rents in Chino have increased significantly from the time of our underwriting and today, rents have increased an additional 20%. We forecast approximately a 6.9% GAAP yield, and that's first-year cash over GAAP investment basis. We think these buildings would trade at a four today.
Great. Thank you.
Thanks, John.
As a reminder, if you would like to ask a question, please press star one on your telephone keypad. Your next question comes from the line of Michael Mueller from J.P. Morgan. Please go ahead. Your line is open.
Hi. Couple questions. First of all, it doesn't sound like it, but are you seeing anything at this point that would lead you to believe that your average CIP balance next year, which you have under process of, call it $150, give or take this year, I guess before the project was placed in service, that you'd see a material change in that amount of development?
Michael, we don't give guidance in terms of how much we're going to construct. I can tell you right now we have this $136 million, which we're focused on executing, finishing up the rents, and then leasing everything. I would say that if you turn to page 22 of our supplemental, we have land that substantially entitled that we can build on. Nothing to announce at this time, we continue to review. You know that year to date, we've bought sites in Southern California and Phoenix, which we have had recent success. We will let you know once we start the new projects. We're optimistic that these investments that we've made in land will bear fruit.
Mike, this is Scott. We're continuing to look for other land sites now to do future development as well. We have the land inventory that Jojo just discussed, and again, we're in the market all the time looking for other development opportunities.
Got it. Just I guess a clarification question. Peter, in your opening comments, you said that you reminded people that your GAAP yield is your cash NOI over the GAAP basis in the building. I guess when I think of a GAAP yield, I usually think of the GAAP NOI over the cost. I'm curious, what's your definition of your, I guess, a cash yield?
Mike, it's Scott. I think there are different ways that people use that definition. When we established this back, I think in about 2011, we came up with GAAP yield at that point in time. I think the way you think of cash yield is the way we think of GAAP yield. The reason we call it GAAP yield is because we use the GAAP basis as a denominator. Truly, the first-year cash is the numerator. I think what we call GAAP yield is probably what you think is cash yield, and that's something that we Yeah, cash yield.
It's really cash on cash.
Yeah. That's something we probably should look at on a go-forward basis because we have other questions on that from other investors and analysts as well.
Okay. That was it. Thank you.
Your next question comes from the line of Jon Peterson from Jefferies. Please go ahead. Your line is open.
Great, thanks. Probably just one question for Scott. I'm curious if we can get an update on your guys' dividend policy and just kind of remind us of where the dividend stands versus taxable income and how much NOLs you guys kind of still have in the bank to kind of shield against that. Just trying to figure out if you kind of been going four quarters and then a raise, and four quarters and then a raise. Are you going to be able to get the next two more quarters without needing to raise?
Sure, Jon, it's Scott. When we look at the first six months of 2017, we're in very good shape from a taxable income point of view. The wild card that we have in the last six months is going to be from property sales and what those tax gains are. We've been pretty successful in doing 1031 exchanges with acquisitions, and if we have future acquisitions in the last six months of the year, we can do that. You're right, if that doesn't work, we do have $60 million of NOLs that we can use. We think we're in pretty good shape when it comes to taxable income for 2017. As far as future dividend growth is concerned, if you looked at what we've done is whenever cash flow has grown, the dividend has grown as well.
obviously, that's something that the board determines, but that's generally been our dividend policy on an annual basis.
Got it. All right, that's it. Thanks.
Your next question comes from the line of William Crow from Raymond James. Please go ahead. Your line is open.
Hey, good morning, gentlemen. A question from me is on merchant builders. There's been some speculation if the pace of activity on their part has increased significantly over the past year. What are you seeing out there as far as who's doing the building? How confident are you that the discipline that we've seen thus far can kind of sustain itself?
Yes. Bill, this is Jojo. Part of the increase in development has been by merchant builders. There is a significant amount of interest from investors' point of view in buying industrial. Wherever we go in conference, and we meet, industrial really is a top product type to invest in. Of course, people build, and they sell. In terms of how it's affected the markets, Bill, we went through a number of markets that we have our eye on because tenants have more choices. Far, we continue to see, especially where we develop, we're developing markets that we think demand will still outstrip supply. On top of that, not only do we focus on sub-markets, we focus on size ranges because not all size ranges are made the same.
We have a very local bottom-up, also competitive analysis that we do, that we focus on not only the sub-markets that are underserved, but the size ranges that are underserved. That's how we deal with potential competitive supply.
Jojo, would you say that the percentage of total development being done by merchant builders is picking up relative to the REITs? Is that a fair statement?
That's a fair statement.
Okay. Very good. Maybe just if you could talk about the lending environment. There's no sign, I assume, yet that the lenders might be pulling back even in some of these more concerning markets. Is that fair?
Yeah. That's fair to say. The lending community is still fully engaged. We haven't seen that diminish at all.
When we have conversations with our bankers and then on the private side, the lenders require recourse, full recourse, especially in spec deals.
Okay. I appreciate the comments. Thanks.
Your next question comes from the line of Eric Frankel from Green Street Advisors. Please go ahead. Your line is open.
Thank you. Just a few quick follow-ups. Jojo, just to confirm, you are talking about land prices in the Inland Empire in Chino. When you say $30 per square foot, you mean land square foot, not building square foot, correct?
That's right. That's land foot. In Chino, in Ontario, that's land foot. Yes.
That translates to more like $55, $60 per square foot or $60-$65 per square foot, excuse me, on a building square foot basis?
Yes, on a building sq ft basis. In smaller buildings, you won't build more than [45]. Yeah, you're right. You adjusted for that already. You can build to 50%, but you'll build less. Yep, you're right.
Okay. Just regarding same store performance, or actually, well, just the operating portfolio. The re-leasing spread numbers obviously was pretty terrific. Could you provide a rough breakdown which markets produced the highest spreads?
Yeah, Eric, this is Chris. Again, the first half of the year we showed overall cash rent increases of 7.2%. The markets that drove that the most were our Chicago market, our L.A. market, and then our Dallas market. All of those markets had rental rate increases in cash increases in excess of 15%.
Oh, that's helpful. Thank you. Final question, just regarding development. Certainly, I think your equity raise. You're leasing with, in Phoenix certainly implies you're going to be doing more development in the second half of the year. Would you expect those starts to be based on land you don't own yet, or that's in your land bank?
It would be either. Like Scott had mentioned, we continue to look at other land sites. It could be either, Eric. It could be either a land site that we acquire pretty soon and build on it, or it could be on our existing land holdings.
You must have a rough idea, though, just based on we're a third of the way through the third quarter. I'm assuming you have a rough idea of how-
Yes
what your starts are going to look like.
Correct. Eric, it was more probable on the land that we own.
Okay. That's all I've got. Thank you.
Okay.
As a reminder, if you would like to ask a question, please press star one on your telephone keypad. There are no more questions in the queue at this time. Mr. Harmon, I turn the call back over to you.
I'll turn it back over to Mr. Baccile because it makes a lot of sense. Thank you.
Thank you, operator, and thank you all for participating on our call today. As always, please feel free to reach out to Scott, Art, or me with any follow-up questions. Enjoy your summer.
This does conclude today's conference call. You may now disconnect.