Welcome everyone to the First Industrial session. I'm Nick Thillman, a senior analyst at Baird covering office and industrial REITs. Today I'm joined by Peter Baccile, President and CEO of FR, along with Scott Musil, CFO, and Peter Schultz, EVP of the East Region. I'm going to hand it over to Peter for some remarks, and then we can proceed with the Q&A after.
Okay. Thanks. For those of you who aren't familiar with us, we're a U.S. only focused industrial developer, owner, and manager. We've got about 70 million sq ft, ±$12 billion-$13 billion of total value. Our primary growth engine is speculative development. We do acquire as well, not on a volume basis, not as much. Over the last 10 years, we've created $1.3 billion in value through our development pipeline, generating 7% cash yields and about 50% margins. Turn it back over to you, Nick.
Yeah. Feel free to come up to the mics if you have specific questions, but I'll kick off with a couple of them for you, Peter. Has there been any noticeable impact on tenant activity due to the recent conflict in Iran and/or rise in oil prices or interest rates?
When we first saw that at the end of February, we thought, here we go again. Last year it was tariffs, and that cooled demand for our space, and now this. I have to say that we've seen no discernible impact on tenant activity or tenant demand since the beginning of the war back in the end of February. Maybe the input prices for most of our customers, transportation and labor, are the highest, and those have grown the most over the last 20 years or so. Interestingly enough, I did a little math this morning. A gallon of gas 20 years ago on average was $2.63. Today it's $4.31. I know it's much higher in some places. That's about a 2.5% CAGR on gas prices, which is exactly equal to inflation over that same time period.
That might explain why it's kind of been a yawner for all of the tenants that are prospects for our space.
Maybe dovetailing that a little bit to the leasing demand for some of your developments and your larger vacancies, including the 700,000 sq ft vacancy in Pennsylvania. I guess demand seems as though we had to be a little bit of stop start post Labor Day, and it's started to pick up some volume and we saw some momentum in the first quarter, but maybe what you're seeing from that element on those.
Sure. The last six months we've seen a big pickup in tenant activity and traffic. In fact, the last six to eight weeks, it's gotten even better. That traffic is around much larger spaces as well as the smaller spaces. In many markets, there are still, let's just say, several alternatives for tenants in the kind of 250-750 range. Activity, Peter Schultz is our East Region Head and is responsible for our 708,000 sq ft in PA. Why don't you talk about what's going on there?
Sure. Pennsylvania is probably the most active market we have in the country today together with our Texas markets. Nick, to your question on our largest vacancy, the 708,000 sq ft building in Central PA, we have a couple of active prospects we're in discussions with for the full building, as well as some interest from a couple of other tenants. Our recently completed project, our First 33 project in Lehigh Valley, just in the first quarter, which is two buildings of 150,000 and 211,000 sq ft. We've seen really great demand for that 50-200 range. In fact, we already signed a lease for 54,000 sq ft in that building within just a couple of months of completion. Activity, as Peter said, is good across the country.
A lot of the prospects we're seeing today, including the couple that we're actively working with, weren't even on our radar screen at the beginning of the year. That's giving us some more encouragement about the pace and cadence of demand and some tenants making decisions with more urgency.
You maybe just touched a little bit on it from Pennsylvania standpoint, but from overall best markets today and most challenged as you look at the portfolio?
Look, best markets, Nashville is still one of the best markets. Certain sub-markets in Dallas, Houston, South Florida. SoCal we would say is stabilized. Rents will be flattish, we think, this year there. There are still some alternatives in terms of lease-up there. More alternatives than we'd like to see. Denver remains a market that's behind in this recovery. It is the one market in our 15 markets where new starts didn't stop for probably three or four quarters behind when the rest of the markets around the country did. There's a little bit more alternative there for tenants as well. Weaker, call it Denver, stable SoCal, and then those bigger eastern markets are doing pretty well, including, as Peter said, Central PA very well.
Maybe outlining some of the embedded growth within the portfolio and cash leasing spreads overall. You guys are guiding to 30%-40% for 2026. What are your thoughts on 2027 and beyond, just for rental spreads, given the embedded run-up we've had since COVID?
Sure. We don't forecast the leasing spreads. What I can say is a couple of things. First, we've got a lot of development leases that we signed pre the peak. That's one of the good things about our strategy through this cycle is we have assets that we leased pre-peak because we built them new. You can see that that rent growth should have some legs, at least for a while. Secondly, our mix for rollovers in 2027 is approximately the same as the representation of those markets in our portfolio, with a slight overweight in Dallas and Atlanta. Those two markets have done very well, did not have quite the same amount of rent run-up and therefore rent fall or rent decline as, say, the West Coast markets did. Again, that's another tailwind, if you will, to our cash rents in the future.
That's helpful. Maybe on the capital deployment and priorities today. You guys put in the buyback recently. Just ranking and what you're seeing between new development starts, acquisitions, and repurchases today.
It's all about economics. As I've said in the past, we're a profit shop and not a volume shop. We take the precious capital that we do have and consistently evaluate where best to use it. Our growth engine, as you know, over the last decade or more, has been through speculative development. That'll still be the case. We have land holdings today that are about 75% entitled, where we can invest about $2 billion at about a 6.9 yield. Very healthy yields and returns. Of course, we're not going to build into markets where there are already too many alternatives. We need to see some sustained leasing for developments in these markets before we're going to get going in some of them. We have had new starts, as you've seen in Pennsylvania, in South Florida. We've built out our land in Nashville.
We're looking for more land in Nashville. We continue to love that market. As far as you mentioned the stock buyback. Over time, our board has considered that topic many times. We have always had great opportunity and continue to invest dollars in high-growing real estate assets. As we looked at some of the market dislocations over time, we thought, "Well, gee, we have a very strong conviction on our stock over the long term. When the markets swoon by 10, 20, 15, 25%, maybe we should think about taking some shares off the table." That's what we're going to do with that allocation, that $250 million. It'd be very opportunistic. We don't really have a target. It's just about when we see an inflection point that we think just ignores the value of our long-term portfolio.
As a reminder, if anyone has any questions, feel free. There's a mic over there. Maybe touching on rents a little bit, and just, you talked a little bit on Denver and the starts there. As you look at the competitive landscape for starts today, are you seeing any markets where you're starting to see ramping of starts? I guess from a just overall that standpoint, you've mentioned Nashville, where do you feel like you have the land to develop in today's market?
In terms of starts, there will be more starts for us this year. We're not going to quantify that. It'll be in some of the stronger markets that I highlighted earlier. We are looking for land, as I said, in Nashville. Hopefully, we will tie some down soon. It's a very competitive market. We compete not really necessarily with the other public industrial REITs. It's more with private capital, where the capital is priced, in our opinion, very thinly. What we do is we leverage our platform. We have about a dozen offices around the country. We have people in these offices that have been around for 15, 20 years, or even 30 years in these markets and have great relationships. They're making hundreds of unsolicited offers a quarter.
We have to have a lot of balls in the air because, by definition, the success rate is not super high. We're trying to find those opportunities that come few and far between, where we can make a lot of money for shareholders and not get caught up in any kind of broadly distributed bid process. That process can take a while, but once we get to know those landowners who might be reluctant sellers at the beginning, and they get to know us, they have a level of comfort with us, and therefore we're able to tie up those deals, perhaps with minimal competition. There's always some competition. Perhaps with minimal competition. In many occasions, our teams are able to tie up land and have it get entitled while the seller still owns it.
That means our capital is not burning while that process is going on. It's a pretty involved process. It allows us to have a very low basis relative to most of our peers. We also build a different product than the private market tends to build. We don't overbuild the sites. Maybe we cover 36 or 7 or 8%, whereas others are in the high 40s. We make sure we have ring roads. Our ability to secure truck courts, 180-foot truck courts. We spend the extra dollar and a half and build taller buildings. Not only is our basis in a very good place, that allows us to offer the best product, the most competitive product in the marketplace. That's really why we benefited during this cycle. 10 years ago, we said we're going to build a portfolio that outperforms through the cycle.
You've probably seen, if you paid attention, our cash rental rate growth for the last few years has been really large, 58%, 50%, 35%. That we attribute to the way we do business and that portfolio that we wanted to build that would outperform through the cycle.
Maybe touching a little bit on market cap rates. What are you seeing for market cap rates in your markets today?
Cap rates vary. For Class A space, new space, 5-5.5 would be the range. Doesn't mean you won't see some transactions take place in the fours, you will, but the bulk of the capital's in that 5-5.5 range.
I know you guys have been evaluating some of your land purposes and even some of your operating portfolio for data center-related uses. You completed a large data center sale this quarter. Are there any other opportunities you've identified in the portfolio or are seeking out on your land bank today?
We've been very pleased with what we've been able to do in Phoenix. We had two joint ventures there. We bought, combined between the two JVs, about 1,100 acres. We ended up, it wasn't part of the initial plan, but both of those JVs are wrapped now, wrapped up. We ended up selling 500 acres for data center use, and we got three times industrial value. Not three times our cost, three times industrial value for those sites. We could have developed those sites, leased the buildings, and not made as much money as we did selling the land for data center use. We've taken a very detailed look at the rest of our portfolio, land and cash flowing properties. We boiled it down to, as you can imagine, it's not an easy process. First and foremost, power.
If you're in jurisdictions where power is not available, those assets aren't going to work. You have to be able to get power. Number 2, you have to be able to get power in a reasonable period of time. 2030 is reasonable. Beyond that, it's not so reasonable. Number 3, if the building or the land is tied up by a tenant for the next 10, 15, 20 years, take that off the list. We've narrowed it down to about a handful of potential opportunities. On one in particular, we're going to put a full-court press on trying to get power soon. Probably if something happens, you're not going to see that happen before 2027 in terms of monetizing those opportunities. The upside, you already heard on the land, is kind of three times industrial value. With cash flowing buildings, it's a very wide range.
For a lot of different reasons, it can be 50%-100% higher than industrial value. That's a process that we're going through, and we're hopeful that we're able to monetize some of those assets that way.
Scott, maybe touch on a little bit on what you're seeing on the overall tenant credit and the health of just your overall tenant base today. You did have something with a 3PL tenant. Overall credit within the portfolio, what are you seeing there?
Very healthy. Our bad debt expense in the first quarter was only $100,000. That's about 10 basis points of total revenues, lowest in our sector. As far as tenants on the watch list, these are the couple of tenants we've been discussing over the last year. A tenant called Boohoo. They lease 1 million sq ft. They're paying timely, and we also have a letter of credit that covers about a year's worth rent. The 3PL tenant, we entered into an agreement right before our first quarter earnings call. They paid back 60% of their arrearage. They're required to pay the rest back by the end of the year, and they're current on their plan as well. Nothing else material on the watch list. From a credit point of view, looking pretty good, Nick.
One more thing to add on the data center opportunity. The data center business, which we are not in and don't want to be, is also providing a bit of a tailwind for demand for our space. The entity that we sold 300 acres to in Phoenix ended up leasing half of a 940,000 sq ft building we have there because they intend to build 14 data centers over time. That's going to be a very long-term tenant. They use that space for staging and storage of equipment, and so the more manufacturing that happens in the data center business, the power business, as you know, everyone's trying to figure out how to generate more power. That is also a tailwind for demand in our space. Together, these aren't as strong as e-commerce.
As we know, e-commerce has been a huge tailwind for our space for a long time and will be for a long time to come. For now, and probably for the next 10 years or so, it will be a nice tailwind.
For some that aren't as familiar with the story, the broader rotation from the Midwest markets to the coasts and these core population hubs from a distribution side, you're mostly wound down with that, but what percentage of the portfolio do you view as somewhat non-core in the recycling of that capital, and is that program mostly complete? Where do we go? What's the next 5-10 years look like?
The last dozen years or so, we have sold about $2.5 billion. Remember, 10 years ago, our total market cap was about $4 billion, so we've sold two thirds of what we had at the time. Today, two thirds of what we have is new-ish since 2010. The other third is what I call legacy. That's the best of the best of what we had. We're pretty much through that. We are through that transformation. Again, you've seen the results in our great cash leasing spreads and our growth trajectory, same store, et cetera.
We will continue and will always be looking to maximize the value of our dollar invested, and if we see an asset or certain assets in a certain market that don't have the growth future that we want to see, we will continue, of course, to pare off that bottom of the portfolio. The transformation was completed really at the end of 2023. It's been quite dramatic.
You'd say growth into other markets. As you look at the portfolio today, do you feel that you got enough capacity to develop and/or acquire in your existing footprint, or do you think there's new markets that you look to evaluate longer term?
Nashville is a market that I would say is "new now." We've always had space there, but very small percentage of the portfolio. About 10 years ago, we said, "Hey, let's go bigger in Nashville. The demographics look really good." It's been a great move. We did the same thing in South Florida. We had 1.2% of our portfolio there. It's up to a little over 6% today, and may be heading to a top three or four market for us soon. That's been a great move. You talk about high barriers. It's 21 miles from the Atlantic Ocean to the Everglades and about 115 miles from Homestead to Jupiter, so not a lot of room there. It's very tough to buy land there, and that's a market we continue to love. That'll be the focus going forward.
Peter, how much of that is your responsibility then going forward?
Most of that.
Yeah. Well, Jojo Yap is not here to defend himself.
That's right.
I figured I'd have to chime in. Scott, maybe going back to you guys did your first bond issuance last year, a while back. As we look at funding needs and going forward, I guess, what are your preferred sources of capital to fund the continued development?
The next three quarters, so remainder of the year, the development expenditures projected are about $90 million. We generate about $85 million of excess cash flow a year. That's number 1 on the list. We also disclosed in our first quarter call a land sale in Phoenix, which actually closed, I think, last week. That's a source. If we need other funds, we can obviously tap the bond market as well.
What's pricing today for?
I would say it's probably about 100 basis points for a five-year and around 120 basis points for a 10-year. Those are the spreads.
Yep. As we're just thinking about the balance of the year, I guess what keeps you up at night, Peter, from a demand standpoint? Seems as though conditions are still humming along despite some geopolitical uncertainty and some macro headlines and maybe a potential weakening consumer. I guess, what are you monitoring most right now to see?
It's always leasing. That's our lifeblood. In good times and in bad, you lose sleep over that. Everything else creates volatility. We're in the forever ownership business. That's why we pursue the business the way we do, why we're focused on the 15 higher barrier markets where it's more difficult to build. Rents are going to grow the fastest. Doesn't mean you can't make money in other markets and in other ways, but in our view, they require market timing. We think over the long term, you're probably going to lose, if maybe come out 50/50 at best. We like to be in the forever markets, and we think that's going to lead to the greatest appreciation in the share price.
Maybe just lastly, on just upside, you think on rents here relative to maybe when you're rolling your second-gen leases relative to where replacement rents are for new deals. I guess, how much room is there on that as you look at it?
We can build in a lot of markets. I would say even some of our land in SoCal pencils today, but if there are already alternatives, they're not going to build. Rent growth, we think is going to be 0%-5%. SoCal, probably flat. You could have markets like Nashville and Dallas grow higher than that, maybe as much as 8%. These markets are beginning to get better. That loss to lease factor is going to go to 0 in a lot of places where it isn't right now. I can't really project when you're going to get there for SoCal.
Not for you guys? Is it not you or the market? It seems like 27 is still a pretty good setup.
27 is a good setup.
Yeah.
Here's the thing. I said this earlier. We're now in a more predictable, stable growth trajectory in this sector, one that goes back to pre-2000, pre-The Great Recession. Since then, it's 20 years, but you've had The Great Recession. Nothing was built in this space for three years. You had a big run-up to 19, and then when COVID, everybody brought out the hockey sticks. Everything grew like crazy. Now we've come down the backside of that. We've had these big volatility-creating events for 20 years. If you go back to the 2002- 2006 period, this business grew at a pretty steady, decent rate and a reliable rate. I think we're about to enter into that part of the cycle again. That's good for business.
Any questions from the audience?
Got a question. Can you talk about how the return, would you say, construction costs have been impacted from the conflict in the Middle East?
Construction costs and impacts from what else?
From the Middle East conflict.
Yeah. Construction costs from the peak have come down. At the peak, we like to bid to three GCs, potential GCs. We got to the point at the peak where they would refuse. They wouldn't do it. That's changed 180 degrees now. People are asking for business, costs have come down. There's been no real impact from the conflict in the Middle East. We haven't seen a rise in the cost of anything really. Steel, concrete, nothing. It's been pretty stable though the last couple of years. That drop in expenses, cost happened 2024 and 2025.
The other thing I'd add to that is with less development and construction underway, subcontractors and labor has gotten a lot more competitive because they're chasing work now compared to what Peter said, where they would refuse to bid previously.
Maybe a follow-up on that. Just are you guys seeing competition when it comes to just data center development, like bidding for a new start?
We're not having any difficulty getting multiple General Contractors and highly qualified subs to bid our projects. Certainly, data centers are absorbing more land, which is reducing the supply of land available for industrial development. That's good as an owner of assets. We've not had any difficulty at all getting people to bid our projects competitively.
Anyone else? Yep.
Oh, I think you said that within Southern California this year, your prediction was less growth, but maybe looking out a couple of years, you make a prediction of normal growth. What would be the direction of growth?
Yeah, that completely depends on the pace of take-up of the existing inventory. We said a couple of years ago that decision-making was taking a long time. Everybody wants to know why it takes a long time. It continues to be somewhat slow in that market because there's no cost to waiting. What's a cost to waiting? A cost to waiting is you can't get the building you want, or you can't get it at the rent that you want. Competitively, you're not investing in growth like your peers are, and you're going to fall behind. Those dynamics need to be in place for rents to start to really grow. In particular size range in SoCal, there are 80 buildings available. Now, it's a 2 billion sq ft market, so it sounds like more than it is, but 80 is still 80.
We need those buildings absorbed. It's happening. That number was a lot higher a couple of years ago. The Inland Empire is about a 700-million sq ft market. New starts are in the single-digit millions. There's almost no new starts. I can't put a timeframe on when you're going to see real rent growth there, but it's certainly not that far away.
We're all set.
Okay.
Yeah.
Yeah.
I'll conclude. Thanks everyone for showing up. Feel free to reach out if you have any follow-ups with the team.
Thank you, everyone. Thank you. All right. Good job.
Thanks, man.