Earnings Call: Q3 2020

Nov 6, 2020

Good morning, and thank you for standing by. Welcome to the Ag Industrial Incorporated Third Quarter 2020 Earnings Conference Call. At this time, all participants are in 2020 Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. Please note this conference is being recorded. I will now turn the conference over to your host, Matt Spennard, Senior Vice President, Investor Relations for STAG Industrial. Thank you. You may begin. Thank you. Welcome to STAG Industrial's conference call covering the Q3 2020 results. In addition to the press release distributed yesterday, we have posted an unaudited quarterly supplemental information presentation to the company's website at www.savindustrial.com under the Investor Relations section. On today's call, the company's prepared remarks and answers to your questions will contain forward looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ from those discussed today. Examples of forward looking statements include forecasts of core FFO, same store NOI, G and A, acquisition and disposition volumes, retention rates and other guidance, leasing prospects, rent collections, industry and economic trends and other matters. We encourage our listeners to review the more detailed discussions related to these forward looking statements contained in the company's filings with the SEC and the definitions and reconciliations to non GAAP measures contained in the supplemental informational package available on the company's website. As a reminder, forward looking statements represent management's estimates as of today. SAG Industrial assumes no obligation to update any forward looking statements. On today's call, you will hear from Ben Butcher, our Chief Executive Officer and Bill Crooker, our Chief Financial Officer. I will now turn the call over to Ben. Thank you, Mats. Good morning, everybody, and welcome to the Q3 earnings call for SAG Industrial. We're pleased to have you join us and look forward to telling you about our Q3 results. Presenting today, in addition to myself, will be Bill Crooker, our Chief Financial Officer, who will discuss the bulk of the financial and operational data. Also with me today are Steve Mecke, our Chief Operating Officer and Dave King, our Director of Real Estate Operations. They will be available to answer questions specific to their areas of focus. A phrase that I've heard frequently over the past few months has been, it's good to be in industrial, and that is certainly true. Industrial remains one of the few favorite asset classes in commercial real estate. Fundamentals are strong. Tenant leasing demand slowed only briefly at the outset of the pandemic. It resumed quickly and has continued to be strong throughout the quarter. This resilience has been seen across virtually all markets with e commerce supply chain build out leading the way. Supply remains a concern, but most markets are at or near equilibrium and are and or operating at occupancy levels where the levels of incremental supply are not unwelcome. Capital is readily available and acquisition opportunities abound. Not surprisingly, our portfolio continues to perform well despite somewhat uncertain economic conditions. The demand for our space is broad based. The 5,600,000 square feet leased in the 3rd quarter represents the largest total square footage leased during a single quarter in STAG's history. Our occupancy level remains high, 96.3 percent at quarter end, a reflection of solid retention and shorter downtime experience. Included in this quarter's leasing activity was the successful backfill of our 1,000,000 square foot building located in Hampstead, Maryland, one of the 2,000,000 square foot facilities with tenant non renewal expected to occur in 2020. We budgeted between 12 18 months of downtime prior to re tenanting this facility given its size and location. Thanks to the efforts of our asset management team, we significantly outperformed our budget and successfully released the building to a single user while incurring no downtime. The building was leased to a substantial credit for over 5 years with minimal tenant improvement work and 3% annual rental escalators. The second 1,000,000 square foot building we have discussed is our GSA building located at Exit 6A of the New Jersey Turnpike in Burlington, New Jersey. This is one of the premier submarkets on the East Coast and a version in e commerce hub. Our current budgets reflect the midpoint of 9 months downtime for this asset. We continue to receive interest from both potential buyers and potential users for this building and it's included 500,000 square foot potential additional development. Our guidance assumes we hold this asset for the foreseeable future. However, given the attractive returns of a potential sale, we believe there is an increased likelihood that we monetize this asset. As expected, the acquisition market has returned to pre pandemic levels, both in terms of investment opportunity and pricing. The fundamental strength of the industrial real estate sector going forward has not been lost on investors. As a result, investor appetite industrial real estate continues to grow. However, our acquisition platform is well established across many markets in which we operate. Our ability to identify relative value investment opportunities is reflected in our acquisition pipeline amount of over $2,800,000,000 today. We recently completed our 4th annual tenant survey. Not surprisingly, there are more and less fortunate industries during the pandemic. The more fortunate include 3rd party logistics providers and the home improvement industry and of course, anything e commerce related. Less fortunate include tenants in the trade show industry and certain small automobile tenants. E commerce remains a dominant theme. Approximately 40% of our respondents across our portfolio utilize a portion of their space to conduct e commerce activity and approximately 15% of our buildings are solely dedicated to e commerce. Our tenants reported an increase in the percentage of their warehouse footprint focused on e commerce activity, and increased from 30% in 2018 to almost 40% in 2020. STAG is in an enviable position as we approach the end of the year. Our balance sheet is defensively positioned and our liquidity is high. The STAG team is working effectively and efficiently in the current work from home environment with strong engagement across the organization and a resilient culture. With that, I'll turn it over to Bill, who will discuss our Q3 operational results and updates to our 2020 guidance. Thank you, Ben. Good morning, everyone. Core FFO was $0.46 for the quarter and leverage remains at the low end of our guidance range. Net debt to run rate adjusted EBITDA was 4.4x prior to factoring in the outstanding forward equity proceeds related to our January equity offering and 4.0x when those proceeds are included. Acquisition volume for the Q3 totaled $64,700,000 with stabilized cash and straight line cap rates of 6.3% and 6.8%, respectively. Subsequent to quarter end, we've acquired an additional 9 buildings for $258,000,000 This brings 2020 closed acquisition volume to $454,000,000 through today. Additionally, we have acquisitions totaling 216 $1,000,000 currently under contract or subject to letter of intent scheduled to close by year end, bringing 2020 total acquisition volume to $670,000,000 as of today. For the quarter, 5,600,000 square feet of leases commenced with cash and straight line re leasing spreads of 1.3% and 4.7%, respectively. New leasing spreads were negative 4.7% this quarter, which was driven by 2 leases. The new lease related to the 1,000,000 square foot asset located in Hempstead, Maryland, as discussed by Ben, resulted in a roll down of 2.2%. Note that this lease was an as is transaction and required minimal tenant improvement or other capital work. The second lease reflects the phased negotiation of a long term lease with the tenant initially agreeing to a 1 year lease at below market rent while simultaneously negotiating a market rate long term lease. Excluding these two leases, new leasing spreads increased to 12.4% on a cash basis and 21.5% on a straight line basis for the quarter. Additionally, we leased 82,000 square feet of value add buildings during the quarter. Retention was 72.1% for the quarter and is 81.4% for the year, both of which include the impact of the 1,000,000 Square Foot Solar Cup non renewal, which is backfilled with 0 downtime. Retention was equal to 88.6% for the quarter and 91.5% for the year when excluding the impact of the Solo Cup non retention. Same store cash NOI increased 0.8% for the quarter and 1.8% year to date. For the Q3, we collected 98.2 percent of our base rental billings. Of the remaining 1.8%, 60 basis points have been deferred with repayment generally expected by year end. As of November 5, we have collected 96.9 percent of our October base rental billings. An additional 60 basis points of October base rental billings yet to be received relates to investment grade tenants and tenants who pay in arrears. We expect these tenants to remit payment within the next 2 weeks, bringing the total to 97.5%. The timing of these expected payments is consistent with past practices. Of the remaining 2.5% of uncollected base rental billings, 1% has been deferred and 1.5% is associated with smaller tenants that have been impacted by the pandemic. We have not received any new rent deferral increase in the Q3. We incurred a total of $1,800,000 of credit loss in the 3rd quarter, approximately $850,000 of that loss related to the write off of straight line rent and approximately $950,000 of that loss related to cash credit loss. We have updated guidance for the remainder of 2020. We acknowledge the continued uncertainty related to the health of the economy and we'll continue to update the market as warranted. Components of our updated 2020 guidance are as follows: We have increased our expected acquisition volume range, now projecting between $650,000,000 $750,000,000 with an expected cash cap rate range of 6% to 6.25 percent and expected straight line cap rate range of 6.5% 6.75%. We have increased our 2020 disposition volume range, now projecting between $150,000,000 $200,000,000 We have increased our expected retention range now projected between 70% 75% for the year, which includes 2,000,000 square feet of non retention associated with the Solo Cup and GSA facilities. We have increased our expected annual cash same store range, now projecting 2020 annual same store pool's cash NOI growth to be between 75 and 125 basis points for the year. This range includes a reduction in our annual credit loss guidance to a range of 75 to 125 basis points. We continue to expect G and A to be between $39,000,000 $41,000,000 for the year. We expect to run leverage between 4.5x and 5.25x for the year. Capital expenditures per average square foot is still expected to be between $0.27 $0.31 for the year. We have increased the expected range of core flow per share to be between $1.86 $1.88 for the year, representing a midpoint increase of $0.03 With that, I will now turn it back over to Ben. Thanks, Bill. These remain challenging times as we head towards the end of an unprecedented year, challenging but not unworkable. After a pause for most of the Q2, the industrial acquisition market has found firmer footing. Tenant demand for industrial space is broadly healthy and appears to have substantial legs. We are bullish on the opportunity for STAG to lie ahead. As a reminder, we will provide granular 2021 guidance during our Q4 call. In closing, let me mention that as part of our continuing focus on various ESG initiatives, we have recently set out the STAG Industrial Charitable Action Fund. The fund is a way to formalize and channel our corporate giving. This was done in recognition of and in concert with our augmented commitment to providing substantial financial support to causes and organizations we believe in. Thank you for your time this morning. I'll now turn it back to the operator for questions. Thank you. At this time, we will be conducting a question and answer Our first question is from Danny Corbin with Citi. Hey, guys. Good morning. Good morning, Danny. Maybe just thinking about your disposition plans, have you changed the composition of what you might sell or where you might sell given sort of the way that the market has shifted? I think and I acknowledge that it's Manny, not Danny. I think that we maintain our general philosophy. We'll sell assets when somebody else thinks they're worth more than we do as a part of our portfolio. That having been said, we are getting opportunistically people reaching out to us to acquire individual assets. We did not have plans for a portfolio sale. We certainly when we signed new leases on buildings that extend the term and they may become more attractive to the people that are looking for that kind of asset. We may look at selling things. Certainly, the GSA asset is an asset that we're looking at all times on a buy or sell because of its relative attractiveness and the number of people who are interested in that asset. We're also interested in that asset and we'll do what's best for our shareholders. Hey Manny, it's Bill. We also increased our disposition guidance going into the Q4 primarily related to an asset that we had a reverse inquiry on and we expect strong results from that transaction. And just could you give us an idea of what you think the spread difference might be in cap rates between what you're selling and what you're buying? I think it varies, But I will say it varies obviously on the asset, the market, etcetera. What I will say is on these opportunistic investments, we have experienced double digit IRR return unlevered IRR returns. And so that doesn't mean it's necessarily a so we tend to compare the return on the assets to where we're redeploying the equity. But having said that, the asset that Bill was just talking about is a we will be able to redeploy those proceeds accretively. And just a reminder that the assets that we sold in the Q1 were also a sub 5 cap. So those proceeds were redeployed accretively as well. Right. And then thinking about your acquisition pipeline, that increased meaningfully in the quarter. Have you changed anything there in terms of the types of assets in the markets you're looking at and sort of maybe widened the target a little? No, it's really we've talked about this before and it certainly met our expectations is that one of the impacts of a downturn like the dramatic downturn we had with the onset of COVID is people are reluctant to bring assets to market till they have a better understanding where the market might clear. So you had a big pullback from sellers and brokers advising sellers during the Q2. The expectation was again we're hearing an anecdotally from brokers and to some extent sellers that towards the end of the summer going into the fall, you would have that pent up supply of assets to be traded come to market. Indeed, that has happened. And from talking to the brokerage community, it will continue to happen. There was perhaps dissipate a little now, some belief that their assets need to be sold before year end due to upcoming tax law changes, perhaps that's dissipated a little with the results to date on the election. But we are again, the pipeline is reflective of the same kind of filters we've always used for what gets on to the pipeline. It just expanded because more assets in the market. Great. Thanks everyone. Thank you, Manny. Thanks, Manny. Our next question is from Sheila McGrath with Evercore. Yes. Good morning. Ben, the new acquisition guidance implies a very active Q4, maybe even a record for STAG. Can you give us some insights? Do you have additional assets under contract right now? And then also you guided on the cap rate a little lower, and I'm wondering if that's cap rate compression in the market or is that the mix of assets you're acquiring? So as Bill alluded to during our prepared remarks, we have 200 plus 1,000,000 under contract or LOI, and we're still evaluating assets that might close this year, reflective of the increased pipeline, number of assets came to market, etcetera. So we're we indeed are looking at a 4th quarter that is could be the same as last year's Q4, even larger. It depends on how assets shake out in terms of whether things close, not having the contract always closes, certainly letter of intent don't always close, but we have a high degree of probability that we'll get into those kinds of volumes. The cap rates have moved south a little bit, but they moved south because of mix change, longer leases, less CapEx, in particular when we buy build to suit transactions. These are very clean from a capital required perspective, the longer lease terms, etcetera. So the one thing I will say is that we've maintained our goal on buying accretive transactions and indeed these transactions are again demonstrably accretive on both core FFO and a CAD basis. Okay. And sorry if I missed this, but you did increase your disposition guidance. What kind of assets are you selling and what's the motivation for increasing sales right now? I'm going to let Bill handle this. Sheila, yes, there's the increase in disposition guidance relates to one asset that we are not expecting to sell, but we got a reverse inquiry on. And that asset will be an accretive redeployment of proceeds once we sell that and redeploy it. So it's an attractive return for us and that's the primary reason why we increased disposition proceeds for the Q4. Yes. Sheila, as you know, we have three reasons to sell assets. 1 is opportunistically, which this is Bill just referring to is reflective of. 2 is sort of the color of the herd, our ongoing sale of our relatively de minimis office flex portfolio. I don't believe we have any assets that will be in the remainder of 2020 will fall into that bucket. And the last bucket is when we aren't happy with our cost of capital from regular common or preferred equity issuance, we would sell assets. None of that is planned. Obviously, capital is attractive. The other sources of capital are attractive to that. Okay, great. Thank you. Thank you, Sheila. Our next question is from James Feldman with Bank of America. Hi, good morning. This is Elvis Rodriguez on for Jamie. Just as we think about funding the acquisition pipeline and some of the equity forward you have, your stock today is trading about $1 above where you did that deal in January. How are you thinking about pulling down that equity this year versus potentially doing another equity deal to fund the $2,800,000,000 pipeline that you have laid out for us? Yes. Elvis, obviously the pipeline historically we bought something a relatively small portion of what's on that pipeline actually gets closed. The pipeline is dynamic, so assets come on and off at all the time. But we're certainly not expected to close anything like that large number. The I'm sorry, I just lost my way. Yes, Elvis, it's Bill. And in terms of where we are from a leverage standpoint, as I noted with our forward equity proceeds, we're 4x leverage, so sufficient runway there to get to our 5.25 leverage range this year. As we noted in our investor presentation, our long term leverage range is 4.75x to 6x. So if you were to look at where we are today, including subsequent acquisitions and the forward equity, we could acquire $850,000,000 with all debt to get to the upper end of that long term leverage range. So we have sufficient capacity here. And in regards to taking down the forward equity component, we have until I think mid January to do that. Obviously, given the amount of acquisitions, etcetera, it will be you could surmise that we will be using that equity. That's right. Okay. Well, my question was, would you do another deal in lieu of that deal given your stock is $1 higher today? I don't think that yes, I was I'm sorry if we didn't answer that question. I think they're not necessarily related. We have capital. We have attractive capital available to us and we have capital needs that we can deploy quickly. So they're not it's not either or. I think it's as I said, it's highly likely we would exercise take down that equity, but that doesn't mean that we won't have additional equity needs that we will approach the market on. Appreciate that. And then just one more question. 2021 expirations, you have about 9,000,000 square feet of leases expiring next year. Any chance you can share what the mark to market on those leases are? I think that we what we've said before is that believe our assets are at or slightly below market. I think as we've looked granularly at 2021, we believe that's to be the case for 2021 also For those assets in particular, the other thing I would say is there's nothing very bulky in 2021. The 2,000,000 square foot as we had rolled this year, we don't have anything like that in 2021. Okay. That's very helpful. Thanks guys. Great quarter. Thanks, Elvis. Our next question is from Brendan Finn with Wells Fargo. The term on new leasing this quarter was only like 2.5 years, which looked like it was the lowest since 2017. Was that impacted by those same leases you guys mentioned in the prepared remarks that had an impact on leasing spreads or you guys seeing shorter lease term just across the board? Well, I'm going to give this to Bill to answer, but I mean generally speaking lease renewals tend to be 3 to 5 years. So in the long run trends that's not an unusual number, but I'll turn it to Bill. Yes. Hey, Brendan, that was driven by really one lease and that was one of the leases that rolled down. This was a lease that we signed for a little over 1 year with the expectation that we can negotiate with the tenant for a longer term lease. And the 1st year lease was, call it, a teaser rate. It rolled down 18%, but we expect market is to roll back up about 12% in a year. So it's a little nuance with the way it gets accounted for, but it was a little over a 1 year lease, which drove the weighted average lease term on new leases down a bit. And I'll get the Brendan, I guess, used one of my favorite terms, a small sample anomaly. Sounds good, guys. And then I just wanted to clarify your comments on your plan for the GSA facility. So are you planning to lease that first and then sell it? Or would you be open to selling it before signing a lease there? And then similarly, are you looking to potentially sell the 48 adjacent land once you get the entitlements for development there? Or are you only going to sell the building and then just continue with developing on those adjacent parcels? I think the answer is that we're moving forward on all fronts. We're moving forward to permit the development. We continue to talk to people who are interested in portions or all of the building. And at the same time, we're talking to people that are interested in buying any or all in any mix as we move forward. Dave, do you have anything? No, that's accurate. Thanks, guys. It's just an attractive collection of opportunities between the existing building and the development potential. There's even people who are looking at buying the existing building, scraping it and building a new building. We think you're going to put close to 1,500,000 square feet, I think on there in a brand new building. And although we bought an existing structure, the value of the land in that very attractive submarket has gotten to the point where the land value maybe as much as the existing building and the development potential. So it's a collection of very attractive opportunities. Our next question is from John Massocca with Ladenburg Thalmann. Good morning. Good morning. So if you look at the transactions that closed kind of subsequent to quarter end, it seems you need to kind of just divide the gross numbers by the amount of assets you've closed on, I think a little bit larger in both in terms of square footage and then kind of cost per asset. I mean is there some larger assets in there that are maybe skewing that? Or is it just slightly larger assets all around that you're buying in October November? Yes, John, I'm going to give that to Bill to answer. The answer is yes, larger assets, but Bill will give you some detail. Yes, that's right. I mean, John, it's simple math there, but there's a mix and these are assets that meet our long term investment thresholds. As with every year, there's smaller assets and larger assets that we acquire. I mean, even looking at this quarter, we acquired a small asset at 50,000 square feet and as large as 276, but subsequent to quarter end, there certainly are some larger assets in there. And I guess it's an arbitrary number, but I guess there's some 1,000,000 square footers that are kind of skewing that those numbers in there? Not 1,000,000 square footers, but big buildings. Okay. Understood. And then maybe as we think about kind of the deferrals and the kind of non cash payments, that 1.5%, how is that maybe broken out between people, where you're just having either a negotiation or have been able to have a negotiation in tenants that are currently in default or not in default, but in bankruptcy? It's tenants that have been impacted by the pandemic. I mean, they're not in bankruptcy, but we're having discussions with them. Some of them are we're having discussions about potentially a deferment or a payment schedule. Others there, we're just working with them to understand their situation. So it's just a it's a mix of assets. I will say, and as we said before, all of this is reflected in our credit loss guidance for the year. So I think when you take a step back, that's the focus that's the area you should focus on is what's in our same store, what's our credit loss guidance, what's our FFO guidance, all factored into that. And given, call it, 6, 7 weeks left in the year, we feel really confident with our guidance we put forth. I know I'm asking a bit for kind of early 2021 guidance, but do you think that kind of credit loss outlook flows into next year or you think you can get some recovery on those smaller amounts? Yes. As Ben said, we'll give our guidance in February for 2021. I will say the stimulus has been probably the biggest thing we struggle to estimate and how that impacts our tenants. And thus far, it's been outperforming our estimates in terms of the recovery. As you can see with the guidance this year, our credit loss guidance has continued to come down as we move through the year. Okay. Understood. And then on the investment front, how do you think maybe a potential kind of surge here in pandemic could impact the ability to close deals either 4Q or maybe even 1Q 2021, just given what happened earlier in the year in terms of deal volume with kind of the first phase of the pandemic? So the impact on deal volume earlier was not maybe for a very short period of time was reflective of the fact that we couldn't get people out to see buildings or people weren't working or anything like that the closing process was impacted by that. We have been able to utilizing up to 3rd parties, some level of travel, Google Maps, whatever else and 3rd party consultants obviously to get a closing process that is, I believe, is pretty resilient to whatever happens with the pandemic, short of a total lockdown, which I don't think anybody really expects at this point. So we're feeling very good about our ability to transact. Again, people have gotten used to operate and particularly we have been used to operate in this environment. So we're feeling pretty good about our ability to transact going forward. And the sellers are the initial drawback from offering assets to the market certainly has dissipated or disappeared completely. Understood. That's it for me. Thank you all very much. Thank you, John. Thanks, John. Ladies and gentlemen, we have reached the end of the question and answer session. I would like to turn the call back to Ben Butcher for closing remarks. Thank you all for joining us this morning. The word unprecedented gets used a lot, but certainly we are in unprecedented times generally. I think that the as we just stated, our ability to operate here has been demonstrated. The opportunities abound. The short term malaise that may affect the country as we work through the end of this election, I believe, will be just that short term. We don't expect that to have any long term impact on our business and hopefully no long term impact on our country. Again, we thank you for your time morning and look forward to continue to provide good results for our shareholders. This concludes today's conference. STAG International thanks you for your participation. You may disconnect your lines at this time.