First Industrial Realty Trust, Inc. (NYSE:FR) Q1 2024 Earnings Call Transcript

First Industrial Realty Trust, Inc. (NYSE:FR) Q1 2024 Earnings Call Transcript April 18, 2024

First Industrial Realty Trust, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, and welcome to the First Industrial Realty Trust, Inc. First Quarter Results Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Art Harmon, Senior Vice President of Investor Relations and Marketing. Please go ahead.

Art Harmon: Thank you, Dave. Hello, everybody, and welcome to our call. Before we discuss our first quarter 2024 results and our updated guidance for the year, 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, April 18, 2024. 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 Chief Executive Officer; and Scott Musil, our Chief Financial Officer, after which we’ll open it up for your questions. Also with us today are Jojo Yap, Chief Investment Officer; Peter Schultz, Executive Vice President; Chris Schneider, Executive Vice President of Operations; and Bob Walter, Executive Vice President of Capital Markets and Asset Management. Now let me hand the call over to Peter.

Peter Baccile: Thank you, Art and thank you all for joining us today. Since our last call in February, our team has signed two big development leases and we continue to make progress on our 2024 renewals at strong cash rental rate increases both of which I will discuss shortly. Looking at the industrial market broadly, vacancies ticked up to about 5.3% as new development projects that were started in 2023 have come online. For 2024, CBRE projects completions of approximately 300 million square feet. As those projects are delivered, we expect national vacancy to increase to the mid-6% range in the coming quarters. Importantly, the market has demonstrated some discipline with respect to new starts. No doubt that the high cost of construction debt has helped.

For the past three quarters, starts have averaged just 42 million square feet, which is more than 60% below the recent peak of $114 million in the third quarter of 2022. The increased level of prospect traffic for our development that we experienced toward the end of 2023 has continued into 2024 and some significant leasing decisions have been made. To that end, we signed full building leases at our 500,000 square foot First Rockdale IV in Nashville and our 1 million-square-foot First Stockton Logistics Center in Northern California. Updating you on our progress on lease signings to date related to 2024 expirations, we’ve taken care of 68% weighted on-net rent. Including the impact of new leasing, our cash rental rate increase currently stands at 45%, which is near the midpoint of our 40% to 52% full-year forecast that we provided on our last earnings call.

Our results to date reflect a renewal of one of our three largest expirations, all of which are located in Southern California. For guidance purposes, we have assumed one of the remaining two will renew. Moving now to dispositions. In the first quarter, we sold nine properties comprised of 433,000 square feet for a total of $49 million. This puts us well on our way to achieving our full-year sales guidance of $100 million to $150 million. The largest sale was the five-building 278,000 square-foot portfolio in Cincinnati for $33 million that we discussed on our February call. The remaining $16 million consisted of 165,000 square feet located in Chicago and Detroit. As I noted on our last call, 2024 has been a particularly challenging year to project the pace and timing of leasing in our portfolio due to the economic uncertainty, increasing volatility in the capital markets and the interest-rate outlook and the rapidly evolving geopolitical environment.

Over the past few weeks, these factors have once again given some tenants reason for pause. As a result, with respect to our broad-based same-store leasing assumptions for the year, we decided to make some adjustments, which are reflected in our updated guidance. With that, I’ll turn it over to Scott.

Scott Musil: Thanks, Peter. Let me recap our results for the quarter. NAREIT funds from operations were $0.60 per fully diluted share compared to $0.59 per share in 1Q 2023. As a reminder, our first quarter 2023 results included $0.02 per share of income related to the accelerated recognition of a tenant improvement reimbursement associated with a departing tenant. Excluding that $0.02 per share, first quarter 2023 FFO per share was $0.57. Our cash same-store NOI growth for the quarter excluding termination fees was 10%. The results of the quarter were driven by increases in rental rates on new and renewal leasing, rental rate bumps embedded in our leases and lower free rent, which were partially offset by lower average occupancy.

We finished the quarter with in-service occupancy of 95.5%, the same rate as year-end 2023 with our 500,000 square foot Nashville lease offsetting some expected move-outs. As we continue to lease up our developments, we expect our in-service occupancy to increase in the second half of the year. As we stated on our fourth quarter earnings call, developments that we placed in service in the third and fourth quarters of 2023 that were not fully leased had approximately 240 basis points of occupancy opportunity. With the lease-up of First Rockdale IV, the lease-up opportunity from these developments now stands at 160 basis points. Before I touch on guidance, let me remind you that on the capital front, we are strongly positioned with no debt maturities until 2026, assuming the exercise of extension options in two of our bank loans.

Also, our expected 2024 asset sales, combined with our excess cash flow after capital expenditures and dividends will exceed the amount required to fund completion of our developments in process. Moving on to our updated 2024 guidance per our earnings release last evening. Due to changes in some of our same-store leasing assumptions that Peter discussed, our guidance range for FFO is now $2.55 to $2.65 per share. This is an adjustment of $0.01 per share compared to our prior guidance. Note, as we detailed on our fourth-quarter earnings call, our guidance excludes approximately $0.02 per share of accelerated expense related to accounting rules that require us to fully expense the value of branded equity-based compensation for certain tenured employees.

Including this $0.02 per share of expense, our NAREIT FFO guidance range is $2.53 to $2.63 per share. Key assumptions for guidance are as follows: quarter-end average occupancy of 95.75% to 96.75%, a reduction of 25 basis points at the midpoint. Same-store NOI growth on a cash basis before termination fees of 7.25% to 8.25%, primarily driven by increases in rental rates on new and renewal leasing along with rental rate bumps embedded in our leases. This is an adjustment of 75 basis points at the midpoint. Note that the same-store calculation excludes the 2023 one-time tenant reimbursement that I discussed earlier. Guidance includes the anticipated 2024 costs related to our completed and under-construction developments at March 31st. For the full year 2024, we expect to capitalize about $0.05 per share of interest.

Our G&A expense guidance range is $39.5 million to $40.5 million, and this excludes the roughly $3 million in accelerated expense I referred to earlier. Lastly, guidance does not reflect the impact of any future sales, acquisitions, development starts, debt issuances, debt repurchases or repayments nor the potential issuance of equity after this call. Let me turn it back over to Peter.

Peter Baccile: Thanks, Scott. We’re very pleased with the two major development leasing wins to kick-off the year. Our team is focused on building on that success with additional development leasing and capturing rent growth from lease signings in our in service portfolio. Operator, with that, we’re ready to open it up for questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Ki Bin Kim with Truist. Please go ahead.

Ki Bin Kim: Thank you. Good morning. Congrats on the Stockton lease. So I had a couple of questions on developments. I noticed that the couple of assets that you placed into service that the yield and profit margins were adjusted lower. I mean, thankfully, these are just smaller projects, but just more broadly speaking, should we be just aware of any other risk in the development portfolio as some of these projects near completion or leasing? And if you can provide an update on the prospect activity that you’re seeing in your other development projects, please. Thank you.

Peter Baccile: Jojo, do you want to take that?

Jojo Yap: Yes, Ki Bin. No, I wouldn’t say that the outlook and the forecast is pretty much similar. We made some adjustments though as we do every quarter. We look at exit caps, we look at pro-forma yields and of course, the result of that is the profit margin. So overall, top-level, we increased our exit caps by about 18 basis points. So that’s about, we ended up overall average about 5.22 cap-rate, which we think is appropriate or slightly conservative. And then on the pro-forma side, what we did, we adjusted some rents in pro forma and i.e., that resulted in an increase of about 16 basis points of increase in pro forma, actually a reduction of 16 basis points on a pro-forma yield. If you add that together, Ki Bin, what you’ll notice that that’s our overall reduction on everything in our supplemental in terms of our developments of about 4 percentage points from about 36% to 32%. So it’s a slight adjustments overall in.

Peter Schultz: And then Ki Bin, it’s Peter Schultz. To your second question on activity on the rest of the development pipeline. As you look at what we have in Florida, Pennsylvania, Denver and Jojo can comment on California, activity overall is good. We have active prospects for all or portions of the space. I would say some are moving more deliberately while others continue to move slowly and it’s really about the timing of those decisions more than it is the level of interest. And we continue to see, as Peter remarked in his comments about the evolving narrative on interest rates and some of the geopolitical issues were a little bit of a headwind to people making decisions. But overall activity is pretty good. Jojo?

Jojo Yap: Yes, and just to — nothing really to add to Peter’s comment except that I just said that we appropriately adjusted the sum of the rents.

Ki Bin Kim: And just a quick follow-up on Baltimore. I noticed the occupancy rate dipped a little bit sequentially. I’m not sure about the timing of the Old Post Road lease-up, but I was just curious if there’s anything else that drove the occupancy lower?

Peter Schultz: Ki Bin it’s Peter again. So we had one known move-out at year-end in the Hagerstown submarket, which is along the I-81 corridor, that is part of our Baltimore portfolio, 309,000 square feet. So we’re marketing that space as a portion of a larger building. No other change in occupancy in Baltimore. Your question on Old Post, so the larger Old Post building took occupancy in December of last year and then the lease that we announced earlier, half of the smaller building that commenced in the first quarter.

Ki Bin Kim: Okay. Thank you, guys.

Operator: The next question comes from Rob Stevenson with Janney. Please go ahead.

Rob Stevenson: Hi, good morning, guys. Just a follow-up on Baltimore. I know it’s early, but any markets, assets, submarkets benefiting from additional demand given what’s happened at the port after the Key-bridge tragedy?

Peter Schultz: So Rob, it’s Peter Schultz. We’re not seeing any change in demand or impact to our tenants, given the tragedy, as you said, in Baltimore. You probably know that there are already a couple of temporary channels that have been reopened. A third will be opened in the next week or two. The expectation is the port is back in full service by the end of May. So while it’s inconvenient in the near term, we think that that resolves itself here fairly quickly. We’re not seeing any real change in demand positive or negative from that incident.

Rob Stevenson: Okay. That’s helpful. And then, Scott, the property expenses in the quarter were significantly higher than sort of run-rate. I know that you’ve had — that there was some G&A I believe is the $0.02 in the guidance from the additional expenses. I assume that that’s in G&A. But can you talk about what’s happening on the property operating expense side and what that’s likely to look like throughout the remainder of the year?

Scott Musil: Yes, Rob, it’s Scott. The $0.02 are in G&A, and I’m going to turn it over to Chris to talk about the property expenses.

Chris Schneider: Yes, I just saw the property expenses for this quarter. It was all related to recoverable snow removal expenses are up, so it’s. And again, they’re all recoverable. So that was a reason for that.

Rob Stevenson: Okay. That’s helpful. Thanks guys. I appreciate the time.

Operator: The next question comes from Vikram Malhotra with Mizuho. Please go ahead.

Vikram Malhotra: Good morning. Thanks for taking the questions. Maybe just first one on the, going back to the development. Could you just update us on your new — your development lease-up guide? If I’m not wrong, I think it was like high 2s. I just want to see with all the progress you’ve made, what’s — is there an updated version of that? And then just related to that specifically, can you give us a sense of the timing for all what you’ve done so far? When does that impact FFO?

Scott Musil: Yes. So I’ll walk through that Vikram. It’s Scott. So just a little longer of an answer, but I think it makes sense to go through what we talked about on our fourth quarter call in February. So on that call, we said we had about 2.8 million square feet of development lease-up we included in our original guidance. 500,000 square feet of this pool that was the Rockdale deal was leased up in the first quarter leaving 2.3 million square feet of development leasing still in our forecast. The majority of this leasing is assumed to start in the back half of the year. The other 1 million square feet of development leasing that was First Stockton in the first quarter was not budgeted in our original guidance. As Peter mentioned on our last quarter’s call, development leasing is going to be difficult to predict in 2024.

In some developments, we will beat our forecast and in other cases, we won’t. So some of the development leasing we have completed is ahead of our forecast. So we in essence have used some of this early leasing benefit to offset some other development lease timing assumption changes we made to our forecast. Does that help?

Vikram Malhotra: Yes. That’s helpful. And then just specifically on just the development. I think there’s a big asset in Colorado close to 600,000 square feet. I think in the past, you’ve debated, is there a full user or do we multi-tenant it. Can you just update us on that?

Peter Schultz: Sure, Vikram, it’s Peter Schultz. We continue to see activity for portions of the building as well as a couple of full building users. The larger users, as I said a few minutes ago, the decision-making there tends to be slower. But we continue to have activity for both partial and full building users. The building is designed to be multi-tenanted, which was our expectation when we built it. I don’t have any actionable updates to give you today on any lease signings, but we continue to see activity. As we’ve said a couple of times, it’s more about the timing and the pace of that decision-making that we’re really focused on.

Vikram Malhotra: Okay. And then just one more if I may. Can you just update us on maybe SoCal in general, but just specifically those three — the three expirations, did you — can you just remind us, did you always assume two out of three and one may not renew or just — maybe just walk us through kind of how you’re thinking about those three leases?

Peter Baccile: Yes. Hi, it’s Peter. On the rollovers, we always did assume one would not renew. And so we’re right on schedule with those and Jojo can give you a broader perspective on what’s going on SoCal.

Jojo Yap: Sure, sure. Basically in SoCal, completions exceeded absorption, so vacancy rates, those did tick-up. And so renewal activity, though, continue to be active and discussions are across, I would say all sizes. New leasing though, the environment is slower, just like both Peter Schultz and Peter Baccile said, the prospective tenants are taking more time to decide and are touring more properties before committing and some are deferring their decisions. One other thing in SoCal is that port activity, Q1 of this year as measured by loaded import containers only in Port of L.A. and Port of Long Beach is 26% higher than last year. So we’re hopeful that that has a positive impact going forward.

Peter Baccile: So, that container traffic is about equal to about 2018s.

Jojo Yap: 2018, 2019, correct.

Peter Baccile: Which if you recall.

Vikram Malhotra: Got it.

Peter Baccile: Pretty good, market.

Vikram Malhotra: Makes sense. Thank you.

Operator: The next question comes from Todd Thomas with KeyBanc Capital Markets. Please go ahead.

Todd Thomas: Hi, thanks. Good morning. Just I wanted to first ask about, just given some of the progress that you’ve made now on the SPEC leasing development in the quarter and we saw the increase in your SPEC leasing cap. I’m just curious, you’ve talked about build-to-suits and some developments moving forward, curious what the appetite is like here, how we should think about the timeline for you to maybe, you know, shift offense a little bit more just given that new starts are down more broadly, 50% or more in most market.

Peter Baccile: Yes. So we do have about $300 million now of capacity in our cap. That’s a number actually that’s pretty similar to what we used to carry on a regular basis through call it 2018, ’19, ’20. It is very possible that in the near term, you’ll hear from us on a couple of starts. As we’ve said on previous calls, those are likely to be in South Florida. As we evaluate other start opportunities across the country, those decisions will be made largely based on how we see development leasing proceeding in those markets. We have some existing assets in those markets. And when we lease those, we’ll have a better view about the stickiness of demand and the pace of decision-making. So again, as those deals come to fruition that would give us confidence that more starts in those markets are warranted.

Todd Thomas: Okay. And then just a question on the guidance in terms of the guidance revision and sorry if I missed this in the commentary, but I’m just curious if what the offset is to the decrease in the same-store growth forecast, which is a little bit more than the $0.01 FFO revision that was made. What’s the offset to that decrease?

Scott Musil: Well, the penny decrease is primarily due to same-store. So there’s a little bit of, we’re ahead of budget on those two development leases. We utilized a little of that, but we also utilized that ahead of budget leasing, Todd to adjust some of the lease-up assumptions we have for the remaining developments. So that’s the math from that point of view.

Todd Thomas: Okay. So it’s primarily on the development lease-up offsetting the same store. Got it. Okay. All right. Thank you.

Operator: The next question comes from Rich Anderson with Wedbush. Please go ahead.

Rich Anderson: Hi, thanks. Good morning, everyone. So I want to talk about tenant behaviors and leasing decisions are delayed but not done. And you yourself are looking at that situation and actually raising your speculative capacity. What gives you confidence that it is just a push-back in timing and not something more permanent in terms of tenant demand. Are you talking to people saying, we’re going to do this, but we just need more time. There’s every possibility that we could have more of a permanent depressed demand condition, could we not? And if we do, then what’s the reaction from First Industrial?

Peter Baccile: Yes, I’ll give you kind of a broad overview and then Peter and Jojo will give you their thoughts. These discussions are happening over a pretty long period of time. And we can see from those discussions on the level of enthusiasm as it changes based on what’s been happening in the broader markets and by broader markets, I mean everything from what’s being talked about with inflation, the Fed and rates, all the negative news we’re getting from around the world, it’s — you can see where that is having a big impact on how aggressively or otherwise these conversations are proceeding. By and large, it’s not like these tenants are going away and doing trades elsewhere. We’ve had tenants come back after two or three months and want to reinvigorate conversations.

It’s just a — we have a good sense there that it is a matter of when and not if. Now, if the world gets a lot worse, it could be a matter of if, but we aren’t seeing that right now. Peter, you want to add to that?

Peter Schultz: Sure. I would say, demand continues to be very broad-based. E-commerce and particularly the largest occupier in that space was very active in the first quarter. Indications are they’re on track to lease more in the first half of this year than they leased all of last year. Market expectations is they may double what they did last year. So that’s certainly a good sign, which has tended to be a catalyst for other companies making decisions as well. We continue to see a lot of activity from 3PLs, but those decisions in particular, because they’re waiting on the commitment of customers continue to be elongated for all the reasons we’ve talked about before. We’re seeing some retailers, we’re seeing some automotive, we’re seeing some medical and food and beverage.

So the breadth of the activity continues to be good. And nobody’s, rarely do we see people tell us that their requirement is canceled. It’s simply a matter of, in some cases, they have more choices, so there’s less urgency and that varies from market to market. But we feel good about the breadth, we feel good about the activity across some of our smaller spaces has held up very well and it seems to be the larger spaces have more choices and just slower decision-making today. But overall, we feel pretty good. Jojo, anything else you want to add?

Jojo Yap: Yes, the only thing that I would add is that in the biggest part of our business, which is the leasing our existing buildings, our renewal activity, discussions has continued to be solid. The executions there have been pretty much the same as last year. You can see that in our cash rent change, and a number of tenants in our discussions would like to expand, hit the pause button as well. And so those give us confidence that a lot of our portfolio, which is a bigger part of our business is feeling good about operating out of our spaces.

Rich Anderson: Great. Thanks for that color. And then the second for me. I don’t know if you said what your mark to market is, but let’s say it’s 50% or whatever and you have flattish market rent growth and still your typical contractual escalators. Is it as simple as that? Like in terms of how the mark to market will move as you release space? And at what point do you get into a situation where the mark-to-market becomes more pedestrian? And just because of the — sort of the flatness of the market and the ongoing rent escalators, I’m just curious, what’s the tail here that’s still in front of you?

Peter Baccile: Yes, rents have grown so much that there is some resiliency in the durations of that mark. Now that’s in a scenario where rents are, let’s say, falling as much as 5% or flat or up five in that range. Obviously, if rents fell significantly more, the duration of that mark comes down. But at this point, it looks like the sector should enjoy some pretty good rent increases for some time.

Scott Musil: And Rich, just to be clear, we haven’t given a mark to market calculation.

Rich Anderson: Okay. Thanks very much.

Operator: The next question comes from Craig Mailman with Citi. Please go ahead.

Craig Mailman: Hi, just going back to the kind of the hesitancy of tenants here to make decisions. I mean, how much is rent, actual nominal levels of rents coming into play in certain markets like LA or New Jersey, where rents on a per square foot basis are just higher than other markets? Is that playing into their kind of mentality at all and leading to hesitancy? Or is it just — really just the uncertainty on playing the business at this point?

Peter Baccile: Craig, probably the best indicator or the best way to answer that question is that, yes, in the markets where rents have grown the most obviously SoCal in a period of two years, they practically doubled in ’21 and ’22. They grew decently last year. Those are markets where the probability of deals getting done at a little bit lower or lower than peak rent is higher. And as we do both — have both rollover and renewal discussions and talk to tenants about taking new development space again that phenomenon plays into that conversation. I wouldn’t call it an affordability thing. That’s not the issue. It is that rents have grown tremendously in some markets and that would impact the pace of those discussions.

Craig Mailman: Okay, then you guys have mentioned and others had mentioned clearly Amazon’s coming back into the market. So e-commerce feels like maybe we’re in a period of expansion. But as you goes through, kind of where, if you could gauge kind of by industry vertical, where there’s the most hesitancy to make decisions today versus where people are more close to kind of needing to take space to fund the five-year business plan. Is there any kind of discernible trends you’re seeing?