First Industrial Realty Trust, Inc. (NYSE:FR) Q4 2023 Earnings Call Transcript

First Industrial Realty Trust, Inc. (NYSE:FR) Q4 2023 Earnings Call Transcript February 8, 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. Fourth Quarter Results Call. All participants will be in listen-only mode. [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: Thanks very much, Dave. Hello, everybody and welcome to our call. Before we discuss our fourth quarter and full year 2023 results and our initial ’24 guidance, 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, February 08, 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, and thank you to all of the members of the First Industrial team who navigated a challenging 2023 to once again produce some great results. We delivered another record year of cash rental rate growth on new and renewal leasing and then laid the groundwork for another strong year in 2024. We executed on both sides of the transaction ledger with attractive new investments and impactful sales. We finished a year with some key leasing wins in our in-service portfolio and our developments. Moving now to the broader industrial market, the increased level of tenant traffic we saw towards the end of 2023 has continued into 2024. With the overall economic picture and interest rate environment becoming a bit more clear and with slightly lower market volatility, more businesses are revisiting their space needs for growth.

On the supply side, as you know, starts nationally ramped up in 2022 and early 2023 to meet customer demand driving national vacancy to around 5%, still low by historical standards. Those projects have made and are making their way into inventory with completions for 2023 totaling $487 million square feet compared to net absorption of 239 million square feet according to CBRE. Importantly, the market has responded to this imbalance appropriately with new starts down around two-thirds from the peak. Within our portfolio, broader activity has resulted in several signed leases in both our in-service portfolio and new developments. We’re pleased to announce two big long-term leasing wins in Baltimore. We leased 100% of the 644,000 square foot old Post Road asset to a government-related 3PL and 50% of our neighboring 349,000 square foot asset.

In our development portfolio, inclusive of our Phoenix Joint Venture, we signed a total of 651,000 square feet of leases since our last call. In the fourth quarter, we signed a 209,000 square foot lease at our First Park 94 building in the Kenosha submarket of Chicago. We also signed a 26,000 square foot lease at our first loop development in Orlando. So far in 2024, we’ve signed a 40,000 square foot lease at our first 76th Logistics Center in Denver. Also, in our Phoenix Joint Venture, we signed two leases at the 376,000 square footer to bring that building to 100% lease prior to completion. We’ve now fully leased two of the three JV buildings with the thirds slated to be completed in the second quarter. For the developments we placed in service in the third and fourth quarters of 2023 that are not currently fully leased, we have approximately 240 basis points of occupancy opportunity.

We’re seeing prospect activity at most of these assets, so we hope to have more progress to report throughout 2024. As I mentioned in my opening remarks, we set a new annual record for cash rental rate increase for new and renewal leasing in 2023 of 58.3%. 2024 is also off to a good start. To-date regarding lease signings related to 2024 commencements, we’ve taken care of 53% by rental income at a cash rental rate change of 39%. We have a few leasing opportunities within our Southern California portfolio over the balance of the year, which we expect will bolster this metric. Overall for 2024, we’re currently forecasting cash rental rate growth on new and renewal leasing of 40% to 52%. Moving now to the investment side, we brought home a few attractive deals during the fourth quarter for an aggregate purchase price of $37 million.

In Southeast Houston, we added a fully leased 54,000-square-foot building at our Energy Commerce Business Center asset. With this addition, we now own all five buildings totaling 676,000 square feet in this well-located park with frontage on Beltway 8. We also completed a sale leaseback transaction for a 69,000-square-footer in the Inland Empire West. Longer term, this investment provides us an opportunity to build a new 175,000-square-foot building on the site when the lease expires. Lastly, we acquired a nine-acre land site in Orlando for which we have a built-to-suit tenant in tow for 112,000-square-foot project. Our total investment, including the land, will be approximately $21 million, and the tenant is expected to take occupancy in 2025.

Moving now to dispositions. In the fourth quarter, we sold 785,000-square-feet for $64 million. The largest sales were two buildings in Cincinnati for $23 million and a 264,000-square-footer in Central PA for $21 million. For the year, we sold 1 million-square-feet plus two land sites for a total of $125 million. With these property sales, we ended the year with 95% of our rental income in our 15 target markets, meeting the goal we laid out at our 2020 investor day, and 57% in our coastal markets, which exceeded the 55% high end of our target range. Scott will update you shortly on how we performed on our $260 million AFFO opportunity. Thus far in 2024, we closed on a five-building, 278,000-square-foot sale in Cincinnati for $33 million. For the full year 2024, we expect sales of $100 to $150 million.

Regarding our dividend, given our performance and outlook for growth, our board of directors has declared a dividend of $0.37 per share for the first quarter of 2024, or an annualized rate of $1.48. This represents a 15.6% increase from the prior rate and a low payout ratio of approximately 70% based on our anticipated 2024 AFFO, as defined in our supplemental. With that, I’ll turn it over to Scott to provide additional details on our performance and our 2024 guides.

Scott Musil: Thanks Peter. Let me recap our results for the quarter. NAREIT funds from operations were $0.63 per fully diluted share compared to $0.60 per share in 4Q 2022. For the year, NAREIT FFO per share was $2.44 compared to $2.28 in 2022. Excluding $0.02 per share of income related to the accelerated recognition of a tenant improvement reimbursement associated with a departing tenant, 2023 FFO per share was $2.42. As a reminder, our fourth quarter and full year 2022 results included a penny per share of income related to the final settlement of insurance claims for damaged properties. Excluding this impact, fourth quarter and full year 2022 FFO per share was $0.59 and $2.27 respectively. Our tax same-store NOI growth for the fourth quarter excluding termination fees was 7.2% and for the year it grew 8.4%.

Our 2023 results were driven by increases in rental rates on new and renewal leasing, rental rate bumps embedded in our leases, and lower free rents were partially offset by a slightly lower average occupancy and an increase in real estate taxes. We finished the quarter with in-service occupancy of 95.5%, 10 basis points from the prior quarter helped by leases in Baltimore and Chicago partially offset by developments placed in service. Now we’d like to take a moment to recap our $260 million AFFO opportunity that we laid out at our 2020 Investor Day. We discussed the opportunity to grow our AFFO as defined in our supplemental to $260 million or $1.97 per share on a steady-state basis by fiscal year 2023, including the $41 million potential NOI impact related to the funded portion of our unleashed developments for 2023 AFFO approximates $289 million, $2.13 per share, which is well above the opportunity we discussed at our 2020 investor day.

Before I review guidance, let me remind you that on the capital fund we are strongly positioned with no debt maturities until 2026, assuming the exercise of extension options in two of our bank loans. Also with our planned 2024 asset sales that Peter discussed and our expected excess cash flow after capital expenditures and dividends, we will have sufficient funding to complete our developments and process. Moving on to our initial 2024 guidance for our earnings release last evening, our guidance range for AFFO is $2.56 to $2.66 per share. Note that guidance excludes approximately $3 million or $0.02 per share of accelerated expense related to accounting rules that require us to fully expense the value of granted equity based compensation for certain tender employees.

Including this $0.02 per share of expense, our NAREIT AFFO per share guidance range is $2.54 to $2.64. Key assumptions for guidance are as follows. We are projecting quarter and average occupancy of 96% to 97%. Same-store NOI growth on the cash basis before termination fees are 8% to 9%, primarily driven by increases in rental rates on new and renewal leasing and rental rate bumps embedded in our leases. Note that the same-store calculation excludes the 2023 tenant reimbursement that I discussed earlier. Guidance includes the anticipated 2024 costs related to our completed and under construction developments at December 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.

This includes the roughly $3 million in additional expense I referred to earlier. We expect first quarter G&A expense to be higher than each of the remaining quarters. 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. Thanks again to my teammates for all of their efforts in 2023. We’re excited about the opportunity to drive cash flow growth by continuing to capture market rent growth in our portfolio from new and renewal leasing, the embedded NOI opportunity within our completed and in-process developments and from our annual escalators and our leases. Also, we are well-positioned with coastally oriented land sites that can be put into production and provide attractive risk-adjusted returns as market conditions warrant. Operator, with that, we’re ready to open it up for questions.

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Q&A Session

Operator: We will now begin the question and answer session. [Operator Instructions] Our first question comes from Vikram Malhotra. Please go ahead.

Unidentified Analyst: Good morning. This is Georgie [ph] on for Vikram. Can you walk us through your thoughts on further leads up and in which markets have you seen any signs of weakness and strength?

Peter Baccile: I think you asked if we can comment on leasing prospects and weaknesses and strengths across markets. Is that right?

Unidentified Analyst: That’s correct.

Scott Musil: Okay, Peter.

Peter Schultz: Sure. This is Peter Schultz. Generally speaking, we’ve seen an increase in activity and tenant engagement in the last 60 days or so from the second half of last year. Activity, broadly speaking, is better in the smaller mid-sized spaces. And that’s relative to which submarkets and markets. Those are in, as an example, in Denver and South Florida, that might be 50,000 feet and under, in Pennsylvania and Nashville that’s 300,000 to 500,000 feet. Jojo, I’m sure we’ll have some comments about California for you. We’ve also seen a higher level of urgency in some cases from some tenants making decisions quicker. Although I would say a lot of tenants still continue to be somewhat cautious and methodical about their decisions. But we’re encouraged by the level of activity that we’re seeing today. Jojo, anything you want to add to that?

Jojo Yap: Yes, thanks, Peter. So in the last 60 days, activity, tour activity, proposal activity has increased over Q4, ’23. And what I’d just like to add to is the major companies that are touring in both 3PLs, I would say, general retail wholesale, food and beverage, e-commerce, and manufacturing, and auto related.

Unidentified Analyst: Thank you. That is helpful. And just a follow up for me. What rent spreads are baked into the guidance? And where do you see overall market rent growth this year?

Peter Schultz: I’m sorry, the first part of your question.

Scott Musil: Rent spreads in the guidance, which is the 40% to 52% cash rental rates that we have articulated in our script.

Jojo Yap: Right, so, a midpoint of 46%.

Unidentified Analyst: Yes.

Peter Schultz: Rent growth in ’23. So we, at the beginning of ’23, expected it to be about five to 10% kind of a wide range. We weren’t real sure in a year where the markets were moving quite a bit with a lot of volatility. It ended up by rent grew in our portfolio about 8%. So we’re right in the middle of that range. For 2024 we’re looking at rent growth that approximates inflation plus a point or two. So say 3% to5% is our expectation.

Unidentified Analyst: Thank you for taking my questions.

Operator: The next question comes from Ki Bin Kim with Truist. Please go ahead.

Ki Bin Kim: Thanks. Good morning. And congrats on leasing up Old Post Road. I know that was your favorite topic.

Scott Musil: Peter is smiling.

Peter Schultz: Thank you Ki Bin.

Ki Bin Kim: So turning to Inland Empire project, I think the last time we spoke. You talked about for all your projects. You had about one or two prospects with obvious challenge being that these tenants have multiple options. So could you just provide an update on the tenant demand that you’re seeing that market? Perhaps how you’re calibrating leasing strategy and just overall, like, how should we think about the pace of lease up?

Scott Musil: Yes, I will start. And then Jojo will talk more about SoCal in particular. This year, honestly, is a difficult year to project. The pace is tough to call. We’re in this period of time now where we think things are improving, less market volatility, a little bit more confidence, inspiring economic data coming out. What I mean by that is, it’s easier for potential tenants to begin to make decisions about what would be rather large investments if they take down larger properties, so all that is good. The difficult part, Ki Bin, is deciding, what the pace of that activity is with respect to the activity turning into ink. So that’s part of the challenge for us this year and the projection and Jojo, you can talk more about traffic.

Jojo Yap: Sure. And so, in terms of, you know, in Q4, there’s quite a bit of lots of monster of new completions that exceed instructions. So the market is digesting through digital supply. Some of the positive things that we’re seeing in the market right now is that if you look at the productivity in the last four months of ’23, compared to the last four months of ’22, it actually increased by 20%. So that’s, you know, if that continues, then there’s definitely going to be a little bit more activity. Recently freight activity, when I say freight, truck freight activity has been increasing. We think we’re recovering from the bottom. So that’s clearly a sign of maybe a little bit of a positive GDP growth, a little bit of a positive impact from maybe retailers restocking their inventories.

So that’s what we’re looking at. At the end of the day, if you look at our assets, I would say, I won’t go through each one of them. But I would say that in each of our new developments, each of the submarkets, they are top tier, I would say, in terms of quality and functionality, they’re about top 15%, maybe top 10% even on some of the submarkets. But so what we’re focused on is trying to lease them up.

Ki Bin Kim: Okay. And on the G&A guidance of $40 million and the accelerated equity investing, I just want to understand that a little better. Are these equity programs like a multi-year program, so next year, that $3 million portion won’t repeat?

Scott Musil: The program we have in place is very similar to other companies for tenured employees. So basically, once they reach certain milestones, age, years of service, their equity awards are expensed immediately for accounting purposes. I would say specifically the $3 million charge that we assume this year we’re not going to incur that in 2025. And in fact, probably a lot of that’s going to reverse. So that’s going to be the impact that $3 million on a go forward basis.

Ki Bin Kim: Okay. Thank you, guys.

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

Rob Stevenson: Good morning, guys. Can you talk about current trends in material labor pricing and how the next batch of starts compares to the seven four cap and 38 to 48 profit margin on the current six projects under construction?

Scott Musil: Jojo, do you want to take that?

Jojo Yap: Yes, I can take the construction pricing part. So if you look at middle of last year and ’23 overall prices, material and labor prices came down anywhere from 5% to 8%. Our view is that in 2024, first half, it will be flat outside of any supply chain shop. It’s going to be flat or even kind of declining. But we’re not underwriting that. We’re underwriting inflationary in any of our contemplative development projects. And right now, we have nothing new to announce, but that’s the trend of construction material and labor prices. If there’s a wide chain of materials, it’s better. The environment right now is better, much better than last year in terms of getting materials. Everything now is really coming into schedule except this year. And that’s basically a lot of it’s due to the supply cliff that the industry is facing right now. Record low development starts.

Peter Baccile: With respect to your question on margins, if you look at our portfolio of opportunities, so the land holdings that we have, the entitlements that we have, et cetera, it’s a very large investment opportunity. That taken as a portfolio, will yield 7% or better. And that’s being underwritten at today’s rate, so significant margin opportunity there.

Rob Stevenson: Okay, that’s helpful. And then now that the Baltimore assets are largely leased, where’s the biggest vacancy upside beyond just the recently developed projects and those under constructions? And any known move-outs of consequence in ’24 or ’25 at this point?

Peter Baccile: Chris, you want to take that?

Chris Schneider: Yes. As far as known move-outs, we’ve got 3.1 million square feet still rolling in 2024, and there’s no significant known move-outs in that population.

Rob Stevenson: And any sort of vacancy targets in the stabilized portfolio that you’re looking to lease up at this point? Or is that all just little pockets here and there of vacancy beyond the development pipeline?

Scott Musil: I’ll take that, Rob. It’s Scott. There’s a couple of leases that we do have budgeted forecasted for a couple hundred thousand square feet that are scheduled to lease up this year. So that’s in the core portfolio, so non-development.

Rob Stevenson: Okay. That’s helpful. Thanks, guys. Appreciate the time.

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

Todd Thomas: Hi, thanks. Good morning. Just wanted to follow up, I guess, on that last question, the last bit there. Scott, what’s embedded in the guidance in terms of additional lease-up and commencements related to the developments that are completed and that are not in service? That’ll be transitioned into service during 2024. Is there anything embedded in the guidance for those projects?