INDUS Realty Trust, Inc. (NASDAQ:INDT) Q3 2022 Earnings Call Transcript

INDUS Realty Trust, Inc. (NASDAQ:INDT) Q3 2022 Earnings Call Transcript November 12, 2022

Operator: Good morning. And welcome to INDUS Realty Trust 2022 Third Quarter Earnings Conference Call. This call will be followed by a question-and-answer session. It is now my pleasure to turn the program over to Ashley Pizzo, Vice President of Capital Markets and Investor Relations at INDUS. Please go ahead.

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Ashley Pizzo: Thank you, and good morning, everyone. Welcome to our 2022 third quarter earnings call. In addition to regularly available earnings materials, INDUS has also published a supplemental presentation, which is available on its website at www.indusrt.com under the Investors tab. The conference call will contain forward-looking statements under federal securities laws, including statements regarding future financial results. These statements are based on current expectations, estimates and projections, as well as management’s beliefs and assumptions. Forward-looking statements are not guarantees of performance and actual operating results may be affected by a variety of factors. For a list of those factors, please refer to the risks listed in the company’s most recent 10-K filing as updated by its quarterly report on Form 10-Q and subsequent quarters.

Additionally, the second quarter, I am sorry, the third quarter results press release and supplemental presentation contain additional financial measures such as NOI, FFO, core FFO, AFFO and EBITDA. These are all non-GAAP financial measures. The company has provided a reconciliation to those measures in accordance with Regulation G and Item 10e of Regulation S-K. The company speakers this morning are Michael Gamzon, INDUS’ CEO, who will cover recent activity, market conditions and updates on our pipeline. He will be followed by Jon Clark, the company’s CFO, who will cover the third quarter results in detail. After the prepared remarks, the line will be opened up for your questions. With that, I will turn the call over to Michael.

Michael Gamzon: Thanks, Ashley. Good morning, everyone, and thank you for joining us today. The operating fundamentals in the industrial market remain quite good. Tenants are active in our markets and supply remains relatively in check due to strong absorption and the continuing delays in the delivery of new buildings. With that said, we recognize the overall macroeconomic environment remains uncertain with inflation running high and interest rates significantly above the levels at the start of the year. The resulting increase in the cost and availability of capital has impacted the investment sales market with very few transactions occurring, and also started to slow down new development starts. Within this backdrop, we believe INDUS is well positioned and prepared for a changing market environment.

We effectively have prefunded the majority of our upcoming acquisition and development pipelines, which includes having all fixed rate debt at well below current market rates. We also continue to look to recycle capital, notably undeveloped land. We are focused on maintaining high occupancy and actively leasing upcoming deliveries, and we generate cash flow from our portfolio, which we expect to grow significantly as recent and upcoming developments and acquisitions roll into our NOI. Speaking to our current results, in the third quarter, we continued to deliver strong internal and external growth. Our portfolio is well leased at 97.6%, with the only vacancy in the recently delivered two building development in Orlando. We have no bad debt expense in 2022 to-date and all of our leases are triple net.

We have effectively addressed most of our lease rollover through the end of 2023, with leases accounting for only approximately 2% of our total portfolio square footage expiring before 2024. Of the upcoming role, we do have one vacancy expected in the near-term as the tenant that leased our 234,000 square foot delivery in Connecticut has been able to get fully operational in the new space quicker than expected, and therefore, be vacated into existing 73,000 square feet in short order. Since last quarter, we successfully retenanted the property in Charlotte that we acquired earlier this year. This new lease to an investment-grade rated retailer was at a rent 39% above the previous amount paid by the short-term in-place tenant and resulted in a yield 50 basis points above what we had originally forecasted we would achieve at the time of the acquisition earlier this year.

We also completed a renewal extension in Hartford with a global delivery company. This company exercised the last of its existing one-year fixed renewal rights in September, and during that process, they sought to secure their access to the space for longer term. As a result, a few weeks ago, we executed an additional two-year extension with this tenant, with a 16% increase in starting rental rate over the recent renewal rent. We are making good progress on leasing up the recent Orlando delivery and feel good about the current tenant activity and the very strong rental rates in recent proposals, which we believe will result in us exceeding our most current underwriting. We continue to experience strong rent growth across our markets and we currently estimate the mark-to-market rent in our portfolio at 26% on a cash basis and 31% on a GAAP basis.

We believe we are conservative in our estimates, typically using known lease comps rather than quoted rates or the levels on current proposals. Additionally, our portfolio is relatively young and has grown significantly. This quarter’s mark-to-market calculation was impacted by an unusually large number of newly added developments and signed leases amounting to nearly one-fifth of our estimated rent on a go-forward basis. Given how recent these leases are, they have a lower mark-to-market opportunity and also had very little impact on our third quarter cash NOI. We estimate that this group of leases lowered our mark-to-market calculation this quarter by several hundred basis points. With respect to our pipeline, we have leased 60% of the remaining vacancy in Nashville, leaving this project with one vacant space of 42,000 square feet for which we have good tenant interest.

We have pushed the closing on this acquisition to the latter half of the first quarter of 2023. The buildings are essentially complete, but there’s been a delay in completing the connection to public sewer, which we require to close on this acquisition. Since the start of the year, we have added over 900,000 square feet, representing an 18% increase to our in-service portfolio. We expect our three most recent developments, Chapman’s Drive in the Lehigh Valley, 110 Tradeport in Connecticut and Landstar Logistics in Orlando, to generate an initial stabilized yield of around 7% using the actual in-place rents at Chapman’s and Tradeport and our current estimates for Landstar at a 95% occupancy level. This is well above our initial underwriting at the time we put the land sites under agreement or even when we commenced construction.

As we continue to evaluate land for future development opportunities, we believe we remain conservative in our budgeting. Our initial underwriting assumes our view of today’s market rents and construction costs, even if the delivery is two or more years away and we initially assume a 95% occupancy at stabilization. Our current development pipeline includes one project of 206,000 square feet in the Lehigh Valley, which we expect to complete late in the second quarter of 2023. The Lehigh Valley market remains very tight with asking rents above $10 per square foot and supply in core locations remaining in check given few remaining development opportunities. We have a very well-located project at an attractive basis that we feel will deliver a strong return.

Since we do not have construction commencement dates for several of our other land sites, we are now listing these as land for potential future development rather than including them in our active development pipeline. This quarter, we disclosed on new land site under agreement in the Charlotte market, where we expect we can build four buildings totaling just under 600,000 square feet. The necessary approvals for this site include an Army Corp permit, which extends the time to complete the entitlements. Therefore, we do not expect to close on the purchase of this land until later in 2023. So any significant investment remains a bit far off. Overall, construction is continuing to experience certain challenges, including ongoing permitting delays by understaffed municipalities and shortages of key — certain key materials, which are somewhat exacerbated by Hurricane Ian.

That said, we are starting to see improvements both in cost and lead times in some areas, such as structural steel and we expect these trends to continue to improve. We have a number of first-generation leases signed or expected in our pipeline and we expect some of these near-term construction matters to continue to push out the lease and rent commencement needs beyond what we have typically experienced. We continue to proactively order materials, building more improvements into the base development designs and work with our tenants earlier in the process on their needs to try to mitigate all these impacts. We continue to believe the long-term outlook for logistics properties remain strong and we will continue a very targeted pursuit of land and building acquisitions.

The current uncertain environment we believe will produce good opportunities. As an example, we already are seeing a slowdown in certain proposed development starts, as developers that rely heavily on debt financing are reevaluating opportunities and dropping some land sites. We have the financial flexibility to pursue select opportunities, while maintaining conservative leverage ratios using the capital on our balance sheet, undrawn lines of credit and asset recycling. On that last point, we have our small flex office portfolio under contract for $11 million and the closing is expected later this quarter. As a reminder, this portfolio is carried in discontinued operations, so it’s not included in our reported NOI or core FFO metrics and — though the sale remains subject to typical closing conditions.

Additionally, we have several undeveloped land sites under agreement for a total of approximately $25 million, which we have put on a schedule in our supplement. The largest is a $15.5 million potential sale of 48 acres of industrial land on Goodwin Drive in Connecticut. The buyer intends to build a 450,000-square-foot manufacturing facility for its own use on the site. The other parcels represent the sale of nonindustrial land in Connecticut and Southern Massachusetts. All of these sales, including the office flex portfolio are subject to a number of contingencies including receipt of necessary approvals for the buyer’s intended uses and note the potential closings will take place over the course of 2023. In aggregate, if all these sales were to close, we generated over $35 million in proceeds or about $3.50 per share, with no impact to our existing NOI, while providing dry powder for future investment.

I will conclude with thanking the INDUS team for their continued hard work and exceptional performance. We take great pride in our very low employee turnover and is through our team’s effort that we achieve our strong results and are in a position for future success. With that, I will turn it over to Jon for a financial review.

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Jon Clark: Thanks, Michael. We are pleased to report strong performance again this quarter. Core FFO for the 2022 third quarter was $5.7 million, a 52% increase over the comparable quarter of the prior year and up 15% from the second quarter of this year. Core FFO benefited the most from the growth in NOI. NOI from continuing operations was $10.2 million for the third quarter. That’s up 34% from the prior year’s third quarter. The largest contributor to the growth was the net addition of 1.2 million square feet to our portfolio over that time period. NOI growth was also driven to a lesser extent by leasing activity and escalations. Additionally, the 2022 third quarter included a one-time lease termination fee of just under $400,000, which we mentioned last quarter and that was included in our prior guidance provided.

AFFO for the 2022 third quarter was $3.8 million, compared to $3 million for the prior year period. Maintenance capital expenditures were $810,000 this quarter, which were primarily related to seasonal repaving projects. We also incurred $513,000 in second-generation leasing costs, mostly related to TI work on recent renewals and new leases. Cash same-property NOI for the 2022 third quarter was up 13.7% versus the comparable 2021 period. About 8% of this increase in same-property NOI is related to the burn-off of free rent on tenant leases, comprising about 348,000 square feet. The remainder of the increase is related to the commencement of leases on previously vacant first-generation space and standard lease escalations. Our same-property portfolio has been 100% leased for the last several quarters and while our leasing spreads have been strong, we have only had a few leases expire this year or expected next year, all of which may impact same-property NOI growth in future quarters.

Wrapping up just a few things on the income statement. Interest expense was $1.5 million for the third quarter. This is net of $430,000 of capitalized interest, which was largely unchanged from the second quarter’s numbers. We would expect that capitalized interest for Q4 will be lower given the recent deliveries of 110 Tradeport and Landstar. General and administrative expenses were $2.9 million in the third quarter or $3 million if you exclude the benefit of the non-cash mark-to-market charge related to the non-qualified deferred compensation plan. One item to add for future consideration on G&A is the sale of the office flex portfolio that Michael mentioned, includes office space that we occupy in Connecticut. So going forward, our G&A will include approximately $200,000 annually for occupancy costs related to leasing the space from the new owner of the portfolio.

Finishing up here on liquidity and debt, at the end of August, we repaid our $26.3 million floating rate construction loan with cash on hand, reducing our outstanding debt balance to be $141.3 million. Right now, 100% of our debt is fixed rate or swapped to fixed at an overall weighted average interest rate of 4.13%. Debt to third quarter annualized EBITDA was 4.6 times or 3.8 times net of cash. Our $150 million delayed draw term loan, which we completed and swapped into a fixed rate in early April was well timed as we believe the term loan market has become more difficult to access. Many of the larger banks have pulled back on financing due to their own capital requirements and rates have moved considerably since then. With our current facility, our liquidity at the end of the third quarter was $216 million, which reflects $26 million in cash, $90 million of available draws on the term loan and $100 million of borrowing capacity under the revolving credit facility, which is undrawn.

We expect to draw approximately $30 million on the term loan in the fourth quarter, with an expectation that the balance will be drawn in the first half of 2023, again, all of which has been hedged at an effective rate of 4.15%. With the term loan fully drawn, we expect to remain at conservative debt-to-enterprise value ratios. Further, we effectively have no debt outstanding that matures before 2027. With our current credit facilities, cash position, income from the portfolio and capital recycling that Michael discussed, we are well positioned to complete our pipeline and pursue select opportunities. Our new term loan includes an accordion feature that could grow this bank facility from its current $250 million up to $500 million. We also will continue to look for diverse and attractive sources of capital to fund future growth.

But importantly, we are well capitalized to fund our current activities, which will add another 1.2 million square feet or nearly 20% of the portfolio in 2023. Lastly, in this quarter’s release, we provided some additional earnings guidance information for the fourth quarter. We estimate NOI from continuing ops of between $10 million and $10.3 million for the fourth quarter. This results in a full year NOI estimate of $38.1 million to $38.4 million, which is up from our prior guidance of $36.5 million to $38.0 million last quarter. This forecast reflects our expectations that no new additions to our portfolio and no significant new lease commencements will occur in the fourth quarter. We estimate G&A for the fourth quarter, excluding the mark-to-market charge for the non-qualified deferred comp plan to be $3.1 million to $3.3 million.

This will bring the full year G&A forecast to between $11.3 million and $11.5 million, which is down slightly from last quarter’s full year guidance. The full year forecast includes the benefit year-to-date from the non-cash mark-to-market of our non-qualified deferred compensation plan, which overall has lower G&A for 2022. Without this benefit, our G&A for the nine-month period would have been about $9.1 million as opposed to $8.2 million. As a reminder, we typically forecast this amount of zero and exclude the amount from our core FFO calculation. Finally, we estimate interest expense to be $1.7 million to $1.8 million for the fourth quarter. This interest expense reflects the benefit of the paydown from the construction loan in August and it’s partially offset by the scheduled draw on our term loan a little later this quarter.

Guidance also assumes a lower level of capitalized interest in the fourth quarter as compared to year-to-date levels due to the completion of several projects in the third quarter. Michael, that’s all I have with that.

Michael Gamzon: Thanks, Jon. I want to thank all of you today — on today — all of you here today on today’s call and all of our stockholders for their continued support. Our business is performing well and we are optimistic that despite the current macroeconomic and capital market environments that we are well positioned to grow our cash flow, net asset value and most importantly, shareholder value over the long-term. That concludes our prepared remarks and I will turn it back over to the Operator for your questions.

Q&A Session

Operator: Our first question is from Dave Rodgers with Baird. Please go ahead.

Dave Rodgers: Yeah. Good morning, everybody. Michael, I wanted to go back to the acquisitions that you have got under contract, the forward purchases that you have done a while ago. Maybe give us your comfort level with those today. I know I think you quote a 5.1% to 5.5% average underwritten yield, I am wondering what that might be on today’s rents, but also kind of your comfort with stepping more into land acquisitions or forward purchases, just kind of given where the capital markets are?

Michael Gamzon: Yeah. Thanks, Dave, for the question. I think as we disclosed the underwritten yields kind of in that low- to mid-5% range at 95% occupancy and that’s using our estimate of rents as of today, not upon delivery. So we are just using our best guess of market rents. I mean, a couple of those are expected to deliver in the first quarter, a couple of them are a little bit later towards the second quarter or third quarter, we are seeing really good activity on the two, obviously, the Nashville one is — the bulk of it is leased. The one in Charleston, we are seeing very good tenant activity at rates right in line with where our most recent forecasts are or better. So we still think really like all those projects, we think they are really well located, really good quality buildings, really perfect for the markets they are in.

So we are excited to have those deliver and think we will be really successful leasing them up and generating good returns. In terms of future forwards, they still are out there. I think today we are probably a little more focused on trying to find land opportunities ourselves. Yeah, I think, as I mentioned earlier in the call, we are starting to see a number of deals sort of fall apart that others have land sites under control. I think that’s a mixture of capital availability, both on the equity and debt side, cost of debt and probably some more uncertainty as to where exit cap rates are for merchant builders, but we think that creates a really good opportunity on land. Land sellers typically are a little bit sticky on price, principally because often they don’t really have any debt.

It may be farmland they have owned forever. But that said, there are some motivated sellers out there. There are people who have land under agreement that’s getting dropped and if we can find the right parcels, we think that’s a good opportunity. We think — it takes a while to entitle it. So it gives us some time to work through the land, evaluate the cost and make a good judgment going forward. So we are focused on land. You have the right forward opportunity came along. We certainly still will look at that and we continue to look at acquisitions. And again, we don’t typically do long-term single net stabilize. So everything almost falls into the value-add bucket and we think we will increasingly see some opportunities there, either as debt needs to get refinanced as people adjust to the new normal in the capital markets or what have you.

So kind of looking at everything, but that’s how we think about what we have today and where we are looking.

Dave Rodgers: I appreciate all that color, Michael. And then maybe just one more for me, on the leasing front, obviously, maybe it focuses on the same kind of bucket of assets under acquisition or under contract. But are you seeing any slowdown in terms of the conversations that you are having with tenants taking longer, fewer tenants kind of coming to the assets, putting things on hold. Is that part of what’s happening or is it you just have the time to complete? Just a little more conversations or color on the conversations around leasing would be helpful as well?