First Industrial Realty Trust, Inc. (NYSE:FR) Q3 2023 Earnings Call Transcript

First Industrial Realty Trust, Inc. (NYSE:FR) Q3 2023 Earnings Call Transcript October 19, 2023

Operator: Good day and welcome to the First Industrial Realty Trust, Inc. Third Quarter Results Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Art Harmon, 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 third quarter results and our updated 2023 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, October 19, 2023. 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, Senior Vice President of Operations; and Bob Walter, Senior 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. We continued to deliver strong cash rental rate growth on new and renewal leasing and we’re making good progress on our 2024 expirations which I will touch upon shortly. We also achieved some leasing wins at our developments in Pennsylvania, Northern California and Orlando. And we’re capturing significant value from the sale and ground lease of our on-balance sheet land sites in Phoenix. As expected, our quarter end occupancy metric was impacted by a few recently placed in-service developments that remain in lease-up. As we noted on our last call, prospective tenants continue to be deliberate in making significant commitments for new space in the face of the uncertain interest rate, economic and geopolitical environment.

This is being reflected broadly in the national vacancy figures as new supply continues to come online. National vacancy was up 50 basis points in the third quarter but still at an overall low of 4.2%. In our 15 target markets, vacancy is 4%. As we discussed on our last call, there is a fair amount of new supply expected to be delivered nationally in roughly the next 12 months. Based on CBRE’s analysis, there is approximately 475 million square feet under construction across the U.S., 30% of which is preleased. Focusing on our 15 target markets, completions are expected to be approximately 325 million square feet. New starts naturally have trended downward, with third quarter 2023 starts down more than 60% compared to third quarter 2022. This market response is being driven by the rapid increase in the cost of capital and the uncertain economic environment.

In our portfolio, we’re capturing strong rental rate increases on our renewals, realizing the benefit of the healthy market rent growth we’ve seen for the past several years. Tenants continue to renew well in advance of their lease expiration dates, reflecting continued confidence in their core business. Overall, leasing market dynamics continue to favor the landlord, particularly with renewals, given the low vacancy levels I discussed earlier. Through yesterday, with 97% of our 2023 lease expirations in the books, our cash rental rate increase is 60%, with average annual rental rate escalators of 3.8%. A big driver of our cash rental rate increases has been the outperformance of our Southern California assets, where we’ve achieved a cash rental rate increase of 151%.

Looking ahead to 2024, we’ve taken care of 40% of next year’s lease expirations and a cash rental rate increase of 38% which is similar to our pace of progress at this time last year. Our 2023 rental rate increase has benefited from slightly more than 25% of rental income coming from leases signed in Southern California. Due to a few Southern California leases that expired in 2023 that are assumed to lease up in 2024, we expect the Southern California portion of lease signing by rental income in 2024 will be roughly the same as 2023 at a little over 25%. We will give you a refined view of our thoughts on our 2024 cash run rate increase on our fourth quarter call with the benefit of our budget reviews. We anticipate our cash rental rate increase on new and renewal leasing will be in excess of the 38% we currently achieved on lease signings related to 2024 expirations.

Moving on to development leasing. Since our last earnings call, we leased half of our 699,000 square foot First Logistics Center at 283 Building B in Central Pennsylvania. We also leased our 37,000 square footer in Northern California and our 17,000 square feet at our First Loop Park [ph] in Orlando. With these lease signings, the capacity on our self-imposed $800 million speculative leasing cap today stands at $108 million. We continue to monitor tenant demand for new growth to determine the appropriate time to start new developments. As I discussed earlier, tenants’ decision-making on space for new growth continues to be deliberate. When we do decide on new starts, we’re well positioned with our existing coastally oriented land bank that can accommodate 15.2 million square feet.

This represents approximately $2.4 billion of potential new investments based on today’s estimated construction cost in the land or book basis. Moving now to dispositions. Since our last call, we completed a significant sale of 39 acres of land at our PV-303 project in Phoenix for $41 million to a data center user. We also entered into a ground lease with that buyer for the remaining 100 acres of land at this project. The ground lease is for 5 years and includes a purchase option exercisable beginning in year 3. Our year-to-date sales totaled $61 million. We now expect sales for the full year to be $75 million to $150 million. With that, I’ll turn it over to Scott for some additional commentary and updated guidance.

Scott Musil: Thanks, Peter. Let me recap our results for the quarter. NAREIT funds from operations were $0.62 per fully diluted share compared to $0.60 per share in 3Q 2022. Our cash same-store NOI growth for the quarter, excluding termination fees, was 7.4%. The results in 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, partially offset by slightly lower average occupancy and an increase in real estate taxes. We finished the quarter with in-service occupancy of 95.4%, down 230 basis points compared to 2Q 2023 and primarily due to completed developments placed in service in the third quarter. Summarizing our building leasing activity during the quarter, approximately 1.4 million square feet of leases commenced.

Of these, 300,000 were new, 500,000 were renewals and 500,000 were for developments and acquisitions with lease-up. As a reminder, we are strongly positioned with no debt maturities until 2026, assuming the exercise of extension options in 2 of our bank loans. Moving on to our updated 2023 guidance per our earnings release last evening. Our guidance range for NAREIT FFO is now $2.40 to $2.44 per share. Excluding the $0.02 per share income item discussed in our first quarter call, our guidance range is now $2.38 to $2.42 per share which is a $0.01 increase at the midpoint. Key assumptions for guidance are as follows: we are projecting year-end occupancy of 94.25% to 94.75%. This range assumes that the 644,000 square foot Old Post Road asset is leased up in 2024.

We have made this assumption based upon our experience with the asset and the delays in the final governmental award process experienced by our prospective 3PL [ph] tenant. Year-end occupancy guidance also assumes the lease-up of our developments placed in service in the third and fourth quarters will now occur in 2024 due to prospective tenants’ measured pace in making significant commitments. I would note that if you excluded the impact of these developments being placed in service, our midpoint for year-end occupancy would be approximately 97%. Our 4Q occupancy assumption implies a quarter and full year average of 96.5% to 96.6%. Moving on to other guidance components. Fourth quarter same-store NOI growth on a cash basis before termination fees of 6% to 7.5%.

This implies a full year quarterly average growth for this metric of 8% to 8.5%. Note that the same-store calculation excludes $1.4 million of income related to insurance claim settlements recognized in the fourth quarter of 2022. Guidance includes the anticipated 2023 costs related to our completed and under construction developments at September 30 for the full year 2023 and we expect to capitalize about $0.10 per share of interest. Our G&A expense guidance range is $34.5 million to $35.5 million, an increase of $0.5 million at the midpoint. And 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 and thank you to all my teammates for all that you have accomplished thus far this year. Together, we’re focused on delivering strong cash flow by pushing rental rates on new and renewal leasing and the continued lease-up of our development pipeline. Operator, with that, we’re ready to open it up for questions.

Operator: We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Rob Stevenson with Janney.

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Q&A Session

Rob Stevenson: A couple of questions on development. Are you expecting to start any new developments in the fourth quarter or early first quarter at this point? And then first state, move from a first quarter completion to a fourth quarter completion? Can you update us what’s going on there?

Peter Baccile: Yes, I’ll take the first part of that, Rob. Look, development starts are going to be a function of market strength, tenant velocity, the economic outlook and of course, lease-up of our completed developments. Given our desire to operate with additional capacity under our self-imposed cap so that we can take advantage of potential stress in the market, it’s unlikely we’re going to have any additional starts this year. And as you know, we don’t give guidance on starts. So I won’t comment on 2024.

Peter Schultz: Rob, it’s Peter Schultz to your question on first date crossing, our construction schedule has gone well. We’ve had great weather. So the building is a little bit ahead of schedule and that’s what’s allowed us to move it from first quarter of ’25 — I’m sorry, first quarter of ’24 to fourth quarter ’23 for completion.

Rob Stevenson: Okay. And then — Peter talked about the macro in the core market as a whole supply picture. Which of your core markets are you seeing the least amount of new supply in relative to size?

Peter Baccile: Yes, there are a number of markets that didn’t have any starts in the third quarter. Starts are down pretty significantly across the country, in some markets, 100%, in the 90% range. I’m not going to go market by market but many, many markets have seen little to no starts. A couple of markets, starts went up in Q3. Orlando and Denver would be two markets that that happened. But by and large, the vast majority of the markets are down significantly.

Operator: Our next question comes from Ki Bin Kim with Truist.

Ki Bin Kim: Can you help us better understand your commentary about new leasing demand being deliberate? Maybe you can put it in — maybe you can frame it versus 2019 in terms of the type of feedback you’re hearing or the number of prospects that you’re fielding. I’m just trying to get a better grasp of how things might be changing.

Peter Baccile: I’ll take the front end of that and Jojo and Peter should chime in, too. I think when we talk about 2018, 2019, when we had a perspective when we had a space available, we were usually talking to 1 or 2, maybe 3 tenants in ’21 and ’22. Maybe it was 5 or 6. So we’re back down to a smaller number of prospects. Obviously, with the increase in development deliveries, we also have a little bit more competition than we had in ’21 and ’22 for new space. Peter, do you want to talk about your regions?

Peter Schultz: Sure. Ki Bin, Peter Schultz here. I would say a couple of things. The overall level of activity, to Peter’s point, has been generally consistent. But what we are seeing is tenants being cautious and really delaying their decision making. We’ve seen a number of deals where they had a targeted commencement date, only to see those push back as tenants are hesitant to make those commitments given some of the macroeconomic and geopolitical issues that Peter touched on in the script. We have seen a little bit of increase in activity coming out of the summer. Activity levels are better in the smaller and midsize spaces than they are in the biggest spaces, for the most part. But the primary headwind is just the lack of — and the slower cadence of decision-making by tenants. Jojo, anything else you want to add?