First Industrial Realty Trust, Inc. (FR) Q1 2013 Earnings Report, Transcript and Summary

Good morning. My name is Devlin, and I will be your conference operator today. At this time, I would like to welcome everyone to the First Industrial First Quarter Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. I would now like to turn the conference over to Art Harmon, Senior Director of Investor Relations.

Thank you, Devlin. Hello everyone and welcome to our call. Before we discuss our first quarter 2013 results, let me remind everyone that speakers' on today's call will make various remarks regarding future expectations, plans and prospects for First Industrial. These remarks constitute forward-looking statements under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. First Industrial assumes no obligation to update or supplement these forward-looking statements. Such forward-looking statements involve important factors that could cause actual results to differ materially from those in forward-looking statements, including those risks discussed in First Industrial's 10-K for the year ending December 31, 2012, filed with the SEC; and subsequent 1934 Act reports. Reconciliations from GAAP financial measures to non-GAAP financial measures are provided in our supplemental report, which is available at firstindustrial.com under the Investor Relations tab. Since this call may be accessed via replay for a period of time, it's important to note that today's call includes time sensitive information, that maybe accurate only as of today's date, April 26, 2013. Our call will begin with remarks by Bruce Duncan, our President and CEO, and our CFO Scott Musil, after which, we will open it up for your questions. Also on the call today are Jojo Yap, our Chief Investment Officer; Chris Schneider, Senior Vice President of Operations; Bob Walter, Senior Vice President of Capital Markets and Asset Management; and Peter Schultz, Executive Vice President for our East Region. Now, let me turn the call over to Bruce.

Thanks Arthur, and thank you to everyone for joining us today. Our year is off to a good start. Thanks to the good work of my First Industrial teammates, on the capital, investment and leasing front of our business. That good work has been supported by positive sector fundamentals, as the growing economy supports gradual absorption space, while new supply remains measured. On the capital side, our major actions were the $132 million equity offering, which was largely used to fund the redemption of the remaining $100 million of our 7.25% series J preferred stock, completed in April. Through these transactions, we have brought down our coverage inclusive of preferred stock even further. The redemption will also help our fixed charge coverage ratio, which is an important metric for the rating agencies, on our path back to investment grade. With the benefit of these capital actions, we believe our balance sheet is now positioned to support up to $250 million of speculative development at any one time, as we grow and continue to upgrade our portfolio. As we have discussed before, the investment market is very competitive, especially for quality leased acquisitions. In response to this pricing environment, we have shifted our investment efforts more heavily towards development. The combination of our boots on the ground local market experts, and our strengthened balance sheet, puts us in a position to capitalize on development opportunity. We will continue to look for acquisition candidates as well. But the risk adjusted returns we can earn from new construction projects, has been more drastic. We acquired three new development sites during the first quarter. The first of which is in a familiar location, the Moreno Valley in the Inland Empire, Southern California. With this investment, we plan to build upon the success of our…

Thanks Bruce. First, let me walk you through our results for the quarter. Funds from operations were $0.24 per share, compared to $0.25 per share in 1Q 2012. Please note that FFO for the quarter reflects $262,000 of NAREIT-compliant gains, due to the sale of two land parcels, Bruce mentioned. Comparing 1Q 2013 to 1Q 2012, before onetime items, namely the early retirement of debt and the NAREIT gains, funds from operations were $0.25 per share, versus $0.25 per share in the year ago quarter. EPS for the quarter was a loss of $0.05 versus a loss of $0.04 in the year ago quarter. Moving on to the portfolio; I will start with recent volume. In the quarter, we commenced approximately 5.1 million square feet of leases. Of these, 0.6 million square feet were new, 2.8 million were renewals, and 1.7 million were short term. Tenant retention by square footage was 79.7%. Same-store NOI on a cash basis, excluding termination fees was positive 2.4%, due primarily to occupancy growth, and the impact of rental rates. Same-store NOI growth including termination fees, was a positive 2.3%. Lease termination fees were $80,000 in the quarter. Looking ahead to the same-store metric for the second quarter, I would like to note that the comparison to the year-ago period, is going to be challenging, due to largely, the $1 billion of restoration fees we earned in the second quarter of 2012. As Bruce noted, cash rental rates reached positive territory, up 1.2%, and on a GAAP basis, they were up 6.7%. Leasing costs were $1.88 per square foot, benefitting from the high percentage of renewals. Our G&A for the first quarter were $6.5 million. While this was above the run rate reflected in our full year guidance, due to higher compensation expense, associated with…

Thanks Scott. Before we open it up to questions, let me say that we are off to a good start, but we have much work to do, and leasing to achieve our occupancy goals, and getting our new developments built on-time, on-budget and (inaudible), and in continuing our addition by subtraction strategy of targeted asset sale. As a team, we are focused on meeting our goals, doing more of what we have been doing to enhance the value of our company, by growing cash flow, including our portfolio, and closing the gap in valuation to our peers. We will now be happy to take your questions. As a courtesy to other callers, we ask that you limit your questions to one plus a follow-up, in order to give other participants a chance to get their questions answered. You are welcome to get back into the queue. That's now operator, may we please open it up for questions?

[Operator Instructions]. Your first question comes from the line of Craig Mailman.

Hey guys. Bruce, just curious if you could comment? I know you said (inaudible) leasing activity remains good, but maybe just what you are seeing on the small, medium sized kind of front, and are you seeing any increase in housing (inaudible) that some of your peers have talked about?

Craig, we are seeing good activity on both large tenants and small tenants. Why don't I ask Peter Schultz, who runs our Eastern region to comment on that?

Good morning Craig, it's Peter. We are seeing good activity across the entire portfolio, and while our job is to lose all of the spaces, we are seeing an improvement in the small spaces, and while I think it's too soon to say, there is a trend from housing related companies. We are definitely seeing a pick-up on those small spaces from those prospects.

That's helpful. Then just as a follow-up, I know the new leasing was a little bit late in the first quarter. Just how much you guys have a sense for maybe how you are modeling or just the visibility you have? How do you think occupancy ramps, as we progress through the year? Is it more heavily weighted towards back-end, or should we see that pick up in second quarter, more towards the 90.5% to 92%/

Well here, if you look at it, and again, we had the first quarter dip now, over the last few years, [that's basically] down half a point versus 30 basis points. So, what we have done over the last two or three years, is we had a pick up in the latter part of the year, and so we are -- again, to hit our 92% goal, we have got a seasoned traction, we are seeing good activity. But our job is to move this good activity into signed leases, and we will focus on it, but again, it will be more back-end loaded, in order to hit the 92%.

Great. Thanks guys.

Thank you.

[Operator Instructions]. The next question comes from the line of John Stewart.

Thank you. Scott, I presume that since the same store guidance is essentially unchanged, is it fair to infer that the variable in terms of bottom line FFO per share guidance, is really the equity issuance?

John, that's correct. So let me break the equity issuance into two pieces; the first $100 million was used to redeem the series J preferred stock in April. No accretion or dilution related to that piece. The remaining $32 million was used to pay down our line of credit, that's where the $0.01 of dilution came from, from the equity offering. Now as we use those dollars to spend on the developments that we have in process, and as those become leased up, obviously, we will see an increase in FFO from the redeployment of those funds. So it was related to the $32 million paydown from the equity offering, John.

Okay, great. And just, my follow-up would be, couple of references to the path back to investment grade. Just wondering where, what you are hearing in your conversations with the rating agencies?

Sure. John, we have discussions with the agencies on a periodic basis. What we can say is this, on the past calls I have mentioned one, by say it, the (inaudible) we've had with the agencies, is our fixed charge coverage ratio, and in order to get that to investment grade rating, John, we'd need about 2.20 times fixed charge coverage to get to that area. If you look at our fixed charge coverage in the second quarter on a standalone basis, post equity offering, post redemption of the series J, we are going to be between 1.95 to 2.0 times; and obviously as the year goes on and NOI increases, that will only improve. So we think we -- we've hit these metrics and we hope to see traction, shortly from the agencies. But that's something that they'll have to decide.

Okay. Thank you.

[Operator Instructions]. And there are no further audio questions in the queue. I will now turn the conference back over to Bruce Duncan.

We will give it a second for the queue to come back up. Anyone has any follow-up questions or additional people in the queue.

Okay. You do have a follow-up question from the line of John Stewart.

Thank you. Couple of things. I guess, first of all, would it be possible to get an update on the top 10 vacancies?

Sure. Bob?

Sure, this is Bob Walter. If you look at our numbers, as of the end of the quarter, we were pretty flat from the fourth quarter, we have about 100 basis points of potential pick up from the original top 10 list. But I'd also like to bring in Peter Schultz to talk specifically about some of those opportunities.

Thanks Bob. John, a few of those remaining vacancies are in Atlanta and Central Pennsylvania. Atlanta, you know, continues to trail some of the other larger distribution markets, with an occupancy in the low 80s, which is about where our portfolio is. So there continues to be a lot of supply. But we are now encouraged by the activity that we are seeing in -- as Bruce and others have said, it's our job to get the leasing done to drive cash flow. In Central Pennsylvania as well, we have seen an increase in activity on those bases, and we continue to see good activity in the market for our new spec building. So we continue to be encouraged by that.

Okay. Thank you. I think Eric has got a question as well.

Thank you. Just a question on the Inland Empire development. Obviously, you've, I think really created (inaudible) with a lack of a project for leasing up, but you are facing a potentially more competitive environment, in terms of new supply, just curious on your thoughts on your projects going forward?

Sure. We are pretty encouraged, if you look at supply and demand. But Jojo, you want to comment on that?

Sure. The demand in (inaudible) continues. There is still strong net absorption and we believe that net absorption will continue. In addition to that, the strongest part of the market, are that space is over 0.5 million square feet, and that's what we are building. When looking at selecting sites or building design, what we try to do is, we try to really offer the prospective tenant the highest class property, and that means highest clear ceiling heights, really top loading, in terms of (inaudible) to cost addition. Very generous trade of (inaudible) and then, (inaudible) out of the site. So those I think what we look at. And also the other thing that we look at is being in [infill land] on a competitive basis, and we have achieved all that. And I just want to also remind you that, as we sit today, the only development that we are permitting to, in the Inland Empire East, is a $32 million investment, which is a 555,000 square feet that Bruce has mentioned. So we think our investment is measured.

Again, the purpose (inaudible) to the leasing goals on time, on budget and get leased it pro forma, or hopefully, ahead of pro forma. So we acknowledge that we've had good success to date and we got to just keep going, and we are focused on it.

Great. Thanks guys.

Thank you.

We have a follow-up question from the line of Craig Mailman.

Scott, just on the same store, you had mentioned the tougher comps in 2Q because of the restoration gain, I guess in 2Q of last year. Is that what might be the drag on -- or keeping you guys from kind of getting a little more aggressive on the same store outlook for the year, and that, (inaudible) in the 1% to 3% range, or it is still just expensive?

Craig, this is Chris. Yeah, that certainly is an impact and that our original guidance was 1% to 3%. We had obviously anticipated that we have the restoration piece rolling down the second quarter. So that was (inaudible).

And Craig, the other piece of it there as well is we have very low bad debt, as we have been saying on the past calls over the last year or so, we had low bad debt in 2012. We had low bad debt in the first quarter '13, but for the second quarter to the fourth quarter of 2013, we actually budgeted in a higher dollar amount of bad debt expense. It was to budget in what a more normalized rate would be. So from a -- if we are able to continue this trend of low bad debt from the second quarter to fourth quarter, we should be able to pick up same store little bit. But that will be something that we will discuss on a quarterly basis, on the next couple of calls.

Okay. That's fair. Then just a question on land acquisition environment. You guys have obviously been pretty successful lately. Is it just personal relationships here, or are we seeing private guys -- just the land into cost of the carrier, and they are just starting to put it out in the market. Any trends you are seeing?

Well let me ask Joe Gearen, again we are very pleased with the land acquisitions we have done, especially the one we finished yesterday, which is the (inaudible).

Yes Bruce. Really, we are building on our success of sale of the 692,000 square foot building that we built and leased, and so we are very focused in that submarket, that we felt that it was really strong. So our team really kind of went out, and looked for potential to acquire land off market, and that's what we've delivered as of -- that Bruce mentioned yesterday, and that's through our land assemblage of -- from a number of owners, to be able to acquire that kind of site, that's not readily available in the market today. These will be used in different markets. So our land acquisition strategy is very-very targeted. You know, the market in the Northwest is very strong today, and we think it will continue to be strong, and so, our team is looking at that particular submarket, and not using a (inaudible) approach, for example, to go and looking for that in the submarket. Hope that answers your question.

What other market would you guys be most interested in, and where are you sort of seeing the best opportunities?

We will actually know when we close.

All right. That's fair. Thanks.

[Operator Instructions]. Your next question comes from the line of Jon Petersen. Jon Petersen - MLV & Co.: Thanks. I was hoping you guys could maybe give a little more color on the leasing spreads turned positive, so that's obviously great. Maybe you could breakdown by market, which markets you are seeing have the highest positive leasing spreads, where rents will be covered, and which one is still in the process of recovering?

Again, what you are seeing in terms of the market, if you just look at the market, we are seeing very good rental rate growth in the Inland Empire, we see good rental rate growth. LA, we are seeing very good growth there. We are looking at Houston, Miami, have all been good markets for us. Indianapolis, we have seen some growth in Indianapolis in terms of rates. So overall, the markets have done well. Chris, you have any other color, you want to add?

Yeah, I mean just, as far as the commentary, looking at leases that were rolled over from peak years in 2005, 2008, as we look forward to 2014 of the leases expired, that its only 13%. So we are seeing less and less of those peak year leases rolling, so that we are getting close to the consistent positive spreads. Jon Petersen - MLV & Co.: Okay. And then I apologize if you already talked about this, I (inaudible) but in terms of dispossessions that you guys still have left in terms of your non-strategic portfolio. I mean, where are those located, and then maybe in the really strong markets like Inland Empire and Houston where acquisition CapEx is too low for you to acquire, are they so low that maybe you guys are looking to sell some of the assets in those markets?

Again, we have identified -- we have a couple of hundred million dollars of assets, so we want to sell over time and view that if its legally saleable in the next couple of years, and they are really all over the country, again, and more, we are going to continue to sell these in typical one-off basis, because we have the best execution for that, in terms of pricing. But, things can change.

Overall, the LA market, the Houston markets are strong. So we expect good rent growth from those, and we are not looking to sell. Jon Petersen - MLV & Co.: Okay. That's fair. Thank you.

[Operator Instructions]. There are no further questions at this time. I will now turn the conference over to Bruce Duncan.

Great. Thank you operator. Again, we appreciate your interest. Please call Art or Scott or myself if you have any questions. We look forward to seeing you in June, in Chicago, our favorite city, for NAREIT and again, thank you for your interest in our company. Thank you.

Thank you. This concludes today's conference call. You may now disconnect.