Industrial Logistics Propertie [ILPT] Conference call transcript for 2022 q2
2022-07-27 16:21:03
Fiscal: 2022 q2
Operator: Good morning, and welcome to the Industrial Logistics Properties Trust Second Quarter 2022 Earnings Conference Call. . I would now like to turn the conference over to Kevin Barry, Director of Investor Relations. Please go ahead, sir.
Kevin Barry: Good morning, everyone, and thank you for joining us today. With me on the call are ILPT's President and Chief Operating Officer, Yael Duffy; and Chief Financial Officer, Rick Siedel. In just a moment, they will provide details about our business and our performance for the second quarter of 2022, followed by a question-and-answer session with sell-side analysts. First, I would like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company. Also note that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on ILPT's beliefs and expectations as of today, Wednesday, July 27, 2022, and actual results may differ materially from those that we project. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call. Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission, or SEC, which can be accessed from our website, ilptreit.com or the SEC's website. Investors are cautioned not to place undue reliance upon any forward-looking statements. In addition, we will be discussing non-GAAP numbers during this call, including normalized funds from operations or normalized FFO, adjusted EBITDA and cash-based net operating income or cash basis NOI. A reconciliation of these non-GAAP figures to net income and the components to calculate cash available for distribution, or CAD, are available in our supplemental operating and financial data package, which also can be found on our website. With that, I will now turn the call over to Yael.
Yael Duffy: Thank you, Kevin, and good morning. Before I review ILPT's performance for the second quarter of 2022, I would like to start by discussing the announcement earlier this month that we have temporarily reduced ILPT's quarterly cash dividend. We recognize the value of the dividend to our investors, and the decision was not made lightly. As you know, earlier this year, ILPT closed on the strategic acquisition of Monmouth Real Estate Investment Corporation with significantly enhanced ILPT scale, tenant base and geographic diversity. As we discussed on our call last quarter, our long-term financing plan predominantly included property sales and the sale of an additional equity interest in ILPT's consolidated joint venture. However, as interest rates have increased debt rates significantly higher than projected, it has led to a meaningful deterioration in real estate market conditions with buyer seeking steep discounts on marketed properties, or, in many cases, walking away from transactions. As we are not a distressed seller, we have made the decision to move -- to remove the 30 Monmouth properties totaling 4.9 million square feet from the market and plan to reengage in marketing efforts when debt and capital markets normalize. Additionally, we have paused discussions with potential partners for the Mountain Industrial joint venture. We continue to believe in the strength of these properties and the robust industry tailwinds underpinning demand for our real estate. Accordingly, we plan to remain disciplined when considering future sales of properties or equity interest to ensure that we maximize value. As it is taking us longer than we originally expected to complete our long-term financing plans, we felt it was prudent to temporarily reduce the dividend to provide us with short-term flexibility. The reduction of the dividend preserves approximately $20 million of cash flow per quarter, which will enhance the nearly $300 million of cash we had on hand at the end of June. Additionally, it provides us time to evaluate alternatives to repay our bridge facility. These alternatives may include enduring longer duration debt, exploring additional joint venture opportunities with properties where fixed rate debt is already in place in asset sales. To be clear, ILPT continues to operate business as usual, and all leasing efforts and capital projects are progressing as scheduled. Now turning to portfolio fundamentals and operating results. As of June 30, 2022, ILPT's consolidated portfolio included 412 warehouse and distribution properties in 39 states, totaling approximately 60 million square feet with occupancy of nearly 99%. The total portfolio has a weighted average remaining lease term of approximately 9 years with 78% of our revenues coming from investment-grade tenants or subsidiaries or from our secure Hawaii land leases. During the second quarter, ILPT continued to benefit from favorable operating trends, which included record leasing activity of 3.9 million square feet at weighted average rental rates that were 61.3% higher than prior rental rates for the same space. Normalized FFO per share was $0.43 and same-store cash NOI grew 2.6% year-over-year. We executed 8 new leases for approximately 2.7 million square feet at an average roll-up in rents of 104.7% and 22 lease renewals for approximately 1 million square feet at an average roll-up in rents of 29.1%. In total, new and renewal leasing yielded a weighted average roll-up of 82.8%. New leasing activity was driven by 2 leases with Home Depot in Hawaii for approximately 2.5 million square feet at an average roll-up in rents of 110.3%. By way of background, last year, Home Depot submitted a request for proposal for an 84,000 square foot ground lease for its retail operations. As discussions progress with the RMR Group's property and asset management teams, a strategic opportunity emerged with Home Depot committing to a larger retail footprint of nearly 300,000 square feet as well as a 2.2 million square foot parcel, which will serve as a warehouse and distribution hub. We are thrilled to expand our relationship with Home Depot, an A-rated investment-grade tenant across 3 states and totaling 3.4 million square feet. Home Depot ranks as our third largest tenant, representing 5.7% of ILPT's lease square footage and 4.4% of annualized revenues. Renewal leasing activity included 5 lease extensions with FedEx for approximately 396,000 square feet at an average roll-up in rents of 17.2%. I highlight this as I believe there is a misconception in the market that all FedEx leases are above market, which we do not believe to be true. As we work through the portfolio and see firsthand the intense market demand and record low vacancy in the market, which our properties are located, we continue to achieve roll-ups in rent as these leases expire. We spent $3 million on recurring capital expenditures, including $2.6 million, or just $0.07 per square foot per lease year attributable to tenant improvements and leasing commissions. Additionally, we spent $7.1 million on development activity, predominantly related to multiple parking lot expansions for FedEx. As a reminder, by partnering with FedEx on these projects, there is an opportunity for ILPT to grow rents ahead of natural lease expirations, while achieving a return on capital of 8% to 10%. Now turning to our leasing opportunities. Given all we have accomplished over the last year, with nearly 100 leases signed, totaling 7.1 million square feet, only 2.2% of total annualized revenue is set to expire during the second half of 2022. As such, our focus is on addressing lease expirations in the upcoming years where approximately 22% of ILPT's portfolio is scheduled to roll by the end of 2025. We believe there is ample opportunity to maximize mark-to-market rent growth and increase cash flows consistent with the 39% roll-up in rents we achieved over the past 12 months. Our leasing pipeline includes 33 deals for approximately 4 million square feet, and we anticipate a near-term conversion of approximately 25% of our pipeline given that roughly 1 million square feet of current activity is in advanced stages of negotiation or lease documentation. Before turning the call over to Rick, I wanted to make you aware of the recent publication of the RMR Group's Annual Sustainability Report. The report highlights insights, accomplishments and data regarding our managers' commitment to long-term ESG goals. Also, for the first time, there is a sustainability supplement focused specifically on ILPT. We are proud of the progress made to strengthen ILPT's sustainability practices and enhance our ESG transparency and disclosure. You can find links to the complete report as well as the ILPT sustainability supplement on our website at ilptreit.com. I'll now turn the call over to Rick to review our financial results.
Richard Siedel: Thanks, Yael, and good morning, everyone. During the second quarter, total portfolio same-property NOI grew 10.8% from the prior year. This reflects the favorable impact of approximately $3.4 million due to the noncash write-off of a below market lease that we terminated in order to execute 1 of the new leases with Home Depot. On a cash basis, same-property NOI increased 2.6% year-over-year, driven by a 3% increase in Hawaii and a 2.1% increase on the Mainland. This growth was due to higher rental rates and contractual rent steps in our leases across the portfolio. Adjusted EBITDA increased nearly 100% year-over-year to $80.8 million, which reflects our same-property NOI growth and the Monmouth acquisition. Interest expense came in at $77.5 million during the second quarter. This includes approximately $34.4 million of amortization of financing fees, of which $30.3 million related to our bridge loan facility used to fund the acquisition. The balance of $43.1 million is related to cash interest expense. Second quarter normalized FFO was $28.3 million or $0.43 per share, which includes the favorable impact of approximately $0.05 per share related to the write-off of the below-market lease obligation I mentioned a moment ago. Net loss for the quarter was $151.3 million, which included a noncash impairment charge of $100.7 million. This charge was related to our decision not to sell in the current environment and subsequently reclassified 30 properties from held for sale to held for use due to the deterioration of the real estate transaction market caused by rising interest rates. While we have seen stable and strengthening operating trends throughout our portfolio, the accounting rules required that we adjust the properties to fair value upon reclassification. Our estimate of fair value was partially based on the offers we received as well as trends we are seeing in the financing and transaction markets. We continue to believe in the long-term prospects of these properties and are not willing to transact in the current environment. Turning to our balance sheet and financing activities. At the end of the quarter, we had total consolidated debt of approximately $4.5 billion. It had a weighted average interest rate of 4.2% and a weighted average maturity of 4.1 years. The components of the debt included the following: a $1.4 billion bridge loan facility at a floating interest rate of 4.2% that matures in February of 2023, $1.4 billion of JV CMBS loans at a floating interest rate of 4%, and approximately $1.7 billion of fixed rate loans with a blended interest rate of 4.2%. While interest rates have continued to increase since the end of the second quarter, it is important to note that we do have interest rate caps in place that begin to protect us against further increases in interest rates, if SOFR exceeds 2.7%. We ended the quarter with $292 million of cash on hand and debt to annualized adjusted EBITDA of 12.4x. As Yael mentioned, the implementation of our long-term plan to finance the Monmouth acquisition is taking longer than expected. Since we committed to the acquisition, the term SOFR forward curve for the end of 2022 has increased by approximately 300 basis points. To allow maximum short-term flexibility as we evaluate alternatives to repay our bridge facility, we reduced our quarterly dividend to $0.01 per share. This equates to more than $20 million of cash flow in each quarter and provides us with sufficient cash reserves to give us refinancing options and continue operating business as usual. That concludes our prepared remarks. Operator, please open up the line for questions.
Operator: . And our first question will come from Bryan Maher with B. Riley FBR.
Bryan Maher: And maybe just sticking with the debt for a moment since you just addressed it. The cash on hand and the availability of the dividend for the next couple of few quarters, do you suspect that the combination of those two items when we get to February of next year, assuming you haven't layered on another JV partner and assuming you haven't sold any assets, would give you the capital available to get into some type of refinancing agreement with the banks to address the bridge loan?
Richard Siedel: Thanks for the question, Bryan. Yes, that's right. I mean we feel really good about the assets. We're going through the process to have the bank's update appraisals and all the things you need to do to get secured debt in place. We are glad to see that the markets -- the CMBS market, in particular, is open. There is certainly still some price discovery that we'll need to go through, but it is positive that the market's open. We are continuing to monitor that closely. And we do have additional options to consider refinancing with our bank group and everything else. So the extra liquidity provided by the dividend reduction just gives us additional flexibility. We don't have to finance at the same loan to value. We'd be able to bring it down, if that's what -- if that will help us get a better price on a refi. So we felt it was a prudent thing. And again, the real positive here is the assets are great.
Bryan Maher: And on the JV partner, I believe Yael, maybe you said that, that has paused. Is there just 1 JV partner in addition to the 1 already onboarded in the mix? Or is there more than 1 potential second JV partners you're speaking with?
Yael Duffy: So we have been talking to multiple groups, and we were, I would say, further along with 1 additional partner. But as with the volatility in the interest rates and the JV does have floating rate debt in place, I think we just felt it was best to pause conversations until things stabilized.
Bryan Maher: Okay. And maybe last for me. On this 30 MNR assets that you kind of withdrew from marketing, is it safe to say that at some point, you plan on remarketing those in the next couple of few quarters? Might you market some, but not all, and maybe just keep some for the long term? I mean, what are the thoughts there over the next maybe 6 to 12 months on those 30 properties?
Yael Duffy: So I think we're flexible. Again, it depends on where the markets land. I think we feel these are really good assets that are representative of the larger Monmouth portfolio. And so I think the problem today was that we had gone down the path and had awarded 27 of the 30 properties, but as -- and we have come to a price which reflects the $100 million impairment that Rick talked about. But these buyers are coming back and asking for additional price reductions given the volatility in the market, and it was just something that we felt was unwarranted given the class and quality of these assets. And so -- and also no assurances that they weren't going to come back to the table asking for more. So I think we feel, again, really good about these properties and are willing to hold them if that's what we decide to do.
Operator: Our next question will come from Michael Carroll with RBC Capital Markets.
Michael Carroll: Yael, in your prepared remarks, you kind of highlighted that there are -- that you might look to joint venture other properties. I mean, has that process started yet? Have you identified any other properties that you might joint venture?
Yael Duffy: So we haven't identified anything yet, but we do have 203 properties, both on the Mainland and in Hawaii that have $1.7 billion of fixed rate debt in place at an interest rate of approximately 4.2%. So I think that just presents us another opportunity, if our potential partners are easy with the floating rate debt.
Michael Carroll: I guess when does that process start? Like if you started that now, I mean, how quickly could you execute a JV deal?
Yael Duffy: So again, I think we haven't gone down the path yet. And I think for the same reasons why we took the other properties and halted discussions with potential partners for the Mountain Industrial, I think it really will be further down the line if we need to.
Michael Carroll: Okay. And then can you talk a little bit about the interest in the Hawaiian portfolio? I'd imagine that there would be some interest within those assets. I mean, would you look harder to joint venture some of those properties to pay down the bridge loan?
Yael Duffy: I think -- I don't think that it would be -- I don't think we do it to pay down the bridge loan. I think our first action would be to enter into longer duration debt to repay the bridge facility just because it provides us flexibility. And again, those Hawaii properties are so valuable. We've seen significant growth in rents. We've improved the credit profile. And the scarcity of industrial land in Hawaii is -- I think the vacancy rate is 1% right now. So we wouldn't do anything -- any -- we wouldn't enter into any joint venture at pricing that wasn't at a premium.
Michael Carroll: Okay. And then can you talk about the refinancing options that you have for the bridge loan? It seems like that's your #1 goal. I mean, when could something be announced there?
Yael Duffy: I think we'll definitely have something done before February '23.
Michael Carroll: And what's the current rates that are being quoted on refinancing that?
Yael Duffy: We don't have rates yet.
Richard Siedel: It's a little early to put a price on it at this point, Mike. We are watching the market pretty closely. Back in February, we were 276 or so basis points over SOFR. We saw a transaction in the market last week around 300. So it's possible that it's a little higher, but again, really great quality assets. We'll see where it lands, and we'll look to provide those updates as we can.
Michael Carroll: Okay. And then, Rick, I know you mentioned that you could reduce the LTV to probably get a little bit of a better rate. I mean what's the LTV that the bridge loan is based off of right now? And how far would you have to reduce that to get a more attractive rate?
Richard Siedel: It's a good question. I guess, it will depend on where the market is. But I mean, the good news, again, Mike, is that the markets are open. And we do have cash on the balance sheet in order to bring down the LTV. So we've got some flexibility, and the dividend further adds to that. The bridge loan was probably in the mid- to high-70s loan-to-value. So we have the ability to bring it down to a more conservative number and to get the refinancing done, but we're going to evaluate all our options.
Michael Carroll: Okay. And then, Rick, can you talk a little bit about the credit facility? How's the discussions of the reimplementing a credit facility for the company?
Richard Siedel: Yes. The credit facility, we've gone fairly far down the road. I think we are pretty much ready to go, but a lot of it was contingent on -- the new credit facility was the last piece to take out the bridge and we needed to execute on the sale of the JV interest in the 30 properties. And because of what's happened with interest rates in the market, that just didn't happen, but that's not because of our bank group. Our lenders were fantastic going through that process. And I think a number of them are still kind of disappointed that, that deal didn't close. But we're, again, going to continue to evaluate all of our options and seek flexibility where we can and think we'll be in a good position.
Michael Carroll: Okay. And then just last, can you talk a little bit about the -- I think the Home Depot lease is probably the bigger lease that's kind of impacted your leasing stats. When did that lease commenced? I mean, did they start paying cash yet? Or is that the reason why your straight-line rent jumped up pretty significantly this quarter compared to the prior quarter?
Yael Duffy: Yes. So for the larger of the 2 deals, there was 1 for 300,000 square feet and 1 for 2.2 million square feet. And so the larger of the leases actually doesn't commence until another lease -- another tenant's lease expires in early 2024. So it was -- they did a proactive strategic lease to make sure that they got that property.
Michael Carroll: Okay. So will earnings -- how much will earnings tick higher next quarter? It sounds like that most of the leasing activities in 2024, so the near-term earnings won't be materially impacted.
Yael Duffy: Well, we have -- I mean we do have -- we have some good -- we have 3.5 million square feet coming up on the Mainland in '23 and then another 4 million in '24. So I mean, we still do have some good opportunities to continue to drive rents in the next coming years.
Richard Siedel: Mike, overall, from an earnings perspective going into next quarter, the results of the portfolio are continuing to be really strong, but the interest headwinds are real. So based on where interest rates are today, we expect to see further deterioration in FFO. But again, I mean, I think we're being pretty transparent about looking to move forward and refinance the floating rate debt that we have.
Operator: . Our next question will come from James Feldman with Bank of America.
Unidentified Analyst: This is on for Jamie. Could you talk about what you were seeing in terms of how much deals are repricing by or where cap rates were trending for the assets you had on the market before you start or stopped marketing?
Yael Duffy: So I think we're seeing generally a 50 to 75 basis point swing in cap rates. And again, I think that's the initial in that range as the initial. And then I think buyers are being opportunistic and coming back and asking for additional discounts, just assuming that some sellers are desperate to sell, which we are not.
Unidentified Analyst: Okay. Great. And then can you talk about what a 50 or 100 basis point increase in interest rates would mean for your interest expense or FFO per share?
Richard Siedel: Yes. So we mentioned last quarter that every 50 basis points increase in interest in SOFR translates to about $0.04 of FFO per quarter. And that will continue for -- well, it's actually hard for us to go up 50 basis points from where we are today. SOFR, I think yesterday was 2.32%, and our caps kick in at 2.7%. So another 40 basis points or so, and we'll start to see some of the protection from the caps. But the rule of thumb was every 50 basis points translates to about $0.04 of FFO.
Unidentified Analyst: Okay. Great. And then are you seeing a pullback in leasing activity from any of your tenants? And specifically, what you're seeing from investment-grade tenants versus noninvestment-grade?
Yael Duffy: No. I think really, I mean, I think our demand has been throughout -- I mean, throughout the pandemic and even this inflationary market and rising interest rates, I think, if anything, I think there's a lack of supply and the demand continues to be there.
Operator: Our next question will come from Tom Catherwood with BTIG.
William Catherwood: Just trying to triangulate a few things here. So you mentioned 27 of the 30 assets were in contract. So I get the buyers trying to retrade and then pulling them off the market. For that $100 million impairment, was that kind of representative on the pricing on the 27 assets? Or is that across the full 30 that you pulled from the market?
Yael Duffy: That's across the full 30. So when we bought the Monmouth portfolio, we assigned a value of approximately $725 million to those 30 assets. And then as we work through, and we kind of came to terms with buyers, we had a value of $625 million. And that -- and since we had agreed to sell 27 of the 30 properties at that $625 million, and they were held for sale and then we put them back into service, we had to adjust that difference in valuation.
William Catherwood: Got you. So let me just clarify that. So the $625 million was for the 27 assets?
Yael Duffy: It was for the whole 30.
William Catherwood: Okay. Okay. Got it. Got it. Got it. Then I want to do a bit -- I'm going to get a sense of timing here because something doesn't line up for me. So the Monmouth deal was originally announced November 5. The deal closes end of February, 3.5 months later. At what point in time did those packages or what have you, on those 30 assets get out to market?
Yael Duffy: So we began marketing them almost simultaneously with when we closed and if you might recall, I think we talked about this at NAREIT. We had originally planned to sell either 1 or -- 1 large portfolio or 2 portfolios. And I think that's when the markets have started to erode. And so our brokers suggested that we try to market them individually or in small clusters because they thought we'd be able to maximize value. So we had come to an agreement, as I mentioned, on 27 of the 30 properties, I would say, in late April and May. And the buyers kicked off diligence. We were working through legal docs. And as everybody was going through the process and working towards closing, these buyers, a lot of them, some withdrew all together and others came back and asked for meaningful price adjustments, 10% or more. And really provided us with no assurances that they weren't going to come back to the table and ask for more of a price reduction as they completed their diligence so interest rates continue to rise. And it just was something we couldn't get behind because we really feel that these are really good assets and assets that ILPT would be happy to continue to own. So that was kind of the background of why we pulled them.
William Catherwood: Got it. Understood. And then kind of final one for me. Yael, you mentioned in your prepared remarks, this market impression that the FedEx leases are above market, and that was not the case in the 2 that you addressed this quarter. In general, when you look at that portfolio now that it's under your umbrella, do you have a sense of where those assets overall, the FedEx ones are per market? And then kind of maybe more broadly, do you have a sense for your Mainland portfolio overall, what that looks like on a mark-to-market basis?
Yael Duffy: Yes. So we actually did 5 lease renewals with FedEx this quarter. And so I think it really depends market by market and also the expiring rent because in some cases, it has amortized TI into those rents. And so I think the markets generally, where these FedEx locations are, are experiencing rent growth. And so we've been able to continue to push. FedEx does have a hesitancy to put annual increases into their lease structures, but we've been really -- the team has really been pushing to try to get those when we can. And then I think we -- again, with Monmouth, we didn't have too many empty buildings when -- I think we had 1 vacant building that we acquired, and we have a couple that we think we're going to get back, and we've been -- I mean, I think we'll have -- we've executed 1 since we've -- subsequent to Q2, but we've been able to get 10% to 15%, in some cases, 20% roll-ups in rents in those Mainland properties.
William Catherwood: Got it. And just on those amortized TIs, is that all of the FedEx leases? Is that half the FedEx leases?
Yael Duffy: No, no. I think it's -- I mean, maybe 25%, I think, have it. But again, I think as the market rents have grown, we've been able to bridge the gap of -- we're able to recoup it as we do renewals. So it might not be a 30% roll-up, but it's still a 5% roll-up.
Operator: Our next question will come from Connor Siversky with Berenberg.
Connor Siversky: I just wanted to touch again on the comments related to that 60 to 75 basis point increase in some of the cap rate estimates on those properties that were previously held for sale. Just considering that all of those lease terms, the durations, weren't the same for the Monmouth portfolio, was there any material difference in those assets with shorter durations versus those, let's say, the 15 -- the full 15- or 30-year lease term? What I'm trying to get at here is to see if there was less of a movement in the shorter duration leases versus the longer ones.
Yael Duffy: Listen, it's actually -- it's an interesting question because we joke here that it used to be great to have long-term walls and now in the way that the market rents have been growing that all buyers and investors are looking for shorter walls. I think it was really -- it was kind of a mixed bag. Again, like somewhere -- some of the buyers were smaller local players who actually wanted the long term so they could have steady cash flows. But I think in general, 50 to 75 basis points was kind of across the board.
Operator: Our next question will come from Mitch Germain with JMP.
Mitchell Germain: I think you might have just answered it, Yael, but was there any sort of characteristics about the profile of the buyers you were talking to?
Yael Duffy: It was -- I mean, there were some -- we had 10 unique buyers. And I would say, 50% of them at least were institutional and some were local players.
Mitchell Germain: Last question for me. Given your commentary about additional JV, can we just interpret it that if it's not in a JV right now that the property could potentially be candidate or a JV candidate, anything that's wholly owned? Is that the way that we should be thinking about this now?
Yael Duffy: I think that's a fair way to look at it.
Operator: This concludes our question-and-answer session. I would like to turn the conference back over to Yael Duffy, President and Chief Operating Officer, for any closing remarks.
Yael Duffy: Thanks, everyone, for joining us on the call today. ILPT's operating performance remains solid, and we expect demand for our properties to persist as we execute on our financing plans. We look forward to providing you with updates on our progress and speaking with you soon. Thank you.
Operator: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
