First Industrial Realty Trust Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
October 19, 2023

There are 19 speakers on the call.

Operator

Good day, and welcome to the First Industrial Realty Trust, Inc. Third Quarter Results Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. Please limit yourself to one question and one follow-up.

Operator

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.

Speaker 1

Thank you, Dave. Hello, everybody, and welcome to our call. Before we discuss our 3rd 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.

Speaker 1

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 ks 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

Speaker 2

at

Speaker 1

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 Walters, Senior Vice President of Capital Markets and Asset Management. Now let me hand the call over to Peter.

Speaker 2

Thank you, Art, and thank you all for joining us today. We continue to deliver strong cash rental rate growth on new 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 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 and making significant commitments for new space in the face of the uncertain interest rate, Economic and geopolitical environment.

Speaker 2

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 3rd quarter, but Still at an overall low 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 475,000,000 square feet under construction across the U.

Speaker 2

S, 30% of which is pre leased. Focusing on our 15 target markets, completions are to be approximately 325,000,000 square feet. New starts nationally have trended downward with 3rd quarter 2023 starts down more than 60% compared to Q3 2022. This market response It's 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.

Speaker 2

Tenants continue to renew well in advance of their lease expiration dates, Lease expirations in the books, our cash rental rate increase is 60% with average annual rental rate of 3.8%. A big driver of our cash rental rate increases has been the outperformance of our Southern California assets, 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 signings by rental income In 2024, we'll be roughly the same as 2023 at a little over 25%.

Speaker 2

We'll give you a refined view of our thoughts on our 2024 cash rental rate increase on our Q4 call with the benefit of our budget We anticipate our cash rental rate increase at 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 17,000 square feet at our First Loop Park in Orlando. With these lease signings, the capacity on our self imposed $800,000,000 speculative leasing cap today stands at $108,000,000 We continue to monitor tenant demand for new growth to determine the appropriate time to start new developments.

Speaker 2

As I discussed earlier, Tennant's 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 15,200,000 square feet. This represents approximately $2,400,000,000 of potential new investment based on today's estimated construction costs and the land on our book basis. Moving now to dispositions. Since our last call, we completed a significant sale of 39 acres of land at our PB-three zero project in Phoenix for $41,000,000 to a data center user.

Speaker 2

We also entered into a ground lease With that buyer for the remaining 100 acres of land at this project. The ground leases for 5 years and includes a purchase option exercisable beginning in year 3. Our year to date sales totaled 61,000,000 We now expect sales for the full year to be $75,000,000 to $150,000,000 With that, I'll turn it over to Scott for some additional commentary and Updated guidance.

Speaker 1

Thanks, Peter. Let me recap our results for the quarter. NAREIT funds from operations were 0.62 dollars 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.

Speaker 1

We finished the quarter with in service occupancy of 95.4 percent, down 2 30 basis points compared to 2Q 2020 3, primarily due to completed developments placed in service in the 3rd quarter. Summarizing our building leasing activity during the quarter approximately 1,400,000 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 20 23 guidance per our earnings release last evening.

Speaker 1

Our guidance range for NAREIT FFO is now 2 point 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 percent to 94.75%. This range assumes that the 644,000 Square Foot Old Post Road asset 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 tenant. Year end occupancy guidance also assumes the lease up of our developments placed in service in the 3rd and 4th quarters will now occur in 2024 due to prospective tenants' measured pace and making significant commitments.

Speaker 3

I would note that if

Speaker 1

you excluded the impact of these developments being placed in service, our midpoint for year end occupancy would be approximately 90 4th 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 $1,400,000 of income related to insurance claim settlements recognized in the Q4 of 2022. Guidance includes the anticipated 2023 costs related to our completed and under construction developments at September 30. For the full year 2023, We expect to capitalize about $0.10 per share of interest.

Speaker 1

Our G and A expense guidance range is $34,500,000 to 35 point $5,000,000 an increase of $500,000 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.

Speaker 2

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

Also, please limit yourself to one question and one follow-up re queue to ask additional questions. Our first question comes from Rob Stevenson with Janney. Please go ahead.

Speaker 4

Good morning, guys. A couple of questions on developments. Are you expecting to start any new developments in the Q4 or early Q1 at this point? And then First State moved from a 1st quarter completion to a 4th quarter completion. Can you update us what's going on there?

Speaker 2

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 passed the 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.

Speaker 5

Hey, good morning, Rob. It's Peter Schultz. To your question on First State Crossing, our construction schedule has gone well. We've had great weather. So So the building is a little bit ahead of schedule and that's what's allowed us to move it from Q1 of 'twenty five I'm sorry, 1st

Speaker 6

Okay.

Speaker 4

And then, Eddie, if 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 and relative to size?

Speaker 2

Yes, there are a number of markets that didn't have any start Starts are down pretty significantly across the country. In some markets, 100% in the 90% range. I'm not going to go But many, many markets have seen little to no starts. A couple of markets, starts went up in Q3, Orlando and Denver would be 2 markets that happened. But by and large, the vast majority of the markets are down significantly.

Speaker 7

Okay. That's helpful. Thank you, guys.

Operator

Our next question comes from Ki Bin Kim with Truist, please go ahead.

Speaker 6

Thanks. Good morning. Can you help us better understand your commentary about new demand being deliberate, maybe you can put it in maybe you can frame it versus 2019 in terms of type of feedback you're hearing or the number of prospects that you're fielding, Just trying to get a better grasp of how things might be changing.

Speaker 2

I'll take the front end of that and Jojo and Peter should chime in I think when we talk about 2018, 2019, when we had a perspective when we had a space available, we were usually talking 1 or 2, maybe 3 tenants in 2021 2022, 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 2021 2022 for new space. Peter, you want to talk about your region? Sure.

Speaker 2

Kevin, Peter Schultz here. I would say a couple of things.

Speaker 5

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 midsized 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.

Speaker 5

Jojo, anything else you want to add?

Speaker 3

Yes. So for me, kind of bottom line is In 2019, businesses are focusing more on growth, and they're focused on where their Expansion is because of new business coming in. Today, they're more securing their current commitment and making wanting to make sure they got Good enough space to run their business and let's focus on growth. In 'nineteen, there was a little bit more of a fear of missing out on space because they're being gobbled up quickly. Today, tenants have a little bit more choices, so they're more deliberate And they're shopping around a little bit more.

Speaker 6

So how does that impact your strategy In terms of leasing up your development space or I guess any space, is cutting rents A practical solution or if the pool of new if the pool of customers is just smaller, maybe cutting rents doesn't do the trick, Maybe increasing leasing commissions, I guess, how are you trying to handle that?

Speaker 2

Right now, concessions are not increasing meaningfully. And I say use the word meaningfully because here and there, we are seeing some Sponsor owners, increased free rent a little bit. We typically offer, call it, half a month of free rent per lease year, and we're seeing that in In some cases at a month. But again, not other than that, that's about it. TIs are standard packages, etcetera.

Speaker 2

The other thing that I would point out is that we have developed properties that are incredibly competitive relative to the set of primarily merchant build that's out there. So from a functionality standpoint, we are superior. And When we talk about having more competition, that's not we don't mean there are 6 or 8 other opportunities, there might be 2 or 3. So it's not that the market isn't flooded. So right now, the market is holding pretty steady.

Speaker 2

Occasionally, you'll see somebody get a little extra free rent. But right now, it's holding steady.

Speaker 5

Ki Bin, the other thing I'd add is, over the last several years, you've seen a lot of our developments leased to single tenants. As you know, we take a lot of time in the design making sure these are functional, can be demised for multiple We're seeing, as I said a few minutes ago, better demand from smaller, midsize and the buildings are ready and prepared to be Demise for multiple tenants, office multiple office pods, stock packages, in some cases, demising. So We have the flexibility given the quality point that Peter made to accommodate that. So you might see us do more multiple tenants Than what we've done in the last several years, which has really just been a function of the market.

Speaker 3

Thank you, guys.

Operator

The next question comes from Nicholas Yulico with Scotiabank. Please go ahead.

Speaker 8

Hi, good morning everyone. First, I just wanted to ask about the development projects that I guess already delivered this quarter and Still will come in the next couple of quarters in Inland Empire. Could you just talk a little bit more about What sort of competitive level of supply you're dealing with there relative to those projects? We do see just stats in here commentary that Inland Empire East is where there is more of that supply impact, but just wanted to hear your thoughts on that.

Speaker 2

Jojo, you want to cover that?

Speaker 3

Sure. I'll touch on the Inland Empire. Overall, the Inland Empire still has a Historically, a very low vacancy at 3.5%. We do expect a long term that it will still have positive rent growth. In terms of our developments, we have 5 in DIE, 2 we just completed and 3 under construction.

Speaker 3

They're all of different size ranges and in different submarkets, namely Fontana, 215 Corridor and then Redlands. So we're not over invested or over built on any market. If you look at each of these properties, there are no more than 2 competing properties in terms of quality and location with these properties, and there are even 2 properties where we couldn't find really a comparable Property, we feel really good about these projects. Roughly, they're about $200,000,000 And Today, we're projecting a 9.3% yield, which is a little bit under 90% margin. So we feel really good about of course, our job is to lease those, but we feel very good in creating value for shareholders going forward on those.

Speaker 8

Thanks. That's helpful. The second question is, I want to see how we should be thinking about the pace of Development projects leasing up over the next year just in terms of a timeframe from when it gets delivered to Ideally a more stable occupancy level. And then the other question is related to capitalized interest. It seems like there could be some sensitivity there over the next year based on how long projects take to lease.

Speaker 8

And just Any thoughts or reminders you can tell us about how to think about the capitalized interest impact in the development pipeline vis a vis how long buildings can really stay within capitalized interest after being delivered?

Speaker 2

Yes. So I'll cover the first part of that and Scott will talk about capitalized interest. In terms of lease up timing for next year, obviously, we're going to be spending a lot of time on that topic when We sit down to do our budgets for next year. At this point, in terms of new developments, we're not anticipating changing our 12 month downtime assumption. When we think those are going to lease next year based upon the level of dialogue that we're having, with our prospective tenants today.

Speaker 2

So I Can't really give you much more than that on that question. Scott, you want to cover the capitalized interest?

Speaker 1

Sure, Nick. So we stop capitalization of interest once Development is completed. So we've got a handful of developments that are scheduled to be completed up until the Q2 of So we will have capitalized interest for the 1st 6 months of that period. For the back half or the last 6 months of

Operator

The next question comes from Craig Mailman with Citi. Please go ahead.

Speaker 9

Hey, good morning. Just wanted to hit on the data center ground lease in Phoenix here. Just had a couple of quick questions on this. Just first, Scott, from a run rate perspective, is the full run rate In the 3Q number or do we need to think about additional revenue coming in the 4th quarter to annualize it?

Speaker 1

Yes, Craig. So there's a little bit of lease income in The Q3, I think it might be just a half of a month. And then obviously, we're going to get a full quarter in For the Q4 of 2023, take a look at our NAV footnote, Craig. We have some more information on the ground lease that you can get

Speaker 9

Okay. And sir, I apologize, I didn't see that footnote. Did

Speaker 2

We have a pretty strict confidentiality agreement with this counterparty. So no, we can't talk a lot about the Terms and values and things like that. I can say generally speaking,

Speaker 1

the value of Data center land is much higher than

Speaker 2

the value of industrial. So but that's all we can really say. Let's put it this way, we like the economics a lot We wouldn't have done it. Obviously, we yes, go ahead.

Speaker 9

No, no, please your trade offs. Sorry.

Speaker 2

No, no, I mean, it's a great site. And we went into that years ago with big plans for selling to users, developing ourselves, Build to suits, etcetera. For us to be tempted to let that 100 acres go, you can imagine it's got to be a pretty good deal.

Speaker 4

And now

Speaker 9

I guess that was my other question. Is this should we take this as an indication of your concern about overbuilding in Phoenix And doing this deal rather than building it out to industrial rigs, it seems to

Speaker 2

have been a good

Speaker 9

market Since you got involved in it a few years ago.

Speaker 2

This in no way is an indication of our confidence in that We spent a lot of time deliberating whether we wanted to do this. At the end of the day, The economics of this trade pretty much equal the economics of building that site up.

Speaker 9

And then just one quick follow-up or separate question. Just, Scott, on the mark to market, you said You're not giving guidance yet on spreads, but you anticipate next year won't be in excess of that 38%. Is the 40% you leased this year just a mix issue of outside of LA or other markets with Smaller mark to market. Could you just give details of maybe what's net 40 versus what's remaining in the 60 from a market exposure?

Speaker 2

Chris, you want to take that?

Speaker 10

Yes. Craig, this is Chris. Yes, it is definitely a mix issue. So if you look at what's been taken care of, it's only 6% from Southern California, if you look at the rest of the 2024 rollovers, that mix is 56% coming from Southern California.

Speaker 9

Perfect. Thank you.

Operator

Our next question comes from Vikram Malhotra with Mizuho. Please go ahead.

Speaker 11

Thanks for taking the questions. Just first following up on development. I guess some of your peers may be seeing this as if development starts are very low By the end of 'twenty four, there's probably little product to offer, and if demand sort of picking up and there's probably share to be had. So I'm just wondering how do you balance The 2 are there specific markets you can cite where you do feel you might pause in 4Q like you said, but then ramp back up Because in general, there will be a threat of quality product?

Speaker 2

Yes. I mean, one of the big indicator for all of us It's going to be development lease up and we have product in the market now. We're having good conversations. As we've said in various and many different ways, tenants are taking a while. At least a 500,000 square foot building, about a $50,000,000 decision.

Speaker 2

And, the current economic outlook and what's going on around the world That causes people to pause before they put down that $50,000,000 So, yes, it's possible that toward the end of next year, There's not enough supply that would be fine by us obviously. And we really think that the market will Strong in 2025. So with respect to us, looking at what we're going to start potentially start next year, it really is going to depend upon how we feel about lease up.

Speaker 11

Okay. That makes sense. And just following up on the Inland Empire comments you made around the competitive set being small terms of your project, maybe just help us think about how you're seeing what you've seen in terms of market rent growth in SoCal in general what the variability in that region looked like quarter over quarter, any numbers you can share would be helpful.

Speaker 2

Jojo?

Speaker 3

Yes. So kind of address it a little bit because of the low vacancy of LA of sub 2 and then I. E. At about 3.5%. Long term, we would think that it would be a minimum mid single digits going forward.

Speaker 3

But today, as you may recall, SoCal has the highest rent growth of any market in the U. S. For the last 3 years straight. So right now, what the market is doing is digesting the supply In the marketplace, along with a little bit of decline on the inbound TEUs that affected the demand. And I'm I'm not going to be surprised.

Speaker 3

We're not going to be surprised if in the very near term, the rent is flat through the end of the year and maybe Q1 next year, to maybe slightly negative. But that doesn't mean that we can't create value because, like I pointed out to you, our developments, for example, Just a subset, it's about a 9.3% based on current market rents, 9.3% yield.

Speaker 11

Thank you.

Operator

Our next question comes from Caitlin Burrows with Goldman Sachs. Please go ahead.

Speaker 12

Hi, good morning. Maybe somewhat related to the last question, but on the development yields, it looks like today They're expected to be 7.2% for the under construction set of properties, which is up from like 6.5% a year ago. So how are you thinking about your cost of capital today and what yields are required to make development attractive and I guess to what extent is that impacting your activity?

Speaker 2

Yes. Thanks, Caitlin. So sure, the cost of capital has certainly gone up. When we look at that though And compare it to what we think we need to make to make reasonable margins and profits here, the yields on new developments need to be north of 6.5 Expected IRR is north of 8.5%, closer to 9%. And our On a weighted average basis, our pipeline projects hurdle those returns.

Speaker 2

So we're excited about the opportunity as soon as We've digested more of this additional supply coming to the pipe nationally. We've got a lot of great projects that are ready to go In the best markets in the country.

Speaker 12

Got it. Okay. And then maybe on the acquisition side, I know it's historically not been as much driver for you guys and transaction volumes are down significantly this year across CRE. But are you seeing any attractive acquisition opportunities Come to market or do you expect attractive opportunities to come up either of stabilized properties or even lease up properties?

Speaker 2

Yes. I mean, economics certainly make a difference in terms of what's attractive. But Joe, do you want to talk about some of the things you've Seeing the reasons we've taken the path.

Speaker 3

Sure. Yes. So we're on a lookout for those. We're trying to see if there's stress in like merchant developers or owners Middle of their projects or need capital or the sellers who want to get out of real estate. The reality is that there's not a lot of those That fit our quality or geography.

Speaker 3

And in those situations that meet our geography and It doesn't meet our financial criteria, meaning that there are some buyers who are still acquiring real estate as prices don't make sense to us. So there are a few small ones we're in. We have a situation wherein developer didn't have the funds and that they had tied up good build to suit. We're stepping in, and we think that's a great deal. And then we have another situation, not a large deal, a one off, Where the developer needs to fund their speculative project and suddenly the lender pulls a commitment unless the And this developer comes out with more equity and so we're buying one of their buildings that are nice building Lower much lower price because they need to squeeze out equity on that very, very quickly.

Speaker 3

So those are just examples of what we're trying to look for.

Speaker 12

Got it. And just to clarify, those are things that you're looking for or have already been like decided on and Are moving forward.

Speaker 3

Can we give you much more specifics as those are

Speaker 2

We're pursuing. We're pursuing. Yes, we're chasing it. They're not by any means. We may not get it.

Speaker 2

We're pursuing.

Speaker 12

Got it. Okay. Thank you.

Operator

The next question comes from Todd Thomas with KeyBanc Capital Markets. Please go ahead.

Speaker 7

Thanks. Good morning. This is A. J. On for Todd.

Speaker 7

Just going real quick Back to the capitalized interest discussion. You'd say that you stopped capitalizing interest when development is completed. As you look at your construction pipeline today and everything under construction, do you see any potential delays Or anticipate any delays for what's currently supposed to be delivered over the next few quarters?

Speaker 1

I would say that's our best thinking as of this point of time. So if you're asking about developments under construction, we've got estimated building completion in our supplemental. That's our best thinking at this point in time that that's when those developments will be completed.

Speaker 7

Okay, perfect. And then just one question regarding Old Post Road, is the 3PL tenant, are you still engaged are they still engaging? Or is there any update around that contract It's going to be awarded, or are you moving on and looking to market the asset to a new tenant altogether?

Speaker 5

So A. J, it's Peter Schultz. We continue to market the asset. In terms of the 3PL Group, we continue to talk with them. The government continues for whatever reason to postpone the final decision on that contract award.

Speaker 5

The latest information is that they're supposed to issue that award sometime later this quarter. Given our experience With this process over the last year, our confidence level, I would say, is not high, which is why as you heard from us earlier, We decided to push the lease up into 2024. It's certainly possible that this could get done This quarter, but our probability is that it's less likely just given the way this process has gone.

Speaker 7

Okay. Thank you.

Operator

The next question comes from Michael Carol with RBC Capital Markets. Please go ahead.

Speaker 13

Yes, thanks. Just following up on Old I know this has been taking a couple of years to get done. I mean, at what point do you just decide to kind of go multi tenant and try to lease it to some smaller Tenants that might want that space.

Speaker 5

Hey, Mike, that's a good question. It's Peter Schultz again. So we're certainly Have been and are open to that. As we've talked about on some of these prior calls, demand from larger users In this submarket and others has been slower, where historically that size range was very active Along that quarter, that's something we're open to and it's really about the timing of market demand and how tenants make decisions.

Speaker 7

Okay. Thanks for that.

Speaker 13

And then just real quick on your comments on the smaller blocks of the space. I know for the past few quarters, You've highlighted the tenant activity for those small to midsize blocks as we're still pretty healthy. I mean, is that still a fair comment today? Or has that changed over the past 3 plus Given kind of the slowdown that you've seen in demand?

Speaker 5

So I would say it's consistent. If you look at our in service portfolio, Occupancy is very, very high. We continue to see good demand and backfilling spaces quickly. But for The Old Post Road building that we just talked about and a couple of our developments that are larger, right, demand continues to be very active. I mean, there's And those tenants operate with more urgency and diligence than some of the bigger commitments to our earlier points They're just not in a hurry to make those decisions and commitments today given the broader macro factors that are impacting everybody.

Speaker 1

Great. Thank you.

Operator

The next question comes from Nick Thielman with Baird. Please go ahead.

Speaker 14

Hey, good morning. Question on the land bank. It looks like the fair value of the land bank was marked Down like 10% quarter over quarter. Some of that could be related to some land sales, but just curious if you did make some changes in your Estimate for fair value of the land and maybe which markets in particular saw the biggest haircut.

Speaker 7

Scott, do

Speaker 1

you want to take that? Yes, Nick, it's Scott. A couple of things happened is From the land bank, we removed the land in Phoenix related to the land sale and then we removed the land that's being ground leased. So that's going to cause a fair value drop alone in 3Q compared to 2Q because it's no longer in the population. And I'll have Jojo talk about adjustments we made to the What's left over and over again?

Speaker 3

Sure. And then on that, in addition to what Scott said, we added, of course, the land, National Land Acquisition, And then we made some adjustments to our land values. Those were in Chicago and Florida. And then we also slightly adjusted some lands. So we did it asset by asset.

Speaker 3

Some land we started to make improvements, So if you took all of that together, that resulted in the difference.

Speaker 14

Was there any specific markets that were haircut like Significantly in this process or not really?

Speaker 3

No, I would say that we didn't do it market by market. We did it property by property. I would say the change was anywhere from 5% to 15%. And then Chicago, we, for example, took down Orlando, we took down in terms of the value. We adopted it.

Speaker 3

So yes, so I mean, we did it probably by property.

Speaker 14

And then quick one for Scott, maybe just an update on how bad debt is tracking year to date and any updates on the tenant watch list.

Speaker 1

Sure. That's very low for the Q3. It's about $100,000 And that's compared to our guidance assumption of $250,000 so still in very good shape. If you look year to date 3rd quarter, We've expensed about $275,000 compared to our original guidance for those 1st 3 quarters of 700 50,000, so doing very well against our forecast. As far as tenants on the watch list, no material tenants are on the watch list at this point in time.

Speaker 14

Great. Thanks.

Operator

Our next question comes from Rich Anderson with Wedbush. Please go ahead.

Speaker 15

Hey, thanks and good morning. So when I was kind of looking back in time, Peter, Back in 2019, I asked a question of you, what trigger points are you looking for as it relates to build to suit versus spec development? You talked a lot about it here on this call. One of the things you said then, not to put you on the spot is, this so called musical chairs phenomenon where tenants have the ability to move around from one asset to another because they can. And that to you would be an indication of market You talked about the hesitancy of tenants and so on that's going on today.

Speaker 15

But are you also seeing that with the elevated level of deliveries is Creating optionality, is that another sort of dynamic that you're seeing happen in your space?

Speaker 2

Kudos to you, Rich, for remembering that and bringing that up. That's good. Good question. No, we're not seeing that. What we're seeing And we have a current example in the portfolio where a tenant moved out to consolidate it to bigger space and that's Still the theme, if we lose a tenant, it's because we can't accommodate their additional growth needs.

Speaker 2

And in terms of people leaving buildings, it's very expensive to move. So the deal in quotes that they can achieve somewhere else has to be Pretty outstanding and that is not reflective at all of where we are right now, even with the additional supply coming to the market. As we pointed out, vacancy rates at 4% in our markets, that's still a very, very low vacancy rate. That's not going to generate the kind of financial arbitrage that is going to cause a tenant to leave to go to another building. So good very good question, but we're not seeing that phenomenon right now.

Speaker 7

Okay. Second question for me

Speaker 15

is, Scott, you gave your guidance 94.5 percent occupancy at the midpoint and 97% if you didn't include the development deliveries. So 250 basis points spread. How does that number compare to when Everything was white hot and you kind of got further along in the leasing process by the time buildings were delivered. Is 250 Significantly higher than that time. I assume it's above it.

Speaker 15

And where do you think it's headed from here when you kind of take your pulse of things going forward?

Speaker 1

Yes, it's definitely significantly higher. Our placed in service policy is 12 months after development completion. And we've generally, if you look a year, 3, 5 years ago, we've leased up everything inside of that 12 months, so that spread is definitely higher. We did have a little bit of that type of dynamic during COVID with a couple of our developments. So I would say at this point in time, it's higher.

Speaker 1

On a go forward basis, Rich, it really depends on an asset by asset basis what we get leased up. And We'll go through our budget process here at the end of the year and we'll give you a little bit more color on our Q4 call.

Speaker 15

Okay, good enough. Thanks very much.

Operator

Our next question comes from Vince Tibone with Green Street Advisors. Please go ahead.

Speaker 16

Hi, good morning. Could you discuss how 3PL tenants are performing in your portfolio? And Do you have a sense of where their current volumes are relative to peak activity 12, 18 months ago? I'm just trying to understand how much Kind of excess capacity there may be among 3PLs and how that dynamic could potentially impact near term demand?

Speaker 2

Peter, you want to take that?

Speaker 5

Sure. Vince, it's Peter Schultz. First, I would say that our teams report high utilization of all of our spaces around the country. 3PLs continue to be the top most active prospect That we're seeing for new buildings and existing availability. And in general, they're all looking for more space, not less space.

Speaker 5

So I would simply tell you that we're not J. Ju, anything you want to add

Speaker 4

to that? J. Ju, anything you want to add to that?

Speaker 2

J. Ju:]

Speaker 3

Yes. The only thing is that definitely the 3PL in our experience, 3PL Business is not recession proof, but it is a business wherein when things slow down with companies that are not in the fulfillment business, they go to 3PLs. These GPOs are more efficient and more cost effective than doing fulfillment themselves.

Speaker 16

Thank you. That's really helpful. And then one more industry kind of wide question for me. Could you just discuss Trend among sublease space within your markets, any notable changes there?

Speaker 2

That's a pretty yes, That's an intricate topic because not all sublease space is created equal. Peter and Jojo, you want to come in with some Sure.

Speaker 5

So this is Peter Schultz. I would first say that sublet space at the headline is certainly up a little bit, But I think you have to break it down and it's a couple of different buckets. One is a corporate occupier saying 1,000 square foot building gets an edict from their corporate to sublet 200000 or 300000 square feet. That's a hard deal to make for tenants and generally doesn't happen. We don't really view that as competitive sublet space.

Speaker 5

Some of the sublet space has a time or term limit of only a couple of years, and most tenants are not going to take advantage of that. We've also seen some sublet space come on the market and be pulled back by the prime tenant because they need the space again. So yes, there is some sublet space. We don't view it as a high concern today. And then I would just end with, as I said a couple of minutes ago, the space utilization in our portfolio is very high.

Speaker 5

We're not really seeing Any change in sublet space across our portfolio. Jojo?

Speaker 3

Yes. I just want to just add to Peter when we surveyed really our We haven't really lost anything close to anything significant in the sublease space, just like Peter said. And if we did, these are the subleases that are long term, long term subleases, very good for long term user. But the problem is that most of leases don't fit that. Most of leases are short term.

Speaker 3

And therefore, frankly speaking, we'd like to compete with sublease Because a lot of times, the tenants that we're pursuing can't really operate out of a short term lease. It's like Peter Vasily said, It's caused to be

Speaker 16

moved. Great. Thank you.

Operator

Our next question comes from Mike Mueller with JPMorgan. Please go ahead.

Speaker 17

Yes. Hi. So for the two questions. The first one is For the development leases you signed in 3Q and 4Q, how did the rents compare to the original underwriting? And the second question is a little bit more Clarification.

Speaker 1

When you

Speaker 17

were talking about 24 leasing, did you say 56% of the remaining expirations We're in Southern California. And if so, how does that compare to what the mix was of what you signed already?

Speaker 2

Chris, take the first part. Yes. Last part first. Yes.

Speaker 10

So correct. The remaining 2024 lease expirations are 56%. And again, the ones that have been signed already, the mix with Southern California was only 5%. So obviously, it's going up quite a bit.

Speaker 2

Do you want to cover the first part of that question? Do you remember the first part of the question? Do you

Speaker 5

remember the first part of the question again, please?

Speaker 17

Yes. It's for the development leases signed in 3Q and 4Q. How are the rents versus what you originally underwrote?

Speaker 5

Significantly ahead of what we underwrote.

Speaker 6

Got it. Okay. Thank you.

Operator

Next question comes from Anthony Powell with Barclays. Please go ahead.

Speaker 7

Hi, good morning.

Speaker 18

I guess a question on data centers. As I look at Land Bank, are there any kind of obvious opportunities for you to do additional joint venture

Speaker 3

So we are well, in terms of we're We're very pleased that we were able to get the highest and best use for this piece of land that we have in Phoenix. So Very excited about that. When you look at all across the board in terms of what we own, we're always looking for higher and better use. So if we come to a situation wherein we are offered a price that it Doesn't make any sense to build an industrial building or exceeds our profit, margin potential and product potential on development, we would consider selling. So that's basically a rule and a practice that we do in FR.

Speaker 3

Now in terms of obvious candidates for future data centers right now, I will say that we don't have any pending offers or pursuits of additional data center situations.

Speaker 18

Got it. And I guess these will all be sales or joint ventures. You wouldn't do development on your own balance sheet Datacenters, is that fair?

Speaker 2

That's fair to say, yes. We're going to stick to our bread and butter.

Speaker 18

All right. Thank you.

Operator

Our next question comes from Caitlin Burrows with Goldman Sachs. Please go ahead.

Speaker 12

Hi. Sorry, just one follow-up, which is Similar to the question that was just asked. But in terms of the mix of expirations in 2024, I think you had previously said on Other calls that 2024 would have less SoCal than 2023. So I'm wondering as you compare 2024 to 2023, if that changed or just that kind of Exposure that you were talking about, that might be confusing. I'm just wondering how the 2024 SoCal exposure compares to 2023?

Speaker 10

Yes. Caitlin, this is Chris. So if you because there was a couple of leases that originally were going To they expire in 2023, you're not going to lease up in 2024. The allocation between the 2 years is both around 25% plus.

Speaker 2

Yes. We're talking about 1 month

Speaker 10

difference. So very, very similar between the 2 years.

Speaker 12

Got it. So it was some that had originally been thought of to be 23, but now there'll be 24, making them more even.

Speaker 10

Correct.

Speaker 12

Got it. Okay. Thank you.

Operator

Our final question comes from Craig Mailman with Citi, please go ahead.

Speaker 9

Yes, not trying to make the call a little longer, it needs to. But just There's a lot of focus on market rent growth these days and it just feels like a lot of the stats being put together by brokers and talked about are kind of Asking rents, which are some markets being driven by just new product that's coming on the market versus maybe where taking rates are. And I'm just kind Curious as you guys go through your market exposure, is there a rosier picture On the taking rate side of things versus the trend in asking rate, maybe you could talk about or?

Speaker 2

Yes, it's a complicated subject because market rent growth is tracked differently by a lot of different brokers. Taking rents right now, they report are More like 15%. We don't quote that. We think the asking rent number is more accurate. Our expectation for rent growth for 2023 was mid to high single digits.

Speaker 2

That was with asking rents in mind. So far, year over year, CBRE reports to the 3rd quarter that number is 7.5%. So it's right in the middle of what we expected. So yes, we're looking more to 7.5% rental rate increase across the markets that we're active in. We don't look at the the taking rents are higher because of all taking rents by definition have to include Some amount of mark to market as opposed to just what's happened in that quarter or that year.

Speaker 2

So we don't pay attention to that.

Speaker 9

Okay, great.

Operator

This concludes our question and answer session. I would like to turn the conference Back over to Peter Fasilli for any closing remarks.

Speaker 2

Thank you, operator, and thanks to everyone for

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Earnings Conference Call
First Industrial Realty Trust Q3 2023
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