ILPT (2020 - Q3)

Good morning, and welcome to Industrial Logistics Properties Trust's Third Quarter 2020 Financial Results Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Kevin Barry, Manager of Investor Relations. Please go ahead. Kevin Ba

Good morning, everyone, and thank you for joining us today. With me on the call are ILPT's Chief Executive Officer, John Murray; Chief Financial Officer, Rick Siedel; and Chief Operating Officer, Yael Duffy. In just a moment, they will provide details about our business and our performance for the third quarter of 2020, followed by a question-and-answer session with sell-side analysts. First, I'd 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, October 28, 2020, 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-based 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 can also be found on our website. With that, I will now turn the call over to John.

Thank you, Kevin. Good morning, and welcome to ILPT's Third Quarter 2020 Earnings Call. This morning, we reported solid results for the third quarter that reflect the strength and stability of our portfolio of e-commerce focused industrial and logistics properties. ILPT continues to benefit from robust industry fundamentals, a portfolio of high-quality warehouse and distribution assets, and high-quality credit tenants. During the third quarter, same-property cash NOI increased, FFO grew year-over-year, and liquidity remained strong. Despite the impact of COVID-19 on the economy, we executed nearly 800,000 square feet of leasing activity and demand for our properties was strong, with occupancy rates holding steady at 99%. After giving effect to modest rent deferrals granted to certain tenants, we collected 98% of our contractual rents during the quarter. Also, earlier this month, we maintained our regular quarterly distribution to shareholders. We continue to evaluate opportunities to grow our portfolio, but did not make any acquisitions this quarter despite submitting letters of intent for 16 properties with an aggregate value in excess of $950 million since our last earnings call. Consistent with the market conditions we experienced during the second quarter, interest in industrial real estate remains very aggressive and continues to attract capital looking for deployment opportunities. The acquisition environment is very competitive, and cap rates are steady or declining by about 50 basis points in top markets, especially for newer, long-term leased credit tenant buildings, which ILPT targets for its portfolio. While we are maintaining a disciplined approach to potential investments, our pipeline of acquisition opportunities remains steady, and we are prepared to react quickly to opportunities to complement our portfolio. In terms of dispositions, we entered into an agreement to sell a noncore building with approximately 300,000 square feet in Winchester, Virginia for $11 million. This is a relatively minor transaction. It reflects an opportunistic sale that will enable us to further reduce borrowings on our line of credit. We remain on track with our plans to expand our JV with private capital. However, the timing of closing remains uncertain. The pandemic had made it challenging to complete property due diligence, and there have been some delays working through documentation. We continue to view this venture as an important vehicle to support ILPT's growth and value creation over the long term. Now I'll turn the call over to Yael to review ILPT's operating results for the quarter.

Thanks, John, and good morning, everyone. I'll start with a brief overview of our portfolio and then provide details on leasing activity and collections during the third quarter. Today, ILPT owns and leases industrial assets that we believe are critical to sustaining and supporting essential products and services across the United States. Our portfolio consists of 301 warehouse and distribution properties in 31 states, totaling approximately 44 million square feet that are 98.8% leased. Our mainland portfolio includes 75 properties in 30 states totaling 27 million square feet that are 99.8% leased. Approximately 41% of ILPT's annualized rental revenues are generated by 17 million square feet of valuable industrial land and properties in Hawaii. Our top 3 tenants are Amazon, FedEx and Procter & Gamble, representing approximately 16%, 4%, and 4% of total annualized rental revenues, respectively. Investment-grade rated tenants, or subsidiaries of investment-grade rated parent entities, make up nearly 2/3 of our mainland revenues. Looking at the entire portfolio, more than 3/4 of revenue comes from those investment-grade rated tenants or subsidiaries, or from our secure Hawaii land leases. The total portfolio has a weighted average remaining lease term of approximately 9 years. During the third quarter, leasing activity remained strong and active. Despite aggressive market conditions for industrial and logistics properties and an existing portfolio occupancy of 98.8%, ILPT executed 776,000 square feet in leasing activity that was approximately 9.6% higher than prior rental rates for the same space. In the third quarter, we executed 10 new and renewal leases for approximately 486,000 square feet at rental rates that were approximately 7.9% higher than prior rates, with an average lease term of 4.4 years and commitments for leasing capital of $0.44 per square foot per lease year. While this roll-up in rent is below our historical averages, it should be noted that our results were negatively impacted by 3 relatively short-term leases in Hawaii. The balance of our leasing activity consisted of 2 rent resets totaling 290,000 square feet in Hawaii at rents that were 15.6% higher than prior rents. In October, we executed an early renewal with Amazon for a 1 million square foot sorting facility in Whitestown, Indiana. The current [reps] for this property represents nearly 2.3% of ILPT's annualized rental income. While the renewal resulted in 1.5% roll-down in rent, we exceeded our acquisitions underwriting of a 13% roll-down, which was expected due to the current leases amortization of excess tenant improvements. Amazon is the leading demand driver in the rapidly growing e-commerce space, and we are pleased to continue our existing relationship with them at this property. As our scheduled rent resets and lease negotiations for 2020 are essentially complete, our continued focus has been on lease expirations in the coming years. In 2021, excluding the early renewal completed with Amazon, the majority of lease expirations will be driven by 4 tenants on the mainland totaling approximately 1.1 million square feet, or 2.2% of total annualized rent. In 2022, the majority of expirations will be driven by tenants in Hawaii totaling 2.2 million square feet, or 6.3% of total annualized rent. Our real estate services and asset management teams have been in proactive discussions with many of these tenants and plan to address these expirations in a way that will maximize rent growth while minimizing potential downtime and capital costs. As such, our current leasing pipeline has grown to 5.9 million square feet, up from Q2 levels of 4.5 million square feet and includes 90,000 square feet of new prospects that could partially absorb the 542,000 square feet of vacant space across the portfolio. We anticipate a near-term conversion of approximately 17% of our pipeline, given that roughly 1 million square feet of current activity is in advanced stages of negotiation or lease documentation. Turning to rent collections and rent deferrals, we are pleased to report that rent collections remained strong during the third quarter, and rent deferral requests continue to stabilize. After taking into consideration granted rent deferrals to certain tenants, 98% of contractual rent due was collected in Q3. Since our Q2 earnings call in July, we granted 1 new rent deferral request to a tenant who leases multiple parcels from us in Hawaii. As of October 23, we have granted rent deferrals to 43 tenants. The total amount of rent deferred to date is $3.6 million, which represents 2% of the contractual cash revenue over the month with deferrals, which is April through December. To date, we've collected $338,000 of these deferrals, and our current balance of deferrals outstanding is approximately $3.2 million. Lastly, we are encouraged that Hawaii has taken steps to reopen the state with a pre-travel testing option. As of October 15, travelers can bypass the 2-week quarantine with a negative COVID test within 72 hours of departure. We are cautiously optimistic that this is the first step in reopening the local economy and supporting small businesses that rely on tourism. We will continue to monitor tenant activity and work with our tenants to support their long-term success while positioning ourselves as the landlord of choice. I'll now turn the call over to Rick to provide details on this quarter's results and financial position.

Thanks, Yael, and good morning, everyone. Total portfolio same-property cash basis NOI for the third quarter increased 1.9% year-over-year, with a 2.1% increase on the mainland and a 1.6% increase in Hawaii. The mainland increase was primarily driven by contractual rent steps and the Toro expansion project completed in Q4 of last year that we've discussed on prior calls. The increase in Hawaii was a result of our leasing activity, partially offset by lower occupancy year-over-year. This same-property NOI growth, along with our other results, contributed to third quarter normalized FFO of $30.1 million, or $0.46 per share, up 5.7% year-over-year. Adjusted EBITDA for the quarter was $46.1 million, up 5.2% year-over-year. We currently have no debt maturing until our credit facility in December of 2021, which is subject to 2 6-month extensions at our option. As of September 30, we had approximately $39 million of cash on hand and $430 million of availability on our revolving credit facility, which has increased to $457 million of availability as of today. We ended the quarter with consolidated net debt to EBITDA of 7.3x. Excluding the debt and EBITDA related to the joint venture, the rest of the portfolio was at 6.4x debt to EBITDA. We remain confident that our current liquidity and financial profile supports our ability to operate our business effectively and materially. Our property portfolio had minimal capital requirements during the third quarter. We spent approximately $1.2 million on capital expenditures. The majority of the spend pertained to improvements at 3 of our mainland properties, 2 of which were for roofing projects and the other related to a truck court improvement. As John mentioned earlier, in October, we entered into an agreement to sell a property in Winchester, Virginia for $11 million. This asset is reported as property held for sale on our balance sheet as of September 30, 2020. Earlier this month, we declared our regular quarterly distribution to shareholders of $0.33 per share, which is unchanged from the prior level. Our normalized FFO payout ratio is just under 72%. Our Board evaluates the dividend at every meeting and has been reluctant to raise it due to our current dividend yield relative to our peers. We are encouraged by ILPT's third quarter results and believe that our business will continue to withstand the economic downturn caused by the ongoing pandemic. Our balance sheet is strong, our portfolio remains stable, and we expect the resilient and growing industrial sector will continue to support our results. That concludes our prepared remarks. Operator, please open up the line for questions.

[Operator Instructions] The first question comes from Bryan Maher of B. Riley FBR.

A couple of quick questions, and maybe I missed this; and if I did, I apologize. But was there any update on the potential second JV partner that would have come into that first JV that you set up?

There was an update, just that we continue to work towards adding that second partner. And the timing has been elusive because the diligence process, which is now complete, took more time than we expected because of the pandemic, and there's still some final documentation matters that are being worked through, but the documentation has been provided to our lenders to get their consent. So we're in the latter stages, we believe, and we're confident that we will get it done.

Okay. Great. And then, when we look at the number of tenants, I think there's 43 or so that were granted deferrals, are those all or primarily Hawaii tenants? And I'm guessing that they're probably smallish in size and related to tourism. Can you give us a little more color on that?

Bryan, this is Yael. So you're right, 81% of the tenants that we've granted rent deferral to were in Hawaii, but they only account for $1.9 million of the deferred, of the $3.6 million. And it's interesting, because a lot of these tenants indirectly have to do with tourism. We have some dry cleaners. We have some tenants that conduct luaus and organize those. So I think that, while they might not be exactly in tourism, they support tourism. So we're really encouraged that Hawaii has allowed tourism back in with a negative COVID test. And we've actually even seen unemployment start to drop. I think in April, it was almost 24%; and as of September, it was 15%. So it's moving in the right direction.

Okay. And then, just 2 more for me. When it comes to the other bidders you're competing against for these assets, has there been a change in that mix? And how much of that's really being private equity-driven with all the capital that they have on the sidelines?

That's a good question. We don't get all the gory details, but we do know that, when we get color from brokers, that there seem to be a substantially higher number of bidders from most of the properties that we're looking at. And the most common bidders that we run up against, the private equity, other REITS, pension money, and then some family office, as well. So I think all of those participants are active. Private equity definitely is.

Okay. And then just lastly, operating expenses were just a little bit higher than we had been modeling. Is there anything going on there? I think I maybe noticed property taxes up a bit. Is there anything there that we should be thinking about as we model for '21 and '22?

No. I think, Bryan, like said, we certainly had some increases in real estate tax. We were able to escalate a good chunk of it, but there is certainly some flowing through to the bottom line. We had some kind of seasonal repair and maintenance expense projects that we try to knock out during this time of year. It was a little bit unfavorable, as well. But for the most part, it's a pretty decent run rate within the expenses.

[Operator Instructions] The next question comes from James Feldman of Bank of America Securities.

This is Elvis Rodriguez on for Jamie. I just had a quick question on the leases done in the quarter. You mentioned $0.44 of TI per square foot per lease year versus $0.04 in Q2. Can you just maybe discuss a little bit of what drove higher TIs in this quarter's leases versus last quarter?

Sure. We had a couple instances where we actually had to pay brokers who helped us with some of these leases, which is atypical for us. And we also gave some of the -- where these were 4 of the leases completed were new leases, we do give a little bit of TI there, as well.

And then can you maybe talk a little bit about -- a little bit more on the Amazon lease? You mentioned the roll-down, but doing better than expectations. How many more of these type of leases do you have in your portfolio in the coming years?

So we have some big tenants rolling in 2023, '24. And I think the tenants, such as Amazon, Procter & Gamble, Whirlpool, they really have, I guess maybe to use the word "purchasing power," so they're tough negotiators. And so I think, there, I think we'll try to do our best to get roll-ups in rent, but some of these leases are first-generation leases that have amortized TI into the rental rate. So we might see that we'll do market deals, but just where their expiring rent is, and there might be minimal roll-up versus what we're seeing on new leasing.

And do these tenants have a lot of other options within those markets that these buildings are located in? Because it seems like the industrial space seems pretty robust across all -- across the country. So it surprising to hear that there's roll-downs occurring on these long leases.

Well, I guess, again, for this Amazon lease, they had $0.75 in amortized TI into their base rent, so that was really the reason for the roll-down. But for this property in Indiana, Amazon leases 8 different locations within the greater vicinity, and so there is spec construction happening, and they have options. So it's important for us -- we felt it was important for us to retain them; and again, where we did a market deal.

And then just one more question. Can you just discuss -- I know you're in, like, 30 markets in the U.S., so maybe we don't have to drill into each, but just maybe the supply demand dynamics as we head into '21. Are your markets seeing more supply relative to the rest of the U.S.?

I think there's just a lot of activity. And so, I guess I can't speak for all 31 markets. We're pretty well leased, especially on the mainland, at almost 100%. So the activity that we've seen has been really more around renewal conversations. And I think from the acquisitions side, as we've been reviewing potential acquisitions, we're seeing that there's a lot of activity; but also, even with some of those new construction, there's a lot of available land. So I think there's spec construction happening, which will obviously bring competition.

The next question comes from Michael Carroll of RBC Capital Markets.

Can you guys talk a little bit about the 2% uncollected rent? I know it's pretty small, but how does that compare historically? And when does that typically get paid? I guess who are the tenants? And I guess what's some of the reasoning behind -- by that unpaid portion?

Mike, this is Rick. Maybe I'll take a stab at it, and Yael can add some color if she wants. But I think when we give that collections metric, it's really over contractual rents due. So we don't actually book revenue, and we generally haven't booked revenue on that 2% for quite some time. There's always some tenants in the space that we don't expect to pay, and we're kind of working through the process. So at this stage in the game, the 98% collected in Q3 and the 97%-plus in October that we've collected, we'll get a little bit more in the October, but we're not holding our breath for some of the Q3 rents. I mean, the team will continue to try to chase it down, and we'll collect what we can. But realistically, that's never really been reflected in our revenue. We've also historically had some slower payers in Hawaii because we're dealing with smaller businesses in a lot of cases. And just the nature of the beast, it tends to come in a little slower.

Okay. And is there an ability to get that space back and re-leased eventually? Or is that just kind of that maybe you get that space back, but then you have other smaller issues, so it's always kind of right around that 2% range?

It's historically been around that 2% of kind of, I'll say, gross potential rent, or gross contractual rent. We do, from time to time, have bad debt. I mean, a year ago; you see this year, we have a pretty favorable comp on the GAAP NOI line because we had some pretty substantial straight-line bad debt charges last year. You don't see that on the cash line as much. But as a percent of our GAAP revenue or our cash revenue, we typically see bad debt averaging somewhere around 50 or so basis points. It does move a little bit. It could be up to 150 basis points one quarter. That's what we saw last year in Q3. It could vary and be a 7 basis point recovery, which we saw a couple of quarters ago. So it does move around a bit. But on average, it's somewhere in that 50 to maybe 75 basis points of kind of normal bad debt, and that's using our revenue as a denominator as compared to the contractual amount, which, again, our team is really pretty good about chasing down; and if somebody is not going to pay us, getting them out of the space as quickly as possible.

And then, can we talk a little bit about the Amazon lease? I guess, what was the new term? I guess, it expired -- was it this year or next year? I guess, how many years did you get on that lease? And that 1.5% roll-down, was that a GAAP number or a cash number?

Yes. This is Yael. So we signed a 64-month lease with them. Their lease expired in April of 2021, and the roll-down in rent was a GAAP number.

Okay. Could you provide us what was the cash number there?

The cash rent?

Yes.

Yes. So [410] a square foot with 2% increases.

And how much was the roll-down in cash rents compared to the prior lease?

$0.30.

And then, I guess, last question for me is I know the JV kind of mentioned a little bit earlier in your prepared remarks, I guess. What's the expectation there in terms of timing? Is it still just a little bit uncertain until you can get contracts signed? Is that something that could still happen this year? Is it next year? Or what's the expectation?

There is still some uncertainty around it, but we're cautiously optimistic that we'll get it done later this quarter, so before year-end.

This concludes our question-and-answer session. I would like to turn the conference back over to John Murray, President and CEO, for any closing remarks.

Thanks, everyone, for joining us today, and we look forward to speaking with many of you at the upcoming virtual Nareit. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.