ILPT (2020 - Q4)

Good morning. And welcome to the Industrial Logistics Properties Trust Fourth Quarter 2020 Financial Results Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. 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, sir. 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 Seidel; and Chief Operating Officer, Yael Duffy. In just a moment they will provide details about our business and our performance for the fourth quarter of 2020 followed by a question-and-answer session with sell-side analysts.

Thank you, Kevin. Good morning, everyone, and thanks for joining us. On today’s call, I’ll begin with a brief update on our results and the progress we made on key priorities during the fourth quarter, Yael will review our latest property portfolio statistics and recent leasing activity and Rick will discuss our financial results in more detail. We will then take questions. Turning to our quarterly results, we closed out the year with continued financial growth, solid leasing activity, execution on our joint venture strategy, reduced leverage and high quality industrial acquisition. During the fourth quarter our portfolio achieved 1.6% normalized FFO growth year-over-year. We collected over 98% of contractual rent after giving effect to modest rent deferrals granted to certain tenants earlier in the pandemic. We executed new and renewal leases for 253,000 square feet while sustaining high occupancy at 98.5%. In November, we took another step forward with our joint venture initiative adding a top tier global sovereign wealth fund with a 39% equity investment in the existing 12 property JV for approximately $109 million of proceeds.

Thanks, John, and good morning, everyone. I’ll start with a brief overview of industry and market trends, provide an update on ILPT’s portfolio after the deconsolidation of the joint venture assets and then summarize leasing activity for 2020, as well as the fourth quarter. As you know, the pandemic has been a catalyst for industrial real estate due to accelerated e-commerce demand for consumer products, groceries, home furnishings and improvements. Retailers are opting for multiple warehouses in the single area, evaluating supply chain optimization and stockpiling inventory to meet consumer needs.

Thank you, Yael, and good morning, everyone. Total portfolio same property cash basis NOI for the fourth quarter decreased 1.8% year-over-year. This decline was primarily due to the change in timing for recognition of percentage rents that resulted from our execution of a lease amendment during the fourth quarter of 2019. As discussed on previous calls, we amended that lease and began recognizing approximately $1 million randomly throughout 2020. Excluding the impact of that change, same property cash basis NOI increased 20 basis points year-over-year. From a property type perspective, we reported a 2.9% decrease in same property cash NOI in Hawaii, excluding the percentage rent timing change, same property cash basis NOI in Hawaii increased 1.2% year-over-year.

Certainly. And our first question today will come from Bryan Maher with B.Riley. Please go ahead.

Good morning, everyone. Two questions for me this morning. One, can you expand a little bit upon your acquisition of the Kansas City property? We’re not familiar with the tenant, Excelligence Learning Corporation? And also what are your thoughts there on expansion of that property? And then I have a follow up. Thanks.

Sure, Bryan. That tenant is in the business of providing educational materials and education-related equipment, primarily focused on preschool and elementary school age students and they’ve recently consolidated much of their operations. They had several different locations where they were distributing their products from they’ve consolidated them to this new building. And we think that they’re -- they have a good business model. They -- the higher cap rate on this transaction reflects that they are not the strongest credit, but we believe, particularly with the current remote learning environment for many students across the United States that they have a bright near-term future and as they continue to grow their long-term future is respectable too. So we think that’s a good acquisition. It’s a reasonably new building. It does have expansion capabilities. We don’t see that happen -- expansion happening in the near-term. But we do have the ability to either add on to this building or potentially down the road, if we subdivide this land from the existing parcel, where -- we could develop a separate industrial building.

Great. And then as it relates to your leverage now being substantially below 6 times net debt-to-EBITDA, do you anticipate getting or lobbying for an investment grade rating in 2021 and how do you think about deploying your excess liquidity in this kind of heated market for industrial assets? Thank you.

Yeah. Bryan, it’s a good question. It’s one we have discussed internally quite a bit. Initially when we did the IPO, we came out with really low leverage and the plan was to seek an investment grade rating. And then we had the opportunity to try to demonstrate the value at Hawaii portfolio with some CMBS financing. And when we look at the portfolio now, we think about our cost of capital. I’m not sure that the investment grade rating would really help us all that much. We do have a significant number of offline assets encumbered with that CMBS debt for through 2029. We’ve got great relationships with banks. We’ve got other capital partners that we could work with. So, from a long-term capital perspective, we obviously want to maintain a fairly conservative balance sheet and remain well positioned. But I don’t know that it’s as much of a priority as it might have been a couple years ago. And then from a liquidity perspective or how to deploy that capital, I…

Yeah.

… turn things on to Rick.

Yeah. In terms of deploying capital, we’re actively looking at potential transactions to acquire high quality industrial properties. We have, I don’t know, five or six offers that are outstanding at the current time, several of which are moving into a second round. So the opportunities to invest are plentiful, but exceeded only by the amount of investors who are chasing them. So who knows whether we’ll be successful or what -- at what cap rates, but that’s our current plan is to continue to grow. And we’re making acquisitions that we’re happy for ILPT to be the sole owner of long-term, but we also -- we do have the joint venture setup with both investors part of the joint venture now and so we have the ability to offer properties to the joint venture partners and may from time to time sell some of the acquired assets into that joint venture and continue our growth in that manner, so that we would own just 22% of those properties going forward. So we have good liquidity today on our -- mostly through our revolver, but we have -- even with our share price that what we believe is depressed level, we have access to attractively priced capital through the joint venture for equity capital should we need it.

Yeah. Thanks, John.

Thank you.

And our next question will come from Jason Idoine with RBC. Please go ahead.

Thanks. In the prepared remarks, I think, you guys mentioned some potential for development opportunities and then, obviously, the Kansas City acquisition has some land on it as well. So just thinking about, I guess, what’s the investment pipelines allocation to development opportunities versus stabilized acquisitions today? And then going a little further, how do you weigh those opportunities going forward?

We don’t have a specific allocation between growth through acquisition or through development. The properties that we own today, there’s a number of them that have excess land, where we could expand existing facilities, but they are triple net leased properties. So it’s -- the tenant needs to want to expand, we can’t just go in and build or expand on their buildings without their desire. So it depends on the growth of their business and other locations that they may have. So it’s hard to predict. We do have some opportunities -- other opportunities within the RMR Group of companies where there’s some vacant land where we may in the future acquire land from other entities and just develop properties ground up. But that’s not going to be a material component about growth going forward. So I think development growth for us in the near-term is just going to be sort of a peripheral portion of the growth, it’s primarily going to be through acquisitions. Over time, we’d like to make it more towards development, when -- if cap rates are going to remain as competitive as they are today.

Okay. And then, I guess, what are your expectations for the Hawaii lease rolls in 2021 and 2022? I don’t know if you’ve had any early renewals or I’m sure those discussions are ongoing. But if you could just provide any color on where you’d expect those rental rates to come in, obviously, that’s been an area that’s been, I guess, more impacted than the mainland portfolio by the pandemic. So how are you guys thinking about that?

Sure. So we have 53 leases expiring in 2022 in Hawaii, so I think we have a real opportunity there to continue to see roll up in rents. As I mentioned in the prepared remarks, we’re engaging with brokers to help us with a little over half of those leases. And I think the 14% roll up we saw this quarter is a good indication of market. I think there’s definitely some parcels where we’ll be able to exceed that expectation, but 15% to 20% I think is a good gauge.

Got it. Thanks.

And our next question will come from Aaron Hecht with JMP Securities. Please go ahead.

Yeah. Thanks for taking my question. Just want to hit on those lease rolls a little bit more. 2022, 2023, 2024, I think, that combined to over 30% of your total rents. I am wondering if you could separate those between Hawaii and the mainland, and maybe if you could talk about where they sit relative the market, you talked about 22 for Hawaii, but just overall for all of those expirations, if you can give any insights?

Yeah. So, on the mainland, we only have two leases expiring in 2021, about 222,000 square feet. We’re in active discussions with both of those tenants. I think it’s a little too early to say, we haven’t reached terms yet, but I think the renewals will be if we’re able to complete them will be at market. Again, ‘22 is a big year in Hawaii. We’re in discussions with -- I think we have 3.3 million square feet expiring between ‘21 and ‘23 in Hawaii and we’re in discussions or at least have proposals out to 53% of that number, so about 1.4 million. And then for some of the other mainland properties, ‘22 is a light year as well, it’s only about 715,000 square feet and ‘23 we have a little over 2 million. And believe it or not a lot of those tenants have already started to talk to us about renewals. So, again, I think, we’re -- I think where the market is right now and it’s -- everybody is trying to gobble up any vacancy that’s coming on Board. I think the tenants want to remain in our buildings and they don’t want their businesses to be disrupted. So I think we have an active audience.

And any thoughts on where your mainland portfolio? What -- where’s the market today versus maybe a year ago and just sort of your thoughts on that to give context for what could happen in future?

In terms of rent?

Yeah.

I think it’s competitive. I mean, it’s hard to say, because a lot of these leases will be second generation. So we’re competing against newer product, as well as some of the rents in the original leases have amortized TI in them? So, I think, there might -- I don’t know that we’ll be seeing 5%, 6% roll ups in rents, but I think, 2% to 3% is probably where we expect to be.

Got you. And then one more if I could, could you guys give some thought on the investing in multi-tenanted facilities, maybe drive a little bit higher yield or is that just not a model that ILPT wants to go and approach?

We’ve primarily invested in single-tenant properties, but we do look at both and we actually have offers out currently on two different multi-tenant properties. So we’re not against them. It just really depends on who the tenants are and how the space is laid out, and what we perceive as the risks of re-tenanting those properties if space becomes available. So you may see some multi-tenant properties added as we go forward.

Any thoughts on yield spread between the two types of assets, single tenants that you traditionally work in and multi that you -- that you’re looking at?

It really depends on where the markets are and who the tenants are, but I’d say, maybe 25 basis points to 50 basis points. Honestly, it feels like transactions are so aggressively bid right now that it’s -- in some markets that there doesn’t seem to be that much recognition of the difference.

Got you. Appreciate it guys. Nice quarter.

Thank you.

And our next question will come from Jamie Feldman with Bank of America. Please go ahead.

Great. Thanks and good morning. I think you had said on an adjusted basis your same-store growth was 20 basis points in the quarter. And I just want to understand, as we look at the year ahead, is that a good run rate for this portfolio, like, what are the moving pieces that are going to get that number higher or lower? And I know you’d said, some of these renewals you’re doing are kind of flattish. So I’m just trying to under -- I just -- I’d love to get your view on what does the kind of core growth outlook look for these assets?

I think it’s a little different in the mainland than it is in Hawaii. This quarter had a little bit of noise, I mentioned slightly higher, non-escalatable expenses, for example, and really what that was some repairs, there was a sewer line issue in Hawaii and then we had some hail damage that we -- that wasn’t able to pass-through the tenant on the mainland. So when you put some of that together, it does certainly drive the growth down a little bit. And then, we do have a multi-tenant building in the portfolio today and one of the three tenants is struggling a bit and we have a little bit of noise in the P&L related to that. But, Yael, can probably speak to it better than I can. But the great news is that there is a backfill pretty much ready to go. So, again, I think from time to time, when your portfolio is essentially full, any little disruption kind of drags you down. But it’s a high quality portfolio with good future prospects. So I would expect to be higher than where we are, aside from the occasional bumps in the road that will come with the business.

So, I mean, how would you layout the building blocks, like, on a cash basis? Like what are your average rent bumps? What do you think occupancy can do and what do you think leasing spreads would look like?

I mean, historically, we’ve said that, if you look at history, Hawaii has grown around 3%. There is a little bit of occupancy decline that we’ve had there. We’re hopeful to get that back. So, I mean, in the short-term with the impact of the pandemic, if that’s growing at 2.5% to 3%, I think, we’re pleased in the short-term until some of those leases roll. And then on the mainland, again, long-term lease to high credit quality tenants before getting 1% bumped in cash. I think that’s pretty solid for where we are today.

Okay. It sounds like kind of a 1% to 2.5%-ish range is more reasonable for this year.

Yeah. I think that’s a reasonable conservative expectation.

Okay. And then you gave net debt-to-EBITDA, I think, it’s on a consolidated basis. Do you have that number as like a look through leverage number?

What do you mean by look through leverage number?

Well, your share of JVs?

Yeah. The share -- in our EBITDA calculation now kind of following the EBITDA i.e. definition from NAREIT, you can clearly see our portion of the JV. This quarter it was $939,000 I believe. I don’t have the supplemental in front of me, but on a go-forward basis, I think, I said, our levels will settle in if that kind of 5.5 times range.

And that’s a look through, that’s not just consolidated?

That’s correct.

Okay. So your JV income you’re saying is currently at $900,000 or so?

That was the half quarter impact. So on a go-forward basis, I would expect, probably, $2 million round numbers of our share of EBITDA from the JV.

Okay. All right. Great. Thank you.

And this will conclude our question-and-answer session. I’d like to turn the conference back over to John Murray for any closing remarks.

Thanks, everyone, for joining us today. Look forward to hopefully seeing you soon at least virtually at some investor conferences. Thanks.

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect your lines at this time.