ILPT (2021 - Q2)

Good morning, and welcome to Industrial Logistics Properties Trust Second Quarter 2021 Financial Results Conference Call. After today’s presentation, there will be an opportunity for you to ask questions. Please note, this event is being recorded. I would now like to turn the call 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 second quarter of 2021, followed by a question-and-answer session with sell-side analysts.

Thank you, Kevin. Good morning, everyone, and welcome to ILPT’s Second quarter earnings call. I’ll begin with a brief update on ILPT’s second quarter performance and then turn the call over to Yael and Rick for details on ILPT’s portfolio statistics, leasing activity and financial results. We reported second quarter results that were highlighted by same property cash NOI growth and strong demand for our properties with solid leasing momentum and portfolio occupancy of 99%, up 40 basis points sequentially. We generated normalized FFO of $30.6 million or $0.47 per share, which was stable year-over-year despite the deconsolidation of our joint venture. We executed 564,000 square feet of leases and rent resets, resulting in an average rent roll-up of approximately 18%. In June, we completed our acquisition of a high-quality industrial property in the Columbus, Ohio market area, one of the country’s premier distribution corridors due to its strong rental growth in central location, providing access to nearly 60% of both the U.S. and Canadian population within a one-day drive. The building is 100% net leased to Synnex Corporation for seven years and includes excess land that can accommodate a future expansion of more than 100,000 square feet.

Thanks, John, and good morning, everyone. I’ll begin with an overview of ILPT’s portfolio and then summarize our leasing activity for the second quarter. As of June 30, 2021, ILPT’s portfolio consisted of 291 warehouse and distribution properties in 32 states totaling approximately 35 million square feet. Overall occupancy increased to 99%, a 40 basis point increase compared to the prior quarter. Our mainland portfolio includes 65 properties in 31 states totaling 18 million square feet that are 100% leased. The balance of the portfolio is comprised of 17 million square feet of industrial land and properties in Hawaii. Occupancy in Hawaii was 97.8% at quarter end, a sequential improvement of 80 basis points. The total portfolio has a weighted average remaining lease term of approximately nine years. ILPT’s portfolio remains strong with a diverse roster of credit quality tenants. Our top 20 tenants represent 45% of total annualized rental revenues with Amazon, FedEx and Restoration Hardware representing approximately 10%, 5% and 3% of total annual revenue -- rental revenues, respectively. Investment-grade rated tenants or subsidiaries of investment-grade rated entities make up more than half of our mainland revenues. Looking at the total portfolio, more than 70% of revenue comes from those investment-grade rated tenants or subsidiaries or from our secure Hawaii land leases. From a geographic perspective, ILPT’s top three markets after Hawaii at 51%. Our Ohio, South Carolina and Indiana representing 7%, 5% and 5% of our total annualized revenues respectively.

Thanks, Yael, and good morning, everyone. Our rental income and substantially all of our expenses decreased year-over-year following the deconsolidation of the 12 properties in our joint venture during the fourth quarter of 2020. Total portfolio same-property cash basis NOI for the second quarter increased 1.4%, driven by a 1.7% increase in Hawaii and a 1.1% increase on the mainland. The increase in Hawaii was the result of new leasing activity and rent resets combined with higher occupancy year-over-year. The mainland increase was primarily driven by contractual rent steps in our leases. This same-property performance, along with decreases in general and administrative expense and interest expense, and including our share of FFO from our unconsolidated joint venture contributed to second quarter normalized FFO of $30.6 million or $0.47 per share. Our results were flat compared to Q2 of last year despite the deconsolidation of 9.2 million square feet in our joint venture. Adjusted EBITDA for the quarter came in at $40.9 million, and we ended the quarter with debt-to-EBITDA of 5.3 times, which is approximately two times lower than we reported a year ago. Our property portfolio had minimal capital requirements during the second quarter. We spent approximately $1.1 million on capital expenditures, including $1 million related to recurring CapEx for building improvements and leasing costs. Earlier this month, we declared our regular quarterly distribution to shareholders of $0.33 per share. This equates to an annualized dividend yield of approximately 4.9% based on yesterday’s closing price. Our dividend remains well covered at a 70% normalized FFO payout ratio. As of June 30, we had approximately $537 million in total liquidity, including cash on hand of $31 million and availability on our revolving credit facility of $506 million. We are well positioned to continue to grow our industrial portfolio, increase cash flow and enhance returns to our shareholders over the long-term. That concludes our prepared remarks. Operator, please open up the line for questions.

Thank you very much. We will now begin the question-and-answer session. We take our first question from Bryan Maher from B. Riley Securities.

Good morning. A couple of questions from me and it relates to Hawaii. About a year ago, I think that there was a little bit of tenant stress for those who had kind of a hospitality-centric business. Has that effectively abated at this point with travel to Hawaii resuming? And are you seeing any pushback on rate increases as those renewals come up?

Hi, Brian, not at all, actually. We’ve -- as you mentioned, effect starting July 8, say, Hawaii took away the mandatory quarantine for vaccinated travelers. We’re seeing that there’s been increased air passenger counts, I think retail spending is up. So I think our tenants are well positioned, and we haven’t seen any -- I think that the land is valuable and they know it, and they’re really not barking at the rental increases.

Okay. Great. And then maybe we can touch a little bit upon the land parcel you purchased in Dallas. That combined with at least one or couple expansion potentials you have at existing sites. John or Yael, can you talk a little bit about the appetite of ILPT and the Board to pursue development on those sites, given how competitive cap rates are? And if you were to pursue that, what kind of dollars and what kind of timeline we would be looking at?

Well, I’ll start. Yael, you can add as you prefer. We wouldn’t have bought the land in Mesquite, Texas, which is in the Dallas submarket, if our Board wasn’t on board with the idea of possible development. That said, it’s not a huge parcel of land. So it’s not going to be a very significant building in our portfolio when we decide to develop, but I think the yields you can get developing in certain markets or expanding existing properties where you have excess land are much better than the yields you can get from acquisitions today. So we are -- RMR group has a development and construction group. We’ve built buildings in various sectors, including expanding in some of our industrial properties already, and we expect to continue to do that for some of our existing tenants. And again, I don’t expect it to happen that quickly that we’re developing this Mesquite property. It’s -- we’re doing some zoning work on it currently. So it’s probably over a year away from actual moving dirt and putting up a building, but it is something we’re going to continue to do.

And maybe just last for me on that note. Given how tough it is to find developed sites already at acceptable cap rate, how easy is it to find these type of development sites around the countries in high profile, strong markets like you’ve seen in Columbus and others. Is there a good bit of availability to continue to acquire land for development?

It hasn’t been our primary focus to be looking for sites. Our primary focus remains on acquisitions of existing properties. So I can only give you a partial answer on that. I can tell you that we have, as an example, TravelCenters of America. It’s got sites along the U.S. Interstate highway system, outside of almost every major market in the United States. And their site -- their travel centers average 20 acres of land.

Thanks, John. That’s all for me.

Thank you. The next question is from Elvis Rodriguez from Bank of America. Please go ahead.

Good morning, thank you. I was hoping that maybe you can dive in a little bit into the 28% that you mentioned of pipeline in advanced stages. Where are the properties, potential yields and timing on closing?

So I mean, as I mentioned, we’re still in negotiations. So it isn’t final until it’s executed. But the ones -- the 28% that I talked about are mostly in Hawaii. We have a couple of renewals that we’re working on the mainland. I would say we’re expecting to see probably the 15% to 20% roll-up in rent in Hawaii as we have in the past two to three quarters. And then probably again, the mainland is a little bit less clear, because it’s a little earlier on in negotiations, but hopefully 5% to 10%.

Are you able to share the cash roll up-in those as opposed to the GAAP roll up?

So we report everything based on GAAP, I mean, I guess, for your modeling purposes, we could say, I think in Hawaii, annual increases between 2% and 2.5% on the mainland and 2.5% to 3% in Hawaii.

Okay, thanks. And then I know you bought the land parcel, but do you think that over the last few years, you haven’t been as aggressive on acquisitions. I mean, cap rates have compressed tremendous amounts, specifically over the last year. So how are you thinking about buying land that’s not sort of delivering income today but could deliver income and yield in the future versus perhaps buying assets that are actually income producing?

Well, the Mesquite purchase was just a couple of million dollars. So I don’t think that, that’s a big -- it doesn’t have a material impact on our investment activity. We are aggressively pursuing acquisition activity. We just -- there are a lot of groups who are aggressively pursuing acquisition activity. So, we have our cost of capital. We’re not going to buy aggressively just to run in place or to go backwards. So, when we’re achieving cap rates that we think are the right risk-adjusted returns, we go as aggressively as we can, and some markets it works and in some cases, we may have less comfort because of tenant credit quality or we may have less comfort because of the amount of development and the timing of when rent renewals are coming up. And so we may not get as aggressive as other parties so you just -- you do the best you can.

Thanks, John. And just one more for me. How much of cap rates moved on sort of the acquisitions that you were targeting, call it two years ago, a year ago versus today?

I’d say we did some deals in the sixes in 2018, 2019 time frame. And cap rates are regularly in the low fours, occasionally sub four, depending on the market. But I’d say over 200 basis points.

And then if I could just follow-up, you mentioned that some deals, you’re just not comfortable with the releasing risk, potentially taking on releasing risk, but you have this RMR structure that’s pretty strong and can get the leasing done. So -- and the market is pretty hot and demand is pretty robust. So, why not perhaps move out a little bit on the scale?

We do evaluate moving out on the scale, but perhaps, it’s because we have such a good market presence around the country and that we may understand the risks and sometimes having a presence, you know the market too well, and so the perceived risk may be higher, because you do know from experience what -- how long it takes to renew, what local market rents really are versus what brokers may be telling you in an offering memorandum or sales process. So I think we feel very good about the qualifications of our team, both on the asset management, real estate services side, and we put a lot of faith in the information that they provide as well as the information we get from third-party sources, and we take the risks, we think are acceptable.

Okay, thank you.

Thank you. The next question is from Tom Catherwood from BTIG. You may go ahead, please.

Thank you, and good morning, everybody. Just to kind of follow-up on Elvis’ question. John, your opening remarks, you kind of alluded to having a strong acquisition pipeline. And you then kind of sound a little more cautious on kind of what’s happening in the market right now, which is understandable, given cap rate compression and all the interest in industrial right now. But can you kind of provide us some more color on what’s in your pipeline, kind of what you’re looking at, how you’re sourcing deals now? And kind of what’s your level of confidence that you’ll be able to close on some of the deals you’re looking at right now?

I’d rather not go into too much detail there. But we do have transactions we’re pursuing that where purchase and sale agreements are being negotiated and diligence is being conducted. We have other transactions where we’re -- we’ve advanced past the first round. I think we have one where we’ve gone through a buyer interview around, but have not gotten feedback yet on where we stand. So -- and then we have a long list of properties in our acquisition pipeline report where we’re currently doing our underwriting. So, we have a big funnel and like every funnel, it gets narrower as you get closer to finding out if you won or lost. And so we have a few properties that we’re hopeful that we’ll be able to talk about in more detail on our next call when we complete them, and we have others that we’re working hard on it and we’ll see what happens.

Got it. Thanks, John. And then, Yael, last quarter, you had mentioned bringing in some brokerage firms in Hawaii to help assist with the leasing and the reset process in 2022? And then in your prepared remarks, you mentioned kind of setting up a plan to both maximize rent upside and minimize downtime or tenant loss. Can you provide maybe a little bit more detail on kind of what the approach is there? And maybe is the approach now different than you typically do or different than you’ve done before in that market?

Yes. So we’ve -- historically, we’ve handled all of the renewals direct without engaging brokers, but where we have just so much volume in 2022, we devised a plan. I think we’re -- the ratio is about 40% we’re handling direct and 60% we’ve engaged third-party brokers. So we’re working with three different groups. And it’s really depending on the different -- the different parts is how we’ve broken it up. But so far, I think we’ve only signed four of the leases we’ve done so far for expirations in 2022 have been with brokers. So I think that we kind of frontloaded or own renewals that we thought we’d be able to handle direct and then maybe some of the tenants who are either were more reluctant in responding to our initial proposals we’ve engage brokers to help us and I think we’ve actually seen a lot of momentum as we’ve engage brokers I think the tenants are taking the renewals a little more seriously and worry that they might be have competition for their parcel. So it’s been – we feel good, we have – as I mentioned pretty healthy pipeline in Hawaii. So I think we’ll be able to get a lot it tackled before the leases come up in 2022.

Makes sense. Thank you for that. And then just one more question for me, in the JV portfolio and I know this isn’t kind of have a huge impact on earnings. But one expiration left in 2021, and then nothing really rolling until 2024. What are your expectations on that one lease that still coming due this year?

So we actually executed that last week. So five year renewal on that one.

Rent roll-up?

Yes.

That’s it. Thanks everyone.

Thank you.

The next question is from Elvis Rodriguez from Bank of America. Please go ahead.

John, just a quick follow-up on your interest in potentially doing like a public-to-public M&A or acquiring any big portfolios that are out there. I know, you’ve mentioned from a cost of capital perspective, your stock is so trading at a discount. But just curious how you view potential opportunities to do a bigger portfolio.

I won’t comment on whether we are looking at anything like that, but it’s -- generally speaking, it’s just as easy to buy a large portfolio of properties at one time, than as it is to buy one or two properties individually. So whenever we become aware of an opportunity, whether it’s a corporate transaction or a large portfolio transaction, we almost always write it up and review with that credit committee and if necessary with our board. So it’s something that we regularly evaluate.

Great. Thank you.

Thank you. Next question is from Aaron Hecht from JMP Securities. Please go ahead.

Hey, guys. I think you made the comment that after 2022, the majority of the turn leases and rent growth will be coming out of the mainland. It sounds like value could be maximized or at least for a period of time on the Hawaii portfolio in that scenario. Any thoughts on monetization events once assets have experienced maximized NOI? Thank you.

In Hawaii, specifically, or.

Yes. It sounds like after those 2022 leases turn that you may have hold a lot of the juice out of Hawaii?

Yes. Well, we’ll have a quick break in 2023, but then we have 2.8 million square feet in 2024 rolling, which is 17.1%. So, I think Hawaii continues to really be a huge driver for us. So I don’t -- I mean, year-over-year, we’re continuing to see rent growth. So I don’t think we have any appetite to do any dispositions there.

Got you. Thank you.

Thank you. 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.

Thank you for joining us on the call today. We look forward to seeing as many of you as possible in person at the upcoming NAREIT conference. Thank you.

Thank you. With that, we conclude this conference call. You may all now disconnect. Thank you.