Duck Creek Technologies, Inc.
Q1 2017 Earnings Call Transcript

Published: 6 May 2017

[Operator:]

Good morning and welcome to the DCT Industrial First Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] 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 Vice President of Corporate Communications and Investor Relations, Melissa Sachs. Please go ahead.

[Melissa Sachs:]

Thank you. Hello everyone and thank you for joining DCT Industrial Trust’s first quarter 2017 earnings call. Today’s call will be led by Phil Hawkins, our President and Chief Executive Officer; and Matt Murphy, our Chief Financial Officer, who will provide details on the quarter's results and guidance. Additionally, Neil Doyle, our Managing Director of the Central Region, will be available to answer questions about the markets, developments and other real estate activities. Before I turn the call over to Phil, I would like to remind everyone that management’s remarks on today’s call will include forward-looking statements within the meaning of federal securities laws. This includes, without limitation, statements regarding projections, plans or future expectations. Actual results may differ materially from those described in the forward-looking statements and will be affected by a variety of risks, including those set forth in our earnings release and in our Form 10-K filed with the SEC, as updated by our quarterly reports on Form 10-Q. Additionally, on this conference call, we may refer to certain non-GAAP financial measures. Reconciliations of these non-GAAP financial measures are available on our supplemental, which can be found in the Investor Relations section of our website at dctindustrial.com. And now, I will turn the call over to Phil.

[Phil Hawkins:]

Hey, good morning and thanks for joining our call today. 2017 is off to an excellent start for DCT as our business continues to perform at a very high level. Market fundamentals remain as strong as ever with excellent tenant demand, declining market vacancies and continued healthy rent growth and yet developers are responding to this environment by building more buildings, but in our view, these decisions remain rational and disciplined. In every one of our markets, the amount of unleased space under construction is still well under trailing 12 month of net absorption. This absorption, combined with historically low vacancy rates and rising development cost, leads us to remain bullish on future rent growth and equally important, since the capital behind virtually everyone of these new projects is institutional equity, leasing decisions remain highly disciplined and long-term focused. Developers are not sacrificing targeted rental rates and long-term returns in favor of quickly results. Reflecting this favorable market backdrop and the quality of our buildings in prime locations our portfolio continues to perform very well. Rents on leases signed during the quarter increased 24.9% on a straight-line basis and 11.3% on a cash basis, while same-store NOI in the quarter increased 10.4% on a cash basis and 5.7% on a straight-line basis. These results together with our continued optimistic view of market fundamentals led us to increase our financial and operating guidance for the year. The second quarter is off to a strong start as well with a little over 1.2 million square feet of leases signed so far in our operating and value-add properties with several significant leases out for signature. Development remains the best opportunity to create value in this environment. Our local market teams continue to prove time and again their ability to assemble and entitle well located sites at cost to provide very strong risk-adjusted returns. In addition to the predevelopment sites identified in our supplemental, we've under contract and are working through entitlements on a number of high-quality land parcels located in markets such as New Jersey, the Lehigh Valley, Southern and Northern California and Seattle, which will provide future infill development opportunities at very attractive yields. Our current development pipeline totals 4.3 million square feet with a projected total cost of $368 million and a stabilized yield of 7.4%, more than 200 basis points over stabilized cap rate for these assets. The pipeline is 31% leased with strong activity on each of our projects including a number of leases currently in negotiation. Given this activity we're confident that actual lease up will average less than 12 months we assume in our financial projections for the project. Before I turn the call over to Matt, I wanted to acknowledge Bruce Warwick, who decided to retire from our Board of Directors as of this week's Annual Meeting. Bruce joined our Board back in 2005 and has been a strong force behind DCT's transformation and growth. His extensive business, real estate and development experiences has been invaluable to all of us at DCT. He was our Lead Director at the time of great change and always helped the Board and management team, keep a steady eye on where we wanted to go and maintain the patient and discipline to get there. I am grateful for his service and advice and look forward to benefiting from his continued counsel as a friend and ongoing supporter of DCT. With that, let me turn it over to Matt.

[Matt Murphy:]

Thanks Phil and good morning, everyone. The first quarter was an excellent beginning to 2017 at DCT as the fundamentals of our business continue to reach new heights. Virtually all of our operating metrics were ahead of plan for the quarter and our outlook for the remainder of the year also improved, leading to the increases in guidance that Phil mentioned. I will dive into some of the results more deeply as well as outlining the specifics of guidance for the remainder of the year. Without question, the bright spot of the quarter from an operational standpoint is once again the same-store NOI growth generated by our portfolio. The 10.4% growth in cash NOI and 5.7% growth on a straight-line basis, exceeded our expectations and contributed to the increase in guidance that I'll talk about in a moment. The most encouraging aspect of our same-store NOI growth in my opinion is the source of that growth. $5.9 million or 94% of our cash same-store NOI growth in the quarter came from an increase in base rent. Half of that amount came from the contribution of embedded rent bumps and positive releasing spread taking effect. Said another way, an increase of just under 5% in NOI year-over-year is directly attributable to the increase in cash rental rates. It's exactly this type of organic NOI growth combined with the positive trajectory of market fundamentals, which makes us optimistic about DCT's future. Is also important to note that we achieved a 7.8% increase in cash revenues in the first quarter, despite a decline in miscellaneous income of over a $1 million. To put that in context, a $1 million equal a 170 basis points of first quarter 2016 same-store cash NOI. Turning to guidance, our excellent start combined with a positive outlook for the remainder of the year, has resulted in us raising and narrowing our guidance for 2007 from operations to between $2.36 and $2.44 per share. We are also increasing our guidance for same-store NOI growth to between 3.25% and 4.25% on a GAAP basis and between 6.5% and 7.5% on a cash basis. Similarly, we are raising our average occupancy guidance to between 96.5% to 97.5%. From a capital deployment perspective, we continue to be encouraged by our market team's ability to find and execute on attractive development opportunities and accordingly, we are raising our guidance for development starts for the year to between $250 million and $350 million, an increase of $25 million at the midpoint. Before I turn it over for questions, I wanted to discuss the changes and clarifications that we made to the definitions of several operating metrics as reflected in our supplemental reporting package and press release. As all of you are aware, there has been a fair amount of investor and analyst confusion and maybe even some frustration about perceived and actual inconsistencies between how the various public industrial REITs calculate and/or describe some common operating metrics. In response to this, myself and a number of my counterparts from other industrial REITs began a series of conversations with the objective of creating a consistent methodology of counseling these metrics. I believe I can speak for the Group well enough to say that we all felt strongly that it was in everyone's best interest to create a framework whereby investors, analysts and companies could more confidently compare results on apples-to-apples basis. It became obvious early on that there were far more in common in our definitions than there were differences and the unanimous desire to achieve consistency made it easy to create a unified template that we could all adhere to. Given the fact that we were already in the process of refining and clarifying our own definitions, plus the fact that there were no significant differences between our existing definitions in the new template, we decided to adopt to revised definitions immediately. As you can see from our press release and supplemental, we've tried to be as clear and transparent as possible with respect to what changed and the impact of those changes. I hope you all find the enhanced disclosure clear and useful as always, I'm willing to listen to suggestions on how we can improve any aspect of our reporting. With that I'll turn it over to the operator for questions. Thank you.

[Operator:]

We'll now begin the question-and-answer session. [Operator instructions] Our first question comes from James Feldman with Bank of America. Please go ahead.

[James Feldman:]

Thank you and good morning. I guess the increase in your development starts guidance, can you -- and then time that into Phil your helpful comments on supply in your markets, can you tell us where you're more confident starting more projects and if there are any markets where you do see that balance a little bit less favorable than others if you could highlight that?

[Phil Hawkins:]

I think in general, you'll find them New Jersey, Lehigh Valley, Seattle, Northern California and even Southern California where there is a smaller building, more infill, very infill locations. I think we will continue to be bias towards this environment, small and medium-size buildings and supply constrained markets is one site, which we worked on a couple years ago in Dallas, North Dallas that we're close to taking on, or closing out if we get up to approvals, it was denied by the municipality, believe it or not in Dallas a couple years ago. We're back at it. We think there of getting approval. The first to go to build there were phenomenally successful because of the location and the size. So, we'll go ahead with that, but I think you'll see bigger boxes in New Jersey with a smaller building as well on each of the sites we've got under control. Southern California is smaller, Seattle is smaller in addition to what we have in the Port where it will be a fairly medium-size building. When I think about supply, clearly everyone is talking about it as they should. I think about supply is it's been and tends to have been in bigger box and in further out locations Inland Empire East as an example, South Dallas is an example, Jefferson County and Henry County in Atlanta, sites that don't compete with us in any way but certainly ones that influence the numbers. Further on demand, I look at demand under construction, half of our markets under construction went down, half when up. The overall increase in our construction over the last quarter is about 5% or 6% in our markets but the majority of that increase was in one market and that was the Inland Empire, one where certainly we were going to watch closely. A lot added in the East in lesser supply constraint locations but it all relates to each other. I suspect that a lot of what's going on in Inland Empire will hopefully landlords and developers will react to that like they have in other markets where you see them come down, markets where construction went down, Houston, Chicago, Dallas, glad to see it. So, to me, when I think about supply, the real question rather than equilibrium was the word that we would like to use. To me the real question is, do you see a place where developers and owners are likely to change the behavior with respect to rental rate discipline and even start discipline over the next year or two? And I'm optimistic that that's not the case. That they will continue to, there is enough out there, a strong demand, costs are going up, long-term perspective of capital, but as a result, I am still optimistic that for the reason we've been talking about for years that those factors will lead to continued discipline and good results in our business, but it's certainly something I know all investors and analysts and all of us on the management side will keep watching.

[James Feldman:]

Okay. And you mentioned municipalities and getting approvals, like how has that changed this cycle and how much of an impact you think that's having?

[Phil Hawkins:]

The change has been since the last couple years, two things. One municipalities are under-staffed. They laid off a bunch of people in '08 '09 and they've not replaced them. So, it just takes time. Most of our projects frankly while they reset quicker, they start they start later and as we try to bake that into our planning, we still won't get it right. We're still too optimistic about starting. And then it remains difficult even where zoning is applicable to get approvals. Eventually you get it through but just adds to the time factor, like I said even in Dallas who would've thought that we would be two or three years into a project and hoping we get approval of a building that in a location that clearly would be very well suited for a distribution building.

[James Feldman:]

Okay. That's really helpful. Thank you.

[Operator:]

The next question comes from Emmanuel Korchman from City. Please go ahead.

[Emmanuel Korchman:]

Good morning, guys. Matt if we just think about your same-store NOI guidance, can we just talk about the trends for the year and if there's anything unusual driving it up in 1Q versus a good quarter that's going to just lower through the year in whatever happens?

[Matt Murphy:]

Yeah, I think from a turn perspective, I think it looks excellent throughout the year. I think there's no question that the first quarter was more significantly impacted by the burn off of free rent than the remainder of the year will be. We have approximately $2.5 million of free rent comparatively lower free rent in the first quarter. Beyond that both occupancy of the continuation of rent bumps, the continuation of the impact of releasing spreads remains relatively constant. So, I think first quarter is probably a little bit atypical in a good way, the remainder of it remains from where I look today it looks reasonably constant.

[Emmanuel Korchman:]

All right, thanks and then Phil, on the increased development starts, just if we think about the way that your approach starts, how much of it is each of the projects that you're comfortable with, how much is it that you don't want that dollar figure to get too big? How much is it -- you pushing your guys to do more, what's the flavor of how you -- how you increase the number of starts and how you cap that?

[Phil Hawkins:]

I think all the above. We certainly start with the market itself, the individual markets, not just the national market and the really get down the project very quickly and who it's competing against and what it's competing against. Our balancing risk management, we have turned down more projects in the last few months than we probably had in the first three years of the cycle and we came down for a variety of reasons, one might be location wasn't quite as stellar as we want. Second, returns didn't quite work as well for us investment community as it might have in the eyes of the market leader. And then third, we are able because we got more opportunities coming in, we are able to be more selective and so like we sell the bottom portion of our portfolio every year, well the same is true to triage out to the development project. To me the biggest criteria right now is are we leasing, are we leasing in that market and are our competitors leasing? We see a deal probably three times at least from the time we first tied up and approved due diligence money and pursued dollars to them buy the land after due diligence is done and final cost estimates are there and then lastly when we go vertical. So, we get to see the competitive set at my level at least three times and then of course we're out there joint projects and stuff on our own as well. And seeing what's going on in the market and the changes that have happened, have they been faster or slower than expected in the first memo for example, that's a key consideration. We're paying attention. While we're optimistic about the environment, very optimistic, that doesn’t mean we are complacent and take it for granted and so we're challenging and debating and scrutinizing every day.

[Emmanuel Korchman:]

Thanks very much.

[Operator:]

The next question comes from John Guinee from Stifel. Please go ahead.

[John Guinee:]

Great. Thank you very much. Phil no secret land costs have gone up significantly in the last year, hard costs have gone up, can you talk to what magnitude they’ve gone up in different markets and then also how you've been able to maintain a GAAP yield on cost North of 7%?

[Phil Hawkins:]

I am going to first hand off to Neil who can talk little closer to it and maybe then I'll come back to yields and where I think they're going. Neil?

[Neil Doyle:]

Okay. Sure. Good morning, John. John we're seeing across the Board of the Central region is land prices are flat to up in a measurable way, but maybe 5%. It's really -- it depend on the market, depending on where you're looking, certain places, take Cincinnati, which has been on an absolute tear. Land prices are up significantly. Chicago, they're pretty stable. Dallas, they're pretty stable. Houston, they're stable to down and really just I think a result of the industry confirmation bias on what's happening in Houston. More importantly than land right now, from what I'm seeing is labor costs, material costs etcetera and where you've got for example in Houston major petrochemical projects, labor is still an issue. Dallas is expanding roads, bridges on top of a huge real estate boom, labor is an issue. Chicago, which has more than 50 high-rises under construction 50 at the moment, labor is an issue and that's driven up some of our cost. So, let's say land is 0% to 10%, construction costs are 4% to 6% that's averaging to a building of maybe 5% to 6% more expensive than a year or two ago.

[John Guinee:]

Would you make that same sort of -- thanking you wonderful job, you Phil make that same sort of numbers if you look at the East Coast or California and the West Coast?

[Phil Hawkins:]

Yeah, I think land, price going up is slow. I think land is slowing in appreciation. Cap rates have bottomed for the most part, you still find evidence and keep going down, but certainly the trajectory has slowed of declining cap rates. Yields really start coming down a year or more ago and I'll get that part of the question. You're seeing some developers, 100 basis points spreads over current cap rate, buying land and so that I think is land is slowing, which is a good thing, but probably going up in the 3% to 5% range and maybe you can find acceptance for that, probably a little more than that in Seattle but is slowing. From a yield perspective, I think there is two reasons our yields have held up pretty well and they're related. The first is we're pursuing projects that we're adding value to the land process. Almost every one of the projects we're on -- we are looking at working on, we spent a considerable amount of time solving a problem, assembling the site, trying to get approval through wetlands or other environmentally if you saw. And then the second thing is because of that time, time passes and if land was going up 5% to 10% a year maybe a little more in some of these markets and we had a contract for two years, there is a benefit right there from a passage of time where on the sellers nickel we've got some deposit money down and we're spending our own time and money, but for the most part, we tied up and add value and then closed, that's also helped our yield hold up. I got to say, yields that you're looking at now are low to mid-sixes in many markets California where we've not been -- Southern California we've not been a significant player low five, you hear examples of some developers going ahead with high four. So, yields are definitely in general down significantly over what you're seeing in our supplemental.

[John Guinee:]

Great. Thank you.

[Operator:]

The next question comes from Eric Frankel from Green Street Advisors. Please go ahead.

[Eric Frankel:]

Thank you. Phil, could you -- I think there's been a lot of press and attention kind of on e-commerce and how that's impacting supply chain. I think you're seeing that a little bit into how you're a little bit more infill losing or leasing for last purposes. Can you discuss the trends and whether buildings and a lot of your markets are actually suitable to take it -- take advantage of this trend? Or if it's much related to the trend at all?

[Phil Hawkins:]

Well it's a trend, it's not the only positive out there, but it's certainly a very positive trend and in my opinion eCommerce last mile location is important, but also functionality is important and I think I saw one of our peers in a joking way, but a serious way and an accurate way mention that every brokerage package the worst the building, the more quickly you'll see last mile on it and it's not a Band-Aid for a lousy building. E-commerce requires efficiency of movement and access and I think that's our focus on quality ultimately will pay off over the long-term in all uses I think, but particular you're certainly including eCommerce whether it's a 50,000-foot building, and 200,000 building or a million-square foot building access location, parking, clear height through a reasonable extent, lack of columns, all that matters and to me it's exactly where we've been moving our portfolio over the last 10 years.

[Eric Frankel:]

Okay. Somewhat related question. I think related to that, you probably, I think, market participants stated that the pricing for peak quality assets had not declined much in the last year or so or the cap rates spread between, call it, Bs and As has maybe compressed a little bit. Any thought in terms of how much are lower quality assets your portfolio are willing to sell in the next year or two?

[Phil Hawkins:]

Well first Bs in the eyes of the beholder. I would -- and if you are a seller it's a B plus, if you are a buyer, it might be a B minus. I would say that, I want to be a little more precise on your statement or other statement. In our opinion, in experience higher quality functions B might be 24 foot clearer, might be 20 years old but functional, good decent parking, Those are selling quite well in significant good locations, not commodity locations. Those are selling very well. On the other hand, quote B that is not as functional there is a much thinner buyer pool, deals will not happen to the extent that you would think. Cap rates have probably gone up some for those. So, I think that's the environment we're in. We absolutely have a desire to sell. We're selling not necessarily just based on quality but on economics. We may be exiting a market or two that where leasing has gone very well recently. I would like to see that happen for sure and what we're selling right now we had a couple I would say lower quality assets under contract where cap rates are probably in the mid-seven. We also have the opportunity to sell assets, high-quality well leased assets in in markets that aren’t best for us, but others may like in mid five to mid-six cap rate. So, I think our sell process will remain focused on one one-off assets and not necessarily just quality or just markets.

[Eric Frankel:]

Okay. Thanks.

[Operator:]

The next question comes from Craig Mailman from KeyBanc Cap Markets. Please go ahead.

[Craig Mailman:]

Hey guys. Just curious where on the rent side you and peers are pushing spreads pretty nicely here. I'm just curious are you seeing any kind of push back maybe by size or kind of non-proximate to infill, can any trends you're seeing on the ability to push rents either also whether it's eCommerce three PL or just kind of a more traditional industrial use?

[Phil Hawkins:]

I think Craig one of the advantage we're having local people is that really becomes a local building-by-building, space by space, market by market decision. The better the building, the better location, the lower the neighboring vacancy, obviously the more likely are the push. In general tenants are less price sensitive than I would've expected given how far rents have moved, but they're smart and in many cases almost most cases of the tenants we deal are professional, they do a lot of this and as a result, they're savvy but also, they need the space, they need to make a decision. They get to an answer they think is fair and you don't I suppose. It's easy for me to say that maybe more difficult for our market leaders, but I think it really depends on all the above, how good of a position you're in and you know it and do you play your hand well or do you overplay it or underplay it. Hopefully we've got I think a great team of people out there, I hope they will plan their hand just right and maybe blocking once in a while to the positive, but you know what.

[Craig Mailman:]

No, that's helpful and then just secondly, anything you're seeing on just the velocity of demand as you guys look to either absorb minimum empty space you have or backfill renewals, is there anything on the competition side for space?

[Phil Hawkins:]

Neil, go ahead take that one.

[Neil Doyle:]

Sure. Craig, I believe obviously eCommerce is still pushing the envelope and is pushing the envelope in different locations in different ways. In Chicago, Amazon absorbed over 6 million square feet in 2016. I can't believe that will happen again in 2017 especially as they move away from fulfillment in sortation centers down to is there called the last mile facilities. But you go to Houston and I think where the infancy of eCommerce and I can't tell you why there are six million people there why the eCommerce movement is a bit behind? My guess it's because of a bit of a lack of density of the population but eCommerce is well advanced in the city like Chicago in its infancy in Houston. So, we see demand taper in one and pick up in the other. The other big trends I'm seeing are the typical consumer goods, food and beverage is hot as ever, transportation, logistics, otherwise known as the 3PL continues to be one of our most active client base and one that requires a lot of work because they're trying to be as efficient as possible, moving different accounts in the same buildings and it's a real opportunity for us to actually partner with a client. And finally, what I'll note that in and mainly in Cincinnati, in Chicago in a bit in Dallas, is a noticeable uptick in manufacturing uses. There was 0.5 million square feet taken down for manufacturing in the first quarter in Chicago and in fact in Cincinnati we just leased a 120,000 square feet to a 3PL work in a GM account. So, manufacturing has been a noticeable uptick, more noticeable in other quarters and I hope that trend continues to complement the other basic four, which continue to move along at the pace they’ve shown us for the last couple of years.

[Phil Hawkins:]

So, it's smaller in volume but not because of number of leases, a lot of housing related deals that I am familiar with related to people furnishing their houses, building houses, building apartments, building hotels, furnishing hotels, there are a number of those going on in pretty much every market of the country.

[Craig Mailman:]

If I could sneak a third one in, are you guys -- what are you guys seeing on the utilization side as you monitor tenant spaces?

[Phil Hawkins:]

Neil, do you have any thoughts on that?

[Neil Doyle:]

Craig, you mean relative to utilization of the clear height of the facility?

[Phil Hawkins:]

Just are people warehousing warehouse space? Are they busting at the scenes?

[Neil Doyle:]

I would say you're starting to see busting at the scenes probably drop a bit as tenants have gotten smarter and as tenants have found confidence in the recovery, they're making longer-term more intelligent decisions on their facilities and so, I feel as though we're getting better term deals with better utilization to the facility today than we were five years ago, and I believe that's just a confidence in the economy, a confidence in their business, the willingness of banks to lend their business. But all that is caused more utilization the way you define it.

[Craig Mailman:]

Great. Thanks guys.

[Operator:]

The next question comes from Tom Lesnick from Capital One. Please go ahead.

[Tom Lesnick:]

Good morning, guys. Most of my questions have been answered at this point, but just wanted to circle back on the retail environment generally, obviously retail has kind of taken it on the chin here as of late. Obviously, eCommerce trends are positive for industrial real estate, but as you look at the overall retail picture and the prospect of a softening consumer environment, how do you see that playing out for industrial demand generally and what kind of lag historically have you seen between a weakness in the consumer and that flow through into physical real estate?

[Phil Hawkins:]

That's a great question, when we spent a fair amount of time talking about it at our Board Meeting a few days ago from a variety of different perspectives I'll let Matt go in a little bit detail on the rolling portfolio, but typically we don't have a lot of direct business with retailers and we certainly have no exposure as part of the area that ones that are the news that who is next. I think we're in the 3% in terms of the our total exposure to retailers. You also have exposure 3PLs in some of their business is clearly retailers-driven, but we've seen from them even able to shift accounts around they’ve been able to move into the eCommerce world. So, it's a fairly smaller exposure and I think my guess is reflective of the overall markets we're in as well. So, you'll notice whereby your own portfolio or by your neighbors and I think that's fairly representative and as long as demand elsewhere housing, food and beverage eCommerce remains as hot as it is, I think it's less of an issue, but it's certainly one that's becoming more and more front center because of somebody don't think about and follow both at the Board level as well as the operating level here at DCT. Matt, do you have anything you want to add?

[Matt Murphy:]

No, I think you talked a lot of it. It's interesting that the question is it comes up quite a bit and what is a retailer and there's not -- certainly not a monolithic answer to what is a retailer I think so, put the number that I think as inclusive as I think you can make it realistically, we are a total under 3%. We haven't had any exposure to the names that you read in the news even that it's gone down or are perhaps teetering with the one exception, we talked about on the last call, I talked about on the last call to a 250,000-square foot move out in Chicago that was Craig. They actually made it till the end of their lease term and left. So, we obviously have no more exposure to them.

[Phil Hawkins:]

And that was a mutual decision and Neil is going to explain to you, but that's just while they were current, we had no desire to go further unless certain terms were met and whatever reason then we mutually started phase and gives us a head start on leasing that space.

[Tom Lesnick:]

Got it. That's really helpful guys. Appreciate it.

[Operator:]

The next question comes from Ki Bin Kim from SunTrust. Please go ahead.

[Ki Bin:]

Hey. Good morning, everyone. So, can you give us your internal rent forecast for industrial or at least the assets that you're end markets that you're operating in for maybe this year and maybe go through for next year, but maybe can take a guess.

[Phil Hawkins:]

Well I press the ball as probably more cloudy than some other peers who appeared to have very clear crystal ball. I think we don't roll it up. It's a by space by space, building by building analysis in our forecasting and budgeting process. My guess is the only numbers are based on what 3% to 5% maybe a little bit more is some markets and I think that we've proven to be conservative, not my intent but by result over the last couple years. It's appearing to be the case this year again and I'm happy to accept that being wrong and I believe given what's going on with low vacancy, healthy demand across sectors and sizes and markets, I think the psychology of brokers and tenants is well lead us to be pretty bullish about rents next year. Probably this early in the stage say 3% to 5% and I hope I was wrong next year as I have been the last couple.

[Ki Bin:]

Okay. And what is your concurrent philosophy on not A versus B, but maybe secondary markets? Do you think, so the Kansas or South Carolina with the number of markets that you're not in, do you think those have been almost two beneficially treated well by the uprising industrial demand or do you think those are the markets where you would be little more careful about deploying capital?

[Phil Hawkins:]

Well first we made decisions on which markets to be in based clearly on a view of the market, but also on the recognition that we have to focus our resources. We aren’t a company with unlimited resources and so we're going to be focused and so we've exited markets. A few guys say, I like that market, I just don't think we can afford to be there and we're not going to be there in a meaningful way with people and that's the capital why be there at all. So, to me that's where it starts, my personal view and it's self-serving is that I think the market that market overvalues lower quality assets and lower quality markets relative to the market the private market, but that's a self-serving comment given the direction we've been heading.

[Ki Bin:]

That's all right. I always view it as a forward guide, so all right. Thank you.

[Operator:]

[Operator instructions] Our next question comes from Eric Frankel from Green Street Advisors. Please go ahead.

[Eric Frankel:]

Thank you. Two quick follow-ups, out Phil, do you see a possibility down the road, obviously you've consistently stated that supply is in fact by seasonal capital, any thoughts of DCT recapitalizing some of those projects if for whatever reason institutional capital wants to flee for whatever reason obviously everyone seems to be interested in industrial right now but may not happen forever. So, any thought in terms of recapitalizing some of the newer supply that's coming online?

[Phil Hawkins:]

Well it's one of the situation I don't hope for because it would reflect a period of stress and illiquidity but clearly one of the reasons we maintain a low leverage balance sheet and continue to de-lever where we can, is to be ready to go on offense if that was ever the case. We're always looking for opportunities that create value and make money and if the cycle moves in a way that there is no liquidity that we can solve in a way that we feel is the right decision long-term and profitable, heck yeah, we'll jump into it. I don't think that's going to happen. These are deep-pocketed investors smart, experienced industrial investors, the pension funds that are in this business have been reader to in this business. Obviously, the public REITs, they are well capitalized. They’ve been in this business a long time. Most of them, not all them, most have been funding development or in the development part of the business for a long time. As a result, I just don't think you're going to see a very quick or sudden panic if you even have a view that the environment may get that way in the near future, which obviously I don't yet but if it happens, well we'll be ready

[Eric Frankel:]

Okay. And question I guess for you Neil, I noticed your remaining lease expiration in Chicago represents a pretty different number of that. Could you comment on what's rolling your confidence in leasing that space?

[Neil Doyle:]

Absolutely, so we're running about Eric about 8 million square feet in Chicago on a consolidated basis. We're a little over 92% occupied. The role is severe in '17 while it was maybe severe is too strong of a word. It's significant as it was in '15 and '16. We're currently looking at about a million feet of current vacancies among seven buildings and we are in the final stages of negotiations in my opinion on about 350,000 square feet of that. So, we've got one space that is new to the vacancy list, that's the H.H. Gregg space that Phil mentioned, or I am sorry Matt mentioned, that's another 250,000 of that. It's an 88, it's got highway visibility, it's got great access in its Class A. So, feeling pretty confident, but it is a challenge and as far as my region goes, every city has a challenge every year. The role in Chicago is a challenge for the region this year, remain very confident. Absorption has been great. We're seeing just an absolute differential of users across the Board. Everything seems to be on track. We came out roaring in the first quarter. I expect it to continue and hopefully by the second or third, this will no longer be the challenge that it is today.

[Eric Frankel:]

Okay. Thank you.

[Operator:]

Our next question comes from Rich Anderson from Mizuho Securities. Please go ahead.

[Rich Anderson:]

Hey thanks for sticking around. So, part of the problem with 10.4% same-store cash NOI growth is you need 11 next year for everyone to stay happy and I am being tongue-in-cheek of course that's a great number, but I'm curious not to ask for 2018 guidance, but is there an element of the same-store that is not necessarily repeatable whether it's burn off of free rent or whatever that may be -- should be communicated now to prepare people for a more sustainable number in the future.

[Phil Hawkins:]

Yeah Rich. Clearly, I would hope that we've been doing that already. Like I said one of the things I was really, really encouraged by saw it coming to some degree, but it was even better than I thought. I repeat this in my prepared remarks, just about 5% growth of our NOI was about rental rates increases and rent bumps. That obviously doesn't take into account, we had a 90-basis point increase in average occupancy that contributed to the 10.5%, 10.4% cash growth. We had a burn off of $2.5 million of free rent which is unlikely to be repeated anytime soon because honestly in some ways that's the byproduct of the increase in occupancy that happen in that portfolio, really ultimately in late 2015, which manifested itself in free rent in early 2016. So yes, I don't think it's probably a new flash to assume that we can extrapolate 10% cash growth -- revenue growth, but 5% revenue growth that is just about rental rates, which is what we just experienced that is in and as I mentioned in a question that's pretty well represented through the back half of the year. I am not going to get into '18 that's pretty darn healthy growth and that's based not on one timers or aberrations, that's based on the harvesting of what's been going on in the markets over the last several years.

[Rich Anderson:]

And for the record, I think you have done a good job communicating I was trying to get to the bottom line opportunity with some sustainability and if that number is five than that's the number, but I'm just wondering if there's any more moving parts beyond that?

[Neil Doyle:]

Yeah, I don't think so. It's pretty simple business. We have the vast majority of our expenses pass through to our tenants. It's not perfect, but it's pretty close and have your own views about occupancy. Obviously, we're in pretty rarefied area from an occupancy perspective. However, given what happening in the market today, I don't see the force that's going to change that dramatically. It will move quarter-to-quarter. So really what you have is rents and as I've mentioned rent comps get a little harder with respect to we're basically in the last year of rolling against trough -- a significant portion of trough rents. So that's obviously not just sort of algebraically helpful, but the flipside of that is what's been going on since then has been pretty dramatic market rental rate growth that has continued to fuel the re-leasing spreads that we've talked about.

[Rich Anderson:]

And then just a quick follow-up unrelated I guess but on the development pipeline, 31% leased. I know you're targeting a fairly rapid lease up profile, but I'm just curious if you can get -- is 31% kind of what you would you as the floor to the preleased number for your development pipeline or would you be willing to let it drift lower with future earnings reports because of the confidence you have in leasing up quickly?

[Phil Hawkins:]

It's not a floor. It's project by project. We are given the lack of land banking and effectively we love our land sites. We want to put them in production quickly. We're not a big build-a-suit company. We'll do it couple a year, but we're not a build-a-suit company. We've had good fortune that we've had that number in the 25% to 50% range for quite a while, but if we lease up a bunch now and then start a another ones I've talked about my prepared remarks all at once, I can go from 30 to 50 to 20. That would not be on itself concerning to me and I look at our current pipeline where a lot of it is still in construction, much of that is not in 12 month lease up beyond that I am fine with 31. Last quarter it was 25, I would rather have it higher trust me. On the other hand, what we want to do is if we've confidence in the projects that we've been thankfully able to deliver over the last five years for the project we will start and hope that our convictions are well proven.

[Rich Anderson:]

Fair enough. Thanks very much.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Phil Hawkins for any closing remarks.

[Phil Hawkins:]

Okay. Thanks everyone for joining our call today and your interest in DCT. 2017 is certainly off to a good start and we look forward to seeing many of you at NAREIT. Take care.

[Operator:]

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