Duck Creek Technologies, Inc.
Q4 2017 Earnings Call Transcript
Published:
- Operator:
- Good morning ladies and gentlemen and welcome to the DCT Industrial Trust Fourth Quarter and Full Year 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 [Operator Instructions]. Please note todayβs event is being recorded. At this time, I would like to turn the conference over to Melissa Sachs, Vice President of Investor Relations. Please go ahead.
- Melissa Sachs:
- Thanks Denise. Hello everyone and thank you for joining DCT Industrial's fourth quarter and full year 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 our 2018 guidance. Additionally, Neil Doyle, Managing Director of DCT Central Region, will be available to answer questions about the markets developments and other real estate activity. 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 limitations, 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:
- Thanks Melissa. Good morning everyone and thanks for joining our call. The fourth quarter capped off another excellent year for DCT. Rent and NOI growth were strong as market dynamics remained favorable for owners and developers of well located, high quality distribution assets. Leasing and other development pipeline is also progressing well. In the fourth quarter, we stabilized four assets with projected investment of $144 million at an 8.2% yield and an estimated value creation margin of 49%. With the stabilization of these four buildings and the start of two new projects in Atlanta and South Florida, the current pipeline is now 19% leased. However, on a same portfolio basis, last quarter's pipeline is now 40% leased. Leasing discussions are active on all projects in the lease-up phase and we expect a number of leases will be executed in the near future. During the quarter, we took advantage of the strong investment sales market by selling 10 assets for just under $130 million and are projected year on yield of 6.3%. For tax reasons, four of these assets closed in January. These assets were 99.9% leased, consistent with our philosophy of selling stabilized assets to further maximize value. These sales completed our exit from both Memphis and Charlotte. And earlier in 2017, we exited Louisville, reflecting our strategic objective of focusing our capital end markets, which we like long-term and where we have a strong presence in terms of both people and real estate. Looking ahead, our outlook for 2018 is very similar to 2017. We expect customer demand will remain healthy, market rental rate growth will average in the mid-single-digits, and while supply will continue to move up modestly in response to low vacancy rates, developer behavior will remain disciplined with respect to both starting new projects as well as leasing them. As a result, our strategy for operating our portfolio, deploying capital, and selling assets remains the same. While we're not projecting our occupancy levels to move up from here, we expect that significant growth in rents, as well as rent bumps, we'll continue deriving same-store results. And in this environment, we remain focused on developing new assets, mostly on a speculative basis as quickly as we're able to compete the land acquisition and entitlement process. We also expect that our market teams will continue to find at least a few quality acquisitions that provide attractive longer term growth opportunities and we will continue to be an active seller of stabilized assets where values have been realized and we have better uses for the capital. With that, let me turn over to Matt, who will provide more color in Q4 results and our initial guidance for 2018.
- Matt Murphy:
- Thanks Phil and good morning everyone. 2017 was a remarkable year, both in our industry and specifically at DCT. Market occupancies continue to improve from what were already historic levels and the active demand for space has driven rental rates to new heights, particularly in prime locations in major metropolitan areas. Perhaps more importantly, users of industrial space are continuing to invest in their logistic networks and facilities, both in terms of their own capital investments and the rents they're able and willing to pay as they seek to generate efficiencies and competitive advantages in the rapidly evolving distribution world. DCT's ability to capitalize on these trends served us very well in 2017 and we believe many of these trends are just beginning to take shape, which bodes well for 2018 and beyond. Our fourth quarter was very -- was a very solid conclusion to an exceptional year. Operating metrics, including occupancy, rent growth, NOI growth, and retention for the quarter were all consistent with our lofty expectations and our exceptional portfolio, rent roll, and development pipeline leave us very well-positioned to drive operating performance and earnings growth along with creating substantial value in 2018. We're initiating our 2018 funds from operations guidance of between $2.52 and $2.62 per fully diluted share. From an operating perspective, we expect our metrics to remain very strong in 2018. Our guidance is based upon consolidated operating occupancy averaging between 96.7% and 97.7%. We expect releasing spreads in 2018 to be similar to or perhaps a little below those we achieved in 2017. Although, as always, these numbers tend to vary from quarter-to-quarter. We expect these releasing spreads despite the fact that only 8% of leases expiring in 2018% were signed during the recession compared to almost 40% in 2017. We continue to experience and project very positive trends in market rental rates and other lease terms, including free rent and ramp-ups. All of these factors should combined to produce same-store NOI growth for 2018 of between 4% and 5% on a cash basis and between 2.8% and 3.8% on a straight-line basis. The growth in cash NOI will be driven by strong releasing spreads, a slight decline in free rent, and excellent rent bumps, which currently exceed an annualized 3% for those leases that have future ramp-ups. Currently, 95% of our releases greater than one year included rent bumps and 88% of those have a future ramp up. At the midpoint of guidance, our average occupancy in our 2018 annual same-store portfolio is expected to be essentially flat as compared to the 97.5% average occupancy portfolio experienced in 2017. The annual same-store portfolio represents all buildings stabilized as of January 1st, 2017. It should be noted that guidance for all operating metrics does not include the potential impact of any future acquisitions or dispositions. Turning to capital deployment. Our guidance contemplates development start of between $175 million and $275 million. All the anticipated starts are online at that we currently own or control. We feel confident in the bottom end of the range and starts in the upper end of the range or beyond will depend on leasing in our existing projects, under development and/or successfully securing final entitlements on several projects, a process that continues to get more challenging in today's environment. Our guidance also includes between $50 million and $150 million of acquisitions in 2018. While it's a very challenging acquisition market today, we are optimistic that our market teams will continue to find opportunities that simultaneously create value and upgrade our portfolio at attractive risk adjusted returns. With respect to our capital plan for 2018, our guidance is based on a funding plan, which will maintain a debt to EBITDA ratio similar to what we achieved in 2017. Our sources of capital will likely be a mix of opportunistic like equity issuance and dispositions with a continued bias towards selling assets. Our guidance contemplates up to $100 million in equity issuance and dispositions between $200 million and $300 million, which includes the approximately $100 million, which closed in January. We believe that the continuous improvement of our portfolio, both for addition and subtraction, is a critical element of our strategy to drive per share value and long-term cash flow growth, even if it may come at the cost of modest short-term dilution and earnings. Finally, our capital plan contemplates a $300 million debt transaction towards the middle of the year with proceeds targeted towards funding debt maturities we have in 2018 as well as paying down our revolver. In summary, we are very proud of what we've accomplished in 2017 and over the last several years at DCT. We have created an organization that is incredibly focused on creating and maintaining a best-in-class portfolio and optimizing the operation of that portfolio, which has allowed us to generate exceptional financial reports and produce long-term value for our shareholders. We're also very fortunate to be in an industry that is directly benefiting from significant changes in the way American consumers are procuring goods today, positive changes that we and I think most people believe will continue for many years. And so we embark on 2018 with a sense of purpose and optimism. Pleased with our past results on track record, but also very aware that our success is ultimately defined looking forward. With that, I'll turn it over for questions. Thank you.
- Operator:
- Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question will come from John Guinee of Stifel. Please go ahead.
- Aaron Wolf:
- Hey all. This is Aaron Wolf calling in for John Guinee. How is everyone doing?
- Phil Hawkins:
- Good.
- Aaron Wolf:
- Great. Quick question, how much do the $130 million or so in asset sales? What type of drag did that have on 2018 FFO?
- Matt Murphy:
- Yes, this is Matt. It's a somewhat difficult question to answer specifically because you've got to make other assumption about what would have happened otherwise. According to my math and it's really not just the ones that we closed in the fourth quarter, but the expectations for or dispositions we have throughout the year, it's probably somewhere around between $0.03 and $0.04 a share on a leverage neutral basis, if you assume you're looking at it on a leverage neutral basis. So, a little less than 2%.
- Aaron Wolf:
- Okay, great. Thank you. And one more. I noticed -- we noticed that G&A, as a percentage of NOI, came down pretty significantly. And just wondering if anything unusual there if tax rebates or anything like that helped bring that number down.
- Matt Murphy:
- No, I think the short answer is we've got NOI growing at a faster rate than G&A. G&A is sort of inflation-ish, perhaps maybe a little bit more than inflation and NOI just growing faster.
- Aaron Wolf:
- Okay, great. Thanks for taking my questions.
- Operator:
- The next question will come from Manny Korchman of Citi. Please go ahead.
- Manny Korchman:
- Hey good morning everyone. Matt, in your occupancy guidance, do you have any large basis or outsized basis that are known move-outs?
- Matt Murphy:
- Yes, known move-outs, but the short answer is we have basically six basis of greater than 200,000 feet that are rolling. The three largest of those -- or the three of those, including the largest, we feel pretty good about. Two, we know we're losing, although we have a 400,000 square foot space in Atlanta that we know we're going to get back this year. It's scheduled to expire in April. We think there's a potential for some short-term, but they are moving into a build-to-suits. So, we know we're moving that one. We have two others sort of 200,000-ish known move-outs, one of which we're pretty sure we won't get any occupancy in 2018. The other, we have pretty good, healthy negotiations going on to backfill that space the day it expires. Beyond that, there's probably 500,000, between 100,000, 200,000 square feet basis that we "know we're going to get back." Most of those tend to be a little bit more back end weighted in terms of timing. So, -- but I also will tell you that what I would have thought were known move out at this point last year, we rescued probably three or four. So, known move-out is not only certain. But I think we have a fairly low level of expirations remaining in 2018, and I would characterize this as pretty much far off the course.
- Manny Korchman:
- Got it. Thank you. And then in terms of developments, have your recent assumptions changed at all especially in terms of timing?
- Phil Hawkins:
- No, we've under it in 12 months. We've been fortunate to be a little short of that. Thankfully, in the past, expect on average, we'll be pretty close to 12 months, maybe a little short as well. We have a couple of project go longer, a few that go a lot shorter and a bunch that take between 10 and 12 months to get -- it's not just leased, but occupied in my mind. And just getting tenant build outs more sophisticated, it takes a little longer to get a tenant through the process.
- Matt Murphy:
- And to add to that, I'll tell you from a budgeting perspective, you have underwriting. But budgeting, I am assuming for all new developments that there's 12 months downtime unless we know there's a lease coming.
- Manny Korchman:
- Good. Thanks guys.
- Operator:
- The next question will come from Jamie Feldman of Bank of America Merrill Lynch. Please go ahead.
- Jamie Feldman:
- Great. Thanks and good morning. I guess just going back to the known move-outs. I just -- can you -- what's the total amount of space you think is moving out? And is that a meaningful drag on same-store? And as we look out into 2019, is that -- will there be a drag there or do you think it's not that meaningful?
- Matt Murphy:
- Yes, the way I look at it, the total amount of square footage that I think is going to move out is within a range like it is just kind of went through the specific assumptions on a few of the spaces. I don't have a number in front of me and I'm not sure I would share; I might grow [ph] a number anyway. What I would say is I don't think it is -- our retention numbers have been extremely strong for the last few years. I'll tell you that I'm probably budgeting lower retention that we've experienced in the last couple of years. But I don't think that there is anything that's sort of unusual that would say 2018 is adversely affected nor do I think the result of that is going to be a problem for 2019. In fact, I think as I think about it, it's about re-leasing the space that does move out, and we continue to see such excellent prospect activity as soon as the space became available that I feel like the general trends that we've been seeing are likely to continue. The fact, the move-out that I just talked about, as I said, are not anything atypical. I think the only thing that's probably a little bit unusual is that we're -- the roll happens later in the year that I would think of as normal and honestly, that probably has an adverse impact on 2018 same-store because the standard math that everyone says of 20% rolls and you get X percent of releasing spreads, it translates into Y from a same-store growth perspective. In fact, if you have a smaller amount of space that's happening a little later dampens a little bit of 2018, but perhaps sets you up better for 2019. But it's all just -- these are all assumptions of uncertain future events.
- Phil Hawkins:
- I assume it had too much budget discussion. But our budget retention in 2018 is very similar with budget in 2017. You may get some wins that we didn't count on in the budget. You may get a few losses. You just don't know. But there's nothing in the 2018 retention budget that is different than the 2017 budget.
- Jamie Feldman:
- Okay, that's helpful. And then maybe just a bigger picture questions here question. Can you talk about your thoughts on tax reform? What it's going to mean for demand? And any early thoughts on the NAFTA negotiations for warehouse?
- Phil Hawkins:
- I think, to me, it's too early to tell how much of a benefit it will be. But I believe it will be a benefit. Maybe a modest, maybe a little more than modest as companies invest more into their businesses because of the benefits of tax reform, not just lower corporate rate, but accelerated appreciation on equipment. They don't get accelerated depreciation in real estate. So, it doesn't set us up as we could've, if they did by putting us in a competition with corporate buyers. So, I think overall, tax reform will be at least a modest positive, haven't seen any change in the trajectory of demand. Demand has been so strong that I'm not sure we will notice it anyway. But it maybe one more factor that keeps demand healthy.
- Jamie Feldman:
- Okay.
- Phil Hawkins:
- I might also add -- I'm appreciative of the fact that will say it was treated well. REITs was treated well. The 1031 exchange, the dividend benefits, I mean, I mean, I think REITs, hats off to NAREIT for communicating so well with the Hill. But thankfully, REITs were treated well, too, which could, was not a given a year ago.
- Jamie Feldman:
- Okay. And then any early read-out at NAFTA or--
- Phil Hawkins:
- I sure hope, I believe in the benefits of global trade. And anything that impairs global trade, I believe, is a mistake for our country and for our economy. If NAFTA -- I think the question becomes, if its change, what changes? If it's canceled, terminated, what happens? I just -- I hope that it will -- the results that will be certainly, more modest over time, but we'll find out in a more hopeful or I hope that our politicians and the negotiators will see rational -- have rational thoughts and reach conclusions and compromises that work for all three countries.
- Jamie Feldman:
- Okay. So, I guess, too early for a redo for like warehouse markets and demand based on what you [Indiscernible]?
- Phil Hawkins:
- Yes, couldn't help, maybe more subject on-shore manufacturers in Mexico, maybe. As I heard, trade between the two and therefore, have some impact on warehouse demand, maybe. But if consumption remains consistent and I think in the short run, it likely would regardless of NAFTA. If consumption is good, our customers will be focused on getting product into and out of their warehouses and that's good for us. It might have a very modest impact on one market, submarket versus another. But overall, I think consumption will move -- march right on.
- Jamie Feldman:
- Okay. All right. Thanks guys.
- Operator:
- The next question will come from Craig Mailman of KeyBanc. Please go ahead.
- Craig Mailman:
- Hi guys. Matt, you guys have had a pretty good track record over the couple of years of setting initial same-store guidance, at one level coming in 100 basis points, 200 basis points ahead. I know you talked a little bit about some of the expiration headwinds and occupancy headwinds with some of the move-outs. But could you kind of talk about what could cut your way that could kind of be a tailwind here as we go throughout the year?
- Matt Murphy:
- Well, I think there's probably three things that have the potential to. We touched on one of it. It's interesting. I read the notes last night, and we talked about conservative same-store guidance. In some ways, I get that because I'm predicting average occupancy is slower that where we sit today in a very hot market. So, you could look at that as being assertive. The other thing I look at is I've got same-store guidance with bull's-eye is on 97.5% occupancy. That doesn't strike me as terribly conservative. Honestly, the budget is predicated on the move-ins of currently vacant space are a little back-end waited. It's the natural sort of psychology of budgeting. It's hard to predict someone is going to move in February if you're not trading paper with it today. Having said that, we've seen tenants make fast moves based on the limited availability space. So, occupancy is a long way to saying occupancy would certainly be a benefit. It's not a birthright that we're going to get 97.5%, either. So, that's why there are ranges. The other thing that's probably much of historical precedent, if any, is rents. We have -- we've said this time and time again and I think you've heard others in our industry say it; we have underestimated the impact of the growth in rents. It's such a tight market. Some of these commodities or at least -- some of these locations are so important to these companies that they're willing to pay what they need to be in some instances to get it. And as a result, we've underestimated rents. I think as based on what I was talking about in terms of when space rolls, it's probably as much potential upside in 2019 as it does in 2018 because there's -- those higher rents that we get them were not going to be outstanding for that longer period of time. But clearly, both [Indiscernible] and history would tell you that there is a potential upside with respect to rents. And the other one is probably less likely to be significant. But I talked about it before and it's a reality is that miscellaneous income, which is -- we talk about this theoretical same-store NOI growth and we're always talking about the mechanics of rent. Well, while rent is an enormous majority of what's going on in NOI if not all, that NOI. And so we're projecting miscellaneous income in 2018 that is less than what we actually experienced in 2017. It's a high six-figure number, low seven-figure number, not a huge one and that's just -- that is a prediction of a totally ring of series of events. So, that has both potential upside and potential downside. So, as I've said before, what our same-store number is a bull's-eye in my budget. And clearly, there is less absolute upside on occupancy than we've had in the past when you're staying at 98%, it doesn't go a hell a lot higher, but that's the way I think about it.
- Craig Mailman:
- That's helpful. And then maybe, Phil, on dispositions. You guys obviously executed on the bigger sales early in the year. Just curious what you're seeing in that market from demand perspective for single assets versus portfolios. Is that premium back with Blackstone back in the market being very active? And just how are you guys thinking about, as you look at the portfolio today, are there whole markets you'd rather get out? Was that easier today to do than it was 12 months ago? Or is it just going to continue to be opportunistic pruning?
- Phil Hawkins:
- Well, it's a lot there. The answer is the market is strong, maybe stronger today than it was even a quarter ago in almost all markets in all sizes. More significant change we've known over the last three or four months is there's more of a bid for lower quality assets, but the portfolio premium is there. The reason we decided to sell what we call the Southeast portfolio, which was one in Orlando, one in Charlotte and two in Memphis, was we believe in competition with our growth that there would be a portfolio premium. And indeed, while it's hard to measure, I guess, at the end because you don't know what you would have gotten if you would looked it up. But we call it -- we actually have that portfolio 4%, 5% and which is why it would lead us to that execution. On the other hand, we don't have large portfolios left that are homogenous relative to markets or product type. And so I don't think you'll see something like that in 2018. We have a couple of packages out now that are one or two buildings in size because that's what we want to do. It's the right execution for us, and we expect the pricing will be quite healthy. The demand is from all across. The Southeast portfolio, it's public knowledge the Canadian REIT bought that. But we saw pension funds and private equity industrial focus funds compete actively for it. We had four very strong bidders at the end right on top of each other and we picked we felt was a very close call. But we had the luxury of having a choice. Similar with the other sales we've done, we've had a pretty deep pool. And I'd say it's a deeper pool today than it would have been even six months ago. There's a lot of money out there.
- Craig Mailman:
- Great. Thank you.
- Operator:
- The next question will come from Eric Frankel of Green Street Advisors. Please go ahead.
- Eric Frankel:
- Thank you. I just want to talk about development guidance in your starts for the fourth quarter. It seems based on 3Q guidance that your development starts from the fourth quarter came in a little bit below expectations. You obviously feel that was a fairly large acquisition. But then 2018 starts, as you implied, probably are dependent on the type of process for a few different sites. So, that also came in a little bit light relative to robust demand on the tenant side. So, maybe you can extend on that a little bit more and see -- maybe characterized the probability of increasing your development guidance in 2018?
- Matt Murphy:
- Well, Eric, so I'll start. I'll certainly take the first part of that. Our guidance in 2017 -- the midpoint of our guidance was $325 million. We started at $326 million. So, I think that was right down the middle. I've gotten a couple of questions last night that is hard to figure out what the final tally is because we don't disclose development starts independently in the fourth quarter because you enroll the guidance. But the absolute number was $326 million and the guidance was $325 million. And then I don't know, if you, Phil?
- Phil Hawkins:
- I think that development over the last several years I made a similar comment at this time each year, we're not here to overpromise on development starts when there's a lot we don't control with respect to procurement of land entitlements and leasing. Although hopefully, we have some to look over leasing. I certainly like the opportunity in 2018 for development. But I believe it's much better to focus on assets that we love, that we control and make sure that we lease what's already in the pipeline and not put ourselves in a position of overpromising on a faster lease-up than we otherwise underwrite in the prior project that maybe in that same market. So, I think our guidance in 2018 is very consistent with how we thought about guidance the last several years and from of our perspective, it's probably not a lot different either. There is always room for upside. This is also -- there also, honestly, as Matt just said in his remarks, the downside is the lower end of the range, we feel highly confident in. I feel good about the midpoint of the range and I feel okay about the range, and I also think there's a chance to beat it. But I'm not holding out that as something people should be thinking about or counting on because we are thinking about quality of projects and results and performance more than we are quantity, but we do like quantity -- more quantity of high quality projects is better and we're prepared to do more if we can get it.
- Eric Frankel:
- Okay. Thanks for the clarification. Regarding the fourth quarter acquisition. I think that looks like a relatively new asset. Neil, since in Chicago, I'm assuming you were involved with that transaction. Maybe you can talk about the current circumstance, that type of deal and whether more of those are kind of in the just kind of given that development volume increasing generally, maybe more of these opportunities will become available.
- Neil Doyle:
- Sure, Eric. Yes -- I mean, this is an acquisition from a private developer. Essentially, it's a brand-new Class A building. As always, we prefer to build everything ourselves, but we can't be everywhere at all times. So, now and then, our strategy and goals sort of complement that, the private developer. I think the mindset here was really to get a state-of-the-art, 36-foot clear asset in I-55, and you know the submarket, 2015 land pricing, 2016 construction pricing. And we take it to market for leasing in 2018. Things in 55 are pretty good. They have been pretty good. It's tough to get in there. So, when the opportunity presents itself, I mean, you probably 85% is institutionally owned in I-55. So, opportunities don't show their faces every day. But when they do, we decided to jump. When I look at the size of the building. And this, I think, was probably what you're looking for and probably the most attractive point that I can come up with when we first looked at this was there was one facility in I-55, which is roughly 100 million feet, the sub market, one facility over 700,000 feet available today, and that's ours. I do think this building probably divides itself. And if that's the case, there will be three competitors out right, two of those are Class A, and there'll be two buildings that can divide as a competitive set. But if we will back trailing maybe 2011 on, you're going to see about eight deals a year in the 400,000 to 500,000 square feet range. And so the math says we're going to -- we should be pretty comfortable with our lease-up period. The math says that we should have a deal here. And really looking forward to having an asset of that quality right smack that in the middle of 55. So, it was a late year deal, but we'll see how it turns out. We're pretty excited about it. And specially is that submarket sort of turned itself over. Going forward, a lot of your competition is going to be second generation. And that's 20 for clear in I-55 and we'll will be sitting at 36. So, great deal. We hope to-date it is and then we'll see if anything else appears on the horizon in a similar fashion in 2018. I hope that answers your question.
- Eric Frankel:
- Not exactly, but I'll jump back in the queue.
- Operator:
- The next question will come from Ki Bin Kim of Sun Trust. Please go ahead.
- Ki Bin Kim:
- Thanks. Good morning everyone. Just going back to your comments about lease spreads in 2018 and 2019, Matt. If you look at the mix and volume that is coming due next year, is there actually a chance that lease spreads accelerate?
- Matt Murphy:
- Well, sure, there's a chance. As I've said many times, my least favorite thing to try and predict is releasing spreads because it takes into account such a wide range of potential outcomes. I do think we spent a lot of time -- I spent a lot of time of talking about the impact of the really sort of the comparisons to the really, what I think of as totally defensive leasing we were doing in 2010 and 2011. And that is, as I mentioned in my comments, there's only 8% of the remaining lease roll that is compared against those. And I think that has an impact. Having said that, market rents have grown so rapidly in the last several years that it -- and I talked about this in previous quarters, that you've seen the post-recession leasing actually exceed the pre--- the during the recession leasing. So, I think it's got a potential. I think it's honestly unlikely to exceed it, but that doesn't mean it won't. I wouldn't have predicted what happened in 2017 a year ago. So, I feel like I have credibility issues. I think it's possible.
- Ki Bin Kim:
- And I haven't checked your company math lately. But your Northern California exposure, you have about 40% expiring really all rental in 2019. Where is that exactly? And what do you think about the basis in that -- in those rents?
- Matt Murphy:
- Well, that's pretty granular. I don't have detailed enough information to answer that, Ki Bin, sorry. I know -- as a general rule, Northern California is a pretty darn good place to be releasing space today. Yes, I mean, we have 300,000 square feet, which is a little less than 8%. So, I mean I don't think of that as a huge concentration. We have; obviously, the biggest leasing activity in our northern California is our development project. But I don't think of Northern California as having outside, which is why I was struggling to come up with what the big [Indiscernible]
- Ki Bin Kim:
- I meant for 2019, will you have 1.9 million square feet expiring?
- Matt Murphy:
- Sorry, that, I'm definitely not prepared to talk about 2019.
- Ki Bin Kim:
- All right. Thanks guys.
- Operator:
- The next question will come from Blaine Heck of Wells Fargo. Please go ahead.
- Blaine Heck:
- Thanks. Good morning. Phil, the development pipeline prelease rate is one of the lowest we've seen in a while. And it seems, I think, pretty similar to 2015, when you started with very little preleasing, but you guys were able to lease a lot of that space up just in a couple of quarters. So, I guess given what you're seeing as far as demand in the markets you're developing in, do you think that dynamic can be similar and you can see some big strides in leasing on the development pipeline in the coming quarters? Or is there any reason to think it might take a little bit longer at this point in the cycle?
- Phil Hawkins:
- Back then there was a little more of a -- we started much more at one-time. This is a little more diffused than that. So, therefore, the jump may be a little bit more modest. But what I said in my remarks was absolutely a fact. We've got a number of leasing prospects that the teams feeling pretty good about at each of our buildings that are now in lease up and even most that are under construction. What I -- what we need to happen is to some or all of those terms of personal were being shifted back and forth and NOIs that are being negotiated to get to a lease. But it could happen where we have a fairly quickly in one fell swoop. But I don't know if that's going to happen. I just -- I am confident that we have a number of leases, five to five in the next month or two that happen. Could there be more than that? There's enough proposal activity that the answer is yes. But until it gets to a lease, I'm not prepared to even say that any of them will happen because -- but I mean, we're optimistic. We certainly expect that to go up before it goes down.
- Blaine Heck:
- All right, and that's helpful. And then maybe I can go back to Neil for the second question. Chicago's DCT second largest market for AVR. We've been hearing from some peers that there's an uptick in supply there recently. Can you just give us your thoughts on the market as a whole? And then how you feel about your position within the market?
- Neil Doyle:
- Sure. The market as a whole. 2017 was another great year of absorption and 2017 was an awful lot of supply as well. Most of that has been absorbed. And I think what's happened is there was a bit of a hesitation, call it, middle year in 2017 on the absorption side. And if you look at the numbers, and you probably got half the product under construction now as you did a year ago, what it has halted is the leapfrogging of expect development on the private developer side. So, I do think that it began to tamper itself naturally. And if the absorption keeps up the way current demand is said to be, is quoted to be, it will outstrip supply in 2018. I think that's what we're all banking on. If I take a step back and look at the six or seven sub markets where we're focused, four of our seven submarkets are sub 4% vacancy. I mean, O'Hare is in the middle twos. So, we feel really good about the tight infill markets. I think -- and I've said this before, so I hate to repeat myself. But when you really look at Chicago supply and demand, you need to look at it with and without the IAD submarket and I think will give you a much clearer picture. IAD always drive construction. It always drives absorption by default. But every building that's built on there is a needle mover at 1 million plus. So, if you take that out of the equation, I think you get a better sense. And Chicago is tight, as I've experienced, and we'll see what happens in 2018. But the "user activity" bodes very well for the supply at hand.
- Blaine Heck:
- Got it. Very helpful. Thanks.
- Operator:
- The next question will be from Nick Yulico of UBS. Please go ahead.
- Nick Yulico:
- Thanks. I guess touching on a couple other markets where it sounds like supply may be picking up to meet demand, Atlanta, Dallas. What are your thoughts on how supply is impacting pricing and occupancy of those markets?
- Phil Hawkins:
- True, submarkets we're in. Neil's answer for Chicago applies for both Atlanta and Dallas. A lot -- you got to look at the commodities sub markets, which is in Atlanta as far North, as far South and then Dallas in the far south. And where the big box are being built, and those boxes sometimes lease-up pretty quickly and sometimes don't. But if you look at the infill markets in those two -- inflows sub markets in both those cities, they are very strong. And if you look at Atlanta, Atlanta supply and demand numbers is healthy. Dallas, it's -- the buildings we've been building have been leasing up as fast, faster relative to our pro forma than other buildings around the country. It's just a very strong demand market. We think you need to stay insulated inside closer to the city. And so it's a strategy, frankly, almost everywhere. But it definitely applies to both Atlanta and Dallas and Chicago, where you've got commodity locations, where you can buy lots of flat, cheap land. But so far away that, frankly, many of the customers we try to cater to just aren't interested.
- Nick Yulico:
- Okay, that's helpful. Just one other question. On the projected stabilized yields for the development pipeline that you quote, what are your assumptions there on how long it takes to lease up to get to stabilized deals?
- Matt Murphy:
- As I mentioned earlier, it's almost -- it's Matt. It's almost always. In fact, I can't think of an exemption to it 12 months that you're assuming that it will occupy, as Phil mentioned, not lease, but occupy it 12 months out from completion.
- Phil Hawkins:
- Unless there's a lease in place that obviously, we update for re-leasing activity.
- Nick Yulico:
- Okay. Thanks guys.
- Operator:
- The next question will come from Michael Mueller of J.P. Morgan. Please go ahead.
- Michael Mueller:
- Hey, just a quick one here. Matt, for the debt deal that you mentioned, can you give us an idea the duration you're thinking about and just any ballparks on pricing?
- Matt Murphy:
- Yes. So, yes, clearly, it's a little early to get into specifics, BUT I think the duration is easy. By far, by far, I'm thinking primarily in terms of the public market, and the public market is far most liquid in the 10-year tenure. I think given where treasuries are likely to be, I'm assuming to give you a range. I don't exactly know where treasuries are going to be in the middle of the year. I'm thinking plus or minus 4%, probably between 4% and 4.25% for a 10-year deal.
- Michael Mueller:
- Okay. That was it. Thank you.
- Operator:
- The next question will come from Jeremy Metz of BMO Capital Markets. Please go ahead.
- Jeremy Metz:
- Hey guys, good morning. Just in terms of your leasing activity, I was just wondering if you can kind of comment on a broad level which markets perhaps are underperforming your expectations right now. And then any new markets that are coming on to the watch list from a supply perspective?
- Neil Doyle:
- The answer -- the similar answer to both of those is none and none. And not to be -- I can't be short so I'll add little bit color. Across the Board, the market are doing well. Houston clearly has come back. Although we had a great year in 2017 in Houston in terms of both leasing and rent spreads. So, we, thankfully, never took a pause there. Our development leasing, we don't want to inspect building and we got lease on that. I would add a market to the quote watch list. And from a supply perspective, it's the same ones. We've mentioned it in it the commodity location. It's Inland Empire East, Chicago, IAD, it's Dallas and Atlanta that I talked about. Central Pennsylvania, you might add to that, into that list. It's where the big boxes get built. And frankly, we try to stay away from them.
- Jeremy Metz:
- Okay, appreciate that. Just want to switch gears quickly on development. Matt, in your opening remarks, you had mentioned that you expect starts are all coming from the land you currently or have under option. So, be honest, do you have enough land today that continue that same sort of start scheme past 2018? Or you need to replenish the land being further? And thinking the way of that, what sort of pressures are you using more broadly on land prices today?
- Phil Hawkins:
- This is Phil; let me take a shot at that. The answer is we are clearly working on 2019 now. 2018, there may be a few pieces of land that we finally get going right away. But the most part, it takes long -- it's long enough cycle that we need to work on land now to go into 2019. I think, as a company, I think about $150 million to $250 million. I don't want [Indiscernible] million of starts is being the right kind of cadence, if you will, or volume. Some years, depending on markets and our entitlement process that might be a little above that, other times, it might be a little below that. But the $200 million in the sweet spot and $250 million and the higher end and $150 million on the lower end. That's how I think about it. And I would think at this point, that's how 2019 will likely set up. God willing, if the market continues to cooperate. The land process hasn't changed. It's tough. Prices keep going up, so economics are challenging. But really -- beyond that, it's the entitlement process that is also tough. The good news is it's tough for everybody else and hopefully, we're better as than most. And so it becomes, in many ways, a positive once you're successful. But I would say the land market hasn't changed and our strategy has not changed. We are not land banking. So, we don't know much land and won't own much land in 2018 that we'll be starting in 2019. And certainly, not 'til we into late 2018 when we start buying land that will be for 2019. There will be exceptions, but we're not land bankers. I don't think it's the right economic use of capital. By land, you're ready to go and you feel good about, get it going and lease it and not trying to hold it over too many years because time is not your friend usually.
- Jeremy Metz:
- Thanks guys.
- Operator:
- The next question will be from Rich Anderson of Mizuho Securities. Please go ahead.
- Rich Anderson:
- Thanks. Good morning. So, if I could just kind of return to tax reform for a second. One of the another outtake for corporate America is rents continue to be fully deductible where its interest does not. It has at least the cap on it. I'm curious, when you think about the business of industrial real estate, it's been fortunate that Amazon has generally been a renter of distribution space while others like Walmart and Target have not. I'm wondering if there's any relevance to the shift -- maybe you're not seeing it did, but do you think that there's a chance that you can actually see more business, not so much from the benefits of lower tax as a corporate America, but because of this -- of the fact that rents continue to be deductible for them.
- Phil Hawkins:
- By the way, Walmart and Target are very active leasing -- leasers -- or lessees.
- Rich Anderson:
- But they own some.
- Phil Hawkins:
- They own some. But there's a lot of reasons that get going to a company decision to own or lease. Certainly, their cost of capital and their availability of capital, the amount of money they're going to invest in space, the length of time they believe they need it and the predictably of the business. They're -- when there's a number of things that happen at the accounting rules that have you thought would have driven more corporations to own than lease. And we got that question probably three or four years ago and those happened. We didn't see it. I think there's a lot more going on out there that is strategic and operational that drives those decisions. So, tax reform may have a very incremental, modest impact, haven't seen it yet, obviously. But I don't believe it will be enough weight to shift the mat, if you will, of the company's -- each company decision. We've been buying buildings from companies and leasing them back. We've been buying buildings from companies and then letting them -- and take them vacant. We've been selling for users and we're happy to sell to users. There are no better buyer out there in this universe than -- and every one of the buildings we own is for sale at the right price. It's a beauty about industrial. We're not in love with any one of our buildings. So, we'll react to the environment and more likely probably on the ground company-by-company or customer-by-customer discussions and we'll make the best decision possible for -- based on the circumstances at the time.
- Rich Anderson:
- Is the fact that you said the best buyer is the owner/occupier. Is that because they're not doing the NOI math and cap rate and they're judging at differently unless you can get better pricing that way?
- Phil Hawkins:
- Exactly, exactly.
- Rich Anderson:
- And then just a quick one for Matt. Do you have any lease termination income baked into your 2018 outlook?
- Matt Murphy:
- No, it's not 100% true. I have a couple of $100,000 in the first quarter that I'm pretty sure is [Indiscernible]. Beyond that, the answer is no.
- Rich Anderson:
- Okay. Thanks guys.
- Phil Hawkins:
- Thanks Rich.
- Operator:
- The next question will be from Jon Petersen of Jefferies. Please go ahead.
- Jon Petersen:
- Great. Thanks. Pretty much everything has been asked. But I just had one modeling question. Straight line rents and free rent were a lot lower in 2017. They've been a long time. 2016 was like a really big year. I guess, as we think out towards 2018, how you kind of expect those line items to trend and maybe bigger picture, I'm just curious how much free rent is factoring in those negotiation.
- Matt Murphy:
- So, I think the way to think about big pictures are frankly easier. What you saw in 2016, there is definitely a high correlation to the initial lease-up of development properties and free rent. And free rent is in the part that always drives big swings and straight-line rents. Straight-line rent without free rent is extremely boring. It's a positive number in the first half of the lease; it's a negative number in the second half of the lease, assuming you have normally distributed bumps. So, as I think about -- we have a pretty healthy development pipeline right now that is likely to lease up over 2018 and 2019 that will drive free rent, which will push up straight line rent, the balance sheet element of the straight line rent. And so at the end of that day, I don't -- I think it will most closely follow whatever assumptions you're making about the lease-up of the development space. It's not that free rent only happens in development, but they tend to be longer leases. And as a result, free rent is almost always negotiated when it's present at all in terms of months free per year of term and development leasing tends to be longer. That's a long-winded non-answer, I apologize. It's hard to predict. It's funny when you model stuff out straight line rent in year four or five always turns to be a reduction of cash, but it never actually by the time you get there, it never happens. I've never seen straight line rent being overall debit in a company that I've been associated with. I've seen it in my forecast. I've seen it keep close, but it never actually happens because you continue to have new leases on top of it that have bumps. And bumps are the other part that's driving it when you initiate a rent, that number is always a positive, as a credit, if you will, to the income statement when you start.
- Jon Petersen:
- Okay. Thank you.
- Operator:
- The next question is a follow-up from Eric Frankel of Green Street Advisors. Please go ahead.
- Eric Frankel:
- Thank you. Just to clarify. Neil, I do appreciate the very detailed response. You gave a good explanation on why you did that particular investment. My broader question was regarding opportunity to buy more merchant developed assets over the next couple of years given that more than that has already been built. I think the way you described it that you're buying base off 2015 land price and 2016's construction pricing was interesting. So, I was wondering if you think more about opportunities could come along.
- Neil Doyle:
- Eric, my fault from misconsuming that. We -- that is exactly an opportunity set. It's been there before. In fact, just in Chicago at DCT, we purchased an asset from the same guys three years ago, something they had bought as a value-add. They stabilized. It was priced correctly. I do believe that the private developer world is certainly one of the many sources of opportunity for more the long-term hold type companies. They're part of our business. You need to hang around. You need to keep in contact. And once in a while, our goals will intersect and I think we can complement each other. So, we'll see what happens. Go ahead.
- Phil Hawkins:
- I will just add real quick, Eric. Neil said along the line, once in a while, I don't think it's a big part of our business plan. The intersection of our ability to pay and their willingness to sell is more seldom than frequent. But when at happens and we've got to the ability to take on that risk, we're happy to do it. We've rather -- as Neil said in his first answer, we've got to do it ourselves. But we can't do everything. And we're a developer as sign an opportunity and executed on it and it makes sense for us to take them out early, we'll consider it. It's not a--
- Eric Frankel:
- Okay. Thanks. One more question for you, Neil. There obviously isn't a lot of lease roll-over in 2018, but a lot of it is actually concentrated in Cincinnati. So, maybe you could talk about your leasing outlook there and the overall investment outlook in that market.
- Neil Doyle:
- Absolutely. Cincinnati is, without a doubt, one of the strongest markets we have in the Central Region today. This Amazon push, on top of just being a strong market, this Amazon push into the Northern Kentucky Airport has just been amazing for demand. And it really hasn't began much in the way of operations here. They are flying, but not to the extent they are going down the road. So, Cincinnati is extremely tight. Absorption has been extremely strong. I do think you'll see some reactive supply in 2018 and 2019, and we'll deal with that as it comes. But from our portfolio perspective, this is -- 2018 is a little year on the heavier side for us in Cincinnati, but I'll put it in perspective for you. We have 29 leases in 2017 in that market. We need to do 22 in 2018. We've got, let's call it, 800,000 feet, a full half of that, 400,000 feet, is between two tenants where we are well down the road towards renewing. So, after that, we've got a lot of small units to go, not easy. But track record says it's just another year. So, pretty confident that market has been very good to us the last three years running. And again, with this Amazon boost, I expect Cincinnati to stay strong.
- Phil Hawkins:
- And Eric I'll add one comment there to put pressure on the local team. In addition to that, we're hopeful we'll have a development project in 2018 as well. So, that's how we feel about the market.
- Eric Frankel:
- Okay. Is there anyone else on the queue? I don't want to take up too much more of your time.
- Phil Hawkins:
- Go ahead.
- Eric Frankel:
- It was related -- this is actually speaking of Amazon. So, I think there's a rumor, maybe you confirm rumor out there that they're kind of experimenting with their supply chain, adding a new property type where it's an ultra-high, clear high building that has a small footprint in population dense areas. Can you talk about their leasing activity or their expected leasing activity over 2018 and over the next couple of years and how that's likely to evolve and whether you'd participate in building unique assets for them potentially down the road?
- Phil Hawkins:
- I don't -- I can't speak to the details of that. But I can tell you, it isn't our sweet spot. To build a specialty asset in an urban are is probably not something that we're likely to be involved with. There -- as far as I -- what we can tell they are planning activities, when they're paying us and others, they are pretty active right now for both builder suits, which is not again, that's not our sweet spot, we don't have a land bank. But in terms of both first generation, special development as well as second generation vacancy and the renewals with them, all going -- it remains pretty robust.
- Eric Frankel:
- Okay. Thanks. That's all I've got.
- Phil Hawkins:
- Thank you, Eric.
- Operator:
- Ladies and gentlemen, this will conclude our question-and-answer session. I'd like to hand the conference back over to Phil Hawkins for his closing remarks.
- Phil Hawkins:
- Hey, thanks, everyone, for joining. We've got a good year in front of us, I hope, which is going to be focused on executing. We're going to have a number of investment conferences up over the next month and look forward to seeing many of you who are on the call there. And Matt and I are also available by phone if you want to talk further about any aspects of our business or company, happy to do that any time. With that, take care and have a good weekend.
- Operator:
- Thank you, sir. Ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. At this time, you may disconnect your lines.
Other Duck Creek Technologies, Inc. earnings call transcripts:
- Q1 (2023) DCT earnings call transcript
- Q3 (2022) DCT earnings call transcript
- Q2 (2022) DCT earnings call transcript
- Q1 (2022) DCT earnings call transcript
- Q4 (2021) DCT earnings call transcript
- Q3 (2021) DCT earnings call transcript
- Q2 (2021) DCT earnings call transcript
- Q1 (2021) DCT earnings call transcript
- Q4 (2020) DCT earnings call transcript
- Q3 (2017) DCT earnings call transcript