Duck Creek Technologies, Inc.
Q1 2016 Earnings Call Transcript

Published: 7 May 2016

[Operator:]

Good morning and welcome to the DCT Industrial Trust first quarter 2016 earnings conference call. [Operator Instructions] I would now like to turn the conference over to Melissa Sachs, Vice President, Corporate Communications and Investor Relations. Please go ahead.

[Melissa Sachs:]

Thanks, Amy. Hello, everyone, and thank you for joining DCT Industrial Trust first quarter 2016 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 updated guidance. Additionally, Bud Pharris, our Managing Director of the West Region will be available to answer questions about the market, development and our 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.

[Philip Hawkins:]

Thanks, Melissa, and good morning, everyone. The first quarter was a strong start to 2016, as customer demand remains robust, whilst new supply remains well in check. Better than expected operating results, including occupancy, rent growth and same-store NOI, led us increase operating and financial guidance for the year, as we remain confident in our business and market fundamentals. Despite significant volatility in the capital markets, related in part to economic uncertainty, our customers' behavior has not wavered. They continue to make decisions promptly, and their need for more and better distribution space remains unabated. While e-commerce has been a clear tailwind for our sector and DCT, customer demand is active across all industry verticals and size ranges. On the subject of e-commerce, I like how DCT is positioned with our high-quality infill focused portfolio. Following a very active e-commerce year in 2015, we recently signed two full building leases, totaling just under 500,000 square feet in California, one with a leading e-tailer near the L.A. Airport and the other with a leading package delivery and logistics company in a building we are completely redeveloping in Hayward, a submarket in the East Bay of Northern California. We also have a third significant lease pending with the leading e-tailer in an infill location in Atlanta. Leasing in the second quarter has gotten off to a strong start as well, with 2.2 million square feet signed in our operating portfolio since the end of March, 700,000 square feet from new leases and 1.5 million square feet from renewals, further reinforcing our confidence for the year. Reflecting the favorable market environment, our development and redevelopment business continues to perform very well. During the quarter, we stabilized seven buildings, totaling 2.4 million square feet, with a projected cost of $167 million and a yield at 8%. We estimate that we have created $63 million of values from these projects, a 38% margin based on Class A cap rates for each market as estimated by CBRE. We also started three new development projects totaling 780,000 square feet since January 1. And most importantly, leasing of our development and redevelopment pipeline continues to exceed expectations with 900,000 square feet of leases signed so far this year. Our current development pipeline of 4.2 million square feet is 63% leased, a very healthy number, especially considering the 2.4 million square feet of 100% leased development projects that were placed into the operating pool during the quarter. Our building at Hayward that I previously mentioned is an excellent example of our approach to creating value. We acquired this building in 2015 with a redevelopment plan to shrink its size by 25%, in order to create a large truck court with generous trailer parking. Features that didn't exist previously and are critical to modern distribution needs, including those of e-commerce related tenants such as the one we just signed. We are also increasing the floor slab thickness to increase weight load capacity and adding ESFR sprinklers. All this in combination with clear height in access of 28 feet will result in a highly functional Class A distribution building in a heavily land constrained infill market with virtually no vacancy. While we have only just finished the demolishing phase of this project, our vision for the asset was confirmed by the recent full building pre-lease that I mentioned earlier. The tenant will move in October 1, right after all the improvements are completed, a great job by our Northern California team. In addition to this project, we have recently completed a number of successful redevelopments in Chicago and Dallas among other markets, and we will continue to look for similar opportunities to redevelop buildings in strong infill submarkets. Before turning the call over to Matt, I do want to acknowledge Tom Wattles' substantial contributions to DCT as Board Chairman, since the company's founding. Tom has decided to retire from our Board, but I am pleased that he will remain involved with the company as Chairman Emeritus, serving our management's executive and investment committees. I also look forward to continue working with Tom August, who assumes the role of Board Chair. Many of you know Tom August, and no doubt would agree that we are fortunate to have him as a Board member and now as our Board Chair. With that, let me now turn the call over to Matt, who can provide more detail on our first quarter results and our outlook for the balance of the year. Matt?

[Matthew Murphy:]

Thanks, Phil, and good morning, everyone. Our first quarter was very positive at DCT, both financially and operationally. Almost every metric was ahead of plan, as rents and tenant demand continue to surpass our ROE optimistic expectations. I'll walk through some of the details of the quarter and talk about their impact on our full year 2016 guidance. FFO for the first quarter of 2016 was $0.54 a share, which was roughly $0.02 ahead of our internal projections, driven by a number of factors, including better than expected occupancy as well as a couple of unbudgeted one-time items. Consolidated operating occupancy was 95.8% at March 31, which was considerably higher than expectations. This favorable outcome was driven in large part by a 400,000 square foot tenant in Atlanta unexpectedly staying in their space through the end of March, as well as two wins leasing up space early in Atlanta and Southern California totaling almost another 400,000 square feet. The delayed move out is frankly just good fortune in a building we acquired in 2015, knowing that the tenant would vacate. However, the two leasing wins are just the latest example of how quickly tenants are willing to move to lock-up space in tight infill locations. Neither of these now existing tenants were even serious prospects only three months ago. In addition to the excellent operating results, our numbers also benefitted from two one-time items. First, we received a settlement of approximately $500,000 from a manufacture, related to a roofing product liability claim. The cost to repair those roofs was incurred and reflected in 2015. Second, we received a payment of a little under $1 million for a restoration fee from a tenant, who were released early from their lease. Concurrently with their release, we signed a new tenant to backfill the 100,000 square foot space, once the improvements are completed. The way the accounting works is that the restoration fee is included in NOI and the improvements will be reflected as turnover cost, which is one reason you see somewhat elevated turnover cost in our leasing stats this quarter. Turning to capital markets. We raised net $48.6 million under our ATM program, issuing 1.2 million shares at a weighted average price of $39.93 per share. We issued a vast majority of these shares in early April, as we took advantage of the enhanced liquidity during the window just prior to our inclusion in the S&P Midcap 400 Index. Given the price and our stated desire to further drive down leverage, we decided it was an excellent opportunity to raise capital to fund our development pipeline as well as delever in the most efficient manner possible. This is the first equity we have issued since 2014 and we do not have additional equity issuance included in our capital plan for 2016. On the guidance, we have increased our 2016 guidance for FFO as adjusted to $2.10 to $2.20 per share, up $0.03 per share on each end. This increase is attributable to the items I discussed earlier as well as our modestly improved forecast for leasing for the remainder of the year. These factors have also led us to increase same-store guidance for the year to between 4% and 5% on both a GAAP and cash basis, up from between 3.6% and 4.6%. Also, our improved leasing experience and outlook as well as to increase our expectations for 2016 average occupancy in our operating portfolio to between 94.75% and 95.75%. Due to the equity issuance I described, we are lowering our disposition guidance to between $100 million and $150 million. Given the combination of equity and dispositions in our plan, we expect that our debt to EBITDA ratio will be at or below 6x by the end of the year, while comfortably funding our development pipeline. Finally, we are increasing our guidance for development starts to between $175 million and $275 million, all of which can be achieved on land we currently own or control. As a reminder, for further details about the elements and assumptions inherent in our guidance, please refer to Page 18 in our supplemental reporting package. In summary, the first quarter was a very encouraging beginning to the year. We had a few operational wins and the fundamentals in our business remain in excellent shape. We continue to incrementally improve our credit metrics and our balance sheet will provide us with tremendous flexibility to execute our strategic plan. Perhaps most importantly, our high-quality infill oriented portfolio appears very well-positioned to benefit from e-commerce and other logistics tailwinds in our business. 2016 is shaping up to be another very successful year at DCT. With that, let me turn it back over to Amy for questions. Thank you.

[Operator:]

[Operator Instructions] Our first question is from John Guinee of Stifel.

[John Guinee:]

A quick question for you. On land, you're down to basically a couple different projects in Miami, 40 acres in Northern California, a relatively modest 12 acres in Orlando, 13 acres in Seattle. Do you expect that to continue to shrink or do you expect to ramp up in your land inventory?

[Philip Hawkins:]

I think we'll continue the process, which is replenish as we go. In almost everyone of those markets that you mentioned, we have land sites that we're working on right now under contract or maybe just shy of that, looking at entitlements, environmental approvals. We're typically looking at projects where we're assembling land or taking it through re-entitlement. The project in one of the markets you just mentioned, where actually the market believed that it will be a lot lands on there and we believe there wasn't, and we just confirm that we were right. As an example, we're just trying to create value through the land process. Very difficult right now for us to buy land in auction processes, land that's already entitled, ready to go, that's just not our game. But we'll continue to replenish with an eye towards staying offense, but without getting too heavy on land bank, which we know where that eventually ends.

[John Guinee:]

So if I'm just looking at this quickly, you have projects in process in Dallas, Chicago, D.C., Atlanta and Southern California, but no land in inventory. Will you expect to continue to develop in those markets or is there any of those markets that you think are pretty overdone?

[Philip Hawkins:]

None of them are overdone from a supply and demand perspective. Like each of the ones you mentioned, our focus is really can we find a land side at the right price in the right location, which accommodates a building and a site plan that we believe is state-of-the-art, and not talk ourselves into lesser quality locations or lesser quality site plans or frankly lesser quality financial returns. I'd say a number of sites we're working on are in those markets, either redevelopment or straight up land. But in some cases, we'll be knocking down buildings or redeveloping buildings. And then none of them what we're working on is clearly yet reflected on the balance sheet, because its not closed or done. But we got a pretty good -- I'd say, we have a pretty active pipeline of ideas. When you're working on that kind of project, John, as you know, you're not always successful. So we've got great hopes. We've got every reason to be optimistic about each of the things we're working on, but we got a lot of work to do.

[Operator:]

The next question is from Manny Korchman of Citi.

[Manny Korchman:]

Maybe given sort of the peak occupancies in the portfolio and good trends throughout, how do you think about rental rate growth versus occupancy or giving up one versus the other in today's environment?

[Philip Hawkins:]

Well, in favor of both, clearly. But I think in this environment, we've been focused on it actually for more than a year. Now, this is an opportunity to push rents in rent bumps and other lease terms. Occupancy is going to happen. We've got significant tailwinds in our business that I'm very grateful for. And the question is, how do we leverage that without overleveraging it, obviously, and we're trying to be too crazy here. But I think right now in most markets, most buildings we have, we're very mindful of unique opportunity we have to push rents, achieve good rent growth, maybe even lead the market and encourage the rest of the market to push rents. And our teams on the ground are thinking about that all the time. Again, without being overly arrogant about it, we're in a very good business and we continue to enjoy that luxury.

[Manny Korchman:]

And then, Matt, are there any other sort of one-time items hanging out, out there similar to the insurance settlement that we should be aware of that may be coming in coming quarters?

[Matthew Murphy:]

There is probably a significant restoration fee coming in the second quarter. I don't want to get too specific, as those are always negotiated deals. I call it one-time items. We probably have a restoration fee or two or more every quarter. The fact that they approach seven figures gets to be a little bit unusual. That's the only one I can really think of. Yes, and that transaction is included in guidance.

[Manny Korchman:]

So maybe the total magnitude of those types of events in guidance for the year, if that doesn't tip your hand too much?

[Matthew Murphy:]

Well, to be honest, that's the only one, other than what's actually happened. That's the only significant, again, one-time item. I sort of don't like that characterization necessarily. They're less common. That's a natural part of our business, the fact that it's that big. So there probably other ones that are smaller fees that are out there that I'm not thinking about. That's the only significant one that I can think of that is included in the guidance.

[Philip Hawkins:]

Fairly one ancillary benefit of a strong market is this kind of situation. We're negotiating leases and enforcing leases in a way that perhaps in a weaker environment, we may not be able to or if you're dealing with a weaker credit tenant, you may not be successful. So I consider this another one of many examples of strong market and where our property management teams and market teams are really mindful of those leases and extracting revenue that were earned, we've earned and we deserve. But perhaps a team that is not as diligent or a market that's not as favorable, we may not be getting them.

[Operator:]

The next question is from Eric Frankel of Green Street Advisors.

[Eric Frankel:]

I wanted talked about the revised disposition guidance and the equity raise. Is that all a reaction to where lower quality properties are pricing today?

[Philip Hawkins:]

No. Not at all, actually. Our guidance has been reduced by actually reducing the top-end of the quality of the assets we were expecting to sell this year, assets that our market teams would rather not sell. But when compared to the use of capital i.e., development pipeline that is performing vey well, made sense. As Matt mentioned, liquidity and pricing it felt to us like we could -- it made sense to us as we evaluated source and uses of capital and potential other source of capital to do that. As Matt mentioned, there is nothing in the plan to sell more. I would say it's unlikely we will, barring a substantial increase in the development pipeline. What we are continuing to do is sell the assets that we consider to be non-strategic. The assets that our market teams want to sell for whatever reason as soon as we're able to sell them from a leasing perspective.

[Eric Frankel:]

Do have a rough sense of what percentage of your portfolio you would consider non-strategic today?

[Philip Hawkins:]

Well, it depends on the price. It depends on what we've accomplished. What we're selling today is far better quality than we were a year ago. The West Chicago that we sold is a submarket that Neil has not targeted. He provided reasons and he can fairly describe it far better than I can. We're not big fans of that market, that submarket. We love Chicago and obviously we're growing a lot in Chicago. We got a couple of buildings in Indianapolis that we're working on selling right now that we would certainly consider non-strategic had some good leasing success recently, working on that. A couple of non-functional or lower functional buildings in Cincinnati are on our list, probably being more specific than I should be. And then we've got a couple of buildings here and there, frankly. And then it's probably a market or two that I'm not thinking about, where we got building or two. We're talking about a handful of buildings left that at the right price we're sellers and at the wrong price we're holders. We're not highly motivated sellers, but we are prepared to sell the lesser strategic, the lesser lower growth assets that are more attractive to other types of buyers, other types of owners than they are to us.

[Eric Frankel:]

I have a couple follow-up questions. I'll jump in later in the queue. But you talked about how supply is still relatively disciplined. Are there any markets in particular though, where you feel like you might be a little bit stretched? I mean, we obviously heard some other management teams make their comments over the last couple of weeks.

[Philip Hawkins:]

From a supply perspective?

[Eric Frankel:]

Yes.

[Philip Hawkins:]

I guess, I pick on some of the same ones. Dallas is on fire from a demand perspective and where we are focusing on, which is north and by the airport, north and northwest and in smaller medium-size building is in grate shape. Demand in that market, it just defies historical perspective, but on the other hand sort of supply. And to me we see high demand, high supply, you're creating leverage there, where at some point that can turn on you. No doubt about it. I would say, we continue to think about, talk about, Houston. I was with Justin two weeks ago, had a great trip. That market continues to hold up well. There is some amount of square feet under construction there, but four of that is in a build-to-suit for one tenant under one roof, which is a pretty amazing situation. And another 800,000 feet of that's, so almost 5 million feet in build-to-suit. The other 800,000 is for FedEx. So you got to have Houston on that list, not for any statistical or date research that shows on the data today, but you got to have it on the list. We like Eastern Pennsylvania, I know that's been -- one of our peers mentioned is that, I think it was actually more Pennsylvania, which is too generic too broad. I would agree with the comment, that Eastern Pennsylvania is in good shape, good demand. Our focus there is in small and medium buildings not the big boxes, but they is certainly big box demand, big box growth. Central Pennsylvania, we don't have a big presence. It's a little bit less land constraint than Eastern Pennsylvania. Strong demand, it's a major distribution market, but I don't put Pennsylvania on that list. But I comment on it because I know a few of my peers that have gone before have on both sides of that coin. That'd be it.

[Operator:]

The next question is from Steve Sakwa of Evercore ISI.

[Steve Sakwa:]

I was wondering if you could just maybe talk a little bit about tenant psychology and the demand. I guess, Phil, I just wanted to follow-up on the comment you made about a couple of the buildings or maybe it was Matt, who talked about some of the leases that you weren't expecting that kind of happened very quickly. And I'm just curious, as you're out talking to tenants sort of what their expectations are about the economy, how they start to think about leasing and some of the bigger issues that you're talking to them about?

[Philip Hawkins:]

That's a perfect question for Bud Pharris to start with.

[John Pharris:]

Great question. I think what we're seeing is the size requirements, not just the big box basis, but now less than big boxes, smaller infill needs are really heating up. And in some instances, and this has been gone up for a couple of quarters now, some of the tenants that are stepping up to the plate are not doing so and making decisions quick enough, and they're actually getting bumped for other tenants, who really understand how important it is to act quickly. And so that's one of the phenomena we're seeing and the activity has been very strong.

[Steve Sakwa:]

And I guess, second, to maybe go back to a question John Guinee asked, just about development, Phil. As you just sort of think about it, you started the year cautious, maybe cautiously optimistic, and have been measured in the development business. Obviously, it's been good. I'm just trying to think, what other steps or what other measures are you putting in your underwriting to just sort of minimize risk besides just not land banking? Are you just thinking about anything differently, longer lease ups or hair-cutting rents or putting in bigger contingencies? How do you sort of think about it this late in the cycle?

[Philip Hawkins:]

Nothing different from what we've been doing, but a friendly reminder, each time I see employment growth this morning or whatever to be diligent about doing what we say we're going to do. Really, honestly underwriting assets and markets to make sure that we're not believing our own rhetoric. I can tell you, the length of each investment committee meeting is significantly longer today than it was two years ago. We've kicked a number of projects aside, because they were mediocre locations. And they work in today's market, but not if today's market goes away, where returns that we just didn't feel we'll get enough. We've had several projects, particularly when they get auctioned, where we -- once again, just like buildings, it's pretty hard for us to compete in an auction environment, when we've got the capability to create land and create land opportunities and others don't. And those others may have bigger appetites or lower cost of capital or whatever. So I think it's just a reminder, as I said in last call, risk management from a corporate level is really important as is project underwriting at the local level. And we've got, I consider them great debates, our market leaders may not think there is much fun, but they're incredibly important. I want to make sure we don't turn away projects that are quality projects. On the other hand, I really don't want to believe our own rhetoric and talk ourselves into something that really shouldn't be talked into that the market wasn't this good. The market is great. I see no signs from tenants and brokers in our own activity and that's going to change. But clearly we know it will change someday. And I just want to make sure we are managing the company, as if that will happen, but not managing the company believing it's going to happen tomorrow, because I don't.

[Steve Sakwa:]

And then just last, just remind me, do you have any kind of parameters or guardrails or max kind of development levels you think about, kind of total spend as a percentage of enterprise value? Just remind us sort of how you think about development as relative to the size of the company?

[Philip Hawkins:]

Yes. No more than 10% of our total assets should be in the form of at-risk development assets and redevelopment. So build-to-suit was necessarily kind of against that, but certainly speculative development would. We've not come up, I think we're about 7% or 8% right now, Matt, a total development and that's 60% at least. Although much of that development pipeline started off as spec. And then it's really by a submarket not trying to compete with ourselves. No matter how bullish we are, we really don't want to get over our skis and be overly confident, again, by doing two or three instead of just one, even though we might believe two or three projects today might work. We're trying to take a measured, meaningful bet on development, but one that is manageable from a company perspective.

[Operator:]

The next question is from Juan Sanabria of Bank of America Merrill Lynch.

[Juan Sanabria:]

You guys mentioned a lease on a development to a premier e-commerce retailer. Would that be a new build-to-suit or would that be to fill current development that's not yet leased?

[Philip Hawkins:]

Neither. In existing second generation operating building that they are looking, we have leases out. Now, again, I mentioned as an example of e-commerce activity not as a guarantee, we're going to close the deal. And I'm sure Mike Ruen is going to shoot me for even talking about it. But, no, it's an infill existing building, second generation. Good quality buildings, but not a new development or redevelopment in that case. And by the way that's not the only example where our existing buildings non-development, non-redevelopment have benefitted from direct e-commerce related business. There is a lot of business out there. You have no idea. Clearly, 3PL business, but even some direct user business that it's hard to measure whether it's e-commerce or not and what percentage, but clearly, when certain names you know, you know what's going in there, other names should don't.

[Juan Sanabria:]

And then just on the releasing spreads, been very strong the last few quarters. Any color on expectations for the balance of the year? Is the first quarter a good run rate or are there tougher comps with what's expiring coming up for the rest of 2016?

[Matthew Murphy:]

I do think its representative. As I've talked about a number of times before, the easiest way to measure that, because you don't have to have as precise the knowledge of where market rents are, is if you just look at what the lease comps are. And what's remaining for 2016, just to refresh anybody's memory, the way I think about it is sort of are the comps pre-recession during the depths of the recession or post-recession. For the full year, there was 42% of it that was in the depths of recession i.e. the easiest comps. The remainder of the year, it's slightly lower than that, but it's in high 30s, it's not a lot lower than that. So I think its representative, that's not a prediction. You're never going to get a prediction out of me on this, but the environment for the rest of the year is not any different than the environment for the first part.

[Operator:]

The next question is from Blaine Heck at Wells Fargo.

[Blaine Heck:]

Matt, just wanted to get some color on same-store NOI. And I hope I didn't miss this, but you saw same-store expenses decrease again this quarter. Did that have anything to do with snow and ice, maybe being dry last year or some other one-time item or is that kind of a sustainable decrease going forward?

[Matthew Murphy:]

That is exactly -- it's not all of it, but that is by far the biggest piece of it. Actually, we had a number of markets that had a pretty tough first quarter this year too. So --

[Philip Hawkins:]

Including your home town. Your current town

[Matthew Murphy:]

Right, but that is absolutely the biggest driving factor.

[Blaine Heck:]

And then maybe, Phil, can you just talk about the three speculative developments you guys started this quarter? And what makes you confident on the demand side in those markets?

[Philip Hawkins:]

Our experience. They are markets we've already developed in; pre-leasing activity, another example, and frankly then just our understanding of the overall market. We're talking about Orlando, Miami and Atlanta all very strong markets, markets where we've got a good track record in. Miami project is really right next door to what we had done couple of years ago. Orlando is part of the same park we've been developing. Atlanta is a site we've owned for a number of years. Bought our joint venture partner out recently, got a number of buildings around that area. We are embedded in these markets with strong market teams and a lot of experience.

[Blaine Heck:]

And then just maybe one quick last one on the 400,000 square foot tenant in Atlanta that stayed in place. Did you guys do a short-term extension on that, and should we be aware that coming up again soon? Or was it a longer-term deal?

[Philip Hawkins:]

The short-term extension was what got us from January to -- they're out of the building. They moved out April 1. And Blaine, congratulations or maybe condolences, I'm not sure which, but on your sitting in the number one chair.

[Operator:]

The next question is from Craig Mailman at KeyBanc Capital Markets.

[Craig Mailman:]

Just curious, I guess following up on Bud's comment about this infill tenant demand and how some tenants aren't being quick enough, and just as that relates to rent growth. Just curious kind of the elasticity of demand in your infill markets versus what you guys are seeing in non-infill?

[Philip Hawkins:]

Bud, you want to handle that one.

[John Pharris:]

Sure. I think the non-infill markets are still very strong and there is quite a bit of tenant activity. But the infill markets, literally tenants, they don't have options. So in some instances, where tenants might try to go out and find a different alternative, they're finding that the ability for them to find those alternatives is really non-existent. And then the landlords are renewing and/or extending at favorable rates and I think that's where you're seeing much of the activity and rent growth.

[Craig Mailman:]

So I guess if we're looking at your ability to capture the mark-to-market maybe there isn't one, but just your sense of if rent growth has been 5% to 10% in infill or even more, kind of how much of that in multiple of what you guys are seeing in non-infill and your ability to really get that because of the lack of supply?

[Philip Hawkins:]

Bud, maybe a comparison of Inland Empire East versus West. We don't have much in the East, but I think that is an idea.

[John Pharris:]

Yes. We really don't I think. I think it is a great point, Phil. We don't have a ton of exposure in the Inland Empire East. But I would say that from an occupancy and a rent growth standpoint, the West clearly, I shouldn't say clearly, that West does better than the East. The rent growth is better and it's stronger, and frankly, the occupancy is better. And there is a less construction in the West, as there is in the East. And there is fewer barriers to entry in East. So it's a fairly common cycle that we see, but we're still very bullish on what's happening, clearly in the infill. But in the non-infill or outer infill, we're still very confident and feel good about what's transpiring from a fundamental standpoint.

[Philip Hawkins:]

Craig, from my perspective, unlike last cycle or the last several cycles where tenants would chase lower cost yields and further out locations in most major metropolitan areas, the next cornfield on the interstate further out, what we're seeing now is tenants are paying up to be closer to the urban core. And they're not reacting -- the price elasticity, I think that was your word, is indicating that there are other costs or the benefits of being closer there to the urban core far outweigh the cost that we're charging and the rent growth that we're seeing. There is always exceptions, but if you look at every market, even the Midwest markets, the closer in you are with land or buildings, the better you're doing, and the more you are able to push rents, which has been our theory frankly for 10 years as we've been repositioning this company is we really want to be in markets that are closer to the urban core, not as susceptible to excess land and easy building environment. I think from the real estate perspective that makes sense, but it makes sense also from a tenant perspective, they want to be there, they're paying for it.

[Craig Mailman:]

And kind of dovetails to my follow-up here, as you guys think about what's non-core at this point, is it more kind of a bottoms up or a top down in terms of how you think the portfolio should be positioned longer term to capture this kind of move to more urban, and the realization that to be seen that you need to be there, maybe to eliminate some other costs that previously people are just underestimated or ignored?

[Philip Hawkins:]

Well, thankfully it's both, because the market leaders, I learn a lot from them as does Teresa Corral who runs asset management and dispositions and actually acquisition process, but we see at the same way. What we want to do is be with where our market leaders believe a future of the markets is. And that's specific sub-markets and certainly general philosophy of closer in, more barriers entry. So we think about even Dallas, where you don't describe Dallas as the high barrier entry market. But the sub-market that Art Barkley has been able to identify land in and assemble tract the land from five sellers and are true infill with barriers entry ,and lack of land is much more attractive to me then going south in Dallas and competing with four or five major developers building million foot projects. That's our strength to stay infill, to work hard, and invest a lot of time, as well as money into assembling and creating infill development opportunities. But then as far as specific asset selection it's very much bottoms up. Market leaders work with Teresa to identify assets from a financial perspective and an operating perspective, that they believe are the lower part of their portfolio. And then we begin to look -- then that starts a process of valuation, a little more financial scrutiny, and eventually as leasing permits pull the trigger to put on the market. And then a pricing permits to then pull the trigger and sell it.

[Operator:]

The next question is from Mike Mueller at JPMorgan.

[Mike Mueller:]

A couple quick ones. With respect to the tenant who moved out at the end of March, are you expecting occupancy to dip in Q2? Or do you think you hold the line there?

[Matthew Murphy:]

Yes, it will. I mean that's 50 basis points all by itself. So I do think it will drop a little bit, I said that three months ago too, but yes, I do think it is. And there is couple of other tenants that are in excess of 100,000 square feet that have moved out in April already, so yes, I do believe it will dip a little. I don't think it will be significant.

[Mike Mueller:]

And then just when you talked about that restoration fee in the second quarter, did you say that that was in guidance or was not in guidance?

[Matthew Murphy:]

It was in guidance. Sorry, if I was unclear.

[Operator:]

The next question is from Ki Bin Kim at SunTrust.

[Ki Bin Kim:]

Could you talk a little bit about SCLA? And I noticed that one of your development starts was in that location. I remember back in the day that was one of the upside options for your company, and just curious if that has become a more viable use of land or you could maybe start more projects on that piece?

[Philip Hawkins:]

Yes, I think clearly activity up there has been very good. We started a building, it was sort of a quasi build-to-suit, there was a tenant that signed a 10 year lease that basically leased half of what became a 445,000 square foot building. We felt very good about the potential for an existing tenants in the park to take remainder of the building and that's exactly what happened. And we believe there is still more demand for exactly that sort of thing. So there is clearly a lot more activity up there in the last six, nine, 12 month, then there has been since before we got into the recession. The nice thing about the structure that we have at SCLA is we have a very low land basis that allows us to -- we bought the land, we have out there for $0.02 a foot. So it allows us to be patient, it allows us to capture. There are very compelling reasons to be in Victorville for specific companies that continue to respond to that being a good fit for what their business is. So yes, the activity is better than it has been in recent memory.

[Ki Bin Kim:]

And could you just remind us of some stats? Last time, I remember you guys have about 4,300 acres under option. Any update on that?

[Philip Hawkins:]

The structure hasn't change. I mean, the redevelopment, there's a very long answer to that question that's probably not worthy of this forum. We have as much land -- the beauty of that structure is we have access to a lot of land, but not obligations to a lot of land. We have access to more land than we are likely to use in the timeframe that any of us care about. And so as activity goes, that's again, the beauty of the structure. We can take down land as we needed. It's not that simple. It's not like going to Kmart, but there is a mechanism for us to take that land that will satisfy the needs that we have for the foreseeable future.

[Matthew Murphy:]

And I also say that our team there has done a great job making a relationship with the redevelopment authority in the city of Victorville which will help us react to tenant opportunities, react to changing markets. We are working on an idea right now that may result in I think our acquiring some land on a very nice basis. So I just think that it's going well there. Nothing has changed as far as -- it's got a great set of amenities and offers strength that if there are important to tenants, they're going to be want to be there and they're not they're not.

[Ki Bin Kim:]

And just any general expectations for how much you are going to start there over the next year or two?

[Matthew Murphy:]

No, I mean, again, I think I'm not sure how useful it is to start projecting that far out into the future. We're confident in the activity that's going on now.

[Philip Hawkins:]

I think more than zero.

[Matthew Murphy:]

Yes, it will be more than zero.

[Operator:]

The next question is from Tom Lesnick at Capital One Securities.

[Tom Lesnick:]

Just a couple of quick ones on same-store to start. Obviously 5.4% in 1Q is higher than the 4% to 5% range for 2016. I guess first, can you talk about the quarter-by-quarter cadence of your tougher comps expectations heading into the last three quarters of the year?

[Matthew Murphy:]

Yes. I think it is -- ironically the toughest comp is going to be the second quarter. I mean, it's just the way occupancy, the way the ebb and flow of NOI growth, so toughest comp we'll have for the year will be in the second quarter. The numbers are predicated on the idea that we will continue to have strong demand, and therefore, you will occupancy climb up modestly through the year. So frankly, the second quarter is the toughest comp, beyond that they're all -- we had a pretty good year in '15 throughout. The NOI, the specific numbers for the pool that we're comparing against, the toughest comp is the second quarter.

[Tom Lesnick:]

And then the 40 basis point upward revision in the range, was that solely due to 1Q's outperformance or are you baking in stronger expectations for the remainder of the year as well?

[Matthew Murphy:]

Little bit of both. Probably 50-50 and that's a copout answer, but I think it's mathematically true. We had both of those leasing wins that I talked about -- obviously, the building, the 400,000 they didn't move out isn't a same-store building because we bought it in '15, but both of the leasing wins that I talked about are same-store and they were both supposed to be down for meaningful parts of the year according to the budget. So it's a little bit above.

[Tom Lesnick:]

And then just looking where your stock price is right now, I know you talked about no expectations for further equity issuance this year, but if your stock remains elevated where it is today is there any propensity to overcapitalize or just take advantage of the pricing in the market today to shore up the balance sheet even more than what you're contemplating?

[Philip Hawkins:]

Probably not. We've already brought down our debt to EBITDA metrics. We've got a run rate of EBITDA that's being created through the development pipeline that's going to be a tailwind on that. I feel like we already have delivered. No plans to delever further. Clearly, it can happened by great development leasing that generate EBITDA quicker, or frankly more likely to happen, if we got an unsolicited offer at a good price from a user for building that wasn't in the plan, we'll sell. We are not going to not sell. We're happy to sell for the right price, even if it wasn't in our cop plan, if it is a building in a price that we think translates into a sale decision, but it won't be because of equity.

[Matthew Murphy:]

I like the way Phil said it earlier, to me the only thing that significantly raises the potential to do this is if we start seeing uses of capital that are well in excess of what we have in our business plan. I think just because I don't think it makes sense to go out and issue a bunch of equity for sort of momentary reasons. I think our capital plan contemplates our strategy, contemplates our level of activity, and it doesn't see like the right thing to do to jump in, because we can. I think our investors have and will continue to reward us for being prudent in terms of how we raise capital for the company.

[Tom Lesnick:]

And then just one final one for me. Can you talk a little bit about your development underwriting on build-to-suits. Do you guys underwrite to a specific rents or are you underwriting to a specific yield and building any clauses where any cost overruns or savings are passed along to the tenant in the form of the price.

[Philip Hawkins:]

Well, we're not a big build-to-suite player. We don't have a land bank, which makes it how to be a build-to-suit player. What we're doing is pre-leasing buildings that we've designed. We are leasing them at market rents not some cost plus typically. And we are taking the development risk, which we're very comfortable doing. We've been doing this quite a while. We've got a great track record on cost management. In fact, they've all come in under budget. We've got healthy contingencies in there. Like I said, we are not in the construction build-to-suit design build world, we want to build buildings that we want to own. We're happy to lease them sooner than we expected. And we've been forcing them to do that pretty regularly. But we're, like I said, we're not in the cost plus game building their building at some cost plus arrangement.

[Operator:]

The next question is from Mitch Germain of JMP Securities.

[Mitch Germain:]

Just a quick one for me. Phil, just curious about some of these markets where you've got just a handful of assets, call it, 10 or less. What's the plan for them over time?

[Philip Hawkins:]

Well, I'd say, for example, Charlotte we have one building. We bought it in a portfolio at a phenomenal price. We love that building. We actually bought out our JV partner in that case, fairly large transaction. I don't remember the total size, but it was pretty healthy transaction, a couple of million bucks if I remember right. And we love that building, knew that building, knew the tenant, had a short-term left on the lease when we bought it three years ago. Tried to renew it early to sell it, the tenant wanted a favor. What they wanted to renew we thought it was not a price we want to pay. We're now hopeful of renewing that tenant. We'll probably sell it. Although, and we love the building and the location, I'm not sure it makes sense on one building in Charlotte. Couple of other market where we don't have people -- particularly where we don't have people, where over time we may look for opportunities, but for example, we don't have anybody in Nashville and we don't have a huge portfolio. We love that market. And love the rent growth imbedded in our portfolio. Hard to buy in that market, it's very competitive. But on the other hand, we like what we own, not likely to exit anytime soon, this is an example; on the other hand, small markets where we've got good teams; our competitors, most of whom are also driving or flying in, we cover that out of Atlanta. Atlanta team did a great job. So as an example, unlike Charlotte that's not likely on the exit list.

[Operator:]

Our next question is from Eric Frankel, Green Street Advisors.

[Eric Frankel:]

Just one quick comment, Matt. You talked about taking down land at SCLA. I think you can think of a more expedient retail experience than Kmart just based on the online [multiple speakers].

[Matthew Murphy:]

So you want to talk about an example of e-commerce, I don't do a lot of actual shopping anymore.

[Eric Frankel:]

It is quite ironic. Question for you, Bud. I can certainly appreciate that supply seems relatively constrained just given the demand backdrop. Can you comment on what you think institutional investors are underwriting for development? What type of yields and spreads to market cap rates they're expecting? Because from what we understand institutional capital seems to be a little bit less interested today in older assets and going towards more institutional quality, modern warehouses in better locations?

[John Pharris:]

Great question, Eric. We are looking at development opportunities really throughout the western region. As Phil had mentioned, we've got a number of opportunities that we're working on. But in terms of the highly marketed or the auctioned, if you will, land sites, it's very difficult to compete, because some of our competitors are underwriting to levels, returns on costs that are just are not attractive to us, we really like to make sure that we're getting paid for the risk we're taking. And so on some of the deals we're just not a player. And that's why we're looking at these other off-market opportunities or putting together parcels of land or things along that line.

[Philip Hawkins:]

Bud, Feel free to throw out specific, at least, our view of what the stabilized yields are on some of the auction land sites that you've seen in Southern California.

[John Pharris:]

Do I really have to?

[Philip Hawkins:]

You don't have to. I think you're afraid to that's why wanted to mention it.

[John Pharris:]

That's right. So we've seen returns on costs of our competitors just drop well below 6% into that 5.75% range. And recently, there was a fully auctioned site. It was taken down by one of our competitors and by our underwriting standards that was 5.45% return on cost. And our understanding is they're willing to go below that as well. And those numbers are number I've never seen before.

[Philip Hawkins:]

Eric, one thing I want to just comment on, your question was right on, but you're theory, I think, is a little off. I don't think investors are shifting away from all their assets if they're functional. I don't think those investors have ever been want to take down non-functional assets or low functional assets. The market for functional B, we've not seen that change, in fact, it's healthy as ever. There are subset of investors, and I'm not sure they're linked to even those that are willing to invest in B, just those that have a plenty of money, pension funds, non-traded REITs, et cetera who tend to gravitate more towards ready-to-go development and ready-to-go land, and they clearly have a strong appetite for development and a strong appetite for placing capital and a lower cost of capital. But it's not coming at the expense, in our view, of functional high-quality B. That market, I'll tell you, if we saw a change, we'd be more active buyers. We just don't see it, and therefore that's why we have to redevelop or develop. I in some ways wish that that market would come back as we are big believers, if you can acquire a highly functional B asset in a great location infill; buy all day along. Unfortunately, we're not the only ones who think that.

[Eric Frankel:]

Final question for you, Phil, I think we talked about market rent growth last quarter. And I think you gave your expectation of what market rent growth would be for the year. Even though, it's a pretty nebulous concept. Have your thoughts changed based on first quarter activity?

[Philip Hawkins:]

Yes. Going into the year certainly, at the time, mindful of mixed at best economic reports and global uncertainty and still positive on the business back then, but I'm more positive even today. When you go through the first quarter despite what the capital markets are telling you or if you think are telling you, and your tenants are behaving in a much stronger confident way, and when you're talking tenants, and I've met with several of them in my last recent few trips, you meet with brokers, what they see coming down the road. I think that demand is likely to stay strong and given low vacancy rates, relatively disciplined supply, I think rent growth will surprise to the positive this year.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Phil Hawkins for closing remarks. End of Q&A

[Philip Hawkins:]

Well, thanks, everyone, for joining our call today. Matt and I are available for any follow-up questions. And we look forward to seeing many of you at NAREIT, in June. Take care.

[Operator:]

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