Duke Realty Corporation
Q3 2021 Earnings Call Transcript

Published: 28 Oct 2021

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the Duke Realty Earnings Conference Call. As a reminder, today’s call is being recorded. I’d now like to turn the conference over to your host, Ron Hubbard, Vice President, Investor Relations. Please go ahead.

[Ron Hubbard:]

Thank you, Sean. Good afternoon, everyone and welcome to our third quarter earnings call. Joining me today are Jim Connor, Chairman and CEO; Mark Denien, Chief Financial Officer; Steve Schnur, Chief Operating Officer; and Nick Anthony, Chief Investment Officer. Before we make our prepared remarks, let me remind you that certain statements made during this conference call maybe forward-looking statements subject to certain risks and uncertainties that could cause actual results to differ materially from expectations. These risks and other factors could adversely affect our business and future results. For more information about those risk factors, we would refer you to our 10-K or 10-Q that we have on file with the SEC and the company’s other SEC filings. All forward-looking statements speak only as of today, October 28, 2021 and we assume no obligation to update or revise any forward-looking statements. A reconciliation to GAAP of the non-GAAP financial measures that we provide on this call is included in our earnings release. Our earnings release and supplemental package were distributed last night after the market closed. If you did not receive a copy, these documents are available in the Investor Relations section of our website at dukerealty.com. You can also find our earnings release, supplemental package, SEC reports and an audio webcast of this call in the Investor Relations section as well. Now, for our prepared statement, I will turn it over to Jim Connor.

[Jim Connor:]

Thank you, Ron and good afternoon everybody. The fundamentals in our business continue to be the best we have ever seen. I will share a few highlights for the quarter and then turn it over to the rest of the team. We now have had three successive quarters of demand at or near all-time records and projected market level rent growth has risen from the 10% range to the mid-teens percent nationally and in some submarkets as high as 35%. During the quarter, we began roughly $350 million of new developments with expected strong value creation and IRRs and we raised our full year guidance on starts once again. Cap rate compression and rent growth continued to outpace material cost increases, allowing us to drive improved margins. The margins on our development pipeline are now over 60% and our core portfolio achieved record rent growth of 22% on a cash basis from second generation leasing activity. These quarterly results and our improved outlook for the balance of the year resulted in our raising key components of our 2021 guidance, including year-over-year core FFO growth now expected to be at 13.8% and growth in AFFO per share of 11.6%. Based on these results and our optimism about the balance of the year, we have raised the dividend by almost 10%. Mark will go over these changes in detail momentarily. Now, let me turn it over to Steve to cover the real estate operations in more detail.

[Steve Schnur:]

Thanks, Jim. I will first cover market fundamentals and then review our overall operational results. Industrial net absorption registered 121 million square feet, which is only 1 million square feet less than the all-time record. This was more than enough to offset the new supply as completions came in at about 79 million square feet. This positive net absorption over deliveries for the quarter reduced vacancy down to 3.6%, setting yet another record low. The strong fundamentals increased nationwide asking rents during the third quarter by 10% compared to the previous year. CBRE now projects demand for the full year in the mid 300 million square foot range and likely to break the all-time 2016 record of 327 million square feet. Completions for the year are projected to be about 270 million square feet. National asking rents for the full year are expected to be in the mid-teens with some markets like Northern New Jersey and Southern California likely to see increases of 30% to 35%. The reaction to supply chain bottlenecks continues to be in the early stages of a long-term boom for our sector, with CBRE reaffirming roughly 1.2 billion square feet of projected aggregate demand over the next 5 years. Increasing inventory levels, safety stock, consumer spending and online shopping trends are driving much of this demand. Demand by occupier type remains broad-based with e-commerce and logistics services companies continuing to make up roughly 60% of our activity, with the e-commerce contribution about 10% lower compared to 2020 and the 3PL contribution about 10% higher than this time last year. It is also noteworthy that Amazon’s share of demand this year is about 10% of overall total demand compared to 18% of demand in 2020. Turning to our own portfolio, we executed a very strong quarter by signing 9.5 million square feet of leases. The strong lease activity for the quarter resulted in continued growth in rents within our portfolio as we reported 35% on a GAAP basis and 22% cash, notably, with only 25% of our transactions occurring in coastal Tier 1 markets. We now project our mark-to-market on a GAAP basis within our portfolio to be 28%. We started $349 million of new development totaling 2 million square feet that consisted of 6 speculative projects and 2 build-to-suits in the quarter. 80% of this volume was in our coastal Tier 1 markets. Our team has continued to lease our speculative projects successfully as evidenced by stabilizing 7 new developments during the quarter and increasing the development pipeline to 60% leased. To put our track record of leasing speculative projects in context, the $897 million of projects that we placed in service this year through September 30 increased from 39% leased when the construction started to 90% leased when they were placed in service. For all of our speculative developments, we have started since the beginning of 2019, our average lease-up time is less than 2 months from the dates the projects were placed in service. Our team’s continued ability to quickly lease up speculative development projects will be a key contributor of our future growth. Sticking with the development pipeline, at quarter end, we totaled $1.1 billion, with 86% of this allocated to Tier 1 markets and 60% pre-leased. We now expect value creation from this pipeline of over 60%, which is primarily due to rapid appreciation of rents and land. We are also very proud to remind everyone that we target only developing the lead certified standards. We expect the lead percent of our total NOI to trend towards 25% by the end of 2022. On the construction cost side of things, our teams have taken steps to mitigate schedule risk related to materials, such as contracting for steel nearly a year out and we have only had minor delays in a few of our projects. The outlook for new starts is strong and is reflected in our revised guidance of our midpoint being up $175 million. On a longer term basis, we either own or control land, primarily in coastal infill markets that can support roughly $1 billion of annual starts over the next 4 years if the supply and demand picture remains robust, which we believe it will. It is also important to note the market value of the land we own is about 2x our book basis, and on average, we have only owned this land for about 2 years. Land we control and will be closing over the next few quarters is also well below market. The favorable land value, we will continue to support high development margins and very good IRRs long-term. And overall, we believe we are very well positioned to continue to lead the sector and grow through new development. I will now turn it over to Nick Anthony to cover the acquisition and disposition.

[Nick Anthony:]

Thanks, Steve. For the quarter, disposition proceeds totaled $738 million, including outright sales and contributions to joint ventures. The outright sales comprised our entire remaining portfolio in St. Louis, 3 buildings in Indianapolis and 1 building in Chicago. The activity also included the first two tranches of the Amazon property contributions to our newly formed joint venture with CBRE Global Investors. The pricing in aggregate was at an in-place cap rate of 4.8%, which was inflated a bit by a High 5 cap rate for the St. Louis portfolio in which pricing was impacted by expected rent roll-downs on looming tax abatement expirations. We acquired one facility in the third quarter totaling $24 million, a 63,000 square foot facility in the San Gabriel Valley submarket of Southern California. This third quarter activity has further shifted the geographic position of our portfolio on an NOI basis to approximately 40% in the coastal Tier 1 market. Let me also note that just after quarter end in very early October, we closed on the sale of a 517,000 square foot Amazon facility in Columbus, Ohio. This sale represents our final property disposition for the year. I will now turn our call over to Mark to discuss our financial results and guidance update.

[Mark Denien:]

Thanks Nick. Core FFO for the quarter was $0.46 per share, which represents 15% growth over the $0.40 per share from the third quarter of 2020. AFFO totaled $151 million for the quarter compared to $135 million in the third quarter of 2020. Same-property NOI growth on a cash basis for the 3 and 9 months ended 2021 compared to the same periods of 2020 was 3.8% and 5.3% respectively. The growth in the same-property NOI for the third quarter of ‘21 compared to the third quarter of ‘20 was mainly due to rent growth, partially offset by an 80 basis point decrease in occupancy in our same-property portfolio due to an extremely high occupancy comp of 98.6% in 2020. Our balance sheet is in great shape, with plenty of dry powder to fund our growth. We had $273 million of sale proceeds in 1031 escrow accounts at the end of the quarter that will be used to fund near-term building and land acquisitions. We finished the quarter with reduced leverage as a result of the significant disposition activity during the quarter, but intend to return to recent leverage levels by the end of the year as we continue to grow through development. As a result of our continued strong operating results, we announced revised core FFO guidance for 2021 in the range of $1.71 to $1.75 per share compared to the previous range of $1.69 to $1.73 per share. The $1.73 midpoint of our revised core FFO guidance, represents a nearly 14% increase over 2020. For same-property NOI growth on a cash basis, we have increased our guidance to a range of 5.0% to 5.4% from the previous range of 4.75% to 5.25%. We continue to outperform our underwriting assumptions for speculative developments both in the timing of lease-up and in the rental rates we are achieving, while we have maintained a solid list of build-to-suit prospects as well as land sites in various stages of due diligence and entitlements. Based on these prospects, our revised guidance for development starts is between $1.3 billion and $1.45 billion compared to the previous range of $1.1 billion to $1.3 billion. We have updated a couple of other components of our guidance based on our more optimistic outlook as detailed in our range of estimates exhibit included in our supplemental information on our website. I will now turn it back to Jim for a few closing remarks.

[Jim Connor:]

Thanks Mark. In closing, I am incredibly proud of our team’s execution in leasing, capital deployment and development starts. We started the year with very solid growth expectations and have exceeded every one of them, resulting in a nearly 14% growth in core FFO at the revised midpoint. Our shareholders should be very pleased with our dividend increase of $0.025 per share. This 9.8% increase marks our seventh straight year of annual dividend increases, representing a growth of over 65% over that period. Looking out to the next few years, our operating platform is perfectly positioned to take advantage of the numerous growth drivers benefiting the logistics sector. These drivers, combined with the undersupply of new available warehouse product, will allow us to maintain our high occupancy rates and rent growth, while creating substantial profit margins on our $1 billion plus development pipeline. The net result of these factors is our belief we can continue to grow earnings at approximately 10% pace for the foreseeable future. With that, I want to thank you for your interest and your support of Duke Realty. We will now open it up for questions. We will ask that you limit your engagement to one or perhaps two short questions. And of course, you are always welcome to get back into queue. Sean will now open it up and take our first question.

[Operator:]

Thank you. We are going to take our first question from the line of Dave Rodgers. Please go ahead.

[Dave Rodgers:]

Yes, good afternoon everybody. Steve, I think you alluded in your comments to about $1 billion of potential development starts over the next 4 years on owned land and that might have just been a nice average. But maybe the question for you or Jim is you had historically said you wanted to limit the size of the development pipeline in terms of kind of your internal capacity, now, it’s pushing 50% above that. So, how do you feel about that? Have you added people? Is it just more dollars? Can you give us some more color on that, please?

[Jim Connor:]

Yes, Dave. It’s Jim. I will start out. I would tell you that as prices have grown on these projects. There is some internal organic growth on the development pipeline. But given the success that we are having, leasing up spec development virtually before it comes in service has allowed us to ramp up the spec development pipeline. That combined with the build-to-suit pipeline, which continues to remain healthy is going to allow us to operate at these elevated levels that we are seeing today. So, Steve, do you have more color on that?

[Steve Schnur:]

Yes, Dave. We have averaged over the last 4 years, somewhere around $1 billion of starts. We see that pace continuing. We have got land either owned on our books or under control or option or covered land plays to continue to do that as long as the market bears. And as Jim said, our pre-leasing in that pipeline remains best-in-class. And as long as we are achieving that, we can grow through development.

[Dave Rodgers:]

And I guess maybe I just want to make sure I understand that point is we are not necessarily expecting a slowdown. So, when you say $1 billion, that’s just more an average over that period of time. Given where you sit today at 60% pre-leased, we should anticipate that this momentum is continuing for your ‘22 kind of out...

[Steve Schnur:]

Yes. I guess I didn’t – I guess, maybe I didn’t understand your question. We are not slowing down. We are – given the market conditions and our teams and what we control out there, we like where we stand. This year is obviously we raised our guidance and we don’t see that changing the foreseeable future.

[Jim Connor:]

Dave, I think just to finish that point, without giving 2022 guidance as Mark is kicking me under the table, I think we like where our elevated development pipeline is, our ability to keep that pre-leasing percentage high. And that’s one of the key contributors to our being able to drive this high level of growth, 10% plus, for the foreseeable future.

[Dave Rodgers:]

Great. I appreciate you clarifying that answer. And then maybe just the second was just other market exits now that St. Louis has gone. As I said – I heard you guys say no more asset sales this year after the most recent Amazon sales, but I guess as you look to next year, do we kind of re-up that pipeline of disposition?

[Nick Anthony:]

Yes, Dave, this is Nick. There is no specific other markets we plan to exit. We will continue to strategically prune assets to improve the overall portfolio. But I wouldn’t expect us to see – in fact, I would actually expect disposition volume to level off after this year to be at more moderate levels going forward, because we just don’t have that many assets that we are looking to prune.

[Dave Rodgers:]

Great. Thanks, everyone.

[Operator:]

Next, we will go to the line of Blaine Heck. Please go ahead.

[Blaine Heck:]

Great. Thanks. Good afternoon, everyone. Mark, I wanted to ask about cash same-store NOI this quarter. Obviously, it dipped a little bit from what you guys have been used to. Number one, was that all due to tougher occupancy comps from last year? And then number two, how should we think about the fourth quarter in that respect as it looks like the occupancy comps could be tough again, but you also increased full year guidance. So, just trying to reconcile those two factors?

[Mark Denien:]

Yes, sure, Blaine. Yes, it’s mainly just a tough occupancy comp. And I got to be careful to make it sound like we lost a bunch of occupancy. We are 80 basis points lower this quarter than last quarter, but our occupancy is obviously very healthy, pushing 98%, but this time last year, we were at 98.6%. So, that 80 basis point change in occupancy cost us about 1.2% to 1.3% of NOI. So, if you would have just had a level occupancy, we would have been closer to 5% this quarter. You are right we did raise guidance on our occupancy. I think that we have got some momentum going into the rest of the year here that you will see a little bit of an increase overall such that even though we do have that tough occupancy comp in the fourth quarter again, I think we won’t lose the 80 basis points. So we will be closer to flat in the fourth quarter. And then if you just average the quarters out that would infer close to a 5% give or take growth rate in the fourth quarter to get to our 5.2% midpoint.

[Blaine Heck:]

Great. Very helpful. Jim, there is a recent article I have read about Amazon kind of shifting from leasing buildings to purchasing properties themselves. Obviously, Amazon still leases way more than they own and nothing is going to happen overnight, but do you see that as a trend that could become more of a risk to the demand side of the market in the future or is it a little sensationalized at this point?

[Jim Connor:]

Blaine, I would tell you I think it’s a little sensationalized, because historically, they have chosen not to own anything. They are very good partners of ours. We are very active. Of the Amazon assets that we have sold outright or contributed to the joint venture, they have not exercised any of their rights to acquire those. So I don’t think it’s going to be nearly as big a trend as some people might like to make it out to be. The other thing I’ll just comment is, as Amazon continues to mature in the markets, I think this is probably just a natural progression where they’ll start to control some of their larger key facilities. From our perspective, we’ve really slowed down doing the big build-to-suits for them out in a lot of the secondary markets. Most of our Amazon activity today is infill. And it’s really spec leasing or pre-leasing of land we have controlled and under entitlement that we’re not willing to sell to Amazon or to investors. So I don’t think it’s going to impact our business with Amazon at all.

[Blaine Heck:]

Great. Very helpful. Thanks, guys.

[Operator:]

Next, we will go to the line of John Kim. Please, go ahead.

[John Kim:]

Thank you. The cash leasing space you had were a historic high. It sounds like you’re not really favoring pushing ones too hard to get occupancy down necessarily, but just wondering if that commentary you made on occupancy is going to hold through until next year. And the second part of that is, is there a big difference between the new and renewal cash rent spreads that you had this quarter?

[Steve Schnur:]

Yes, John, this is Steve. Thanks for the question. I think it’s something we deal with on a daily basis with our teams and our tenants, our clients. The rent dynamic going up is happening rapidly, and it’s something we keep pushing on and trying to push the market on. So I feel optimistic about where we’re headed, but it’s a balance, right, losing occupancy versus retaining tenants. We feel markets go up 30%, 35%. So we will keep swinging and pushing rents where we can.

[Mark Denien:]

Yes. And John, your question on the difference between new and renewal. We’re really not seeing much of a difference. It’s not like our tenants that are in the space coming up for renewal or getting any kind of bargains at all. The spreads are pretty consistent whether it’s new or renewal.

[John Kim:]

Okay. And then you mentioned having success on leasing spec developments. So I imagine some of your competitors are having a similar amount of success. Are there any markets where you’re concerned that there is too much spec development that’s being started today?

[Steve Schnur:]

Yes. I mean I think the supply picture is getting some headlines about how much under construction projects are out there, 65% of the whatever you want to call it, $450 million in the under construction pipeline, 65% of that is in markets that we don’t own property in. So you look at Phoenix is getting a lot of headlines. We’re not in Phoenix some of the markets around Fort Worth, we’re not in Fort Worth. So I’d say the supply picture in the markets we’re in remains very much in balance as evidenced by the vacancy rates and the rent growth numbers, but...

[John Kim:]

It’s very helpful. Thank you.

[Operator:]

Next, we’re going to go to the line of Caitlin Burrows. Please, go ahead.

[Caitlin Burrows:]

Hi, everyone. Good afternoon. You mentioned that you’ve been outperforming your underwriting assumptions for speculative developments. I was wondering, given increasing costs maybe land materials, labor, do you think your development yields can stay in the mid- to high 6% range?

[Steve Schnur:]

Yes. Caitlin, this is Steve. Thanks for the question. I do. I think our – a couple of to that one. As I mentioned, our land that we have on our books today is well below fair market value. Our teams are doing a nice job of replenishing that land and being in the markets they are able to find good deals that help us – prop up some of those margins with our land basis. Rent growth has been through the roof to the markets we’re doing so it’s more than offset it. So I think as we look out into our pipeline, I think you’ll see the margins probably more importantly, I think margins have been expanding for the last number of quarters for us to get 62% margins right now in our development pipeline.

[Caitlin Burrows:]

Great. And then also, I mean, it seems like speculative development is a great opportunity right now. But could you just talk a little bit about build-to-suit activity. Are potential partners there, just more impatient and the activities going to speculative? Or is the build-to-suit activity also going strong?

[Steve Schnur:]

Yes. The build-to-suit activity for us is still good. I think to your point, this construction material issue that we’re dealing with when you think about the lead times for steel and for precast. Steel is out almost a year right now. Tapering effect on what traditional build-to-suit has been. I think what we’re starting to see with some of our clients is them adjusting their specs to take more things that are ready to go. And I think – so you’ll probably see that trend. I think until some of these timing issues on materials begin to level out.

[Caitlin Burrows:]

Got it. Great, thanks.

[Operator:]

Next, we will go to the line of Emmanuel Korchman. Please, go ahead.

[Emmanuel Korchman:]

Hey, guys. Jim, I think in your remarks, you broke down the demand from e-commerce and 3PLs. I was just interested to hear that 3PLs have increased their business so much when their inventories are probably the hardest for them to get, especially quickly, and that’s in the business that a lot of them are in. So are they taking space hoping that the supply chain for their own inventories ramps? Is it just not affecting their business? Or am I just misthinking what their business is today? Thanks.

[Jim Connor:]

No. You got to remember the 3PLs are only taking space when they have got contracts for customers. And the material is their customers’ material. So whether they are doing 3PL work for a pure Amazon, who does use 3PLs outside of their own supply chain or a traditional retailer. They are fighting much the same struggles. They have got labor issues. They have got the flow of product that’s been somewhat disrupted. But they are – like everybody else, they are managing through as best they can.

[Emmanuel Korchman:]

Thanks. And one for Mark, maybe, Mark, if we go back to discussion on future growth. Any change in the way you plan to fund that, especially with development, seemingly becoming a bigger piece of that growth?

[Mark Denien:]

Manny, you cut out. Could you repeat that, please?

[Emmanuel Korchman:]

I said is there any – are you thinking about future funding in any different way to sort of match that bigger growth profile that you’re now talking about?

[Mark Denien:]

No. I think that what I tried to point out is if you look at our balance sheet at the end of the quarter, our leverage levels were really low. We’ve been running right around call it, 5.0 on debt-to-EBITDA, and we’re down more like 4.4. I was just trying to point out that’s more of just a short-term timing blip sitting on a lot of 1031 escrow money that will get redeployed here in the fourth quarter. You’ll see that leverage level by the end of the year, probably get back up to 5.0 on debt to EBITDA and then just kind of stay at that level going forward. And we will fund our business the way we’ve been funding it all along. There’ll be a – first and foremost, free cash flow, which were up to over $200 million a year now on free cash flow. And any additional beyond that will be a combination of debt equity and sale proceeds. But always maintaining that kind of 5.0 longer term run rate on debt to EBITDA.

[Emmanuel Korchman:]

Thank you.

[Operator:]

Next to the line of Vince Tibone. Please, go ahead.

[Vince Tibone:]

Hi, good afternoon. You mentioned only 25% of third quarter leasing was in the Tier 1 coastal markets. Was that an outlier versus other quarters this year? And then if you could provide some color on the ‘22 lease roll as well in terms of the mix of the Tier 1 coastal markets, that would be really helpful.

[Mark Denien:]

Yes, Vince. Actually, the 25% is really not much of an outlier this year. We’ve been doing 20% to 25% of our role in the coastal Tier 1 markets for really the last 1.5 years or so. What we’re really just trying to point out, it is an outlier versus our total portfolio. That’s closer to 40%. So we’re newer in those coastal markets. So we haven’t experienced the level of role in those markets commensurate with our exposure in those markets, if that makes sense. So, looking out beyond this year, next year, we will probably look a lot like this year kind of in that 20% to 25% range, rolling in the coastal markets. You got to get up to about 23, 24. That’s when we will start really seeing an uplift in our rollover coming in those coastal markets. So I think we’re still very bullish about our ability to keep putting up rent growth numbers right around where we’ve been doing. And then looking out past , that’s when you can really see an uplift and get even better based on the coastal market role getting higher.

[Vince Tibone:]

That’s really helpful. One more for me, I mean you mentioned that Southern California, New Jersey are the leading markets in terms of rent growth, which is no surprise. But in what coastal – or excuse me, what non-coastal markets are you seeing the best rent growth today? And how much lower is that growth compared to some of the best coastal markets?

[Steve Schnur:]

Yes, Vince, this is Steve. And I would tell you, you really need to dive into submarkets. When I look at the airport market in Dallas, that’s been a great market for us, Chicago around the Airport has had some really strong rent growth as well as the corridor. There are some markets in Cincinnati where we’ve had huge rent growth in our portfolio. So you really need to dive into the weeds to look at those. But obviously, it seems to be good in most places. It’s just levels of how far you can push it in different submarkets.

[Vince Tibone:]

That makes sense. That’s helpful. Just – are you seeing north of 20% rent growth in some of the submarkets you just mentioned?

[Steve Schnur:]

Yes.

[Vince Tibone:]

Alright. Thank you.

[Operator:]

Next, we go to the line of Nick Yulico. Please, go ahead.

[Nick Yulico:]

Thanks. So I just wanted to talk about cap rates a little bit. You did reduce the cap rate on your development page this quarter I think it was about 20 basis points. Can you just talk about what you’re seeing in terms of cap rate compression in your markets? And as well, how we should sort of think about the numbers you cited on that page, which are specific to your development pipeline, versus the rest of the portfolio where you have some below-market rents and presumably, cap rates could be even lower in some cases?

[Nick Anthony:]

Yes. Nick, I’ll start and then others can jump in. But yes, we continue to see cap rates compress. It’s a little tough to sort of draw broad conclusions because we’ve seen so much volatility in rents it has such a large impact on the cap rates. And so the assets depending on when the leases have been signed or when they are being signed and so forth and when we originally underwrote them, they can change quite a bit. But yes, we continue to see the cap rate compression, and it’s really in all the markets. In fact, we’ve seen the other major markets, the gap between them and the coastal Tier 1s to actually decline to more narrow levels than what they have been historically. So it’s been pretty broad based.

[Mark Denien:]

Yes. And Nick, the only thing I would add to that, and I think you were alluding to this, is that 3.62 cap rate that’s disclosed on our development portfolio, you got to keep in mind that’s based on market rents because it’s still under development. So the rents will be or at market. I think if you took and looked at our operating portfolio, we would expect an even lower cap rate because they are way below market. So you’re going to get a lower cap rate because you got below-market rents in our operating portfolio.

[Nick Yulico:]

Right. That makes sense. And Second question is just going back to, I guess, somewhat related, but in terms of acquisitions. I mean, last earnings call, you did talk about a sort of bigger acquisition pipeline. I think you were saying it was almost $1 billion deep, but you didn’t get much done in the third quarter. How should we just think about – I mean, acquisitions, have they now become more tougher – have they become tougher because of the decline in cap rates? I mean how should we think about that aspect of the business?

[Nick Anthony:]

The acquisitions have been tough for a while. The deals that we’re pursuing are not the fully marketed assets. Typically, we’re trying to find lightly marketed or off-market transactions. I would say I wouldn’t read too much into just the low activity in the third quarter. We still have a pretty good pipeline. We’re working on diligence on several transactions. In fact, we raised our midpoint guidance and acquisition about $50 million to $500 million this quarter. So we continue to find deals, but it’s difficult.

[Nick Yulico:]

Okay, great. Thanks, everyone.

[Operator:]

Our next question will come from the line of Rich Anderson. Please, go ahead.

[Rich Anderson:]

Hi, good afternoon, everyone. So turning back to the supply chain disruptions we all know what’s going on, everything is costing more containers, vessels and rents for warehouses. And I’m curious on what the – where the rubber meets the road for you in warehouses. How impactful is that to your rent growth? I don’t know if you can quantify this at all. But we obviously have great demand from e-commerce and 3PLs going on. But is there another layer of growth that’s actually more than just a rounding error that’s coming from the disruptions?

[Jim Connor:]

Yes, Rich, it’s Jim. Let me start and then Steve can jump in. The supply chain has gotten a lot of ink lately, a lot of airtime. I would tell you that’s a separate and distinct issue from the growth drivers that we’re seeing. We’ve talked in investor meetings and in our material about the five main drivers of our business today, and that has nothing to do with supply chain. That’s growth in e-commerce sales, reverse logistics, near-shoring and on-shoring, safety stock. That’s what our – that’s what’s driving our customers’ need for more space. If you go back and look at the IS ratio today, which has historically been between 1.4 and 1.5, sits at 1.1. So what that means effectively is our customers need to bring in another $1 trillion of inventory into the U.S. Occupancies are at historic highs in the portfolios. Utilization rates within ours and our peers’ portfolios are at historic highs. So that’s what’s driving this projected demand over the next 5 years of a huge, huge amount of space. So it really doesn’t have a whole lot to do with the supply chain disruption. It really is driven by growth in sales, need for a lot of new facilities and a lot of different facilities than the traditional. We’ve talked in the past about the need for modern buildings for fulfillment centers, for infill development for last-mile facilities, and our customers need a lot more of that.

[Rich Anderson:]

Okay. And then – so obviously, a lot of those incremental costs – sorry, sticking with the supply chain theme now. Marketing passed on to consumers these days, and we will see the longevity of inflation. But we get a GDP print of 2% growth for the third quarter. And perhaps there is some risk that the Fed could start to think about tightening to restore some order between the balance of consumer demand and just the supply of goods. Is this at all worrisome to you? In other words, everything is great, but do you have your finger on the pulse of all of those factors? Because if the consumer breaks down, you could argue that something gives – is given back in terms of your business?

[Jim Connor:]

Yes, Rich, I would love to tell you, I have my pulse on all of those things. I don’t know how close I am. But the reality is if – I think we all expect prices to go up. I think we expect to see some inflation the level of which we will see when we get to the end of the year. I think the Fed has indicated that they are comfortable with some slightly elevated levels for a few quarters before they really react. So I think we can expect what we’re experiencing to be with us for the foreseeable future. And we will have to see. But as you look at consumer spending, today out there, it’s driving a great deal of business for us.

[Rich Anderson:]

Okay, thanks.

[Operator:]

Next, we go to the line of Michael Carroll. Please, go ahead.

[Michael Carroll:]

Yes. Thanks. Nick, can you provide an update on the CBRE joint venture. Is third tranche still on track to close in early 2022? And is there a desire both from you and/or CBRE to add to this joint venture in the near-term? Is that something that could be announced as we go into 2022 also?

[Nick Anthony:]

Yes, Michael. The first two tranches have closed. And then we’ve got a third tranche that consists of three assets that will close in January of next year. We push it there for tax reasons. There are no existing assets that are definitely going into the joint venture right now but we are talking about a couple of them. And I would expect that to happen over time. And as far as the relationship, we’ve got a long-term relationship with CBRE Global. We’ve had other joint ventures with them in the past. And the relationship’s still very good. And they are looking for assets, and we’re looking to identify assets that fit the profile that we want to put in this joint venture.

[Michael Carroll:]

Okay, great. And then obviously, industrial cap rates have compressed fairly meaningfully. I mean is there a risk, especially for the properties that have long leases with these investment-grade tenants that those cap rates could rise if interest rates or inflation rise if that ever happens, or do you just not see that given the demand for industrial just overall?

[Nick Anthony:]

I would tell you that, obviously, interest rates matter, but also rental rate increases matter, too. And that’s been a large piece of it driving down these cap rates. Yes, that could happen. I would tell you that we have priced some stuff recently. And I know rates really haven’t moved that much, but they have moved a little bit. And we have – we have continued to see compression despite that. So, we haven’t seen anything happen yet.

[Michael Carroll:]

And then just real quick on – what about the properties that have 10-year type leases. Obviously, you are not going to be able to re-price those for the next 10 years. I mean your cap rate is still pretty sticky and potentially compressing even for those types of properties?

[Nick Anthony:]

They are still very good. We just priced a 15-year deal recently and exceeded expectations. In fact, I would tell you, over the last 12 months, our dispositions have exceeded the midpoint broker guidance by more than 10%, which is kind of unusual because they are usually very aggressive trying to win the business, obviously.

[Michael Carroll:]

Okay, great. Thank you.

[Operator:]

Next, we will go to the line of Brent Dilts. Please go ahead.

[Brennan Hawken:]

Hi. Good afternoon. This is Brennan for Brent Dilts. Could you walk us through your expectation on recapturing your mark-to-market lease spread closer to historical averages over the next year or 2 years? Is this something you can keep up with, or do you expect that 20% spread to widen further? Thanks.

[Mark Denien:]

Yes. I will take that one. The 28% mark-to-market that we quoted, I would tell you, you got to keep in mind that, that includes every lease in our portfolio. It includes the leases we just signed that are at or close to market. So, if you – I would tell you that what’s coming at us over the next few years, we expect it to be quite a bit better than 28%. So, just look at this year, we are posting 35% GAAP growth this year in kind of high-teens on a cash basis. I would tell you that’s what we would expect looking forward over the next couple of years on our portfolio. And we do expect, if market rents continue to move in the direction they have been moving. Even if they are not as moving as fast as they had last year, that 28% will grow. That our overall mark-to-market will do nothing, but get higher and we will gradually – as those leases churn, we will get very good FFO and cash growth from those.

[Brennan Hawken:]

Thank you.

[Operator:]

Next, we will go to the line of Jamie Feldman. Please go ahead.

[Jamie Feldman:]

Thanks. I was just wondering your latest thoughts on getting at some of your early expirations early next year. So, beyond kind of what’s scheduled to expire. Do you think you can – how much of the 23, 24 leases, you think you can get early renewals?

[Mark Denien:]

Yes, Jamie. So, I think a good way to think about it is if you look at what we did this year. If you would have looked at our supplemental at the end of 2020, I think it said we had 7% of our leases rolling in ‘21. We are going to do about 11% in ‘21. So, that’s a combination of – and I am not talking way early pull forwards. We disclose in our supplemental in the early renewals we do beyond the year out. But I think that as we sit here today, looking at ‘22 we have 7% rolling in ‘22. And I would expect at this time next year that we are going to be sitting here talking that we rolled 10% to 11% in ‘22, not 7%.

[Steve Schnur:]

Hi Jamie, this is Steve. I will add that I think we are starting to see more customers approach us on as well with the tightness of the market and supply chain issues. I think brokers are advising their clients to get in front of landlords earlier. And given what’s happened in the markets for rent growth, these are good conversations to have.

[Jamie Feldman:]

Okay. And you say you think that trend is accelerating?

[Steve Schnur:]

Yes.

[Jamie Feldman:]

So, do you agree with the 10% to 11%, or do you think you could actually do more?

[Steve Schnur:]

I will – sitting here today, I would tell you, I think it’s – we will see it, right. As we look at what’s happened to the markets and how tight the markets are and what’s going on with rents, we don’t want to leave money on the table either. So, it won’t be – it won’t – it would not materially differ from what Mark laid out.

[Jamie Feldman:]

Okay. And then just thinking about the types of products you will be building. When you think about that, whether it’s the $1.2 billion over the next 5 years of total demand, I mean, what are you guys thinking now in terms of good – the right building size. And I assume what you are trying to go with infill as to as you can, but I am just curious how you think that might change?

[Steve Schnur:]

I will start. Jamie, I think we look for the right opportunities in the market. I know obviously, people think of us as a larger box company. We have got buildings under construction as small as 40,000 feet. So, it really depends on the opportunities we can find in the marketplace. For us, I will tell you that the sweet spot is a larger building in an infill market. Those are really, really hard to find and get through entitlements and produce. So, we build everything from 30,000 feet, 40,000 feet up to over 1 million feet and put it in the right place.

[Jamie Feldman:]

Okay. Thank you.

[Operator:]

Next, we will go to Ronald Kamdem. Please go ahead.

[Ronald Kamdem:]

Hi. Just two quick ones for me. Just the first is just on the leasing. 9.5 million feet in the quarter and you talked about sort of the new development that’s leasing up in two months. Obviously, a lot of that’s reflected in the rents you are getting. But is there anything different about the lease structure, higher bumps or anything to call out maybe over the last 2 years to 3 years as this demand is just accelerating?

[Steve Schnur:]

Yes. I will jump in here. I would tell you, I think the biggest change we have seen outside of the headline rent growth that our sector is experiencing. Escalations have – with what you are seeing going on in inflation. And I think all of us at high occupancy levels, there is definitely a push in taking what was traditionally probably a 2% to 3% escalation and pushing that north of 3%. So, call it 3% to 4% escalations are becoming standard in the marketplace.

[Ronald Kamdem:]

Got it. That’s helpful. And then I just wanted to dig into the comments – opening comments about sort of mitigating, I guess schedule risk and so forth. So, when you are thinking about construction, obviously, owning the land, having control of the land over the next 4 years to 5 years is really helpful. But any more color in terms of – so you are buying materials a year out early, but what are you doing maybe different over the next 3 years to 5 years in terms of labor, for example. And are you going to continue to sort of buy sort of deliveries a year ahead of time as you are building out this pipeline. So, just more color on mitigating that scheduling risk on the material and the lease?

[Jim Connor:]

Yes, Ron, I would tell you a couple of things. I think with the elevated levels of development going on across the country, I think we would all like to believe that material supply will get caught up, and this is not a challenge that we are going to be dealing with for the next 5 years. If it is, I think we are one of the better ones position. First of all, we have the balance sheet. We have the ability to commit the dollars to these projects of land that we control so that we can secure the development in the time period that we want to put the project into production. We have the expertise with our construction and development teams to get these projects designed earlier and allow us to secure the construction materials in advance and keep our development pipeline at the high level it is. We have talked in the past couple of months about having everything in the 2020 pipeline secured. Then Steve’s teams moved into the first half of 2022, we have now got all of that secured, and we are working on securing the second half of 2022. So, it’s an ongoing battle for us, one that we would like to believe that we will get back to some level of normalization. But in the foreseeable future, it’s going to stay high pricing and extended delivery times, and we are managing our way through it.

[Ronald Kamdem:]

Helpful. Thanks. Congrats on a great quarter.

[Operator:]

Next, we will go to Ki Bin Kim. Please go ahead.

[Ki Bin Kim:]

Thanks. Just wanted to clarify something you said earlier. I think you mentioned that you can do $1 billion of development, did you – per year for the next 4 years. Did you mean off of the land that you own and control, or was that just like longer term appetite?

[Steve Schnur:]

That would be off of the land that we own and control. And I think it’s important to find looking back over the last 4 years, Ki Bin, we have acquired about $300 million a year, and we have monetized about $300 million a year. And I think our assumptions would be on a go-forward basis that whatever that dollar amount is, we are going to continue to be able to do that.

[Jim Connor:]

Yes. I think, Ki Bin the other color I would add is the difference is you see what’s on our books, the land that’s on our books, which has been in the high $200 millions to mid-$300 millions. And we have got land under contract. We have got land under options, that’s not on the books yet. And in a perfect world, we are entitling that and putting that into production in the same quarter, so it actually never hits the books. And that’s what Steve’s guys have gotten really good at is efficiently managing that land portfolio. And so as we look out over the next few years, we look at what we have got under control, entitled an option plus what we have and we are comfortable we can maintain that level of development.

[Ki Bin Kim:]

Got it. In your supplemental, in the land bank section, I mean you guys control about 300 acres owned. And then there is about 575 acres that are under option, but it’s I think all in Columbus, Ohio. So, I mean obviously, you are not going to do all Columbus, Ohio construction going forward. So, figure into – you will be a king of Ohio. So, how does that configure into your development thoughts, especially given that a lot of the acreage is in Columbus?

[Jim Connor:]

I think that’s just – that’s a residual joint venture agreement that we have with the airport authority, where we control an enormous amount of land. Most of the land that I am referring to are covered land plays both short and long-term and land that we have under contract that we are working through the entitlement zoning design process.

[Mark Denien:]

And that’s on the coastal markets, Ki Bin, that other land that Jim just mentioned.

[Ki Bin Kim:]

Okay, thank you.

[Operator:]

Next go to the line of Mike Mueller. Please go ahead.

[Mike Mueller:]

Yes. I just have a quick one at this point. It looks like in the quarter you had a small restructuring charge. I am just curious what’s that related to?

[Nick Anthony:]

Yes, Mike. We basically move some folks around to better align our construction group, construction and development group with where we are doing development now. So, our development now is predominantly in those coastal markets and then some of the other Tier 1 markets. And we had a lot of people that weren’t sitting in the right place, quite honestly. So, that’s what those charges were.

[Mike Mueller:]

Got it. Okay, that was it. Thanks.

[Operator:]

We are going to go to the line of Bill Crow. Please go ahead.

[Bill Crow:]

Hey, good afternoon. Thanks. It’s pretty clear the tenants are price-takers at this point. What are the tenant reps asking for aside from base rents and bumps? Is there anything that they are looking for as a win for the tenants? Are they trying to negotiate anything that’s non-monetary that they can go back and tell the tenant they won something?

[Jim Connor:]

Mercy. That’s what they are asking, I am kidding, Bill. Look, good brokers are our best friend, because they educate their clients on what the state of the market is. So, when Steve talks about engaging customers 12 to 24 months in advance, they come to the table with a very good understanding of what the landscape is. How little opportunities there are in the market in terms of other vacant space, what the cost of new construction is, what the cost of relocation is. So as you have seen from us and I am sure from some of our peers, you have seen rents continue to climb. Concessions are at very, very low levels. Obviously, we are still paying commissions in new condition. We have got what I would call very normal amounts of TI to build out space, but the days of free rent, the days of outside tenants finish as an enticement for above standard improvements, amortization of tenant improvements of material handling equipment, racking and things like that, that’s all gone by the wayside.

[Bill Crow:]

Yes, okay. Alright. Appreciate it. Thank you.

[Operator:]

And at this time, I have no further questions in queue.

[Ron Hubbard:]

Thanks, Sean. We would like to thank everyone for joining the call today. We look forward to engaging with many of you at the NAREIT Conference in a few weeks and into the early part of next year. Operator, you may disconnect the line.

[Operator:]

Thank you. Ladies and gentlemen, that will conclude our conference for today. Thank you for your participation for using AT&T Event Services. You may now disconnect.