Duke Realty Corporation
Q1 2018 Earnings Call Transcript

Published: 26 Apr 2018

[Operator:]

Ladies and gentlemen, thank you for standing by. And welcome to the Duke Realty Quarterly Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct the question-and-answer session and instructions will be given at that time. [Operator Instructions] And as a reminder, this conference is being recorded. I'd now like to turn the conference to our host Mr. Ron Hubbard. Please go ahead, sir.

[Ron Hubbard:]

Thanks, Greg. Good afternoon everyone, and welcome to our first quarter earnings call. Joining me today are Jim Connor, Chairman and CEO; Mark Denien, Chief Financial Officer; and Nick Anthony, Chief Investment Officer. Before we make our prepared remarks, let me remind you that statements we make today are subject to certain risks and uncertainties that could cause actual results to differ materially from expectations. For more information about those risk factors, we would refer you to our December 31, 2017, 10-K that we have on file with the SEC. Now for our prepared statement, I'll turn it over to Jim Connor.

[James Connor:]

Thanks, Ron, and good afternoon everyone. We filed up a very strong 2017 with a fantastic start to 2018. We had a big quarter of leasing, maintained our high occupancy levels, we grew rents at an all time record high, and we also had a big quarter of development starts. During the quarter, we increased our in-service occupancy by a 130 basis points to 97%. This was driven primarily by strong leasing of recently delivered speculative projects and recently acquired facilities. Our stabilized in-service portfolio occupancy held firm at 98.5%, our total portfolio occupancy including projects under development increased by 50 basis points to 94.4%. Nationally, net absorption numbers for the quarter in our coming year at a very solid 41 million square feet, which is up about 8 million square feet compared to the first quarter a year ago. New supply in the first quarter was 35 million square feet which is down from 45 and 50 million square feet range from the first quarters of 2016 and 2017. On a trailing full quarter basis, the overall spread between net absorption and supply remains in the 20 million to 25 million square foot range. With these favorable supply demand metrics and nationwide vacancies in the 4.5% range, the logistics real estate business remains in the sweets spot. Leading economic indicators has also been very good for the last few months with the GDP outlook for 2018 remaining in that 2.5% to 3% range. All of these drivers indicate continued strong demand for our product and our ability to maintain our high occupancies and continued rent growth. Turning to our own portfolio as evidenced by our occupancy levels, our team continued this great execution with the completion of over 6.9 million square feet of leasing for the quarter. With this strong leasing, our high occupancy we continue to be able to improve rents. Rent growth for second generation leases averaged 26% on a GAAP basis and 12% on a cash basis. We are seeing this rent increased growth all across the markets. We renewed 68% of expiring leases during the quarter yet after considering immediate backfills we effectively released 94% of our expirations. We had an exceptional activity in the southeastern part of the country, including a 760,000 square-foot lease signed with [3PL] in Atlanta, which was an immediate backfill of the large expiring space. In Savannah, we signed six new leases totaling 1.1 million square feet, a majority of which represented immediate backfills from expiring tenants and reflective of the very strong fundamentals of the Port of Savannah. All of these deals resulted in substantial rent growth over the previous leases. We also executed notable leases on two vacant facilities that were part of the Bridge portfolio acquisition. Overall, the tenant acquired Bridge average assets are now 90% leased with commitments for two of the last three spaces. We would expect these assets to be 97% leased next month, several months ahead of our original underwriting. This increased occupancy taking place earlier in the year was the basis for increasing our full year occupancy and earnings expectations. Mark will discuss this in just a moment. Leasing momentum is strong in our speculative development pipeline as well which is expected to contribute significant earnings growth and cash flow growth, as we close out 2018 and head into 2019. We’ve had a great start to the year and new development starts with $226 million of projects in six markets totaling 2.5 million square feet that were 45% preleased in aggregate. Our overall development pipeline at quarter end had 18 projects under construction, totaling 9.6 million square feet at a projected $808 million in stabilized costs for our share. These projects are 57% preleased and our margins on the pipeline are expected to continue in the 20 plus percent range. Our development opportunities continue to be very strong. In fact, we’ve started three more developments earlier this month, totaling an additional 2 million square feet and a $111 million in projected costs, that are 91% preleased. And our pipeline for prospects for the remainder of the year is strong as well which has led us to increase our development expectations for the year. Now, let me turn it over to Nick Anthony to cover our acquisition and disposition activity for the quarter.

[Nick Anthony:]

Thank you, Jim. We had an active quarter on the disposition front. Building dispositions totaled a 117 million and included the three data centers in the Washington D.C. market totaling 447,000 square feet. This project was developed on land we had owned for quite a while, part of which included demolition of an obsolete office building for one of the site. This project represented accretive land redevelopment by our DC team and generating significant value creation for our shareholders. We also disposed the property in Nashville totaling 160,000 square feet. This transaction represented part of a property swap whereby we acquired two facilities in Southern California as part of the tax deferred exchange by the other party. These Southern California properties we acquired were located in the Orange County submarket and total about 120,000 square feet. Regarding the broader acquisition market, we continue to look at many opportunities as we're aware the market is extremely competitive and thus making a difficult to find appropriate risk adjusted returns. As Jim is noted a few times recently, it will be extremely difficult to replicate an investment like a Bridge portfolio transaction we did last year. We have experienced 40 to 50 basis points of cap rate compression in the Northern New Jersey market as these types of high quality assets are now selling at sub 4% cap rates. Even so, our team is continued to seek out opportunity that may make economic sense today. On the positive side, we originally grow stabilized yields in the mid 4% range for the Bridge transaction and expect to outperform those levels to higher rents and quick lease up. Through our outperformance of lease-up timing and loan rate increases along with the cap rate compression, we believe we have already realized 6 to 7 basis points of value creation on that transaction. I would also like to revisit our prospective Columbus portfolio disposition discussed in the last earnings call. We are in negotiations with prospective buyers and anticipated closing late in the second quarter. Also as you recall from our January call, one of the 4 billion has leased to Bon-Ton representing about 20% at the NOI of the portfolio for sale. While Bon-Ton is in bankruptcy protection, they’re still current on monthly rent to us. The bankruptcy proceedings are expected to resolve in the liquidation of the Company. The prospective buyers are aware of the situation and we do not expect the Bon-Ton liquidation to be any surprise to expect the closing of this transaction. I would now turn our call over to Mark to discuss our financial results and guidance update.

[Mark Denien:]

Thanks Nick. Good afternoon everyone. I’m pleased report the core FFO for the quarter was $0.30 per share consistent with core FFO of $0.30 per share fourth quarter of 2017. Growth in core FFO from newly acquired or developed properties during the first quarter compared to the fourth quarter of 2017 was offset by increased non-cash G&A expense triggered by the accounting requirements to immediately expense a significant portion of our annual stock-based compensation brand. This higher level of G&A expense in the first quarter is consistent with past years due to this accounting treatment. We reported FFO is defined by NAREIT of $0.31 per share for the quarter compared to a $0.33 per share for the fourth quarter of 2017 with the decrease largely pertaining to changes deferred tax assets and higher gains on land sales during the fourth quarter of 2017 compared to the first quarter of 2018. AFFO totaled $108 million for the current quarter compared to $84 million for the fourth quarter in 2017. This increase was attributable to significant lease related costs reducing AFFO in the fourth quarter 2017 as well as overall improved operating results and the positive impact of new acquisitions and developments in the first quarter of 2018. Same property NOI growth was 3.4% on a cash basis. It was about 160 basis points higher than that on a GAAP basis. The two biggest factors closing our GAAP number to be higher than cash is free rent that we had in quarter one of 2018 from all the leases we have signed over the last two quarters along with some bad debt expense on a straight line basis that we had in quarter one of 2017 related to last year's HHGregg bankruptcy. We expect our cash and property numbers to accelerate over the next couple of quarters as this free rent burns off and significant increase in rental rates on these recently signed deals kick in. We continue to operate with our balance sheet at A level metrics. We plan a leverage capacity and liquidity to fund our business well under 2019 without any equity needs and we will have the opportunity to lower our overall borrowing costs later this year with $227 million of secured loans during interest to7.6% are repayable. From a financial and capital standpoint, we’re progressing according to plan. We are well-positioned to continue to grow our portfolio. Let me now address revisions to our 2018 expected range of estimates, which is an exhibit at the back of our quarterly supplement and on our website. In the reflection of better-than-expected rent growth and lease up of vacant space and speculative development completions and recent acquisitions adding faster pace than anticipated. We raised guidance from core FFO to a range of a $1.26 to $1.32 per share or $0.02 per share increase at the midpoint. Similarly, we increase the range of growth and adjusted funds from operations on a share adjusted basis to a range of 4.5% to 10% from the previous range of 2.7% to 8.2%. We increase the range for a stabilized portfolio average percentage lease to 97.5% to 98.5% up 40 basis points from the previous midpoint. We increase the range for total in-service percentage lease to 96% to 97% of 50 basis points from the previous midpoint. We did not make any changes to our same property NOI guidance as we're still comfortable with our original range. As we've been saying for several quarters and disclosed in our investors slide deck, we have opportunity in our portfolio to grow overall NOI and earnings by substantial amount, but much of this growth would come from properties that are not currently part of our same property pool. Our current quarter results in the guidance changes reflect this. The estimate for building dispositions was also increased to a range of 370 million to 550 million up $50 million from the previous midpoint, reflecting our ability to take further advantage of the overall significant demand for Class A properties across the U.S and record low cap rates and use these proceeds to fund our growing development pipeline. Regarding development expectations given the strong start in Q1 and the three additional starts thus far in April and along the strong prospects for the remainder of the year. We increased guidance for development starts to a range of 650 million to 850 million up $150 million at the midpoint. This should support incremental earnings growth as we get into the next year and generally speaking we expect to continue to drive strong preleasing levels in this pipeline to maintain strong risk-adjusted return profile on our growth plans. We revision the certain other guidance factors can also be found in the Investor Relations section of our website. Now, I will turn the call back over to Jim.

[James Connor:]

Thanks Mark. In closing, the logistics real estate demand drivers remain very strong in both traditional distribution and e-commerce fulfillment. In particularly, the e-commerce sector is creating new customers for us and foreseeing players to modernize their supply chain strategies for delivering goods faster and more efficiently. We’re very pleased with our team's execution through the first quarter of leasing performance, capital redeployment and development starts and we’re optimistic about our strong performance for the remainder of the year. We will now open up the lines to the audience and we would ask to keep the dialogue to one question or perhaps two very short questions and you of course are welcome to get back in the queue. We will now turn it back over to the operator, Greg, for the first call.

[Operator:]

[Operator Instructions] And our first question comes from the line of Manny Korchman. Please go ahead your line is open.

[Manny Korchman:]

Jim, when you spoke about the increased development pipeline or the rents in development pipeline you spoke about an increase in prospects. So I was wondering those are tenant prospects in terms of build-to-suits? Or is that land that has either come to entitlement task or have you found new land opportunities that you can develop on?

[James Connor:]

Well, Manny, I’d tell you it’s a little bit of both. Obviously, we have committed to keep our preleasing percentage at or above that 50% range. So, we are finding more build-to-suits and we are filling the pipeline with additional build-to-suit opportunities that we think look pretty good for the second half of the year. And then secondarily based on our occupancies and the leasing that we've done, we have got ample opportunities to start additional spec projects. All of that requires the land that you've referenced. So, we have either got land that we can put in service or we've acquired land recently that’s now entitled and ready to go. It's all driving the development machine right now pretty well.

[Manny Korchman:]

And a quick one for Nick. You talked about the lack of acquisition opportunities out there mentioning that place would have been hard to find today. What do you have to do to get acquisitions done as it looked for bigger portfolios, smaller portfolios, development assets? How do you solve for that lack of acquisition.

[Nick Anthony:]

Well, I guess the best example was our Southern California acquisition. We were able to provide an exchange property in Nashville that some of our competitors were not able to provide which allowed us to acquire that property we think that’s below market pricing. So, it's just getting creative a natural thing, but I’m not going to kid you it is very competitive out there right now. And get even with the recent rising interest rates, cap rates have compressed.

[Operator:]

And next we turn to line of Jamie Feldman. Please go ahead.

[Jamie Feldman:]

Jim, you had commented that the Southeast is particularly strong. Can you give some more color about what you are seeing in that region specifically? And then, are there any regional differences that standout?

[James Connor:]

Yes, I would -- I think our guys, our teams in the Southeast particularly Atlanta and Savannah had a great quarter, backfilling that 760,000 put vacancy right away was really key for us, got us off to a strong performance. And then there is just incredible demand going down at the port of Savannah. We actually met with the port leadership just literally a couple of days ago and it's the fastest growing port on the eastern seaboard and is clearly seeing the benefit of the expansion of the Panama Canal which opened up a couple of years ago. So that’s obviously helping us drive business down there. So as all of our peers have reported in the last week or 10 days, most all of the markets are really pretty good. That that team down there for us had a really good -- did a really good job in the first quarter.

[Operator:]

And we have a question from the line of Jeremy Metz. Please go ahead.

[Jeremy Metz:]

Jim, in your opening remarks you mentioned the national supply and demand numbers and you talked to supply of I think it was 35 million square feet being down on a relative basis so far this year. Just wondering given the strength in the sector, the attractive development spreads, were you surprised at all by that number? And I mean, if we just look at your own portfolio you ramp starts your peers are doing at, so should we expect to see that supply figure really ramp back up here throughout the year?

[James Connor:]

Yes, Jeremy, I would agree with you. I think we were all very pleasantly surprised by that. I wouldn’t read too much into that, that's just a quarter number I think most of us are expecting pretty close to equilibrium this year being plus or minus 200 million of demand and plus or minus 200 million square feet of supply. So, we keep pretty close tabs on all of the markets and the submarkets within their, and while there is a little softness in a couple of submarkets that we've all talked about from time to time. When you are at 4.5% vacancy across the entire country we're in a really good spot right now, and I'm not particularly worried about supply at least for the forcible future.

[Jeremy Metz:]

And no real change in your forecast at this point, right?

[James Connor:]

No, I think we could see those absorptions and supply numbers flip flop next quarter I mean I'm not making the projection but you could. Again at the end of the year, I think most of us are pretty much consensus at or about equilibrium, but as I've been saying for quite some time equilibrium at 4.5% vacancy nationwide is a pretty good place to reach equilibrium.

[Jeremy Metz:]

And just as a follow-up question. In terms of the Bridge portfolio, it sounds like both the timing and the achieve rents there have been ahead of schedule. I think when you originally announced then you talked about underwriting it to just under 5% stabilized yield. So wondering where does that yield pencil out today on a stabilized basis?

[Mark Denien:]

It's Mark. We -- I think when we originally underwrote that we were talking mid four 45 or 46 something like that. Based on what Nick said earlier with the cap rate compression and our better performance and we had underwritten, we think we've got 60 basis points to 70 basis points of value creation. So, you could add another 20 basis points on that original underwriting and that's probably where it's going to stabilize that.

[Operator:]

And we have a question from the line of Ki Bin Kim. Please go ahead.

[Ki Bin Kim:]

Could you just help by the lease spreads and if there is any trends in, was there fairly in market size that were driving it or was it comp broad based?

[James Connor:]

Ki Bin, it was really across the board. I guess probably our best performing markets were the once Jim already commented on. Savannah was very, very strong underwritten growth, but it was really broad-based across the board. They weren't a lot of trophies as it rolled either so it's just substantial at rent growth. The one benefit when you got longer term leases in environment like this the rents you had in place for a little bit lower, but it was pretty much across the country.

[Mark Denien:]

Yes, I think the only color I would add Ki Bin would be, if you discount the immediate backfills, I think we renewed 65% -- 68% which is down a little bit for us. And when we're highly occupied, it really gives our leasing and development professional the ability to go out and push rents because they just don't have that much occupancy. So that's what they've been doing and consequently when you're not renewing a tenant and you're immediately backfill in space with the 298% of everything, it's aspiring, it's a pretty good place to be for a land right now.

[Ki Bin Kim:]

Okay and you have a couple larger assets -- development assets than I think in Allentown, still on lease. I mean given your track record I am not too worried about it, but any kind of color on momentum you’re seeing there from tenants?

[James Connor:]

Yes, we’ve got a lot of activity, I can tell you that any of our exposure that we’ve either got in the portfolio today or that we’re -- that’s in the development pipeline coming at us in the next six months, worries me at all. There’s a lot of activity in the Greater Lehigh Valley right now, shortlisted on budget deal. So, I think we’ll continue to see pretty consistent performance as we did in the last quarter of us ability -- our ability to lease this space as it comes online.

[Operator:]

And next we turn to the line of Dick Schiller. Please go ahead.

[Dick Schiller:]

Two quick ones for me. First of all, could you guys clarify the impact on the change in the same store methodology and the detriment to 2018 that you'll see there? And then secondly, the Bon-Ton assets I understand one of the assets is set for sale in Columbus was the asset in Chicago released?

[Mark Denien:]

I’ll cover the same property and I’ll let Nick or Jim cover the second question, Dick. Our same property number for the current quarter, the new methodology was 3.4. If you look at the prior quarter -- I am sorry the sequential prior quarter, so the fourth quarter of 2017 we reported 3.2, if you would have used our current methodology back in that prior quarter that 3.2 would have been 2.5 so a 70 basis points reduction if you will under the new methodology. So the way we look at it quarter-over-quarter, we grew from 2.5 in the fourth quarter to 3.4 this quarter so was about 70 basis point difference. And then, I’ll let Jim or Nick address the second question.

[James Connor:]

Yes, Dick. Nick addressed Bon-Ton in Columbus. So, we think we’re in a pretty good place there. Bon-Ton has been publicly reported is now in the liquidation phase. Our expectation is that they will likely be in through most of the summer. The liquidated that was selected is now in the process of breaking up the building, the business, selling the assets. There are several potential buyers of the business that occupies the space in Chicago, which for us is 270,000 square feet, so 40-foot clear building. So it’s a really nice asset. In addition, we've actually got to increase from our own portfolio in Chicago looking at the building. So I think, in short order this will be a little bit like the HHGregg. I think it will be short-term pain, long-term gain because I think we’ll backfill that space in fairly short order and we’ll improve the NOI for the space and obviously get a better quality tenant.

[Nick Anthony:]

And I would just clarify on the Columbus facility, it’s one of four assets that are -- we’ve to sell right now and that asset only represents 20% of the overall portfolio.

[Operator:]

And we’ve a question next from the line of Blaine Heck. Please go ahead your line is now open.

[Mark Denien:]

We like your question best Blaine.

[James Connor:]

Okay, operator, we'll go to next one. Blaine will get back.

[Operator:]

Mr. Heck, your line is open, again, if you would like to give it a try, sir. You might have your phone on mute.

[James Connor:]

Or maybe Blaine is not there. Who is next in the queue?

[Operator:]

Next is John Guinee. Please go ahead. Sir, your line is open.

[John Guinee:]

I’ll ask the question that Blaine was going to ask.

[James Connor:]

Sure, you will John.

[John Guinee:]

So, Nick, you’re selling 4 out of 15 assets in the Columbus. Can you sort of talk about why those 4 relative to the other 11? And how you’re thinking about tightening up various portfolios and places like Columbus?

[Nick Anthony:]

Yes, we’re constantly trying to diversify our portfolio from a geographic perspective. The 4 assets that we’re selling are in West Jefferson, which is the west submarket of Columbus along Interstate 70. That’s a park that we option land over the years and done a lot of build-to-suits on that. And so as we’re trying to right size portfolio as it was made logical sense to go ahead monetize those assets and redeployment other geographies.

[John Guinee:]

Okay. And then that was a softball. Then the other question Blaine was going to ask is, if you look at industrial product, it’s maybe 30% to 40% leased to traditional retailers. And when Jim you brought up the Bon-Ton situation remind me of this. The other issue dropped anytime soon where e-commerce gets so strong that the traditional retailers need less space?

[James Connor:]

Well, John, I think you had to step back and look at. E-commerce represents about 9% or 10% of sales in the U.S. and while everybody expected to grow bricks and mortar sales are still the vast majority of the sales, I think $3.6 trillion. And we spent a lot of time in meetings and on conversations like this. Talking about good retailers and bad retailers and unfortunately, there is a few of the Bon-Ton and HHGregg that tend to get a lot of the headlines and are in tough shape. And whether their over leverage or they haven’t been able to invest in their business or they haven’t embraced e-commerce, they’re not doing do well and many of them will not survive. But a lot of retailers have in fact made those investors. They've kept their stores up. They’ve been smart about opening new facilities. They’ve invested in their supply chain and they’ve embraced e-commerce. And they continue to grow sales and they continue to grow it through the use of e-commerce. So, I think it’s a case of the glass half full or the glass half empty. We tend to focus on the strong guys that are doing well. We tend to try and stay away from the guides that are doing so well. And Bon-Ton is unfortunately one of those, but I think we’ve mitigated that risk with the sale of Columbus portfolio and hopefully will be able to have the Chicago assets backfilled by the end of the year. And as we've discussed, we don’t have that much tough retail exposure out there in our portfolio. So, it’s not one of the things that keeps me awake at night.

[John Guinee:]

Now that I will ask Blaine’s question perhaps my question.

[James Connor:]

Sure.

[Operator:]

Okay, we turn to the line of Blaine Heck. Please go ahead. Your line is now open.

[Blaine Heck:]

And good job John on the question, but couple more for me. In the guidance think it shows that you are focused on acquisitions in Tier 1 markets. Can you give any more specific on where the markets are and maybe what the cap rate on the acquisitions maybe?

[Mark Denien:]

So, on the acquisition side, we’re focused on high day two or one, so Southern California, South Florida and Northeast primarily Northern New Jersey, and then we're also looked to some transition in the East Bay. You know right now, most in those market trades are going off and breaking forecast now in lot of those markets or very low forecast numbers. Fortunately for us, there been more development opportunities to make up for the lack of acquisition opportunities for us.

[Blaine Heck:]

That’s fair. And then just a quick one on the data center sales, you guys have any other opportunities to do similar deals. I think a lot of it to do with the location of the land and infrastructure around, but I wanted to get some color on whether we’ll be seeing any more of that?

[James Connor:]

Yes, Blaine, we actually do have opportunities. I can't tell you that we have a great deal of expertise there and we're now trying to find data center land. Sometimes, it's just better to be lucky than good that we've done a number of those as Nick referenced the once we just sold in. In D.C. at some of the lands that we got there has the potential to go that way. We've also done a number in Chicago in and around the O'Hare market again where we bought really industrial land and it happened to be a viable for data center. So, that business that we’re trying to find that every now and again, we've got a good piece of land that makes lot of sense for the data center guys. And if the pricing is right, we can develop it then we’re more than happy to do that.

[Operator:]

Next we turn the line of Eric Frankel. Please go ahead.

[Eric Frankel:]

I just want to quickly focus on same store results. The operating expense increase, can I assume that that increase has been passed on through tenants?

[James Connor:]

It has Eric and the reason expenses were up so high this quarter over last year was snow. Snow removal expenses were quite high this quarter over last year and it was all passed through.

[Eric Frankel:]

Okay, thank you, and you acquisition and disposition activity this quarter is quite interesting. Actually that property swap is pretty good take study. Nick, want to get your sense, what do you think is the right cap rate spread for buying in Tier 1 market and maybe selling a little bit more assets in the Midwest or England markets?

[Nick Anthony:]

Well for that particular swap, we look at more on the IR basis -- on IRR basis. But I would tell you that we talked about the cap rate in the high barrier Tier 1 a lot and how low they are, but the Midwest cap rates are at record levels too and numbers we have not seen before. So, they're getting very low as well. I think the spread does take two markets between SoCal and Indianapolis is as low as 100 to 125 bps right now.

[Eric Frankel:]

Very interesting, so it would be fair to say that you will be pretty willing to both increase your acquisition and disposition guidance if you found pricing similar to today and assuming cap rates don’t move?

[Nick Anthony:]

No I think that, first of all, our portfolio, we are pretty happy with it right now. So all we are doing is the last little bit of repositioning around the system. We will continue to do that from year to year. But I think to -- I think we would rather redeploy that into development right now because we think that’s much more accretive going forward for us.

[James Connor:]

The other thing I’d mention Eric is we raised our guidance on development. We just still think that’s the best place to put new capital out right now and raise our guidance on dispositions to pay for some of that. We did not touch our acquisition guidance and I think as we see today we would think that’s probably going to trend more towards the lower end on the acquisition side.

[Operator:]

And next we turn to line of Michael Carroll. Please go ahead.

[Michael Carroll:]

Jim, I know you have touched on this earlier on the call, but can you add some color on what you are seeing in the market today with regards to new development starts? Where are these opportunities? And similar to the acquisition strategy are you focused on the Tier 1 markets?

[James Connor:]

Well, Mike, I’d tell you, clearly we are doing more development activity in the Tier 1 markets. I am trying to remember the exact number. We had a board meeting yesterday and I think it's 65% of the development activity in Tier 1 market. So that’s South Florida, Atlanta, New Jersey, the Lehigh Valley, Chicago, Dallas or Southern California for us that would be how we will define that. And that's really where we are trying to really grow our portfolios. I think you will continue to see us developed in all the other markets that we are in, but there I think you'll see us, as Nick explained in the Columbus portfolio continue to every now and again harvest some gains and right size some of those portfolios. And we would expect some pretty healthy gains coming out of the Columbus sales as we've done I think that’s four build-to-suits that we've done over the last six or seven years and we think we will get some really good pricing out of that. I think you will continue to see us to do that.

[Michael Carroll:]

And what type of deals are you willing to pursue outside of those Tier 1 markets? Are those mostly build-to-suits with existing relationships?

[James Connor:]

Now, it's both build-to-suits in spec but it's on land that we own that we have got a fairly attractive basis. So, we are making really good stabilized returns in those projects. So we continue to do development in the Annapolis and St. Louis, you saw us do a build-to-suit and a spec building in Minneapolis. I think that this just will continue for us.

[Operator:]

And next we turn to the line of Michael Mueller. Please go ahead.

[Michael Mueller:]

In terms of development leasing and just thinking about activity levels, can you give us some sense as to how many serious proposals, tours, looks are getting from tenants on a typical building that now as shall complete that you are trying to lease up? And how is that level compared to say a year or so ago?

[James Connor:]

Well, let me answer the second question first. It's pretty consistent. When we talk about having good activity across the board, we review every month with our leadership team all the major vacancies. We review all the build-to-suit prospects that we have got. And the activity level, I would tell you, has been consistently good month-to-month and quarter-to-quarter for the last several years. In terms of the individual spaces, our leasing guys have an expression, it only takes one. So you can have four or five different proposals out on the space or you can have one, and it's just takes the one guy that's willing to step up and sign for the right term. So sitting here today as I answered one of the earlier questions, we've got really good activity across the board. We start following spec developments at the moment we approve them internally so even when they are in just coming out of the ground. And some of those the activities is modest or non-existing at that point, but some of them already have great activity because they are in established parts and it's really good land and in a very competitive environment. So that's a long way of challenges kind of all over the board but month in and month out we got pretty good activity everywhere.

[Operator:]

[Operator Instructions] Next we turn to line of Jamie Feldman. Please go ahead.

[Jamie Feldman:]

I guess just sticking with the land, can you talk about the land bank and how it lines up with your development opportunities and maybe Tier 1 versus Tier 2 markets?

[James Connor:]

Yes, sure Jamie. Our land bank at the end of the quarter was up to about 270 million hours had gotten down into the low 200s not even touch 200 million, which was really low for us. And we acquired about I want to say 60 million of land in the quarter, and we monetize about the same amount through either minimal land sales but monetize it through development. So over the years, we've told people that we're comfortable as long as you think we are in a healthy economy and a healthy market with the land portfolio or landholdings of 300 to 400 million. So we're currently well below that. Some of the players that were making and some of the high barrier Tier 1 markets are bigger and more expensive. So I would anticipate that land bank for us is going to kind of stay between the $250 and $300 million mark for the balance of the year. We've talked in past calls about the pricing on land and the difficulty and the challenges that we face every day to get good sites at reasonable prices and then be able to get entitled. And I had spoken before that I think that's one of the governors that is keeping supply and check from the U.S. industrial market. This land is not as plentiful as a lot of people would think. And it’s a very expensive today and the entitlement process is expensive and lengthy and that's keeping the amount of expect development across the country to a reasonable level.

[Jamie Feldman:]

So, how does it line up with your development opportunities in terms of helping up the 270 what's Tier 1 and what's Tier 2?

[James Connor:]

I don’t have a breakdown in front of me I would tell you that and this is the problem that I have every year, I have too much land in some markets and not enough land in other markets and it c changes year-over-year. So we are actively looking for land in markets like New Jersey where we have no vacant land in our inventory because we put the last two sites into production, we're looking for land in the Lehigh Valley because I think we've only got site for one more development right now. Other places we've got more than ample land for the next five or six projects like a market like Atlanta. So there's a good healthy mix, we don't have that much what we would call surplus land anymore I think our surplus landholdings are down under 20 million of land that’s held for sale right now. So over the last few years we’ve really been able to prune that portfolio get it down to a very nice healthy level and get rid of all the nonstrategic land, and again remember we own residual retail land and residual office land from where we were in those businesses and now all that’s gone and we’re really focusing on the core industry.

[Jamie Feldman:]

And then you mentioned governors, or land of the governor, are you seeing any change in appetite for speculative element from the merchant builders for higher construction costs or higher interest rate?

[James Connor:]

I think construction costs is another one of the governors that’s keeping things in place and as we’ve talked before, financing, financing levels are much more reasonable compared to previous cycles, so you’re still looking at most o the merchant builders having to have institutional equity in order to get financing and move ahead on spec projects, even as good as the market is today, so I think the combination of those things has kept speculative element at a very reasonable level.

[Jamie Feldman:]

So, would you say there’s been a change recently or not really in terms of their appetite?

[James Connor:]

No, I think there's a lot of people in the world that would build more spec today if they could, if they had land at a better price, or they could get entitled sooner, or they could get it financed or construction costs were little more reasonable but the combination of all those things right now makes it a little bit more challenging, it puts that development out into the marketplace and I think the market has been at this kind of level, some 5% vacancy for a couple years now, so I don't think you’re seeing any increased demand to do more spec, I think that's been there pretty consistently, throughout the last few years.

[Operator:]

And we’ve a follow-up from the line of Dick Schiller. Please go ahead.

[Dick Schiller:]

I am good, I don't have a follow-up guys. Thank you.

[James Connor:]

Thanks Dick.

[Operator:]

And our final question comes from the line of Eric Frankel. Please go ahead.

[Eric Frankel:]

I do have follow up question. Can you describe in your recent leasing activity given that labor is becoming more expensive and less plentiful whether there is more CapEx incurred by the tenants so installed automated operations in the spaces and maybe your new development projects?

[James Connor:]

Sure, Eric. Let me give you two answers to that question. One of the things that we do and I can’t speak to my peers, one of the things that we do is before we buy a major piece of land, we do a labor stay. So we’re not investing how many million dollars in a land site, if we don’t have the answers on the labor study before hand, because we know that such a key criteria for many of our big logistic fulfillment client, so that’s answer number one. We’re comfortable with the labor for every one of the sites that we own and anything that we’re pursuing. In terms of your second question about CapEx, yes, I think a lot of retailers and e-commerce companies are looking to put more automation, and more material handling into the buildings, to get faster and more efficient. That’s not part of the CapEx for us. So, our CapEx has listened to docks and lights and little bit of office, shipping warehouses, things like that. So those dollars are going up, but that’s not part of the TI package that we’re putting into any of our deals.

[Eric Frankel:]

Right understood. But do you have a sense of how much the tenants are putting and just to get a sense of how your operations are evolving?

[James Connor:]

I think at the high end, Eric, I think it is a, like 10 multiple of our cost of the building or some of these highly sophisticated fulfillment centers with material handling, robotics, multiple levels. And that’s the investment the Company makes before they book $1 of inventory or they higher 1%. And they're hugely, hugely sophisticated buildings. They have the big capability to run 24x7 and these are the companies that are making this kind of investment, that are getting much more efficient. They are in a position to get products to the consumers whether that’s the store, the consumer’s house, faster and more efficiently. And those are the guys that are going to survive.

[Jamie Feldman:]

One, final question. You just spoke quite extensively on the land and entitlement process and why development volumes are probably a little bit less lower than people would normally expect in this part of the cycle. All the just secrete that, it’s particularly hard to build in the Tier 1 market you’re describing. Can you talk about how the entitlement and development process now have changed in some of more your traditional markets in more England and more the England part of U.S.?

[James Connor:]

Yes. I’ll give you a great example, this is very tight and it’s Huston, Texas. So in Houston, they have just passed ordinances that have made it particularly restrictive and difficult to develop industrial on a site that is in the 500-year floodplain. And there is a lot of industrial that is in the 500-year floodplain in Houston. We’re not talking about 100-year floodplain. We’re talking to 500-year floodplain. I was with the leader of our Houston office, David Hudson, on Tuesday and Wednesday. And he believed that’s going to take the normal entitlement process for piece of raw land in Houston from -- what would normally have been probably 9 to maybe 10 or 11 months to somewhere between 12 and 18 months.

[Jamie Feldman:]

And you think that, is that probably applicable to other similar markets?

[James Connor:]

Yes. I think that’s an extreme, but I think even some of the most business friendly Midwestern markets that we’ve operated in for a long time are continuing to make the entitlement process and the approval processes that much more challenging. They’re sensitive to cars on the road. They’re sensitive to trucks. Incentives are getting harder and harder to get and it’s just the result of the strength of the economy and the strength of the markets.

[Ron Hubbard:]

I’d like to thank everyone for joining the call today. We look forward to seeing many of you at the NAREIT Conference in New York in early June. Operator, you may disconnect the line.

[Operator:]

Thank you, sir. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference service. You may now disconnect.