Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

DCT Industrial Trust Inc. (NYSE:DCT)

Q3 2008 Earnings Call Transcript

November 5, 2008, 12:00 pm ET

Executives

Sarah Knapp – Corporate Communications

Phil Hawkins – CEO

Jim Cochran – President and Chief Investment Officer

Stuart Brown – CFO

Analysts

Paul Adornato – BMO Capital Markets

Michael Mueller – J.P. Morgan

Mitch Germain – Banc of America

Cedrik LaChance – Green Street Advisors

Chris Pike – Merrill Lynch

Chris Haley – Wachovia

Operator

Hello and welcome to the DCT Industrial 2008 third quarter earnings conference call. All participants would be in listen-only mode. There will be an opportunity for you to ask questions at the end of today’s presentation.

(Operator instructions)

Now, I would like to turn the conference over to Sarah Knapp. Ms. Knapp, the floor is yours ma’am.

Sarah Knapp

Thank you. Hello everyone and thank you for joining DCT Industrial Trust third quarter 2008 conference call. Before I turn the call over to Phil Hawkins, our CEO, I would like to mention that management's remarks on today's call may include statements that are not historical facts and are considered forward-looking within the meaning of applicable securities laws, including statements regarding projections, plans or future expectations. These forward-looking statements reflect current views and expectations which are based on currently available information and management's assumptions. We assume no obligation to update these forward-looking statements and we can give no assurance that the expectations will be attained.

Actual results may differ materially from those described in the forward-looking statements and will be affected by a variety of risks including those set forth in our earnings release and in our Form 10-K filed with the SEC as updated by our quarterly reports on Form 10-Q. Additionally, on this conference call we may refer to certain non-GAAP financial measures. Reconciliation of these non-GAAP financial measures are available in our supplemental package which can be found in the industrial relations section of our website at www.dctindustrial.com.

Now, I'll turn the call over to Phil.

Phil Hawkins

Thanks Sarah and welcome everybody. Joining me in presenting on this call will be Jay Cochran, our Chief Investment Officer; and Stuart Brown, our Chief Financial Officer. Also in the room to answer your questions are Daryl Mechem, Head of Operations; and Matt Murphy, Head of Capital Markets.

To begin, the lack of (inaudible) understatement have certainly been interesting and hopefully something we will not have to go through again. No one could have anticipated the magnitude of changes or the stress to our financial system, the economy, or the commercial real estate markets. We have been through significant market downturns before and have not forgotten the lessons learned from those experiences.

I do believe we prepared the company well to weather the storm as well as to capitalize on the opportunities arising from it, but we would have undoubtedly done some things differently if we’ve been publicly clairvoyant a year ago. I do believe our tactics have been directionally correct.

We entered 2008 with a plan to maintain balance sheet capacity and liquidity knowing that the operating environment was likely to soften. We put the brakes on capital deployment, executed a number of dispositions at attractive cap rates especially in hindsight and put in place a new term loan which increased our liquidity at attractive rates.

From an operating perspective, we took a defensive strategy at the beginning of the year, aggressive leasing and emphasis on early renewals and a bias towards occupancy over rate. I believe the results of this approach are reflected in our third quarter operating results.

In the third quarter, we leased 3.5 million square feet of which 1.4 million square feet related to the early renewal of 2009 and 2010 expirations. Tenure attention remained very healthy at 78.6%. Occupancy of our consolidated portfolio increased slightly to 91.9% from 91.8% last quarter. Rent growth was 2.8% cash and 8.9% GAAP. All in all my view these are respectable metrics given the environment and serve as a testament to the strength of our operations team.

In terms of the leasing market going forward, we expect continued softening given the ongoing chaos in our financial system. However, leasing has not ground to a halt at this point despite the recent turmoil. We signed 750,000 square feet of leases in October which is on pace with the first two quarters of the year although behind the third quarter record number. About two-thirds of this activity was renewals and one-third new tenants.

Our pipeline of leases out for signature remained at about the same level as prior quarters although we do expect that deals in the pipeline will take longer and experience a higher casualty rate than it was normal perhaps 6 or 12 months ago. But, the point is the activity were perhaps slowing a bit has not dropped to zero. We see concessions increased in almost every market which isn’t surprising. Our operating strategy remains the same; an aggressive focus on renewals and a strong bias towards occupancy over rate in attracting in-tenants with an emphasis on credit.

Stuart will comment on guidance in some detail but I want to make a few comments as well. We are projecting FFO of $0.50 to $0.58 per share for 2009 compared to our current guidance for 2008 of $0.60 to $0.62. But believe me, we would rather be projecting increased FFO in 2009. We’ve attempted to be realistic about the current environment. Other than co-investments with our joint ventures, we have assumed no on balance sheet capital deployment in 2009.

Let me now move to the reduced dividend, a decision which the Board did not take lightly but which we felt appropriate and prudent given the current environment. As most if not all of you know, we have not covered our dividend on a FFO basis from the beginning. At the time of our IPO two years ago, we believed it best to grow into the dividend over time and not disrupt our retail shareholder base. We had the balance sheet and liquidity to comfortably fund the dividend shortfall, and our FFO and AFFO were on a growth trajectory to cover it in a reasonable timeframe. Obviously, a lot has changed in the past few months which in our view made it necessary for us to reevaluate the dividend level.

First with economic slowdown, the path to growing our dividend has certainly lengthened. Second, capital has become much more scarce and precious. While our balance sheet is strong enough to carry on the status quo at least for some time, we did not think it a wise use of capital in this environment. Given the severity of issues facing our economy and the credit markets, we also felt it was best to attack now and fairly decisively rather than attempt to postpone the decision or to lessen the reduction.

As a result, we reduced the dividend from an annual rate of $0.64 per share to $0.32 per share, a level which we believe gives us good coverage even at the low end of our 2009 guidance and is at about the statutory minimum in terms of projected taxable income. This reduction will further contribute to our balance sheet strength and position us to meet the challenge of the current environment, and eventually take advantage of investment opportunities that no doubt will emerge from the financial crisis.

Since the beginning, we are navigating rough waters, but I believe we have taken the appropriate steps in anticipation of and in reaction to the downturn. We have in place prudent operating and capital deployment strategies and are continuing to position DCT to grow earnings and return of investment in the longer term.

With that, I’ll turn the call over to Jim Cochran.

Jim Cochran

Thanks Phil. First I’ll make a few comments on the real estate and capital markets climate. The industrial market slowed further in the third quarter as the vacancy rate increased by another 40 basis points. Businesses have been putting expansion plans on hold in this uncertain economic environment which has helped renewal percentages, but has been a negative for development pipelines.

As anticipated, there have been few new starts during the quarter and as a result, the level of new construction to be delivered to the market will be down significantly in 2009, which will help keep supply in check.

The investment market has become increasingly difficult as buyers have become very cautious and expect 2009 to be a tough year. The mindset has become increasingly cautious over the past four weeks. Cap rates for Class A products are up 75 to 100 basis points from the peak in 2007 and are likely to continue to rise by plus or minus 50 basis points until liquidity returns to the market. Private equity capital raising is challenging as new allocations to real estate have slowed due to economic and capital markets uncertainty, as well as the denominator effect which has caused real estate allocations to exceed desired levels for many pension funds.

While there are a few buyer transactions have occurred by the level down 70% from last year. During the quarter, we sold $42.5 million in four transactions. In total for 2008, we have sold $120 million at a profit of $20 million as we continue to recycle capital and provide liquidity to the balance sheet.

Our development pipeline continues to decrease as 873,000 square feet of stabilized space moved to the operating portfolio during the quarter. At the end of the quarter, we had 8.3 million square feet under development including forward commitments. We have been pleased with our activity in Mexico, SCLA, and our Washington D.C. Dulles project. Rising cap rates, however, are putting pressure on development margins, which is why we’ve been conservative in our expectations for gains for 2009.

The Inland Empire market of Southern California has slowed as vacancy has increased from 4.3% in Q4 2007 to 8.1% today. Despite this slowdown, we remain encouraged by the level of activity at SCLA for both our speculative product and land sales to users. We expect Dr. Pepper Snapple Group to close on a 55-acre parcel this year. We feel this land sale has a high degree of certainty given that they have issued press releases regarding their new 850,000 square foot facility and had a formal groundbreaking last month.

We have strong interests from other users for land acquisitions that we expect to close in 2009. In addition, we have real prospects for all of our speculative products, which is encouraging. Leasing activity in Mexico has far outperformed the US for the first three quarters of the year. To date, we have either leased or sold to users 944,000 square feet of space in seven transactions. However, we have started to see a slowdown in Mexico, which is not surprising given the fact that 80% to 85% of product manufactured in Mexico is consumed in the US.

In our opinion, the capital and investment markets in Mexico have been overheated as cap rates decreased to historical lows. As a result, we have been very patient in Mexico this year. In October, we made our only acquisition, a $5 million building, and throughout the year, passed on multiple land opportunities where development yields did not make sense, at least to us.

While leasing real slow over the next six to twelve months and cap rates will undoubtedly rise, we remain very positive about Mexico long-term for many of the same reasons that caused us to go there in the first place. We expect a pullback in capital, caused by the current environment, will simply create more profitable opportunities for us in the future.

Overall, we have been concerned about the economy and overheated capital markets for quite some time, which has led to our conservative approach to capital deployment in 2008. We will continue to be patient and expect opportunities in both the US and Mexico to become much more attractive in the next 12 months.

With that, I’ll now turn it over to Stuart.

Stuart Brown

Thank you, Jim, and good morning or good afternoon to everyone. After walking through our third quarter results and then our expectations for 2009, I’ll review our debt maturities and liquidity position given the dislocation in the capital markets.

Operating performance in the third quarter was in line with our previous guidance and generally consistent with what we saw in the first half of the year despite the increasing economic issues. As Phil mentioned, we’ve been aggressive on leasing and performance this quarter shows the results with a record 3.5 million square feet of leases signed, bringing our total activity this year to almost 8 million square feet. Both our retention of existing tenants and rent growth on signed leases have remained strong.

Further, our lease terms remain favorable averaging 62 months with turnover cost of $1.72 per square foot. Same-store net operating income was flat on a cash basis compared to a year ago when we reported strong same-store growth of 3.9%. Same-store NOI growth was impacted by the cycling of higher than normal expense recoveries a year ago and higher legal fees related to a tenant dispute.

On a GAAP basis, same-store NOI declined to 2.3% as straight-line rent income decreased $850,000 on less free rent, and we had lower amortization from below market rents and acquired buildings. Same store average occupancy for the quarter was consistent with 2007 at 92.6%. As a reminder, our same-store net operating income excludes termination fees which were $282,000 this quarter versus year ago.

Looking at our receivables and bad debt, total accounts receivable continues to trend favorably and our aged receivables balance remains low due to our ongoing collections emphasis. We had no unusual write-offs this quarter and essentially no bad debt expense, bringing total bad debt expense to near $900,000 year-to-date or less than 0.5% of rental revenue.

For the remainder of 2008, we have narrowed our guidance for funds from operations and earnings per share, as we reduced expected gain on sale to a range of $0.00 to $0.02 per share from $0.00 to $0.04 per share previously. We are now guiding to FFO per share of $0.60 to $0.62 for 2008. As Phil discussed, we continue to focus on the strength of the balance sheet and therefore, do note expect any significant new capital deployment in the fourth quarter.

Same-store cash NOI growths for the year should be between 0% and 1%, and occupancy of our opening fourth quarter portfolio should be consistent with our previous guidance near 92%. We are expecting fourth quarter operating results to be in line with our year-to-date run rate.

Turning to 2009, while visibility is limited given the economic turmoil, we believe it is important to give some direction as to how we see next year unfolding. Our initial guidance for 2009 is for FFO per share of $0.50 to $0.58, and earnings per share between $0.00 and $0.06. Our guidance assumes the economy will remain in a downturn for much of 2009, but stabilize somewhat in the back-end of the year.

Starting with operations, we expect average occupancy rates to decline to the first half of 2009 due to higher lease rollover, with some pickup in the back-half of the year. Our guidance for average occupancy next year ranges from 88% to 92%. With this, we are expecting cash same-store net operating income to range from flat to a 3% decline on the impact of lower occupancy and rising property expenses including bad debt.

Tenant retention should remain stronger at 75%, limiting downtime and turnover costs. We are not forecasting any development starts or on-balance sheet acquisitions. Though as Jim discussed, we will continue to evaluate opportunities which may arise due to pressure on developers or owners from this economic dislocation and we will continue to pursue dispositions of non-strategic properties. Overall, we are expecting total investment in real estate to remain relatively flat in 2009, absent any extremely competitive value add opportunities.

Our guidance includes development gains of $0.00 to $0.04 per share being generated from a combination of land sales at SCLA and sales of stabilized developments. Regarding expectations of the general and administrative costs, we expect expenses to be $0.11 to $0.12 per share.

The key causes of the decrease from the midpoint of our 2008 FFO guidance of $0.61 per share to the midpoint of our 2009 FFO guidance of $0.54 per share are; first, interest expense increases of about $0.035 per share, of which about $0.02 per share relates to our average interest rising a little over 30 basis points as we move to a higher percentage of fixed rate debt, and the remainder due to lower capitalized interest on developments.

Second, the dilutive impact of dispositions, as we have sold approximately $120 million in 2008, creating balance sheet capacity but at the expense of short-term earnings amounting to approximately $0.02 per share until we re-deploy the capital.

Third, occupancy decreases and higher expense reduced operating earnings by about $0.01 per share. The remainder of the change in run rate is caused by a number of smaller items, including the somewhat higher general and administrative costs.

Before I turn the call over to questions, I would like to discuss our balance sheet position and liquidity in light of the markets. In terms of capital market activity, in early October, we exercised our option on the second tranche of our June 2008 term loan, taking down the remaining $200 million and using the proceeds to fully pay down our credit facility. The second tranche’s floating rate and the current interest rate is 4%. The first tranche of $100 million was used to repay maturing notes and swapped to fix in the second quarter at an all-in rate of 4.73%.

Today, excluding loans we can extend, we have only $50 million of debt outstanding that matures in the next two years. Our next significant credit maturity would be our credit facility, which is undrawn today but matures in 2010. In unconsolidated development joint ventures, our projected pro-rata share of maturing construction loans is only $41 million in 2009 and $49 million in 2010. Further, we have no debt maturing in our capital management ventures in 2009 or 2010, but we added detail about their future maturities in our supplemental reporting package.

On the existing development commitments, they are limited and amount to approximately $55 million including completion of existing developments and Mexico forward commitments. This compares to available liquidity today of nearly $340 million, including our credit facility and cash on hand. We expect to maintain a solid fixed charge coverage in 2009 and we’ll be patient with our capital. The history has shown that times these often provide some of the best returns for those with the ability to invest.

As the economic outlook for the remainder of 2008 and for 2009 has worsened, the importance of a strong balance sheet has increased. Credit capacity is important to ensure that we can weather the environment and take advantage of unusual opportunities to invest at very attractive returns, which often accompany an economic dislocation. It is with this in mind that we’ve reduced our dividend which will conserve $66 million on an annualized basis, as Phil discussed. Our company continues to be extremely focused on execution, and we are confident our business plan prioritizes long-term performance.

With that, we’ll turn the call over for questions.

Question-and-Answer Session

Operator

(Operator instructions) The first question we have comes from Paul Adornato of BMO Capital Markets.

Paul Adornato – BMO Capital Markets

Hi. Phil, I was wondering if you could update us on the big picture strategy. I remember last year you were talking about perhaps trying to decrease exposure to non-port areas of the country, primarily the midsection of the country while increasing exposure to the coasts. I was wondering if that strategy is still viable or even desirable in this environment.

Phil Hawkins

Well, short term, it's hard to do a lot obviously to move the needle either in terms of disposing of assets or in terms of acquiring new assets. The strategy actually remains very much the same and I'll describe it as follows; first is to increase our exposure to the coastal markets and then over time decrease the exposure at least on a relative basis to the interior markets. We’ve made some progress if you’ll notice dispositions that we made this year have been in those non-coastal markets. We’ve also been growing through development in some of the coastal markets. Obviously, SLCA is a key contributor to that but then also Washington, Dallas, Florida, et cetera. Markets in some cases maybe softening but over time we’d like to increase our presence. The other aspect to our strategy which remains very much the same is to grow our presence in Mexico and build a platform in Mexico.

As Jim mentioned, and we probably said on the call several times, that has taken us longer than we would have liked. In hindsight, I think we’ll probably be pleased with our patience although at times that patience can be frustrating at least internally, but we very much remained committed to Mexico and are excited about the potential there, particularly with a pullback in capital where there was definitely a flood of capital competing for assets and land over the last year or two.

Lastly, looking to joint venture relationships to leverage our expertise as well as to co-invest our capital also remains important in moderate levels. We are not anticipating becoming a fund manager, but I believe that it is appropriate to utilize third party capital that has objectives in a view point consistent with our own, which I think we have been fortunate to find in our two current partners and over time we would love to have both extend those relationships if possible but also to expand them to fill in gaps that we believe may be out there.

The other comment I'll make is that over time, I would say we would be focused on fewer markets in terms of deployment consistent with our strategy of growing coastal markets, but will be coming our deployment dollars which are limited in very sense anyway really focusing them on fewer markets in the 28 that we started of with.

Paul Adornato – BMO Capital Markets

Thanks, it's helpful. I was just wondering if you could just comment on your two JV partners. What is their status, do they have money coming in, what’s their investment appetite, et cetera?

Jim Cochran

This is Jim. Let me handle that one. Both groups and our current partners J.P. Morgan and Dividend Capital TRT, we have increased our fund business with both of them this year although to a small degree. The market has in effect an appetite for real estate. To a certain degree, we serve as an adviser to them and we’ve outlined our concern about investing in a rising cap rate environment. Both groups are knowledgeable and both groups had access to capitals, it’s really deciding the appropriate time to reenter the markets. We are optimistic that when the time is right, we will have active relationships with both partners.

Paul Adornato – BMO Capital Markets

Thank you.

Jim Cochran

Thanks Paul.

Operator

The next question we have comes from Michael Mueller of J.P. Morgan

Michael Mueller – J.P. Morgan

Hi. Question about the occupancy and the 0 to 400 basis points decline for next year. Based on what you’re saying so far, I mean can you give us the read into the fourth quarter and first quarter, just trying to get a sense as to how visible maybe the low end is versus just being conservative.

Daryl Mechem

Mike, this is Daryl. First part of the question, which is the rest of 2008, we’re very comfortable with the guidance that we’ve expressed and the occupancy levels related to that. Moving into the first quarter, as Stuart referenced in his opening comments, we do have a little higher roll in the first half of the year and we’re also aware of the couple of larger space coming back to us so we expect occupancy to drop in the first quarter and into the second quarter of 2009.

Michael Mueller – J.P. Morgan

Okay. And based on what’s known now of those larger tenants, I mean, is that 100 basis points in and of itself or a couple of hundred basis points?

Daryl Mechem

Closer to 70 basis points on a known aspect price. But I should probably also add to that, as Phil mentioned in his comments, activity is still out there so our expectations for retention in the first quarter are still – we expect strong retention on the remaining portion of those deals. We got a pipeline now of 6 million square feet of deal that are being negotiated at the proposal level, and we also have a lease negotiation pipeline of 2 million square feet being negotiated today and that’s – those are deals that once you get to the lease negotiation stage, highly likely they’re going to close.

Michael Mueller – J.P. Morgan

Okay. And I know you mentioned with respect to the $0.00 to $0.04 of gains next year, it was a mix of land sale gains as well as development sales and it will obviously be driven based on what hits during the time period. But can you make any generalizations about either the margins or the volume that you expect to have versus where you thought it would have been a quarter or two ago?

Stuart Brown

Mike, this is Stuart. I will start off on that. We are not going to really – given what’s going on and there’s not a lot of transactions being done out there for us to say, ”Hey, here’s where a lot of these things are trading for today.” So this is not enough clarity for us to put development margin guidance out.

Phil Hawkins

Our margin on SCLA is close to infinite. Clearly, SCLA is where we are probably more confident in our ability to generate gains and that’s an appropriate part of that business plan to begin with. The rest, if they come and that’s why we’ve given a range, but if they come, my guess will come from such things as user sales. A couple of situations for example that we are looking at right now that maybe not materialize but at least let you know that internally that we – no discount. We don’t think that it's a certainty there’ll no transactions with a double pipeline next year. Although it’s not impossible, I mean there are no transactions that generate gains.

Michael Mueller – J.P. Morgan

Okay, great. Thank you.

Stuart Brown

Thanks Mike.

Operator

Next question we have comes from Mitch Germain of Banc of America.

Mitch Germain – Banc of America

Hey guys. What’s going on? Can I get some status of some of the stabilization dates of the development? Is there any way we can drill on that a little further? I guess without having a lot of progress on leasing, when do these developments begin to be a drag on earnings?

Stuart Brown

Mitch, this is Stuart. Obviously in the supplemental, we list out our projects with what the anticipated stabilization dates are. We saw last quarter in the supplemental we pushed out the dates on a couple of projects. It’s something we look at obviously very closely in terms of what the leasing is. So, first time – in terms of when it becomes a drag on earnings and we stopped capitalizing interest and operating expenses after 12 months from shelf [ph] complete, so we get projects that are on our development schedule today that we are no longer capitalizing on. We had the same question in (inaudible) that says if you want to take them off the schedule after 12 months. I mean some of these is just that so people understand what the status is.

I think overall if you look at what we would assume in terms of development lease up for next year, actually I don’t know if we’ve been conservative, I mean, we’ve got some work to do obviously. Our development pipeline is currently 17% leased. Our average for next year of this development pipeline probably rises around 30% to 35% in terms of where our guidance is for next year.

Phil Hawkins

We have always underwritten our development in a conservative fashion and regardless of the accounting treatment from a business standpoint that put 18 months lease up period in many of our developments including everything at SCLA.

Stuart Brown

80% of our projects are within their pro forma lease up stage today.

Mitch Germain – Banc of America

Okay great. And Jim just going on to the Inland Empire, I know you’ve previously referenced a significant amount of product and that – was it about 200,000- to 250,000-square foot range? What’s driving the increase in market vacancies? Is it that product or is it that size product is something bigger or smaller? If you could just gleam on that please?

Jim Cochran

Sure. It’s really the – well, we have a couple of projects in the 400,000- to 450,000-square foot range, so it’s really that 200,000 to 500,000 as a rough generalization, and two things have occurred. I mean, clearly, the economy’s down. Port activity is down and therefore, net absorption in the Inland Empire. And the other factor that impacted this size range, especially in the Inland Empire East was that; one, just due to land availability. To build a million square footer, for example, takes 50 acres and that’s a tough piece of land to find in the Inland Empire; but two, certain cities in the Riverside Marina Valley, for example, basically said no to the large regional distribution centers in excess of 500,000 square feet. The market was still performing very well, so many developers went and built, say, two 500,000 instead of 1 million square footer, so that helped add to the, basically, over-supply of space in that size range today.

Mitch Germain – Bank of America

Great. Thanks, guys.

Operator

(Operator instructions) And the next question we have comes from Cedrik LaChance of Green Street Advisors.

Cedrik LaChance – Green Street Advisors

Thanks. In regards to your focus on occupancy, by how much do you think you’ve been reducing your asking rents versus where you were three and six months ago?

Daryl Mechem

Hey, Cedrik, it’s Daryl. I think the first portion was the fourth quarter. You asked for the fourth quarter?

Cedrik LaChance – Green Street Advisors

No, I’m just curious given that now you’re putting the emphasis on occupancy. You’re implicitly saying that you’re going to the yield of rents that are perhaps – which you would have done a few months ago. I’d like you to quantify that. So if today, you’re asking a particular amount, you think you would have asked 5% extra three months ago or even 10% extra. By how much have you had to move the rent needle?

Daryl Mechem

Yes, it’s by markets but overall, we’re looking at about a 5% reduction in rents right now.

Cedrik LaChance – Green Street Advisors

Good. Are there any markets where you have to be more aggressive and any markets where you don’t have to be so aggressive?

Daryl Mechem

Sure. On the markets we need to be more aggressive; Phoenix, we’re being very aggressive due to the fact there’s a lot of over-supply there; Atlanta, very aggressive for the very same reason; Dallas, any other markets where they have over-supply, we are exceptionally aggressive in trying to attract deals in those markets specifically. Now, as it relates to some stronger markets, Seattle is holding up very nicely for us. San Francisco is holding up well. Effectively, the port markets are doing better than the rest.

Cedrik LaChance – Green Street Advisors

Okay. In regards to debt covenants, Stuart, could you give us a sense of what are the main covenants that you have to meet on your own secured debt or on your bank loans? And where do you stand on those covenants based on the calculation that has to be applied on those covenants, not necessarily on the calculations presented in the supplemental?

Matt Murphy

Hey, Cedrik, it’s actually Matt. I think I’ll take that one. As you can imagine, both the revolver and the term loan have our most restricted covenants. And candidly, I mean, we are in excellent shape on virtually all of them. There’s nothing particularly exotic. There’s leverage covenant. There’s coverage covenant both in terms of interests and fixed charges. When you look at it in terms of which ones are we closest to? The honest answer is that we’re not really that closely anyone. So for instance, from a leverage perspective, in order for us to get into our near tripping net, it would have to add more than $1 billion on both debt and assets, so we have a lot of room there. From a fixed charge coverage, it doesn’t always work this way but it does in terms of the third quarter. Our fixed charges as of calculated per both credit agreements, fixed charges are 2.68 times and the covenant’s 1.5 times; so as you can imagine, we’ve got a lot of room in that regard as well. So it’s something I spent a lot of time watching even in normal times, even more so today, but candidly we just have a lot of room under every one of them so.

Cedrik LaChance – Green Street Advisors

Okay, thanks. Just only one last question. Jim, you talked about Dr. Pepper having groundbreaking on their site at the SCLA but clearly, they haven’t bought the land from you yet. Can you elaborate on that?

Jim Cochran

It’s strange, right?

Phil Hawkins

It’s a buying signal though.

Jim Cochran

Exactly. We have not put a press release out. We’re especially being very conservative, not talking about deals till they happen. It’s not done until it’s done, I always say; but given that, they’re very committed to this facility. They have a schedule, and so they had issued press releases. They have scheduled a groundbreaking. There’s – this is all in the airport’s property. There’s just some minor glitch that needs to be resolved and they want a close, a closure on the deal so. I don’t know if I can elaborate further but we feel very good about it given the fact that when they’ve issued press releases, they’ve lined up contractors. This is a facility that they already see the construction themselves. We’re not involved, so we feel highly confident these days about the transaction.

Cedrik LaChance – Green Street Advisors

Okay, maybe one last question. In your supplemental part of the building that you currently own and operate, one of the footnotes refers to 18 buildings are held for contribution. They were held for contribution to which one of your funds? And if they’re available to be sold, why not sell them right now?

Stuart Brown

Cedrik, this is Stuart. So a number – some of those buildings, the majority in terms of property count of NCR [ph] buildings in Mexico, as we’ve talked about it in the past, we anticipate in some point in the future, putting together a fund to recapitalize Mexico. But until there’s enough critical mass, it doesn’t make any sense to do that. So we’re trying to highlight to the people that these are assets that potentially could go into. That’s where the majority of assets are. There’s two or three other assets, stabilized, development assets, in particular, that at the right time, these will be sold and we’re going to look at.

Jim Cochran

But if we have an asset in the US, for example, and if our fund partners are on hold due to the uncertainty of the market, we will look at the prospect of selling it outright, so we are examining that. We’re better at having a stabilized asset though.

Cedrik LaChance – Green Street Advisors

Okay. Sorry, that’s far as rooting at fun in Mexico. It’s not something you’re going to start any time soon, right?

Jim Cochran

Good point. It’s not part of the plan for 2009.

Cedrik LaChance – Green Street Advisors

Okay. All right, thank you.

Phil Hawkins

Thank you, Cedrik.

Stuart Brown

Thank you, Cedrik.

Operator

And the next question we have comes from Chris Pike of Merrill Lynch.

Chris Pike – Merrill Lynch

Good morning. I think it’s still morning there, right? I guess, just a couple of follow-ups here. But I guess back to some of the occupancy degradation next year. I think I’ll refer to a couple of large spaces Stuart referred to – I don’t want be too forward here but it sounded like almost some more bad debt, so are we to assume that some of these large spaces are related to maybe risky operators, folks that are closed to or not going to be in business expected in the first half of ’09.

Stuart Brown

Chris, this is Stuart. We don’t want to buy that at all. I mean, it’s just with the economy, we could expect the economy to continue to down-charge so we’re being, I think, pragmatic. There’s nothing, I would say, are – our watch list, they offer people more detail and the tenants on our watch list, but we’re just going to have normal expirations that are a little bit higher in the first half of next year. And with the downturn of the economy, we expect that debt expense to go up so there’s nothing in particular known out there that we’re highlighting at all.

Phil Hawkins

We don’t know where it’s coming from. In fact, we hope it doesn’t but it seemed prudent to assume that there will be some inquiries over the last couple of years where obviously the environment’s been a lot more favorable.

Chris Pike – Merrill Lynch

Okay. Stu, are there any positive offsets to some of these more conservative posture? I mean, are there any lease term fees that you expect to book?

Stuart Brown

Chris, if you look at – let’s talk about occupancy for a second. So our guidance assumes occupancy range is to 92% of the top end, which is basically flat to where we are today, to 88% in the bottom. And the other, if the occupancy turns around quicker, occupancy could be better. There are a couple of other things that could improve the numbers. As I mentioned, we don’t assume any acquisitions and are in the business next year, so we would pick up some good acquisitions that are accretive. That will continue to add as well and offset some of the dilution that we’ve got from disposals that we’ve and basis in building our balance sheet to put some of that capital work in good acquisitions. But until they happen, we’re not going to put them in our numbers.

Chris Pike – Merrill Lynch

So there are no lease term fees baked in right now in guidance?

Stuart Brown

No, there’s no lease term fees baked in guidance at all, zero.

Chris Pike – Merrill Lynch

Okay. I guess the higher G&A, I mean, how much of that is due to maybe a greater level of capitalized overhead or – versus let’s say just core hired G&A?

Stuart Brown

Right. There are probably a couple of things going on. First of all, we’ve got an extra layer of non-cash amortization of equity grants, so that’s best over four or five years. So once we – being a relevantly new company, those will – we’ll get an extra layer of those next year, as well as the impact of the few hires that we’ve made in 2008, and we got a couple of new hires, select hires in 2009 in the plan as well, but no change in real capitalization, very little impact from some of the teams and accounting rules next year that we were talking about.

Chris Pike – Merrill Lynch

Okay. So when you guys say that the capital deployment is all but seized [ph], there is just nothing going on? No new development except for what has been started or looking to be completed, no new acquisitions, that’s how you’re really thinking about being conservative in preserving the capital that you have?

Jim Cochran

That’s how we budget it and guide it. To say there’s nothing going on due to the fact that I’m assuming respond to that which would be –

Chris Pike – Merrill Lynch

Nothing hard going on?

Stuart Brown

There’s a lot going on out in the markets, staying in touch. But our assumptions, frankly, is that patience will continue to be rewarded at least in the short term. Our assumption happens to be that that short term is flat throughout the 2009. If something compelling comes along, an asset that we like a lot, a location we like a lot, and a return that is really exciting, we’re prepared to move, but what we’re trying to do is communicate I believe that patience we think is still appropriate in this environment. Jim, go ahead.

Jim Cochran

Yes. We are seeing pricing change daily, really. So we’ve – it’s almost like I use an analogy catching a falling knife right now, so we think we should sit back, observe, but still stay in our market so we know when to react to opportunity when they present themselves.

Chris Pike – Merrill Lynch

I can understand what you feel like. I guess the comments that you guys are talking about echoed across not only other industrial REIT management teams but REIT in general where folks are becoming more pragmatic with their capital and they’re waiting for opportunistic investments. You enumerated a couple of them, in terms of let's say market yield, but what are the sign posts that you guys are going to look out for, so that when that inflection does start to manifest itself, you can identify it?

Daryl Mechem

Let me take a whack at that. There are three things I think about. The first is currently this is the economic in credit environment. There needs to be some – I think it’s not always stability. We need some view of that it’s on a path towards recovery and functionality. The second is so fearing of respect in leasing environment and relies to economy obviously. But I think it’s going to come more from the anecdotal feedbacks from our team, and their authorization within the markets is going to come from data, but some anecdotal comfort that we have saw the ability to underwrite leasing both phase and rate. And lastly, some feeling of stability in these equity markets, the private equities markets and so you’ve got a return of capital and some view – we look forward in some view on where exact rates where particular products and particular markets is likely stabilized. So that using Jim’s falling knife analogy, we took – may not cash at the bottom, exact bottom when I hit the floor but we’re close. And we’ll probably start with, I say, some gradual effort. We’re not going to take and draw the chips on the table on the first day. I think that where it takes us to start moving. Those three things in this environment – that I think about it.

Phil Hawkins

And now we just add that this tremendous value in our operations team and our coordination there and it’s the gut feel because they’ll know the number of prospects are increasing that unless they continue certain size and ranges etc. So we know our markets and that’s a very valuable information.

Chris Pike – Merrill Lynch

And I guess this is the last, I think, Stuart, you said $0.00 to $0.04 in gains, some of it is going to be land, and some of it is going to be development. You guys, care to like separate that out. Is it like $0.01 to $0.03, $0.02 to $0.02, I mean, I know it’s a small number. I’m glad you know better things –

Stuart Brown

Enough clarity for us to really be able to break that down any further.

Chris Pike – Merrill Lynch

Okay, great. Thanks a lot guys.

Stuart Brown & Phil Hawkins

Thanks.

Operator

The next question we have comes from Chris Haley of Wachovia.

Chris Haley – Wachovia

Good morning.

Phil Hawkins

Good morning, Chris.

Jim Cochran

Good morning, Chris.

Chris Haley – Wachovia

The occupancy assumption at the midpoint is consistent with what we would expect to start in 2009. Based upon your experience, all your collective experiences, what does your gut tell you regarding the trend into 2010? I know it’s obviously a difficult time to make forecasts, but do you think we’d all take the hit in ’09 or do you think it bleeds into 2010?

Daryl Mechem

Hey, Chris, it’s Daryl. There is a recent report put out by PPR, and they’re actually forecasting vacancy to increase through 2009 and potentially to 2010. We don’t disagree with that, that this could linger into late 2009, early 2010.

Jim Cochran

The interesting part of the business today is that the inventory sales ratio is low, so there’s not a backlog of inventories. So at the same time, we can look at the variety of resources, PPR is just one of them but they also project vacancy rates going down quickly in that 2010/2011 period. So the good news is again, supply is going to slow down dramatically. Yes, we’ll be slowing down demand. We know we’re going to be in for a tough year next year; but the good news about the industrial market given that supply can be cut off, as you all know, fairly quickly, there’s a better chance to get back in the equilibrium quickly as well.

Phil Hawkins

And the key point I’d make, Chris, is we don’t know what 2010 is going to be like, but we’re not assuming a leasing strategy; some pickup in terms of affecting how we think about ’09 and ’10 renewals, for example. So we can hope for the best, but we are executing based on a view that things remain tough longer than shorter.

Jim Cochran

All right.

Chris Haley – Wachovia

And based upon your experience in past down cycles, assuming you want to look at 2002, 2003 or prior to that, what type of rent ammunition would we expect to see generally in industrial over a two to three-year period?

Phil Hawkins

Chris, I have to look back and dig a number up for you. I don’t want to say any absolute not as it should be or exactly as it should be?

Chris Haley – Wachovia

Right, but it sounds like 5% rent of climb today is just the start?

Phil Hawkins

You’re correct.

Jim Cochran

Are you talking that 5% is from previous – I say asking rents recently but with an average lease term of four to five years where that is declined from the old terms – from the old lease to the new lease there’s still be some rent growth in our numbers next year as lease’s rollover.

Chris Haley – Wachovia

Okay. My other question has to do with leasing assumptions. You offered a range of occupancy laws. What is the based upon your 2008 expirations? Can you give us a sense into how much would that would be you’re assuming is renewal versus new deals and that contrast and compare that to what you’ve actually executed in 2008 to let us know how much of a diminution in velocity you’re expecting?

Daryl Mechem

Hey Chris this is Daryl. What we’re looking at in midrange of guidance as it relates to occupancy. What we’re pressured to do is a 75% retention rate on the 8.6 million square feet that is rolling in 2009. That would equate to 6.5 million square feet of renewals. We will need to execute additionally another 2.5 million square feet of new transactions and how that compares to 2008 is from a new transaction front we are expecting to do less than we will do in 2009. News will be probably less than we’ve executed in 2008. We expect to sign 2.8 to 3 million square feet of new transactions by the end of this year 2008 so at 2.5 number is less.

Chris Haley – Wachovia

I see. 75% retention gets me to 6.5 million feet and about 2.5 million feet on top of that new deals?

Daryl Mechem

Correct.

Chris Haley – Wachovia

Which leads me to leasing velocity greater than your expirations?

Daryl Mechem

Using velocity?

Chris Haley – Wachovia

Of 6.5 plus 2.5?

Daryl Mechem

Yes. Yes.

Chris Haley – Wachovia

Are you assuming bankruptcies in there or are you just assuming some deals from 2010 to pull you forward?

Daryl Mechem

Someday in 2010 it would get called for work and also on 2008 and next year’s 2009 transactions.

Chris Haley – Wachovia

And then at the low end.

James Cochran

Yes, same retention rate 75% this is happening in square feet but 1.6 million square feet of new transactions design 2009.

Thank you.

James Cochran

Sure.

Operator

Our last question comes from Mitch Germain from the Banc of America

Mitch Germain – Banc of America

Hey guys just a clarification. Can you acquire assets in Mexico through your funds?

James Cochran

Currently no Mitch. We are doing our Mexico activities on balance sheet. The thought is overtime we capitalize those assets and do funding. I do away about fund would have a proactive feature to it to either acquire assets or take assets from a development pipeline.

Mitch Germain – Banc of America

Okay great, thanks guys.

Operator

At this time we will hand the conference over to Mr. Hawkins for any final comments.

Phil Hawkins

Thank you everybody for participating in the call. We look forward to a continued conversation with many of you and that we will see many of you and NAREIT as well. So thanks again and talk you soon.

Operator

Thank you gentleman, the conference is now concluded. Thank you for attending in today’s presentation. You may now disconnect your lines.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: DCT Industrial Trust Inc. Q3 2008 Earnings Call Transcript
This Transcript
All Transcripts