First Industrial Realty Trust, Inc. (NYSE:FR)
Investor Day Call
November 12, 2013 13:00 ET
Bruce Duncan - President and Chief Executive Officer
Scott Musil - Chief Financial Officer
Bob Walter - Senior Vice President, Capital Markets and Asset Management
Peter Schultz - Executive Vice President, East Region
David Harker - Executive Vice President, Central Region
Jojo Yap - Executive Vice President, West Region and Chief Investment Officer
Bruce Duncan - President and Chief Executive Officer
Well, good morning and thank you for joining us today for First Industrial’s 2013 Investor Day. My name is Bruce Duncan. I am President and Chief Executive Officer. And on behalf of my colleagues, we really do very much appreciate those of you that are here in Los Angeles with us today and going with us on the bus tour, as well as those of you that are on the webcast.
Again, our theme for the day is growing cash flow, delivering value, because at the end of the day, that’s our job. That’s what we must do for our shareholders. Before we go any further, I refer you to your optometrist to read our Safe Harbor language. And again it’s on Page 2 of the presentation and we also refer to prior filings at the SEC. A copy of this presentation is available for viewing and downloading on the website. And for those of you who are not with us, we have also made available the presentation materials for our property tour and market discussions, which will be done following this formal presentation. I would point out that all of data reference today is as of September 30, 2013, unless otherwise noted and lastly some housekeeping items. We will be finished here by 12 PM. We need to leave by 12:15 in order to meet our commitment to get you back at LAX by 5 PM. So when we are done here, if you can head out to the bus and we will have people out there to guide you. Again, it’s important that we stay on schedule, because we all have to make sure we make it up to San Francisco tonight.
Now, on Slide 3 and 4 is the agenda for today. And let me quickly walk you through it. I am going to head, lead off talking to you about the progress we made today as a team, in terms strengthening the foundation of what I think is a very valuable platform. The value of this platform is really in our people. We have a very talented group of people, professionals throughout the country. And you are going to be seeing today some of our leaders that have lead us through the last few years also going forward.
Scott Musil, our CFO will talk about the balance sheet, the opportunities we see. Bob Walter, who runs our Asset Management and Capital Markets, will summarize what we have been able to do in terms of accomplishing to upgrade the portfolio. He will also talk about the opportunity embedded in the portfolio in terms of growing cash flow, especially as it relates to small tenants. Then we are going to hear Peter Schultz, who runs our Eastern division; David Harker, our Central division; and Jojo Yap, our Chief Investment Officer who also runs our West Region. And they are going to talk about the opportunities in our bulk spaces, our key bulk opportunities, large spaces as well as the opportunities we see with our development and the opportunities with some investments we have recently made. Then I am going to come back and sum up what we see if the FR opportunity? Why we think it makes sense to think about us in your portfolio. And then we will open up for questions and answers and then get on with the property tour.
So let’s start, where we have been and where we are going. On Slide 6, we talk about 2009 and 2010, I started in January 2009. When I started we were in a pickle, if you will, along with some other companies, but what had happened is it’s we had a balance sheet that we have a lot of maturities coming due. We had a really fully drawn line of credit. We had a super-sized G&A, because we had a transactional business model and we had a lot of joint ventures. We had a big overhead. And so we needed to sort of redefine the strategy and that we did and we had to do it fairly quickly. And we made some progress. We were fortunate with the maturities. We have basically an unsecured balance sheet. And we were able to cap the secured mortgage market to take care of some of the maturities. We also judiciously used equity to de-lever. And again, we try to be very judicious in the use of equity, because as we have talked about with a lot of our investors, dilution is forever.
We reduced the overhead by over 70%. And again, it was in line with our new business model and the new business model was really to simplify. We simplified it. We reduced the amount of joint ventures and our basic model is to own and operate quality distribution facilities and light industrial facilities in the major markets around the country, take care of our tenants and be very mindful of costs. Again and everything we did in 2009 and 2010 sets the stage for more portfolio refinement. This is the property we acquired in 2010 in Minnesota of about 285,000 square feet. In 2011, to-date, we made good progress as a team.
And let me talk about that, because when we were together, those of you in November of 2011, we sort of set the stage of what we want to accomplish over the next two years. If you remember that time, we are about 86.6% occupied and we set a goal at that time to get to 92%. By December 30, 2013, we are not there yet, but we are on our way when we talk about that. We say we want to strengthen the balance sheet. We really wanted to execute in terms of portfolio refinement, in terms of really move out some of the lower quality assets we had in the portfolio and we wanted to initiate selective growth. And we wanted to come back becoming a dividend paying company.
I would make progress on that. If you look at it on the occupancy since November of 2011, we have gone from 86.6% to 91.2%, up 460 basis points. We are still short of 92%, but as we said on our last call, we are focused on hitting that 92% number by year end and if we don’t I am going to be disappointed and the team will be very disappointed. We have strengthened the balance sheet. Scott is going to talk about that. We have gone from our debt to EBITDA was in the high 8s at that time and we said we are going to bring down the leverage. We have brought it down to the mid to high 6s if you go through that. We implemented our addition by subtraction strategy that is upgrading the portfolio by selling the lower quality assets in our portfolio. We initiated selective growth both by acquisitions, but primarily development, which you are going to see some of those properties today on the tour. And we came back to become a dividend paying stock in the first part of this year at an annual rate of about $0.34. So we made good progress on what we told we are going to do in November of 2011.
This chart on slides, it looks like eight shows you what’s happened. As you can see from the metrics, the occupancy in 2009 we have got from 82% to 91.2%. Again, the real key is not get to 92% by the end of this year, but to get to the mid 90s and we want to go to plus or minus 95% by the end of 2015. Cash rental rates, as you know, they took a big dip in 2009 but again the markets stabilized and rents are going up. And our same store, which again took a dip in 2009 and 2010, we have been positive the last three years. So what this meant for shareholders? Since Investor Day of 2011, November 2011, we have outperformed, grew up 92.6% compared to we have outperformed the NAREIT Industrial Index, the S&P 500 and the Morgan Stanley REIT Index. Alright, we feel very good. That’s great. But you know what, it’s irrelevant, we would like to say there is no future in the past, there really what we want to talk about today is what the opportunity is for shareholders of First Industrial, because we still think there is a very good opportunity that exist. In order to do that, we got to give you a snapshot of where we are and then we will go through in detail the opportunities. Again with 62 million square feet of space in service, coast-to-coast, very diversified. Our top 20 tenants represent 21% of our income.
Slide 11, you see we are in major cities and the keynote is why we are here in Los Angeles is right now, Southern California represents 9.7% of our rental income. And pro forma that it’s on a lease up of some of the developments you see in some of our vacancies. It’s up in 12.5% here in Southern California. We like this market and we are going to see some of the product here. And we are glad you are here to share that with us.
This slide on Slide 12 continues to be my favorite slide, because it shows the opportunity that we see in industrial, not just for us, but for all industrial owners. If you look at what happened, historically, it’s been about 160 million square feet of industrial space built every year. And you can see in 2009, when we had the great recession and demand fell off a cliff, so did supply. And supply has not rebounded anywhere near what you have seen demand and that’s why you are seeing good occupancy increases. We have experienced it. You have seen that our competitors have experienced it, but we view this and again if you look at what the demand is versus supply and especially not what’s it’s been but also the projections. We think that bodes well for owners of industrial space and we are pretty encouraged. And again we are seeing that if you look at business right now. People are filling up, rents are firming up, good things are happening. Now again there is always a risk of development, we will talk about that a lot in the bus tour in terms of too much of development, but right now things are in check and I think we have got a pretty decent runway for the next three to five years.
When we had Investor Day in November of 2011, in order to try and show you why we thought we can get from 86.6% to 92%, we outlined on Slide 13, our top 10 vacancies, which represented about 3.5% of occupancy and we at that session we talked about these 10. I am pleased to report that we made good progress on that, we have reduced that from – picked up 220 basis points of occupancy since Investor Day by leasing that up, so we still have some room to go here. But we thought to make this meaningful for you as we want to give you a new list. And again this is the list we want you to hold us, you can keep asking us about as we will keep reporting on it. And this is our top 10 key bulk opportunities.
As you can see it represents about 220 basis points in occupancy that would get us from 91.2% to 93.3% if we leased it up and probably more importantly $8.3 million worth of income, which represents about $0.07 a share. Today you are going to hear from Peter, David and Jojo about these opportunities. They are going to talk them, you are going to be able to see slides on and you can make your own decisions in terms of what you think whether how leasable they are. But again this is – these are key spaces that we have to lease that we are focused on. We are also going to talk about the embedded growth we have in the investment side. This I-94 distribution center we just bought it in the fourth quarter that’s right north in the border of Chicago and Wisconsin 627,000 feet, $28 million, it’s about 6.7% (indiscernible).
And then you are going to see today First Bandini, this is a 489,000 square foot distribution center here at very infill location in L.A. It’s just finishing up, you will see that, again we are going to lease that up and it’s a great opportunity in terms of delivering cash flow. Peter is going to talk about first on logistics center at I-83, a 708,000 foot development that’s just finished up in the fourth quarter of this year and the opportunity there. Again pro forma 8.4% yield and Rock Creek, Dave is going to talk about this. This is an acquisition we did in December of this year I mean excuse me in June of this year 509,000 square feet, it’s right at the I-80 and I-55 in Suburban Chicago. It’s a good market and we are very excited about that, we bought that with our reproduction costs. We got to lease it up, but it’s good activity, we will talk about that. But again we have $109 million here on top of $20 million there. But this $109 million we have spend basically. And so if we lease this up it’s going to be all incremental to the bottom line.
We also – you are going to see some of these in process developments to-date. First 36 logistics center, Jojo will talk about it 555,000 square feet in the Inland Empire, that could be completed in the second quarter of next year. First Figueroa again a very infill location here in L.A. and we are doing a 250,000 foot expansion for one of our tenants Rust-Oleum in Suburban Chicago. And then within the next 12 months we anticipate starting our first Northwest Commerce Center which is 350,000 square feet in the Northwest quadrant of Houston. Dave will talk to you about that, developing to about an 8% pro forma yield. And the first Pinnacle logistics center in Dallas which will start, which is two building complex about 600,000 square feet, 7.5% pro forma yield. Again those two will be about $46 million of new development.
And then we will talk about some other sites that we have in the portfolio that could possibly go depending on supply and demand and our view of the marketplace. First 33 Commerce Center in Central PA and First Bandini Logistics Center, which you are going to see this site today. In the Inland Empire, which we could do 1,368,000 square foot building. So again we have got good opportunity for growth not only in terms of leasing up, but also the investments we have made in terms of acquisitions but also on the development and we are going to talk about that with my partners.
The western strategy, this strategy is pretty similar to what you have heard in the past. It’s so focused on leasing operations, we want to get the 95% plus or minus by the end of 2015. Markets are firming up. We’ll be able to grow rents. As we lease up the portfolio TIs and leasing commissions will normalize and capital expenditures and we think we’ll have savings there Bob will go through that. We want to continue the relentless focus on customer service and taking care of our customers. In terms of capital management, we want to maintain a strong and flexible balance sheet. As we have talked about, it’s important to us to return to investment grade, our goal to do that is by the end of 2014. We are making very good progress there, if you look at our metrics by any standard, we should get there. Again we will be disappointed if we are not and to optimize our cost of capital.
And on portfolio management side, again we wanted to do selected acquisitions, targeted developments and again addition by subtraction continuing to upgrade the portfolio, asset management is an ongoing process. We want to grow the dividend consistent with sustainable cash flow. What we are going to try and show you today – and I am going to leave you with this – what we think is possible. In terms of growing our cash flow over the next four years by 2017 through the balance sheet opportunities, through small tenant occupancy growth, embedded bumps in the leases through leasing up the key bulk opportunities as well as some acquisitions and developments. We think we can increase cash flow by $52.5 million to $68.5 million, which represents $0.46 to $0.60 a share, which we think is significant when you compare it to our current AFFO of about $0.65.
But again you be the judge there, I want to break this out granularly for you in terms of the opportunities. But we are very excited about the opportunity and we look forward to going through it with you. With that let me turn it over to Scott. Scott?
Scott Musil - Chief Financial Officer
Thanks Bruce. I appreciate it. As Bruce mentioned I am going to walk you through the progress we have made on the balance sheet and when we met last November of 2011, we have made significant progress on the balance sheet, specifically we continue to reduce our leverage specifically our debt and preferred stock to EBITDA. And we have increased our fixed charge coverage considerably as well, why are those important, those are two metrics that the rating agencies look at. So in my presentation today I am going to go over a couple of items. One is progress that we have made with the rating agencies and what the next triggers are to get the next upgrade and secondly the refinance opportunity that we have built-in in our balance sheet.
So what have we been up to, I am on Page 20 now, what have we been up to over the last couple of years. First thing on the list is we have recast our credit facility two times, the benefits of doing this are two fold. We increased our capacity. We had $200 million line of credit at that point of time. We currently have a $625 million line of credit. We love having that additional capacity, it’s important for us, it enables us to take out maturities and it enables us to fund growth initiatives as well. As important, we have reduced our pricing as well. Our spread at that time when we met at Investor Day it was about 275 basis points, we are currently paying about 145 basis points right now. So there is significant cost reduction in that.
The next two items on the list I will look at hand in – together. The first thing that we did is in 2012 we went ahead and we issued about $100 million of secured debt 10-year term, 4% rate. We love the market at that point of time and the plan with that money is we have these debt maturities that we can prepay or pay at maturity at higher interest cost debt. So we went ahead and we used those proceeds and we have paid off some secured debt. So since Investor Day we paid off about $86 million of secured debt with an interest rate a little above 7%. So if you look at the positive accretion, it’s about three percentage points.
Next to go hand-in-hand as well we issued a little over $300 million of equity. Some of that equity was used to fund some of the growth, some of our developments that my colleagues will walk through shortly. Also we used it to redeem our preferred stock specifically our Series J and K preferred stock that had a coupon of about 7.25% that besides being accretive to cash flow that execution really helps us from a leverage point of view and a fixed charge point of view.
And then lastly, we took advantage of some open market repurchases with our unsecured bonds either through open market or through tender offer. So, we’ve retired about $136 million of those unsecured bonds, 6.7% weighted average yield to maturity in the 7.5% interest rate. So, all these items coupled with the great leasing that my colleagues have done over the last couple of years enabled us to re-initiative our dividend and it’s really important to point out that our dividend is at a 55% payout ratio, we think that’s really important because that enables us to fund growth and then also enables us to grow the dividend on an ongoing basis. Again the other benefit related to these items here as we’ve achieved some rating agencies upgrades which I’ll walk through shortly.
So, the next slide goes over where we stood end of 4Q of ’08 as far as total debt and preferred stock and where we stand out, we can see we made significant progress we’ve reduced our total leverage including preferred stock by about 900 million. As of the end of 4Q of ’08, we debt preferred EBITDA of little over 11 times and our total leverage was about 50% – little over 56%. This total leverage is calculated on our bond covenants. Fast forward, we’re at the end of the third quarter, our debt to EBITDA – debt preferred EBITDA is about 6.7 times and our debt to total assets is a little over 40%.
So in 2010, we laid out a leverage goal debt to EBITDA of 6.5 times to 7.5 times. Earlier this year, we beat that goal so we put out a new goal. It was debt and preferred stock to EBITDA a range of 6.5 times to 7.5 times. We thought it was important include preferred stock in that because that impacts our fixed charge coverage ratio which is something the rating agencies look at. What I’m here to tell you today as we have a new goal in mind, it’s debt and preferred to EBITDA of six times to seven times. So again, we put out a new goal for leverage and as my colleagues will walk through today all the cash flow drivers we have in our business, this is a very, very achievable goal.
Next, up here on my Page 22 for folks that are looking online, this is the progress we’ve made with the rating agencies. Bruce and I went out to meet the rating agencies in April, we went over where we were in our metrics we went over our 2013 plan. So, what’s the progress we’ve made? We had some pretty good progress with Standard & Poor’s. They had us rated at a BB flat rating. Subsequent to that meeting, they upgraded us to BB+, one rating away from investment grade, the one trigger that they had in the report in order to get to investment grade BBB- is I wanted to see a fixed charge coverage ratio at 2.3 times or better.
Moody’s next up on the list, they made a progress with them as well. They had us rated at a Ba3 rating with a positive outlook. This is we met with them. Some subsequent to the meeting, they upgraded us to Ba2 and they kept to set a positive outlook. In order to get to a Ba1, which is one notch away from investment grade, they wanted to see a couple of things out of us to couple of triggers, they wanted our occupancy near 92%, debt EBITDA around six times, secured debt under 20% and they wanted our fixed charge coverage ratio about 2.1 times.
Fitch was another meeting that we had made a little bit of progress with them. They had us at a BB flat stable outlook. They upgraded our outlook to positive. So, we made a little bit of progress with them. In order to get the next rating notch, which takes us to a BB+, which is one notch from investment grade, they wanted to see fixed charge coverage ratio of 1.75 times and they wanted us your unencumbered asset ratio above two times.
On Page 23, where do we stand now with these leverage ratios, you can see on the fixed charge coverage since we met last we made significant progress, we’re up 1.55 times fixed charge coverage trailing 12 months and the third quarter trailing 12 month, we went up to 1.95 times. More importantly if you look at third quarter standalone, we’re at 2.2 times. The reason for 3Q standalone is so much greater than trailing 12 months. It has the impact of the two equity raises in the $150 million redemption of the preferred that we did this year.
Debt and preferred EBITDA again progress 8.8 times when we met last at investor day down to 6.7 times. Another step that we look at as well is our secured debt as a mentioned that’s something that Moody’s has an interest in. As you can see we started 2011 at about 21%, 2012 that increases that’s the impact of that debt offering that I discussed as we continue to pay that down, it starts dropping rent 21.8% at the end of the third quarter, end of fourth quarter will be at about 20.5%, we’ll have the benefit of some of our secured debt pay downs.
And as you can see by the end of 2014 will be below 20%. Okay, this is our report card however we’re dealing with specifically the triggers of the rating agencies put out. Again, S&P one notch away from investment grade in order to get upgraded to that level, they want to see your fixed charge coverage ratio at 2.3 times. Third quarter standalone were at 2.2 times, very achieved to get to that 2.3 level in 2014. Moody’s, they laid out a couple of different items here to get upgraded, occupancy approaching 92%. As Bruce mentioned, we were 91.2% at the end of the third quarter on our way to 92% by the end of the year.
Fixed charge coverage they wanted at 2.1 times, third quarter standalone we’re at 2.2 times, we’re already there in fact we exceeded that goal. Net debt to EBITDA they wanted six times, we’re at 6.3 times at the end of third quarter so, we’re on our way and then once secured debt around 20%, we’re at 21.8% at the end of the third quarter will be at about 20.5% at the end of the year. Fitch, couple of items, they wanted our fixed charge coverage above 1.75 times. That number looks a lot lower than these other fixed charges because Fitch in calculating it deducts capital expenditures from EBITDA. Our third quarter standalone result is 1.9 times, way above what their goal is. They wanted our unencumbered asset pool to be greater than two times, go over how that works, they basically value our unencumbered assets and they use a stress cap rate at 9.5%, that’s the numerator, the denominator is the unsecured debt outstanding. They wanted to be greater than two times, were at 2.8 times were way above that.
So as you can in many cases, we met or exceeded the triggers that the rating agencies have to get upgraded to the next level. And in other cases, we’re clearly on our way to meet those goals. Bruce had a slide, I think it was regarding absorption call it is opportunity slide, this is my opportunity slide. This shows the debt that we have coming due all the way out of 2022. It excludes a line of credit in principal amortization so, basically has a bullet maturities our secured debt and unsecured debt. So, over the next four years, we’ve got about $540 million of opportunity. What is that math look like, let’s walk through it, again $543 million we can pay off the next couple of years until 2017, interest rate of 6.32%, we rent it at a 5.5% rate and a 4.5% rate. The pickup is between $4.4 million and $9.8 million, which is $0.04 to $0.09 a share.
Taking the midpoint of that, it’s about $0.65 to buy that by $0.65 of AFFO we have for 2013. That’s about a $0.10 growth in cash flow due to these refinance opportunities. So what are the next steps, pretty easily continue to work with the rating agencies and getting our upgrade and as you can see in many cases, we met or exceeded the triggers that the agencies required to get the next upgrade to run our way and we’re comfortable with our goal of getting that at the end of 2014, and the next having access to that chief unsecured debt market, once you have that investment grade we should be able to take advantage of these refinance opportunities over the next several years.
With that, I’ll turn it over to Bob.
Bob Walter - Senior Vice President, Capital Markets and Asset Management
Thanks, Scott. What we wanted to do now is spend a little bit of time talking about both our portfolio management results over the last couple of years, what we’ve been able to accomplish there. And then secondly, walking the portfolio a little bit deeper to examine some of the cash flow opportunities we have and in some of the topics that Bruce mentioned in his remarks. So first of all portfolio management are as call it addition by subtraction, what you’ll see here is kind of an overview of what we’ve accomplished, $250 million approximately in dispositions over the last three or so years, about 36% over book value, 8.7 million square feet of buildings were $220 million of sales of that 249 overall, but $25 a square foot.
In addition, we sold about 208 acres of land, about 12% overall, our sales volume at about $29 million. So we will obviously hear and have a word over the last couple of years with some of the new land acquisitions that we made. It’s also important to remember that during that same period of time we have been active sellers of some land that we don’t think is a fit with our ongoing asset strategy.
Finally, I think it’s important to point out we have sold about 836,000 square feet of R&D/flex properties over the last three years, about 16% of our overall sales volume. That compares to about 10% of our rental income being in this asset class. So we have clearly been a bit more focused on selling out some of our R&D/flex properties over time and we could anticipate that, that focus will continue as we go forward. From a geography perspective, we said two years ago when we were at this meeting that downsizing our exposure in the Midwest was a major goal for us. And clearly, as you can see from our sales results, that has manifest itself in 65% of our sales being in the Midwest markets with the balance being in the various other markets across the country.
But overall, the most important stat is what, the pricing we have been able to achieve about 6.6% trailing 12-month cap rate on just the buildings, 5.8% if you include the land parcels in that math. So clearly, we have been focused on upgrading the portfolio, selling out of some of the assets and actively involved in asset management in addition by subtraction and doing it on a level that made sense from an overall cost and return perspective for the shareholders.
So what has that meant for the overall portfolio? And for those of you on the web , I am on Slide 29. Well, overall since 2010, we have made new investments of about $337 million. Now, this includes at full development costs our First Figueroa and first 36 logistics center developments that we have talked about. It includes our land parcels that we talked about in Moreno Valley First Nandina as well as our First Northwest Commerce Center and the acquisition we made in Chicago that we announced on our earnings call a couple of weeks ago. So overall, that $337 million represents about 12% of an increase over a starting spot of third quarter of ‘09 book value of assets or $2.9 billion.
Now, from a disposition perspective, we just talked about that, about $250 million overall about a 9% decrease. So overall, we turned the portfolio over about 20% over the last three or so years, nearly $600 million in value of those assets, but most importantly is the fact that we have been able to do that really on a non-dilutive basis at least on a long-term basis. The new investments we have made averaged about 6.7% on either a GAAP pro forma or initial yield and our sales as we just mentioned about 5.8% overall. So the volume is important, but making sure we did it in as non-dilutive fashion as possible is probably more important.
Let’s move to the portfolio. I am on Slide 30 for those of you on the web. One of the things that we talk about and look at repeatedly in our portfolio is retention. Now, Bruce touched on the fact that our teams in the field do a magnificent job on customer service. And in many businesses, it’s very difficult to ascertain what customer service means in terms of the metrics of the business. Well, this is our scorecard. And clearly, the correlation that we see in terms of steadiness over the last eight years or so through some good markets and bad markets, we have been fairly relentless in hitting this 70% plus or minus kind of retention ratio. This factors in to a lot of the dynamics and metrics in our portfolio and the cash flow that it produces overall. So clearly, this is and continues to be a big focus for us and the result of our customer service.
So let’s move over to some of the cash flow opportunities, particularly in small tenant and then let’s talk about a path to that plus or minus 95% number that Bruce touched on for year end goal in 2015. Now, before we talk about small tenants, we got to talk about big tenants for a moment, because that factors into the past math, if you will. And Bruce laid out a path of 3.1 million square feet of bulk tenant opportunities that Peter and David and Jojo will go into a lot more detail about. But what you see is that 220 basis points is that opportunity in the overall portfolio, but with respect to only this asset class or bulk warehouse, it would take occupancy over 96%. So for purposes of demonstrating a path to 95%, we are going to round that down to 96% flat.
Now, let’s talk about some of the small tenant opportunities. In our regional warehouse inventory, we had about 8.2 million feet at the end of the quarter, it’s about 92% occupied, 96% is where our target is. So how do we get that? Well, two years ago, when we are together we are at 86% in that asset class. So we have grown about 610 basis points. We think to be safe it’s very conservative to assume that we hit the same level as bulk warehouse or 96% overall. And at $4.30 in net rent with operating expense recoveries of about $1.50, that’s just under $2 million in incremental net cash flow.
With respect to light industrial, as you see we have just under 15 million square feet, we are 88.2% occupied as of the end of the third quarter. Again two years ago, we are 84.5%. So we picked up about 370 basis points. We think that’s the performance we can repeat over the next two years as we drive to 95%. To make the math easy, we are around to 92% overall. And at a net average rental rate as of the end of the third quarter of $5.20, that’s about $4 million with operating expense recoveries in incremental net cash flow. With respect to R&D/flex, we have about 3.6 million square feet as of the end of the quarter. We are just over 83% occupied. Two years ago, at Investor Day, we are 74.4% occupied. Again, we think that’s a performance that 890 basis point pickup that is a performance that we can repeat and achieve that 92% level like we can we believe in light industrial. So $7.88 in net rent with operating expenses, that’s about $3 million in incremental cash flow. Again, all from small tenant types of real estate. In total, about $8.7 million in incremental cash flow.
Now, the obvious question might be well, what’s the likelihood that you can hit that number. Well, to demonstrate that in somewhat of a mathematical sense, we said let’s take all of our vacancy as of the end of third quarter about 5.5 million square feet and go back to that 12/31 of ‘08 timeframe and look at what the occupancy of that space was then. And what we found, it was about 75% occupied back then. So clearly, that 75% on 5.5 million square feet gets you about 660 basis points in incremental occupancy for the overall company. That’s nearly 80% from our third quarter level. So clearly, we think this is a path that’s very achievable and our team is focused on it.
Let’s talk about rental rate bumps. This is an area that is a very big driver of cash flow increases in our portfolio in that of our peers and indeed in the industrial business overall. For those of you on the web, I am on Slide 32. Now, over the last three years, we have averaged about $6.1 million per annum in bump rental income. As you look out over the next four years and this is simply from leases within embedded rent bumps today. This assumes no new leasing, no new rent bumps going forward, just what is there today contractually averages about $3.5 million. Now, you will obviously note that the trend here from 4.8 million in ‘14 to 2 million in ‘17 is decreasing. It’s decreasing because we are not assuming any new bumps in new leases going forward. So the question then becomes well, what’s the likelihood and propensity for that bump income to repeat in compound as you go forward.
I will give you two data points to talk about that issue. First, in 2013, 50% of all of our leases that we have in place had bumps averaging about 4.2%. So rough math, call it, 2% overall on the NOI of the company in 2013. In addition, to give you some perspective on where the market is, 71% of the leases we have signed in 2013 that are 12 months or longer contained bumps averaging about 2.7% annualized. Again, that’s about 2%. So as you look out to 2017 to determine what your overall bump income opportunity is by then, we will suggest a range of 1.5% to 2%. And utilizing third quarter of ‘13 annualized NOI of $230 million, that’s $14 million to $19 million by 2017. Now, this assumes no new sales, no new acquisitions and no new leasing.
Bruce touched on this, the TI leasing commission and CapEx opportunity and normalizing these dollars, this is obviously as a big impact on our overall AFFO of the company and what we can look at paying out from a dividend perspective or reinvesting. Over the last three years, we spent on average just over $50 million per year between tenant improvements, leasing commissions and CapEx. CapEx being things like parking lots, roofs and HVAC equipment CapEx of that component averages somewhere between $15 million and $18 million per annum with the balance being leasing commissions. So again here, the obvious question is what does this number look like over the next four years on kind of an average run rate basis, if you will?
And the one key assumption you’ve got to make there is what are your longer term averages for tenant improvements and leasing commissions for renewals and new leases? Well, from ‘06 to ‘13, we averaged about $1.23 a foot for renewals, for new leases about $4.64 per square foot. In addition, over that period of time, we averaged about $0.19 per square foot in capital improvements in our buildings. The last couple of years, it’s been a little bit higher and indeed this year in 2013 year-to-date, we spent about $0.25 per square foot. So using that $1.23 and $4.64 is kind of the baseline assumption. You could make some additional assumptions, which again I will have to apologize to Bruce’s comment on the optometrist on this one, but if you assume 92% year-end occupancy, your expiration schedule as of 9/30 of ‘13, a 4% average lease term, 1.5% of additional lease up in ‘14 and ‘15 in other words getting into that plus or minus 95% level and that $0.25 per square foot annualized CapEx assumption that we are seeing in ‘13.
What you will see is that it’s about $8 million drop over the next four years on average versus where you have been the last three years. Now, that’s about $0.07 a share. And it’s obviously a pretty interesting opportunity from an AFFO perspective. But two things again that are important to point out. First of all, there are no sales and no acquisitions and no resulting improvement in the portfolio from our ongoing upgrading efforts. Secondly, we talked about at the beginning our focus on selling some of the R&D/flex assets that we have and those assets tend to be the larger consumers of these TI and leasing commission dollars. So clearly, none of those two improvements are factored into this analysis.
Finally, let’s talk about the market and rental rates. Bruce touched on this as well in his comments and there has been a lot of very smart people that have done a lot of very thoughtful research on this topic and what you will see here on Slide 34 is the CBRE Econometric Advisors Data, their total warehouse rental annual rental index from 1990 to what they are projecting through 2018. And what this chart shows is that the previous peak in rents was hit in 2008. Again, that’s a fairly intuitive conclusion given the world we have all lived through over the last five or so years. Rents bottomed in 2010 to 2011 and looking out over the next four years, CBRE suggest that the peak rents will be regained in 2016 approximately and that between ‘14 and ‘17, you will see annual growth in their index of about 4% per year. So as Bruce said in his remarks, we think there is a pretty interesting runway looking forward for year-over-year rent growth and this data kind of backs that up overall.
But in looking at market rental rates and what’s the likelihood that we can push our rates, that’s one piece of the puzzle. The other piece really has to be focused on where your rents are right now. What are those increases, what can they look like given what your rent profile currently exist in your portfolio? Well, what we try to do to demonstrate that level is again take the world as of 1/1/09 and look at the average in-place net rent we have in place today from the vintage of leases that were done prior to that period. And what we found is that was about $4.67, about 9.1 million square feet overall, again, only for leases signed prior to 1/1/09. For leases signed post 1/1/09, there was kind of the great recession on if you will, about 47.2 million square feet, about $4.18 per square foot. So clearly that 12% plus or minus delta would seem – would seem to lead to the conclusion that over time to the extent we can come back to more of the good old days pre 1/1/09, we should see some pretty good rental increases.
Now, CBRE also suggested that peak rents were hit in 2008. So what does our lease vintage look like from that year as well? That was about $4.89 per square foot, about 4.5 million square feet as well. Again, about a 17% difference between those two numbers. So overall, between both the macro environment from what CB and many others are saying should happen over the next three to four years, along with our lease vintage, we think there is a very interesting opportunity to grow rents over time. And again, our team is incredibly focused on it.
So let’s do the math. From a small tenant leasing perspective, we laid out a path to get to 95% and also laid out a path between our regional warehouse, light industrial and R&D/flex to capture $8.7 million in incremental cash flow by 2017. Let’s suggest a range of $8 million to $9 million. Bumps, we suggested 1.5% to 2% as an overall range of an impact in our NOI compounded by 2017. That’s about $14 million to $19 million. TI’s leasing commissions and CapEx about $8 million annual difference in average spend levels going forward for the next four years versus the last three, overall about $29 million to $36 million in incremental cash flow between now and year end 2017.
Now, that sounds pretty attractive on its phase, but before you even get there, we have not factored in what happens with rental rates. And we think again there, that’s a very interesting opportunity that our team is focused on at a lease-by-lease, space-by-space, asset-by-asset basis, so overall, about $0.25 to $0.31 in cash flow opportunity looking out to 2017. We think that’s a pretty interesting and attractive opportunity from our baseline today.
With that, let me turn it over to Peter Schultz, my colleague. He will talk about the Eastern region.
Peter Schultz - Executive Vice President, East Region
Good morning, everybody. I am going to be giving you an overview on the East region. We are going to drill into a couple of our largest markets, talk about several of our key bulk warehouse leasing opportunities and then wrap up with a couple of our growth opportunities.
For those of you listening in, I am on Page 38. The East region represents about $90 million in rental income for the company, about 35% of our portfolio. Our largest markets include Central and Eastern Pennsylvania, the company’s second largest market followed by Atlanta and Indianapolis. As I said, I will discuss these markets in a few minutes and give you a little bit more color on each of them. From a portfolio makeup standpoint, approximately 87% of the portfolio was made up of distribution and light industrial space with the balance being flex R&D in two of our properties, one located in Atlanta and the other outside of Tampa.
From a performance standpoint, as you can see on the chart, occupancy is up in seven of our eight markets from our last Investor Day in November 2011. As of Q3, the East region was 88.1% overall. So clearly work to do as we focus on our year end company occupancy goal of 92%. In terms of what we are seeing around the East region, broad-based activity from a number of different companies across markets and space sizes driven by growth and efficiencies, we are seeing an improvement in smaller and midsized companies and leasing activity with those firms as you see in our increasing occupancy. From a supply standpoint, while it’s increased, it’s really been limited to large distribution centers and we see spec product in New Jersey, Pennsylvania, Maryland, Indianapolis and South Florida. Pennsylvania in particular is seeing strong demand from large users, which I will get into a little bit more in a few minutes. From a portfolio standpoint, you will see the vacancy in a couple of our smaller markets is driven largely by one building. Overall, we continued to be very encouraged by the activity we are seeing.
In terms of drilling down now into our larger markets, first starting in Atlanta, as we have talked about on some of our recent earnings calls, Atlanta is a market that has lagged, but we’re continuing to see a good progress and an improvement in activity. Over the last seven quarters, net absorption spent about 15 million square feet and importantly there has been no real new supply with the exception of two spec buildings were recently completed 650,000 square feet of building on the I-20 West market and an under construction 325,000 square feet building on I-85 south. Our portfolio has demonstrated good visibility particularly with the improvement in small or midsize companies and in fact, our occupancy error is up this year about 430 basis points to 86.7% at the end of Q3.
The challenges have really been obviously supply remains very high and the market remains competitive. Despite all the positive absorption that we had, availabilities hovering around 16%, direct pay can seize about 12.5% so, continues to be very competitive. In terms of the markets that we’re seeing, activity in the Northeast which is the Atlanta market’s largest submarket, northwest, I-85 and I-85 south, which is about 7 o’clock on the dial continue to see the bulk of the activity throughout the market.
Markets that have been weaker include the side and principally Henry County which is I-75 south so I think 5 o’clock on the dial. In fact in Henry County there today over 20 existing buildings that can accommodate tenants of 250,000 square feet or more and that’s about half of the buildings throughout the Atlanta market that kind of accommodate tenants of that size. So we’ve made good progress so far this year but clearly have more work to do and some good opportunities to get there.
Next Central and Eastern Pennsylvania, probably the busiest market on the East Coast in terms of demand from large users, the demand supply balance as I was talking with few of you about before we started continues to be very positive. We continue to see broad-based activity from a number of different industries including e-commerce, traditional retailers, consumer products companies, automotive, food and beverage and of course third-party logistics providers. And with continued absorption in the market is continued to reduce the competitive supply, the availability today of bulk buildings in Central and Eastern PA existing buildings about 500,000 square feet is less than 3%. In Central Pennsylvania, there have been no new speculative starts since we commenced construction of our first logistics I-83, our 708,000 square feet building that we started in Q3 of 2012. The challenges in Central and Eastern Pennsylvania and you’ll see a couple of our key bulk vacancies in a minute have really been uneven demand in the 50,000 to 150,000 square foot range and we have a couple of those.
Having said that, we’ve definitely seeing an improvement in activity in recent months, many of the prospects for these types of spaces our third-party logistics providers and one of the challenges is that many of these companies are really relying on securing contracts with other firms and the timing of securing and winning that business frequently thanks a lot longer than anticipated.
On the supply side, the Lehigh Valley is certainly seeing an increase in new construction with a couple of projects recently started ranging in size from 300,000 to 800,000 square feet, and that’s something that we’re continuing to monitor. Lastly, Indianapolis our portfolio in India has been a pretty consistent performer for us. What we’re seeing there today is an opportunity to increase rents given what we see is accelerating demand from small and midsize spaces – from small and midsize tenants, excuse me, and really given the increase in confidence among these firms the opportunity to push rents as well as lease term. There has been no new supply in Indie in terms of small and midsize spaces so we continue to compete effectively in that market. The challenges in Indie are really the limited barriers to entry on the bulk side and they’re certainly is new construction where several speculative buildings on the west side, there is ample and it generally comes with tax abatements so that’s more competitive from a bulk standpoint.
Skipping now to Page 40, this is our list of six key bulk warehouse opportunities in these regions. Some of you will recognize a few of these from our last investor day list where we made some progress or done some short-term leasing, but still focused on securing permanent tenants for some of these spaces. These are all spaces in multi-tenant buildings and the occupancy contribution from these six buildings is about 130 basis points of the 220 basis points that Bruce talked about earlier in the presentation.
The first one on Page 41 is in Atlanta, our Bonnie Valentine building, one of the best buildings we have in our portfolio built in 2007, 32 foot clear cross dock, all the typical bells and whistles of a modern bulk distribution building located in the Northeast submarket as I said the largest and probably one of the most active submarkets in Atlanta up I-85 so think 2 o’clock on the dials you look at Atlanta. The 212,000 square feet of vacancy, we’ve had some short-term tenants in and out of that and we just inked the short-term deal for about half of that 106,000 square feet and hopefully we’ll see some opportunities to grow that tenant building and we think that at this point the remaining leasing opportunities here are really going to be expansion of one or more of the three tenants in the building.
The next building, South Park in Atlanta, also on our 30 – our top 10 rather from last investor day so, this is a 657,000 square foot building located in good proximity, the Airport and highway access about 5 o’clock on the dial while the occupancy here hasn’t really changed investor day, some of that was short-term at that point and we term that up with our existing tenant and now the balance of the building is really finding the right fit for tenant, good functionality in terms of clear height trailer and outside storage, which is something that’s unique in Atlanta for users chasing that and we have a couple of prospects for the space.
Moving down to South Florida, this is our building in Northwest 74th Street, in Medley and I’m on page 42, this building is about three miles, north of the Miami International Airport so close to the hub of lot of activity there. Originally positioned as a single tenant building, this building we leased about half of it just about a year ago and the remaining half is what we’re marketing today, 24 foot clear, good loading in secured truck storage, trailer parking something tenants looks for Miami and really here it’s about finding the right fit for this space. The demand that we’ve seen recently in Miami is really been in the 30,000 to 50,000 square foot range. This base is not going to demise so, it’s really finding the right fit for somebody who is looking for that 60,000 to 72,000 square feet of space.
Next on the Page 44, this is one of the three buildings that we have in Central and Eastern PA. This is the most northern and eastern in the Lehigh Valley, there is one in Harrisburg and Central PA and the third one I’m going to talk about is in Hagerstown down I-81, it’s about 150 miles from the building in the Lehigh Valley to the building in Hagerstown. This is a well-located building just above the Allentown Bethlehem airport right along state route 22. The building has a variety of different space sizes so, it’s a multi-tenant building about 550,000 square feet overall. Varying clear heights between 18 and 30 clear, the vacancies that we currently have are on the 18 foot clear section.
And what we’re seeing from a demand standpoint, our tenants don’t really need the higher clear height and some of the bulk building so, these are manufactures and third-party logistics companies chasing contracts as I mentioned earlier. They are happy with that kind of clear I don’t want to pay for space that they are not going to use. So, we have spaces available in this building today in the 50,000 and 75,000 square foot range. As I mentioned earlier in my comments, it’s been a little slower on the 50 to 150 improving activity here that we’re pleased to see.
Next is the 301 Railroad Avenue building an infill location on the West side of Harrisburg. This building has good proximity to I-81 in the Pennsylvania Turnpike. This building was a former freezer cooler building and have been for some time and when that lease expired, we have repositioned the building with a number of improvements including ESFR sprinkler system, new loading equipment, new energy efficiency lighting. And we have seen some good results there with some short-term leasing and are encouraged by what we are seeing as more prospects for this space today but it’s still our job to convert that into signed leases, which our folks on the ground are certainly focused on.
And then lastly our Shawley drive building, this is in the Hagerstown submarket at the southern end of I-81 so just over the Pennsylvania Maryland border. This is a 20 million square foot submarket with good corporate profile users like Rust-Oleum, Home Depot, Lennox, and Volvo. This is a 300,000 square foot building, about half the building today is empty and we have seen some activity more recently on this building that we are also working to convert.
Next turning to additional opportunities, this is where the growth is coming from as Bruce and Bob alluded to earlier. So there are three on this list, the first is our new speculative building in Central Pennsylvania the 708,000 square feet that will produce about $2.9 million in annual cash flow. And the other two I will talk about which were both on our Investor Day tour in 2011 where we haven’t really committed to these yet, so the cash will impact still to be determined. So this is our new building in York, Pennsylvania. Well located along I-83 which you can see right on the area that’s I-83 right there great access at an interchange. This building is scheduled to be completed here in the next couple of weeks. Recall that are underwriting assumes 12 months of lease up before stabilization. Building has an 8.4% projected cash yield on our costs.
We very much like how this building is positioned both from a locational standpoint in Central Pennsylvania and along I-83. From a labor standpoint the labor profile in York is much better than surrounding submarkets. And then finally, we have a tax abatement here that none of our competitors have that’s worth about $0.25 per square foot per year over a 10 year basis which is certainly attractive to users. As I mentioned earlier demand continues to be very strong for large users in Central Pennsylvania. Today there are only two other – two existing buildings about 500,000 square feet we are competing with one is in Carlisle and one is further south down the I-81 corridor.
And then when you look at Central and Eastern Pennsylvania together there are really only four existing buildings. As I mentioned no new speculative starts in Central PA yet although there are some starts Lehigh Valley. This our First 33 Commerce Center site Lehigh Valley, on the east side, so great proximity to the New York Metropolitan area. For those of you who are on our 2011 Investor Day tour you remember touring this, I am on Page 49 for those listening in. These are two buildings totaling 585,000 square feet both planned for 32 clear front loader and a rear loader, terrific location right at the interchange on Route 33 together with a couple of commercial lots that we plan to sell. In Lehigh Valley as I said a couple of new buildings have started, so we continue to monitor those market conditions before committing to starting this. But we are encouraged by what continues to be pretty robust demand in that market. This project is fully entitled and we are in the process of finishing some agency and permitting approvals that we should have some done some time in the first half of next year.
Finally, in Covington in Northeast PA, again this was on our 2011 Investor Day tour. So this is a 502,000 square foot proposed building in a park that we developed over a number of years. We built buildings here for Sears Logistics, Maytag, Cat logistics and our 1.3 million square foot building here that is now occupied by Diapers.com who many of you know was bought by Amazon a couple of years ago. This market continues to be a good distribution location as some of you may know Diapers does same day delivery of its products into the New York Metropolitan area from this building.
Our new building, which is – there is a site plan here 502,000 square feet is fully entitled, ready to go and we view this as a build-to-suit opportunity. This is not something that we will spec. The other benefits, that this site has is a tax abatement, that’s worth $0.50 per square foot per year over 10 year basis. So again it’s something that users like to see when they are looking at this market.
In conclusion and I am on Page 51 I have talked with you about our six key bulk warehouse opportunities that have the potential to increase our occupancy by 130 basis points. And our three growth opportunities including our to be completed first logistics center at I-83 building in York that we are excited to complete as well as our two growth opportunities both in Lehigh Valley and Northeastern PA. I would say that we continue to be very encouraged by the broad based activity we are seeing, certainly the positive supply demand dynamic that we are seeing in Central Pennsylvania and we are looking forward to capitalizing on all of these opportunities.
With that let me turn it over to David Harker.
David Harker - Executive Vice President, Central Region
Thank you, Peter. I am happy to be here to talk to you about the portfolio in the Central region. The Central region is basically everything from Minneapolis down to Houston. It totals or it produces about $114 million of rental income of approximately 44% of the company. The markets as you can see nine markets we enjoy very good occupancy across all nine markets. Every one of them is over 90% occupied. And the Central region as a whole was 94.4% occupied at the end of the third quarter. As you can see, we have got fairly good diversification between our markets.
Couple of points I have mentioned on the slide this Chicago number of $17.1 million of rental income that does not include the $1.4 million of Class A space that we are in the process of adding to that portfolio that all happened of after the third quarter, so I will talk about that in more detail later. That 1.4 million square foot of space will add approximately $4 million of rental income when it’s fully leased. As you can see primarily we have bulk distribution with R&D/flex accounting for only 9% of the total. One thing I will mention we had a very active year in R&D/flex leasing this year in the Central region. We leased or renewed approximately a third of that portfolio approximately $3.3 million of rental income.
And then finally just commenting quickly, we have one ADESA land site in Houston and just to give you the idea of how well we like those land sites. That land site happens to be directly across the street from our new development on Greens Road in the Northwest corner of Houston. Just to give you an idea of the good proximity of those land sites. Our focus now on our three largest markets, Chicago, Dallas and Houston those are also the markets that we have targeted for growth and have current growth opportunities all three markets are extremely strong right now experiencing record absorption. In the case of Dallas, this is the lowest recorded vacancy below 7%. We are aware that challenges in each one of these markets, obviously Illinois like many states has got its fiscal challenges. Dallas we are very aware there are very low barriers to entry in that market and has a tendency to get overbuilt. So we keep a careful eye on that.
And in Houston, we keep a close eye on oil prices, because Houston is although it’s much more diversified than it was, it is primarily an energy town. The opportunities in each of the markets, Chicago still second biggest industrial market in the country. You are seeing increased intermodal traffic. You have shortage of land in both O’Hare, one of the major submarkets and now for the first time in my career, I-55. So you are seeing real rental rate increases in those submarkets, Dallas and really all of Texas, just the economy is really strong. Houston, I would say is the strongest. I lived there back in the 80s and I think it’s stronger now than it was during that last boom.
We have only – these were our two largest bulk vacancies in the Central region as of the end of the third quarter. The first one is a little bit out of the ordinary. This is a food processing facility. It went vacant in May of 2013 when a long-term tenant moved out. It is cooler space. It has some special features, epoxied floors, special wastewater treatment system, lot of power, lot of water capacity. So it’s a food processing facility. As you can see from the math, it’s extremely well-located in Franklin Park in Cook County, lots of abundant labor in that area. There is a significant demand from food processors now looking for new facilities. And we are very pleased with the demand that we have seen on this since it went vacant in May. This is a well-located building in right near the St. Louis market. This building went vacant in July 2013. We own five buildings in this immediate facility, what’s called the North County market in St. Louis. So we have got a lot of experience there. We feel confident that we will find a replacement tenant for this one fairly soon also.
Now, to talk about opportunities, as I mentioned, there is three of them in Chicago that are all either done or in the process of being built or leased. The first one, this is the I-94 Distribution Center, just over the border in Kenosha. This is a property that we have purchased in beginning of October of this year. 626,000 feet, what do we like about it? We liked the building. I mean, it’s what we are trying to do its Class A space both distribution 32-foot clear built in 2008. We like the market. We have had extensive experience in the Kenosha market. It is one of the most active submarkets in Chicago right now, the Southeast market in Southeast Wisconsin. We particularly liked this location. We are less than a mile from a four-way interchange on I-94. The price, we bought this building for $45 a foot, which we felt was basically replacement cost, the same cost that we would have been and if we had to build spec up there.
The yield, we bought this at a 6.7% yield. Compare that to other deals that we saw in Chicago that were going in the 5s, mid 5s, low 5s, we felt that this was a yield that we could live with and that yield is on what we consider to be a below market rate. So we felt good about that. It is fully leased to a single tenant and though that income should show up in our statements the next quarter. This is an acquisition that we made end of June 2013. This building we bought 100% vacant. Like the building built in 2005 also Class A 32-foot clear bulk distribution. We really like the location. We are right at the interchange of I-80 and I-55. It is in the I-80 submarket, but we think as the I-55 market, which has improved dramatically over the last year. Those tenants are going to be forced to look down in I-80. And we think we will get the benefits of those coming down.
And then also the increased intermodal traffic, we are only six miles from the intermodal. We think we will benefit from the increased activity in I-80. So this is one that we are very excited about. We like the price. We bought this at $40 a foot. Obviously, we have to carry it. We will put in TIs and commissions, but similarly, we are in a price that we would be at if we had built its spec. We have had good activity on this since we closed on at the end of June and we feel confident that we will meet or exceed our underwriting on this asset. Finally, this is another building in Kenosha, less than a mile from our new acquisition. It’s a 600,000 foot building that’s leased to Rust-Oleum on a long-term lease, still has over 10 years on the lease. They exercised expansion option earlier this year and we are in the process of adding 250,000 square feet to that building.
So finally, next I am going to talk about two developments in Texas, one in Houston and one in Dallas. Both these developments we own the land. We are in the process of permitting of First Northwest Commerce Center in Houston. This is a 350,000 square foot building, very well-located right near Beltway 8. It’s a area, where we have got some experience as I mentioned, it’s right across the street from the 61-acre ADESA parcel that we own. It’s also all less than two miles away from another development that we did earlier that we no longer own. So we have got experience in this submarket. This particular development 350,000 feet, but we are shooting for the 100,000 square foot tenant. That’s sort of our target market. So we think that this building will get leased to three to four tenants, possibly more. We are in the process of getting our permits. We will begin construction on this sometime in the first half of 2014 with the idea having this online in 2015.
First Pinnacle in Dallas, this is a two building project, 220,000 square footer and a 370,000 square footer. This is land that we have had on balance sheet for sometime. And we have been waiting for the right opportunity to develop it. Dallas as a whole as I mentioned, the vacancy is still below 7%. The Pinnacle submarket, likewise, the vacancy has gone to approximately 8% now. So we feel like the timing is right. Our target tenant on this is approximately 150,000 feet. The buildings really work for anything from 100,000 to 200,000. So we are consciously not competing in the big box market, the 400,000 to 500,000 square foot market. That has always been the market in Dallas and in most markets that gets overbuilt the quickest. So we are really aiming more for the infill tenant. The bulk of our portfolio in Dallas is in the GSW submarket. And this is just east of that. So you can see from the map, Pinnacle is – it’s an infill market. This site is just south of I-30. GSW has performed very well over the last year and Pinnacle has to – the vacancy in that market has gone from the high-teens down to 8% over the last 12 months.
Finally, one other piece of land that I will talk about we own 100 acres in Nashville. We presently have no plans to build spec on that, but this is a market that we have extensive experience and we’ve done a lot of development in Nashville. We currently own the building in the Northeast corner of the site the (indiscernible) building. We just renewed that tenant for seven years earlier this year. We previously built those two buildings you see on the right-hand side of the screen, we no longer own those, but this is a market and a submarket, we’ve got a lot of experience in Nashville have seen some good build to suit activity and we are hopeful to get a build to suit their sometime soon.
So, in conclusion I mentioned our two vacancies, the I-94 distribution center that’s fully leased, Rock Creek where we’re still looking for tenant and then Rust-Oleum that’s under construction so, that’s the additional cash flow that we see from the central region.
And with that, I’ll turn it over to my colleague, Jojo.
Jojo Yap - Executive Vice President, West Region and Chief Investment Officer
Thanks, David. Before I cover the top cash flow opportunities in the west, what I do is just give you a brief overview of the region and some of the opportunities and challenges that’s it is facing. So, page 67 please. So as you can see here the western region covers Denver, Phoenix, Salt Lake City, Southern California, and Seattle. Occupancy has improved in Denver, Southern California, and Seattle. In Phoenix, it’s like the lag last year, but that is due to one vacancy and it is one of the top cash flow from opportunity that let, which I will discuss and Salt Lake has been a bit flat.
If you look at the total rental income, western region contributes $54 million, which is roughly 20.8% of rental income for FR and also here you can see the Southern California $25.2 million is the largest market for FR, representing 9.7% of total rental income. And if we finish and lease First Bandini, First 36, and First Figueroa Logistics Center on those developments Southern California upon lease of all those, Southern California will represent12.5% of total rental income.
By product type, basically Southern California and Phoenix is primarily warehouse distribution, just a little bit more live industrial influx in Denver and Salt Lake. Moving on, just quickly on challenges and opportunities in Denver just been a strong resurgence of midsize to small tenant activity and that is driven really by above average in migration of businesses, population and an above average housing recovery. We expect that to continue. So look forward to more activity from midsize to small tenants. One risk in Denver is it’s heavily reliant in energy and federal government.
Moving on to Inland Empire. The opportunities in Inland Empire are best and by this primarily driven by the inbound containerized throughput through port of the LA and port of Long Beach. That has created a lot of net absorption and growth absorption demand in the Inland Empire. Continued supply chain reconfiguration by a lot of companies where there 100% e-commerce or partial e-commerce is affecting activity both in expansion side and consolidation side in Inland Empire.
Today, we feel the market is an equilibrium Inland Empire because we expect anywhere from about 13 million to 17 million square feet of net absorption versus a construction – under construction pipeline right now were about 12.3 million square feet of which, 25% is committed. So in summary, your supply today in Inland Empire is about 9 months to 10 months net absorption depending on what report to review. Not but we’re also very mindful of the construction coming online especially for over 500,000 square feet.
Moving on to LA, very, very in-fill market, one of the most in-fill markets in the U.S., very, very low vacancy averaged about 2% to 2.5% depending on which submarket you’re at. We think that’s going to drive rents as the economy grows especially Southern California. The biggest challenge in LA is that it’s a very, very hard to invest, it’s a tough choice for every type of investor. Cap rates for new lease product is in the force while 4.5% cap so, the opportunities in LA are really limited to selectively development and targeted development that might include tear-downs.
Moving on the next page, on Page 69 now, I have two existing buildings – existing building cash flow opportunities which I’ll discuss. The first one is First Dominguez Gateway Center in Southern California. You will see this building hopefully if traffic cooperates with us today. Our goals we see this building. This building is located in the South Bay. It’s a very in-fill market – it’s the largest submarket in LA it’s over 200 million square feet and just one submarket, occupancy is about 90%, 97.7% inverse of 2.3% vacant market, very tight.
If you look at your lower left-hand corner map that green dot is a straight shot to port of Long Beach to the south through 710. That is what makes this location a very, very attractive to users. Moving on to your upper right hand corner that is an aerial shot of this building the building, this building is 213,000 square foot building well that, but if you look at the left building that is something that not a lot of properties have and it’s a very, very well sought after in LA, this exterior truck lot, that is a big truck lot and that’s very attractive. This building has been vacant for four months. We’re seeing a lot of activity primarily 3PLs and we move look forward, our job is to get a lease and announced to you when it gets done and the cash flow opportunity here is about $2.4 million.
Moving on, the next existing building cash flow opportunities in Phoenix, it’s a 98,000 square foot vacancy on page 71 by the way for those to the web, 98,000 square foot opportunity and 197,000 square foot building. The building is a very nice – has a very nice curb appeal, it’s cross dock. It has modern features. It’s also located if you look at the map, it’s also located in a southwest part of Phoenix, which is the largest bulk warehouse submarket in all of Phoenix.
So if you are a warehouse distributor that’s where you want to locate. Now, despite the attractive features the building, the 100,000 square foot market in Phoenix has been soft and some – for some time, but now we’re seeing more activity and we hope to be able to announce at least soon. And this would represent about $0.5 million of additional cash flow opportunity. Now I’m going to go through now the additional cash flow opportunities, which is primarily development and future development.
So, let’s start off with First Bandini Logistics Center, which you will see also today is part of the tour, its 489,000 square foot, newly built building in the market of commerce Vernon. Commerce Vernon, as you may know whose anybody familiar with LA, it’s a very, very in-fill market, it’s about 160 million square foot submarket just straight shot from port of Long Beach along 710 freeway and it boost about 2.1% vacancy. This facility would be attractive to really any company who wants to upgrade their facility because there is virtually no new construction in the commerce Vernon submarket or those port related users. Our projected investment is $54 million and we’re projecting a 6.5% gap yield, like I mentioned to you, lease product in the Los Angeles area that would trade in the mid-4s cap rate. When we get this leased, we are expecting a $3.5 million additional incremental cash flow.
Moving on this is a building we have under construction in the Inland Empire, in Moreno Valley, which is very close to our building that we completed sometime ago, First Inland Logistics Center and subsequent to leased to Harbor Freight. It’s a 555,000 square foot building. We expect to get it completed second quarter next year. Inland Empire continues to be the preferred location for a lot of warehouse division users. Couple of things about this building, we added some features where we saw that there might be some customers and clients out there that might need some additional features in the building. It’s 36-foot clear, 8-inch floors, which means that it could take little bit more loading and it has very, very – it has above average auto parking and trailer parking as well. You will also see this in the tour today.
Moving on to First Figueroa Logistics Center, on Page 75, this building will be – is under construction as well. It’s a 43,000 square foot building in the heart of South Bay. As you can see in the map, this is very, very close to LAX and it’s also very close to 110, which is a straight shot to Port of LA as opposed to 710 freeway straight shot to Port of Long Beach. So we hope to attract those tenants who would want to be really proximate to those LAX or Port of LA. Our projected investment is $9 million. The estimated gap is slow at 3.6%, because we bought the land at the peak. The incremental yield or additional dollars is about 6.7%. And we hope to complete – we plan to complete the building third quarter of next year and this was – we expect this project to contribute $300,000 to the bottom line per year.
The next, you will also see this in the site, the next, I am on Page 76, I am now going to talk a little about the land we acquired in Moreno Valley. If you look at your slide, you will see the right in the middle is Harbor Freight Tools that is the tenant who is occupying the building we build that we call First Industrial Logistics Center. That’s a 691,000 square foot building that we developed years ago and to the lower right hand corner of that building is the excess truck lot that we built for them as well. This site as you can see is outlined in yellow on the lower left hand side of that picture again Page 76. Now, we – this site could accommodate as much as 1,368,000 square foot building. And initial designs would allow us to build a building with significant, significant functionality.
Let me just quickly give you some stats, 225 docks, 590 trailer stalls, 360 car parking and the truck depth on both sides span from 240 feet to 295 feet. Once we build this, there will be very few buildings that will boast these physical characteristics. Now, one thing I also want to point out is that, there is recently been a quite a bit of activity on the million square foot side. If you look at the upper left hand corner of this area that site and that is now going to be completed in about another six months. Amazon.com just recently announced they are going to take 1.2 million square feet of that building. For people in the room, I would point this out. Within less than a mile radius, Procter & Gamble also has a 1.4 million square foot built to suit.
To finish up just to give you an overview on the large buildings here, Haines, Whirlpool, Ross Department Stores, Lowe’s Home Improvement and Harbor Freight, all are tenants that have significantly space over 1 million square feet. Last point, I want to make on this – on the slide is that, it’s very hard to find large piece of land in the Inland Empire and we acquired this land site through a land assemblage. It took us nine months to acquire this site. We went directly to 11 different sellers and through 12 separate contracts, we basically negotiated a deal in over nine months in over 30 contract modifications, got it closed.
And the only way you can do this is if you have boots in the ground and boots in the ground and then local, basically local market expertise. Why do we do that, because we are really focused on our return on invested capital. By acquiring land at attractive basis that will help us achieve higher return on invested capital. In terms of just value creation at work, I will mention to you that there is – that we have this, there is just this site, just south of our First 36 site. We just traded – we just traded recently in the $10 square foot range. Our basis in our land, which could build a slightly larger building, is in the mid-5s. Now, we are not merchant sellers, but I just wanted to give you a sense on why we do the things we do, for example, land assemblage.
This is a – we are now at Page 77, First Center Logistics Center potential expansion. We just want to let you know that you know that we acquired a site north of this truck lot that is within the Harbor Freight, adjacent to the Harbor Freight Tools building. And here we can either build a truck lot, we can either build 188,000 square feet and right now we are under entitlement for a 394,000 square foot building. So we can give Harbor Freight some future expansion. Of course, this is dependent upon their approval and their needs.
Just to finish off, the last cash flow opportunities that we have a 70-acre site in Stockton, that is very well-located. Stockton is in the Central Valley and it is a very good distribution, an attractive distribution location for companies serving Northern California. Here we have the ability to build a 1.2 million square foot building. And at this point, we are getting approvals to get the site ready. We are working through the City of Stockton and that could take a bit of time.
So in summary, Page 79, the Western region has approximately $8.9 million of cash flow opportunity and that excludes First Nandina, the potential expansion for First Inland Logistics Center and the Stockton land. At this point, I want to turn it back to Bruce.
Bruce Duncan - President and Chief Executive Officer
Thanks, Jojo. Alright, so we had a chance to sort of go through this and see what the opportunity is. I am here to sort of wrap it up and sum up what we think the opportunity is for First Industrial. Basically, we think this is an opportunity to really significantly increase our cash flow over the next four years. We have talked about it, heard about it today. Scott went through the balance sheet opportunity with that what that means to us for $10 million potentially. Bob talked about the small tenant opportunity, the bumps that are embedded in the leases and the ability to reduce expanses as we stabilized occupancy in terms of lower TI leasing commissions and capital expenditures. Peter went through the opportunities in the East $6 million to $7 million; David in the West I mean, in Central $5 million to $6 million; and Jojo in the West of $8.5 million to $9.5 million. So it totals $52.5 million to $68.5 million. And that’s really Bob pointed out is talking about any increases in rental rates, because when you look at supply and demand, you really think things are pretty good and we should do better than that. That’s the opportunity and we as a team have to deliver on that.
So when I look at it and I say our AFFO today at $0.65. If we can hit this and achieve this and were to get the $0.46 to $0.60, that’s a big – it’s pretty good growth. And then we look at that growth in context of how we trade today vis-à-vis, our peers because I think that’s – what’s really important in terms of right now even with the what we’ve done over the past few years to close the valuation gap, there still remains a big valuation gap between First Industrial and our industrial peers.
This chart shows as of October 31, this is on Slide 83, First Industrial versus a couple of our peers, but this is as of October 31 when our stock is trading at $18.07 a share, today this morning I check I think it was down like $17.10 which in terms of the opportunity, it’s a greater opportunity today than what was October 31. But if you look at today at our $17.10, the cap rate down about – it’s probably 6.8% cap rate. I – we think that’s good value. We think more importantly, we think we have good growth and when we combined the two, we can execute on that. We should be able to deliver good value to our shareholders. Again you are the experts, you do this every day, you know what – how you compare and contrast everyone and he would compare and contrast what the opportunity is, but for us as we look at this, we think First Industrial is interesting today.
We think in terms of the growth we have embedded in our portfolio. We think about what we’ve done to reconfigure the portfolio and you look today you will get – see some of the developments we’re doing and some of the potential developments. We have a great opportunity here. So I am going to leave you with what the focus is so, when we get together in our next investor day what we said we’re going to do. And again the program is continued relentless focus on leasing in operations, we want to get the first – the first one we get the 92% by the end of this year.
As we said we were going to do the goal back and we did Investor Day in November 2011. But we want to get the plus or minus 95% by the end of 2015 and grow rents bring down our capital expenditures in TI leasing commissions continue again the relentless focus on customer service. The balance sheet again maintained a conservative and flexible balance sheet as Scott talked about we love having the excess capacity we have with our (indiscernible) line. We love the opportunity of getting to investment grade as soon as we can because again there is a great opportunity to lower our cost and we want to optimize our cost of capital.
And on portfolio management again more of the same has done a good job operating the portfolio, but we will continue that with selective acquisitions. A continued focus on development because again we focus on that over the last two years because we think our risk-adjusted basis does two things, how to upgrade the portfolio get the product we want and the markets we want and we think returns are pretty good, but again it’s up to us to build these projects on time, on budget and get them leased up on our ahead of pro forma. And again addition by subtraction, keep weeding out the bottom part of the portfolio that we’re making good progress. In all of this in terms of this increasing cash flow gives us the ability to grow our dividend in line with the sustainable cash flow. That’s the goal that we’re focused on and we look forward to taking your questions. We look forward to doing the tour again.
So with that, I’d like to ask my partners to come up here and we’ll open it up for questions. So thank you.
Thanks. Great presentation. Just very quickly just regarding some of the targets for the increase in targeted occupancy for R&D/flex, how much of that might come from addition through subtraction, your potential sales, it is what you talk while you’re on that topic, I know you’ve referred to an 8 million drop in TIs etcetera, how much of that drop might also come from the same process? Thanks.
Good question. The question you have to – Bob, I’ll refer it to you, but in terms of some of it will come from sales, that is we will – as we said a couple of years ago, we’re going to reduce our focus on flex and we done that in certain markets particularly Dallas reduced by little bit. Bob, do you want to add to that?
Yes, on the R&D/flex question, I would say that we’ve seen a pretty remarkable recovery in that asset class in a variety of markets across the country. From a new construction perspective, you’re really seeing no construction of flex R&D product. So, we’re really focused on just a lease up aspect of it, now clearly as a side bar, we will continue to focus on downsizing for the purposes of that exercise we’re focused on lease up, one market and actually couple of markets to think about in Denver R&D/flex inventory is about 94% lease and we’d likewise seeing some very good growth in markets like Tampa as well as Minneapolis. So we are bullish on it, but at the same point, we realized over time we want to downsize and focus on the regional bulk and light industrial aspects of the portfolio. Question?
Just too quickly follow-up on that, actually on Page 31, it says that your target occupancy in R&D/flex doesn’t assume any sales?
Our targeted occupancy to get to the 95% plus or minus some of that will come from sales.
Okay. Alright, and I found interesting the $5.5 million of vacancy as of September 30, 2013 that 75% of that will leased on the end of 2008. How about the remaining 25%? Has that been leased in the past five years or is that where I would maybe consider structural vacancy in your portfolio?
I would say that over the last five years, if you look at that 1.4 million, less than a 0.5 million square feet has been not really leased over that period of time the balance has been. And clearly there is some ins and outs in that inventory, but if you look at here, to answer to your question specifically plus a 0.5 million feet.
Okay. Now last question have you look at overall portfolio given where market rents are market-by-market, where your mark-to-market would be?
Given in terms of mark-to-market, we haven’t look at that but again we were going to be giving guidance next year, I mean, in fourth quarter for what we see for 2014, but as Bob pointed out what we tried to point out in this presentation sort of like where rents were prior to 2009 and then subsequent 2009 and what they were at the peak so, again we think there is an opportunity therefore, we’re not – really we don’t have a mark-to-market.
Just to clarify, your $0.45, $0.46 to $0.60 of cash flow growth that you bring out in the first two slides that have include any upside from mark-to-market, is that correct?
Yes that’s just taking today’s rent. Bob, you can go through that.
It clearly is just those opportunities that we laid out. And then as Bruce pointed out, it’s not counting any growth from increasing rents.
Just a follow-up on the mark-to-market not included with occupancy assumption then we get to 95%, just curious to kind of philosophy of really aggressively pushing rents versus just continuing to push occupancy in kind of what you’re telling the different teams.
I’d say, it depends on the product and depends on the – it’s really market-by-market in terms of asset-by-asset. For instance – but as we’ve been that stands before as the occupancies are going up in the markets, it’s change in terms of the dynamic of people thinking in terms of the pushing rents. Certain product, we really are making a conscious effort, not the lease at a rent that we don’t think it’s appropriate given that asset because once you lease that your leasing up five years or seven years, we lose that opportunity and certainly even though you might be able to fill it today. We think the assets too good to fill at that lower rates so, we’re waiting to pushing, trying to get that rate up.
How is your current 55% payout ratio of AFFO for the dividend compared to your taxable income and then going forward through 2017, how should we expect taxable income to trend in terms (indiscernible).
Sure. If you look at 2013 as of the third quarter, our preferred and common distributions exceeded taxable income, the wildcard that you have is property sales whether those are gains or losses. I think we have a fair amount of cushion in 2013 to handle that clearly on a go forward basis with the opportunities we have in there, there is going to be an increase in taxable income. Keep in mind though we do have about $62 million of net operating losses that we could use to help against say one-time items such as gains on sales and things like that.
Okay. On Page 15, we have the most recent buildings that are being completed or have been acquired. Can you give us the first year cap rate on the incoming for the first year I see you have the GAAP yield here and how much capitalized interest and capitalized leasing commission do we have in the total construction cost?
Scott, you want to do that?
Yes. So on Page 15, the yields are GAAP yields, so basically what it assumes is in the basis capitalized interest up into the point that the building has been completed. If you ran capitalized interest out up into the lease update, which in our case it’s a one year pro forma, it will drop these yields a little bit if you look at it from that point of view. Yes, so the GAAP yield is the assuming what a five-year lease or is that the actual first year in cash.
About your credit ratings, as you start pre-leasing some of these development deliveries, do you anticipate getting credit by the rating agencies in terms of your metrics?
We will definitely get credit from the agencies. It will only drive our fixed charge coverage higher on our debt and preferred stock ratio lower. So we will definitely get credit from the agencies. Our job – Bruce and my job, when we go and meet them is try to get credit before they lease up. So we will try to continue to do that, but definitely when we get lease up, it’s going to help our ratios and our drive to get to investment grade by the end of ‘14.
How sustainable is 95% occupancy given your history?
I think, again, I would say that given the portfolio, I think it’s – that’s why we said plus or minus 95%, whether it’s 94.5% or 95.5%, I think it will be around that neighborhood. I think if you look at see what some of our peers are today, they are near that or at that level. So I think we can do it. And again, that it’s going to be a combination, there maybe some asset sales to get to that number.
In your last Investor Day you mentioned how much of the portfolio was considered non-core and which you want to sell over the next couple of years and what’s that amount now?
I would say that in terms of this year, again, the goal itself $75 million to $100 million of assets, I think in terms of we will have moved out that portfolio within the next couple of years, but again, asset management is an ongoing process. So we will continue to recycle capital if you will and continue to upgrade the portfolio in different markets by adding and selling the assets.
Bruce Duncan - President and Chief Executive Officer
Alright. Well there are no other questions. Again, we appreciate it very much. For those of you on the bus trip, we are going to have plenty of time to talk and answer any questions you have. For those of you that aren’t very – after the bus if you have questions please contact Art, Scott or myself and we’d be happy to answer them. We appreciate very much those of you here in person and we appreciate those on the webcast and again we look forward to our next interaction, which maybe tomorrow in San Francisco. So thank you very much.
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