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Eastgroup Properties, Inc. (NYSE:EGP)

Q1 2014 Earnings Conference Call

April 17, 2014 10:00 am ET

Executives

David Hoster – President & Chief Executive Officer

Keith McKey – Chief Financial Officer

Analysts

Jamie Feldman – Bank of America

Kevin [Behrn] - Citi

[Van Suttleton] – Morgan Stanley

Andrew Schaffer – Sandler O’Neill

Brendan Maiorana – Wells Fargo

John Guinee – Stifel Nicolaus

Brandon Cheatham – SunTrust Robinson Humphrey

George Auerbach – ISI Group

Eric Frankel – Green Street

Bill Crow – Raymond James

Operator

Good morning and welcome to the Eastgroup Properties Q1 2014 Earnings Conference Call. (Operator instructions.) Now it is my pleasure to introduce David Hoster, President and CEO.

David Hoster

Good morning and thanks for calling in for our Q1 2014 conference call. We appreciate your interest in Eastgroup. As usual Keith McKey, our CFO, will be participating on the call. Since we will be making forward-looking statements today we ask that you listen to the following disclaimer covering these statements.

Operator

The discussion today involves forward-looking statements. Please refer to the safe harbor language included in the company’s news release announcing results for this quarter that describes certain risk factors and uncertainties that may impact the company’s future results and may cause the actual results to differ materially from those projected.

Also the content of this conference call contains time-sensitive information that’s subject to the safe harbor statement included in the news release that’s accurate only as of the date of this call.

David Hoster

Thank you. Q1 was another productive one for Eastgroup. Funds from operations of $0.82 per share exceeded the upper end of our guidance range and represented an increase of 7.9% as compared to the same period last year. We have now achieved FFO per share growth as compared to the previous year’s quarter in 11 of the last 12 quarters.

Quarter-end occupancy was again above 95%. Same property cash operating results were positive for the twelfth consecutive quarter and our development program increased to 21 buildings with over 1.8 million square feet. Occupancy at March 31st was 95.1%, our third consecutive quarter over 95.0% which exceeded our internal projections by about 100 basis points. We expect occupancy to slip slightly below 95.0% in Q2 and then finish Q3 and Q4 above that level.

At quarter-end our California markets were our best at 97.9% leased followed by our Arizona markets at 96.7% and Texas at 96.5%. Houston, our largest market with over 5.8 million square feet was 97.5% leased. Leasing activity continues to be good in all our markets from both organic growth of current customers and new prospects to the market and we see no reason for this to change over the foreseeable future.

In Q1 we renewed 78% of the 1.4 million square feet that expired in the quarter and signed new leases on another 8% of the expiring space for a total of 86%. We also leased 265,000 square feet that had either terminated early during the quarter or was vacant at the beginning of the quarter. In addition we have leased and renewed 267,000 square feet since March 31st. Between now and the end of the year we have only 2.2 million square feet, or 6.8% of the portfolio, scheduled to expire.

For the quarter GAAP rent spreads on renewal leases were up 8.7% and down 0.9% on new leases. Cash rent spreads were down 0.4% on renewals and down 6.1% on new leases. Combined, GAAP rents were up 6.2%, the same as in Q4, and cash rents were a negative 1.9%. GAAP rent spreads on renewal leases have now been positive for eight consecutive quarters, a strong trend with a weighted average lease length of 4.4 years, a slight decrease from the previous two quarters but well above our recent averages for the past several years. This probably respects prospects’ growing confidence in the economy.

Tenant improvements were $1.35 per square foot for the life of the lease, or $0.31 per square foot per year of the lease, which is below our recent average. The average amount of tenant concessions continued to decline slowly but leasing commissions remain elevated in most markets. As a result of our continued strong occupancy, Q1 same property operating results increased 1.2% on a cash basis and 1.4% on a GAAP basis with straight line rent adjustments.

During the quarter we significantly expanded our development program to take advantage of improving market fundamentals and increasing demand for new state-of-the-art industrial space. We began construction of eleven buildings containing a combined 894,000 square feet with projected total costs of $65.1 million. Four buildings are in three different submarkets of Houston, two are in San Antonio, two in Phoenix, two in Charlotte, and one in Orlando.

Also during Q1 we transferred three properties to the portfolio – Chandler Freeways in Phoenix, Steel Creek I in Charlotte, and 10 West Crossing III in Houston. They contain a total of 265,000 square feet, have a combined investment of $19.5 million and are 100% occupied.

In addition, at the end of the quarter we acquired 29 acres of land in the North DFW Airport submarket of Dallas for $3 million. It will support the future development of approximately 325,000 square feet in four buildings. In Charlotte we also have approximately 60 acres under contract to purchase for the expansion of our development program there.

During the balance of 2014 we hope to begin development of at least an additional seven buildings with approximately 450,000 square feet and a total projected cost of over $32 million. We have not included any potential build-to-suits in these 2014 projections.

As of today our development program consists of 21 buildings with over 1.8 million square feet and a projected total investment of approximately $133 million. These buildings are currently 33% leased reflecting the large number of properties which were recently started.

In March we sold our 58,000 square foot North Pointe Commerce Center in Oklahoma City for $3.6 million which generated a small gain. North Pointe was our last remaining asset in Oklahoma. Over the balance of the year we expect to have additional property sales of approximately $10 million to $12 million. We did not have any operating property acquisitions in Q1 but we currently have an asset in Charlotte under contract to purchase for approximately $15 million.

Keith will now review a number of financial topics including our earnings guidance for the balance of 2014.

Keith McKey

Good morning. FFO per share for the quarter was $0.82 compared to $0.76 for Q1 last year, an increase of 7.9% and was $0.02 above the midpoint for our guidance. The increase was primarily due to higher property net operating income from occupancy gains and lower G&A costs from capitalization of costs because of increased development activity. We calculate FFO in accordance with the [narrow rate] definition.

Debt to total market capitalization was 31.3% at March 31, 2014. For the quarter the interest and fixed charge coverage ratios were 3.8x, the debt to EBITDA ratio was 6.5x and the adjusted debt to EBITDA was 6.1x. These debt metrics were similar to those for Q1 2013. Our bank debt was $99 million at March 31st and with bank lines of $250 million we had $151 million of borrowing capacity at quarter-end plus the accordion feature on our bank line.

Our continuous equity program continues to provide timely equity funding. We sold 321,645 shares in Q1 for gross proceeds of $20 million or $62.18 per share. In February we increased the shares available to sell in our continuous equity program and have provided a schedule detailing our equity program in the supplemental package.

Also in March Moody’s affirmed Eastgroup’s issuer rating of BAA2 with a stable outlook. In March we paid our 137th consecutive quarterly cash distribution to common stockholders. This quarterly dividend of $0.54 per share equates to an annualized rate of $2.16 per share. Our dividend to FFO payout ratio was 66% for the quarter. Rental income from properties amounts to almost all of our revenues so our dividend is 100% covered by property and net operating income. And we believe this revenue stream gives stability to the dividend.

We have increased the midpoint of our FFO guidance for 2014 to $3.44 per share. This is a 6.5% increase compared to 2013 results. We released a correction on same property NOI cash guidance. We had 2.0% and the corrected amount is 2.6%. We apologize for the error.

Earnings per share is estimated to be in the range of $1.20 to $1.30. And now David will make some final comments.

David Hoster

Thanks, Keith. As I stated during last quarter’s call this is a good time to be in the industrial property business, and that should not change for the foreseeable future. In addition given our strong, flexible and conservative balance sheet we believe that we are well-positioned to take advantage of the increasing opportunities in this improving environment.

Keith and I will now take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions.) We’ll go first to Jamie Feldman with Bank of America.

Jamie Feldman – Bank of America

Great, thank you and good morning. I’m hoping you can talk a little bit more about the new development projects that entered the pipeline this quarter – just a little bit more detail on each of them, what gives you comfort in getting started spec; and then also just bigger picture on where you think we are in the development cycle concerning potential excess supply risk.

David Hoster

First of all, let me remind everybody that traditionally we have been a spec builder – and if you look back at what we were doing really as we grew our development program from about 2000 up through 2008 almost every one of those buildings was built spec; and we project a 12-month lease-up as part of our pro forma in presenting pro forma yields. I don’t think that should be viewed as unusual. We’ve just been spoiled over the last couple of years with the amount of preleasing during construction and the number of build-to-suits that we’ve been able to sign up both the 12 and 13.

Usually most of our developments are subsequent phases in existing parks, or new parks that are reasonably close to where we’ve just finished development. So I’ll start on the Q1 starts and try not to give too much detail to eat up too much time, but Steel Creek III in Charlotte, that was some preleasing for a tenant. So we started that building and because of the leasing activity we have in II and III we have announced the start of Steel Creek IV, a small building that’s just the next phase in that park.

10 West Crossing VI out in Katy, Texas, outside of Houston, again this is the amount of leasing that we’ve done in the first five buildings convinced us it was time for us to start that additional 64,000 square foot building. World Houston 41 is a front park rear-load building and our spec was Houston 37 which is a similar-type building is now over 80% leased, so a good reason to start the next building and not be without any front park rear-load space.

[Karim I and II] are in Chandler and very close to the Chandler Freeways that we finished last fall and leased before it was done, so we thought again it showed the strength of that market. West Road I and II are in Houston just off Beltway 8, and as we have finished up our Beltway Crossing and have it 100% leased this was just the next phase. And we’ve been pleased with the activity, the leasing interest even though we haven’t even tilted the walls on that building.

In San Antonio, Alamo Ridge I and II are on the west side of the city where we own two parks that have had good leasing activity and we thought that there was demand to do some spec building there. Nobody else is building our type building or anybody even building in that submarket. Horizon II in Orlando, we haven’t signed any leases at Horizon I but have had very good interest in that building. It’s 24 clear; Horizon II is 30 clear. We have a prospect who signed a lease for a third of the building that they needed to have a 30 clear and that gave us reason to kick that one off.

So a quick review of what’s going on with those developments. The fact that we’re not higher leased as I mentioned in my remarks is most of these buildings don’t even have the walls tilted yet. So but we’re pleased with the progress we’ve made.

As to how we view the markets, Houston is the only market where we’re building that there’s any significant competition and it’s certainly occurring there. But we think the strength of our locations, the quality of the buildings, our reputation, and probably most importantly the amount of absorption in the market shouldn’t restrict us in terms of being able to lease these buildings in the pro forma 12 months or obtain or be close to the yields that you see in our supplemental data.

In our other markets there’s maybe only one or no other developers building like Charlotte, San Antonio, and Orlando. So I think we’re a long way off from too much supply being an issue. And I’ve used the baseball analogy – maybe we’re in the middle innings in Houston except that that could go into extra innings the way the strength of the market is with all the extra statistics on that city’s growth. And in the other markets we’re only in you know, the second or third inning at best. So hopefully that’s a long-winded answer.

Jamie Feldman – Bank of America

It’s very, very helpful, thank you.

Operator

And we’ll go next to Michael Bilerman with Citi. Your line is open.

Kevin [Behrn] - Citi

Good morning, this is Kevin [Behrn] with Michael. What do you see in the build-to-suit pipeline? How are discussions trending with potential clients?

David Hoster

We’re seeing now more interest in build-to-suit or preleasing in Orlando and San Antonio and a little bit less in Houston at this point. I think maybe there’s less need for it in Houston given the amount of new construction. And as I’m talking about Houston I think the thing that’s very different about Houston in this cycle than in previous cycles is the developers are doing much bigger boxes and they’re leasing. When I say “bigger,” a big building in Houston historically has been 250,000 square feet or greater and those have leased, and there’s supposedly prospects out there for buildings of that size and bigger. So Houston, the range of what to look for in that market has expanded significantly in this cycle.

Kevin [Behrn] - Citi

Okay, thanks, and then just one last question. With more and more investor demand for industrial assets how much competition are you facing when looking at deals, and also how is this impacting valuation?

Keith McKey

There’s no question that in the acquisition market there is a tremendous amount of demand that is not being met by the supply of properties and core A properties for sale. Institutions are all complaining that they’re under-allocated to industrial and as a result the cap rates remain close to historic lows or at historic lows – I would say they’re probably at historic lows in Texas anyway. And I’ve heard that most of these investors don’t want to come off the core assets but they’re starting to go to some of the secondary or a few of the secondary markets in order to get core assets.

I’ve been told by brokers that the volume of transactions was down in Q1 compared to last year but that they expect that to catch up in subsequent quarters, although I don’t think there’s any way in the world that the demand is going to be met through more assets coming to market. So I would expect cap rates to remain at the current low levels for the foreseeable future. So that as a result makes it harder for somebody like us or anybody to buy in especially some of the very hot markets like a Southern California.

Kevin [Behrn] - Citi

Okay, thank you.

David Hoster

Thank you.

Operator

And we’ll go next to [Van Suttleton] of Morgan Stanley. Your line is open.

[Van Suttleton] – Morgan Stanley

Thanks, congrats on the solid results. Just sticking with development for a moment, is there anything you can point to that made you want to pull the trigger on getting a bit more aggressive in development starts this past quarter, in particular when the improving fundamentals have been with us for some time now? Did you see anything really incremental on the demand side over the winter that made you want to really ramp up the construction?

David Hoster

A couple of things. I’d say one is as you mentioned the fundamentals continue to improve in all our markets and we obviously run the numbers on a pro forma of what kind of rent it takes to be building to achieve the yields that we’re looking for. And as rents start to move in these different markets those numbers work better than they would have in the past.

Secondly, the leasing that we’ve achieved in some of our existing parks like World Houston or Beltway Crossing or 10 West Crossing in Katy, we don’t want to be sitting there without any available product . And so as a building leases and we build confidence in the market we start a new building. If you go back to just coming out of the recession we were looking to be two-thirds of 75% leased to start a new building; now we’re looking probably 35% or 40% leased to start the next building just to keep properties in the pipeline. So it was a lot of different factors.

[Van Suttleton] – Morgan Stanley

Okay, that’s very helpful. And then shifting to the pricing side can you give us your sentiment on the relatively high lease expirations coming up next year in 2015? Do you view that as almost pure opportunity on pricing? Is it something that gets you excited? Or is there a significant portion that dates back to the last cycle and could be rolled down?

David Hoster

To be honest with you I’m still worried about ’14. A lot of the ’15 terms are going to be at the end of the year so we’ve got plenty of time to deal with those, and we actually have also started talking to a number of the larger ’15 rolls to move those farther out. So but obviously we’d like to have those roll in an improving market. So we’re optimistic on what we’ll do with them but it’s way too early for us to start to look at what kind of benefit that’s going to give us.

[Van Suttleton] – Morgan Stanley

So the US Postal Service expiration, speaking of 2014, do you think you have a good chance of renewing with them?

David Hoster

Well, we’ve already renewed I guess in the last six months the two biggest Post Office leases and it’s my understanding that we have come to terms on both of the smaller ones in Tampa – the documents just haven’t been signed yet.

[Van Suttleton] – Morgan Stanley

Okay, thanks a lot, David.

David Hoster

Thank you.

Operator

And we’ll go next to Andrew Schaffer with Sandler O’Neill. Your line is open.

Andrew Schaffer – Sandler O’Neill

Thank you. Continuing with your baseball analogy what inning is EGP in with regards to the size of (inaudible) pipeline and should we expect it to peak in ’15 and then begin to moderate?

David Hoster

Again, that’s getting ahead of us. It all depends on leasing. I will suggest that you shouldn’t annualize what we did in Q1. So it all depends on leasing, and for us if the leasing goes strongly on what’s under construction now or that’s just been finished we’ll do more than $100 million in starts this year. If it goes a little bit slowly we won’t. And again, so much as I said before, of what we do is based in existing parks. So if a building leases we build the next one.

In World Houston we look at it even more specifically on whether it’s a front park rear-load or a cross-dock, and we want to have both of those type of facilities with new first generation space available. So it’s a little early to suggest what’s going to happen in ’15.

Andrew Schaffer – Sandler O’Neill

Okay, and then when you look at the leasing levels at the expected sites are there certain ceilings you have or internal controls that you kind of monitor in terms of total construction costs as a percent of assets or enterprise value?

David Hoster

Yeah, we have but we’re not even close to that. Before the recession we had one year where we were a little over $120 million in starts and we’re a bigger company today than we were then. So rather than a hard line that you either cross or don’t cross it’s all a combination of what’s going on in the markets, what the fundamentals are, what we are doing with our assets in the parks where we want to build and what we see as happening with the overall US economy. So there’s too many other factors that we slowed down not because we had a line or a ceiling; we slowed down because we saw the markets were starting to come apart.

Andrew Schaffer – Sandler O’Neill

Okay. And secondly, in regards to rent trends for development is it safe to assume that in certain markets costs are increasing the rate at which you’re seeing your rent pro formas grow, and has that made you table certain projects in these markets that you were expecting to start earlier this year?

David Hoster

There’s no question that construction costs are going up, and this is shell construction costs. It’s 4% to 5% there. In Houston just because there’s so much construction of everything from highways to office buildings construction costs last year were up 3% to 4% and already this year probably up another 3%. But with the land inventory we have and the increase that we’ve had in rents, and the fact that shell construction cost is only about 50% of your total cost of a development, construction costs have not been a limiting factor yet. Hopefully it’ll be for some of our competition.

Andrew Schaffer – Sandler O’Neill

Okay thanks, that’s it from me.

David Hoster

Thank you.

Operator

And we’ll go next to Brendan Maiorana with Wells Fargo. Thank you, please go ahead.

Brendan Maiorana – Wells Fargo

Hey, good morning guys. Probably the question, the first for David: the seven development projects that you expect to start later this year, are some of those in markets where you don’t have a development today – like in Dallas or Tampa?

David Hoster

The only one where we’re not already developing would be Tampa. We have two locations in Tampa – one, our Madison Land and not too far further south our Creek Land. And we would hope to, with a little bit of good movement of rents in Tampa be able to start a couple buildings in Madison.

Brendan Maiorana – Wells Fargo

And the land that you picked up in Dallas, is that not ready to commence development on or is it that you feel like with the market you’d rather be a little more patient?

David Hoster

No, we will be going full speed to, we already started a layout of the – there’s a bigger parcel and a smaller one, the layout of the bigger parcel where we would put three buildings, two rear-loaders and a front-loader. And we’ve not put that in our projections because we first finish the layout, design the buildings, get them permitted. So with a little bit of luck those could be a late ’14 start but right now they’re an early ’15 start in our mind.

Brendan Maiorana – Wells Fargo

Okay, that’s helpful. And then I think you mentioned that you’ve got some land in Charlotte under contract, I think you said 60 acres. Is that the parcel that’s adjacent to your existing Steel Creek project?

David Hoster

Yes, it’s a series of parcels.

Brendan Maiorana – Wells Fargo

Okay, great. And then just the last question for Keith, on the guidance – so you hit $0.82 in Q1, the midpoint of your guidance is $0.84 for Q2. Just to kind of get to the midpoint of the full year guidance suggests that you’re $0.89 a quarter in the back half of the year. It doesn’t sound like occupancy is ramping that significantly. You’ve got more development spend but you’re also issuing some capital or some equity on the ATM. So what drives the big increase in the back half of the year? It doesn’t seem like there are that many moving parts that would drive a $0.05 incremental increase from Q2 to Q3 and Q4?

David Hoster

Well, I’ll jump in on this because most of it would be from operations where as I said in my prepared remarks that we’re probably going to drop dawn again. This is budgeted from our pro forma data about 94.5% in Q2 and then work our way back up to over 95.0% for Q3 and Q4. Also we’ve got some acquisitions built in and we’ve got development assets that’ll be coming into the portfolio – I think World Houston 40, 10 West Crossing V that are both 100% leased will come in mid- or end of Q3. So that’s where we see the improvement, well, the improvement on a quarter-to-quarter basis but just overall operations.

Brendan Maiorana – Wells Fargo

But there’s nothing sort of unusual that would cause Q2 to maybe be lower than what you would expect in the back half of the year, like margins or higher G&A or something like that?

David Hoster

No, it’s lower occupancy and like I say development properties that are under development today that are already 100% leased. So when they come into the portfolio in Q3 it gives us a nice little pop, plus as we say we’ve budgeted some acquisitions for Q3 and Q4, which are hard to predict but we figured we had to put something in there because we have managed to buy every year for as far back as I can remember.

Brendan Maiorana – Wells Fargo

Yeah, understood, just a point of clarification. So the under construction stuff, the things that are pre-leased I understand that those things are going to come in and contribute. In the guidance the projects that are under construction where the completion date is later this year, but the stabilization date or conversion date isn’t until next year, there’s not a presumption of lease-up of those assets and significant NOI contribution in guidance. Is that correct?

Keith McKey

No. What we show on our development summary is what’s in our guidance – they’re not two separate sets of projections.

Brendan Maiorana – Wells Fargo

Okay, got it. Okay, thanks.

David Hoster

Okay.

Operator

Thank you. (Operator instructions.) We’ll go next to John Guinee with Stifel. Your line is open.

John Guinee – Stifel Nicolaus

Great. Happy Easter. Just a sort of an ancillary curiosity question, David, if 29 acres in Dallas, $3 million – a shade over $100,000 an acre, I’m assuming that’s raw land. What’s your per FAR or per buildable to take something from raw land to get it pad ready; i.e., what’s your pad-ready land basis on something like that deal?

David Hoster

I’m going to have to look that back up, John, because it’s in our proposal to the investment committee and it’ll take me a minute to dig that out. That land we think we got for a very good price for a number of reasons. One is some of it is not usable so but we wanted to report the total acreage that we bought. Secondly that has been a market where there’s been a higher price on land where developers can do big boxes. It’s in [Flour Mound] and so the people developing up there have not looked for the smaller buildings which is what we do. So we think that’s a factor, and it was not heavily marketed, hadn’t been for a while. So we’re happy with the buy on it. As I say, we can talk later about the net with what the FAR is. I don’t have that with me.

John Guinee – Stifel Nicolaus

Alright, we’ll just chat next week. Enjoy.

David Hoster

Thank you.

Operator

And we’ll go next to Brandon Cheatham with SunTrust. Your line is open.

Brandon Cheatham – SunTrust Robinson Humphrey

Thanks. Most of my questions were answered but just following up on the development pipeline, are there any markets that are of particular interest that you expect to focus on going forward? And in the same vein, you mentioned Tampa might be an area that you focus on later this year – is that that you’re starting to see the market pick up, that market?

David Hoster

Yeah, slowly. Tampa seems to cycle. It was, through some of last year it was very strong, then it seemed to go actually slightly negative for a couple of quarters. Then in just the last 30 days it’s started to pick back up. And the way we look at it is for our size user. We would still like to be a developer in South Florida, in Broward or Palm Beach Counties so we continue to look for land there, and we continue to look for land in the existing markets where we’re building. You always have to be looking out ahead, so we’re looking in San Antonio, additional land in Houston; and we’re very excited about having an additional piece of land to build on in Dallas. And we’ll continue to look for additional sites for our type product in that large market.

Brandon Cheatham – SunTrust Robinson Humphrey

Okay. So you expect Houston might stay at similar levels today?

David Hoster

I would hope so, yes. As I say, we’re building in three different submarkets so it’s generally different type users because users decided where they want to go. And if they want to be out in Katy you’re not convincing them to go by the airport or the other way around.

Brandon Cheatham – SunTrust Robinson Humphrey

Alright, that’s it from me. Thank you.

David Hoster

Thank you.

Operator

And we’ll go next to George Auerbach with ISI Group.

George Auerbach – ISI Group

Thanks, good morning. For David or John, you seem to have more occupancy upside in Tampa or Jacksonville versus your other major markets. Can you comment on the pace of activity in those markets relative to expectations coming into the year?

David Hoster

They’re both roughly on budget, but as I mentioned before – I didn’t say Jacksonville but Jacksonville and Tampa have been slow for a number of quarters. We’ve done well on renewals but not leasing vacant space and it seems to cycle. You go a couple quarters where there are people looking for big spaces and then it goes down to small spaces, and it’s all what you have available and what prospects you’re looking for. But yeah, I think we have some good upside in both of those markets but particularly Tampa since we have so many square feet there and we have land to build. I think Tampa has more upside certainly than Jacksonville. Orlando though, of the three that’s our strongest market right now.

George Auerbach – ISI Group

Are you seeing the pipeline of activity better in Tampa and Jacksonville better today versus six months ago or is it still-

David Hoster

I would say better today than 90 to 120 days ago but that’s just people looking. So the next call we’ll tell you how we did.

George Auerbach – ISI Group

Great, thank you.

David Hoster

Thank you.

Operator

And we’ll go next to Eric Frankel with Green Street.

Eric Frankel – Green Street

Thank you. David, can you just talk about where you see occupancy dropping next quarter?

David Hoster

We just have a couple of move-outs that we know about. For example, in Jacksonville we have a full building user that bought their own building that’s over 100,000 square feet. We have a couple of move-outs in Tampa and those are related to where they had very low rents during the recession and aren’t willing to pay up, so they will be moving out. And in Phoenix, in Chandler we have a full-building user that’s 70,000 square feet that’s consolidating in another business. But other than what I’ve mentioned there it’s just in 10,000’s and 20,000’s and 30,000’s.

Eric Frankel – Green Street

Okay, thank you. And we noticed that the gap between the cash and GAAP relief in spreads is fairly wide this quarter. I was just wondering if there were any extenuating circumstances behind that gap?

Keith McKey

I would say no and I also always have believed that one quarter isn’t a trend. So again, you’d have to look at two or three quarters on what’s happening with rents or TIs or anything else related to leasing because we’re still at a size where a couple of big leases here or there can affect the numbers either up or down. So just looking at one quarter doesn’t make a lot of sense I think at this point.

Eric Frankel – Green Street

Okay, thanks. And then finally just going back to the amount of investor interest in the industrial sector, maybe you can just comment on the types of buyers out there and maybe some of the motivations for the seller, for some sellers because as you just noted there’s now a few billion dollars’ worth of assets now in the market?

David Hoster

I think you have to, when you look at… Well, you can’t look at what national statistics; you have to look at the markets where the institutional investors want to be or generally already are, or want to expand and want to be. And the institutions are the ones who set the pricing, so it’s the obvious industrial distribution markets across the country plus a couple others like, well Orlando’s picking up from that standpoint and Houston certainly has over the last couple of years.

The sellers of the core properties are the owners who have them in a fund and the time horizon of that fund has expired or is about to expire, and the investors want to recycle the cash. So that’s what we’re seeing. And there seems to be a certain, a good percentage of what’s on the market is not core and so that’s going to have a very different pricing of 150 basis points or 200 basis points higher cap rates in individual markets that you’d see the core A properties bringing; and if you get to some of the secondary markets, like again, Orlando would probably be viewed as a secondary market, they’re probably 75 basis points to 100 basis points higher than in a Dallas or a Houston or certainly a Southern California.

But there hasn’t been enough transactions that I think have closed in this year to have again any meaningful statistics. It’s just in talking to brokers the demand for core industrial far exceeds the supply, and the buyers are the full range from REITs to the pension fund advisors, some of who now are hooking up with merchant builders to develop new assets because that’s the easiest or the only way they can get industrial assets. And they plan to hold them, not flip them. And I’ve been reading that there’s a good many foreign investors looking at US industrial but to date we have not seen where we’ve been in the competition that we’ve gone head-to-head with any of those or that we didn’t realize they were foreign if we did.

Eric Frankel – Green Street

Can you see yourself being a more prominent asset recycler if the benign conditions continue?

David Hoster

I think it all gets down to the assets like in a Houston or a Southern California, they have low cap rates because investors believe those assets have a lot of upside. So if you sell those assets what do you do with the proceeds to own a core asset that has as much upside as what you’re selling? What we’re going to continue to sell are the assets that we think have run their course or are in markets like an Oklahoma City that don’t have much upside; and we’re going to be selling those at higher cap rates because of where they are and the quality of the building.

And like we’re hoping to sell some assets both in Dallas and Houston, and the appeal today is that although there’s a big spread on those B assets compared to A on the cap rate book is that as the A assets have come down so have the B and B minus ones. And so we think we can sell at cap rates that are very attractive compared to what we would have been able to do a couple years ago.

Eric Frankel – Green Street

Okay, thank you very much.

David Hoster

Thank you.

Operator

And we will next go to Bill Crow with Raymond James.

Bill Crow – Raymond James

Good morning, guys. David, as you talk about the supply versus demand by investors for institutional properties could you talk about what’s happened between the spread to build versus acquire and how that’s maybe influencing your expectation for the length of the cycle?

David Hoster

Well, I think the length of the cycle is still long just because most markets haven’t even gotten to a point where it justifies building or justifies doing much building. Where the cap rates have really come down it’s just allowed us to build at a much bigger spread to what we can sell the building for than we had, we were able to do a couple of years ago. So in Houston what we’re building should sell for around [5x] given what we’ve seen transact, so we’re building it close to 300 or a little over 300 basis points in comparison. So I think, and our thinking, it allows us to believe that we’re taking on less risk because if it leases more slowly and we miss our pro forma we still have an awfully good spread over what those buildings could be marketed for.

Bill Crow – Raymond James

I guess I’m looking at your cost to construct or develop at upper $60’s a square foot. Is that right based on your schedule?

Keith McKey

You have to look at each one of the buildings where our front park rear-load is going to be, I don’t know, $10 a foot more than a cross-dock, and different markets – for example, in Phoenix the land is more expensive than what it’s historically been in Texas, so that goes into it. The other thing that we pro forma on all our front park rear-loads is about a 15% office build-out. So a lot of the other developers that are building bigger buildings with pro forma are probably 5% to 8% office build-outs, so that’s going to be a big difference in those numbers.

Bill Crow – Raymond James

So maybe just the last question, how many markets of your major markets, the ballpark percentage where you can buy cheaper than you can build today for like-for-like assets?

David Hoster

That’s a good question. Probably just a handful. But the problem is that when you say “buy” it’s pretty hard to hit a like asset for our fairly disciplined business distribution type product in the kinds of locations where we want to be. So another big benefit for us in building is that we end up with a product that we think is extremely well-located and built to the prospects’ needs or demands for that submarket. So you’re not buying somebody else’s vision of what a tenant wants or their vision on how to maximize return as a merchant builder, or how that vision has changed over the last ten years. So that’s one of the reasons we end up building more than we buy.

Bill Crow – Raymond James

Understood, thank you.

David Hoster

Thank you.

Operator

(Operator instructions.) We’ll go next to Jamie Feldman with Bank of America.

Jamie Feldman – Bank of America

Hi, thanks. So just two quick housekeeping questions, just to confirm: so has your occupancy outlook changed at all from last quarter where I think you said you would dip below 95% in Q2 and then get back above 95% by year-end?

David Hoster

Our Q2 numbers compared to where we were originally are very slightly higher in terms of comparison. But when you look at June 30th it’s just about the same but we are looking a little bit better, and again, it’s a long way out to September, and actually December is the same. So it’s a very slight increase for the remaining three quarters over what we originally projected.

Jamie Feldman – Bank of America

Okay. And what are you assuming for the leasing spreads for the rest of the year?

David Hoster

We don’t calculate that number. We just try to lease every space at the best rent we can get and win the battle to keep the customer or attract the prospect. We’ve never been very good at guessing leasing spreads, and that doesn’t give us information that helps us increase FFO so we’ve never taken the time and effort to come up with those numbers.

Jamie Feldman – Bank of America

Okay. And do you have a sense of mark-to-market of what’s expiring this year and next year?

David Hoster

No.

Jamie Feldman – Bank of America

No, okay.

David Hoster

Again, that information doesn’t affect how we operate the company so we haven’t bothered to do it; and as I’ve said when we’ve tried to do it in the past we’ve generally been wrong so we try to concentrate our efforts on leasing space at the highest rent possible.

Jamie Feldman – Bank of America

Okay, thank you.

David Hoster

Thank you.

Operator

(Operator instructions.) And I’m showing no further questions at this time.

David Hoster

As always we thank you for your interest in Eastgroup and Keith and I will be here for a while if you have any clarifications that you think you need to touch base with us on. So again, thank you, have a great weekend and a good holiday.

Operator

And thank you for joining us today ladies and gentlemen. This does conclude today’s program. We appreciate everyone’s participation. You may disconnect at any time.

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