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

DCT Industrial Trust Inc. (NYSE:DCT)

Q1 2014 Earnings Conference Call

May 2, 2014 11:00 AM ET

Executives

Melissa Sachs – VP, Corporate Communications and IR

Philip Hawkins – CEO

Matthew Murphy – CFO

Jeffrey Phelan – President

Analysts

Kevin Varin – Citi

Jamie Feldman – Bank of America Merrill Lynch

Eric Frankel – Green Street Advisors

Craig Mailman – KeyBanc Capital Markets

George Auerbach – ISI Group

Blaine Heck – Wells Fargo Securities

Erin Aslakson – Stifel

Gabriel Hilmoe – UBS Securities

Mike Mueller – JP Morgan

Mitch Germain – JMP

Sheila McGrath – Evercore Partners, Inc.

David Harris – Imperial Capital

Operator

Good day, and welcome to the DCT Industrial First Quarter 2014 Earnings Call and Webcast. All participants will be in listen-only mode. (Operator instructions) After today’s presentation, there will be an opportunity to ask questions. (Operator instructions) Please note this event is being recorded.

At this time I would now like to turn the conference over to Ms. Melissa Sachs, Vice President, Corporate Communications and Investor Relations. Please go ahead.

Melissa Sachs

Thank you. Hello everyone, and thank you for joining DCT Industrial Trust’s first quarter 2014 earnings call. Today’s call will be led by Phil Hawkins, our Chief Executive Officer; and Matt Murphy, our Chief Financial Officer, who will provide more details on the quarter’s results. Additionally, our President, Jeff Phelan will be available to answer questions about the markets, development and other real estate activities.

Before I turn the call over to Phil, I would like to remind everyone that management’s remarks on today’s call will include forward-looking statements within the meaning of federal securities laws. This includes, without limitations, statements regarding projections, plans, or future expectations. Actual results may differ materially from those described in the forward-looking statements and will be affected by a variety of risks, including those set forth in our earnings release and in our Form 10-K filed with the SEC, as updated by our quarterly reports on Form 10-Q.

Additionally, on this conference call, we may refer to certain non-GAAP financial measures. Reconciliations of these non-GAAP financial measures are available in our supplemental, which can be found in the Investor Relations section of our website at dctindustrial.com.

And now, I will turn the call over to Phil.

Philip Hawkins

Thanks, Melissa and good morning everyone. The first quarter was a good start for 2014. Leasing volume was strong with 4.4 million square feet signed including 1.4 million square feet of new leases on vacant space.

Rents continue the positive trajectory with rent spreads of 15.1% on a GAAP basis and 5.7% on a cash basis, very similar to last quarter’s results.

Total consolidated operating occupancy decreased 30 basis points to 92.8%. However, on a same portfolio basis, it increased 10 basis points to 93.4%.

The environment remains quite favorable with healthy tenant leasing across all of our markets in pretty much all size ranges and customer verticals. And in response to good leasing activity and declining vacancy range, market rents are increasing in almost all of our markets.

Construction has kicked up as well and is the primary area all of us are watching to see how disciplined or not the industry will remain. So far, even in the markets with significant construction underway such as Dallas, Houston and the Inland Empire, levels remain manageable relative to current vacancy rates and recent net absorption.

Moving on to acquisitions, while markets remain very competitive, we continue to find good opportunities mostly off market in typically one or two buildings rather than portfolios.

We have acquired $50 million since January 1 and have a good pipeline leading us to increase our guidance for the year which Matt will detail shortly.

In terms of development, we signed several leases in Houston which allowed us to start construction at DCT Airtex II. And also have good activity on our Seattle Development Projects.

While prospect activity has picked up recently on DCT 55 after a long cold winter in Chicago, leasing the last 200,000 square feet is taking longer than we planned. The good news is we expect both risk and yield on DCT 55 will exceed the initial pro forma once we complete the lease up.

In summary, we are off to a good start in 2014, although we recognize that we have plenty of work to do to achieve and hopefully exceed our goals for the year. With that, let me turn the call over to Matt who will provide more color on the quarter as well as update of our 2014 guidance. Matt.

Matthew Murphy

Thanks, Phil. Good morning everybody. I’ll go into a little more detail on our operation results and talk through our outlook for the remainder of the year. From a financial perspective, the first quarter of 2014 was strong with excellent leasing volume and metrics and FFO that was slightly ahead of plan.

Occupancy in our operating pool was one of the bright spot for the quarter ending slightly ahead of plan at 92.8% despite the 60 basis point dip caused by acquisitions during the quarter and moving DCT 55 and two redevelopments into the operating pool.

On the same portfolio basis, operating occupancy increased 10 basis points. This increase was driven in large part by move-ins associated with our strong first quarter new leasing. Over 900,000 of the 1.4 million square feet of new lease assigned during the quarter moved in prior to March 31st.

In addition, we have 860,000 square feet or 1.3% of our total portfolio leased but not occupied.

Small tenant leasing and occupancy continued its positive trends through the first quarter as well. 30% of the new leasing done in the quarter was for spaces 50,000 square feet or smaller and occupancy in these spaces which represented a little over 20% of our portfolio increase to 150 basis points sequentially.

This activity offset the typical seasonal occupancy decline and also helped to compensate for three unbudgeted non-renewables that moved out during the quarter.

In total, tenants representing 335,000 square feet notified us during the quarter that they would not renew. All but one of these tenants have expirations in the first half of the year.

We also experienced several early terminations in the first quarter totaling just under 400,000 square feet. While the termination fees associated with these transactions will result in these terminations being slightly accretive to 2014 FFO, we exclude such termination fees from the calculation same-store NOI growth impacting our numbers in the first quarter and for at least part of the remainder of the year depending on leasing.

Approximately $900,000 of the $925,000 of termination fees recognized in the first quarter were effectively the prepayment of rent and expense recoveries that would have otherwise been recognized later in 2014 and therefore included in same-store NOI.

The exclusion of this represents an approximately 50 basis point diluted impact on full year cash same-store NOI growth.

Two significant expense variances negatively impacted our numbers in the first quarter. First, snow removal was approximately $1.8 million over budget as many of our markets struggled with brutal weather throughout the winter.

After estimating the impact of recoveries, we were about 325,000 net unfavorable on budget on this item.

Second, in Columbus, we have the tax abatement revoked early on a recently leased 500,000 square foot building at 14-50 Commodity Boulevard. While we will appeal this unusual action by the taxing authority, that outcome is uncertain and the loss of abatement caused an unexpected one time hit of $266,000 which is not recoverable.

The combination of these two items negatively impacted same-store NOI growth by approximately 125 basis points in the first quarter and drove the over 14% increase in expenses over the first quarter of 2013.

Turning to guidance, given the strong leasing we’ve accomplished in the first quarter and excellent fundamentals in our business, we are leaving FFO guidance unchanged at $0.45 to $0.48 per share despite the few variances I’ve discussed.

However, given the same-store NOI growth impact of the early terminations, the budget in non-renewals I described and the expense variances, we are lowering same-store NOI guidance by 50 basis points to between 2.5% and 4% on a cash basis, and lowering GAAP same-store NOI guidance by 25 basis points to between 3% and 4.5%.

We are also lowering our expectation for average operating occupancy for the year to between 93% and 94% based on these same factors as well as the impact of the 900,000 square feet of value-ass assets we acquired in the first quarter which are now on our operating pool.

Finally, given our success early this year and finding and closing attractive acquisition opportunities, we are increasing our guidance for 2014 acquisitions to $175 to $250 million.

Phil said it well, we’re up to a good start in 2014. Although mother nature and a few of our tenants threw us a couple of curve balls during the quarter, we continue to be pleased with the strength of tenant demand across the spectrum of markets, businesses and different site spaces.

Rental rate continue to improve and the optimism of our tenants keep growing. While we still have a great deal to do in 2014 particularly with regard to leasing space, we feel very good about the environment we are in and our team’s ability to continue to deliver excellent results.

With that, I’ll turn it over to Gary for questions.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. (Operator instructions) The first question comes from Kevin Varin with Citi. Please go ahead.

Kevin Varin – Citi

Good morning, guys. Can you just talk about – so in the quarter, you funded growth pretty evenly through asset sells in the ATM. Should we expect this balanced approach to continue in 2014 or do you see one becoming more attractive than the other just especially taking into account the investor demand is high for industrial?

Matthew Murphy

Yes, hi Kevin, it’s Matt. I think as a general statement, the balance that we have sort of achieved over the last few years is a good starting point. However, funding things through a combination of property dispositions as well as the issuance of equity. However, I mean I think you hit it right on the head, given the market today, I think it’s probably likely that we will be more sort of slanted if you will to dispositions. A lot of the assets that we are – the non-strategic assets we’re trying to get rid of and markets where demand is really picking up, economics are getting better. And it’s an environment to sell. So I think we will slant it that way. But I don’t think it dramatically changes the way that we’ve approached that over the last several years.

Kevin Varin – Citi

Okay. And then just one follow up. Can you just dive into what you’re seeing in the acquisition pipeline just given the increasing guidance? The geared more towards value-add just to give us a sense of that.

Philip Hawkins

It’s Phil. It’s a combination. And it typically is our preference is value-add. But we’re also willing and frankly happy to have cash flow day one if we can get it at the right price and if we think there’s enough future growth.

What we’re actually seeing now is our pipeline is a little bit more weighted towards the middle of the country, Chicago for example, than the coast where pricing has just been very difficult. And we’re fairly active developers.

But I think each one – we’ve got as I think about our coastal markets and our primary non-coastal markets, we’ve got acquisitions working in pretty much each of our markets. They may not close, but our team each have at least one deal they’re working on that we’re pretty positive about.

Kevin Varin – Citi

Okay, thanks a lot.

Operator

The next question comes from Jamie Feldman with Bank of America Merrill Lynch. Please go ahead.

Jamie Feldman – Bank of America Merrill Lynch

Great. Thank you. Matt, if we could just go back to your same-store and occupancy guidance. I just want to make sure I understood what you’re saying.

So I guess we started your occupancy is now 50 basis points lower on move-outs you guys didn’t expect. Can you talk more about this space or prospects about, Phil, and who those tenants are and why they moved out?

Matthew Murphy

It’s 10 tenants in total. As I mentioned, it’s about 335,000 square feet of this sort of unbudgeted non-renewables. A third of there is from a tenant perspective a little less than a half occurred – the actual move-out occurred in the first quarter.

There’s mix of reasons why they’re doing it. Some of it is specific logistics change. We had one person that moved out in Atlanta, they’re moving that same regional distribution to I believe it’s North Carolina although I don’t know that for a fact. So that one is just kind of one of the tinkering that companies do.

We had a couple of tenants that needed to expand space that we couldn’t accommodate. We had a couple of tenants that were frankly one of them was getting out of the distribution business in the market they were in. So it’s always kind of a series of individual stories.

I think the prospects for leasing the space, it’s a great market. When you get this thing, it’s funny, a number of these occasions, these tenants had indicated very recently that they were intending to remain in the space. So it will go through the getting the space ready process and feel good generally about leasing demand in the markets where they’re happening.

The other that you’ve got to keep in mind that what’s impacting the occupancy is also the 900,000 square feet that we acquired in the first quarter. That’s 84.5% occupied. That obviously moved the numbers a little bit as well.

I think the way I’d summarize it is, the same-store guidance change is primarily related to the fact that the early termination tenants moved out. The economics are exactly the same as they were before, but because of the fact that some of those termination fees were for periods after the termination occurred, they get excluded for same-store purposes.

It’s unusual that it happens where the vast majority of those dollars are actually related to the period that we’re looking at.

So to me, it’s a 50 basis point drop in occupancy in same-store guidance that is really a change between termination fees and NOI.

And then what else is going on is we had some of these unbudgeted non-renewals. We had the expense variances. And those have been basically compensated for by the strength of the leasing that we’ve had in the first quarter.

So in many ways, we’re exactly where we started off. There’s just a geography change in it in sort of the income statement as to where some of those dollars come in. And so to me, I think of it as somewhat of a distinction without a difference. But it does affect the numbers the way that I’ve just described.

Jamie Feldman – Bank of America Merrill Lynch

Okay. So I guess if you were to back out just seasonality and the weather, what do you think your same-store guidance would be? Or what do you think of what it would have been in the quarter?

Matthew Murphy

For the first quarter, it would have been – guidance, it would have been a little over 2%, between 2% and 2.5%.

Jamie Feldman – Bank of America Merrill Lynch

And that’s with the post of the termination fee.

Matthew Murphy

No, that’s excluding the termination fee. So the termination fee has made FFO better in the first quarter. They slightly negatively impacted NOI in the quarter because those tenants moved out relative to what the plan was.

It was 125 basis point impact of the expenses, just plain and simple, on top of the 60 basis point increase we already had.

So pure math, it’s just under 2%. The little bit, how do terminations not happen. We would have a little bit more NOI which would have gotten us a little bit over 2% on a cash basis, which frankly would have been meaningfully ahead of plan as I talked about.

We had a very comps in the first quarter of 2013, so we’re ahead of the game relative to leasing. And the shift in sort of the cost on the income statement associated with the terminations made same-store [indiscernible].

Jamie Feldman – Bank of America Merrill Lynch

Okay. It sounds like same-store accelerates for the rest of the year based on your guidance.

Matthew Murphy

Yes, clearly. And it’s based on leasing. Some of which has happened and some of which hasn’t. We’re in an environment where seeing growth in occupancy and therefore NOI makes perfect sense. We’ve got work to do. But it’s also on the backs of it. A very good first quarter leasing with is typically not one of our better leasing months. And feel good about the environment where we sit today and looking forward.

Jamie Feldman – Bank of America Merrill Lynch

Okay. And then my final question I guess for Phil. You have commented on supply. It’s something you’re watching. I think last year, there was a lot of concern and then during earnings, the companies were able to calm their concern down. Like how do you feel today? How do things feel differently today on the supply risk versus this time three months ago.

Philip Hawkins

Within markets, within the markets we were talking about last quarter, I don’t feel much differently. Yes, the construction number haven’t changed that much. Houston for example, we’ve cleaned the coastal [ph] down a bit.

I’m sure I’ll bounce back given their chance, Inland Empire [indiscernible]. The one market – the difference is more markets are seeing construction because more markets are further the recovery process – rents have moved, vacancies have fallen, occupancies have increased. And the one that I know, I know periods I’ve talked out is Dallas which has significant increases in the construction over the last three months. Not surprising given how strong demand is in that market. I mean it is a very vibrant market right now.

That construction tends to be like all the markets start at in the – but I’d say Dallas is an example. But you’re seeing constructions pick up in other markets, not as dramatically as Dallas, but they don’t have the dramatic demand dynamics either.

Jamie Feldman – Bank of America Merrill Lynch

Are there any markets where rents are already coming under pressure because of the supply?

Philip Hawkins

No, not that I can think of. Yes, you’re seeing a good, healthy demand, keep up with and still probably even most markets, maybe with a exception of few, exceed the supply being built which of high capital as rushing in to fill that void.

I don’t know. I’ve seen rents continue to move up. By the way, construction cost are also moving up. So each building as announced is likely to be more expensive than the one before it, because both land as well as even a little bit of construction price inflation is hitting economics.

I feel good about rents in the markets that you see construction. Accordingly, as you see more construction, you’re going to see less of an imbalance between supply and demand and therefore less outside price inflation, rent inflation. But you’re still seeing decent rent growth.

Jamie Feldman – Bank of America Merrill Lynch

Okay. All right. Thank you.

Operator

The next question comes from Eric Frankel with Green Street Advisors. Please go ahead.

Eric Frankel – Green Street Advisors

Thank you. I was wondering if you could discuss your disposition, if you have plan for the second quarter. The cap rate actually seems it’s a little bit high given where pricing seems to be today.

Philip Hawkins

The cap rate for the first quarter seem high?

Eric Frankel – Green Street Advisors

Second quarter, whatever you have in your press release. That 7.5% cash field.

Philip Hawkins

Right. Well, it’s a mix driven equation. I would say what we’re going to be selling will probably tend to in the, oh I don’t know, high 6s to mid-7s coming up. Matt.

Matthew Murphy

Yes, the one thing I’d add Eric is one of the things that’s really driving that number up a little bit unnaturally is we have a building that Iron Mountain was leasing in Chicago that has a purchase option that was signed a long time ago. So you got it. You got an 8.2% [ph] cap rate that was – those seeds were sown four or five years ago, that’s really kind of unnaturally driving that number up.

Eric Frankel – Green Street Advisors

Okay, that’s helpful. Jeff, it’s good to have on the call. I was wondering if you can talk about Seattle and Inland Empire a little bit and just give the development environment of both markets especially given your development pipeline there.

Jeffrey Phelan

So in Seattle, we’ve got two buildings that are under construction. One is a 650 in Summer and the other one is 190,000 square foot building. We have good activity today on both those buildings, and feel confident that we’ll get them leased. As you know, that market historically going back in the past three years has absorbed 1 million square feet or more.

And so I think we’re in a good position to lease those buildings. And we have a really good team on the ground that’s going to make it happen.

And as far the Inland Empire, there have been a significant jump in the number of square footers that’s under construction. But again when I talk to the brokers in the market, there’s a lot of activity right now that’s going on in those buildings. And I think that you’ll be pleasantly surprised with the outcome in Q2 with the Inland Empire. And we just started a 920,000 square foot cross dock in Rialto.

And we again feel very confident that we’ll get that building leased and we just – I mean right now we’re just setting up the slab right now. But when I talk to the brokers in the market, there’s a lot of activity in the big box right now.

Eric Frankel – Green Street Advisors

Okay, great. I’ll jump back in the queue.

Philip Hawkins

Thanks, Eric.

Operator

The next question comes from Craig Mailman with KeyBanc Capital Markets. Please go ahead.

Craig Mailman – KeyBanc Capital Markets

Good morning, guys. Matt, could you just walk us through on same-store kind of maybe the components of the 2.5 to 4 in terms of contractual bumps, rent spreads and leasing. And then maybe give us a sense of kind of what’s I the bag already for the year and how much is maybe perspective on the leasing front that needs to get done.

Matthew Murphy

Yes, it’s a good question. So I would say now, I would say that roughly 45% of the same-store growth that we’re projecting is a result of bumps that are 90%, I’ve made that up, but largely in the bag.

And then the remainder of it, there’s a number that’s sort of little in there now. The remainder of it is related to leasing of which probably 40% has been done already. So we’re expecting occupancy increases above that. Some of that baked in based on leasing that’s already done relative to the accounts in ‘13. And some of it is still to be done leasing. Does that make sense?

Craig Mailman – KeyBanc Capital Markets

Yes, that’s helpful. And then maybe on the development side. I know the pipeline shrank a little bit here. But you guys have, the one $200 million guidance for starts. Just curious given your comments around where you’re seeing supply, which markets you’re seeing the best opportunities in, where maybe – are there any markets that for the balance of year you wouldn’t start anything in that you’ve historically done?

Philip Hawkins

It’s Phil, I’ll start. We have really good activity in the markets we’re already developing in. I mean Jeff just talked about Seattle. It’s conceivable or maybe hopeful we’ll start another building or two there before the end of the year.

Certainly, Houston, we’ve had really good activity and are optimistic. We’ve got a pipeline of land behind it that could be there. I would say you may see a few new markets added to it. There’s a – we bought some land as you saw in Dallas. Rather than trying to compete with all the other big box that’s being built there, we see an opportunity to cater to smaller users, to medium size users and build a 100,000 foot building.

We’ve got land under control that’s not on the balance sheet, but it’s currently under control in Lehigh Valley where we are hopeful to be starting something there. We have land under control in Northern California that could lead to a start this year. Probably I’m missing something, but I think you’ll see it’s broaden out a little bit. You also may see a few smaller buildings that we’ve built. And then you may – Orlando is a good example. That’s a market we haven’t developed in in a long time.

And then – yes, but you’ll also see us look at a big box where it makes sense, where we really are comfortable with our location, we [indiscernible] by land. We do by land and more in so locations closer in. We’re not trying pioneer. And so I think you’ll see that, continue with that. That’s based on leasing.

So we’re just going to go [ph] where it is. We feel okay with that guidance. And we’ll see.

Craig Mailman – KeyBanc Capital Markets

Have you guys changed your term hurdles at all on development projects?

Philip Hawkins

Not really. Not in the last say three to six months. Certainly, compared to a couple of years ago, I’m sure we had even a return hurdles as more risk concerns of how to really build in a market that was as early in the recovery as it was two years ago.

Today, we’re still seeing a return – if you believe you’re underwriting where we spend most of our time, not on hurdles, but on the debate itself over the underwriting in the market.

I think our returns remain pretty consistent where they were three to six months ago clearly down from where they were two years ago. But two years ago, well it feels risky today, it was a heck of a lot more uncertain a couple of years ago.

Craig Mailman – KeyBanc Capital Markets

Great. Thank you.

Operator

The next question comes from George Auerbach with ISI Group. Please go ahead.

George Auerbach – ISI Group

Thanks. Matt, just to close the circle on the 1Q expenses in the move-out point, is it fair that all the unexpected events all they do is delay the NOI growth by a quarter or two? There’s no real change to your believe at least at space or – looking forward 2015 growth will just be better now than it would have been in 2014?

Matthew Murphy

That’s a very glass if half full way to look at it, George. But I agree with you, I mean the mechanics of it, you’re exactly right. The leasing still needs to happen. Again, the markets are good. It adds an element of risk to the number that didn’t use to be there.

But it also adds frankly at least the early terminations, they add an eliminate of upside because as I’ve said, we sort of already got the NOI, and we could in fact double up if you will if those spaces lease up early. Having said that, you do need to lease them so there’s risk associated with it.

But I think if you believe the assumption that those spaces is a matter of if not, when, which we do, then your thesis is exactly right.

George Auerbach – ISI Group

All right. And I guess any change to the development start guidance for 2014. I think the last quarter you said sort of 100 to 200 million.

Matthew Murphy

Yes, no, I’m sorry. We’re keeping it at 100 to 200 million.\

George Auerbach – ISI Group

All right, perfect. Thank you.

Operator

The next question comes from Blaine Heck with Wells Fargo Securities. Please go ahead.

Blaine Heck – Wells Fargo Securities

Hey guys. Matt, sorry if I missed your commentary on this. But taxes were up roughly 20% on both the sequential and year-over-year basis. Can you talk about what cause this and if we should expect that level to continue going forward?

Matthew Murphy

Well, as I mentioned in the prepared remarks, one of it 266,000 of it was just a onetime blip in Columbus. I would go into the details later if you want. I won’t get the rest of the group.

And the rest of it, valuations are going up. It’s not surprising that taxes are going up. But clearly the growth in Q1 was outside as a result of both the Columbus issue as well as we won some appeals in 2012 that lowered the number in 2013.

So the growth is definitely outside. We’ll continue to have greater than inflation growth and property taxes. It’s just the reality of valuations increasing the way that they have. But first quarter was unusual.

Blaine Heck – Wells Fargo Securities

Sure, that’s helpful. And then can you give some color on your 363,000 square foot acquisition in Chicago? The 55 cap rate stands out as low compared to the other deals you did during the quarter. So what was it about the property that caused you to maybe stretch a little bit?

Matthew Murphy

Yes, I apologize, I’m not familiar with specifics of the cap rate. I know it’s about the growth and the asset going forward. I apologize I don’t have the specifics in front of me.

Philip Hawkins

This is Phil. We like Chicago long-term. And this asset has in our view outsized growth in front of it. Honestly, midsize cap rates were class A asset is kind of the world we’re in right now.

The question now becomes, how do you like the location of the asset, the growth in that asset, and is in our view an opportunity to expand our portfolio in Chicago, allows us to frankly even reposition the portfolio a little bit. We may sell an asset or two as well in that market or other markets.

Blaine Heck – Wells Fargo Securities

Okay, fair enough. Thanks.

Operator

The next question comes from Erin Aslakson with Stifel. Please go ahead.

Erin Aslakson – Stifel

Hey, good morning. So my question is more regarding the leasing, the releasing markets, very positive again this quarter. Now I wanted to just dive into a little bit in terms of what’s the role or the increase of the TI is playing in this increased rental rates currently?

Matthew Murphy

Yes, Erin, it’s Matt. There’s clearly an element of that. As you can see, the TI number has ticked up during the quarter. We’re in a market today where those TIs where there use to be a bargaining ship a couple of years ago, are now something that you’ll if you’re comfortable of the tenant credit which you’re getting paid for. Yes, you’ll get an 8.5%, 9% returns on that money relative to kind of what shell TI improvements would get to. So that’s certainly an element of it.

There’s also a pretty significant element of it which is just I think what most of us were hoping to see where you’ve got some leases that were signed in 2010 and 2011, there’s a couple of specific examples of that embedded in the numbers, where there were deals done that were defensive in nature, they were flat. And they were done at please stay in our building rates that are now being compared against sort of free market rental rates. And you’re seeing some big increases as a result of that.

But there’s no question that there is a correlation between the amount of TI associated with these lease and the rental rate bumps. It’s just the way the economics work. But that’s not the only thing that’s driving it by any means.

Erin Aslakson – Stifel

Certainly not. And then in terms of the TIs, I mean depending on the building type obviously, if you’ve got more or less the general warehouse building sort of less TIs there. But if it’s more manufacturing oriented, has a higher percentage of office space, what is the kind of the mix this last quarter of those types of assets versus more of a just a big box?

Matthew Murphy

Yes, well, I think as I’ve mentioned in my comments, 30% of the leasing we did this quarter was for 50,000 square foot spaces and below. And it’s just a fact of nature if you will that the cost associated with those are going to be higher on a per square foot basis.

Erin Aslakson – Stifel

Yes.

Matthew Murphy

There was a couple of unusual deals that drove some of the numbers. This quarter we did a renewal, although, it had an expansion element, it’s in the renewal numbers in Houston, where we basically brought the percentage of office up. It was a $16 a foot TI. You wouldn’t do that in anything but Houston. It really got the office level up to a number that’s very much in the middle of the fairway if you will for Houston.

So CapEx numbers associated with leasing are a story by story kind of deal. But I do think mix matters. And like I said, the smaller spaces are driving that number. And you’re absolutely right, the higher finish of a space, the higher the TIs or the re-tenanting cost are going to be.

We also had an unusual jump if you will – not unusual. The length of the leases done in the first quarter was longer than usual, which is just algebraically going to drive the commission element of the TIs up. That impacted it as well. So it’s a number of factors and they’re all kind of specific to the deal, to each individual they’re related to.

Erin Aslakson – Stifel

And then in your guidance, are you assuming that the small tenant leasing continues and accelerates throughout the rest of this year? I would assume.

Matthew Murphy

Continues, yes. Accelerates is probably too strong a word. It was a little bit stronger quite obviously in the first quarter than I thought. So if it continues on that pace, it will be better than what’s in the projections.

But there is in my opinion, no reason to assume. It’s a trend that’s had some – it’s got some legs on it now. No reason to see it turning in my opinion.

Erin Aslakson – Stifel

Great. Thank you, guys.

Matthew Murphy

Thanks, Erin.

Operator

The next question comes from Gabriel Hilmoe with UBS Securities. Please go ahead.

Gabriel Hilmoe – UBS Securities

Hi, thanks. Phil, any update on further prospects as far as leasing in Memphis that pulls [ph] back doing the move on Indianapolis. I apologize if it missed it earlier.

Philip Hawkins

No, we’ve got a decent activity on Memphis. Nothing eminent. Nothing I would say is close to maturing in those changing leases. But we’ve got conservations that are happening that are encouraging.

And honestly, very slow on the Indianapolis building where we still don’t have I guess complete control. But Matt, do you want to add to that?

Matthew Murphy

Yes, I think we have reached I think pretty close to legal resolutions on the Indi space if not financial resolution. We expect to get all four of those spaces back in the second quarter as opposed to the third quarter which is when the leases technically would terminate.

One of the challenge with that whole situation was the tenant was pretty hard on his face, which means it’s going to be harder to get it back in position to lease. I’m not counting much on for that in ‘14. Really nothing at all in terms of NOI.

Gabriel Hilmoe – UBS Securities

Okay. And then just going back to the lease spreads. Can you remind us what’s included in that number? Does that include new leases on properties that I guess have been vacant for more than a year?

Matthew Murphy

It does.

Gabriel Hilmoe – UBS Securities

It does, so it’s not a big number [ph].

Matthew Murphy

Yes. And so really, it represents a little over 94% of the leases. The only thing that’s really being kicked out in the way we’re calculating that is net to gross, gross to net kind of sort of structural differences if you will as well as short-term leases that are not really market rate [ph].

We don’t exclude all short-term leases. But we look at them. There are some of them where people will just drop stuff on the floor for six months and you get a [indiscernible] associated with that. Those are kicked out. At the same time, there’s nine-month leases that are very much market and so those are included. I mean it’s the vast majority, vast majority in the leases.

Gabriel Hilmoe – UBS Securities

Okay. So I guess do you have the number if you included everything, at hand?

Matthew Murphy

I don’t.

Gabriel Hilmoe – UBS Securities

Okay.

Matthew Murphy

Again, a stuff that’s being as good as the [indiscernible]. Well, first of all, it’s 95% of the leases, so the most it could in theory, I mean it would be a very minimal number. The reason they’re excluded is because they’re aberrant if you did include them.

Gabriel Hilmoe – UBS Securities

Okay, thank you.

Philip Hawkins

Both ways.

Matthew Murphy

Both ways. Yes, I don’t know, but it could be better. It could be worse. I have no idea. Because we just drove our calculations [indiscernible] I don’t have it including that.

Gabriel Hilmoe – UBS Securities

Okay. All right. Thanks, guys.

Operator

The next question comes from Mike Mueller with JP Morgan. Please go ahead.

Mike Mueller – JP Morgan

Yes, hi. Looking at your year-to-date acquisitions, I know you talked about going in cash yield I think it was 5.5 and then something north of 6 for stabilized. And a lot of the properties there were 100% occupied. So I mean for those, should we be looking at that component as being stabilized already or is this some sort of angle to them such as you’ve got near-term expirations, the rental rate [indiscernible] marketer or just something else that’s going on.

Philip Hawkins

I’d say for the buildings that are fully leased, there can be exception. If they are stabilized reasonably well for at least next couple of years, nothing I think of that had a kind of a short-term lease in place that we are picking up.

So I would say they’re stabilized.

Mike Mueller – JP Morgan

Got it. Okay. And can I ask for a clarification about an earlier answer to a question?

Philip Hawkins

Of course, you can ask anything, Mike.

Mike Mueller – JP Morgan

There you go. I know there’s a limit to questions. So yes, I think, so you ended the quarter 92.8 on a consolidated basis. Matt, did you say where that was going in Q2 through that whole discussion of the lease terminations, et cetera?

Matthew Murphy

I did not say it, but first of all, I think the one thing to keep in mind, so if Indi moves out, that’s 80 basis points on the portfolio all by itself.

So I think we’ll be flat, slightly positive in the second quarter driven largely by Indi being overcome by leasing that’s already done.

Mike Mueller – JP Morgan

Got it. Okay, that’s helpful. Thank you.

Philip Hawkins

And that’s excluding acquisitions that we might do [ph].

Matthew Murphy

Correct.

Philip Hawkins

And honestly, some of our queue of acquisitions are non-stabilized assets. Our guidance excludes acquisitions and dispositions. So as we sell poorly leased buildings and we buy less [indiscernible] buildings, that by nature will probably reduce occupancy below what we have guided to.

Matthew Murphy

Right, that’s a good point.

Mike Mueller – JP Morgan

Yes, no, exactly, if we’re thinking of that 92.8, we’re in kind of a seams to our bases. It sounds like that will be flat to slightly higher.

Matthew Murphy

I think that’s exactly right.

Philip Hawkins

Same portfolio, yes, correct. I want to make sure.

Mike Mueller – JP Morgan

Yes, definitely. Thanks.

Operator

The next question comes from Mitch Germain with JMP. Please go ahead.

Mitch Germain – JMP

Good morning, guys. Matt, you guys are about 20%-ish. I think you call it legacy markets. How do you foresee that directionally moving? I mean is the goal to kind of bring that down to zero over the next couple of years? And what sort of typing would that be?

Philip Hawkins

No, the goal is not to get to zero. The goal is to reduce it further with no timeframe. But given how some of the markets that we’ve identified as opportunities to reduce, those investment markets have picked up particularly in secondary markets. I think you’ll see that number move down some more in 2014.

The amount of capital that continues to be interested in the industrial spreading out across the country combined with really fast or improving fundamentals in those markets down to more primary markets that have been recovering longer has led to pretty significant increase in interest. And at least in modest decline in cap rates or increasing values, that is pretty encouraging to us.

Mike Mueller – JP Morgan

Thank you.

Operator

Your next question comes from Sheila McGrath with Evercore. Please go ahead.

Sheila McGrath – Evercore Partners, Inc.

Yes, good morning. Phil, I was wondering if you could talk about the acquisition environment, specifically any insights or observations on portfolio activity in the market or currently expected this year.

Philip Hawkins

We – Jeff can probably answer this better than I can. I’ll start and hand it off to Jeff because – we look at the portfolio packages, we haven’t been very successful, particularly the fully marketed ones. My understanding is that packages were light in the first quarter, expected to pick up in the second quarter. Not sure why that is.

So we’re really – we are spending a lot of time – there’s a few packages that are up here right now. I know that Jeff is leading on it. We will give it our best shot. Who knows if we have any chances but, Jeff, anything you want to add to that?

Jeffrey Phelan

Yes. Sheila, for us, it’s been very difficult to compete in the fully marketed packages that are out there today. So where we found our fastball is working with our local groups to find off-market transactions. That number last year for DCT of off-market deals that we’ve sourced was at 60%. This year, that number is ticking at 70% and we’re finding that we’re being able to find the one-off deals in the various focused markets. And that’s really how we’re finding these acquisitions. And not only just the acquisitions of buildings but also in the value added also in the land sites.

Sheila McGrath – Evercore Partners, Inc.

Do you think there’s a pricing premium affiliated if it’s a portfolio?

Jeffrey Phelan

Yes, I do.

Philip Hawkins

Well, I – my understanding particularly for homogenous high quality portfolios, portfolio who’s 5% or 10% relative the underlying individual asset value. People are definitely paying more for more. And there’s even some – what you’re also seeing because we’ve got small and modest-sized portfolios on the market. I’d say you’re also seeing the ability to have a less than homogenous portfolio than while as before you couldn’t.

You can add in a lower quality asset to a higher quality portfolio and you can add in a secondary market to other markets or primary markets. We sold a joint venture portfolio, TIT, which had a mix of primary and secondary markets. That was very well received. And a very deep list of bidders, tight pricing and in the end, since we were a seller, we were fully happy with the pricing.

Sheila McGrath – Evercore Partners, Inc.

Okay. And one other quick question. Just as you look at the leasing activity in the core portfolio for the development pipeline, are there any insights you might give us in terms of tenant industries that are absorbing more space, any notable trends there?

Philip Hawkins

I would say no. There’s no change in trends. It’s really broad based – people talk about eCommerce they [ph] share a consumer, manufacturing related. We don’t have manufacturing going on in our building but we’ve got business to business tenants. 40% of our leases in the –

Matthew Murphy

In the past year, 35% in the last quarter.

Philip Hawkins

And then manufacturing related is an example. The one area that hasn’t picked up from when it first kicked up a year ago is housing. It’s no longer dormant. But we had a pretty good quarter I’d say about a year ago. And I’d say it’s falling off a little bit from there and it’s just coming along and it’s just – some markets like, say, Orlando and Phoenix benefit from housing.

But I’d say housing related tenants, in our world anyway, haven’t been that recovery impetus yet that we had thought might happen a year or so ago.

Sheila McGrath – Evercore Partners, Inc.

Okay, thank you.

Operator

The next question comes from David Harris with Imperial Capital. Please go ahead.

David Harris – Imperial Capital

Yes, good morning. Hi, everybody. With regard to your development activities, how much G&A are you currently capitalizing?

Matthew Murphy

I don’t have it broken out specifically related to development, but it’s a couple million dollars or more – between $2 million or $3 million a quarter in total capitalization which includes leasing cost development, redevelopment, et cetera.

David Harris – Imperial Capital

Okay. It would actually be useful if you could provide us with a development breakout as we go forward. Some companies do it and there is quite considerable variability in the numbers that people are using to capitalize relative to their development cost.

Matthew Murphy

Yes. No, it’s interesting. The SEC is starting to put a little bit of guidance around some specificity around that in SEC filings as well.

David Harris – Imperial Capital

Okay, great. Thank you.

Philip Hawkins

Thank you, David.

Operator

The next question comes from Brandon Cheatham with SunTrust. Please go ahead.

Unidentified Analyst

Thanks. This is actually Keith [ph]. Phil, could you just talk a little bit about the due diligence cost that you guys booked this quarter? It seems like it’s not the same as acquisition cost. $2 million seems like it’s a little bit higher than what you’ve been booking in the past. Is it – could you just put a little more color on that?

Philip Hawkins

Well, the expense accretive [ph] cost here is $724,000 for the quarter, so I’m not sure what that 20 – what that $2 million number you’re referencing.

Unidentified Analyst

On Page 6. It’s like $2.056 million [ph]. If I could ask my next question.

Philip Hawkins

Give us one sec here, Keith [ph]. Oh, I’m sorry, that’s not expense, that’s capital expenditures.

Unidentified Analyst

Right.

Philip Hawkins

Well, that is cost associated with recent acquisitions. It’s sort of immediate deferred capital on recent acquisitions.

Unidentified Analyst

Okay, got it. So second question, have you guys – I’m not sure how much historical data you guys get on your properties that you buy, but on a same store basis, at the peak, what would the occupancy, what would it have been compared to your 93.1 today?

Matthew Murphy

I don’t – we can talk and theorize about that an awful lot. I can’t – I don’t even think – I don’t know how to answer that question off the top of my head.

Unidentified Analyst

Yes, and it’s not an easy stat. And just to ask a quick one, what percent of your leases are gross versus net?

Matthew Murphy

It’s roughly 80% is pure net. It’s like 3% is pure gross and everything else is somewhere in between. There’s what we’ve referred to as modified or industrial gross where you’ll do net for everything – for taxes. So there are combinations of it. But the very large majority is pure triple net and 3% is pure gross.

Unidentified Analyst

Okay. That’s it for me. Thank you.

Philip Hawkins

Thank you.

Operator

(Operator instructions) The next question is a follow-up form Eric Frankel with Green Street Advisors. Please go ahead.

Eric Frankel – Green Street Advisors

Thank you. And Phil, you said you were going to – obviously you’re a little more active in Chicago. Can you just talk about that market in further detail? It seems like it’s had a tough run probably with the last decade if you want to call it with flat rent and a really competitive development environment?

Philip Hawkins

Sounds like a lot of markets. Chicago is one of the largest distribution markets in the world, strong real presence, strong manufacturing presence. There’s a lot going for – obviously a large population. It’s the headquarters of the Midwest. So there’s a lot going for it.

We have a great team on the ground as well that has I think identified the opportunities that on a risk adjusted basis makes sense. So if that – it’s a major market that we intend to be a player in. At certain times in the cycle, it may not be as exciting as others. On the other hand, it’s got a lot of drivers that we think are positive. And while we believe that we can find the opportunities, we’ll continue to grow there. But we also see a sell [ph] too.

Operator

As there are no further questions, this concludes our question-and-answer session. I’d like to turn the conference back over to Phil Hawkins for any closing remarks.

Philip Hawkins

Thank you very much for participating and listening and looking forward to talking with many of you over the next few months and certainly meeting you at the [indiscernible]. Take care.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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

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

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

Source: DCT Industrial Trust's CEO Discusses Q1 2014 Results - Earnings Call Transcript
This Transcript
All Transcripts