EastGroup Properties, Inc. (NYSE:EGP) Q1 2019 Earnings Conference Call April 23, 2019 11:00 AM ET
Marshall Loeb - President and Chief Executive Officer
Brent Wood - Chief Financial Officer
Keena Frazier - Director of Leasing Statistics
Conference Call Participants
James Feldman - Bank of America Merrill Lynch
Alexander Goldfarb - Sandler O'Neill & Partners, L.P.
John Guinee - Stifel, Nicolaus & Co., Inc.
Ki Bin Kim - Suntrust Robinson Humphrey, Inc.
Emmanuel Korchman - Citigroup
Craig Mailman - KeyBanc Capital
Jason Green - Evercore ISI
William Crow - Raymond James & Associates, Inc.
Eric Frankel - Green Street Advisors
Richard Anderson - SMBC Nikko Securities America, Inc.
Good morning and welcome to the EastGroup Properties’ First Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. [Operator Instructions] Please note this call maybe recorded.
It is now my pleasure to turn the conference over to Marshall Loeb, President and CEO. Please go ahead.
Thank you. Good morning and thanks for calling in for our first quarter 2019 conference call. As always, we appreciate your interest. Brent Wood, our CFO is also participating on the call. And since we'll make forward-looking statements, we ask that you listen to the following disclaimer.
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 is accurate only as of the date of this call. The Company has disclosed reconciliations of GAAP to non-GAAP measures in its quarterly supplemental information, which can be found on the Company's website at www.eastgroup.net.
Thanks, Keena. Our team performed well this quarter, starting the year off with a [strong tenant]. Some of the positive trends we saw were funds from operations coming in above guidance, achieving a 5.3% increase compared to the first quarter last year. This marks 24 consecutive quarters of higher FFO per share as compared to the prior year quarter.
Based on the quarter and the market strength, we further raised our annual FFO guidance by $0.05 a share. The vitality of the industrial market is further demonstrated through a number of metrics, such as another solid quarter of occupancy, saw strong same-store NOI results and positive releasing spreads.
As the statistics bear out, the current operating environment is allowing us to steadily increase rents and create value through ground-up development and value-add acquisitions. At quarter-end, we were 97.7% leased and 96.9% occupied. This marks 23 consecutive quarters, where occupancy has been roughly 95% or better, truly a long-term trend and short demand continues growling for our in-fill location small-bay buildings.
Several markets exceeded 98% leased and Houston our largest market was over 97% leased and while still our largest market, Houston has fallen from roughly 21% of NOI to slightly below 14% for 2019. Supply and specifically shallow bay industrial supply remains in check in our markets. In this cycle, the supply is predominantly institutionally controlled, and as a result, deliveries remained disciplined, and as a byproduct of the institutional control, it's largely focused on big box construction.
Our same-property NOI growth was 4.5% cash and 3.7% GAAP. We're also pleased with an average quarterly occupancy of 96.9%, up 60 basis points from first quarter 2018. Rent spreads continued their positive trend, rising 5.3% cash and 14.2% GAAP respectively. Further, the quarterly results were materially impacted by 125,000 square foot in Houston lease where the rents declined. Pulling that one lease out of our pool, our cash and GAAP numbers rise to 10.6% and 20.2% respectively.
Given the intensely competitive and expensive acquisition market, we view our development program as an attractive risk-adjusted path to create value. We effectively manage development risk as the majority of our developments are additional phases within an existing park.
The average investment for our shallow bay business distribution buildings is $12 million. And while our threshold is 150 basis point projected investment return premium over market cap rates, we've been averaging 200 basis point to 300 basis point premiums. At quarter-end, the development pipeline projected return was 7.3%, whereas we estimate an upper 4 as market cap rate.
During the first quarter, we began construction on five buildings and five different cities totaling 650,000 square feet. While coming out of the pipeline, we transferred three 100% leased projects totaling 421,000 square feet into the portfolio with an average yield of 7.4%.
At quarter-end, our development pipeline consisted of 19 projects in 10 cities containing 2.5 million square feet with a projected cost of $230 million. For 2019, we're raising our projected starts to $160 million and as color commentary the $148 million and starts we had last year were a record. So we're excited to raise this year's forecast.
And as further color on our 2019 starts, we project starting over 70% of those by mid-year. So as the year progresses we'll continue to revisit projected starts. And finally, our activity is spread over nine different cities. This geographic diversity reduces risks while enhancing our ability to grow the development pipeline.
First quarter was relatively quiet for acquisitions, but our pipeline was active. We're committed to acquire three separate off market properties. We expect to close soon on a two building 142,000 square foot new development at the DFW airport, which is currently 19% leased for total investment of $15 million.
Next we have a seven acre site in the Miramar area of San Diego under contract were $13 million, which will accommodate a 125,000 square foot building. And finally, we’re reacquiring two buildings totaling 142,000 square feet in Phoenix. We sold the buildings to the Arizona Department of Transportation in 2016, but they were not torn down during freeway construction.
And as a result, we'll reacquire the buildings for just over $9 million and invest in additional $2.6 million to redevelopment. On the disposition side, we sold world Houston five a 51,000 square foot building for $3.8 million in first quarter.
Brent will now review a variety of financial topics included on our 2019 guidance.
Good morning. We continue to experience positive results due to superior execution by our team in the field and the strong overall performance of our portfolio. FFO per share for the first quarter exceeded the upper end of our guidance range at $1.20 per share compared to first quarter 2018 of $1.14, an increase of 5.3%.
As noted in the earnings release, we reported FFO of $1.16 per share during the first quarter of 2018. In connection with our adoption of the Nareit Funds from Operations White Paper titled 2018 Restatement. We now exclude gains and losses on sales of non-operating real estate from FFO.
For comparison purposes, we adjusted the prior year results to exclude the gain on the land sale and to gain on the sale of a partial interest in a private plane. As tradition for EastGroup, we will continue our standard of reporting FFO as defined by Nareit.
Our protracted strong performance both operationally and in share price has continued to allow us to strengthen our balance sheet. While this is demonstrated in metrics in the earnings release and supplemental information, what is less obvious and perhaps sometimes overlooked is the diversity in our revenue stream.
Our 39.6 million square foot operating portfolio consists of an average tenant size of 28,000 square feet and our average building size is a 100,000 square feet. Accordingly, 58% of our rental revenue is sourced from tenants smaller than 50,000 square feet and 84% of our rents are from tenants than 100,000 square feet.
We're benefiting from both our tenant and geographic diversity where we have a presence in 13 of the 15 fastest growing metropolitan areas in the U.S. mitigating concentration risks foreign shareholders.
Looking forward, FFO guidance for the second quarter of 2019 is estimated to be in the range of $1.17 to $1.21 per share and $4.84 million to $4.94 for the year. Those midpoints representative increase of 2.6% and 4.9% compared to the prior year restated respectively and an increase of $0.05 per share and the midpoint of our guidance for the year.
You may recall that in second quarter of 2018 we had a $1.2 million involuntary conversion gain that is included in FFO. Excluding that gain, the midpoint of second quarter FFO guidance represents a 5.3% increase over prior year.
Our first quarter results combined with the leasing assumptions that comprised updated guidance produce an increase in both average occupancy for the year from 96.2% to 96.4% and an increase in cash same-property range of 30 basis points to 3.8% to 4.8%.
Other notable assumption guidance revisions include, increasing development starts by $19 million, increasing value add property acquisitions by $55 million, increasing termination fee income by $315,000 due to no upcoming fees, and increasing our estimated common stock issuance by $85 million as the direct result of finding more opportunities to invest capital.
In summary, our financial metrics and operating results continue to be some of the best we have experienced, and we anticipate that momentum continuing throughout 2019.
Now, Marsh will make some final comments.
Thanks, Brent. Industrial property fundamentals are solid and continue improving in the vast majority of our markets. Based on the strength we are seeing, we continue investing in upgrading and geographically diversifying our portfolio.
As we pursue opportunities, we're also committed to maintaining a strong healthy balance sheet with improving metrics as demonstrated by the equity we raised in the past few years. We view this combination of pursuing opportunities while continually improving our balance sheet as an effective strategy to manage risk, while capitalizing on the strong current operating environment. The mix of our team, our operating strategy, and our market has us optimistic about our future.
And we'll now take your questions.
[Operator Instructions] And our first question comes from Jamie Feldman from BAML. Please go ahead.
Great. Thank you. Good morning.
So I was hoping you could talk a little bit more about the supply picture, and we have seen that showing it is creeping in some markets. I mean can you just give more color around your building size and where you maybe seeing some supply and maybe what gives you some comfort that this can continue for some time where your product takes a little bit more protected than some of the others?
Jamie, good morning. It’s Marshall. Thanks and good questions. You'll see some large supply number, especially in the major markets, at least in our markets. We will see it in Dallas, Atlanta, certainly Inland Empire. And then really what we do or have our teams do a good job of really digging into it.
I would say long-term, if you said what keeps you guys up at night? We would say finding infill – good infill sites that we can get zoned industrial that we can develop into products. So we know how hard it is to find land for that next park. I'll give our team credit that they keep – seem to keep coming up with the next site, but we struggle and the brokers we work with struggle.
A couple of stats to throw at you that we'll kind of demonstrate it and in Dallas for example, there's – and these are CBRE stats that I'm quoting. There's 22.7 million square feet under construction, but 10 buildings count for over 45% of that 22 million. So really it gives you an idea of – and our average building size is a 100,000 square feet. What we develop may get up to 120,000 or130,000 square feet. So if you think of the depth of those buildings and our average tenant size being around 28,000, 30,000 feet, they just aren't configured that up. You could not divide even 400,000 or 500,000 square foot building to accommodate that.
So I was surprised that only 10 buildings count for moving towards half of that supply in Dallas. And then in Atlanta, for example, the market is 6% vacant, but shallow bay and I don’t know CBRE’s definition, it's probably a little bit larger than our average building. It's only 3.7%. So the vacancy rate drops pretty dramatically.
And in Atlanta there's 19.3 million square feet under construction. Last year they absorbed a little over 18 million. So it's pretty much in parity even in the big box, but there's eight buildings that are over 900,000 square feet under construction.
So both in Dallas and Atlanta, and maybe those are extreme in terms of larger markets, most of what's being delivered is big box and we seem to see that pattern whether we're in Denver, Dallas, Atlanta, Houston, where our peers are – it's nice for our smaller sites helps are so much larger. So for them, Clarion, Heitman, AEW whoever to put the capital out they need to, they need to go to the edge of town and build a 600,000 foot building, and by design, our tenants can't make those spaces work. They can't get the loading doors that the buildings are too deep. Hopefully that answers your question.
Okay. Yes, that's great. That's helpful. And then I guess for branches sticking with – moving to the guidance, so you lowered your bad debt expense outlook by $100,000 and you increased your termination fees. Can you just talk about the moving pieces and then maybe also just address your credit watch list and anything we might need to think about here?
Sure. Jamie, on term fees, we did our guidance $315,000, that's primarily being driven by one known large second quarter termination fee of $525,000. It's a 50,000 square foot space in Tampa. The company was closing their North American location. We were able to negotiate what we felt was an attractive termination fee represented just in excess of 16 months of rent. We feel confident in back filling the space timely, so we felt like net-net would come out ahead.
And so that was the primary single driver. There wasn't any kind of ration of people wanting out of their spaces per say, which is really driven by that one particular transaction. Bad debt, we continued to be very pleased, first quarter just $129,000, which was about a $100,000 less than we had budgeted. Yes, just looking at our AR, the good news is just [indiscernible] miscellaneous here and there pretty standard items.
Last time we reported mattress firm that affirmed the bulk of order released with us, they remain current. We've had no issue there. So bad debt, AR, term fees, all of that, it feels good, this early end of the year it feels good.
And I'll add to that. And Jamie, I'll give you and Josh credit. You had pulled the report together showing tenant concentration and happy to see our top 10 tenants have drifted down. We were 8.3% at the end of the year or 8.1% this quarter. So our largest customers, some of them are in multiple locations, multiple buildings. I believe for your report it's the lowest concentration within the industrial sector. And then even when I looked through our top 10 tenants, there's a couple of things going on where I think that percentage is, one is the company grows and then specifically within those tenants where that number should keep drifting down in the next two to three quarters.
All right, thanks. And keep promoting our research. We appreciate it.
And our next question comes from Alexander Goldfarb with Sandler O'Neill. Please go ahead.
Hey, good morning. So just a few questions for you guys. On the guidance Marshall, you guys on the fourth quarter call granted the year ended definitely at low point as far as the capital markets were concerned. But you guys still spoke about your portfolio being strong and tenant demand healthy and yet pretty strong improvement in the guidance from the initial just a few months ago to now.
So is this just that you guys were just too overly cautious when you laid out your initial numbers or as something really fundamentally changed in the portfolio operations that's led to this improvement? Because it doesn't sound like it's anything really one-time apart from that penny of lease term, it sounds like it was just core operations driving it which $0.05 jump this early in the year, look it bodes well for shareholders, but it seems pretty dramatic in just a few months time.
That's a fair question. And my answer is which was it – is almost yes and it was a little bit of both in that. We were pleasantly surprised. This was a record quarter for us it to average 96.9% occupied, last year we averaged companywide 96.1% and typically we would say buildings full at 95%. So our occupancy surprised us to the upside. I don't think we were overly – we did see a little bit of a pause in the world within our tenants.
Not all of them, but a fair number, especially the larger the tenant, probably the more they hit the pause button a little bit, it's hard to tell over the holidays, but a little bit – the world was pretty nervous in December and probably the first half of January. And that fills now like it was two years ago that the tenant demand has picked back up and people seem to have, kind of moving beyond that time where the government shutdown and trade wars and things like that.
So I think it's our job. We care about being paranoidly optimistic. So we were worried about where things were going to head back in January and a little bit cautious, although things were still moving and then they have improved since then.
So I don't like to think we weren't overly cautious based on what we heard and really in the economy, things feel better than they did a couple of years ago based on everything we read, and certainly even more so what we see on the ground.
And Alex, this is Brent. I would just add to that. You've mentioned moving that much earlier in the year. I would just add to that. You mentioned moving that much earlier in the year, I would contain that moving earlier in the year by a fair amount is a little easier to do and then we beat by $0.02, then we raised by an additional $0.03, which at this time of the year basically essentially it comes out to about a penny a quarter.
As you get later in the year, obviously it's harder to move that Delta as much, and as Marsh said, the good news, its being – and to your point, that's not really – one-time items. It's being driven by property, net operating income and especially it’s more point out from our development pipeline. Not included in same-store all the developments that have rolled in since January 1 of 2018 and those properties are contributing more and faster than we then were guiding to quarterly. They continue to out perform, which we'll take that as long as it can happen.
Okay. And then Brent that leads me to the second, part of that $0.05 in total increase, you guys also increased your ATM activity for increased investments. So maybe you could just provide a little bit more color on the acquisition yields? And then 2) given how quickly you were able to match, whether it's chicken and the egg, whether it's better ATM.
So hey guys, go out and get more acquisitions or hey, we have acquisitions if we have better ATM, whichever, it sounds like between the acquisition front and the fact that Marshall I think you said 70% of the starts are going to be by mid-year. It sounds like investment activity in the back half of the year could ramp up even more, which I'm guessing would benefit on the earnings front given that you wouldn't do one without the other. So maybe you can just talk a little bit about the interplay between the cost of the ATM versus the cost and the accretion of the acquisitions?
Yes. I'll start and then let Marshall talk more specific about the assets. But I would just be clear to say that acquisitions are driving our capital at being 21%. I think we ended the quarter at debt-to-total market cap. We obviously have a very strong balance sheet, so we're not issuing an effort to continue to lower that and as we stay at last call or be a little more conscious of trying to line up ATM issuance with a opportunity.
And so opportunity will drive what we do or don't do an ATM. And that's assuming that the price is there and we like it. But right now we view it as readily available. So I'll let Marshall touch on it, whether it's development value-add acquisitions, as long as they stand on their own merit and make good what we feel like are good long-term since then, then we certainly are apt to do it.
Sure. Thanks Brent, and really in terms of color probably two buckets. We feel some visibility on the $50 million in acquisitions this year. Although that's the most – that's the hardest bucket to fill given the competition and everybody's got a checkbook. So we really aren't different from the other bidders, but feel comfortable - more comfortable today on that front. Then we would have say 60, 90 days ago at our last call.
And then the value add we like long-term, they're probably are, they are, they're better benefits for 2020 then 2019 and kind of just walking through them. The two interstate common buildings that were buying back in Phoenix. We had a four building complex. We knew Arizona DOT was going to acquire them.
So we kind of stopped spending money for obviously a couple of years before they acquired them. It's been a couple of years since they've had them. So those all take a little bit to redevelop and release. We'd like it long-term and we think we'll be just north of a seven in terms of once it's redeveloped. So development type yield on a value add there. And DSW, they're brand new buildings, 18%, 19% leased with good activity.
But by the time we get the leases signed, the TIs done and the tenants in and that's in the high sixes type yield, and then the San Diego land that we disclosed, it's – what I like about it. Its right just east, if you know San Diego of the 805 freeway, which may in Miramar. So we're just north of Miramar Naval Air Station. It's a former card a lot. So it's really a better lot than we typically see for industrial land. And it's really a last mile location. Right on the other side of the 805 is [La Jolla]. So if you want to get products delivered quickly into La Jolla, that we think it's a great site.
I said the biggest problem is I wish it was a bigger site. We have a ground lease on it, so we'll get a return until they decide when their lease expires really, and then we'll develop it. So we like all three acquisitions. It'll just take a minute before we can really get them stabilized in the portfolio. And so it’s probably more 2020, but Brent will raise the capital for us to close this year.
Okay. Thank you.
And our next question comes from John Guinee with Stifel. Please go ahead.
Great. Thanks. Hey, just sort of curiosity questions – then you could address them. I noticed somewhere that you bought a property with a 40-year ground lease, which seemed a little bit unusual. Can you talk about maybe some options you have on the background lease at the end of the 40th year?
Second, in your infill development strategy, how often are you actually buying greenfield dirt versus second-generation development where an existing assets being demolished? And then third, when you're leasing up your development, how much of the lease up is basically moving existing tenants of yours into a new building and how much is filling up those buildings with a new non-EastGroup tenants?
Thanks, John. I'll try to answer those and Brent can chime in…
That all John, that all yes…
That was just one question.
On the ground leases, fair observation and good observation. And if you studied DFW, I think the number is 18,000 acres that that airport has and their typical lease is a 40-year ground lease. So there's all types of industrial that's really a who's who in terms of national developers that are there on those ground leases as well as hotel retail office. So the first, we have, call it 39 years left on our 40-year ground lease. Some of the older ones, they'll be [indiscernible] well before we roll and go back into DFW to renew.
So we looked at it, in terms of pricing, kind of maybe walking you through the weeds, but if it were fee simple and it is right at the exit just off one of the tarmacs at DFW. It's probably a four and three quarters yield and in the market. And then talking to some of the brokers, probably 50 basis point premium to get go from fee simple to a ground lease. So that's probably around a 5.25. And as we underwrote market rents and carry and things like that, we're 6.5 to 7 type yields.
So we feel like we're getting paid for the premium of the ground lease there. And it really ties into your second question. Most of what we're looking at it, as I mentioned earlier, we struggle to find good sites. We'd rather be fee simple, but there's simply nothing left at the airport. And in talking to our guys, they had one vacancy in our Dallas portfolio, I mean tenants that wanted to expand.
So buying these buildings at DFW, we'd prefer them to be fee sample. But we like this location, especially given the prominence of DFW airport over the next 40 years and how that continues to grow. Most of what we do build is still greenfield, but all of it seems to have a story where we're relocating someone or – like Churchill Downs, it was semi green, towards the stables down in Miami and we do things, we're looking at a site in Texas that a church would relocate [indiscernible] a ground lease.
We kind of apologize to our investment committee. We promise we're not trying to make things complicated, but infill sites get harder and harder to find and we'll certainly do more and more redevelopment.
And then what's nice about having the parks, where I'll probably call it moving towards 50% of our development leasing is we have someone, and I'll pick Charlotte and Steele Creek III and they need more space. So they’ll either do a renewal, early renewal and expansion and Steele Creek IX or they'll relocate them if they really want to be on one location into the new building.
So that's part of our pitch and the market to tenants. If you're in world Houston or Steele Creek or Kyrene, we can accommodate your growth and every tenant usually probably overestimates. Most people are optimist, how much they're going to grow, but we like that a build, they went into midterm of someone's lease because then they can't move down the street that we can accommodate your growth and fill up our parks.
So it's probably approaching half of our development leasing is the economy's good and tenants are expanding. And then the good news about a good economy, the spaces we're getting back are typically below market. There'll be vacant a little bit, but typically they're both, the leases are a couple of three years old and so those are below market, so we get an early at back – to go back fill those spaces as well.
Right. Thank you.
And our next question comes from Ki Bin Kim with Suntrust. Please go ahead.
Ki Bin Kim
Thanks. Your tenant retention ratio dropped a little bit this quarter. I mean it's just one quarter in a long history of really high retention. But anything noteworthy there?
This is Brent. We had, yes Ki Bin, we had a tenant in California, one of our larger tenants that several at 135,000 square feet to three tenants. Their lease still runs for a number of years and basically those subtenants, we sign leases with them to then lease behind that tenant out into the future.
And just trying to stick to the way wave we could always done things. We thought the fairest way to treat that, we basically treated that square footage during the quarter as a quote non-renewal, which technically it won't be that point will not be renewable. We've leased the space behind that.
So I would definitely call the quarter a little bit that skewed the retention percentage. But again, just in being a comparison friendly to how we've handled that type situation in the past, we treated it the same. So I think you'll definitely see that click back upward in absence of not having another anomaly like that.
Ki Bin Kim
And is there any maybe besides this quarter. Any kind of discernible trends on why tenants too it's not to renew?
Usually I think we can't renewal on it. I think the biggest problem we run into, in some cases we use, we don't have the space more than and they're growing. I would think that typically we average over time around 70% a little over 70%. It's kind of our historical average.
But in Tampa where we had the termination it was a European company and their business model just did not work in the U.S. so they closed or a bankruptcy or probably what we see more and more is they're growing and we try to have that next development ready.
But if we don't have the space, that's probably where we lose. That's probably our biggest reason right now. It was not able to accommodate growth. But that said, I still think by the end of the year will average 70% are low 70s tenant retention.
Ki Bin Kim
Both on the high-class problems.
Knock on wood. I hope so yes.
Ki Bin Kim
All right. Thank you.
And our next question comes from Manny Korchman with Citi. Please go ahead.
Hey guys, it's sounds like or here with Manny. Marshall, given your earlier comments on the oversupply in Atlanta market and also at the same-store results in the quarter. We were perception to that market or desire to grow in that market changed?
In Atlanta, Jill, I'm sorry.
Okay. Yes, we like Atlanta and we’d like to grow there we're just adding in the last week have hired someone kind of at the Vice President level it's a backfill of a spot, but there'll be based in Atlanta and John Coleman, our regional move to Atlanta. So we like the market a lot with our product type under 4% vacant. As I mentioned, there's over, I guess if that helps 19 million square feet under construction, but absorption last year was over 18 million square feet.
So the market is Dallas and Atlanta are a little bit and that you were worried the supply and it kind of takes your breath away, but then you look at the absorption over the last few years and what's being delivered keeps getting absorbed. And thankfully where the numbers get a little bit shocking it is because of those 600,000 square foot buildings and up that most of our peers gravitate to.
So we're pursuing growth but trying to be disciplined in Atlanta and we just came in second unfortunately on the building in the last week trying to acquire yet. So we'll kind of keep picking our battles and trying to stay disciplined. But we liked the market long-term and it's right in our backyard and kind of identified that call at 10 O'clock to 2 O'clock on the map. Right now we're kind of 12 to two, what they call the Golden Triangle of Atlanta seems to be a good fit for hire type building and are, where the path of growth is also an Atlanta up north in terms of residential high or end residential. So hopefully that is helpful.
Okay, great. And any interest in looking at bigger acquisitions or maybe bigger portfolios, just giving away your stock price is trading.
Look at those and yes interests. The bigger the usual care, the bigger the portfolio and the better the sales package, the more intense that competition is. And it just gets priced to perfection really where we would have. Our acquisitions will look, maybe two to four years in the future and not a 10 year [indiscernible] like a lot of our peers and that typically no one underwrites a downturn and you're a spy through seven type thing.
So we tried to not go too far out there and assume too much in terms of rent growth and maybe as a result of that it makes it awfully Harvey. We like them. We certainly have picked up the value-add acquisitions this quarter. We'd like those as almost a shadow development pipeline in terms of getting a good attractive return and managing the risks for our shareholders.
And we, we've felt more comfortable on our acquisition assumption so we'll stay at it. It's just hard. In Atlanta there was a package we looked at in the last year and we were one of 24 25 beds and the initial round and it's just hard to – if you're the winner of it, I'm not, it's hard to believe you're the winner of it almost for, time will tell.
I will take a few years on just how competitive the wall of global capital for industrial as the brokers talk about is real. And we lose a lot of beds each month on those. But we'll keep that, keep trying and I hope we can surprise you with one at some point.
Great. Thanks, Marshall.
And our next question comes from Craig Mailman with KeyBanc Capital. Please go ahead.
Good morning, guys. Marshall, this maybe follow-up on under competition talk, you guess, I was like yields on some of these value add plays is pretty close to development without the construction risk. Can you just kind of talk about what the competition was for these and I sourced them?
Now good question and each of these were off market and no particular order and Dallas, our guys, they're called on the developer. It's a local regional developer and kind of developed a relationship and I think it was going on a year before he agreed to sell that.
And again, I think we liked the yield there. We need to get at least, but we have good activity so far. Interstate comments in Phoenix was an anomaly a little bit and that we had sold the buildings to ADOT and had the right to repurchase if they didn't tear them down.
And now the freeway work is done. So our visibility and access is even better. And thankfully they didn't tear buildings down is up and the process. So there we had a right to repurchase it appraised value.
So again, off market there. And then the Miramar land, it's a little bit the same. It's a 20-year relationship that we've had with a group out of Southern California based in LA. And they had tied up this land thinking it was a friends and family deal and we cajoled them a little bit and letting us participate in it and doing a 95 five JV. So we're excited about the side and it's turning over a lot of stones to maybe find a small deal here or there. But hopefully they add up over the course of the year for us.
So when it goes to market and we'll bid on it, but it's awfully hard to be the winning better in that case, and it's really driving around in a car with a broker, they'll say, if you lob in an offer on this, this seller may be willing to sell and that's all of them are long shots, but that's almost a better path to buy things for us or find value as then to wait and get the email blast that everybody gets.
That's helpful. And I'm like to DFW deal. It sounds like developers got sort of a construction fee. I mean, is there anything on the backend that they try to negotiate with you?
Yes, no, no. Thankfully not on that. It was they were, and all those, a lot of times, and I don't know in this case. I should, I know who the developer is, but I don't know how his financings arranged. Usually it's, they've got a financial partner and we'll get you into your IRR promote and you can go down the road and build your next building, which is really what they typically want to do.
And so they'll make some money and take some chips off the table and will probably move on to his next development, but no promote down the road for him. And he was doing the leasing in house, which is good for him, but we like having a third-party broker that's really fully focused on leasing. And so we think hopefully we can pick up some leasing velocity by stepping. And he did a nice job of finding the side and designing the buildings and hopefully we'll take the back half of it from here.
That's helpful. Then just separately, you guys have a little bit of a different product mix than some of your peers had. I'm just curious, how the – we all know demand is good, but you guys just had sort of a presence in some of your legacy EastGroup markets for a long time. I mean, how have your guys on the ground seeing the demand composition change? Has there been a change? Or is it sort of evolving at ecommerce and those type of tenants evolve?
We would say – and Brent chime in, our traditional tenants are still there and typically almost all of them, it's about 1,500, 1,600 tenants doing well and kind of, if you almost call it old economy. The floor supply guy, the [granite towel], the HVAC contractor, different industries like that all want to be closer to their customer and they typically are doing well.
And as that evolves also in our legacy markets, the traffic gets worse in Tampa and in Dallas and in Houston, so we'll see them like in Dallas, that's what we liked about Fort Worth as you may need Goodman HVAC who is a tenant in Dallas also needed a facility in Fort Worth because it's – you could spend all day in traffic and when your air conditioner is out in Dallas in July, you want someone there immediately.
So we see a little bit of that evolution and then each quarter there's more and more ecommerce tenants or people change their model like Lowe's is a tenant we've worked with recently the retailer where no one drives home with a washer, dryer, refrigerator, but they've leased space with us, a couple of spaces from us as they roll out their strategies.
So you buy it in the store, buy it online and it gets delivered from an EastGroup facility. And that's been a new change. So some ecommerce, some just people closing physical brick-and-mortar and were lower rents. But if it's lower rents and close to the consumer, we can be that last touch and get it to your house fairly quickly.
Yes. The only thing I would add to that, Greg, is a lot of times I think it just – a lot of it is dictated on tenant psychology and I think across the board in all our markets to tenant psychology, how they feel about their business and overall economy is good, and so anytime you have that kind of underlying the current is a positive. And then also I think we have enough depth in activity in most of our markets where there's competition for spaces and always equate this a lot to residential because people relate to that better.
But if you're looking at a home and there's very little activity, you don't feel that pressure to get that offer out very quickly. But if you're looking at residential market where it goes on market, if you don’t put the offering 24 hours, it's going to be gone. So there is that sense of urgency, which are all signs of a landlord market. But there is that bit more sense of urgency in our markets to which all that adds up. And like Marshall said, with the varying type tenants that are out there, and it's all stacking up to just be solid, deep activity.
It’s helpful. Thanks guys.
And our next question comes from Jason Green with Evercore. Please go ahead.
Good morning. Given a good portion of the guidance increase was due to better than expected impact from development, is there any additional upside to that development impact for fiscal year 2019 or is everything more or less baked into guidance at this point?
I hope, I guess I'll preface it by saying I'm an optimist, but we did move it this quarter, call it the $19 million and 70%, a little north of that starts in the first half of the year. So we have our development starts, and really on leasing, what I love about our model is rather than corporately decide that you’re going to go build an 800,000 foot building south of Atlanta or on the southwest side of Phoenix.
It's really almost like a retail store where they're out of inventory and we deliver the next building to put on the shelves. So we keep a shadow development pipeline and that's still a pretty good material size out there. So I'm hopeful there could be upside to our $160 million, although I’m also talking to the guys in the field appreciative that $160 million would be a record this year in terms of starts for us.
So we used to say $100 million and starts and have worked our way up to $140 million and $160 million and so our push it as much as the market allows us to and Brent and the team have done a nice job of deleveraging the balance sheet, which I like having a more as we stretch on some operational risk and a good market.
Let's also keep our balance sheet almost as a hedge safe or unsafe or. So with look – I'd love to bump the 160 up another one of these quarters and have that news for you. I know it'll really depend on what our tenants want to do.
And I would just add to that, Jason, we are a little more back in weighted in the year with our FFO growth, especially third and fourth quarters. And that is being driven pretty heavily by what we're factoring in for development and value-add. And when I say develop the value add I am talking about properties that had been added into the portfolio since 1/1/18, in other words they're not saying store property, so outside of same-store increase.
So we have a fair factor in first quarter, I think we have about 3.3 million of property net operating income from that development pot and we're looking by fourth quarter that grow into 5.7 billion. So it is playing on a large insignificant role and we're counting on it continued to push through the rest of the year.
All right. Thank you. And then maybe we can just touch on the development costs and how those are impacting your yields and how development costs have been trending over the last 12 months?
Yes. Good question. We think rents will keep following and I guess as an aside, and it's easy to say, if we pull them one lease out in Houston, we would have had record gap releasing spreads at over 20%.
So you're seeing a tight market and construction costs, rising construction costs, push rents, we feel alive, but concrete prices, steel prices have gone up. And then underlying all that, it's a good economy. So all of this the GCs and all of the subs are busy and we've even heard stories of competition at one of our sites trying to hire the workers away during construction. Just the labor shortage is also pushing rents up.
So it's probably moved our yields are seven, three, seven, four. I think what we're doing it from memory, what we rolled into the portfolio, was it seven four what's in the portfolio was a seven three. Miami's a little bit lower yield but lower cap rates. So it should come down. But those probably would have been about a 7.5 to years ago. It's just construction prices continued to creep up in a good economy. So that's certainly something we launch and talk about a fair amount.
Okay. Thank you.
And our next question comes from Bill Crow with Raymond James. Please go ahead.
Thanks. Good morning, Marshall. Just curious with your in-fill portfolio. Are you seeing increased demand from grocers? I mean that's one of your retailer it seems to be growing. What is your thought about getting into lease partially if not fully refrigerated space on new developments?
Good question. And we've read about that and that certainly seems to be the trend where things are going. And I and I know there's even cold storage REIT this come public what in the last year, a year and change. And Brent chime in because he's had direct experience with it. We like keeping our buildings fairly generic that when you get into that freezer cooler space sometimes you can have issues.
One the equipment gets dated fairly quickly and then sometimes too it can damage the slab and some issues like that. So and some of the tenants are also startups. So we steered away from a startup and the Bay area just because the TIs were heavy. It was an online grocery, delivery and just all in a tight market we had better options and we could thinking about if something happened and the next tenant down the road.
So we may be missing it. And it seems to be a growing area, but we really haven't pursued it or focused on it because I like having about $0.40 per square foot per year of TI when our tenants move out is what our average is. Brent, you've lived with it until you've had a bad experience or two on that.
Yes, I think Bill, good morning. The talents with freezer cooler spaces, Marshall said ideally on the front end going into it, that's what you're building for because there's designed specific things you would do to protect your slap, protect your sub-slab, meaning the dirt underneath the concrete to keep it from not freezing and unfreezing and the structural issues. And so there would be some commitment of TI or building specific improvements that you would ideally want to do on the front end. And then you're very small percentage chance for us that we would lease to an actual grocers. Then you – that money into the building and it doesn't actually get utilized.
So in a build to suit situation, we would definitely look deeper and you won't plenty of term, but then you can design it more specifically. But on a day in, day out basis, it's just not something prevalent enough we've seen to warrant changing and taking on that additional capital risk on the front end.
So within your markets, you're not seeing Publix, Kroger clamoring to get direct-to-consumer space or anything like that?
Every from the store, where you buying – clicking online, pull up and they bring it out and pick it up, certainly that, but we've not seen a lot of grocers yet out in the market. And it's something that's been tried for a long, long time. We signed the lease with a group called gotoworks.com back in like 2000 – about 18 years ago.
And that didn't work at that time. And here we are 18 years later and still people are trying to figure out how to make groceries online work. So it will get there and some of the heavy metropolitan areas and really densely populated. But I don't see that in the near-term being a big catalyst industrial, not traditional space.
I guess we've seen Walmart, out looking and again, if we could do dry goods, we certainly would, but I wouldn't say a good question. I would read more about it. And then we've seen it in terms of people clamoring, whether as you say, Publix, Kroger, Heb in Texas, people like that. And just haven't seen it.
One last one for me, and this maybe premature, but certainly there's talk in California about the prop 13 changes. Have you done a preliminary assessment of what that might mean to you?
Thankfully we've own some buildings for us, fair amount of time in California, so we would have some times jobs. Everything, almost all of our leases would not 100%. but the high 90% are going to be triple net so we can pass it through and all of our peers would have that. I guess depending on how recently they acquired their building. It could hinder rental rate growth in California.
In short-term, it would have minimal effect, but because we pass it through to our tenants and it would be an impact on them. It would be when those leases rolled, our ability to push those rents to market, that everything's, knock on wood generally well below market in California. If it's just a few years old and it, some of that may end up being [indiscernible] rather than rent was what would happen under prop 13.
So we're watching it and have read about it and just know there'll be – I can't imagine, Irvine Company Watson Land, Carson land. There will be some huge players that get involved in the lobbying for this. That would be pretty heavily in fact, I would imagine how this plays out.
Yep. Okay. Thanks. That’s it from me. Appreciate it.
And our next question comes from Eric Frankel with Green Street Advisors. Please go ahead.
Thank you. Can we just talk about Houston and I think we rolled out our rose fundamentals in the market or a better there, but there seems to be a fair amount of supply in the market. I'm just wondering if that lead's role was an anomaly.
I would call it a good question. Good one, an anomaly and the sense that it was a single chain. I guess what role in Houston, what kind of the details of it? It was a single tenant pre-leased/build-to-suit, 125,000 foot leased up at World Houston. And that tenet, it was about a quarter office within the 125,000 feet and a fair amount of that was 50/50 mezzanine office.
So second storey office, and that tenant also had as a 3PL. They were able to use that outside yard storage. So they consolidated, moved out during the downturn. We sat on the space for a couple of years with it vacant and then decided, this is a little bit of a unique animal and we had a similar situation in Phoenix a couple of years ago where you end up with a building, I'll tie it to freezer cooler when a tenant, when a building becomes pretty specific for attendance used, it makes it harder to release it.
So after a 10-year lease with annual bumps, and it out there vacant, we decided to stretch and just make the deal we could. So without that again are our GAAP numbers would've been as a Company just over 20% and even in Houston our GAAP releasing spreads would have been 19%.
So we can't pick and choose our metrics obviously and we're not doing that. But if it helps you, out of 84 of the 85 leases we signed this quarter all look, you kind of not your head and not along here. We had a pretty tenant specific building that rolled sat vacant for a while and we finally just said, all right, and then my fingerprints are on the gun whether we should have done it or not, hey, let's just take the tenant on hand and partially guilty to Brent's given me a look, if my fingerprints are on it and let's do this deal and move on. And Brent's only defense has been, hey, I wasn't there to do the renewal as well. I would've gotten a better rate where it was his original deal. Any color Brent or did I cover it?
Yes. I think that covers it. I think the bigger point is that the 19% GAAP is what it would have been absent that one lease. And talking to the guys in the field, we don't anticipate. We do think that's a one-off situation, not a – we've got four more of these coming over the next couple of quarters. So I fully expect that to bump back up.
I would just point out to the Texas that pulled Texas down and just again with that, that one lease would go from 3% to 16% as a GAAP increase, which is really where we've been as a run rate as a company for the past when we were there 2017, 2018 and really minus that lease were slightly better than that first quarter 2019.
Couple of other just kind of Houston stats. I was glancing at that. The overall market is 5.4% vacant and the north market – our World Houston Park is 6.2% at the end of first quarter, which is the lowest it's been since 2012. So we were encouraged by that. And then Houston's a little bit of an anomaly market for us as well. And the rents in the north market are pretty much back to peak.
And usually when we say that, people would refer to the downturn, but in north Houston that actually is – they're back to where they were in 2015. So as Brent said, we think this was an anomaly and it's glad to see the market recover back to where we were in 2015. So that was a much more recent downturn then the balance of our markets.
Okay. I appreciate the additional color. Just a follow-up question on external growth and acquisitions and asset pricing. I think you've alluded to a pretty competitive environment, but maybe you could quantify where you think stabilized cap rates have trended for some of the markets you're targeting. There are cap rates down 10, 20, 30 basis points and say six months ago?
Yes, I would say broad brush kind of the major markets is kind of what we hear and see, LA, Dallas, Atlanta, maybe Miami, they’re high 3’s, maybe to 4, and you can get prices per square foot that are pushing $150, $200 per square foot land, approaching $60 a square foot in LA, which is – and then San Diego in the 40’s or we've seen a $70 per square foot land comp in San Diego. And these are all industrial sites.
And then what we've heard, again, I'll quote CBRE, they said they've been predicting cap rates would compress in the secondary markets, meaning that Charlotte, Denver, Phoenix, Tampa, those types of markets and last year they did compress there, so that now you're in the 5 to 5.5 in most of those markets, and it is a long laundry list of international capital that we've seen coming into U.S. industrial.
We've been the favorite asset class we met with – Brent and I met with HFF recently and their comment was there's a bid ask spread and about every product type right now that there's more dry powder on the sidelines then they’ve ever kind of as they measure it, kept track of. And there's a bid ask spread in all product types, but for industrial and there is such demand, it's the most efficient product when they bring properties to market.
That’s interesting. Thanks and just one quick follow-up question. It’s related to I guess the grocery question that was mentioned earlier. Is our tenants investing at all more in some sort of equipment handling budget just move product more quickly to your facilities, so more robotics or they're more just general automation that's occurring in some of the new leases that have been signed?
I would say generally, yes. Usually, the larger the tenant and probably the better capitalized the company. Certainly like we have FedEx in a number of locations, they're cutting edge on that. And tenants do that, certainly they're all of them are doing it a little more. It's just a matter of what their product is and how fast and what their balance sheet looks like.
But we think with the labor shortage, I think it will keep trending that way and they'll get more efficient and how they're moving product through the warehouse and probably – and again, we think we're early on, smaller space is closer to the consumer, so they can get that quick delivery.
Okay. Thank you.
And our next question comes from Rich Anderson with SMBC Nikko. Please go ahead.
Thanks. Good morning. Hey, Brent, did you mention the rise and the G&A guidance from a couple of months ago in your prepared remarks? I don't think I heard it, but if you didn't, I'd love to know what the nature of it is?
Yes. Rich, good to speak with you, get to hear you. Yes, G&A was up a bit and a little bit of its comp and restricted stock oriented. But there is some component of it that relates to a [indiscernible] lawsuit that we've been involved with that, that was discussed in the notes to the 10-K it will be discussed is very summarily in the 10-Q there'll be out in the next day or two.
We incurred I think $320,000 of that costs related to defending ourselves in that suit, which we feel is without merit, but yet you have to defend yourself. And then we have some costs down in, into the year to deal with that. So there are a few moving pieces up and down, but I would say that was the new piece that's primarily drove the increase that you see there in the guidance.
Okay, good enough. And then for Marshall or anyone, I'd like to sort of ask a question about risk management. There's nothing on your balance sheet of course, but you're increasing your development spend, you're going after value add acquisitions and given the demand that's out there for your product. But what are you looking for to not go forward, but just take a step backwards.
You're getting 200 to 300 basis point premium spreads versus acquisitions and development. If that number starts trending down, is that a sort of a foreshadow though? Maybe we got to take our foot off the accelerator or is it maybe the spread between least and occupancy, which is only 80 basis points now? What are some of the things that you're looking for to manage not this year but two or three years from now?
Good. Fair question and you're not usually we'll target, I kind of our internal rule of thumb is 150 basis point premium kind of we do a development over market cap rates. And again, thankfully we've been north of that. And then typically when we do our underwriting, we'll use the yields, we project our own current market rents. So we won't put an inflation factor on rents.
I'll be at, we've benefited from those over the past few years. If that number gets closer to 150, we certainly would take our foot off the accelerator or a like as our model work where I compare this to retail earlier. If we're delivering buildings and they're not leasing up and in during that downturn in Houston, we were able to stop. We stopped development. I'll give our model credit for working.
And same time in Phoenix, we – a couple of years ago we had vacancy and some fairly, within our portfolio and then some new developments and we really stopped development and really stop looking at acquisitions until we kind of caught up and digested what was on our plate.
We've done a little bit, we're about there in Atlanta, but I've even more recently we had added some value add product in Atlanta had vacancy. And so we had – there we've said, let's kind of finish and catch up to what our own internal supply is in that market before we really pursue new acquisitions or new land sites.
So we try to almost market-by-market and what's on the shelves in moving, we won't add to the shelves there. And unless it's – an a compelling reason, and if we've developed vacancy, I don't want to go to our investment committee and say the third or fourth vacant buildings to charm, let us build another one will really get our first buildings leased up and then go back to committee.
But when things are good, I kind of view it, if we can build those yields, will try to make hay while the sun shines where it's been the last couple of years and keep up a safe balance sheet because when things do slow down, they may slow down quickly.
So I liked that we're trying to be more geographically diversified in case it slows down in one market and not another. And then just kind of watch each development, knock on wood, our last, 16 developments that we've started and we'll miss one or two here probably coming up, but have all rolled into the portfolio. We'll roll them in the earlier of when they get 90% leased or one year pass completion.
But our last 16 have all rolled in at 100% which that's an anomaly. But that to me feels like okay, the market's telling you to kind of keep doing that and keep creating that value for our shareholder until you see it starts to slip and then we'll play defense again.
All right, fair enough. And just one comment, I mean if you're making churches move to accommodate your industrial buildings, I just direct, perhaps not walking outside during a lightning storm? And that's all I have. Thank you.
And it does appear that there are no further questions over the phone at this time.
Thank you. Thanks everyone for your time. Appreciate your interest in EastGroup and we're certainly available for any follow-up questions you may have. Take care.
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