This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
spk16: Ladies and gentlemen, thank you for standing by and welcome to the Duke Realty Earnings Conference Call. At this time, all participants are in listen-only mode. Later, we'll have a question and answer session. Instructions will be given at that time. If you should require assistance during today's call, please press star then zero. As a reminder, today's call is being recorded. In honor of the conference of your host, Ron Hubbard, please go ahead.
spk04: Thank you, Sean. Good afternoon, everyone, and welcome to our fourth quarter and year-end 2020 earnings call. Joining me today are Jim Connor, Chairman and CEO, Mark Dineen, Chief Financial Officer, Nick Anthony, Chief Investment Officer, and Steve Schnur, Chief Operating Officer. Before we make our prepared remarks, let me remind you that statements we make today are subject to certain risks and uncertainties that could cause actual results to differ materially from expectations. For more information about those risk factors, We would refer you to our December 31, 2019 10-K that we have on file with the SEC. Now, for our prepared statement, I'll turn it over to Jim Connor.
spk06: Thanks, Ron, and good afternoon, everyone. We hope all of you joining us today, as well as your families, are safe and healthy. Let me start by saying that 2020 was another outstanding year for Duke Realty. Even amidst the global pandemic and a major U.S. recession, We exceeded all of our 2020 goals, including our original pre-pandemic operating and financial guidance metrics. We also capped off the year with fourth quarter leasing volume being the strongest quarter of the year. And just after quarter end, executed a significant debt transaction to bolster our balance sheet, which sets us up for a great start to 2021. Let me recap the highlights of our outstanding year. When the pandemic hit, we engaged our business continuity plan to ensure the health and safety of our employees, our customers, and our construction work sites. This was executed extremely well, and I'm happy to resort cases at Duke Realty were very minimal. We signed nearly 21 million square feet of leases. We maintained the occupancy of our stabilized portfolio between 97% and 98% throughout the year. And our total portfolio, which includes our underdevelopment pipeline, ended the year at 96% lease, the highest level we've ever achieved. We renewed 70% of our leases, or 83%, when including immediate backfills, and attained 29% gap rent growth and 14% cash rent growth on second-generation leases throughout the year. We grew same property NOI on a cash basis 5%, which exceeded our revised guidance expectations. We commenced $795 million in new developments that were 62% pre-leased, 67% of which were in coastal Tier 1 markets. We placed $730 million of developments in service that are now 94% leased. We completed $322 million of property dispositions and $411 million of property acquisitions. We raised $675 million of debt and an average at a weighted average term of 20 years and an average coupon of 2.4%. We increased our annual common dividend by 9.1%. And finally, we've continued to run our company in the most responsible manner with our ESG culture and numerous ESG achievements. Now, let me turn it over to Steve Schnur to cover our operations for the quarter and touch on some market fundamentals. Thanks, Jim. I'll first touch on overall market fundamentals. The fourth quarter demand was exceptional in the logistics sector, with 104 million square feet of absorption, which was the highest on record. Demand exceeded supply for the quarter by about 30 million square feet, which nudged national vacancy rates down to 4.6%, which is still roughly about 200 basis points below long-term historical averages. For the full year, demand was 225 million square feet compared to a supply number of 265 million square feet. Even when adjusting for the significant amount of activity we saw from Amazon this year, the full year 2020 net absorption was still 12% higher than 2019. For transactions larger than 100,000 square feet, e-commerce users comprised 22% of total demand and 3PLs about 26%. Comparatively, e-commerce demand in our own portfolio represented about 20% of our total leasing square footage volume for the year. This segment of the demand market, users over 100,000 square feet, continues to be the most active subset. To that end, we signed 29 deals in the fourth quarter over 100,000 square feet in our portfolio. Asking rental rates rose again in the fourth quarter, up 8.3% over this time last year. This rate of growth is about 100 basis points higher than the five-year historical average of 7.1%. We see this trend continuing in 2021 with macro rent growth levels in the mid single digits. In our own portfolio, we had our strongest quarter of the year with 9.7 million square feet of leases executed, which is our second highest quarter ever in our company's nearly 50-year history. Our average transaction size was 104,000 square feet. In addition, the average lease term signed during the quarter was 7.5 years. On the rent collection side, we averaged 99.9% for the fourth quarter and 99.9% for the full year, arguably best in class in the entire REIT sector. These figures include a very small amount of deferral agreements and credit enhancement collections as detailed in the supplemental package. Looking forward, our overall tenant credit quality is very strong. We do have a handful of tenants and industries most acutely impacted by COVID that are in financial difficulty, which Mark will touch on in a moment, as to their minor impact on our 2021 financial numbers. We do have a strong prospect list of backfills for most of these spaces, so the longer-term impact in this situation we believe will be positive. At quarter end, our stabilized in-service portfolio was 98.1%. The lease activity for the quarter, combined with the strong fundamentals I touched on, led to another great quarter of rent growth of 13% cash and 27% gap. We also had a very strong quarter in first generation leasing. In our speculative developments under construction, we executed two significant leases in the quarter. The first was a 622,000 square foot lease in northern New Jersey. to a leading national home furnishings retailer looking to expand its supply chain network for inventory redundancy, often referred to as safety stock or referred to as increased inventory levels, for them to take 100% of the space in that facility. The second notable lease transaction in a SPEC project was a 290,000-square-foot lease we signed in the South Bay Submarket of Southern California. This lease was to a major national beverage distributor to take 100% of the space as well. It's important to note both these buildings are still under construction and not scheduled to be completed until the second and third quarters of this year. Turning to development, we had a tremendous quarter of starts, breaking ground on eight projects totaling $420 million in cost and 69% pre-leased. Seven of these new developments were part of our detailed press release that we issued on December 7th. And then later in December, we started another project for about 146,000 square feet in the mid-county sub-market of Southern California. In total, nearly 70% of our fourth quarter development starts were in Coastal Tier 1 markets, and five of our eight projects were redevelopments of existing land and site structures. Our development pipeline at year-end totaled $1.1 billion, with 80% of this allocated to Coastal Tier 1 markets. This is a larger pipeline than we had a year ago, and the allocation to Coastal Tier markets is also higher than a year ago. The pipeline is 67% pre-leased, and we expect to generate margins in the 30% to 40% range. Looking forward, our prospect list for new starts in 2021 is very strong, and our land balance at year end totaled $297 million, with nearly 80% of this allocated to coastal Tier 1 markets, setting us up very well for future growth. I'll now turn it over to Nick Anthony to cover acquisitions and dispositions for the quarter.
spk12: Thanks, Steve. We had a very active quarter on both dispositions and acquisitions. Consistent with our strategy to increase our exposure to coastal Tier 1 markets, we sold $276 million of assets in the fourth quarter, comprised of two facilities in the far northwest submarket of Indianapolis, one in the far northeast submarket of Atlanta, one facility in the western portion of the Lehigh Valley, and an asset lease to Amazon in Houston. In turn, we used these proceeds to acquire two assets in Southern California, and a portfolio in Seattle for $305 million that in aggregate are 74% leased with an expected initial stabilized yield in the mid fours and long-term unlevered IRRs in the mid sixes. The Seattle portfolio encompasses three buildings that are 69% leased in aggregate located in the DuPont sub market and adjacent to an existing facility we developed several years ago. For the full year, Our capital recycling encompassed $322 million of asset sales and $423 million of acquisitions. Combined with the development previously mentioned by Steve, this activity moves our coastal Tier 1 exposure to 41% of GAB and our overall Tier 1 exposure to 67%. We expect this recycling to continue in 2021 with dispositions primarily from the monetization of some of our Amazon assets, allowing us to manage our tenant exposure, as well as some Midwestern assets to further refine our geography. I'll now turn it over to Mark to cover earnings results and balance sheet activities.
spk05: Thanks, Nick. Good afternoon, everyone. I am pleased to report the core FFO for the quarter was $0.41 per share compared to core FFO $0.40 per share in the third quarter and represented a 7.9% increase over the $0.38 per share reported for the fourth quarter of 2019. Core FFO was $1.52 per share for the full year 2020 compared to $1.44 per share for 2019, which represents a 5.6% annual growth rate. FFO as defined by NAE REIT was $1.40 per share for the full year 2020, which is lower than the core FFO due mainly to debt extinguishment charges. We grew AFFO by 6.2% on a share adjusted basis compared to 2019. Same property NOI growth on a cash basis for the three months and 12 months ended December 31, 2020 was 3.3% and 5.0% respectively. Same property growth for the quarter was driven by continued strong rent growth and a 20 basis point increase in average commencement occupancy within our same property portfolio from the fourth quarter of 2019. Net operating income from non-same store properties was 17.3% of total net operating income for the quarter. Same property NOI growth on a GAAP basis was 3.1% for the fourth quarter and 2.8% for the full year 2020. Bad debt expense for the year was primarily related to non-cash straight line reserves, which negatively impacted GAAP same property NOI. We finished 2020 with $295 million outstanding on our unsecured line of credit, which we refinanced early this month with a $450 million, 1.75% 10-year green bond issuance, which will bear interest at an effective rate of 1.83%. The pricing on this transaction was very attractive, with our effective rate incorporating a 70 basis point spread over Treasury rates, which at the time was the lowest credit spread ever on a 10-year REIT bond offering. We intend to continue a robust pace of growth in 2021, which we anticipate to fund with a combination of asset dispositions, internally generated cash flow, short-term use of our line of credit, and a potential unsecured bond issuance later in the year. Also, if additional growth opportunities arise, it's possible we issue a modest amount of equity through the ATM on an opportunistic basis. From a macro outlook perspective, we expect a 2021 environment to be overall relatively strong and improving each quarter in light of the expected federal stimulus and vaccinations. Supply and demand are relatively unbalanced. The overall fundamentals picture is quite supportive of continued market rate growth and thus a positive setup for pricing power and new development starts. With this as a backdrop, yesterday we announced the range for 2021 core FFO per share of $1.62 to $1.68 per share, with the midpoint of $1.65 representing an 8.6% increase over 2020. We also announced growth in AFFO on a share-adjusted basis to range between 5.8% and 10.1%, with the midpoint at 8.0%. Our average in-service portfolio occupancy range is expected to be 95.7% to 97.7%. Same property NOI growth on a cash basis is projected in the range of 3.6% to 4.4%. Our guidance for same property NOI includes the negative impact from a few tenants Steve mentioned that we expect to terminate in early 2021. We expect proceeds from building dispositions in the range of $500 million to $700 million which we will use to fund our highly accretive development pipeline. Acquisitions are projected in the range of $200 million to $400 million with a continued focus on infill coastal markets and facilities with a repositioning or lease-up potential. Development starts are projected in the range of $700 million to $900 million with a continuing target to maintain the pipeline at a healthy level of pre-leasing. Our pipeline of bill-to-suit prospects continues to remain robust And the $800 million midpoint of our 2021 guidance is consistent with our actual development starts for 2020. More specific assumptions and components of our guidance are available in the 2021 range of estimates document on the investor relations website. Now I'll turn it back over to Jim for some final comments.
spk06: Thank you, Mark. In closing, I'd like to reiterate what a great year 2020 was for Duke Realty amidst the pandemic and a recession. As we look ahead into 2021, the demand drivers remain exceptionally strong. Supply and demand remain in balance, and we anticipate another year of strong results. This is evidenced in our 2021 guidance of 7 to 900 million of expected new development starts, strong occupancy expected to remain elevated, and most of all, evident with our expected growth in FFO per share and AFFO of 8.6 and 8% in the midpoints, respectively. This level of growth is what we believe should be achievable on a consistent basis going forward. Our performance is the result of a decade of portfolio repositioning with a steadfast focus on quality, investing in selective submarkets, and strengthening our balance sheet. We will continue to see the added value created by our dominant development platform, and we believe we can continue this level of growth well into the future. Finally, I'd be remiss if I didn't thank all of my colleagues at Duke Realty for all their hard work and dedication that has allowed us to achieve the level of success that we have. I also want to thank our investors for their continued support and the recognition of our good stewardship of their invested capital. Now we will open up the lines for questions. We would ask that you limit your questions to one or perhaps two short questions. You are, of course, welcome to get back in the queue. Also, please remember the prompt for our system is now 1-0. Sean, you may open up the lines for our first question.
spk16: Thank you. And ladies and gentlemen, as a reminder, if you do have a question, please press 1-0 at this time. Our first question will come from the line of Blaine Heck. Please go ahead.
spk21: Great. Thanks. Good afternoon. Steve or Jim, maybe we've certainly seen a little bit of a population shift as a result of the pandemic, maybe even an acceleration of of a trend that we saw pre-pandemic with people moving out of higher cost, high density cities like New York and San Francisco and into Sunbelt and Texas cities, which has been very impactful to other real estate sectors. I'm wondering if you guys have seen or expect to see any impacts to the industrial markets in those cities as a result of those shifts in population and consumption.
spk06: Yeah, Blanche, Steve. You know, it is something we're monitoring and tracking. Obviously, our sector is tied to population centers and population growth. I think what we've seen, particularly as it relates to California, you know, a little bit of net migration out. But at this point, it's not something that's been impactful to our business. It is something we'll keep an eye on going forward.
spk21: Okay, that's helpful. And then just a second question real quick. Nick, can you talk about your disposition strategy for the year? I appreciate the comments you made, but maybe get into a little bit more detail if you can. How much of it will be portfolios versus one-off assets? And how much of the disposition goal or guidance is made up of those properties that are leased to Amazon?
spk12: Yeah, I would tell you, Blaine, most of them will be one-off transactions or maybe a couple assets, two or three in a small portfolio going forward. As far as mix, I would say greater than 50% would probably be Amazon volume with a smaller amount of Midwestern assets mixed in. And in terms of volume, I think it will be spread out pretty evenly throughout the year.
spk21: All right. Thanks, guys.
spk16: Thank you. Our next question then will come from line of Samit Sherma. Please go ahead.
spk11: Hey, good afternoon, guys. Thank you for taking my question. And I did get the memo and the dial-in information. So 1-0 was the code. I got that right this time. I guess my first question is do you have any exposure to GameStop? No, no, no, that's not my first question. So could you give me more color on what are you seeing in Atlanta? I'm seeing a lot more marketing materials in Atlanta warehouses that talk about tax incentives, labor shed data, et cetera. And these are pretty big books. And so it tells me that these assets are not easy to lease. And I know that you guys sold an asset that was vacant this quarter. I understand it's de minimis and all of that, but I'm just getting a sense of How does all of these things, how does the recent sales perhaps place you in the sub-market in terms of exposure? And are you looking to sell more from markets like this?
spk06: Sure, I'll jump in, and Nick, you can add as well. I think Atlanta did see a significant amount of construction in the last couple of years, and so It's been one of those, particularly in the northeast side and the far south, that we've had our eye on in terms of we've talked about, you know, submarket level data. But, you know, you look back at 2020 and Atlanta had a record year in absorption with, I think, 26 million square feet absorbed in 2020. So we've seen pretty good activity come back in that market. I wouldn't say that it's out of balance on a macro level. Again, I think you won't see us investing in far south Atlanta. As you move down 75 or far northeast, the disposition we had there was a property in a market that we felt was a little soft, and we felt we could take opportunity and get our vacancy moved.
spk12: Yeah, I wouldn't read too much into the disposition. We have very little exposure in the far northeast submarket, and we don't have any vacant land there right now, so just a couple assets left.
spk11: Thank you for that. Interested in understanding the level of interest on your asset on Rider Street, and I think it's in Paris. It's about 30% of your development by square footage. So intrigued if you have any discussions on early takers, what kind of takers. And more importantly, what sort of free rent would you offer on an asset like this versus, let's say, a normal 500 square K square feet or below? Sure.
spk06: Yeah, we do have very good activity on it. We're very early in the construction process, but as you've seen in any of the write-ups, California, particularly in the large size segment, has been very, very active. We've had great success. We've built, I think, nine buildings out there, and eight of them have been leased before we finished construction in that sub-market. So I think we'll see similar results on this one. In terms of your question on concessions or free rent, there's really not much in terms of concessions in the market today. There might be a little bit on the front end with some deals where a tenant is investing a significant amount of money in the space and needs some fit-out time, but that's usually factored in the overall lease term.
spk11: Thank you.
spk16: Thank you. Our next question will come from the line of Dave Rogers. Please go ahead.
spk15: Yeah, good afternoon. Steve, I was wondering if we could just have a more robust discussion on the tenants that you'll terminate in the first quarter, the event space and other tenants. Could you dive maybe more into the size of that aggregate tenant base, the impact you expect on occupancy, downtime, and then You mentioned it was good long-term, so what do the leasing spreads look like on something like that? Just trying to gauge how much that's impacting same store and the overall results for the year.
spk05: Yeah, Dave, I'll start, and then Steve can add some color. It's about 25 basis points on both a revenue and an occupancy number. We're in the process of evicting three or four tenants. None of them individually are significant. Like I say, they add up to about 25 basis points. We've been collecting rent from all of them through security deposits. So I actually don't think it will be coded as bad debt when it's all said and done. It's part of our decreased occupancy guidance. And it probably will be towards the end of the first quarter by the time we get those tenants out. And then I'll let Steve talk about the backdoor prospects.
spk06: Yeah, Dave, I'd just add that we do have good prospects. Central Florida, Atlanta, D.C. are the three areas where we've got a couple of smaller-sized tenants that we're dealing with. We prefer not to go through the eviction process and work to find a backfill and work out a rearrangement with the tenant to get out of the space. So I think you'll see us backfill probably half of that space in a fairly short fashion. And I'd say our rent growth on those will be consistent with what we've posted in this past year.
spk15: Great. Then maybe just a follow-up on the occupancy. You finished the year at a really strong level. Can you talk about short-term leasing, if any, that you experienced in the quarter, how that might impact the roll forward into the first quarter, and just kind of what your experience has been with shorter-term leases and economics?
spk06: Yeah, I'll start and see if anybody wants to add in. You know, you asked this question, I think, early in 20, Dave, and I think we thought it would start to fall off, but I think as the pandemic drug out, you know, it was a pretty consistent theme. So our short-term leasing this year was, I think, 14% or 15% of our overall volume, which is a little higher than what we did in 19%. And, again, I think if you think about the uncertainty in the economy and some of the pace at which change was happening, that's kind of consistent with what you would expect. You know, I would imagine it would normalize more towards that 10% as we get to, you know, with the vaccine and things starting to level out.
spk16: Okay, great. Thanks. Our next question from the line of Emanuel Corkman, please go ahead.
spk07: Hey guys. Um, in terms of the tenant exposure metric, just wondering how much of a, uh, you know, arm wrestling competition was between Steve and, and, um, Nick thinking about sort of, we have too much exposure to this one single tenant, or this is a tenant that everybody wants to own. And so we're going to get premium pricing for the assets. Um, and which way sort of you guys were thinking about the situation?
spk12: Well, I'll start and Steve can weigh in. Hopefully he won't hit me or anything. Our strategy with tenant diversification, the field is encouraged to do as much business as they possibly can with Amazon. And then we'll take care of the exposure issue at the corporate level through one-off sales or potentially JVs in the future or something like that or whatever. So We're not, like, not doing business with Amazon to manage our tenant exposure. We do all the business we can, and then we'll just manage that on a go-forward basis.
spk06: Yeah. And, man, the only thing I would add is I think, you know, Amazon, we know them very well. They know us very well. They understand that our requirements for where we want to build, where we want to own, the types of assets we want to own have to work for us as well as for them.
spk07: Got it. Thanks. And then, Nick, just thinking about the opportunity set out there to buy stuff, obviously hard and obviously a lot of capital chasing it. But are sale leasebacks a potential opportunity to get to some assets, or is that not a market that you guys are going to play in?
spk12: It definitely is an opportunity for us. We've done a few of those. We did one in Seattle. We just did one in Southern California last quarter. Obviously, we're very cognizant of the credit risk, and sometimes we can mitigate that credit risk either through below-market rents or perhaps some redevelopment opportunity down the road. So we look at them quite often. Obviously, the fully marketed stuff, you know, we're not that competitive on, given where pricing is. We feel like a better use of our capital is some of this more lightly marketed stuff, and then obviously funding our development platform.
spk07: All right. Thanks, all.
spk16: Our next question will come from Michael Carroll. Please go ahead. Michael Carroll, your line is open.
spk19: Sorry. Mark, I was hoping you could talk a little bit about the bond issuance that you guys just completed at pretty attractive rates. I mean, could you be more aggressive and maybe refinance some of the near-term debt maturities that have slightly higher interest rates to kind of take advantage of the rate environment right now? Is that something that you guys would pursue?
spk05: You know, I guess we could, Michael, but there's obviously a cost associated with that. I think a better use of bond proceeds right now is the development pipeline, quite honestly. And, you know, we'd run our line of credit up to $300 million. So this really took that down and gives us some excess cash to pay for some development early in the year. You know, our bond maturities are very, very minimal until we get out to 2023. You know, if we ever, before we sit on cash for a long period of time, you know, we could look at taking some of those out. Certainly, I think our average borrowing rate on the debt coming at us is, you know, pushing 4%. We just did a deal at 175. So there's certainly some upside there. But, you know, with make whole costs and things like that, it's, you know, there is a cost to retire those bonds.
spk19: Okay. And then just to follow up on that real quick, I guess the recent green bond issuance, I guess in the press release, you kind of highlighted that you were able to make some eligible green project investments. Can you talk a little bit about those and how meaningful were those costs?
spk05: Yeah, you know, going back, and Steve, correct me if I'm wrong here, a year and a half ago, we made a commitment that every new development we do is going to be LEED certified. So really, every development we have started, you know, at $800 million a year for the last, you know, year and a half, are all qualifying projects. So it's quite easy for us to allocate this $450 million from this bond to all those eligible projects. So it's not really a new thing. We've had, I want to say, pushing 20 LEED projects before that commitment. But every project we've started in the last year and a half or so is LEED. So we've got well over a billion dollars worth of qualifying projects. So this is just a little piece of that. It sets us up to just continue to do green bonds in the future, quite honestly.
spk16: Thank you. Then our next question will come from Caitlin Burrows. Please go ahead.
spk00: Hi. Good afternoon. Maybe just first following up on the comments about the short-term leasing. You mentioned that in 2020 it was maybe 14 to 15 percent of total volume and normal would be closer to 10. Could you just go through how long are these shorter-term leases that you do, and do you end up getting a premium in pricing, or what makes that kind of the right decision for you guys in 2020 and going forward?
spk06: Sure. Yeah, we define short-term as anything less than a year. So I would say they probably – I don't have an average here, but they probably average eight to ten months. You know, and typically it's a tenant needs to – hold over longer than they intended to move out or it's a short-term requirement for excess space because you know as you imagine a lot of construction projects got delayed in the middle of the year because of the pandemic so people had excess supply they needed to put into inventory into a warehouse um yeah you're you're usually able to get a premium obviously you're not spending any capital capital so you know near term it can help from a cash flow perspective but it also helps you know, at times with some of our existing clients to serve a solution for them and turn into a long-term deal for us. So there's a lot of different factors that weigh into our decision on it.
spk00: Got it. And then maybe just one on development. In 2020, you guys started about $800 million of development. Midpoint guidance for this year is similar. So just could you talk about the runway for this amount of activity to continue both from there's the demand side of it, but also just your ability to get the land and complete projects in the target geography?
spk06: Sure. Yeah, we had a very strong finish to 2020, over $420 million of projects. I would say activity starting out this year looks very strong. We've got, you know, every project, our whole budget of, you know, midpoint of guidance of $800 million has got identified projects. You know, we're very prudent about our pre-leasing percentage. So, you know, our toughest job is finding and securing build-a-suits to feed that pipeline as well as sprinkling and spec projects. You know, it's getting harder and harder to find land sites and infill markets. Our teams are doing a nice job, but that's, you know, that's a governor not only for us, but for the overall market. And I think that's helping keep it in balance. But, you know, hopefully we're sitting here a year from now saying that we did better than we had thought we would do.
spk00: Okay, thanks.
spk16: Our next question will come from Rich Anderson. Please go ahead.
spk02: Thanks, team. Good afternoon. So when you were formulating your outlook for 2021, I'm curious how much of an influence was perhaps the prospects of some economic disruption from increased taxes, the pull forward of demand that happened in 2020 and how that may be difficult to replicate in 2021 and how much you kind of kept an eye on the ball a little bit from the standpoint of expectations so that perhaps you can maybe, not that you sandbag, but that you can maintain at least or beat as you go. So just curious how all those factors weighed into the outlook for 2021.
spk06: Yeah, Rich, it's Jim. Let me give you a couple of observations. You know, we have not factored into our 21 guidance, you know, any real thoughts or outcomes on, you know, any of the proposed tax changes. I think it's obviously a little bit too early. I think the consensus is, you know, whatever gets done, whether it's through budget reconciliation or it gets through both houses, It's probably going to take effect in 2022, so we'll have a little bit more clarity. You know, I think any conservatism that is baked into our budget for 2021 is just – is us being conservative given where we are in the economic recovery and where we are in the pandemic. You know, we all had great expectations in the pandemic that – So many more of us would be vaccinated by this time, and things would be back to normal sometime in the second quarter. And I think expectation is it's going to drag on a little bit longer. And what last year's last round of stimulus is going to do, and is there going to be another round of stimulus? So I think the prudent course of action was – to bake a little conservatism in there. But as I think we've discussed and you've seen, it's consistent with pretty strong performance that we've had in 18, 19, and 20. And so we feel very comfortable we're able to achieve it. And as Steve just said a few minutes ago, I hope to be sitting here in April or July on the first or second quarter call telling you that things are off to a really strong start and we're going to raise guidance.
spk02: Okay. And just a curiosity question, are you guys involved at all in the distribution of the vaccines? I'm sure you don't have minus 70 degree refrigeration systems, or maybe you do, but I'm just wondering if that's a short-term benefit at all to your business.
spk06: We actually do have some really cold freezer space, but no, we are not involved in the vaccine. I think it's full of ice cream and French fries, unfortunately.
spk02: Sounds good to me. Thanks very much. Sure.
spk16: Our next question will come from . Please go ahead.
spk13: Thanks for the questions. It's maybe building upon that last comment about, you know, raising guidance and just kind of hoping to, you know, be in even a better position mid-year. I'm just sort of wanting to get your sense a bit longer term in a post-COVID world with higher e-commerce penetration and, you know, all the other thematic trends we're hearing about. Where do you see sort of, you know, three-year, four-year, you know, sustainable same-strength eye growth, even if it's high level at this point? We're not going to hold you to it, but I'm just sort of wondering, kind of from a cycle and a thematic perspective, how you view sort of the medium-term outlook from a theme store perspective?
spk06: Vic, don't kid us. You'll hold me to it. I know you will. No, all kidding aside, you know, I've said, you know, at the start of this call and other calls and other presentations, you know, we think the next five years for our sector holds great opportunity. You know, this is not just – e-commerce as a result of the pandemic. We do believe that the growth in e-commerce sales, further penetration, more customers, more product, will continue. That is not likely to reverse that trend. We've talked about nearshoring or onshoring of production and manufacturing and that driving more the need for more distribution space. We've talked about safety stock and the inventory sales ratio as low as it is. Major retailers and consumer products companies out in the last part of last year and the beginning of this year taking significant amounts of space. Reverse logistics, handling the returns efficiently from all of this increased e-commerce sales. All of those things, along with just increased U.S. consumption, creates a very, very bright outlook for the next three to five years.
spk05: And let me, Vic, just add some numbers. I can't believe nobody's asked me bad debt yet, so I'll just kind of try to cover that right now. In our 4% number for this year, in short, I agree with Jim. I think the 4% guidance for this year is sort of a baseline to think about as we go forward and could go north of there. Because in the 4% guidance for this year, we've got 30 basis points of bad debt in that number. Our run rate has been well less than 10 basis points, so we've got a little bit more bad debt baked in the number for some of these tenants like we talked about, but I think that's a higher than normal run rate. In that 4% is about a 2.5% average rent bump number that we've been talking about for a few years now, yet we're doing all of our new deals at 3%, so that 2.5% continues to grow. And then we're very bullish, like Jim said, on all those factors that will continue to drive rent growth, you know, close to where we've been. And if you think about it, you know, like Nick said, we're at 40% of our portfolio right now are in these coastal tier one markets, yet that was about 20% of our role. So, you know, that will continue to be a higher piece of the role as we move forward, you know, beyond 21 especially. So I think we're very bullish that, you know, 4% is kind of a good way to think about a baseline. And, you know, we'll adjust guidance from time to time based on other factors, but just to give you some insight as to how we came up with the 4% this year.
spk13: That's really helpful. You sort of took my second question, so thanks for that. I can ask you one more. Just on the comments about nearshoring or reshoring, Any actual evidence or anecdotes you can share with us across any markets in the U.S.? We've heard from some of our own colleagues that cover industrial in Mexico of several examples, but I'm just wondering if you have any specific examples in the U.S. of that phenomenon.
spk06: Yeah, I would tell you Steve can add some color. The earliest and the most prevalent ones that we've seen business that we're chasing has been in Texas, so I think that's logical. More business that was perhaps in the Far East moving to Mexico. I think a lot of people expected early on with the push from the federal government that medical devices, bio and pharma, would be one of the first to make the move. You know, a lot of the stuff that we're seeing is more consumer products, industrial, automotive related. I don't know, Steve, you can give some more color. Yeah, I would just add, I think, you know, we're not as close to the manufacturing side, but some of that has, you know, particularly down south and towards the Carolinas, I know there's a number of requirements in the marketplace for that. We've seen it on the auto side. There were a lot of headlines around some plants that closed and ultimately ended up in the reshoring of supplies to the manufacturer that ended up in the U.S. There's a requirement with Nike that happened in the middle of the country that, again, is a reshoring of the shoes that used to come from overseas that they're now keeping one product line here in a warehouse in the middle of the country. So, yeah, there's more and more examples every day of that taking place.
spk13: Great. Thank you so much.
spk16: Our next question then will come from Mike Mueller. Please go ahead.
spk03: Yeah, hi. can you talk about the cap rate expectations for the, uh, for sale assets for the dispositions? And for the second question, is there a three to five year target for where you want that Amazon concentration to be?
spk12: Uh, Hey Michael, this is Nick. Um, you know, the cap rates are a little bit all over the board, depending on obviously the asset, you know, what is the asset, who's the tenant, what the term is, where the rent is to market. Um, So it's a little bit all over the board and what geography it's in. But I would tell you that, you know, it varies in the low fours to, you know, mid fives, I would say, overall. And then as far as long-term Amazon exposure, we don't have any hard and fast numbers. Obviously, we're not overly concerned given their credit profile. But, you know, we'd probably maintain it somewhere, you know, around 4% to 8% on a go-forward basis.
spk03: Got it. Okay. That was it.
spk16: Thank you. Our next question then will come from Brent Diltz. Please go ahead.
spk20: Hey, guys. Thanks. I'm mostly covered on questions, but I do have one on development guidance. You continue to highlight the strength of the build-a-suit pipeline. How should we think about spec development this year, given that's averaged 40% of your pipeline historically, but market demand's so strong?
spk06: Well, Brent, let me give you a macro comment, and then Steve can give you a little bit of detail. I would tell you we have 3.7 million square feet of vacant spec in our entire portfolio. A great deal of that is not even completed yet. And for a company of our size, that's too little inventory in the market as strong as today. So I would tell you we expect to ramp spec development up. Now, having said that, we're still committed to trying to maintain the pre-leasing percentage of that development pipeline at or about 50%. If we're going to dip below, we generally try and tell people you know, what the result is if it's timing or something like that. But we need to create some more inventory for ourselves around the system. You know, we did so much leasing in the second half of the year that we need a little, you know, we need to fill the coverage, so to speak.
spk16: Okay, great. Thank you, guys. Our next question will come from the line of Nicholas Frahn. Please go ahead.
spk17: Thank you for taking the question. It seems like there continues to be a lot of new investors coming into the industrial space. Could you maybe provide some color on what you're seeing with the transaction in secured debt markets, and could you possibly see cap rates compressing further from here?
spk05: I'll cover the secured debt market, and then I'll let Nick do the rest. I'm probably not the best person to talk to on the secured debt market because we're entirely committed to being an unsecured borrower, but I would tell you that you know, rates, you know, from what I hear and see out there, um, are still very attractive in the, you know, call it, give or take 3% range, depending on, you know, the asset, uh, quality and geography and tenant makeup. And then I'll let Nick talk about.
spk12: Yeah. Yeah. And I think, um, there is low interest rates and a ton of demand from investors. Um, you know, I think you just saw a recent transaction with Exeter where, uh, The investor there was not really in industrial and had moved to get more exposure to industrial. I think you're going to see more and more of that. And I am not going to say cap rates can't go any lower anymore because every time I do, they do go lower. They are very low right now, but, you know, with this increased demand and, you know, all this good activity on the e-commerce side, I think that there's still downward pressure on cap rates as we move forward.
spk17: All right, that's great. Thank you. That's all I have.
spk16: Our next question will come from John Kim. Please go ahead. Thank you.
spk09: Your development margins improved to 30% to 40% this quarter. I realize now you're expecting cap rates, or you've taken down your assumption by four basis points, but can you provide the breakdown of the margin improvement between higher rents, lower cap rates, and costs?
spk05: I'll start. I don't have the exact numbers for each of the categories you talk about, but I would tell you that it's really not cap rate driven. The reason the cap rates came down is just moving properties out of the pipeline, putting them in service, and moving new projects into the construction. Most of the construction we're doing now are in the coastal Tier 1 markets that have lower cap rates. It's not really too much related to a methodology change in the cap rate. It's just a mix. The overall reason that the margins are coming down is You mentioned it. It's rental rates. Rates are better than we expected, and we're leasing our assets up quicker than our original underwriting. So when we start a project, we always underwrite 12 months of downtime, and that's baked into our basis, the carry cost for that 12 months. And then we're typically, not always, but a lot of these projects that are in there are getting leased before they even go in service. So you take a full year of carry cost out of that equation and that drives your margin up pretty quickly. So those are the two main drivers.
spk09: And on the Amazon asset that you sold during the quarter, can you comment on how deep the buyer pool was versus prior sales? And as a follow-up, can you remind us why you're reducing your Amazon exposure? If that's driven by credit rating agencies or if there are other reasons? I mean, they're your highest credit tenant.
spk12: Yeah, so as far as investor buyer pool depth, it's very deep and it's very diverse. You've got domestic groups and foreign groups. And, yeah, there's plenty of supply. We get a lot of reverse inquiries as well. You know, the Amazon exposure is not driven by the rating agencies per se. It's just a matter of just being prudent portfolio managers and maintaining, you know, good diversification, both in terms of geography and in terms of your tenant base. You know, that's the real reason we're doing it. We do like, you know, Amazon as a tenant. They're obviously a great tenant, and we'll continue to do a lot of business with them. But we do want to manage that exposure.
spk16: Our next question will come from one of Amatoyo Akasanya. Please go ahead.
spk10: Yes, good afternoon, everyone. Great quarter, great outlook. The top 20 tenant list, a couple of movements there, a couple of people moved on, a couple of people moved on. HV supply and a couple of others. Could you just kind of talk a little bit about some of that movement? Is that because some assets were sold or some big leases were signed? Just trying to understand some of that movement.
spk06: It's all of the above. You can sell a million square foot building and that will move somebody from the top 10 to the next tier. You can sell a couple of buildings, HD and HD supplies, merger, move them up the list. So, it's all of the above. You know, we can talk specifically if you have a question about who's new or who left and why, but there's all, you know, all the normal reasons you would think.
spk10: But it wasn't, there's no one leaving because, I mean, they moved out or they went through bankruptcy.
spk05: No, no. The two big ones that moved off the list was HD Supply, but they just moved into the Home Depot line because of their merger. And then the other one that moved out was CNH, and that was part of the Indianapolis assets that we sold.
spk10: Gotcha. Okay. That's helpful. And then my second question, again, So many great tailwinds, you know, for the overall business right now, DRE, you know, specifically. Could you talk about the other side of the equation of kind of what could happen to kind of impact, to negatively impact this kind of very strong multi-year story, multi-year earnings growth story that we seem to have in front of us in regards to DRE? Like what would keep you, the proverbial what keeps you up at night questions?
spk06: Well, you know, the 160 million square feet in 20 markets, there's a lot of things that keep you up at night. But, you know, I would tell you first and foremost is the supply side of the equation. You know, if you look back at any of the downturns in our sector, the vast majority of them have been driven by oversupply, which is why we keep such very close eye quarter to quarter on the supply-demand metrics and where overall vacancy is. As you heard us talk about, our strategy is really sub-market based, so we tend not to be too concerned about macro numbers. We've talked about some of the soft markets around the country and how little exposure we have in them. So that would be first and foremost. And I think beyond that, some of the issues that we have been dealing with, Trade tensions that would affect imports and, you know, and exports. You know, a subsector of that could be, you know, trade tensions or tariffs that affect some of the construction materials, create shortages or spikes in prices. You know, labor always is a big one for our clients, but it's one that we watch as well. So, you know, those are probably the top three or four that, you know, that we watch on a regular basis.
spk10: Gotcha. All right. Thank you.
spk16: Our next question will come from the line of Kim. Kim, please go ahead.
spk01: Thanks. Good afternoon, everyone. Can you provide some details on your $300 million land bank? I'm just curious about how much development it can support and if the rents are there in those markets to support development economically today.
spk06: Sure. Our $300 million land bank... is probably needs to be a little higher. We've got about, I'd say that's about 18 to 24 months of development supply for us at the pace we've been developing. As I think I indicated, and if I didn't, 80% of the land we have in that bank is in coastal tier one markets. So You know, land is one of the toughest things we do, right? It's very expensive in the markets we want to develop. It's tough to get entitled to work through the process. As I indicated in my points on the call, a lot of it is redevelopment, which typically adds environmental and risk like that that we need to weigh through. Yeah, we run with 18 to 24 months of supply for our development pipeline, and that's a good pace to run at. Yeah, Keevan, I would add just a couple of comments. In addition to the roughly $300 million we have, we've got another, I think it's about $50 or $60 million in covered land plays. Those are land sites that are covered by leases that will work their way back into the pipeline in the future. The other thing, and Steve's absolutely right about the challenges with land today, but every one of the developments that we have slotted in to make up that $800 million budget guidance number, all but one of those is land that we already own. You know, we're in pretty good shape in terms of, you know, the near term and our land and being able to move forward with the development that we have in the budget.
spk01: And, Jim, your development pipeline that starts has hovered around $800 million for the past four years. And during that time, obviously, Duke has, you know, thankfully grown bigger over that time. So the development as a percent of the company is a smaller number. I'm curious if that at all comes into the equation when you're thinking about how much development you need to do or how much development you want to do, or is $800 million pretty much, hey, these are the pockets of demand that we see. Here's what we're going to build. And comparing it to the size of the company doesn't really matter. I'm just curious where you're thinking with that.
spk06: No, you know, that's a factor. I would tell you a couple of things. It's a very comfortable number that we know that we have the land that the balance sheet and the construction development resources to be able to manage. In 2019, we were just over a billion. And then before that, you'd have to go back probably 10 years to two or three years. So we have the ability to flex up and do volumes in excess of that. And if we find the right opportunities, we'd be happy to do that. So, I think, you know, it's a combination of the right opportunities in the marketplace. You know, we've always said if we accelerate development and or acquisitions, we've got a number of levers that we can pull in order to fund that. You know, we can take on additional debt, we can tap the equity markets, and we can accelerate dispositions. So, you know, we've got the capacity. If we can find the right opportunities in the right markets, Keep that development pipeline pre-leasing percentage where we want it to be. You'll see us accelerate development.
spk16: Okay, thank you. Our next question will come from Jamie Fieldman. Please go ahead.
spk08: Hi, good afternoon, everyone. This is Elvis on for Jamie. Just a couple questions. So in the opening remarks or during the Q&A, you mentioned that 17% of your portfolio is... non-same store pool, what impact will that have in the future on the 4% baseline that Mark shared?
spk05: I don't have the exact number, but the way it generally works is the year it comes into the pool, it's pretty accretive because generally these are development projects and you always have a little bit of free rent on a development project. So you have generally some free rent burn off from the first year of the second year, if that makes sense. By the time it gets into the second year of the pool, then it's just simply whatever the rent bump is. Um, and like I say, most of the rent bumps we're doing on development projects, depending on, you know, the lease term and the tenant is somewhere between two and a half and three and a half percent.
spk08: Okay. That's helpful. And then I have, I have one more, um, occupancy question so occupancy is expected to decline 60 basis points at the midpoint of your range but you're only losing 25 basis points from the tenants that are moving out in one queue can you just sort of share where the other 35 basis points move out to coming from or is that just Duke being conservative this early on so Elvis could you just I want to make sure I answer your question right could you which numbers are you you know we discussed so many so I know. So you shared a range of 96.6 and 98.6, but you ended the quarter at 98.1 least. And you mentioned in your opening remarks or in the Q&A that you would lose about 25 basis points from the three or four tenants that you're going to evict.
spk05: Correct. Okay. So, yeah, going from 98.1 down to the 97.6, that's your question. So we're going down 50 basis points.
spk08: Correct. About 50 to 60. Yeah, correct. 50 basis points. Yeah.
spk05: Yeah, yeah. So we'll keep in mind the end of the year is one number. The 97.6 is an average number, okay? So part of it is the 25 to 30 basis points of one tenant, and then the other part of it is most likely due with some of the spec space that have been coming online and or some spec space in some of these acquisitions. So if you look at all the components, the decrease is actually a little bit higher than the 50 basis points, but then we're very bullish on demand to backfill a lot of that space, like I said. So that'll get you back up. But part of the problem is I think you're comparing an end-of-the-year number to an average guidance number for the next year.
spk08: All right, that's fair. And since I waited so long, I'll just ask one more. Any early thoughts on Biden, climate change, and any particular focus for the industrial sector there?
spk06: Well, I can't tell you that we see any of his initial actions or thoughts that are going to directly affect the industrial sector, other than his Buy American program, which is you know, really a continuation of, you know, the previous administration. And we've talked a little bit about what we think the impact of reshoring or nearshoring will be, which is, you know, potentially a positive for us. You know, the other one is the uncertainty about tax changes. and whether there's a major overhaul of the tax code or there's some smaller things done through a budget reconciliation. The other thing that obviously would be a concern to us is the elimination or, you know, further changes to 1031 Tax 3 exchanges. And... You know, we monitor that situation. You know, the real estate roundtable in Naree, you know, consistently does a pretty good job working with the administration and both houses on what the impact of that, you know, that would be. And that's survived for many, many years. And so our hope is that it will continue to survive.
spk08: Thanks, guys. Great quarter and good luck on the year.
spk06: Thank you.
spk16: Once again, ladies and gentlemen, if you do have a question at this time, please press 1-0 on your touchtone phone. If you wish to remove yourself from the queue, you may also press 1-0. We have a question from the line of Jamie Feldman. Please go ahead.
spk05: I think, Copper, I think that was our last question.
spk04: I think there was one more person in the queue. We'll give them 10 seconds, otherwise we'll end the call. Okay.
spk16: We do have a question from the line of Emmanuel Corkman. Please go ahead. Hey, it's Michael Billerman here with Manny.
spk18: How are you?
spk14: Michael?
spk18: Yeah, that's me. Can you hear me okay?
spk14: Yeah.
spk18: All right. Just under the wire. So, you know, I know you're terminating some of these event tenants that obviously have had their businesses affected by the pandemic. But I want to know, are you seeing any green shoots out there or you know, obviously there's a lot of industries and a lot of tenants that have been negatively impacted by the pandemic, a number of which have industrial space, um, that have continued to pay because it's, you know, space that they probably couldn't get if they gave it up. So are you having any conversations with like retailers or, you know, anything in food service and catering or office furniture, even like, you know, any entertainment based entertainment, like the event stuff that would use industrial where they're sort of looking at the next six to 12 months, everyone's going to get vaccinated, uh, Things are going to reopen, and they're going to want to get the space. You may want to terminate those event tenants, but I just wanted to know, are you seeing anything that gives you more as another demand driver? We all know about all the great things that you talked about earlier about industrial, but could we see an even greater impact as a lot of these other businesses start to take it? And I just didn't know if there's some color that you can share with us if that's at all happening in your conversations.
spk06: Let me start at a high level, Michael, and then Steve can give you a little bit more color. That's actually conversations in a process that has been going on for virtually almost a year now, 10 months, which is the conversation with any of our clients. that are in, you know, economic distress. And, you know, we have very open and candid conversations. We go over all of the financials. And we decide if we think it's worthy of us giving them a short-term rent deferral to help them through this crisis because we think underlying they have a good, solid foundation of a business. And as we reported, I think, in the second quarter last year, we did 85-ish rent deferral agreements with tenants across the country. You know, I think our people have done an outstanding job in terms of making the decisions they did with the people they did because we're getting complete repayment on all those deferrals. We've had a few people come back to us and say, you know, we thought six months was going to be enough and we need a little bit more time, and we're working through that process again. But I don't know of anybody, you know, that in the industries that you outlined that, you know, can't pay today that, you know, we think is going to come back even stronger. I mean, clearly convention, tourism, you know, a lot of those businesses have been hugely negatively impacted and will come back someday. But we're not engaged, I don't think, at least in individual tenant discussions. Steve, why don't you? Sure. The only thing I'd add, I think, you know, we've seen some tenants pivot the way they're doing business and trying to adapt, and we've worked with some of those. You know, I think in terms of a bright spot coming out of this, there's certainly been a number mentioned, but I don't think we've touched on it on this call, but, you know, reverse logistics continues to be a field that I think we'll see significant growth from. You know, you think about Opturo, Happy Returns. You know, UPS just acknowledged they were returning 9 million packages a week around the holiday season. You know, as we shift towards this digital economy, I think that whole customer segment and how those goods enter back into the supply chain is a big demand driver for our segment.
spk16: Okay, thanks for taking the time, Nick. At this time, I have no further questions in queue.
spk04: Thanks, Sean. I'd like to thank everyone for joining the call today. I look forward to seeing many of you in person at the various reading industry conferences throughout the year. Thank you.
spk16: Thank you. That does conclude our conference for today. Thank you for your participation for using AT&T Event Services. You may now disconnect.
Disclaimer