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spk10: fourth quarter 2021 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I'd now like to turn the conference over to Marshall Loeb, President and CEO. Please go ahead.
spk11: Good morning and thanks for calling in for our fourth quarter 2021 conference call. As always, we appreciate your interest. Brent Wood, our CFO, is also participating on the call. Since we'll make forward-looking statements, we ask that you listen to the following disclaimer.
spk00: Please note that our conference call today will contain financial measures such as PNOI and FFO that are non-GAAP measures as defined in Regulation G. Please refer to our most recent financial supplement and to our earnings press release, both available on the investor page of our website at and to our periodic reports furnished or filed with the SEC for definitions and further information regarding our use of these non-GAAP financial measures and a reconciliation of them to our GAAP results. Please also note that some statements during this call are forward-looking statements as defined in and within the Safe Harbors under the Securities Act of 1933, the Securities Exchange Act of 1934, and the Private Securities Litigation Reform Act of 1995. Forward-looking statements in the earnings press release along with our remarks are made as of today, and we undertake no duty to update them whether as a result of new information, future or actual events, or otherwise. Such statements involve known and unknown risks, uncertainties, and other factors including those directly and indirectly related to the outbreak of the ongoing coronavirus pandemic that may cause actual results to differ materially. We refer to certain of these risks in our SEC filings.
spk11: Good morning and thank you for your time. I'll start by thanking our team for a great quarter and year. They continue performing at a high level and capitalizing on a very positive environment. Our fourth quarter results were strong and demonstrate the quality of our portfolio and the strength of the industrial market. Some of the results the team produced include Funds from operations coming in above guidance up 17% for the quarter and 13% for the year, well ahead of our initial forecast. This marks 35 consecutive quarters of higher FFO per share as compared to prior year quarter, truly a long-term trend. Our quarterly occupancy averaged 97.3%, up 40 basis points from fourth quarter 2020. And at year end, we're ahead of projections at 98.7% least, and 97.4% occupied. Our occupancy is benefiting from a healthy market with accelerating e-commerce and last mile delivery trends. Quarterly releasing spreads were 31.5% gap and 18% cash. Similarly, for the year, those results were at a record pace of 31.2% gap and 18.4% cash. And finally, cash same-store NOI rose a healthy 6.4% for the quarter and 5.7% for the full year. In summary, I'm proud of our team's results, creating arguably the best year in our history. So now on to 2022. Today, we're responding to strength in the market and demand for industrial product by both users and investors by focusing on value creation via development and value-add investments. I'm grateful we ended the quarter at 98.7% least, one of our highest quarters on record. And to demonstrate the market strength, our last five quarters marked the highest five quarterly rates in the company's history. Looking at Houston, we're 95.9% least, and Houston is projected to represent under 11% of 2022's NOI total, falling 130 basis points from 2021. I'm happy to finish the quarter at $1.62 per share in FFO and the year at $6.09 per share, up six cents from our most recent annual guidance. Helping us achieve these results is thankfully having the most diversified rent roll in our sector with the top 10 tenants only accounting for 7.6% of rents. Brent will speak to our 2022 guidance which I'm pleased is to a midpoint of $6.63 per share, up roughly 9% from 2021's record level. As we've stated before, our development starts are pulled by market demand. Based on the market strength we're seeing, we're forecasting 2022 starts of $250 million. We plan to closely monitor leasing results along the way and expect to update our starts guidance throughout the year. To position us for this market demand, we've acquired several new sites with more in our pipeline, along with value add and direct investments. More details to follow as we close on each of these opportunities. Brent will now review a variety of financial topics, including our 2021 results, and introduce our 2022 guidance.
spk08: Good morning. Our fourth quarter results reflect the terrific execution of our team, strong overall performance of our portfolio, and the continued success of our time-tested strategy. FFO per share for the fourth quarter exceeded our guidance range at $1.62 per share and, compared to fourth quarter 2020 of $1.38, represented an increase of 17.4%. The outperformance continues to be driven by our operating portfolio performing better than anticipated, particularly occupancy and rental rate growth. From a capital perspective, during the fourth quarter, we issued $120 million of equity at an average price of $205 per share, and in October, we repaid a maturing $33 million mortgage loan that had a rate of 4.1%. After year end, we agreed to terms on the private placement of $150 million of senior unsecured notes with a fixed interest rate of 3.03% and a 10-year term. We expect to issue and fund these notes in April. Also after year end, we agreed to terms on $100 million senior unsecured term loan with a total effective fixed interest rate of 3.06% and six and a half year term. The loan is expected to close on March 31st. That activity combined with our already strong and conservative balance sheet has kept us in a position of financial strength and flexibility. Our debt to total market capitalization was a record low 13%, and for the year, our debt to EBITDA ratio finished at 5.2 times, and our interest and fixed charge coverage ratio was 8.5 times. Our rent collections have been equally strong. Bad debt for the year was a net positive $475,000 as tenants whose balances were previously reserved came current, exceeding new tenant reserves. This trend continues to exemplify the stability, credit strength, and diversity of our tenant base. The dynamic growth of our earnings, as well as exhausting a prior tax accounting change benefit, pushed us to increase the dividend for a second time during the year from $0.90 to $1.10 per share, an increase of 22%. We anticipate that the rate of our dividend increase will normalize in 2022. Looking forward, FFO guidance for the first quarter of 2022 is estimated to be in the range of $1.59 to $1.65 per share and $6.56 to $6.70 per share for the year. 2022 FFO per share midpoint represents a 9% increase over 2021. Among the notable assumptions that comprise our 2022 guidance include an average occupancy midpoint of 97%, cash same property midpoint of 5.6%, bad debt of 1.5 million, operating and value-add acquisitions of 76 million, offset by 70 million in dispositions, issuing 375 million in unsecured debt, which will be offset by 75 million of debt repayment, and common stock issuances of 120 million. As Marshall mentioned, our projected development starts are 250 million, which is down from 341 million in 2021. However, recall that last year's amount includes 90 million for a large build-a-suit in San Diego. Our 2022 start guidance does not include any unknown build-a-suits that might occur through the course of the year. In summary, we are very pleased with our record-setting 2021 results. As we turn the page to 2022, We will continue to rely on our financial strength, the experience of our team, and the quality and location of our portfolio to maintain our momentum. Now, Marshall will make some final comments.
spk11: Thanks, Brent. In closing, I'm excited about the year we just completed. We're now carrying that momentum into 2022. Our company, our team, and our strategy are working well, as evidenced by the results posted, and it's the future that has me excited for each group. Our strategy has worked well the past few years, and now we're seeing an acceleration in a number of positive trends for our properties and within our markets. Meanwhile, our bread and butter traditional tenants remain and will continue needing last mile distribution space and fast-growing Sunbelt markets. These, along with the mix of our team, our operating strategy, and our markets has us optimistic about the future, and now we'd like to open up the floor for questions.
spk10: We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. Please limit yourself to one question and one follow-up. If you have further questions, you may reenter the question queue. At this time, we will pause momentarily to assemble our roster. Our first question comes from Alexander Goldfarb from Piper Sandler. Please go ahead.
spk02: Hey, morning. Morning down there. So the first question is on the supply chain. Now we have truckers part of the fund and the headlines. But between the ports, factories trying to catch up with orders, shipping and all this stuff, What are your tenants saying as far as when they see the normalization of the supply chain? Because obviously it's been great for you guys for demand and certainly, you know, the just-in-case type, you know, conversion on distribution thoughts. So just trying to see how much longer you guys think that we'll be in this tight supply market.
spk11: Hey, Alex. Good morning. It's Marshall. You know, it's I guess maybe I'll preface it with a positive. We have about 1,600 tenants, and they're a little over 7.5% of our NOI. So that's a pretty low number, just a wide range of tenants. So maybe with that preface or caveat, I think there's probably a mix of answers, but you're right. Whether it's the truckers or backlogs at the port or just trucks, pure warehouse workers or the warehouse is closed and kind of hiring shortages. I think by and large, most people or our tenants are feeling like the demand is there today and feel optimistic about their business. But we, I really don't, as we order building materials ourselves and then dealing with our tenants, I think we'll go through 2022 before the supply chain. You know, there may be improvements during the year, but it'll still be kind of a mess. And I think the other kind of help for all the industrial REITs that we'll participate in is people that move to more safety stock or I've heard it called just-in-case inventory. And to date, I think there are a number of tenants who would like to do that, but the best description I've heard is someone called it a pipe dream, that most of our tenants or most people are out there scrambling to meet current demand, much less where Demand is going, and at least the charts and things you see and read, it looks like the inventory to sales ratios are still pretty historically low. So we think, I guess the good news if you think of, as I or we think about it, is we're pretty full, we're pushing rents, it's hard to deliver new product, and people still are scrambling to add more inventory. So we, at least in terms of our planning for this year, and we'll adjust it, As best we can on the fly, we think there's going to be more demand and supply, and people will be scrambling to meet that growing demand. And it probably won't change until next year.
spk02: Okay. And then maybe as a follow-up to that, Marshall, you guys, you know, every year you say, you know, we got lucky last year. Last year was an amazing year. This year is going to be tough, and I think we're now going on, you know, I lost count how many years that you guys have beaten and raised. The story that you're laying out is still, you know, pretty similar to last year. Really strong demand. The external environment remains tough, but you guys seem to find a way. It doesn't seem like you have any pushback on pricing. And, you know, the capital markets are favorable for you on the financing side. So what truly gives you pause versus you guys just, say, hey, we're 97%, you know, maybe it's tougher to exceed from there. But, you know, Brent made the point about the dividend going back to a normalized growth level, and yet everything that you guys have described on this call speaks to a still, you know, robust, abnormally superior growth environment.
spk11: Yeah, no, fair question. I guess I'd say one is, It probably speaks to management or my personality to a degree. Just conservative. Last time I've been to a casino, it's been a while, so I'm probably a little bit conservative. I'll confess to being a little bit conservative, and I'd love for you to be able to say I told you so later in 22 that we were conservative. You're right. At 97% average occupancy, if we just met our budget, that would be our second highest year in the company's history, second to last year, which was 97.1 so I don't you know hopefully we'll get maybe we could go a little better on the rent increases but that'll probably benefit 2024 and later years more depending on when that lease expires this year it's probably more the external environment is where I felt like and probably twofold one if given the supply chain shortage and the tightness in the market hopefully you know if we get ahead we're seeing more activity earlier on developments For spec developments, we usually, kind of our rule of thumb is once you tilt the walls, then the tenant rep brokers start to take your delivery dates more seriously and the activity picks up. But given the tightness in the market, we've seen more activity earlier in our development pipeline. So that gives me some, I guess, hope rather than pause. And then hopefully we can find some acquisitions out there, but we didn't want to, kind of as by our nature, put some big acquisition targets in our budget. and then feel like you have to go meet them. Because I'd rather look if something makes sense. You're right, the capital markets are attractive and we'll acquire it. But if we go a number of months and there's really nothing that makes sense to us and as competitive an environment as I've ever seen it to acquire good industrial properties, we're okay being patient and sitting on our hands in that regard too.
spk02: Okay.
spk11: Okay. Thank you. You're welcome.
spk10: The next question comes from Elvis Rodriguez from Bank of America. Please go ahead.
spk07: Good morning, guys, and congrats on another good year. Just following up on the external front, Marshall, you bought a piece of property in San Diego, the Siempre Viva value-add deal, 65% leased. Why would a developer sell this given how strong the leasing market is and You know, what opportunities do you see out there to do more of these type of transactions?
spk11: Okay. Good morning, Elvis, and thanks. You know, on this one, it's the Siempra Viva. You may remember we own, in separate transactions, we bought Siempra Viva 1, then 2. And kind of in last year, early in the year, we had 40 acres that we really had outlined and worked with the architects. We're going to build a business park. And then Amazon came along, and thankfully, and they said, we'll take all 40 acres. So that's our speed distribution center that's under construction and we hope to deliver in late first quarter. And then since then, we've been looking for additional land for opportunities or some value-add opportunity with vacancy. This is, I guess without naming them, I don't want to violate our confidentiality, our large pension plan. It had kind of reached the life of their hold period. They still own buildings in this park and in this sub-market. They had bought it with the way the market had run. They had a good profit on this investment and had a large tenant, I believe it was a 250,000-foot tenant, go bankrupt. It's right along the border with Mexico. We're near the border crossing, what we liked about it. and they're building a new kind of better technology high-speed border crossing that's under construction. So we're really right there between the two border crossings and really building up our presence. It's the same developer, local developer that built this park. So I think it really hit their whole period for the pension fund, the state pension plan that owned it. They had a good profit in spite of the vacancy. As we were bidding on it, it was 50% lease. During due diligence, we were able to get a 3PL, a tenant in, and so we've got it at about 65% lease today and good activity. As I view it, almost like an assembly line. We'll finish this project up and then find that next opportunity in San Diego. We like the proximity to the border. If you think long-term, that there'll be maybe more near-shoring for manufacturing projects It'll take years, but leaving China and coming to Mexico, and then with the move in San Diego more to life science and creative office, a lot of the traditional office in the center of San Diego is becoming more lab space, so the traditional industrial users are getting pushed south towards the border as well. So we really like the kind of geographic dynamics of this location. Probably a longer answer than you were seeking, but that was what attracted us to this one.
spk07: Thank you. And maybe one from Brent. What's the impact from higher borrowing rates that you're seeing today relative to 2021 in the future? How should we be thinking about capital allocation with rising rates for East Group? Thank you.
spk08: Yeah. Good morning, Elvis. It's something we're keeping an eye on. You saw us act pretty quickly early in the year here locking in as we disclosed, $250 million between two loans and locked that in at just a shade over 3%, which we were, frankly, pretty satisfied with. I think that'll insulate us some from early part of the year. Also, we only have one maturing mortgage. It comes up here in a couple months or at the end of this month, and that rate's over 4%. So, again, we're retiring one at a higher rate than I think we'll anticipate incurring. So it's like we've kept an eye on both lanes. So we were very active on the ATM with equity in fourth quarter. We really like the pricing. Again, we've started early part of the year with placing some of our debt early with anticipation the rates will go up. But over time, as we move out, if rates do rise, I mean, that'll be part of the environment. But historically speaking, they're still very attractive. And when you compare whether it's 3%, if that grows to 3.5% or whatever the number turns out to be, when you look at our ability to continue to put money out, especially on the development side, at that mid-6 to 7 range, we want to make as big a spread as we can, but it's not, I guess I would say, stressing the yield spread there. We'll continue to play both sides. We have a very conservative balance sheet. We've intentionally put ourselves in a position to where if the markets were to turn such on the equity side that would have plenty of runway on the debt side. And if both are attractive, which we view it now, you'll probably see us continue to play both sides.
spk07: And just to squeeze one more from Marshall, any read-throughs on what could potentially happen to cap rates?
spk11: To date, we've not seen any. With the debt market moving up, have not seen any movement in cap rates. It's hard to say they're falling, but they probably are slightly, or really maybe the biggest difference, say over 12 months, is the differentiation between cap rates that we used to, maybe outside of a Dallas, LA, Atlanta, there'd be a little bit higher cap rate in Phoenix or Las Vegas, Denver, Charlotte, but those secondary markets are just as intensely competitive and the pricing on those assets, it's really not much different than it is in Southern California. There just still seems to be this wall of capital out there that likes, and us included, that like a well-located, well-designed industrial product, and we've kind of learned the hard way. Having a checkbook is not a competitive advantage in the bidding process. There's a lot of folks out there with a lot of dry powder trying to buy industrial and This is more hypothetical, but until people get more comfortable underwriting office buildings and work from home and maybe retail and hotels and things like that, it feels more and more crowded in the industrial space or new competitors arriving every month, depending on which market we're talking about.
spk10: Thank you.
spk11: Sure.
spk10: The next question comes from Craig Mailman from KeyBank Capital Markets. Please go ahead.
spk03: Guys, Marshall, just wanted to touch on your commentary about e-commerce. We all know it's extremely strong and definitely the demand is broadening out beyond Amazon. But just kind of curious, this is a tenant that's coming to your market more recently, and the CFO was recently saying they're going to moderate their appetite for industrial. I'm just kind of curious what your thoughts are on that and whether you've seen anything on that.
spk11: Yeah, I guess I'm not, I don't know the tenant specifically, but in general, we still think whether it's e-commerce or delivery, a number of our buildings get used for delivery, and I think there'll be more and more shifts away from, you won't close your traditional brick and mortar, but you'll have omni-channel retail where it can be, here's our class, you know, our A prototype retail store and the A retail property in town, or maybe two in town, and you'll have more curbside pickup is where we'd love to go, and we're aware of a couple of tenants that have moved to that within our properties, or at least designated those, you know, or showrooms in our property that we see, especially like the Ferguson Plumbing, Dowel Tile, Ensor Tile, some of those kind of home improvements. So, I think, as one of our directors described it, when COVID hit, it demystified e-commerce for a large portion of the population. It's continuing to grow. And I think with Amazon's dramatic growth over the last couple of years, if you and I were at a retailer, we would have to be thinking of how do I shorten my delivery times and keep up with Amazon, or they're going to take my market share, depending on what where you fit in, but Amazon seems to be getting into about every, you know, whether it's pharmaceuticals or this or that, about every different type business, which I think puts, you know, more logistics pressure on all the other retailers in time kind of to keep up with Amazon's growth.
spk03: So it kind of, your feeling is even if Amazon kind of pulls back, there's plenty of demand behind them. from competitors that you shouldn't see a big fall off.
spk11: I'm an optimist, but I think so, or tell me, I guess I've thought if Amazon has just dramatic amounts of square footage that they've gobbled up, if you're at Lowe's, Home Depot, Best Buy, RH, you name our house, you name the retailer, or online mattresses and things like that, you know, we see pharmaceuticals getting pushed more and more online as a way to manage cost within our buildings. I think all those folks would have to just, if you're from, you know, just a business strategy, have to find ways to meet Amazon delivery-wise, and so many people realize it's so easy and convenient to order online versus driving, and especially during COVID and which wave we're in versus traditional brick and mortar, and I don't think brick and mortar will will ever go away. I think it's a social activity, but I think it continues to grow and capture a bigger and bigger piece of the retail pie.
spk03: Okay, that's helpful. Then just on development, you guys, you know, what you started subsequent to year end, you're kind of already a third of the way to your development start guidance. You know, as you look at the runway, you mentioned you had a big development last year, but do you guys feel like you can close the gap Relative to what you did in 21 and then just also on the yield side, I know you guys get asked all the time, yields are kind of sticky in that high 6% range despite inflation and higher land costs. I mean, do you feel like the market rent growth aspect of things can continue to keep yields up in that area? Yeah.
spk11: Maybe, yeah, I've got two thoughts. One, I hope so. I mean, we'll go as, usually kind of our motto is always internally, but we'll go as fast as the market leases our buildings. And last year went quickly. I think as one of your peers pointed out, we started the year, it just shows how bad I am at forecasting, at 205 million in starts and finished at 340. And we did have that $90 million speed pre-lease move the needle, obviously, a lot. I hope, you know, look, I hope the market's as strong as we're thinking it will be and that leasing activity picks up on our developments and that we can beat the $250 million. So I'd like to think, as you said, we started a lot this quarter. We're seeing good activity within our leasing, you know, good movement from last quarter to this quarter as you kind of compare the percent lease. So hopefully there's upside there. And then on the development yields, we'll Our underwriting will use today's construction costs and really today's rental rates because it gets to be a slippery slope if we start projecting where rents will be when we deliver the building. As we underwrite them, we have seen some degradation in returns, but then by the time, six, eight months when we deliver the building and the team starts leasing them up, we have been able to catch up. And I guess what hit me, if you look within our supplement, what we pulled out of the development pipeline, it was 17 projects last year, about 280 million. And we were able, and thanks to the team, to average a 7.2% yield. And I think it's unreasonable. You could say a 3.6 market cap rate just because I can do the math on that. So it really doubles the value. of what we pulled out of the pipeline. So to me, if you say that's a 100% profit margin, even if we get pulled backwards on some of those yields, if we earn a 70%, 75% value creation factor, I think that's a great return. And the trick is we'll go as fast as we can. We could start more. It's really more how fast do they lease up. And then as you saw in fourth quarter, we're trying hard to find whether it's vacancy and value adds where we can find space near term while the demand's there and or find land sites as much competition is out there and the growth we're seeing demand from industrial tenants, record absorptions in about all of our markets. How can we find land that we can pencil and make sense of? We like the value creation component, especially when core leased assets or extremely competitive to bid on. So that's an awful lot of our focus. And hopefully we can hang in there with those yields, even with prices going up. We'll do our best. Hopefully rent can help keep offsetting those increases.
spk03: Great. Thanks.
spk11: You're welcome.
spk10: The next question comes from Manny Korchman from Citi. Please go ahead.
spk01: Hey, it's Chris McCurry with Manny. I was wondering if you could comment on on-shoring trends and specifically the impact of labor costs, inflation, and just hiring shortages on any of these conversations.
spk11: Yeah, I think a good question. It's hard to even call it on-shoring. Probably where we've been more effective is We do see a number of tenant relocations from California to Arizona, Nevada, Texas. We've seen more that are relocations into the state of Florida. So we definitely see the population growth. Onshoring, you know, I actually, as we've talked about it, given the labor shortage and the cost of labor, we feel better about nearshoring maybe. It'll take a while. We'll move plants to Juarez, where we have a presence in El Paso or a building, or we talked about South San Diego to Tijuana, or even Nogales, Mexico, which is near our Tucson properties as well as our Phoenix. So I think longer term, I think with trade tensions with China that even were started before COVID and the supply chain issues of getting your properties in, we feel that we're optimistic longer term about nearshoring. I think that would take a while to, you know, close a plant somewhere else and move it into Mexico. And I think that would be, would seem to me to be, and with the preface of what do I know, but would seem more attractive than opening, you'll see some manufacturing in it. And we certainly see that in Atlanta or in Dallas, but there it's just so competitive for workers and things like that. It's, probably a little more difficult, I would imagine, than moving, if you're Home Depot, your supplier to Mexico from China.
spk01: Got it. Yeah, just one more for me, and I guess it kind of builds off that, but with some of those near-shoring conversations and just like supply chain issues in general, are those impacting any real estate decisions for some of your auto and home building tenants, or have you seen any long-term or near-term change in trends with those two categories?
spk11: A little bit of study, I mean, and maybe give me a month, you know, and this probably speaks more to one of our prospects we're working with and things, where they are touring and focused a little bit on nearshoring and their logistics. So we've kind of worked our way, it's kind of interesting timing, just a conversation this week within their real estate team, and even their CEO is out touring some of the assets now. So we're seeing some of that. We have You know, we did lease a building to a German automotive company in Atlanta within, you know, it's probably eight, nine months ago. So we're seeing some movement like that. Within home building, we're definitely seeing that activity pick up, and that's probably more just, I guess in my mind, a function of the housing demand in places like Florida and Georgia and Arizona and places, you know, we are seeing those type tenants. definitely pick up. We just, you know, one of the buildings in Fort Myers which just leads to a Canadian company that serves the home building industry and we've, you know, it's kind of other, as an aside, interesting trend we've seen. We build our same multi-tenant buildings but we've seen more and more in the last year where a single tenant will come along and even though we've designed it to be able to multi-tenant the building, they'll take the entire building and that's Really, the other factor that obviously helps speed up our development pipeline is we'll move to the next building in the park as quickly as we can.
spk10: Got it. Thank you.
spk11: Sure. You're welcome, Chris.
spk10: Again, if you have a question, please press star, then 1. Our next question comes from Samir Kanal from Ivercore ISI. Please go ahead.
spk12: Hey, Marshall. Good morning here. I guess my question is around the guidance of sort of 5.5 at the midpoint for NOI, which is similar to what you did in 21. But, you know, considering how strong demand is and all the rent growth you hear about, I would have thought that would have been a little bit higher. Just trying to figure out, you know, are there any sort of headwinds we need to think about or contemplate to get you kind of the midpoint or even the low end here, which is the 5.1? I guess I'm trying to see how much conservatism you're baking in here. Thanks.
spk08: This is Brent. I'll jump in there. Our midpoint of guidance is 97%. As Marshall mentioned, that would be our second highest year on record if we even just meet that. That equates to, as you mentioned, 5.6% same store midpoint. Most of that, obviously, I can see being at that level, you're I see increases, basically, we're not baking into being really a component or part of same-store growth. So then you're really heavily leaning into the rental rate increase side, which, again, has been very good for us, the low 30% gap and very, very high teens cash. And so we're projecting similar, I guess what I would say, we're projecting similar record-type results, but we hope that we can build off those in terms of higher increases, but We'll see if the year plays out where February of the year, and so that's where we're at at this point. But really, it's maybe trickier than you think when you're early into a year and you start looking at all the assumptions. Our guys in the field go space by space on our rollovers and vacancies, looking at rental rates. Certainly, if rental rate growth power continues to grow during the year, that could give us some more room to push there and to beat. Yeah, again, it's a midpoint. It's what factors into our FFO midpoint of guidance. And so we'll see. I would say we've probably leaned a little more conservative into our development or spec leasing into the overall budget, maybe more so than the operating side.
spk12: Yeah, that's it from you guys. Thanks.
spk09: Thanks. Thank you.
spk10: The next question comes from Vince Tabone from Green Street Advisors. Please go ahead. Hi, good morning.
spk13: Could you discuss the supply landscape for shallow bay products in your markets? Are there any regions or metros where supply is potentially becoming a concern?
spk11: Hey, Vince, good morning. It's Marshall. You know, I'm really not. I mean, there is some supply there. For the most part, if you ask me if we were building a model or something, a rule of thumb is we'll typically say where there's, I'll pick up a market with a lot, I'm just looking at my Dallas numbers, where Dallas has 55 million under construction, which has probably got to be close to a record, but last year absorptions was 40 million square feet, and over 60% of that's in South Dallas and North Fort Worth, where we're not, and probably... What would be shallow bay is probably usually our team estimates 10% to 15% of the total market supply. So again, maybe for me, as I use a rule of thumb, it's usually about that amount. Or again, as I'm kind of looking at my market numbers, and this one I even, I'll credit it, hesitate to repeat, but in CBRE's numbers for Atlanta, at the end of the year, there's a little over 35 million square feet under construction. And of that, they designate 76,000 square feet as shallow bay. So, I mean, it is just, that's minimal. There's more competition than, again, I think 10% is better than the 76,000. I like that number. And there's always, you know, the tenants always seem to have an option. But if we were starting a development company, and I'm biased, maybe it's a grass is greener, It would be easier for you and I, I'll stick with Atlanta, to go to South Atlanta, find a site, and build an 800,000-foot building and put more capital to work because so many of our peers are bigger, or even if you're a local regional developer, your promotes are better building an 800,000-foot building than a 120,000-foot multi-tenant building. So that's Where we see so much of the competition, and I can't fault them. I say that because those buildings are getting leased and it's working for them. It's just not kind of where we fit on the playground. We really try to pace it more into demand and there's always an option, but it's usually a local regional developer with a building here or there. There's just not that much shallow base supply. I hate to say that out loud on a public earnings call, but it seems to be so much of our competition really falls more into bulkier big box buildings.
spk13: No, Matt, that's really helpful and consistent with what you said in the past. I just find it interesting that, you know, especially given the profit margins each group's developed at in recent years, that maybe more people aren't pursuing a similar strategy, but it makes sense on the, yeah, just kind of the different points you laid out. So that's really helpful.
spk11: You know, I think part of it helps too, Vince, or just for you to get, one reason we think, because we have that same conversation internally, it's awfully hard to find those good infill land sites and you're figuring out how to kind of almost Rubik's Cube, you know, a handful of buildings to build our parks. And it takes longer to go through zoning and entitlement and things when they're infill versus the edge of town. So thankfully with the REIT model, we can spend a few years. Like the Charlotte land that we closed, I think we had it under contract for about a year and a half before we closed it and worked our way through it. So that's just a different model than a lot of the private developers that we thankfully can have the luxury of patience and work on a lot of these sites for. It feels to me like an iceberg that we're working on it, working on it, and then you all see it when we finally close on it.
spk13: Got it. That's all helpful commentary.
spk10: Thank you.
spk11: Okay. You're welcome. Thanks, Vince.
spk10: The next question comes from Jason Idoin from RBC. Please go ahead.
spk06: Hey, good morning, guys. Quick question on the disposition front. So you guys had your first and only disposition of the year in the fourth quarter and then started the year with another disposition. So I guess my question is, what led to the determination to prune these properties from the portfolio and What are some of the common characteristics that you're looking at when you decide kind of maybe where you maximize value? Sure.
spk11: Jason, good question. The one in Tampa, we had acquired it in the 90s. It's well located, but a lot of small tenants. Some of the project, smaller buildings, smaller tenants, non-sprinkler. So we had it kind of as we worked through. In my mind, it's almost like a batting order. And they're We were, knock on wood, the team did a good job. We were able to get a little under a 4% cap rate on it for going on a 40-year-old project for maybe just over 40 years. The property in Phoenix, originally we thought we were going to have it closed last year. We had to switch buyers. The brokers did a good job. We had a backup buyer and it drifted into the first week of this year, but And then it's one of our few service centers. We bought it in a portfolio in the 90s. And it was right at a four cap two. And to give you an idea, as I've mentioned the demand out there for industrial product, I would have put both of those in the six. I'm looking at Brent as I say it. Six to seven percent cap rates, maybe 18, 24 months. And we were able to get four caps or just below that on both of those. We've got you know, another small service center out on the market today in South Florida, knock on wood. And then as we kind of will develop and create the value in Houston, we've got another project in Houston. And so anything that's got a little more office component, a little bit more age, I think it's one of our really responsibilities to always kind of be pruning our portfolio and Typically, we'll ask the team, Jason, if you came in in the morning and you got an email or a call telling you one of your tenants just went bankrupt, what building do you hope that's not in? That really gives us our disposition list. Hopefully, it's a form of capital. We like the equity markets and the debt markets, but if we can sell things And if we can sell at a four in Tampa and develop into the sixes to maybe even a seven, we'd like that model a lot. And that's really what we've been doing in Houston the last couple of years is we think there's some development opportunities. We closed on some land there, but also sell in the threes to four if we can kind of keep that model.
spk06: Okay. Yeah, no, that makes sense. And then touching on Houston, I know on the last call you guys mentioned that you expected that exposure to drop further, and I guess I was just trying to put some rails around that. So is that from selling assets, or is that more just from growth in other markets?
spk11: A little of both. I mean, predominantly it's been growth and rising rents in other markets. We still like Houston. We have a good team there, fifth largest city in the country in the value creation, but we're – We're under contract, knock on wood, with a Houston asset presently looking at something else. So we'll kind of tread water in Houston a little bit while the other markets where we're under-allocated continue to grow. And thankfully this year, as we were looking at our kind of projected NOIs, it's fallen below 11%. So it continues to just drift lower and lower. And we certainly won't exit Houston, but we like Houston. We like a geographically diversified portfolio, and we had gotten too heavy being north of 20 a handful of years ago, and I'm glad we're under 11% this year.
spk06: Okay. And then with all the change in the energy markets, I guess are you seeing any changes in the underlying key drivers in Houston? Are you seeing some of that excess supply maybe get absorbed more quickly or any changes on that front?
spk11: Houston, they had a lot of markets. Record absorption last year was 28 million square feet, which is a big number. There's about a little over 18 million square feet in Houston under construction that's 40% leased. So the market definitely has improved over the last two years. Houston's probably better today than it has been at any point in the last couple of three years. We were asking the same thing with oil getting to $90 a barrel, and maybe there's just so much uncertainty in that industry. We're feeling demand in Houston, but not, I don't believe, increased demand from oil and gas companies there. It's more the tenants we see in other markets. As an aside, and we're not seeing that in Houston, but seeing it in some other markets, we are seeing energy-related tenants, but they're more... green energy-related, where a tenant once converts buses from gas to electric, someone making electric batteries, and things like that. So we are seeing energy-related tenants. They're green energy-related, and oddly enough, or maybe not, they're in markets like Phoenix and Greenville, South Carolina, and Atlanta. They're not in Houston. Okay. Thank you. Sure.
spk10: The next question comes from Amit Nihalani from Mizuho. Please go ahead.
spk04: Good morning. Are you guys able to comment on your bad debt reserve for your 2022 guidance? I know back in 2019 you had mentioned you were signing a number of leases with Peloton.
spk08: Yeah, good morning. This is Brent. I guess two parts to that. One, as far as our bad debt guidance of $1.5 million, Uh, obviously in 2021, we had just, you know, really an anomaly year. I would call it. We had a actually bad debt recovery of 475,000. Um, so, you know, just a reminder when we entered, entered last year, uh, or looking back at a year ago, we had a little deeper, uh, reserve allowance at that point, not knowing exactly how everything was going to pay out, play out hard to think, but a year ago, we were still shy of a vaccine. So this year, our allowance as the years played out has come down. So we're not entering this year. For example, last year we had 26 tenants included in the total reserve. This year, entering January, we only have 12 tenants. So I don't think there's going to be nearly as much reversal of bad debt to potentially offset bad debt. So we look more from a historical perspective. The $1.5 billion represents... 0.33 of 1% of our revenue, which is a trend track record that we've looked at, our historical average. Do I hope we beat that? Yes. But when you start talking about 1,600, 1,700 tenants, depending what size of what tenant may happen, maybe what their straight line balance is, that type thing, again, we're going to enter the year looking more at our past and dialing all of that in rather than just a very quick glimpse. In terms of Peloton, we have. I know in South Florida we leased space to them and maybe another market or two. But, I mean, they're current. We've had, you know, no issues there. And obviously they've been in the news some lately, but they're not a top ten tenant. And it sounds like at the end of the day that that credit could, if anything, maybe get enhanced, you know, if something were to potentially happen there. But, you know, they're something that you see in the news but nothing, thankfully, that's been – anything we've had to deal with specifically.
spk04: Great, thank you. And just where would you guys like your Houston exposure to be? Ideally.
spk11: Yeah, certainly under 11. It'll probably, you know, just the reality, it'll probably continue to drift down. You know, we've said if it's, you know, 10%, a little under 10%, you know, my goal would always be to have runway in any market in case you do find that kind of aha opportunity. And I think we do at under 11%, unless we bought something huge there. But it'll probably continue to, I think over the next year or two, continue to drift down, and you'll probably see it below 10% here in another 12 to 18 months.
spk10: Great. Thank you.
spk06: You're welcome.
spk10: The next question comes from Ronald Candon from Morgan Stanley. Please go ahead.
spk09: Hi, Timmy Long for Ronald Camden. Can you just talk a little bit about the guidance reflecting conservative assumptions of the speculative leasing? Just maybe provide some color on the type of leasing you're expecting with the current development pipeline and how that compares to 2021 levels. I'm just thinking about 2021 and how the same sort of guidance was roughly in mind, but that ultimately came in ahead.
spk08: Yeah, you're referencing a comment I made earlier, and it's just a general assumption where You know, we have a fair amount of our development income that's dialed into the budget already covered via, you know, existing and prior leasing. You know, leases, there are a lot of leases that aren't in the same store. You would have to have been an asset effective January 1 of 21 to be in the same store mix for this coming year. So we have a lot in that interim period. So a lot of that income is covered. But, you know, from an operating standpoint where you've got 97% or 8% occupancy as you're analyzing the rent roll and the rollovers, obviously it's, you know, if you can run a 75% or so tenant retention, that's a little, you know, easier to guide and project. Whereas, you know, our development, just the nature of it is pretty much speculative oriented for the most part. And so in those cases, just by virtue of the definition of being spec, we don't have tenants in hand. So the timing of those, and then once you sign them, how quickly you might be able to get the permit done, get it built out, get the tenant placed, get the lease started. So that side of things can be just by its nature trickier to project. And so, like I said, we tend not to get, I guess what I would say, aggressive with those assumptions. And what that difference might be, it would be hard to tell just because of, again, delivery times and those type things. But again, we have both sides, both upside on both operating and in development. And as you saw in the guidance, too, even on acquisitions, we're basically showing acquisitions and dispositions being pretty much a wash. So anything that we might could acquire, which again, as you said here today, nothing under contract, but you never know. And that would be incrementally positive, too, especially if that were to occur earlier in the year.
spk05: Yeah, that makes sense.
spk10: The next question is a follow-up from Elvis Rodriguez from Bank of America. Please go ahead.
spk07: Hey, guys, just a quick follow-up on mark-to-market for the entire portfolio. Are you able to share on a gap in cash basis? Thank you.
spk11: Yeah, you know, not very well and not accurately. You know, a number of our peers do that, and we've said it's just, you know, thankfully having seen other sectors, it's easier to do in office, easier to do than... and retail than it is industrial because whether it's an in-cap space or it's air conditioned, things like that. That said, mark to market, we've seen our gap numbers and our annual numbers were low 20s, I think it was 22% in 2020, 31% in 2021, and I would Some of it will be the mix. We had a lot of big leases where we were able to capitalize on some larger increases last year, but certainly would feel comfortable in the 20s this year on a gap basis, I would suspect. Maybe if we can get back to 30, that would be, I think, the rent pressures there. It may be the mix of leases rolling. And then on a cash basis, we're probably in the teens on the mark-to-market, and we certainly are seeing what's also helping those gaps numbers in more and more of our markets where the annual increase used to be two and a half to three percent. Now we're moving to threes to fours in a number of our markets. So that'll help those gaps. That's obviously helping those gap rent increases too. So I think they're certainly there. They're a little bit tricky to predict. And in any quarter, it'll depend on the mix that rolls. But I would think we'll be back in the upper teens on a cash basis and in the 20s to maybe a 30 if we push things. And I hope I'm conservative on that this year in terms of rent increases.
spk07: Thanks, Marshall. And just one more while you made a good statement, a good point there on the new leases having higher rental bumps. Can you talk about that? What percentage of leases are above 3% today and what are you seeing your ability to sort of get to that 4% across markets?
spk11: Yeah, I think the ability, we're really, you know, I guess the good news is we're, you know, we could push for 4%, but you really need it in the market. And so I think given the tightness in the market, we're seeing our peers do that. So you are seeing that more and more. And it's really not a lot. That's probably shifted by market within the last 12 to 18 months. So we haven't been able to implement. We typically roll about 14%, 15% of our portfolio in a given year. And given that the market's just gotten to that in the last 12 months, we still have a lot of runway to go on increasing rents. And I think given where we think the supply chain issues are, we've kind of internally said where we struggle to get roofing materials and steel and everything else delivered and it takes longer and is more expensive than it historically has, that's tricky for call it the two and a half million square feet we're trying to build at any given time, but that's great news for the 50 plus million square feet that we own. So I think that will continue to keep those 4% bumps being the market everywhere and we'll be able to bump reps you know, when they roll and get that higher increase. And that's why we like gap rent numbers. The other thing we're seeing shrink is the free rent period. Usually tenants will say, if I move, I've got moving costs and this and that. And so you can get a look. We still see some of it, some free rent in there, but there's downward pressure on free rent in the market as well.
spk10: Great. Thank you.
spk01: You're welcome.
spk10: There are no more questions in the queue. This concludes our question and answer session. I'd like to turn the conference back over to Marshall Loeb for any closing remarks.
spk11: Okay. Thank you. Again, we appreciate everybody's time. Thanks for your interest in East Group. Hopefully, it feels like we're getting near the point in the year where we'll actually be able to see some people in person, and we look forward to that. And in the meantime, we're certainly available for any follow-up questions. Thanks again.
spk10: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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