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spk03: Good day, and welcome to the first Industrial Realty Trust, Inc., third quarter results call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on a touch-tone phone. To withdraw your question, please press star, then two. Please limit yourself to one question and one follow-up. Please note this event is being recorded. I would now like to turn the conference over to Art Harmon, Vice President of Investor Relations and Marketing. Please go ahead.
spk10: Thank you, Dave. Hello, everybody, and welcome to our call. Before we discuss our third quarter results and our updated 2023 guidance, let me remind everyone that our call may include forward-looking statements as defined by federal securities laws. These statements are based on management's expectations, plans, and estimates of our prospects. Today's statements may be time-sensitive and accurate only as of today's date, October 19, 2023. We assume no obligation to update our statements or the other information we provide. Actual results may differ materially from our forward-looking statements, and factors which could cause this are described in our 10-K and other SEC filings. You can find a reconciliation of non-GAAP financial measures discussed in today's call in our supplemental report and our earnings release. The supplemental report, earnings release, and our SEC filings are available at firstindustrial.com under the Investors tab. Our call will begin with remarks by Peter Basile, our President and Chief Executive Officer, and Scott Musil, our Chief Financial Officer, after which we'll open it up for your questions. Also with us today are Jojo Yap, Chief Investment Officer, Peter Schultz, Executive Vice President, Chris Schneider, Senior Vice President of Operations, and Bob Walters, Senior Vice President of Capital Markets and Asset Management. Now let me hand the call over to Peter.
spk15: Thank you, Art, and thank you all for joining us today. We continue to deliver strong cash rental rate growth on new and renewal leasing, and we're making good progress on our 2024 expirations, which I will touch upon shortly. We also achieved some leasing wins at our developments in Pennsylvania, Northern California, and Orlando, and we're capturing significant value from the sale and ground lease of our on-balance sheet land sites in Phoenix. As expected, our quarter-end occupancy metric was impacted by a few recently placed-in service developments that remain in lease-up. As we noted on our last call, prospective tenants continue to be deliberate in making significant commitments for new space in the face of the uncertain interest rate, economic, and geopolitical environment. This is being reflected broadly in the national vacancy figures as new supply continues to come online. National vacancy was up 50 basis points in the third quarter, but still at an overall low 4.2%. In our 15 target markets, vacancy is 4%. As we discussed on our last call, there is a fair amount of new supply expected to be delivered nationally in roughly the next 12 months. Based on CBRE's analysis, there is approximately 475 million square feet under construction across the U.S., 30% of which is pre-leased. Focusing on our 15 target markets, completions are expected to be approximately 325 million square feet. New starts nationally have trended downward, with third quarter 2023 starts down more than 60% compared to third quarter 2022. This market response is being driven by the rapid increase in the cost of capital and the uncertain economic environment. In our portfolio, we're capturing strong rental rate increases on our renewals, realizing the benefit of the healthy market rent growth we've seen for the past several years. tenants continue to renew well in advance of their lease expiration dates, reflecting continued confidence in their core business. Overall, leasing market dynamics continue to favor the landlord, particularly with renewals given the low vacancy levels I discussed earlier. Through yesterday, with 97% of our 2023 lease expirations in the books, our cash rental rate increase is 60%, with average annual rental rate escalators of 3.8%. A big driver of our cash rental rate increases has been the outperformance of our Southern California assets, where we've achieved a cash rental rate increase of 151%. Looking ahead to 2024, we've taken care of 40% of next year's lease expirations and a cash rental rate increase of 38%, which is similar to our pace of progress at this time last year. Our 2023 rental rate increase has benefited from slightly more than 25% of rental income coming from leases signed in Southern California. Due to a few Southern California leases that expired in 2023 that are assumed to lease up in 2024, We expect the Southern California portion of lease signings by rental income in 2024 will be roughly the same as 2023 at a little over 25%. We will give you a refined view of our thoughts on our 2024 cash rental rate increase on our fourth quarter call with the benefit of our budget reviews. We anticipate our cash rental rate increase on new and renewal leasing will be in excess of the 38%. we've currently achieved on lease signings related to 2024 expirations. Moving on to development leasing. Since our last earnings call, we leased half of our 699,000 square foot first logistics center at 283 Building B in Central Pennsylvania. We also leased our 37,000 square footer in Northern California and a 17,000 square feet at our first loop park in Orlando. With these lease signings, the capacity on our self-imposed $800 million speculative leasing cap today stands at $108 million. We continue to monitor tenant demand for new growth to determine the appropriate time to start new developments. As I discussed earlier, tenants' decision-making on space for new growth continues to be deliberate. When we do decide on new starts, we're well-positioned with our existing coastally-oriented land bank that can accommodate 15.2 million square feet. This represents approximately 2.4 billion of potential new investment based on today's estimated construction costs and the land at our book basis. Moving now to dispositions. Since our last call, we completed a significant sale of 39 acres of land at our PB303 project in Phoenix for 41 million to a data center user. We also entered into a ground lease with that buyer for the remaining 100 acres of land at this project. The ground lease is for five years and includes a purchase option exercisable beginning in year three. Our year-to-date sales total 61 million. We now expect sales for the full year to be 75 to 150 million. With that, I'll turn it over to Scott for some additional commentary and updated guidance. Thanks, Peter.
spk09: Let me recap our results for the quarter. Nary funds from operations were $0.62 per fully diluted share, compared to $0.60 per share in 3Q-2022. Our cash same-store NOI growth for the quarter, excluding termination fees, was 7.4%. The results in the quarter were driven by increases in rental rates on new and renewal leasing, rental rate bumps embedded in our leases, and lower free rent, partially offset by slightly lower average occupancy and an increase in real estate taxes. We finished the quarter with in-service occupancy of 95.4 percent, down 230 basis points compared to QQ 2023, primarily due to completed developments placed in service in the third quarter. Summarizing our building leasing activity during the quarter, approximately 1.4 million square feet of leases commenced. Of these, 300,000 were new, 500,000 were renewals, and 500,000 were for developments and acquisitions with lease-up. As a reminder, we are strongly positioned with no debt maturities until 2026, assuming the exercise of extension options in two of our bank loans. Moving on to our updated 2023 guidance per our earnings release last evening. Our guidance range for Nate Reed FFO is now $2.40 to $2.44 per share. Excluding the two cents per share income item discussed in our first quarter call, our guidance range is now $2.38 to $2.42 per share, which is a one penny increase at the midpoint. Key assumptions for guidance are as follows. We are projecting year-end occupancy of 94.25% to 94.75%. This range assumes that the 644,000 square foot Old Post Road asset is leased up in 2024. We have made this assumption based upon our experience with the asset and the delays in the final governmental award process experienced by our prospective 3PL tenant. Your end occupancy guidance also assumes the lease-up of our developments placed in service in the third and fourth quarters will now occur in 2024 due to prospective tenants' measured pace in making significant commitments. I would note that if you excluded the impact of these developments being placed in service, Our midpoint for year-end occupancy would be approximately 97%. Our 4Q occupancy assumption implies a quarter-end full-year average of 96.5% to 96.6%. Moving on to other guidance components. Fourth quarter, same store and OI growth on a cash basis before termination fees of 6% to 7.5%. This implies a full year quarterly average growth for this metric of 8 to 8.5%. Note that the same store calculation excludes $1.4 million of income related to insurance claim settlements recognized in the fourth quarter of 2022. Guidance includes the anticipated 2023 costs related to our completed and under construction developments at September 30th For the full year 2023, we expect to capitalize about 10 cents per share of interest. Our G&A expense guidance range is $34.5 to $35.5 million, an increase of a half of a million dollars at the midpoint. And guidance does not reflect the impact of any future sales, acquisitions, development starts, debt issuances, debt repurchases or repayments, nor the potential issuance of equity after this call. Let me turn it back over to Peter.
spk15: Thanks, Scott, and thank you to all my teammates for all that you have accomplished thus far this year. Together, we're focused on delivering strong cash flow by pushing rental rates on new and renewal leasing and the continued lease-up of our development pipeline. Operator, with that, we're ready to open it up for questions.
spk03: Dave? 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 are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star, then 2. Also, please limit yourself to one question and one follow-up. to ask additional questions. At this time, we will pause momentarily to assemble our roster. Our first question comes from Rob Stevenson with Jannie. Please go ahead.
spk06: Good morning, guys. A couple of questions on development. Are you expecting to start any new developments in the fourth quarter or early first quarter at this point, and then first state move from a first quarter completion to a fourth quarter completion? Can you update us what's going on there?
spk15: I'll take the first part of that, Rob. Look, development starts are going to be a function of market strength, tenant velocity, the economic outlook, and, of course, lease-up of our completed developments. Given our desire to operate with additional capacity under our self-imposed cap so that we can take advantage of potential stress in the market, it's unlikely we're going to have any additional starts this year. And as you know, we don't give guidance on starts, so I won't comment on 2024. And good morning, Rob.
spk12: It's Peter Schultz to your question on First State Crossing. Our construction schedule has gone well. We've had great weather, so the building is a little bit ahead of schedule, and that's what's allowed us to move it from first quarter of 25, I'm sorry, first quarter of 24 into fourth quarter of 23 for completion.
spk06: Okay. And then, Eddie, Peter talked about the macro and the core market as a whole supply picture. Which of your core markets are you seeing the least amount of new supply in relative to size?
spk15: Yeah, there are a number of markets that didn't have any starts in the third quarter. Starts are down pretty significantly across the country. In some markets, 100% in the 90% range. I'm not going to go market by market, but many, many markets. I've seen little to no starts. A couple of markets, starts went up in Q3. Orlando and Denver would be two markets that that happened. But by and large, the vast majority of the markets are down significantly.
spk06: Okay. That's helpful. Thank you, guys.
spk03: Our next question comes from Keebin Kim with Truist. Please go ahead.
spk02: Thanks. Good morning. Can you help us better understand your commentary about new leasing demand being deliberate? Maybe you can put it in, maybe you can frame it versus 2019 in terms of the type of feedback you're hearing or the number of prospects that you're fielding, just trying to get a better grasp of how things might be changing.
spk15: I'll take the front end of that and JoJo and Peter should chime in too. You know, I think when we talk about 2018, 2019, when we had a perspective, when we had a space available, We were usually talking to one or two, maybe three tenants in 21 and 22. Maybe it was five or six. So we're back down to a smaller number of prospects. Obviously, with the increase in development deliveries, we also have a little bit more competition than we had in 21 and 22 for new space. Peter, you want to talk about your region?
spk12: Sure. Kevin, Peter Schultz here. I would say a couple of things. The overall level of activity to Peter's point, has been generally consistent. But what we are seeing is tenants being cautious and really delaying their decision-making. We've seen a number of deals where they had a targeted commencement date only to see those push back as tenants are hesitant to make those commitments given some of the macroeconomic and geopolitical issues that Peter touched on in the script. We have seen a little bit of increase in activity coming out of the summer. Activity levels are better in the smaller and mid-sized spaces than they are in the biggest spaces for the most part. But the primary headwind is just the lack of and the slower cadence of decision-making by tenants. Jojo, anything else you want to add?
spk05: Yes. So for me, kind of bottom line, it's like in 2019, businesses are focusing more on growth and they're focused on where their expansion is because of new business coming in. Today, they're more securing their current commitment and wanting to make sure they got good enough space to run their business and less focused on growth. In 19, there was a little bit more of a fear of missing out on space because they're being gobbled up quickly. Today, tenants have a little bit more choices, so they're more deliberate and they're shopping around a little bit more.
spk02: So how does that impact your strategy in terms of leasing up your development space, or I guess any space? Is cutting rent... a practical solution, or if the pool of customers is just smaller, maybe cutting rents doesn't do the trick, maybe increasing leasing commissions. I guess, how are you trying to handle that?
spk15: You know, right now, concessions are not increasing meaningfully, and I say use the word meaningfully because here and there, we are seeing some sponsor owners increase free rent a little bit. We typically offer, call it half a month, a free rent per lease year, and we're seeing that in some cases at a month. But again, other than that, that's about it. TIs are standard packages, etc. The other thing that I would point out is that we have developed properties that are incredibly competitive relative to the set of primarily merchant builds that's out there. So from a functionality standpoint, we are superior, and You know, when we talk about having more competition, we don't mean there are six or eight other opportunities. There might be two or three. So it's not that the market isn't flooded. So right now the market's holding pretty steady. Occasionally you'll see somebody get a little extra free rent, but right now it's holding steady.
spk12: Kevin, the other thing I'd add is You know, over the last several years, you've seen a lot of our developments leased to single tenants. As you know, we take a lot of time in the design, making sure these are functional, can be demised for multiple tenants. We're seeing, as I said a few minutes ago, better demand from smaller midsize, and the buildings are ready and prepared to be demised for multiple tenants. Multiple office pods, dock packages, in some cases, demising. So we have the flexibility, given the quality point that Peter made, to accommodate that. So you might see us do more multiple tenants than what we've done the last several years, which has really just been a function of the market.
spk03: Thank you, guys. The next question comes from Nicholas Uliko with Scotia Bank. Please go ahead.
spk04: Hi. Good morning, everyone. First, I just wanted to ask about the development projects that I guess already delivered this quarter and still will come in the next couple quarters in Inland Empire. If you could just talk a little bit more about what sort of competitive level of supply you're dealing with there. you know, relative to those projects. You know, we do see just stats and hear commentary that Inland Empire East is where there is more of that supply impact, but just wanted to hear your thoughts on that.
spk15: Jojo, you want to cover?
spk05: Sure. I'll touch on the Inland Empire. Overall, you know, the Inland Empire still has a, historically, a very low vacancy at 3.5%. We do expect a long-term that it will still have positive red growth. In terms of our developments, we have five. In the IE2, we just completed in 300 construction. They're all of different size ranges and in different sub-markets, namely Fontana, 215 Corridor, and then Redlands. So we're not over-invested or over-built on any markets. If you look at each of these properties, there are no more than two competing properties in terms of quality. on location with these properties, and there are even two properties where we couldn't find really a comparable property. We feel really good about these projects. Roughly, they're about $200 million, and today we're projecting a 9.3% yield, which is a little bit under a 90% margin. We feel really good about, you know, of course our job is to lease those, but we feel very good in creating value for shareholders going forward in those.
spk04: Thanks. That's helpful. This second question is I want to see, you know, how we should be thinking about the pace of, you know, development projects leasing up. over the next year, just in terms of a time frame from when it gets delivered to ideally a more stable occupancy level? And then the other question is related to capitalized interest. It seems like there could be some sensitivity there over the next year based on how long projects take to lease. And, you know, any thoughts or reminders you can tell us about how to think about, you know, the capitalized interest impact in the development pipeline vis-a-vis how long buildings can really stay within capitalized interest after being delivered?
spk15: Yeah, so I'll cover the first part of that, and Scott will talk about capitalized interest. In terms of lease-up timing for next year, obviously we're going to be spending a lot of time on that topic when we sit down to do our budgets for next year. At this point, in terms of new developments, we're not anticipating changing our 12-month downtime assumption. But with respect to the projects that have been completed and gone into service, we'll be focused on when we think those are going to lease next year based upon the level of dialogue that we're having with our prospective tenants today. So I can't really give you much more than that on that question. Scott, you want to cover the capitalized interest?
spk09: Sure, Nick. So we stop capitalization of interest once the development is completed. So we've got a handful of developments that are scheduled to be completed up until the second quarter of 2024. So we will have capitalized interest for the first six months of that period. For the back half, for the last six months of the period, that will be dependent upon new starts.
spk03: The next question comes from Craig Mailman with Citi. Please go ahead.
spk16: Hey, good morning. Just wanted to hit on the data center ground lease in Phoenix here. Just had a couple quick questions on this. Just first, Scott, from a run rate perspective, is the full run rate in the 3Q number, or do we need to think about additional revenue coming in the fourth quarter to annualize it?
spk09: Yeah, Craig, so there's a little bit of lease income in the third quarter. I think it might be just a half of a month. And then, obviously, we're going to get a full quarter in the fourth quarter of 2023. Take a look at our NAV footnote, Craig. We have some more information on the ground lease that you can get some of the economics.
spk16: Okay. Sorry, I apologize. I didn't see that footnote. Did you guys put in what the purchase option is in there in terms of the pricing and how that compares to what the value would have been if you had just kept this as industrialized?
spk15: We have a pretty strict confidentiality agreement with this counterparty, so no, we can't talk a lot about the terms and values and things like that. I can say generally speaking, the value of data center land is much higher than the value of industrial. But that's all we can really say. Let's put it this way. We like the economics a lot. Or we wouldn't have done it, obviously. Yep, go ahead.
spk16: No, no, finish your thoughts.
spk15: No, no, I mean, it's a great site. And we went into that years ago with big plans for, you know, selling to users, developing ourselves, build the suits, etc., for us to be tempted to let that 100 acres go, you can imagine it's got to be a pretty good deal.
spk16: I guess that was my other question. Should we take this as an indication of your concern about overbuilding in Phoenix and doing this deal rather than building it out to industrial lakes? It seems to have been a good market for you guys since you got involved in it a few years ago.
spk15: This in no way is an indication of our confidence in that market. We spent a lot of time deliberating whether we wanted to do this. At the end of the day, the economics of this trade pretty much equaled the economics of building that site up.
spk16: And then just one quick follow-up or separate question. Just got on the mark-to-market. You said you're not giving guidance yet on spreads. but you anticipate next year won't be in excess of that 38%, is the 40% you leased this year just a mix issue of outside of L.A. or other markets with smaller market markets? Could you give details of maybe what's in that 40% versus what's remaining in the 60% from a market exposure? Chris, do you want to take that?
spk11: Yeah, Craig, this is Chris. Yeah, it is definitely a mix issue. So if you look at what's been taken care of, It's only 6% from Southern California. If you look at the rest of the 2024 rollovers, that mix is 56% coming from Southern California.
spk16: Perfect. Thank you.
spk03: Again, if you have a question, please press star, then 1. Our next question comes from Vikram Malhotra with Mizuho. Please go ahead.
spk17: Thanks for taking the questions. So just first following up on development, I guess, you know, some of your peers may be seeing this as if development starts are very low, by the end of 24, there's probably little product to offer and it's demand sort of picking up and, you know, there's probably share to be had. So I'm just wondering how do you balance the two? Are there specific markets you can cite where you do feel you might pause and fork you, like you said, but then ramp back up because in general, there will be a growth of quality product?
spk15: Yeah, I mean, the big indicator for all of us is going to be development lease-up. And we have product in the market now. We're having good conversations, as we've said, in various and many different ways. Tenants are taking a while. You know, to lease a 500,000-square-foot building, that's about a $50 million decision. And the current economic outlook and what's going on around the world, that causes people to pause before they put down that $50 million. yes, it's possible that toward the end of next year there's not enough supply. That would be fine by us, obviously. And we really think that the market will be particularly strong in 2025. So with respect to us looking at what we're going to start or potentially start next year, it really is going to depend upon how we feel about Lisa.
spk17: Okay, that makes sense. And just following up on the you know, Inland Empire comments you made around the competitive set being small in terms of your project. Maybe just help us think about how you're seeing, what you've seen in terms of market rent growth in SoCal in general, what the variability in that region looks like quarter over quarter. Any numbers you can share would be helpful.
spk15: Jojo?
spk05: Yes. So, kind of address a little bit because of the low vacancy of LA of sub two and then i.e. at about three and a half. Long term, we would think that it would be a minimum mid-single digits going forward. But today, as you may recall, SoCal has the highest rent growth of any market in the U.S. for the last three years straight. Right now what the market is doing is it's digesting the supply in the marketplace along with a little bit of a decline on the inbound TEUs that affected the demand. And I'm not going to be surprised, we're not going to be surprised if in the very near term the rent is flat through the end of the year and maybe first quarter of next year to maybe slightly negative. But that doesn't mean we can't create value because, like I pointed out to you, our developments, for example, just a subset is about a 9.3 based on current market rents, 9.3 yield.
spk17: Thank you.
spk03: Our next question comes from Caitlin Burrows with Goldman Sachs. Please go ahead.
spk13: Hi, good morning. Maybe somewhat related to the last question, but on the development yields, it looks like today They're expected to be 7.2% for the under construction set of properties, which is up from like 6.5% a year ago. So how are you thinking about your cost of capital today and what yields are required to make development attractive and I guess to what extent is that impacting your activity?
spk15: Yeah, thanks, Caitlin. So sure, the cost of capital has certainly gone up. When we look at that, though, and compare it to what we think we need to make to make reasonable margins and profits here, The yields on new developments need to be north of 6.5 expected IRRs, north of 8.5, closer to 9. And on a weighted average basis, our pipeline projects hurdle those returns. So we're excited about the opportunity. As soon as we've digested more of this additional supply coming through the pipe nationally, we've got a lot of great projects that are ready to go in the best markets in the country.
spk13: Got it. Okay. And then maybe on the acquisition side, I know it's historically not been as much of a driver for you guys, and transaction volumes are down significantly this year across CRE, but are you seeing any attractive acquisition opportunities come to market, or do you expect attractive opportunities to come up, either of stabilized properties or even lease-up properties?
spk15: Yeah, I mean, economics certainly make a difference in terms of what's attractive, but Joe, do you want to talk about some of the things you've seen and the reasons we've taken a pass?
spk05: Sure, yeah. So we're on a lookout for those. We're trying to see if there's stress in, like, you know, merchant developers or owners or middle-of-their projects or need capital or just sellers who want to get out of real estate. The reality is that there's not a lot of those that fit our quality or geography, and in those situations... that meet our geography and it doesn't meet our financial criteria, meaning that there are some buyers who are still acquiring real estate at prices that don't make sense to us. But there are a few small ones who are in We have a situation where a developer didn't have the funds and that they had tied up a good bill to suit. We're stepping in, and we think that's a great deal. And then we have another situation, not a large deal, a one-off. where the developer needs to fund their speculative project and suddenly the lender pulls the commitment unless the developer comes up with more equity. And so we're buying one of their buildings, a nice building, at a much lower price because they need to squeeze out equity on that very, very quickly. So those are just examples of what we're trying to look for.
spk13: Got it. And just to clarify, those are things that you're looking for or have already been decided on and are moving forward.
spk05: Can we give you much more specific that those are... We're pursuing.
spk15: We're pursuing.
spk05: We're chasing it.
spk15: They're not by any means. We may not get them, but we're pursuing.
spk13: Got it. Okay. Thank you.
spk03: The next question comes from Todd Thomas with KeyBank Capital Markets. Please go ahead.
spk14: Thanks. Good morning. This is AJ on for Todd. Just going real quick back to the capitalized interest discussion, you say that you stop capitalizing interest when development is completed. As you look at your construction pipeline today and everything under construction, do you see any potential delays or anticipate any delays for what's currently supposed to be delivered over the next few quarters?
spk09: I would say that's our best thinking as of this point of time. So if you're asking about developments under construction, we've got estimated building completion in our supplemental. That's our best thinking at this point in time that that's when those developments will be completed.
spk14: Okay, perfect. And then just one question regarding Old Post Road. Is the 3PL tenant Are they still engaging, or is there any update around that contract that was going to be awarded, or are you moving on and looking to market the asset to a new tenant altogether?
spk12: So, AJ, it's Peter Schultz. We continue to market the asset. In terms of the 3PL group, we continue to talk with them. The government continues, for whatever reason, to postpone the final decision on that contract award. The latest information is that they're supposed to issue that award sometime later this quarter. Given our experience with this process over the last year, our confidence level, I would say, is not high, which is why, as you heard from us earlier, we decided to push the lease up into 2024. It's certainly possible that this could get done. this quarter, but our probability is that it's less likely just given the way this process has gone.
spk14: Okay. Thank you.
spk03: The next question comes from Michael Carroll with RBC Capital Markets. Please go ahead.
spk19: Yep, thanks. Just following up on Old Post Road, I know this has been taking a couple years to get done. I mean, at what point do you just decide to kind of go multi-tenant and try to lease it to some smaller tenants that might want that space?
spk12: Mike, that's a good question. It's Peter Schultz again. So we certainly have been and are open to that. As we've talked about on some of these prior calls, demand from larger users in this submarket and others has been slower, where historically that size range was very active along that corridor. That's something we're open to, and it's really about the timing of market demand and how tenants make decisions.
spk19: Okay, thanks for that. Real quick on your comments on the smaller blocks as the space. I know for the past few quarters you've highlighted the tenant activity for those small to mid-sized blocks as we're still pretty healthy. I mean, is that still a fair comment today, or has that changed over the past three-plus months given kind of the slowdown that you've seen in demand?
spk12: So I would say it's consistent. If you look at our in-service portfolio, occupancy is very, very high. We continue to see good demand and backfilling spaces quickly. But for the old post road building that we just talked about and a couple of our developments that are larger, demand continues to be very active. And those tenants operate with more urgency and diligence than some of the bigger commitments to our earlier points where they're just not in a hurry to make those decisions
spk07: commitments today given the broader macro factors that are impacting everybody okay great thank you the next question comes from nick thillman with fared please go ahead hey good morning uh question on the land bank it looks like the fair value of the land bank was marked down like 10 quarter over quarter some of that could be related to some land sales but just curious If you did make some changes in your estimates for fair value of the land and maybe which markets in particular saw the biggest haircut?
spk09: Nick and Scott, a couple of things happened is from the land bank, we removed the land in Phoenix related to the land sale, and then we removed the land that's being ground leased. So that's going to cause a fair value drop alone in 3Q compared to 2Q, because it's no longer in the population. And I'll have Jojo talk about adjustments we made to the what's left over.
spk05: Sure. And then on top, in addition to what Scott said, we added, of course, the land, Nashville land acquisition. And then we made some adjustments to our land values. Those were in Chicago and Florida. And then we also slightly adjusted some lands, so we did it asset by asset. Some land we started to make improvements, whether it's off-site improvements, and therefore that added to the value. So we added our cost to those additional investment in the land. So if you took all of that together, that resulted in the difference.
spk07: Was there any specific markets that were haircut significantly in this process or not really?
spk05: No, I would say that we didn't do it market by market. We did it property by property. I would say the change was anywhere from 5% to 15%. And then Chicago, we, for example, took down. Orlando, we took down in terms of value. We adjusted it. So, yeah. So, I mean, we did it property by property.
spk07: And then quick one for Scott, maybe just an update on how bad debt is tracking year-to-date and any updates on the tenant watch list.
spk09: Sure. Bad debt's very low for the third quarter. It's about $100,000, and that's compared to our guidance assumption of $250,000, so still in very good shape. If you look year-to-date third quarter, We've expensed about $275,000 compared to our original guidance for those first three quarters of $750,000, so doing very well against our forecast. As far as tenants on the watch list, no material tenants are on the watch list at this point in time. Great.
spk03: Thanks. Our next question comes from Rich Anderson with Wedbush. Please go ahead.
spk08: Hey, thanks, and good morning. So when I was kind of looking back in time, Peter, back in 2019, I asked a question of you, what trigger points are you looking for as it relates to build-to-suit versus spec development? And you talked a lot about it here on this call. One of the things you said then, not to put you on the spot, is this so-called musical chairs phenomenon where tenants have the ability to move around from one asset to another because they can, and that to you would be an indication of market weakness. You talked about the hesitancy of tenants and so on that's going on today, but are you also seeing that where the elevated level of deliveries is creating optionality? Is that another sort of dynamic that you're seeing happen in your space?
spk15: Kudos to you, Rich, for remembering that and bringing that up. That's good. Good questions. No, we're not seeing that. What we're seeing, and we have a current example in the portfolio where a tenant moved out to consolidate into bigger space, and that's still the theme. If we lose a tenant, it's because we can't accommodate their additional growth needs. In terms of people leaving buildings, it's very expensive to move, so the deal, in quotes, that they can achieve somewhere else has to be pretty outstanding, and that is not reflective at all of where we are right now, even with the additional supply coming to the market. As we pointed out, vacancy rates at 4% in our markets, that's still a very, very low vacancy rate. That's not going to generate the kind of financial arbitrage that is going to cause a tenant to leave to go to another building. So very good question, but we're not seeing that phenomenon right now.
spk08: Okay. Second question for me is, Scott, you gave your guidance 94.5% occupancy at the midpoint and 97% if you didn't include the development deliveries. So 250 basis points spread. How does that number compare to when everything was white hot and you kind of got further along in the leasing process by the time buildings were delivered? Is 250... significantly higher than that time? I assume it's above it. And where do you think it's headed from here when you kind of take your pulse of things going forward?
spk09: Yeah, it's definitely significantly higher. Our placed-in-service policy is 12 months after development completion. And we generally, if you look a year, three, five years ago, we've leased up everything inside of that 12 months. So that spread is definitely higher. We did have a little bit of that type of dynamic during COVID with a couple of our developments. So I would say at this point in time, it's higher. On a go-forward basis, Rich, it really... depends on an asset by asset basis what we get leased up. And, you know, we'll go through our budget process here at the end of the year, and we'll give you a little bit more color on our fourth quarter call.
spk08: Okay. Good enough. Thanks very much.
spk03: Our next question comes from Vince Taboni with Green Street Advisors. Please go ahead.
spk18: Hi. Good morning. Could you discuss how 3PL tenants are performing in your portfolio and Do you have a sense of where their current volumes are relative to peak activity 12, 18 months ago? I'm just trying to understand how much excess capacity there may be among 3PLs and how that dynamic could potentially impact near-term demand.
spk12: Peter, you want to take that? Sure, Vince. It's Peter Schultz. First, I would say that our teams report high utilization of all of our spaces around the country. 3PLs continue to be the top most active prospect that we're seeing for new buildings and existing availability. And in general, they're all looking for more space, not less space. So I would simply tell you that we're not seeing really any stress there. To Scott's question, nobody on the watch list and no bad debt, but they continue to be an important and active component of demand. Jojo, anything you want to add to that?
spk05: Yeah, the only thing is that definitely the 3PL, in our experience, 3PL business is not recession-proof, but it is a business where when things slow down with companies that are not in the fulfillment business, they go to 3PL. Because 3PLs are more efficient and more cost-effective than doing fulfillment themselves.
spk18: Thank you. That's really helpful. And then one more industry kind of wide question for me. Could you just discuss trends, you know, among sublease space within your markets? Any, you know, notable changes there?
spk15: That's a pretty, yeah, that's an intricate topic because, you know, not all sublease space is created equal. Peter and JoJo, you want to come in?
spk12: Sure. So if it's Peter Schultz, I would first say that, you know, sublet space at the headline is certainly up a little bit. but I think you have to break it down and it's a couple of different buckets. One is a corporate occupier saying a 700,000 square foot building gets an edict from their corporate to sublet two or 300,000 square feet. That's a hard deal to make for tenants and generally doesn't happen. We don't really view that as competitive sublet space. Some of the sublet space has a time or term limit of only a couple years, and most tenants are not going to take advantage of that. We've also seen some sublet space come on the market and be pulled back by the prime tenant because they need the space again. So, yes, there is some sublet space. We don't view it as a high concern today. And then I would just end with, as I said a couple of minutes ago, the space utilization in our portfolio is very high. We're not really seeing any change in sublet space across our portfolio.
spk05: Jojo? Yes, I just wanted to add to Peter when we surveyed really our teams is that we haven't really lost anything close to anything significant to the sublease space, just like Peter said. And if we did, these are the subleases that are long-term. A long-term sublease is very good for a long-term user, but the problem is that most subleases don't fit that. Most subleases are short-term, and therefore, you know, frankly speaking, we'd like to compete with sublease because a lot of times, you know, the tenants that we're pursuing can't really operate out of a short-term lease. Like Peter basically said, it's constantly a move.
spk03: Great. Thank you. Our next question comes from Mike Muller with J.P. Morgan. Please go ahead.
spk20: Yeah, hi. So for the two questions, the first one is, for the development leases you signed in 3Q and 4Q, how did the rents compare to the original underwriting? And the second question is a little bit more of a clarification. When you were talking about 24 leasing, did you say 56% of the remaining expirations were in Southern California? And if so, how does that compare to what the mix was of what you signed already? Chris, take the first part.
spk11: Yeah, so correct. The remaining 2024 lease expirations are 56%. And again, the ones that have been signed already, the mix with Southern California was only 5%. So obviously, it's going up quite a bit.
spk15: Do you want to cover the first part of that question? Do you remember the first part of the question? Give the first part of the question again, please.
spk20: Yeah, it's for the development leases signed in 3Q and 4Q. How are the rents versus what you originally underwrote?
spk12: Significantly ahead of what we underwrote. Got it. Okay, thank you.
spk03: The next question comes from Anthony Powell with Barclays. Please go ahead.
spk01: Hi, good morning. I have a question on data centers. I just looked at your land bank. Are there any obvious opportunities for you to do additional joint ventures or development deals in the space?
spk05: Well, in terms of we're very pleased that we were able to get the highest and best use for this piece of land that we have in Phoenix, so we're very excited about that. When you look at all across the board in terms of what we own, we're always looking for higher and better use. So if we come to a situation wherein we are offered a price that it doesn't make any sense to build an industrial building or exceeds our profit potential, margin potential, product potential, and development, we would consider selling. So that's basically a rule and a practice that we do in FR. Now, in terms of obvious candidates for future data centers right now, I will say that we don't have any pending offers or pursuits of additional data center situations.
spk01: And I guess these will all be sales or joint ventures. You wouldn't do development on your own balance sheet data centers. Is that fair?
spk15: That's fair to say, yes. We're going to stick to our bread and butter.
spk00: All right.
spk15: Thank you.
spk03: Our next question comes from Caitlin Burrows with Goldman Sachs. Please go ahead.
spk13: Hi. Sorry, just one follow-up which is similar to the question that was just asked. But in terms of the mix of expirations in 24, I think you had previously said on other calls that 2024 would have less SoCal than 2023. So I'm wondering as you compare 24 to 23 if that changed or just that kind of exposure that you were talking about. That might be confusing. I'm just wondering how the 24 SoCal exposure compares to 23.
spk11: Yeah, Caitlin, this is Chris. So because there was a couple of leases that originally were going to, you know, they expired in 2023, they're not going to lease up in 2024, the allocation between the two years is both around 25% plus.
spk15: Yeah, we're talking about a couple of months difference. Right.
spk11: So very similar between the two years.
spk13: Got it. So it was some that had originally been thought of to be 23, but now they'll be 24, making them more even.
spk03: Correct.
spk13: Got it. Okay, thank you.
spk03: Our final question comes from Craig Mailman with Citi. Please go ahead.
spk16: Yeah, it's not trying to make the call the longer it needs to, but just, you know, there's a lot of focus on market rent growth these days and it just feels like a lot of the stats being put together by brokers and talked about are kind of asking rents, which are, are, you know, some markets being driven by just new product that's coming on the market, um, versus, you know, maybe we're taking rates are, and I'm just kind of curious as you guys go through your market exposure, is it, is there a, uh, a rosier picture on the taking rate side of things versus the trend in asking rate? Um, you know, you could talk about or,
spk15: Yeah, it's a complicated subject because market rent growth is tracked differently by a lot of different brokers. Taking rents right now, they report are more like 15%. We don't quote that. We think the asking rent number is more accurate. You know, our expectation for rent growth for 2023 was mid to high single digits. That was with asking rents in mind. So far, year over year, CBRE reports to the third quarter. That number is 7.5, so it's right in the middle of what we expected. So yeah, we're looking more at a 7.5% rental rate increase across the markets that we're active in. We don't look at the... The taking rents are higher because of all... Taking rents, by definition, have to include some amount of mark-to-market as opposed to just what's happened in that quarter or that year. So we don't pay attention to that.
spk16: Okay, great.
spk03: This concludes our question and answer session. I would like to turn the conference back over to Peter Basile for any closing remarks.
spk15: Thank you, operator, and thanks to everyone for participating on our call today. If you have any follow-ups from our call, please reach out to Art, Scott, or me. We hope to connect with many of you in person in the coming months. Be well.
spk03: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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