STAG Industrial (NYSE:STAG) Q3 2020 Earnings Call

0:00 Good morning, and thank you for standing by. Welcome to Stagg Industrial, Inc.'s third quarter 2020 earnings conference call. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. Should you require operator assistance during the conference, please press star zero to signal an operator. Please note this conference is being recorded. I will now turn the conference over to your host, Matts Pinard, Senior Vice President, Investor Relations for Stagg Industrial. Thank you. You may begin. Thank you.

0:31 Welcome to STAG Industrial's conference call covering the third quarter 2020 results. In addition to the press release distributed yesterday, we have posted an unauded quarterly supplemental information presentation to the company's website at stagindustrial.com under the Investor Relations section. On today's call, the company's prepared remarks and answers to your questions will contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters that are subject to risk, and uncertainties that may cause actual results to differ from those discussed today. Examples of forward-looking statements include forecasts of core FFO, same-store NOIs, G&A, acquisition and disposition volume, retention rates and other guidance, leasing prospects, rent collections, industry and economic trends and other matters.

1:18 We encourage our listeners to review the more detailed discussion related to these forward-looking statements contained in the company's filings with the SEC and the definitions and reconciliations and non-GAAP measures contained and a supplemental informational package available on the company's website. As a reminder, forward-looking statements represent management's estimates as of today. Stagg Industrial assumes no obligation to update any forward-looking statements. On today's call, you'll hear from Ben Butcher, our Chief Executive Officer, and Bill Crooker, our Chief Financial Officer. I will now turn the call over to Ben.

1:49 Thank you, Matts. Good morning, everybody, and welcome to the third quarter earnings call for Stagg Industrial. We're pleased to have you join us and look forward to telling you about our third quarter results. Presenting today, in addition to myself, will be Bill Crooker, our Chief Financial Officer, who will discuss the bulk of the financial and operational data. Also with me today are Steve Mechie, our Chief Operating Officer, and Dave King, our Director of Real Estate Operations. They will be available to answer questions specific to their areas of focus. A phrase that I've heard frequently over the past few months has been, it's good to be an industrial, and that is certainly true. Industrial remains one of the few favored asset classes in commercial real estate. Fundamentals are strong. Tenant leasing demand slowed only briefly at the outset of the pandemic. It resumed quickly and has continued to be strong throughout the quarter.

2:38 This resilience has been seen across virtually all markets with e-commerce supply chain build-out leaving the way. Supply remains a concern, but most markets are at or near equilibrium and are operating at occupancy levels where the levels of incremental supply are not unwelcome. Capital is readily available and acquisition opportunities abound. Not surprisingly, our portfolio continues to perform well despite somewhat uncertain economic conditions. The demand for our space is broad-based. The 5.6 million square feet leased in the third quarter represents the largest total square footage leased during a single quarter in Stagg's history. Our occupancy level remains high, 96.3% at quarter end, a reflection of solid retention and shorter downtime experience.

3:23 Included in this quarter's leasing activity was the successful backfill of our 1 million square foot building located in Hampstead, Maryland, one of the 2 million square foot facilities with tenant nominal expected to occur in 2020. We budgeted between 12 and 18 months of downtime prior to re-tenanting this facility, given its size and location. Thanks to the efforts of our asset management team, we significantly outperformed our budget and successfully released the building to a single user while incurring no downtime. The building is leased to a substantial credit for over five years with minimal tenant improvement work and 3% annual rental escalators. The second 1 million square foot building we've discussed is our GSA building located at Exit 6A of the Jersey Turnpike in Burlington, New Jersey.

4:09 This is one of the premier submarkets on the East Coast and a version of e-commerce hub. Our current budgets reflect a midpoint of nine months downtime for this asset. We continue to receive interest from both potential buyers and potential users for this building. and it's included 500,000 square foot potential additional development. Our guidance assumes we hold this asset for the foreseeable future. However, given the attractive returns of a potential sale, we believe there is an increased likelihood that we monetize this asset. As expected, the acquisition market has returned to pre-pandemic levels, both in terms of investment opportunity and pricing. The fundamental strength of the industrial real estate sector going forward has not been lost on investors. As a result, investor appetite for industrial real estate continues to grow.

4:56 However, our acquisition platform is well established across many markets in which we operate. Our ability to identify relative value investment opportunities is reflected in our acquisition pipeline amount of over $2.8 billion today. We recently completed our fourth annual tenant survey. Not surprisingly, there are more and less fortunate industries during the pandemic. The more fortunate include third-party logistics providers and the home improvement industry, and of course, anything e-commerce related. Less fortunate include tenants in the trade show industry and certain small automobile tenants. E-commerce remains a dominant theme. Approximately 40% of our respondents across our portfolio utilize a portion of their space to conduct e-commerce activity, and approximately 15% of our buildings are solely dedicated to e-commerce. Our tenants reported an increase in the percentage of their warehouse footprint focused on e-commerce activity, an increase from 30% in 2018 to almost 40% in 2020.

5:54 STAG is in an enviable position as we approach the end of the year. Our balance sheet is defensively positioned and our liquidity is high. The STAG team is working effectively and efficiently in the current work-from-home environment with strong engagement across the organization and a resilient culture. Then I'll turn it over to Bill who will discuss our third quarter operational results and updates to our 2020 guidance.

6:16 Thank you, Ben. Good morning, everyone. Core FFO was 46 cents for the quarter and leverage remains at the low end of our guidance range. Net debt to run rate adjusted EBITDA was 4.4 times prior to factoring in the outstanding forward equities proceeds related to our January equity offering and 4.0 times when those proceeds are included. Acquisition volume for the third quarter totaled $64.7 million with stabilized cash and straight line cap rates of 6.3% and 6.8% respectively. Subsequent to quarter end, we've acquired an additional nine buildings for $258 million. This brings 2020 closed acquisition volume to $454 million through today. Additionally, we have acquisitions totaling $216 million and many more. For the quarter, 5.6 million square feet of leases commenced, with cash and straight line releasing spreads of 1.3% and 4.7%, respectively.

7:11 New leasing spreads were negative 4.7% this quarter, which was driven by two leases, The new lease related to the $1 million-square-foot asset located in Hampstead, Maryland, as discussed by Ben, resulted in a roll-down of 2.2%. Note that this lease was an as-is transaction and required minimal tenant improvement or other capital work. The second lease reflects the phased negotiation of a long-term lease with the tenant initially agreeing to a one-year lease at below market rent while simultaneously negotiating a market-rate long-term lease.

8:05 Excluding these two leases, new leasing spreads increased to 12.4% on a cash basis and 21.5% on a straight line basis for the quarter. Additionally, we leased 82,000 square feet of value-add buildings during the quarter. Retention was 72.1% for the quarter and it's 81.4% for the year, both of which include the impact of the 1 million square foot solo cup non-manual, which is backfilled with zero downtime. Retention was equal to 88.6% for the quarter and 91.5% for the year when excluding the impact of a solo cup non-retention. Same-store cash and Y increased 0.8% for the quarter and 1.8% year-to-date.

8:54 For the third quarter, we collected 98.2% of our base rental billings. Of the remaining 1.8%, 60 basis points have been deferred with repayment generally expected by year end. As of November 5th, we have collected 96.9% of our October base rental billings. An additional 60 basis points of October base rental billings yet to be received leads to investment grade tenants and tenants who pay in arrears. We expect these tenants to remit payment within the next two weeks bringing the total to 97.5%. The timing of these expected payments is consistent with past practices. Of the remaining 2.5% of uncollected base rental billings, 1% has been deferred and 1.5% is associated with smaller tenants that have been impacted by the pandemic.

9:46 We have not received any new rent deferral inquiries in the third quarter. We incurred a total of $1.8 million of credit loss in the third quarter, approximately $850,000 of that loss related to the write-off of straight-line rent and approximately $950,000 of that loss related to cash credit loss. We have updated guidance for the remainder of 2020. We acknowledge the continued uncertainty related to the health of the economy and will continue to update the market as warranted. Components of our updated 2020 guidance are as follows. We have increased our expected acquisition volume range, now projecting between $650 and $750 million, with an expected cash cap rate range of 6% to 6.25%, and expected straight line cap rate range of 6.5% to 6.75%.

10:41 We have increased our 2020 disposition volume range, now projecting between $150 million and $200 million. We have increased our expected retention range, now projected between 70% and 75% for the year, which includes 2 million square feet of non-retention associated with the Solo Cup and GSA facilities. We have increased our expected annual cash same-store range, now projecting 2020 annual same-store pools cash and Y growth to be between 75 and 125 basis points for the year. This range includes a reduction in our annual credit loss guidance to a range of 75 to 125 basis points. We continue to expect G&A to be between $39 and $41 million for the year.

11:29 We expect to run leverage between 4.5 and 5.25 times per year. Capital expenditures per average square foot is still expected to be between 27 and 31 cents per year. We have increased the expected range of core flow per share to be between $1.86 and $1.88 for the year, representing a midpoint increase of 3 cents. With that, I will now turn it back over to Ben.

11:55 Thanks, Bill. These remain challenging times as we head towards the end of an unprecedented year. Challenging, but not unworkable. After a pause for most of the second quarter, the industrial acquisition market has found firmer footing. Tended demand for industrial space is broadly healthy and appears to have substantial legs. We are bullish on the opportunity for STAG to lie ahead. As a reminder, we will provide granular 2021 guidance during our fourth quarter call. In closing, Let me mention that as part of our continuing focus on various ESG initiatives, we have recently set up the STAG Industrial Charitable Action Fund. The fund is a way to formalize and channel our corporate giving. This was done in recognition of and in concert with our augmented commitment to providing substantial financial support to causes and organizations we believe in.

12:41 Thank you for your time this morning. I'll now turn it back to the operator for questions. Thank you. At this time, We will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. If, at any time, you wish to remove your question from the queue, please press star 2. For participants using speaker equipment, it may be necessary to pick up your headset before pressing the star keys. Our first question is from Danny Corbin with Citi.

13:15 Hey, guys. Good morning. Maybe just thinking about your disposition plans, have you changed the composition of what you might sell or where you might sell given sort of the way that the market has shifted?

13:31 I think, and I'll acknowledge that it's Manny, not Danny. I think that we maintain our general philosophy that we'll sell assets when somebody else thinks they're worth more than we do as a part of our portfolio. That having been said, we are getting, opportunistically, people reaching out to us to acquire individual assets. We did not have plans for a portfolio sale. We certainly, when we sign new leases on buildings that extend the term and they may become more attractive to The people that are looking for that kind of asset, we may look at selling things. Certainly the GSA asset is an asset that we're looking at at all times on a buy or sell because of its relative attractiveness and the number of people who are interested in that asset. We're also interested in that asset and we'll do what's best for our shareholders.

14:23 Hey, Manny, it's Bill. We also increased our disposition guidance going into the fourth quarter primarily related to an asset that we had a reverse inquiry on. and we expect strong results from that transaction.

14:36 And could you give us an idea of what you think that the spread difference might be in cap rates between what you're selling and what you're buying?

14:45 I think it varies, but I will say it varies obviously on the asset, the market, etc. What I will say is on these opportunity investments, we have experienced double-digit IRR, unlevered IRR returns. And so that doesn't mean it's, you know, necessarily a, you know... So we tend to compare the return on the asset to where we're redeploying the equity. But having said that, the asset that Bill was just talking about is a, we will be able to redeploy those proceeds accretively.

15:14 And just a reminder that the assets that we sold in the first quarter were also a sub-five cap, so those proceeds were redeployed accretively as well.

15:25 Right, and then thinking about your acquisition pipeline, that increased meaningfully in the quarter. Have you changed anything there in terms of the types of assets in the markets you're looking at and sort of maybe widened the target a little?

15:40 No, it's really, we've talked about this before and it's certainly met our expectations is that one of the impacts of a downturn like the dramatic downturn we had with the onset of COVID is People are reluctant to bring assets to market until they have a better understanding of where the market might clear. So you had a big pullback from sellers and brokers advising sellers during the second quarter. The expectation was, again, we're hearing an anecdote from brokers and to some extent sellers, that Towards the end of the summer and going into the fall, you would have that pent-up supply of assets to be traded come to market. Indeed, that has happened. And from talking to the Brokers Committee, it will continue to happen. You know, there was, perhaps it's dissipated a little now, some belief that their assets need to be sold before year-end tax law changes. Perhaps that's dissipated a little with the results to date on the election.

16:36 But again, the pipeline is reflective of the same kind of filters we've always used for what gets onto the pipeline. It's just expanded because there are more assets in the market. Thanks, everyone. Thank you, Manny. Thanks, Manny. Our next question is from Sheila McGrath with Evercore.

16:56 Yes, good morning. Ben, the new acquisition guidance implies a very active fourth quarter, maybe even a record for SAG. Can you give us some insights? Do you have additional assets under contract right now? And then also you guided on the cap rate a little lower, and I'm wondering if that's cap rate compression in the market, or is that the mix of assets you're acquiring?

17:21 So as Bill alluded to during our prepared remarks, we have $200-plus million under contract for LOI, and we're still evaluating assets that might close this year, reflective of the increased pipeline, number of assets came to market, et cetera. So we indeed are looking at a fourth quarter that could be the same as last year's fourth quarter, even larger. It depends on... and how assets shake out in terms of whether things close. Not having the contract always closes, certainly letter of intent doesn't always close, but we have a high degree of probability that we'll get into those kinds of volumes. The cap rates have moved south a little bit, but they moved south because of mixed change.

18:06 Longer leases, less CapEx, in particular when we buy, you know, build-to-sue transactions. You know, these are very clean from a capital-required perspective. the longer lease terms, etc. So the one thing I will say is that we've maintained our goal on buying accretive transactions and indeed these transactions are again demonstrably accretive on both core FFO and CAD basis.

18:33 Okay, and sorry if I missed this, but you did increase your disposition guidance. What kind of assets are you selling and what's the motivation for increasing the sales right now?

18:45 I'm going to let Bill handle this. The increase in disposition guidance relates to one asset that we were not expecting to sell, but we got a reverse inquiry on, and that asset will be an accretive redeployment of proceeds once we sell that and redeploy it. So it's an attractive return for us, and that's the primary reason why we increased disposition proceeds for the fourth quarter.

19:09 Yeah, Sheila, as you know, we have three reasons to sell assets. One is opportunistically, which this is Bill just referring to as reflective of. Two is sort of the culling of the herd, our ongoing sale of our relatively de minimis office flex portfolio. I don't believe we have any assets that will be in the remainder of 2020 that will fall into that bucket. And the last bucket is when we aren't happy with our cost of capital from regular common or preferred equity issuance, we would sell assets. None of that is planned. Obviously, capital is attractive. The other sources of capital are attractive today.

19:45 Okay, great. Thank you.

19:47 Thank you, Sheila. Our next question is from James Feldman with Bank of America.

19:54 Hi, good morning. This is Elvis Rodriguez on for Jamie. Just as we think about funding the acquisition pipeline and some of the equity forward you have, you know, your stock today is trading about a dollar above where you did that deal in January. How are you thinking about pulling down that equity this year versus potentially doing another equity deal to fund the $2.8 billion pipeline that you have laid out for us?

20:25 Yeah, Elvis, obviously the pipeline, historically we've bought something A relatively small portion of what's on that pipeline actually gets closed. The pipeline is dynamic, so assets come on and off it all the time. But we're certainly not expected to close anything like that large number. I'm sorry, I just lost my way.

20:47 Hey Elvis, it's Bill. In terms of where we are from a leverage standpoint, as I noted with our forward equity proceeds, we're at four times leverage, so sufficient runway there. to get to our five and a quarter leverage range this year. As we noted in our investor presentation, our long-term leverage range is 475 to six times. So if you were to look at where we are today, including subsequent acquisitions and the forward equity, we could acquire $850 million with all debt to get to the upper end of that long-term leverage range.

21:18 So we have sufficient capacity here. In regards to taking down the forward equity component, we have until, I think, mid-January to do that. Obviously, given the amount of acquisitions, et cetera, you could surmise that we will be using that equity. That's right.

21:35 Okay. Well, my question was, would you do another deal in lieu of that deal, given your stock is $1 higher today? Okay.

21:44 Yeah, I'm sorry if we didn't answer that question. I think they're not necessarily related. We have attractive capital available to us, and we have capital needs that we can deploy accretively. So it's not either or. I think, as I said, it's highly likely we would exercise, take down that equity, but that doesn't mean that we won't have additional equity needs that we will approach the market on.

22:08 Appreciate that. And then just one more question. 21 expirations, you have about 9 million square feet of leases expiring next year. Any chance you can share what the mark to market on those leases are?

22:22 I think that we, you know, what we've said before is that we believe our assets are at or slightly below market. I think as we've looked granularly at 2021, we believe that to be the case for 2021 also. for those asked in particular. The other thing I would say is there's nothing very bulky in 2021. The two million square footers we had rolled this year, we don't have anything like that in 2021. Okay.

22:47 That's very helpful. Thanks, guys. Great quarter.

22:50 Thanks, Elvis. Our next question is from Brendan Finn with Wells Fargo.

22:58 Hey, guys. Good morning. The term on new leasing this quarter was only like three and a half years, which looked like it was the lowest since 2017. Was that impacted by those same leases you guys mentioned in the prepared remarks that had an impact on leasing spreads, or are you guys seeing shorter lease term just across the board?

23:23 Well, I'm going to give this to Bill to answer, but I mean, generally speaking, lease renewals tend to be three to five years, so in long-run trends, that's not an unusual number, but I'll turn to Bill.

23:33 Yeah, hey, Brendan, that was driven by really one lease, and that was one of the leases that rolled down. This was a lease that we signed for a little over one year with the expectation that we can negotiate with the tenant for a longer-term lease. and the first year lease was, call it a teaser rate, it rolled down 18% but we expect markets to roll back up about 12% in a year. So it's a little nuanced with the way it gets accounted for but it was a little over a one year lease which drove the weighted average lease term when the lease is down a bit.

24:11 And I'll get the, Brendan, I get these, one of my favorite terms, a small sample anomaly.

24:17 Sounds good, guys. And then I just wanted to clarify your comments on your plan for the GSA facility. So are you planning to lease that first and then sell it, or would you be open to selling it before signing a lease there? And then similarly, are you looking to potentially sell the 48 adjacent land once you get the entitlements for development there, or are you Thank you, guys.

25:16 It's an attractive collection of opportunities between the existing building and the development potential. There's even people who are looking at buying the existing building, scraping it, and building a new building. We think you could put close to a million and a half square feet, I think, on there in a brand new building. And although We bought an existing structure. The value of the land in that very attractive sub-market has gotten to the point where the land value may be as much as the existing building and the development potential. It's a collection of very attractive opportunities. As a reminder to the audience, if you'd like to ask a question, please press star 1. Our next question is from John Masoka with Leidenberg-Dolman.

26:03 Good morning. Good morning. So if you look at the transactions that close kind of subsequent quarter end, they seem to be, if you kind of just divide the gross numbers by the amount of assets you've closed on, it seems a little bit larger in both in terms of square footage and in kind of cost per asset. I mean, is there some larger assets in there that are maybe skewing that, or is it just, you know, slightly larger assets all around that you're buying? in October and November.

26:32 Yeah, John, I'm going to give that to Bill. The answer is yes, larger assets, but Bill will give you some detail.

26:38 Yeah, that's right. I mean, John, it's simple math there, but there's a mix, and these are assets that meet our long-term investment thresholds. As with every year, there's smaller assets and larger assets that we acquire. I mean, even looking at this quarter, we acquired at Small of an asset of 50,000 square feet and as large as 276, but subsequent to quarter end, there certainly are some larger assets in there.

27:04 I mean, I guess it's kind of an arbitrary number, but I guess there's some million square footers that are kind of skewing those numbers in there.

27:11 Not million square footers, but big buildings.

27:15 Okay. Understood. Okay. And then maybe as we think about kind of the deferrals and the kind of non-cash payments, that 1.5%, how is that maybe broken out between people who are just having either a negotiation or haven't been able to have a negotiation and tenants that are currently in default? Or not in default, but in bankruptcy.

27:37 It's tenants that have been impacted by the pandemic. I mean, they're not in bankruptcy. But we're having discussions with them. Some of them, we're having discussions about potentially a deferment or a payment schedule. Others, we're just working with them to understand their situation. So it's just a mix of assets. I will say, and as we said before, all of this is reflected in our credit loss guidance for the year. So I think when you take a step back, that's the area you should focus on is what's in our same store, what's our credit loss guidance, what's our referral guidance. It's all factored into that. and given, you know, call it six, seven weeks left in the year, we feel really confident with our guidance we put forth.

28:17 I know I'm asking a bit for kind of early 2021 guidance, but do you think that kind of credit loss outlook flows into next year or do you think you can get some recovery on those smaller amounts?

28:27 Yeah, as Ben said, we'll give our guidance in February for 2021. I will say the stimulus has been probably the biggest thing we struggle to estimate and how that impacts our tenants and Thus far, it's been outperforming our estimates in terms of the recovery. As you can see with the guidance this year, our credit loss guidance has continued to come down as we move through the year.

28:50 Okay. Understood. And then on the investment front, how do you think maybe a potential kind of surge here in pandemic could impact the ability to close deals in either 4Q or maybe even 1Q21 Just given what happened earlier in the year in terms of deal volume with kind of the first phase of the pandemic.

29:11 So the impact on deal volume earlier was not maybe for a very short period of time was reflective of the fact that we couldn't get people out to see buildings or were here, and I think the closing process was impacted by that. We have been able to, utilizing trusted third parties, some level of travel, Google Maps, whatever else, and third-party consultants, obviously, to get a closing process that I believe is pretty resilient to whatever happens with the pandemic, short of a total lockdown, which I don't think anybody really expects at this point. So we're feeling very good about our ability to transact. Again, people have gotten used to operating, and particularly we have gotten used to operating in this environment. So we're feeling pretty good about our ability to transact going forward. And the sellers are, you know, the initial drawback from operating assets to the market certainly has dissipated or disappeared completely.

30:13 Understood. That's it for me. Thank you all very much. Thank you, John. Thanks, John. Ladies and gentlemen, we have reached the end of the question and answer session. I would like to turn the call back to Ben Butcher for closing remarks.

30:26 Thank you all for joining us this morning. You know, the word unprecedented gets used a lot, but certainly we are in unprecedented times generally. I think that the, as I just stated, our ability to operate here has been demonstrated. The opportunities abound. The short-term Millais that may affect the country as we work through the end of this election. I believe it will be just that short term. We don't expect that to have any long-term impact on our business and hopefully no long-term impact on our country. Again, we thank you for your time this morning and look forward to continuing to provide good results for our shareholders. This concludes today's conference. Stack International thanks you for your participation.

31:12 You may disconnect your lines at this time.