2023-04-24 10:41:33 ET
Summary
- First Industrial's exposure to strong infill markets, such as Southern California, is continuing to provide favorable operational tailwinds.
- Positive lease-up progress in their sizeable development pipeline is further encouraging, especially considering the speculative nature of new developments.
- Recently released results show that the company is off to a strong start in 2023, with record quarterly cash spreads and positive revisions higher in guidance.
- Despite the positives, I view shares as fairly valued at current pricing due to their valuation and performance in relation to their peer set. I also continue to view their speculative development pipeline with caution.
First Industrial Realty Trust ( FR ) is off to a strong start in fiscal 2023. The company turned in quarterly results that included record cash spreads and positive revisions to guidance, as well positive updates on their sizeable development pipeline.
The company’s industrial exposure to supply-constrained infill markets, such as Southern California, which represents over 20% of their total revenues, continues to be a tailwind that is enabling them to drive rents while holding occupancy at nearly 100% levels.
Over the past six months, shares have tracked most of their peers, up about 18.5% during this period.
Seeking Alpha - 6-Mth Returns Of FR Compared To Peers
And though they are still down nearly 18% over the past one year, they’ve still outperformed their peer set.
Seeking Alpha - 1-Yr Returns Of FR Compared To Peers
The outperformance over the past year, along with their current trading multiple, lead me to conclude that shares are fairly valued, at present. While results and forward guidance are both largely positive, their speculative development pipeline is a key sticking point that I believe warrants a pause on new or further initiation. And most recently, development spreads have pulled back due to cap rate expansion, creating another risk to the pipeline, in addition to the threat of new incoming supply. Given these considerations, I am maintaining a “hold” view on shares of FR.
Record Quarterly Cash Rent Spreads On Still-High Occupancy Levels
Occupancy at the end of the first quarter came in at 98.7%. Though this was down slightly on a sequential basis, it was still up 70 basis points (“bps”) compared to the same period last year. In addition, tenant retention held at a healthy 63%.
During the quarter, 4M SF of leases commenced. About 60% of this activity was related to renewals. And 7.5% was related to developments and acquisitions with lease up.
FR realized cash rent spreads of 58.3% for leases commencing in Q1, a new quarterly record. And looking ahead, 63% of their 2023 lease expirations are locked in at a cash rental increase of 56%. For their remaining expirations, management is expecting spreads on new and renewal leasing to be 50% at the midpoint. This would be up 5% from the midpoint provided on their prior quarter’s release.
Positive Lease-Up Progress On New Developments
Within their development pipeline , the company made lease-up progress on several projects. They signed full building leases on two projects in their Southern Florida and Eastern Pennsylvania markets, and, in addition, they are also at around 50% leasing at two other properties in their Seattle and Orlando markets.
During the quarter, the company had one development start in their Philadelphia metro market, situated just 12 miles from the Philadelphia Airport. This project is expected to have a total estimated investment of +$61M and a projected cash yield of 6.8%.
Including this project, the company had total developments of +$569M. In aggregate, the projects are 12% leased and are expected to have an overall development margin of 65%.
Q1FY23 Investor Supplement - Summary Of FR's Development Pipeline
Looking ahead their balance sheet has the capacity to support an additional +$2.1B in potential new investment.
Additional Incremental Revenue Source
Camelback 303 is a +$1.5B global logistics park being developed via joint venture near Phoenix, AZ, where FR owns a 43% interest. During the quarter, FR sold a share of their land held within the venture for a total sales price of +$50M.
In conjunction with the sale, the venture provided the buyer the option to purchase an additional 71 acres within the next two years, after having already purchased 31 acres. As part of the agreement, the buyer is required to lease the ground for up to two years. At share, this provides FR an additional +$200K/MTH in rent.
The expected uplift on earnings from the additional rental income is about $0.02/share. Assuming the buyer exercises their right to purchase the land, the company would lose the earnings tailwind from the income.
Offsetting this loss, however, would be the net gain proceeds and the distribution from the joint venture, which could be used to pay down their line of credit, thereby reducing their future interest burden. The net effects, then, of any exercise in an early purchase, is likely to be muted.
Positive Revisions To Guidance
Overall funds from operations (“FFO”) during the quarter landed at $0.59/share. This was up about 11% from the same period last year.
Same-store net operating income (“NOI”), excluding termination fees, was up 8.1%, driven primarily by increases in rent, embedded escalators, and higher average occupancy.
Looking ahead , management sees 2023 FFO coming in at a midpoint of $2.38/share. This would be a $0.04/share increase at the midpoint from their previously released guidance.
Driving the increased expectations is recent leasing performance, as well as the additional funds the company is expected to receive from a new ground lease agreement signed during the quarter via their joint venture. This is expected to add about $0.02/share to FFO.
In-service occupancy is expected to be up slightly to 98.3% at the midpoint. And same-store NOI, excluding termination fees, is expected to be up 8.25% at the midpoint. This would be 25bps greater than what had been forecasted in their prior earnings call.
Q1FY23 Investor Supplement - Summary Of Full Year 2023 Guidance
Final Thoughts
FR is continuing to see broad-based sector demand, and management sees overall activity as characteristic of the 2018/2019 fiscal years, which would be a normalization from the peak levels experienced during the COVID period but still impressive relative to historical averages.
Within the near-term, a significant amount of new space is expected to come online. Within their markets, management sees about 400M to 450M SF of new building supply.
While the supply is not all speculative, as they are about 20-25% pre-leased, it will still bump up the overall vacancy rate in their markets, at least in the near-term.
New starts, however, are falling off due to the funding environment. This should provide a counteracting balance to the supply dynamics for the back half of 2023 and into 2024.
Rising supply is a risk that impacts FR more so than other industrials due to their sizeable pipeline of speculative developments. If the market turns for the worse, the company could be stuck with sizeable losses on projects that fail to lease-up.
Despite the speculative nature of their projects, however, FR is still successfully leasing up newly completed properties. Several projects, for example, were 0% leased at the end of 2022, yet are now either fully leased or at a leased rate of around 50%. While the expected timeframe for lease-up has increased to about twelve months from six previously, the demand environment still appears robust.
An expansion in cap rates, however, has taken a bite out of their profit margins. On a YOY basis, cap rates are up about 125bps. And sequentially, they are up 25bps. In the prior quarter, the company’s expected development margin was in the upper 70s.
But that has since fallen to the mid-60s. Part of this is due to their newly initiated development near Philadelphia’s Airport, which is expected to generate margins of about 65%.
While the margins are expected to be lower, full year guidance was still revised higher on both leasing and rental growth strength. The company is also sitting on near-full occupancy levels and low vacancy rates.
At 22x forward FFO, however, I view shares as fairly valued in this market environment. Larger sized peer, Prologis ( PLD ), trades at a similar multiple, and I would prefer to direct competitive investment dollars to PLD than FR. PLD’s development pipeline, for example, is more diversified. FRs, on the other hand, is principally speculative, which I view as a key risk, especially if the market were to make an unexpected turn for the worse. As such, consistent with my prior views on the stock, I maintain a neutral view on FR.
For further details see:
First Industrial: Positive Developments And Forward Guidance But Shares Appear Fairly Valued