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Industrial Logistics Properties Trust (NASDAQ:ILPT)
Q2 2019 Earnings Call
Jul 30, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning and welcome to the Industrial Logistics Properties Trust, Second Quarter 2019 Financial Results, Conference Call. [Operator instructions]. I would now like to turn the conference over to Olivia Snyder, Manager of Investor Relations. Please go ahead.

Olivia Snyder -- Manager Investor Relations

Thank you and good morning, everyone. Thanks for joining us today. With me on the call is ILPT's President John Murray, Chief Financial Officer Rick Siedel and Vice President Yael Duffy. In just a moment, they'll provide details about our business and our performance for the second quarter of 2019, followed by a question and answer session with analysts.

First, I would like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the Company. Also, note that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on ILPT's beliefs and expectations as of today Tuesday, July 30, 2019, and actual results may differ materially from those that we project.

The Company undertakes no obligation to revise or publicly released the results of any revision to the forward-looking statements made in today's conference call. Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission or SEC, which can be accessed from our website ilptreit.com or the SEC's website..

Investors are cautioned not to place undue reliance upon any forward-looking statements. In addition, we will be discussing non-GAAP numbers during this call, including normalized funds from operations or normalized FFO and cash-based net operating income or cash-basis MOI. A reconciliation of these non-GAAP figures to net income and the components to calculate cash available for distribution or CAD are available in our supplemental operating and financial data package, which also can be found on our website. And now I will turn the call over to John.

John Murray -- President and Chief Executive Officer

Thank you, Olivia. Good morning, everyone, and welcome to ILPT's second-quarter earnings call. This morning, we reported second-quarter normalized FFO of $29.8 million or $0.46 per share. As of the end of the second-quarter ILPT's portfolio consisted of 298, primarily warehouse and distribution properties with 42.4 million square feet, located in 30 states. They were 99.3% occupied. Approximately 41% of ILPT's annualized rental revenues come from 16.8 million square feet of industrial properties located on the island of Oahu, in Hawaii.

Our Mainland portfolio consists of 72 properties, with 25.6 million square feet located in 29 states that are 100% leased. During the quarter, we focused on integrating our 2019 acquisitions into our existing portfolio operations and maintaining a strong leasing activity. As discussed on prior calls, during the first half of the year, we acquired two portfolios for approximately $905 million. The 28 properties containing 12.9 million square feet have been integrated into our portfolio with the expertise and support of the RMR Group's National Platform of Real Estate Professionals in more than 30 offices across the country.

Our top three tenants are Amazon, FedEx and Procter and Gamble, representing 14.6%, 4% and 3.8% total annualized rental revenues respectively. Investment-grade rated tenants or subsidiaries of investment-grade rated tenant entities make up 62% of our Mainland revenues. Looking at the entire portfolio, nearly three quarters of revenues come from those investment-grade tenants or subsidiaries or from our secure Hawaii land leases. Our top three markets after Hawaii at 41% are Indiana, Ohio and Virginia representing 10%, 8.2% and 5.2% of our total annualized rental revenues, respectively.

A quarterly dividend of $0.33 per share continued to be well covered with a payout ratio of 71.7%. On prior calls, we discussed the possibility of raising our dividend following the closing of the two portfolio acquisitions. ILPT's Board considers many factors when setting dividend rates, including peer evaluation and investor feedback. Our current dividend yield is nearly twice the industrial peer group average. Our share price suggests that we are not getting credit for the high and well-covered yield and the Board questioned whether bringing yield higher will draw more investors to the stock or scoop them. We also know there is investor concern about leverage levels and the possible equity issues. Considering these and other factors our Board decided to maintain the current dividend level rather than raising our dividend this quarter and to use increased cash flow from our acquisitions to reduce leverage. As we have said previously, we will not issue common equity at current share price levels.

Before I turn over the call to Yael to discuss our leasing activity, I'll quickly mention that earlier this month the Governor of Hawaii vetoed legislation that would have disallowed the dividend pay deduction on income taxes for REITs. This is an important win for Hawaii, ILPT and other REITs doing business in the state, as it will continue to provide stable growth through job creation and economic development.

Analyst -- President and Chief Executive Officer

Thanks, John. During the second quarter, leasing activity was focused within our Hawaii portfolio. We entered new and renewal leases for approximately 359,000 square feet at rent that were 27.5% higher than prior rents for an average lease term of 11years. Leasing capital and concessions for new and renewal leases were approximately $0.12 per square foot per lease-year. There were no rent resets in the second quarter.

Now to highlight a few positive leasing transactions. In Q2, we negotiated an early termination of a lease with a local beverage company ahead of its contractual lease expiration. At the same time, we were able to sign a 15-year lease with FedEx at a nearly 25% blow up in rent. We are pleased with the upgrade in tenant credit and our ability to release the property with no downtime.

Turning to the slight decrease in same-store occupancy. In April we negotiated a lease termination with a tenant in default, while at quarter-end we show a temporary decrease in occupancy. The property was released to a new tenant in July with rents that are 13.5% higher than the prior tenant's contractual rent. These transactions illustrate that while small businesses in Hawaii may occasionally fail, the strong demand for our Hawaii products has historically allowed us to release the parcels within a short period of time and increase rental rates.

Also in Q2, we signed a new space lease for our property that had been previously ground leased, while this resulted in our reported total lease square footage decreasing by approximately 80,000 square feet, the rent we will receive is nearly 90 % higher than previous rent for this parcel. On the Mainland we have no significant near-term lease expirations with only 10 basis points of total annualized rents expiring over the remainder of 2019 and 1% expiring by the end of 2020. In Hawaii, one lease for approximately 1.2 million square feet, for $1.9 million of annualized rent is scheduled to reset in 2019. Our leasing team, has begun discussions with the tenant and we expect to have further clarity in the coming months.

The industrial market continues to display strong fundamentals nationally as industrial sector jobs maintain their steady upward trend in industrials zone land continues to increase in value. On the Mainland market vacancy rates remain near historical lows of 5%, while Hawaii is even stronger, with a vacancy rate of just 2%.

Specifically in Hawaii, with high construction costs and the scarcity of developable land, we expect demand for our products to remain high.

I'll now turn the call over to Rick to provide details on this quarter's financial results.

Richard Siedel -- CFO

Thanks Yael. And good morning, everyone. Normalized FFO for the second quarter of 2019 was $29.8 million or $0.46 per share, up from $0.39 per share for the second quarter of 2018. Adjusted EBITDA for the quarter was $44.2 million, up 30% from last quarter and 50% year-over-year.

Total rental income for the second quarter of 2019 increased by $21 million to $60 million representing a 52% increase over prior year results. This increase primarily reflects our acquisition activity, as well as increases from leasing, rent resets and real estate tax expense reimbursement. This quarter also included a $0.5 million of rental income related to the elimination of a below-market lease obligation following the termination of a lease that was in place when we acquired the property back in 2003.

Total portfolio, same-property cash basis in Hawaii increased by 2.6% over the prior year. Hawaii same property cash basis NOI increased by 3.2% over the prior year, reflecting increases in rents from new leasing and resets.

Mainland same property cash basis NOI increased by 1.8% over the prior year, primarily reflecting contractual rent steps in our leases and some recovery of expenses at certain properties that tenants had previously disputed.

General and administrative expense for the second quarter totaled $4.9 million and depreciation expense was $16.7 million. The increase in both expenses primarily reflects our acquisition activity, since last year.

Interest expense increased by $10.4 million to $13.9 million primarily due to a full quarter of expense on our $650 million mortgage loan that was obtained in January of 2018, as well as balance and interest rate increases on our revolving credit facility, at rates of 4.3% and 7.3% respectively, both providing attractive sources of low-cost capital to fund our external growth.

Our recurring capital expenditures for the quarter totaled $2.1 million. The majority of these expenditures were building improvements from the Mainland, including parking lots, building facades and sprinkler and roof upgrades. Our redevelopment capital expenditures of $2.6 million related to the building expansion in Iowa discussed on previous calls.

We finished the quarter with $608 million outstanding on our revolver resulting in debt-to-adjusted EBITDA of 7.6 times.

We were opportunistic with the two portfolios we acquired, but slightly exceeded our long-term target leverage. As mentioned last quarter, we remain comfortable operating the business at this level due to our stable, predictable and growing cash flows and the well covered dividend.

Over time, we expect to have a fair amount of cash flows from our portfolio to organically reduce leverage reaching mid-six times in the coming years. However, in light of investor feedback and the appreciation in value across our portfolio, we have discussed several capital recycling strategies, including taking on a new partner, and we will keep you updated on any developments in the future.

We want to reiterate that we will not raise common equity at our current share price.

That concludes our prepared remarks. Operator, we are now ready to take questions.

Questions and Answers:

Operator

We will now begin the question-and-answer session. [Operator instructions]. At this time, we will pause momentarily to assemble our roster. The first question comes from Bryan Maher of B. Reilly FBR. Please go ahead.

Bryan Maher -- B. Riley FBR -- Analyst

Good morning, guys. And John, thanks for that information on the leverage and the dividend thought process from the Board. That's helpful. But when we think about the leverage and the fact that most of the RMR REITs have stayed in that 40% to 50% leverage area and have maintained investment grade ratings, what's the thought process on ILPT of being above that? And what's the view on an investment grade rating over the long-term?

Richard Siedel -- CFO

Hey, Brian, this is Rick. The one thing I would just point out, that leverage metric that you mentioned kind of net debt-to-total gross assets does look a little high at 53% compared to some of our other REITs. But it is important to remember just how low our basis in these assets is. If you were to adjust just our Hawaiian assets, that would put the financing on up to the $1.4 billion of fair value that's there. That ratio drops down to high 30% or about 40%. So it's really not out-of-line with peers or some of our other REITs, but that metric does look a little higher. From a debt-to-EBITDA perspective, we are a little higher than our long-term target. But again, we are comfortable given the stability and strength of our portfolio and we do have the ability to bring that down organically over time if we're patient and just let the portfolio generate cash and run. But again, as John mentioned, due to some of the investor feedback, we may take some steps to move a little faster on that. Looking at various capital recycling strategies and things like that would help us achieve our target faster. But overall, we're very comfortable where it is.

Bryan Maher -- B. Riley FBR -- Analyst

And the thought process on the investment grade rating over the longer-term. I mean, given that RMR typically had that with the REITs, what's the thought process ILPT?

Richard Siedel -- CFO

I think when we did the secured financing on Hawaii, our rationale was that it was an attractively priced source of capital before we had finished the seasoning process for ILPT, the new company. It was less than a year old at that point and just determined that we were able to get better pricing using other sources of capital.

John Murray -- President and Chief Executive Officer

I think -- longer term I think we'd like to eventually get an investment grade credit rating like some of the other RMR REITs because it allows you to access the very deep capital market and to do so pretty quickly. And it makes it a lot easier to say you have no financing contingencies when you're making offers for properties.

But I think we have a pretty good reputation for being able to raise capital. So that isn't a huge concern for us, and so there's no specific timeline. You know, we're not trying to get there 2021 or 2022 necessarily, we're more interested in growing our portfolio with high-quality properties, maintaining reasonably conservative leverage levels.

As Rick pointed out, some of the metrics that people quote are a little bit disconnected because some of the -- there's valuation issues within the portfolio that may under-appreciate it. So, we're comfortable for the next several years at least to be primarily secured debt and not as focused on an investment grade credit rating.

Bryan Maher -- B. Riley FBR -- Analyst

Okay. That's helpful. And then given how strong your activity was in the first half of the year -- maybe this question is for Rick to a degree, what is your availability currently for new acquisitions? And then, maybe for John, what would you need to see in the marketplace for attractive industrial assets on a cap rate basis to actually pull the trigger on more acquisitions this year?

Richard Siedel -- CFO

So to start with my piece, Bryan. This is Rick, I guess, I don't think that the financing is necessarily a problem. Again, I think we've got a longer-term leverage target, but I think we've remained opportunistic and we are still have $150 million or so capacity under our revolver today and still have plenty of room under our covenant. So I think the question really falls more squarely to John.

John Murray -- President and Chief Executive Officer

All right. Well, when we're looking for reasonably new high-quality properties that are well-located, and so from a cap rate basis, it's as you know, it's very competitive, we've seen some large portfolio transactions announced in the last -- during the last quarter that have been in cap rates, I think 4% to 5% range, I don't expect to see ILPT purchasing properties at that price point. You'll see us transacting, if we transact on other acquisitions in the near-term, they would be in high-fives, low-sixes, if we can identify properties that are high-quality that are available at that price level.

Bryan Maher -- B. Riley FBR -- Analyst

Okay, thank you.

Operator

The next question comes from Michael Carroll of RBC Capital Markets. Please go ahead.

Michael Carroll -- RBC Capital Markets -- Analyst

Yeah, thanks. I guess, off of that last question, John, can you talk a little bit about your desire to deploy capital, given where your leverage is right now? Would you go out and acquire assets or would you want to kind of stay pat until you can put leverage closer to your long-term target?

John Murray -- President and Chief Executive Officer

Our primary focus is on managing the existing portfolio, asset managing it and bringing leverage down. As Rick said, we do have a small amount of capacity, if the right transaction came along and wasn't -- was bite size, we might take advantage of the opportunity. But we're not focusing on acquisitions currently, we're focused on asset managing our existing portfolio and reducing leverage.

Michael Carroll -- RBC Capital Markets -- Analyst

Okay and then can you talk a little bit about your goals to reduce those leverage metrics? I mean, are you happy just letting it trend a little bit lower by retaining cash flow or do you want to do something bigger, such as a joint venture with some of your Mainland assets to accelerate that reduction?

John Murray -- President and Chief Executive Officer

Well, I think we're willing to allow leverage to drift down organically. However, there are lot of opportunities in the marketplace. And if we follow that route, we'd be probably have limited acquisition and limited growth for a couple of years. And so, I think while we're pursuing that path, we're also pursuing other strategic opportunities, considering them and including joint ventures. And we've done joint ventures and other RMR managed REITs. And I think we could do something similar here with a select group of our Mainland assets to show how they've increased in value in the short period time, since we've owned them and have that be an effective way to provide new capital into ILPT to continue to grow.

Michael Carroll -- RBC Capital Markets -- Analyst

Is it fair to assume that a joint venture transaction is likely in the horizon over the next 6 to 12 months? Or is that still on the table and you're still debating on what to do there?

John Murray -- President and Chief Executive Officer

I think it's reasonable to expect within the next 12 months that we might announce a transaction like that or -- yeah, I think that's -- it may not happen but we are talking to-we are talking about it and it may happen.

Michael Carroll -- RBC Capital Markets -- Analyst

Okay. And then, just lastly on the dividend, I know if you can provide us some insights on what the Board is thinking, I mean, is it fair to assume that the dividend is going to stay at this current level if the stock price stays in the low $20 range? Or is that something going to change as you improve leverage and you still have that healthy payout ratio, would you think about increasing the dividend over the next several quarters?

John Murray -- President and Chief Executive Officer

I think our board meets, you know, five or six times a year on a regular course and at every one of the meetings, we discuss the dividend. And so, I definitely would not rule out that we might increase the dividend. I think if we're organically lowering leverage and the share price is in the vicinity of where it is today, it's more likely that the dividend rate would remain flat. And if we do other transactions that bring in new capital and if the share price reacts favorably to any of the things that we've done, I think that increases the likelihood that the Board would be more open to the idea of a dividend increase. We certainly have very secure, predictable cash flows and we certainly have a very safe payout ratios. So the ability to raise the dividend if we wanted to do so, is there. It's just that the Board feels like there's a message being sent -- leverage reduction is more important than a dividend increase since our dividend is so high relative to our peers.

Michael Carroll -- RBC Capital Markets -- Analyst

All right. Thank you.

Operator

The next question comes from Mitch Germain of GMP Securities. Please go ahead.

Mitch Germain -- managing director

Rick, appreciate your thoughts on the dividend and then leverage, if you just organically try to reduce debt-to-EBITDA to targeted levels, how many quarters, how long would it take us to get to where your target is, assuming you don't pursue any sort of JV or asset sales?

Richard Siedel -- CFO

Sure. So I guess one of the things that might be helpful to remember is that over 40% of our Hawaiian revenue either rolls or resets the market through 2023. So I think when I say the next few years, that's kind of the horizon and that would take us down to mid six times without doing anything else in the portfolio. So again, it's longer-term than I think some of us are willing to wait. But we are talking about some other capital recycling strategies to do something sooner. So it is a little bit longer than we expected, just because as the portfolio is growing it takes a little bit more to move the needle.

Mitch Germain -- JMP Securities -- Managing Director

Great. And just with regards to a potential JV your discussion has always been regarding Mainland properties, correct?

Richard Siedel -- CFO

That is more likely. I think we've already kind of demonstrated the value of our Hawaiian portfolio through the financing and getting that appraisal and things like that out there. Also, our Hawaii industrial land is somewhat irreplaceable, real estate like that doesn't come along every day. We also I think, you know, a lot of the investors we meet with understand the value of our Hawaiian properties and are -- there's probably more confusion on the Mainland assets. And I think we might have an opportunity to show just how opportunistic our recent acquisitions were, if we were to take a handful or select number of those properties and demonstrate that we got a good deal on them.

Mitch Germain -- JMP Securities -- Managing Director

Excellent. Thank you.

Operator

The next question comes from Alexander Pernokas of Bank of America Merrill Lynch. Please go ahead.

Alexander Pernokas -- Bank of America Merrill Lynch -- Analyst

Hi, again. I was just wondering if you could give me a better picture of your NOI breakdown, as we move forward between Mainland and Hawaii, and are there any new sub-markets or markets that you're looking to expand into through these acquisitions?

John Murray -- President and Chief Executive Officer

Currently about, just a little over 40 % of our revenues come from Hawaii and about right around 60% come from the Mainland. There is limited amount of industrial land in Hawaii. And what's there transacts very infrequently. So I think the expectation should be that the vast majority of our growth going forward will be on the Mainland and not in Hawaii. We'll try when we see opportunities in Hawaii -- we've had very good experience there and we'd love to own more property there. But it's -- those opportunities are few and far between and generally very expensive because of that value. So we'd be focused on the Mainland. You know, over time we'd like to -- we target top 25 markets. We try to target properties that are new. We may try to increase our concentration along the coast. Again, property is more expensive in some of those coastal markets. So a lot of the recent acquisitions have been in Indiana, Ohio markets like that, more in the central part of the United States, but still top 25 markets predominantly.

Operator

And the next question is a follow up from Mitch Germain of JMP Securities. Please go ahead.

Mitch Germain -- JMP Securities -- Managing Director

Yeah. Quick question on the rent resets. Is it a safe assumption that over time the number of leases scheduled for reset will decline to more traditional lease structure?

Richard Siedel -- CFO

Mitch, we have said that oftentimes we'll be opportunistic and if we can negotiate, converting a reset into a normal lease with rent steps, we've been more likely to do that. So we have seen the number of resets in the portfolio decrease. That's partly for the tenants, so that they're not shocked with a giant increase one year and it also helps us as we look to reduce our leverage and increase our cash in Hawaii year after year.

It's been a little bit more palatable that way. We generally do try to make sure that we do see stable growth over the period. But I don't think there's anything particularly interesting changing with the resets that we're currently working on.

Mitch Germain -- JMP Securities -- Managing Director

Thank you.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to John Murray, President and Chief Executive Officer, for any closing remarks.

John Murray -- President and Chief Executive Officer

Thank you, everyone, for joining us on today's call. Have a great rest of the summer.

Operator

[Operator Closing Remarks]

Duration: 29 minutes

Call participants:

Olivia Snyder -- Manager Investor Relations

John Murray -- President and Chief Executive Officer

Richard Siedel -- CFO

Mitch Germain -- managing director

Analyst

Bryan Maher -- B. Riley FBR -- Analyst

Michael Carroll -- RBC Capital Markets -- Analyst

Mitch Germain -- JMP Securities -- Managing Director

Alexander Pernokas -- Bank of America Merrill Lynch -- Analyst

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