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First Industrial Realty Trust Inc (NYSE:FR)
Q3 2020 Earnings Call
Oct 22, 2020, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the First Industrial Q3 Results Call. [Operator Instructions]

I would now like to hand the conference over to your speaker today, Art Harmon, Vice President, Investor Relations and Marketing. Thank you. Please go ahead.

Arthur Harmon -- Vice President-Investor Relations and Marketing

Thanks a lot, Chris. Hello, everybody, and welcome to our call. Before we discuss our third quarter 2020 results and updated 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, Thursday, October 22, 2020. 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 earnings release and our SEC filings are available at firstindustrial.com under the Investors tab. Our call will begin with remarks by Peter Baccile, our President and Chief Executive Officer; and Scott Musil, our Chief Financial Officer, after which we'll open it up for your questions. Also on the call today are Jojo Yap, our Chief Investment Officer; Peter Schultz, Executive Vice President; Chris Schneider, Senior Vice President of Operations; and Bob Walter, Senior Vice President of Capital Markets and Asset Management.

Now, let me turn the call over to Peter.

Peter E. Baccile -- President and Chief Executive Officer

Thanks, Art, and thank you all for joining us today. We hope each of you and your loved ones are doing well, staying healthy and productive. I would like to once again thank the entire FR team for all of their efforts over the past seven months while navigating the pandemic to maximize collections and achieve our leasing, investment, operating and capital markets objectives. In the third quarter and fourth quarter-to-date, the industrial market has experienced an increased level of leasing activity, with e-commerce leading the way and other broad-based industries represented among new lease signings. In its preliminary third quarter report, CBRE reported 56 million square feet of net absorption versus 68 million square feet of completions.

I'll discuss what this pickup in business activity means for our upcoming speculative development efforts in a moment. But first, let me briefly touch on cash rental collections. Our results continue to be very strong, reflecting the quality of our tenant base and portfolio as well as the great work of our team. For the second and third quarter, we've collected 99% of monthly rental billings and all nine of our remaining rent deferral agreements are current. Scott will walk you through collections and our third quarter bad debt expense in more detail later. I would like to highlight several key leasing solutions executed by our team in Southern California. We successfully replaced the largest tenant on our watch list at a 225,000 square-foot building in the Inland Empire.

By executing the new lease at current market rents, we captured a 27% rental rate increase. In other major leasing wins, the Southern California region executed on a comprehensive plan to replace three tenants in the South Bay market of LA. These transactions allowed us to significantly enhance the credit profile of those tenancies and meaningfully increase rental rates at those properties. With a moratorium on evictions in California, these solutions generated substantial value in a fraction of the time it would have taken to go through the courts. We were able to accommodate a leading e-commerce tenant's need for our 214,000 square foot building, which will serve as a state-of-the-art last mile delivery facility and which also resulted in a 9% rental rate increase.

We successfully moved the prior tenant to a smaller 23,000 square-foot building that better suited their current needs for a 58% rental rate increase. Lastly, we also replaced the tenant at our 63,000 square foot transload facility at a 92% increase. Based on these successes, cash rental rate growth for leases commenced in the quarter was 20.3%. For the full year 2020, we expect the increase in cash rental rates on new and renewal leasing to approximate 14%, which would be at the top end of the original range we set forth on our pre-COVID fourth quarter 2019 earnings call. To give you a look into cash rental rate growth for 2021, as of today, we have signed approximately 32% of our 2021 rollovers at a cash rental rate increase of 12%.

Now I'd like to share with you some recent development leasing progress since our last earnings call. We signed a tenant for 100% of our 103,000 square foot First Sawgrass Commerce Center in South Florida on a long-term basis, which is set to commence upon completion in the fourth quarter. In Dallas, we signed a full building lease for the 199,000 square foot First Fossil Creek Commerce Center that commences November 1. We also leased 37,000 square feet at one of our first Park 121 buildings, which is slated to commence January 1. That 125,000 square-foot building is now 80% leased. The investment market continued to rebound during the quarter, and the industrial sector continues to be favored by institutions, local investors and users given the solid fundamentals and the secular driver of e-commerce.

The sector remains highly competitive, and we continue to use our platform to uncover select opportunities in target markets. Acquisitions totaled $20.2 million in the quarter and included three well-located land sites. In Seattle, we acquired a 6.6-acre site developable to 129,000 square feet. We added a 26-acre site in Central Florida that can accommodate up to four buildings totaling 329,000 square feet. Lastly, we acquired 3.1 acres in the Inland Empire West adjacent to our First Elm site, which will enable us to build 84,000 square feet on the new larger combined site.

Turning now to our development program. We're excited to launch our first speculative development projects since the beginning of the COVID-19 pandemic. We plan to start the first phase of our First Park Miami development in the fourth quarter. Recall that we acquired this 60-acre site in the first quarter in the Infill Medley submarket near the airport, but put the start on hold due to the pandemic. We can build a total of 1.2 million square feet, and the first phase will be three buildings totaling 600,000 square feet. Total estimated investment for this phase is approximately $90 million, and our targeted cash yield is in the mid-fives.

We also plan on starting the 141,000 square foot First 95 distribution center, a little further north in Pompano Beach. Total investment is approximately $21.7 million with a targeted cash yield of 6%. To support our ramp-up of our developments at First Park Miami and First 95, and potentially other sites in target markets which we continue to monitor, we tapped our ATM program during the quarter, issuing approximately 1.84 million shares at an average price of $43.16, generating net proceeds of $78.7 million. Adjusted for our fourth quarter starts, our on-balance sheet land holdings can accommodate approximately 13 million square feet of future development with the vast majority of sites entitled and ready to go.

Summing up our development pipeline at September 30, we had a total of $245 million of developments under construction or in lease-up, comprised of 2.6 million square feet, which is 39% leased as of today. With a projected cash yield of 6.6%, our estimated average margin on this batch of developments is approximately 47% when compared to prevailing market cap rates for similar leased assets. Updating you on our joint venture activity, we successfully leased the 644,000 square foot spec building at PV 303 to a single tenant. The building remains on track to be completed early next year. Our portion of the investment is $20 million, and our cash yield is 7.1%. We also sold two land sites at PV 303 in the fourth quarter, totaling 93 acres to two separate users with our share of the sales price totaling $11 million.

Today, the venture has 139 of the initial 532 developable acres remaining and has returned 137% of the originally invested capital. In the third quarter, we formed a new JV that acquired a 569-acre site, about one mile north of PV 303. We're pleased to partner once again with Diamond Realty, the U.S. real estate arm of Mitsubishi Corporation. Together, we purchased the site for $70.5 million in an all-cash transaction with our interest at 43%. Like the PV 303 venture, the new venture will engage in speculative development as well as build-to-suits and one-off land sales to users. First Industrial will earn development asset management, property management, disposition and leasing fees, and we have the opportunity to earn and promote beyond an established return. Our rationale for this investment is the same as our PV 303 venture. The new JV provides us the opportunity to capitalize on a large investment without incurring outsized risks and market concentration in Phoenix.

Moving on to dispositions. During the quarter, we sold two properties for $15.2 million, and we completed the sale of the $55 million Phoenix asset for which the tenant exercised its purchase option last year. Thus far in the quarter, we've sold two buildings comprised of 194,000 square feet for $5.6 million. Excluding the purchase option related sale, we've sold 759,000 square feet for a total of $61.8 million year-to-date on our way to meeting our sales target range of $125 million to $175 million. In summary, we had an excellent quarter with great execution by our team. We're very excited about restarting our speculative development program and taking advantage of the great growth opportunities in our target markets.

With that, let me turn it over to Scott.

Scott Musil -- Chief Financial Officer

Thanks, Peter. Let me start with the overall results for the third quarter. Diluted EPS was $0.28 versus $0.62 one year ago and NAREIT funds from operations were $0.49 per fully diluted share compared to $0.44 per share in 3Q 2019. Excluding approximately $0.04 per share of income related to the final settlement of an insurance claim, 3Q 2020 FFO was $0.45. Third quarter 2020 FFO includes approximately $400,000 of cash bad debt expense related to tenant accounts receivable. As Peter discussed, we were able to replace the largest tenant on our watch list in Southern California. As a result, the replace tenant will not impact our bad debt expense going forward. The other tenant on our watch list we discussed on the second quarter call has paid through September.

Note that we added another tenant to our watch list, which occupies a 137,000 square-foot building in Chino in the Inland Empire West. Let me walk you through some additional details on collections. Our regional teams continue to do a fantastic job. As of yesterday, we had collected 99% of monthly rental billings every month from April through September, and so far this month, we have collected 99% of October billings, assuming collections from government-related tenants that pay at the end of the month. On rent deferrals, the total outstanding balance is only $250,000, all of which is expected to be paid off by year-end, and all tenants with deferral agreements are currently in compliance.

Please note, in our calculation of the collection percentage metric, the numerator only reflects cash collections, and we do not give ourselves credit under our methodology for the application of security deposits unless it is for a terminated tenant. Occupancy was strong at 96.3%, down 140 basis points from both the prior quarter and from a year ago. As expected, Pier 1 vacated our 644,000 square-foot building in Baltimore on September 1, which impacted occupancy by 1.1 percentage points. We are under way with some make ready work at the asset and are marketing the building for lease. We consider the lease-up of this facility as similar to a speculative development, so we are assuming 12 months of downtime. As always, we will strive to beat that.

As for leasing volume during the quarter, we commenced approximately two million square feet of leases, 800,000 were new and 1.2 million were renewals, and tenant retention by square footage was 68.4%. Same-store NOI growth on a cash basis, excluding termination fees, was 1.3%, helped by an increase in rental rates on new and renewal leasing and rental rate bumps embedded in our leases. This was partially offset by lower average occupancy, an increase in free rent and slightly higher bad debt expense. Cash rental rates were up 20.3% overall, with renewals increasing 14.9% and new leasing up 29.7%. On a straight-line basis, overall rental rates were up 33.9%, with renewals increasing 28.1% and new leasing up 43.8%.

Moving now to the capital side. As announced on our previous earnings call in July, we closed on an extension of our term loan that was scheduled to mature in January of 2021 that effectively has a three-year term. On September 17, we closed on our $300 million private placement of 10- and 12-year notes with a weighted average interest rate of 2.81%. At September 30, our net debt plus preferred stock to adjusted EBITDA is 5 times. Please note that we have excluded the onetime insurance claim settlement amount from EBITDA and we normalize G&A. The weighted average maturity of our unsecured notes, term loans and secured financings was 6.6 years with a weighted average interest rate of 3.7%, and these figures exclude our credit facility.

Moving on to our updated 2020 guidance per our earnings release last evening. Our guidance range for NAREIT FFO is now $1.82 to $1.86 per share with a midpoint of $1.84. This is $0.04 per share higher than the midpoint of our guidance discussed on our second quarter call due to income related to the final settlement of an insurance claim previously discussed. Our guidance range for FFO before this item is $1.78 to $1.82 per share with the midpoint unchanged. Key assumptions for guidance are as follows. In-service occupancy at year-end fourth quarter of 94.5% to 95.5%, which implies a full year quarter end occupancy range of 96.4% to 96.7% with the midpoint of 96.5% unchanged. Our cash bad debt expense assumption remains $900,000 for the fourth quarter.

And please note that guidance does not include any potential write-offs of deferred rent receivables related to tenants that are having financial difficulties. Fourth quarter same-store NOI growth on a cash basis before termination fees of negative 0.75% to positive 0.75%, with the midpoint being flat. In addition to the NOI impact from Pier 1 vacating, fourth quarter same-store NOI also reflects the impact of free rent from the leasing solutions in the South Bay market we discussed earlier. Incorporating this fourth quarter guidance, our full year 2020 quarterly average cash same-store NOI growth guidance is 3.8% to 4.2%, an increase of 25 basis points at the midpoint, reflecting third quarter results and a tightening of the range compared to our prior guidance.

Our G&A guidance remains unchanged at $31 million to $32 million. And guidance also includes the anticipated 2020 costs related to our completed and under construction developments at September 30, plus the expected fourth quarter starts, a First Park Miami and First 95 distribution center. In total, for the full year 2020, we expect to capitalize about $0.05 per share of interest related to our developments. Our guidance does not reflect the impact of any other future sales, acquisitions or new development starts after this call, other than the expected fourth quarter First Park Miami and First 95 development starts. The impact of any future debt issuances, debt repurchases or repayments after this call and guidance also excludes the potential issuance of equity.

Let me turn it back over to Peter.

Peter E. Baccile -- President and Chief Executive Officer

Thanks, Scott. Before we open it up to questions, once again, let me thank our team for their great performance and commitment to our customers, each other and our business objectives. We are excited about restarting our speculative development program to drive future growth. We also look forward to the further recovery of our economy and continued progress in the fight against COVID-19 and the careful restoration of so many important aspects of our daily lives. Lastly, I would like to remind everyone about our upcoming virtual Investor Day on November 12. There, we will lay out in much greater detail the state of the industrial sector, the strength of our platform and current portfolio and our vision for growth. We hope you plan to tune in. Please reach out to Art Harman, if you would like to RSVP or with any questions.

With that, we will now move to the question-and-answer portion of our call. [Operator Instructions] Operator, please open it up for questions.

Questions and Answers:

Operator

Thank you. [Operator Instructions] The first question is from Craig Mailman with KeyBanc Capital Markets. Your line is open.

Craig Mailman -- KeyBanc Capital Markets -- Analyst

Hey, good morning everyone. Peter, I appreciate your commentary on kind of swapping some of those tenants out that were on the watch list. I'm just curious, kind of an update on maybe what the watch list looks like today and how much you guys have looked at the percentage of your tenants that really relied on the PPP program and what this delay in kind of the second stimulus is ultimately doing to kind of their creditworthiness as we continue to go without a deal.

Peter E. Baccile -- President and Chief Executive Officer

I'll start out, and then Scott will pick up for the rest. As far as how many or how much of our rent took advantage of the PPP, we really don't know. We do know a number of tenants did take advantage of it. We don't know what they spent the money on. We don't know if they spent it on personnel or rent. But it wasn't a big number. And Scott, you want to talk about watch list and to go forward?

Scott Musil -- Chief Financial Officer

Yes, sure. Correct. There's two tenants on the watch list, one a carryover that we talked about in our second quarter call, one a new one. Their quarterly rent is about $450,000. One of the tenants also owes us about $400,000 prior to fourth quarter. So if everything goes bad with those two tenants, your total bad debt expense would be about $850,000 compared to our guidance of about $900,000. But I would say that the good thing about these two tenants is if we're able to get to these spaces early, both tenants' rents are below market. So if we're able to work some magic there and work our way to get those tenants out, hopefully, we can push rents up a little bit higher.

On your question on PPP, payments have been very strong. It's 99% for every month since March. I would say the payments' activity was a little bit stronger in the last couple of months. My feeling is that if there is not a new stimulus package passed, I still think our tenants will do pretty well from a collections point of view. I hope that helps.

Craig Mailman -- KeyBanc Capital Markets -- Analyst

No, that is helpful. And then just switching to development. You guys are kind of turning on spec. One of your peers is turning on spec a little bit. Could you just talk about the risk appetite and kind of maybe the conversation you guys have an investment committee today versus pre-pandemic about that decision to start an incremental project, particularly with some availability still left in the other construction and the kind of lease-up segments of your pipeline?

Peter E. Baccile -- President and Chief Executive Officer

Sure. Obviously, at the beginning of the pandemic, there was enormous uncertainty. We hadn't gone through what we have just gone through. And so shutting down the development pipeline made a lot of sense. It was certainly prudent. Now we've had the benefit of the past six or seven months to see how we handle this as a nation, how we manage it, how it impacts health and how it impacts the economy. And so there's a lot more information there. In addition, the business activity has picked up significantly.

It began really in June. And I would say, back in June, it was a lot of conversation. And in the last two or three months, it's been much more in the way of people making decisions and signing leases. And so that's all good. So from a risk standpoint, we think that focusing on the higher barrier markets, the coastal markets, where consumption is still going to be the highest, business activity will be the highest, is the best place for us to begin new speculative developments. What was the second part of your question?

Craig Mailman -- KeyBanc Capital Markets -- Analyst

No, just in terms of -- did any of your underwriting criteria change or get more stringent to start new projects? Just kind of curious conversations within committee around starting the new projects.

Peter E. Baccile -- President and Chief Executive Officer

No. I think, look, when we first went into the First Park Miami opportunity, the math associated with that hasn't changed. So the initial underwriting we did has been confirmed by the economics and the general outlook for the economy that we have today. So yes, I mean, if we saw a deterioration in those economics relative to the risk, we'd obviously make a different decision.

Craig Mailman -- KeyBanc Capital Markets -- Analyst

Great, thank you.

Operator

Our next question is from Michael Carroll with RBC Capital Markets. Your line is open.

Michael Carroll -- RBC Capital Markets -- Analyst

Yeah. Thanks. Scott, can you talk a little bit about the 137,000 square foot tenant in Chino? Why were they added to the watch list this quarter? Was there a specific catalyst that occurred over the past few months?

Scott Musil -- Chief Financial Officer

This is a tenant we've been working with on payment. They're very actively using the space. We've had a lot of dialogue with the tenant, and we weren't able to make an agreement with them on payment. So this has been going on a quarter or so. So we decided to add them to the watch list, Mike. That's basically the story behind that new tenant.

Peter E. Baccile -- President and Chief Executive Officer

I'd remind you on this, that California has a moratorium of evictions, and this particular tenant seems to want to take advantage of that.

Michael Carroll -- RBC Capital Markets -- Analyst

Okay. And then when you -- is there an ability -- I know that you kind of mentioned this earlier about replacing your tenant, like you did in South Bay with the new tenant and moving them to a different place. It sounds like this tenant in Chino does not want to do that. What about the second tenant that's on your watch list? Are they open to that type of move?

Johannson Yap -- Chief Investment Officer

This is Jojo. Definitely, that's part of a potential solution. We are not ready to announce yet what solution we come to, whether it has a solution or at the end of the day, we collect the full rent or we accept any kind of plan. So that's in the works. We're very pleased we were able to execute that in a multiple number of buildings. And what Scott mentioned is 137,000 is in our new developments, First Ranch, which is one of the tightest submarkets in LA.

The other 45,000 footer is in the heart of South Bay, and that's in a new development, too. And that in-place rents maybe about 40% below market. So like Scott said, one I support that we'd be happy to take back that space. But the conversations are ongoing. A lot of owners have priced their business, and they want to keep their business. So we're just trying to get to a win-win approach just like the other three leases we mentioned in our prepared remarks.

Michael Carroll -- RBC Capital Markets -- Analyst

Thanks.

Operator

Our next question is from Ki Bin Kim with Truist. Your line is open.

Ki Bin Kim -- Truist -- Analyst

Thanks Don, and good morning, guys. So you guys mentioned that you signed about 1/3 of the 2021 lease rollover at a 12% cash lease spread. Any particular, like, details behind the remaining 2/3 of what's rolling in terms of like, should we -- is there any reason to expect, at least expect to be materially different than 12% going forward?

Christopher Schneider -- Senior Vice President, Operations and Chief Information Officer

Ki Bin, this is Chris. Obviously, we're pleased with what we've signed so far on the 12%. Right now, we're going through our budgeting process. We'll give you more outlook on that when we do the earnings release in February. But we're very pleased with the 12% so far.

Ki Bin Kim -- Truist -- Analyst

Okay. And any update on the couple of pockets of vacancy that you have remaining in the development pipeline for assets like Redwood or Independence? Any kind of color you could provide on just the activity you're seeing from prospective tenants?

Peter E. Baccile -- President and Chief Executive Officer

Peter Schultz, do you want to talk about Independence? And then Jojo can talk about the rest.

Peter Schultz -- Executive Vice President-East

Sure. Good morning, Ki Bin. On Independence, that's our 100,000 square-foot building that we finished in Philadelphia at the end of the second quarter, which, as you might recall, was delayed a couple of months because of the construction shutdown. So we're one of very few choices for tenants. We have had some activity on the building, but nothing to really comment on today, but we continue to be encouraged by that opportunity to outperform.

Peter E. Baccile -- President and Chief Executive Officer

Jojo?

Johannson Yap -- Chief Investment Officer

Yes, Peter. Ki Bin, hello. In terms of our developments that will be completed, overall, as you know, we're 24% leased. Basically, we -- Houston -- our Houston development project, Houston, somewhat slow. There is supply that came in that exceeded net absorption, but we love our project in Grand Parkway, great access to the freeway. And that's one of the best products with a freeway frontage. What we've noticed in that market is that, basically, in the second quarter, the activity kind of shut down, but now the activity is starting to pick up and we're responding to more RFPs. In terms of the projects at Inland Empire West, which is First Redwood logistics one and two.

In that two situations, those buildings are completed already. We're getting a lot of activity. And we're responding to a significant amount of proposals and a lot of inquiries. So we're very bullish on that. So we're very happy where that's been. And in terms of the buildings in Dallas, in Northwest Dallas, we're very happy with that. As you know, we have -- we built a big building there just not yet completed. That is now 77% leased at 433,000 square feet. Now we have two smaller buildings there, which right now is about 20% or slightly over 20% leased. So that has seen good activity as well.

Ki Bin Kim -- Truist -- Analyst

Okay, thank you.

Operator

[Operator Instructions] The next question is from Rob Stevenson with Janney. Your line is open.

Rob Stevenson -- Janney -- Analyst

Hi, good morning guys. With the start of Miami and First 95 and then you guys completing Sawgrass and Park 121, the development pipeline looks like it's going to be 85% South Florida a few months. Is this just a timing quirk? Is this concentration on purpose? Is South Florida that strong right now to have 1.2 million of spec space under construction? Help us understand that one?

Johannson Yap -- Chief Investment Officer

Sure, sure. Basically, Sawgrass, as you know, now is 100% leased, and we're very pleased about that because we're not even done that building. So in terms of the starting of new projects, they're catering to different submarkets. One, the FP 95 is further north. There's very, very little vacancy. And that's very, very accessible to the freeway, very small, low vacancy in that submarket. And the FP Miami, that is right in the heart, just north of Doral. And that's a very, very tight market. We're very bullish in that. We're very excited about that project because our project there would probably be one of the most highest quality locations that you can find out there, First Park Miami. So bullish about that project, lot of activity. Of course, our job is to execute on the building completion and lease it up. But we're already getting inquiries despite the fact that we just started on our First Park Miami.

Rob Stevenson -- Janney -- Analyst

Okay. And then you guys talked about rents being up on the new leasing, both in the quarter and the stuff for 2021. What about the cost to get them signed? Any notable changes to leasing costs today versus previous quarters, previous years?

Christopher Schneider -- Senior Vice President, Operations and Chief Information Officer

This is Chris. As far as the leasing costs, obviously, new deals are typically four or five times more than a renewal deal. But as far as what we're seeing, we're seeing any real changes as far as the cost. Obviously, if you have longer terms, you might -- the total dollars will go up, but really not seeing any significant changes from that standpoint.

Rob Stevenson -- Janney -- Analyst

Okay, thanks guys.

Operator

The next question is from Sumit Sharma with Scotiabank. Your line is open.

Sumit Sharma -- Scotiabank -- Analyst

Hi guys. Thank you for giving me an opportunity to ask a question. I'm just wondering, with regards to some of the recent large leases, First Nandina to PV303, First Fossil Creek, what's the free rent period look like in terms of accretion into the cash NOI stream?

Johannson Yap -- Chief Investment Officer

Basically, market and market today is basically less than 1/4 to have a month of free rent per year of lease in the deal. That's across the market and it hasn’t changed. So again, let me repeat, it's a range from a quarter to half a month, and it depends across the country, per lease year.

Sumit Sharma -- Scotiabank -- Analyst

Got it. Thank you so much. Also wondering about this topic that has been brought up by one of your peers, shadow supply conversions from retail. A lot of focus is on complete conversions of existing retail into warehouses, which have their own sort of issues. But just wondering whether you're here -- what you guys are hearing from your clients, network planners, site feasibility guys, whether the tenants are actually looking to run smaller fulfillment operations from existing retail footprints? And if that is the case, and whatever the bogey you put on that? Just wondering how you guys are thinking about it with regards to your portfolio in terms of shadow supply risk? So conversions have been a topic for quite some time now.

Johannson Yap -- Chief Investment Officer

We have been saying really all along that, that's really not going to be a significant part of the overall supply base. We've got 17 billion square feet approximately of industrial square feet around the country, you're looking at a much, much smaller amount of conversion space that's going to make sense from an economic standpoint. We also don't have a lot of retailers in our tenant roster. So we wouldn't be having discussions necessarily about the conversion of retail and what they might do there. So it's going to happen here and there. You've got lots of different barriers. Economics are a major barrier.

The rents for industrial are much lower than the rents for retail or mixed use. And you've got also the permitting and approval process where the neighborhoods don't want 53-foot trucks or even big vans going through the neighborhood. So it will happen here and there, but we don't see it as being a big component of the overall competitive set.

Sumit Sharma -- Scotiabank -- Analyst

Thank you very much.

Operator

Your next question is from Eric Frankel with Green Street. Your line is open.

Eric Frankel -- Green Street -- Analyst

Thank you. Can you just help provide the bridge to your somewhat lower same-store NOI growth results from the last quarter? So it makes sense with the occupancy drop with Pier 1 that same-store results would be a little bit lower. But maybe you can provide just a breakout of what the cash -- what the free rent and bad debt did to same store.

Scott Musil -- Chief Financial Officer

Eric, this is Scott. I'll compare the first half of the year to the back half of the year because I think that's the big change. So there's a couple of different items there. The impact of free rent is going to be the largest item. And remember, in the first half of 2020, we had the burn-off of the free rent period of First Nandina, the big development in the Inland Empire. Also, the back half of 2020, we had a little bit more free rent offered. Again, these great lease transactions that Jojo and the Southern California team worked on.

We had a little bit of free rent with that. There's also an impact due to the drop in occupancy. And then obviously, Pier 1 is a big factor in that. That building is going to be vacant for four months at the back half of the year where it was occupied 100% for the front half and then bad debt expense is going to be about 50 basis points of the beta as well. So those are the three large drivers that are causing the decline of same-store NOI from the front half of the year to the back half of 2020.

Christopher Schneider -- Senior Vice President, Operations and Chief Information Officer

Eric, this is Chris. [Speech Overlap]. So it's a big part of the drop. Keep in mind, in the fourth quarter, we're coming from a year ago at 97.8%, so a very high occupancy. So just put it in perspective.

Eric Frankel -- Green Street -- Analyst

Yes. And the 50 basis point bad debt expense, that's 50 basis points of bad debt higher than last year, correct? It's not the absolute number?

Peter Schultz -- Executive Vice President-East

Well, that 50 basis points is going to be more of a drag in the back half of the year compared to the front half of the year. And the big driver of that is our bad debt expense. So I think it was like $400,000 on average for the first half. And then the back half of the year, I think we got $400,000 in the third quarter and $900,000 in the fourth quarter. So the main driver of that is our guidance assumption in the fourth quarter, Eric.

Eric Frankel -- Green Street -- Analyst

Okay. Okay. Maybe I'll look at that after the call. That would be great. Maybe -- sorry, go ahead.

Peter Schultz -- Executive Vice President-East

Yes. And I would say the bad debt expense triggered in 2019 was very small. That doesn't really have the impact on it. It's really -- more bad debt expense we're factoring in the back half of the year. And again, it's the guidance assumption that we put in, in our fourth quarter.

Eric Frankel -- Green Street -- Analyst

Great. I'll appreciate the follow-up. Just geographically, maybe you got -- maybe your team can provide some context of which markets are doing well, which others are not doing so well. So it looks like from your comments and what your peers have said that Southern California has kind of recovered pretty quickly and then it's a little bit -- maybe a teeny bit slower elsewhere, or maybe you can provide some context?

Peter Schultz -- Executive Vice President-East

Sure. If you just look at, Eric, kind of a lot of activity and leasing that we've done, of course, SoCal, and that basically includes La all the way to Inland Empire West and East. So that's a big market. We're also seeing in Phoenix, has been a big performer for us in terms of leasing, you see a lot of activity there. Dallas also continues to have a large gross absorption, Eric. Moving on, Florida, South Florida, overall, has seen also pretty good absorption. And then, of course, Eastern PA have seen a lot of absorption as well. So I mean, that comes to mind, Eric. I guess, what's really kind of slowed down kind of sit down in second quarter and still has quite of supply to work through is Houston.

Eric Frankel -- Green Street -- Analyst

And the Midwest, how is that holding up?

Peter Schultz -- Executive Vice President-East

In Midwest, it's kind of flat to positive, meaning that you're kind of it goes, we will be, you do have supply, but you do have demand, it's kind of treading water a bit.

Eric Frankel -- Green Street -- Analyst

Okay. Final question. So you set your disposition target roughly at the same level as prior years. Do you have a lot of properties under contract to sell? Or you just think that those are going to be a -- or you just have a lot of properties in the hopper that you think you can sell?

Peter E. Baccile -- President and Chief Executive Officer

We've got a lot of assets under way and in various stages of the process. So we feel pretty good about the guidance range. As last year, you may recall, we had a big flurry of closings at the end of the year. So the guidance range feels pretty solid.

Eric Frankel -- Green Street -- Analyst

Looking forward to our Investor Day.

Peter E. Baccile -- President and Chief Executive Officer–

Thank you.

Operator

Thank you. [Operator Instructions] The next question is from Dave Rogers with Baird. Your line is open.

Dave Rogers -- Baird -- Analyst

Yes. I wanted to start with a follow-up, maybe on the concessions as well as some of the movement in South Bay. It looked like -- and I understand the concession comment you made earlier that they haven't really changed that dramatically, but concessions in the quarter were up quite a bit from the trend. So did that have something to do with the activity that you saw in Southern California? And also, Scott, did you see any straight-line rent write-offs in the third quarter related to any of that activity?

Scott Musil -- Chief Financial Officer

Dave, no straight-line rent write-offs in the third quarter, and I'll turn it over to Chris on the concession question.

Christopher Schneider -- Senior Vice President, Operations and Chief Information Officer

Yes. Dave, as far as the actual dollar amount on concessions, certainly, the Southern California transactions contributed to that. As far as Jojo's comment about where our concessions, again, very consistently, we're at that a quarter to a half a month per year lease term.

Dave Rogers -- Baird -- Analyst

Okay. On the backfill of Pier 1, you guys talked about maybe a year or so that you're giving yourself. Does that asset need a lot of capital? Will you have to demise that at all? I mean, what are you thinking of today in terms of the ability to get out and lease that fairly quickly.

Peter E. Baccile -- President and Chief Executive Officer

Peter Schultz, do you want to take that?

Peter Schultz -- Executive Vice President-East

Sure. Good morning, Dave. It’s Peter Schultz. We have some make ready work under way at the building, but it's what we would typically do. It's new energy-efficient lighting, some loading dock packages and the like, and just a little bit of general cleanup, but nothing unusual. We're continuing to see pretty good activity in the market, particularly from larger users where demand, I would say, there and in other markets has been most consistent, but we thought it was simply appropriate to use that 12-month assumption, as Scott mentioned, similar to some of our other developments. We've already had a couple of tours in activity, and we'll certainly keep you up-to-date on our progress there.

Dave Rogers -- Baird -- Analyst

Great. Last question for me, maybe for Jojo, on the investment sales market, where you guys have been selling assets, maybe more center of the country, let's call it. Can you give us an update on the activity level, any bid-ask spread? Or are you still feeling pretty good about the ability to transact in the areas you want to sell most actively?

Johannson Yap -- Chief Investment Officer

Yes. We feel very good, Dave, in terms of being able to sell because the market is really strong. There are actually more buyers today than even last year and because a lot of investors are wanting to get into the industrial product space. A lot of them we find are underallocated. And the even none -- even in the past when the non-industrial buyers are now into the market because they like the fundamentals. Users are active too. They're taking advantage of low interest rates to buy properties for their own account. So yes, so I mean, the selling market is a good market.

Dave Rogers -- Baird -- Analyst

Great. Thanks everyone.

Operator

The next question is from Caitlin Burrows with Goldman Sachs. Your line is open.

Caitlin Burrows -- Goldman Sachs -- Analyst

Hi, good morning. Maybe on the capex side, we saw that recurring capex increase in the third quarter. It was 56% year-to-date, not quite as much, but still up. And the non-leasing capex per square foot also increased year-to-date. So I was wondering if you could go through maybe what's behind these increases and if you expect them to continue?

Scott Musil -- Chief Financial Officer

Catlin, it's Scott. A couple of things is we think our capex will be $38 million, $39 million this year, a little bit higher than what we anticipated at the beginning of the year. Really, it's pulling forward work. A couple of things. One is on the Pier 1 building that Peter Schultz talked about. We had some work to do, for instance, a roof replacement in a couple of years. So instead of doing that a couple of years out, we pushed it into 2020. So that was work that we pulled forward. Also with the additional leases that we did in Southern California that we talked about in our script, we incurred additional leasing costs with that as well.

Again, instead of paying those leasing costs at exploration, we paid them now that we were able to terminate the tenants, which was an absolutely fabulous move because we were able to raise those rents on those buildings quite considerably. So I would say those are the -- probably the two main drivers of the increase in capex.

Caitlin Burrows -- Goldman Sachs -- Analyst

Got it. Okay. So it sounds like 2020 might be not a good, I don't know, go buy for future years in terms of that activity.

Scott Musil -- Chief Financial Officer

Absolutely correct. I wouldn't use that as a run rate for the future years, correct.

Caitlin Burrows -- Goldman Sachs -- Analyst

Okay. Got it. And then just in terms of dispositions in the third quarter, excluding the Phoenix sale, the cap rates were just over 9%. And year-to-date, they've been just under 9%. So I guess going forward, do you expect the additional dispositions that you're talking about doing in the fourth quarter, and I guess, into 2021 to have similar cap rates? Or are those more reflective of the specific properties that have been sold so far this year and not necessarily representative of the future ones?

Johannson Yap -- Chief Investment Officer

Absolutely. It's Jojo, by the way. Absolutely, more specific to this quarter. In the third quarter, we sold the portfolio of Minneapolis that had peak rents and then probably flatten or come down and with significant capex. So the AFFO that we're going to get from that, if we continue to own that, would be much lower than the 9% cap rate. So that was an outlier there, and that skewed the numbers quite a bit.

Peter E. Baccile -- President and Chief Executive Officer

Yes, we take that cash out of that building that's yielding less than 4% AFFO and put it into new development at a 5.5%, 6% yield and new developments don't require capital for a long time. So that's a much better use for that capital.

Caitlin Burrows -- Goldman Sachs -- Analyst

Okay, thanks.

Operator

The next question is from Rich Anderson with SMBC. Your line is open.

Rich Anderson -- SMBC -- Analyst

Thanks and good morning. So thinking forward here in kind of a post COVID environment. In the present tense, you have had an unnaturally active leasing environment for e-commerce. Perhaps inventories have been building, and putting aside the dark realities of COVID-19, perhaps this has been a tailwind, more than a headwind for your business. So do you -- can you envision a scenario where your business actually decelerates after we have some sort of medical treatment and some pure and people get back to work? Or are there offsets that come back to life that make you think you continue to accelerate things on a go-forward basis?

Peter E. Baccile -- President and Chief Executive Officer

Yes. Good question. We think a lot about that. So the jump in the trajectory of e-commerce, obviously, was caused by COVID and we used to say that the incremental demand from e-commerce was more like 25%. And now it's kind of 35% to 40%. The trajectory of the growth should stay the same. It's just now a step function, it's stepped up. It's very possible if we have a vaccine, etc., and everyone's feeling a lot more safe and comfortable that you might see a small lull in next summer when people go out to celebrate life, that will certainly happen. But if they're buying product, that's also still somehow going through our spaces. But we think that you've got millions of new adopters to e-commerce. They're not going to go away. And so we think that's going to continue to be a very, very strong tailwind going forward for our business.

Rich Anderson -- SMBC -- Analyst

Okay. Great. Thanks for that color. And second question is, when does excess supply matter in this business? We're -- you can all agree that we're developing more than absorbing at this point in time, and that might -- that spread might continue to widen. But then again, where a rent payment exists in the capital stack or expense structure of your tenants is somewhat small. So I'm wondering, price sensitivity, all those considerations, when do we get to a point where, yes, we've got to start paying attention to the fact that there's more supply in the market than there is demand.

Peter E. Baccile -- President and Chief Executive Officer

Yes. I would say this. I mean, one of the things that we learned from the Great Recession, what you're really trying to figure out is where does the balance of power shift from the landlord to the tenant. And it's really when the national vacancy rate is something like 8% or 9%. Now that's a very much a generalization, right? Because if your portfolio is largely coastal in high barrier markets, the national vacancy rate of 8% or 9% might not really apply to you. And frankly, that's one of the reasons that's where we focus on our new capital. So when you ask about when does new supply or excess supply matter, that would be a general and very high level answer, but the specifics in the submarkets and where you are and all that matters more.

Rich Anderson -- SMBC -- Analyst

Okay, great, thanks very much.

Operator

The next question is from Tayo Okusanya with Mizuho. Your line is open.

Tayo Okusanya -- Mizuho -- Analyst

Yes, good morning. I was just curious if you could talk a little bit about how you expect the level of spec development to either increase or hold steady going forward given the amount of demand that you're seeing.

Peter E. Baccile -- President and Chief Executive Officer

Yes. So as you know, we don't really guide on starts. I would say that going back to my earlier remarks, in a pre-COVID world or a COVID-free world, certainly development volumes, we would expect development volumes across the sector to go back to kind of where they were pre-COVID, and there wouldn't be any specific reason why we wouldn't do the same.

Tayo Okusanya -- Mizuho -- Analyst

Got you. And then for clients that are -- or tenants, I'm sorry, that are now on the watch list, including the new ones, are these or some of the new ones, are they kind of tenants in the industry you kind of earmarked during 2Q earnings as industries that are particularly challenged at this point?

Johannson Yap -- Chief Investment Officer

I would say one of them is in an industry like that. And the other one, again, their business seems to be doing really well when we drive by. So I would call that tenant more of a bad actor.

Peter Schultz -- Executive Vice President-East

Yes. The larger one is the very robust business activity in the space. And sometimes you find a bad apple.

Tayo Okusanya -- Mizuho -- Analyst

Understood. Thank you.

Operator

The next question is from Mike Mueller with JPMorgan. Your line is open.

Mike Mueller -- JPMorgan -- Analyst

Yeah, hi. For the JV with Diamond, the new one, you referenced the Phoenix exposure. So if that project would have been outside of Phoenix, do you think you would have done it on the balance sheet? And as a follow-up, how should we think about future transactions with Diamond?

Peter E. Baccile -- President and Chief Executive Officer

Right. So it is -- how do I want to answer that question? We love diamond for starters, and we would absolutely like to do more transactions with them. They have been a great partner and the chemistry that we have with them, our interests are absolutely aligned. So that answers that part. As far as other ventures and outside of Phoenix, there -- look, I mean, there are certain markets where we're not going to want to venture because, frankly, we want the additional exposure, and we like the risk reward trade-off. And while we really, really like Phoenix, taking down over 500 acres by ourselves in that one place on both occasions didn't seem like the right thing for us to do. So it really depends on the market. Yes, we would certainly consider ventures with Diamond elsewhere, but the probabilities of that happening in some of the other coastal markets are lower just because of our appetite for growth in those markets.

Mike Mueller -- JPMorgan -- Analyst

Got it. So that's good color. That was it. Thank you.

Operator

The next question is from Bill Crow with Raymond James & Associates. Your line is open.

Bill Crow -- Raymond James and Associates -- Analyst

Thanks, good morning guys. Two questions. On Houston, is it a supply issue or a demand issue?

Johannson Yap -- Chief Investment Officer

Bill, this is Jojo. It's a little bit of both. Although the demand or interest in RFPs increase have started to pick up. 2Q was really slow, it kind of sit down. And now we're seeing more demand. But it's also compared to other markets, a little bit more of a supply issue, too, because a lot of completions came in well above net absorption, Bill.

Bill Crow -- Raymond James and Associates -- Analyst

Yes. And my other question is really on development leasing. And if you go back historically, I think it's always been kind of completion of construction plus one year was the goal. And I think it sounds like you're there again on at least one of your projects. But it seems like the last few years, we've gone to a lease-up within a few months and maybe even before construction completion. So are we seeing that stretch out again? And if so, is that a COVID issue? Is that a supply demand issue? Any comments there would be great.

Peter E. Baccile -- President and Chief Executive Officer

Yes. Our track record is clearly leasing kind of zero to six months after completion. We always build in 12 months into our underwriting. This year has been a different year, a special year, thanks to the virus. And so you're seeing what I would call aberrations. You're seeing some things happen that haven't happened. Now, this is great real estate. We love the real estate. We love the markets. So we're not worried about it. But the real answer to the question is I wouldn't use 2020 as any indication of any big change in the leasing velocity in what we're building.

Bill Crow -- Raymond James and Associates -- Analyst

Okay, that's it from me. Thanks.

Operator

The next question is from Eric Frankel with Green Street. Your line is open.

Eric Frankel -- Green Street -- Analyst

Thank you. Just a follow-up question. Is there a particular reason why you projected occupancy to decline further in the fourth quarter? I'm not sure if we've heard an explanation.

Scott Musil -- Chief Financial Officer

Eric, it's Scott. I'll walk through that. There's three spaces. Two of them are developments that we're placing in service in the fourth quarter. One is in Dallas, one is in Houston, all the product Class A. But due to COVID, we lost about four months in the market where folks really weren't looking at the space. So that's going to get pushed to 2021. We also discussed on our call on our script, a new lease in Southern California with an e-commerce provider. That lease starts in January, and that's about 45 basis points.

So those three spaces are causing the drop. I would say the good news is do you want to get back from 95% to 96.3%, the new lease in SoCal, it's done. It's signed. The tenants is going to take occupancy in January and the two new developments that we all have been talking about in the call are great located developments, Class A product. They'll get leased up. It's just going to take a little bit longer to lease them up because of COVID. So we think that's more of a 2021 event. That's it. Those are the three drivers.

Eric Frankel -- Green Street -- Analyst

Perfect. I appreciate the color.

Operator

There are no further questions at this time. I'll turn the call over to Peter Baccile.

Peter E. Baccile -- President and Chief Executive Officer

Thank you, operator, and thanks, everyone, for participating on our call today. As always, please feel free to reach out to me, Scott or Art with any follow-up questions. Take care.

Operator

[Operator Closing Remarks]

Duration: 61 minutes

Call participants:

Arthur Harmon -- Vice President-Investor Relations and Marketing

Peter E. Baccile -- President and Chief Executive Officer

Scott Musil -- Chief Financial Officer

Johannson Yap -- Chief Investment Officer

Christopher Schneider -- Senior Vice President, Operations and Chief Information Officer

Peter Schultz -- Executive Vice President-East

Craig Mailman -- KeyBanc Capital Markets -- Analyst

Michael Carroll -- RBC Capital Markets -- Analyst

Ki Bin Kim -- Truist -- Analyst

Rob Stevenson -- Janney -- Analyst

Sumit Sharma -- Scotiabank -- Analyst

Eric Frankel -- Green Street -- Analyst

Dave Rogers -- Baird -- Analyst

Caitlin Burrows -- Goldman Sachs -- Analyst

Rich Anderson -- SMBC -- Analyst

Tayo Okusanya -- Mizuho -- Analyst

Mike Mueller -- JPMorgan -- Analyst

Bill Crow -- Raymond James and Associates -- Analyst

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