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Industrial Logistics Properties Tr (NASDAQ:ILPT)
Q3 2021 Earnings Call
Oct 28, 2021, 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 Third Quarter 2021 Earnings Conference Call. [Operator Instructions]

I would now like to turn the conference over to Kevin Barry, Director of Investor Relations. Please go ahead.

Kevin Barry -- Investor Relations

Good morning, everyone, and thank you for joining us today. With me on the call are ILPT's Chief Executive Officer, John Murray; Chief Financial Officer, Rick Siedel; and Chief Operating Officer, Yael Duffy. In just a moment, they will provide details about our business and our performance for the third quarter of 2021, followed by a question-and-answer session with sell-side 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, Thursday, October 28, 2021, and actual results may differ materially from those that we project.

The company undertakes no obligation to revise or publicly release 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, adjusted EBITDA and cash-based net operating income or cash basis NOI. 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 can also be found on our website.

With that, I will now turn the call over to John.

John Murray -- President and Chief Executive Officer

Thank you, Kevin. Good morning, everyone, and welcome to the third quarter earnings call for Industrial Logistics Properties Trust. In a moment, I will highlight ILPT's third quarter performance and recent acquisitions. Then I'll turn the call over to Yael and Rick for details on ILPT's portfolio statistics, leasing activity and financial results. We reported third quarter results that were highlighted by solid growth in same-property cash NOI. Strong leasing trends, 99% portfolio occupancy and continued expansion of ILPT's high-quality industrial and logistics portfolio. Normalized FFO came in at $0.46 per share, which was stable year-over-year despite the deconsolidation of our joint venture. Cash NOI growth on a same-property basis increased 3.4% in the third quarter over the third quarter last year. We entered new and renewal leases and completed rent resets for approximately 818,000 square feet of industrial space at weighted average rental rates that were over 20% higher than prior rental rates for the same space. This accelerating rental rate growth reflects continued strong demand for ILPT's properties as well as ongoing market strength within the broader industrial real estate sector.

Turning to acquisitions. We remain focused on acquiring high-quality properties with stable cash flows and a favorable risk-adjusted return profile. During the quarter, we closed on a portfolio of three Class A industrial buildings totaling approximately 1.3 million square feet in the Memphis industrial market for $100 million, representing a GAAP cap rate of 4.7%. The buildings are 100% leased to five tenants and well located with excellent airport, rail and interstate highway access. The industrial real estate sector continues to benefit from strong fundamental tailwinds, leading to intense competition for acquisitions. Our pipeline of opportunities remains active. However, we continue to maintain a disciplined approach to potential investments as cap rates continue to trend lower. With modest leverage on our balance sheet and healthy liquidity, we remain well positioned to pursue additional opportunities to complement our portfolio and drive cash flow growth.

Now I'll turn the call over to Yael to review ILPT's portfolio and leasing activity for the quarter.

Yael Duffy -- Vice President and Chief Operating Officer

Thanks, John, and good morning, everyone. Like prior calls, I'll begin with an overview of ILPT's portfolio and then provide an update on our leasing activity for the third quarter. ILPT has a diverse tenant base with exposure to highly sought after industry verticals, including e-commerce, distribution and consumer goods. More than 70% of ILPT's annualized rental revenues come from investment-grade rated tenants or subsidiaries or from our secure Hawaii land leases. On the Mainland, investment-grade rated tenants or subsidiaries of investment-grade rated parent entities account for more than half of ILPT's revenues. Our top 20 tenants represent 44% of total annualized rental revenues. Amazon is our largest tenant, representing nearly 10% of annualized revenue, followed by FedEx and Restoration Hardware at approximately 4% and 3% of total annualized rental revenues, respectively.

As of September 30, 2021, ILPT's portfolio consisted of 294 warehouse and distribution properties in 33 states totaling approximately 36 million square feet. Today, 70% of our Mainland portfolio is located within the top 30 industrial markets and our goal is to continue to expand within those markets as evidenced by our recent acquisition of three Class A properties in Memphis that John discussed earlier. Memphis is ranked within the top 15 industrial markets and has seen nearly 7% rent growth in 2021 and over 26% growth since 2017, according to Cushman and Wakefield. With this acquisition, ILPT expects to roll up rents and capitalize on the strength of the market given the relatively short remaining lease term of approximately 3.5 years for this portfolio. ILPT's portfolio has a weighted average remaining lease term of approximately nine years and overall occupancy of 99%, an increase of 20 basis points year-over-year. Our Mainland portfolio includes 68 properties in 32 states totaling approximately 19.8 million square feet that are 100% leased. The balance of the portfolio is comprised of 16.7 million square feet of industrial land and properties in Hawaii. Occupancy in Hawaii was 97.8% at quarter end, which was a 70 basis point improvement compared to the prior year.

During the third quarter, ILPT achieved its highest level of leasing activity in over a year, driven by continued demand for industrial real estate. We'd executed leases for 818,000 square feet at rents that were 20.5% higher than prior rental rates for the same space. We executed 15 new and renewal leases for approximately 771,000 square feet at rental rates that were 19.5% higher than prior rates, with an average lease term of 8.2 years and commitments for leasing capital of $0.40 per square foot per lease year. Our results reflect strong performance in Hawaii where we signed 13 leases, including a rent reset at a 32.6% roll-up in rent. With these leases, we were able to negotiate contractual annual increases of 2% to 2.5% on the Mainland and 2.5% to 3% in Hawaii, which will provide steady rental income growth. Our scheduled lease expirations and rent resets for 2021 are essentially complete. In 2022, 6.6% of total annualized revenue is rolling, mainly driven by Hawaii where 11.2% of annualized revenue is up for renewal. We remain focused on adjusting expirations in a way that will maximize mark-to-market rent growth while minimizing potential downtime and capital costs. Over the past three quarters, ILPT has signed 12 leases representing approximately 20% of the annualized rental revenue that was scheduled to expire during 2022 in Hawaii.

Beyond 2022, expirations on the Mainland will drive most of our leasing activity. Given the aggressive market conditions resulting from record-breaking net absorption, increased acting rents, low vacancy and new supply constraints, several tenants have engaged us in early renewal discussions. While tenant retention and portfolio is important, we are focused on achieving favorable lease terms that will drive growth within our portfolio.

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

Richard W. Siedel -- Chief Financial Officer and Treasurer

Thanks, Yael, and good morning, everyone. Total portfolio same-property cash basis NOI for the third quarter increased 3.4%, driven by a 6.7% increase in Hawaii and a 50 basis point increase on the Mainland. The increase in Hawaii was a result of new leasing activity that Yael discussed on this call as well as prior calls, combined with higher occupancy year-over-year. The Mainland increase was primarily driven by contractual rent steps in our leases, but partially offset by one time repair and maintenance expenses. This same-property performance along with year-over-year decreases of 9% in general and administrative expense and 30% in interest expense contributed to third quarter normalized FFO of $30.3 million or $0.46 per share. Adjusted EBITDA for the quarter came in at $41.2 million, and we ended the quarter with debt-to-EBITDA of 5.8 times, which is approximately 1.5 times lower than what we reported a year ago and up modestly compared to the prior quarter as a result of our Memphis portfolio acquisition. We spent approximately $3.4 million on capital expenditures during the third quarter. Slightly more than half of this capital related to tenant improvements and leasing costs, while the remainder was spent on recurring capex for building improvements throughout the portfolio.

Earlier this month, we declared our regular quarterly distribution to shareholders of $0.33 per share to be paid on November 18 to shareholders of record on October 25. This equates to an annualized dividend yield of 4.7% based on this morning's share price. Our dividend remains well covered at a normalized FFO payout ratio of just 72%. As of September 30, we had approximately $440 million in total liquidity, including cash on hand of $44 million and availability on our revolving credit facility of $396 million. That concludes our prepared remarks.

Operator, please open up the line for questions.

Questions and Answers:

Operator

[Operator Instructions] Our first question today comes from Bryan Maher with B. Riley. Please go ahead.

Bryan Maher -- B. Riley -- Analyst

Good morning. A couple of questions for me. Maybe start with Rick. I think your credit facility comes due later this year. What are the thoughts there? Is the plan to put a new one in place, extend the existing one? Can you give us a little color on that?

Richard W. Siedel -- Chief Financial Officer and Treasurer

Sure. I guess the main thing, Bryan, is to point out that we still have some flexibility. We do have two six-month extension options. So we have enough -- over a month to decide on whether to exercise those options or not. But as you can imagine, we have started talking to our banks about the facility, and we'll likely make a decision in the next few weeks.

Bryan Maher -- B. Riley -- Analyst

Great. And given your credit metrics and what's going on in the marketplace, and I believe that important, I might have made a comment about this recently. The thought process, I think, when you guys originally spun out was to have a couple of years go by and then maybe seek an investment-grade rating. But I think I recall Adam saying recently that the bond market is such that there's so much demand for just below investment-grade rating that it didn't seem as profoundly important as maybe a year or two ago. Are there any thoughts there at ILPT on seeking investment-grade rating next year?

Richard W. Siedel -- Chief Financial Officer and Treasurer

Yes. I think shortly after the IPO, I think that was the direction we were headed, seeking to get investment-grade rating. But I think what we've seen is that there is a disconnect in valuation between the private and public markets and we've been able to raise fairly attractively priced equity capital through using JV partners, and that's something we'd likely continue with versus issuing shares at a substantial discount to NAV. And our thoughts on leverage are kind of similar. Last year, when we deconsolidated the joint venture, certain -- the private markets thought that the 60% of loan-to-value leverage that we had on those properties was conservative. But meanwhile, it was over 10 times debt to EBITDA, and we were under pressure in the public markets to reduce leverage. So it is interesting how the different markets are using leverage differently. So again, with our cost of equity capital, where it is, I think we are looking to utilize more debt. So I wholeheartedly agree with the strategy of using a little bit more debt and that's why you saw our leverage tick up ever so slightly this quarter. But we're going to continue to look to deploy capital accretively.

Bryan Maher -- B. Riley -- Analyst

And then just last for me, and I think Yael might have touched upon this. I believe the new acquisition you made in Memphis has 3.6 years left on those leases. When you acquired the property, I mean, what were the thoughts there with respect to renewing those? Do the current tenants -- are they planning to renew in place? Is the location so good, you're just not worried about it? Can you give us a little color on that thought process? Thanks.

Yael Duffy -- Vice President and Chief Operating Officer

I think it's a little bit of a combination of all of those things. Two of the larger tenants both have below-market rents in relatively short remaining lease term. I think one of the larger tenants, their rents are about 13% below market. The second largest is about 6% below market. We also feel Memphis is a strong industrial market. The buildings are Class A construction. So even if they were to vacate, we feel like our opportunity to release these spaces would be relatively short. So I think it's a combination of all of those factors.

Bryan Maher -- B. Riley -- Analyst

Okay. Thank you. That's all for me.

Operator

[Operator Instructions] Our next question comes from Jason Idoine with RBC Capital Markets. Please go ahead.

Jason Idoine -- RBC Capital Markets -- Analyst

Yes. I think John in the prepared remarks mentioned some potential disposition opportunities. I was just looking for some additional color around that, maybe what markets you guys would be interested in selling out of and what type of valuations you would expect.

John Murray -- President and Chief Executive Officer

I did stumble over a couple of words in the middle of my prepared remarks. But I think you may have misheard me. We're not currently looking at dispositions. We've -- we made the Memphis portfolio acquisition. We continue to look at a pretty good pipeline. So we're focused on growth. We sold the property earlier in the year that didn't really meet our investment criteria. But otherwise, we're generally happy with the portfolio we have, and it's very difficult to replace the yields that we get on the properties currently with better yields in the current investment market. So we're not actually looking to dispose of anything currently.

Jason Idoine -- RBC Capital Markets -- Analyst

Got it. Okay. And how should we think about funding? I know you guys do have some additional buffer here before you get to the low end of that leverage target. But if you guys are active making investments, how should we think about that more longer term? What are the types of sources of capital? And how comfortable would you be leverage tick up toward the higher end of the range?

John Murray -- President and Chief Executive Officer

I'll let Rick fill in behind me on this one. But I think we're comfortable with leverage ticking up, as Rick indicated earlier, and using a little bit more leverage than where we had brought it down to. We do have an off-balance sheet joint venture. Our joint venture partners, being sovereign wealth fund-type investors, move a little bit less quickly than publicly traded REITs move. And so they're evaluating the possibility of taking on some of the properties that we've recently acquired. So I think we have a plan there that may take some time to roll out. But where we would, I guess, going back, maybe the same goes back to your disposition question. To the extent we disposed of properties, we would sell them into our joint venture and retain the 22% interest. And so we would use the proceeds from that process to pay down our line and provide more bandwidth for executing on acquisitions.

Jason Idoine -- RBC Capital Markets -- Analyst

Got it. Thanks.

Operator

Ladies and gentlemen, this will conclude our question-and-answer session. I'd 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

Thanks again for joining us today, and we look forward to speaking with many of you at the virtual NAREIT that's coming up soon. So thank you.

Operator

[Operator Closing Remarks]

Duration: 20 minutes

Call participants:

Kevin Barry -- Investor Relations

John Murray -- President and Chief Executive Officer

Yael Duffy -- Vice President and Chief Operating Officer

Richard W. Siedel -- Chief Financial Officer and Treasurer

Bryan Maher -- B. Riley -- Analyst

Jason Idoine -- RBC Capital Markets -- Analyst

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