Duke Realty’s (DRE) CEO James Connor on Q4 2017 Results – Earnings Call Transcript

Duke Realty Corp. (NYSE:DRE) Q4 2017 Earnings Conference Call February 1, 2018 1:00 PM ET

Executives

Ron Hubbard – Vice President of Investor Relations

James Connor – Chairman and Chief Executive Officer

Mark Denien – Chief Financial Officer

Nick Anthony – Chief Investment Officer

Analysts

Manny Korchman – Citi

Jeremy Metz – BMO Capital Markets

Ki Bin Kim – SunTrust Robinson Humphrey

Blaine Heck – Wells Fargo Securities, LLC

John Guinee – Stifel Nicolaus & Co

Rich Anderson – Mizuho Securities

Eric Frankel – Green Street Advisors

Richard Schiller – Robert W Baird

Jamie Feldman – Bank of America

Michael Mueller – JP Morgan

Michael Carroll – RBC Capital Markets

Michael Bilerman – Citi

David Rodgers – Robert W Baird

Operator

Ladies and gentlemen, thank you for your patience and standing by. And welcome to the Duke Realty Quarterly Earnings Conference Call. At this time, all of the participant phone lines are in a listen-only mode, and later there’ll be an opportunity for your question. [Operator Instructions] I’d also like to remind you that today’s conference is being recorded.

And I’d now like to turn the conference to Vice President of Investor Relations, Ron Hubbard.

Ron Hubbard

Thank you, Justin. And good afternoon, everyone, and welcome to our fourth quarter earnings call. Joining me today are Jim Connor, Chairman and CEO; Mark Denien, Chief Financial Officer; and Nick Anthony, Chief Investment Officer.

Before we make our prepared remarks, let me remind you that statements we make today are subject to certain risks and uncertainties that could cause actual results to differ materially from expectations. For more information about those risk factors, we would refer you to our December 31, 2016, 10-K that we have on file with the SEC.

Now for our prepared statement, I’ll turn it over to Jim Connor.

James Connor

Thanks Ron, and good afternoon, everyone. Let me start by that 2017 was another outstanding year for Duke Realty. We exceeded all of our beginning of the year goals including completing the transformation of the company that evolved over the last eight years to what is now the largest domestic only pure play industrial REIT. We also kept off the year with an excellent fourth quarter from an operational and financial perspective that sets us up for a great start to 2018.

Let me recap our outstanding year. We signed nearly 24 million square feet of leases which are impressive given our all time high occupancy levels. We improved stabilized occupancy to 95.8%, up from 98.1% at yearend 2016. We grew same property NOI at 4%. We attained over 19% rent growth on second generation leases. We commenced $866 million in new development starts that were in aggregate 60% released. We completed $3.1 billion in property dispositions culminating in the sale of our medical office platform at a much better than expected 4.65 cap rates. We sold $66 million of non strategic land and monetize another $226 million through our development activity. We recycled the majority of the capital received from disposition accretively into industrial investment, de-lever the balance sheet and returned a portion to our shareholders in the form of $0.85 per share special dividend.

We also deferred some of the sale proceeds in the form of seller financing to minimize dilution and fund the future investments. Even as the results of shrinking the company in the short term for stronger future growth, we were still able to grow AFFO on a share adjusted basis by 3.8%, and increase our regular quarterly common dividend by 5.3%. Now let me turn to our leasing and development results from the fourth quarter. We had our strongest quarter of the year for with 7.8 million square feet of leases executed. We signed 19 leases in excess of 100,000 square feet individually, demonstrating the continued strong demand for mid sized and large basis. We also signed 4.3 million square feet of renewal leases including Electolux in Chicago for $960,000 fee prime distribution in Indianapolis for $1.2 million square feet and ConAgra in Northern California for $727,000 fee.

Turning to our development activity in the fourth quarter. We started $207 million of projects. We started 368,000 square foot 44% pre released facility in Houston at our Gateway North Business Park. On the speculative development side, we started two deals that were both at Tier 1 markets. The first project is a 282,000 square foot facility in the Inland Empire West submarket and the second project is the 659,000 square foot development in the Newark submarket of New Jersey, just north of the Newark airport, a land we acquired during the quarter as a part of the Bridge portfolio acquisition.

Our development pipeline at yearend is $676 million and 63% pre released and is expected to generate GAAP yields of 6.4% with margin in excess of 20%.

I’ll now turn it over to Nick Anthony to cover the acquisitions and dispositions activity for the quarter.

Nick Anthony

Thanks Jim. We had a very active quarter on both acquisitions and dispositions. Building dispositions total $248 million in the fourth quarter, the largest of which was the final assets sold as part of our MOB sale. Also included in fourth quarter dispositions was our suburban office building located in the South Florida and the final sale in the quarter was a non strategic industrial property in Columbus, Ohio.

Turning to acquisitions. We closed $367 million during the quarter. The majority at the fourth quarter acquisitions comprised five assets in Northern New Jersey totaling 1.8 million square feet which represents the final closings of the Bridge portfolio we announced last quarter. We also acquired a 100% lease two building portfolio totaling 772,000 square feet in the Port submarket in Houston. Finally, we acquired a 100% lease 71,000 square foot facility in the south based submarket in Southern California. As noted last quarter, the 3.4 square foot Bridge portfolio was 58% leased when we agreed to terms when we had signed and we had signed additional leasing to bring it to roughly 70% leased at the time of the various closing phase in late Q3 and Q4. While we underwrote to stabilize the assets 12 months from the acquisition day, the markets are very strong and market rent growth exceeded our original expectations. We are now 80% leased and in active lease negotiations on two more spaces in the portfolio, which would bring the occupancy into this portfolio to over 95%.

Lastly on the Bridge transaction. Let me remind everyone how unique and opportunistic our acquisition of some of these assets is for Northern New Jersey. In the Meadowlands submarket they are roughly 1,300 building yet only 18 of them are 1997 or newer with 30 foot or greater clear height. In the Newark submarket there are 730 building but only 4 are 1997 or newer with 30 foot plus clear height. Obviously, all the buildings we acquired at this criteria making them truly unique assets for this high barrier submarkets.

I’ll now turn it over Mark Denien to cover our earnings results and balance sheet activities.

Mark Denien

Thanks Nick. Core FFO for the quarter was $0.30 per share compared to core FFO of $0.30 in the third quarter of 2017 and $0.31 per share in the fourth quarter of 2016. The slight decrease to Core FFO compared to the fourth quarter of 2016 was due to the temporarily dilutive effect of the medical office disposition. The impact of the medical office disposition was largely offset by improved operational performance, new properties being placed in service and lower interest expense. We reported core FFO of $1.24 per share for the full year 2017, compared to a $1.20 per share for 2016. The impact of the lower interest expense achieved through using dispositions proceeds to significantly reduce leverage in 2017 improved operational performance and new properties being placed in service which more than enough to offset the dilutive effect of the medical office disposition.

We reported FFO as defined by NAREIT of $1.27 per for the full year 2017, compared to a $1.21 per share for 2016. In addition to the factors driving the increase in core FFO, FFO is defined by NAREIT also increased due to lower losses on debt extinguishment in land and premature use in 2017 compared to 2016. AFFO totaled $399 million for the full year of 2017 and $84 million for the fourth quarter. Our annual results represented roughly a 4% increase to AFFO on a share adjusted basis which is impressive given the short-term dilution from the MOB transaction.

Same property NOI growth for the three months and twelve months ended December 31st, 2017 was 3.2% and 4.0% respectively. This growth is mainly the result of increasing rental rate within our same property population as occupancy and its portfolio for the quarter was down 20 basis points compared to previous used quarter and for the full year was up only 40 basis points compared to previous years.

With regard to capital activities during the quarter. We issued $300 million of 10 year unsecured notes n December, to bear interest of 3.375%, earlier in the quarter if we previously announced we extended our $1.2 billion unsecured revolving credit facility from January 2019 out to January 2022 at a current variable rate of LIBOR plus 0.875%. These capital transactions improved our weighted average cost to borrowing and will allow us ample capacity to fund future growth of approximately $1.2 billion to $1.4 billion without any equity need, while still maintaining our leverage metrics within our current ratings level. We finished the quarter with no outstanding borrowing on our line of credit and have no significant debt maturities until 2019.

Now I’ll turn the call back over to Jim to discuss our outlook for the coming year.

James Connor

Thanks Mark. From a macro outlook perspective we expect the economic environment in 2018 to improve over 2017. GDP forecast are in the mid to high 2% range with some probable upside from the recent tax cuts. The secular growth trends in ecommerce sales continue to be very strong. We continuing forecast in the mid to high teens percent growth for 2018. Similar to the last few years, we believe moderate but increase in GDP growth and continued double digit growth in ecommerce will drive outsized demand for modern industrial logistics facilities.

In 2017, demand continues to outpace supply. Nationwide vacancies continue to decline to an all time low of about 4.4%. Other demand indicator for industrial real estate remains positive as well. Port container traffic was up 6.6% year-over-year and interposal rail volume was up 2.1% year-over-year. Also some of this week’s general economic reports bode well for growth in 2018. For instance, the Commerce department noted consumer spending accelerated at 3.8% on an annualized basis during the fourth quarter, the fastest rate in three years. In addition, consumer confidence reported was stronger than expected in January hovering near 17 year high. These dynamics contributed to year-over-year rent growth in the 5.5% range, a bit below 2016 levels but still very strong. Sitting here a year ago we expected to reach supply demand equilibrium by about this time. However, demand exceeded our expectation and supply has been more disciplined during the cycle as we previously discussed. Our industrial outlook for 2018 continues to be favorable based on strong demand and adequate governors on supply. We expect absorption to outpace supply and vacancy to maintain the current trend down to the low 4% range and expect rent to grow in the mid to high single digits depending on the market. These dynamics have still favorable for us to drive portfolio rent growth, maintain our high occupancies and strong leasing volumes for the foreseeable future.

With this macro perspective in mind, yesterday we announced our range for 2018 core FFO per share of $1.27 to $1.30 with a midpoint of $1.27. In addition, we announced a range for NAREIT defined FFO per share of a $1.24 to $1.32 with a midpoint per share of a $1.28. We also announced growth in AFFO per share basis to range between 2.7% and 8.2% with the midpoint of 5.5%. As we have mentioned before the timing of last year’s asset sales and redeployment of the capital is expected to produce modest earnings growth in the first half of 2018, with acceleration in the second half of the year. In fact, we expect earnings in the second half of 2018 to be approximately 5% to 8% higher than the first half of the year as our newer development and acquisitions that were funded with MOB proceeds become stabilized. We think this growth rate we expect to achieve in the second half of the year is more indicative of our ability to grow earnings moving forward.

Now Mark will touch on a few key performance metrics outlined in the 2018 range of estimates which is in exhibit at the back of our supplement package and available on our website.

Mark Denien

Yes, thanks, Jim. Our average stabilized in-service portfolio occupancy range is expected to be 97.1% to 98.1% which compares to the 98.1% record average we experienced in 2017. The slight decrease we expect for 2018 is due partly to the current un-stabilized project that will reach their one year in-service state at some point in 2018 and then move into our stabilized portfolio, but are not expected to be fully leased at that time. Same property NOI growth is projected in the range of 3.25% to 4.75%. The base case for this assumes a slight occupancy decline from our current record levels. In addition, we continue to expect strong rental rate increases from both embedded lease escalators as well as re-leasing efforts on the approximately 7% of our total portfolio square footage that expires during the year.

Also keep in mind that we will benefit from all the rent growth we achieved on 2017 rollovers as the impact from those transactions will not be fully reflected until 2018. I’ll point out that as we disclosed in our press release a few weeks ago, we are changing our methodology for the pool of properties to make up distinct property NOI growth calculation. We will no longer include un-stabilized properties that were in-service at the beginning of the prior year. But rather will only include properties that were stabilized at the beginning of the prior period. We expect this change in methodology to have 20 to 80 basis points negative impact on a reported same property growth depending on the level of un-stabilized properties in the service portfolio. Our reported 2017 full year same property growth of 4.0% would have been 3.2% under this new methodology. In comparison, the midpoint of our 2018 guidance of 4.0% represents an acceleration in same property NOI growth over 2017 levels which using the same methodology.

Separately with respect to same property NOI we expect to see an approximately 35 basis points positive impact from the 2017 hhgregg bankruptcy. This is in part of an offset of the negative 50 basis point impact from this event on 2017 same property NOI. It is not 1 for 1 reversal due to the timing of 2018 lease commencements and some free rent. In regards to overall NOI growth potential, keep in mind including recently completed development projects that are not yet included in our same property population along with our current development pipeline, our total portfolio upside to NOI from the fourth quarter of 2017 is approximately 17% to 18%.

On the capital recycling front, we expect proceeds from building dispositions in a range of $300 million to $500 million. The majority of these dispositions will come from two small portfolios that we expect to sell by early in the second quarter. The first is the three building portfolio datacenters that we built and are leased to Amazon in the Washington DC market and expected to close early in the second quarter. The second portfolio consistent of four buildings in the West Jefferson Industrial Park located in Columbus, Ohio. This portfolio is currently being marketed. One thing to note with this portfolio is that Bon-Ton stores currently comprises 20% of the total square feet of this portfolio. Bon-Ton has been in the news recently with some financial concerns. They are current on all of their rent and this property is critical to their supply chain as referenced in their recently filed 8-K. But regardless of any potential negative outcome on their operations, we do not believe it will have any impact on any of our guidance metrics including same property NOI growth as we expect to sell these properties as part of the portfolio by early in the second quarter.

Acquisitions are projected in the range of $100 million to $500 million focusing on Tier 1 markets. And development starts to project in a range of $500 million to $700 million. This modest decline in development starts from 2017 is largely due to beginning 2018 with a significant backlog of development projects currently under construction as well as continuing a disciplined approach to managing lease-up risk and maintaining our development pipeline in a healthy level pre-leasing. Our pipeline of build-to-suit prospects continues to remain steady.

James Connor

Thanks Mark. In conclusion, as I wrap this up and we turn it over to Q&A. We believe the reposition company, our high quality assets, exceptional balance sheet and the best in class operating team we have put us in a great competitive position to take advantage of the attractive long term industrial fundamentals. With this we are confident in continuing to drive long-term cash flow growth and annual dividend growth for our shareholders. Before we open up the lines, I’d like to acknowledge the entire Duke Realty team leadership for its efforts and producing another great year of execution on our real estate operations and capital activities.

Now we’ll open it up to questions. I’d ask everyone to limit themselves to one or perhaps two short questions and you are always welcome to get back in the queue.

Question-and-Answer Session

Operator

[Operator Instructions]

It looks like our first question comes from the line of Manny Korchman. Your line is open.

Manny Korchman

Hey, good afternoon, guys. Just thinking about acquisitions in 2018 do you think those would mimic the acquisitions you did in 2017 in terms of markets pricing, occupancy levels, age of assets et cetera?

James Connor

Yes. Manny, I think from a general perspective I think we would start off thinking that way. Clearly, I’d like to believe Nick is going to do better and find better properties. But and you know it’s pretty frothy and expensive out there which is why our acquisitions number is at fairly low range compared to years gone by. And we are looking to lot of things in this Tier 1 markets but it’s hard to find things that we think we can justify are creating value. So that’s why the range is a little lower than normal and we are little bit vague at this point in time just simply because we are not sure what we will be able to find.

Manny Korchman

Then maybe one to Mark. If you had to tag a sort of mark-to-market across the whole portfolio where do think that would be?

Mark Denien

Maybe we should just start to try to figure out that I guess Manny since we’ve always say we don’t calculate that because we don’t look out 10 or 15 years on some of our leases. So I’ll give you the standard answer. I think we give every quarter, looking out over the next 12 to 24 months, which we have obviously a lot of good visibility on that, we are expecting rent growth right around the same range that we had in 2017. So call it high teens to low 20s on a GAAP basis and probably mid to high single digits on cash basis. Beyond that it’s average everything beyond that. If I bring that level down a little bit, obviously the longer in the future this rolling the more recently we probably signed the lease so it’s not quite at that level. So it’s probably 500 basis points lower than that maybe.

Operator

Thank you. We have the line of Jeremy Metz. Your line is open.

Jeremy Metz

Hey guys. Jim, I was just wondering if you could give us a little bit more details around your supply and demand expectations. How those are relative to the 2017 levels and then maybe where you think the most vulnerability lies in your forecast?

James Connor

Yes, thanks, Jeremy. It’s — I think we all look at all of these different metrics and every one of them is — it’s just matter of how high they are up. So I think everybody believes we are going to continue to see strong demand. I think some of the weakness in demand that we’ve seen in the last few years is really driven by a lack of available opportunities in the marketplace. So I think we have a lot less concern about supply than we may have had in the last few years. I do not think we reached equilibrium in 2016. I think with the expected growth in GDP and all of these other positive metrics, I think again we will outpace, absorption will outpace supply. And that’s going to drive that overall vacancy rate down into the low 4% range. In terms of where I most concerned, it’s the bigger low barrier market. Right now if you look at Chicago and Dallas and Inland Empire, they all had phenomenal years in 2017 in terms of their net absorption all in the 20 million square foot range. But they also had completions that are slightly more than that. Dallas has probably the biggest gap, which is about 5 million square feet of completions more than net absorption. Now for market of that size 5 million square feet is not all that significant. But a lot of the other Tier 1 market absorption last year outpaced supply. So you’ll continue to see vacancy rates fall. So those are probably the three that are on the top of our list.

Jeremy Metz

Great, appreciate that color. And then the follow up here. Obviously, you posted really strong renewal rate in the quarter over 19%, the foot size at the market is really strong from a demand perspective you just talked about that as well and rents continue to push higher. So as obviously an argument that can be made then maybe you should have pushed harder here. So can you just comment on that and how you think about balancing retention here given the strength in rents?

James Connor

Well, I think we are comfortable that we are pushing pretty good when we are achieving 19% rent growth. Rental earnings, we always have to balance is the rent growth we are getting from a renewal tenant versus rent growth we might get on the next turn. However, you got to factor in the downtime and the increase cost of the transaction. So our guys are pretty sensitive to that. And if you are pushing rents on renewals 19%-20%, I got to believe your eliminating the risk on the roll; I think we are pretty happy with that level.

Jeremy Metz

Make sense.

Operator

Next in queue we have the line of Ki Bin Kim. Your line is open.

Ki Bin Kim

Good morning. Did you guys commented on the cap rate for planned dispositions and the range for acquisitions for next year or I guess 2018 this year?

Mark Denien

No. We didn’t keeping that from acquisition standpoint. I mean we really have no visibility on what is even out there right. I mean it’s not like we have anything hot right now. So no visibility on the cap rate from acquisition other than to say like Jim mentioned, it will probably end market similar to the markets we are doing right now. So it will probably be — probably in the high 4s, low 5s something like that. I don’t know. Nick, do you have anything to add?

Nick Anthony

Well, I don’t think we’ve seen a change in cap rate yet from 2017 so we expecting to be consistent with where they were in 2017.

Ki Bin Kim

Okay. Going back to the same store NOI construct, could you help us just walk through the various levers of how you get to that 4%, specially given that you are partially looking at moderating occupancy and the fact you are not really a rolling whole lot every year. So just curious how you get to that 4%?

Mark Denien

Sure. Let me try that Ki Bin. One thing I think that you need to keep in mind is we gave guidance on stabilized occupancy, that doesn’t necessarily 1for 1 translate to the same property pool. For the stabilized portfolio changes by the day as we either buys a building, sells a building, building reaches stabilization and gets included. So that is a moving portfolio, if you will. But it does come probably pretty close to the same property pool. I would tell you that we expect just a moderator decline in same property occupancy probably not quite to the 0.5% decline that we expect in the overall stabilized portfolio. So something little less than that. So just a little bit of decline in occupancy but then you offset that with the rent bumps we embedded in our existing leases which we average about two on our quarter on our existing portfolio. But the deals that we are doing today and really that we did in 2017 are closer to 3% rent bumps. So you get some pretty good growth there. And then the thing I think people miss is not only that you need to look at the 2018 roll that we have coming at us which seems pretty low at 7% but it’s a level that we quite honestly like, at least from the risk adjusted basis. We do expect very good growth in that 2018 roll but you also got to look at all the deals we did in 2017. And especially when you look at the fourth quarter 2017, we signed by far in a way our highest quarterly leasing in 2017 at 20% rent growth. So you don’t really get any other rent growth from those deals in 2017. It all hits in 2018. So you add all that up and that’s kind of how you get to the 4%.

Ki Bin Kim

Anything unusual year-over-year that would help or hurt?

Mark Denien

No. I think the only probably unusual thing is probably hhgregg. Hhgregg hurt 2017 by 50 basis points should help 2018 by about 35 basis points. It’s all re-lease, we don’t get all 50 basis points back. So there is a little bit of free rent here earlier in 2018 but that’s really the only thing I would point out.

Operator

Next we have the line of Blaine Heck. Your line is open.

Blaine Heck

Thanks. Given the dynamics you talked about with demand continuing to outpace supply. Does it make sense to get a little bit more aggressive as far as spec development goes? And do you think it’s likely you guys could increase start cut and says we progress throughout the year?

James Connor

Blaine I certainly hope so. We have always committed to you guys that we would keep that development pipeline above 50%. I think today we are about 13% above that. So I think as long as we can continue to see good volume and good activity in the marketplace, I think you’ll continue to see us push on the spec side. Our built-to-suit pipeline is also very strong. We did a lot of great volume last year but we didn’t do as many of the big projects as we had historically done. So I think if we were to land a couple of those and we are able to continue to lease our spec space, yes, I think you could see us revive that guidance upward.

Blaine Heck

Okay. And related to that Jim, your land back has definitely decreased pretty substantially over the past couple of years. You’ve got more dispositions planned, a little bit more planned but now you’ve got a lot of cash to put into the development pipeline, do you think you are going to have to be purchasing land more aggressively to feed the pipeline or how should we think about that?

James Connor

Yes, absolutely. And the good news is yes we have been. We bought $240 million of land last year. The good news is we put $226 million in production. So our land inventory is actually up slightly from the low point in 2017. We are actually under $200 million I think we bought it down at about $190 million. And we are back up to about $240 million. So we’ve been able to put some land on the book to New Jersey, South Florida, Chicago and Southern California, Tier 1 markets where we needed some more land to be able to compete for build-to-suit and do some spec development.

Operator

Next up we have the line of John Guinee. Your line is open.

John Guinee

Great. Sometimes you guys are very straight forward and sometimes you talk in code. Mark, thinking about you, when you say that the portfolio NOI can increase 17% to 18% over the fourth quarter number, is that GAAP or cash number?

Mark Denien

Cash number, John. And all this is taken; it’s just fully stabilizing everything that we have in service not just the same property pool. We do have a lot of assets in the un-stabilized in-service. So just stabilizing those and then completing the development projects. So it’s no future development but it does include completion of the current development pipeline we have. You add all that up and NOI on stabilized basis should be 17% to 18% higher than the fourth quarter number.

John Guinee

So it includes acquisitions and dispositions?

Mark Denien

No.

John Guinee

And then you said the basically your FFO guidance is backend weighted 5% to 8% higher. Should I assume that 2018 FFO is maybe $030, $0.31, $0.33, $0.34?

Mark Denien

We don’t quarterly guidance, John. We are just trying to give you a sense for the run rate growth that we are looking forward once we get our balance sheet that closer to what I call the pre-MOB levels which still really won’t even be there by the end of 2018 if you look at our guidance. We’ll still be under levered but I think will be at pretty good position.

John Guinee

Great, okay. And I think someone asked you about the cap rate on the datacenter I think you –did you give that I missed it?

Mark Denien

No, we didn’t.

John Guinee

Can you?

James Connor

Hasn’t closed yet.

John Guinee

I know that Jim.

James Connor

That’s me telling, Nick. No, he can’t tell you.

John Guinee

Call me back, call me later, Nick, thanks.

Operator

Next we have the line of Rich Anderson. Your line is open.

Rich Anderson

Thanks. Good afternoon. So I am going to maybe play a little more cynical role in the dialogue and ask, how much do you have your antennas up? I know Jim you said things are just great, it’s just matter of how great they are but when you start to see this little whispers of occupancy trending down a little bit, I know it’s not much but little bit supply and some very important markets outpacing absorption. To what degree is Duke like at already to be a more significant net seller in advance of some inevitable deceleration in the fundamental picture for logistics and industrial real estate?

James Connor

Well, Rich, I think accelerating dispositions is always one of the levers we can pull. We have talked throughout 2017 and even 2016 where we have accelerated some dispositions because our development volume and our opportunities under development side were better than expected. And so it’s a combination of selling or pruning so more the bottom of the portfolio but at the same time we’ve always harvest some nearly nice gains on some of this big build-to-suit that we’ve done. We’ve sold a number of big Amazon build-to-suits in the last couple of year. That’s a very, very nice pricing. So I think that’s one of the things that we are always watching is what is going on our development front. What is the next couple of quarters look like and is there an opportunity to for us to accelerate development both on the build-to-suit or on an speculative basis, And if so where do we choose to raise the funds to do that. We’ve got lots of room on balance sheet to lever up at still very effective interest rates. Or do we choose to accelerate some of the dispositions.

Rich Anderson

Okay, great. Yes, I mean obviously things are great just looking for second derivative from here but really great quarter of course. Question number two on the Bridge deal, I mean you have some standout quality there in Northern New Jersey. I am curious how that come about in a sense of you happened to have the proceeds from the MOB sale. Was it just kind of almost lucky in the sense that it became available at that time or how would you characterize that and to the extent that there is opportunity similar to that elsewhere in your markets of interest?

James Connor

Well, let me answer this and then Nick can give you some color. This is the tribute to Nick and his team. The opportunity for the big Bridge deal came from a smaller Bridge deal that we did earlier in the year. And it’s a combination of — you are absolutely right, having the capital and proactively outworking in the markets for some of these off market deals. And having a good reputation, our ability to perform with the seller and put this kind of transaction together. Nick can give you little bit more color but that’s why this deal wasn’t widely shot because we had a relationship with these guys. We done a deal and proven ourselves. And we have the capital and I think they believe they got a fair price and so do we.

Nick Anthony

Yes. We knew we would have the proceeds from the MOB sale. And we were working that long before that profit even started in earnest because we knew we have — we’d want to — exchanges and redeploy the capital. And Jim said, we really strategically focused on a smaller deal to get them comfortable that we are performers on a transaction and we do what we said we are going to do. And we worked with them and they worked with us. And it was a great partnership to get the transaction over the goal line.

Rich Anderson

Right. To what degree you are nudging today other folks in a similar way.

James Connor

Now let’s just say Nick is going to get on the phone at 4 O’clock when we are done this all and see if you can find some more deal. That’s a big part of what we are always trying to do and the beauty of where our portfolio is performing today is we can take on spec risk and we can take on development risk. And we are very comfortable with our operating teams and all of those local market and we believe we can underwrite those appropriately as evidences by the fact that we are outperforming even in our own underwriting from the second quarter of last year. So we will continue to look for opportunities.

Operator

Next in question we have the line of Eric Frankel. Your line is open.

Eric Frankel

Thank you. I know this has kind of been beaten to death, just the same-store NOI growth methodology, but could you confirm, Mark? So your 2018 NOI growth, if you had used the old methodology, you would say that it might be 20 to 40 basis points higher than what you’re actually guiding to, is that correct?

Mark Denien

Probably right. Probably towards the low end so it all comes down Eric is you probably know that how many properties you have in that un-stabilized pool under the old method. It’s not there in the new. We have a lot of those last year. So we heard last year’s number by taking those out by about 80 basis points. That’s why we went from 4.0 down to 3.2 on the restated new method if you will. Then you go to the 2017 to 2018 number that we just guided to under the new method at 4.0. I would tell you it probably hurt us probably towards the low end of only about 20 basis points. So we would have probably guided another 20 basis points higher, if we would have included those un-stabilized properties. Because I think we only have four un-stabilized properties 1-1 of 2017. Thereby pulling those out it just wasn’t that significant. But it would have been little bit higher.

Eric Frankel

Okay, that’s helpful. So thanks for the update regarding the potential sale there of some buildings in the — near Columbus. So related to Bon-Ton, I guess, one, are there any of their credit issues that you incorporated in the guidance, just assuming Bon-Ton is not going to — you’re going to sell the asset? That’s my first question related to that.

James Connor

Nothing individually significant, Eric. I would just tell you we kind of took our normal bad debt run rate that we would always do. It was obviously little bit higher in 2017 and normal because of hhgregg. So our guidance is more of a normal probably 20 basis point impact. And other than Bon-Ton which we do have Bon-Ton in Columbus, there is also in about 250,000 square feet in Chicago. But that was also distribution location that they mentioned in the 8-K they filed that they plan on keeping as part of their strategic plan. So we don’t think anything imminent there, you never know but there is nothing other than Bon-Ton that I would consider to be significant. And the biggest Bon-Ton risk we have is in Columbus. Nick can talk a little bit about the pricing but we don’t think it’s going to hold up that transaction at all and be able to sell that by late first quarter early second quarter.

Nick Anthony

Yes. So it’s only about 20% of that portfolio. So it shouldn’t have that dramatic effect on pricing and we don’t know what’s going to happen or when it’s going to happen. So we feel like it’s the right time to go ahead and move forward with the transaction in that submarket.

Eric Frankel

Okay, yes, that should be an interesting bellwether. All right. I’ll jump back into the queue. Thank you.

Operator

Thank you. We have the line of Richard Schiller. Your line is open.

Richard Schiller

Thanks, good afternoon, guys. Can you guys provide the timing for commencement back filing the 3 hhgregg vacancies that in 2017 now that all the 750 square feet are leased?

Mark Denien

Well, they all have commenced I believe right, Jim. So they all commenced, there is — I am thinking out loud here, I think there is one of the spaces was in paying rent kind of early fourth quarter. The other two, one started paying right at the end of the fourth quarter and we got a little bit of free rent on the third space for the first couple of months of 2018.

James Connor

Yes. Richard, I would say of the top of my head and we can circle back and get you the data. I think its October, December and probably February.

Richard Schiller

Got it, thank you. And for the leasing activity in the fourth quarter you guys had a 4.2 million big number of renewals. What percentages would you say are early renewals versus the regular renewals? And do you see that continue into 2018?

Mark Denien

Yes. We had — I would say probably about 30% of that is what I would call early renewals that we pull forward. One of them is close to 12 months early and then the other 70% was probably the normal 1 to 3 months early. So do we see that going forward? Yes, I mean with only 7% of our leases rolling in 2018, we’re already looking at 2019 leases and trying to be proactive.

James Connor

Richard, the other color I would add is the brokers in the service companies had actually been really good at this because what they are telling their client is if you have a mission critical facility and you got a lease rolling in the next three years, you are better off engaging do now than three years from now. And so we have had the ability throughout 2017 to pull forward leases probably as far as 18 months and I think we’ll continue to have that opportunity to pull those forward for all of 2018 and into 2019.

Operator

Next up in queue we have the line of Jamie Feldman. Your line is open.

Jamie Feldman

Hey, thank you. Jim, you sounded even more confident in this time last year on the supply demand equilibrium. And I think you made the comment about even more governors on supply. Can you just talk about what feels different starting this year than it did last year? Especially on those governors.

James Connor

Yes. The first on the macro side. I think everybody’s expectation was before the tax reform was passed, the GDP was going to be 25 to 50 basis points higher just because of the growing strength in economy. I think you factor-in conservative expectations on what this tax reform another 25 to 50 basis points. So I think that’s a big part of it. And then as you look at all the other drivers, it’s just really hard to find a place that is giving you any indication that you are going to see a slowdown on the demand side. I think probably today one of the biggest things that are a governor on the new supply piece is land. And there isn’t nearly the amount of available land, we’ve talked on past calls and meetings at NAREIT about the cost of land going up, the cost and the difficulty to entitle site. Construction cost are probably the least of worries while they are going up, they have been going up at what I would call modest rate or modest increases that we’ve been able to pass through the customers. But I think that’s a big part of it is. You just — particularly in these more land constrained Tier 1 markets, you just can’t go and find a site put it under contract and start build the building.

Jamie Feldman

Okay, that’s helpful. And then as you think about — you mentioned that the Bridge rents are higher and faster than you expected. What are your latest thoughts on stabilized yields from that investment?

James Connor

We haven’t looked at it. But I think when we talked to most everybody at NAREIT, we had underwritten that at just slightly above where we bought or where we sold the MOB at 4.65 or 4.68 and I think depending on the final few leases the rents and everything else, I think we are expecting that to probably work up towards a 4.8. They are all nodding in agreement. So I must be right.

Mark Denien

Well, good rent ups, that’s the initial.

Operator

Next we have the line of Michael Mueller. Your line is open.

Michael Mueller

Hi. Mark, you talked a little bit about the bumps on new leases versus existing leases. I know that partially drives the GAAP spreads but I guess as you are looking out over the next few years, are you expecting a similar GAAP between the cash and GAAP spread or do you think there will be some contraction between the two?

Mark Denien

From state property perspective, Mike?

Michael Mueller

Yes.

Mark Denien

Yes. We don’t disclose really calculators look at GAAP as closely as we do cash. I’d tell you that probably there has been a 50 to 100 basis points GAAP on average between cash and GAAP with cash obviously being higher because of those rent bumps but I suspect what you said is probably accurate, well probably expect that GAAP to become a little tighter as we look forward based on that. The other thing I would point out if you went and looked at 2017, we had a significant GAAP rent growth in those deals that we signed. It’s not fully reflected like I said on a cash basis either till 2018. But when you are doing 20% GAAP deal, it’s really eating into that split. So I think you are probably right that GAAP cash spreads will continue to get closer. But we are more comfortable talking on a cash basis because that’s what we really look at. But I expect to run it.

Michael Mueller

And if you take that conversation and just apply to the leasing spreads as well, would you expect some contraction there as well between in terms of the GAAP size?

Mark Denien

I think all that depends on the length of the lease. I think that’s probably the biggest factor between the two. If just looking at renewal or rollover rent growth, the longer the lease could affect the GAAP a lot more than it could the cash. So said differently, the shorter the lease term I think the closer they get, the longer the lease term they further away they get.

Michael Mueller

Got it. So it sounds like the deals are signing or generally little bit longer on average and you kind of expect them to stay that way.

Mark Denien

Yes. They are pretty typical on rollover deals, you are generally looking five years on a renewal and a new second generation lease a long one 10 years, the development yields are obviously longer than that. But on a rollover deal it should probably in that seven year range on average.

Michael Mueller

Got it.

James Connor

Yes. Mike, the other thing I would to that is one of the benefits of the bigger buildings which we have on our portfolio is the credit tenants that we have tend to make longer term commitments.

Operator

Next up we have the line of Michael Carroll. Your line is open.

Michael Carroll

Yes, thanks. Nick, can you talk a little bit about the types of deals you’re pursuing today? Is there any specific market that you’re focusing on? Or is it just the number of the opportunities that you’re finding?

Nick Anthony

We are almost exclusively focusing on the high barrier Tier 1 market on the acquisition side to balance out our geography. There are a lot of deal supporting around out there right now, they starting to pickup little bit more in the last week or so. But really what we are trying to do is balance out our geography with the acquisitions as we sell that in the non strategic market.

Michael Carroll

And then can you remind us why the Columbus asset was a non-strategic asset? Is that due to the specific asset or that market in general? Would you like to reduce your exposure to Columbus in general?

Nick Anthony

Yes. We want to reduce our exposure in Columbus, that was an older asset that we bought — it was 22 years old and it was sort of one off asset. It is in submarket that we I think acquired back in the 90s to do a build-the-suit. So it was the right time for us to monetize that asset.

Operator

Next we have a follow up question from the line of Manny Korchman. Your line is open.

Manny Korchman

Hey, guys. Just quick one for me. Earlier in the call you talked about the couple of assets coming into the leasing stats from the development pipeline that just simply were, I think you use term under leased at the moment, just given the strength of demand and sort of everything else we talked about which has been lot of positive, what’s causing those assets to take longer lease up and I assumed you would expect it — it is something specific with the asset in the market? Or just something else that we should be thinking about?

Mark Denien

Manny, I don’t know, a lot of — is there any specific assets, obviously we are looking forward. So we just have — we’ve got a lot of still vacancy in that un-stabilized portfolio. So I think we are just trying to be cautious on our guidance there. We still underwrite one year for stabilization on our development. I’d tell on average we are coming in and around right eight months. So we are beating it almost across the board. But when you look at it we’ve got 3.2 million square feet of spec in that population that’s roll ahead. But I think we are just kind of taking a conservative view and say there are maybe few of those assets to lease when they hit that one year period.

Michael Bilerman

Hey, it’s Michael Bilerman speaking. Just quick question on the same store and I appreciate the fact that all you guys got together and set your egos aside and agreed on definitions for all the variables. So thank you for doing that.

Mark Denien

We don’t have egos.

Michael Bilerman

Okay. You said you have to tell every other sector that they should do the same. But you only release the cash same store guidance. Is there a difference on GAAP and will you sort of report those and just so that we should expect, a, about the differential between GAAP and cash and how you will be reporting it going forward?

Mark Denien

No. This is — we’ve work– we’ve been consistent in how we done this since the beginning of time of Michael. What I would tell you is what I told the previous caller, I can’t remember who he was. On a GAAP basis I think you could expect our number to be probably 50 to 100 basis points lower than our cash number on average. But I would tell you that this year I don’t think it will be quite that much. I think it would be probably closer to the cash number because of the significant GAAP rent growth we experienced on leases we signed at the end of 2017. It will be more of a pick up on GAAP basis than it will be for cash in 2018. So we are pretty close to the same number probably for 2018.

Operator

Next we have the line of David Rodgers. Your line is open.

David Rodgers

Hey, good afternoon, guys. I wanted to ask a little bit more about acquisitions and I do get on the call late. So I apologize if this has been asked in a different way. But I heard you talked a little but about the acquisitions but Jim in the past you said you were comfortable doing voyage kind of with or without the MOB sales. Mark I think most recently even in NAREIT you talked about kind of getting leveraged back up and moving back into kind of maybe more normalized range for you guys. But acquisition guidance versus dispositions came out what I would think is fairly conservation development spend or development starts per 2018 or down from 2017. But your comments in general were really robust. So maybe the simplistic portion of the question is do you anticipate beating the acquisition guidance this year? Is that a far stretched in your mind to kind of put much more dollars out to work in the current environment? Kind of given what you have already said.

James Connor

Dave, I would tell you of the development guidance, the disposition guidance and the acquisition guidance, I think the probability of beating the high end of the acquisition guidance is probably the lowest probability. I mean clearly we would like to do more development and we will continue to push. We got room on the amount of spec development just simply because our pre-leasing percentage into the development pipeline is now 63%. So we can continue to do so more spec development and bring that down into the low 50s. We’ve got a good build-to-suit pipeline. We talked earlier about one of the levers we can pull as accelerating dispositions whether it’s older assets that we want to prune from the bottom of the portfolio, or some of our second, third tier exposure like we talked about with Columbus. But I got to tell you much as we saw cap rate compressed in 2017 and the record level of pricing and the amount of capital they are chasing, I just think opportunities for us to find another Bridge at a yield, going to yield of — in the high 4s is — I just don’t think if there is high probability to that. And most of the stuff and as Nick said it’s really near bottom line of activity. But most of the stuff we’ve seen is one off deals, smaller deals. And look, we will continue to do some infill deals in Miami, New Jersey and Southern California. But buying in $20 million and $30 million eclipse doesn’t give you a lot of confidence that we are going to get in excess of $500 million. So that’s probably really long -winded answer but I think that gives you some color. And that was long-winded question. So thanks.

Operator

Next looks we have again line of Eric Frankel. Your line is open.

Eric Frankel

Thank you. Just a couple of quick follow-ups. One, regarding the development on Delancey Street in Newark. Obviously, it looks like that market’s performing really well and should lease up fairly quickly. But obviously, the value per square foot, just given land and development cost there is quite — it’s higher than normal industrial developments. Have you thought about the prospect of doing multi storey at a site like that?

Mark Denien

We did Eric. And that development was a little far down the road for us to seriously look at it. Plus it’s an awfully big building to do multi level. That would have taken it to over a million square feet. One of the reasons the cost is little higher there obviously we got great loading but we did go to 44 clear on spec on there because we think that’s a great opportunity for some of our ecommerce clients to be very close in to the Manhattan area. So we went ahead and spend the extra money for that.

Eric Frankel

Okay. And then just a follow-up question for Mark regarding your office portfolio. Can you just clarify, I thought I heard you say you sold your last office building, but I’m assuming that your non-core portfolio is comprised solely of your smaller office assets that are still to be sold. Is that correct?

Mark Denien

Correct. We sold our last office building in South Florida. Maybe we should emphasis the in, Eric, sorry for that confusion.

James Connor

I want to thank everyone for joining the call. I look forward to seeing many of you during the year at industry conferences as well as getting you out to visit our regional markets. Thank you.

Operator

And ladies and gentlemen, that does conclude the conference for this afternoon. We do thank you very much for your participation and for using our AT&T executive teleconference service. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY’S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY’S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY’S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source Article