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Edited Transcript of DCT earnings conference call or presentation 3-Nov-17 3:00pm GMT

Thomson Reuters StreetEvents

Q3 2017 DCT Industrial Trust Inc Earnings Call

DENVER Nov 7, 2017 (Thomson StreetEvents) -- Edited Transcript of DCT Industrial Trust Inc earnings conference call or presentation Friday, November 3, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Matthew T. Murphy

DCT Industrial Trust Inc. - CFO

* Melissa Sachs

DCT Industrial Trust Inc. - VP of Corporate Communications and IR

* Michael J. Ruen

DCT Industrial Trust Inc. - MD of East Region

* Philip L. Hawkins

DCT Industrial Trust Inc. - President, CEO & Director

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Conference Call Participants

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* Blaine Matthew Heck

Wells Fargo Securities, LLC, Research Division - Senior Equity Analyst

* Craig Allen Mailman

KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst

* Emmanuel Korchman

Citigroup Inc, Research Division - VP and Senior Analyst

* Eric Joel Frankel

Green Street Advisors, LLC, Research Division - Analyst

* James Colin Feldman

BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst

* John W. Guinee

Stifel, Nicolaus & Company, Incorporated, Research Division - MD

* Ki Bin Kim

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Richard Charles Anderson

Mizuho Securities USA LLC, Research Division - MD

* Robert Matthew Simone

Evercore ISI, Research Division - Associate

* William Andrew Crow

Raymond James & Associates, Inc., Research Division - Analyst

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Presentation

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Operator [1]

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Good day, and welcome to DCT Industrial Third Quarter 2017 Earnings Conference Call. (Operator Instructions) Please note today's event is being recorded.

I would now like to turn the conference over to Melissa Sachs, Vice President, Investor Relations. Please go ahead.

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Melissa Sachs, DCT Industrial Trust Inc. - VP of Corporate Communications and IR [2]

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Thank you. Hello, everyone, and thank you for joining DCT Industrial's Third Quarter 2017 Earnings Call. Today's call will be led by Phil Hawkins, our President and Chief Executive Officer; and Matt Murphy, our Chief Financial Officer, who will provide details on the quarter's results and update to guidance. Additionally, Mike Ruen, our Managing Director of DCT's East Region, will be available to answer questions about the market, development and other real estate activity.

Before I turn the call over to Phil, I would like to remind everyone that management's remarks on today's call will include forward-looking statements within the meaning of Federal Securities Laws. This includes, without limitations, statements regarding projections, plans or future expectations. Actual results may differ materially from those described in the forward-looking statements and will be affected by a variety of risks, including those set forth in our earnings release and in our Form 10-K filed with the SEC, as updated by our quarterly reports on Form 10-Q.

Additionally, on this conference call, we may refer to certain non-GAAP financial measures. Reconciliation of these non-GAAP financial measures are available on our supplemental, which can be found in the Investor Relations section of our website at dctindustrial.com.

And now, I will turn the call over to Phil.

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Philip L. Hawkins, DCT Industrial Trust Inc. - President, CEO & Director [3]

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Hey, good morning, everyone, and thanks for joining our call today. We are thrilled to report another strong quarter of operating and financial performance. DCT is fortunate to be in a very dynamic business with an organization, operating portfolio and development pipeline that position us well to continue delivering top-tier results and value creation.

Tenant demand remains strong with significant upward pressure on rents, driven by historically low vacancy rates and rational levels of new supply. Occupancy in our operating portfolio ended the quarter at 98%, a level that was unimaginable a few years ago, but speaks to the strength of our business as well as the quality of our assets and their locations. This very favorable leasing environment is reflected in our rent spreads on signed leases of 24% on a straight-line basis and 10% on a cash basis.

Based on the quarter's strong results as well as our confidence in market fundamentals, we increased guidance for FFO per share and same-store NOI growth, which Matt will discuss in more detail shortly. We also increased our quarterly dividend 16% as we look to maintain our payout ratio at the minimum level required by REIT laws.

Leasing in DCT's development pipeline is on, if not, ahead of schedule and at rents typically more favorable than our initial underwriting. As with our operating portfolio, we are more focused on rents and tenant quality than speed of lease-up. The current development pipeline has a projected yield of 7.2% and an average estimated value creation margin of 43%, representing a very attractive risk-adjusted return on capital. In addition to executing ahead of plan on our current development pipeline, our market gains continue to demonstrate their ability to source new opportunities. While the market for great development sites is competitive, our teams leveraged their knowledge in relationships to identify infill land sites that others may have overlooked because of challenges associated with zoning, impediments, wetlands or environmental issues or adjacent structures that need to be addressed.

To successfully execute our strategies to develop the very vast infill sites in our markets, we are willing to invest our time and our capital to solve these problems, creating substantial value for the process rather than simply buying ready-to-go land, which typically delivers lower returns and value-creation margins.

In short, we have the ability, patience and commitment to take on difficult and time-consuming projects, which allow us to source excellent locations and deliver higher returns.

As I mentioned last quarter, we put several packages of assets on the market to fund our development pipeline and maintain balance sheet capacity. They have all progressed the contract and due diligence stage, with closing expected this quarter or for tax purposes, early next year. Investor interest in the packages has been strong and pricing has surprised to the upside. I believe that given current pricing, selling assets rather than issuing equity is a preferred source of capital that allows us to continually enhance portfolio quality and future per share growth potential and we redeploy that capital in a new higher returning development with excellent returns.

With that, let me now turn it over to Matt.

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Matthew T. Murphy, DCT Industrial Trust Inc. - CFO [4]

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Thanks, Phil, and good morning, everyone. The third quarter was yet another reminder of the strength of our business at DCT. Our occupancy, rent growth, leasing and NOI growth reflect a business and organization that are very well positioned to take advantage of current and future trends in today's logistics world. I will go through some of the details for the quarter and talk about guidance for the balance of the year.

From an operating standpoint, same-store NOI growth continues to be a highlight for DCT. For the quarter, cash same-store NOI grew 10.9% in our quarterly same-store portfolio, well ahead of expectations. This number was enhanced by free rent declining $3.4 million in 2017 versus 2016 and same-store average occupancy increasing 50 basis points to 97.9%.

As I've said before, the benefits of the burn-off of free rent in this portfolio will likely moderate significantly going forward and it's hard to imagine that we enjoy further increases in occupancy. However, even without these components, cash same-store NOI growth would've been 5.3% for the quarter. These very positive results built on the foundation of improving rent bumps and very strong releasing spreads is as good a testament to the strength of our business and our portfolio as I can think of.

Another example to strength and resilience of our business comes from an unlikely source. We experienced several early terminations in the third quarter. In some cases, these were the results of actual or impending bankruptcies, and in some cases, they were orchestrated by our market teams as they constantly look for ways to either unlock the potential of below market leases and/or replace tenants that aren't as likely to remain in the space beyond their maturities.

In total, we got back approximately 450,000 square feet of space related to these early terminations. The bad news is that these events cost us approximately $900,000 this quarter in NOI and FFO as the result of bad debt, lost rent and the write-off of straight-line receivables, of which approximately $600,000 impacted same-store NOI. The very good news is that approximately 350,000 square feet, or almost 80%, has already been released and a positive releasing spreads of almost 40% on a straight-line basis and almost 25% on a cash basis, which will be very beneficial to growth going forward. I think this is an excellent indication of both how little high-quality spaces available in our markets today as well as the creativity our teams exhibit in their pursuit to optimize and accelerate growth.

Before turning to guidance, I want to point out a typo that was discovered in our press release. In the second sentence of the property results and leasing activities section on Page 1, we mistakenly wrote that the impact of acquisitions, dispositions and placing developments and redevelopments and service increased occupancy by 30 basis points, when, in fact, the impact actually decreased occupancy by 30 basis points. None of the actual occupancy numbers were incorrect. I apologize for any confusion.

With respect to guidance, we are increasing and narrowing our 2017 FFO guidance as adjusted to between $2.44 and $2.46 per share, an increase of $0.03 at the midpoint. This increase is the result of better-than-expected operating results, changes in the expected timing of dispositions and a delay in the issuance of long-term debt, each of which I'll discuss in a moment.

From an operating perspective, we are increasing and narrowing our expectations for 2017 average operating occupancy between 97.25% and 97.75%. We are also increasing and narrowing our expectations for cash same-store NOI growth to between 7.5% and 8%.

With respect to capital deployment, we are increasing and narrowing our projections for development starts to between $300 million and $350 million and setting our projections for acquisitions to $82 million, the amount we have already closed this year.

While our teams continue to look for transactions that will be accretive to our portfolio of quality and growth prospects, our guidance does not contemplate any incremental transactions.

With respect to dispositions, we are increasing and narrowing our guidance to between $200 million and $225 million, much of which we expect to close very late in the year. In fact, the closing to some of these assets may be pushed into early 2018 for tax reasons. The combination of more and later dispositions, lower acquisitions and somewhat slower development expenditures in the back half of 2017 has resulted in us delaying the execution of our next debt transaction into 2018.

We began 2017 with an optimistic outlook about our business and with high expectations for financial results at DCT. This has proven to be well founded and even a little understated as our company and our industry continue to establish new heights in terms of occupancy and rental rates.

As we prepare to turn the page into 2018, we continue to have a positive outlook based primarily on the continued strength of tenant demand in general and with the behavior of our own tenants, who are showing their commitment to their distribution networks through their own investment and actions. It's becoming abundantly clear that more and more companies are viewing their distribution facilities as a critical element of their strategic success as opposed to an unavoidable cost of doing business. We believe that this is a trend that is, in many ways, just starting to take shape and that bodes very well for the future.

Let me now turn it over to Rocco for questions. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Today's first question comes from Jamie Feldman of Bank of America Merrill Lynch.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [2]

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Matt, I want to go back to your last comment about it's being abundantly clear that companies are viewing their distribution network as key assets. Can you just give more color on how different it really feels today than maybe earlier this cycle or even the beginning of last year?

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Matthew T. Murphy, DCT Industrial Trust Inc. - CFO [3]

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Yes. I think it manifests itself in a number of ways. So I think, one, you're seeing companies really invest a lot of capital into their own spaces, really enhancing the efficiency of their operations. I think the other one that feels pretty apparent to me is, and we've talked about it frankly a number of quarters a row, is that people are no longer choosing their facilities based on their costs, they're choosing it based on their ability to positively impact their operations. And I really do feel like it is -- it feels like a monumental shift from 5 years ago and it feels like something that is happening at an increasing rate, if you will, even over the relatively short term. And like I said, it manifests itself differently in every customer, but there's a lot of common themes and they're becoming more and more prevalent.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [4]

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Okay. And then for my follow-up, Phil, you were talking about -- you guys are willing to do the work to find land that maybe others can't get a hold of or can't put into service. As you think about your development starts in '17 and you think about your land being as it sits today and the demand profile that sits today, do you think you could have more starts in '18? Or just -- there's just not enough land to do it?

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Philip L. Hawkins, DCT Industrial Trust Inc. - President, CEO & Director [5]

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Yes. We got a pipeline that could generate start activity consistent with '17, plus or minus. The question becomes, can we get it through the approval process quick enough? And will there be leasing in some of the adjacent sites -- sometimes you have a 2-building site, will leasing go according to plan or faster? And will the approval process go according to plan or faster? And that we said this many quarters in a row, the approval process takes longer. And we have been -- it's taken us longer than we've expected in more and more cases. But that's a positive in a sense it's also applying to everybody else as well. I think '18 sets up to look similar to '17 in general, though.

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Operator [6]

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And our next question today comes from Manny Korchman of Citi.

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Emmanuel Korchman, Citigroup Inc, Research Division - VP and Senior Analyst [7]

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Phil, maybe one for you. Just as the space remains strong and as acquisitions become more difficult, do you get sort of more aggressive in your underwriting and try to go outside of where you felt comfortable in the past to make deals happen?

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Philip L. Hawkins, DCT Industrial Trust Inc. - President, CEO & Director [8]

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I mean, price level per foot or whatever maybe, at these current levels would've maybe very uncomfortable 5 years ago, but the underwriting itself relative to current market rents, fairly conservative estimates of growth on those rents, where we've proven to be too conservative actually looking backwards. In estimation of residual cap rates, I think we are viewed to be, by many brokers, on the more conservative side of that. What has changed in our thinking has been growth of income from growing rents is much more dramatic than it was 5 years ago and much more of a driver in how we think about assets. The Anaheim asset we bought this quarter is a great example, where it's a fully-leased building, but in less than -- in about a year, the lease in place rolls and it is 15% below market. So we get it at a fairly quickly below market rents as opposed to waiting 3 or 4, 5 years. We have to hope that your view of the future holds, which sort of gives us really good growth, strong IRRs, assuming some level of residual cap rate that's reasonable and an asset that while we are not stealing it from a price per foot, is Class A, new, irreplaceable in an infill location in a market that's less than 1% vacant. To me, that is a great sort of example or prototype of what we like -- we'd love to do more of those. The problem is, that's the hard part.

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Emmanuel Korchman, Citigroup Inc, Research Division - VP and Senior Analyst [9]

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And then, maybe switching to tenants for a second. You mentioned that cost is less of a factor, is that true across different industries and user types? And if so, how hard do you look at sort of really pushing in place tenants rent to where a different industry might be paying it rather than a similar sort of asset in the market, if that question makes sense?

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Philip L. Hawkins, DCT Industrial Trust Inc. - President, CEO & Director [10]

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I'm going to answer it really on a space-by-space, case-by-case, tenant-by-tenant basis as opposed to industry in generality, but for the most part, I'd say, across the board, demand from traditional uses of distribution space, not just e-commerce, are less price-sensitive and more location- and function-sensitive. Having said that, there are clearly -- a lot of the supply increase that we've seen in the numbers from CoStar and others comes from, what I will describe as commodity locations: South Dallas, South Atlanta, North Atlanta; West, Far West Chicago; Inland Empire East. So clearly, there are tenants that view the trade-off between location and costs differently. But there are -- the preponderance of users across industries are much more location- and function-sensitive and less price-sensitive, which is why when Matt talked about buying tenants out, exactly what we're trying to do or when I say we're trying to be more patient with respect to focusing on tenant quality and rent than speed, because that first lease-up in a development project or the next lease-up in an existing asset is critical. That sets you up for renewal and maybe that renewal comes at a time when there aren't as many tenants out there and you're not as indifferent about renewal or relet. So again, it comes right down to that, it's an on-the-ground decision based on knowledge of the tenant -- knowledge of the building, and more importantly, knowledge of your competitors to push rents.

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Operator [11]

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And our next question comes from Craig Mailman of KeyBanc Capital Markets.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [12]

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Matt, maybe for you, just on the sustainability of rent spreads here, they continue to be really strong. In the past, you've talked about kind of trough rents versus post-trough rents and kind of breakdown there. Could you run through whether any of this is being skewed by kind of prerecession or early post-recession leases coming due? And then, just also on that point, your expiration schedule for '18 is a little bit light in terms of what you actually get at. You talked about taking back some space through early terminations. Maybe give us a sense of what percent of the portfolio you think you could roll in '18 to kind of get at these spreads?

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Matthew T. Murphy, DCT Industrial Trust Inc. - CFO [13]

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Okay. Hopefully, I'll get to all that, remind me if I don't. I think the way I -- the term I use to talk about your first question, which is lease vintage, which is about what are the -- when was the previous lease signed, and that's where you get in to, I think about it as prerecession, during recession and post-recession. I think there's always been, and quite honestly, for a while, I shared the view that the really meaty re-leasing spreads were going to be the function of the ones that were compared against the leases that were signed when we were pretty darn defensive during the trough. And that clearly was true as the recovery was gaining legs. I think what's been very encouraging to me, when I look at third quarter numbers, and I'm going to make the same caveat I always do when you're talking about re-leasing spreads. They tend to be more volatile because they're very, very transaction-specific. But for the first time that I've noticed while I've been looking at this, the post-recession re-leasing spreads were actually very slightly better than during the trough re-leasing spreads. They were both in the 24%, so they were very similar. I think what you're seeing is market rent growth that's going on both for the last couple of years and is happening currently is now starting to catch up to the comparisons of the very low rents we did. So I think -- I do think that dynamic is changing. I think it's reflective of the current market that, based on the lack of available space we've had today, based on all the topics we talked about, you are seeing rent growth, market rent growth being very strong today. And it's -- so I don't think the party's over with regard to re-leasing spreads. I'm not going to break tradition and start predicting what I think they're going to be for any given period of time, but I do believe that there is, assuming that tenant demand stays in the same basic format it is today, there is still quite a bit of legs to that phenomenon. The other comment that you asked or at least that I remember, was with regard to a relatively small amount of space that's still to roll in 2018. And while that's true, I mean, we have about 10% of square footage that's going to roll in '18 on top of about 1% that's left in '17, that's really only a little short of 9% in terms of annualized base rent. The other thing to keep in mind is that part of the reason that number is as low as it is, is because we've addressed a lot of maturities that already happened. We re-leased those spaces in 2017. There is about 2.5 -- a little than 2.5 million square feet of leases that have already been renewed but have not commenced. And so really, the roll is about 14% that will have happened by the time we're done with the year. So in this market, you almost wish you'd have 30% rolling. Our business doesn't play out that way and I'm sure I don't really mean that. And with regard to how can we manufacture expirations, which I think was the last part of your question, you've seen -- I went through some examples of how it can happen, it's a difficult thing to predict because it needs to be the confluence of varying things. So I'm not going to put a number to that because I wouldn't know how, but I'm quite confident that some of it'll happen. And so again, I think that bodes well. It's a great spot to be where you're not only not afraid of expirations, but in some case, you're actively pursuing it. And again, I think that's just a tremendous indication of the way our business is today.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [14]

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That's helpful. And maybe slipping a follow-up here separately on dispositions and so some of this may be addressed in kind of the package you guys have coming, but just looking at the portfolio, do you have a few markets where you have less than 1 million square feet? Kind of how do you view cleaning up the portfolio or cleaning up markets here as you go forward, take advantage of pricing and maybe calling some markets where your bigger exposure that the growth long term may not be as high as some of your COSO exposure?

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Philip L. Hawkins, DCT Industrial Trust Inc. - President, CEO & Director [15]

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Yes, I think, for the most part, our sales process is focused on asset selection as opposed to market selection. In that we sold a building in Northern California, we will -- we sold out (inaudible). I think you'll see us exit a couple of other markets over the next 12 months, including 2 markets there and one of the packages that we have out there now is in due diligence under contract and nearing the end of the due diligence process. I think you'll see us exit 2 more markets. We've said before, I'd prefer not to be in markets that are impacted by tax abatements, property tax abatements that incent new supply and they put the current landlords, current owners at a disadvantage relative to rent growth and NOI growth. So those -- that thinking, from a market perspective, will apply, but for the most part, it's asset by asset. And while we've made tremendous progress on our portfolio repositioning, I think 70% or more of our assets today didn't exist at the IPO, which is, to me, a pretty remarkable stat. It never ends, because assets get older every year. We execute strategies that may maximize value in our view and result in lower growth going forward. Markets change, some markets change. And we need to continually upgrade our portfolio to maintain the company's vitality.

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Operator [16]

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And our next question comes from John Guinee of Stifel.

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John W. Guinee, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [17]

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Phil, if you think about what it is costing you to develop versus this time last year, talk a little bit about how much land has gone up and how much hard costs have gone up in your key markets?

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Philip L. Hawkins, DCT Industrial Trust Inc. - President, CEO & Director [18]

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I'm going to give -- as Mike dialed in, I'm going to give Mike Ruen a chance to answer the question. I can follow as well. Mike, you want to start?

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Michael J. Ruen, DCT Industrial Trust Inc. - MD of East Region [19]

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Sure. Sure. We -- overall, John, we've seen hard cost of construction stabilize a bit. Commodities are now flat. Some of the spikes that we were seeing in contractor margins and in spikes in labor seem to have leveled off. So when you look at just construction cost across the country, we're comfortable and feel it's more predictable today, and we're using a range of about 3% to 5% overall. The wildcard as always, is the land. Not only finding the land that supports our strategy but the cost and the site work that goes with it. So we've seen probably something closer to 10% to 15% pop in land over the last 12 months.

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Operator [20]

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And our next question today comes from Eric Frankel, Green Street Advisors.

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Analyst [21]

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As you'd -- might guess, given kind of the substantial investor interest in the sector, there's a couple of large portfolios coming to market. Can you maybe talk about your criteria for whether you'd consider a larger investment?

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Philip L. Hawkins, DCT Industrial Trust Inc. - President, CEO & Director [22]

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Yes. It starts with what our strategy is today, which is market focus, focus on markets that we believe are -- have higher than average growth relative to national averages. Portfolio quality is very important and then locations within those markets, submarkets that we consider to be good long-term growth opportunities rather than some commodity location where we'll see less rent growth and be less protected as a long-term landowner. So that -- we'd apply that to any particular portfolio and portfolios of that size tend to be somewhat eclectic as you pointed out, actually, in your note, I think it was last night, I think your note was right. They're fairly eclectic and probably not well suited for DCT strategy, for us to go take down a large portfolio and the financing risks that brings on to then have to sort through and keep half or less than half, but -- is a pretty inefficient way to acquire assets, particularly when you have portfolio of premiums in this environment that are probably 5% or more. So it's expensive to acquire a portfolio like that.

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Analyst [23]

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Okay. I'll jump back in the queue. Just a quick follow-up. One market, I noticed, there's a lot of lease roll next year, is Cincinnati. Matt, maybe you can just discuss kind of your portfolio that you have one there, and your prospects for leasing that space?

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Matthew T. Murphy, DCT Industrial Trust Inc. - CFO [24]

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Yes, I think you're right. I mean, it's a factual answer. Cincinnati does have a lot of roll next year. I think the only known move out, I know, we've got basically 225,000 square feet that rolls, I believe it's in October, I think October 31, it actually rolls in November. We're pretty sure we're getting that space back. Beyond that, I think the team really likes the assets that we have, that are -- the space that's coming due. The market is very tight, particularly for high-quality space. There's the Kentucky, Cincinnati, it's not a homogenous market. And I think we really like the space that we have in general, but it's specifically the space that we're getting back. So there's a lot of work to do. We got a team that I think is ready for it and the market is going to be receptive to it. Like I said, they do have the largest known move out that I know of in our portfolio, but all in all, I think it's a good time to be getting space in Cincinnati, if it's ever a good time to get space.

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Operator [25]

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And our next question comes from Blaine Heck of Wells Fargo.

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Blaine Matthew Heck, Wells Fargo Securities, LLC, Research Division - Senior Equity Analyst [26]

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Just following up on John's earlier question, how do you think about the effects of rising construction costs on yields, just as we think about your recent starts and looking forward into 2018?

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Philip L. Hawkins, DCT Industrial Trust Inc. - President, CEO & Director [27]

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Well, they're certainly baked into our projections and one of the benefits of having tied-up land, most of the -- all of our '18 starts will be on land we control today. And so as a result, we've got visibility. Certainly, construction costs are going to move up, but as Mike said, they're fairly well stabilized at this point. Some are predictable. We have fairly, I think, conservative contingencies as well for cost increases due to either prices or to encountering unexpected issues in the development process. So to me as an owner, we are a far bigger owner than we are a developer, it lifts the ceiling for rent growth, which is a significant positive. As you need to develop new space to meet current demand, the cost of that marginal demand -- meeting that marginal demand is going up 5%, 8%, 10%, if you pack it in land. And that is a very good thing for an owner of real estate.

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Blaine Matthew Heck, Wells Fargo Securities, LLC, Research Division - Senior Equity Analyst [28]

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Got it. That's helpful. And then, looks like the implied same-store NOI guidance for the fourth quarter is in the 4% to 5% range. Matt, as you said, you guys are probably not going to see much benefit from occupancy growth at this point. But do you think that kind of 4% to 5% growth is sustainable going forward, given what you're seeing on the rent growth side?

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Matthew T. Murphy, DCT Industrial Trust Inc. - CFO [29]

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Yes, honestly, I do. I think it's -- first of all, your math is right as it usually is. And I think it's probably a little higher than it looks because I know what the fourth quarter of '16 was and you don't. I think we will actually face a little bit of occupancy or potentially, the midpoint of guidance would imply occupancy tailwinds in the fourth quarter. So yes, I keep coming back to -- we're getting to the point where our average bump is pretty generally above 3%. And so it comes down to -- and if you assume a static occupancy, which I'm not saying you should assume, but if you assume a static occupancy, what really is left is re-leasing spreads. And given what we've talked about, that seems like a pretty -- obviously, we're talking about cash here, it seems like a pretty reasonable starting point. Given short-term periods may ebb and flow from that for mix reasons, one of the things that is confounding when you try and compare modeling to the real world is we tend to think of bumps as happening homogeneously during the year, they don't. They happen at generally the one-year anniversary of the last bump or the beginning of lease. I think that's a pretty good sort of logical starting point.

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Operator [30]

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And our next question today comes from Rob Simone of Evercore ISI.

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Robert Matthew Simone, Evercore ISI, Research Division - Associate [31]

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Just wanted to see if you guys have a comment on a theme we've been hearing. And that theme being that given the cost of land and rising construction costs and the relative inability of land, that there's actually an unhealthy, like "unhealthy" level of supply out there. So it's great for landlords like you guys that have boxes in the air because you are driving this crazy pricing power, but have you guys thought at all about like what second-order effects could be down the road from an unhealthy supply environment? Just wondering your general thoughts on that.

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Philip L. Hawkins, DCT Industrial Trust Inc. - President, CEO & Director [32]

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I just want to make sure you think it's unhealthy that there's too little supply being built?

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Robert Matthew Simone, Evercore ISI, Research Division - Associate [33]

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Yes, that's right. The tenant demand is so far outpacing the amount of supply that can be built of institutional quality in well-located areas that -- I guess, it's more unhealthy from a tenant's perspective right now, but are there any like second-order effects that could trip you guys up at some point, if at all?

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Philip L. Hawkins, DCT Industrial Trust Inc. - President, CEO & Director [34]

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I don't think it's a negative at all. In fact, you see supply is fairly healthy and I think both demand in many of our markets. Low vacancy rates and the cost of that new suppliers what is driving rents. It isn't a relatively lack of supply itself. I mean, it's not oversupply, but I don't describe it as tremendously undersupplied either. To me, what's driving rents is tenant choices. Tenants could, right now -- there's plenty of supply in commodity locations in every major market we're in. The lease-up of those buildings -- and they tend to be larger buildings as well, but the lease-up of those buildings is slower despite rents being lower than more infill locations. And to me, that says not that there's some second derivative coming or that's unhealthy, but this has been a significant change in tenant behavior that we've been talking about for now some time and have built our strategy around, which is if they need to be closer to the urban core, closer to their customers, and that is what's driving rent increases because the cost of that supply, the land itself is more expensive, the entitlement is more expensive. It's more timely. It takes more time. All of that is what -- and it is less of it. So clearly, there's a constraint on supply in non-commodity locations, which is very real. But it's a natural outgrowth of where tenants want to be. They want to be in places that industrial hasn't necessarily been before or it's very old industrial product that needs to be redone and it just takes time, and it's expensive. So I don't think -- I'd love to see supply even lower and I wouldn't even worry at all about the negative consequences of that outcome.

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Robert Matthew Simone, Evercore ISI, Research Division - Associate [35]

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Okay. That's helpful. And then just one quick follow-up. Do you guys ever hear -- well, let me rephrase that. So one other theme that we've heard is that it's getting to a point that some tenants, big global tenants that are in many different geographies, both domestic and international, are almost at the point where they're completely agnostic to pricing, which is, again, great for you guys. But just in terms of tenants' cost of distribution facilities within their supply chain, is there a limit to that? Like do you guys have a view on how much upside there could be on that percentage of total cost before like tenants do care again about pricing?

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Philip L. Hawkins, DCT Industrial Trust Inc. - President, CEO & Director [36]

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I think simply we've gotten carried away. I'm not a tenant who is agnostic on pricing in any way, either by the way, they behave or the way they talk. I think it's at last call. These are professional negotiators that are very focused on costs. They're making trade-offs. We need to understand what they're looking for and not necessarily say yes too quickly, but this is a -- they're not agnostic. They're very cost conscious. They just are not willing to go to lower cost submarkets or lower cost product because the performance of that product relative to the supply chain needs or objectives is -- would be less performance. I think -- I just don't -- we're never going to be in a world where we just get a name price and it just that level of -- it just doesn't exist.

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Operator [37]

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And our next question today comes from Ki Bin Kim of SunTrust.

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Ki Bin Kim, SunTrust Robinson Humphrey, Inc., Research Division - MD [38]

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So going back to the lease expiration questions, if I look back about a year ago in your previous supplemental regarding the leases set to expire this year, their average rent was about $4.28 and then if I look at the supplemental this year, what's going to expire for next year is about $4.84. I know there is a market mix change. Obviously, this year or in 2017, you had more Southern California, Orlando, Memphis, and Chicago expiring. In next year, like Eric said, was more Cincinnati, less Southern California. So obviously, a mix change maybe a vintage change. But just curious, given those numbers, do you think the lease spreads that you've been achieving so far are achievable next year?

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Matthew T. Murphy, DCT Industrial Trust Inc. - CFO [39]

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I think -- so this is Matt. Again, but as I said, I don't like to try and predict lease spreads for any period of time. I think mix always matters. So the way I hear you, you mixed 2 concepts. One is re-leasing spreads and one is average rent. And so the average rent of the portfolio is -- or the average rent of leases that are done in any given time is hugely dependent on not only geography but space size, percent of build-out, et cetera. So I think, to me I don't ever try and think in terms of average rent because that's so determined by the individual space we're talking about. I think in terms of re-leasing spreads, I'll go back to what I said a minute ago, which is market rent -- current market rents are growing at very healthy paces, to really, really healthy paces, and there is some distinction between markets. And I think the variability associated with the lease, the comparison lease, the old lease, is getting less and less pronounced as we get further away from the recession. So I think the trends are positive. I don't want to try and compare the actual end result in '17 versus a predicted result in '18. I won't even do that 90 days from now when we're actually giving guidance for '18. I think the environment's very healthy.

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Ki Bin Kim, SunTrust Robinson Humphrey, Inc., Research Division - MD [40]

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Okay. And a follow-up question on the land that you're buying. Can you help me better understand the extra additional yield that you can basically earn from taking more of a risk from beginning to end when the site is ready? And on the flip side, is there actually any downside from buying more challenging land?

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Philip L. Hawkins, DCT Industrial Trust Inc. - President, CEO & Director [41]

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Yes. I'll take that. I'll give you one example. PetroPort, which is a land site we acquired this quarter in Houston, not surprising, but given the name the port submarket of Houston. And you think -- you don't think of Houston as being all that difficult from a land, there's no zoning, so you think, what's the big deal? That site took Justin and his team 19 months, once we had them on a contract to work through, entangled pipeline easements that were below ground, worked with a seller on environmental issues, acquired small pieces that actually, at one point, were owned by all subsidiaries of the seller but a subsidiary has been spun out, so that had to be consolidated. We had to bring utilities to the site. The result of that when we tie it up and even now, today, the land is 40% below what a developer would pay for it ready-to-go today. So that, to me, is a -- and that's not unusual. So even in Houston, we are -- hard for us to compete on land ready-to-go when there's lots of capital chasing easy development. The down -- the benefit, obviously, is we get a pipeline of, in our view, better quality sites and better returns. The downside is twofold. One is that time right now is going to benefit, rents have been growing, but also that could turn on us if the market ever turns. And the second downside is the cost that we're incurring to pursue those entitlements, while a lot cheaper than buying the land itself. There's pursuit costs that are involved, that would be written off. There've been -- and the last, I guess, downside is, once in a while, we're unsuccessful. We've had a couple of sites they're not big -- not huge pursuit dollars where we just didn't -- we got to the end and lost. And that's always a nature of the business we're in. We don't expect about a thousand. We certainly try, but that's the nature of our business. If it was risky and easy, the returns we're seeing wouldn't be available to us.

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Operator [42]

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And our next question comes from Bill Crow of Raymond James.

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William Andrew Crow, Raymond James & Associates, Inc., Research Division - Analyst [43]

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Two quick follow-ups. First of all, just curious -- and maybe this is a question for Mike, but in the areas surrounding the hurricane damaged cities, I wonder if there's any impact yet on construction costs, labor availability, et cetera, as the rebuilding effort takes place?

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Michael J. Ruen, DCT Industrial Trust Inc. - MD of East Region [44]

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Well, there certainly is. I'm sorry, you go ahead, Phil.

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Philip L. Hawkins, DCT Industrial Trust Inc. - President, CEO & Director [45]

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You go ahead, Mike.

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Michael J. Ruen, DCT Industrial Trust Inc. - MD of East Region [46]

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All right. Well -- and we're certainly seeing a spike in costs, but as you might imagine, it's limited to smaller, one-off contractors that are able to go in and command a much higher price than they normally would for basic services. The impact to us and our peers with respect to commercial and industrial, it really has not, because the brunt of the storm actually hit much further south in Miami, in the Keys, in particular, Islamorada and south of Big Pine. So they got some real devastation. So it's been very minimal as far as the overall impacts on construction. I would add though that we are all extremely fortunate in the path of the storm that it really missed us and came up via the central part of the state. So we did not have any flooding. And in fact, there was not one insurance claim that impacted our portfolio. So we were very fortunate.

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William Andrew Crow, Raymond James & Associates, Inc., Research Division - Analyst [47]

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Okay. Second, the comment you made earlier, Phil, that you'd rather fund your development pipeline with asset sales than issuing equity. Is that a statement on your part that private market valuations are still above public market valuations?

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Philip L. Hawkins, DCT Industrial Trust Inc. - President, CEO & Director [48]

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No, not necessarily. I think -- I'm not going to argue that our overall stock price is below NAV. I do think though that the benefits of continually upgrading your portfolio have -- were lessons everyone can learn from the past and something we believe the last 10 years as we took the company public, that you only need to manage that portfolio. It's not to say we won't issue equity. We have in the past. It's not an absolute yes or no on equity, it's just we have a bias towards selling assets first as we get them leased and where we think maximizing value and growth relative to the future, we'll sell those assets, and I'd much rather do that. And so individual assets then sell a small piece of the company via an equity issuance. But on the other hand, equity has its benefits, it's quicker, certainly less dilutive, but we will continue to use both over time, with a strong bias towards asset sales because of the portfolio of quality benefits.

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Operator [49]

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And our next question comes from Rich Anderson of Mizuho Securities.

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Richard Charles Anderson, Mizuho Securities USA LLC, Research Division - MD [50]

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So earlier in the call, somebody identified the packages that are out there for potential sale are eclectic, and you agreed with that sort of comment. Are your packages eclectic, too, those that you're attempting to sell?

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Philip L. Hawkins, DCT Industrial Trust Inc. - President, CEO & Director [51]

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Well, first -- the last question is more about the $1 billion-plus portfolios that are out there. We're still -- what we think sells best, from an execution perspective, are fairly homogenous portfolios that where the markets are similar, assets are similar in quality and therefore, you maximize -- in our view, maximize execution. In one case, we did consolidate a package into a larger one. It's a $100 million plus or minus package. That was, in our view, to maximize price because there was some portfolio premium benefit because of the homogeneity of it. So yes, we've tried to -- we think we try to keep a focus. But you're getting those big packages, the buyers are thinking differently. And we are not a very effective buyer, I don't think, on $1 billion portfolios, even if they were willing to take stock, it's just not a good fit for DCT. There will be a, I'd suspect, a lot of interest for the -- those packages that are -- that have been talked about in various trade publications and rumor blogs that it just won't be a good fit for DCT.

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Richard Charles Anderson, Mizuho Securities USA LLC, Research Division - MD [52]

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Okay. Fair enough. I was just thinking in terms of how you're marketing your stuff, with that kind of observation in mind, you answered the question. The second is, Matt, you mentioned some of these [BKs] that have happened and you've been able to resolve a lot of that through re-leasing. I'm curious if there's a strategy that can be created around this, assuming a lot of this is bricks-and-mortar retailer-type tenants. Do you think that there's a way for you to sort of seek out these potential problems and sort of orchestrate these opportunities for DCT? Or is that just taking on too much risk?

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Philip L. Hawkins, DCT Industrial Trust Inc. - President, CEO & Director [53]

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We want to. This is Phil, jumping in front of Matt, but -- and I think this is more of a strategic or conceptual comment. We encourage our market teams to actively manage their tenant portfolio. And if we've got opportunities in a strong market to upgrade rent and tenant quality proactively, we'd love to do it, even if...

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Richard Charles Anderson, Mizuho Securities USA LLC, Research Division - MD [54]

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Well, let me just interrupt you. I'm meaning like you go out and buy something with the expressed intention of something potentially going wrong.

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Philip L. Hawkins, DCT Industrial Trust Inc. - President, CEO & Director [55]

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We would love to buy. We'd have a value-add orientation how that might come forward, either in a tenant that's unlikely to renew or we try to get out early. We bought a number of buildings over the last several years where we saw the opportunity to eliminate the current tenant and re-lease it or let the current -- and with the downside being, let the lease expire and they move out. That's been one of many components we think about as we look for value-add opportunities in existing buildings. I guess something we're good at. We're not the only ones, we were good at it. We've got people on the ground, aggressive, creative people and it's a -- one of -- a number of ways you can add value to existing assets.

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Operator [56]

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(Operator Instructions) And it looks like our next question is a follow-up from Eric Frankel of Green Street Advisors.

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Analyst [57]

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Matt, just a follow-up on the same-store calculation. Can you share just the differences between cash and GAAP same-store NOI growth, excluding the free rent burn-offs, I think it's at 5.3% against the 3.5 percentage number?

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Matthew T. Murphy, DCT Industrial Trust Inc. - CFO [58]

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Really, I mean, the primary difference is -- the only significant difference is, our straight-line rent and that manifests itself, both in free rent and in bumps. You can have a little bit of cash versus when you get to the writing off receivables, there can be a slight difference between what's a cash write-off and what's GAAP. And really, those are the only differences, and I think if I heard your question right, between GAAP and cash.

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Analyst [59]

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Yes, yes, yes. Okay. I think -- we asked this question in prior calls. And maybe you can address some of the construction delays that looks like occurred in the development portfolio in terms of when buildings will be completed?

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Matthew T. Murphy, DCT Industrial Trust Inc. - CFO [60]

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Yes. It's interesting. I almost jumped in when we were talking about costs because when we're talking about the costs associated with the hurricanes, costs here I checked for and costs associated with time, I think it's really remarkable to me. So Florida, in particular, you've seen a number of our buildings pushback in Florida, that is entirely a function of the power crews. Both the crews and the transformers, the difficulty of getting those to the sites, has had a meaningful impact on the timing for our assets in Florida. It also had an impact on our asset in Denver, although I don't think we actually pushed the date back because power wasn't the last piece in Denver, but Public Service Colorado sent half of their crews to -- the combination of Houston and South Florida to deal with those issues. We had an interesting situation, I don't want to get into too much detail, in the Stockyards project we had in Chicago, where we had a water hookup, that our plan was approved with the hookup in one place and then when it came time to actually hook up, the water company said, "Well, you can't hook up there." And so there was a long negotiation. It's one we could have solved the problem with cash had we wanted to. So that's kind of a unique situation. Our asset in Chicago, the FedEx facility in Central Avenue, getting the final sort of change orders, touches on the work that they wanted us to do in the facility, I think, took longer than any of us thought. I'm trying to think if there's -- we had some weather issues in Arbor Road in Northern California. I think that's all of them that had any meaningful movement, so I think that sums it up.

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Analyst [61]

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Okay. Mike, while you're on the call, maybe you can just kind of give an update of the market conditions for the regions that you cover? Obviously, Atlanta seems to have pretty healthy level of both supply and demand, but it looks like rents are up at least in the lot of sunbelt markets -- are up pretty big in sunbelt markets, so maybe you can address that?

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Michael J. Ruen, DCT Industrial Trust Inc. - MD of East Region [62]

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Yes, sure. Our markets are all really healthy. And your comment about Atlanta, in particular, Atlanta has really, really been strong the last 3 years in particular, with absorption levels in the mid-teens. Right now, we're projecting net absorption in '17 will outpace '16. The pockets where we're seeing some run-up in supply or, again, what Phil would call more commodity markets, we're not even operating in those submarkets, and that would be the far out Northeast I-85 corridor and the South I-75 corridor. However, if you look at the deal volume, we're not hearing about our peers or competitors worrying too much. They do have stock in those submarkets. But for us, we are -- our strategy is infill. Even the large box that we have underway in Atlanta is close in I-20 location, so it's a big box, but it's infill. But overall, the markets are all really strong.

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Operator [63]

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And this concludes our question-and-answer session. I'd like to turn the conference back over to Phil Hawkins for any closing remarks.

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Philip L. Hawkins, DCT Industrial Trust Inc. - President, CEO & Director [64]

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Hey, thanks, everyone, for joining our call today and your interest in DCT. We had a great quarter, and hope to see many of you at NAREIT in Dallas to talk more about that as well as our outlook for the future. Take care, and if you have any questions, feel free to give Matt or me a call. Bye-bye.

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Operator [65]

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And thank you, sir. Today's conference has now concluded. I want to thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.