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Edited Transcript of DRE earnings conference call or presentation 30-Jan-20 8:00pm GMT

Q4 2019 Duke Realty Corp Earnings Call

INDIANAPOLIS Feb 3, 2020 (Thomson StreetEvents) -- Edited Transcript of Duke Realty Corp earnings conference call or presentation Thursday, January 30, 2020 at 8:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* James B. Connor

Duke Realty Corporation - Chairman & CEO

* Mark A. Denien

Duke Realty Corporation - Executive VP & CFO

* Nicholas C. Anthony

Duke Realty Corporation - Executive VP & CIO

* Ronald M. Hubbard

Duke Realty Corporation - VP of IR

* Steven W. Schnur

Duke Realty Corporation - Executive VP & COO

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Conference Call Participants

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* Emmanuel Korchman

Citigroup Inc, Research Division - VP and Senior Analyst

* Eric Joel Frankel

Green Street Advisors, LLC, Research Division - Senior Analyst

* Frank Lee

BMO Capital Markets Equity Research - Senior Associate

* James Colin Feldman

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

* John William Guinee

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

* Joshua Burr

Scotiabank Global Banking and Markets, Research Division - Associate

* Ki Bin Kim

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Michael William Mueller

JP Morgan Chase & Co, Research Division - Senior Analyst

* Nicholas Patrick Thillman

Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst

* Richard Charles Anderson

SMBC Nikko Securities America, Inc., Research Division - Research Analyst

* Vikram Malhotra

Morgan Stanley, Research Division - VP

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. Welcome to the Duke Realty Quarterly Earnings Conference call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Mr. Ron Hubbard. Please go ahead.

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Ronald M. Hubbard, Duke Realty Corporation - VP of IR [2]

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Thanks, Alicia. Good afternoon, everyone, and welcome to our fourth quarter and year-end 2019 earnings call. Joining me today are Jim Connor, Chairman and CEO; Mark Denien, CFO; Nick Anthony, Chief Investment Officer; and Steve Schnur, Chief Operating 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, 2018 10-K that we have on file with the SEC.

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

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James B. Connor, Duke Realty Corporation - Chairman & CEO [3]

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Thanks, Ron, and good afternoon, everyone. Let me start by saying that 2019 was another outstanding year for Duke Realty. We met or exceeded all of our 2019 goals, including our revised guidance throughout the year. We also capped off the year with an excellent fourth quarter from an operational and financial perspective that sets us up for a great start to 2020 and beyond.

Let me just recap some of the highlights from our outstanding year. We signed nearly 26 million square feet of leases, we maintained our stabilized portfolio at about 98% leased on an average throughout the year, and our in-service portfolio at about 96% leased on average. We renewed 77% of our leases and obtained 29% GAAP rent growth and 12% cash rent growth on second-generation leases for the full year, respectively. We grew same property NOI at 4.7%, which exceeded our revised guidance expectations. We commenced $1.1 billion of new development starts that were 55% preleased, 73% of which were in coastal Tier 1 markets.

We placed $715 million of developments in service that are now 75% leased. We completed $494 million of property dispositions and $217 million of acquisitions. We've raised $575 million of debt at an average yield of 2.85%, including the first U.S. issued green bond offering by an industrial REIT and raised $266 million of equity. We grew FFO per share and AFFO on an adjusted basis by 8.3% and 10.2%, respectively, and increased our regular quarterly common dividend by 9.3%. And finally, we continue to run our company with a most responsible manner in an ESG culture with numerous ESG achievements.

Now let me turn it over to Steve Schnur to cover our -- to cover the fourth quarter and touch base on the market fundamentals.

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Steven W. Schnur, Duke Realty Corporation - Executive VP & COO [4]

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Thanks, Jim. I'll first touch base on the overall market fundamentals. Supply exceeded demand for the quarter by about 7 million square feet and for the full year by about 35 million square feet, which nudged up national vacancy rates from about 4.2% earlier in the year to 4.4% at the end of 2019. We anticipated this happening, and I think it's important to note that vacancy at 4.4% is still about 200 basis points below the long-term average. Market rents continue to grow across the country at about 4% during 2019 over the prior year. The under-construction pipeline at year-end was about 310 million square feet or about 2.1% of the U.S. stock.

As we discussed the last few quarters, there are a handful of submarkets currently out of balance. If we add up the 5 mentioned last quarter and now add North Houston to that watch list, our total NOI exposure to these submarkets is approximately 4.3%, and the tenant roll over the next 2 years in these submarkets for us is less than 1% of our total revenue. So we have now modest, yet manageable exposure to these high-supply submarkets and obviously they're not the focus of our expected 2020 development activities.

Moreover, demand in the U.S. remains very solid nationwide and exceptionally strong in the submarkets we're focused and to grow. In fact, we had our strongest quarter of the year, as Jim mentioned, with 8.3 million square feet of leases executed, which finished a string of 3 consecutive quarters of leasing over 7 million square feet, which was a record for us. We signed 20 leases in excess of 100,000 square feet and 6 leases over 500,000 feet, with an average of all leases signed of 139,000 feet, demonstrating a continued strong demand for well-located spaces across the entire size spectrum. In addition, the average lease term we signed during the quarter was 9.2 years. A few of the more notable lease transaction this quarter were repeat business transaction with customers, including Samsung, Home Depot, Amazon, US Foods and Crate and Barrel.

I'll also highlight an incidence in Northern New Jersey, where our team got in front of a known late 2020 lease expiration. We signed a new lease to backfill a 650,000 square foot facility when it expired in the third quarter of 2020. The new lease has a term of 15 years, had a GAAP rent growth of in excess of 50%. We also had a tremendous quarter on the first-generation leasing side. When excluding build-to-suits, we signed 2.3 million square feet of space and recently completed or still under-development spec projects, all of which outperformed our original underwriting projections by about 3 months on the lease-up and roughly 25% on rental rate. One of these was a 1 million square foot spec project in Southern California that some of you may have seen in our NAREIT property tour in November. It was a 9 parcel land assemblage and took 3 years to entitle. We broke ground in early '19. And by November, before the building was completed, we have signed a lease for the entire building with a major e-commerce retailer.

The second example was in the New Jersey Meadowlands submarket, where we delivered a 660,000 foot spec facility in the fourth quarter and, immediately upon completion, signed a lease with a major e-commerce user for the entire building. We believe this is yet another example of the e-commerce demand for mid- to large-sized facilities as well as our development expertise in densely-populated and infill markets.

At quarter end, our stabilized in-service portfolio was 97.8% leased. The lease activity for the quarter, combined with strong fundamentals, led to another great quarter of rent growth for us with 12% cash and 32% GAAP. And looking at the GAAP rent growth by size, for the full year in 2019, we realized 24% growth for deals under 250,000 feet and 32% for deals over 250,000 feet. We expect rent growth in 2020 to be relatively similar to 2019 by capturing rent upside on our lease expirations over the next 18 months, which continue to be supported by mid- to single-digit market level rent growth and, in general, a mark-to-market in the 14% to 18% range in our portfolio.

We also had a tremendous quarter on development starts in the fourth quarter, breaking ground on 5 projects totaling over $300 million. These include a 665,000 foot build-to-suit for Home Depot in Atlanta near the Hartsfield Airport as well as spec projects in Northern New Jersey and Southern California. Our development pipeline at year-end totaled $1 billion with 74% allocated to coastal Tier 1 markets. The pipeline was 56% preleased and is expected to generate margins in excess of 33%.

One last note on development. As you saw from a recent press release earlier this month, we've established a policy to develop all future facilities to attain LEED certification. Not only will this initiative enhance our own corporate responsibility goals, but it'll help to meet the needs of a growing universe of our customers with sustainability objectives. We also believe over the long term, it will improve the desirability and operating efficiency of our own portfolio.

And with that, I'll turn it over to Nick Anthony to cover the acquisitions and disposition activity for the quarter.

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Nicholas C. Anthony, Duke Realty Corporation - Executive VP & CIO [5]

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Thanks, Steve. We had an active quarter on both dispositions and acquisitions. Consistent with our strategy to increase our exposure to coastal Tier 1 markets, we sold $110 million of assets in the fourth quarter, comprised of 2 facilities in Indianapolis and 1 facility in Columbus, Ohio. In turn, we used a portion of these proceeds to acquire 2 projects totaling $68 million. One of the investments was a 240,000 square foot newly completed asset in South Florida at our Countyline Park in the Medley submarket, a transaction I mentioned on last quarter's call.

The second investment was a 220,000 square foot facility in the East Bay submarket of Northern California. While there'll be some minor dilution from these asset trades initially, we anticipate long-term accretion, given the higher growth profile of the assets we are acquiring. We expect this recycling to continue in 2020 with dispositions mostly in our Midwest markets and potentially a few buildings outside the Midwest to manage tenant exposure.

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

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Mark A. Denien, Duke Realty Corporation - Executive VP & CFO [6]

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Thanks, Nick. Good afternoon, everyone. I'm pleased to report that core FFO for the quarter was $0.38 per share compared to core FFO of $0.37 per share in the third quarter and represented an 8.6% increase over the $0.35 per share reported in the fourth quarter of 2018. Core FFO was $1.44 per share for the full year 2019 compared to $1.33 per share for 2018, which represents an 8.3% annual increase. The increased core FFO for both the year and the quarter compared to 2018 was a result of our continued investment in and lease-up of new developments as well as rent growth on second-generation leases and increased occupancy.

FFO, as defined by NAREIT, was $1.40 per share for the full year 2019 compared to $1.34 per share for 2018. AFFO totaled $476 million for the full year 2019 and $115 million for the fourth quarter. Our annual results represented a 10.2% increase to AFFO on a share adjusted basis.

Same-property NOI growth on a cash basis for the 3 months and 12 months ended December 31, 2019, was 3.7% and 4.7%, respectively. Same-property growth for the quarter was driven by continued strong rent growth, which offset a 40 basis point decline in average commencement occupancy within our same-property portfolio from the fourth quarter of 2018. We anticipate net operating income from non-same-store properties, which was 18.5% of total net operating income for the quarter, will continue to be a source of growth as we lease up recently-developed properties and keep up a robust pace of new development starts. Same-property NOI growth on a GAAP basis was 2.7% for the fourth quarter and 3.3% for the full year 2019.

During the fourth quarter, we issued $400 million of green bonds, the first such issuance by an industrial REIT in the U.S. at a face rate of 2.875%. We also redeemed $250 million of unsecured notes, which were set to mature in early 2021. We now have no significant debt maturities until 2022 and finished 2019 with no borrowings on our $1.2 billion line of credit.

We intend to fund growth in 2020 and beyond, with $111 million of cash on hand at the end of 2019, $110 million that we received earlier this month for the final payment on the seller financing from our medical office portfolio cell. Annual funds available for reinvestment after dividends, which are expected to exceed $150 million in 2020 as well as proceeds from expected 2020 asset sales. With these sources of funding and potentially opportunistic ATM equity issuance, we expect to be able to finance continued growth with a moderate increase in leverage levels.

I'll turn it back over to Jim to provide a macro outlook before I get into our guidance components.

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James B. Connor, Duke Realty Corporation - Chairman & CEO [7]

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Thanks, Mark. From a macro outlook perspective, we expect the economic environment in 2020 to be relatively steady compared to 2019, with GDP forecast currently around 2%, with some potential upside from the recent easing of trade tensions, continued strong labor markets and consumer confidence as evidenced by news earlier this week.

Regarding real estate fundamentals, the supply pipeline today is a bit elevated, but not of material concern, as Steve alluded to earlier. In fact, I'll share a downside statistic that I've done before. If the estimated unleased segment of the 300 million square feet in the national pipeline, which will remain vacant once complete, vacancy rates would only rise to about 5.5%, which is still 200 basis points below U.S. historical averages. Our view is that if we can maintain a steady macro environment as just depicted and the majority of our submarkets remain supply constrained, the overall fundamentals picture is quite supportive of continued market growth and, thus, sets up a positive year for pricing power and new development starts.

With that, let me turn it back over to Mark to discuss our 2020 guidance metrics.

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Mark A. Denien, Duke Realty Corporation - Executive VP & CFO [8]

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Thanks, Jim. Yesterday, we announced a range for 2020 core FFO per share of $1.48 to $1.54 per share with the midpoint of $1.51. We also announced growth in AFFO on a share adjusted basis to range between 3.1% and 7.7%, with the midpoint of 5.4%. Our average in-service portfolio occupancy range is expected to be 95.1% to 97.1%.

Same-property NOI growth is projected in the range of 3.6% to 4.4%. Same-property growth will largely be driven by rent growth as we actually expect a slight decrease to occupancy in our same-property portfolio as we focus on maximizing rent growth when leases roll, which at times may result in temporary periods of vacancy. In addition, we continue to expect strong rental rate increases from our re-leasing efforts on the approximately 5% of our total portfolio that expires during the year. This low level of expiration is a result of our leasing teams being able to accelerate early renewals at very favorable new rental rates. Similarly, we expect to be able to pull some 2020 lease expirations into 2020 -- pull some 2021 lease expirations into 2020 to take advantage of the current environment, similar to what we did in 2019.

On the capital recycling front, we expect proceeds from building dispositions in the range of $300 million to $500 million. The majority of dispositions are expected to come from certain Midwest submarkets as well as some modest pruning-related, managing-tenant exposures Nick alluded.

Acquisitions are projected in a range of $100 million to $300 million with a continued focus on coastal Tier 1 markets. Development starts are projected in a range of $675 million to $875 million with a continuing target to maintain a pipeline at about 50% preleased. Our pipeline of build-to-suit prospects continues to remain robust, and our 2020 guidance is higher than the initial development guidance we provided for 2019.

Our range of G&A expense is $55 million to $59 million (technical difficulty). These G&A levels are slightly lower than 2019, which was impacted by the implementation of a new ERP system.

On the balance sheet side, we expect net debt-to-EBITDA to be in a range of 5.2 to 4.8x and fixed charge coverage should be in a range of 5.0 to 5.4x. These leverage metrics are comparable to 2019 levels. And with the embedded sources of capital mentioned earlier, we expect to be able to finance continued growth, while staying well within the parameters of our current credit rating. More specific assumptions and components of our 2020 guidance are available in the 2020 range of estimates document on the Investor Relations website.

Now I'll turn it back to Jim for final comments.

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James B. Connor, Duke Realty Corporation - Chairman & CEO [9]

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Thanks, Mark. In closing, I'd like to reiterate what a great year 2019 was for Duke Realty, with many all-time first and record highs. As we look ahead into 2020, we remain very optimistic about our ability to replicate the type of results we've been able to achieve since becoming a pure-play industrial logistics company in 2017. With best-in-class operating teams on the ground in all of our markets, our balance sheet, as Mark just alluded to, is as good as it's ever been and positioned to fund our growth well into the future.

The value creation of our development pipeline will create strong earnings growth beyond 2020 at exceptionally high margins. We have developed our ability -- we've demonstrated our ability to grow in the coastal Tier 1 markets and we'll continue to do so. Finally, I'd be remiss if I didn't thank all of my colleagues at Duke Realty for all of their hard work and dedication that has allowed us to achieve the level of success we have. I also want to thank our investors for their continued support and the recognition of our good stewardship of their invested capital.

Now we'll open it up for questions. (Operator Instructions)

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Manny Korchman with Citi.

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Emmanuel Korchman, Citigroup Inc, Research Division - VP and Senior Analyst [2]

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Nick, I think you mentioned this first and then Mark repeated, but you talked about selling assets to manage tenant exposure. Is that managing tenant exposure on weak side where you want to trim those exposures where you think there could be tenant issues? Or is it trim tenant exposure just from the fact that you've gotten too big with some of your larger tenants?

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Nicholas C. Anthony, Duke Realty Corporation - Executive VP & CIO [3]

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It's the latter, Manny. We -- obviously, we have a large tenant that we continue to do a lot of business with. And we have consistently done this over the years, is prune to some of those assets as we continue to do more business with them.

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Emmanuel Korchman, Citigroup Inc, Research Division - VP and Senior Analyst [4]

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And then in terms of managing the relationship between retention and occupancy and rental rate growth, do you guys have a revenue management system in place? Are you building a revenue management system to just sort of control that? Or is it more touch and feel and using your market teams to determine what's appropriate or not?

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James B. Connor, Duke Realty Corporation - Chairman & CEO [5]

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Yes, Manny. We've got part of our budgeting forecasting system. We do have basically downloads that we get with market data and can compare projected deals with what we believe is market rental rate deals to make sure we're getting fair pricing. So we do have that capability.

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Operator [6]

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Our next question comes from the line of Rich Anderson with SMBC.

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Richard Charles Anderson, SMBC Nikko Securities America, Inc., Research Division - Research Analyst [7]

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I couldn't figure out the 1-0, queue, so sorry for that. Anyway, maybe a question for Jim. In the age of e-commerce, there has not been a condition of damaging oversupply. I think that's correct because obviously things have ran from an e-commerce perspective over the past several years. Do you guys have any sense of what that might look like? Because even in a situation of national oversupply now, you're still getting fairly substantial market rent growth. I just wonder what your vision would be of when those trees do stop growing to the sky here. What is it going to look like? Do you think it could be a substantial sort of drop off or more of a sort of an easing type of an event?

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James B. Connor, Duke Realty Corporation - Chairman & CEO [8]

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Well, Rich, let me answer it in a couple of ways. I mean the one correction I would point out is we don't think there's national oversupply. We've all spent a lot of time talking about oversupply being limited to a handful of submarkets in what are otherwise generally pretty healthy markets. And we won't digress into all the different submarkets. But more specific to your question, you have to remember, Amazon and the e-commerce industry was around not to the extent that they are today in the financial crisis. But I think what you're seeing today is their primary activity is their desire to get closer into major population areas, and that's typically not where we're seeing the oversupply. The oversupply is greenfield development in submarkets with low barrier to entry. And I think most of the major e-commerce companies and, quite candidly, the retail companies and the consumer companies already have most of those regional facilities in place that would be ideal for that. Most of what Amazon and the others are looking at today is much closer in -- to drive that last-mile 24-hour fulfillment promise that they made starting about a year ago.

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Richard Charles Anderson, SMBC Nikko Securities America, Inc., Research Division - Research Analyst [9]

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Okay. And so with that in mind, do you see yourselves perhaps moving closer in? Obviously, you have a lot of different-sized categories in the portfolio, but do you have an appetite to get smaller as the e-commerce business evolves over time?

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James B. Connor, Duke Realty Corporation - Chairman & CEO [10]

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Absolutely. I would make a couple of comments. If you've just touched on the highlighted transaction that Steve covered from the fourth quarter, major deals with Home Depot and Amazon in the Meadowlands, I mean you can't get much closer in the tri-state area, a lot of our infill redevelopment in Southern California projects that we have teed up for 2020 in the East Bay, in the San Francisco market and the same in Dade County down in Miami. So you will continue to see us focus on that in those coastal Tier 1 markets. But the other comment I would make, if you -- we get a lot of headlines from the million square footers, and we all love that. But as Steve said in his comments, I think our average deal size in the fourth quarter was 139,000 feet. So it's not about million square footers. We're doing plenty of 75,000 and 100,000 square footers along with the other mix.

We've just been trying to combat for the last couple of quarters that people think the rent growth and the performance of the smaller buildings is better than the bigger buildings. And quite candidly, we just haven't seen that in our portfolio. Not that 24% rent growth in the smaller buildings is bad. It just happens to be better in the bigger buildings, but you'll continue to see us take a very broad-based focus on development. Steve has, from time to time, gone through the development pipeline with people. And we have buildings from 75,000 square feet to 1 million square feet. So you'll continue to see us focus on that.

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Operator [11]

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Our next question comes from the line of Nick Thillman with Baird.

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Nicholas Patrick Thillman, Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst [12]

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It's Nick here with Dave Rodgers. Looking at dispositions, you had like roughly $500 million last year and around $300 million to $500 million this year. Is that a good run rate looking into like 2021?

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Nicholas C. Anthony, Duke Realty Corporation - Executive VP & CIO [13]

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Yes, I would say so. I -- probably a little higher this year. But yes, I would say, that we'll consistently run at that -- those levels for the next few years.

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James B. Connor, Duke Realty Corporation - Chairman & CEO [14]

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Nick, I would add the variable to that is, it all depends what the development pipeline looks like. Our guidance was a little lower at the start of last year, just simply because the markets did not perform particularly well at the end of 2018 going into 2019, but obviously we were able to accelerate development activity over the course of the year, and that's one of the levers we can pull to help fund that development activity has increased dispositions by $100 million or $150 million.

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Operator [15]

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Our next question comes from the line of Jamie Feldman with Bank of America.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [16]

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Great. I want to go back to the supply question. And -- can you hear me?

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James B. Connor, Duke Realty Corporation - Chairman & CEO [17]

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Sure, Jamie.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [18]

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Okay. Good. I want to go back to the supply discussion. So I mean you talk about these oversupply specific submarkets. And I'm just curious, like, in the broader markets, when you have an oversupply submarket, how does that impact fundamentals in the not-oversupply submarkets? Like, our people just completely treating them as different and you're still able to push rents and people aren't pushing back on concessions or anything like that. Can you just give some color on how that's playing out within the same market?

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James B. Connor, Duke Realty Corporation - Chairman & CEO [19]

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Yes, let me start with that and then Steve can give you a little bit more color. Take any of the major metros, take Chicago. And we've talked in the past, although, I would tell you Chicago's kind of off of our watch list, simply because they had a huge second half of the year and took vacancies in that I-80 corridor, down probably 300 basis points. But when you have softness in that market, particularly in the big box side, but you have markets in Chicago like DuPage County and O'Hare, which are probably 20 to 40 miles away, and they suit different customer base. So very few people in our world are going to leave one of those markets to go to the I-80 corridor to take advantage of the softness of the market and drive the prices down. And I think you'd see the same in Dallas, if you were in the DFW market. There's very few people that are going to leave that market and go 30 miles south to South Dallas to take advantage of the softer market. Now it could happen, but, generally, people are where they are because they -- that's where they need to be.

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Steven W. Schnur, Duke Realty Corporation - Executive VP & COO [20]

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Yes. Jamie, I'll add to that is I think an advantage we have with our local operating teams is knowing the markets very well. There is some -- obviously, there's some drafting and some of the tenant rep folks out there try to do the best they can for their clients, but knowing your product, knowing your submarkets, I think, it pays dividends and cases like that.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [21]

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So when you think about your weaker submarkets, are there any that do have more bleed across the entire market? Or it's pretty consistent?

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Steven W. Schnur, Duke Realty Corporation - Executive VP & COO [22]

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No. I mean I think the big metros, if you're looking at, like Jim mentioned, south of Chicago, there's I-80 drag down a little bit in I-55. Again, it depends on the kind of requirement that there is and what the ultimate use of that facility is. I'd say, the same with South Dallas. Again, it depends how far south, what size use it is. You really need to drill into that level of specificity to understand if that's going to affect you or not.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [23]

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Okay. And then finally for me, if you think about your guidance last year, I think you came out at a much lower same-store NOI growth rate than you -- I think you came out at 4.5%, and you're ending -- ended much higher than that. I think you initially guided to like $700 million of starts and you're now finishing the year at $1.1 billion. Can you just talk through kind of how you got to -- how you're getting to your initial numbers for this year? And what the -- what would take it a lot higher or even lower? Just how much conservative is baked into your current estimates?

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James B. Connor, Duke Realty Corporation - Chairman & CEO [24]

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Yes. Jamie, I'll start and then Mark can chime in. We start our budget process literally in August and build it up from there. We think the budget today, and our guidance has, what I would tell you is, the appropriate amount of conservatism in it. It's not overly aggressive. We don't think given everything that we're seeing in the world, it's a time to put an overly aggressive budget out there. What would lead us to be able to outperform like we did last year and the last couple of years since we become pure-play, Steve alluded to, it's build-to-suit activity to keeping that development pipeline above 50% preleased. It's leasing our first-generation spec space as it comes into service or before, keeping that second-generation occupancy up as well with our continued focus on rent growth. So we can continue to do that, which we did last year. That will give us the ability to outperform.

The other thing, which we've talked about earlier is, you got to remember that even if we outperform on the new development starts by, pick a number, several hundred million dollars, that's not going to fall to the bottom line in 2020. That's future growth beyond because those are buildings that we're starting this year. Even if they're build-to-suits, there's very, very little income that's going to come in from those in 2020. So what we're doing is building in growth for 2021 and 2022. But leasing, keeping the pipeline occupied and continue to focus on rent growth, will allow us to continue to outperform in all the metrics.

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Mark A. Denien, Duke Realty Corporation - Executive VP & CFO [25]

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And Jamie, the only thing I would add to that, from a same-property perspective, we had virtually no bad debt or tenant default issues in our same-property portfolio in either '19 or '18. But we believe from a budgetary guidance perspective, it is prudent to build a little bit more of a normalized amount in there. If it doesn't happen and we have another successful year of not having any issues like that, there would certainly be some upside based on that.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [26]

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Okay. So how much -- how many basis points of your same-store growth is? Is that a drag?

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Mark A. Denien, Duke Realty Corporation - Executive VP & CFO [27]

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If you look at occupancy, bad debt, whatever you want to call it, which sometimes are one and the same, it's about 50 basis points.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [28]

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50, 5-0. Okay.

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Operator [29]

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Our next question comes from the line of Vikram Malhotra with Morgan Stanley.

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Vikram Malhotra, Morgan Stanley, Research Division - VP [30]

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Just so on this, the big box, small box numbers you alluded to, I just wanted to clarify the rent numbers that you were giving, the 14% to 18% overall. I'm assuming those were cash rent spreads. And can you give us a sense kind of how that may look across the property sizes? And just related to that, one of your peers alluded to the fact that smaller retailers are now sort of starting to retool their supply chains, maybe lagging some of the larger ones. And so there's a pickup in big box demand. Is that what you're seeing as well?

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James B. Connor, Duke Realty Corporation - Chairman & CEO [31]

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Well, that's one of the things we alluded to in earlier calls is e-commerce has been a great tailwind for us. But the other one that doesn't get nearly as much credit is, as you alluded to, retailers and consumer products reengineering their supply chain because, effectively, Amazon has set consumer expectations at overnight, 24-hour delivery. So if you want to compete, you have to have a supply chain in place that can allow you to do that. So there's been a lot of that repositioning. And that's been obviously another big benefit for us. And then I'll let Steve give you some of the details.

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Steven W. Schnur, Duke Realty Corporation - Executive VP & COO [32]

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I guess I'd add one thing before I get into the rent growth side. Just from a demand standpoint, I mentioned in my comments, it's pretty broad and widespread. I think the category is leading that demand or 3PL, e-commerce, retail, food and beverage, and we saw some auto deals as well this past year. So back to your question on rent growth by size, I'll give you our breakdown. For deals under 100,000 feet for '19, our cash rent growth was 10.6% and our GAAP was 25%; between 100,000 and 250,000 was 10% cash, 24% GAAP; 250,000 to 500,000 was 14% cash and 29% GAAP; and over 500,000 was 16% cash and 44% GAAP. So again, I think as Jim made a comment, very good across the board, in particular, to the assets we own, quite opposite of some of the big box headlines that have been out there in the past.

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Vikram Malhotra, Morgan Stanley, Research Division - VP [33]

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Okay. Great. And then just last one for me. So some of your -- some of the 3PLs have cited maybe slowing down or hesitating to go into certain submarkets or markets, not because of supply or just the absolute level of rents, but more because of labor and the challenges to find labor. Are there any markets that you would -- I don't know, if you want to call it -- if we'd call it a watch list, but any markets where you are seeing tenants just sort of step back and say, "Hey, how do I get this fully operational because of labor issues?"

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James B. Connor, Duke Realty Corporation - Chairman & CEO [34]

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Yes. I mean I guess I think 2 things. One, I think the labor issue and the oversupply issue, there's -- not surprisingly, there is a little bit of overlap there. Labor is a big issue for our tenants. It is something that we take very serious on our side, and we do labor studies on every major parcel land we look at as well as any big exposures we have so that we're prepared in how to address that and whether we want to make that investment as it relates to land. But yes, labor is a concern. And I'd say, if you're looking for specific markets or submarkets, it actually overlays pretty well with the ones you mentioned what we've talked about from an oversupply standpoint.

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Operator [35]

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Our next question comes from the line of Eric Frankel with Green Street Advisors.

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Senior Analyst [36]

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Just per your same-property NOI growth guidance, can you just provide the explanation of what drives the difference between your GAAP and cash same-store NOI growth?

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James B. Connor, Duke Realty Corporation - Chairman & CEO [37]

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Yes, Eric. Probably the biggest thing is if you look at 2020 same property, we added 34 properties to the pool. So these are properties that got stabilized kind of at the end of 2018. So now if you go to 2020, it's the first time you've got 2 full years. So you add those 34 properties in, most all of which were already leased on 1/1/19. So the GAAP rent growth is exactly 0, but you do have some cash rent growth either through some free rent burn off and/or you get the rent bumps at least. So that's probably the biggest factor that's driving that, maybe a little bit bigger than normal gap between the cash and the GAAP number.

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Senior Analyst [38]

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Okay. And then just per your investments this quarter, Nick, I think you always say that the yield you get on acquisition is a little bit lower than your disposition cap rates. But it actually looks somewhat narrow this quarter on a relative basis. Maybe you can provide just some color on the deals you've struck? And what kind of yield you expect in a couple of years on your acquisitions because actually -- 4.8% actually looks fairly high?

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Nicholas C. Anthony, Duke Realty Corporation - Executive VP & CIO [39]

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Yes, it was a little narrower this quarter, partially because it was more of a pure quarter in terms of we're trading industrial for industrial. Some of the other quarters, we may have had some flex assets or some other assets in there that made the spread a little bit wider. And it's also just the mix. We actually sold a couple of Class A facilities in our Midwest markets that got very good pricing. So I think going forward, depending on the mix, you should see a similar results on spreads.

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Operator [40]

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Our next question comes from the line of Frank Lee with BMO.

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Frank Lee, BMO Capital Markets Equity Research - Senior Associate [41]

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You mentioned earlier, you're able to complete a decent amount of early renewals, with only 5% of the portfolio expiring this year. Just want to get a sense of how do you balance decisions on early renewals versus holding off a bit potentially for higher rents?

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Mark A. Denien, Duke Realty Corporation - Executive VP & CFO [42]

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I'll start and then maybe Steve can chime in a little bit. If you look at 2019, we actually kind of doubled the amount of leasing we did on a renewal basis from what was going to expire. So if you look and forecast that that would happen again in 2020, that 5% that's expiring, I think we can actually roll closer to 10% of those leases. The only thing -- and I'll let Steve talk about the economics, how we look at it. But just keep in mind that when we talk about early renewals, for the most part, we're talking a couple of quarters early. We're not talking a couple of years early. By the time the lease comes to -- the lease maturity date comes, if you haven't already got it renewed a quarter earlier, you're going to lose that tenant. So a lot of deals that are going to be expiring in the second and third quarter, we're doing those deals now, and the early renewals we'll be talking about in 2020 will likely be the first half of '21. So they're not extremely early, and then I'll let Steve comment on how we look at it from an economic perspective.

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Steven W. Schnur, Duke Realty Corporation - Executive VP & COO [43]

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Yes. I think from an operations perspective, it's an asset management focus in terms of getting out in front of where our exposure is. But as Mark mentioned, it's -- this is still a landlord's market. So many times, these, what we'll call, early renewal discussions happen from the other side of the table, where the tenant deems their facility is mission critical and they want to make an investment in their facility, they want to lock -- tied up longer term and we welcome those discussions.

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Frank Lee, BMO Capital Markets Equity Research - Senior Associate [44]

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Okay. Also -- and then you mentioned in your prepared remarks that you expect a similar level of rent spreads this year. Are you able to break that down, your rent growth expectations between Tier 1 versus non-Tier 1 markets?

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Steven W. Schnur, Duke Realty Corporation - Executive VP & COO [45]

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It's actually pretty consistent across all of our markets. And a lot of that has to do with lease term, because, obviously, the rents in the coastal Tier 1 markets are growing a lot faster than they are in the noncoastal markets. But we've got a lot of longer-term leases that have several years of embedded rent growth in them. So we're really seeing a pretty consistent rent growth across all of our markets.

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Operator [46]

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Our next question comes from the line of Michael Carroll with RBC Capital Markets.

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Unidentified Analyst, [47]

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This is [Jason] on for Mike. Just a follow-up on Nick and Mark's comments around dispositions. I'm wondering what level of concentration with single tenant you're comfortable with before you begin looking to trim that exposure.

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Mark A. Denien, Duke Realty Corporation - Executive VP & CFO [48]

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Well, we've always said, we would start getting concerned when somebody approach 10%. Last year, our largest single tenant from an NOI perspective was 6% going to 7.5%, I think. And what we're seeing simply because of the amount of business that we have going with that tenant is that number approaching 10%. So we're just trying to be proactive and manage that. Look at our portfolio, look at lease expirations with that tenant and try and select the most appropriate targets to peel out of the portfolio and hopefully get the best pricing on.

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Operator [49]

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Our next question comes from the line of John Guinee with Stifel.

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John William Guinee, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [50]

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Jim, there might be a typo in your financial statements, but it looks like you've reduced your land held for development down by about $95 million in the last 12 months, and you're down around $240 million. If that's correct? And not sure it is. And then you assume, say, $20 per buildable square foot, you're only down to, say, 12 million square feet of development capacity. If those numbers are right, and correct me if I'm wrong, where do you have your land inventory?

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James B. Connor, Duke Realty Corporation - Chairman & CEO [51]

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Well, John, I assure you the numbers are correct. And that's actually -- we finished the year a little lower than we had anticipated. I would have told you 60 days ago that we thought that number would probably be a little bit closer to $300 million, but robust development activity in the fourth quarter and our ability to push some land closings into the first quarter of 2020 gave us a somewhat more favorable balance. You also have to remember, we control land that is under contract. It's not on the books yet or that's under option agreement. So we do have access to more land or just the $240 million that's referenced there.

And I will tell you, and we've all talked about this, land is one of our biggest challenges. We are out every day, pursuing a lot of different sites, particularly, as we've talked about in the coastal Tier 1 markets in the infill markets. And that's an area where we've been able to differentiate ourselves. Quite candidly, the more complicated the site, the better the opportunity for us. So you will continue to see us be very active on the land acquisition side, with the one caveat that, given where we are in the cycle, we're probably not interested in making really huge land bets that are going to take 3 or 4 years to entitle or put into the development pipeline. I just think that's probably a little bit careless at this point in the cycle. But we monetized $360 million to the land last year, doing $1 billion of development. As I said, answering some earlier questions, we can keep the build-to-suit pipeline going. We can keep our occupancies up. We'd sort of like to replicate that, and that will have us out buying another $300 million to $350 million worth of land.

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John William Guinee, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [52]

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Okay. And then Nick or Mark, what was your most recent dividend increase? And where are you up against your dividend payout ratios relative to taxable income? And how much if any gains in the disposition pipeline can be sheltered versus a need to 1031 Exchange them?

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Mark A. Denien, Duke Realty Corporation - Executive VP & CFO [53]

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Yes, John, we -- our last increase was in October. We raised our dividend -- our quarterly dividend $0.02 in October. We're pretty much up against it, quite frankly, but we've been able to shelter all the gains through 1031s. Most of those 1031s have been development because we can 1031 our development. It's somewhat complicated, but we've been able to do that. So we've been able to shelter those -- the gains that Nick's creating through 1031s. 2020 is the last year we have taxable income coming in from the medical office cell. I mentioned in my prepared remarks that we collected the final installment on our note there of $110 million. So that will trigger another gain in 2020 as well. But long-winded answer, I don't think we have to raise our dividend to meet our requirement, but we're pretty close.

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Operator [54]

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Our next question comes from the line of Jamie Feldman with Bank of America.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [55]

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I'm sorry if I missed it. Did you guys say what you think rent growth could be this year across your markets -- market rent growth?

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Mark A. Denien, Duke Realty Corporation - Executive VP & CFO [56]

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Yes, Jamie, I think we said that. Generally, for the next 12 to 18 months, we think rent growth is going to look pretty similar to what it was in '19, kind of that low double digit, kind of around 10% or maybe a little better on the cash and mid- to upper 20s on a GAAP basis.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [57]

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This is your leasing spread or actual -- I'm thinking about market rent growth.

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Mark A. Denien, Duke Realty Corporation - Executive VP & CFO [58]

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Oh, I'm sorry. Yes. I think we said in my comments, Jamie, I think we'll see U.S. market rent growth similar to what we had in '19, which is sort of probably mid-single digits in the middle part of the country, and you'll see some higher single digits to double digits on the coast.

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Operator [59]

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And we do have a follow-up question from the line of Eric Frankel with Green Street Advisors.

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Senior Analyst [60]

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Can you just help me understand how much of your development starts' expectations for '20 is kind of already called for -- or accounted for, excuse me?

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James B. Connor, Duke Realty Corporation - Chairman & CEO [61]

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For 2020, our development starts?

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Senior Analyst [62]

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Yes.

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James B. Connor, Duke Realty Corporation - Chairman & CEO [63]

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I mean I would tell you, short of the build-to-suit side of the house. Obviously, we've got the spec projects identified with land that we either own or control. Our build-to-suit pipeline today looks good, but that's the variable component. If that answers your question?

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Senior Analyst [64]

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Yes.

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James B. Connor, Duke Realty Corporation - Chairman & CEO [65]

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That mix is 50-50. We did 25 projects this year in 2019, I should say, and 13 were spec and 12 were build-to-suits.

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Senior Analyst [66]

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Okay. And then just your -- the timing of some of your Midwest sales this year, is that going to be towards the beginning of the year, end of the year, or is that just kind of dependent on your investment activity generally?

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Nicholas C. Anthony, Duke Realty Corporation - Executive VP & CIO [67]

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It depends on our investment activity, but it will be spread pretty evenly throughout the year. That's sort of how we stage it out. I think we've closed one asset so far this quarter. I think maybe first quarter might be a little lighter, and the second and third quarter will be a little heavier.

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Operator [68]

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(Operator Instructions) And we do have a question from the line of Michael Mueller with JPMorgan.

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Michael William Mueller, JP Morgan Chase & Co, Research Division - Senior Analyst [69]

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I was wondering is the mix of building sizes or would you consider to be infill when it comes to your 2020 development starts. Is that any different than what you saw over the past few years?

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James B. Connor, Duke Realty Corporation - Chairman & CEO [70]

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No, I don't think so. You have to remember, a lot of the infill, the size of the building is driven by the land size. We're simply trying to max out the building. So in one case, it might be a mid-sized building of 150,000 feet, the next one might be 350,000 square feet. So it's not that we're specifically trying to target one size versus the other. On the infill, we're trying to maximize the value. It's really what we're trying to do.

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Operator [71]

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Our next question comes from the line of Nick Yulico with Scotiabank.

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Joshua Burr, Scotiabank Global Banking and Markets, Research Division - Associate [72]

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This is Josh Burr on for Nick. Could you give us a breakout of your current exposure to the Tier 1 markets? And if you could get to that 70% goal this year, given your higher development and disposition guidance? And then can you talk about the development spreads you're getting in the Tier 1 markets? And how you see that trending?

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Nicholas C. Anthony, Duke Realty Corporation - Executive VP & CIO [73]

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Yes, I'll start with that. Basically, on the coastal Tier 1, we moved that from 31% to 37% on a gross asset value basis by year-end of 2019. And we just -- because 75% of our land bank is in coastal Tier 1 markets, we expect that to continue to grow. And then just overall, on Tier 1, the gross asset value went from 59% to 65%. So the noncoastal Tier 1s are basically holding steady, and most of the growth is in the coastal Tier 1s.

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Mark A. Denien, Duke Realty Corporation - Executive VP & CFO [74]

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And then I would just comment on the yields. I think you had a question on the yield spreads. I'd tell you, the margins are still very, very healthy. I think our whole pipeline is at 33% from a margin perspective. I think we expect that to continue. Our yield did come down. It really came down during the year, but that's just a factor of what Nick just went through. It's because more of our development is done now in these infill high-barrier markets. And we're creating a great deal of value, but the yield is lower on a GAAP basis because the cap rates are lower.

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Operator [75]

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Our next question comes from the line of Ki Bin Kim with SunTrust.

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Ki Bin Kim, SunTrust Robinson Humphrey, Inc., Research Division - MD [76]

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Going back to the submarkets that are prone to oversupply, I know you don't have a lot of exposure there. But I'm just kind of looking at that as maybe as a lesson learned for how those markets behave when it is becoming oversupplied. Is it fairly typical to what we've seen in other cycles, like higher TIs or free rent and lower rent? Like what are you seeing in those submarkets?

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James B. Connor, Duke Realty Corporation - Chairman & CEO [77]

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Yes. I think in those submarkets that don't have the barriers to entry that we talked about, you're seeing concessions in terms of free rent starting to creep in, obviously, you're seeing pressure on rental rates. We've seen TIs creep up. So yes, those are the things. I mean I would tell you that the bigger concern, whether it's these handful of submarkets or anything else, a lot of headlines gets talked about relative to supply. I think you need to keep in mind, we still did 185 million feet of absorption for the year and that's better than the historical average of about 175 million. And as long as that number keeps up, we'll continue to see good economics in our space.

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Ki Bin Kim, SunTrust Robinson Humphrey, Inc., Research Division - MD [78]

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Well, what do you think like the net effective rent declines are in those markets?

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James B. Connor, Duke Realty Corporation - Chairman & CEO [79]

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It's hard to say. I mean I think you've probably seen -- probably in the worst submarkets, maybe you've seen 10% declines. But I mean that's a nuance type of stat.

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Ki Bin Kim, SunTrust Robinson Humphrey, Inc., Research Division - MD [80]

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Okay. And just last question. Within your Tier 1 bucket, what submarkets are you in? I guess I should say it this way, are you pretty satisfied with the submarkets you're in within those Tier 1s? Or do you think there's even more kind of movement that you want to do or portfolio reshuffling within those Tier 1 buckets to go into that barrier submarkets?

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Nicholas C. Anthony, Duke Realty Corporation - Executive VP & CIO [81]

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Well, I mean Ki Bin, we're always looking at our portfolio and ways that we can improve it. So there will be times where we may have an asset or 2 that we either got through a portfolio acquisition or something that we've had for a while in a submarket that we may prune out one of the Tier 1s. I would say, it's mostly going to be in the noncoastal Tier 1s if that would occur, not the costal Tier 1s. We're relatively new in those markets, and we're very happy with where those portfolios are situated right now.

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Operator [82]

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(Operator Instructions)

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Ronald M. Hubbard, Duke Realty Corporation - VP of IR [83]

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Well, I'd like to thank everyone for joining the call today. We look forward to seeing many of you during the year at various industry conferences as well as hopefully getting out to our regional markets. Thanks, again.

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Operator [84]

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That does conclude our conference for today. Thank you for your participation and for using AT&T conferencing service. You may now disconnect.