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Edited Transcript of EGP earnings conference call or presentation 19-Oct-18 3:00pm GMT

Q3 2018 Eastgroup Properties Inc Earnings Call

Jackson Oct 23, 2018 (Thomson StreetEvents) -- Edited Transcript of Eastgroup Properties Inc earnings conference call or presentation Friday, October 19, 2018 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brent W. Wood

EastGroup Properties, Inc. - Executive VP, CFO & Treasurer

* Marshall A. Loeb

EastGroup Properties, Inc. - President, CEO & Director

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Conference Call Participants

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* Alexander David Goldfarb

Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research & Senior REIT 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

* Jason Daniel Green

Evercore ISI Institutional Equities, Research Division - Analyst

* John William Guinee

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

* Richard Charles Anderson

Mizuho Securities USA LLC, Research Division - MD

* 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, everyone, and welcome to the EastGroup Properties Third Quarter 2018 Earnings Call. (Operator Instructions)

It is now my pleasure to turn the call over to Marshall Loeb, President and CEO.

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [2]

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Good morning, and thanks for calling in for our third quarter 2018 conference call. As always, we appreciate your interest.

Brent Wood, our CFO, is also participating on the call this morning and, since we'll make forward-looking statements, we ask that you listen first to the following disclaimer.

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Unidentified Company Representative, [3]

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The discussion today involves forward-looking statements. Please refer to the safe harbor language included in the company's news release announcing results for this quarter that describes certain risk factors and uncertainties that may impact the company's future results and may cause the actual results to differ materially from those projected.

Also, the content of this conference call contains time-sensitive information that's subject to the safe harbor statement included in the news release is accurate only as of the date of this call. The company has disclosed reconciliations of GAAP to non-GAAP measures in its quarterly supplemental information, which can be found on the company's website at www.eastgroup.net.

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [4]

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Thanks, Tina.

Our team performed well this quarter. As a result, it was a strong quarter with a continuation of EastGroup's positive trends. Funds from operations came in ahead of guidance, achieving an 8.3% increase compared to third quarter last year. This marks 22 consecutive quarters of higher FFO per share as compared to the prior year quarter. We are especially pleased with third quarter FFO, given that equity raised year-to-date has far exceeded our original budget. The strength of the industrial market and our team is further demonstrated through a number of metrics such as another solid quarter of occupancy, same-store NOI results and positive re-leasing spreads. As the statistics bear out, the current operating environment is allowing us to steadily increase rents and create value through ground-up development and value-add acquisitions.

At quarter end, we were 97.1% leased and 95.7% occupied. This marks 21 consecutive quarters, or since third quarter 2013, where occupancy has been 95% or better, truly a long-term trend. Looking at our specific markets at quarter end, several of our major markets, including Phoenix, Orlando, Los Angeles, San Francisco and Charlotte, were each 98% leased or better; and Houston, our largest market, was 97% leased. While still our largest market, Houston has fallen from roughly 21% of NOI to a projected 14% at year-end. Supply, and specifically shallow bay industrial supply, remains in check. In this cycle, supply is predominantly institutionally controlled. And as a result, deliveries remain disciplined and as a byproduct of the institutional control, it's largely focused on big-box construction.

Our quarterly pool same-property NOI growth was strong at 6.2% cash and 5% GAAP. We were pleased with average quarterly occupancy at 95.7%, up 50 basis points from third quarter 2017 while rent spreads continued their positive trend, rising 5.6% cash and 16.6% GAAP, respectively. Further, our year-to-date GAAP re-leasing spreads are 15.6% and when omitting Santa Barbara R&D space, they're at 16.3%. Given the intensely competitive and expensive acquisition market, we view our development program as an attractive, risk-adjusted path to create value. We effectively managed development risk as the majority of our developments are additional phases within an existing park. The average investment for our shallow bay business distribution buildings is below $12 million. And while our threshold is 150 basis point projected investment return premium over market cap rates, we've been averaging 200 to 300 basis point premiums. At September 30, the development pipeline's projected return was 7.6%, whereas we estimate an upper 4 as market cap rate.

During third quarter, we began construction in 4 cities on properties totaling 670,000 square feet with a total projected investment of $53 million. Coming out of the pipeline, we transferred two 100% leased buildings totaling 286,000 square feet. Demonstrating the strength we're seeing in the market, our development pipeline and value-add percent lease rose from 27% to 43%, even with the 5 new additions and 2 100% leased buildings transferring out. As of September 30, our development pipeline and value-add properties consisted of 20 projects in 11 cities containing 2.5 million square feet with a projected cost of $220 million. And for 2018, we originally projected $120 million in starts. Today, that forecast is $145 million. Additionally, we have several projects that, pending weather and obtaining permits, will either commence late 2018 or create a solid start for 2019.

One of the things I'm excited about has been this greater number of development markets. This diversity reduces our risk and continues enhancing our ability to grow the pipeline. During the quarter, we acquired Allen Station, a 2-building, 227,000 square foot, 87% leased property in Allen, Texas, a Northeast Dallas suburb, for $25 million. We also acquired the 115,000 square foot Siempre Viva Center in San Diego for $14 million. This property, which became vacant post-closing, is now 100% leased. And on the disposition front, we closed the sale of the 50-plus-year old, 125,000 square foot 35th Avenue Distribution Center in Southwest Phoenix for roughly $8 million or a slightly sub-6 cap rate.

Brent will now review a variety of financial topics, including our updated guidance.

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Brent W. Wood, EastGroup Properties, Inc. - Executive VP, CFO & Treasurer [5]

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Good morning.

We continue to see positive results due to the strong overall performance of our portfolio. FFO per share for the quarter exceeded the upper end of our guidance range at $1.17 compared to $1.08 for the same quarter last year, an increase of 8.3%. The outperformance was primarily driven by a terrific leasing results in both the operating and development programs, which pushed occupancy and net operating income above our budgeted range. Notably, all 7 projects listed in the lease-up phase of the development and value-add pipeline experienced additional leasing success with 5 becoming 100% leased. Other positive contributors for the quarter were lower interest and G&A expense.

Our balance sheet is strong and flexible, and our financial ratios continue to trend in a positive direction. Our debt-to-total market capitalization was 24% at quarter end. And our adjusted debt-to-pro-forma-EBITDA ratio, which normalizes the impacts of acquisitions and active development, was 4.65, down from an already healthy 5.44 at December 31. From a capital perspective, we issued 31 million of common stock under our continuous equity program at an average price of $96.56 per share. That increases our year-to-date gross equity raised to a record high of $114 million.

For -- FFO guidance for the fourth quarter of 2018 is estimated to be in the range of $1.17 to $1.19 per share and $4.66 to $4.68 for the year. Those midpoints represent an increase of 3.5% and 8.9% compared to the prior year, respectively, excluding the involuntary conversion accounting gain recorded earlier in the year. The increase in the guidance midpoint for the year of $0.06 is the result of a $0.03 outperformance in third quarter driven by successful leasing results. This activity then reduced leasing risk for the remainder of the year, increasing our budgeted average month in occupancy in the -- for the fourth quarter by 120 basis points to 96.3% and raised our estimated occupancy for the year about 40 basis points to 96.0%. As a result, we increased the midpoint of our same-property guidance from 3.2% to 3.9% on a GAAP basis and to 4.3% on a cash basis.

You will also notice that we enhanced our same-store presentation in both our guidance table and supplemental package to provide clarity among the various metrics. We hope you have found these changes informative and useful. Other notable guidance assumption revisions for 2018 include increasing our estimated common stock issuances by $34 million to $144 million. And as a result, we deferred our next budgeted debt closing to early first quarter 2019.

In summary, our financial metrics and operating results continue to be some of the best we have experienced and we anticipate that momentum continuing into 2019.

Now Marshall will make some final comments.

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [6]

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Thanks, Brent.

Industrial property fundamentals are solid and continue improving in the vast majority of our markets. Based on this strength, we continue investing in, upgrading and geographically diversifying our portfolio. As we pursue these opportunities, we're also committed to maintaining a strong, healthy balance sheet with improving metrics as demonstrated by our year-to-date equity issuance. We view the combination of pursuing opportunities while continually improving our balance sheet as an effective strategy to manage risk while capitalizing on a strong operating environment. The mix of our operating strategy, our team and our markets has us optimistic about the future.

And now, we'd be happy to open up and take any questions you may have.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we will take our first question from Jamie Feldman.

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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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I'm hoping you guys could talk a little bit about -- just more about the types of tenants that are leasing space. I know you've mentioned you're a little bit protected from the big-box construction. But business sounds like it was better than you thought it would be. Can you just talk about the specific markets and the specific types of tenants and uses that are driving this?

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [3]

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Yes. Now good question. It's -- what we liked about this quarter and what got us excited, it was very broad-based. We kept hearing over the summer and probably mentioned even a little bit in the second quarter that what we were hearing from our guys and the brokers we work with that everybody was having a busier-than-normal summer. And thankfully, that activity turned -- and I know sometimes you have that. It won't turn into a lease. But thankfully, they turned into leases. And it's been pretty broad-based if we can put it into 2 different buckets. What's nice about this economy is our traditional businesses, whether it's homebuilding or construction, plumbing, all of those tenants, we continue to see more and more expansions within our portfolio. That's what helped us kickoff one of the Houston developments that we have underway, for example. And then within that -- those can be last mile -- of last mile for the HVAC guy to get to homes in North Atlanta or Northeast Dallas. But also last mile, we've signed a few leases with Wayfair and have them as a prospect of kind of, let's say, a material prospect within our development pipeline, whether that happens or not, time will tell. We're talking to Amazon really as they continue to roll out their last mile. One, I hope not violating them. But we've seen Lowe's is rolling out a program where you order your appliances online and you can either -- probably could pick it up or probably more likely deliver it to your home. We signed a lease with them, which was one of their first locations, as I understand it, under this program and are hopefully close to a lease on a second location with Lowe's. So it's been pretty broad-based, medical and kind of pharmaceutical. Arizona Nutritional Supplements has jumped up on our top 10 list as a tenant we've had for a while that they've expanded their private manufacturer distributor of supplements. We've seen online pharmacy fulfillment grow. Those seem to be mainly in Arizona and Florida. So it's been pretty broad-based tenant wise. And this quarter, what we'd liked as we rolled up the numbers, I was curious, was it 1 or 2 market, say, a Dallas or Orlando, that really drove our beat. But it was every market was a little bit ahead and when we added those up, all of a sudden, we were $0.03 ahead for the quarter. And that momentum was carrying over into fourth quarter, is what we're seeing.

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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. That's helpful. And then as you think about the development opportunities looking ahead to next year, do you think you could do more starts in '19 than '18?

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [5]

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Yes. Without -- with a -- my crystal ball has been known to be wrong as often at least as it's right. But as I mentioned, we could potentially beat our $145 million. There are some starts that -- for example, the Houston, the pre-lease that we have there, that's not in our $145 million but the lease is signed. So we're committed to this building at World Houston, which we're excited about. Our $145 million could grow still in 2018. But if that doesn't grow, we'll really have a good running start of -- if you look through, for example, our development pipeline, the CreekView project, we're basically out of space in that park in Dallas and are hurrying to catch up with demand a little bit and the same thing with Steele Creek in Charlotte and then Gateway down in Miami where we've leased space. We've got the balance of the building accounted for with leases out, so all of those -- some could still fall into this year. But if not, it makes me comfortable that we could meet or exceed our $145 million in 2019. And my huge assumption in all that is this operating environment, the economy, it doesn't need to improve. But if it stays where it is today or it doesn't materially get worse, we could beat, meet or exceed it next year.

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Operator [6]

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And we will take our next question from Alexander Goldfarb with Sandler O'Neill.

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Alexander David Goldfarb, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research & Senior REIT Analyst [7]

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Two questions. First, on Mattress Firm. If you could just give us an update on where you think your expectations for that tenant, if you think they're staying or going. And then if they are departing, what you think the downtime or the impact would be.

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Brent W. Wood, EastGroup Properties, Inc. - Executive VP, CFO & Treasurer [8]

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This is Brent. I would say with Mattress Firm, they're current at all 5 of our locations. And we've received no closure notice thus far. And in fact, we've had dialogue with them about their existing leases, that's still somewhat of a fluid situation. But I would point out that Mattress Firm only equates to 1% of our annual revenue. And that's actually declining over time as we continue to bring properties into the operating portfolio. And our top 10, as a whole, is only just slightly over 8%, which I think the best -- if not the best, one of the best in the industrial sector in terms of diversity. So the 1%, we're keeping an eye on it. For the most part, their rents are less than market. At each of those locations, they're in newer buildings. The average building age is 6.5 years in those 5 locations. So we're in contact with them and monitoring from what we're seeing and anticipating. Again, we have just the distribution centers. They've announced, I think it's in the neighborhood of 400 retail closures so far and that may go as high as 700, we understand. But in our markets, they haven't closed more than just a few locations, which lead us to believe they're going to continue to need the distribution. So the good news, they're moving quickly. I think they would like to have a forward plan in place before the end of the year. And so we're going to stay on top of it. But right now, we're cautiously optimistic about what the end result will be, but time will tell.

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Alexander David Goldfarb, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research & Senior REIT Analyst [9]

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Okay. And then the second question is, as we think about next year, clearly, the momentum that you guys have in the third quarter and fourth quarter is pretty strong. But Brent, as we think about the properties and lease-up, how much are those properties on the lease-up schedule are contributing in the third quarter versus those are yet to deliver, meaning yet to be in the pipeline? So the $0.03 beat this quarter, the $0.02 beat next quarter. These lease-up ones would be additive to that. I'm just trying to break out what's already in the run rate NOI versus what would be incremental, too.

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Brent W. Wood, EastGroup Properties, Inc. - Executive VP, CFO & Treasurer [10]

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Yes. At Page 9 of our supplemental where it lists the development value-add properties, there is no leasing in the third quarter certainly attributable to any of the properties in lease-up and there would be -- I'm looking at the anticipated conversion date, there would be minor impact in the fourth quarter. Most of the impact doesn't occur until you look at Page 10, those are the properties that have transferred into the portfolio. It [isn't until] their end and churning that they actually contribute. So none of the properties in current lease-up contributed other than the 2 properties you see. We had 2 third quarter roll-ins, Kyrene 202 and Steele Creek. Those 2 might have nominal impact just because they did roll in third quarter. But as we point out, we've got over 200 -- somewhere $210 million, $220 million between lease-up and under construction. And none of that come through to the bottom line from an earnings standpoint.

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Alexander David Goldfarb, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research & Senior REIT Analyst [11]

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Okay. I appreciate it.

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [12]

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Some of the things that helped then is just that last year, we were $120 million in starts. And so that's what's helped. And then our -- we've called our value-add kind of platform, our shadow pipeline of -- it's gotten to about $150 million over the last, call it, 2.5 years and that's -- all that's pretty much stabilized other than a project we acquired in Atlanta at the very end of last year. So all that is -- the size of the market and the ability to simply raise rents, I think that as we can -- as we view our development pipeline, as we stamp out building after building, that is what's pushing our NAV and also helping our earnings.

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Operator [13]

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And we will take our next question from John Guinee with Stifel.

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John William Guinee, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [14]

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A couple little cleanup questions. First, what do you expect to happen to G&A in '19, 2019, because of the lease accounting rules and capitalizing versus expensing your in-house leasing people? Second, can you talk a little bit about your 12.5% dividend increase and the ability to maintain that? And then third, are your very attractive return on cost based on the fact that you got your land at a really low basis? Or that's just the market return on cost in your markets?

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [15]

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I'll take the first...

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Brent W. Wood, EastGroup Properties, Inc. - Executive VP, CFO & Treasurer [16]

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Do. And then you can maybe remind Marshall what the third is when we get there. But on the 2019 G&A, we do finally have what we feel is a solid run rate. Remember last year, we had conversion to the straight line, bright-line testing for compensation that caused last year to be heavier. But our $13.8 million that we're budgeting for this year or $13.6 million, we view that they will just be your typical increase year-over-year, nothing significant. And we're only considering about $175,000 based on the last year or 2 of impact from the changes in having to expense some lease-related costs. As a reminder, we have no in-house leasing personnel, so we haven't had a big internal overhead G&A allocation or capital offset for those services. For us, it would primarily just be a third-party attorney that we use that reviews the majority of our leases. So we think it will be a pretty minimal impact for us. As far as the 12.5% increase in the dividend, our philosophy is that our cheapest capital is the capital we don't have to expend. The good news there is that it was just simply driven by our significant and steady growth that was -- especially with the last year or 2. And last year, we were fortunate to kind of scrub just barely above the number, but that all led to the 12.5% increase. We certainly view that, that dividend can be maintained into next year but certainly not that dividend growth rate. We think that would moderate and certainly not be at the level of 12.5%, but we certainly think that, given the positive momentum into 2019, that we think that dividend will certainly be maintainable. I'll let Marshall touch on the reason we have such good returns in the development pipelines.

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [17]

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And John, part of this, I'll say, is -- I can only speak factual for what we do and then a little bit since we don't build big box. But this kind of -- the second half of my question is maybe a little more speculative. But I think our guys do a great job of finding land at reasonable prices. Really, the cheap land we bought the last downturn, we pretty much burned through. So everything -- our goal is now, as soon as we acquire land, to put it into production. And I'd like to think as we build out a park -- you think we've got shared driveway, shared retention within our parks, so there's maybe some economies of scale as compared to a stand-alone big-box building. Our office content, while not high at probably 10% to 20%, is higher than a big box that would be maybe 5%. So that -- usually, as we put our dollars in and also the tenants usually put their own dollars into that build-out, that pushes the rents a little higher and probably helps our return. And then the third part -- usually, if you're doing a large -- say, a 700,000-foot lease with a whirlpool target at Walmart, they know the value, they've got their own real estate department, they've got a broker or brokerage team and several people. If you pick, say, South Dallas or South Atlanta, there's usually pretty intense competition for those type of tenants. They know the value they bring when they sign a lease. So those are -- I view those as awfully out and advanced and heavily shopped and tough negotiations where, a lot of times, ours is someone looking and they need space fairly quickly, I think our tenants and the tenant rep broker certainly negotiate hard. But I like -- what I usually say, I like where we fit in the food chain. It's not as intensely competitive. It's less of a commodity. And so our cost within their distribution system is pretty low and the spaces are a lower component. So I think it gives us the ability to price a little better versus an 800,000-foot building on the far west side of Phoenix, for example.

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John William Guinee, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [18]

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So you like your business model better than the big-box model?

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [19]

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Yes. I like the guys that [at Duke] and those (inaudible). If I can say anything, they make money, too. But I like where -- I'm glad we do what not everybody else is doing, maybe another way of -- a fair way to say it.

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Brent W. Wood, EastGroup Properties, Inc. - Executive VP, CFO & Treasurer [20]

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It's a big tent, John.

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Operator [21]

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And our next question will come from Rich Anderson with Mizuho Securities.

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Richard Charles Anderson, Mizuho Securities USA LLC, Research Division - MD [22]

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So Brent or whoever, can you hazard a guess, the utilization of ATM to do a lot of your funding? How much is that impacting what you could otherwise have achieved from an FFO standpoint? Is there a number of -- a dilution that you're willing to take on because you're going that route with your stock trading well above NAV?

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Brent W. Wood, EastGroup Properties, Inc. - Executive VP, CFO & Treasurer [23]

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Yes. It's a good question, Rich. We look at it and actually, a tricky computation because as you move different parts -- the way we look at it, at some point, beyond this near term, you're going to go need either equity or debt. And so we just view what the premium to the stock with the value that we perceive as being north of an NAV, certainly north of an NAV consensus, that we view that as attractive and so we've been -- we've used that as a mechanism to raise equity in the last couple of years, more so than normal. But we've also seen periods of time where that equity is not available and we're certainly well positioned then to switch gears and go the debt route. Being only 24% debt-to-total market cap, there's certainly room there. So we have these internal discussions probably once a week about what's enough and what's not too much and Marshall always reminds me, he wasn't a hoarder until he likes our stock price and then he becomes a hoarder. So -- but it's something we monitor and we feel like -- the good news is we have good uses for all this capital. We're putting money to work at an average of 7.5% to an 8% and that volume has picked up and the leasing has been terrific. So it's a little bit of a dance between the 2. But my guess is, going into '19, if the stock price maintains its healthy course, we'll continue to certainly utilize the ATM as a method of proceeds.

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Richard Charles Anderson, Mizuho Securities USA LLC, Research Division - MD [24]

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But in terms of -- it's -- is it almost the cost of debt versus the cost of equity almost on top of one another in the sense that it's not creating a whole lot of dilution for you, whichever direction you go?

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [25]

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Yes. They're our internal calculations that...

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Brent W. Wood, EastGroup Properties, Inc. - Executive VP, CFO & Treasurer [26]

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Yes. Just give or take, it's probably within 30 basis points, which, for us, is -- that's as historically tight as that's been. Typically, the debt is a good bp, less expensive than the equity. But -- yes, it's in the small category and that certainly avails the ATM to use too because it's not as expensive to do as it sometime can be.

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [27]

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Another thought. I agree with Brent. Another comment. A few years ago, we had looked and kind of some of the attributes of the -- not simply industrial REITs we admire where they had strong balance sheets. So we have said that's -- of the blue chip REITs, that was one common trait we could imitate. So we like having a strong balance sheet. And then we've had internal debates. We're certainly not seeing it, but everybody says, "This real estate cycle has lasted so long. Are you nearer the end than the beginning?" And we could debate that, the balance of the day, but we've set up -- I like the combination of a healthy development pipeline that, as long as the market's supporting it, let's kind of keep delivering and completing the next building. But it makes me feel better that, at the same time, we're -- if the market allows us, that we can keep deleveraging the balance sheet. I think those 2 risks offset themselves, in my mind, a little bit if our balance sheet is stronger. And as we grow our development pipeline, hopefully, it's giving us that much more safety. And hopefully, as our balance sheet gets stronger, I'd argue we should trade at a higher multiple versus if we were 45% leased with a large portion of that in floating-rate debt, for example.

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Richard Charles Anderson, Mizuho Securities USA LLC, Research Division - MD [28]

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Right. So you almost answered my next question. But, I mean, part of that risk I think here is meeting expectation is the new miss in your space and maybe largely in your stock. And so markets kind of pricing and these beating the race type of quarters. How much are you perhaps planning for the inevitable point where performance perhaps falls short of expectations? Is this -- and what you're perhaps doing today is not so much a present tense consideration, but considering what could be happening down the road, say 2, 3 years from now when the market is chirping about a possible recession in some period in the next couple of years. Are you -- when you think about all the things that you're doing, whether it's capital raising or investing or whatever it is, is there an eye -- is there a very significant eye towards the next couple of years? Or are you thinking more "Well, the market is giving me this now, so I'm going to take it"? I'm wondering how the longer term is influencing you.

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [29]

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Yes. We certainly think longer term. I mean, as you say it, I was kind of -- Keith McKey, our prior CFO, always said, "Take equity when you can. Be opportunistic. It won't always be there when you need it." And then right now, we do need it with our development pipeline and value add. So we like it from that perspective. And I guess it always -- you're not the only person that's mentioned to us that we have our guidance and the market expects us to beat it, whatever we say. And so I think of beat and a [raise], if that's expected of us, gosh, that's the best compliment we could get as a company. I hope that the market thinks -- I'd like to be viewed more conservative than aggressive. And if people think we're going to outperform, then yes, I guess we'll hate at the quarter when we miss it. But I'm proud of the team and I'm happy with that reputation. If we can earn it, that people expect you to be there and improve and if we -- most people don't regret. At some point, it is a cyclical business, so it'll slow down and -- I remember having a discussion with our board 2.5 years ago in our annual planning meeting that they thought the cycle was ending then. And thankfully, the market will let us know when it's over. Thankfully, we didn't pull our horns in then, for example. So we'll -- and we'd rather have better balance sheet and we think, a couple of years down the road. But other than worry about it, I don't know much more we can do about it.

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Operator [30]

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And our next question will come from Bill Crow with Raymond James.

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William Andrew Crow, Raymond James & Associates, Inc., Research Division - Analyst [31]

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A question for you. We've talked a lot in the past about the inflation in construction costs. So I'm just wondering if -- for whatever reason, if construction costs were to turn around and fall 15% or 20%, how long would it take for the market to kind of get out of balance from a supply/demand perspective? Are there a lot of projects out there that might go ahead if it was cheaper to build that would throw us out of whack?

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [32]

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Good -- I guess good. I like the thinking on it. Interesting thing -- we struggle so hard, yes, this is Marshall, to find land that we think, even when construction prices were low, supply didn't get out of balance. So if you said what, besides Rich's question down the road, the downturn, what really keeps us up at night is finding the next land sites to kind of continue building our parks. So we're not -- on a construction pricing, I like your optimism. We don't see you talking to outsiders, the shortage in workers and what we're seeing in steel prices, the construction went up probably 10% to 20% fairly quickly and has been more moderate. But we've even heard stories in one of our markets, for example, that the people are so short on workers that they were -- a concrete company was showing up at our job site trying to hire the workers away while they were pouring the slabs and things like that and you -- seen things that we watched where Amazon raised their minimum wage for employees. We've heard that FedEx is doing kind of several different things to kind of retain their employees as well. So we don't think, unfortunately, that the labor shortages -- it's here and may last for a while. But thankfully, our -- what we view as our -- we're full and our markets are pretty full. And with rents, we're hoping rents keep pace with inflation basically, is what will be my best guess.

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William Andrew Crow, Raymond James & Associates, Inc., Research Division - Analyst [33]

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So Marshall, do you think that the cost inflation has moderated from, you quoted, 10% to 20%? Are we running 5%, 6% a year, you think now?

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [34]

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Maybe a little bit. I guess just talking to the guys in the field. There, for a while, every pro forma -- one -- I'm thinking when Reid, who runs our Texas group said the pro forma [I sent] earlier in the week, I had -- I thought was conservative. And 3 days later, we got bids in. And now, I'm learning that it's not. And they're saying prices are more moderate. So yes, maybe that 3% to 5%. And again, pending how trade talks go with China and everything else, we were happy to see a trade agreement get resolved with Mexico. And again, without getting details with the autoworkers where we're hearing auto components made need to contain more U.S.-based product that, that probably benefits us being near so many auto plants and things like that, but we're happy to hear that construction prices, although they spiked, have kind of leveled out a little bit. And I hope that holds.

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Operator [35]

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And our next question will come from Manny Korchman with Citi.

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Emmanuel Korchman, Citigroup Inc, Research Division - VP and Senior Analyst [36]

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Marshall, if we go back to the conversations you're having with tenants, how many of those conversations are leading you to think about markets you're not in or is the conversation more focused on land or a building you have and presenting it to a batch of tenants?

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [37]

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It's -- we're -- primarily the latter. When we look at what opportunities can we find, we like the markets we're in within our existing markets. We do spend time looking at new markets. Even if we pass, we feel like we're learning about that market. And we've also said, kind of maybe touching earlier, if there's a downturn, I'll use 1 market, we've kicked tires in for a while and probably should have entered years ago, Nashville, Tennessee. It fits in our footprint. It's been a great economy. It's hard for us to think we can jump in there today and add a lot of value. So we do look at markets but by and large -- maybe 2 part, by and large, we think of how can we accommodate our tenants' growth and the opportunities we're seeing within Orlando where we're running low on land today or continue to find land in South Florida or Dallas or things like that. The other trend we're seeing more and more, it probably will fit more the big-box tenants, but we're seeing it in our smaller, shallow bay buildings, is we're running into the same tenants and the same brokers over and over again in different markets, be it a Wayfair or a Lowe's or Amazon where -- or even some of our HVAC contractors where we are working on having a conforming lease and accommodating them makes it easy for them to lease space in Orlando and go to San Antonio and maybe to LA as well. So we are seeing more tenant and broker overlap than we probably saw a few years ago. And that potentially could lead us to a new market, but we really, at least, like our footprint today and are hesitant to enter new markets, especially probably later in the cycle than early.

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William Andrew Crow, Raymond James & Associates, Inc., Research Division - Analyst [38]

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And then if we think about the transaction or acquisition environment, what would you need to change in order to increase those volumes? Is it a matter of losing deals based on price? Is it that the types of assets that [you're flown] in and like aren't available? Where do things sort of sit?

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [39]

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Yes. Good question. We see properties we like a lot. It's -- we just can't afford them. I mean, that's it. We passed on a large number of deals in California and, for example, and all of -- South Florida, we just -- we'll make it first, second, maybe the third round, which is really the buyer interview and we try to set a ceiling before we start bidding because once you start bidding, everybody, me included, you get emotional about it. You get excited about the property. So they're out there. It is the -- CBRE refers to it, the wall of capital, which really comes from all over the globe. There's a lot of people that like U.S. industrial real estate right now. And I'm glad we build it. And we're better off finding -- for example, I'll stick with our -- the property we just bought in South San Diego, we bought it, we expanded 2 tenants, it's fully leased now. And we're in the low 6s. We're in the same park buildings, which we looked at, are going to trade sub-5. So we could buy them. We're just trying to -- we watch our cost of capital and the growth that we think we're going to have on those leases. And there's usually -- everybody's got a checkbook and there's someone that's willing to outbid us that usually lost the last deal or 2 and we go to bat a lot and we don't get many hits, basically.

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Operator [40]

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And our next question will come from Craig Mailman with KeyBanc Capital.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [41]

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Marshall, maybe just a follow-up on the land conversation you kind of threw out. Orlando is one where you guys are looking for more inventory. And just looking at the list of markets you have, I mean, Atlanta is kind of running low here. Can you just give us a sense? Do you have anything in the tail on some of these markets? I mean, is there even really any land on the market that fits kind of what you guys want to do and the locations you want to do? I'm just trying to get a sense of -- we're talking about development starts into next year. Just to be able to do it on a broad base, I just want to know what the probability of that is given land inventory.

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [42]

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Sure. We feel, at least near-term, pretty good that we can keep our development starts. Again, if the economy hangs in there, we can maintain the run rate. If you said what markets are you -- maybe another way, a little bit like Orlando, as we mentioned, where Allen and John Coleman and Chris, they have a few sites where we're pursuing. Nothing we're there to close or announce. Tampa is another market that we've been in Tampa 20-plus years, we really like. But we're -- we don't have developable land there and it's a balance. You don't want to get too much land and then you have to carry it and your yields go down. Atlanta, given the value-add properties we bought there, and as I mentioned, not everything -- we've had a good quarter, proud of the team, there's always a place or 2 -- Atlanta, we've chased a lot of deals and haven't landed them. So we'd like to finish our value-add project in Atlanta before reloading with the next batch of land. So it's tight in Atlanta, but we've seen a couple of sites we've looked at. And that was -- maybe I'll tie it to the prior question, one of the things we liked about when we entered Atlanta, I was shocked. This was a few years ago when we sat down with brokers, how little land they could find us within a market as big as Atlanta or how hard it is in Dallas. So that makes us feel good about supply, which is great, but it worries us about ability to grow going forward. We've -- those are probably the markets where we're light today, those 3.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [43]

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That's helpful. Then just as we're later cycle now, just curious on your thoughts internally about kind of caps on development. I know the company's got bigger, balance sheet is in great shape. I'm just curious, how much -- how big the pipeline you want to be carrying is at this point?

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [44]

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I guess it -- yes, good question. A lot of it depends where in the pipeline, but there's -- I'm looking at our pipeline now, there's a handful of deals that are all 100% leased. So again, that's pretty atypical. But once we get there, I worry less about those. I guess you still worry about all of your kids, but worry less about those. We typically target about 6% of our assets as kind of an informal of what we want to have at least in terms of land on the balance sheet. And then we also track what are between value-add and construction and simply land of what is that as a percent of our balance sheet. So obviously, that's a higher number. But when they get closer to coming out of the pipeline and as they're leasing or pre-leased building like several of the starts we had this quarter at the bottom of our development pipeline, all had a fair amount of pre-leasing, we feel a little bit better. So it's a -- I'm not giving you a very exact number because maybe it's not an exact science, balancing act. But we -- I'm sure there's an absolute number. $220 million in our pipeline, that's about as big as it's ever gotten, but several of these are going to roll out in the next 30, 45 days, too.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [45]

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That's helpful. Just lastly, you guys clearly had a great quarter on the leasing front. Just curious, the guidance you gave last quarter, it seemed like it assumed some move-outs. I mean, did those move-outs happen and you guys just backfilled way quicker than you thought? Did tenants that you had a higher probability of leaving stay? Can you kind of give us some context of was it more people just realized they couldn't leave and so they stayed? Or was it just really quick backfills on some of the things that did rollout?

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [46]

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Kind of a yes is the answer. It was a little of all -- a good -- some tenants that we -- again, we usually say, don't project 90% retention rate. We typically average around 70% historically. So some of the tenants were -- we budgeted people to leave because we didn't want to budget 90% of our tenants staying. So some stayed that we had budgeted vacating. Some held over longer, so there were some of those where the tenants and they -- a few of those who are still there, where -- it doesn't mean they're there permanently, but hey, we're a few months behind your lease expiration and they haven't worked out a deal or stayed -- to either stay or leave. And in those cases, we'll collect a premium rent typically on those. And then in some markets, I'm thinking like in Tucson where we relocated, built a new building for Chamberlain, moved them out of 160,000 feet into a new building, we -- Mike Sacco was able to backfill that with 2 -- with 1 existing tenant, 1 new tenant way ahead of what we thought in a small -- we like Tucson, but it's a smaller market. So now we're back to 100% leased in Tucson, so that was a nice budget pickup in that market, for example. Brent, anything?

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Brent W. Wood, EastGroup Properties, Inc. - Executive VP, CFO & Treasurer [47]

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Yes. Basically, like Marshall said, it was well spread out. And I'd also point out that our development pipeline that the leasing and getting permits in a little faster than we had budgeted there also was part of the help. So it was broad-based leasing combined with a few tenants staying that we'd budgeted to move out, but it was really across-the-board.

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Craig Allen Mailman, KeyBanc Capital Markets Inc., Research Division - Director and Senior Equity Research Analyst [48]

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If I could just sneak one last one in. I mean, as you guys are budgeting people to move out, is it because of -- they're outgrowing the space, in your opinion? Or you don't think that they want to pay the rents that you're going to roll them up to? I'm just curious how you guys think about that, space by space? What's the biggest driver at this point of the cycle, kind of utilization or cost?

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [49]

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It's typically more cost. I mean, sometimes, you'll hear a tenant bought their own building or they made a decision. Sometimes it is simply -- and those are the ones that make me feel better, it's an assumption. Hey, we -- if you're one of our asset managers, Craig, don't budget. You're going to renew all 10 tenants. Even if you think that, somebody's going to surprise you and decide to leave. But a lot of times -- we just had a conversation about a tenant in California, for example. There, it ends sticker shock over their renewal rate, but the renewal rate we're proposing them is that market. And most everybody we deal with has a tenant rep broker probably, thankfully, at this point in the cycle, that educates them of they maybe a little bit in shock on the rents, but there's nowhere else for them to go and incur the moving cost that -- and so it's typically that people have outgrown our building, which is one of the other things we really like about building the park settings, a lot of our new development comes as a way to accommodate an -- we've got an existing tenant, they've paid the rent for a while and thankfully, their business is good. Like I mentioned Arizona Nutritional Supplements, ANS, earlier. We -- they're in a building and they filled up a new development we had, thankfully. So if we can move people from building 3 to building 8 in a park, for example, that's one of the beauties of building a park.

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Operator [50]

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And our next question will come from Eric Frankel with Green Street Advisor.

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Analyst [51]

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First off, Brent, thanks for the clarified disclosure on same-store reporting. I think that should be helpful to everybody. First question, I know you've diluted your exposure to Houston. But maybe can you just talk about leasing trends a little bit there? It seems that your leasing spreads have been a little bit choppy. You've had some good quarters and not-so-good quarters, and this quarter seems to be pretty healthy.

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [52]

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Sure. What Brent -- thanks for the comment on same store. And I remember our conversation from a quarter ago, so I'm glad that's helpful. And Houston's certainly recovering. We said a couple of kind of big -- a big picture comment and then more detail on leasing. We were -- we started the year hoping and really expecting to start a building in Houston. And we did. And that one's 100% leased. And then we had an existing tenant expand and extend their lease and that kicked off our second building at 10 West Crossing. And now we've gotten the building, which we haven't broken ground on but the pre-lease. So all of a sudden, the Houston economy has picked up with oil and just the economy in general. They've added 110,000 new jobs in the past 12 months, which has to put it #1 or 2 probably them and Dallas in the country over the last year. Our leasing spreads, the market is recovering there. The rents are not back to their peak in Houston, but they're certainly moving in that direction. It was a good quarter. And really, last quarter, we stretched to -- it was a large building at World Houston to make the deal, a single-tenant building. And so it was probably a little bit of an arbitrary kind of odd data point that pushed it down. That one's probably -- shows a little bit worse than the market, but the market's still not back to its peak in Houston. But it's 5.1% vacant and recovering pretty nicely. So we're happy with Houston. And it -- again, we're certainly cognizant of having been at 21% and been in the penalty box on Houston a few years ago. And so we're glad to see it roll down to 15%. As I mentioned, the 3 starts -- I wouldn't want you or anyone on the call, as we roll forward, if you took our portfolio, annualized it and really stabilized the development portfolio, that actually gets -- and that -- so you're getting a year down the road or a little more gets Houston down below 14% of our NOI. So we like the market a lot. We're good historically. Brent and Kevin and Reid and the team have created a lot of value in Houston over the years. But we like that we're able to play offense there and continue to shrink it as a -- it kind of ended as a portfolio allocation more than anything indicative of the market.

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Analyst [53]

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Okay. Just a follow-up question. I know you obviously are going to introduce guidance in the next quarter, maybe you could talk -- I was wondering, though, if you could talk about any plans, given where asset prices are, to maybe clean up the portfolio a little bit more and add some more non-core assets and maybe you can also add in some commentary on how Santa Barbara is doing, especially with the lease roll there next year.

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [54]

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Okay. Yes. Santa Barbara, we pretty much addressed the large vacancy we had a year ago, that 51,000 feet, 44,000 feet of it has now been leased thankfully. And so we've got 1 7,000-foot space and we're talking to a couple of prospects. We have a prospect that we'll see, hopefully we'll fill in. And we have a larger renewal there next year, another lease that rolls at the end of this year. So we'll see how -- it's a little bit early than -- I hope we can renew the tenant. The market is reasonably healthy. And you're right, in terms of non-core assets, we bought our -- you may remember, we bought our partner out of 2 of the buildings last year. Reworked a little bit of the partnership there. That is 1 over time, given that it's 2-story R&D buildings and in a market they've -- they're good assets, but we'd like to reduce our exposure in Santa Barbara over time and kind of -- and some other ones. We've got another asset or 2 lined up that we'd like to sell next year.

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Eric Joel Frankel, Green Street Advisors, LLC, Research Division - Analyst [55]

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Okay. Just final question. Regarding some of the last mile requirements that seemed to be picking up steam. Are you seeing any sort of automation or robotics in those buildings in terms of their use? Or is it still fairly manual?

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [56]

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I'm sure more than we've seen -- certainly, the -- like the pharmaceutical kind of online pharmacy, there's a lot of technology and a lot of investment in that -- kind of in the medical. We're seeing more HVAC warehouse, things like that. And that is -- that's part of our geography, I think. I think it's coming, but we're not heavy, heavy there yet. And then probably last mile is certainly not the automation technology that the big box has, but it's -- with the labor shortages and all that, it's coming our way. But you can overcome some -- we don't think any of our buildings are obsolete, but you can overcome obsolescence with location on a lot of those properties, too.

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Operator [57]

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And our next question will come from Jason Green with Evercore.

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Jason Daniel Green, Evercore ISI Institutional Equities, Research Division - Analyst [58]

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You guys have talked about kind of the scarcity of land assets out there and the amount of capital that's chasing them. I'm curious kind of how competition for land assets has changed today versus about a year ago.

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Brent W. Wood, EastGroup Properties, Inc. - Executive VP, CFO & Treasurer [59]

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Yes. For land acquisitions, this is Brent telling you, we've seen really that what you have to have is a more in-depth guys on the ground that can look -- the days of just driving in that decimate area, where you drive up where there's roads and infrastructure. You just buy land and build buildings, that -- in the major markets, that's gone. So you've got to really spend some time. Our Eisenhower Point project in San Antonio, that was a 2-year process to get that land zone changed, bought. And it's doing terrifically now. But -- so I would say what's changed is it's -- and it's part of what's kept supply down is not as easy to just go [top] piece of land and begin to put up buildings and flip them and sell them, especially for local developers. You've got to really be willing to put in the time and in some cases, do a conversion like the Gateway project in Miami where we converted the horse stables to the Churchill Downs racetrack. We've converted old municipal golf courses. We've changed retail zoning to industrial zoning, which is not easy to do. So I would just say that, as the opportunities get more difficult, you've got to think outside of the box more. And along with that comes a little longer lead time. So I know John, in Florida, there's -- it takes quite a bit of time to get land ready there. So you want to be looking well in advance of when you actually think you may actually need to put the dirt into progress.

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Jason Daniel Green, Evercore ISI Institutional Equities, Research Division - Analyst [60]

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I guess today versus a year ago or kind of 1.5 years ago, there are far more bidders for land assets or that hasn't really changed at all?

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [61]

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That probably hasn't -- most of the land we acquire isn't -- maybe it's listed, but it's not -- maybe 1 comparison is like if it's a building, a large brokerage group will come out where the bids are due on this day, and if you make it through that round, they have a second round of bids. And it's a pretty orchestrated process. Land feels like it's out there on the market and there's bidders, but it is not all of you show up with your bid on Wednesday by 5:00. So there's -- probably, there have to be, given the returns and the profits they made, they're more -- there's less land out there and there's more people kind of scouring through it to find land, certainly California, South Florida, those markets. But I don't know that it's gotten much more intensely competitive for that. It has, for the last few years, been very intensely competitive for just the core acquisition that -- we were shocked in Atlanta, for instance, since recently, there were -- we were one of on a package and they were good buildings, but probably 20 years old, we were 1 of 24 or 25 bidders in that first round. So that gives you a sense of what your odds -- and we weren't -- we didn't win it. So what the competition's like. Same thing in the San Diego package I mentioned earlier, we bid on it, but it was a who's-who list of institutional bidders that wanted to buy those. We'd like to have owned them, but we just got outbid. And I don't think we made the second round in that round of bidding.

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Operator [62]

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And we will take our last question from 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 [63]

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I just wanted to get some -- your thoughts on cap rates. I mean, are you guys still seeing cap rate compression across your markets at this point? Or you think they've kind of stabilized?

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [64]

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I guess it's interesting with -- interest rates going up, I'm not -- they were compressing -- probably, major markets have held flat and could be sub 4. We felt like there was contagion that markets like Denver, Phoenix, Las Vegas cap rates came down. They're not rising with interest rates. I had a conversation with one of the national kind of investment guys with one of our brokerage groups earlier this week -- earlier in the week and he said they've gone up on triple net and certainly B and C industrial but A quality industrial -- I don't think they're coming down anymore, but they haven't moved. Maybe a couple of bidders that use a lot of debt have dropped out, but for the most part, they've been flat for -- probably in the last 60, 90 days, but still a healthy number of people that want to acquire industrial.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [65]

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And I guess are you talking specifically about your product type or just industrial overall? I was -- I'm wondering about the overall...

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [66]

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Yes, probably he -- and again -- and probably -- Mike -- I'm just kind of -- I'm assuming from my conversation and this was -- again, it was one of the national partners with the group. He was probably lumping industrial in as whole. I mean, he knows our product type. We worked with him before. So certainly, our product type. But I'm thinking big box is the same, and we see those packages as they come out and kind of track them just to see where the market is. So there are still 4s and sub-4 in California, sub-4 South Florida, things like that, big box and shallow bay.

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James Colin Feldman, BofA Merrill Lynch, Research Division - Director and Senior US Office and Industrial REIT Analyst [67]

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Okay. I mean, would shallow bay later to compress the cycle? That's what I was wondering, if it can kind of continue for longer, but maybe not.

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [68]

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Probably a little bit later. It seems like if you have a package, the more dollars you can put out, the more bidders it seems to attract, which seems to -- so if it can be a package cabin and some groups like that have been very good at buying wholesale and selling retail by putting things into a portfolio. And so that maybe is 1 disadvantage shallow bay has had a little bit is just you can't put as many dollars out unless, like in Atlanta, it was almost 1 million square feet, so it was shallow bay but it was enough buildings that it attracted enough institutional bidders to get the dollars out. So that probably drives it a little more than product type.

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Operator [69]

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And we have no further questions at this time.

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Marshall A. Loeb, EastGroup Properties, Inc. - President, CEO & Director [70]

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Okay. Thank you, everyone, for your time. Thank you for your interest in EastGroup. Have a good weekend. And if we can answer any follow-up questions, we will be around later today.

Take care.

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Operator [71]

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This does conclude today's program. Thank you for your participation. You may disconnect at any time.