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Edited Transcript of ILPT.OQ earnings conference call or presentation 29-Apr-19 2:00pm GMT

Q1 2019 Industrial Logistics Properties Trust Earnings Call

May 1, 2019 (Thomson StreetEvents) -- Edited Transcript of Industrial Logistics Properties Trust earnings conference call or presentation Monday, April 29, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* John G. Murray

Industrial Logistics Properties Trust - President, CEO & Managing Trustee

* Olivia Snyder

Industrial Logistics Properties Trust - Manager, IR

* Richard W. Siedel

Industrial Logistics Properties Trust - CFO & Treasurer

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Conference Call Participants

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* Bryan Anthony Maher

B. Riley FBR, Inc., Research Division - Analyst

* Michael Albert Carroll

RBC Capital Markets, LLC, Research Division - Analyst

* Mitchell Bradley Germain

JMP Securities LLC, Research Division - MD and Senior Research Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to the Industrial Logistics Properties Trust First Quarter 2019 Financial Results Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would like to now turn the conference over to Olivia Snyder, Manager of Investor Relations. Please go ahead.

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Olivia Snyder, Industrial Logistics Properties Trust - Manager, IR [2]

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Thank you, and good morning, everyone. Thanks for joining us today. With me on the call are ILPT's President, John Murray; and Chief Financial Officer, Rick Seidel. In just a moment, they will provide details about our business and our performance for the first quarter 2019 followed by a question-and-answer session with analysts.

First, I would like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company. Also note that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on ILPT's beliefs and expectations as of today, Monday, April 29, 2019, and actual results may differ materially from those that we project.

The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call. Additional information concerning factors that could cause such differences is contained in our filings with the Securities and Exchange Commission, or SEC, which can be accessed from our website, ilptreit.com or the SEC's website. Investors are cautioned not to place undue reliance upon any forward-looking statement.

In addition, we will be discussing non-GAAP numbers during this call, including normalized funds from operations, or normalized FFO, and cash-based net operating income, or cash-based NOI. A reconciliation of these non-GAAP figures and net income and the components to calculate cash available for distribution, or CAD, are available in our supplemental operating and financial data package, which also can be found on our website.

And now I will turn the call over to John.

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John G. Murray, Industrial Logistics Properties Trust - President, CEO & Managing Trustee [3]

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Thank you, Olivia. Good money, everyone, and welcome to ILPT's first quarter earnings call. This morning, we reported first quarter normalized FFO of $26.4 million or $0.41 per share.

As of the end of the first quarter, ILPT's portfolio consisted of 277 primarily warehouse and distribution properties with 33.2 million square feet located in 28 states. Approximately, 52% of ILPT's annualized revenues came from 16.8 million square feet of industrial land located on the island of Oahu in Hawaii. Our mainland portfolio consisted of 51 properties with 16.4 million square feet located in 27 states that were 100% leased with an average lease term of approximately 6.5 years as of quarter end. Including our recently announced transactions, we own a total of 296 properties with 42.4 million square feet located in 30 states, and our mainland portfolio consists of 70 properties with 25.6 million square feet located in 29 states that are 100% leased with an average lease term of approximately 7.4 years.

During the first quarter, we continue to execute on our business plan with strong leasing activity and mainland acquisitions. Starting with acquisitions, as we discussed during our fourth quarter 2018 earnings call, during the first quarter of 2019, we agreed to acquire 2 portfolios with a total of 26 properties containing 12.9 million square feet for a combined purchase price of $904.7 million at a weighted average cap rate of 6.3%. 7 of the properties closed during the first quarter and 19 subsequent to quarter end. Since 19 of the properties were acquired subsequent to quarter end, we have provided enhanced disclosure in our financial supplemental, including the list of properties acquired as well as proforma portfolio information, such as top tenant concentration and tenant credit characteristics.

Postacquisitions, our top-3 tenants are Amazon, Procter & Gamble and FedEx, representing 14.7%, 3.8% and 3.4% of total annualized rental revenues, respectively. Investment-grade rated tenants or subsidiaries of investment-grade rated parent entities make up 62% of our mainland revenues.

Looking at the entire portfolio, nearly 75% of revenue comes from those investment-grade tenants or subsidiaries or from our secure Hawaiian land leases. The top 3 markets after Hawaii, at 40.9%, are Indiana, Ohio and Virginia, representing 9.8%, 8.3% and 5.2% of our total annualized rental revenues, respectively.

We're very pleased with these acquisitions of well-located, high-quality industrial properties leased to strong credit tenants that we expect to provide growing cash flows to enhance our ability to grow distributions to shareholders in the coming quarters. Also, as a reminder, over 70% of the total purchase price was funded by our mortgage financing in Hawaii that was completed in January and demonstrated the tremendous value of our unique Hawaiian industrial land assets.

Turning to leasing. We executed lease renewals for approximately 271,000 square feet, all in Hawaii, at rents that were 15.8% higher than prior rates from same space with an average lease term of 9.4 years to leasing capital per square foot per lease year of approximately $0.03.

We also completed rent resets in Hawaii for 483,000 square feet at rents that were 28% higher than prior rental rates. Portfolio occupancy as of the end of the first quarter was 99.4%, up from 99.3% last quarter. We have no significant near-term lease expirations on the mainland with only 0.2% of total annualized rents expiring over the remainder of 2019 and less than 2% expiring by the end of 2020.

Moving to Hawaii. We have 394,000 square feet of leases for $862,000 of total annualized rents scheduled to expire during the remainder of 2019 in addition to 1.2 million square feet for $1.9 million of annualized rent that is scheduled to reset. The industrial market on the island of Oahu continues to be favorable to landlords this quarter with continued positive net absorption, occupancy rates over 98% and average rents for warehouse space at their second-highest level since the end of the Great Recession.

As a reminder, ILPT's Hawaii portfolio occupancy has never fallen below 98% since it was first acquired in the early 2000s. We continue to be encouraged by our leasing results and look forward to executing on the more than 50% of our Hawaii leases that were mark-to-market either through rent resets or as leases roll over, over the next 5 years.

As you may have seen in our proxy statement that was filed earlier this month, we have begun to undertake changes to our governance policies in response to shareholder engagement feedback. First, we've adopted a proxy access bylaw, which enables a shareholder or group of up to 20 shareholders to include trustee nominations in the company's proxy materials for the Annual Meeting as opposed to being responsible for their own solicitation.

We are also starting the process to expand our Board with additional independent trustees. We've engaged an executive search firm to help us identify qualified and diverse candidates, and we will keep you updated on the expansion process, which is expected to take place over several years.

Also, in response to shareholders' suggestions, we changed the benchmark index by which potential incentive management fees paid to the RMR Group are measured, from the SNL U.S. REIT Equity index to the SNL U.S. REIT Industrial index, effective January 1, 2019. Building and keeping shareholder confidence is an important part of our business in long-term value creation.

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

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Richard W. Siedel, Industrial Logistics Properties Trust - CFO & Treasurer [4]

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Thanks, John, and good morning, everyone. Normalized FFO for the first quarter of 2019 was $26.4 million or $0.41 per share. Adjusted EBITDA for the quarter was $34.1 million, up 10% from last quarter and 14% year-over-year. Our quarterly dividend of $0.33 per share continues to be well covered with a low payout ratio of 80.5%.

Total revenues for the first quarter of 2019 increased by $5.4 million to $46 million, representing a 13.3% increase over prior year results. This increase primarily reflects our acquisition activity as well as lease renewals and rent resets at our Hawaii properties. Total portfolio same-store cash basis NOI increased by 4.6% over the prior year.

Hawaii cash basis NOI increased by 5.5% over the prior year, reflecting increases in rents from lease renewals and resets. We also collected percentage rent of $1.2 million, which was $220,000 more than that received in the prior year period. As a reminder, this percentage rent is recognized annually during the first quarter of the year.

Mainland cash basis NOI increased by 3.5% over the prior year, reflecting our leasing activity and decreases in seasonal expenses, including snow removal costs from the prior year. Our recurring capital expenditures for the quarter totaled $215,000. The majority of these expenditures were leasing capital, specifically commissions related to a mainland lease extension as well as renovations at 1 of our 13 owned buildings in Hawaii.

General and administrative expense for the first quarter totaled $3.8 million, and depreciation expense was $9.6 million. The increase in both primarily reflects our acquisition activity.

Interest expense increased by $3.8 million to $7.6 million primarily due to the $650 million mortgage loan that was obtained in January of 2019 at just over 45% loan-to-value, which was discussed on last quarter's earnings call. The 10-year nonamortizing loan at a fixed interest rate of 4.31% was used to pay down floating rate debt on our revolving credit facility and provided an attractive source of low-cost capital to fund our acquisition.

We finished the quarter with $50 million outstanding on our revolver, resulting in debt to adjusted EBITDA of 5.5x. As mentioned last quarter, proforma leverage to the 2 portfolio acquisitions will be higher than our long-term target, but we remain comfortable at this level due to our stable, predictable and growing cash flows and well-covered dividend. We do not plan to seek investment-grade ratings in 2019 and, accordingly, can be patient with higher leverage levels, which also allows more flexibility to increase our dividend now that the $905 million of acquisitions have closed.

We have received a few investor questions about the shelf registration statement we filed last week. As a general rule, our policy is to always have a shelf available to maximize flexibility, but the timing of our filings was tied to the completion of the audits of the financial statements for the acquired portfolios. We want to be clear that we have no plans to raise equity through the sale of shares at today's market prices. That concludes our prepared remarks.

Operator, we're now ready to take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question today comes from Bryan Maher of B. Riley FBR.

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Bryan Anthony Maher, B. Riley FBR, Inc., Research Division - Analyst [2]

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Two questions from me. One, we came across the article on -- I guess it was SNL or something like that a week or 2 ago on Hawaii legislation looking to build REITs. I'm sure you guys are familiar with this legislation that's out there. Can you give us a couple of comments as to what you think about that, the prospects for its passage? And we did run some back-of-the-envelope numbers on how it might impact you, and it did not seem material, but I just wanted to confirm that.

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John G. Murray, Industrial Logistics Properties Trust - President, CEO & Managing Trustee [3]

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Yes. I'll start, Bryan. Thank you. That's a good question, and Rick will fill in the blanks if I miss something, but there -- for a number of years, there's been -- there's litigation potential regarding doing away with the dividends paid deduction in Hawaii. In prior years, it hasn't made it as far as it has this year, but it has passed each of the houses in Hawaii, and they reconciled the 2 different bills and presented it to the -- back to the -- for a final vote, and it's -- it got approved.

So it's heading for the governor's desk. We're hopeful, based on prior commentary that we've heard, that the governor may veto the bill, although there's certainly no assurance that, that will happen. We have -- because we have seen this bill get voted on in prior years, we've been careful about how we have structured different transactions we've done. And we believe that there are ways to take advantage of depreciation deductions and interest deductions and other allocations of revenue among the states such that we can minimize what gets apportioned to Hawaii. And as a result, we feel like the expected impact is going to be -- is not going to be material to ILPT.

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Bryan Anthony Maher, B. Riley FBR, Inc., Research Division - Analyst [4]

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Okay, great. And then, John, in your comments in your earnings release this morning, you kind of hinted at a dividend increase in the near term. You're at normalized FFO payout ratio of about 80.5%. What were you getting at there? Is that something we could see in the next quarter or 2? How material might it be? I know that it's up to the Board, but you opened the floodgate there on the question, so I'll throw it back to you.

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John G. Murray, Industrial Logistics Properties Trust - President, CEO & Managing Trustee [5]

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Okay. That's a good question also. Yes, we completed $905 million of acquisitions earlier this year and, as a result, expect our cash available for distribution to increase. And so I think that, under normal circumstances, it would be reasonable for our shareholders to expect that we would be raising the dividend. Probably the next dividend would probably -- roughly be the timing now that -- since we have closed on all the properties. I think the wildcard is that our share price hasn't really reacted well so far to the investment activity, and maybe some of that has to do with the fact that we filed the shelf last week. Maybe it's just concern over our leverage levels.

If your dividend rate gets too high, then people think that maybe there's a problem that they're missing, and it negatively impacts the share price. So I think we're -- our Board's got a lot of thinking to do about what message we're sending. And we already have the highest dividend I think in the sector or certainly one of the highest in the sector, and so if shareholders are telling us that they're more concerned about leverage than dividend levels, then maybe we'll use the cash to reduce leverage instead. So the Board has to make a decision there. But normally, based on the acquisition activity we've completed, we would raise the dividend probably with this coming dividend payment.

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Operator [6]

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The next question comes from Mitch Germain of JMP Securities.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [7]

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John, maybe -- I think you said that the Board expansion was going to -- obviously, you hired a search firm. It may take a little time to transpire. What specifically -- what type of candidates are you looking to add, maybe from background or whether it would be real estate experience or financial auditing-type experience? Is there a certain profile of what you're looking to add?

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John G. Murray, Industrial Logistics Properties Trust - President, CEO & Managing Trustee [8]

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Well, I think that we're trying to increase the diversity on our Board. And we already -- we only have 5 trustees today. We have diversity among those Board members today, but we could add more diversity. And so I think we'll be looking for that. We'll be looking for different backgrounds, real estate backgrounds, public company backgrounds, just general business backgrounds. I think we haven't drawn any specific targets that we need a certain amount of people from certain categories. We're just -- we're looking to increase the number of independent trustees and increase the diversity of our Board members.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [9]

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And is the goal for these trustees to be independent of other RMR entities as well?

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John G. Murray, Industrial Logistics Properties Trust - President, CEO & Managing Trustee [10]

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I think that's the goal, yes.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [11]

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Okay. Last one from me. I know that, given where the stock price is, you've said equity seems to be out of the picture for now. I know you've mentioned some joint ventures. Is -- a sale of some properties into some sort of joint venture with institutional partner, do you envision that being assets on the mainland portfolio or maybe selling off a minority piece of Hawaii?

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John G. Murray, Industrial Logistics Properties Trust - President, CEO & Managing Trustee [12]

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I think that if we were -- if we do go down the path of some sort of joint venture for tax basis reasons, right now, it seems like doing something with the mainland portfolio would be easier than trying to structure something with the Hawaiian portfolio. Maybe the Hawaiian tax legislation may make us think a little bit differently about that, but I don't think so right now. I think most likely, it would be a mainland portfolio.

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Operator [13]

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

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Michael Albert Carroll, RBC Capital Markets, LLC, Research Division - Analyst [14]

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Yes. I just wanted to go off of Mitch's last question. I mean how are you thinking about joint ventures right now? Have you started discussions with anybody? Or is that still just a thought process right now?

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Richard W. Siedel, Industrial Logistics Properties Trust - CFO & Treasurer [15]

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We've just spent some time internally talking about either selling a property or 2 or taking on a JV partner to recycle some capital and demonstrate to the market the value for our mainland portfolio. We'd like to think that the Hawaii financing with the appraisal being out there publicly and some fairly large banks getting behind it kind of supported the value of our Hawaiian assets and wondering if doing something on the mainland would be helpful. Again, here at the RMR Group, we've got a number of relationships. There are a few JVs in portfolios, and we know how the process works. It's just a matter of determining that that's the best course of action and going forward with it.

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Michael Albert Carroll, RBC Capital Markets, LLC, Research Division - Analyst [16]

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But you haven't had any discussions with any other potential partners to joint venture any of your assets yet?

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Richard W. Siedel, Industrial Logistics Properties Trust - CFO & Treasurer [17]

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There's always some discussions with various partners, but nothing that we're prepared to announce at this point.

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Michael Albert Carroll, RBC Capital Markets, LLC, Research Division - Analyst [18]

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Okay. And then I think, Rick, did it -- is it going to take about roughly 12 months to execute that joint venture once those discussions start? Is that correct?

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Richard W. Siedel, Industrial Logistics Properties Trust - CFO & Treasurer [19]

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It varies on the portfolio. Some of these are pretty straightforward, and I think folks could get due diligence a lot faster. So it's hard to say. I mean, but it's a -- it depends on the partner, and it depends on the assets. Most of our mainland assets are pretty straightforward with great credit tenants in a hot sector right now. So I'd like to think we could do it faster than a year. But again, we're in no rush. We like the cash flow from the properties right now and are comfortable with leverage levels where they are.

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Michael Albert Carroll, RBC Capital Markets, LLC, Research Division - Analyst [20]

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Okay. And then just real quick on the dividend policy. Is there a target payout ratio that the Board looks at when setting the dividend?

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Richard W. Siedel, Industrial Logistics Properties Trust - CFO & Treasurer [21]

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I don't think we've stated it publicly, but postacquisitions, with the current dividend, we're down in the low 70s. So it's fairly low relative to all of peers I believe or most of the peers. Just in general that feels like a level that would support it. But to John's point earlier, the question about a dividend increase being spinning in the wind is not lost on us. So we'll continue to model it, and the Board has some thinking to do and a decision to make.

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Michael Albert Carroll, RBC Capital Markets, LLC, Research Division - Analyst [22]

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Okay. And then when you think about a dividend increase, is there something that you typically want to do every year? I guess we're into the -- through the first quarter, and we didn't get a dividend increase since the IPO was completed? Or is it as you kind of look at -- when you have a big acquisition or earnings pop, that's when you'll think about the dividend increase, I guess. What does the Board think about? And when do they think about increasing it?

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John G. Murray, Industrial Logistics Properties Trust - President, CEO & Managing Trustee [23]

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The Board discusses the dividend at every meeting. There's been a lot of change that's happened since the IPO and recent acquisitions and financing of the Hawaiian properties. And so I think there isn't a formal policy, but we'd like to be in a position where we're raising the dividend on a regular basis, preferably annually. But we haven't sort of set a set policy or a target quarter for when those increases may occur. It just -- it depends on activity and what else is going on within the company.

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Operator [24]

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This concludes our question-and-answer session. I would like to turn the conference back over to John Murray for any closing remarks.

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John G. Murray, Industrial Logistics Properties Trust - President, CEO & Managing Trustee [25]

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Thank you, everyone, for joining today's call. We've had a busy and successful start to 2019, and look forward to earnings growth and value creation for shareholders over the course of the year. We hope to see many of you at the upcoming NAREIT conference in June. Thank you.

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Operator [26]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.