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Edited Transcript of STAG earnings conference call or presentation 3-May-17 2:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 STAG Industrial Inc Earnings Call

BOSTON May 6, 2017 (Thomson StreetEvents) -- Edited Transcript of STAG Industrial Inc earnings conference call or presentation Wednesday, May 3, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Benjamin S. Butcher

STAG Industrial, Inc. - Founder, Chairman, CEO and President

* David G. King

STAG Industrial, Inc. - EVP and Director of Real Estate Operations

* Matts Pinard

STAG Industrial, Inc. - VP

* Stephen C. Mecke

STAG Industrial, Inc. - COO and EVP

* William R. Crooker

STAG Industrial, Inc. - CFO, EVP and Treasurer

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Conference Call Participants

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* Barry Paul Oxford

D.A. Davidson & Co., Research Division - VP and Senior Research Analyst

* Blaine Matthew Heck

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* David Bryan Rodgers

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

* Joshua Dennerlein

BofA Merrill Lynch, Research Division - Research Analyst

* Michael William Mueller

JP Morgan Chase & Co, Research Division - Senior Analyst

* Mitchell Bradley Germain

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

* Neil Malkin

RBC Capital Markets, LLC, Research Division - Associate

* Sheila Kathleen McGrath

Evercore ISI, Research Division - Senior MD and Fundamental Research Analyst

* Thomas James Lesnick

Capital One Securities, Inc., Research Division - Associate

* William Andrew Crow

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

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Presentation

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Operator [1]

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Greetings, and welcome to the STAG Industrial First Quarter 2017 Financial Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Matts Pinard, Vice President ,Investor Relations. Thank you, Sir. You may begin.

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Matts Pinard, STAG Industrial, Inc. - VP [2]

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Thank you. Welcome to STAG Industrial's Conference Call covering the first quarter 2017 results. In addition to the press release distributed yesterday, we posted an unaudited quarterly supplemental informational presentation on the company's website at stagindustrial.com under the Investor Relations section.

On today's call, the company's prepared remarks and answers to your questions will contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ from those discussed today. Examples of forward-looking statements include statements relating to earnings trends, G&A amounts, acquisition and disposition volumes, retention rates, debt capacity, dividend rates, industry and economic trends and other matters.

We encourage all of our listeners to review the more detailed discussion related to these forward-looking statements contained in the company's filings with the SEC and the definitions and reconciliations of non-GAAP measures contained in the supplemental informational package available on the company's website.

As a reminder, forward-looking statements represent management's estimates as of today. STAG Industrial assumes no obligation to update any forward-looking statements. On today's call, you will hear from Ben Butcher, our Chief Executive Officer; and Bill Crooker, our Chief Financial Officer.

I will now turn the call over to Ben.

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [3]

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Thank you, Matts. Good morning, everybody, and welcome to the first quarter earnings call for STAG Industrial. We're pleased to have you join us and look forward to telling you about our first quarter results. Presenting today, in addition to myself, will be Bill Crooker, our Chief Financial Officer, who will discuss the bulk of the financial and operational data.

Also with me today are Steve Mecke, our Chief Operating Officer; and Dave King, our Director of Real Estate Operations. They will be available to answer questions specific to their areas of focus. Let me start the call by saying that we had another great quarter. Our strategy and investment thesis have remained constant over our 6 years as a public company.

Our adherence to our strategy/thesis, the execution by our great team and the strong industrial fundamentals that exist in our markets have led to our strong performance; performance that we expect will continue into the foreseeable future. On a macro level, the first quarter saw a degree of return to the patterns of recent times. Gridlock in Washington and declining long-term interest rates, the ones that mattered to the real estate industry. These patterns bode well for industrial real estate and REITs in general. The industrial sector, on an aggregate basis, continues to perform well, even though by some reports, supply-demand equilibrium was reached in Q1 '17. The prior 27 straight quarters of excess demand has resulted in market conditions, i.e., low vacancy, they remain very favorable to landlords. Thus, supply concerns are more likely to be manifested as a moderation or perhaps cessation of future rent growth, rather than some type of market collapse.

As we look forward, we're quite comfortable with our mix of market exposures. CBRE Econometric Advisors' projections for the national industrial market has a 5-year rent growth at a 2% compounded annual growth rate. The primary markets at a 2.1% 5-year CAGR, and the 6 super primary markets at a 1.9% 5-year CAGR. 5-year rent growth for our markets that are covered by CBRE Econometric Advisors, weighted by our exposure to each of these markets, is projected at a 2.5% CAGR. These projections are consistent with our expectations that the STAG portfolio mix of markets will outperform over portions of the business cycle.

Our buildings serve primary demand in both primary and secondary markets. As expected, our portfolio continue to perform well to start 2017. We executed 9,000 square feet of new leases and 2.7 million square feet of renewal leases.

This level of new leasing activity for the first quarter exceeded our full-year total for all of 2016. On a total 3.6 million square feet lease during the quarter, we experienced cash rent change and GAAP rent increases of 4% and 10%, respectively. Our tenant improvement spend continued to be quite low, $0.28 per square foot on these leases.

In reviewing our earnings release, you may have noted that our tenant retention for the quarter was 51%, lower than our long-term expectations of circa 70%. Our retention leases resulted in cash and GAAP rent increases of 13% and 24%, respectively.

Higher retention is generally a good thing for operating results, but not always. If we were to add back the no-downtime leasing, i.e., where the building is already leased prior to the current tenant's departure in the quarter, retention would've been 82%. The new leases for these incremental buildings had a cash rollup of 22.5%.

For the full year 2017, we continue to expect retention to be between 65% and 70%. On the external growth front, we acquired $100 million accretive assets at a stabilized cap rate of 8.2%, our largest first quarter acquisition total ever. Perhaps even more significantly, we are scheduled to close between $200 million and $250 million in the second quarter, another historic quarter.

We continue to see attractive opportunities for acquisitions as we look broadly across the U.S. industrial landscape. Our pipelines sits at $2.1 billion and consist primarily of granular single-tenant industrial buildings. The increased pace of acquisitions this year is due, in large part, to the continuous improvement of our underwriting process and systems.

Our investments in the STAG machine are showing results.

As a result of this higher first quarter acquisition pace, we are increasing the lower end of our acquisition guidance for 2017. We now expect to close between $550 million and $600 million of assets in 2017, within the same previously guided stabilized cap rates averaging between 7.5% and 8%. These acquisitions, both close and projected, continue to reflect the parameters of the assets acquired over the last few years.

The level of FFO per share accretion on these acquisitions has been enhanced by our reduced cost of capital. We have continued to utilize our ATM-to-issue equity as needed to fund our accretive external growth. Over the last 3-plus quarters, we've raised nearly $500 million of common equity through this very efficient method of issuance.

Our principal focus continues to be on the bottom line, and we are very happy to report another quarter of year-over-year accretion.

With that, I'll turn it over to Bill to walk you through our first quarter results.

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William R. Crooker, STAG Industrial, Inc. - CFO, EVP and Treasurer [4]

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Thank you, Ben, and good morning, everyone. We've been very successful on the acquisition front this quarter and into the second quarter. We closed less than 10% of the transactions we underwrote, which is in line with past years, but the number of transactions we have underwritten has increased.

We continue to maintain our pricing discipline as evidenced by the 8.2% stabilized cap rate we achieved in Q1. We closed approximately $100 million of acquisitions in Q1 and $21 million thus far in Q2. During the quarter, we disposed of one building for $4 million, which was a noncore asset. We continue to expect to have noncore and opportunistic dispositions between $40 million and $80 million in 2017. At quarter-end, we owned 324 buildings with a total of 63 million square feet.

Occupancy for the operating portfolio stands at 95.8%, with an average lease term of 4.4 years. Cash NOI for the quarter grew by 14% from the prior year Same-store cash NOI decreased by 1.1% over the prior year first quarter, excluding termination income, and was up 20 basis points over the same period when including the impact of cash termination income.

The quarterly same-store decline was primarily driven by an average occupancy reduction of 50 basis points. It's important to note that our same-store pool represents only 78% of our total portfolio. The portion of our operating portfolio, excluded from our same-store pool, is 96% occupied and has annual fixed rental bumps of 2%. We expect 2017 annual same-store cash NOI to be down between 1% and 1.5%.

As we have said in the past, our primary focus is on the bottom line Core FFO. During Q1, we grew Core FFO by 27%, compared to the first quarter of 2016. On a diluted per share basis, Core FFO was $0.41, an increase of 5.1%, compared to the last year. This also represented our highest first quarter Core FFO per share in the company's history. The growth in our per-share metrics, coupled with growth in long-term cash flow, remains our primary focus for our company and is a central consideration in our acquisition and operating decision making.

Our G&A for the quarter was $8.8 million, which is not a representative run rate for the year. The first quarter G&A is seasonably higher due to year-end public company costs. We continue to expect full-year 2017 G&A to be between $33 million and $34 million. If acquisition volume hits the high-end of our guidance range, G&A will likely be on the high end of the guidance range as well. We have continued to maintain a very strong and flexible balance sheet.

In Q1, we raised $69 million of gross proceeds from our ATM and raised an additional $135 million subsequent to quarter-end. ATM issuance continues to be a very effective and efficient tool maximizing cash flow for our investors. At quarter-end, our immediately available liquidity was $383 million, our net debt to run rate EBITDA was 5.3x and our fixed charge coverage ratio was 3.7x.

At quarter-end, we had approximately $1.1 billion of debt outstanding with a weighted average maturity of 5.3 years and a weighted average interest rate of 3.7%. All of our debt is either fixed rate or has been swapped to a fixed rate, except for our revolver. Looking forward, we have a very attractive refinancing opportunity in August, when we have the ability to refinance $88 million of legacy secured debt bearing a weighted average interest rate of approximately 6%.

I will now turn it back over to Ben.

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [5]

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Thanks, Bill. STAG sits in an enviable position. We have a proven investment thesis, ample opportunity to execute on it, an attractive way to price capital to deploy.

We will continue to demonstrate discipline in all phases of our business, including acquisitions, asset management and balance sheet management. At the same time, we are cognant of the current and persisting opportunities to deploy capital, both in our existing portfolio and on accretive acquisitions.

Our focus remains on delivering bottom line performance for our investors. As Bill noted, our Core FFO per share grew 5.1% over the first quarter of 2016. We've consistently demonstrated a commitment to provide our shareholders with not only growth, but also income. On May 1, our Board of Directors approved a dividend increase to $1.41 per share annually. This continued focus and demonstrated capital discipline, combined with the abundance of accretive acquisition opportunities, makes for a very bright future for our company. We thank you for your time this morning and for your continuous support of our company.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Sheila McGrath with Evercore.

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Sheila Kathleen McGrath, Evercore ISI, Research Division - Senior MD and Fundamental Research Analyst [2]

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Ben, you raised $135 million subsequent to the end of the quarter. I'm just wondering if you have increased visibility on near-term closings. Or if there's a portfolio acquisition on the horizon?

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [3]

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Well, as -- Sheila, as we discussed in the call, we have a very active second quarter of closings. We're expecting to close $200 million to $250 million, so we're raising in anticipation of those closings. We typically run around 60% equity, 40% debt, so 60% of $250 million is $120 million to $150 million of equity required. So we're looking to keep our leverage in that lower band of 5x to 5.5x, lower end of our 5x to 6x. That's the EBITDA. So we're raising in anticipation of those closings and keeping our leverage at a place where our balance sheet has capacity to handle future growth.

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Sheila Kathleen McGrath, Evercore ISI, Research Division - Senior MD and Fundamental Research Analyst [4]

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Okay. And as a follow-up, can you talk about the acquisition market in terms of competition since you've been successful in this niche? Are you seeing more organized capital as competitors?

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [5]

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Surprisingly, not really. We note that Duke obviously just came into a bunch of money, but I don't think you'll see Duke competing broadly across the markets. We have both the desire and the ability to look broadly across the industrial universe and to identify and underwrite assets across a very wide swathe of markets, and that sets us apart.

I don't think there's anybody else who has that capacity to do that and that allows us to find these accretive acquisitions. As Bill mentioned, we're requiring about 10% of what we underwrite, but we underwrite less than 30% of what we identify as worth underwriting. And there's a triage even earlier than that as to whether or not it's even worth considering underwriting. So it's a very selective process, and -- but results in accretive acquisitions that we find. A long answer, no, I don't think the competition is changing very much.

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Operator [6]

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Our next question comes from the line of Dave Rodgers with Baird.

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David Bryan Rodgers, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [7]

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Ben, just from a bigger picture standpoint, the retention that you talked about, and I did hear the caveat that you made to that in terms of maybe quicker move-ins, but the 65 to 70 range for the year is kind of lower than you -- I think if typically run long term. A lot of the issues you've talked about historically, either it would be credit or tenant outgrowing your space, but how much of your tenants are just outgrowing space? How much are they being reconfigured to different areas, different locations? How much of that is impacting decision making right now?

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [8]

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So the principle reason remains the building is not big enough. Typically that is because of consolidation. So it's not a 200,000-foot building needing to go to 225,000. It's a 200,000-foot building and 2 other 200,000-foot buildings being consolidated, and say, 0.5 million square feet.

So that kind of consolidation continues to be a primary reason that we're seeing. It is not a credit issue where we continue to experience very low, really no defaults, it's rather fault-related losses in tenancy. So it continues to be tenants that are -- who are feeling good about their business and doing positive things for their business and consolidating M&A activity, et cetera.

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William R. Crooker, STAG Industrial, Inc. - CFO, EVP and Treasurer [9]

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And Dave, more specifically on this quarter, as Ben mentioned, the lower retention was related to these 2 tenants who backfilled with no downtime, but we didn't see any tenants moving out of the markets per se. It was just moving buildings within the market.

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David Bryan Rodgers, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [10]

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Got you. And then maybe a follow-up on what Sheila had asked. The cap rates in the first quarter closings were a little higher than the range. Did you see any pullback from private investors as interest rates bounced around late last year or early this year, that made it more compelling for you to be in the market? Or anything unusual around that scenario?

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [11]

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We -- you look at sort of the higher-level themes like potential rise in interest rates or potential changes in tax laws. And you sometimes expect there to be -- even with marginal change in interest, you expect there to be changes in the small acts or behavior, either buyers or seller. I don’t think we've really seen very much change down at the granular level.

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Stephen C. Mecke, STAG Industrial, Inc. - COO and EVP [12]

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Yes, this is Steve. I agree with Ben. We thought once the short-term interest rates popped up earlier in the year that we would start seeing some of the -- some [better] retrading and things like that going out in the market, but it really hasn't materialized, so we really haven't seen much of a change at all in that.

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David Bryan Rodgers, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [13]

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Last question from me. And I know you maybe haven't historically given this number out specifically, but do you have a mark-to-market for the portfolio now that you're getting a lot more price discovery out there in the market with regard to leasing activity?

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [14]

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No, I think we generally believe that the portfolio is marked at or around market, maybe slightly below. I think that the lease rules would indicate that it's marked below, but quarter-to-quarter, obviously it depends on which leases are rolling and when they're originally signed, all that sort of stuff.

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Operator [15]

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Our next question comes from the line of Mitch Germain with JMP Securities.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [16]

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So just to the question about acquisitions and the investor markets. The increase in the deal pipeline itself, are there more portfolios? Are you stretching in terms of the geographies you're looking at? Is there anything that's really behind that increase that we're seeing?

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [17]

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I think Bill alluded to it. What you're seeing is the effect of -- are the people that we have in the markets living a longer experience in the markets, being better known in the markets, generally the STAG name being better known in the markets, our reputations for transactional certainty being better known, as well as we have 6 outward-facing acquisition people, but we have some of their support team, the analyst team, has started to pick up some outward exposure as well. So at the margin, that probably helps. But I think it's more just a maturation of the machine, I know you love the word "machine," but the -- it's maturation of the machine and the maturation of the individuals and also the support, the analytic support, we're just more efficient, able to underwrite more deals, and as Bill alluded to, we closed something around 10% of the deals we identify and decide to underwrite. So the amount of throughput is increasing and the amount of closings are increasing. The amount of access to get on the pipeline is increasing. It all flows through.

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Mitchell Bradley Germain, JMP Securities LLC, Research Division - MD and Senior Research Analyst [18]

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And then, one more from me. The same store, I know you guys kind of alluded to it being toward the lower end of the range that you established previously, but you backfilled those 2 spaces with no downtime. So I'm just trying to understand what's really driving that decline?

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [19]

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We still have a lots, I'm sorry, go ahead, Bill.

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William R. Crooker, STAG Industrial, Inc. - CFO, EVP and Treasurer [20]

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Yes, it was really just driven by the average occupancy loss of 50 basis points and the related carrying cost of those tenants. So even though we backfilled 2 of those tenants with little to no downtime with positive rent bumps, there was still an average occupancy loss in the quarter of 50 basis points.

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [21]

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And Mitch, we've obviously -- that may sound a little bit like a broken record, but we don't think same-store NOIs are particularly meaningful statistics for a growth company such as ourselves. We push you to look at the, what we feel is the more important factor is, bottom line per share growth.

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William R. Crooker, STAG Industrial, Inc. - CFO, EVP and Treasurer [22]

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And in addition, as I said in the prepared remarks, Mitch, we gave the rental bumps on the remaining 20-plus% of the portfolio being 2%, so that try -- we try to capture the full portfolio with that statistic.

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [23]

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That’s the contractual, obviously the contractual bumps, the lease contractual bumps.

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William R. Crooker, STAG Industrial, Inc. - CFO, EVP and Treasurer [24]

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That's right.

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Operator [25]

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Our next question comes from the line of Tom Lesnick with Capital One.

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Thomas James Lesnick, Capital One Securities, Inc., Research Division - Associate [26]

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I guess, first, just going back to portfolios for a second. I was wondering if you could talk about portfolio evaluation in the context of where you're acquiring single assets today, plus or minus cap and where you're seeing larger entity-level transactions taking place.

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [27]

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Yes, I mean, I think as we've talked about when we sold the small portfolio last year, our prior -- our experiences prior to starting that portfolio when we're a private company, we've seen pretty consistently 100 to 150 basis points of compression between where those individual assets are acquired and where portfolio of those assets can be traded. That is driven by, we think, 2 factors. One is the portfolio is more easily financed, it's more easily capitalized, folks are looking to be able to put out money in larger amounts, but also, we think that the -- our ability to -- or the work that we have done to amass 6 assets to sales, as Bill alluded, by 10% of what we underwrite. We had to identify, underwrite and acquire -- well not acquire, but identify and underwrite 60 assets. So being paid for the work we've done in aggregating those portfolios. It is a phenomenon that has been consistently observable throughout our history since 2003, that these portfolios will trade on that 100 to 150 basis points inside. We also believe that, that's on the -- that's for a nonmanaged pool of small pool of assets that the enterprise value of a managed pool of assets is another -- you pick a number, 100 to 150 basis points inside of that. More reflective of where you see some of the implied cap rates on the other industrial operating companies.

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Thomas James Lesnick, Capital One Securities, Inc., Research Division - Associate [28]

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Got it, I appreciate that, inside on. And then, final one from me. You guys obviously achieved a significant amount of leasing in the quarter. Just looking at your lease expiration schedule, you've got 5.3% of rents remaining on the expiration schedule for 2017. Just wondering how we should think about the leasing volume for the remaining 3 quarters of the year in the context that a lot of the expirations have already been cleared out for'17?

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [29]

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Well, before I turn it over to Dave, I will say that we probably were remiss not crowing more about the leasing success in the first quarter. Some very, very strong leasing, not only in the amount but in the achievement of rent. So, having said that I'll turn it over to Dave to talk about the rest of the year.

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David G. King, STAG Industrial, Inc. - EVP and Director of Real Estate Operations [30]

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And through the rest of the year, I think we anticipate being in the 70% or high 60% retention rate. We do anticipate continued high volume of deal flow and tenant confidence and certainly deal velocity. Their willingness to sign leases for longer terms remains high, and we expect it to continue.

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Operator [31]

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Our next question comes from the line of Blaine Heck with Wells Fargo.

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Blaine Matthew Heck, Wells Fargo Securities, LLC, Research Division - Associate Analyst [32]

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So you guys have definitely favored equity funding recently and issuing on the ATM has been pretty efficient, but your acquisition pipeline and targets each year have grown. So assuming equity remains attractive, do you see foresee having to incorporate more overnight offerings into the strategy? Or do you think the ATM is sufficient for now?

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [33]

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Well as we remarked, we've been able to raise circa $500 million under the ATM since last July. I think that one of the reason why we're able to do that is we have demonstrated that the ATM is going to be our main source of issuance, so investors, including the rededicated investors, if they want to take a position in the stock, they do it through reversing query under the ATM. We, obviously, are very happy with the ATM issuance. It is relatively just-in-time funding. It obviously has a significantly lower cost to the company and to the existing shareholders than the follow-on offering. And we think we are able to talk enough with our existing shareholders and with potential shareholders through the conferences and nondeal roadshows that the advantage of the follow-on as a chance to talk to investors is mitigated by those activity. So we're pretty comfortable that the ATM will allow us to fund our growth going forward. Having said that, if it doesn't, we are very conscious also of balance sheet management and not desiring to get above our [proper] debt levels. So if we need to go to something, whether it's a bought deal or a follow-on offering, we certainly aren't reticent about doing that with the caveat that we like the ATM and continue to issue under the ATM is sort of a self-fulfilling prophecy or effectiveness is because that's the way you do it.

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Blaine Matthew Heck, Wells Fargo Securities, LLC, Research Division - Associate Analyst [34]

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That's helpful. And then, when I look at Page 14 of the supplement of the leasing and retention statistics, there seems to be a pretty big difference in the rent spread you're achieving on the retained square footage, which is around 13% on a cash basis, relative to total renewal at 3.2%. Is that just indicative of better pricing power when the tenant waits until the last minute to renew? Or is there something else going on there?

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William R. Crooker, STAG Industrial, Inc. - CFO, EVP and Treasurer [35]

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Yes, Blaine. It's just a mix. The retention square footage is the square footage that rolled this quarter, so some of those leases were signed this quarter and some were signed prior to this quarter. The renewal leases, the same thing, some of those leases will impact this quarter and some of those leases will impact future quarters. So it's just a mix of tenant -- of leases rolling and when we sign them.

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Blaine Matthew Heck, Wells Fargo Securities, LLC, Research Division - Associate Analyst [36]

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So it's not really an indication in that sense, I guess, the early renewals are at lower spread, so we should expect lower spreads in the future?

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William R. Crooker, STAG Industrial, Inc. - CFO, EVP and Treasurer [37]

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No. Because some of the retained square footage were early renewals as well.

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Operator [38]

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Our next question comes from the line of Barry Oxford with D.A. Davidson.

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Barry Paul Oxford, D.A. Davidson & Co., Research Division - VP and Senior Research Analyst [39]

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Just building on the financing terms, kind of going forward. How would you guys look to bring in maybe a JV partner, given there's a lot of demand for industrial out there in the marketplace and it strikes me as you guys could -- if you guys were inclined to do a JV, you could actually get some fairly favorable terms, maybe even better cost of capital than your stock price, how do you think about that?

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [40]

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Barry, the trade-off in that kind of JV, sort of a equity capital JV, is transparency, simplicity, operating efficiency versus potential cost of capital effectiveness, and I think that we have come down firmly on the side of maintaining a simple balance sheet, a simple income statement as opposed to accessing that capital. The other analogy I have used is that when you enter into a JV, it's like being in a dance and when you ask the girl to dance, you're not asking for a dance, you're asking for 5 years of dancing and it may be a really good idea entering into the dance, but do you really want us sign up for that, for that long a period. I think that the other thing is that when you look back -- we're very confident of our ability to identify and acquire accretive asset. When you look back at the cost of capital, what may have looked like at the outset a cheap source of or a cheaper source of equity will in effect actually not be a cheap source of equity, because we will deliver we think very good returns, very solid returns, to that joint venture partner. So I think we're pretty solely on the raised common equity, occasionally preferred equity, standard forms of debt and deliver the value and the accretion to our shareholders.

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Operator [41]

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Our next question comes from the line of Joshua Dennerlein with Bank of America Merrill Lynch.

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Joshua Dennerlein, BofA Merrill Lynch, Research Division - Research Analyst [42]

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Question on the 2Q transaction that it sounds like you're with $200 million to $250 million. Is that all single transactions? Or is there a portfolio in there?

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [43]

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It would have maybe, there might be a couple of 2 asset transactions, but it is all granular. No portfolios.

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Joshua Dennerlein, BofA Merrill Lynch, Research Division - Research Analyst [44]

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And then for kind of expected cap rate going forward, do we expect the cap rate in 2Q to be closer to 1Q? Or down at 4Q level or a little lower?

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [45]

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We're expecting the run for the year in 7.5% to 8% range. So the achievement in the first quarter of H2 is really a mix. There were obviously or perhaps not obviously -- there were some assets that slid from the first quarter to the second quarter. Had they closed in the first quarter, it would've brought that -- those cap rates down into the 7.5% to 8% range. Just really a mix.

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Operator [46]

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(Operator Instructions) Our next question comes from the line of Neil Malkin with RBC.

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Neil Malkin, RBC Capital Markets, LLC, Research Division - Associate [47]

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Given that the strength you're seeing in the leasing environment and the favorable supply-demand dynamics, and that there are some -- I'm sorry, let me go back. Yes, given that the strength that you're seeing, I'm wondering if there are any known vacates that you have coming up you could talk about or maybe, vacate that you can actually pull forward to take advantage of some better pricing in the market?

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [48]

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Yes, and I think that the reality is that if you have a good tenant in the building and the tenant wants to stay in the building, you're going to find a way to renew that tenant. It's very -- even in the strong market, it's very hard to overcome downtime and the increased tenant improvement cost of changing a tenant out. So 3 to 5-year leases, even if your downtime, true downtime of lease being paid -- rent being paid is only 6 months, that's still a 3-year lease, that's a very large loss of income, 5-year lease obviously a little bit less, but it's -- we find that it is better -- it's almost always better to retain. We obviously had some very good experience this quarter with some rent roll-ups on nonretained tenants, but I think, in the long run, we are focused on retention when we can.

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Neil Malkin, RBC Capital Markets, LLC, Research Division - Associate [49]

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Okay. And then, there's been talk of some outdated supply in certain markets. I'm wondering if you think that is an opportunity for you guys to potentially get into some newer market to diversify your portfolio further.

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [50]

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Yes, I think it's an opportunity to diversify the portfolio. We're certainly seeing opportunities to acquire newer buildings, just deliver buildings, et cetera, where the developer and/or owner of that building may be a little nervous about those markets. Having said that, our mix of markets, as we alluded to in the call, and perhaps we didn't highlight this enough, we expect to have a better rent growth in our mix of primary and secondary markets than either the primary or the super primary markets will have over the next 5 years. That's just a reflection of sort of ways we move through the latter stages of the expansion cycle into the other parts of the cycle, we have, again we think, very strong market exposure.

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Neil Malkin, RBC Capital Markets, LLC, Research Division - Associate [51]

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Okay, great and then last from me. The $2 billion or $2.1 billion pipeline you have. I mean, what is the actual number of -- how -- what is the relative to the actual number of transactions you're looking at or underwriting each quarter?

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [52]

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That pipeline is assets that have made it through an initial triage. So they're assets that we believe that are worth underwriting and assets that we've at least got a preliminary underwriting on.

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David G. King, STAG Industrial, Inc. - EVP and Director of Real Estate Operations [53]

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So we've gone through, we've modeled them, we've looked at them, we've discussed them. So it's; they're fully vetted versus just a quick pass and thrown under the pipeline.

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Neil Malkin, RBC Capital Markets, LLC, Research Division - Associate [54]

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And again, what's the likelihood of close on those? You say that you typically gets 10% of everything you underwrite or a little less, sorry. What is the likelihood of close on like that $2.1 billion, for example, what's the hit rate on that?

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [55]

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10%, we expect to close 10% of those assets. Now that is a dynamic pipeline, obviously, assets go on and off at all the time. So obviously, if we're going to buy $500 million during the year, then there was $5 billion on that pipeline at some point during the year of individual asset.

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William R. Crooker, STAG Industrial, Inc. - CFO, EVP and Treasurer [56]

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Yes, and some assets stay on that pipeline for 60 or 90 days if we take them from the beginning all the way to close.

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [57]

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Some may stay longer, because there are unrealistic expectations by the seller because there is a leasing process even though they are listed there, there is a lease renewal or new lease negotiation ongoing where they sort of hang fire, if you will. So there's a variety of times that assets can sit on the market or sit in our pipeline. But for the most part, they're going on and off, as Bill said, on a fairly regular basis. But if you -- again, thinking back, if we're going to do $500 million or -- we've actually said $550 million to $6 billion, that means -- $600 million, that means $5.5 million to $600 million -- excuse me, $5.5 billion to $6 billion will be on the pipeline at some point this year.

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Operator [58]

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Our next question comes from the line of Michael Mueller with JPMorgan.

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Michael William Mueller, JP Morgan Chase & Co, Research Division - Senior Analyst [59]

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A couple of questions here, and I apologize if I missed the first one. But in terms of dispositions, can you talk a little bit about what exactly you're selling? And is it market based? Is it kind of fully priced? Or just stuff you just don’t want over the long run?

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [60]

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So we have talked about it before. We have sort of 3 categories of sales. We have noncore dispositions, which is primarily our flex/office portfolio, which are assets that we will sell opportunistically as we move through that portfolio. We're continuing the process through that. We -- in the next couple of years, those will disappear. Now, there may still be assets in the portfolio that we don’t want to own long term, but I think, again, once we get through the flex/office portfolio, that will be largely gone. The other 2 are capital sourcing, like the portfolio that we sell last year, that is a opportunity to raise capital. It's accretive, but it's not -- we don’t think the best methodology for our shareholders long term, as we grow the company. So that is an arrow in the quiver for capital raising, but it's not one that we're looking to use again in short term. The other, the third leg, if you will, that still is opportunistic sales, where asset is worth more to somebody else than it is to us in our portfolio, and that occurs very frequent. It occurs when we've a building that has gone vacant, a user shows up and says I'll pay you the value as if it was leased or perhaps even more than the value if it was leased, and we've had a number of those over time. They result in very strong returns. I think, we -- last year, we're talking about mid-single digit -- mid-teen unlevered IRRs and those types of sales. So the other -- and the other opportunistic whenever when we sign a long-term lease with a desirable credit, it's likely that somebody will find that asset to be more valuable than we view it as in our portfolio. But dispositions are not, as Bill alluded, $40 million to $80 million?

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William R. Crooker, STAG Industrial, Inc. - CFO, EVP and Treasurer [61]

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That's right.

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [62]

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Dispositions are not expected to be a big part of the STAG story going forward.

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Michael William Mueller, JP Morgan Chase & Co, Research Division - Senior Analyst [63]

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Okay. And then separately, just in terms of cap rate, I know in the past, you've talked about the same-store NOI growth, how it can be slightly negative because you buy products that's 100% leased and then naturally goes to 95% or just more of a natural occupancy level, and I guess, the question is, when you're talking about cap rates that are 8%, does that assume the occupancy is at 100% and then it's going to gravitate down, so an 8%, effectively 7.5%? Or does that automatically assume it's underwritten it to 95%, where it's going to gravitate to?

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [64]

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No, we're underwriting actual cash flow.

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William R. Crooker, STAG Industrial, Inc. - CFO, EVP and Treasurer [65]

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It's -- Mike, it's a stabilized cap rate, so it is first year NOIs if the asset was 100% occupied. So in Q4, we bought a vacant asset and our cap rate for Q4 represented a stabilized cap rate for that asset as well. So there is no haircut to the 95% occupancy level.

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [66]

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Obviously, Mike, one of the things is the reason we do that is that we think that, obviously, actual will reflect the cash flow that we receive in the short term and the money that you -- or the rent that you receive as these assets continue to be 100% occupied, as the occupancy normalization occurs is still real cash flow.

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Operator [67]

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Our next question comes from the line of Bill Crow with Raymond James.

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William Andrew Crow, Raymond James & Associates, Inc., Research Division - Analyst [68]

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Ben, you've got about 15% to 20% of your annual acquisition bogey already done at an 8.2%. In order to hit the lower end of 7.5%, you'd obviously have to buy a significant number of assets below 7.5%. And I'm just wondering where you're comfortable? How well you are comfortable in going before you think it changes the perception of the story?

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [69]

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Well, I think, Bill, we're looking obviously, thanks for the question. We're looking at our average acquisition returns, both cap rate, but more importantly, our FFO per share over 3 to 5 years, our cash flow over the 3, 5 and 10 years. Different metrics that assess the cash that we'll receive over time. So there is -- there can be some lower cap rates that are longer-term leases with no capital required. They are very clean cash flows where we can develop the requisite long-term returns that we're looking for. So as we average 7.5% to 8%, there'll be numbers, obviously, below 7.5% and above 8% that are part of that average. With the $100 million that we closed in the first quarter and another $20 million after that, is roughly 20% of what we're closing for the year, so the other 80% obviously, can come in at 7.5% and still be averaging between that 7.5% and 8%.

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Operator [70]

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Mr. Butcher, we have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

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Benjamin S. Butcher, STAG Industrial, Inc. - Founder, Chairman, CEO and President [71]

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Thank you for your questions. We are very excited about the strong start to 2017, and our expectations for the full year. We'll continue to execute on our business plan to capitalize on the persisting investment opportunity in single-tenant industrial real estate and the ongoing strength of our portfolio. Our goal is, and will continue to be, delivering best-in-class, risk-adjusted returns to our shareholders. We appreciate your time this morning and your continued support of STAG.

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Operator [72]

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Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.