Q2 2023 Industrial Logistics Properties Trust Earnings Call
Participants
Brian E. Donley; CFO & Treasurer; Industrial Logistics Properties Trust
Stephen Colbert
Yael Duffy; President & COO; Industrial Logistics Properties Trust
Bryan Anthony Maher; MD; B. Riley Securities, Inc., Research Division
Jing Xian Tan Bonnel; REIT Analyst; BofA Securities, Research Division
Michael Albert Carroll; Analyst; RBC Capital Markets, Research Division
Mitchell Bradley Germain; MD & Equity Research Analyst; JMP Securities LLC, Research Division
Presentation
Operator
Good day, and welcome to the Industrial Logistics Properties Trust Second Quarter 2023 Financial Results Conference Call. (Operator Instructions) Please note, this event is being recorded. I would like now to turn the conference over to Stephen Colbert, Director of Investor Relations. Please go ahead, sir.
Stephen Colbert
Good morning. Joining me on today's call are Yael Duffy, President and Chief Operating Officer; and Brian Donley, Treasurer and Chief Financial Officer. Today's call includes a presentation by management followed by a question-and-answer session with analysts. Please 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, July 26, 2023, 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 those 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 statements.
In addition, we will be discussing non-GAAP financial numbers during this call, including normalized funds from operations or normalized FFO, adjusted EBITDA and cash-based net operating income or cash basis NOI. This quarter, we are also introducing our calculation of cash available for distribution or CAD. A reconciliation of these non-GAAP figures to net income is available in our supplemental operating and financial data package, which can be found on our website. And with that, I will turn the call over to Yael.
Yael Duffy
Thank you, Stephen, and good morning. On today's call, I will review ILPT's operating and leasing performance and then provide an update on our disposition activity before turning the call over to Brian to discuss our financial results.
As we enter the second half of the year, we remain encouraged by the continued demand for ILPT's high-quality portfolio and the strength in the industrial real estate -- in real estate fundamentals. In the first 6 months of 2023, we signed 32 leases totaling more than 3.1 million square feet at weighted average rental rates that were 23% higher than prior rental rates for the same space. The impact of this activity is an increase of $4.8 million in annualized rental revenue, of which more than half will take effect in the second half of 2023 or in 2024. These results, along with a tenant retention rate of 87%, showcase our ability to generate organic cash flow growth while maintaining portfolio stability.
As of June 30, 2023, our portfolio, which consists of 413 warehouse and distribution properties, achieved 99.1% occupancy, representing a 40 basis point increase sequentially. During the quarter, we executed 17 new and renewal leases and 3 rent resets for nearly 2 million square feet at a weighted average lease term of 8.9 years. This activity resulted in GAAP and cash leasing spreads of 29.6% and 10.2%, respectively.
Highlighted in these results is the robust activity within our Hawaii portfolio. With a market vacancy rate under 1%, strong tenant demand and minimal new construction in the pipeline, we have been able to take advantage of mark-to-market opportunities. We executed 855,000 square feet of leasing in Hawaii at weighted average rental rates that were 41.7% higher than prior rents, including 5 new leases totaling 195,000 square feet at increases in rent of 62.2%.
Leasing in our wholly-owned Mainland portfolio was also strong with total leasing of approximately 428,000 square feet including 1 new lease and 3 renewals at weighted average roll-ups in rent of 50% and 36%, respectively. Looking ahead, 12 million square feet or 16% of ILPT's total annualized revenue is set to expire through 2025. We believe there is ample opportunity to increase cash flows consistent with the 30% roll-up in GAAP rents we achieved over the past 12 months.
Turning to transactions. Among the most frequently asked questions we receive is when we expect to resume our disposition program to reduce leverage. Based on what we are seeing firsthand and through discussions with brokers, we believe the market has slowly begun to thaw as investors look for opportunities to deploy capital. We consistently receive unsolicited offers for the high-quality properties in our portfolio.
However, given we are not a distressed seller, it isn't as simple as finding a buyer. As we evaluate each opportunity, our ability to transact is dependent on pricing and the impact to our financial position. For each offer we may receive, we compare the potential transaction price to the allocated loan amount under our debt agreements and confirm that we can maintain the required debt service coverage ratios.
Additionally, potential tax gains and the impact to our overall liquidity needs to be considered. As such, disposition opportunities have been limited in this challenging sales market. Given these obstacles, we are happy to report that we currently have 3 properties, 2 that are encumbered totaling 762,000 square feet under agreement to sell for an aggregate sales price of $65.3 million. We hope to continue to improve our financial position with additional disposition opportunities. However, we expect activity to be limited in the short term. I'll now turn the call over to Brian.
Brian E. Donley
Thank you, Yael, and good morning, everyone. Starting with our consolidated financial results for the second quarter of 2023, normalized funds from operations was flat on a sequential basis of $0.12 per share, a decline compared to the prior year quarter, primarily as a result of our higher interest expense incurred under our floating rate debt instruments.
Cash available for distribution in Q2 was $9.8 million, and adjusted EBITDAre was $81.3 million for the quarter. Our leasing activity generated increases in cash rents for our comparable portfolio of $1.8 million or 2% per year, year-over-year. However, our rent growth was partially offset by operating expense increases, which resulted in a net 50 basis point increase in total portfolio same-property cash basis NOI for the second quarter. Comparisons of same-property GAAP NOI were negatively impacted by a $3.4 million write-off but below market lease liability in the prior year quarter related to a lease termination.
Interest expense increased $24.6 million compared to the prior year quarter, excluding the impact of the amortization of bridge loan costs recognized in the prior year. This quarter, we executed on a cash out refinancing within our consolidated joint venture. We entered a new $91 million fixed rate interest-only loan secured by 4 properties that bears interest at 6.25% and used part of the proceeds to repay 4 amortizing loans with a total principal balance of $35.9 million. As a result, our current estimated quarterly interest expense run rate is approximately $73 million, consisting of $60 million of cash interest expense and $13 million of noncash amortization of financing costs, including existing interest rate caps.
Turning to our balance sheet. Including extension options, ILPT's weighted average debt maturity is 5.5 years with no maturities until 2027. As of June 30, our total debt either carry a fixed rate or was fixed through interest rate caps for total weighted average interest rate of 5.46%. As Yael mentioned, we have 3 wholly-owned properties under agreement for sale of $65.3 million. Assuming those transactions close, $42 million of the proceeds from 2 of the properties will be used to repay a portion of the $1.2 billion floating rate CMBS loan. The amount to re-lease a property from the collateral pool under this loan is the greater of 115% of the allocated loan value under our debt agreement or the net sales proceeds. We also need to maintain the overall debt service coverage ratio that was in place when the loan was underwritten.
For these dispositions, ILPT can transact without needing to contribute additional cash to maintain the loan covenants. So we currently have $71.7 million of cash on hand as well as $138.7 million of restricted cash in our consolidated joint venture. We continue to look for opportunities to build our cash reserves. Accordingly, the proceeds from the sale of the 1 unencumbered asset will be held to further enhance our liquidity.
In closing, our portfolio remains strong with an exceptional tenant roster, near full occupancy and rising rents across our portfolio. And we expect that ILPT will continue to benefit from industry demand for high-quality industrial real estate. That concludes our prepared remarks. Operator, please open the line for questions.
Question and Answer Session
Operator
(Operator Instructions)
The first question comes with Bryan Maher with B. Riley Securities.
Bryan Anthony Maher
Just a couple for me this morning. When we think about the asset sales and building cash reserves and paying down some debt, how big of an opportunity do you think that, that is over the next couple to few quarters?
Yael Duffy
Bryan, I think we're reviewing opportunities as they come. Two of the properties on the disposition list came through our leasing efforts. One of the properties is vacant and the other soon to be vacant, so we haven't launched a formal disposition campaign. And so we're continuing to evaluate pricing and our portfolio and see what other opportunities we have. So I don't have a number for you to project.
Bryan Anthony Maher
And I suspect that when you chip away at this debt with some asset sales over the next, let's say, 12 to 15 months before the first extensions would be due on some of your variable rate debt, that, that's going to potentially lower the cost of future caps needed to get those extensions done. Maybe Brian, you can talk about for a second, if we were to sit here today and have to redo those caps to get the extensions, what the cost might be relative to what you had to pay last year. Just some broad stroke ideas.
Brian E. Donley
Sure, Bryan. And I think we talked about this last quarter and it's -- buying an interest rate cap, it's a very volatile instrument. The pricing changes week to week, day to day. And I think last quarter, I might have quoted something around $50 million. And we consult with various experts on this that the deal in caps and our current estimate today on the $1.4 billion floating rate debt could be anywhere from $17 million to $20 million if we were to buy that same cap.
So again, it changes with the wind, so it's very important for us to continue to build cash reserves. But to your other point, yes, if we were to chip away at the debt and repay meaningful amounts, the cost of that cap would also decline because it's based on the principal -- the notional amount of principal debt that you're taking -- that you're capping.
Bryan Anthony Maher
And just maybe 2 more quick ones for me. On the rent roll-ups, I mean, those were pretty juicy roll-ups for the second quarter. Yael, what do you think it would be for the full year? When we look back at 1Q, when we think about 2Q, do you have something in your mind for what you think it is for all of 2023?
Yael Duffy
I think we're hoping that it's somewhere between 25% to 30% for the year on a GAAP basis.
Bryan Anthony Maher
Okay. And just my last question. The Blackstone deal to sell $3.1 billion in warehouses and industrial assets to Prologis, when you look at that transaction, does it seem like more of a one-off on the part of Blackstone to raise capital relative to some of the capital that's been called away from them in BREIT, et cetera? Or is there something else going on there as it relates to demand for assets? And that's all for me.
Yael Duffy
I think industrial, in general, along with multifamily, is probably the most in-favor asset class. So if investors are looking to deploy capital, I think it's in one of those categories. So I think it's promising for the industrial landscape. I think that deal was a huge deal.
And in speaking with brokers, we're seeing -- they're seeing that more one-off deals are coming into the market but they haven't seen the bigger portfolio. So I think time will tell, and I think everybody is kind of looking for September to get here and see what that brings because generally, the summer is slow.
Operator
Next question comes with Mitch Germain with JMP Securities.
Mitchell Bradley Germain
I'm trying to understand some of the puts and takes in your same-property growth. And despite some of these pretty healthy rent spreads that you are getting on these leases, your revenues are only up from prior year about less than 1% but your operating expense is up significantly more. So I'm just trying to understand kind of when does this upside in rents begin to materialize and have a meaningful impact on your rental income?
Yael Duffy
Yes. So I think some of these roll-ups, we've had this historically. We're doing -- we're not seeing the cash impact right away because we're doing deals ahead of lease expiration. And so for the activities we've done so far this year, I think almost 2/3 will be in the later half of the year and into 2024. So I think that's impacting some of the growth, and we're not seeing it this quarter.
I think also as far as the expenses go, I think some -- we have some very sophisticated tenants that when they negotiate their leases, they put caps in for how much expenses can get passed back for maintenance and repairs. And so I think there is a little bit of leakage on the expense side.
Mitchell Bradley Germain
Okay. And then with regard to your expirations in the back half of the year, is there anything that -- of note that we should be aware of? I mean, you've had almost a 90% retention rate so far. So is there any kind of planned move-outs that we should be aware of?
Yael Duffy
So we know of 2 known vacates in the second half of the year. Both of those properties actually have pretty good activity on them. One has assigned LOI, and the other, I think we've traded a couple of proposals with prospective tenants. So there isn't anything that should be a needle mover in '23.
Mitchell Bradley Germain
Okay, cool. I appreciate the extra color in terms of kind of suggest kind of where mark-to-market is going. How should we think about that, though, if we like bifurcate Mainland versus Hawaii?
Yael Duffy
Yes. So as you know, Hawaii has always been really strong for us. And so I think 30% to 40% roll-ups in Hawaii going forward are -- would not be surprising, I think 30% on the conservative side. On the Mainland, we had really good leasing results this quarter, almost 40% on the Mainland from a GAAP perspective. And even on the cash perspective, it was 30%.
I think it really depends market to market. I think we have some areas like Memphis, South Carolina that we've been seeing huge roll-ups in rent and others that have been single digits. So I think 10% is probably a good estimate for the Mainland.
Operator
The next question comes with Camille Bonnel with Bank of America.
Jing Xian Tan Bonnel
Just following up on, Yael, your response to an earlier question about how like the leasing spread impact, you'll see that start to follow through in the back half of this year. Can you just speak to why, like, you think tenants are willing to renew their leases so far in advance? I think in some cases, you've been signing leases like 18 months-plus, which really differs from your -- some of the peers' strategies in the market currently?
Yael Duffy
Yes. So I think in Hawaii generally, the tenants are more of they kind of wait until the last minute generally because they are smaller tenants, and just they're kind of running their business and they don't have a whole team focused on their leasing efforts. I think for the Mainland, these are large properties that are very important to the tenant's business. And they need to make sure that if they're going to not be able to do a renewal with us and we can't come to terms, they're going to have to move their operations.
And if you're 1 million square feet, it's really hard to wait 6 months out if you have to relocate and build all the infrastructure again. So that is, I think, generally why we're starting negotiations early. Plus we also want to have an indication if a tenant is not going to renew, we want to limit our downtime because by the time you hire a broker, start marketing it, if you need to do any work to multi-tenant the property potentially, that takes time and we're trying to limit our downtime.
Jing Xian Tan Bonnel
That's helpful. And what are you seeing in terms of market rent growth particularly in the mainland U.S.?
Yael Duffy
About 10%. Again, it depends market to market. Some are higher, some are a little bit lower but we're continuing to have -- we've been able to continue to push rents.
Jing Xian Tan Bonnel
And has that changed? Because I think that 10% is on an annual basis. So have you seen any change sequentially?
Yael Duffy
No. What we've been seeing more is that tenants are taking a little longer to make a decision and I don't know if that's just the impact of the summer. People generally, this is a slow time for leasing because people are on vacation. But no, we haven't seen it, tenants pushing back.
Jing Xian Tan Bonnel
All right. And lastly, do you have any update on the interest around the space in Hawaii that Home Depot was going to take in '24?
Yael Duffy
Yes. So we've officially launched it at the beginning of the month, and we've gotten a lot of inbound calls, mostly from Mainland tenants looking to kind of have a presence in Hawaii. So we feel optimistic that we'll be able to get that re-leased ahead of the March 2024 lease expiration.
Operator
The next question comes with Michael Carroll with RBC Capital Markets.
Michael Albert Carroll
Can you quickly touch on your financing strategies? I guess what's the reasoning for issuing the $90 million of secured debt and repaying the smaller balances that are outstanding in debt? I think it was like $30 million that you repaid. It looked like that $30 million was going to expire in 2020 -- or in 2030 time frame. So was it just a way for you to get more cash or was that the whole goal of that the reason why you're willing to give up that lower interest rate debt?
Brian E. Donley
Michael, thanks for the question. Yes, that's exactly right. It was an opportunity to actually improve our cash flow. The coupon and the interest expense on our income statement will go up because of the rate differential. But again, it's not -- a new loan is interest-only versus amortizing principal payments over those other mortgages, so it was a way to capture some cash as well as improve ongoing cash flow available to the company. So that was the thought process there.
Michael Albert Carroll
Okay. And then on the asset sales that you announced, I guess how much NOI from those properties were generated in 2Q? I know you said 1 was vacant and 1 was soon to be vacant. But when we're looking at our models, I mean, I guess what was the trailing cap rate on those assets that we can assume kind of flows out of the run rate estimate going forward?
Yael Duffy
So one of the properties is our development project in Mesquite, Texas, so that also had no cash flow associated with it. And the other one, as I mentioned, was a small property that was formerly leased to FedEx that was also not cash flowing. And the other 1 is in Indiana. It was a bigger property, 535,000 square feet that was scheduled to be vacant in June of '24, and we had about $3 million in NOI for that property.
Michael Albert Carroll
Is that an annualized number or quarterly?
Yael Duffy
Yes, annualized, yes.
Michael Albert Carroll
And then Yael, when you start looking at potential asset sales, I know you said earlier that you haven't started a process yet to sell properties. I mean, do you need to start thinking about pursuing something like that before the interest rate caps expire? Or are you willing to kind of continue to kick the can down the road, waiting for a better market before you even think about bringing properties to the market to sell?
Yael Duffy
Yes, we have no urgency. We feel that we have the cash reserves to buy the caps with what we have today, the cash on hand today. So I think we'll be patient until we get a better sense that the capital sales market has really opened.
Brian E. Donley
Yes. We want to make sure we actually delever, but with any transaction and as we sort of outlined in our prepared remarks, there are multiple considerations before we're willing to actually pursue a transaction, and evaluation is everything.
Michael Albert Carroll
And what do you have to see for you to be willing to bring assets to the market? I mean, do you need to see interest rates stabilize or do you need to see them actually start to tick lower from this point?
Yael Duffy
I think it's more just to understand what the market is. I think there's still price discovery. I know the Blackstone deal was a big one but it was also a one-off. And so I think we're kind of waiting to just get more data.
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Yael Duffy for any closing remarks. Please go ahead.
Yael Duffy
Thank you for joining us on the call today and hope to speak with many of you soon.
Operator
This conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
