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Eastgroup Properties Inc
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Good morning, and welcome to the EastGroup Properties Second Quarter 2018 Earnings Conference Call. [Operator Instructions]. Now it is my pleasure to introduce Marshall Loeb, President and CEO.
Thank you. Good morning, and thanks for calling in for our second quarter 2018 conference call. As always, we appreciate your interest. Brent Wood, our CFO, is also participating in the call and since we'll make forward-looking statements, we ask that you listen to the following disclaimer.
The discussion today involves forward-looking statements. Please refer to the safe harbor language included in the company's news release announcing results for this quarter that describes certain risk factors and uncertainties that may impact the company's future results and may cause the actual results to differ materially from those projected. Also, the content of this conference call contains time-sensitive information that's subject to the safe harbor statement included in the news release, is accurate only as of the date of this call. The company has disclosed reconciliations of GAAP to non-GAAP measures in its quarterly supplemental information, which can be found on the company's website at www.eastgroup.net.
Thanks, Tina. The second quarter saw a continuation of EastGroup's positive trends. Funds from operations came in above guidance, achieving a 7.6% increase compared to second quarter last year, excluding insurance proceeds. This marks 21 consecutive quarters of higher FFO per share as compared to the prior year, and we're especially pleased with second quarter FFO given our equity raise. The strength of the industrial market is further demonstrated through a number of our metrics such as another solid quarter of occupancy, strong same-store NOI results and positive releasing spreads. As the statistics bare out, the current operating environment is allowing us to steadily increase rents and create value through ground-up development along with value-add acquisitions.
On leasing, we were 97% leased and 96.4% occupied, and this marks 20 consecutive quarters, or since second quarter 2013, where occupancy has been approximately 95% or better, truly a long-term trend. Drilling into specific markets at quarter end, a number of our major markets, including Orlando, Jacksonville, Charlotte, Phoenix, San Antonio, San Francisco and L.A. were each 98% leased or better. In Houston, our largest market was 95.8% leased. And while still our largest market, Houston has fallen from roughly 21% of our NOI to a projected 14% at year-end. Supply, and specifically shallow bay industrial supply, remains in check in our markets. In this cycle, the supply is predominantly institutionally controlled, and as a result, the deliveries remain disciplined, and as a byproduct of this institution controlled, it's largely focused on big-box construction.
Our quarterly same-property NOI growth was strong at 6.5% GAAP and 6.4% cash, and we're also pleased with average quarterly occupancy at 96%, up 110 basis points from second quarter of 2017.
Rent spreads continue their positive trend, albeit at a slower pace this quarter. Rents was 2.7% cash and 11.9% GAAP. After removing an R&D property in Santa Barbara, these figures rise to 4.9% and 13.5%, respectively. Further, our year-to-date GAAP releasing spreads unmuting this R&D space are 16.1%. The takeaway being that the industrial market remains solid with rising rents. We simply had an unusual mix this quarter versus our prior several quarters. And given the intensely competitive and expensive acquisition market, we view our development program as an attractive risk adjusted path to create value. We believe we effectively managed the risk as the majority of our developments are additional phases within an existing park. The average investment for our business distribution buildings is below $12 million, and we target 150 basis point minimum projected investment return premium over market cap rates. At June 30, the projected return on our development pipeline was 7.7%, whereas we estimate the market cap rate in the upper 4s. Further, we're continuing to see cap rate compression in our markets.
During second quarter, we had fluid development pipeline as we began construction on 5 properties totaling 719,000 square feet with a total projected investment of $65 million. And coming out of our pipeline we transferred 6 buildings totaling 705,000 square feet, for an investment of approximately $57 million.
Four of our five completions rolled into the portfolio at 100%, and the one exception was progress center in Atlanta, which we anticipated as it was a December 2017 value-add acquisition. In sum, we removed 35% of the previous quarter's pipeline and added the same into the current pipeline. This high-volume transition dropped our percent leased from 51% to 27%, and as context, this change is reflective of the volume of early stage projects rather than the state of the market. At June 30, our development pipeline consisted of 17 projects in 10 cities containing 2 million square feet with a projected cost of $171 million. And for 2018, we're raising our projected development starts to $140 million and 1.7 million square feet.
One of the things I'm excited about this year is a greater number of development markets. This diversity reduces our risk and is enhancing our ability to grow the development pipeline. I'm also excited about where we stand in terms of our projected starts. As a reminder, our leasing results are what drive our starts, and the $140 million in projected starts consists of 12 separate projects, and I'm pleased that we've either already begun or have approval for 10 of these 12 starts. We'll continue revisiting our forecast as the year progresses.
In terms of acquisitions, in late April, we acquired Gwinnett 316, a 65,000 square foot 100% leased building in Atlanta for $4.4 million. Later in June, we closed on the 182,000 square foot Eucalyptus Distribution Center in Chino, California for $23.3 million. This property is also 100% leased. And finally, after quarter-end, we acquired 115,000 square foot Siempre Viva Distribution Center in San Diego for $14 million. Each of these was an off-market transaction.
And now Brent will review a variety of financial topics, including our updated guidance.
Good morning. We continue to see positive results due to the strong overall performance of our portfolio. FFO per share for the quarter exceeded the upper end of our guidance range at $1.16 compared to $1.05 for the same quarter last year. $0.03 of second quarter FFO was attributable to an involuntary conversion gain, recognized as the result of roof damage from a hail storm. Excluding the involuntary conversion gain, FFO per share was at the upper end of our guidance range at $1.13 per share, an increase of 7.6% over the same quarter last year. Operations have benefited from the continual conversion of well-leased development properties into the operating portfolio, an increase in same property net operating income and value-add acquisitions. Our balance sheet is strong and flexible and our financial ratios continue to trend in a positive direction.
From a capital perspective, we had an active quarter. We issued 68 million of common stock under our continuous equity program at an average price of $91.01 per share. In April, we closed on $60 million of 10-year senior unsecured private placement notes at a fixed rate of 3.93%. In June, we extended the maturity date and expanded our borrowing capacity on our revolver facilities. They were scheduled to mature in July 2019 and now mature in July 2022. The total capacity was increased from $335 million to $395 million. The interest rate remained at LIBOR plus 100 basis points. We were pleased that the same group of 9 banks not only remained in the revolver but also increased their participation levels.
FFO guidance for the third quarter of 2018 is estimated to be in the range of $1.12 to $1.14 per share and $4.57 to $4.65 for the year. Those midpoints represent an increase of 4.6% and 7.5% compared to the prior year, respectively, excluding the involuntary conversion accounting gain.
Our first 2-quarter results, combined with the leasing assumptions that comprise guidance, produced an average quarterly same-store growth of 4.2% for the year, an increase of 20 basis points from last quarter's guidance. This is the result of outperforming our budget expectations in the second quarter, along with continued optimism for the remainder of the year. Other notable guidance assumption revisions for 2018 include, increasing our projected development starts by $20 million to $140 million, increasing projected property acquisitions by $40 million to $80 million, and increasing our estimated common stock issuance by $60 million to $110 million, of which $85 million has already been executed. In summary, our financial metrics and operating results continue to be some of the best we have experienced, and we anticipate that momentum continuing throughout 2018.
Now, Marshall will make some final comments.
Okay. Thanks, Brent. Industrial property fundamentals are solid and continue improving in the vast majority of our markets. Based on this strength, we continue investing in, operating and geographically diversifying our portfolio. As we pursue opportunities, we're also committed to maintaining a strong healthy balance sheet with improving metrics, as demonstrated by our year-to-date equity issuance. We view this combination of pursuing opportunities while continually improving our balance sheet as an effective strategy to manage risk while capitalizing on the strong current operating environment. The mix of our operating strategy, our team and our markets has us optimistic about the future, and we'll now open it up for questions.
[Operator Instructions]. And at this time we will go ahead and take our first question from Jamie Feldman with Bank of America Merrill Lynch.
So Marshall, I want to go back to your comment about a very aggressive acquisition market, a pricey acquisition market, and then the deals you guys did in the quarter, some larger than your typical size and in expansion markets for you. Can you just help us understand the, I guess, the return, the yields on those acquisitions and the returns and just the thought process of doing acquisitions when it does seem like it's a pretty competitive market for you.
Thanks, and good question, and I'm trying to answer all 3 acquisitions at once a little bit. What we liked or appealed to us about all 3 were, one, we found them really through leasing brokers, so none were fully brokered transactions. The acquisition in Atlanta, it's a single-tenant building with about 11 years left on the lease. And it's kind of in the low to mid-6s in terms of yield. So given our cost of capital at the time, it's in the Northeast Atlanta i85 submarket, it was near our Broadmoor property, it kind of fit our targeted submarket in Atlanta. So that one is -- if it helps, that one is kind of that acquisition. And then the next one was a building -- we literally, we were looking at a different property arriving with the broker, and they pointed out Eucalyptus, and that it was a family-owned building and business where the sellers sold it. And they kind of said, "We think you can acquire that one."
So we have acquired Eucalyptus. Signed a three-year lease with the seller. And really, it will be in the low to mid-4s. We saw an asset trade in Chino just prior to this in the high 3s, so we liked our pricing per square foot. There's a chance the tenant and that they own the business and the building, could exit the lease prior to the expiration. And if you marked it to market today, which we would view as a good opportunity, it would trade in the low 5s. So it's a good current return, and really a better long-term investment when we get another [indiscernible] that last Inland Empire vacancy sub-2%. So we're -- we like the yield today. We think the tenant will either reserve through their term or vacate early. And if the market holds, we have good upside on it. And then the Siempre Viva is in South San Diego. This building is literally on the border. It was off-market. We have 2 tenants at our Ocean View project that's nearby that actually need expansion space.
We like this building. We found that the seller is going to vacate the building. They've signed a short-term lease. And we're leased out to backfill the majority of this building and have other prospects that we're talking to, and that would get us into the kind of low -- probably low to kind of medium distant 6s. And the market, we think, there's certainly a little bit of uncertainty with trade and tariffs and things like that, but Southern California and San Diego is probably a high 4s at this point. Cap rates, we like all 3 have some moving parts before we really get to the full value. But we like the returns on each, and we're kind of -- I would sum up our California strategy as we've talked, of we like the market, we want to grow there. But we're going to be patient and disciplined and probably do more value-add things in California like these 2 rather than, I agree with you, CBRE and the other groups do a great job of marketing them. And anything that's fully market and stable is hard to find value or create value at this point in the cycle on this.
Okay. So how do you think about your stabilized yields versus your cost of capital?
We'll look at our cost of capital, and we're below it today versus -- and I'll let Brent jump in if he'd like to. Usually kind of call it rounding 2/3 equity, 1/3 debt. And so that -- if you kind of run through the math and what we can place 10-year debt for today on our debt. And that gets you -- I'm rounding into the higher 4s, call it a 4 3/4 range. And 2 of these 3 were above it. And then in Southern California, it's really about on the Eucalyptus, long-term, that it will get -- it may take as much -- as long as 2 years, but we'll get above our cost of capital there. And long-term, we really like that Southern -- and kind of like the rest of the world, we like the Southern California market because of the growth and just simply the lack of land there for industrial space.
Okay. And then a question for Brent, just thinking about your Top 10s and just credit watch, can you talk about the -- I think you were reserving but you haven't really taken any, or they don't see any reason to have taken any so far. Can you just talk about how we should think about that?
Yes, we remain real pleased with where our bad debts are, really lack thereof. We basically had no bad debt this quarter net. We actually had a recovery of a prior balance in Houston that effectively caused bad debt to be 0 for the quarter. The one tenant that we have fielded questions on over the past 6 to 9 months or year is Mattress Firm, which is third on our top 10 list. And again, a reminder, their facilities with us are obviously their distribution centers in any particular market. And they're current, and they're still -- what we hear more is a retail consolidation where they bought a lot of other chains and then they're diminishing their retail footprint from a distribution standpoint. We've looked in the warehouse that they're in with us. They're very active, very busy, so there's nothing reserved there because they're current. So knock on wood, our tenant collections have been very -- continue to be very good.
[Operator Instructions]. And we will take our next question from Manny Korchman with Citi.
Marshall, you touched on global trade. Could you just give us your thoughts more generally? Or anything you're hearing from your tenants either positive or negative as to how it might affect their businesses?
Sure, good question. Yes, with our tenants and kind of internally, it's really all -- knock on wood, it's all been discussion at this point. No one's really felt any impact, and we're not seeing it affect our leasing. We've got one lease out on an expansion and a renewal that's overseas, and that has us, I'll admit it -- admittedly, a little bit nervous about it. But today, it's been much more smoke and fire. I'd like -- and then I guess it's all relative. Any kind of trade tariffs and slow down isn't good for anyone or any of the industrial REITs. I'd like to think we're -- we believe we're a little more protective, and then our buildings are where the consumers are and really not so much along the logistics chain from China to Chicago or Northern New Jersey, for example. So we're really based -- we're much more last mile and where end products are going. So we think we're relatively more insulated than some of our peers, but we're certainly watching it. And today, have really not felt the impact, but we're certainly talking about it. And from the leasing perspective, the brokers that we're working with. Brent and I were in several Texas markets last week, and those guys never came up in our discussions at all.
Great. Maybe turning back to your favorite topic was Houston. You mentioned that things were doing reasonably well and that your exposure's going down. If we hadn't pushed so hard, if the market hadn't sort of focused on Houston as much as it had, would your exposure still going to 14%? Or do you think that was more of a reaction? And where would you like that exposure sort of to be, notwithstanding all the comments that were made a year ago?
No. I guess it's hard to, for me, to dissect it exactly. I don't disagree with the market that 21% was a lot. So I think the pushback was probably justified. I think -- I hope we would all agree Houston actually performed. I'm surprised how well Houston did through the downturn and never get to 6% vacant. I think we would have gone -- we would have gone down in terms of Houston as a percent regardless of the market. But the market, certainly, that was a topic we had in Houston a year ago. In every one of our meetings, I like that we sold our older buildings in Houston and a good market to sell assets in. We didn't sell things purposefully that we would -- thought we would regret long-term. And then really, I'm excited that our denominator in terms of that calculation were growing in Miami and in Dallas and Charlotte, any number of California number of markets that as we -- and there'll be twists and turns along the way as we projected out even beyond 2018, Houston got into the mid- to lower 13%.
So I think as a percent, you'd love for no market to be maybe more than a couple of hundred basis points ahead of your #2 or 3 market. And long-term, as I mentioned, we were in Texas last week and talking with our team there. We've been in Houston 20-plus years. Brent lived there for a long time. We're good at creating value. We just needed to kind of back up to create runway, which we have now. I feel like we can grow in Houston at 21%. It was hard to find -- keep growing and finding new opportunities now. I feel like we have -- ideally, you'd have runway in every one of your major markets to go create value. So I think we're there now. And as we ran the projections, I was pleased to see how it continues to drift down. But we're looking for opportunities in Houston still. But I think it will keep drifting down as we develop out in Miami and a number of our other projects.
And we will take our next question from Tom Catherwood with BTIG.
A question for Brent. You mentioned same-store NOI growth in your prepared remarks on the cash side. But if we look at the straight-line side, you're still guiding to 3% full year growth. So far this year, you've done about 4.6%. So just a pretty market slow down on the straight-line side to the back half of the year, that would imply less than 2% same-store growth. Are we missing something here? Or are there some kind of onetime items that could drag down second half internal growth?
That's a good question. It's a bit of a frustrating question for us internally because the annual same-store pool as you look at our guidance of 2.5 to 3.5, just a reminder, that particular pool is a static pool, meaning that it's for properties held January 1 '17 all the way through December 31, '18, so it has to be in that 2-year period. That's one reason we've begun to show our average quarterly same-store where from quarter-to-quarter, it's more current, and we show that being an average for the year of 4.2% and actually increasing in our guidance. What I would point out to that annual pool, Tom, is there's -- for example, there's over $400 million now of our operating assets that aren't picked up in that particular same-store pool. A lot of those assets are value-add oriented like Parc North or Jones or Western and some of the other value-add projects that we've added, and they're just not included there.
Our internal assumptions do show a fourth quarter slow down within that static pool. Part of it is we had a $270,000 termination fee last year that's not included this year. That's a small part of it. But I would just point out, that's our budget and we're just disclosing what we have in our assumptions. But we certainly hope to outperform it and beat it. And so far, we've been fortunate enough to do that. I would just say, we get accused, and maybe rightly so, of being conservative, but it's more challenging than you might expect to budget and analyze everything, and to come away and try to budget it at 97% leased or occupancy is just very difficult to do. It just puts yourself, I guess, we view as an unneeded corner. But so maybe a little bit of slowdown in our underwriting, but it's nothing that we're feeling. So hopefully, we'll continue to outperform through the year as we have.
Got it. I appreciate that. And then, Marshall, you mentioned you're continuing to see cap rate compression. Kind of a multipart question here, but how much cap rate question are you seeing? Is it across all your markets? And has the bidder pool shifted at all for much deals?
I don't know that the bidder pool is shifting a lot. I guess, we -- I would say there's a couple of portfolios we're looking at now, and then some one-off acquisitions. The quantity of bidders has been surprising to us and to the listing brokers, and that you're getting into the 20s on some of the -- well over a dozen to 20-something bidders that there is a lot of global capital chasing constructive leased industrial product. The cap rates continue to compress probably slightly in the major markets, and then our great thought, which probably wasn't so unique, was we looked more at some -- I'm going to call it, maybe not the top 5 markets, but it's markets #6 through 30, like a Charlotte, like Phoenix, Denver, and that's where we've seen the compression. Tampa, even Houston, cap rates have been in the upper 4s, and Houston 4 3/4, that they continue to come down. We're seeing 4.5 in Denver with a large bidder pool on a couple of portfolios that it is awfully hard to find value.
I mean, we could be wrong. But at this point, what we're guessing is probably later than early in the cycle. And that what we're hearing is people are underwriting within that bidder pool, and they may be right, higher rent growth going forward than -- usually people underwrite, say, 3% rent growth in a 10-year [indiscernible]. But for the listing brokers, people are getting to the same IRRs but underwriting higher rent growth going forward. And then the other feedback, which we feel like we're seeing, too, is potentially late in the real estate cycle, but still pretty early in the logistics shift within retail to e-commerce, and especially within the last mile, which is really the type buildings that fit our portfolio that we're chasing. So that demand for our type assets, we're -- the good news is we make it. The bad news is when we try to buy it, there's a large pool of people out there chasing things. And one comment we had from our brokers, the last -- they'll usually give us thresholds, target and stretch pricing about the last half-dozen sales they had. They all went above what they had considered their stretch pricing.
And we will take our next question from Craig Mailman with KeyBanc Capital Markets.
Marshall, just going back to your commentary that there's kind of an unusual mix of leasing in 2Q that kind of drove the rent spreads there. I mean even if you stripped out Santa Barbara, the lease spreads on new leases were a little bit softer than what we would have thought given what peers have been doing. I mean, was that kind of contemplated in your budget? Or how does that come in relative to expectations? And as you guys look at the back half of the year, kind of how do you see that trending?
Good question. You're right on Santa Barbara. And it's probably a little bit of a perfect storm, in a good way, a perfect storm that we would do again in second quarter. And that I would describe almost all of our market rents at peak. And the two exceptions would be Santa Barbara, where we have -- it's really kind of four 2-story buildings in suburban Santa Barbara. We had a tenant -- a 51,000-foot building the tenant vacated last year. The good news is we're 95% leased now in Santa Barbara. But by the time that tenant finish construction of their new building, we had pushed rents pretty hard, and it was a big rent. It was in the low 20s and current rents are probably 18 net.
So the square footages get amplified within our portfolio. 50,000 feet doesn't sound like that much, but when the rents are 3 to 4x greater than average industrial rents, it amplifies it. And then the other market that I'd say rents are not at peak is Houston came -- it hit its peak when you're looking at -- kind of looking at the CBRE stats. During 2015, they dropped and they're climbing back, but they're not back where they were. And we had a few leases in Houston that we did. We're 96% leased there without a lot rolling. But one of the ones that hit us, especially this quarter, was at World Houston, single-tenant building, 107,000 square feet. It was a little bit larger building than our prospect wanted. We all talked about it and stretched and made the deal also. And so I'd say perfect storm and that we -- good news is we did a lot of leasing in Santa Barbara, and that hurt our releasing spreads. And the good news is we got leasing done in Houston and it's pretty full without much roll. So balance of the year, we won't have the exposure to those two markets that we did in second quarter. So I think, knock on wood, I think you'll see it rebound more to normal rates. We're not seeing a slowdown in our markets. We had an unusual mix this quarter of a lot of Houston and a lot of Santa Barbara, and that's where our Achilles' heels are within our portfolio.
Got you. That's helpful. And then just circling back to Chino. So it sounds like you guys struck a deal with the seller for a rent that's 10% to 20% below market. Does that sound about right?
Yes, it steps up each year. So it's a 3-year lease chance they could exit early, and that was part of our deal with the family that owned the building. So we kind of stepped their rent up. It's below market. So it starts in 4s and will end in the low 5s.
And then did you say what you're going to have to spend in San Diego because you guys are classified as a value-add?
Yes. I don't know that I did, but I can tell you, we bought the building for just under $14 million and probably all in, we'll spend about another $600,000 to $700,000 between the TI and commissions.
I know I'm going over my two-question limit, but it just relates to kind of what you guys have thought in the West Coast and maybe Jamie's kind of question about cost of capital. I'm just curious, if you guys think big picture, and you want to get more into L.A., which is just a lower cap rate market as we've seen here, kind of how you think about that cost of capital, but also how you think about the ability to get assets with maybe better growth potential from the other markets and the kind of cushion you get from developing almost close to 8% on newbuild and kind of how you look at the overall blend and how much of a cushion you think that gives you to take some shots here and there for some lower than maybe what the market would expect from your cap rate acquisitions?
Yes. And I think that's a good enough question that I'm glad you went over the limit, how about that? And you're right, we look at it as a mix. I mean, it's a portfolio of assets, we like the current -- I guess kind of for next quarter, we like the yields we're getting in Carolina -- in North Carolina, in Florida and in Texas. And at the same time, we like the insulation, the diversity it gives our portfolio, going back to Manny's question earlier on Houston, to mix in with California, and we're just going to be patient. We've done more this year than we've done in the prior several years combined in California. We've certainly chased a lot and lost and tried to find value add, and we realized, it always won't be peak pricing in California.
So we'll add in a few assets that are value add today, and at some point, we like where our balance sheet is today that we're all below our debt targets long-term, that when the cycle -- eventually, all the cycles turn, and when that cycle does turn, we'll hopefully have the dry powder again, maybe load up a little more heavily in California, too. But you can't wait for that point in time and hire someone, open an office, get to know the markets better, get to know all the brokers and things like that. So we'll continue to mix in California, knowing it's going to be at or slightly below our cost of capital. But as you said, I think the other parts of our portfolio allow us that cushion. And 20 years down the road on some of these assets, I'm really glad we own the buildings we do in Southern California and in the Bay Area, it's great. When the leases rolled there the last couple of years, they really helped, and I wish we were bigger there. And so that's kind of what -- how we're thinking about, is long-term -- I hope Ryan's with us who runs California for 20 years, and he'll -- there'll be years he buys a whole lot more than others. And so we're excited about these 2, and looking at a few more right now, and we'll just be patient.
And we will take our next question from Ki Bin Kim with SunTrust.
Just one quick question on development yields. What are you guys developing to versus exit values today? And how has that kind of trended over the past year or so?
Kind of blended average is a 7 7, between leased up and under construction. As you can see, under construction is a little bit lower. Some of that -- and that's probably driven by 2 parts. One, construction costs are up, so that's put some pressure. And then some of it is just the mix that we added in our gateway project in Miami where we've been saying we're developing to an 8 and the market cap rates are 5, call it. But with Miami, it's probably a 4 or upper 3s, if that part were built and fully marketed today. So we're building in the mid-6s and call it, so 250 to 275 basis points above market cap rates there. So a little bit mixed in composition. We try to -- kind of our rule of thumb is 150 basis point premium over market cap rates, and thankfully, we've been closer to 250 to 300 basis points. The other thing we're seeing, and I'll hear from our team, we'll use today's construction prices, but we don't project rents forward. We'll look back kind of within our -- usually, say it's building 5 within a park. We'll look at the leases we signed in building 4. So typically, our rents have, in the past few years in a rising rent market, have proven to be conservative. So I hope we're conservative with our rent projections because we're looking back, not forward, too. But that's the other thing that's probably pushed us a little bit. Our denominator has picked up with construction pricing, and we haven't pushed rents where I think they'll ultimately come out, but that's how we underwrite them.
Okay. And given your land bank, do you think that kind of above normal spread probably last for a little bit longer?
Yes, it should. I mean, it's always a tricky balance where our land bank where we've got it, where I've only said, ideally, you will have room for 4 more buildings whatever the market. And in some markets, we're getting a little bit thinner on our land base than we would like. And then yes, and you hope that's -- if you said long-term, what worries us is keeping that land bank where we need it to be. I love that we have a kind of proven, long-term way to create NAV, create value for our shareholders, it's just that manufacturing process to kind of keep turning out buildings, 250, 300 basis points in value as we finish them, and we need that land bank but by the same token, you don't want it to be too big because at some point, the music stops and then it goes from being a land bank to carry at that point.
And we will take our next question from Eric Frankel with Green Street Capital.
Brent, I have a quick question about your same-store calculations. It's little bit confusing. You didn't really change your cash same store guidance this year, and obviously, your second quarter numbers are quite strong. But your year-to-date same-store NOI growth of about 4.5% would imply that your NOI growth for the first quarter was 2.5%, yet your first quarter release said that your same-store results -- growth was actually 4.5%. So can you clarify how you calculate your same-store numbers?
Sure, I'll try to follow you on that. I guess, Eric, what I look at or maybe refer to the most is in our release and also in our supplemental. We put our guidance assumptions in that chart. We basically give a guidance for a quarterly same-store, which in this case, for third quarter guidance, the cash guidance of 5 2 to 5 6, for example, are for properties that would be held July 1, '17, also July 1, '18 through the third quarter. The year-to-date for 2018 would be at the footnote, so they're footnote 1. Those are properties held for the entire 2017 physical calendar year compared to 2018. So the quarterly pools are different than the annual pools. And as I mentioned the annual pools just get very dated because 1/1/17 is virtually the cutoff. So again, we raised our guidance 20 basis points on our average quarterly for the year, which we're excited about. We'll continue to see good operations across the board from a same-store perspective. So I hope that clarifies it. If not, we can talk offline and get it in the weed as much as you would like.
I guess that's fine. But I thought the agreement that everybody made in terms of -- that all the companies in the industrial sector made in terms of calculating same-store pools was just to keep the pool consistent starting at the beginning of the year, just so everyone -- so that you can compare same-store numbers across REITs reasonably well, and it makes it a little bit tougher to do that when the pool changes every quarter. And I'm not sure if any other REIT's now changing their pool every quarter. So I think that's a challenge.
Yes. We're also absolutely under the same way with it. We compute same-store. Obviously, within that same definition, there's different periods that you can grab. It's ranging from people disclosing 3 to 1, and we do 2.
Right. But you added in properties into your same-store pool for the second quarter, correct?
For the second quarter, same-store pool, yes.
Yes. So I thought that the pool kind of set as you stated at the beginning of the year, and so it just...
Yes. That's the annual same -- that's annual same-store pool. So there's -- again, it's all computed. What's included in the pool's the same. But again, we can talk offline. I can walk you through that.
Okay, okay. And then just to clarify, or just to expand upon some of the trade arguments. Marshall, I'm sure you've probably read the headlines this morning that our President is consider -- would consider putting a tariff on all Chinese goods, not just probably what 5% or 6% of goods that's getting a full tariff now. And it terribly seems like they're taking a pretty tough negotiating stance on NAFTA in Mexico. And so it seems like your portfolio is -- I understand that there's a last mile component to it and it's based on local consumption, but aren't a lot of your markets and your economies somewhat are pretty heavily dependent on trade with Mexico at the least? And wouldn't those markets and leasing activities suffer pretty greatly if NAFTA was repealed and nothing comparable could be put in place?
It won't be good for us or anybody. I mean, really, if you shut down global trade -- so you're right, whether it's China or Mexico. And yes a number of our markets, parts -- certainly parts in Texas, parts in Arizona and Southern California will slow down, and some, to greater or lesser degrees. A number of markets are all driven -- I'll pick one, Tucson, for example, where we do have long-term leases in place in all of these markets. So even if trade gets bad, unless our tenants go bankrupt, we can weather the storm more than maybe the manufacturers or different people like that, that may not be as focused on the consumer. And we're always going on -- at least using Tucson as an example, you do have a major university and you have tourism, and in some cases, a state capital here or there. So it won't -- at the margins, it will hurt. I'm hopeful that they resolve it quickly. I can't imagine the worst thing Trump can do for reelection would be to throw the economy into recession, and he can be a -- I won't speculate on a wildcard of a negotiator. So we'll see how it plays out. And to date, our leasing is not slowing down, frankly, because of the discussions. But you're right, we did read the headlines, and we're watching it and nervous like everyone else. I'm glad our position -- our portfolio is more positioned on the end consumer, but we do have some markets -- that's one of the reasons why we like being so well geographically-diversified. We're not all along the border, but we do have some assets that are closer to the border than others.
And we will take our next question from John Guinee from Stifel.
Two quick questions . First, how did you ever buy 4 2-story buildings outside of Santa Barbara?
We didn't, I guess. We merged -- this goes back to '96. We acquired Copley REIT, which I guess is part of -- I have to believe is part of AEW now. So they had a mortgage REIT. And within those kind of dozen properties that we acquired a lot in L.A. or parts of L.A. and Northern California, South Florida assets, they had 4 R&D buildings in Santa Barbara within their REIT. So we've -- it's been there for 20-plus years.
Interesting. Okay.
Yes, that's the history, anyway.
Got you. Okay. Second question. You signed a lot of short-term leases, so the end result is between '19, '20 and '21, over half your leases expire. Just ballpark, do you think those leases are -- is 5% below market on a cash basis and 15% below market on a GAAP basis a reasonable number? Or do you think that's off appreciably?
No. We're not good at projecting embedded growth. Just I guess we typically have shied away from that. But maybe another way of trying to answer it. When we look back, we, from a GAAP perspective, which we like, because you capture free rents and all the other metrics in there. We were -- if I can do this from memory, we were up 12% in 2015 and 2016. Last year, we were up 17%. And this year, absent the 4 buildings in Santa Barbara we just discussed, we're up 16%. So we do feel that there's continued embedded rent growth, and this is more martial speculation in fact. But with rising construction cost and the scarcity of land, I'm probably -- I am more bullish, absent a trade war, more bullish about rent growth over the next 12 to 18 months than I was probably the past year. So if anything, we felt rent growth should be picking up going forward based on where construction pricing is and where the economy is.
And are those numbers GAAP or cash?
GAAP.
Our next question is from William Crow with Raymond James.
Marshall, I'm trying to put all your comments together, and it sounds like you're a little more cautious on where we are in the cycle. There are some economic or political headwinds out there, rising construction costs. Are you underwriting your new developments any differently? Are you -- is there a little bit more of a yellow light out there from a new construction perspective?
No. I'm glad you asked. I really don't mean to sound cautious. That maybe the recovering CPA within me as I am. We upped our starts this year, and I'm excited about that, going from $120 million to $140 million. We've stepped on the equity pedal fairly heavily year-to-date. I mean, I guess comparing to our original budget, we thought we would've raised $25 million year-to-date, and we're at $85 million. So we're seeing the opportunities out there, and we like deleveraging the balance sheet while we're pursuing those opportunities. We're underwriting them the same way probably our projected yields deals, and I thought you mentioned this in your piece. It's the same way we always underwrite them, but now, with construction costs going up, call it, 10% to 20% in the last 12 months, it's compressed the yields a little bit. But I'm also optimistic by the time the buildings get delevered and we get leased, that the rents will keep pace or close to keep pace. And at the same time, cap rates continue to either stay where they are to fall, so we have a much greater spread over cap rates than we -- that our 150 basis point kind of internal policy.
So we're on another side, and I'm just pointing at facts, I'm pleased that we -- when we quoted our 97% leased and 96.4% occupied, oddly enough, it's the third quarter in a row that we've had those exact same numbers. So I've accused our accounting team of having that hardcoded in and not calculating it. But usually, we drift down in second -- during the summer months, and so that's partially how we got ahead, especially with the equity raise, is that our occupancy has stayed flat from year-end, which that's pretty atypical as we went back the past several years. So we're bullish. And then maybe I think it's probably good. You always want a little bit of fear out there in the economy. Otherwise, all the developers would just go crazy, I suppose. But we're watching those, and it's easy to -- we'll watch the news and I'll get pessimistic, and then I'll get a call from our team and they've got a tenant that wants to expand. And that's -- I hope that balance stays in there.
Yes, just to add to that, Bill. This is Brent. I've tagged along with Marshall last week to Texas, and I've not been back in the markets in a while. It's fun to go back and see the team. But I was really impressed with the activity in all our Texas markets, Dallas, San Antonio, even Houston. The level of activity, the proposals, the deals they're working was -- I was quite impressed and came away feeling very, very positive about that. And as Marshall mentioned in his written remarks in the beginning, we've 12 projected starts this year, and we've already commenced 10 of them. Now some of them are very early on. But we've been very pleased with the leasing velocity we're seeing across the board, especially in the development portfolio.
Yes. One follow-up on construction cost. You know that we're up 10% to 20% over the past few years. Has that been kind of a steady push higher? Or has it changed at all in the margin, the rate of increases as we progressed?
It's been fairly steady, maybe a little more over the last handful of months. And talking to our team, I guess whether it's industrial or any property type, all the subs are busy and everyone can pick and choose their jobs. And there's -- sometimes, it's materials. I ran into a friend that's a multifamily developer, and I guess hardwoods are at their historic high price. And so between that and a labor pricing, and that people are just bidding and picking the jobs where they make money. So it seems a little more the back half of the year that it's got to 10% to 20%, and we don't really -- unfortunately, I don't see that slowing down unless the economy slows down. But that should help us push rents.
And our next question is from Blaine Heck with Wells Fargo.
Just a follow-up on the land topic. Can you just comment on which markets you guys are targeting at this point to grow the land bank? And whether there are any specific markets where land costs are becoming an issue when you look at replenishing the development pipeline and getting to an acceptable kind of pro forma yield?
Sure. A couple that are near, and we're still active there. But we love our -- a good problem to have. We love our Horizon Park in Orlando, for example, but we're down to the last few buildings. So we're looking in Orlando and Tampa are two that come to mind. We're glad we have the land in Miami and Fort Myers. So Florida, we've got runway, but Central Florida, we could use a little bit more land there. We haven't closed. We would be out in Phoenix. We've developed our last building there. It's great that we're running through our land. We have some land tied up there that we think will close this quarter that will give us that next path. Kind of same thing in Dallas and San Antonio.
On the flip side, where it is awfully hard is parts of L.A., land probably starts in the mid-30s per square foot, and we've seen as high as $60, not per under the building but just gross per pricing per square foot. In Orange County, I've seen where they've repurposed buildings and they actually had negative supply. The same thing in Hayward and that East Bay Area of San Francisco where the good news about industrial in terms of oversupply is almost everything -- I guess there's one in Seattle and a little bit in New York. Almost everything -- 99-plus percent of the supply is single story. So it can -- industrial can get priced out in the market, and you can get pushed pretty far inland in L.A. and in the Bay Area now because it's hard to underwrite. But that's -- the good news is we own some assets there and that's putting a lot of upward pressure. So we try to have a balance of, again, a perfect world. You always have room for those next 5 buildings in our major markets, and it doesn't always come in sizes for those next 5 buildings. We also -- as we think about our land bank, and we thought the cycle was a little bit long for probably 3 years now. So anything we acquire, our goal, we're not stealing land at this point, so we try to put it into production and run through it as quickly as leasing allows us to. So we're not buying anything and saying, "Hey, we'll start on this down the road." It's usually immediately in production -- always immediately in production.
Okay. That makes sense. And then Marshall, you touched on this a little bit, and maybe Brent wants to chime in, too. But balance sheet is in great shape. You guys are around 5x right now. And it looks like your guidance for asset recycling and assumption for NOI growth could result in a little reduction throughout the rest of the year. So I guess, how do you think about the balance between having the safety of a strong balance sheet versus possibly higher earnings growth with a little more leverage at this point in the cycle?
Yes. I'll jump in. Marshall has touched on that some. And I'm glad you picked on that up. We were very excited to have issued the amount of equity we did, and then still come in at the high end of guidance. I think that may have been lost on some folks. From what we have projected to what we've actually done, had put it by the $0.02 to $0.03 decrease or drag on '18 -- our '18 projections. And again, we're still projecting to the high end, which is very nice. Blaine, to answer your question, we just -- when you're at the pricing, and we talk about this almost daily because you're staring at the market and the price and we're keeping a pulse on -- we have good opportunities to put the capital out. It's just right now, we're taking advantage of what we feel is a very good price relative to NAV. And so you grab it while you can. It's not really an objective to continue to go to a certain number in terms of, right now, we're 24% debt-to-market cap. But that equity is available. Sometimes, it's not. And when the market were to turn and if that doesn't look as attractive, then we've given ourselves a lot of runway to go get that, and we have room to do it, we could continue to grow the pipeline. So we're just looking at it as an opportunity. When one good opportunity presents itself, you act on it. And that's really what's freed us up to do all 3 of our primary gross, which is development, value-add acquisition, and then a few select strategic acquisitions like we recently did in California. So if we continue to see the opportunities, the price stays there, I think you'll see us remain fairly active on the ATM.
And our final question today is from Zach Silverberg with Mizuho Securities.
Putting aside the same-store pool definition, what is the assumption for occupancy change sequentially for 3Q '18 and the remainder of the year? Is it flat or down a bit for now, or with some conservatism dialed in?
Well, as we show the assumptions, we're projecting 3Q being at 94.8 average for the quarter, and then I think up a little bit in fourth quarter from there. But again, I would just stress, those are -- we're just being very transparent in showing what is in our -- basically, our guidance assumptions. The guidance range that we're giving for FFO, we're showing what that consists of. And then from there, any one can add or subtract to that as they might want. But so that's what's in the budget assumptions. On the ground, what we're feeling is a pretty comparable back end of the year, I feel like, to what we've seen in the first half of the year. We like that activity. We like what the guys in the field or the feedback we're getting. Our tenant, at an average 25,000 or so average tenant size, we're not seeing any impact from all the trade talk rhetoric. So we still feel pretty upbeat about the back half of the year.
Okay. And have you seen any instances of construction cost outpacing rents at all?
Probably short-term, yes. Long-term, we still think -- and maybe I'm thinking out loud, which is dangerous on a call. Maybe construction prices can move pretty quickly; and rents, it takes a bit. Construction, it's pending up how many subs are out there at any given moment in Charlotte, for example, or San Antonio, so it can escalate pretty quickly. Where on rents, there's -- which is true there's very limited shallow bay supply industrial being delivered. But there's -- that said, there's always competition. So given instance, construction can outpace rents. But I think rents will, over time, catch up if the economy stays where it is, and especially given the -- with pricing up on construction and the lack of available infill land, that makes me more bullish about rents than construction pricing over a longer period of time.
And we have no further questions at this time, so I will turn the call back to Mr. Loeb for any closing remarks.
Thank you, Catherine. Thanks, everyone, for your time. We appreciate your interest in EastGroup. Brent and I are certainly available for any follow-up questions or clarifications you may have and have a good weekend. Thanks, everyone.
Thank you.
This does conclude today's program. Thank you for your participation. You may disconnect at any time and have a wonderful day.