First Industrial Realty Trust Inc

NYSE:FR

Earnings Call Analysis

Robust FFO Growth with Solid Guidance

The company reported a steady growth in funds from operations (FFO), which rose to $0.62 per fully diluted share in the fourth quarter, edging out the $0.60 from the previous quarter. Significantly, the company expects continued momentum, forecasting strong sales for the upcoming year ranging from $75 million to $150 million. This projection sets an optimistic tone for investors, hinting at robust operational performance and potential value appreciation.

Firm Financial Performance and Projections

The company had a fruitful quarter, delivering NAREIT funds from operations (FFO) of $0.62 per fully diluted share, a slight increase from the $0.60 per share in the same quarter the previous year. The positive results stemmed from rental rate increases on new and renewal leases, as well as rental bumps already embedded within current leases. However, it wasn't all positive; these gains were slightly offset by a minor decline in average occupancy and an uptick in real estate taxes. Closing the quarter, the in-service occupancy stood at 95.4%, down 230 basis points from the prior quarter. The dip was attributed to developed properties placed into service during the quarter.

Leasing Activity and Financial Positioning

The leasing activity highlighted about 1.4 million square feet of space commencing leases. This was divided into 300,000 square feet of new leases, 500,000 square feet of renewals, and 600,000 square feet associated with developments and acquisitions in lease-up stages. Investors would appreciate to know the company's solid financial positioning, underscored by the absence of debt maturities until 2026, given the utilization of extension options on two bank loans.

Guidance for Investors

Looking into the future, the company updated its 2023 guidance for NAREIT FFO to be in the range of $2.40 to $2.44 per share. After adjusting for a specific income item previously discussed, the forecast changes to $2.38 to $2.42 per share, presenting a modest $0.01 increase at the midpoint. A year-end occupancy is projected between 94.25% and 94.75%, taking into account the full lease-up of the facilities going into service in the final two quarters of the year. Without these new developments, the occupancy rate would target around 97%. The guidance also anticipates fourth-quarter same-store Net Operating Income (NOI) growth between 6% to 7.5%, rounding out the year with an average growth of 8% to 8.5%. General & Administrative (G&A) expenses are expected to lie between $34.5 million and $35.5 million. Importantly, the guidance excludes potential future sales, acquisitions, new development starts, or changes in debt/equity situations.

Sales Forecasts and Strategy Considerations

On the sales front, year-to-date transactions have fetched $61 million. The company expects sales for the full year to reach $75 to $150 million. For investors considering the company's strategy moving forward, it is clear that developments will be influenced by market conditions, tenant demand, the overall economic environment, and the progress of current projects. A notable mention was the unlikely addition of new starts for the year due to a strategic choice to maintain capacity, enabling the company to capitalize on market fluctuations.

Earnings Call Transcript 2023-Q3

[Operator]

Good day, and welcome to the First Industrial Realty Trust, Inc. Third Quarter Results Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Art Harmon, Vice President of Investor Relations and Marketing. Please go ahead.

[Art Harmon, executive]

Thank you, Dave. Hello, everybody, and welcome to our call. Before we discuss our third quarter results and our updated 2023 guidance, let me remind everyone that our call may include forward-looking statements as defined by federal securities laws. These statements are based on management's expectations, plans and estimates of our prospects. Today's statements may be time-sensitive and accurate only as of today's date, October 19, 2023.

We assume no obligation to update our statements or the other information we provide. Actual results may differ materially from our forward-looking statements and factors which could cause this are described in our 10-K and other SEC filings. You can find a reconciliation of non-GAAP financial measures discussed in today's call in our supplemental report and our earnings release.

The supplemental report, earnings release and our SEC filings are available at firstindustrial.com under the Investors tab. Our call will begin with remarks by Peter Baccile, our President and Chief Executive Officer; and Scott Musil, our Chief Financial Officer, after which we'll open it up for your questions. Also with us today are Jojo Yap, Chief Investment Officer; Peter Schultz, Executive Vice President; Chris Schneider, Senior Vice President of Operations; and Bob Walter, Senior Vice President of Capital Markets and Asset Management.

Now let me hand the call over to Peter.

[Peter Baccile, executive]

Thank you, Art, and thank you all for joining us today. We continued to deliver strong cash rental rate growth on new and renewal leasing, and we're making good progress on our 2024 expirations, which I will touch upon shortly. We also achieved some leasing wins at our developments in Pennsylvania, Northern California and Orlando, and we're capturing significant value from the sale and ground lease of our on-balance sheet land sites in Phoenix.

As expected, our quarter end occupancy metric was impacted by a few recently placed in-service developments that remain in lease-up. As we noted on our last call, prospective tenants continue to be deliberate in making significant commitments for new space in the face of the uncertain interest rate, economic and geopolitical environment. This is being reflected broadly in the national vacancy figures as new supply continues to come online.

National vacancy was up 50 basis points in the third quarter, but still at an overall low of 4.2%. In our 15 target markets, vacancy is 4%. As we discussed on our last call, there is a fair amount of new supply expected to be delivered nationally in roughly the next 12 months. Based on CBRE's analysis, there is approximately 475 million square feet under construction across the U.S., 30% of which is preleased. Focusing on our 15 target markets, completions are expected to be approximately 325 million square feet.

New starts naturally have trended downward, with third quarter 2023 starts down more than 60% compared to third quarter 2022. This market response is being driven by the rapid increase in the cost of capital and the uncertain economic environment. In our portfolio, we're capturing strong rental rate increases on our renewals, realizing the benefit of the healthy market rent growth we've seen for the past several years.

Tenants continue to renew well in advance of their lease expiration dates, reflecting continued confidence in their core business. Overall, leasing market dynamics continue to favor the landlord, particularly with renewals, given the low vacancy levels I discussed earlier.

Through yesterday, with 97% of our 2023 lease expirations in the books, our cash rental rate increase is 60%, with average annual rental rate escalators of 3.8%. A big driver of our cash rental rate increases has been the outperformance of our Southern California assets, where we've achieved a cash rental rate increase of 151%.

Looking ahead to 2024, we've taken care of 40% of next year's lease expirations and a cash rental rate increase of 38%, which is similar to our pace of progress at this time last year. Our 2023 rental rate increase has benefited from slightly more than 25% of rental income coming from leases signed in Southern California. Due to a few Southern California leases that expired in 2023 that are assumed to lease up in 2024, we expect the Southern California portion of lease signing by rental income in 2024 will be roughly the same as 2023 at a little over 25%.

We will give you a refined view of our thoughts on our 2024 cash run rate increase on our fourth quarter call with the benefit of our budget reviews. We anticipate our cash rental rate increase on new and renewal leasing will be in excess of the 38% we currently achieved on lease signings related to 2024 expirations.

Moving on to development leasing. Since our last earnings call, we leased half of our 699,000 square foot First Logistics Center at 283 Building B in Central Pennsylvania. We also leased our 37,000 square foot in Northern California and our 17,000 square feet at our First Loop Park in Orlando. With these lease signings, the capacity on our self-imposed $800 million speculative leasing cap today stands at $108 million. We continue to monitor tenant demand for new growth to determine the appropriate time to start new developments.

As I discussed earlier, tenants' decision-making on space for new growth continues to be deliberate. When we do decide on new starts, we're well positioned with our existing coastally oriented land bank that can accommodate 15.2 million square feet. This represents approximately $2.4 billion of potential new investments based on today's estimated construction cost in the land or book basis.

Moving now to dispositions. Since our last call, we completed a significant sale of 39 acres of land at our PV303 project in Phoenix for $41 million to a data center user. We also entered into a ground lease with that buyer for the remaining 100 acres of land at this project. The ground lease is for 5 years and includes a purchase option exercisable beginning in year 3. Our year-to-date sales totaled $61 million. We now expect sales for the full year to be $75 million to $150 million.

With that, I'll turn it over to Scott for some additional commentary and updated guidance.

[Scott Musil, executive]

Thanks, Peter. Let me recap our results for the quarter. NAREIT funds from operations were $0.62 per fully diluted share compared to $0.60 per share in 3Q 2022. Our cash same-store NOI growth for the quarter, excluding termination fees, was 7.4%. The results in the quarter were driven by increases in rental rates on new and renewal leasing, rental rate bumps embedded in our leases and lower free rent, partially offset by slightly lower average occupancy and an increase in real estate taxes. We finished the quarter with in-service occupancy of 95.4%, down 230 basis points compared to 2Q 2023, primarily due to completed developments placed in service in the third quarter.

Summarizing our building leasing activity during the quarter, approximately 1.4 million square feet of leases commenced. Of these, 300,000 were new, 500,000 were renewals and 500,000 were for developments and acquisitions with lease-up. As a reminder, we are strongly positioned with no debt maturities until 2026, assuming the exercise of extension options in 2 of our bank loans.

Moving on to our updated 2023 guidance per our earnings release last evening. Our guidance range for NAREIT FFO is now $2.40 to $2.44 per share. Excluding the $0.02 per share income item discussed in our first quarter call, our guidance range is now $2.38 to $2.42 per share, which is a $0.01 increase at the midpoint.

Key assumptions for guidance are as follows: we are projecting year-end occupancy of 94.25% to 94.75%. This range assumes that the 644,000 square foot Old Post Road asset is leased up in 2024. We have made this assumption based upon our experience with the asset and the delays in the final governmental award process experienced by our prospective 3PL tenant.

Year-end occupancy guidance also assumes the lease-up of our developments placed in service in the third and fourth quarters will now occur in 2024 due to prospective tenants' measured pace in making significant commitments. I would note that if you excluded the impact of these developments being placed in service, our midpoint for year-end occupancy would be approximately 97%. Our 4Q occupancy assumption implies a quarter and full year average of 96.5% to 96.6%.

Moving on to other guidance components. Fourth quarter same-store NOI growth on a cash basis before termination fees of 6% to 7.5%. This implies a full year quarterly average growth for this metric of 8% to 8.5%. Note that the same-store calculation excludes $1.4 million of income related to insurance claim settlements recognized in the fourth quarter of 2022. Guidance includes the anticipated 2023 costs related to our completed and under construction developments at September 30 for the full year 2023, and we expect to capitalize about $0.10 per share of interest.

Our G&A expense guidance range is $34.5 million to $35.5 million, an increase of $0.5 million at the midpoint. And guidance does not reflect the impact of any future sales, acquisitions, development starts, debt issuances, debt repurchases or repayments, nor the potential issuance of equity after this call. Let me turn it back over to Peter.

[Peter Baccile, executive]

Thanks, Scott, and thank you to all my teammates for all that you have accomplished thus far this year. Together, we're focused on delivering strong cash flow by pushing rental rates on new and renewal leasing and the continued lease-up of our development pipeline.

Operator, with that, we're ready to open it up for questions.

[Operator]

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Rob Stevenson with Janney.

[Robert Stevenson, analyst]

A couple of questions on development. Are you expecting to start any new developments in the fourth quarter or early first quarter at this point? And then first state, move from a first quarter completion to a fourth quarter completion? Can you update us what's going on there?

[Peter Baccile, executive]

Yes, I'll take the first part of that, Rob. Look, development starts are going to be a function of market strength, tenant velocity, the economic outlook and of course, lease-up of our completed developments. Given our desire to operate with additional capacity under our self-imposed cap so that we can take advantage of potential stress in the market, it's unlikely we're going to have any additional starts this year. And as you know, we don't give guidance on starts. So I won't comment on 2024.

[Peter Schultz, executive]

Rob, it's Peter Schultz to your question on first date crossing, our construction schedule has gone well. We've had great weather. So the building is a little bit ahead of schedule, and that's what's allowed us to move it from first quarter of '25 -- I'm sorry, first quarter of '24 to fourth quarter '23 for completion.

[Robert Stevenson, analyst]

Okay. And then -- Peter talked about the macro in the core market as a whole supply picture. Which of your core markets are you seeing the least amount of new supply in relative to size?

[Peter Baccile, executive]

Yes, there are a number of markets that didn't have any starts in the third quarter. Starts are down pretty significantly across the country, in some markets, 100%, in the 90% range. I'm not going to go market by market, but many, many markets have seen little to no starts. A couple of markets, starts went up in Q3. Orlando and Denver would be 2 markets that happened. But by and large, the vast majority of the markets are down significantly.

[Operator]

Our next question comes from Ki Bin Kim with Truist.

[Ki Bin Kim, analyst]

Can you help us better understand your commentary about new leasing demand being deliberate? Maybe you can put it in -- maybe you can frame it versus 2019 in terms of the type of feedback you're hearing or the number of prospects that you're fielding. I'm just trying to get a better grasp of how things might be changing.

[Peter Baccile, executive]

I'll take the front end of that, and Jojo and Peter should chime in, too. I think when we talk about 2018, 2019, when we had a perspective -- when we had a space available, we were usually talking to 1 or 2, maybe 3 tenants in '21 and '22, maybe it was 5 or 6. So we're back down to a smaller number of prospects. Obviously, with the increase in development deliveries, we also have a little bit more competition than we had in '21 and '22 for new space. Peter, do you want to talk about your regions?

[Peter Schultz, executive]

Sure. Ki Bin, Peter Schultz here. I would say a couple of things. The overall level of activity, to Peter's point, has been generally consistent. But what we are seeing is tenants being cautious and really delaying their decision making. We've seen a number of deals where they had a targeted commencement date, only to see those push back as tenants are hesitant to make those commitments given some of the macroeconomic and geopolitical issues that Peter touched on in the script.

We have seen a little bit of increase in activity coming out of the summer. Activity levels are better in the smaller and midsize spaces than they are in the biggest spaces, for the most part. But the primary headwind is just the lack of -- and the slower cadence of decision-making by tenants. Jojo, anything else you want to add?

[Johannson Yap, executive]

Yes. So for me, kind of bottom line is like in 2019, businesses are focusing more on growth. And their focus on where the expansion is because of new business coming in. Today, they're more securing their current commitment and making -- wanting to make sure they've got good enough space to run their business and let's focus on growth. In '19, there was a little bit more of a fear of missing up in space because they're being gobbled up quickly. Today tenants have a little bit more choices, so they're more deliberate, and they're shopping around a little bit more.

[Ki Bin Kim, analyst]

So how does that impact your strategy in terms of leasing up your development space or I guess any space? Is cutting rents a practical solution? Or if the pool of new -- the pool of customers is the smaller, maybe cutting rent doesn't do the trick. Maybe increasing leasing commissions. I guess, how are you trying to handle that?

[Peter Baccile, executive]

Right now, concessions are not increasing meaningfully. And I say -- use the word meaningfully because here and there, we are seeing some sponsor owners increased free rent a little bit. We typically offer, call it, half a month of free rent per lease year. And we're seeing that in some cases at a month. But again, not -- other than that, that's about it. TIs or standard packages, et cetera.

The other thing that I would point out is that we have developed properties that are incredibly competitive relative to the set of primarily merchant build that's out there. So from a functionality standpoint, we are superior, and -- when we talk about having more competition, that's not -- we don't mean there are 6 or 8 other opportunities. There might be 2 or 3. So it's not that the market isn't flooded. So right now, the market is holding pretty steady. Occasionally, you'll see somebody get a little extra free rent. But right now, it's holding steady.

[Peter Schultz, executive]

Ki Bin, the other thing I'd add is over the last several years, we've seen a lot of our developments leased to single tenants. As you know, we take a lot of time in the design, making sure these are functional, can be divided for multiple tenants. We're seeing, as I said a few minutes ago, better demand from smaller midsize and the buildings are ready and prepared to be demised from multiple tenants office -- multiple office pods, stock packages, in some case in demising. So we have the flexibility given the quality point that Peter made to accommodate that. So you might see us do more multiple tenants than what we've done in the last several years, which has really just been a function of the market.

[Operator]

The next question comes from Nicholas Yulico with Scotiabank.

[Nicholas Yulico, analyst]

First, I just wanted to ask about the development projects that, I guess, already delivered this quarter and still will come in the next couple of quarters in Inland Empire. If you could just talk a little bit more about what sort of competitive level of supply you're dealing with there relative to those projects, we do see just stats in your commentary that Inland Empire East is where there is more of that supply impact, but just wanted to hear your thoughts on that.

[Peter Baccile, executive]

Jojo, do you want to...

[Johannson Yap, executive]

Sure. I'll touch on the Inland Empire. Overall, the Inland Empire still has a historically a very low vacancy at 3.5%. We do expect long term that we will still have positive rent growth. In terms of our developments, we have 5 in [ VIE 2 ] we just completed in [ 300 ] construction. They're all of different size ranges in different submarkets, mainly Montana, 250 in corridor and then Redlands. So we're not overinvested or overbuilt or any market.

If you look at each of these properties, there are no more than 2 competing properties in terms of quality on locations with these properties, and there are even 2 properties where we couldn't find really a comparable property. We feel really good about these projects. Roughly, they're about $200 million. And today, we're projecting a 9.3% yield, which is a little bit under a 90% margin. So we feel really good about -- of course, our job is to lease those, but we feel very good in creating value for shareholders going forward on those.

[Nicholas Yulico, analyst]

That's helpful. The second question is, I wanted to see how we should be thinking about the pace of development project leasing up over the next year. Just in terms of the time frame from when it gets delivered to ideally, a more stable occupancy level. And then the other question is related to capitalized interest. It seems like there could be some sensitivity there over the next year based on how long projects take to lease? And any just -- any thoughts or reminders you can tell us about how to think about the capitalized interest impact and the development pipeline vis-a-vis how long buildings can really stay within capitalized interest after being delivered?

[Peter Baccile, executive]

Yes. So I'll cover the first part of that, and Scott will probably talk about capitalized interest. In terms of lease-up timing for next year, obviously, we're going to be spending a lot of time on that topic when we sit down to do our budgets for next year. At this point, in terms of new developments, we're not anticipating changing our 12-month downtime assumption. But with respect to the projects that have been completed and gone into service, we'll be focused on what we think -- when we think those are going to lease next year, based upon the level of dialogue that we're having with our prospective tenants today. So I can't really give you much more than that on that question. Scott, do you want to cover the capitalized interest?

[Scott Musil, executive]

Sure. Nick, so we stop capitalization of interest once the development is completed. So we've got a handful of developments that are scheduled to be completed up until the second quarter of 2024. So we will have capitalized interest for the first 6 months of that period. For the back half or the last 6 months of the period, that will be dependent upon new starts.

[Operator]

The next question comes from Craig Mailman with Citi.

[Craig Mailman, analyst]

Just wanted to hit on the data center ground lease in Phoenix here. Just had a couple of quick questions on this. Just first, from a run rate perspective, is the full run rate in the 3Q number? Or do we need to think about additional revenue coming in the fourth quarter to annualize it?

[Scott Musil, executive]

Yes, Craig. So there's a little bit of lease income in the third quarter. I think it might be just half of a month. And then obviously, we're going to get a full quarter in the fourth quarter of 2023. Take a look at our NAV footnote, Craig. We have some more information on the ground lease that you can get some of the economics.

[Craig Mailman, analyst]

Okay. Sorry, I apologize, I didn't see that footnote. Did you guys put in what the purchase option is in there in the terms of the pricing and how that compares to what the value would have been if you had just kept this as industrial ads?

[Peter Baccile, executive]

We have a pretty strict confidentiality agreement with this counterparty. So no, we can't talk a lot about the terms and values and things like that. I can say, generally speaking, the value of data center land is much higher than the value of industrial. So -- but that's all we can really say. Let's put it this way, we like the economics a lot. Or we wouldn't have done it. Obviously, we -- yes. Go ahead.

[Craig Mailman, analyst]

No, no. Finish your phrase off. Sorry.

[Peter Baccile, executive]

No, no. I mean it's a great site, and we went into that years ago with big plans for selling to users, developing ourselves, build-to-suits, et cetera. For us to be tested to less than 100 acres go, you can imagine, it's got to be a pretty good deal.

[Craig Mailman, analyst]

And I guess that was my other question. Is this -- should we take this as an indication of your concern about overbuilding in Phoenix? And doing this deal rather than building it out industrial legs, it seems to have been a good market for you guys since you got involved in it a few years ago.

[Peter Baccile, executive]

This in no way is an indication of our confidence in that market. We spent a lot of time deliberating whether we wanted to do this. At the end of the day, the economics of this trade pretty much equal the economics of building that site up.

[Craig Mailman, analyst]

And then just one quick follow-up or a separate question. Just Scott, on the mark-to-market, you said you're not giving guidance yet on spreads. But you anticipate next year, it won't be in excess of that 38%. Is the 40% you leased this year just a mix issue of -- outside of L.A. or other markets with smaller mark-to-market? Just give details of maybe what's net 40 versus what's remaining in the 60 from a market exposure?

[Peter Baccile, executive]

Chris, do you want to take that?

[Christopher Schneider, executive]

Yes, Craig, this is Chris. Yes, it is definitely a mix issue. So if you look at what's been taken care of, it's only 6% from Southern California. If you look at the rest of the 2024 rollovers, that mix is 56% coming from Southern California.

[Operator]

[Operator Instructions] Our next question comes from Vikram Malhotra with Mizuho.

[Vikram Malhotra, analyst]

Just first following up on development. I guess some of your peers may be seeing this as -- if development starts are very low, by the end of '24, there's probably a little product to offer. And if demand is sort of picking up and there's probably share to be had, so I'm just wondering how do you balance the 2 other specific markets you can cite where you do feel you might pause in 4Q like you said, but then ramp back up because in general, there will be a dearth of quality product?

[Peter Baccile, executive]

Yes. I mean one of the big indicator for all of us is going to be development lease-up, and we have product in the market now. We're having good conversations. As we've said in various in many different ways, tenants are taking a while. To lease a 500,000-square foot building, that's about a $50 million decision. And the current economic outlook and what's going on around the world, that causes people to pause before they put down that $50 million.

So yes, it's possible that toward the end of next year, there's not enough supply. That would be fine by us, obviously. And we really think that the market will be particularly strong in 2025. So with respect to us looking at what we're going to start to potentially start next year, it really is going to depend upon how we feel about lease-up.

[Vikram Malhotra, analyst]

Okay. That makes sense. And just following up on the Inland Empire comments you made around the competitive set being small in terms of your project. Maybe just help us think about how you're seeing -- what you've seen in terms of market rent growth in SoCal in general, what the variability in that region looks like quarter-over-quarter? Any numbers you can share would be helpful.

[Peter Baccile, executive]

Jojo?

[Johannson Yap, executive]

Yes. So kind of address it a little bit because of the low vacancy L.A. of sub-2. And then i.e., at about 3.5. Long term, we would think that it would be minimum mid-single digits going forward. But today, as you may recall, SoCal had the highest rent growth of any market in the U.S. for the last 3 years straight. So right now, what the market is doing is digesting the supply in the marketplace, along with a little bit of a decline on the inbound TEUs that affected the demand. And I'm not going to be surprised. We're not going to be surprised. In the very near term, the rent is flat through the end of the year and maybe first quarter next year to maybe slightly negative. But that doesn't mean that we can't create value because I'd point out to you, our developments, for example, just a subset, it's about a [ 93 ], based on current market trends, rent to yield.

[Operator]

Our next question comes from Caitlin Burrows with Goldman Sachs.

[Caitlin Burrows, analyst]

Maybe somewhat related to the last question. But on the development yields, it looks like today, they're expected to be 7.2% for the under construction set of properties, which is up from like 6.5% a year ago. So how are you thinking about your cost of capital today and what yields are required to make development attractive? And I guess to what extent is that impacting your activity?

[Peter Baccile, executive]

Yes. Thanks, Caitlin. So sure, the cost of capital has certainly gone up. When we look at that though and compare it to what we think we need to make, to make reasonable margins and profits here, the yields on new developments need to be north of 6.5%, expected IRRs north of 8.5%, closer to 9%. And our -- on a weighted average basis, our pipeline projects hurdle those returns. So we're excited about the opportunity. As soon as we've digested more of this additional supply coming to the pipe nationally, we've got a lot of great projects that are ready to go in the best markets in the country.

[Caitlin Burrows, analyst]

Got it. Okay. And then maybe on the acquisition side. I know it's historically not been as much of a driver for you guys, and transaction volumes are down significantly this year across CRE. But are you seeing any attractive acquisition opportunities come to market? Or do you expect attractive opportunities to come up, either of stabilized properties or even lease-up properties?

[Peter Baccile, executive]

I mean, economics certainly make a difference in terms of what's attractive. But Jojo, do you want to talk about some of the things you've seen and the reasons we've taken in the past?

[Johannson Yap, executive]

Sure, yes. So we're going to look out for those. We're trying to see further stress in like merchant developers or owners or middle of their projects or need capital or just sellers who want to get our real estate. The reality is that there's not a lot of those that fit our quality or geography. And in those situations that meet our geography and -- it doesn't meet our financial criteria, meaning that there are some buyers who are still acquiring real estate at prices don't make sense to us.

But there are a few small ones we're in. We have a situation where a developer didn't have the funds and that they kind of good build-to-suit. We're stepping in, and we think that's a great deal. And then we have another situation, not a large deal, a one-off where the developer needs to fund their speculative project, and suddenly the lender hold commitment unless the -- this developer comes out with more equity. And so we're buying one of their buildings that are nice building lower -- much lower price because they need to squeeze out equity on that very, very quickly. So those are just examples of what we're trying to look for.

[Caitlin Burrows, analyst]

Got it. And just to clarify, those are things that you're looking for or have already been like decided on and are moving forward?

[Johannson Yap, executive]

I can't really give you much more specifics as those are...

[Peter Baccile, executive]

We're pursuing. We're pursuing.

[Johannson Yap, executive]

We're chasing it.

[Peter Baccile, executive]

They are not by any means -- we may not get it. But we're pursuing.

[Operator]

The next question comes from Todd Thomas with KeyBanc Capital Markets.

[Unknown Analyst]

This is A.J. on for Todd. Just going real quick back to the capitalized interest discussion. You said that you stopped capitalizing interest when development is completed. As you look at your construction pipeline today and everything under construction, do you see any potential delays or anticipate any delays for what's currently supposed to be delivered over the next few quarters?

[Scott Musil, executive]

I would say that's our best thinking as of this point of time. So if you're asking about developments under construction, we've got estimated building completion in our supplemental. That's our best thinking at this point in time that that's when those developments will be completed.

[Unknown Analyst]

Okay. Perfect. And then just one question regarding Old Post Road. Is the 3PL tenant -- are you still -- are they still engaging? Or is there any update around that contract that was going to be awarded? Or are you moving on and looking to market the asset to a new tenant altogether?

[Peter Schultz, executive]

So A.J., it's Peter Schultz. We continue to market the asset. In terms of the 3PL group, we continue to talk with them. The government continues, for whatever reason, to postpone the final decision on that contract award. The latest information is that they're supposed to issue that award sometime later this quarter. Given our experience with this process over the last year our confidence level, I would say, is not high, which is why, as you heard from us earlier, we decided to push the lease up into 2024. It's certainly possible that this could get done this quarter, but our probability is that it's less likely just given the way this process has gone.

[Operator]

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

[Michael Carroll, analyst]

Just following up on Old Post Road. I know this has been taking a couple of years to get done. I mean at what point do you just decide to kind of go multi-tenant and try to lease it to some smaller tenants that might want that space?

[Peter Schultz, executive]

Mike, that's a good question. It's Peter Schultz again. So we're certainly -- have been and are open to that. As we've talked about on some of these prior calls, demand from larger users in this submarket and others has been slower, where historically, that size range was very active along that quarter. That's something we're open to. And it's really about the timing of market demand and how tenants make decisions.

[Michael Carroll, analyst]

Okay. And then just real quick on your comments on the smaller blocks of the space. I know for the past few quarters, you've highlighted the tenant activity for those small to midsized blocks as were still pretty healthy. Is that still a fair comment today? Or has that changed over the past 3-plus months, given kind of the slowdown that you've seen in demand?

[Peter Schultz, executive]

So I would say it's consistent. If you look at our in-service portfolio, occupancy is very, very high. We continue to see good demand and backfilling spaces quickly. But for the Old Post Road building that we just talked about and a couple of our developments that are larger, right, demand continues to be very active. I mean there's -- and those tenants operate with more urgency and diligence and some of the bigger commitments to our earlier points where they're just not in a hurry to make those decisions and commitments today given the broader macro factors that are impacting everybody.

[Operator]

The next question comes from Nick Thillman with Baird.

[Nicholas Thillman, analyst]

Question on the land bank. It looks like the fair value of the land bank was marked down like 10% quarter-over-quarter. Some of that could be related to some land sales, but just curious if you did make some changes in your estimates for fair value to land and maybe which markets in particular saw the biggest haircuts.

[Peter Baccile, executive]

Scott, do you want to take that?

[Scott Musil, executive]

Yes. Nick, it's Scott. A couple of things happened is from the land bank, we removed the land in Phoenix related to the land sale, and then we removed the land that's being ground leased. So that's going to cause a fair value drop alone in 3Q compared to 2Q because it's still longer in the population. I'll have Jojo talk about adjustments we made to the -- what's left over...

[Johannson Yap, executive]

Sure. And then on -- an additional, as Scott said, we added, of course, the land -- Nashville land acquisition. And then we made some adjustments to our land values, those were in Chicago and Florida. And then we also slightly adjusted some lands. So we did this asset by asset. Some land, we started to make improvements, where it's off-site improvements, and therefore, that added to the value. So we added our cost to those additional investment in the land. So if you took all of that together, that resulted in the difference.

[Nicholas Thillman, analyst]

Was there any specific markets that were haircut like significantly in this process or not really?

[Johannson Yap, executive]

No, I would say that we didn't do it market by market. We did it property by property. I would say the change was anywhere from 5% to 15%. And then Chicago, we, for example, took down Orlando. We took down in terms of value, we adjusted it. So, yes. So I mean we did it property by property.

[Nicholas Thillman, analyst]

And then a quick one for Scott. Maybe just an update on how bad debt is tracking year-to-date? And any updates on the tenant watch list?

[Scott Musil, executive]

Sure. Bad debt's very low. For the third quarter, it's about $100,000, and that's compared to our guidance assumption of $250,000. So still in very good shape. If you look year-to-date third quarter, we've expensed about $275,000 compared to our original guidance for those first 3 quarters of $750,000. So doing very well against our forecast. As far as tenants on the watch list, no material tenants are on the watch list at this point in time.

[Operator]

Our next question comes from Rich Anderson with Wedbush.

[Richard Anderson, analyst]

So when I was kind of looking back in time, Peter, back in 2019, I asked a question to you, what trigger points are you looking for as it relates to build-to-suit versus spec development. You talked a lot about it here on this call. One of the things you said then, not to put on the spot, is the so-called musical chairs phenomenon where tenants have the ability to move around from one asset to another because they can. And that, to you, would be an indication of market weakness. You talked about the hesitancy of tenants and so on that's going on today. But are you also seeing that with the elevated level of deliveries is creating optionality? Is that another sort of dynamic that you're seeing happen in your space?

[Peter Baccile, executive]

Kudos to you, Rich, for remembering that, bringing that up. That's good. Good question. No, we're not seeing that. What we're seeing, someone -- and we have a current example in the portfolio, where a tenant moved out to consolidate it to a bigger space. And that's still the theme. If we lose a tenant, it's because we can't accommodate their additional growth needs.

And in terms of people leaving buildings, it's very expensive to move. So the deal "that they can achieve somewhere else has to be pretty outstanding," and that is not reflective at all of where we are right now, even with the additional supply coming to the market. As we've pointed out, vacancy rates, that 4% in our markets, that's still a very, very low vacancy rate. That's not going to generate the kind of financial arbitrage that is going to cause a tenant to leave to go to another building. So good -- very good question, but we're not seeing that phenomenon right now.

[Richard Anderson, analyst]

Okay. Second question for me is, Scott, you gave your guidance, 94.5% occupancy at the midpoint and 97% if you didn't include the development deliveries. So 250 basis points spread, how does that number compare to when everything was white hot and you kind of got further along in the leasing process by the time buildings were delivered? Is 250 significantly higher than that time? I assume it's above it. And where do you think it's headed from here when you kind of take your pulse of things going forward?

[Scott Musil, executive]

Yes, it's definitely significantly higher. Our place in service policy is 12 months after developing completion. And we've -- generally, if you look at year 3, 5 years ago, we've leased up everything inside of that 12 months. So that spread is definitely higher. We did have a little bit of that type of dynamic during COVID with a couple of our developments, so I would say at this point in time, it's higher. On a go-forward basis, Rich, it really depends on an asset-by-asset basis when we get leased up and we'll go through our budget process here at the end of the year, and we'll give you a little bit more color on our fourth quarter call.

[Operator]

Our next question comes from Vince Tibone with Green Street Advisors.

[Vince Tibone, analyst]

Could you discuss how 3PL tenants are performing in your portfolio? And do you have a sense of where their current volumes are relative to peak activity 12, 18 months ago? I'm just trying to understand how much kind of excess capacity there may be among 3PLs and how that dynamic could potentially impact near-term demand?

[Peter Baccile, executive]

Peter, do you want to take that?

[Peter Schultz, executive]

Sure. Vince, it's Peter Schultz. First, I would say that our teams report high utilization of all of our spaces around the country. 3PLs continue to be the top most active prospect that we're seeing for new buildings and existing availability. And in general, they're all looking for more space, not less space. So I would simply tell you that we're not seeing really any stress there. To Scott's question, nobody on the watch list, and no bad debt, but they continue to be an important and an active component of demand. Jojo, anything you want to add to that?

[Johannson Yap, executive]

Yes. The only thing is that definitely the 3PL -- in our experience, 3PL business is not recession-proof, but it is a business wherein -- where things slow down with companies that are not in the fulfillment business, they go to 3PLs because 3PLs are more efficient and more cost-effective than doing fulfillment themselves.

[Vince Tibone, analyst]

That's really helpful. And then one more industry kind of wide question for me. Could you just discuss trends among sublease space within your markets? Any notable changes there?

[Johannson Yap, executive]

That's a pretty -- that's an intricate topic because not all sublease space is created equal. Peter and Jojo, do you want to come in with some...

[Peter Schultz, executive]

Sure. So it's Peter Schultz. I would first say that sublet space at the headline is certainly up a little bit, but I think you have to break it down, and it's a couple of different buckets. One is a corporate occupier saying a 700,000 square foot building gets an edict from their corporate to sublet 200,000 or 300,000 square feet. That's a hard deal to make for tenants and generally doesn't happen.

We don't really view that as competitive sublet space. Some of the sublet space has a time or term limit of only a couple of years, and most tenants are not going to take advantage of that. We've also seen some sublet space come on the market and be pulled back by the prime tenant because they need the space again. So yes, there is some sublet space. We don't view it as a high concern today. And then I would just end with, as I said a couple of minutes ago, the space utilization in our portfolio is very high. We're not really seeing any change in sublet space across our portfolio. Jojo?

[Johannson Yap, executive]

Yes, I just want to just add to Peter, when we surveyed really our teams is that we haven't really lost anything close or anything significant to subleased space, just like Peter said. And even if we did, these are the subleases that are long-term, a long-term sublease is very good for a long-term user. But the problem is that most of leases don't fit that. Most of the leases are short term. And therefore, frankly speaking, would like to cope with sublease because a lot of times, the tenants that we're pursuing can really operate out of a short-term lease. It's like Peter Baccile said, it's constantly moving.

[Operator]

Our next question comes from Mike Mueller with JPMorgan.

[Michael Mueller, analyst]

So for the -- 2 questions. The first one is, for the development leases you signed in 3Q and 4Q, how did the rents compare to the original underwriting? And the second question is a little bit more of a clarification. When you were talking about '24 leasing, did you say 56% of the remaining expirations were in Southern California? And if so, how does that compare to what the mix was of what you signed already?

[Peter Baccile, executive]

Chris, take the first part -- second part first.

[Christopher Schneider, executive]

Yes. So correct. The remaining 2024 lease expirations at 56%. And again, the ones that have been signed already, the mix with Southern California was only 5%. So obviously, it's going up quite a bit.

[Peter Baccile, executive]

Do you want to cover the first part of that question? Do you remember the first part of the question?

[Peter Schultz, executive]

Give the first part of the question again, please.

[Michael Mueller, analyst]

Yes. It's -- for the development leases signed in 3Q and 4Q, how are the rents versus what you originally underwrote?

[Peter Schultz, executive]

Significantly ahead of what we underwrote.

[Operator]

The next question comes from Anthony Powell with Barclays.

[Anthony Powell, analyst]

Just a question on data centers. And as you look at your land bank, are there any obvious opportunities for you to do additional joint ventures or development deals in the space?

[Peter Baccile, executive]

So we are land positions and...

[Johannson Yap, executive]

Well, in terms of -- we're very pleased that we were able to get the highest and best use for this piece of land that we have in Phoenix. So we're very excited about that. When you look at all across the board in terms of what we do, we're always looking for higher and better use. So if we come to a situation we're in, we are offered a price that it doesn't make any sense to build an industrial building or exceeds our profit potential -- margin potential and product potential and development, we would consider selling. So that's basically a rule and a practice that we do in FR. Now in terms of obvious candidates for future data centers right now, I will say that we don't have any pending offers or pursuits of additional data center situations.

[Anthony Powell, analyst]

Got it. And I guess with all these sales or joint ventures, you wouldn't do development on your own balance sheet data centers. Is that fair?

[Peter Baccile, executive]

It's fair to say, yes, we're going to stick to our bread and butter.

[Operator]

Our next question comes from Caitlin Burrows with Goldman Sachs.

[Caitlin Burrows, analyst]

Sorry, just one follow-up, which is similar to the question that was just asked. But in terms of the mix of expirations in '24, I think you had previously said on other calls that 2024 would have less SoCal than 2023. So I'm wondering, as you compare '24 to '23, if that changed or just that kind of exposure that you were talking about -- that might be confusing. I'm just wondering how the '24 SoCal exposure compares to '23.

[Christopher Schneider, executive]

Yes. Caitlin, this is Chris. So if you -- because there was a couple of leases that originally were going to -- they expire in 2023 are not going to lease up in 2024, the allocation between the 2 years is both around 25%-plus.

[Peter Baccile, executive]

Yes. We're talking about a couple of months difference. So...

[Christopher Schneider, executive]

Right. So very similar between the 2 years.

[Caitlin Burrows, analyst]

Got it. So it was some that had originally been thought of '23, but now they will be '24, making them more even?

[Christopher Schneider, executive]

Correct.

[Operator]

Our final question comes from Craig Mailman with Citi.

[Craig Mailman, analyst]

I'm not trying to make the call a lot longer than it needs to. But just -- there's a lot of focus on market rent growth these days. And it just feels like a lot of the stats being put together by brokers and talked about are kind of asking rents, which are -- some markets being driven by just new product that's coming on the market versus maybe where taking rates are. And I'm just kind of curious, as you guys go through your market exposure, is there a rosier picture on the taking rate side of things versus the trend in asking rate that you could talk about or...

[Peter Baccile, executive]

Yes. It's a complicated subject because market rent growth is tracked differently by a lot of different brokers. Taking rents right now, they report are more like 15%. We don't quote that. We think the asking rent number is more accurate. Our expectation for rent growth for 2023 was mid- to high-single-digits. That was with asking rents in mind. So far, year-over-year, CBRE reports for the third quarter, that number is 7.5%. So it's right in the middle of what we expected.

So yes, we're looking more at a 7.5% rental rate increase across the markets that we're active in. We don't look at the -- the taking rents are higher because of all -- taking rents by definition have to include some amount of mark-to-market as opposed to just what's happened in that quarter or that year. So we don't pay attention to that.

[Operator]

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

[Peter Baccile, executive]

Thank you, operator, and thanks to everyone for participating on our call today. If you have any follow-ups from our call, please reach out to Art, Scott or me. We hope to connect with many of you in person in the coming months. Be well.

[Operator]

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