I further acknowledge the strong industry position and great history the Company has. The final “cherry on top” is the culture here and the team I work with including keeping David Hoster, our retiring Chief Executive Officer, around to chair our Board and our Investment Committee and Leland Speed, our retiring Chair, as Chairman Emeritus.
As we have stated many times, our strategy is simple, straightforward and it works. We develop, acquire and operate multi-tenant business distribution facilities for customers who are location sensitive. Our properties are designed for users primarily in the 5,000 to 50,000 square foot range and are clustered around major transportation features in supply constrained submarkets in the traditionally high growth major Sunbelt metropolitan areas.
We have been asked how we will change as a result of our management transition. EastGroup’s operating and conservative balance sheet strategies have served the Company well over a long period of time through up and down economic cycles. Given these time tested proven results, we have no plans to change our strategy. That said, we do plan to constantly evolve and improve as the industrial markets allow.
This continues to be a great time to be an investor in industrial real estate in the Sunbelt. Property fundamentals are good in our markets, and we see no reason this should change in the near term.
In 2015, we grew all aspects of our business – funds from operations, same property operating results, new development, and acquisitions. This was again achieved while maintaining a strong balance sheet.
This past year was a bit of a Tale of Two Cities as we were disappointed with our stock performance while our operating performance was as strong as it has ever been. We achieved a record high FFO per share and paid out a record annual recurring dividend. That said, our total return to shareholders was negative 8.5%. We believe this resulted from market concerns over a number of factors, including our holdings in Houston and the economic impact of the downturn in the oil industry. Towards that end, we’ve been renewing our Houston tenancy as early as they are willing, reducing our development pipeline there and have begun marketing several of our Houston assets for sale.
We’re a strong believer in the fourth largest city in the country, but value portfolio diversity. We’ve created a lot of shareholder value in Houston. Given the disconnect between public market concerns versus strong private market valuations, we believe it makes sense to harvest some of that value. While the stock market was disappointing in 2015, over the longer term, EastGroup’s annual total return to shareholders was 5% for three years, 10% for five years, 7% for ten years and 12% for 15 years.
RESULTS
Funds from Operations (FFO) for 2015 were $118.2 million or $3.67 per share as compared to $109 million or $3.47 per share in 2014, a strong increase of 5.8% per share. This represented the highest FFO per share in EastGroup’s history, and the fifth year in a row of growth in FFO per share as compared to the previous year’s results. In addition, we have achieved quarterly increases in FFO per share as compared to the previous year’s quarter for 18 of the last 19 quarters.
The 2015 FFO growth was due to continued improvement in property operations, new development, lower interest rates and acquisitions in both 2014 and 2015. Portfolio occupancy was 96.1% at year end. And our fourth quarter occupancy was the tenth consecutive quarter at 95% or above.
We experienced an 11.9% increase in rents for leases (both new and renewal) executed in 2015 with straight lining (average rent over the life of the lease) and a 3.8% increase without it (sometimes referred to as cash rent). Both of these figures represent increases over 2014 results continuing a five year positive trend.
EastGroup’s customer base is large and diverse which we believe increases the stability of our operations. At year-end, we had approximately 1,500 customers with an average size of 23,500 square feet and a weighted average lease term of 5.4 years. If you exclude the leases under 2,500 square feet, which
are primarily in Tampa, our average customer size is approximately 25,000 square feet.
It is also important to note that EastGroup’s customers, whether national or local, primarily distribute to the metropolitan area in which their space is located rather than to a much larger region or to the entire country. This means that the economic vibrancy and growth of these metro areas is a major determinant of our customers’ success and our results. This is the reason we are investing in the fast growing major Sunbelt markets.
Another trend we are watching closely is the maturation of the e-commerce delivery model. As e-commerce delivery times become more critical to their business model, we believe the big box, edge of town fulfillment centers will require accompanying in-fill site business distribution centers. Simply put, the traffic congestion within major markets will necessitate close in, smaller distribution space to meet accelerated delivery times. It is within this niche that we view EastGroup as uniquely well positioned among our peers. The majority of our institutional industrial ownership peers have developed large, big box (250,000 square feet and above), less in-fill projects. Whereas, our typical building is 80,000–130,000 square feet in in-fill locations near transportation hubs, making them ideally suited for the prospective new and growing demand source. At 97.2% leased at year-end, we have the luxury of patience as this supply chain evolution plays itself out. We are, however, looking ahead and watching the trend for this new demand driver.
FINANCIAL STRENGTH
At December 31, 2015, our debt-to-market capitalization was 36.4%, and our floating rate bank debt was 5.3% of total market capitalization. The debt-to-market capitalization rose from previous years primarily due to a decline in share price. If the ratio was calculated instead using consensus net asset value per share by contrast the ratio falls to 33.3%. For the year, our interest and fixed charge coverage ratios were both 4.43 times, our fifth year in a row of improvement over the previous year.
In March 2015, Moody’s Investors Service affirmed EastGroup’s issuer rating of Baa2 with a stable outlook. Also in March, Fitch Ratings affirmed its issuer rating of BBB with a stable outlook.
During 2015 we renewed and expanded our lines of credit all at a lower cost. As a result, we now have a total of $335 million unsecured revolving credit facilities with a group of nine banks. The interest rate on these facilities is presently LIBOR plus 100 basis points, with an annual facility fee of 20 basis points. The lines of credit, which do not mature until January 2019, can be expanded by $150 million and have options for one-year extensions.
We primarily use our lines of credit to fund our development program and property acquisitions. As market conditions permit, we issue equity and/or longer term debt to replace the short term bank borrowings.
Approximately four years ago, we began the switch from traditional insurance company first mortgage secured debt to unsecured term loans with banks and the private placement of bonds. Both of these types of debt have interest only payments until maturity, and the rates are fixed for the life of the debt. We plan to primarily obtain unsecured fixed rate debt in the future as market conditions permit. One of the appealing factors of the unsecured fixed rate debt is the greater asset level flexibility it allows after closing.
In March 2015, we closed a $75 million senior unsecured term loan at an interest rate of 3.03% with a seven year term and interest only payments.
In October 2015, we issued $75 million of senior unsecured private placement notes with two insurance companies. The 10-year notes carry a weighted average interest rate of 3.98% with semi-annual interest payments.
In March 2015, we repaid a maturing mortgage loan with an outstanding balance of $57.4 million and an interest rate of 5.50%. Then in November, we repaid a $24.4 million maturing mortgage with a 4.98% interest rate.
The continuous equity sales market has been an attractive source of capital the past few years. During much of 2015, however, our stock price was below where we thought it advisable to issue equity. As a result, it was minimally used (approximately $6 million versus $79 million in 2014). We remain committed to maintaining a healthy balance sheet and to the value creation our development program produces. Our balance sheet allows us to meet both goals today. Even so we are extra sensitive to capital market allocations due to the weaker equity market. We will continue to monitor the equity market, market conditions and capital needs, to determine the level of equity issuance, if any, during 2016.
DEVELOPMENT
EastGroup’s development program has a long and successful record of creating and accumulating value for our shareholders over the past 19 years. We have added over 14 million square feet of quality, state-of-the-art assets. As a result, we have built almost 40% of our current portfolio through our development efforts, and these assets generated approximately 41% of our total property net operating income in 2015.
Our early development efforts consisted of just one or two building projects. As EastGroup grew and the program successfully evolved, we began to develop parks with the potential for multiple buildings where we create and control a uniform high quality environment. This also allows us the flexibility to better serve our customers by being able to meet their changing space needs over time.
EastGroup is an “in-fill” site developer. Although we have built a number of build-to-suit and partially pre-leased developments, we are comfortable initiating speculative development in submarkets where we have experience and an existing successful presence. These development submarkets generally are supply constrained due to limited land for new industrial development or have cost or zoning barriers to entry. In addition, the vast majority of our new developments are subsequent phases of existing multi-building industrial parks, therefore, we view the risks materially lower versus traditional greenfield developments.
Further reducing our risk is our approach to not bank land on our balance sheet. In other words, we actively work to minimize the time between closing and ground breaking. Within our business park phase developments, we typically start construction as leasing within the park dictates. For example, if we have more prospects than space, we have optimism about the next building as opposed to relying on
a consultant’s market study.
Due to the improving industrial property fundamentals and our own leasing success, we began construction of 11 projects containing 1.3 million square feet with projected total costs of $87 million in 2015. Three are in three different submarkets of Phoenix, two are in two different submarkets in both San Antonio and Houston, two are in an Orlando submarket and, finally, one each in Charlotte and Tampa. During the year, we transferred 17 properties with 1.4 million square feet into the portfolio which were 96% leased as of December 31.
An important element of a successful development program is well located industrial land acquired at the right price. In 2015, we purchased 113 acres for new development for a combined investment of $19 million. These parcels are located in Charlotte, Houston, Dallas, Phoenix and San Antonio with construction already underway on the San Antonio and Phoenix land.
We believe our development program will continue as a major creator of shareholder value. We have the right land, permitted buildings, available capital and an experienced and proven development team. We expect to continue our development momentum in 2016 at approximately the same pace as 2015. As always it will be set by our own leasing activity as opposed to set targets or simply high level market research.
During the recovery Houston drove our development program. Given the instability of oil pricing during 2015, we were pleased to maintain our development pipeline while Houston shrank to below 15% of 2015 starts. Looking ahead we forecast the ability to maintain the size of our development pipeline with no Houston starts in 2016.
CAPITAL RECYCLING
Recycling of capital through asset sales and the redeployment of the proceeds in acquisitions and development has historically been an integral part of our strategy. This process allows us to continually upgrade the quality, location and growth potential of our assets. This capital allocation option took on increased emphasis as we shift away from the continuous equity sales program mentioned earlier.
During fourth quarter, EastGroup acquired 335,000 square feet of new properties through two separate transactions for a combined investment of $31.6 million. We purchased with Section 1031 Like Kind Exchange disposition proceeds, Southpark Corporate Center and Springdale Business Center both in Austin. Austin was a target market for us for many years, which we entered in 2014 with the acquisition of Colorado Crossing. What attracts us to Austin is the mix of a stable metro economy created by the state capitol and the University of Texas; job growth which has consistently been above the national average and, moreover, is largely driven by technology jobs; and finally supply constraints created by the topography and strict local development guidelines. Southpark, which was constructed in 1995, is a two building business distribution project in southeast Austin near our Colorado Crossing asset. Meanwhile, Springdale is a two building project developed in 2000 on the eastern side of the City. Both properties are presently 100% leased.
We also sold our oldest Dallas property and a small parcel of land for a total disposition price of $5.4 million which generated combined gains of $3.0 million. The operating asset we sold in Dallas contained 185,000 square feet and was constructed in the 1950’s. Given the attractiveness of the private transaction market we plan to continue to dispose of older assets in 2016 as market conditions allow. We are attracted to the opportunity to sell older assets and recycle those proceeds into development thus creating incremental net asset value. The tax implications from some of our sales will impact the percentage of sales proceeds we are able to recycle into our development program.
Since year-end we sold Northwest Point Business Park in Houston for $15.6 million.
DIVIDENDS
In September, EastGroup raised its quarterly dividend to $.60 per share which represents an annualized dividend rate of $2.40 per share, an increase of 5.3%. The December dividend was our 144th consecutive quarterly cash distribution to shareholders. We have now increased or maintained our dividend for 23 consecutive years and raised it 20 years (including the last four) over that period.
Our goal in the future is to be able to continue to have annual dividend increases as we achieve increased FFO. We hope to increase the annual dividend at a rate greater than the increase in the rate of inflation but less than the rate of increase in FFO. Also, rental income from properties amounts to almost all of our revenues so we are not dependent on other sources of revenue to fund our dividend. Reflecting EastGroup’s improving operating results, our 2015 FFO dividend payout ratio stood at only 64% in spite of the increase.
THE FUTURE
It’s hard to start a conversation about the future without first looking back. I, personally, and our Company want to express our deep gratitude to David Hoster and Leland Speed for their decades of efforts forging EastGroup into what it is today. We thank you for all you’ve done. We also welcome you with high expectations to your new roles as Chair and Chair Emeritus, respectively. Within our Board of Directors, David Osnos will be stepping down after 22 years of service. I learned a great deal from Mr. Osnos. We will miss his amazing intellect and his leadership.
In 2015, we achieved the highest FFO per share in EastGroup’s history. We accomplished this with high occupancy levels, rent growth, successfully bringing new development online and taking advantage of the low interest rate environment. To our shareholders please know that in spite of the transition, our commitment is to maintain the long term results, broad strategy and culture you’ve come to expect but continue to evolve as our markets dictate and allow.
We have a strong and experienced senior management team with a cycle proven track record, and we believe that we will continue this positive momentum through 2016 and future years.
Marshall A. Loeb
President & Chief Executive Officer
