Business Context and Reporting Period
Industrial Logistics Properties Trust filed an unaudited Form 10-Q for the quarter ended March 31, 2018. The company is a Maryland REIT that owns and leases industrial and logistics properties. As of March 31, 2018, it owned 266 properties totaling approximately 28.5 million rentable square feet, with 99.9% leased to 243 tenants and a weighted average remaining lease term of approximately 11.2 years.
The company completed its initial public offering on January 17, 2018, issuing 20.0 million shares for net proceeds of $444.3 million. Because the IPO materially changed the company’s capital structure and operations, management cautions that historical results may not be indicative of future results.
Financial Performance and Liquidity
| Metric | Three Months Ended March 31, 2018 | Three Months Ended March 31, 2017 | Change |
|---|---|---|---|
| Total revenues | $40.6 million | $39.4 million | 3.0% increase |
| Rental income | $34.8 million | $33.9 million | 2.8% increase |
| Operating income | $23.0 million | $20.9 million | 10.1% increase |
| Net income | $19.2 million | $20.4 million | 5.5% decrease |
| Net income per share | $0.31 | $0.45 | 31.1% decrease |
| Net operating income | $32.5 million | $32.4 million | 0.3% increase |
| FFO | $26.1 million | $27.2 million | 3.9% decrease |
| Normalized FFO | $26.1 million | $29.6 million | 11.7% decrease |
| Operating cash flow | $22.1 million | $24.0 million | Decrease |
Revenue growth reflected higher occupancy, leasing activity and rent resets at certain Hawaii properties. Operating income increased primarily because general and administrative expense declined 44.5%, partly offset by higher real estate taxes and other operating expenses. Net income, FFO and per-share results declined mainly because interest expense increased to $3.8 million from $0.6 million and the weighted average share count increased 36.5% following the IPO.
Cash and cash equivalents were $19.8 million at March 31, 2018. Operating activities provided $22.1 million, investing activities used $1.3 million, and financing activities used $0.9 million. Capital expenditures and other property-related investments included $1.3 million of real estate improvements.
Total assets were $1.43 billion and total liabilities were $400.4 million at March 31, 2018. Debt consisted primarily of $302.0 million outstanding under a $750.0 million unsecured revolving credit facility and a mortgage note with a $48.8 million principal balance. The revolving facility had $448.0 million available, matured December 29, 2021, and carried a 3.23% interest rate at quarter-end. The mortgage note bears interest at 3.99% and matures in 2020.
Material Changes Versus the Prior Comparable Period
- Revenue increased 3.0%, while property-level NOI was essentially stable.
- Other operating expenses increased 29.8%, primarily because of higher rent reserves and snow removal costs compared with unusually low prior-year expenses.
- General and administrative expense declined by $2.1 million, largely because the prior-year period included $2.4 million of allocated estimated incentive management fees related to Select Income REIT.
- Interest expense increased by $3.2 million because of changes in the company’s post-IPO capital structure and borrowings.
- Weighted average shares outstanding increased to 61.4 million from 45.0 million, reducing reported per-share earnings.
- Occupancy improved to 99.9% from 99.6%, and average effective rental rates increased to $5.69 per square foot from $5.58.
- The company entered leases and renewals covering approximately 296,000 square feet at weighted average rental rates approximately 45.9% above prior rates for the same areas.
- The IPO generated $444.3 million of net proceeds, which were used substantially to reduce revolving credit borrowings. Revolving debt declined from $750.0 million at December 31, 2017 to $302.0 million at March 31, 2018.
Guidance, Outlook, Risks and Unusual Items
Management stated that expected operating cash flows, cash on hand and availability under the revolving credit facility should be sufficient for operating and capital expenses, debt service and distributions for the next 12 months and the foreseeable future. The company did not provide specific earnings or revenue guidance.
The company declared a prorated distribution of $0.27 per share for the period from January 17 through March 31, 2018, based on a quarterly distribution rate of $0.33 per share, or $1.32 per share annually. The approximately $17.6 million distribution was expected to be paid on or about May 14, 2018.
- Approximately 60.3% of annualized rental revenue was derived from Hawaii properties. Many Hawaii land leases reset periodically based on fair market values, and future rent increases are dependent on market conditions.
- Amazon subsidiaries represented 10.5% of first-quarter revenue and approximately 10.2% of rented square footage and annualized rental revenue at March 31, 2018, creating tenant concentration exposure.
- Only approximately 1.1% of rented square feet and 0.8% of annualized rental revenue were scheduled to expire through December 31, 2018; however, 16.6% of rented square feet expires in 2024 and 17.1% expires in 2027.
- The revolving facility has floating-rate exposure. A one-percentage-point increase in rates would increase annual interest expense by approximately $3.0 million at the March 31, 2018 balance, or approximately $7.5 million if fully drawn.
- The company relies on RMR LLC for business and property management and has no employees. Related-party relationships with RMR LLC and Select Income REIT may create conflicts of interest.
- Environmental remediation liabilities of $7.0 million were accrued at March 31, 2018. Management did not believe known environmental conditions would have a material adverse effect, but future remediation costs could differ.
- The company expects to qualify as a REIT for federal income tax purposes beginning with the 2018 taxable year and generally must distribute at least 90% of REIT taxable income, limiting retained capital.
- Management reported compliance with the revolving credit facility covenants, no material off-balance-sheet arrangements and no swaps or hedges at quarter-end.
- The filing states that there were no material changes to the risk factors previously disclosed in the 2017 Form 10-K.
Important Facts for Investors to Verify
- Assess post-IPO operating performance separately from the 2017 comparison because the IPO changed share count, debt, management arrangements and cash flows.
- Monitor the $302.0 million floating-rate revolving balance, available capacity, covenant compliance and the December 2021 maturity.
- Evaluate tenant concentration, particularly exposure to Amazon and the contribution of Hawaii properties to revenue.
- Review scheduled lease expirations and Hawaii rent-reset dates, including $10.9 million of annualized Hawaii rental revenue scheduled to reset in 2019.
- Reconcile distributions with normalized FFO, operating cash flow, REIT distribution requirements and capital spending needs.
- Review fees and potential conflicts under the 20-year business and property management agreements with RMR LLC.
- Monitor environmental remediation obligations and any future changes in the use or redevelopment of Hawaii properties.