Business Context and Reporting Period
Industrial Logistics Properties Trust filed an unaudited Form 10-Q for the quarter ended March 31, 2019. The company is a REIT that owns and leases industrial and logistics properties in one operating segment. At quarter-end, it owned 277 properties totaling approximately 33.2 million rentable square feet, leased 99.4% to 254 tenants, with a weighted average remaining lease term of approximately 10.2 years.
Approximately 52.2% of annualized rental revenues came from Hawaii Properties. Amazon.com Services, Inc. represented 11.7% of annualized rental revenues and 10.6% of reported rental income for the quarter.
Financial Highlights
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Rental income | $46.0 million | $40.6 million | 13.3% increase |
| Net operating income | $37.0 million | $32.5 million | 14.0% increase |
| Net income | $16.8 million | $19.2 million | 12.7% decrease |
| Net income per share | $0.26 | $0.31 | 16.1% decrease |
| FFO and Normalized FFO | $26.4 million | $26.1 million | 1.1% increase |
| FFO and Normalized FFO per share | $0.41 | $0.42 | Decrease |
| Cash flow from operations | $28.3 million | $22.1 million | Increase |
NOI margin was approximately 80.5% of rental income, compared with approximately 80.0% in the prior-year quarter. Net income margin was approximately 36.5%, compared with approximately 47.4% in Q1 2018. The decline in net income primarily reflected higher depreciation and amortization, general and administrative expenses and interest expense.
At March 31, 2019, total assets were $1.82 billion, cash and cash equivalents were $16.1 million, and shareholders’ equity was $1.02 billion. The company paid a quarterly distribution of $0.33 per share, totaling $21.5 million, in February 2019.
Debt, Liquidity and Cash Flow
- Cash provided by operating activities was $28.3 million.
- Cash used in investing activities was $281.9 million, primarily for real estate acquisitions.
- Cash provided by financing activities was $260.1 million, including $650.0 million of mortgage proceeds, net revolving credit activity and the $21.5 million shareholder distribution.
- The company had $50.0 million outstanding under its $750.0 million unsecured revolving credit facility and $700.0 million available at March 31, 2019.
- Mortgage notes had a principal balance of $698.8 million, including a new $650.0 million, fixed-rate, non-amortizing mortgage loan at 4.31% maturing in February 2029.
- The revolving facility bears interest at LIBOR plus 130 basis points; its stated borrowing rate was 3.71% at March 31, 2019 and its maturity date is December 2021, subject to extension options.
- Management stated that the company was in compliance with its debt covenants and believes available liquidity and operating cash flow will be sufficient for operating needs, debt service and distributions for the next 12 months and the foreseeable future.
Material Changes Versus the Prior Comparable Period
- Rental income increased by $5.4 million, primarily from acquisitions, leasing activity, rent resets and tenant reimbursements.
- NOI increased by $4.6 million. Comparable-property NOI increased 3.1%, while acquired properties contributed $3.6 million of incremental NOI.
- Interest expense nearly doubled to $7.6 million, primarily because of the $650.0 million mortgage loan obtained in January 2019.
- Depreciation and amortization increased 39.8% to $9.6 million, and general and administrative expense increased 47.6% to $3.8 million.
- Weighted average shares increased 5.8% to 65.0 million, contributing to the decline in earnings per share.
- Occupancy declined modestly to 99.4% from 99.9% at March 31, 2018; comparable-property leased percentage was 99.2% versus 99.9%.
- Average effective rental rates increased to $5.89 per leased square foot from $5.69.
- The company adopted the new lease accounting standard on January 1, 2019 without a material impact on its financial statements.
Acquisitions, Outlook and Management Commentary
In February 2019, the company acquired seven industrial properties in the Indianapolis and Cincinnati markets for an aggregate purchase price of $250.2 million, including acquisition costs, totaling approximately 3.7 million rentable square feet. These properties contributed $2.5 million of revenue and $0.2 million of net income during the quarter.
After quarter-end, the company acquired the remaining property in the eight-property portfolio for $30.5 million and acquired 18 additional industrial properties in 12 states for $624.7 million, including the assumption of $57.0 million of mortgage debt. The filing states that these transactions are expected to increase future cash flows, but no formal earnings or distribution guidance was provided.
During the quarter, the company renewed approximately 271,000 square feet at rental rates approximately 15.8% above prior rates and completed rent resets covering approximately 483,000 square feet of Hawaii land at rates approximately 28.0% above prior rates. Only 1.3% of rented square feet and 0.6% of annualized rental revenues were scheduled to expire through December 31, 2019.
Management expects leasing activity and recent acquisitions may increase future cash flows and enhance the ability to increase distributions in the near term. On April 18, 2019, the company declared another $0.33-per-share quarterly distribution, expected to total approximately $21.5 million.
Risks, Contingencies and Unusual Items
- Future acquisition activity, financing availability and capital costs are uncertain. The company expects leverage to increase following the 2019 acquisitions, which is expected to increase the revolving facility interest rate by 10 basis points after second-quarter results are reported.
- Hawaii land rents periodically reset based on fair market values. Future resets may not produce increases comparable to historical results and could result in lower rents.
- Tenant concentration, tenant credit quality, lease renewals and economic conditions could affect rental income and occupancy. Amazon was the largest tenant by annualized rental revenue.
- Environmental remediation may be required at certain Hawaii properties. Accrued environmental remediation costs were $6.9 million at March 31, 2019, and the company generally lacks insurance specifically covering environmental conditions not caused by an insured event.
- The company has no employees and relies on RMR LLC for business and property management. Related-party relationships and potential conflicts of interest are material considerations.
- The company has exposure to floating LIBOR-based debt and noted that LIBOR is expected to be phased out in 2021. A one-percentage-point increase in rates would increase annual interest expense on the then-outstanding revolving debt by approximately $0.5 million, or approximately $0.04 per share based on the filing’s calculation.
- The company had an estimated remaining cost of approximately $14.1 million to expand an existing property and $472,000 of unspent leasing-related obligations.
- No material changes to previously disclosed risk factors were reported, and no material off-balance-sheet arrangements were identified.
Investor Verification Priorities
- Verify the completion, financing and contribution to revenue and NOI of the post-quarter-end acquisitions.
- Reconcile the growth in rental income and NOI against occupancy, rent resets, lease renewals and acquired-property results.
- Review leverage, covenant compliance, available revolver capacity and the effect of additional acquisition financing on interest costs.
- Assess tenant concentration, particularly Amazon and major Hawaii land tenants, together with upcoming lease expirations and rent-reset exposure.
- Evaluate whether FFO growth supports the $0.33-per-share distribution and whether future acquisitions can increase cash flow after debt service.
- Review related-party management fees, governance arrangements and potential conflicts involving RMR LLC, RMR Inc., OPI and Affiliates Insurance Company.