Photo by Rocky Kneten David Hoster II, President & CEO, EastGroup Properties

Focus and location are EastGroup's main ingredients for success

By Jennifer D. Duell

EastGroup Properties, Inc. (NYSE: EGP), the Jackson, Miss.-based industrial REIT has a simple recipe for investment success: strong sector focus and highly targeted locations.

The industrial REIT is relatively small compared to others in the sector, employing approximately 65 people. "Our story is simple, and all of our employees are on the same page when it comes to our strategy," says President and CEO David Hoster II. "We are focused on developing, acquiring and operating multi-tenant industrial properties."

		Upside-Downside Samplings of what analysts are saying about EastGroup Properties, Inc.

Paul Adornato, an analyst with BMO Capital Markets, says that EastGroup's management team is "among the best" in the REIT sector. "They know their property type very well," he says. "They've been together for a very long time—the importance of stability in senior management can't be overestimated these days."

In fact, the REIT's small size is a boon to the company. "David can talk fluently about every property in the portfolio, and he knows almost every tenant," says Art Havener, a vice president of A.G. Edwards & Sons, Inc. "That's unique because many portfolios are so big that top management can't be hands-on." That personal touch has paid off: as of Dec. 31, 2006, the EastGroup portfolio was 95.5 percent occupied.

Ingredients for NOI Growth

Today, EastGroup's portfolio consists of 22.1 million square feet of industrial properties clustered in major Sunbelt markets. Additionally, the REIT has 19 projects totaling 1.5 million square feet under development with a price tag of $108 million.

Hoster noted that the industrial sector enjoys the advantages of a shorter development cycle, which allows industrial players to respond more quickly to demand fluctuations. Moreover, he notes that there's not as much danger of industrial sites losing their usefulness.

EASTGROUP PROPERTIES, INC. One Jackson Place 188 East Capitol Street Jackson, MS 39201 PHONE: 601.354.3555 WEB SITE: www.eastgroup.net MANAGEMENT: Leland Speed, chairman; David Hoster II, president & CEO; N. Keith McKey, chief financial officer TICKER SYMBOL: NYSE: EGP •52-WEEK HIGH: $57.55 •52-WEEK LOW: $47.55

While some other industrial REITs tend to develop big-box distribution facilities on the fringes of large metro areas with plenty of land for competitive projects, EastGroup develops and owns assets located in close proximity to transportation arteries such as airports and interstate highways. "A good location today should be a good location for the foreseeable future," Hoster says. "There's not much changing in the transportation infrastructure—seaports are growing, but they're not moving, and neither are the airports or highways."

"When you're building on the fringe of development, rental rates become the only way to compete, and then the industrial space becomes a commodity," says Chief Financial Officer N. Keith McKey. "That's what we are trying to avoid."

For example, the REIT owns approximately 2 million square feet in Houston, next to George Bush Intercontinental Airport. "It's illogical to think that someone could compete with properties like that," Havener says, who has followed the REIT for more than 10 years.

McKey notes that EastGroup's tenants are very location-sensitive because they use their space to distribute to the metro area in which they're located rather than for regional distribution. "These tenants will pay a bit more for a location that helps them serve their customers better," he says.

By targeting infill locations and location-sensitive users, EastGroup has produced same-store net operating income (NOI) growth of 4 percent to 5 percent, which is about 100 basis points higher than expected from an average industrial property landlord, says Stephanie Krewson, an analyst with BB&T Capital Markets.

Moreover, EastGroup's focus on smaller tenants ranging from 5,000 square feet to 50,000 square feet is a profitable niche. "The smaller tenants tend to lead economic recoveries," Adornato says.

Sunbelt Expansion

Under Hoster's direction, EastGroup has focused its growth on Sunbelt markets. Today, 90 percent of EastGroup's assets are located in Arizona, California, Florida and Texas. "During recessions, we've found that Sunbelt markets have more vibrancy," he says. "During good times, these markets get a larger share of job growth."

"A good location today should be a good location for the foreseeable future."

The REIT has regional offices in Houston, Orlando and Phoenix and continues to refine its geographic strategy. "We like metro areas with more than a million people and that also project significant population growth," Hoster says.

He adds that the REIT has "no desire" to go global. "We're happy operating in the United States." He says there are plenty of domestic opportunities to keep the company busy. More importantly, those opportunities offer a level of risk and return that is attractive.

Acquisition Strategy

Hoster says that the REIT's acquisition strategy is different from most in the industrial sector. EastGroup will buy buildings that the bigger REITs won't because the deals are either too small or have too much "hair" on them. "We buy empty buildings, buildings with unattractive first mortgages and buildings with problems," he says. "We'll do some acquisitions that other buyers just don't want to deal with." The payback, he says, is that the REIT is able to expand its acquisition pipeline, add quality assets to its portfolio and generate value-added returns that exceed core investments.

Over the past three years, EastGroup has expanded to three new markets, entering San Antonio in 2004, Fort Myers, Fla. in 2005 and Charlotte, N.C. in December 2006. The REIT's Charlotte acquisition — four buildings totaling 322,000 square feet for $19.5 million — was the only 2006 purchase, Hoster says, due to a difficult acquisition environment.

The Recipe for Success EastGroup hasn't always focused on industrial properties. The REIT grew out of Third ICM Realty, a New York City-based land investor that was established in 1969 and went public as a REIT in 1971. In the early 1980s, ICM Realty moved to Jackson, Miss. with the name EastGroup Properties. Until the mid-1990s, EastGroup's portfolio was mixed, consisting of office, apartment and industrial assets. However, Hoster narrowed the REIT's focus to multi-tenant industrial. "We see industrial as a more stable investment than other property types," he says. "We don't feel it has the highs and lows, and that's where we saw opportunity. Industrial fits our conservative style."

Since December 2006, EastGroup has acquired three more facilities in Charlotte, boosting the company's presence to more than 500,000 square feet. The REIT plans to grow the Charlotte portfolio to more than 1 million square feet in the next 12 to 24 months, Hoster says.

Earlier this year, EastGroup made acquisitions in markets where it is more established, including a 60,000-square foot building in Dallas for $2.9 million. It also is under contract to purchase 231,000 square feet in San Antonio, a deal that is expected to close in 2007.

Development Driven

Even with the REIT's success in acquisitions, Hoster says that development offers the best growth opportunities for EastGroup. The company has more than $80 million worth of industrial buildings under construction in several markets, including Houston, Fort Myers, Fla., Phoenix and San Antonio. Hoster expects to break ground on an additional $80 million to $100 million in 2007.

Industry analysts agree that development is key to EastGroup's future success. "The company has great development returns of 8 percent to 9 percent¯some of the best returns on development out there," Havener says. "They're creating a lot of shareholder value via their development pipeline."

EastGroup's World Houston International Business Center in Houston consists of more than 1,500,000 square feet.

In 2006, EastGroup's funds from operations (FFO) per share were $2.81 compared with $2.64 per share for 2005, an increase of 6.4 percent. The increase in FFO was attributed to $3.8 million from same property growth, $3.1 million from newly developed properties and $2.5 million from acquisitions.

Krewson expects EastGroup's same-store NOI growth and solid development pipeline to drive long-term FFO per share growth of 8 percent to 10 percent. Historically, the REIT has delivered more moderate FFO per share growth of 5 percent to 7 percent. However, BB&T's analysis indicates that EastGroup will fund an increasing portion of its operations and new developments with free cash flow, thereby lowering the cost of capital and raising its return on equity.

"The compounding effect of plowing back cash super-charges EastGroup's future earnings growth potential," Krewson says.

Adornato's 2007 FFO estimates aren't quite as robust; he forecasts FFO per share growth of 6.8 percent compared to 6.4 percent for all industrial REITs and 10.2 percent for the entire REIT universe.

In 2006, EastGroup paid an annualized dividend of $1.96 per share, representing a yield of 3.4 percent. The dividend yield is the lowest it's ever been, Havener says, but asserts that the REIT is "still one of the most attractive companies out there."

EastGroup's assets are mostly located in Sunbelt market such as Arizona, Florida and Texas.

Although Havener acknowledges that decreased demand for industrial space could impact EastGroup's growth, he's hesitant to be too gloomy. "The company does development in small steps, and they're not taking any big bets. So it's hard to say that development is going to hurt them," he says.

Hoster says that EastGroup's dividend is completely covered by rental income, unlike many REITs that derive significant revenues from non-rent sources. While many REITs are pursuing the asset management model, EastGroup doesn't develop or manage properties for third parties.

"EastGroup has such low leverage that it doesn't need to bring in extra cash through fees," Adornato says, noting that the REIT's ratio of debt to market capitalization is 25.5 percent.

In fact, capital availability doesn't rank as one of EastGroup's biggest challenges: finding new development and acquisition opportunities is what occupies most of Hoster's time. "Because of our size, we don't have to invest millions to move the needle for our shareholders," he says.