Rexford Industrial Realty, Inc. (NYSE:REXR) Q3 2023 Earnings Call Transcript

Rexford Industrial Realty, Inc. (NYSE:REXR) Q3 2023 Earnings Call Transcript October 19, 2023

Operator: Greetings and welcome to Rexford Industrial Realty, Inc. Third Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce David Lanzer, General Counsel. Thank you. You may begin.

David Lanzer : We thank you for joining Rexford Industrial’s third quarter 2023 earnings conference call. In addition to the press release distributed yesterday after market close, we posted a supplemental package and investor presentation in the Investor Relations section on our website at rexfordindustrial.com. On today’s call, management’s remarks and answers to your questions may contain forward-looking statements as defined by federal securities laws. Forward-looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ. For more information about these risk factors, please review our 10-K and other SEC filings. Rexford Industrial assumes no obligation to update any forward-looking statements in the future.

Additionally, certain financial information presented on this call represents non-GAAP financial measures. Our earnings release and supplemental package present GAAP reconciliations and explanations of why such non-GAAP financial measures are useful to investors. Today’s conference call is hosted by Rexford Industrial’s Co-Chief Executive Officers, Michael Frankel and Howard Schwimmer; together with Chief Financial Officer, Laura Clark. They will make some prepared remarks, and then we will open the call for your questions. Now I turn the call over to Michael.

Michael Frankel: Thank you, David, and welcome, everyone, to Rexford Industrial’s third quarter earnings call. I’ll begin with a few remarks, followed by Howard, who will provide some additional market operational color, then Laura will provide more detail related to our performance and financial results. To begin with, I’d like to thank our Rexford team for delivering a strong quarter across all of our value creation initiatives. Compared to the prior year quarter, our team grew FFO by 33% and grew FFO per share by 12%, driven by strong same property pool average occupancy of 97.8%, exceptional leasing spreads of 65% on a GAAP basis and 51% on a cash basis as well as the substantial cash flow per share growth generated from our investments completed over the prior year.

Tenant demand within our infill Southern California industrial markets continues to demonstrate resilience with market occupancy hovering around 98%, roughly equating to the 2019 market occupancy levels immediately preceding the pandemic. As expected, we continue to see market rent growth normalizing from the unprecedented growth we experienced during the pandemic. With regard to our Rexford portfolio, providing high-quality prime locations within our submarkets, we continue to experience healthy diverse tenant demand as reflected in our strong operating metrics. Although general economic conditions remain uncertain, Rexford remains well positioned. The company is currently situated with an estimated 33% embedded cash NOI growth within our existing portfolio, realizable over the next two years, assuming today’s rents.

Our largest of NOI growth derives from our repositioning and redevelopment work, which we continue to grow as we mine our in-place portfolio for incremental value creation opportunities. And as we layer in new investments, that are delivering strong levels of FFO per share accretion. Looking forward, as markets nationwide normalize towards their post-pandemic levels of equilibrium and supply, we believe Rexford’s entrepreneurial asset management, repositioning and value-add investing programs will enable the company to further differentiate our performance and FFO per share growth. We also believe over the near term, that the favorable supply-demand dynamics associated with our infill Southern California industrial markets will continue to drive the strongest tenant demand fundamentals of any major market in the nation.

Further supporting Rexford’s favorable outlook, we remain focused on maintaining our investment grade, low leverage balance sheet ending the quarter at 16.7% net debt to total enterprise value, which provides the ability to both protect the company during uncertain times while also positioning Rexford capitalized upon accretive investment opportunities as they may arise. With that, I’d like to acknowledge our Rexford team once again for your market-leading efforts that continue to differentiate Rexford’s performance. And now it’s my pleasure to hand the call over to Howard.

Howard Schwimmer: Thank you, Michael, and thank you, everyone, for joining us today. Rexford concluded the third quarter with strong results, driven by a high-quality portfolio and execution of value creation initiatives. With regard to market conditions, infill Southern California continues to demonstrate superior long-term demand fundamentals with a virtually incurable supply-demand imbalance. According to CBRE, in the third quarter, infill Southern California markets experienced 2.6 million square feet of positive net absorption. The infill Southern California market continues to outperform with vacancy at 2.2%, the lowest vacancy in the nation. The sequential 30 basis point vacancy increase compares favorably to an average increase of 70 basis points for the other major U.S. markets.

Also, supply risk continues to be substantially lower for infill Southern California compared to the nation’s other major markets. Core traffic may also be on track towards normalization following the resolution of the dockworkers contract with the most recent L.A./Long Beach port activity, reflecting a 20% increase month-over-month and the second highest volumes in the past 12 months. While in contrast, the East and Gulf Coast ports experienced a decrease in activity. Turning to the Rexford portfolio. Third quarter performance continues to demonstrate our favorable position within the infill Southern California market. Our team executed 1.5 million square feet of lease activity, driving 100 basis points of positive net absorption and highlighting the sustained demand for our highly functional portfolio.

Annual embedded rent steps in our executed leases increased to 4.3%, demonstrating our tenants’ ability to pay increasing rent for their mission-critical locations. In regard to market rents, we observed 3% year-over-year market rent growth for highly functional product comparable and quality to the Rexford portfolio impacted by a 1% sequential decline quarter-over-quarter. Interestingly, the 1% decline was principally driven by larger buildings. Turning to our investment activity in the quarter. We closed 6 transactions for a total of $315 million bringing year-to-date investment activity to approximately $1.2 billion. Our third quarter investment collectively generates an initial yield of 5.2%, a projected unlevered stabilized yield of 6% on total cost.

In addition, we currently have a pipeline of approximately $400 million of highly accretive investments under contract or accepted offer. This includes the imminent closing of $245 million of investments in the San Gabriel Valley submarket that has an aggregate 6.8% initial yield. This pipeline, including the imminent transaction is subject to customer closing conditions. With regard to our robust internal growth initiatives, we have approximately 4 million square feet of value-add repositioning and redevelopments in process or projected to start within the next 24 months. These projects are expected to deliver an aggregate unlevered yield on total cost of 6.4% and representing an estimated $500 million of value creation. Lastly, I’d like to thank our entrepreneurial Rexford team for their dedication and for delivering on another strong quarter.

I will now turn the call over to Laura to discuss our financial results.

Laura Clark: Thank you, Howard, and thank you to our incredible Rexford team. Your exceptional performance and value creation focus continues to differentiate Rexford. In the third quarter, core FFO per share grew 12% over the prior year quarter, driven by same-property NOI growth of 9.5% on a cash basis and 8.9% on a GAAP basis. Third quarter leasing spreads outperformed projections and year-to-date leasing spreads are 62% and 82% on a cash and GAAP basis, respectively. The portfolio is positioned for significant internal cash NOI growth into the foreseeable future. Just considering the next two years, value-add repositioning and redevelopment representing our largest driver of growth, are projected to contribute $71 million of incremental NOI.

Annual embedded rent steps of 3.5% for the total portfolio are projected to contribute another $26 million. And acquisitions closed in the third quarter and fourth quarter, to date, contribute an incremental $28 million. In addition, the net effective portfolio mark-to-market is estimated at 56% representing $77 million of incremental NOI over the next two years. As we look further out, the conversion of the total portfolio net effect of mark-to-market equates to $350 million of incremental NOI growth equal to $1.70 per share of FFO contribution or 79% FFO per share growth. Now to our funding strategy and balance sheet. Our focus remains on internal and external investments that drive near- and long-term accretion and NAV growth. We continue to demonstrate a highly selective rigorous approach to capital allocation as reflected in our investments to date that are driving substantially higher accretion than our prior year investments, inclusive of today’s higher cost of capital.

We will continue to assess accretive capital sources to fund internal and external growth opportunities, including dispositions. Our sustained focus on maintaining a fortress balance sheet positions us to capitalize on our value-driven business strategy in the current environment. At quarter end, net debt-to-EBITDA is 3.7x and we have liquidity of $1.5 billion. This includes $83 million of cash on hand, full availability on our $1 billion revolver and approximately $450 million of forward equity remaining for settlement. Turning to guidance. We are increasing our 2023 core FFO per share guidance range to $2.16 to $2.18 per share, up from our previous guidance range of $2.13 to $2.16 per share. Our revised guidance range represents 11% year-over-year earnings growth at the midpoint.

Please note that our guidance range includes the imminent closing of the San Gabriel Valley transaction, Howard mentioned. No additional acquisitions, dispositions or related balance sheet activities that have not yet closed are included in our updated guidance range. Our projected 2023 cash and GAAP same property NOI growth remains unchanged at the midpoint compared to our prior guidance, and we have tightened our ranges to 9.75% to 10% on a cash basis and 8% to 8.25% on a GAAP basis. Average same-property occupancy for the full year is projected to be approximately 97.75%, unchanged at the midpoint compared to our prior guidance. Other assumptions in our same property guidance include full year cash and GAAP leasing spreads are now projected to be 60% to 65% and 75% to 80%, respectively, an increase of 500 basis points at the midpoint, driven by higher-than-expected third quarter executed leasing spreads.

And lastly, bad debt as a percent of revenue is expected to be approximately 35 basis points. in line with our prior guidance and below the historical average of 30 basis points, reflecting the continued health of our tenant base. Further guidance updates including a roll forward of our revised FFO per share guidance range can be found in our supplemental package. Finally, as part of Rexford’s continued commitment to creating value through a comprehensive ESGi approach, we are excited to announce our target to reach net zero greenhouse gas emissions by 2045, as well as near-term reduction targets. Our emission targets were validated by SBTi and are a testament to our focus on driving substantial internal value through our differentiated business model.

Thank you all for joining us today, and we now welcome your questions. Operator?

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Q&A Session

Operator: Thank you. Ladies and gentlemen, at this time, we’ll be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from the line of Camille Bonnel with Bank of America.

Camille Bonnel : Can you talk to the change in market net absorption, which turned positive this quarter? What is driven by any particular submarket. And given today’s economic outlook feel very different than it was 3 months ago? Do you expect this trend to continue?

Howard Schwimmer : Hi, Camille. It’s Howard. Nice to hear your voice. There was an uptick in absorption in the Inland Empire West submarket that was, I think, neatly responsible for a large amount of absorption.

Laura Clark: Hi, Camille. It’s Laura. I’ll talk a little bit about our portfolio as well. Howard mentioned the market change but our portfolio did experience an increase in absorption of about 434,000 square feet. That represents about 100 basis points. Importantly, we’ve experienced positive absorption within our portfolio every quarter this year, certainly outpacing the market and really demonstrating the differentiation of our portfolio in the market, which we’ve been discussing. In terms of select markets, we actually — if you dive into the absorption, we saw positive absorption in every one of our markets from Greater LA, i.e. West Orange County and San Diego.

Camille Bonnel : And it looks like some of the stabilization date in your redevelopment program were pushed out. What were the factors influencing this and how is your leasing pipeline tracking?

Laura Clark : I’ll take that, Camille. So in terms of timing pushes in terms of repositioning and redevelopment, there’s a couple of drivers there. One is around the permitting and approval process, which has continued to impact construction timing. The other is around timing of our lease-up. It’s certainly returning to more normalized levels. If you look back historically pre-COVID, lease-up timing upon completion of redevelopment was about 6 months. During the last few years, we saw that timing compressed pretty significantly given the friendly levels of demand. But as we look forward, currently up timing, we believe, will be more consistent with pre-COVID levels, which is around that 6-month area.

Camille Bonnel : And finally, can you please walk through the drivers behind the mark-to-market changes in your lease expiration schedule as well as the changes in cumulative FSR contribution. It’s driven by changes in the overall portfolio proposition. One hasn’t the lease expiration schedule remain relatively stable?

Laura Clark : Hi, Camille. Great question. And I think it’s important to walk through the various components that contribute to mark-to-market. First, we’re certainly excited to be able to capture the mark-to-market and convert that into FFO and cash flow. But as we’ve communicated in the past, the mark-to-market is going to decline, and that’s going to be driven by a number of factors. The first and really most significant is that the substantial embedded mark-to-market that we’re able to recognize today was driven by the incredible market rent growth that we saw since 2019, if you look back to the fourth quarter, market rents has grown 80%. So as we convert market — convert the mark-to-market in the cash flow and FFO unless market rent growth continued at those same levels, the mark-to-market is going to decline.

Second, mark-to-market is impacted by the leases that we’re signing and that conversion of the mark-to-market into FFO. And so if you look year-to-date, we’ve executed on an impressive leasing spreads, 5.4 million square feet of leasing, 82% GAAP spread, 62% cash spread. The conversion of mark-to-market represents an incremental $50 million of annualized NOI just this year alone through three quarters. The last real component that moves around the mark-to-market had impact is certainly the properties that move in and out of the pool. For example, when we move a property into repositioning or redevelopment, that property gets removed from the mark-to-market pool, and that value creation is now represented an accretive stabilized yields. Today, our repositions and redevelopments are generating 6.4% stabilized yields.