Rexford Industrial Realty, Inc. (REXR) Earnings Call Transcript & Summary

This webcast presentation is for Bank of America clients only. If you are a member or representative of the press or media, please disconnect now. And now I'd like to turn the call over to Elvis Rodriguez.

Thank you, Sarah, and good afternoon to those joining us from the East Coast, and good morning to everyone else. This is Elvis Rodriguez, office and industrial analyst on BofA's U.S. REIT team. I am joined today by Alex Pernokas on our team and we would want to welcome you all to BofA's Global Real Estate Virtual Roundtable Discussion with the senior management team from Rexford. Rexford is focused on creating value by investing and operating industrial properties located in Southern California's infill markets. Rexford owns 234 properties for approximately 28 million of rentable square feet and manages another 20 properties with approximately 1 million of principal square feet. Joining us today from the Rexford team are Michael Frankel, Co-CEO; Howard Schwimmer, Co-CEO; Laura Clark, CFO; and David Lanzer, General Counsel. We have a large global audience joining us today, so management will spend the first 5, 10 minutes of our discussion, providing an introduction to the company and an update on operating conditions. We will then move to Q&A. We hope to make this as interactive as possible, so please ask your questions on the Veracast platform so we can weave them into the discussion. I would now like to turn the discussion over to Michael to get us started. Michael?

Thank you, Elvis. And on behalf of Rexford Industrial and our entire team, many thanks to BAML for facilitating today's roundtable, and thank you all for joining today. We hope you and your families are well during these challenging times. Rexford Industrial is the nation's third largest and fastest-growing logistics REIT. We are an investment-grade S&P 400 company with an equity market cap of about $6 billion. Perhaps our greatest differentiator is our sector-leading performance. This starts with earnings growth, dividend growth and total shareholder returns that has consistently been the highest of any logistics REIT listed in the United States, where they're looking back 3, 5 or 7 years. By way of indication, over the prior 3 years, our FFO growth has averaged about 35% per year, our FFO per share growth has averaged 12.5% per year despite maintaining the lowest leverage of any industrial REIT, and our total shareholder return has also substantially led the pack by returning about 300% to stockholders over the prior 7 years. Our infill Southern California focus and our value creation-oriented business model are also key differentiators. Our target infill Southern California industrial market represents the largest, strongest and most supply-constrained logistics market in the country. We are currently experiencing peak levels of tenant demand, and e-commerce continues to represent an increasing demand driver. Despite robust and growing tenant demand, supply growth within our infill markets is virtually impossible, and we see an ongoing incurable supply demand imbalance into future periods. In fact, supply is generally diminishing over time due to the conversion of existing industrial product to other nonindustrial uses. Our 28 million square foot industrial portfolio represents an exceptionally high-quality portfolio, principally serving warehouse and distribution-oriented uses. We are 100% located within prime infill Southern California submarket, and we're positioned to outcompete within our submarkets due to superior functionality, locations and management. These unique market and company fundamentals represent some of the reasons we elect to remain focused on creating value within infill Southern California, where we continue to see a substantial growth opportunity ahead, and where we believe we are positioned more strongly than ever to continue to deliver sector-leading performance into the foreseeable future. And with that, I'll turn it over to Howard.

Thanks, Michael, and welcome, everyone. With concern around the pandemic, I'll begin with some brief comments on market conditions. We've experienced a dramatic acceleration in tenant demand starting in June with both tenant demand reentering the market as well as new demand from a range of sectors, notably distribution and e-commerce-oriented tenants. Port volume is also indicating signs of recovery with loaded containers arriving into the U.S. last month, up 6% year-over-year and August data for the LA Long Beach port complex showing a 15.8% year-over-year increase. Our target infill southern California industrial markets continue to operate at historically high occupancy levels approaching 98%. Turning to an update on our portfolio. Our performance reflects the favorable market backdrop as well as our team's highly entrepreneurial approach to asset management. Our third quarter leasing activity is up significantly, with almost 40% more leasing volumes so far this quarter on a year-over-year comparison. Leasing spreads remain strong and are tracking at near pre-COVID levels. Net absorption so far is approaching 400,000 square feet for the quarter with potential for further gains. Our value-add construction projects are fully on track despite nominal delays caused by city and permitting processing during COVID. During the quarter, we stabilized 4 of our repositioning projects, totaling 345,000 square feet as an aggregate unlevered yield on total cost of 5.8%. With regard to our external growth, we are operating in high gear. We are approaching $1.5 billion in acquisitions over the prior 18 months with over $350 million closed this year during the pandemic. Our research-driven proprietary originations process continues to differentiate Rexford in our ability to enable a high-volume of off-market and lightly marketed transactions, which translates directly to differentiated higher cash yields, greater cash flow and value growth as compared to typical institutional or core returns. In fact, over 80% of this and last year's transactions were completed through off-market or lightly marketed transactions. Our pipeline of new acquisitions continues to be robust with over $200 million under contract or LOI, with a healthy pipeline of emerging opportunities into the foreseeable future. I'll turn it over to Laura now.

Thanks, Howard, and good afternoon, everyone. It is so good to be a Rexford veteran already. I am so excited to join this Rexford team due to its unique and consistent business model, high-quality portfolio, expansive growth opportunities and top-notch team, with a strong culture of innovation and collaboration. I am very eager to help take Rexford's great platform to its next level of growth, cementing a scalable platform to support our growth objectives while enhancing value creation for our shareholders. I really look forward to continuing and building upon Rexford's foundation of disciplined investing and best-in-class balance sheet execution. Rexford's fortress balance sheet and strong liquidity have positioned us for offense and ready us for defense, with the lowest leverage in the industrial REIT sector, ending the prior quarter at 2.9x net debt to EBITDA, equating to approximately 10% debt to enterprise value with over $1 billion in total liquidity. As the effects of the pandemic are top of mind, I would like to provide an update on COVID-related impacts. You can find further details in our recently published investor presentation, which is available on the Investor Relations section of our website. We saw a healthy increase in cash rate collections in July and August, both coming in at 96% compared to 87% in Q2, and now sit at pre-COVID levels. We are especially pleased with July and August cash collections given the COVID-related reclosures experienced in July and August, coupled with the fact that nearly all deferments were already burned off. September collections are strong, essentially tracking at pre-COVID levels, though we are still early in this month cycle. David will discuss the proactive approach we took around deferment at the beginning of the COVID pandemic. But through August, we have executed $4.5 million as deferments with an average deferral period of 1.5 months, with the majority of the repayments expected to occur in Q4. In the face of the multiple headwinds our tenants have experienced over the previous months, Rexford's strong collections and overall operating performance is truly a reflection of the superior credit quality and resiliency of our outstanding tenant base. David?

Thanks, Laura. Turning to the legal backdrop due to COVID. In March, the state and many municipalities in California enact orders protecting commercial tenants from eviction and creating tenants' rights to defer rent. However, within the last few weeks, we've seen some positive changes from the landlord perspective. First, the California Judicial Council, which establishes the court rules, reopened the course for commercial evictions. Additionally, on the final days of the California legislative session, the state enacted a residential-only eviction and rent deferment law. The good news for commercial landlords is the law was residential-only not commercial. Governor Newsom's March emergency order, which opened the floodgates to local eviction moratoria and rent deferment orders is set to expire September 30. When the governor first issued the emergency order, it was under the premise of giving the California legislature time to act. Given that the legislature did act, and the act only applies to residential tenants, we're hopeful that the governor's order will expire in September and no longer apply to commercial leases. With that backdrop, since March, we had our work to do in the face of over 45 local orders we actively track, with a typical city giving tenants the unilateral right to defer rent up to 6 months and then repay the deferred rent over periods of up to 12 months. We quickly identified our leverage points to proactively structure rent deferment agreements with much better terms than tenants might have otherwise realized have they utilized local orders. Our leverage points included clawback of lease inducements previously granted, such as upfront rent abatement and tenant improvement allowances, loss of future scheduled rent abatement and allowances, loss of renewal and expansion options, helping focus tenants on their ability to maximize CARES Act loans and loan forgiveness and the fact that tenants have few other options for space in our markets. Available functional space is so scarce within most of our submarkets that tenants are highly motivated to work with us to ensure their long-term occupancy needs can be retained within our properties. As Laura noted, our proactive rent deferment agreements achieved significantly better terms than the local municipal deferment orders would have otherwise allowed. Due to these proactive efforts, the majority of our rent deferments were only 1 to 2 months, with most of those being repaid during 2020. And with that, I will turn it over to Elvis and your audience for any questions you might have.

Thanks, David. Maybe we can just start with like a high-level question. Just within the real estate industry, the industrial asset class has held up fairly well through the pandemic. Can you give us an update on sort of Rexford's positioning in Los Angeles? And any current thoughts that you have, whether positive or negative on how the pandemic has helped your operations?

Maybe just briefly, I'll give an overview, and maybe Howard can then drill down a little bit on what we're seeing on the ground as well. But it's true, the industrial sector has held up relatively well among asset -- real estate asset classes. But infill Southern California is really in a class by itself in terms of market fundamentals and overall tenant quality and resilience. There's [indiscernible] infill Southern California, where we truly have the supply/demand imbalance that is incurable. There is no other market of this size or nearly the size that has these types of fundamentals. And furthermore, I think one thing that you asked about the pandemic and clearly, the pandemic has driven an increase in the range of goods and the range of customers now transacting through e-commerce. So it's helped to accelerate e-commerce adoption across the board. And infill Southern California is the largest zone of consumption in the country. By definition, we will benefit from growth in e-commerce like no other market in the nation. So I think there are a range of things that differentiate infill Southern California as compared to any other market in the country. Howard, do you want to elaborate a little bit in terms of the intensity of tenant demand we're seeing today that further differentiates us?

Yes, I can certainly do that. The type of tenants and the velocity really surprised us. In June, the market just took off again. And it hasn't slowed down at all. I think the best way to describe, really what we're seeing on the ground is, at least from Rexford's perspective, is that if you didn't even know about COVID, you would think we're operating in pretty normal times and having a great quarter. The market is really firing on all cylinders. We're not just seeing demand from e-commerce or COVID-related business growth. It's really a lot of pent-up demand from a multitude of different industries in Southern California, including the obvious 3PL type growth, which is tied in a lot with some of the e-commerce, but aerospace, auto parts, computer equipment supplies and a multitude of other uses. And really, as far as the market, I think I might mention also on the availability of supply. There were some slowdowns, I think, in construction starts, mainly in the Eastern Inland Empire, where Rexford is not a player, but we have a de minimis amount construction activity in the greater Los Angeles, or rather, greater LA markets and really the entirety of the infill markets, which approach about 1.8 billion square feet. Most of that construction is really just replacing older supply. We have no more land. So there's really no notion of adding supply to the markets. It's really maybe changing out some of the older stock of product and creating better functioning real estate. So yes, it's an interesting time for us, and we're really excited about what we're seeing here on the ground.

Thanks for that -- I mean great comments there. I think one of the biggest concern that investors have had is that Rexford portfolio and infill assets, in particular, tend to have smaller, less creditworthy tenants, which may face a greater hardship as they might have throughout the pandemic, but clearly are now starting to pay rent again as compared to larger cap tenants. Given your portfolios use these smaller and medium type tenants, can you talk about how the resiliency of these tenants and maybe some of the overall risk that you may see or foresee near-term and long-term to the portfolio?

Yes. No, that's a terrific question. Thank you. And I think nothing could be further from the truth. I think if you look at the simplistic lens of the small tenants must be suffering more than large tenants, maybe that's true on some global scale, depending upon how you look at it, but it is certainly not the case with respect to infill Southern California tenants relative to any other tenant base in the country, large or small. And I think that's been proven through prior cycles, including the great financial crisis, and it's continuing to be proven through this cycle. And just briefly, it's kind of ironic because we did hear some of that sentiment in the marketplace as we entered the pandemic. And as we work through the pandemic, I think everybody on this call probably saw notices every week of numerous bankruptcies throughout the country. And those are national companies, national retailers, national companies. We saw a lot of bankruptcies. But frankly, within our portfolio, and we have about 1,500-some-odd tenants, I think throughout the entire pandemic, we received notice of one bankruptcy. And again, similar patterns that we saw during the great financial crisis. And I think the bigger issue for our tenants and the bigger driver of collections, and collections in our portfolio tracked very closely to our industrial peers who have national footprint, maybe we're a couple of basis points here or there, a little lower. And I think the driver of that delta, although it was de minimis, was frankly not the pandemic itself. Rather, it was the unique circumstances in infill Southern California for our local municipalities, as David described, gave our tenants the unilateral ability to defer rent. And we know because we know and understand many of our tenant circumstances. We know that there were tenants who simply took advantage of those new found right to defer rent. And they were -- despite the fact that they were very healthy financially, had very deep balance sheet and were fully capable of paying rent. And so I think the key driver of any delta in terms of collections was really driven by our tenants' ability to defer rent, which was unique in California. And frankly, if we look at the collections numbers, where we're at today and where they've come through July, August and September, I think it really validates those points. And I think that, to your question, Elvis, it really goes to the nature of our tenants. And what's different about our tenants compared to, say, a lot of national tenants that are focused more on global logistics, is that if our tenants can't operate within our space, within our infill markets, then they cannot operate their business. Meaning our spaces, on average, are truly mission-critical to our tenants. Therefore, they are sticky because they have to be sticky. And by the way, infill Southern California is the most expensive operating environment in the country and has been for many decades. And to give you a sense of it, rental rates alone are over 80% higher in infill Southern California than the average of the next 5 or 10 best markets in the country. And that's also reflective of the superior fundamentals here in Southern California. So if these tenants could operate in other locations or didn't need their space, they probably moved out of the region decades ago, frankly. And I think that it's just one of the things that makes this market the strongest and the best in the country. And one of the many reasons we stay focused here. So I think that those are the proper ways or the proper lens to think about tenant quality, tenant resilience. And frankly, we believe that in the aggregate, we've got the best credit that you can find in the entire industrial sector.

Great. And then one of the things that's come out of the split role measure that's going to be on the November ballot or Prop 15, is that it could potentially impact smaller tenants more. Can you just update us on what you're seeing on the ground and maybe conversations with tenants of what they're thinking if this ballot were to pass?

Yes. And Laura actually has done a fairly deep dive on this. Laura, would you mind to maybe give a little of your thoughts? And also relative to like whether the impacts are for small tenants versus large tenants?

Yes, absolutely. So if approved in November, just a little background here, November is on the ballot for Prop 13, would result in separate tax rules for commercial and residential owners. That's the split role, overturning Prop 13 as we all know it. As a reminder, Prop 13 caps property taxes and best values increases at the time of purchase. So that benefits those owners who hold properties for a longer period of time. So we believe that Rexford's portfolio is better positioned than most from the passage of Prop 15. With the majority of the portfolio, as you know, has been acquired over the past few years. So our average reassess here for the entire portfolio is 2016. So that means that those -- the majority of our properties the tax basis has already stepped up. And importantly, approximately 97% of our leases allow for the recovery of the Prop 15-related tax increases. So to your question around the impact to our tenants, the vast majority of our tenants have already been paying a stepped-up basis in taxes. So we -- although our leases do allow for the passthrough, we are in a different -- I'd say, we're in a different playing field than some of the other property owners in our region that have maybe owned their properties for a longer period of time. And so when we look at our estimated impact to a Prop 15 implementation, it's less than $0.01 per share on an FFO basis annually. I will note, though, that we do see some potential incremental benefits to Rexford if Prop 15 were to pass. We do believe that it could level the playing ground from a leasing perspective. When you think about all-in occupancy cost, those owners that have owned their properties for a long period of time, there's a lower all-in occupancy cost from a tax standpoint and many times from lower rent. And those property owners have, by and large, not put in the capital investment to their properties as well. So when those properties receive a stepped-up basis, and the all-in occupancy cost increases for those tenants, our Rexford space are much more higher quality, better functional space is certainly going to be a competitive advantage for us. And we also think that there could -- that the passage of Prop 15 could also trigger additional investment opportunities as well as those property owners aren't able to or don't have a willingness to invest that needed capital. So we're keenly aware that Prop 15 will result -- could result in an increase in all-in occupancy cost for tenants and could impact overall market rent growth. But as you've heard us talk about, on the call today already, there is an extreme ongoing supply/demand imbalance within our market. And we believe that, that will mitigate any impact to the rent growth dynamics.

Thanks, Laura. That's very helpful and good information. Just -- I know on the presentation you released yesterday, you had your rent collection numbers in both July and August are at, call it, pre-COVID levels now. Perhaps if you could walk us through the disclosure you shared, but in particular, perhaps add to what you're seeing for September and then, is the speed of collection getting better? So are you receiving payments perhaps more in the first 10 days of the month as opposed throughout the full month as you have in these prior months?

Yes, I'll take that one as well, Elvis. Yes, we are -- as we mentioned in our prepared remarks, we're really encouraged by the increase in collections. And I think important to note that, that increase in collections is after these deferments have burned off. So those tenants receive, there are 1 to 2 months of deferments and then have been able to pick back up and start paying their full rent payments again. So I think that's extremely encouraging. When we look at September collections, and if we look at the same point in the month of July and August, September is trending ahead at the same point in time. So again, really encouraging payment trends. And I think that matches the environment that Michael and Howard described that we're seeing on the ground.

Great. And then are you receiving any new deferral requests from tenants? Or would you say that most of it was in March and April?

At this point, it's really de minimis. I would say that we're really focused now and our property management teams are in constant communication with our tenants, is around our Q4 deferment payments that are coming due. So we have, as I mentioned in my remarks, we deferred about $4.5 million of base rent in the second quarter. And of that $4.5 million, about $3.5 million of that is due in Q4, so we are keenly focused on the collection of those deferrals. We've had very, very little deferrals that have been due to this point, I'd say, only about $100,000. And I can say that we've collected 100% of the deferrals that have been due to this point. But really, October and November and December is when the vast majority of that comes due.

And Elvis, if you were asking if we're having ongoing requests for deferment, that's not happening.

Right. Okay. Great. Howard, you talked about development or more like redevelopment of your assets and in your submarkets, and we also had a question coming from an investor asking if you could talk about the -- how is your pipeline structured in terms of spec versus potentially before you even decide to do a redevelopment, you get a build-to-suit lease or something like that? Any sort of acquisitions that you may think about doing with any potential build-to-suit or tenant needs in mind? Anything you can share around that could be helpful.

Absolutely. First of all, the Southern California market, in terms of the infill areas, functions much differently than the way people think of development in other markets around the country that are not land constrained. So when you're operating in a marketplace that literally has no land and occasionally has some development, all that development is done on a speculative basis. And what we see, though, happening on these developments, whether they're Rexford or other developers in the market, is that the majority of them tend to lease up either before they're completed or very quickly after completion. And so we've always functioned that way in the infill market. That's nothing new. And so people -- there's no thought process going forward, should be -- we wait to lease something before we break ground. The demand seems to be more immediate in terms of tenant needs in the marketplace. And so tenants generally have focused on buildings that are available and move-in ready. And that's why we've had an uptick in our new leasing, frankly, for the third quarter, is due to COVID, there's been an extreme focus on vacant move-in ready space because people haven't been too eager to go into spaces occupied by other tenants. More of those tenants really wanted to roll out the red carpet to allow people in to tour their space. So really, vacant space is where all the activity is in the market. And the fast pace in leasing is really just the norm here.