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

Hey, everybody. Thanks for joining us. Very happy to have the Rexford team here. My name is Jon Petersen. I cover Rexford. I'm the head of the REIT team here at Jefferies. Really happy to have Co-CEOs, Howard Schwimmer and Michael Frankel; as well as CFO, Laura Clark; and Head of IR, Kosta Karmaniolas. Did I get that right? I'm going to hand it over to Laura for some opening comments, and then we'll jump into some questions.

Thanks, Jon, and good afternoon, everyone. It's awesome to have you join us today, and we appreciate you spending time with Rexford. So before we jump in to Jon and your questions, I'll provide a quick overview of Rexford and our recent results. So for those of you that don't know us, Rexford is the third largest and fastest growing industrial REIT in the United States. We have an enterprise value of over $9 billion. We are singularly focused on infill Southern California, which is the nation's largest, most sought-after industrial property market, and it's also the fourth largest industrial market in the world. Infill Southern California has the highest occupancy among all U.S. industrial markets with a vacancy rate of 1.9%. We see substantial opportunity to accretively expand our 1.8% market share in infill Southern California, and that's really driven by our proprietary research-driven approach, which we're happy to get into more detail around on this call. And that has led to over 70% of our acquisitions sourced from off-market or lightly marketed transactions since 2013. Our portfolio is truly irreplaceable given the substantial barriers to entry, scarcity of supply, coupled with the relative functionality of our high-quality product compared to the market. We own over 32 million square feet. Our product is generally generic, high-demand industrial space occupied by a very diverse and high-quality tenant base. And we are truly passionate about ESG, and our differentiated business strategy ensures the positive impacts that we have on the environment and our communities. Our balance sheet remains a fundamental focus at Rexford. We have purposely constructed a low-leverage investment-grade balance sheet, and that has allowed us to be opportunistic across all phases of the capital cycle and is amongst the strongest in the entire REIT sector. We have significant liquidity of $1.2 billion today, debt-to-enterprise level of 13% and a very low net debt-to-EBITDA of 4x. Lastly, let me quickly highlight our recent activity and performance. So in 2020, we acquired $1.2 billion of properties, and year-to-date, we've added another $232 million. We do have another $525 million of acquisitions that are under contract or LOI as we continue to find -- really find significant opportunities to accretively grow our portfolio today. We had robust leasing activity of 6.3 million square feet in 2020. And in this first quarter, we leased another 2 million square feet, and that resulted in portfolio occupancy that's now sitting at 98.3%. In addition, re-leasing spreads continue to track at record levels. In the past quarter, they averaged 33% on a cash basis and 47% on a GAAP basis. And most importantly, we project an incremental $54 million of NOI growth or 18% over current levels from our in-place portfolio, assuming no further acquisitions over the next 18 to 24 months. So with that, Jon, I'll turn it back over to you.

Great. Thanks, Laura. Maybe just to kind of start with the market that you're in, the SoCal industrial market. It's been hot for many years in a row now. I guess can you talk about what the largest demand drivers are in the SoCal market and whether you see these factors changing at all going forward?

Thanks, Jon. I appreciate the question, and thank you for moderating today. And many thanks to everybody for joining us today. It's Michael Frankel, Co-CEO of Rexford. And obviously, it's a great question to start off with. And very briefly, key demand drivers today -- by the way, tenant demand is more intense today than we have ever seen it despite the pandemic, despite all other factors. And the demand drivers are very broad-based indeed in the sense that -- and I have to segment that into 2 areas. One are just the secular growth in demand among a range of business sectors, and those sectors are diverse. We're seeing a lot of demand -- incremental demand from consumer staples; consumer products; health care; pharmaceuticals; electric vehicles and all the entire ecosystem that goes into designing and all the components for the electric vehicle marketplace; aerospace and space technology, this is a center for that in the United States; and of course, the building trades. And the building trades, by the way, it's not just about the pandemic boom we've heard about in some of these neighborhoods. In California, for instance, the municipalities have a mandate to grow housing by 20%. That's not -- that doesn't happen in a year. That doesn't happen in 5 years. That takes time. And so we're seeing a substantial growth in that sector, which we believe is more medium and longer term as well. And then the other area of growth is really what we're seeing in terms of a fundamental shift in the distribution ecosystem, and I don't say just e-commerce. E-commerce is a part of that. And so you layer in on top of all that secular demand across those range of sectors, the impact of e-commerce. And not only do we have an acceleration in e-commerce adoption through the pandemic, but we have adoption from a segment of the population that would have never otherwise adopted, meaning a lot of elderly folks. And they're going to be sticky in terms of continuing to utilize e-commerce. And in addition, we have a structural shift within the distribution ecosystem as businesses large and small start to emulate certain aspects of, for instance, what Amazon is doing, and we'll go more into that later on. But suffice it to say that we're in the very early stages -- based on what we're seeing and based on what we're seeing large retailers doing like Walmart and Target, we're in the very early stages of e-commerce and last-mile distribution in terms of the shift -- a structural shift that is driving a dramatic increase in demand for even more local warehouse replenishment centers, which naturally drives right into demand for our last-mile portfolio.

Great. And then maybe if we just think about the last year with the pandemic. I mean, how has the pandemic impacted the warehouse market in Southern California? And then now that we're kind of shifting to the reopening phase, I mean, does that change any of the dynamics of what you've seen over the last year?

Thanks, Jon. This is Howard Schwimmer, for those that aren't watching on video. It was really interesting what we saw through the pandemic. Obviously, in the early stages, we saw a dramatic slowdown in activity, but it really quickly picked up in May and then into June. And literally, at this point, I think you can only describe activity is literally just blasting off. I mean we're at levels that we've never experienced before. During the pandemic, I think we might have been the only state in -- that really had this unilateral right to defer rent that tenants had through the moratoriums, and in spite of that, our product really performed exceptionally well. Only a small amount of our ABR was impacted through tenants not paying rent. And today, we've collected practically all of our deferred rent that was granted, which was actually a fairly small amount as well through the pandemic. And then, today, where we sit, as Michael mentioned, there's such a diversity of uses and industries. In Southern California, we're seeing strong demand from all those traditional businesses as well as the layering in of e-commerce and accelerating demand there. But I think what's really different really is back to that rent growth story. We looked at our own internal data year-over-year and really found that rents had grown about 10% in the infill markets. And the rent growth is really, I think, differentiated in Southern California versus throughout the rest of the country. There was a white paper that CBRE put out last year that put projections in place for all the larger industrial markets. And what was interesting is they projected the Greater Los Angeles, L.A. County markets to have about a 7.1% compound annual growth expectation over that 5-year period, and that compared to about the next, I think it was, 10 largest markets at about 2.9%. So we're talking about more than 2x greater rent growth being projected in our markets. And what we're seeing now also is not only are we seeing higher contract rents but we're seeing rent increases in leases that are much different. For many, many years, it was just accepted that you'd sign a lease, rents would grow by about 3% per annum. And we're now seeing rents increasing well above the 3% into the 4% range as well. We're seeing that it started in smaller spaces, and now pretty much every size category in the market has these outsized increases, and it is really through the entirety of our marketplace throughout all the markets in Southern California now. And so our biggest, I think, challenge going forward is really the lack of supply. We don't have any more land. Multistory, which we continually evaluate, really isn't viable in terms of being able to develop that product on the continually increasing land basis -- cost, rather, that we see here. And so we're really set up to continue with the outsized rent growth and the inability to introduce more supply.

Great. And then -- yes. So internal growth has obviously been really strong in your portfolio. You guys have always been -- also had this lane of growth through acquisitions and tend to increase your volumes year after year. I guess can you speak to how you source acquisition opportunities and maybe how being a Southern California-only company helps create some of those opportunities?

Yes, Jon. I'll take that. I'd say that our proprietary acquisition approach is definitely one of the elements that is -- that truly differentiates Rexford, and it is truly unique. And when we think about the uniqueness of our approach, I think it's really twofold, and the first is around a research-driven approach. So over the last 30 years, we've developed a very extensive database of properties, and that takes a long time to develop the database that we have. It includes what are -- what would be transaction-driven catalysts for nearly 200 million square feet of opportunities that we have identified and that we're actively monitoring and pursuing today. So those catalysts can be anything from generational shifts, capital needs, debt maturities, and we also maintain a very extensive list of master owners as well. And if we had more time, we'd pull it up on the screen and we'd show you our internal workflow system. It's really dynamic, and it's really cool. So hopefully, for those of you that haven't seen it, we'll be able to meet with you one day and show that to you. But what it really does is it shows you the volume of the opportunities in our markets and that we're tracking. Again, over 200 million square feet of opportunities that we're tracking today. So that internal workflow system is what tracks how often we're touching on these properties and creating those touch points, so what assets are we touching on a weekly basis, monthly basis, quarterly, et cetera, so next time, we'll jump into that workflow system. And then the second -- I mentioned our approach is really twofold. So versus the research-driven approach and then the thing is really around our extensive broker marketing, loyalty incentive program, really working alongside our robust Rexford acquisition team and gives us truly differentiated access in the market. So when you think about our proprietary approach and what is really a multi-decade research platform, that is our single best source of opportunities, and that platform continues to grow year after year. And that's what's enabled us to acquire -- since IPO, 70% of our investments have been off-market or lightly marketed transactions. And when I say that those opportunities continue to grow, I think you're seeing that in the activity and the acquisitions that we've acquired in the last few years. Last year, over 80% of our acquisitions were off-market or lightly marketed. And when you look at what we've acquired today, it's actually pushing 90%. So the model continues to produce more and more opportunities. And then the last thing that I'll touch on is -- I think another driver of acquisition opportunities for us here in Southern California is our ability to issue UPREIT units. And we've had a lot of great success in using UPREIT units to attract sellers, and these units offer tax protection to the seller and give the seller the opportunity to continue to invest in infill Southern California industrial market. So these are mostly owners that have been invested in infill Southern California for their entire career. And it's time -- they've made that decision that it's time to sell, but it gives them the ability to continue to invest here in a market that they believe in and that they know but, at the same time, to invest in Rexford. And they can see the appreciation and the total return from Rexford. And what's happened is the UPREIT units and transactions and the interest there has continued to grow as well. So if you look at our transactions last year, we closed on $1.2 billion, and nearly 1/3 were executed through UPREIT. So we're seeing this as a growing competitive advantage as well in our markets.

Great. And then I wanted to touch on cap rates. So they seem to continue to fall across the country, especially in Southern California. Cap rates that start with a 3 seem to be becoming very common. I guess where do you think cap rates go from here? And then interesting to transition maybe to what sort of IRRs you guys underwrite to and how we should think about going-in cap rates versus your long-term return potential.

Yes. Maybe I can start with the cap rates and then pass it off to Howard and Michael for the IRRs. But it's interesting, Jon, that you're talking about the 3s, and I remember when cap rates in the South Bay hit 4s a few years back and said -- and everyone said, "It can't get much lower than this." Here we are talking about 3s now. A few things to keep in mind. Cap rates have always been lower in Southern California, and I think that's evident by the fact that we have the best market rent growth in this area. And in fact, market rent growth has accelerated, I think, much faster than cap rates have compressed. You heard Howard talk a little bit about the CBRE forecast a few moments ago, that the next 5 years, infill Southern California is projected to grow at 2x the national average. So I think that is pretty telling. And then the other factor is the lack of supply. Not only is there no developable land where we operate. In fact, if you go back the last 20 years, we've actually lost about 100 million square feet of industrial product because it's been converted to other asset classes, right? So that's maybe my long-winded way of saying -- could cap rates go lower? Probably. Everyone that's called the bottom in the last few years has obviously been very wrong. But maybe I'll leave you with this point before I turn it over on the IRR, and Laura touched on this so I won't go into a lot of detail. But keep in mind, Rexford is not a cap rate buyer. We have that proprietary research-driven acquisition model that we've compiled over decades, and we can source deals that -- these off-market and lightly marketed deals that in the end, the yields that we're transacting at are well in excess of market cap rates. So maybe that's a good segue into the IRR discussion.

Thanks for that. And I'll take the IRR question. IRRs are interesting because, in many ways, they are a great indicator; in many ways, they are synthetic because they're subject to such key variables, primarily, in our case, market rent growth and exit cap rates. And so one team's IRR can be very different than another team's IRR just because of the assumptions that go into it. And so a couple of things on our assumptions. One, we're very conservative in our market rent growth assumptions, so we are not projecting anything close to what we're seeing in the market. Today, we've been seeing about 10% market rent growth. By comparison, our acquisition models are projecting, if it's the right asset, the right situation, maybe 5% the first year, then moderating to 3% years thereafter. And on exit cap rates, we do hear from a lot of other management teams and acquisition teams, and oftentimes, you'll see teams that are underwriting with an exit cap rate equal to where the market cap rates are when they buy the asset. So let's just say market cap rates in Southern California today on a quality marketed product are 4% or even below 4%. You'll see in many of those models an exit cap rate of 4% or even below 4%. So at Rexford, we're probably about 100, 150 basis points actually cap rate decompression on our exit as compared to our entry cap rate. And those 2 factors have a dramatic impact on IRR. So just to give you an example, a 5% IRR for Rexford might be a 6% or 7% IRR for somebody else. I mean that's not dramatic. When you have those 2 math factors working in concert, it has an exponential impact on your IRRs. And so with that background, how we think about IRRs is a couple of things. One, we're buying a basket of assets, and call it, 75% of what we buy in infill industrial fit into that core-plus orientation, where we're generating cash yields in excess of 5% on a stabilized basis. And then maybe 25%, 30% have a stronger value-add component, where we're driving cash flow yields much greater than 5%, as high as 7% and sometimes 8% unlevered cash yields. And then we'll buy some core products, maybe 25%, 30%, which has a little bit lower yield, maybe a little -- sub 5%, north of 4%. And on an IRR basis, when you blend it all together and put it all together in the mix, we're solving for materially above 5% IRRs overall based on that conservative underwriting.

Got it. Okay. That's helpful. And then this is more academic, but just curious how you weigh the quality, like the physical quality of a warehouse versus the strength of the location. Like which one -- where are you willing to pay more money, the clean shiny building or the one that's in the best location?

Yes. I like that question. It is thought-provoking. Our strategy has always been, in the infill markets, to focus on the best locations. Coincidentally, the best locations were typically developed first versus some of the other product in these markets. But I think you really have to define the definition a little bit differently, and it applies -- it can be applied differently in each of the different submarkets. Because, for instance, if you're in the Inland Empire West, which we own a large portfolio in and that's considered to be an infill market, that market is newer product for the most part. So we won't own the best product in that marketplace. And in that market, if you're going to own a 100,000-foot building, you really don't want to own a 20-foot clear building, right? That building could almost be considered obsolete at this point. Take the inverse of that. Go to the South Bay, which is the lowest vacancy rate market in Southern California, and put that 20-foot clear building over there. And you'd love to own a portfolio chockful of that type of product because what's driving the market over there is not clear height. It's the amount of loading doors and excess land for container parking. So you'd be happy to own a building that has even lower clearance than that 20-foot example in that South Bay marketplace. And in that market, location and quality of building are less important. It's really more about the quality of what you're delivering. So our strategy, as I mentioned, is to own not just the best locations but own the best quality product in those locations. So we go in and proactively renovate and modernize these assets that we buy to unlock that value potential in them and modify them so that we're delivering the right product in that market. So you've seen us deliver, in some of these South Bay or port-centric type markets, product where we might even tear down a portion of the building so that we can increase the amount and the functionality of the loading. We'll go ahead and upgrade the fire sprinkler systems in some of these older buildings so that even if it might have 20- or 22-foot clearance, a lot of times, the fire suppression system won't allow you to stack product more than 12 feet high in the buildings. And we, of course, go in and modernize and create high-quality office -- generic-type office components and so forth. And so we really have now adapted those buildings to unlock the value to meet the demand that we see as the highest amount of emerging demand in the markets. But occasionally, you'll be able to buy the best location and the highest quality product. Last year, we brought -- we bought about 1 million square foot project in the Mid-Counties market called Gateway Pointe. And it had 32-foot clear ESFR, an overabundance of truck loading and container parking, and we paid up for it. And we looked at where land values were going. We looked at those replacement costs, and we saw that on the near horizon, we weren't going to be too far off on what we paid up. We paid $300 a square foot for that project. And flash-forward, literally, I think, 6 months, 8 months, we're seeing replacement costs now starting to approach that cost we paid. We're hearing that the next jump in values is going to be toward $400 a square foot. So we're going to quickly be seeing a lot of product transacting further from the port area north of $300 a square foot. We've already seen multiple transactions and a lot more to come in the port markets that are well over $300 a square foot. So sometimes, paying up when you see the quality of the product and the location and you have the ability to roll those leases in the near term, you're going to be able to stabilize at rents that might be even higher than you projected in your underwriting. And we've seen that play out time and again. So hopefully that didn't give rise to even more questions, but I think that wraps a little bit of our thinking around the question, Jon.

All right. Great.

Jon, just to add a little to that. I think as a reminder to the audience, we are in a great position because the only market we focus on is infill Southern California. So that entire market is the best market in the nation, maybe the world, by many measures. And so -- and we're focusing on the best locations within that market. And so we don't really have to make a big trade, location versus functionality. We are only focused on the best market in the nation.

Makes sense. All right. We've got about 3 minutes, so I'll make my last couple of questions really good. So I want to make sure we touch on inflation and maybe quickly, what impact that is having on Rexford's business. It's having impacts everywhere. Maybe I'll just kind of leave it open ended. What impacts do you think inflation is having?

I'll go with that one, and I'll go very quickly so we can get to some more. I think Jon, what you're seeing with inflation is, right now, it doesn't appear to be permanent. It's really related to pent-up demand and low inventory of goods. In other words, it's consumption related, which is good for our business. I think -- just thinking about it from another aspect. We're not in a stagflation-type environment. There appears no risk of that happening. So I don't think you'll see cap rates expand, which was kind of the opposite question that you asked earlier, right? There's no near-term pressure to raise interest rates. I think at the end of the day, the inflation that we're seeing is ultimately good for our business in that we're going to see more consumption come out of it. Maybe just the last point there is, keep in mind, with respect to our portfolio, more than 95% of it has an annual rent escalator of 3% or higher. So our cash flow is pretty much protected from that. I mean the U.S. hasn't seen that level of inflation in decades. But interestingly enough, year-to-date, about 35% of the leases that we have signed have seen rent escalators between 3% and 4%, and we're starting to have those -- more conversations with that formula.

All right. Last question to Laura on the balance sheet. You guys have kept leverage fairly low. You're about 4x debt-to-EBITDA in the most recent quarter. Maybe talk about your leverage strategy and maybe how it changes based off your stock price. I was looking. I think you're at a 52-week high right now. So how does that factor into leverage?

Yes. I mean, I think, Jon, great question. And we're clearly really focused on continuing to maintain a low leverage balance sheet through all parts of the capital cycle, so through the ups and downs, which will really truly position us to be able to take advantage of opportunities and to be opportunistic. It doesn't take much disruption to send leverage higher, so I think managing the balance sheet in a prudent way and maintaining that low leverage is really critical through all phases of the capital cycle. And I think it gives us the opportunity to be opportunistic when the capital -- when it makes sense. Last year, you saw us issue our inaugural public bonds. We raised $400 million at 2 1/8% coupon to fund acquisitions -- primarily to fund acquisition opportunities and taking our leverage still to the low 4x area. So we're going to continue to maintain that low leverage balance sheet and obviously, focus on also our investment-grade ratings and further increasing those ratings as well.

Great. Lighting round. We had one investor question come in. Your thoughts on Sam Zell entering the market through the EQC merger. I'm going to answer it for you. Good for the market probably, unless...

Michael?

Generally, an indication of the demand for industrial. It's interesting if you see what my -- what one time they considered smart money just kind of being a follower. So that's kind of interesting. So no real impact to our business because they won't be able to penetrate infill Southern California. So they're just going to be another competitor out there finding marketed transactions in your other major markets and just an indication of capital maybe -- it doesn't feel like they have many options out there and more capital flowing in industrial.

Sounds great. All right, guys. Thank you so much. Appreciate your time.

Thank you.

Thank you, Jon.

Thank you, everyone.

Have a great day.

Thank you, everybody, for joining us. Thank you, everyone, for joining us today.