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

Welcome, everyone, to the 9:15 a.m. session at Citi's 2023 Global Property CEO Conference. I'm Craig Mailman with Citi Research, and we're pleased to have with us Rexford Industrial and CEOs Michael Frankel and Howard Schwimmer. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. For those in the room or the webcast, you can sign on to liveqa.com and enter code citi2023 to submit any questions if you do not wish to raise your hand. And I want to remind you, if you do want to raise your hand, you have to hit the button and have the mic light up. Otherwise, no one will hear you. So Michael and Howard, we will turn over to you to introduce the company and any members of management that are with you today and then turn it over to Q&A. Thank you.

All right. We're going to let Laura kick it off. And we just want to thank everybody for joining today.

Great. Craig, would you like me to answer your 3 questions?

If you want to jump in to the first question or give a quick overview of Rexford.

How about I do both. I'll give a quick overview of Rexford, and then you asked us to give the top 3 reasons why to buy Rexford today. So a quick overview of Rexford. Rexford Industrial is the nation's largest pure-play U.S.-focused industrial REIT. We have an entity value over $14 billion. We are solely focused on Infill Southern California, and Infill Southern California is the fourth-largest industrial market in the world behind the U.S., China and Japan. Our portfolio consists of 44 million square feet of high-demand, generic-use industrial space occupied by a very exceptional and stable and diverse tenant base. Our proprietary investment, sourcing advantage, unique market access and value-add expertise enable us to generate returns that are substantially above market. We maintain a very low leverage balance sheet with the sector low net-debt-to-EBITDA of 3.7x, and that provides us with tremendous flexibility and access to many attractive sources of capital to fund all of our future internal and external growth opportunities. In 2022, our entrepreneurial approach to creating value drove 20% core FFO per share growth. That brought our average annual growth to 22% and substantially higher than all the other industrial REITs, which averaged 13% over the same period. That nearly 70% outperformance is what we like to call the Rexford Alpha. So to your question, what are the top 3 reasons an investor should buy Rexford today? So number one, first is the persistent and incurable supply and demand imbalance in our Infill Southern California markets. Market vacancy today in Infill Southern California is approximately 1%. That's well above structural full occupancy levels. Our markets have an extreme scarcity of land and development constraints that prevent really any material increase in new supply. You couple this with continued strong and diverse tenant demand. Our tenants serve a consumption base of over 22 million people that have growing purchasing power. So when you put all this together, these unique market dynamics and the current activity we're seeing in the market, we're projecting approximately 15% market rent growth in 2023 within Infill Southern California. The second reason to buy Rexford today is our ability to deliver investment opportunities that generate substantially above-market returns. We do this through our proprietary data-driven acquisition sourcing that enabled us to acquire last year. Our $2.4 billion that we acquired in 2022, 90% of that was off-market or in lightly marketed transactions. We also combine this with our value-add expertise that enables our execution on today. Our pipeline or in-process repositioning/redevelopments totaled $1.1 billion that we expect to start in the next 2 years and projected unlevered returns on total investment at 6.5%. So when you look at what we've closed year-to-date of $405 million as well as the $125 million we have under contract or accepted offer, in aggregate, our investments today are positioned to generate higher FFO accretion compared to last year, and that's inclusive of today's cost of capital. Finally, the third reason to buy Rexford today is our exceptional projected embedded NOI growth today sits at over 43%. That equates to $200 million of NOI growth over the next 24 months. And that assumes no acquisitions, and that assumes today's market rent without future growth. So when you look at -- break down the $200 million, that's comprised of $78 million of NOI growth. It's driven by the mark-to-market of our leases as well as our contractual rent steps. The weighted average mark-to-market of our portfolio today sits at 73% on a net effective basis and 58% on a cash basis. The second component of that growth is $48 million of NOI from repositioning and redevelopments that will stabilize in the next 2 years; and then finally, $74 million of NOI from recent investments that we closed in the fourth quarter and year-to-date. And I know, Craig, you only asked for 3 things, but I have to acknowledge our team, because they're truly the primary determinant of our success at Rexford. And it's their entrepreneurial, collaborative and dedicated efforts that truly enable the great business that we have today and where we're going in the future. So with that, I'll turn it back to you.

Perfect. And you're the first company to offer a fourth. So you get the early award for that.

I have more.

Keep going. We got a few minutes. No...

Fill the whole half an hour.

And correct me if I'm wrong. The 73%, is that an update from the call? That seems higher.

No. That's the net effective number from the call.

Okay. Perfect. So I want to start with acquisitions, because following a $2 billion a year and dislocation in the acquisition market, maybe we all thought there would be a slowdown. But you guys have come out of the gates pretty strongly here with $400 million in the bag, another $100-plus million under LOI. You're on track to do another strong year. And yields are moving higher commensurate with kind of where cost of capital is going. So I'm just kind of curious, beyond what's under LOI and close, what does the broader opportunity pipeline look like at this point?

It's very strong. We're tracking 200 million square feet of product in our proprietary database. And near term, the pipeline is even stronger, I'd say. Our team does a tremendous amount of research. We have these amazing relationships into the marketplace, which help us generate those 90% off-market and lightly marketed transactions, as Laura mentioned. And today, we're better positioned than we were a year ago. There is less competition in the markets. Rexford has tremendous access to capital and a reputation in our markets, in which brokers can rely on our ability to close, which is much different than others. So the pipeline is actually just building by how we've structured and really operated in the marketplace itself. And I want to touch on one other point that you mentioned about the market. Interest rates are moving up, but yields haven't really dramatically changed in the marketplace. There's still people that are coming into our markets and buying at lower yields. There's 2 transactions that are tied up right now in the Inland Empire. And one is at a 1.9% yield that will stabilize in 5 years at a 4.5% yield. The other is inbound at a 2.4% and it will stabilize at a 4.3%. So that's kind of what's happening today on the ground.

I'd just add to that briefly because -- I think Howard did a good job of describing the dynamics in terms of how we're acquiring. But Craig, you mentioned that you kind of expect yields to have gone up commensurate with the cost of capital. But actually, what we're seeing at Rexford is our yields have gone up substantially greater than the increase in the cost of capital, particularly the debt markets. And in fact, inclusive of today's cost of capital, yields on our investments are about 40% more accretive on an FFO per share contribution basis than they were 1 year or 1.5 years ago when cost of capital was substantially lower.

So I want to go back and kind of bridge, Howard, your commentary that you're still having these deals go off in the IE and elsewhere in Southern California at cap rates, even on a stabilized basis well below where you guys are finding assets today. Is it just that the deals you're quoting are highly marketed core deals that are still attracting institutional capital versus you guys going after deals that maybe are not the high profile, you're sourcing them off market? Kind of what's driving that delta relative to where you guys have been able to kind of get assets here over the last couple of months?

Right. No, that's a great question. And yes, there's always been a difference between how we buy and how the rest of the capital accesses the market. And you're seeing exactly that. And yes, so those deals that I mentioned, those were marketed. And as I just mentioned earlier, 90% of what we buy is really not actively on the market. So there's always a difference.

And Laura, maybe this one is more for you, but you got to finance this growth, right? And so just kind of curious on -- you guys did the equity raise back in November, but the deal flow that you guys have done has kind of eaten through some of that. From here, kind of what kind of capacity do you have left given your target leverage levels? And as you look at the market today, where debt pricing is, where equity costs are, where your ability to sell assets and redeploy that, kind of what's the funding plan here for the balance of the year?

Yes. I mean, I think because of the low leverage on our balance sheet, we really optimize kind of all the abilities to fund the business, right? 3.7x net-debt-to-EBITDA, we target to be somewhere in that 4 to 4.5x area. So we certainly have a lot of flexibility in terms of how we want to fund, and we have access to a lot of different sources of capital. Equity, obviously, favorable from a cost basis today, especially given where we're acquiring. As of the quarter end, we had about $73 million of proceeds forward remaining outstanding for settlement. We just renewed our ATM, so that has $1.25 billion capacity. And then when you think about dispositions, certainly could be a source of capital. We're constantly kind of assessing the portfolio and looking for opportunities. We haven't sold as much in the last couple of years. Really, when you look at the embedded growth within these assets and you look at the mark-to-market, it's been a little bit more challenging to sell the assets, because there's still a lot of value to capture there. But we could sell incrementally some properties over the next 12 months. So we're in a really favorable position. That's why we manage the balance sheet at this level, right? It puts us in a position where no matter where we are in this economic cycle, it puts us in a position to be able to be opportunistic.

And where do you think you would price debt today? Kind of where in the curve would you look to kind of fill in from a maturity ladder that you have today as well?

I mean, our maturity ladder is really well staggered. We could issue anywhere from 3- to 10- to 30-year debt today and feel really comfortable about adding, at any point, some in the ladder.

And where do you think you would price the range from 5, 7, 10 years?

Yes. I mean, I think 10-year debt for us is probably today -- the 10-year is trading down today -- probably around 175 basis points, 170, 175 over.

And I guess, as you think about that, you guys are buying in the 5, so there'd be maybe a little bit of negative leverage out of the gate. But what are you guys throwing off from a cash flow perspective as well that you're reinvesting to lend that cost of capital down as you're potentially looking to maybe get up to that 4% to 4.5% debt-to-EBITDA range?

Yes. I mean, look, we're not necessarily trying to get back to 4 to 4.5x, right? I mean, we're going to source capital that's accretive to the business. So we're buying today -- if you look at our pipeline today, initial yield is about $125 million pipeline or about 5%, but stabilized yields are 6-plus. So we're going to make sure that we're focused on funding the business where we're generating accretion in the near term and the long term.

And I'd just add to that, that our uses of capital also includes our repositioning, where we're deploying capital into repositioning many of our assets. And those are generating yields. For instance, last year, we generated, I think 200 -- about 8.9% aggregate yield on our repositionings that were stabilized. As Laura mentioned earlier, we've got over $1 billion of repositionings in the pipeline, stabilizing at about 6.5%. So these are very accretive uses of even today's capital at its current costs.

And not to belabor the balance sheet here because you're in great shape. But as I'm thinking about your same-store growth has been high single digits, if not potentially getting to the low double-digit range. So your EBITDA is growing quite fast, right? And so your capacity every year, even if you're not trying to lever up, you're naturally delevering, right? And so you have more debt capacity than most other companies that we think about because of that outsized growth that you have runway here for probably a couple of years. I don't want to put words in your mouth, but you guys are in a little bit of a different situation to where at a point in time, if you go to that 4.5% range, you naturally can delever quicker than others, right? And so...

That's correct.

Kind of how do you balance that optic of hitting that top end versus you knowing that the portfolio is going to allow you to -- without worrying about selling assets or other issuing equity that others have to kind of pull that lever that you're naturally going to come back down?

Yes. I mean, look, I think the -- when we think about the balance sheet, I'm not afraid of running a lower-levered balance sheet than we sit today, right? At the end of the day, we're thinking about how we're going to fund the business on an accretive basis. So there's going to be points in time -- I mean, if you think back to -- it was the fourth quarter of 2020, I believe our balance sheet was closer to 3x levered, which gave us the opportunity to opportunistically add debt to the stack. And we were able to go and issue 10-year paper with the 2 handle on it -- low 2 handle on it. And so I think that's what running the balance sheet at these levels allows you to do is be opportunistic at those right points of time in terms of how you're going to source capital.

That's helpful. So now to go back to the fun stuff, the leasing environment, right? Because it's still doing quite well. But at the same time, I can tell you, certain people have come up to me and expressed some concerns already at the conference about Southern California, right? The IE, you're seeing maybe market rent growth slow a little bit sequentially. The moratorium in the Inland Empire, what does that do structurally to a market that's already at 1% vacancy, right? If you can't grow as a tenant in the market, what are your alternatives? So I'm just kind of curious, you guys are a sharpshooter in the Southern Cal market. So maybe you're a little bit more biased than others that can allocate capital in and out of the market. But where do you see -- or what pushback would you give to those concerns about Southern California being a little bit at risk here fundamentally because of some of those concerns I just went through?

Maybe I'll start and, Howard, you can maybe fill in a little bit. But to begin with, I think your concerns are valid. And that's why Rexford only focuses on Infill Southern California. So you mentioned the IE, the Inland Empire. That's the Eastern segment of Southern California, for those of you who are less familiar with the geography. The Inland Empire is an area in the east section of Southern California that has a nearly endless supply of land, all the way to Las Vegas. You could continue to build buildings. And that is fundamentally why we choose not to focus in that market. And so yes, if I was an investor focused on the Inland Empire, I would be very concerned. However, that having been said, that's only about 20% of the total market in Infill Southern California. The infill market where we focus in and among the population centers, Greater L.A. County, Greater Orange County, the Ontario market, that's about 80% of the market in Southern California. And I don't have a worry in the world about fundamentals for that marketplace. We have an extreme supply-demand imbalance that is only going to worsen, worsen because we continue to see industrial property get cannibalized as it gets converted to other uses. And increasingly, it's going to get converted to housing. California has an extreme housing shortage that is going to be resolved to some degree over the next 20 to 30 years. We see increasing regulation and constraints around industrial use and trucking. So that's going to further constrain the availability of industrial, not just in Inland Empire, but also in the infill market to some degree. It's going to further reduce supply. So that's the backdrop in Infill Southern California. So we have not a worry in the world. And trust me, we look for cracks in the market like nobody's business, because that is our business. And we're just simply not seeing it. And with that, maybe I'll turn it over to Howard to talk a little more in detail about the leasing market.

Well, I'll just mention also about Michael's comments on the Inland Empire. That's really the relief valve for new deliveries, because there is land in the Eastern Inland Empire. But even if you look at just the Inland Empire West, there is some construction, and 75% of that is 250,000 feet and larger. 50% of it is 500,000 feet and larger. And then you look at our portfolio, our average building size in that market is about 85,000 feet. So the reality is most of those deliveries aren't competing with our product that we already own. In terms of the overall market, as Michael mentioned, we're looking for the cracks every day. But I can tell you today that the demand we're seeing is actually stronger than it was even 30 days ago. So our team resets their rents -- the forecasted market rents every quarter. So it's not very long ago that we just finished reforecasting those rents. And in terms of the leasing we're doing right now, we're still exceeding those recently forecasted rents. So the tenants are strong in terms of the amount of demand we're seeing in the marketplace. We're not seeing any change. In fact, still an outperformance in our ability to achieve better rents than we even forecast. So as Michael said, where are the cracks? We're not seeing them.

I mean, remember, this is a market, the Infill Southern California market, it's almost 2 billion square feet at about 1% vacancy. Many of our submarkets, which are larger than most other markets in the country, are well below 1% vacancy, 0.5%, 0.7% vacancy. So it's just really a favorable market backdrop for Rexford.

And then just one last thought. It might be different for other owners in the marketplace, because we deliver the best quality product in each one of the submarkets we're in. And that tends to drive higher rent and less vacancy and a faster lease-up. We've learned that through many cycles. And so the program at Rexford is different than others in the marketplace. So our performance, obviously, could be different and generally is different, we think, than most others.

And you make the point, right? When you look at industrial, sometimes you start nationally with SKUs relative to other REITs. And then you look at a market like Southern California that's 2 billion square feet, to drill down to the submarket level, right? I mean, as you look across your submarkets, are there any big differences, fundamentally or from a rent growth perspective, that you could flag? Or is it generally they're all kind of moving same, similar magnitude in same, similar direction?

Well, if you look at our portfolio, it's about 70%, 75% Greater L.A. County, Greater Orange County and the Ontario market, and a little bit in San Diego, a little bit in Ventura. And across the areas where we own, we see similar tenant demand fundamentals, in great part because we focus on the same type of product. We focus on what we call generic industrial. So for example, we don't get involved with heavily built-out lab space in San Diego. We stay away from that. And by staying true to that generic industrial footprint, meaning maybe it's 3% to 18% office, the rest is warehouse and loading doors. We keep it simple, whether we deliver that in a small package or in a big package. And the beauty of that is a couple of things. One, it enables us to appeal to the deepest, broadest and most diverse tenant base probably in the world. And number two, it dramatically reduces any friction associated with retenanting, meaning lowest time frames and lowest cost associated with retenanting. And so by sticking to that generic product type, irrespective of where we're focused within our target markets, the tenant demand fundamentals are pretty similar, not dramatically different and very strong.

And also, Craig, as far as the rent growth, San Diego, Ventura have always had a bit lower rent growth than those real strong infill markets. Michael mentioned L.A. County, Orange County, and Inland Empire West. And that's where we continue to see that type of performance.

Are you feeling -- I always make the point that rent is a very small component of the tenant supply chain. There's still a lot of inflationary pressures in labor and transportation. I mean, are we still -- as you talk to tenants who maybe move out, your retention rate is high, so clearly, rent is not as big of an issue. But for the tenants that do move out, does rent even clock in the top 5 reasons? Or is it other reasons? Like, how much pushback are you getting when you're going to reset rents? Because sticker shock should be pretty well known at this point for tenants in the market if you want to stay. I'm just curious of how many tenants are actually getting priced out of the market versus kind of pushing back and planning, trying to get some type of a better deal than maybe you're initially offering?

I'd say, at this point in time, we have very few tenants leaving the market, leaving our infill markets because of the cost of rent. I think that occurred over the last 20 to 30 years, because this has been the most expensive operating environment for decades, even though we didn't see the kind of rent growth until very recently that we've seen recently. So it's been the most expensive operating environment and the most restrictive operating environment from environmental regulation, all sorts of issues, taxation. It's been an expensive operating environment. So if you didn't have to be there, you probably left 20 years ago. And today, the composition of our tenant base is such that they're in our spaces because they require our spaces in order to run their business. They're predominantly consumption-driven, and they're delivering into the largest zone of consumption, the largest regional population in the country. And I hate the word mission-critical, because it's overused. But these tenants, they've proven to us that these locations are truly mission-critical to their businesses. So when you talk about, yes, rent is a very small percentage of the economics for that business, that's true. Transportation costs for their goods are much more impactful and a much greater percentage on average of their company's economics. That's true. Being close to their customers, being close to the ports actually helps reduce their transportation costs, keep them low. That's true. But at the end of the day, the biggest issues for our tenants is if they don't have these locations in their portfolio, they have no business.

And Craig, I'll just add that when you think about the tenant's ability to pay the rent, I think the annual embedded rent steps that we're achieving and that we've been able to continue to push higher is a really great reflection of how they're thinking about their ability to pay rent, right? So since pre-COVID, since the beginning of time in industrial real estate in Southern California, the annual steps were 3% or lower. And then about 2 years ago, we saw the ability to start pushing those higher and have pushed those higher pretty much every quarter for the last, call it, 2 years. Last year, annual rent steps in our portfolio averaged about 4.3%. So we're still seeing the ability to continue to push annual embedded rent steps somewhere in that 4% to 4.5% range. So I think it's a great reflection of how the tenants are thinking about rent.

And between those embedded steps, the mark-to-market now north of 70% on a net effective basis, I'm assuming it's somewhere in the 60s on a cash basis?

Yes. Yes, we're right there, around about 60%.

Right. And so your ability, if you're rolling 15% a year, you're getting almost 9% from your rents. You're getting another 3% to 4% just from your steps, right? And then you have lesser miles on the occupancy. I mean your ability to continue to grow the core portfolio in the high single-digit range seems pretty sustainable here for at least the next year. So am I missing anything?

No. You're not missing anything. You got all the math -- you got all the components, Craig. We're projecting that cash same-property growth in our portfolio should be 10-plus percent over the next 2 years. That assumes that kind of steady occupancy levels. But we do see -- when you think about the mark-to-market, we expect kind of the same mark-to-market to continue over the next few years as we roll the leases. And market rents -- and that assumes that market rents aren't growing as well, and we are projecting 15% market rent growth this year.

Right. To go back to -- I know, looking for cracks in the armor. I'm getting a question here from someone who lives in Texas and just talking about the out-migration there. And really, part of it being housing-driven. We've talked about the tax situation and everything. But just longer term, I don't know if it's measured in 5, 10, 15 years, how do you view that? Is this just the continuation of the conversation we've had for the last 20 years about everyone leaving California? And it's still kind of a populous state, population-dense, kind of views there. And I'm going to dovetail that also with, we are starting to see for the first time some port diversification really coming out of COVID, where people are considering not stopping just at L.A. Long Beach, but bringing stuff from Asia through to the East Coast and how that's sort of impacting tenant decisions and their locations, right, whether it's Phoenix, whether it's Dallas, what have you, just kind of your longer view. Again, maybe this may be a rehash of a question you've already hit on. But just as you guys think of the evolution here of the market and some of these dynamics, which are a little bit different now, especially on the port diversification side.

Maybe I'll jump in on the port question, and Laura and Michael can talk on the population. As far as the ports, we have a major contract that still has not been settled, and we've seen this through cycles. Every time that contract comes up, there's a lot of shift because of the potential for strikes. And that is something that major importers, retailers, et cetera, they don't want to be caught in the middle of the strike at the L.A. at Long Beach ports. And so a lot of the diversion we think is happening because it's always happened that way. And there have been some things happening at the port, some slowdowns. It's contentious, that negotiation. But Southern California is still the gateway from Asia to a shortest path in. And we believe in the long run, some of that will normalize out after the contracts are settled.

I'll try to answer the bulk of your question. I'll try to be brief because we're running out of time. But if you look at the cause of the relative out-migration, first of all, it's small numbers. It's less than 1% of the population. Number two, driven by a couple of factors, an imbalance in deaths versus births. So with the pandemic, we had incrementally more deaths. And also for political reasons and others, we've had almost 0 immigration -- I'm sorry, I'm sorry, the births have been relatively declining. So the balance there has been a negative factor on the population. Then you layer in immigration. Immigration has been, for all intents and purposes, 0, and that's starting to come back. And so just from a baseline perspective, the near- and medium-term expectation is that we revert to sort of a 2% growth as immigration starts to fill back in, and that unusual level of relative deaths starts to go back to more normalized levels. And then if you look at who's leaving and who's coming, the people that are leaving, to your point, Craig, have to do with cost of housing, cost of living. They're not your high-income earners. The people that are coming into California tend to be highly educated, younger. We're the 11th youngest state in the country, and they tend to be higher wage earners and a higher consumption factor. So net-net, we're not really too worried about the long-term ramifications of what we're seeing. It's been more of a short-term trend. And I think I'll just add with regard to the East Coast ports, people have looked to diversification because of the bumpiness with China and the COVID impacts there, factory shutdowns and all the rest. And I think net-net, that really doesn't have a lot of impact for us because, again, our tenants are predominantly consumption-driven occurring within our region. So we don't really see a big long-term impact there either.

That's helpful. And before we jump to rapid fires, I'm just kind of curious, your #1 ESG priority for 2023?

Well, it's really hard to pick just one, but I'll try to pick just one, Craig. At the core of our business really is recycling buildings and reinvigorating the communities in which we all live and operate. And so that allows us to reduce our environmental footprint and also have a very positive impact on all of our stakeholders. So this year, of our many ESG priorities, we're probably most excited about setting science-based targets and making a net-zero commitment and which truly will deepen our commitment to reducing our environmental impact and having that positive impact in our communities. So to achieve these targets, we're going to continue to raise the bar when it comes to how we're building green. Last year, we completed our first LEED Gold building. We're even looking to expand our LEED certifications into repositioning projects. So we're excited about all of our initiatives from that perspective. And then we're increasing our investments in renewable energy. So that's expanding our solar program, battery storage, EV charging, et cetera. So we're really excited about all that we're doing from an ESG perspective and look forward to sharing an update with everybody with our annual ESG report that will come out in May.

Perfect. So rapid fire time. Same-store NOI growth for the industrial group, not Rexford, in 2024?

7%.

Best real estate decision today, buy, sell, build, redevelop or hold?

All.

Will your property -- will industrial have fewer or the same number of companies this time next year?

Same.

All righty. Well, thank you all for your time.

Thanks, everybody.

Thanks so much.

Thanks, everybody.