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

Why don't we get started? I know it's 4:30. This is the last panel of the day. So I know everybody is excited from that perspective. So welcome to the Rexford Roundtable. Happy to have Laura Clark, CEO, up here. Laura, why don't you introduce your team? I mean, we have a big group here and give us any opening remarks.

It sounds good. Well, thank you all for joining us today, and thank you for your interest in Rexford. Thank you all for hosting Bank of America. With me today are Mike Fitzmaurice, who is our CFO; John Nahas, our COO; and Doug Bettisworth is our SVP of Investor Relations and Capital Markets. So before we move to your questions and Q&A and any questions that we have in the room, I'd like to provide an update on what we're seeing in the overall Southern California industrial market and an update on our current strategic priorities. So let me start with the market. The leasing activity continues to improve in our market. We are seeing evidence that demand is strengthening across Southern California. In the second quarter, the market generated nearly 6 million square feet of positive net absorption, resulting in the first decline in overall vacancy that we've seen in the market in 4 years. Leasing activity has been strong throughout the third quarter, and we are seeing demand from a broad range of industries, including advanced manufacturing, logistics and consumption-based users like food and beverage, automobile and construction-related businesses. Of note, demand across the market is broadening, and that's a good sign. We're seeing activity across more submarkets and size ranges than we were earlier in the year and leasing momentum remains strong in spaces under 50,000 square feet, while activity in larger Class A spaces, especially in the North Orange County and Mid-Counties market has improved as corporate users have become increasingly active. While availability in the market remains elevated, we are moving in the right direction. That said, incremental tenant demand driving net positive absorption is fundamental to the market's continued recovery. So turning to our strategic priorities. We have taken decisive actions this year to strengthen our platform and sharpen our focus. Earlier this year, we completed a comprehensive portfolio review, and we identified approximately $2 billion of noncore assets for dispositions. This initiative reflects a very disciplined effort to concentrate our portfolio around properties we believe offer the strongest long-term growth and value creation potential. Including our recently announced $1.2 billion transaction with EQT, we have closed or have under contract approximately $1.5 billion of dispositions year-to-date, which positions us to achieve our full year disposition objectives. Proceeds from our dispositions will enhance our ability to execute on our capital allocation priorities and increase financial flexibility. We are reducing near-term debt maturities, repurchasing shares when attractive opportunities arise, and we are continuing to invest in our high-return repositioning and development opportunities across our portfolio. At the same time, our conviction in the long-term outlook for infill Southern California industrial real estate remains strong. The Southern California industrial market benefits from one of the most diverse demand bases in the country. At the same time, supply under construction has fallen to multi-decade lows and increasing restrictive state and local regulations, specifically including AB 98 and State Bill 415 are making new development increasingly more difficult. These dynamics further strengthen the long-term value of our portfolio and our differentiated platform. Before I conclude, I want to recognize the Rexford team. The progress that we've made this year reflects the exceptional execution across the entire organization. So in closing, we have acted decisively to strengthen Rexford. We have sharpened our portfolio. We have enhanced our balance sheet strength. We have improved operational efficiency and all reinforcing our long-term growth platform. So as market conditions continue to improve, we believe that Rexford is exceptionally well positioned to create value for shareholders and capitalize on the opportunities ahead. So with that, I'll turn it to you for questions, Samir.

Yes, I'll start, and I want to keep this interactive. So if anybody has questions, please. So maybe talk about the submarkets, right? I mean there are certain markets that are clearly doing well in L.A. and South Bay, but talk just kind of broad kind of what you're seeing within the markets.

Yes. I'll start a little bit higher level and then John can dive into some of the submarkets. As I mentioned in my prepared remarks, what we've seen from the second quarter into the third quarter is, I'd say, just a broad pickup across the market in terms of activity, and that includes across submarkets and size ranges. As I mentioned, that sub-50,000 square feet continues to be strong. That's been a spot of strength for several quarters now. We've even seen market rent growth for the past 2 quarters within that product, the sub-50,000 square feet. And what we've seen generally in the third quarter is that pickup in Class A, driven by those corporate users, as I mentioned, and that's been very positive for the pipeline, the leasing pipeline that we have from a development and repositioning perspective. So generally, we've seen more activity and more lease executions around those assets that we have for lease-up in the development and repositioning pipeline. John can certainly speak more about some of the submarkets.

Yes. So you touched on South Bay. We've been describing that market in 2 parts. There's the coastal portion, which I think most people are familiar with. Advanced manufacturing demand is quite robust, and that is continuing. But that is acutely focused on the most coastal areas of the beach cities between El Segundo down to Torrance with some spilling over into Long Beach. When you look beyond that one tenant sector beyond advanced manufacturing, it is a bit different. General logistics demand is there, but not nearly at the level that we're seeing with advanced manufacturers. And so the whole market is a bit bifurcated. And we're seeing rents and occupancy and absorption behave differently across those 2 areas. Similarly, we have other markets like the San Gabriel Valley, which are exhibiting strength in pockets around the city of industry. That's one area, as Laura mentioned, where we're seeing increased demand for Class A product. We have a couple of development sites that were completed and are happy with increased activity we're seeing there. But like the South Bay, there's a bit of a bifurcation. And when you look at the Irwindale portion, which is the north part of the San Gabriel Valley market, it's not quite the same. We're seeing healthy demand sub-50,000 square feet, as Laura noted, and as well as with product that's Class B with higher functionality, but Class A remains a bit slower in that market. Logistics demand is one of the bigger drivers for San Gabriel Valley overall. That is also true for the Inland Empire West. And so we're continuing to see good demand coming from those sectors. Our product in the IE is on the smaller scale as compared to most. Our average unit size in that market is 30,000 square feet. Nevertheless, we do own a few bigger boxes and have some exposure to some of the increased 3PL and warehousing tenant demand that we've seen there. Probably most notably, what's different from earlier this year, certainly even last quarter is some of the Class A demand focused on markets like Orange County and Mid-Counties. Those markets year-to-date have been a bit quieter in that space. And over the last 60 to 90 days, we've seen increased activity and more deals getting to the finish line. Light manufacturing, some advanced manufacturing is driving a lot of that tenant activity in those markets. Mid-Counties, you'll see a little bit more logistics there as well. And then real quickly rounding out San Fernando Valley, which is a big presence for us. Class A remains a bit slow there, but Class B product and smaller sized units are continuing to lease and perform very well. That market does historically have a larger component, roughly around 20% that's tied to entertainment. That sector has not gotten any better. It's still a lot of the same. And so we haven't seen that demand portion come back yet. But overall, again, activity generally is going in the right direction across all the markets and most size ranges that we operate in.

John, remind the audience, what is your exposure to South Bay?

Yes. It's our largest submarket, and we have product there that ranges as small as 2,500 square feet up to a few hundred thousand square foot size boxes. It's concentrated mostly in the coastal and Harbour Gateway corridor areas of the market, which are focused on the logistics corridor that extends from the port to Downtown L.A. as well as the advanced manufacturing epicenter that I described earlier.

I think it's around 12 -- it's about 7.5 million square feet. Is that 12% to 15% or something like that?

Yes, in that ballpark.

Yes.

Okay. And is there a way to bifurcate A product versus B which you own in South Bay? Just curious.

We have a bit of everything in that market. It's hard to give you a number off the top of my head. We also have a couple of projects in our development pipeline that are underway that are going to increase our presence in that submarket.

Why don't you maybe talk a little bit more about the development pipeline? It sounds like you've seen some more activity there this quarter.

Yes. That largely aligns with the Class A tenant activity trends that we're describing. We have product in our pipeline that is completed and in lease-up. Those buildings are generally located in Orange County, St. Gabriel Valley. There's a few others in a couple of other markets, but that's the higher concentration. And so we're pleased with the increased activity that I was describing earlier. In terms of the future pipeline, we have a few projects that have started and will start as we get through the end of the year. Those are all projects that we're really excited to get underway and deliver to the market. They are projects that meet our current financial threshold guidelines and will deliver differentiated product to the market, which is really important. The big element of our strategy is to make sure that across our operating platform and when we do development that our product has a competitive advantage. And so the projects that are in our future development pipeline are great examples of that.

Yes. And just from a financial perspective on development, we're selling for between 150 and 200 basis points on top of a market cap rate. So right now, that's about a 6.5% to 7% yield, which are in line with other projects that we've started this year. And as we look ahead, it has to hit that hurdle for us to greenlight it. Otherwise, it's a no-go. And as we look at our development pipeline going forward, it's smaller. We sold 6 development sites earlier this year and/or they didn't pencil, and we were penciling between 3.5%, 4% because they're largely bought in '22 and '23. So as we move forward, the focus is going to be more on the repositioning, the light CapEx work inside the 4 walls of the building where it's lower CapEx, lower downtime, much bigger tenant demand, broad-based demand from different tenant sizes and industries. So it's a big change in how we allocated capital in the past.

And Laura, when you mentioned -- I just want to make sure, when you say demand is strengthening, you're talking across the board, right? Yes.

Yes, yes, yes. And I mean, as John mentioned, I mean, we're certainly seeing -- when you dive into the submarket level, right. There's a differentiation in terms of the performance within a submarket and within size ranges. But even when you compare to the levels of activity 3 months ago, 6 months ago, 9 months ago, generally speaking, the levels of activity across the board are higher. And I would say the demand pool is also deeper.

Is there like a leasing pipeline? Can you -- are you able to quantify versus like...

Yes. We haven't reported kind of mid-quarter stats which we will certainly. We report earnings in 45 -- less than 45 days from now. And so we'll certainly provide updates at that point in time.

And you've talked about the demand improving. I mean have you seen a sort of a shorter time line for decision-making as well from customers?

Yes, I think that's been -- I'm glad you asked that question because I think that's really key. I think we've had periods where we've had leasing activity going to pick up. But what we've seen is the tenants are executing leases, they're making decisions. And I think that the tenant decision-making period has shortened as well. I think there's a lot of reasons that can be driving. I don't think it's just one thing. We certainly continue to see the reconciliation of spaces. Tenants are very focused on driving efficiencies within their operations. They're also very focused on being in the right buildings from a functionality and quality perspective to be able to drive their businesses forward in the most efficient way possible. When you think about given the fact that there's more availability in the market today, there's more options, you see them going and looking at those options, looking at where rates are today and wanting to lock in today's rates in better buildings. And so we certainly benefit from that from our portfolio, from -- especially Fitz mentioned in terms of our value creation model is about delivering the most functional and highest quality space on a relative basis to the market. And so we're certainly benefiting from that inflow. And I do think that tenant decision-making is strengthening just generally around the tenants are seeing activity pick up across the market and wanting to lock in today's rates. Some are trying to push that decision-making sooner. Maybe I've got a renewal in a couple of years, and I'd like to go ahead and lock in today's rates and extend my term substantially. So we are seeing that, I think, is also part of the driver there.

Can you talk about the lease negotiation process a little bit? Like now that tenants are coming in and wanting to lock in today's rates, how much are you able to push on the annual escalator? Is that still like in the 3-ish percent range?

Yes, around 3.5%, 3.5%. Yes. And that's been pretty sticky over the last few quarters. It feels like overall, the market has settled at that number. In our smaller size spaces, think sub-10,000 square feet, we're still able to achieve a bit higher, average is around 4%. But really, what it's coming down to because that's pretty sticky. Concessions are still pretty sticky. It's generally about a month per year of term for new deals and TIs aren't super meaningful in terms of overall dollar value and the deal economics, it's coming down to rate and it's coming down to commencement date. And going back to your question, Samir, and what Laura touched on, the urgency shows up in 2 ways. There's tenants that have been putting off decision-making and now they want to go, and they want to get in the building in 3 weeks, which is great. We love that. Then there's other tenants who are entering the market proactively much earlier than they otherwise would to take advantage of where rates are today. And so the 2 biggest conversations our teams have is around rate and commencement date, some being accelerated, some being, as Laura was touching on, maybe further out in the future so that they can benefit from today's market versus what they might be dealing with later down the road if the market continues to improve.

And maybe on the rate piece, market rates have been declining, but the pace of the declines have slowed the last couple of quarters. I guess, just any general sense of how close we are to sort of more of a flattish point?

Yes. I would say what's been going on with market rates is a bit expected. We still have elevated availability and vacancy across all of our submarkets. And so with that, the tenants have options and can leverage that. The net absorption that we've been seeing, especially what we think is happening on the ground today in the market is very encouraging, and there's steps in the right direction of chipping away at that elevated vacancy and availability. Until that comes down, we expect there to be continued pressure on rents because the landlords like us are competing for deals coming back to what I was mentioning before, rate is one of the big topics of discussion. So it's expected. We think that's going to continue, Generally speaking, getting through this year and '27 and the first part of '28, we're going to be dealing with 2021, '22 and early '23 vintage leases that are expiring where tenants are going to reconcile their space needs and make different decisions in today's market versus what they decided to do when back in '21 and '22 vacancy was really low, and they didn't have a lot of choice. So we expect it to continue to fluctuate. The rate of decline in rents flattening out has been helpful. And then there are certain areas of the market, particularly spaces under 50,000 square feet, rents have been stable, and we've actually seen some growth over the course of this year. So it's important because when you think of Rexford, remember that our average unit size is 28,000 square feet. So we have a lot of exposure to that segment of the market, which is pretty stable.