Rexford Industrial Realty, Inc. (NYSE:REXR) Q1 2024 Earnings Call Transcript April 18, 2024
Rexford Industrial Realty, Inc. reports earnings inline with expectations. Reported EPS is $0.27 EPS, expectations were $0.27. Rexford Industrial Realty, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Thank you for standing by. My name is Fabilo, and I will be your conference operator today. At this time, I would like to welcome everyone to the Rexford Industrial Realty, Inc., First Quarter 2024 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. I would now like to turn the conference over to David Lanzer, General Counsel. You may begin.
David Lanzer: We thank you for joining Rexford Industrial’s first quarter 2024 earnings conference call. In addition to the press release distributed yesterday after the market closed, we posted a supplemental package and investor presentation in the Investor Relations section on our website at rexfordindustrial.com. On today’s call, management’s remarks and answers to your questions may contain forward-looking statements as defined by Federal Securities Laws. Forward-looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ. For more information about these risk factors, please review our 10-K and other SEC filings. Rexford Industrial assumes no obligation to update any forward-looking statements in the future.
In addition, certain financial information presented on this call represents non-GAAP financial measures. Our earnings release and supplemental package present GAAP reconciliations and an explanation of why such non-GAAP financial measures are useful to investors. Today’s conference call is hosted by Rexford Industrial’s Co-Chief Executive Officers, Michael Frankel and Howard Schwimmer, together with Chief Financial Officer, Laura Clark. They will make some prepared remarks and then we will open the call for your questions. Now, I will turn the call over to Michael.
Michael Frankel: Thank you, David. And welcome everyone to Rexford Industrial’s first quarter earnings call. I’ll begin with a few remarks, followed by Howard, who will provide market and operational detail, then Laura will provide our financial results and outlook. I’d like to begin by thanking our Rexford team for your strong results and another quarter marked by substantial value creation across the Rexford platform. On the leasing front, the team completed 3.2 million square feet of leasing activity at very favorable spreads as we continue to monetize the substantial mark-to-market for lease rates within our in-place portfolio. And notably, we extended our largest tenant, which Howard will detail shortly. On the investment front, our team completed over $1 billion of acquisitions, delivering substantial initial and longer-term accretion.
Our activity included a large off-market portfolio purchase acquired from a combination of Blackstone-affiliated entities for approximately $1 billion, comprising over 3 million square feet of high-quality warehouse products focused within Premier, Los Angeles and Orange County submarkets with tenant sizes averaging 43,000 square feet. The transaction is notable for the high quality of assets and significant levels of cash flow accretion contributed to our portfolio. In 2024 alone, the portfolio is expected to contribute an incremental $0.04 of FFO per share net of funding cost, along with an estimated 25 basis point to 50 basis point increase in operating margin. Additional growth over time will be driven by some value-add improvements, as well as the 3.9% embedded average annual rent increases within the portfolio.
The investment was also unique as it was a result of an off-market collaboration between the Rexford and Blackstone teams. We work together to curate the portfolio by selecting assets to optimize the blend of quality, return on investment and accretion to our business. The transaction is a testament to the benefits associated with working principle to principle to drive a superior outcome for both parties. The transaction is also indicative of a range of portfolios that we continue to track, which may be catalyzed from time-to-time by potential seller or market circumstances. With regard to market conditions, we are seeing some current choppiness, particularly within certain submarkets and size ranges. We expect some ongoing relative volatility within our markets through the near term, principally driven by heightened uncertainty in the interest rate environment, exacerbated by the current global geopolitical unrest.
However, despite some relative market uncertainty, we believe our infill Southern California industrial tenant base will continue to prove itself by demonstrating the nation’s strongest tenant and supply-demand fundamentals over time. Although we can’t predict how our market may perform in the future periods, so far, we are seeing a distinct and accelerating differentiation between the stronger relative performance of our infill SoCal portfolio, whether measured by net absorption, change in rents, or related metrics as compared to the relative performance of larger products sized over 200,000 square feet, primarily located in non-infill big-box markets, such as the Inland Empire. Big-box larger space is typically part of a super-regional or global logistics network where space needs are relatively fungible across locations and where demand for any single space can be highly elastic and reactive to short-term demand drivers.
In contrast, our smaller infill tenants are generally serving the nation’s largest first and last mile of distribution focused on regional consumption within the nation’s largest and most diverse regional economy, where performance through cycles has tended to be more durable. Big-box markets such as the Inland Empire are also subject to volatility, driven by substantial increases in new supply impacting occupancy through cycles as compared to our high-barrier infill market, which is subject to an ongoing scarcity of supply with a virtually incurable supply-demand imbalance over the long term. Consequently, and as we’ve observed through prior cycles, our Rexford tenant base, which averages 26,000 square feet in size and is 100% located within prime high-barrier infill SoCal markets is outperforming the big-box market and product type.
Looking forward, the growth opportunity embedded within our existing portfolio continues to be substantial. Over just the next three years, we expect cash NOI to increase by $282 million or 47%, growing to $876 million in total NOI. Importantly, this assumes today’s rents and no future acquisitions and is comprised of $94 million of incremental NOI related to repositioning and redevelopments stabilizing over the next three years, $88 million from the conversion of below-market leases to market rents, assuming today’s rents and no future market rent growth, $58 million related to acquisitions closed year-to-date and $42 million from the 3.6% embedded contractual rent steps within our current portfolio. We continue to be positioned to execute upon our expected 11% to 13% three-year average annual core FFO per share growth through 2026, which assumes no future acquisitions.
Please note, that we plan to update our long-term core FFO per share growth forecast on an annual basis at the beginning of the year. With that, I’d like to thank the Rexford team once again for your tremendous dedication and results. And I’m pleased to turn the call over to Howard.
Howard Schwimmer: Thank you, Michael, and thank you all for joining us today. Rexford began the year with strong execution across our value-creation initiatives. During the first quarter, our team completed a very strong 3.2 million square feet of leasing by executing on the increased tenant activity we experienced during the first quarter, driving 140,000 square feet of positive net absorption. Notably, we extended Tireco, our largest tenant occupying 1.1 million square feet into 2027. During the quarter, Tireco’s in-place rent increased by 4%, which was carried forward. The extension includes a 4% bump in year two and a two-month rent concession. With this lease execution, we derisked our largest near-term lease expiration, securing favorable and growing cash flow for the next three years.
Excluding the Tireco extension, leasing spreads in the quarter were 53% and 34% on a net effective and cash basis, respectively, and were in line with our expectations. Concessions increased normally from a weighted average of 1.2 months to 1.4 months sequentially. Additionally, annual embedded rent steps averaged 4% for the first quarter executed leases continuing to demonstrate our diverse tenant base’s ability to pay higher rent in future periods. Within our portfolio, with an average base size of 26,000 square feet, we observed market rent growth that was flat sequentially and approximately negative 2% year-over-year for highly functional product comparable in quality to our Rexford assets. As we have communicated, particularly with respect to select submarkets and size ridges, we expect to continue seeing some near-term fluctuations in market rents.
However, as demonstrated by the leasing activity within our portfolio and what we are seeing on the ground today, tenants are evidencing their comfort with today’s rent levels, plus 4% embedded annual rent steps. According to CBRE, vacancy in the infill markets increased 45 basis points sequentially to 3.2%. Notably, Rexford’s portfolio continues to outperform the market due to our superior quality and functionality. By way of example, Rexford’s first quarter net absorption was positive 30 basis points in contrast to the overall market’s negative 20 basis points of net absorption. In analyzing net absorption in the market, similar to prior quarters, nearly 80% of buildings that contributed to negative absorption were of lower quality, dysfunctional or obsolete, and generally non-competitive with Rexford’s portfolio.
In stark contrast to the market, Rexford’s strong new and renewal activity in the quarter drove an exceptional retention plus backfill rate of 87%. We continue to see relatively healthy tenant interest for our higher-quality product with activity on approximately 85% of our vacant spaces. Turning to Rexford’s investment activity during the quarter. We completed $1.1 billion of investments across 3.2 million square feet through off-market transactions. Subsequent to quarter-end, we closed one stabilized transaction for $27 million at a 5.5% initial unleveraged deal. Additionally, we have $275 million of pipeline acquisitions under contract or accepted offer, which are subject to customary closing conditions. The near-term pipeline investments, coupled with our year-to-date activity are projected to generate an aggregate initial yield of 5%, growing to a 5.7% unleveraged stabilized yield on total cost.
Moving to our [indiscernible] position and capital recycling program. Subsequent to quarter-end, we disposed of one property for $10 million, generating a 13% unlevered IRR. In addition, we have approximately $50 million of dispositions currently under contract or accepted offer, which are subject to customary closing conditions. Regarding our repositioning and redevelopment activity, during the quarter, we stabilized and leased approximately 40,000 square feet of repositioned property in Central San Diego, achieving an aggregate 10.8% unlevered stabilized yield on total investment. Looking forward, we have 4.6 million square feet of value-add repositioning and redevelopments in process or projected to start within the next 18 months with the remaining incremental spend of approximately $410 million, which we expect to deliver an aggregate unlevered stabilized yield on total investment of 6.2%.
Finally, I’d like to thank our Rexford team for their innovation and collaboration, driving another strong quarter of results. Now, I’m pleased to turn the call over to Laura.
Laura Clark: Thank you, Howard, and thanks to the Rexford team for your market-leading efforts that drive our strong near and long-term value creation. First quarter core FFO per share increased a strong 12% over the prior year quarter to $0.58 per share and was in line with our expectations. Same-property NOI growth was 8.5% and 5.5% on a cash and net effective basis, respectively. Leasing spreads over the trailing 12-month period of 71% on a net effective basis and 52% on a cash basis drove strong rental income growth. Turning to the balance sheet and capital markets activities, this quarter we opportunistically leveraged the balance sheet to fund accretive external, as well as internal growth opportunities, including funding incremental spend of $455 million related to the near-term pipeline of repositionings and redevelopments that are projected to generate an incremental return of approximately 15%.
At quarter end, net debt to EBITDA was 4.6 times and we anticipate that embedded internal growth alone will reduce leverage within our target 4 times to 4.5 times range in the near term. During the quarter, we executed on a number of capital markets transactions. We completed the issuance of $1.15 billion of three-year and five-year exchangeable notes at an average coupon of 4.25% and a 30% conversion premium. Let me pause here and take a few minutes to describe the mechanics of these exchangeable notes, also known as converts. Recent changes in accounting rules combined with the ability to issue converts under the Net Share Settlement method known as Instrument C have created a unique opportunity and an additional attractive capital source.
Under the Net Share Settlement method, the par value of the convert, which in this case is $1.15 billion in aggregate, is treated like a bond, whereby Rexford will pay the par value in cash at maturity. Regarding the conversion premium, if Rexford’s share price at maturity is 30% or more than the price on the date of issuance, the excess conversion value over par is settled at maturity in cash, shares or a combination of the two at Rexford’s option. This provides us with maximum flexibility at any future point in the capital market cycle. The accounting for converts has also been substantially simplified. On the income statement, the coupon, which averages 4.25% for our issuance is reflected as interest expense. In regard to the share count, only the net shares equivalent to the excess conversion value are added to the share count if and when the stock is trading above the conversion price.
Importantly, the par value of the convert has no impact to share count as it is always settled in cash. Under this structure and with the accounting rule changes, there is no immediate dilution upon issuance and any potential future dilution is mitigated through the net share settlement mechanics as well as the flexibility for Rexford to settle any excess share value above the 30% conversion premium in cash or shares in the future. Continuing with our first quarter activities and concurrent with the exchangeable note offerings, we completed a public offering of 17.1 million shares of common stock to an existing long-only investor based on the West Coast subject to forward equity sale agreements for a gross offering value of $841 million. And during the quarter, we settled the remaining forward equity sale agreements related to prior offerings for net proceeds of $290 million.
We currently maintained substantial liquidity of $2 billion comprised of $837 million of net forward equity remaining for settlement, $185 million of cash-on-hand, full availability under our $1 billion revolver, as well as expected proceeds from our capital recycling program as we harvest value through dispositions. Finally, we have no material debt maturities until 2026, inclusive of extension options. Moving to full-year guidance. As a result of the positive contribution from our first quarter investment activity, we are increasing full-year 2024 core FFO per share guidance to a range of $2.31 to $2.34, up $0.04 at the midpoint when compared to our prior guidance. Please note that our 2024 guidance range does not include acquisitions, dispositions or related balance sheet activities that have not yet closed.
In regard to our same-property guidance, our forecast assumes a range of expectations and is based upon the market dynamics we are observing today, including leasing activity and demand, current supply, and the overall health of our tenant base. To the extent circumstances our markets deteriorate beyond the current levels we are experiencing today, we will update guidance accordingly. Our 2024 cash same-property NOI guidance remains unchanged and is projected to be in the range of 7% to 8%. Net effective 2024 same-property NOI guidance has been increased to 4.25% to 5.25%, up from 4% to 5%, driven by the strong level of early renewal activity in the quarter that generates higher straight-line rental revenue. Components of our projected same-property guidance remain unchanged and includes full-year average same-property occupancy in the range of 96.5% to 97%, which is primarily driven by lease timing and average downtime.
Cash leasing spreads of approximately 50% and net effective spreads of approximately 60%, excluding the impact of the aforementioned Tireco lease extension. Note, that leasing spread guidance incorporates current market rents and leasing spreads quarter-to-quarter are impacted by the mix of leases we expect to execute. Bad debt as a percentage of revenue is expected to be in the 40 basis point to 50 basis point range and in line with pre-pandemic levels and average concessions in the 1.5 month area. Thanks again to the Rexford team for your outstanding work that differentiates our business and enables our ongoing success. We now welcome your questions. Operator?
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