Rexford Industrial Shares: This Industrial Champion Is a Problem for Me (NYSE:REXR)

Rexford Industrial (NYSE: REXR) is a unique industrial REIT that focuses its portfolio 100% on Infill Southern California. As of July 16, 2024, the company owned 422 properties comprising ~49.7 sq m. ft. of common leasable area with over 1600 customers.

Its diversified portfolio of properties attracts strong tenants operating in various niches. The key areas of its holdings are in warehousing/transportation, wholesale and manufacturing.

What is unique about REXR? Market perspective

Some context – the oversupply of headwinds facing industrial REITs

For context, the industrial real estate market has faced some supply headwinds since mid-2022 as demand cooled and substantial new supply hit the market. The situation differs from state to state, but in general it can be considered as ongoing.

For example, the new supply exceeded 100 sq m. ft. for the eighth consecutive quarter. At the same time time, despite an increase from quarter to quarter, demand remained modest and net take-up was recorded at 30 sq m. ft in Q2 2024.

The negative supply-demand relationship has driven the market vacancy rate to a new high of 6.5% in recent years, reducing landlords’ bargaining positions (reflected in lower occupancy rates and lower asking rent growth).

REXR has a unique position – 100% SoCal Infill portfolio

The company focuses on one of the largest industrial markets, consistently experiencing high demand and low supply, resulting in a favorable environment for landlords and healthy occupancy. As mentioned earlier, the relationship between supply and demand is different from state to state, so concentrating 100% on a certain area can be a risk factor if that region experiences negative market conditions; however, the REXR market has typically performed well.

REXR’s target market is accompanied by a low risk of oversupply due to:

• high barriers to development due to scarce developable land
• limited supply new to market
• contraction of the offer as a result of the transformation of industrial buildings for other purposes

While the Company’s Total Portfolio recorded an occupancy rate of 93.7% (modest level), REXR also distinguished the Same Properties Portfolio to remove changes resulting from non-performing businesses (acquisitions, disposals, etc.). The occupancy rate for its portfolio of same properties stood at a solid 97.3%.

In addition, there are signs of future market improvement

As we all know, investing is not only about values, valuations and current market circumstances. It is crucial to consider future expectations regarding the development of the analyzed business and the market in which it operates.

Earlier, we highlighted only the negative takeaways from the latest market data, but there are some positives to consider as well. For example, the net absorption that I mentioned earlier has seen a quarter-over-quarter increase in seven quarters.

What is even more important – the state of construction of the industrial space. Many markets are struggling with an oversupply of industrial space due to the significant supply hitting the market each quarter. This “new supply” results from construction projects started quarters/years ago.

That said, industrial space under construction has gradually shrunk over the past two quarters, meaning that completed construction is not being replaced by new construction starts. This is a valuable insight that suggests future quarters/years will not see such substantial construction completed, leading to an improved supply/demand relationship.

Other key considerations

Lease Expiry Schedule and Potential for Rent Increases

In Q2 2024, REXR saw cash rent increases of 49%. Some of you may be wondering how such a substantial increase occurs. Let me explain. Leases often include contractual rent escalators, which typically amount to single digits annually. On the other hand, the last two years have produced a substantial increase in rents for industrial space.

Therefore, as REXR’s leases expire, the Company may increase its rent through mark-to-market. Therefore, a relatively low weighted average lease term that often occurs in industrial REITs can be considered a double-edged sword. On the one hand, it provides less predictability of cash flow and can occupy the team with intense periods of negotiations, but on the other hand, it gives REITs the ability to adjust their rents more frequently.

Robust financial performance

With its Q2 2024 results, REXR updated its guidance for 2024. This update was positive, leaving most key positions intact while increasing net income and Core FFO per share. The target range for Core FFO per share of $2.32 – $2.34 represents an estimated growth of 6-7% y/y (6.5% mid.

REXR still has substantial growth opportunities and its portfolio growth has been dynamic (~22% annually since IPO).

Moreover, the past 5 years have seen REXR outperforming some of its peers (well chosen by REXR). The company recorded a substantially higher CAGR of:

• FFO per share
• WE consolidated
• DPS

“Sleep sound” financing structure.

The REXR funding structure presents:

• debt maturity schedule reasonably
• 100% debt structure with fixed rating
• relatively short term, but in line with its peers, the term of maturity of the debt
• Credit rating BBB+
• 23% of the debt in the financing structure
• 4.6x net debt to adj. EBITDA

For reference, review selected credit scores of REXR and some of its peers.

Given the relatively low impact of the high interest environment on REXR’s financial performance, investors can rest easy. The Company’s debt is 100% fixed rated and will have relatively low maturities in the coming years. One factor to consider is the somewhat high AFFO payout ratio, which is slightly above the level I’d like to see at ~88% on a forward-looking basis.

In addition, REXR has multiple expansion potential

As an M&A advisor, I typically rely on a multiple valuation method that is a leading tool in transaction processes because it allows for affordable and market-based benchmarking.

The prospective P/FFO multiple stood at:

• 21.0x for REXR
• 16.4x for STAG Industrial (STAG)
• 24.1x for Prologis (PLD)
• 21.2x for First Industrial Realty (FR)
• 28.4x for Terreno Realty (TRNO)
• 23.7x for Americold (COLD)
• 22.2x for EastGroup Properties (EGP)

I have no reason not to like REXR. The company features a unique investment strategy, a secure funding structure, a strong negotiating position in attractive supply-side markets, and a history of outperforming some of its peers.

Despite this, its P/FFO multiple is below most of its peers. Therefore, I consider REXR undervalued and expect the multiple to expand into the 22-23x range (in a conservative scenario).

Thesis Investments and Risk Factors

For transparency, I recently established my first position in REXR as I believe it is one of the top picks in the industrial space. Apart from REXR, I own PLD and FR.

Every investment in the stock market is accompanied by specific market and company risk factors, which in the case of REXR include:

• uncertainty regarding the interest rate environment
• uncertainty about supply-side headwinds across the sector
• high concentration of the geographic portfolio
• Somewhat high AFFO payout ratio

However, I believe that REXR will greatly benefit its shareholders over the long term, as the company offers a clear path to double-digit total returns resulting from:

• additional dynamic FFO per share growth through its investment activity and significant rent increases at lease expiration
• attractive dividend yield (among peer companies), showing remarkable growth
• multiple expansion potential

Therefore, REXR is a “strong buy” for me. I followed my own advice and am bullish on Rexford Industrial. Thank you!