Good afternoon. Welcome to Citi's 2024 Global Property CEO Conference. I'm Craig Mailman with Citi Research, and we're pleased to have with us Rexford and co-CEOs Michael Frankel and Howard Schwimmer. This session is for Citi clients only. If me 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 go to liveqa.com and enter code GPC24 to submit any questions if you do not want to raise your hand. So, gentlemen, I'll turn it over to you to introduce Rexford and the team. Provide any open remarks. Tell the audience the top reasons an investor should buy your stock today, and then we can head into Q&A.
Hi, Craig. Well, thank you so much for having us today, and thank you all for being here. I'm Laura Clark, CFO, and I will take your question. Rexford is favorably positioned today given our unique value creation strategy, and that enables outsized returns and superior cash flow growth. That's demonstrated by our earnings per share growth, which has averaged 16% annually over the last five years, outperforming the peer group by nearly 50%. That's enabled by several key factors, which I'll touch on now. First is our extensive internal and external growth that's driven by our value add, repositioning, and redevelopment expertise. That's focused on renovating and repositioning assets to higher quality and functionality, as well as our proprietary sourcing advantage and unparalleled market depth and expertise. The internal earnings growth embedded within the portfolio today, assuming no further acquisitions and no market growth, is significant.
Over just the next three years alone, we project internal cash NOI growth of 42%. That's equal to $240 million, which is expected to grow NOI to over $800 million over the same period. This substantial internal NOI growth within our existing portfolio is projected to generate average annual core FFO per share growth over the next three years in the 11%-13% range. In addition, our external growth opportunity continues to expand, driven by our proprietary acquisition sourcing platform, which in just the prior three years has generated over $5 billion of highly accretive investments, predominantly through off-market and lightly marketed transactions, that are producing substantially above market returns on investment. Our external growth opportunity is extensive as the depth of our market coverage and informational advantage is increasing in quality and volume each year through our dedicated research and unprecedented market relationships.
This positions Rexford to expand upon our current 2.5% market share within the highly fragmented 1.8 billion sq ft Infill Southern California market. Second is our sole focus within Infill Southern California , which is the fourth largest market in the world and the highest barrier, highest demand, and lowest supply industrial market in the nation. That enables outperformance through cycles. Demand today is very diverse, and it's growing for our Inland Empire mission-critical locations. There is an inability to increase new supply due to scarcity of land and development constraints within Infill Southern California . This persistent supply-demand imbalance insulates the Rexford portfolio and positions us for continued outperformance.
Third is our irreplaceable portfolio, which consists of 46 million sq ft of highly functional generic-use industrial product that's occupied by an exceptionally stable and diverse tenant base, serving the largest regional zone of consumption in the nation and the most diverse regional economy in the nation with over 24 million people. Fourth, we maintain an investment-grade, low-leverage balance sheet with a net debt to EBITDA at 3.6 times, which provides us with tremendous flexibility and access to attractive sources of capital to fund accretive growth opportunities. We take a very rigorous approach to capital allocation that's focused on driving shareholder value. By way of example, our investments over the prior year are driving 50% higher earnings per share accretion when compared to investments made over the preceding two years, inclusive of recent higher cost of capital.
Lastly, our holistic focus on positive environmental, social, and governance impacts that drives exceptional resiliency and long-term value creation. We are committed to mitigating climate-related risk and recently published our validated Science-Based Targets and Net Zero commitment. Finally, it's important to recognize that our Rexford team is the primary determinant of our success. It's their innovation, their collaboration, and market-leading efforts that enable our great business today and into the future. Back to you, Craig.
Perfect. Why don't we start with Southern California fundamentals? This is on top of everyone's mind here. But Southern California, for you guys, is a very large area, right? And so can you walk through the different submarket exposures to give people a sense of differing kind of demand and rent growth conditions across the different submarkets that you traffic in and maybe help us with putting around exposure either on a per square foot or NOI or ABR basis to kind of put in context where the pockets of strength are and where you guys are most exposed versus maybe where there's a little bit of weakness, but putting context to the exposure to those submarkets.
Maybe I'll start. Thanks for the question, Howard. Maybe you can add a little color as well. But first of all, let's start with our exposure. So Rexford Industrial is focused on the infill market in Southern California. 80% of our assets and portfolio exposure is in the greater Los Angeles, greater Orange County, a little bit of San Diego, a little bit of Ventura markets. 20% of our exposure is in what we call the Inland Empire West, which would be more that Ontario market, also a good, very strong market. And with respect to market conditions, for instance, over the prior year, over the bulk of our markets where we hold 80% of our assets, excluding the IE West, last year, for instance, we saw about 4% rent growth for assets that are comparable to Rexford's functional and quality and location.
In the IE West, it's a little bit of an outlier, particularly in the larger size space, 100,000-300,000 sq ft. We saw a little bit of weakness, principally driven by some new supply, some new development that came into that market specifically, which was a direct result, frankly, of the fact that rents in the IE West increased about 165% through the pandemic years, enabling developers to do a little more work. Development starts even in that market have been zero and will continue to be zero for some time. And we see that market being absorbed naturally in the larger size range over the next 12 months or so. And frankly, it's not a real threat to Rexford considering our average space size in that market is only about 30,000 sq ft.
With respect to bringing that forward to today, demand is very broad-based across industry sectors ranging from consumer products, electric vehicles, aerospace, you name it, which is really characteristic of our markets. Incrementally, with increases in port volumes to L.A. and Long Beach, we do see incrementally more activity from the 3PL and distribution businesses, which is not unexpected. With that, maybe I'll turn it over to Howard.
Yeah. Thanks, Michael. So when you look at our markets, I think you heard most of you probably heard us on our earnings call where we talked about demand had picked up. That's built into even today where we see substantial demand and activity on really almost all of our vacant space in the market. It's following a natural progression where you initially have people looking, and then we've had LOIs, and now we're trading a lot of lease documents around. So we're really, really happy with where we see demand. Just, Craig, your question was about where we see soft spots. I mean, Michael really identified the main place that's a little soft, and that's the Inland Empire West. We reported last quarter there was about a 10% decrease in market rents in that market.
But really, if you look at the 80% of the infill markets where Michael also mentioned our concentration is, there's robust demand, and we don't have the notion of new supply, which is really what's disruptive to a market and can lead to fluctuations in rent, which you're seeing in the Inland Empire, mostly actually in the Inland Empire East. Just by example, we're delivering a couple of projects today. I'm thinking of one in the San Fernando Valley, for instance. It's thinking about 140,000 sq ft. Well, we'll have the only new building in the San Fernando Valley. And that's a 170 million sq ft marketplace. And we're going to do really well in that building.
We have no worry at all about the velocity of leasing, etc., for most all of the projects, or probably all of them, frankly, that we're delivering through our pipeline into the marketplace. So our market functions much different than all of the other larger national markets that have land availability and the ability to continually introduce supply, where we're fully built out. There's literally no land availability, and we don't even really think of the disruptions that new supply can produce within 80% of our infill markets.
And let me add just one more thing about the IE West market. So when we talk about the softness in the IE West market, it's particularly in that 100-300,000 sq ft range where you did see an outsized amount of deliveries. The good news in that size range is that there's really been no new starts in the last few quarters there. Rexford doesn't have a lot of exposure there. Our average tenant size in the IE West market is 30,000 sq ft. We do have two boxes available today in that size range. And the good news is that we have multiple offers on both of those spaces today. And that is an increase in activity over the past, call it 45-60 days.
Getting a question coming in. Anything you can give us in terms of a real-time update on where occupancy is trending this quarter and where quarter-to-date rent spreads are trending?
I think go ahead.
We can't really give disclosure on things we haven't yet publicly disclosed, like spreads and whatnot. But we can say that when we say that leasing activity is strong, I think that implies that we're tracking well in terms of occupancy.
Yeah. In line with our projections, we can tell you that.
As we think about vacancy has moved up in a lot of markets, but that's on a total level. As you guys look at your competition set for your size submarkets, kind of where is vacancy in that competitive set relative to maybe where the total market may be trending?
Craig, that's a great point. If you look at our markets today in Inland Empire, Southern California overall, we have about 2.75% vacancy. But if you were to look into the vacant buildings to see of the vacant buildings, which and how many of them actually even begin to compete with our product on a quality, functional, locational basis, and by the way, we do this work, and it is less than half of the stated market vacancy that even begins to compete with us. And it's so interesting. If you look last year where there was negative absorption in the markets, we actually looked at every material building that drove negative absorption. And it was probably 80%+ comprised of buildings that were truly obsolete that don't even begin to compete with us on a locational or functional basis. So there is a distinct bifurcation in the market.
I guess that leads into also, right, price is just one component of that discussion versus functionality of a building, location to highways, and consumer. As you guys have been seeing demand kind of rebound here a little bit, what are the pressure points you're seeing with tenants? Is it around price, or is price sort of a byproduct of these other kind of asset-specific characteristics?
Well, the tenants are telling us they expect to pay more rent. So they don't seem to be terribly price-sensitive, frankly. And by way of example, a great leading indicator is the fact that on all of our leasing activity, in our markets, we have annual escalators built into our leases. And we have not been signing anything less than 4% annual escalators in our leases. And so clearly, the tenants are telling us they expect to and can and are comfortable to pay more rent. And so the key drivers around market rents really are more about sentiment among owners. We do have a lot of non-professional owners in our market who have low basis in their properties, who might be happy to not push the rents to the max, that sort of has a governing effect on market rents from time to time.
But the governor is certainly not the tenant's ability to pay rent.
Yeah. And I think I'll add to that that what the tenants are telling us is they're no longer waiting to make decisions. Last year, middle of the year to sort of later in the year, we saw tenants really a bit frozen, frankly. And that activity started picking up. A lot of them were burning through excess inventory. Without interest rate stability, it was hard to make some decisions. Now that we have interest rate stability and a hope that we might see some cuts, I think tenants are seeing through and looking more toward the future and really doing what they have to do now to operate their business. And so we saw a bit of pent-up demand that now is releasing into the marketplace.
Another question coming in just on portfolio sublease. Kind of what's in your portfolio today? How does that compare to kind of the market averages?
I mean, from a subleasing perspective, we haven't seen any material increase in subleasing in our portfolio relative to the last prior years.
How much does that impact you in industrial, the increase in sublease as you guys may be competing against the space? Is it as impactful as maybe what we're used to in some other property types?
Well, I think look, you've seen more subleasing in larger buildings, mostly out east in the Inland Empire. The subleasing came about, first of all, because of people now needing to reset some of their expectations. When vacancy was below 1%, people took literally any building they could get their hands on. And many times, it was more than they needed, or they made decisions thinking businesses would grow at the same rate we saw during the COVID years. So as we're normalizing out, people had to do some right-sizing. And that's what also has been going on for the past year. And I think we're seeing sort of the end of that. The majority, I'd say, of the sublease space that was out there was in the bigger boxes, though.
We didn't really experience much of it and still don't in these spaces that we have, which are just really more essential to the consumptive base that our tenant base focuses on. So for our business, benign. Perhaps if you're in the big box business, a lot more relevant.
Maybe shifting, Laura, to your commentary or discussion around kind of that three-year FFO growth that's basically somewhat baked into the portfolio, right, not dependent on external growth. Can you talk about the cadence of that, given maybe some of the drag from more space coming offline for redevelopment this year versus what you have kind of delivering this year and next year on sort of a full-year annualized run rate and how we should think about annual-type growth rate over the next three years and the differences in that as stuff comes on and off?
Yeah. Great question, Craig. So I talked about in the prepared remarks that we have $240 million of internal embedded growth in the portfolio. So that's no acquisitions and no market rent growth. And $95 million of that is from repositionings and redevelopments. And so that's translating into a significant component of the 11%-13% average annual core FFO per share growth that we expect to achieve over the next three years. The cadence of that growth, though, is a bit more weighted towards 2025 and 2026. Our growth this year is projected to be 5%. So that implies a higher growth rate into 2025 and 2026. And really, what that's being driven by is the timing of the repositioning and redevelopments and really the ins and outs of NOI.
We have just the same amount of NOI coming online from repositionings and redevelopments as we have coming offline in 2024. As we look forward, and in 2024, that's about $13 million coming online. As we look forward, we expect for the majority of that NOI is going to be coming on through 2025 and 2026 as we complete and stabilize those properties.
So if you had to break it out as you get to that ramp, and if you're at 11-13 and your growth this year is a little bit lower, so maybe you're in kind of the mid-teens, I think Michael said maybe 15-17 in 2025 and 2026 just the way the math works, what would the breakout be of the contribution from the NOI from redevelopments coming on a net basis versus sort of what the portfolio is going to put up from a GAAP same-store basis?
Yeah. Well, we haven't put out same-property guidance for the next three years, but I can tell you the other components of the $240 million. So $95 million is from repositioning and redevelopment. Another $95 million is from the mark-to-market of our below-market leases in the portfolio. And the cadence of that varies a bit, but pretty consistent over the next three years. $40 million is attributed to the embedded rent steps that are in our portfolio. Today, the portfolio averages 3.6%. Michael talked about how we're signing 4% average annual rent steps on our new leases. So we do expect for that 3.6% in the portfolio to continue to grow. So those are the components of the growth. Important, though, maybe I'll talk a little bit about the range of 11%-13% and what assumptions are embedded in that.
At the low end of that range of 11%-13% growth over the next three years, the low end assumes zero market rent growth for three years. It also assumes 96.5% occupancy stable for the next three years. No change in occupancy. 96.5 is the low end of our occupancy guidance for 2024. The high end, the 13% growth, assumes 5% average annual market rent growth and assumes occupancy levels closer to 98%. Again, that 11%-13% assumes no acquisitions.
As we think about the NOI coming from the redevelopments, if you had that slide in there two years ago when cost of capital was cheaper, what would be the margin compression that you guys are seeing on this redevelopment from when maybe you put some of these assets in the portfolio with the intention of redeveloping down the road and maybe even more broadly from a kind of a development margin that we've seen cap rates back up a little bit here relative to two years ago? I'm just trying to get a sense of how good you still feel about the overall kind of value creation from this engine today, given that some of its kind of legacy when the world was in a different place and how you're underwriting additional projects to come in going forward, where those kind of yields could go.
That's a great question. I would say let's approach that from two perspectives. One is the legacy assets we bought, call it during the pandemic, which is part of the question. Two, let's carry it forward to the investing we've been doing more recently. In both cases, by the way, they're fueling the company with tremendous positive growth and not diminished growth compared to when we were buying, call it three or four years ago. I'll explain why. Three or four years ago, as we entered the pandemic and worked through the pandemic, we were acquiring with deeply below-market in-place rents because market rents were increasing so dramatically. Remember, on average, rents increased in our markets by 80%-100% or more across our Inland Empire submarkets.
So for the vast majority of those assets that we bought during the pandemic, actually, the repositioning or redevelopment margins has increased, not decreased. And I think the proof is kind of in the pudding because if you look at all the deals we've stabilized that represent vintage investments during that timeframe, they've pretty much all stabilized at achieved levels of cash flow that exceeded their underwritten levels of cash flow consistently. And then if you flash forward to today and you look at the investing that we've been doing, call it for the last 14 months since the capital markets really started to shift in earnest, what's ironic is that despite the higher cost of capital, the yields we've been able to solve for more recently are at such levels that they more than overcome the higher cost of capital. And actually, we've measured that.
We've looked at all the investing activity we've done for the last, call it, 3 or 4 years. We've looked at the FFO per share contribution over the first 5 years of holding all these investments. What we found is that the investing we were doing over the last, call it, 12, 13, 14 months, the FFO per share contribution is 45%-50% higher, inclusive of today's higher cost of capital, as compared to the investing we were doing 2, 3, 4 years ago at a substantially lower cost of capital. I think that's the thing that's sometimes counterintuitive.
Frankly, the investing we've been doing over the last year or so is probably some of the best investing in terms of value creation, both inbound yields averaging about 5.5% and stabilized unlevered yields averaging well over 6%, probably some of the best investing we've done since we went public 10 years ago.
No, that's helpful. Maybe sticking with just the transaction market, you guys don't give guidance with incremental transactions and that you've been a prolific buyer the last couple of years. Michael, you've expressed that this could be a very interesting time with a lot of opportunities. So what are you guys seeing from a deal pipeline perspective today? And Laura, maybe how are you thinking about financing those deals if they do come to fruition?
Yeah. I'll mention, well, in our last earnings call we reported, we had about $150 million under contract or LOI. There's still a lot of capital on the sidelines in our marketplace. Some's come back. But predominantly, people that could step up and perform are sort of rare to find. And so the opportunity set in that sense is increased for Rexford. We have a tremendous amount of activity in our acquisition group. And I really look forward to updating everyone on our next earnings call, but we really can't give you any more detail around numbers. But I think we're really pleased with what we're seeing. And Michael's comment as to the yields and so forth that we're looking to buy at still hold.
But the one thing I will point out is that when the Fed does start the first cut in interest rates, we know there's a ton of capital that's going to come back into the markets. And we do expect some pretty quick cap rate compression could happen later in the year in our markets.
Yeah. And in terms of funding, we obviously are going to continue to stay focused on maintaining a very low-leverage balance sheet. And so you'll see us fund with a mix of debt, equity, and dispositions also can be a source of funding. But the reason that we maintain a low-leverage balance sheet is it does allow us to be opportunistic at certain points in the cycle and also allows us to be opportunistic for different types of transactions. And so if there are opportunities where we're able to flex that balance sheet, our long-term leverage target's to be in the kind of 4-4.5 times area.
But for the right opportunities and in the right market conditions, you may see us flex the balance sheet potentially even above those levels with certainly an eye back to that 4-4.5 times leverage level long term.
I guess more of a thought exercise, but if you guys were a private company, would you be doing anything differently? I know it's been a decade or so or close to it now that you've been a private company, but would that at all change your mindset in this type of environment?
Well, I would say not generally. However, if we were a private company and was all our own capital, you'd probably see us make more investments that have a longer-term horizon to value creation. But that's just a function of being in the public markets. Other than that, I don't think we'd change much at all.
We're almost halfway through the conference or a little more than that at this point. As you've been meeting with investors, do you feel like there's one misconception you guys have had to address continually that you would, whether it's a market-specific, a company-specific, guide-specific, that's worth kind of clarifying in a more public setting?
I think the most recent investor discussions have been very positive, focusing on the key drivers of our business, which is great. It's reassuring because last year, there was a lot of noise in the markets, normalization after the pandemic, capital markets, uncertainty, etc. I would say the one area, perhaps, we're a unique, very different business relative to most REITs in that Rexford is a growth company. We have a massive growth opportunity ahead of us. We only own about 2.5% market share right now. It's a very potent, highly accretive growth strategy. So that's very different than what folks are generally used to in the REIT world. So, for example, the kind of knee-jerk reaction to cost of capital. There's this notion of, "God, when cost of capital's low, you can buy, buy, buy, and grow, grow, grow.
When cost of capital goes up, oh my goodness, you better shut it down." Without looking more granularly at the business and the fact that our levels of accretion are far greater today, actually, inclusive of the higher cost of capital, that's pretty exciting if you're an investor. But it's hard to digest sometimes if you're just looking broad brush and only considering the changes in the capital markets on a strategy. So I think that's an area that folks that dig in a little bit, they get it quite clearly. But there's the big capital movements that tend not to necessarily discern that. So maybe that's an area that you could say where we results in a little perception issue.
We got one more coming in through live QA. So just on capital recycling, is there a spread or target return or margin that you're underwriting for dispositions to fund current and new projects?
It's not something we've really disclosed, but we do have a very material capital recycling program in place where we see an opportunity to sell some assets where we've harvested value. You'll see that ongoing. I think this year is certainly a better environment for selling assets than last year was. Remember, we still have about a 51% mark-to-market on average across our portfolio in terms of our in-place leases. There's still a lot of value to harvest there. We're super excited about the opportunity to recycle as well. You'll see some of that this year.
As you guys are looking at acquisitions, are you seeing more of the product maybe coming in the IE as some developers try to get out of things that they've built recently? Or is there more of the fragmented ownership generationally as people get close to retirement, maybe want to move from California? Where's the predominant product coming from that you guys are most interested in?
Well, first of all, I think we certainly had an expectation there could be more distress in the marketplace, but we're not seeing it. And surprisingly, even in that bandwidth that I think Michael or Laura might have mentioned, that 100-300,000 sq ft range that's taking longer to achieve lease up, there's little to no distress in terms of people trying to sell those assets, partly because most of it is institutional partners. The developer may have been squeezed out, but the institutional money's hanging on because they like the assets and their basis. But I think it's sort of business as usual for us. You've heard us in the past talk about this generational change in ownership that's been occurring. A lot of the assets have been held in partnerships, individual owners. And these people are aging out.
I mean, they're literally probably, on average, a lot of them are 90 years old ±. And that has been and continues to be our single greatest source of opportunity in the marketplace. And I think what's really interesting is if you think about those people, they have a different business model. They sell for continuous cash flow. They don't want a disruption because maybe a new tenant will pay them more rent. So in-place rents are very low. They don't invest in these buildings. And it provides a tremendous opportunity for us to unlock the value in those assets as we cure functional issues and modernize the structures and so forth. So it's really an exciting time. And that opportunity set just continues to march toward us in greater volume.
You had mentioned if the Fed does cut rates, you feel like there could be maybe a rerating, seems maybe quickly. We had another private peer here at this conference who was talking about the CMBS market and the spread tightening that they're seeing there. Does this make it harder for you guys to buy assets with a tighter spread if the public markets don't kind of help you out a little bit on the cost of capital here? Is that kind of a governor at this point? Or to your point, you guys have other areas of capital that you can tap through their dispositions or elsewhere?
Well, we'll continue to have a relative cost of capital advantage, but that's not going to be the key driver of differentiation in the investment market. The key driver of the differentiation in the investment market is going to be the efforts we make internally. We have that dedicated research team, and we have a market presence in depth that is unprecedented. And the result of that is that 80%-90% of our investments have been through off-market or lightly marketed transactions that we are largely catalyzing, insulating us from that marketed world, right? And those folks that are competing on those marketed transactions are largely not even seeing the deals we buy. And it's astounding when you look at the volume we do. It's impressive. And that translates directly into better investment yields and returns. That's why we do it. That's why we make that effort.
That's why, as Laura cited earlier, our cash flow growth is substantially higher than what you can achieve in most other business structures that are focused on investing in our market. The last five years, CAGR has been 16% FFO per share growth. And frankly, if you look at our positioning today on a look forward, we're positioned even stronger.
I'll add to that, the type of transactions that you're referring to with that CMBS-type capital is not really. They're not value creation opportunities that we focus on. There is none of that capital available to facilitate people buying those type of opportunities, which is primarily our focus and sort of the secret sauce of Rexford.
Perfect.
Can I ask one quick?
Yeah. If I can figure this out.
First of all, here.
You guys just mentioned that activity picked up in the last 45 days, I guess. What do you attribute that to? Is that the labor contract? Is it the canals? Anything else? Then is that kind of in line with your projections for when you set your rent growth forecast for the year?
I'd say it's a whole range of factors, frankly. Number one, we definitely saw some pent-up demand from last year coming back to market. Remember, last year, there were a lot of unknowns: normalization from the pandemic, demand for goods and services for our tenants, interest rates, tremendous impact on tenant demand. Today, there are fewer unknowns. We have a more stable interest rate environment, and folks are really comfortable with where demand is for their goods and services. And I think that so we have a lot of pent-up demand coming back into the market. And plus, we have the current demand that you'd normally see on top of that incrementally due to the port traffic that you mentioned, incremental demand from 3PLs and distribution businesses as well. So very broad-based.
Generally speaking, on track or better compared to our projections and the expectations that we set earlier.
Rapid fire. Same starting yield for 2025 for the group.
For the peer group.
Yes.
Mid single digits.
Number of public companies in the industrial space in 12 months: more, fewer, the same.
Same.
Best real estate decision: buy, sell, redevelop, or repurchase stock?
Reposition and redevelop.
Perfect. Thank you, guys.
All right. Thank you all.
Thanks, everybody.