Rexford Industrial Realty Inc (REXR) 2013 Q2 法說會逐字稿

Greetings and welcome to the Rexford Realty Trust second-quarter 2013 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation.

(Operator Instructions)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Brad Cohen of ICR. Thank you, Mr. Cohen. You may begin.

Good morning. We would like to thank you for joining us today for Rexford Industrial's second-quarter 2013 earnings conference call. In addition to the press release distributed this afternoon, we have filed a Form 10-Q with the SEC and posted a quarterly supplemental package with additional details on the Company's results in the Investor Relations section of the website at www.rexfordindustrial.com.

On today's call, Management's remarks and answers to your questions may contain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are usually identified by the use of such words as anticipates, believes, estimates, expects, intends, may, plans, projects, seeks, should, will, and variations of such words or similar expressions. Forward-looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ from those discussed today. Examples of forward-looking statements include those related to revenue, operating income, or financial guidance. As a reminder, forward-looking statements represent Management's current estimates and expectations. Rexford Industrial assumes no obligation to update any forward-looking statements in the future. We encourage listeners to review the more detailed discussions related to these forward-looking statements contained in the Company's filings with the SEC.

In addition, certain of the financial information presented on this call represents non-GAAP financial measures. The Company's earnings release and supplemental information packets, which were released this afternoon and are available on the Company's website, present reconciliations to the appropriate GAAP measure and explanation of why the Company believes such non-GAAP financial measures are useful to investors. This call is hosted by Rexford Industrial's Co-Chief Executive Officers, Mr. Michael Frankel and Mr. Howard Schwimmer, together with Chief Financial Officer Adeel Khan. They will make some prepared remarks and then we will open the call for your questions. With that, I will turn the call over to Michael.

Thank you and welcome to Rexford Industrial's first earnings conference call as a publicly-traded Company. I will begin with a brief overview of our Company and our operating strategy. Howard will then provide an overview of our acquisitions and recent investment activity. Adeel will then follow with a review of our second-quarter financial results and an update on our balance sheet. Our predecessor was formed 12 years ago to focus exclusively on value-driven investment and management of industrial properties in infill Southern California. Today, we are the only pure-play public industrial REIT solely focused on Southern California, which we believe is one of the nation's most significant and most attractive industrial real estate markets. Rexford Industrial's target market comprises the Southern California infill market, which generally includes Los Angeles and Orange County, as well as parts of San Diego County, Ventura County, and the western Inland Empire, for a total infill market of over 1.6 billion square feet, within the total 2 billion square-foot Southern California industrial market.

This is the largest, most diverse industrial market in the nation. In fact, the Southern California industrial market is about 70% larger than the next largest regional market surrounding Chicago. Despite its tremendous size, the Southern California infill market also demonstrates the highest occupancy and highest rental rates of any industrial market in the nation, with many of our primary target sub-markets performing at 95% to 98% occupancy today. Southern California is home to the largest base of manufacturing, distribution, and info-tech businesses in the nation. Southern California is also the most populous region in the United States, with population growth projected at 20% over the next generation. In addition to these underlying growth drivers, Southern California benefits directly from some of the most significant economic transitions currently underway. For example, the ongoing trend of offshoring manufacturing to Asia continues. Much of this product must then be shipped back through the nation's two largest ports of Los Angeles and Long Beach.

Also, infill Southern California is a hub for the nation's eCommerce business and captures a disproportionate share of the expansion in Internet retailing, which in turn is driving significant growth in the distribution of goods and services in the region. A significant portion of this product is imported through the ports of LA and Long Beach and is then delivered regionally, direct-to-consumer, or to local retail stores requiring local replenishment from locations in close proximity to the distribution end-points. We believe our focus on high-barrier, tight-supply sub-markets is a significant advantage. Our infill markets are surrounded by permanent natural barriers such as mountains, ocean, and growing population centers that limit the introduction of competing product.

In addition, the construction of new industrial product for lease is limited by lease rates that do not justify the exceptionally high cost of land and development in infill Southern California. In fact, there is an ongoing reduction in competing product as industrial land and buildings in our sub-markets are being redeveloped into alternative uses such as multi-family, office, or other uses serving the growing population. Since 2001 alone, it is estimated that over 30 million square feet of infill industrial product has been taken out of the market and converted to other uses. With over 60% of our portfolio located in the most densely-populated areas of Los Angeles and Orange Counties, we believe our portfolio is particularly well-insulated from supply risks.

Our portfolio is comprised of approximately 60% multi-tenant properties, which we believe reduces risk and enhances earning stability. We serve an exceptionally diversified tenant base, which includes some large companies, but we generally focus on small and medium-sized businesses or divisions of larger companies. Many of these businesses are deeply ingrained or structurally tied to the infill Southern California economy and must locate within our target infill markets. Our portfolio is well-positioned to capture strong and sustainable growth. Market dynamics overall are improving and this should result in favorable internal growth in revenue and net operating income as the economy and the economic recovery is extending to include small and mid-sized businesses. In fact, rental rates for small and mid-sized spaces in infill Southern California have only recently begun to move from their recessionary lows, while rental rates for large, big box tenants, more typically occupying space in the non-infill eastern Inland Empire, have already recovered to near-peak levels.

Consequently, rental rate growth in our target markets and portfolio is expected to substantially outpace rental rate growth for larger big box space over the next several years. We are well-positioned to capitalize on the market rental rate recovery, with over 40% of our leases rolling over the next two years. We are already capturing the early benefit of an improving market as our consolidated portfolio generated over 350,000 square feet net positive absorption for the first two quarters of 2013. In other words, our net absorption equaled 6.8% of our entire portfolio and illustrates our strong leasing momentum. Rexford Industrial's strong external growth capabilities within infill Southern California is what truly differentiates our Company. We have a deep and active pipeline as demonstrated by our recent acquisition activity, which Howard will detail in a few minutes.

Finally, I'd also like to briefly acknowledge our exceptional team. We've built Rexford Industrial from the ground up over the prior 12 years, exclusively focused on investing and adding value in infill industrial property in Southern California. Rexford Industrial possesses every skill set required to identify, acquire, create value in, and operate infill industrial property. From a G&A perspective, we believe we have the current capacity to more than double the size of our portfolio without a significant increase in G&A expense in the coming years. In short, after completion of our recent IPO, we believe we are well-positioned to continue to build what we believe will be the most successful industrial property Company in the largest, most dynamic industrial market in the nation. With that, I'll turn the call over to Howard to discuss our acquisition strategy and recent investment activity.

Thank you, Michael, and thank you everyone for joining us today. I will address our targeted acquisition strategy and then review our recent quarter acquisition activity. Starting our with our targeted acquisition strategy. We focus on buying industrial properties in the best locations and providing the highest-quality, most competitive product in each targeted sub-market by proactively renovating and improving our assets. We view our predecessor's established presence and deep knowledge of our sub-markets as a major competitive advantage.

Since the start of the second quarter of 2013, we have acquired six industrial properties for $87.8 million. Over the years, we have developed an extensive set of deal-sourcing methods, which allows us to originate and negotiate off-market investment opportunities. We have a dedicated research team that enables us to identify transaction opportunities. We leverage our brand and relationships, as well as an extensive broker marketing program to identify potential transactions ahead of the broader market. We interact with over 3,000 industrial brokers in Southern California on a consistent basis, leveraging technology and our acquisitions team. Since our formation, we estimate that approximately 50% of our investments have been acquired through off-market or softly-marketed deals. We believe we are in the middle of a generational shift in ownership, with over 1 billion square feet of industrial assets built prior to 1980 that may face ownership transition. In many cases, younger generations lack the willingness or ability to actively manage the real estate and our ability to offer competitive tax-efficient exchanges for OP units is a distinct advantage.

A great example of this opportunity is our recent purchase of two properties, Tarzana and Orion, in the San Fernando Valley, one of the lowest vacancy sub-markets, with a vacancy rate of 1.2%, as reported by CBRE. We were able to negotiate a purchase before the properties were formally marketed, thanks to a long-term relationship with the listing broker. The seller, who inherited the properties, was not actively involved in their management and their desire to sell is indicative of the generational change in ownership that is occurring in our markets. The properties had been under-managed and were only 84% occupied. We acquired the properties at an attractive initial yield with significant upside potential through lease-up to market occupancy levels and by addressing deferred maintenance to drive rental growth.

Our target infill markets are very fragmented and inherently less efficient than the big box markets our peers generally focus on. A significant percentage of infill industrial property landlords are private family owners or partnerships and are typically not real estate professionals. In fact, if we consider the aggregate square footage owned by all public REITs, including Rexford Industrial, it would represent less than 3% of the Southern California industrial market. Consequently, Rexford Industrial is positioned with what we believe to be [superior] access to capital in an exceptionally fragmented, relatively inefficient target market. Further, our markets contain a substantial number of properties suffering from a lack of professional management and cyclically low in place rents. We focus on opportunities to increase cash flow by resolving functional obsolescence and by applying professional property and asset management to unlock value.

Rexford Industrial's second-quarter acquisition of Benson, a multi-tenant project in the Inland Empire West, provides a good example of a selling partnership in need of liquidity. We were able to acquire the property in an attractive going end yield by leveraging our relationship with ownership. The property had been poorly maintained due to cash flow issues related to the recession and as a result occupancy was only 84%, well below market levels. We plan to increase cash flow through lease-up by proactively addressing deferred maintenance and improving the marketability of the project, which sits on a high-traffic corner with frontage on two main streets.

Our target investment opportunities include both stabilized and value-add properties. A great example of a stabilized investment is our recent acquisition of Glendale Commerce Center, a multi-tenant industrial complex, for $56.2 million. This is an irreplaceable 473,000 square-foot property, representing what we believe is the highest-quality product in that sub-market. The property was 100% leased at acquisition. This was a complex transaction involving an offshore seller who was rapidly exiting the US property market. The property had recently fallen out of escrow with another buyer and we were able to leverage key inside relationships to acquire the property before it could be actively marketed. We were able to acquire the property at a favorable above-market yield.

Our recent acquisition of 240th Street in the South Bay sub-market of Los Angeles is an example of our value-add strategy and capabilities. The property was designated as excess corporate real estate by the seller and was brought to us as an off-market opportunity. The building had some great features but suffered from a lack of dock-high loading, as well as deferred maintenance, which required repositioning capital and expertise. Consequently, we were able to acquire the property at an attractive basis. We plan to fully renovate the building and improve the functionality with additional loading and fire sprinkler upgrades. We estimate that the project will generate a very attractive stabilized yield on total cost when completed and stabilized.

In summary, so far in 2013, we are on track for another year of strong growth for the Company. With our public Company capital structure, we are well-positioned to continue to execute on our growth strategies going forward. I'll now turn the call over to Adeel to discuss our second-quarter results, balance sheet, and financing activities.

Thank you, Howard, and good afternoon, everyone. In my comments today, I'll first review our operating results for the second quarter; then I will review our balance sheet and recent financing transactions. As a reminder, the Company's IPO took place in the third quarter so second-quarter results cover our predecessor business. Starting with the second -quarter results, our portfolio generated solid performance in the second quarter. The total consolidated portfolio was 90.3% leased at the end of the quarter. Our same-property portfolio, which includes 48 of our properties, was 88.2% occupied compared to 77.3% at the end of second quarter a year ago, an increase of 10.9 percentage points. On a same-property basis, we generated a 12% increase in second-quarter revenue, as compared to prior-year period, which was driven primarily by an improvement in average occupancy. We have reduced same-property operating expenses by 3% over the prior-year period, resulting in a same-property portfolio NOI increase of 18% year-over-year. On a cash basis, our same-property portfolio NOI was up 21% year-over-year.

With regard to leasing, for the consolidated portfolio, we signed 489,000 square feet from 93 leases during the second quarter, which includes 46 new leases and 47 renewals. This generated 161,000 square feet of lease-up, net of space vacated, representing 3.1% of portfolio square footage. Year-to-date, Rexford Industrial has leased 1.1 million square feet with 356,000 square feet of net lease-up. While Rexford Industrial has been focusing driving portfolio occupancy higher, rent spreads have -- turning positive, as well. [GAAP] rental rents on comparable new and renewal leases were 8.2% higher than the expiring leases. We are seeing a reduction in concessions across our markets, which is helping to drive the positive GAAP releasing spreads. On a cash basis, rents rolled on 2.8%; however, this is weighed down by a few large leases as more than 80% of renewals achieved flat to positive releasing spreads. Excluding one large renewal in Los Angeles County on 68,000 square feet that was renewed on a 10-year lease, cash spreads would have been roughly flat. As our portfolio occupancy approaches stabilized levels, we expect cash releasing spreads to turn positive.

Turning now to our balance sheet and financing activities. At the close of second quarter ended June 30, our predecessor entity had total consolidated debt outstanding of approximately $351 million. Subsequent to the quarter closing in July, we completed our IPO and related formation transaction, which increased our liquidity and substantially reduced our indebtedness. Through our IPO, concurring private placement, and formation transaction, we raised gross proceeds of $277 million through the issuance of 19.8 million shares issued at $14 per share. In connection with the formation transaction, we issued an additional 8.6 million share of common stock in operating units to our predecessor entity. We also entered into a $60 million term loan and a $200 million unsecured revolving credit facility, which has an accordion feature that allows the Company to increase the facility to $400 million subject to certain requirements.

Using proceeds from the IPO, the concurrent private placement, and the above-noted new borrowings, we repaid $303 million of the $351 million outstanding debt, secured by the properties we acquired in our formation transaction. As a result, as of July 31, our total debt balance was approximately $121 million, with an average term to maturity of 4.5 years. We enjoyed low leverage with a pro-forma debt-to-market capitalization of 24.7%. We had cash in hand [of] totaling [$90 million] and $110 million of available capacity on our revolving line of credit. Going forward, we expect to maintain a strong balance sheet with ample capacity to support our growth strategies. With that, we will open the call to your questions. Operator?

Thank you. We will now be conducting a question-and-answer session.

(Operator Instructions)

Blaine Heck, Wells Fargo.

In looking at your uncommenced leasing schedule on Page 15 of the supplemental, it looks like your pro-forma occupancy was roughly unchanged from where it was in the prospectus, despite the roughly 160,000 square feet of net absorption, so I was just wondering if you guys could reconcile those two numbers?

Are you asking what is the -- pro-forma occupancy is 90.3%, that's consistent with what we had projected previously in the S-11, so I'm not clear exactly on what your question is.

Okay, so in the prospectus, you had a pro-forma occupancy of 90.1%. I'm assuming that's from March 31, so given that there was 160,000 square feet of net absorption, I would have thought that would have gone up a little bit more than to 90.3%?

This is the deal. The pro-forma occupancy that was in the S-11, the 90.1% that you've referenced, was effectively around June 4, if I recall correct, so there was just a little bit of lag from that perspective until June 30.

Okay, great. That makes sense. And also staying on that schedule, if I look at the total pro-forma annualized base rent, that also went down from $44.1 million on the prospectus to $40.4 million. Can you expand on what caused the decrease in that one?

The key thing there is that we're recording -- this is Adeel, by the way -- we're reporting the June 30 numbers and what's not including those in these numbers are Orion and Oxnard.

Okay.

And we were presenting the S-11 -- we were presenting the Orion and Oxnard--

Pro-forma.

Right, so that's your difference.

Okay, great. And then if you can just give an update on what you're seeing in the acquisition market and whether or not you have seen any change in cap rates given the volatility in interest rates we've seen lately?

Sure, this is Howard. I'll say that our pipeline for acquisitions has never been stronger. We're very excited about what we see moving forward. We feel we're very much on track with our goal of completing an additional $50 million in acquisitions for the remainder of second half of 2013. And I'll comment -- as to your question on cap rates, Rexford -- we are not typically a cap rate buyer. We don't necessarily always look at the initial cap rate of where we buy. We're more focused on where we stabilize assets in a year or two and so for us looking at the broader market, our acquisition goals really are more in terms of an unlevered return, in which we're focusing on 8% to 11% returns.

Have you changed any of your underwriting assumptions given the increase in interest rates?

Well, we -- you want to comment on that one then?

Yes, I'd say a couple things. One, really of course, we haven't really seen an impact from interest rates so far and also we incorporate a level of cap rate decompression in our underwriting to leave a substantial buffer for things like increasing costs, whether it's interest rates or otherwise, that limit our cash flow or value.

All right, great, thanks.

Michael Mueller, JPMorgan.

Looking at Page 10 in the supplemental at the same-store occupancy of 88.5% at June 30, can you talk about what that same-store portfolio was occupied on March 31 and then any notable changes by market in there?

Well, we're looking -- this is Adeel. We're looking at the Q1 '13 same-store occupancy and we'll deal with the question regarding the market first.

One comment I'll make on the market is the product type we focus on is -- in the infill markets, the multi-tenant and some of the smaller business-type product, we're still at the early stages in our recovery. We've seen a good increase in net absorption, as well as rental rates starting to firm up. This is a little bit different -- this story than some of the big box product, predominantly that was in the Inland Empire, where you saw a more rapid recovery in that product some time ago and they are already at or even above some of their peak-level occupancies or rental rates. Just to give you an example, for us, San Diego had been a lagging market and in the past quarter, we saw San Diego make substantial progress in terms of occupancy recovery and rental rate growth and, in fact, for us San Diego, on a cash basis, our leasing spreads were 6% positive and 28% on a GAAP basis.

Michael, to go back to your other question, I'll have to deal with that question offline, to give you the Q1 same-store occupants percentage, so just stay tuned.

Okay, that's all I had, thanks.

(Operator Instructions)

Nikhil Bhalla, FBR.

Adeel, just the first question is for you. Just give -- if you can just provide what the pro-forma debt is at the moment with all of the acquisitions you've just announced?

$121 million as of --

$121 million, as of now. Okay. And the next question is for Howard. Howard, you talked about the generational shift here. Can you give us some sense of what percentage of the pipeline that you're tracking right now is attributable to that generational shift?

Well I'll give you an even better example of the acquisitions we've made over the past probably 2 years, 2.5 years, approximately 50% of those acquisitions we feel the catalysts were related to the generational shift. So what that means is either people doing estate planning, ownership transitioning as partners or primary owners have passed away and so forth. So it's quite an interesting phenomenon and one that we see actually growing and becoming an even stronger part of the active pipeline.

Okay, and just when you look at the market right now overall, your current rates, are they -- do you feel that they're at market, below market, how much different they are than where the market is at the moment for your existing portfolio?

We feel we're -- within the existing portfolio, we believe we're at market.

Okay.

That's really on average and it's a great question because when you look at this infill market that we focused in, CBRE projects rental rate increases growing at 8% per annum for the next two years and in three years reaching -- rather even starting to exceed back to peak-level market rents so we still have quite a way to go in terms of recovering to peak-market rates.

Got it. Thank you.

(Operator Instructions)

Thank you. We have no further questions at this time. I'd like to turn the floor back over to Management for any additional remarks.

I just want to say thank you to everybody for dialing in today and we look forward to moving forward with you together.

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.