Rexford Industrial Realty Inc (REXR) 2024 Q2 法說會逐字稿

Thanks for standing by. My name is Mondy, and I'll be your operator today. At this time, I'd like to welcome everyone to the Rexford Industrial Realty, Inc. second quarter 2024 earnings call. (Operator Instructions)

I would now like to turn the call over to David Lanzer, General Counsel. You may begin.

Thank you for joining Rexford Industrial's second quarter 2024 earnings conference call. In addition to the press release distributed yesterday after market close, 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 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.

Additionally, certain financial information presented on this call represents non-GAAP financial measures. Our earnings release and supplemental package present GAAP reconciliation and explanation of why such non-GAAP financial measures are useful to investors.

Today's conference call 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'll turn the call over to Michael.

Thank you, David, and welcome, everyone, to Rexford Industrial's second 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 the strong results, demonstrating the strength of our Rexford platform and the resilience of our infill Southern California industrial market. As a reminder, we are the only industrial REIT focused exclusively on investing principally and smaller and medium-sized spaces within infill Southern California where refined superior tenant demand fundamentals and substantial opportunities to add value.

With our portfolio's average space size equal to 26,000 square feet, we operate in a fundamentally different segment of the market as compared to the big box market comprised of buildings in the 250,000 to over 1 million square foot range. Our segment of the market is a much larger portion of the market is a much higher percent of the market, and our target until the tenant base has proven to be more stable through cycle as compared to the big box market within Southern California.

Turning to our second quarter performance, we are pleased with the team's strong operating results, which continue to track the expectations we set earlier this year. On the leasing front, the team completed 2.3 million square feet of leasing activity, generating leasing spreads of 68% on a net effective basis and 49% on a cash basis. We generated 400,000 square feet of positive net absorption to end the quarter with our same property portfolio occupancy up 70 basis points to 97.3%.

Our second quarter consolidated net operating income was up 21%, and our FFO per share was up 11% compared to the prior year quarter. Net operating margins were up 50 basis points to 77.7% compared to the prior year quarter, demonstrating the quality of our growth through increased operating leverage.

As expected, our infill industrial markets continue to normalize from the pandemic area levels of frenzied demand, which continues to be impacted by persistently high interest rates and uncertain domestic political environment and ongoing global unrest. Despite these macroeconomic factors, our infill Southern California industrial markets continue to demonstrate relative resilience, supported by the strongest underlying long-term supply demand fundamentals of any major industrial market in the nation.

Drilling down into our segment of the infill Southern California industrial market, we continue to see a distinct bifurcation in relative performance in favor of higher quality, highly functional, small-to-medium sized spaces compared to the older vintage less functional product that makes up the vast majority of our 1.8 billion square foot infill market. The long-term outlook for our infill Southern California market remains very positive due to a virtually incurable long-term supply demand imbalance. The near-term outlook for market rents may continue to reflect a nominal level of volatility. However, we believe the foundation for market rent growth is inherent within our markets.

Our tenants are indicating through their behaviors that they expect to pay higher rents in the future. They are expressing these expectations through their proactive renewal activity and through the average compounding 4% annual contractual rental rate increases we are embedding within our leases.

The relative resilience and superior performance of the Rexford portfolio reflects our differentiated business model and market opportunity focused on value creation. The single greatest driver of our growth over time is generated through our value-add modernization, repositioning and redevelopment of vintage and underutilized properties within Southern California. With over 1 billion square feet of product built prior to 1980 within our target infill market, we benefit from an almost limitless pallet of opportunities to drive value creation into the foreseeable future by substantially increasing the cash flow generating capacity of these properties through physical improvements that are not reliant upon market rent growth to create value.

Rexford's forward internal growth opportunity is also substantial and reflects the balance and strength of our business model. Over just the next three years, we expect cash NOI to increase by $229 million or 35%, driven significantly by our value-add property improvements repositioning and redevelopment, importantly, the system's today's rents and no future acquisitions.

With that, I'd like to thank Rexford team once again for your sector leading results, driven by our entrepreneurial passion for creating value. Lastly, I'm pleased to acknowledge that Howard and I just completed our 20th anniversary as partners growing Rexford together. Howard, it continues to be a true privilege and great fun to work with you and the entire Rexford team, and I couldn't be more excited about the next phase of Rexford's growth.

And with that, I'm pleased to turn the call over to Howard.

Thank you all for joining us today, and thank you, Michael. It continues to be an incredible journey. And I am thrilled and also very excited for Rexford's future growth. Rexford delivered solid second quarter operating result, delivered by the sustained strength of our high-quality portfolio and great execution by our entrepreneurial team.

As Michael mentioned, we continue to see a bifurcation in performance between higher quality product compared to the older vintage, less functional product that represents the majority of our vast infill Southern California market. It is important to recall that our value creation mandate focuses on converting those older vintage properties into the most functional, highest quality assets within their respective submarkets. These modernization and functional improvements substantially increase the utility and the per square foot value of our spaces for tenants, positioning Rexford to outcompete through all phases of the economic cycle.

The favorable relative performance of our portfolio compared to the market is noteworthy. For example, our 400,000 square feet of positive net absorption equal to 80 basis points of our total square footage towards activity in the market, which saw 10 basis points of positive net absorption according to CBRE. Our positive net absorption contributed a 70 basis point increase in our same property occupancy, ending the quarter at 2.7% vacancy, which compares favorably to the overall infill market vacancy of 3.9% according to CBRE.

Another positive leading indicator is our continued strong renewal demand in the second quarter, with 79% net effective rent spreads and 58% cash spreads. This resulted in a strong quarter retention and backfill rate of 80%.

Looking at general market conditions within infill Southern California, the second quarter leasing activity was strongest in the 10,000 to 100,000 square foot size segment, up 24% compared to the prior quarter according to CBRE. With about 60% of Rexford ABR coming from spaces below 100,000 square feet and given our second quarter average of lease size of approximately 18,000 square feet, our irreplaceable assets are ideally positioned at the strongest demand segment in the market, a direct result of our strategic value driven business model.

Regarding rent levels, as expected, we continue to see choppiness across submarkets and size ranges with rents down approximately 2% sequentially for highly functional product comparable in quality to our Rexford assets. Year over year, taking rents for high quality product comparable for our portfolio off about 4.5%, which compares favorably to the overall infill market.

The relatively favorable performance of well-located, highly functional product within our markets is logical as we have generally noted over recent quarters that a majority of vacancy contributing to a negative absorption in the market is typically comprise of lower quality, older vintage or obsolete products. Although we expect some continued near-term relative volatility, the current supply-demand backdrop seems to be supporting current rent levels within a relatively tight range and maintaining the foundation for potential future growth.

This favorable backdrop is further supported by the fact that it is nearly impossible to materially increase net supply within our markets. Construction of new products in our size range is at near zero, and it's expected to continue to be de minimis. When little construction may occur within our size range, it's generally replacing older product and is not adding to net supply.

Turning to Rexford's investment activity during the quarter. We completed $170 million of investments, comprising approximately 500,000 square feet, generating an aggregate initial yield of 5.8% and a projected unlevered stabilized yield of 6.1% on total cost. Looking forward, we currently have approximately $160 million of investments under contract or accepted offer, which are subject to customary closing conditions.

Moving to our capital recycling program, during the quarter, we disposed the four properties for an aggregate sales price of $37 million, generating a weighted average of 12.9% unlevered IRR. In addition, we have over $20 million of dispositions currently under contract or accepted offer, which are subject to customary closing conditions.

During the quarter and subsequent to quarter end, we leased four repositioning and redevelopment projects, totaling approximately 380,000 square feet across the Orange County, San Gabriel Valley at South Bay submarket, which are projected to stabilize at an aggregate 8.8% unlevered yield. We stabilized two projects with rent commencement in the second quarter totaling approximately 85,000 square feet with a total investment of $54 million, generating a weighted average unlevered stabilized yield of 9.5%. Looking forward, we have 4.2 million square feet of value-add repositioning and redevelopment in process or projected to start within the next 18 months with the remaining incremental spend of approximately $340 million, which are expected to deliver 8% -- 6% unlevered stabilized yield of total investment.

Finally, I'd like to thank our Rexford team for your dedication in delivering another strong quarter results. Now, I'm pleased to turn the call over to Laura.

Thank you, Howard, and thank you all for joining us today. Second quarter results were strong with FFO in the quarter of $0.6 per share, reflecting 11% year over year earnings growth. Same-property NOI growth was 6% on a net effective basis and 9.1% on a cash basis, driven by strong leasing spreads executed over the trailing 12 months, a 61% and 43% on a net effective in cash basis, respectively. Our tenant base continues to exhibit strength and resiliency as represented by continuing nominal levels of bad debt at percent of revenue at 30 basis points in the quarter.

Moving to the balance sheet, our low leverage balance sheet strategically positioned record, allowing us to be opportunistic through cycles and to selectively capitalize on accretive opportunities that deliver earnings per share growth and net asset value appreciation. At the end of the second quarter, net debt to EBITDA was 4.6 times near our long-term target leverage range of 4 to 4.5 times.

We currently have nearly $2 billion of total liquidity, comprised of approximately $830 million from four equity proceeds available for settlement, $126 million of cash on hand, and our $1 billion revolving credit facility. We have no near-term debt maturity until mid 2026, assuming extension option.

Rexford's differentiated business model is positioned to continue to deliver near and long-term outsized NOI growth, with $229 million of incremental cash NOI growth embedded within our in-place portfolio, realizable over the next three years, and irrespective of market growth. The largest component of our embedded growth is generated from our value-add repositioning and redevelopment, which is expected to deliver $95 million of incremental NOI.

The mark-to-market of our below market leases to current market rate is currently 38% on a net effective basis and 26% on a cash basis, and it's projected to generate another $82 million. In addition, the average annual embedded rent spread of 3.7% for the total portfolio, which is up 10 basis points compared to prior quarter is estimated to contribute $47 million. Accretion from second quarter investments is expected to deliver an additional $5 million. Together, cash NOI is projected to grow to $886 million over the next three years, equal to 35% internal NOI growth. Note that this strong embedded growth assumes today's market rents and no future acquisitions.

Turning to guidance, our 2024 FFO per share guidance range has been increased by $0.01 at the low end of the range and is now $2.32 to $2.34, representing 6% to 7% year-over-year earnings per share growth. Note that our guidance range does not include future acquisitions, dispositions, or related funding that has not yet closed.

Full year 2024 same property cash and net effective NOI growth is estimated to be 7% to 8% and 4.25% to 5.25%, respectively. This remains in line with the expectations we laid out at the beginning of the year. Other components of 2024 guidance projection include average same-property occupancy of 96.5% to 97% in line with our prior projection. The guidance does imply a deceleration occupancy in the second half of the year. This was contemplated in our initial guidance as we have a few expected move-outs in the third and fourth quarter.

The full year net effective and cash leasing spreads are now estimated in the 55% and 40% area, respectively, excluding the large tire-to-lease extension we executed in the first quarter. When compared to the prior quarter, the decrease in leasing spreads is primarily driven by the change in the mix of leases we expect to execute in the second half.

Concessions for the full year are projected to be in the 1.5 months area, consistent with our prior forecast. While concessions here today are slightly above our full-year estimate, the leases we expect to execute in the half of the year are projected to have lower concession, driven by the composition of new and renewal leases, term link, and specific submarket.

Full year bad debt as a percentage of revenue is unchanged at 40 to 50 basis points. And lastly, the full year incremental FFO per share contribution from repositioning and redevelopment is $0.01 lower than the prior quarter estimates.

Rent commencement timing has been cut by an average of one month to get some properties outperforming, reflecting faster lease-up, and a few properties where rent commencement was pushed out by construction delays, driven by construction delays, mainly associated with municipal and utility approval, as well as expectations around that timing of lease up. Looking forward, the incremental NOI from repositioning and redevelopment project at over the next three years is in line with our prior quarter projection at $95 million.

Finally, I would like to thank our Rexford team for their relentless pursuit of excellence that drives the successive record today and through our exciting future ahead. We now welcome your questions. Operator?

(Operator Instructions) Craig Mailman, Citi.

So it's actually Nick Joseph here with Craig. I guess just maybe first on external growth, I was hoping you could touch on the appetite for acquisitions today and what type of opportunities that you're seeing.

Hey, Nick, it's Michael. Thanks so much for joining us today. Great question. And with our appetite for acquisitions is as it's always been in the sense that we look for quality of acquisitions, we look for appropriate yield profiles, we look for investments that deliver the quality of products.

And the cash flow per share growth that we feel is going to be accretive to the portfolio on the near- and long-term basis. And that's going to contribute strongly to NAV growth. And so that's the criteria. So again, we don't put volume targets out there internally or externally for the very reason that we're solely focused on quality.

Thanks. And then just on the announcement in June on looking for CFO. I was hoping to get an update on the timing there and the opportunity for the newly created COO position.

Yes. It's a great question. And we couldn't be more excited about the opportunity for the company, first, eventually, to elevate Laura to the Chief Operating Officer role. And as you mentioned, we're in process searching for CFO replacement. Laura has created some big shoes to fill. So we're very surprised in the early stages of that recruiting efforts to see some fantastic candidates. But we're looking to recruit the best athlete on the planet. So hard to predict how long that will take, but we're seeing great progress.

Thanks. And then just on the COO opportunity and how that will add to the organization.

We see a range of opportunities in the company. First of all, Laura, we've talked about this I think before as well. But Laura plays a pretty broad role as CFO, probably a little more broadly than your typical CFO generally speaking. And so we see this as a natural extension of the impact that Laura is able to make in the company.

And as we grow, today, we're about 50 million square feet with a significant opportunity ahead of us for additional growth. And we see a lot of opportunity to drive operating leverage, to drive further efficiencies in the business, and to become just better at what we did.

John Kim, BMO Capital Markets.

Thank you. Good morning. I wanted to ask about the occupancy guidance. And although you touched upon it a little bit with some of the move-outs expected in the second half of the year, but how should we be modeling the 50 basis points decline? Will it be even throughout the next couple of quarters, or will that possibly end the year below the 96.5%?

Hey, John, thank you so much for joining us today. In terms of occupancy, we don't guide on a quarterly occupancy rate. But what I could say is that those results are projected later in the third quarter and into the fourth quarter.

Okay. And similar question on the commenced leases, I think like $8 million of ABR, which is a little bit over 1%. Are these going to be commenced in 2024 or thereafter?

It certainly varies, and the commencement of those is included within our current guidance.

Got it. I know you don't put the annual mark to market by year, but the last time you did provide it, the peak years of the mark-to-market on the exploration were this year and 2026. I'm wondering if that's still the case., I know you've done some acquisitions since then.

Yes. We do have significant mark-to-market, obviously, embedded within that portfolio. This year, this quarter alone, we were able to capture $13 million of that. And we have, just over the next three years, another $82 million NOI to capture through that conversion of this below rent to market rates. And so that will occur over the coming years, and we're not going to guide on the mark to market going forward by here.

Understood. Great. Thank you.

Blaine Heck, Wells Fargo.

Great. Thanks. Michael, I think you talked about near-term nominal volatility in market rent that's expected to continue. So I just wanted to get yours and maybe Howard view on what the catalysts might be to see rent growth inflect from the flat to negative growth we've seen for several quarters now. And any thoughts on potential timing from your standpoint?

Hey, Blaine, thank you so much for joining us today, and it is a great question. Yes, maybe that's one of the million-dollar questions today. But unfortunately, it's just hard to predict timing. But I think we're super comfortable with the fact, as I mentioned, that the potential for rent growth is truly inherent in our markets.

The long-term underlying fundamentals are exceedingly strong. And in fact, in some ways, the market is performing better than it was in 2019, particularly if you look at the embedded rent that's where we're placing our leases. And given the proactive, as I mentioned, renewal activity in the tenant base, the diversity of demand in the tenant base, we still see a high level of e-commerce interest in our leasing activity.

And we're seeing a broad base from a sector perspective, a broad-based demand base today from consumer products, household goods, pure distribution company. Actually, apparel is coming back. So it's aerospace, pharmaceuticals. So I think that all those are very positive leading indicators, but difficult to predict the timing when we start to see more persistent growth.

Okay, great. That's helpful. And I think you alluded to this, but obviously discussions around the election and potential impacts of new legislation in each scenario have been picking up. And I think with respect to industrial, a lot of the conversation has been focused on potential impacts from increased tariffs. So just wanted to get your thoughts on that subject and whether you guys have any concern on the potential impact to demand in the Southern California market.

Well, we've probably seen a slight uptick in interest from some of the Asian importers who are more aggressively looking for space within infill Southern California in anticipation of the possibility of higher tariffs for their goods coming overseas. So they're looking maybe for some more manufacturing domestically and from other locations like Mexico. So we do see some early indications of that, which is incrementally favorable for us actually. And historically, when we saw tariffs established, we really didn't see any negative impact to demand in our markets.

Great. Thank you, guys.

Mike Mueller, J.P. Morgan.

Yes, hi. I was wondering, can you talk a little bit about the bid-ask spreads that you're seeing in the market for acquisitions? And I apologize if I missed it, but for your pipeline of transactions that are under contract, what's the mix of off-market opportunities in there?

Yes, hi, Mike. It's Howard. I could hear your voice.

Likewise.

On the latter part of your question, we really don't distinguish between off or on market in terms of the pipeline. For the year, over 90% of our transactions that we've closed have been off-market or lightly marketed. So that's significantly above prior years.

And then first bid-ask spread, yes, it's still out there. We've obviously had success in closing transactions. But overall, if you look to the market, the transaction volume is being fairly light, which seems to indicate that there still is some significance in terms of the bid-ask spread.

Got it. Okay. That was it. Thank you.

Samir Khanal, Evercore ISI.

Hey, good morning, Howard and Michael. Just in terms of market rent growth, I know you don't provide a forecast for the year. But as you think about the Inland Empire West, I mean, that got incrementally worse in the quarter. Just trying to understand like what are the dynamics you're seeing on the ground there. Is this -- do you feel like we're getting to the bottom here and you feel like we're turning the corner, or just trying to understand a bit more what you're seeing on the ground there?

Hi, Samir, it's Michael. Thank you so much again for the question and for joining us today. That's a great question. And I'd say from our current activity in the Inland Empire West submarket, actually, we're seeing a lot of good activity, strong activity, strong lease up for us internally in that market.

And I'll remind you that that market saw the most aggressive acceleration in rental rates through the pandemic of any submarket within our region here in Southern California. And actually, today, despite the recent relative volatility, it's still probably has the highest rent growth since the beginning of the pandemic of any regional submarket in the region. So I think that if you want the truth, it's a strong performing market. Although, again, as we've said, you should expect to see some nominal levels of volatility quarter over quarter.

Okay. Got it. And I guess on the redevelopment pipeline, just in terms of the lease up there with demand normalizing. I mean, how should we think about the timing of the lease up? Are you seeing any slippage in timing at all? And I'm just trying to get an idea of the lease up of the pipeline, given that demand continues to normalize. Thanks.

Yes. So hi, Samir. It's Howard. There's always some components that are moving around. We've had a few delays here and there related to some permitting and utility timing. And then we've had some things that have moved forward a little quicker as well as off sale on the leasing side. We've had rates -- well, we have some adjustments in timing related to permits, et cetera, the leasing timeframe, sometimes given that. But all in all, just a nominal change when you look in aggregate over the prior quarter.

Yes. And Samir, just to put some context on that. Given a few pushes in terms of recommencement but certainly some that we've had that are accelerating, the nominal change is about one month from our prior forecast.

Okay. Thank you.

Vikram Malhotra, Mizuho.

Good morning, guys. Thanks for taking the questions. Maybe just on the redevelopment side, you mentioned it's just been put very modestly by one month in terms of I think you said lease-up or stabilization. I'm just wondering for projects that may be -- and that's the average for projects that may be taking a bit longer. Are these more tenant delays? Are they just construction? It's taking a bit longer because of supply chain issues. Like what's causing the delay in your stabilization estimates?

Yes, Vikram, it's all of the above. And as Laura mentioned, sometimes we are able to push things a lot quicker, and other times there are situations where they're just out of our control. We're dealing with cities and utility companies, and we just can't control the timing on that.

But again, these are fairly normal adjustments. And the market, I think as we've indicated, is still doing pretty well in strength in terms of leasing activity. So we're optimistic that we'll actually beat some of these timeframes as we move forward.

And Vikram, I'll also add that if you look at -- we've talked about the nominal one month push in terms of timing. But if you look at our stabilized yield, our stabilized yield are largely right in line with our expectations that we said at the beginning of the year for repositioning during development and some in aggregate.

Okay. That's helpful. So obviously, you had good spreads this quarter. You mentioned the cash mark-to-market is now 26%, I think. So if I just take that forward and use your estimates for the three-year opportunity on mark-to-market, assume flat occupancy -- I'm not putting words in your mouth, but I'm getting to 6%-ish same-store NOI growth next year. And if I lever that up, add your benefit acquisitions, I'm just wondering can you still generate that 14% to 17% FFO growth next two years? Or does that get pushed out, or the trajectory gets changed a little bit over the next few years?

Yes, great question. In terms of -- at the beginning of the year, we provided our forecast and I look forward to our expected three-year average annual FFO per share growth. And we provided a range of 11% to 13% over the next three years.

And if you think about our guidance for this year and implies 6% to 7% growth, so that would imply a higher growth rate for FFO per share into '25 and '26. And while we're not going to update that forecast today, we're going to update that on an annual basis. I will say that we are still comfortable with the projection of 11% to 13% average annual FFO growth over the next three years.

Got it, and then just one last one. It's clear you mentioned versus your product and portfolio that there's a difference between the average older product. But I'm wondering just maybe private players that are somewhat similar to your portfolio, like are the tactics different from those private players in terms of lease up or gaining share? Like are they pushing incentives or prices? And could that dynamic cause may be a bit somewhat of a mini price war over the near term? Just some of the larger private guys who have maybe similar portfolios.

Hi, Vikram. It's Michael, thanks for joining us today. When you think about the landscape of ownership within our infill market, it is, as you say, predominantly private ownership. These we call mom-and-pops because they're not real estate professionals who own the vast majority of our infill market, again, comprised of small and medium size properties.

And they're relatively passive owners, so they're not generally investing and improving our assets, number one. Then there's another very small segment, and we have some private people not public REIT who are investing for the purpose of generating acceptable yields throughout their cost of capital. That, frankly, is a really small segment of the marketplace. Nobody with anything even close to the scale of Rexford, not even a rounding error, frankly. And honestly, there's just -- we don't really see anybody deploying a strategy of any magnitude that we would call material improving assets the way Rexford is, frankly, some very small players here and that.

But keep in mind, Vikram, if you're a private owner and you have a lower quality asset, it is a price war because there's not as much value in that asset and utility for the tenant to use the space. And the only way they win is on pricing.

Which is in contrast to our property, frankly, because we're investing, we're improving the functionality, we're competing on a different playing field of higher quality, highly functional space, which there's an exceedingly low availability. And historically and typically, through periods, when you see the stated, for instance, market vacancy, when we drill down into the market vacancy, generally speaking, and we look of the vacant buildings in the market at the time, how many of those buildings actually begin to compete with the Rexford portfolio on a quality functional locational basis? And typically, it's well under half the stated market vacancy rate that actually even begins to compete with Rexford on a quality and functional basis.

So it is the tale of two markets. And I know that might sound a little bit counterintuitive. But remember, Rexford is only about 2.7% market share. So through the quality and the functionality, we are really able to compete on a different playing field.

Thank you.

Greg McGinniss, Scotiabank.

Hey, good morning out there. So based on the opening remarks, it sounds like new supply is not a significant factor within the submarkets that Rexford operating. So the increase in vacancy purely a demand-side concern. And I understand predicting an inflection point is difficult, but in the near term, what are you expecting on rent growth based on tenant industry demand trends that you're seeing right now?

Hey, Greg. Thanks so much for joining us today. So in terms of supply, when we talk about that, you can't increase net supply for all practical purposes. We're really talking about the small or medium size segment of the market, our average space size of 26,000 square feet. And that is a size where it's simply -- it's not economical to construct new product. It just doesn't pencil, hasn't for a very, very long time.

Where you see some supply increases in the larger sized spaces, which again is not generally our target market. And I think that's been disproportionately impacting the vacancy factors. The other bigger factor, frankly, also is the lower functional space, the obsolete space, which in our markets has been the primary driver contributing to any negative absorption and increasing vacancy in our market. So again, not directly competitive to the Rexford product.

And with regard to market rents, again, we're not really giving any guidance. We're not going to speculate where market rents are going.

Okay. I can understand the different type of product that's competing. But the disclosure that you do provide on rent growth is for our comparable portfolio. So you are seeing the headwinds on rent growth on a comparable portfolio basis. So I'm just trying to get some understanding as to what you think in the near term some of the factors that could be driving that higher or lower.

No, I think it's a great point. Thanks for the clarification. Yes, again, as we mentioned, we do see and expect to see some nominal levels of volatility in occupancy in rents over the near term. But again, I think as we described, we see the foundation for the potential for market rent growth within our markets today.

When sentiment turns, that catalyst could be interest rate driven. Some of the other factors that we talked about, we're certainly seeing a very strong, broad base of demand out there. So I think if you want my personal opinion off the record, I'd say it's going to be a little bit more macro-driven, frankly.

Okay. All right. Thank you, and then one for Laura. The midpoint of core FFO per share guidance implies a $0.01 headwind for the back half of the year compared to the first half. Just trying to understand what some of the drivers are there.

Yes, great question. In terms of the FFO run rate through the rest of the year, I think it's important to talk about a couple of items. Number one is one-time item this quarter, which was around interest income. So we did hold a higher cash balances this quarter.

Just as a reminder, we closed on the convertible issuance that we did at the end of last quarter. And we have higher cash balances associated with that $1.15 billion issuance. And that resulted in higher interest income, and we don't expect to hold cash at the same levels in the second half. So that's about a penny.

There's another penny of impact from higher G&A that we expect in the second half of the year. Our G&A guidance remains unchanged. It's just the cadence and timing of that G&A, the timing of hiring. Fourth quarter tends to run a bit higher because of bonuses. And the potential CFO hires also included in the back half of the year. So those two items have about 2% impact when you look at the run rate.

Okay. Thank you, Laura.

Nick Thillman, Baird.

Hey, good morning out there. Maybe starting with Howard or Michael, you've talked a lot about product quality in this conversation. So maybe just what percentage of the so-called market do you view as competitive to yours? And then maybe tying that into a little bit on the acquisition opportunity set and what you're evaluating today. What's the mix between redevelopment and repositioning versus, say, a traditional stabilized property?

So hi, Nick. On the first part of your question, it's really market driven. If you're in a market, let's say, like San Fernando Valley, which was started -- I guess those things develop more in like the '50s and '60s. The quality product in that market as a percentage of total is fairly low. We're obviously -- if you go to the Western Inland Empire, the product quality is substantially higher.

So it's hard to just grab one figure around it all. And this is a huge, huge market. And frankly, that's the advantage we have here, is really having our team focus on every opportunity every building. And so we really just look at it holistically and uncover those opportunities in the marketplace.

And what was the second part? What was the second part of your question?

It was the mix and the transactions you're underwriting today between repositioning redevelopment versus traditional stabilized assets.

Well, obviously, with some of the opportunities we've found in these higher yield profiles, those are very attractive as they come in with very limited risk to them. In fact, if you look at the portfolio of assets we bought this year, everything came in that $1.4 billion or $1.3 billion, that 98% occupancy, which is very different than you've seen in prior years where we had a lot more value add where we're buying vacancy.

So some of these opportunities coming in are short-term leases where we're capturing income and our planning to projects will occur at later date. But these types of yields, we're definitely leaning more in terms of focus to current cash flow, in terms of where things are in the market today.

And what I'll add to that, Nick, is our acquisition opportunity set is very much curated by us. And when we think about how we're investing capital, we're very much thinking about the accretion that's going to drive today and then how they're embedding that cash flow growth into the portfolio over time. And so that's what drives the decisions we make around capital allocation and the *opportunities that we're seeing in the market.

And I hate to add on, but I will add one more to that, which is just that what you hear from Howard and Laura is that our inbound yields are very strong on the acquisition activity. But that doesn't mean that we're sacrificing the stabilized yields.

In fact, the beauty of our buying and being able to do in this marketplace where we have a lot of buyers not present is that we're able to drive current initial cash flow actually and still have higher stabilized cash flows on average than we were able to achieve, let's say, three, four, five or six years ago. And so that is really the beauty of the investing opportunity today.

That's very helpful. And then maybe following up with Laura. It sounds as though credit quality is still -- and credit metrics are tracking on the tenant side relative to first quarter. So maybe clarifying and correct me if I'm wrong. And then if you could just give what the underlying sublease percentages as a percentage of the portfolio today?

Yes, absolutely. Yes, so in terms of tenant health, we remains extremely stable. We have a watch list of tenants that we focus on. The net watchlist is about five or six tenants, and that's remained consistent really for the past several years, and we have over 1,600 tenants.

So our guidance implies bad debt in the second half of the year of about 30-ish basis points -- 30, 35 basis points. And just as a reminder, historical average pre-COVID, we ran about a 50 basis point area. So tenant credit remains very strong.

And then in terms of subleasing activity, this quarter in our portfolio, there were eight new sub leases signed representing about 275,000 square feet. That compares to 12 subleases that were signed last quarter and the first quarter. In terms of historical averages, I'd say that subleasing activity is pretty much in line with what we've seen if I look back over the prior five years on a historical basis.

That's very helpful. That's it for me. Thanks, everyone.

Camille Bonnel, Bank of America.

Hi. It seems like the probability of East Coast port strikes is rising every day and the West Coast are benefiting from the boost from this. So I know you operate in a slightly different area of the market, but I wanted to get your views on how much of these port volumes do you think is temporary in nature. Or are you starting to see excess warehouse capacity come down leading to any leasing?

Hi, Camille. Howard. Yes, I think that's definitely been part of the challenge in the marketplace, especially on the 3PL world, there's been excess capacity. And that capacity has to get absorbed before you see any dramatic increase in leasing, even though the ports have had fairly large increases in the volume coming through.

And look, at the end of the day, in terms of it is going to be sticky or not, LA from the Asian ports is going to be the fastest entry point. It's the cheapest and fastest way not just obviously to LA but to distribute and move product into the middle of America. And that's really what grid e-sports. And that's the advantage that that we'll continue to have here.

So if that pricing and timeline changes, obviously, that could be something to think about. But we don't see any dramatic change in that sense. And yes, even though there's obviously onshoring and some shifts in manufacturing that are occurring, there's still going to continue to be a tremendous amount of products that come through the ports.

Because this for us is that we're focused on local consumption in our portfolio. And so a lot of these trade flows and changes in terms of volumes through the ports really don't have much if any of an impact on our core tenants needs within our markets.

Thanks for the color there, Howard. Laura, I wanted to clarify on your comment about concessions being lower in the second half. Are you seeing a down shift because these markets are tighter? Or as and another way, if you were to sign these leases a year ago, would the concession levels be the same as what you're budgeting today?

Well, in terms of concession levels, for the full year, we're estimating 1.5 month concessions and that compares to last year, on average, concessions were 1 month. So that 1.5 months compared to 1 month, it indicates a tick-up and concessions. But I would say that we've expected that. As the market normalizes, I think 1.5 months is more consistent with the normal market.

And when you look at the concessions that we expect to execute in the second half and why we projected to be lower, it very much depends on the composition of what we expect to sign. So the new and renewal leases, the term of those leases, obviously, shorter term deals have lower concessions. The submarkets, the size of the units, all of those are indications of concession. And so as we look forward, the leases that we are projecting to execute have lower concessions.

Got it. And I just have one more question. Like depending on which broker you speak to, it seems like there are different views of where rents have peaked and declined to. And if we just step back and consider that the average lease rate you executed in 2023 was at a 7% premium to market rents. Are you still signing leases at these premium levels today, or has that gap narrowed?

Camille, I think that the premium you're referring to is just the typical that we're getting, receiving, and taking as compared to what we're seeing in the market. Again, it's a reflection of the higher quality of the portfolio. And remember, it's not just that we put the properties to look better. We invest in these properties so that you can stack more product and then you can utilize the clear heights inside the property. We create and enhance that high loading and access to the property. We basically maximize the throughput of goods and minimize the cycle time of getting goods in and out.

Our property is actually worth more to the tenants on a per square foot basis. So naturally, you should expect that premium to continue, and generally speaking, it is.

Thank you for taking my questions.

Rich Anderson, Wedbush.

Thanks. Good morning. And my first Rexford experience, so thanks for having me. The cash releasing spread of 49% I think you said for the second quarter and in combination with declining market rents. At what point do you see a material reduction in net cash releasing spread math? Do you start to see it start to trend down meaningfully over the next couple of years? Or do you still have plenty of runway to continue to produce that type of number for shareholders?

Hey, Rich. It's Laura and thank you for joining us for your first Rexford experience. In terms of -- so I think that goes back to the mark to market, and so the mark to market that's embedded in the portfolio today. And as I mentioned, over the next three years, as we will roll these below-market leases to market, that's going to generate an incremental $82 million of NOI. So you would expect that we'll be able to continue to achieve.

I really think higher leasing spreads as we're rolling the increases, but we're certainly not going to guide around leasing spread expectations beyond this year or the mark to market. But I do think it's important to point out that Rexford has a very differentiated driver of growth beyond the mark to market, and that's more significant than the mark to market impact. And that's through our repositioning and redevelopment, and the value that we're able to add there. And that really is the true differentiator of Rexford that enabled us to drive leading FFO per share growth as we have demonstrated over the past five years.

So as we execute on that, repositioning redevelopments -- over the next three years, we expected to generate $95 million of NOI growth that will continue to differentiate our growth. If you really look back over the last five years, we have demonstrated that growth. Over the last five years, Rexford has been able to achieve FFO per share growth of 16% annually, and that compares to the peers at 9%. So 75% differentiation. And that lever that we have, that repositioning and redevelopment, is what will continue to differentiate us into the future.

Okay. Fair enough. And so you pivoted to value-added redevelopment, and that was going to be my next question anyway. What is your comfort level of having investments in that important arm of your portfolio of your strategy as a percentage of total assets? Is it time to ramp that up or pull it back in again relative to the entirety of the company?

Yes. I mean, look, as I mentioned, that's the differentiator of our growth and a really important part of our strategy. But we're going to balance that rate with the core opportunities that we embedded into the portfolio so that we can continue to drive that outsized FFO per share growth consistently and overtime.

And also, Rich, we think about it a little bit differently. The most discussions would be about land bank, which is basically (inaudible) income. And we're typically buying an income, and through the redevelopment process and repositioning process, we're raising the income. So it's not like we have hundreds of millions of dollars on our books that have no -- no income being generated. It's really a different type of business as (inaudible)

Fair enough. Fair enough. It's not a zero-income business, I get that. But if there is an element of risk associate with is I guess I would say.

Last question for me, you mentioned Asian importers. Are there any utility issues in the area that would need to be addressed if there was a meaningful movement through manufacturing in the region? And what's the appetite of Rexford to be a party or landlord party to increase manufacturing activity? Thanks.

We typically focus on generic space, meaning the friction in terms of cost and time for tenants to move in and out the building is relatively low. The needs of the warehouse users today are greater in terms of power, and power has become an important issue in the marketplace in terms of availability and utilities, timing of delivery, and so on and so forth.

So part of our strategy right now is actually to spec a tremendous amount of power into our repositioning and redevelopment assets, which frankly are ideal for not just the warehouse increased power needs but also manufacturing. So if the demand is out there, we're in a great position to capture those manufacturing instances.

Great. Thanks very much.

Brendan Lynch, Barclays.

Great. Thank you for taking my question. I'm also a long-time listener, first-time caller. So glad to be here with you guys on record call today. One of the things that you mentioned was that you're embedding 4% escalators, which are above the long-term industry standard. Maybe you could talk about a little bit where you think the limit might be there and whether you have tried to push escalators even above 4%, or if that's a consideration for the future?

Hi, Brendan. Thanks so much and appreciate your first question here with Rexford. It's true that we're embedding pretty consistently 4% or better escalators in leasing activity that we are completing. And we have done as high as 5% or even isolated examples a little bit above 5%. But in terms of underwriting, it seems that 4% is pretty reliable at this point.

And it's hard to say what the limits are. I think the fact is that rents still represents a very small share of the overall economics or expense structure of a typical tenant. So I think that we still have a lot of runway in terms of rent growth. And so where those escalators play, we'll see. But we're super excited and very comfortable about what we're seeing today.

And when you're pushing the escalators, are you getting the sense that tenants are looking for additional concessions? Is that part of the reason that maybe we're seeing 1.5 month to 50 this year versus 1 last year, or that kind of unrelated?

Generally speaking, I'd say that's unrelated.

Okay. Thank you very much for the color.

Thank you.

That concludes our Q&A session. I will now turn the call back over to management for closing remarks.

We'd like to thank everybody today for joining us, for your interest in Rexford. And we look forward to reconnecting next quarter. Thank you so much, and wish you all a great day.

This concludes today's call. You may now disconnect.