- REXR has several advantages, but is completely overlooked by most investors.
- They deleveraged their balance sheet while driving NAV per share dramatically higher through prudent investment.
- The Southern California real estate market for industrial real estate continues to demand premium rents, faster rental rate growth, and high occupancy.
- REXR trades right around NAV (net asset value). That's actually quite cheap for them. REITs that regularly grow NAV tend to trade at premiums.
- There are some weaker REITs which often trade at huge discounts to NAV. Those weaker REITs tend to deliver much weaker long-term performance.
- Looking for a portfolio of ideas like this one? Members of The REIT Forum get exclusive access to our model portfolio. Get started today »
Rexford Industrial (NYSE:REXR) has been on our radar for the last year. The main strengths are:
- Outstanding property quality in a fragmented market.
- An edge in evaluating physical real estate and sourcing deals.
- Exceptional balance sheet, prepared for growth.
- Strong management team.
- Shares frequently trade over NAV, enabling accretive growth.
The downsides are:
- Investors need to accept a high price to FFO multiple and low dividend yield.
- Investors need to be ready to pay a premium to NAV to open positions.
Index Card For REXR
The quick stats are summed up in the index card below:
Source: The REIT Forum
No One Covers REXR
It felt like we never heard other analysts talking about REXR, so we did a quick search on Seeking Alpha. We see a lack of coverage. We scanned for articles which satisfy two traits:
- About the common stock (not the preferred stock)
- Has either a bullish or bearish outlook (no neutral)
There were precisely two articles to meet those criteria since June 2015. Why isn’t anyone talking about REXR? They are an outstanding industrial REIT with a common equity market capitalization slightly under $5 billion. That’s big enough to warrant coverage.
To put that in perspective, Plymouth (PLYM) has seven articles since June 2018. PLYM only has a market capitalization for common equity of $215 million. How is it that PLYM can acquire seven articles with bullish or bearish ratings on the common shares in under two years, but REXR only gets two in five years?
Is it because PLYM was a better investment? No, that isn’t it:
The reason is simple. PLYM has a big sucker yield dividend. REXR only has a 2.22% yield, so it doesn’t draw as much attention. Picking REXR isn’t cool. Telling investors they can get a 10.27% yield while getting a hot industrial REIT draws in investors. Who doesn’t want that? Investors are eager to believe, so they go along with it. The result is dramatic underperformance. We don’t want that. So let’s get into our research of one of the best industrial REITs available.
Rexford Industrial is a pure-play REIT. This is industrial real estate in Southern California. Why do we like this real estate so much? The market is exceptionally tight with high occupancy rates (running around 98% in each of the last four years) and rental rates are significantly higher than average for the United States:
Because the investment is built on the location of the real estate, REXR provides a vastly more detailed map than other REITs:
With 100% of its portfolio in Southern California and a market capitalization of nearly $5 billion in common equity, REXR has greater expertise than other REITs can manage:
A smaller REIT simply wouldn’t have the resources to attract the top talent. A more diversified REIT wouldn’t have as much expertise in locating properties within this market. Despite REXR having a reasonable size and 100% exposure to Southern California, they still only have a 1.5% market share. That leaves REXR plenty of room to grow.
If you’re not familiar with the magnitude of the industrial market in Southern California, it may help to have a few comparisons. By square feet, Southern California’s industrial real estate exceeds the total industrial real estate in Germany, Canada, or France.
Due to the combination of higher average rents and more square feet, the total market rent (in dollars) for industrial space in Southern California is comparable to all the industrial real estate combined across:
- Northern New Jersey
- Dallas / Ft. Worth
Consequently, one part of one state is still a large enough market for REXR to grow dramatically without needing to acquire any real estate in any other market.
Southern California’s industrial property is still a highly-fragmented market. There isn’t major ownership from one individual REIT or from institutional capital. REXR is the REIT ready to capture the opportunity. There are significant economies of scale to be unlocked here, so it makes sense for at least one major player to emerge. As a publicly-traded REIT, REXR has better access to capital (issuing shares and/or issuing debt). That's a significant long-term advantage that should help them defeat other investors who don’t have access to the financing a publicly-traded REIT can access.
By growing quickly and continuing to enhance their already significant economies of scale, REXR can establish themselves as the leader in one of the most attractive property markets. Over 30% of REXR’s new leases were related to e-commerce. Further, e-commerce is expected to require 2-3x as much industrial space as the traditional retail channels. That means each dollar going from physical retail to online sales is requiring the merchants to lease more industrial space:
The Local Advantage
Rexford utilizes its emphasis on Southern California to build deep connections and identify opportunities to acquire real estate on attractive terms:
A pair of recent acquisitions demonstrate that local expertise:
Industrial properties, especially in Southern California, tend to trade at low capitalization rates. Consequently, you would expect to see lower yields on the deals. For instance, the following non-Rexford transactions demonstrate pricing within the market:
Cap rates are low because the rent is growing very quickly (low cap rates and high growth go together):
Market rental rates have regularly risen at a substantial pace. Just looking at current market rents, the expiring leases already are 15% below market. Consequently, it shouldn’t be any surprise that REXR posts strong occupancy and strong re-leasing spreads:
Same property NOI (net operating income) was up 5.5%. Using cash NOI (excludes some GAAP adjustments) the same property NOI was up 7.2%. Spreads on new leases and renewals were massive. So what’s the difference between the cash spread and the GAAP spread? Lease rates increase over time. Often each year in the lease will include an increase in the rental rate. Under GAAP, the company would record the average amount of rent for the year under the lease. Using the cash rates, we’re comparing the actual cash rent paid in the final year of one contract to the actual cash rent paid in the first year of the next contract. As a rule of thumb, cash spreads are generally much lower than GAAP spreads. However, we can see that the strong cash spreads are reflecting a huge difference between expiring rental rates and the rates the market is willing to pay.
Growth in FFO per share and AFFO per share has been exceptional in the last few years, but investors might be concerned about the weaker numbers leading from 2014 to 2015:
Source: Author’s chart with data from REITbase.net
Since Southern California is so attractive for industrial real estate, investors could reasonably have expected growth to show up for every year. It didn’t. So what happened? REXR started with very high leverage. The company needed to grow the portfolio, but they also needed to reduce leverage.
To grow the portfolio while reducing leverage ratios, a REIT needs to issue new shares. Issuing new shares can be accretive to long-term shareholders. However, when the process starts with high leverage, it often has a negative impact on FFO per share. That’s acceptable.
If REXR still had the level of leverage they had when they went public, they would be a far riskier investment. From 2014 to 2015, the weighted average common shares increased by 61%. Since then it has grown around 13% to 23% per year. REXR’s debt-to-EBITDA ratio (a key factor in assigning risk ratings) came down to 3.7 as of 2019:
Despite an exceptionally low debt-to-EBITDA ratio, REXR’s credit rating is still at BBB:
Their current leverage ratios would suggest that a higher credit rating would be warranted. However, large companies also have an easier time getting higher credit ratings. Consequently, if REXR continues to grow while maintaining the same leverage, we wouldn’t be surprised if they got bumped up to BBB+ or even A-.
Note: We currently have a risk rating of 2.0 on REXR. If they continue to grow with similar leverage, we would expect to reduce the risk rating to 1.5. Size is a factor here.
Why does that matter? Beyond the simple fact that lower leverage leads to a lower risk rating, it also leads to a lower rate on new debt. As REXR grows, if they continue to issue new debt to maintain similar leverage, we would expect them to issue at rates significantly lower than the weighted average 3.5% on their existing debt. When an equity REIT grows and gets a lower rate on new debt, each acquisition is more accretive to FFO per share because a greater portion of the NOI goes to shareholders. The existing debt won’t start rolling off until 2022, but REXR’s acquisitions in 2019 came to nearly $1 billion. If they continue to grow anywhere near that fast, new debt would be issued to go along with new shares.
The REIT has delivered significant dividend growth to shareholders as well:
Source: Author’s chart with data from REITbase.com
This is a metric that can be overlooked by most investors, but it's actually quite useful. Remember that REXR plans to grow dramatically. They want to own a much larger portion of Southern California. The higher they push their share price, the more accretive their acquisitions can be. So how do you get a higher share price? One way is to make your company more appealing to funds focused on ethical investing:
Beyond the benefits of a broader appeal, these initiatives have helped the company save money on repositioning properties. As an added perk, we love to see the breakdown of roles:
Notice that the Chairman is in an advisory position, not one of the executives. This is considered a “best practice” for corporate governance. It helps the shareholders to have better representation. There are some great companies that don’t follow this technique. Most companies don’t do it. However, the companies which have adopted it are less likely to trigger any red flags in our process.
Trading Above NAV
NAV, short for “Net Asset Value,” is an estimate of the value of the company’s real estate net of their debts. It's one of the tools we use in evaluating equity REITs.
Since June 2016, shares have rarely traded under NAV for more than a week or two:
We like to see a consistent premium. Most of the best-performing REITs since the turn of the century had a premium to NAV for most of that time. REITs get that premium by delivering strong growth and running the company well. Once they have that premium, many use it to drive accretive growth by issuing new shares and growing the company. That enables them to outperform peers on other metrics like growth in FFO per share and growth in NAV.
Our ideal situation is to see a REIT which commands a consistent premium, grows FFO per share, has strong releasing spreads (showing demand from tenants), a clear story for why tenant demand will remain high, and recently dipped to trade near NAV again. If all those factors line up, then we probably have a good opportunity to begin building a position.
Other REITs With Frequent Premiums
We’ve often seen premiums to NAV for Realty Income (O), National Retail Properties (NNN), Sun Communities (SUI), and Equity LifeStyle (ELS). Three of those REITs already are in our portfolio. You may recognize them as REITs which have all delivered staggering returns since the start of the century. Even with the recent plunge in triple-net lease REITs, O and NNN have still been rockstars in a longer view.
The Story Investors Hear
This is the story you won’t hear from most analysts. When you hear about “value plays” in equity REITs, it will usually be a crappy REIT with bad management, bad history, terrible growth, and excessive leverage. Those REITs hardly ever get premiums to NAV, so they don’t have this opportunity to grow accretively for the benefit of shareholders.
We can demonstrate this concept by using a few other REITs. We will start with a REIT which doesn’t deserve a premium:
Global Net Lease (GNL) almost has never traded above the median projection for NAV. The price has trended down. Terrible. Now compare it to Realty Income (which deserves a premium):
Even if we started the line for Realty Income around the middle of 2015, we would see NAV trending higher and a slight boost to the share price. Despite a massive decline, O’s price is still basically even with where it was around the middle of 2015.
Let’s move on to an industrial REIT. We’ll start with everyone’s favorite sucker yield, Plymouth Industrial:
The share price trends lower, but we’ve also seen the NAV trend a bit lower. That’s remarkable. Remember that industrial real estate is appreciating. Cap rates are getting lower. NAV should be rising for everyone in the sector, yet the median estimate for PLYM declined from $20.50 to $18.25.
During that same period, from June 2017 through today, REXR’s median estimate for NAV increased from $21.64 to $38.19. That is a world of difference.
The investors who want to focus only on the dividend yield will tell you that PLYM still has upside. Perhaps. Short-term price movements can be a bit wild. Which REIT do you think will generate more wealth for shareholders over the long term though? PLYM, where NAV is usually flat or down, or REXR where NAV increases almost every quarter as the company keeps driving rental rates, net operating income, and FFO per share higher?
Yes, PLYM will pay out more in dividends in the short term. If you just want to get your cash back while ignoring the change in the value of your account, you might as well use a savings account. It's amazing that so many investors still don't realize the value of the capital a REIT reinvests or the risk that comes from REITs with high payout ratios and declining NAV.
REXR is a unique industrial REIT. Their dramatic emphasis on Southern California enabled them to build an extremely attractive property. As a potential leader in that market, REXR commands a premium valuation. They trade above NAV and they trade around 30 times projected recurring FFO per share ($1.34) for 2020. That’s the second-highest multiple in the sector.
Those valuations are going to be more than some investors can stomach. However, we see the current valuation (only a modest premium to NAV) as an appealing opportunity. We expect REXR to spend most of their time trading at a premium to NAV and we expect NAV to trend higher over time.
Further, we believe using current year FFO per share as a key part of the analysis would be a major mistake. That’s why we only discussed FFO per share to demonstrate the growth rate.
REXR’s leases are substantially below market. Consequently, the growth rate in FFO per share should be elevated for several years at least. Do we really want to focus on the current period income, when we can be confident (98% occupancy!) that the REIT can re-lease those properties at higher rates as soon as the current leases expire? Are we terrified that tenants will default on their leases during the pandemic? A tenant has to be incredibly desperate to default on a lease where the rent is significantly below market.
We consider REXR to be a good fit for most long-term dividend growth investors. The 2.22% dividend yield isn’t particularly high, but the payout ratio on FFO is only 64%. Given the strong growth we expect to see each year in FFO per share, we expect dividend growth to continue. For REXR, we believe NAV is more useful than FFO in valuation unless investors are going to factor in the growth rate. We expect shares to spend more time trading above NAV than below it, and we expect management to utilize that price to continue growing the REIT in an accretive manner for shareholders.
This article was written by
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Colorado Wealth Management is a REIT specialist who began his decades-long investment career in a family-owned realtor office before launching his own company and embracing his drive for deep-dive REIT analysis. He passed all 3 CFA exams. He focuses on Equity REITs, Mortgage REITs, and preferred shares.
Features of the group include: Exclusive REIT focus analysis, proprietary charts and data models, real-time trade alerts posted multiple times a month, multiple subscriber-only portfolios, and access to the service's team of analysts and support staff for dialogue and questions on the REIT space.
Analyst’s Disclosure: I am/we are long REXR, ELS, NNN, SUI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.