Rexford Industrial: Nosebleed Valuation But Leverage Is Increasing (NYSE:REXR)

Summary

REXR is the only industrial REIT located primarily in the Southern California market.
The Southern California industrial market benefits from low vacancy rates and dwindling supply.
I am concerned that REXR did not allow leverage to decline in 2019 in spite of nosebleed share price valuations.
I am neutral on REXR due to the aforementioned nosebleed valuation.
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Rexford Industrial (NYSE:REXR) is a top-notch industrial REIT that attributes its relative outperformance to peers due to its presence in the "So-Cal" market. REXR has grown FFO at an impressive 9.4% clip since its IPO, as it has managed strong comparable NOI growth due to high re-leasing spreads. I believe that the past growth rates must revert to the mean and that the low acquisition cap rates validate that belief. In spite of shares trading at FFO multiples in the 30s, REXR has not allowed leverage to decline in 2019, which is concerning. I am neutral on shares due to valuation.

So-Cal Market Leader

REXR owns a diversified industrial portfolio ranging from warehouses to cold storage, serving tenants ranging from wholesale trade to construction:

(2020 Presentation)

REXR boasts that it has outperformed peers by a huge margin since its IPO in 2013:

(2020 Presentation)

Is it luck? Or is there something more to the madness? REXR believes that its secret sauce is its razor-like focus on the Southern California market:

(2020 Presentation)

Why does that matter? As we can see below, the Southern California industrial market has very low vacancy rates and dwindling supply:

(2020 Presentation)

Southern California has the highest occupancy rates in the nation, which has led it to also have the highest rental rates in the nation:

(2020 Presentation)

Some readers may think that this is a cause for concern - would the higher rents mean that tenants can't afford rent increases? I'd argue the opposite - high rents are indicative of high quality because high-quality properties would have lent themselves to high rent increases in the past. It seems to be working, as REXR has delivered a strong 9.4% compounded annual FFO growth since its IPO:

(2020 Presentation)

In 2019, REXR delivered 10% FFO growth on the backs of 5.5% SS NOI growth and 27% cash re-leasing spreads. Those strong results continued in the first quarter with 10% FFO growth, 3.7% SS NOI growth, and 24% re-leasing spreads. For those bewildered by the insane re-leasing spreads, consider that REXR operates in highly populated markets with booming residential and commercial real estate values. Industrial rents are much lower than residential and commercial rents, meaning that growth rates in the industrial space tend to be very high.

During these difficult COVID-19 times, REXR has fared better in rent collection than many REITs in other sectors. REXR noted that it has received 97.9% of March rent and collected or executed on short term rent relief agreements on 95.4% of April rent. REXR has, significantly, lowered guidance as well:

(2020 Q1 Presentation)

I view the 2020 slowdown to be temporary in nature, but even then, I emphasize to readers that the insane growth rates of industrial REITs may inevitably slow down. We are already seeing evidence of this as REXR's acquisitions have come at nosebleed cap rates - their recent acquisition of the San Fernando Business Center has a projected 3rd-year cap rate of 4.7%:

(2020 Presentation)

It makes sense: high growth rates for industrial properties will inevitably increase competition. Realizing that previous growth rates are unsustainable in the long term is critical in understanding the value of REXR's stock - which is one of the subjects of the next section.

What's Going On With Leverage?

REXR has a solid balance sheet rated BBB. As we can see below, REXR had done an amazing job reducing leverage, as debt to EBITDA declined from 6.3 times in 2015 to 3.6 times in 2018. But the debt to EBITDA actually ticked up in 2019:

(2020 Presentation)

I am concerned by the rising leverage because REXR has been trading at arguably bubbly valuations for several years. Even after the recent 20% COVID-19 selloff, REXR trades at 30 times core FFO and nosebleed 4.2% cap rate. Even based on the current 10% FFO growth rate and 3-5% SS NOI growth rate, that valuation is stretched. Considering its valuation, I would have hoped for REXR to continue deleveraging by holding back on debt issuance and focusing on equity issuance to fund acquisitions and investment activity. It is hard to justify issuing 4% yielding 15-year debt (as they did in 2019) when your stock trades at a 3-3.5% FFO yield. In my opinion, it makes more sense to take advantage of a lofty stock valuation than to take advantage of historically low bond yields. I wouldn't be surprised if REXR trades down to 50% to $20 per share, at which point the 15 times FFO multiple would look justified in its FFO growth rate slows down to the "normal" 2-4% level. The good times won't last forever, but REXR has the opportunity to ensure that its balance sheet benefits from the good times for years to come - it's unfortunate that this isn't happening here. For a name that is aggressively issuing equity and reducing leverage, check out my recent report on Terreno (TRNO).

Conclusion

REXR has managed very impressive financial results, and this appears to be due to the supply-constrained Southern California industrial market. Even so, REXR's 10% FFO growth is not enough to justify their 30 times FFO multiple, not to mention the possibility that past growth rates cannot continue into the future. While REXR maintains a conservative leverage profile, I argue that REXR should be continuing to reduce leverage considering the bubbly valuation that its stock trades at. I am neutral on shares, and hopeful that management can return to avoiding debt issuance in favor of issuing equity.

Time To Overweight REITs - Be Choosy

While REXR and industrial REITs are very expensive, not all REIT sectors are overvalued. In fact, the Best of Breed portfolio is overweight several critical REIT sectors that were hammered by COVID-19. The coronavirus has brought extreme pessimism, and with it, the opportunity of a lifetime.

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This article was written by

Julian Lin

30.84K Followers

Julian Lin is a financial analyst. He finds undervalued companies with secular growth that appreciate over time. His approach is to look for companies with strong balance sheets and management teams in sectors with long growth runways.

Julian is the leader of the investing group Best Of Breed Growth Stocks where he only shares positions in stocks which have a large probability of delivering large alpha relative to the S&P 500. He also combines growth-oriented principles with strict valuation hurdles to add an additional layer to the conventional margin of safety. Features include: exclusive access to Julian's highest conviction picks, full stock research reports, real-time trade alerts, macro market analysis, individual industry reports, a filtered watchlist, and community chat with access to Julian 24/7. Learn more.

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