The big news of late for Rexford Industrial (REXR 0.47%) has been rent rollovers. The real estate investment trust (REIT) has warned that the back half of 2023 will be less exciting than the first half, and there are West Coast port union contracts to contend with, too. But so far, Rexford is executing at a high level relative to the West Coast region it serves.
Rexford's advantaged history
The backstory for Rexford is very attractive. While other warehouse REITs have worked to create geographically diversified portfolios, Rexford has gone the exact opposite direction and focused on one region it knows very well -- Southern California. This is a risk that shouldn't be ignored, since something hyper-specific to the region (like the aforementioned union contracts) could end up being a super-sized issue.
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Historically, though, Southern California has been a great place to own warehouses. It is the largest industrial market in the United States, multiples of the size of New York City, Chicago, Philly, or Dallas. There are high barriers to entry as Southern California is focused on building residential properties over warehouses. In fact, warehouses are being torn down so that other property types can be built. This has resulted in very low vacancy levels, which have been hovering around 2% or so across the region.
Since 2019, rent growth for warehouses in Southern California has increased 109%, compared to a U.S. average of 34%. Rexford has benefited from these dynamics, with compound annualized funds from operations (FFO) growth of 15% since 2018, compared to 11% for its industrial peers.
A shift in the trajectory
That said, things are likely to cool off from here. The first piece of the puzzle is broadly affecting warehouses, as demand starts to pull back from peak levels during the early days of the coronavirus pandemic. With people getting back to their daily lives, the need for warehouse space to handle e-commerce isn't as great.
Then there's the aforementioned port union contract, or lack thereof. The union has only just agreed, in principle, to a contract, and it still needs to be ratified. That could take months to achieve. There have been work stoppages around this contract, and some companies have likely shifted goods to other ports to ensure they have smoothly functioning supply chains.
Rexford is also warning that it has renewed its largest and most profitable leases. That leaves smaller leases for the back half of the year, which are likely to be less lucrative. In other words, for the rest of the year, the spread between expiring rents and rents on newly signed leases is likely to be lower than it was in the first half. Investors shouldn't get too upset, however, as this is likely just another sign that the region is cooling off toward a more normal level of activity.
REXR Dividend Yield data by YCharts
But here's the interesting thing. In the second quarter, Rexford's net absorption was 1% versus a 0.3% negative absorption for the rest of the Southern California region. Basically, the company is doing better than its regional competitors, even as the region's huge outperformance is heading back to pre-pandemic levels.
The key is that Rexford focuses on the most modern warehouses, which are what tenants tend to favor. And the REIT has a history of investing in its assets to upgrade them if they aren't industry-leading properties. That sets the REIT apart from the pack and gives it a leg up when leasing out vacant warehouse space or releasing the space, at a higher rent, to the current tenants.
Not as exciting as before, but still attractive
The story behind Rexford isn't as good as it once was, but it is still a solid story. Meanwhile, investors have tightened the yield spread between Rexford and warehouse REIT giant Prologis (PLD 0.69%), making Rexford look historically cheap. Risk-averse investors should probably stick with a more diversified warehouse REIT, like Prologis. But if you can handle a little uncertainty, Rexford still appears to be operating at the top of its game -- even though the game itself isn't quite as attractive as it once was.
