Prologis (PLD 0.69%) and Rexford Industrial Realty (REXR 0.47%) both reported very strong second-quarter financial results. However, there's an important difference between the two real estate investment trusts (REITs): One is highly diversified geographically, and the other is tightly focused on just one region. There could be some short-term implications from that this year given that union members at 29 West Coast ports have been trying to iron out a new contract for over a year.
Spread out or focused?
One of the hallmarks of Prologis' business model is that it owns warehouses in key transportation hubs throughout the world. The basic goal is to be wherever customers might need it to be to facilitate their global trade needs.
At the other end of the spectrum is Rexford, which has chosen to focus on a single, well-situated market, Southern California. The region where it operates has limited warehouse supply and high demand, making it attractive for the landlord.
But when a company focuses on a single region, the risk of a problem in that region creating headwinds increases. That's exactly what Prologis recently warned about with regard to the difficult contract negotiations taking place with port workers in California.
Image source: Getty Images.
The International Longshore and Warehouse Union has been working without a contract since July 2022. There have been work stoppages during negotiations, disrupting port operations. And while a tentative deal has been reached, it still needs to be ratified by the union, which could be a months-long process. There's always a risk the deal falls apart and work stoppages return. So far, there hasn't been much impact.
For example, Rexford's occupancy in the second quarter of 2023 was a strong 98%, and it was able to increase rents on expiring leases by a sizable 74.8% on a cash basis. That's even better than Prologis, which has occupancy of 97.5% and hiked rents by 48.1% on a cash basis.
But things could get worse.
Being in the right or wrong place
During Prologis' second-quarter earnings conference call, Chief Executive Officer Hamid Moghadam said:
I think this labor strike has gone on longer than most people anticipated. And the timing of it was such that people had to make decisions about the Christmas season, and they've shifted volumes to other ports, and that affects Southern California. And honestly, the longer this goes out, I believe the worst it will be for Southern California in terms of doing permanent damage.
Companies that are importing goods into Southern California have to find a new port if they want to ensure their goods reach the U.S. market for the holiday season. They are simply making the supply chain changes they need to, so that their businesses aren't disrupted by the contract dispute.
Any REIT with warehouses in the region could be affected as customers choose to shift their warehouse footprint, and Rexford, with a singular focus on Southern California, would likely be among the worst hit.
Lower demand could mean less ability for the REIT to raise rents as it renews leases and signs new tenants. To be fair, Rexford noted during its second-quarter earnings call that it has already worked through some of its most important lease negotiations for the year. But the rest of the year will see smaller lease deals that often come with shorter lease terms.
Management is still positive about the long-term fundamentals of Southern California, but the temporary strike and ongoing contract tension certainly won't help the REIT. And if the upheaval leads to lower releasing spreads over a longer period, investors will probably rethink the value of Rexford's hyper-focused approach. That might already be taking shape given the convergence of the dividend yields between Rexford and industry bellwether Prologis.
Data source: YCharts.
An important change
It is too soon to know what is going to happen with the new union contract and how the warehouse market will adjust, particularly if there are further work stoppages. But the big story for warehouse REITs right now is their ability to increase rents as leases roll over, which offers built-in growth.
Historically, Southern California has seen some of the largest increases given the high demand and low supply in the region. The port strike and difficult union negotiations could upend that relationship in the near term, and perhaps the long term, if it reshapes where companies lease warehouses.
Any REIT with a property in Southern California will have to deal with this issue, but Rexford will likely be the one that's most vulnerable. Investors should keep an eye on this as the quarters roll by.
