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Rexford Industrial Realty Inc
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Greetings. Welcome to Rexford Industrial Realty, Incorporated Second Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded.
I will now turn the conference over to David Lanzer, General Counsel. Thank you. You may begin.
We thank you for joining Rexford Industrial’s second quarter 2023 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 actual 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 reconciliations and explanation of why such non-GAAP financial measures are useful to investors.
Today’s conference call is 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 turn the call over to Michael.
Thank you, David. I’d like to welcome everyone to Rexford Industrial’s second quarter 2023 earnings call. I will begin with a brief introduction. Howard will discuss our operations, followed by Laura, who will focus on our financial metrics.
I’d like to start by acknowledging our Rexford team for delivering an exceptional quarter, which included a 33% increase in quarterly earnings for FFO and a 10% increase in FFO per share over the prior year quarter. Our strong results were driven by value creation across all of Rexford Industrial’s internal and external growth strategies.
From an internal growth perspective, we maintained same property pool average occupancy of 98%. Our high occupancy was supported by 450,000 square feet of positive net absorption and 2.1 million square feet of lease activity achieved with record leasing spreads of 97% on a GAAP basis and 75% on a cash basis.
During the quarter, our team stabilized four value-add reposition properties that are contributing and estimated $9 million of incremental annualized NOI growing by 4% through our embedded annual rent steps. From an external growth perspective, our team completed approximately $905 million of investments year-to-date generating an estimated $47.5 million of initial annual FFO contribution, which is projected to grow to over $60 million as value-add investments are stabilized over the next 3.5 years on a weighted average basis.
The strength of our portfolios ongoing performance is driven by three key factors, which include our superior functionality relative to an overall infill market comprised largely of older, lower functional product, our premium infill locations and focus on the highest demand lowest supply product categories in each of our submarkets and our entrepreneurial approach to maximizing value.
With regard to market conditions as expected, we are seeing our infill markets normalizing in terms of market occupancy compared to the extraordinary levels achieved during the pandemic. Directionally occupancy is approaching pre-pandemic levels, which at that time also represented a very strong market. With regard to market rents also as expected, we are seeing some normalizing from the torrid rent growth experience during the pandemic, which exceeded 100% market rent growth in our markets.
As our markets adjust to the post-pandemic environment, we expect some volatility in market rent growth in the very short-term depending on submarket, product quality, and category size. However, in the medium to longer-term, our favorable underlying fundamentals position infill Southern California for superior rent growth over time. Just as superior underlying market fundamentals within infill Southern California drove the strongest rent growth in the nation through the pandemic. Those same superior underlying fundamentals continue to drive long-term demand within our markets.
The infill Southern California industrial market continues to benefit from the lowest threat of disruption from new supply of any major market in the nation, driven by an essentially incurable supply demand imbalance for high quality well located space.
Additionally, we focus on providing mission critical locations for the nation’s largest and most diverse industrial tenant base requiring infill locations close to their customers, serving the nation’s largest regional population. As we look forward, the company is well-positioned for substantial internal growth, embedded within our in-place portfolio assuming today’s rents and no future rent growth, we project $165 million of incremental NOI representing 31% NOI growth embedded within our in-place portfolio over the next two years. Our largest internal growth driver comes from our value-add repositioning pipeline, which is projected to contribute about $64 million of incremental NOI over the next two years.
In addition, we project $60 million of incremental NOI generated as we roll below market leases to higher market rents and recent investments completed during the quarter and subsequent to quarter end are expected to contribute $17 million of incremental NOI growth.
In addition to our favorable operating position, the company continues to execute on our strategy to maintain a fortress-like, best-in-class balance sheet, closing the corridor at about 16% net leverage to total enterprise value with $1.9 billion of liquidity affording the company the ability to protect against economic uncertainty while positioning us to capitalize upon accretive internal and external growth opportunities.
Above all else, we thank our Rexford team for your tremendous work and dedication that continue to set our great business apart. Before turning the call over to Howard, we’d like to remind investors that we will be hosting our Investor Day and property tour in Los Angeles on November 13, the Monday preceding the NAREIT Conference. We promise this will be an informative, fun, and memorable opportunity to see both the Rexford team and our value creation in action.
And with that, it is now my pleasure to hand the call over to Howard.
Thank you, Michael, and thank you, everyone for joining us today. Rexford finished the second quarter with strong results demonstrating the sustained strength of our entrepreneurial approach to creating value and our high quality industrial property portfolio. Rexford portfolio continued to outperform the overall infill Southern California market in the second quarter. Our same property occupancy ended the quarter up 10 basis points compared to the prior quarter.
This is in contrast to the overall infill market, which according to CBRE experienced a 40 basis point decrease in occupancy and ended the quarter with 1.9% market vacancy. Our outperformance also included 450,000 square feet of positive net absorption for our Rexford portfolio. With regard to market rent growth for highly functional product comparable in quality to our Rexford portfolio, we’ve observed 9% market rent growth compared to the prior year quarter.
For this functional well located product, we observed sequential growth of 1% bringing year-to-date rent growth to approximately 4%. In regard to the second half of the year, to the extent market rent growth continues at its current pace, this would imply year-over-year mid to high-single digit market rent growth for high quality product analogous to the Rexford portfolio.
While we’ve recently experienced a moderation in rent growth compared to the prior few years of pandemic driven remarkable growth, the estimated embedded mark-to-market for our in-place portfolio of 63% on a net effective basis and 50% on a cash basis is projected to contribute significant long-term NOI growth even without any future growth in market rent.
In fact, the projected 31% embedded NOI growth within our in-place portfolio over the next two years grows to over 50% if we look out over the next four years, again assuming zero market rent growth.
Turning to acquisitions. During the quarter, we closed three transactions for a total of $83 million and subsequent to quarter end, we closed an additional two transactions for $59 million, bringing year-to-date investment activity to approximately $905 million. These investments are collectively generating an initial yield of just over 5% and a projected unlevered stabilized yield of about 6% on total cost.
Looking forward, we currently have over $235 million of transactions under contract or accepted offer, which are subject to customary closing conditions. This includes the imminent closing of a $210 million transaction in the Mid-Counties submarket with a 5% initial yield and a projected unlevered stabilized yield of 6.2% on total cost.
With regard to our internal growth initiatives, in the quarter, we stabilized four repositioning and redevelopment projects representing approximately 375,000 square feet as well as a 209,000 square foot Industrial Outdoor Storage site. These projects achieved an aggregate unlevered stabilized yield of 6.8%, representing a 50 basis point outperformance compared to our reforecast made last quarter.
We have 3.4 million square feet of value-add repositioning and redevelopments in process or projected to start within the next 24 months, which are expected to deliver an aggregate unlevered yield on total cost of 6.4%, representing an estimated over $0.5 billion of value creation.
If we look out over the next four years, we currently project a total of over 9 million square feet of value-add repositioning and redevelopment projects embedded within our in-place portfolio representing substantial projected value creation. Finally, I’d like to acknowledge and thank our Rexford team for their continued excellence this quarter.
And with that, I’m pleased to turn the call over to Laura to discuss our financial results.
Thank you, Howard. In the second quarter, our strong operating performance and accretive capital allocation drove core FFO per share growth of 10% over the prior year quarter. Same property NOI growth was 10% on a cash basis and 8% on a GAAP basis. As we continue to convert our significant embedded portfolio mark-to-market into NOI and NAV growth.
In the second quarter alone, we generated $15 million of incremental annualized NOI growth or $0.08 per share of incremental FFO as we rolled below market rents to market rates. Our high quality portfolio continues to experience healthy tenant demand as represented by our strong leasing activity, record spreads, and 450,000 square feet of positive net absorption in the quarter, evidencing the resiliency of our markets rent steps for our second quarter executed leases increased to 4.1%, bringing our total portfolio annual contractual rent steps to 3.5% an increase of 30 basis points compared to a year ago.
The health of our tenant base also remains strong. Year-to-date, bad debt as a percentage of revenue is in line with our forecast at 35 basis points below the historical average of approximately 50 basis points. The conversion of our in-place portfolio mark-to-market as we roll below market rents to higher market rates represents substantial future NOI growth.
Looking forward, our portfolios estimated in-place mark-to-market of 63% on a net effective basis equates to nearly $380 million of incremental NOI growth equal to $1.88 per share of incremental FFO contribution or 88% growth over remaining weighted average lease term of about four years.
Most importantly, this assumes today’s market rent and does not include any future rent growth. In regard to the balance sheet and funding, we are executing on our judicious capital allocation strategy with a focus on accretive investment that drives substantial earnings per share and net asset value growth. Our fortress balance sheet uniquely positions Rexford in the current environment as of 630 [ph], net debt to EBITDA was 3.7 times and total liquidity was $1.9 billion.
In addition, we continue to selectively evaluate the disposition of assets as a source of accretive capital to fund internal and external growth opportunities. In the quarter, we executed on a forward equity offering, selling 13.5 million shares for a total of approximately $750 million in gross proceeds, which can be settled by October 2024. Proceeds will be used to fund prospective acquisitions as well as our end process pipeline of repositioning and redevelopment projects that have a remaining incremental spend of approximately $420 million and a projected 6.4% unlevered stabilized yield on total investments.
Turning to guidance. We are increasing our 2023 core FFO per share guidance range to $2.13 to $2.16 per share from our previous guidance range of $2.11 to $2.15 per share. Our revised guidance range represents 10% year-over-year earnings growth at the mid-point. Our guidance range includes acquisitions closed subsequent to quarter end including the imminent closing of the Mid-Counties transaction Howard discussed. No further acquisitions, dispositions or related balance sheet activities are included in our updated guidance range.
Components of our guidance include our forecast for 2023 same property NOI growth is unchanged. Cash same property NOI growth is expected to be 9.5% to 10.25% and GAAP same property NOI growth is expected to be 7.75% to 8.5%. For the full year, we continue to project cash leasing spreads of 55% to 60% and GAAP leasing spreads of 70% to 75%, average same property occupancy of 97.5% to 98%, bad debt as a percent of revenue of 35 basis points and year-end occupancy around 98%.
Acquisitions closed since our previous guidance including the imminent closing of the Mid-Counties $210 million transaction are projected to contribute approximately $8 million of incremental NOI in 2023.
And lastly, our components of guidance includes the impact of our equity issuance associated with acquisition funding as well as timing associated with lease up outside of the same property pool.
Before I turn the call over for your questions, I want to highlight our recently published ESGi report, where we took an innovative approach to ESG reporting, quantifying the positive environmental, societal and governance impacts of our differentiated strategies. By way of example, in 2022, we created substantial environmental value by mitigating an estimated 11,000 tons of carbon emissions as we transformed vintage urban buildings.
We created an estimated $1 billion of societal value driven in large part by reinvigorating local communities through our redevelopment work. We generated governance value through our robust and enduring governance practices, cultivating transparency and accountability. Our 2022 ESGi report outlines our many achievements and exciting path forward as we maximize our ESGi impacts for all stakeholders.
Finally, a very special thanks to our incredible Rexford team. Thank you for your continued pursuit of excellence and focus on innovation and value creation that drives Rexford’s future success. Operator?
Thank you. [Operator Instructions] Our first question is from Camille Bonnel with Bank of America. Please proceed.
Hi, good morning. It looks like you had a notable pickup in leasing activity during the last two weeks of the quarter. Was this just timing from delayed decision making or are you seeing a pickup in interest into July?
Hi Camille.
Hi Camille, it’s Michael. Go ahead, Howard.
Yes, yes. Nice to hear your voice. Yes, I think what we see is some sporadic start stops to some of the leasing activity, and I think you’re right. We did see quite a bit of a pickup toward the end there and that that was some nice transactions we did and some great spreads.
And so are you seeing this demand like continue into July or the moderating trends that we’re seeing in the market? Sorry, not sure if you can hear me.
Sorry, Camille. Yes, I’m not sure if Howard heard the question, but no, again, we haven’t disclosed anything post quarter, but safe to say that the market is continues to similar levels of demand.
Okay. That’s great. The leasing activity, your teams are completing really contrast to the market net absorption trends, brokers or reportings, can you provide some thoughts around what’s driving tenants to continue the lease with Rexford and how you balance offering more concessions now to retain occupancy versus having a bit more downtime?
Yes, thanks Camille, it’s Michael. I’ll just give a little color on the first part as why they’re leasing with Rexford or why we’re seeing the level of activity we are compared to the market. And Laura, maybe you can help quantify sort of the level of concessions and what’s not, which continue to be nominal. But I think with regard to tenants leasing with Rexford and the fact that you do see a dramatic difference in terms of the leasing activity for our portfolio as compared to the market has, again, several key factors that we touched on in our prepared remarks, but number one, it’s the quality of the portfolio. Our mandate is to provide the most functional, most well located product in every submarket that we operate in southern California. And if they’re not that way when we acquire the property, our strategy, our business model is to proactively make it so as soon as we can get to the space. And I think you see the results of that work and it really flows through in every aspect of the company and our metrics.
And then I think it’s really attributable to the team. Rexford strategy – we fully acknowledge that our business is not driven by the real estate, it’s driven by the people who create value in the real estate. And I think we have a unique team at Rexford. We’re very entrepreneurial and I think it’s a very different approach to the market as compared to other players in our market. And remember, the vast majority of our market is owned by private owners who are not real estate professionals. So we like to say that we create an unfair playing field in terms of creating the competitive advantage that we have in terms of driving leasing activity. Laura, do you want to touch a little bit on relative concessions?
Yes, absolutely. Hi, Camille. Thanks for your question. In terms of concessions for the full year, we still anticipate concessions will be 1.25 months. That’s what’s embedded into our forecast and is consistent with our prior year – our prior quarter forecast. In terms of the second quarter concessions, they average 1.6 months that increase in concessions this quarter was driven by a longer average lease duration of executed leases in the quarter you saw that pick up to five years. But looking forward, we still continue to see a healthy normal – concessions normalizing to about 1.25 months compared to the prior two years, but still lower than pre-pandemic levels.
That’s helpful. And final question before I pass it along. With your investment in activity to date, you’ve onboarded a significant amount of your space to your platform without increasing your G&A guidance. Could you just talk to how much operating capacity is still left in the platform?
Hi, Camille, thanks for your question. We continue to realize economies within our operating – economies still within our operating platform especially relative to our portfolio growth. I think you’ll – you probably notice that our guidance for G&A has stayed flat for the past two quarters. And that’s even as we’ve added about 3 million square feet year-to-date to the portfolio, that represents a 7% expansion of the square footage of our portfolio with no corresponding and creates of G&A. So as we’ve communicated in the past, we do expect that we’ll realize continued operating synergies as we grow. And you’re also seeing that come through as our G&A as a percent of revenue continues to go down and has gone down in the – over the past quarter as well. So we’re excited about our team’s focus on realizing these operating efficiencies through all their hard work and innovation in the platform.
Thank you.
Thank you, Camille.
Our next question is from Blaine Heck with Wells Fargo. Please proceed.
Great, thanks. Good morning out there. First off, can you just talk about the decrease in market rent expectations and what you think the major drivers of the difference between your initial 15% forecast and the updated mid to upper single digit forecast were and whether you think those headwinds are expected to remain in place for the rest of the year and even into next year?
Hi Blaine, thanks so much for your question. So our prior forecast was based on what we were experiencing at the time and Q1 or year-over-year rent growth was 13.5%. That was certainly in the range of our prior 15% projection. So now we have the benefit of two full quarters of performance, our second quarter year-over-year rent growth is 9% for Rexford comparable products.
So based on the current pace of growth, our year-over-year market rent growth is trending in that mid to high single digit area. When we look at the drivers of that 15% into the mid to high single digit area, I think there’s a few things to consider. I think number one is that we sell market rent accelerate over 100% in our markets, and while the strong fundamentals that led to that outperformance and that growth persists today, we would expect as we’ve discussed that we would see some normalization and that normalization won’t necessarily be linear.
So at the end of the day though, we continue to feel great about the fundamentals of our market. We have a virtually incurable supply and demand imbalance that insulates our infill markets from [indiscernible] net new supply. The demand for our high quality, high functional locations continues to be strong, and that’s demonstrated by the outperformance of our portfolio and the market year-to-date.
So we’re going to be – we’re going to continue to focus on unlocking the substantial embedded value and growth that’s within our business today. And importantly, that does not assume future market rent growth. We mentioned in our prepared remarks, we have – we’ve over $165 million of embedded NOI growth over the next two years in the portfolio. That’s 31% growth in NOI with the largest driver being our repositioned and redevelopment.
And if you even look beyond this two years as we convert our significant embedded mark-to-market, end to NOI cash flow earnings growth that’s $380 million of NOI or a $1.88 per share of FFO, that’s 88% growth in FFO that again assumes no further rent growth. So in summary, we feel great about our infill Southern California market and the ability to drive value creation and outsides returns over the long-term.
Great, that’s really helpful. Just related to that, I guess, do you think the port negotiations had any effect on leasing velocity within your portfolio? And if so, do you think there might be any pent up demand that could come back to the market as a resolution seems a little bit more profitable?
Hey, Blaine, it’s Michael. Thank you so much for joining for the question. And we’re all very happy obviously that the port contracts are negotiated, and it’s certainly positive for the overall market. And that having been said, the port issues really disproportionately impact larger big box properties located in super regional trade or distribution markets, like the Inland Empire East or other national markets, they’re more big box oriented and really have less impact to our tenants. Our tenants in the infill markets in Southern California are disproportionately serving regional consumption and therefore a little bit less concern about how they get the goods there. That haven’t been said, it’s definitely a benefit and for everybody.
And it brings certainty and I think to your point, it does help with decision making and I think we have seen a theme that it’s sort of unlocked the ability for people feel more comfortable with making longer term decisions. And we think it’s going to contribute positively through the end of the year, because don’t forget, we have the whole seasonal holiday season coming up with replenishment. So it’s timely and I think the market was really ready for this resolution. So it’s a very positive development.
Great, thanks for that, Michael. Lastly, I was just hoping you guys could talk a little bit about the types of tenants that are created, the most demand across your portfolio today. And maybe you can touch on tenant size and industry and then also if you’re noticing any differences in demand by submarket within your portfolio.
Maybe I’ll touch a little bit on the dispersion of tenant demand, the types of tenants, and then Laura and Howard, feel free to talk a little bit about the specific submarket activity that’s reflects that. But I think one of the amazing things about our market is that tenant demand is so diverse and so broad. And we continue to see substantial e-commerce driven demand substantial 3PL and distribution related demand, we continue to see a lot of sector driven demand such as the electric vehicle sector, aerospace, consumer products, food products, medical products, pharmaceuticals, actually also the sort of the real estate developer, contractor, housing type tenants, even though housing frankly hasn’t really taken off the way that it would an environment where you might see moderating interest rates or an environment where you don’t see increasing interest rates.
But remember that in southern California, we have a mandate to increase housing by 20%, and I think that’s something like 1.5 million units – housing units that are required to be developed here in Southern California over the near to medium-term. But it’s actually going to take a very long time to do that. So we continue to – despite the interest rate environment, we actually continue to see good demand from the housing trades. So very broad based demand drivers from that perspective.
Yes. And hi, Blaine, it’s Howard. I’ll just mention maybe some of the stronger sub-markets in terms of our net absorption. We had strength in mid-counties, the South Bay and even the Inland Empire West, which is actually an interesting story because that was actually a market that contributed significantly in terms of the growth in those rent spreads that we mentioned. But not surprisingly, there’s a lack of product, which is the focus size in the Rexford portfolio in that market, meaning that if you’re really to look at supply growth, it’s literally 1.2% of that market being supplied that’s under 50,000 square feet, whereas you’re basically nearing 8%, a 100,000in larger square foot buildings.
So Rexford’s got the right product for the market and there’s plenty of demand still for those sizes. That’s why we have the outperformance or strong performance, I’d say, even in that market. But otherwise, I think we’re still firing in all cylinders and really most all of our markets, the demand is still very, very strong, albeit, maybe not people fighting over each space like they were during the pandemic that we’re quite pleased with the performance and outlook going forward.
Great. Very helpful. Thank you all.
Thank you, Blaine.
Our next question is from John Kim with BMO Capital Markets. Please proceed.
Thank you. Good morning. I know there’s a difference between market rental growth, which you can’t really control versus the mark-to-market, which you have a lot of influence on your portfolio. But I mean, there was some deceleration from the first to second quarter. I know I was wondering what you attribute this to and how much of that is temporary versus the new environment just given where market events are today and the softening economy.
Hey John, thanks so much for your question. Yes. In terms of the change in our mark-to-market, when you look quarter-over-quarter, that’s expected. We’re converting our significant mark-to-market into cash flow, which is really exciting for us. And so when you look at the mark-to-market on a net effective basis, it was 66% at the end of the first quarter. We did see some sequential growth of about 1% in the quarter of market rent growth, which increased the mark-to-market, but then we had significant leasing activity. We signed 2.1 million square feet of leasing at 97% spreads. So when you take those spreads into consideration and the growth in the portfolio and the embedded rent steps in the portfolio as well, that brings your net effective mark-to-market to 63% at the end of the second quarter.
We provided some more visibility into expectations around our mark-to-market into the next five years, because we think it’s important to focus on the fact that this projected net effective mark-to-market is going to continue to produce significant FFO per share contribution. And so with that contribution that mark-to-market assumes no future rent growth. And so again, I mentioned in my last answer that that contribution equates to 88% growth and FFO per share as we realize that significant embedded mark-to-market.
Okay. So we should be focusing on that rather than where the market rents are.
Absolutely. I mean, that’s where the opportunity lies within our portfolio and that growth, it’s there for many years to come. And as I mentioned, we did provide some additional disclosure and our investor materials really representing how that conversion of mark-to-market plays out over the next five years.
The market – your mark-to-market held up relatively well considering how much – how many leases do you find this quarter at market? Where do you think this figure ends up by the end of the year?
Yes, at the end of the year, we’re projecting, again, assuming no further rent growth that the net effective mark-to-market will be around 58%. And the cumulative FFO contribution this year – this quarter was $0.04 and that will move to $0.10 by the end of the year.
My final question is on the $210 million acquisition in your pipeline that you’re about to close. It’s a little bit atypical in terms of size and it was fully marketed and leased. But I was wondering where – what attracted you to this asset and the upside potential?
Hi, John. It’s Howard. Yes, it’s really a phenomenal asset. It’s in Santa Fe Springs. It’s very rare to find spaces like this building. It’s a two tenant building, the largest tenants around 400,000 feet, the other’s about 185,000 feet. There’s 91 dock doors. And really I think what attracted us to it is the quality of the building and frankly the upside in terms of we’re able to push rents to. There’s one lease in the space the 185,000 foot lease that’s about 60% below market. And so there’s about a three-year period to move from a 5.1% to 6.2% stabilized yield. And again, just really rare to find this type of product and it performs exceptionally well in the size ranges in the mid counties market.
That’s great. Thank you.
Our next question is from Nate Crossett with BNP Paribas. Please proceed.
Hey, thanks for taking the question. Couple pricing ones. I was wondering if there was any visibility you can give on what leasing spreads have been like so far in 3Q. And then on the investment steps, I think you mentioned 4.1% this quarter, I think last quarter was 4.4%. Maybe you can just talk about how that 4.1% stands today directionally, where do you expect that kind of going?
Hey, Nate, thanks so much for your question. I’ll answer the question on the rent– the embedded rent step. So actually our embedded rent steps on our executed leases actually increased 10 basis points. Last quarter, they were – it was 4%, and this quarter the embedded rent steps and our executed leases was 4.1% – I’m sorry, not percent, sorry, four years and then 4.1 years is where we – was for – our 2Q embedded rent steps. As we think about where embedded rent steps are today, I think it’s really indicative of the strength of the market and resiliency of the market. And the fact that it 4% feels like the new area in which we’re signing these annual embedded rent steps the four years.
In terms of your question around leasing spreads, for the full year, our leasing spread projections for GAAP are 70% to 75% and cash 55% to 60%. What that does imply is that there is – that does imply that we’re going to have lower spreads in the second and fourth quarter compared to what we’ve signed year-to-date. And really important is that that’s not a change in our assumptions from last quarter. Those lower implied second half spreads are purely a function of the spaces and the mix of leases, not a change and our forecast around our market rent assumptions really we tackled most of our larger spaces in the first half. Our second half expirations are weighted more towards smaller spaces that have shortage duration leases that were more recently mark-to-market.
So compared to the first half expirations that have longer duration. So again, what you’ll see in terms of leasing spreads for the back half of the year versus the front half of the year is a function of what’s rolling and not a function of a change in our forecast, as you can see our guidance for the full year is unchanged.
Okay, that’s helpful. Just a question on bad debt. I think it’s 30 basis points year-to-date. I think last quarter, it was zero basis points. So, I’m just curious where the credit issues were this quarter. Is there anyone on the watch list? Has the watch list increased the last three months? And then also what’s the percent of sublease space in the portfolio today?
Yes. Yes, Nate, I’ll tackle both with those with you. So same property, so our bad debt for the total portfolio was 35 basis points this quarter. That compares to 20 basis points last quarter. Our guidance, as I mentioned in my prepared remarks is unchanged at 35 basis points for the full year. Importantly, that’s lower than the historical average of 50 basis points.
In the second quarter, we did have one tenant, a tenant that we’ve been watching has been on our pre-watch list since earlier this year, where we did recognize bad debt for that tenant. That tenant has been in our forecast. It was not a surprise. If you do exclude that tenant, our bad debt as a percent of revenue was 15 basis points, very much in line with last quarter at 20 basis points. So again, guidance remains unchanged at 35 basis points for the full year.
Importantly, a little bit about our tenant base, our tenant base remains incredibly strong, exhibiting strength, stability our current watch list today is actually the lowest that it’s been as a percent of revenue in the past several years. We have seven tenants on our watch list that’s out of over 1,600. It represents about 20 basis points of ABR. Just to put some context around that. Last year, our watch list on average was about 70 basis points of ABR. Again, really, really healthy levels of tenant strength. And just looking into our pre-watch list, that watch list is even smaller. So we feel great about the health of our tenant base, and again, no change in our expectations for the full year. And then your last question was around…
Yes, subleasing.
Subleasing. Yes, when we look at subleasing in the current quarter, subleasing is really right in line with subleasing and last year and the prior year in 2022 as a percent of our total portfolio.
Okay, that’s very helpful. Thank you.
Our next question is from Mike Mueller with JPMorgan. Please proceed.
Yes, hi. A few things here. First, I guess, on the balance sheet for the $400 million term loan that’s maturing next year, what are the plans for that as of now?
Yes, Mike that term loan has two one-year extension options at our option. So at this point, we would plan to extend, we’ve fixed that term loan actually through July of 2025 at this point.
Got it. Okay. And then in terms of just normal course leasing, are you seeing any notable, I guess, slow down in terms of the timeframe to take leases over the finish line?
Hi Mike, it’s Howard. Yes, it sort of ebbs and flows. I think people tend to hold off making decisions I think they’re hoping rents will make some big changes, so they’re waiting as long as possible. So, we tend to see a lot more activity toward the end of the quarter lately than in the early part. But otherwise, I think the velocity is overall pretty steady.
Got it. And then maybe…
Hey, Mike, let me provide a little bit more color around what we’re projecting in terms of downtime or down days in the portfolio, which I think can give you some more visibility there. In the first half of the year downtime was pretty low because of the amount of renewals that we’ve signed a bit below three months. We continue to forecast for the full year that downtime will be about three months. And just to put that into perspective, pre-pandemic downtime or the down dates between lease tenant moving out and rent commencing for a new tenant was four-plus months. So we continue to see a market that exhibits much more healthy downtime than what we even saw in the pre-pandemic days.
Got it. Okay. And just one last thing for clarification. When you were talking about rent bumps, you – what you were talking about was the annual escalator being about 4% on leases sign during the quarter.
Yes.
Is that correct? Okay.
Yes, that’s correct.
And then if you look at the overall portfolio, is that number like low 3s?
It’s 3.5%.
3.5%, okay.
And that, yes, 3.5%, and it’s up from, it’s up about 30 basis points from a year ago. And that’s driven by these escalators that we’ve been able to sign for the past couple of years that have continued to grow.
Great. Okay. Thank you.
Our next question is from Vikram Malhotra from Mizuho. Please proceed.
Thanks for taking the questions. So I just want to understand, again, similar to last on the last call when I asked about the differentiation between your portfolio and your peers, I guess, in the market. You referenced the positive absorption relative to negative. You referenced the five in the mid-to-high single digits in rent growth. So, I’m just wondering what is the average not competitive to Rexford? What is the average product seeing in terms of rent growth. And in that segment, are you starting to see incentives and other things pick up just as they’re trying to compete with the Rexford quality product?
Yes, hi Vikram, it’s Howard. It’s – there’s really a bifurcation in the marketplace. Michael mentioned earlier about when we buy our assets, we will renovate and modernize them. Not many other landlords in this fragmented market do the same thing that Rexford does in terms of creating highly functional, modernized product. And so what you see now is the difference in the performance of those different product types. We’re not tracking the rent growth or some of the other metrics on that lesser-quality product. But our results, I think, speak for themselves in terms of what our quality portfolio within these markets is doing in terms of the performance.
But when we look at, what we do track is the negative absorption. And when we look at, for instance, over the prior quarter, the difference was 4.5 million feet of negative absorption within the market compared to the 450,000 feet of positive absorption for the Rexford portfolio. But what’s interesting is the predominance of that negative absorption, I think probably almost 82% of it, frankly, is made up of lower quality, less functional buildings. So it’s an interesting story that the market is actually laying out and differentiating our product.
Interesting. Just to clarify that, so is it fair to say like the subset of products that are high quality comparable to you, is that that 80/20 split, meaning 20% is higher quality, the rest is all less comparable?
Well, I couldn’t speak to the entirety of the market. I was really referencing just what happened in the quarter in terms of the space that came on the market driving that negative absorption. But yes, in general, the market is made up of older lesser quality space. In fact, if you think about it, about half of the market was built prior to 1980, obviously, some has been modernized and renovated. But most of these one-off private landlords typically just don’t reinvest in the real estate and then not really trying to drive rents through the quality. But in terms of tenants, the quality differential enables more utility in the space and greater value to them in terms of the cubic capacity and the throughput they achieved in utilization?
Got it. And then looking forward, given sort of the change in the rent growth forecast. I know in your future, mark-to-market, you don’t have any rent growth built in. But in terms of acquisitions, are you sort of changing the way you’re looking at acquisitions in terms of cap rates, prices, et cetera? Just now looking forward that it’s a lower rent growth trajectory possibly over a couple of years. I know long term, you said things would be great. But what are you changing as you’re looking at product for new acquisitions? And is it a smaller subset from here?
So why are we saying in terms of just specifically around market rent growth within our acquisitions has always been extremely conservative. And very well – very much below what we actually – what we’ve actually experienced within the market. So really, we’re going to continue to underwrite that a very conservative market rent growth and really not changing from that perspective. What we are really focused on, Vikram, is continuing to be extremely selective and focused on opportunities that drive accretive cash flow and NAV growth.
And so as you can see today, I mean, we’ve been able to drive really – we’ve been able to drive really attractive investments today year-to-date about $1.1 billion, 5% going in yields stabilizing at 6%. And those are really accretive and attractive transactions. And when you take into account the higher yields at which we’re solving to today, even at today’s higher cost of capital, for every dollar we invest today, it’s 45% more accretive to earnings or core FFO compared to our investment last year. So I said another way, the yields at which we’re solving to today are more than overcoming today’s cost of capital, driving substantial accretion and are, again, not dependent on market rent growth.
Got it. Thanks so much. And Laura, just last question. So, I just want to clarify, maybe I missed this in the presentation, but do you still have embedded or expected over the two-year period at 10% cash flow NOI growth baked in on average?
Yes. Yes. If you look at – I mean, if you look at the mark-to-market, if you look at the embedded mark-to-market and we’ve stated this prior, that should imply 10% plus cash same-property NOI growth, assuming static occupancy.
Okay. Thanks so much.
Our next question is from Nick Thillman with Baird. Please proceed.
Hey good morning out there. Maybe a question on redevelopment and positioning. What are you guys underwriting for lease-up time lines on those projects? And has there been any material change in the past six months on that time line?
Hi Nick, yes, I’d say we typically underwrite in the six-month range in terms of the lease-ups. And we’ve really, I think, thinking about just some of the four repositionings this quarter that stabilized, we’ve been inside those time lines.
That’s helpful. And then maybe looking at like lease economics, I know Laura kind of talked about the free rent component of it, but it also looks as though some of the turnover costs were up quarter-over-quarter, I’m just wondering if there is a mix issue there or if we’re starting to see some softening and some net effectives.
No. That’s really being driven by higher leasing commissions, a direct reflection of the continued rent growth in our markets and the record change in rent spreads. In terms of net improvement dollars, really have been largely in line with what we’ve experienced in the past several quarters and haven’t seen a significant change there.
Thanks.
Our next question is from Vince Tibone with Green Street. Please proceed.
Hello. I wanted to follow up around sublease trends. I think you made some comments around your portfolio specifically, but I was just curious kind of what sublease activity or any changes you’ve seen in the broader SoCal [ph] market of late and particularly that how does it compare to pre-COVID levels? And if there are any submarkets where sublease space is elevated.
Yes. I would say, Vice, it’s obviously happening significantly Inland Empire. We’ve gone from people thinking about inventory in terms of just in case quickly back to just in time. And if you have excess capacity in a building and you can generate some revenue out of it, you’re going to put your space on the market for sublease in terms of buildings getting vacant that are trying to be subleased. There’s not as many of those or very few of them. I think most of it is really just space that is currently occupied that people would leave, but they downsize maybe if they could find different tenants to take over the space. And then I think also what we find is some of that lesser quality space, but more in the infill – tighter infill areas versus the Inland Empire West seems to be put out for sublease versus some of the higher quality space as well.
Hey Vince, let me add just a couple of things to that. When you look at subleasing activity again within our portfolio, very consistent with what we saw during the full year of 2022 in terms of percentage of our portfolio. So we have not seen really any material or significant increase in subleasing activity within our portfolio. I think we talked about the absorption – the negative net absorption within the market. And when we look into that and that includes subleasing activity, but when you look into that and we’ve literally drilled into every single space that contributes net absorption, negative net absorption within the market – overall market this quarter. Only 18% of it are so represented what we would deem as high functional high-quality space. So I think that, that can give you a sense of where there is an increase in subleasing in the market kind of the quality and functionality of that product that’s being put into the market.
Got it. That’s really helpful color. I appreciate that. One more for me. So after the Mid-County deal closes, you have pretty little under contract to acquire. So I’m just curious kind of what is your appetite to acquire in the back half of the year at your current cost of capital?
Yes. Well, we’re really selective. And I think you can see it in terms of what we bought and the yield profiles. But I think I’ll say we’re excited about all the opportunities that we are looking at. We’ve got quite a lot on the plate. Our acquisition team is still very, very busy. And I think going forward, we’re not feeling like we’re done, if that’s what you’re trying to ask. And so we remain optimistic that we’re going to still be able to find more opportunities that are highly accretive, similar to what you’ve seen us buy recently.
That makes sense. And then just do you – has pricing moved at all in recent months, just given the kind of normalization of fundamentals?
I spend a little bit – go ahead, Michael. Go ahead.
No, no, that’s fine. I was just going to say pricing as related to cap rates, I think we definitely have seen cap rates tightening a bit into that 4.5% area. And that’s for high-quality product leased at market rents. And I think in addition, I mean, and maybe indicative of capital starting to increasingly flow back into the market, we are seeing some buyers willing to accept very low inbound cap rates substantially below 4% and in situations where they may not be able to get to a re-tenanting or renewal situation the low rents to higher rents and as long as maybe six years to nine years. So we are seeing more patient capital, if you will, starting to come back into the market, which if that is a trend could contribute towards further tightening in market cap rates.
Yes. Vince some of these transactions, Michael was mentioning, we’ve bid on. I can think of one portfolio that literally, we were off by 25% in terms of value versus what another buyer in the market is willing to pay.
Wow, that’s crazy. Well, now this is obviously helpful. Appreciate the time.
We have reached the end of our question-and-answer session. I would like to turn the conference back over to management for closing comments.
Well, we’d like to thank everybody for joining Rexford Industrial’s second quarter earnings call today. We wish you a great summer, and we look forward to reconnecting in about three months. Thanks, everybody.
Thank you. This will conclude today’s conference. You may disconnect your lines at this time. And thank you for your participation.