Fitch Assigns First-Time Ratings to Rexford Industrial Realty, Inc.; Outlook Stable
The Rating Outlook is Stable.
KEY RATING DRIVERS
Rexford's ratings take into account the company's credit strengths, which include a diversified tenant mix across the company's Southern California-focused industrial property portfolio, strong liquidity position, solid fixed-charge coverage (FCC), and limited development risk. Balancing these strengths for REXR is its limited track record as a public company, unproven access to some forms of capital (e.g. unsecured bonds), and concentrated lease maturity and debt maturity schedules.
The Stable Outlook reflects Fitch's expectations that leverage, FCC and the coverage of unsecured debt by unencumbered assets will remain at levels appropriate for a 'BBB-' IDR.
Leverage Expected to Rise
Fitch anticipates that leverage will rise from currently low levels and remain appropriate for the 'BBB-' rating. REXR has funded its recent acquisitions primarily with common equity and also from proceeds from non-core asset sales. REXR's Sept. 30, 2014 leverage was strong for the 'BBB-' rating at 4.7x pro forma for the January 2015 \$176.4 million equity offering (5.3x in third quarter 2014 (3Q'14). REXR reduced leverage meaningfully during 3Q'14 through increased recurring operating EBITDA, debt repayment via an equity offering, and with proceeds from noncore asset sales. REXR's leverage was 10.7x and 7.4x, respectively, for the annualized quarters ended June 30, 2014 and March 31, 2014.
Fitch projects that leverage will initially sustain in the 8x-8.5x range before stabilizing in the mid-6x range (using an annualized run-rate of quarterly EBITDA, pro forma for completed acquisitions) during the next 24 months, as the company deploys cash from equity offerings for debt repayment. There is tolerance within the ratings to exceed Fitch's 6.5x leverage threshold for acquisitions with the expectation that the company deleverages its balance sheet to a level appropriate for the rating within six months. Fitch defines leverage as debt, net of readily available cash, divided by recurring operating EBITDA.
Solid Fixed Charge Coverage
Fitch projects that Rexford's FCC will remain strong but decrease to mid-3x through 2016. This coverage level is solid for a 'BBB-' rated REIT with Rexford's asset profile. Rexford's FCC was 4.3x in 3Q'14 pro forma for the company's January 2015 common stock offering and recent acquisitions (4.5x for the trailing 12 months (TTM) ended Sept. 30, 2014) compared with 4.4x and 5.1x for the annualized quarters ended June 30, 2014 and March 31, 2014. Fitch defines FCC as recurring operating less straight-line rents and recurring capital expenditures, divided by total cash interest incurred.
Factors underpinning Fitch's mid-3x range FCC projection through 2016 include 2.5% to 3% same store NOI growth, mild incremental cash flow from developments and from \$250 million in annual acquisitions at a 7% cap rate. Fitch expects REXR to fund its external growth with unsecured borrowings and to a lesser extent, proceeds from asset sales.
The company's liquidity coverage ratio is strong at 3.7x for the period from Oct. 1, 2014 through Dec. 31, 2016 pro forma for the January 2015 equity offering. Fitch defines liquidity coverage as sources of capital divided by uses. Sources of liquidity include \$57.5 million of readily available cash, 100% availability under the company's \$200 million unsecured revolving credit facility, and \$15 million of projected retained operating cash flows after dividends and distributions. Uses of liquidity include \$52.1million of pro forma debt maturities, and \$23.8 million of recurring, development and redevelopment capital expenditures.
The company's strong liquidity profile is helped by its small development pipeline. As of Sept. 30, 2014, REXR's wholly owned development pipeline had an estimated cost of \$6.5 million or 0.6% of its gross undepreciated assets.
Good Tenant Diversification
Rexford has good tenant diversification with approximately 985 tenants. The company's top five largest tenants represented 9.8% of 3Q'14 annualized base rent (ABR), and its largest tenant, Cosmetic Laboratories of America, was 2.8% of ABR. The level of granularity continues to improve, while still a bit lower than the peer medians of 7.4% and 2.1% of ABR, respectively.
Rexford focuses on tenants with needs for smaller industrial space, typically in the range of 5,000 to 50,000 square feet, enabling it to maintain a large tenant roster which minimizes reliance on any one customer. Most tenants are small local businesses and sole proprietors that have less developed access to capital. This distinguishes Rexford from most other investment grade industrial peers that benefit from a higher percentage of investment grade tenants and greater industry diversification.
Below Market Occupancy
Rexford's portfolio vacancy of 8.5% as of 3Q'14 represents an internal growth opportunity to lease-up repositioned space and re-tenant for higher rents based on the average vacancy of 3.5% in Southern California markets. Additionally, Fitch views Rexford as well positioned to increase rental rates for tenants in the multi-tenant properties, as smaller and medium-sized business tenants begin to gain access to increased liquidity and availability of credit as the economy strengthens.
Rexford has maintained its portfolio occupancy level at over 90% in recent quarters. The below-market occupancy reflects the company's focus on maximizing cash flow through selective re-tenanting and repositioning of properties on an on-going basis while also boosting rental rates.
Limited Track Record and Capital Access
Rexford has a limited track record of devising and executing a strategy as a public company given its relatively short corporate history. However, senior management has a longer track record with Rexford's predecessors. The company's access to capital is less established than its peers in that it has not demonstrated access to the unsecured bond market.
Heavy Near-Term Lease Maturities
Rexford has a concentrated lease expiration schedule, with approximately 70% of the company's leases by ABRs expiring by the end of 2017, compared with 40% for the average industrial REIT. Rexford should be able to manage lease rollovers given the depth of small-tenant demand, limited supply in its markets, and the generic nature of its buildings, which should appeal to a wide number of users. The company's tenant retention has fluctuated from 57% to 79%, which is a bit below average for the sector. Leasing spreads have been strong during the last five quarters, indicating REXR's rents are below market in aggregate, providing opportunity to capture additional rent on lease expirations.
Concentrated Debt Maturities
REXR has a concentrated debt maturity profile as evidenced by the large exposures in 2016, 2017 and 2019, when 15.8%, 18% and 59.3% of the company's debt matures, respectively. Fitch attributes the concentrated nature of REXR's maturity ladder to its smaller size and expects a greater balance going forward as REXR executes on its acquisition-led growth strategy and access to the unsecured debt market.
Small Unencumbered Pool
REXR has a small portfolio of unencumbered assets, constraining this source of contingent liquidity. However, unencumbered NOI divided by a stressed capitalization rate of 9% covered the company's unsecured debt by 3.5x in 3Q'14, which is strong for the 'BBB-' ratings. Fitch expects this ratio to trend toward a low 2x as the company acquires assets and incurs additional unsecured debt, which would remain appropriate for the 'BBB-' IDR.
The portfolio is composed of industrial assets located in supply-constrained, Southern California markets, of which Los Angeles (58%), Orange County (15%) and San Diego County (13%) were the largest contributors. This concentration exposes REXR to seismic risks as well as to the economic and political environments in California.
Rexford's nationally oriented peers have materially greater diversification in terms of geography, number of assets and leases. However, Southern California markets have consistently out-performed other national markets on the basis of occupancy, net absorption and asking rents.
As of Sept. 30, 2014, occupancy was 96.7% and 97% for Los Angeles and Orange Counties, respectively, versus the national average of 93%. Occupancy never dipped below 90%, even during the most recent recession. Since 1995, average rent growth outpaced the largest markets in the nation by approximately 1%.
Fitch's key assumptions within our rating case for the issuer include:
--Forecasts are based on 2.5% to 3.0% same store NOI growth, mild incremental cash flow from developments/re-developments and \$250 million in annual acquisitions at a 7% cap rate;
--External growth is funded with \$100 million in unsecured borrowings and \$180 million in equity issuance during 2015;
--Very modest development pipeline through 2016;
--Dividend payments in line with its historical payout policy of 70% AFFO.
Although unlikely in the near term, the following factors could lead to positive rating momentum:
--Fitch's expectation of leverage sustaining below 6x for several quarters (3Q'14 pro forma leverage was 4.7x and TTM leverage was 6.6x);
--Fitch's expectation of fixed-charge coverage sustaining above 4.5x for several quarters (coverage was 4.5x for the TTM ended Sept. 30, 2014 and 4.3x pro forma).
The following factors may have a negative impact on REXR's Ratings and/or Outlook:
--Fitch's expectation of leverage sustaining above 7x for several quarters;
--Fitch's expectation of fixed-charge coverage sustaining below 3.5x for several quarters.
Fitch assigns the following ratings to Rexford:
Rexford Industrial Realty, Inc.
--Issuer Default Rating (IDR) 'BBB-'.
Rexford Industrial Realty, L.P.
--IDR at 'BBB-';
--\$200 million unsecured revolving credit facility 'BBB-';
--\$100 million unsecured term loan 'BBB-'.