Icarus' dilemma

A successful track record results in unprecedented price levels

September 15, 2016

About the author

Noam Ganel, CFA is the founder of Pen&Paper, a value-oriented, contrary-minded journal of the financial markets. Between 2010 and 2020, Ganel worked for Silvergate as Vice President in Capital Markets. He provides advisory services to family offices,  private companies, and financial advisors.

If you are looking for a second opinion, especially when considering big changes to your portfolio or strategy. Unbiased, professional insights can help you reexamine your assumptions and reduce emotional decisions.

Join the waitlist to learn more.

Rexford Industrial Realty (NYSE:REXR) attributes its competitive strength to a diversified tenant mix which reduces default risk and earnings volatility, and access to deal flow which allowed the industrial REIT to become one of the largest purchasers of industrial properties in Southern California. And its concentration on infill markets, described as high barrier to entry markets, was viewed favorably by investors. In evidence is a recent spike in market value. 

Rexford management has been busy. In 2014, 84 industrial properties with a total of 3.5 million square feet were purchased for $396 million. In 2015, 39 properties, representing 2.1 million square feet, were purchased for $247 million. Because the company operated merely 65 properties at the end of 2013, the acquisition of 123 properties to the company’s real estate portfolio represented a twofold increase.

The buying frenzy was viewed favorably by capital markets. In 2013, an NOI per share of $1.19 was valued at 10.4 times. Now the market is valuing the company’s NOI at 18.6 times. Put differently, to gain exposure to Rexford industrial properties, historically you would pay between an 8-capitalization rate and 10-capitalization rate. But now shares are traded at an exorbitant price of 5-capitalization rate. For a portfolio of industrial properties, it is an unprecedented high valuation.

Yet industrial properties value does not increase much over time. Industrial properties are highly exposed to vicissitudes of the economy. And an industrial property typically has no more than a tenant or two. Compared to an apartment building with multiple tenants who pay rent, tenancy risk is higher. But because tenants are responsible for the operations of the property, the laissez faire management style is often appealing.

Another characteristic of an industrial property is the long-term nature of the lease. In theory, industrial leases expire in 10 to 15 years. But it is not the case for Rexford. Over 55 percent of its leases mature in three years. Out of the 1,285 leases, there are 1,006 leases that will expire in the next three years. While it can be viewed as an opportunity to increase lease rates, skeptics would argue differently by emphasizing the looming vacancy risk.     

Investors now overpay for the company’s assets. In 2013, one dollar of Rexford industrial assets was sold for 40 cents. As of the second quarter of this year, that same dollar of assets is priced at one dollar and ten cents. As a point of reference, at the end of 2015, one dollar of assets could have been purchased for 70 cents.

In short, Rexford management did all the right things. It purchased industrial properties sensibly while using a reasonable amount of debt. And its focus on Southern California has proven successful. Watched by the analysts and capital markets, its share price climbed to unattractive levels, which should now deter investors.