2023-08-07 12:53:07 ET
Summary
- LXP reported 2.0 MSF of leasing activity in Q2, 1.6 MSF of which was attributable to the successful lease-up of two speculative development projects.
- The successful leasing provides confidence of the still-favorable demand environment in their operating markets.
- The company also made progress in their disposition efforts of their office portfolio.
- At current trading levels, I continue to view LXP as an attractive value addition to any portfolio with industrial exposure.
LXP Industrial ( LXP ) trades at a discount to other industrial operators. The performance of their portfolio, however, and current metrics track in-line with the competition. They do carry a higher debt load, but it’s mostly fixed rate with limited near-term maturities. The weighted rate on the debt is also low. In addition to the higher debt load, the company also carries office properties. But the properties are in the process of being sold or marketed. The development pipeline is also lighter, but favorable demand indicators have enabled successful lease-up on those that have completed. This provides confidence of their ability to lease their remaining projects. With all these considerations in mind, I continue to view LXP has a value-buy for those seeking sector diversification.
LXP Industrial Q2 Results
At period end , LXP’s portfolio was 99.5% leased with a weighted average remaining lease term of just under six years. In the remainder of the year and in 2024, about 8% of rent is set to expire. Currently, the company is under negotiation with approximately 70% of their 2024 expirations. I am not expecting the company to have issues renewing these leases.
Subsequent to quarter end, LXP completed a five-year renewal at cash spreads of 16%, with 3.5% annual escalators. And looking at in-place rents through fiscal 2028, rents are approximately 23% below market. This provides the company with a strong tailwind for rental rate growth. At present, the management team expects in-place rents to grow by over 30%, net of escalations.
At the same-property level, industrial net operating income (“NOI”) grew 5.8%, modestly above the full-year range of 4% to 5%. The positive NOI growth translated to second quarter funds from operations (“FFO”) of $0.18/share. This represents a dividend payout ratio of just under 70% for income-focused investors.
Looking ahead to the remainder of the year, full-year FFO guidance was maintained at a midpoint of $0.68/share. At current trading levels, the stock commands a forward multiple of about 14.6x.
Key Takeaways From LXP’s Q2 Results
Successful Leasing Of Two Speculative Development Projects
Of LXP’s 2.0 MSF of leasing activity during Q2, 1.6 MSF was attributable to the lease-up of two speculative developments. This included the 488K SF Cotton facility in Phoenix and the 1.1 MSF Cubes project in Columbus.
The two projects went from 0% leased at the end of Q1 to 100% leased at the end of Q2. Furthermore, the projects were completed at estimated cash yields of 7.5%, which is about 100 basis points (“bps”) over internal targets.
The Phoenix lease was executed with a seven-year lease term with starting rent of $9.60/PSF. While this rate is in-line with the national average, it’s well below average rents of approximately $14/PSF in the Phoenix market, according to market data provided by Cushman & Wakefield ( CWK ). This is offset in part by strong annual escalators of 4%.
The terms on the Columbus facility weren’t all that better, at 10 years with starting rents of $4.85/PSF, which is below both the national and regional average.
Both facilities also require additional build-out. This pushes out physical occupancy to early November for the Columbus facility and January for the one in Phoenix. The build-outs raised the cost of the two projects as well, but this was factored into the previously stated estimated cash yield.
Four Projects Currently Available For Lease
Aside from the two projects that were just leased, LXP has four projects currently available for lease. Two worth monitoring are the Ocala project in Central Florida and Mt. Comfort in Indianapolis. These projects were completed in the first quarter of 2023 but are not yet leased.
CEO, Will Eglin, noted that they have strong tenant interest in the space and expect to make more progress over the course of the year. But little else was disclosed. When questioned by an analyst on timing, CFO, Beth Boulerice, also didn’t reveal much other than to say that classification of the properties would transition from available to in-service in one year’s time. That would imply a Q1FY24 in-service date.
In my view, the property in Florida is less of a concern. Vacancy rates in that market stood at about 3% at the end of Q2. That’s below the 4.1% national average. The market is also absorbing over 1.0 MSF of space. Absorption is even stronger in Indianapolis. But vacancy rates track well above the national average.
Given their success in leasing properties elsewhere and the still-favorable operating environment, I do expect LXP to fully lease both properties by the end of fiscal 2023.
Efforts Continue On Office Sales
While industrial properties account for nearly all of LXP’s operations, they also own a portfolio of office buildings. In aggregate, the operations represent about 7.5% of their total annualized base rents.
Given the outlook for offices, LXP has targeted the properties for sale. Any proceeds could then be rolled into their development pipeline or to debt paydown.
At the 6x range, debt does run higher than most of their industrial peers. So they could benefit from debt paydown. On the other hand, over 90% of their debt holdings are fixed rate with an overall weighted average interest rate of 3.3%. They also have limited near-term maturities and have full availability on their revolving credit facility. These attractive debt metrics provide some breathing room from a servicing perspective.
At any rate, targeted dispositions of their office holdings is likely for the best. The ones in progress include those located at 1701 Market in Philadelphia and the property in Whippany, New Jersey. Due diligence is in progress in Philadelphia and Whippany was under contract through the date of their conference call.
LXP intends to market their two remaining facilities later this year. And for the facility at Palo Alto, they will most likely walk away from it at the end of the year. Currently, the property is subject to a ground lease that expires in December 2023.
And they also have a secured mortgage on it which is due in December. Following the expiration of the lease, LXP wouldn’t have any economic interest in the property. With the maturity coming due in December, then, it makes the most sense to just hand back the keys.
Is LXP Stock A Buy, Sell, Or Hold?
Shares in LXP Industrial continue to lag the broader sector. Shares are down 3% YTD. This compares to positive gains by those elsewhere. Similar-sized peer, Plymouth Industrial ( PLYM ), for example, is up 17% over the same period. LXP has gained about 2.7% since my last update . But this significantly underperforms the comparative gain of over 8% in the broader S&P ( SPY ).
Unlike others, LXP does carry office holdings in their portfolio. But they derive just a small share of rents from this asset class. And even when excluding the contributions from their office operations, same-property industrial NOI growth still tracked above their full-year guidance range. Growth was also in-line with that reported by PLYM.
LXP also appears to be making progress in the monetization efforts of their offices. I expect the sales to close by the end of the year. At that time, LXP also intends on walking away from the facility in Palo Alto. While they will lose $0.02/share FFO contribution from the property, I expect this to be offset by contributions from their newly delivered development projects.
Two projects were made available for leasing at the beginning of this year. Though they haven’t been leased yet, I expect the two properties to be 100% leased by the first quarter of 2024, if not sooner. The successful lease-up of two of their developments during Q2 provides support of the demand indicators.
At less than 15x forward FFO, I continue to view LXP as a value-addition to any long-term REIT portfolio. Shares also include a quarterly dividend payout with an annualized yield of about 5%. This exceeds the yield offered by other industrial operators. Consensus targets view shares as fairly valued in the $11/share range. This would indicate upside potential of over 10%, excluding the returns from the dividend. For investors seeking sector diversification, LXP remains attractive for a second look.
For further details see:
LXP Industrial: Over 10% Upside Potential On Successful Development Activity